Tuesday, February 11, 2014

More On Puerto Rico

Today, the Puerto Rican government issued the following statement:
Puerto Rico expects to issue General Obligation (GO) bonds in the near term to refinance certain outstanding obligations and address the government’s liquidity needs. In order to fully address questions arising from rating agency actions and other recent developments, the Commonwealth’s previously announced quarterly webcast has been rescheduled for February 18, 2014. The webcast will provide additional details about the Commonwealth’s financing plan. Barclays, Morgan Stanley and RBC Capital Markets have been selected as joint lead managers for the upcoming GO bond issuance.
I have been wading into Puerto Rico’s financial disclosure, and would like to share my findings so far. My immediate reaction to what I have found is that this is a credit that is out of control. Disclosure has been chronically late despite repeated assurances to the SEC and the MSRB. The complete absence of fiscal discipline (until very recently) has allowed the government to run huge deficits for years. For example, in FY2012, the deficit was 27% of revenue. Debt has been growing much faster than the government’s deficit: in FY2012, the deficit was $2.4B while debt grew by almost $6.0B, presumably due to borrowing by other related obligors. PR’s debt ratios are on another planet compared to the 50 state medians. Its debt capacity appears to a fraction of its current indebtedness, given the history of intractable deficits.

I am working with the government’s most recent disclosure document, dated Oct. 18, 2013. It is not an audited annual report. The latest audited annual report is dated June 2012, and was filed in September of 2013. The government’s comprehensive annual financial reports have been chronically late.

What does the government’s spotty and untimely disclosure reveal? As far as I can tell, it reveals very substantial cash requirements for FY 2014 (which ends in June). The government says that scheduled FY 2014 debt servicing requirements are $3.4B. In addition, the government faces around $1.0B of debt accelerations consequent to the recent ratings downgrades. The operating deficit for FY 2014 is estimated at around $1.0B. I don’t know what the government’s pension funding requirements are for this year or whether they can be postponed. Assuming that the pension funding requirement is zero, that would suggest that the government must raise $5.4B, give or take a billion. I don’t see how it will be possible to raise anything near that amount without an investment grade rating.

Are my back-of-the-envelope funding calculations correct? The government has not provided a comprehensive schedule of cashflows for FY 2014. The GDB had scheduled an investor presentation for today, which has now been postponed for another week. Will the government use the webcast to provide useful and timely financial information for the benefit of prospective buyers of its new issue?  The onus is on the underwriters--Barclay’s, Morgan Stanley and RBC--to provide sufficient disclosure to prospective investors to satisfy the investors’ due diligence obligations as well as the underwriters’ own liability considerations.

I can't imagine that these banks would agree to underwrite these bonds if they cannot be substantially presold, so they must know something I don’t.

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