Tuesday, December 3, 2013

For Puerto Rico, Low Transparency ==> High Yields

Puerto Rico 10-year bonds have been yielding around 8% in recent weeks. That’s a 400bp premium over bonds over AAA munis and 500bp over Treasuries – for instruments that are triple tax free throughout the US.

Muni market headlines focus on the Commonwealth’s large debt (over 100% by some measures), underfunded pensions and weak economic performance. Yet revenues are rising, the largest pension system has been reformed and the Commonwealth has enough cash on hand to avoid issuing any new GO debt for the remainder of Fiscal 2014.

Perhaps Puerto Rico’s risk is not as great as the 8% bond yields suggest. I say perhaps, because gaps in the Commonwealth’s disclosure make risk assessment and monitoring challenging.

Earlier this year, I built a fiscal model for Illinois that suggested the state’s absolute credit risk was limited. The model estimated the probability that interest and pension costs – two large uncontrollable, senior obligations – would claim 30% of state revenues – a level associated with previous defaults in US states and comparable jurisdictions. The state of Illinois supports modeling of this sort by providing a comprehensive annual financial report, interim financial reporting, a multi-year budget forecast and pension system actuarial reports that forecast contributions, benefit levels and other indicators over the next thirty years.


Puerto Rico provides some of these elements, but many aspects of the Commonwealth’s fiscal disclosure are missing, delayed or incomplete.

For example, the Commonwealth’s 2012 CAFR appeared on September 16, 2013 – more than 14 months after the end of the fiscal year. This is later than every US state, and substantially later than most.

Although it takes time to produce audited financials, unaudited cash statements should be easy to generate shortly after the fiscal year end. Yet, as of early December, a statement of fiscal 2013 full year revenues and expenditures by category was still unavailable (see http://www.bgfpr.com/economy/General-Fund-Net-Revenues.html for where the report is supposed to appear). Since the fiscal year ended on June 30, prospective investors have now been waiting over five months for this statement. The Puerto Rico Treasury Department likely has this data: components have appeared in press releases and Treasury has already published comparable numbers for the first quarter of fiscal 2014.

Another shortcoming is the lack of a multi-year revenue and expenditure forecast. Illinois provides a three year general fund revenue forecast as part of its budget package. I have found no comparable report for Puerto Rico.

Finally, the Commonwealth’s pension reporting is relatively skimpy and has been rendered obsolete by the 2013 reform. There is no document that provides up-to-date forecasts of annual employer contributions, employee contributions, benefit levels, administrative expenses or asset valuations.

Thus, Puerto Rico asks investors to lend it money on a long-term basis but fails to provide them the tools necessary to readily forecast the Commonwealth’s ability to service these debts. The resulting uncertainty may well be feeding the frenzied selling that has recently taken Puerto Rico spreads to astronomical levels.

The current administration has been trying to step up its investor relations. There are investor calls, slide presentations and even a voluminous Commonwealth report. But the volume of interaction is a poor substitute for quality, consistency, and predictability – at least for those in the bond markets.

Rather than providing reams of assertions and stale data, the Commonwealth would do well to provide investors and other stakeholders, concise, timely and complete financial statements and projections. It’s the provision of the expected, necessary, transparency that could yield lower yields.

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