May 30, 2017 – This post was written by FSG Research Intern, Greta Rose Spivey
After a long struggle negotiating with bondholders and perpetually delayed deadlines, Puerto Rico filed for a form of bankruptcy protection on May 3, 2017. The total amount of Puerto Rico’s defaulted debt is $123 billion, consisting of $74 billion in bond debt and $49 billion in pension obligations. For context, Puerto Rico now holds the record for the largest U.S. local government insolvency in history (a title previously held by the city of Detroit, which defaulted on $18 billion back in 2013).
How did Puerto Rico get here?
Just how did Puerto Rico’s debt crisis deteriorate to such a dire level? A series of challenges, including a crippling recession since 2006, idiosyncrasies unique to the Puerto Rican bond market, and political challenges are some of the many factors that coalesced to form Puerto Rico’s fiscal crisis today. For decades, bondholders were seduced by Puerto Rico’s tax-exempt, constitutionally guaranteed debt, which generated a high demand for bonds.
Bondholders now are faced with a bankruptcy-like scenario that was originally blocked by federal law. Curiously, a Federal Law provision was added back in 1984, which barred Puerto Rico from declaring Chapter 9 bankruptcy. It is this provisional quirk that recently forced Puerto Rico’s governor Ricardo Rosselló to turn to PROMESA for bankruptcy-like protection and debt restructuring, effectively Chapter 9 bankruptcy, which is permitted under Title III of the PROMESA law (PROMESA, the Puerto Rico Oversight, Management, and Economic Stability Act, refers to the federal legislation passed in 2016 created with the mission to help Puerto Rico restructure its debt and solve its fiscal crisis).
What is going to happen now?
The first step in this process was for Puerto Rico to submit a new fiscal plan that was then approved by the federal oversight board that was created by the PROMESA bill. The plan has served to established Puerto Rico’s actual ability to pay back its bond holders.
Now, Puerto Rico and its bond holder will adjudicate a debt restructuring under the purview of the New York Southern District Federal Court. The process will be presided over by Federal Judge Swain , who is tasked with evaluating the needs of the island’s economy, bondholders and pensioners. While no reason was provided for her selection, it has been noted that Judge Swain has impressive credentials, including criminal trial experience presiding over former employees involved in Ponzi schemes.
What Does This Mean for Multinationals?
Implications for Healthcare Companies:
- Due to Puerto Rico’s territorial status, it receives significantly less Medicaid funding compared to other states. The public health sector is mangled by debt and insufficient funds, and continues to approach the so called “Medicaid cliff.” Fortunately, Congress recently voted on a spending package deal, which included $295 million to help fund Puerto Rico’s Medicaid budget for 2018. Short-term injections of funding from Congress have helped Puerto Rico to avoid running out of funds and falling off the “Medicaid Cliff,” but an official noted that an additional $300 million is necessary to fund the rest of 2018 Medicaid budget.
Implications for B2C companies:
- Population loss continues to plague Puerto Rico. This issue has only intensified in recent years, with recent surveys indicating that the nation’s capital San Juan registered a 10% decline (40,000 residents) from 2010-2015.Puerto Rico as a whole has lost nearly 9% of its population from 2000-2015, with “three-quarters of this population loss […] taken place since 2010.”
- Austerity measures for pensions are inevitable (adjustments for pension were included in the already approved fiscal plan), although the extent of cuts remains to be determined per Puerto Rico’s upcoming fiscal plan (the deadline for a new fiscal plan is June 30th). Reduced pension benefits would lead to a decline in the outlook for retail sales.
Implications for B2B companies:
- The use of bankruptcy means that the ultimate resolution of Puerto Rico’s fiscal crisis will be significantly delayed, with elevated uncertainty around funding of government projects and local business’ ability to access credit. B2B companies operating in Puerto Rico should continue to protect themselves against non-payment from channel partners and key customers, especially those that have exposure to government budgets and local businesses outside of the tourism industry
What about the statehood option?
Advocates for Puerto Rico’s statehood also see the crisis as a new opportunity to convince citizens that statehood is Puerto Rico’s remedy to help stabilize the economy and attract much needed investment. Puerto Rico, as an official territory of the United States, has grappled with the statehood status question before, and will do so again on June 11th, Puerto Rico will revisit the issue with its 5th national referendum on statehood status.
However, even with a vote for statehood on the island (which is not nearly a guarantee), the U.S. Congress would then have to admit the current territory, which would mean billions of new spending obligations for the federal treasury. During a time of intense budgetary debates in Washington, such a move is unlikely.
Actions to Take
Your team in Puerto Rico will need to survey their own risks to the potential outcomes and consequences, considering both the negotiations around debt restructuring and new austerity measures in the short-term, as well as the potential for medium-term structural changes in the economy. If your team has not already done so, it should be diligently pursuing the following actions:
- Develop scenario and contingency plans to identify and prepare for disruptive events
- Monitor business exposure to volatility in key markets to stay ahead of trouble and capitalize on developing opportunities
- Conduct leading indicator analysis for selected countries or markets
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