In the aftermath of Hurricane Maria, it is abundantly clear Puerto Rico needs massive capital investment in order to rebuild and make it a viable entity for the future.  While assessments are still being made, the numbers range from $60-100BN.  It is inconceivable they will attract anything close to that kind of private capital without powerful US Government leadership.  In fact, if they are perceived to not honor contracts, priority of payments and creditor rights (by acting dishonestly as it relates to existing debt), it is hard for us to see how they will get any private capital to invest.  With that in mind, here is a suggested road map for rebuilding Puerto Rico and setting it on a sustainable course. 

Most immediately, the US Government will have to invest $15-20BN in what is nothing more than humanitarian disaster relief to rebuild homes, schools, hospitals, and deliver basic necessities.  This is something it would do for any other state or municipality in the Country suffering from a similar magnitude disaster and the fact that Puerto Rico is a Territory owned by the US Government, actually taken by force by the US Government over a century ago in the Spanish American War, makes it even more obligatory that it owns up to its obligations there.  This is simply aid/a grant to those hardest hit and most in need. They are not loans and the money won’t be paid back.  It is simply like insurance proceeds with insurance for those who can’t insure themselves provided by the US Government. 

Next, The US Government has an historic and unique opportunity to totally redevelop Puerto Rico into a viable, competitive place to live, work, and raise a family.  This will require large-scale investment in infrastructure for which the Government should be repaid.  First, the US Government should have the assets of PREPA, PRASA, and PR Highways assessed and, in combination with current market prices for the various entity debt, use these valuations, perhaps with a modest premium, to negotiate a purchase of all the assets of these three entities.  The proceeds of that sale of assets should go to current debt holders based on the priority of their claims.  This likely means holders of this debt likely get some premium to current market prices but this debt will be substantially haircut vs. face value.  30-80 cents on the dollar is the likely range depending upon the entity.  At that point, those entities exist to the extent the USG wants them to in order to provide the service and maintenance for the infrastructure now owned by the USG.  Once that transfer of assets is complete, the USG should rebuild modern roads, bridges, water and sewer facilities and a power grid probably at a cost of $30BN.  It would then collect tolls for the next 25-30 years via transponders/technology on the highways, from power providers – wind, solar, natural gas, whatever is most competitive – for use of the power grid, and from users/municipalities for the use of the water and sewer system.  The intent would be to recapture its investment over that time period plus perhaps a SLG rate of interest and transfer ownership to the private operators primarily in the case of highways, perhaps the municipalities in the case of water & sewer (though a number of private waste management companies would be better) and then perhaps a consortium of private providers in the case of the power grid.  In essence, this would look like a form of lease to own, which can likely be accelerated if these systems can be made to function more or less sustainably, owned by private entities that look a lot like regulated utilities on the mainland.

Private insurance proceeds will likely be in the neighborhood of $20BN which will go straight toward rebuilding the higher end properties on the island.  With $65-70BN from the USG and insurance proceeds invested, there is good reason to imagine private capital of another $10-20BN might be attracted IFF it knows it will be treated fairly.  It will only know this if Puerto Rico resolves its current debt issues reasonably.  Assuming all this happens, one can also envision significant Immigration back to the Island by younger, more productive people who now see a real chance to make money and live in a place that is brand new and state-of-the art.  In short, there is potential for a virtuous cycle to be created.

What about the remaining current debt of perhaps $50BN?  All current debt other than GO and COFINA would essentially be wiped out if it is subordinate or has no dedicated revenue stream.  That would leave about $35BN of GO and COFINA debt.  As COFINA is already at risk to the performance of the economy, it would simply receive whatever base amount of SUTs are paid (and not available to the General Fund) and pay those out according to priority between Seniors and Juniors.  If the economy thrives and there are a lot of sales taxes collected, COFINA holders are paid and PR has a viable, credible vehicle which could conceivably issue some additional debt after a few strong years of collections.  If not, they don’t get paid and PR can’t support any more debt anyway. This is simple and straightforward as it has always been.  Conversely, the position of $18BNof GO debt became much more perilous with the advent of the storm, because they were basically lending against the assets and productive capacity of Puerto Rico, most of which was uninsured and destroyed by Maria.  It is likely the debt service simply needs to be pushed out between 5 and 10 years to allow Puerto Rico to get back on its feet, rebuild, see that virtuous cycle accelerate and then it can begin to pay the debts it now owes.  If you pushed all GO debt service out seven years and discounted that back at 7%, GOs would currently be worth about 62 cents.  Ten years at 7% would be 50 cents and 10 years at 6% would be 55 cents.  That seems to be in the range of reason for GOs.

At the end of the 25-30 year period, or sooner if the USG can largely be repaid for its investment, the infrastructure reverts back to whomever on PR has done the repaying – again, preferably a regulated private entity or entities - and one of two things happens:  1) If PR meets basic standards of economic activity, educational attainment, solvency and stability, public health and welfare, etc., it will be offered the opportunity to become a state.  In short, if it looks like a state at that time, the people of PR can vote to become the 51^st state.  Perhaps as an enticement, the date should be either the 2024 or 2028 elections such that if PR does what is needed to become a state, it's people vote for the first time in one of those elections and its condition of limbo is brought to a speedier end.  If PR falls well short of that hoped for result, or if the people of PR decide they do not wish to become a state but would rather be an independent nation, then they become the Commonwealth of Puerto Rico, an independent Caribbean nation. 

We acknowledge there are many details to be worked out at each of the critical junctures, but believe this provides a real, viable framework to finally set Puerto Rico on a course toward sustainability and prosperity while still behaving responsibly to resolve its existing obligations.  In addition, the USG should scrap outdated Jones Act restrictions and provide Medicare on par with states, but also phase out the tax advantages Puerto Rico now enjoys.  In short, give the people of Puerto Rico a fair playing field with some substantial upfront investment and then leave their destiny in their own hands.  By doing so, the US will have fully and fairly met its obligations to this Island it took by force and will have given it all the tools to be a sustainable entity with or without the United States.

The Commonwealth collected 213.4 mlln Sales and Use Taxes in July 2017 versus 209.5 mlln in July 2016. The Sales and Use Taxes support Cofina debt service. In May, the Commonwealth petitioned for Title III restructuring suggesting that they would use the Sales and Use Tax collections to pay General Fund expenses. In normal times, the SUT collections are first used to pay the Cofina debt service reserve funds. These reserve funds are usually funded after 6 months of collections. The Commonwealth is on a July - June fiscal year so by January the Cofina reserves are met. Since the Commonwealth petitioned in May, after Cofina collected their annual debt service, we have not seen how the Commonwealth would handle the new collections that would normally flow to Cofina debt service funds. Obviously, the markets feared that the Commonwealth would redirect the 2017-2018 collections away from the Cofina debt service funds to the General Fund. The July collections show this NOT TO BE TRUE and the Cofina debt service funds collected 122.1 mlln dollars in July....this is the BIG news.

While Incoming Governor Rosello has a very difficult task ahead of him, we believe it is possible for his administration to put Puerto Rico back on the path to sustainability.  Some of what needs to happen is beyond his control, i.e. he will need help from the US Congress, though the Commonwealth will have to take the first steps and they will need to be real and substantial.  In our view, this is a very high level fiscal 'plan' for Puerto Rico going forward: 

First, the Commonwealth must buy time to formulate a thoughtful budget plan. Originally, the Oversight Board wanted to formalize a plan by the end of January, which is concurrent with the expiration of the current debt moratorium. Rosello has formally requested a 45-day extension to present his fiscal plan and a 75-day extension to the debt moratorium. Both of these requests are reasonable and should afford Rosello time to develop a realistic plan with the Board and with creditors.

Second, the Rosello Administration must demonstrate to the US Congress and to the Puerto Rican people that it will not only impose austerity measures, but that austerity measures are good for Puerto Rico. To put things in perspective, the US averages approximately 16.5 students per teacher and approximately 500 civilians per police officer. Puerto Rico averages 12 students per teacher and 250 civilians per police officer. This overstaffed government creates a double whammy of current deficits and then future deficits, as these federal employees demand expensive post-employment benefits. A 25% cut in expenses will generate $25 Bn of savings over ten years. Governor Rosello has already ordered a 10% cut by June 2017 and has suggested that he will order another 10% cut in expenses starting in June.

Third, in conjunction with cutting expenses, Rosello needs to convince the US Congress that Puerto Rico needs help and that tax incentives like Act 54 attract business and jobs. In a worst-case scenario, Congress must maintain current subsidies. In a best-case scenario, Congress should introduce new policies and incentive programs that create growth. Extending Act 54 and maintaining health care funding will generate $25 Bn in additional revenue relative to outgoing Governor Padilla’s final projections, which were certainly intended to paint a dire picture.

After cutting budget bloat and convincing the US Congress to maintain current subsidy levels, the projected $32 Bn operating deficit in Padilla's projections becomes an $18 Bn operating surplus. Over the same ten-year period, Puerto Rico owes Cofina debt holders $8.5 Bn and GO debt holders $14.5 Bn. If the Commonwealth pays Cofina in full, as they are contractually obligated to do to the extent the SUT is sufficient to do so, there will be $9.5 billion left for GO holders, which is a 65% recovery.  There is reason for optimism that Governor Rosello will relieve the Oversight Board of much of the burden of making the hard cuts on the expense side, though both the Administration and the Board will need to be vigilant in enforcement of these cuts.  As we have always believed, the toughest challenge for the Oversight Board will be in determining if or how GO holders and pensioners will share prospective shortfalls.  However, without cooperation and support from the US Congress, frankly, the gap is not feasibly bridgeable.  

On June 30, President Obama signed the PROMESA bill, a bill designed to help Puerto Rico sort out its budget, debt, and economic issues. Democrats carried the bill in both chambers, apparently voting along the lines of 'aiding' Puerto Rico residents. Most Republicans voted against the bill because they did not want to be associated with a 'bailout'. The media has described this bill as the 'magic pill' that will solve all of Puerto Rico's problems.

Despite the confusion among our elected officials and media, this bill does not bring financial 'aide' to Puerto Rico, nor is it a 'bailout' for creditors, not is it a 'magic pill'. This bill is all about  creating two Boards. First, a seven member Control Board has been given the mandate and the authority to understand and fix the Puerto Rican budget imbalances. This Control Board has the power to limit expenditures and restructure liabilities. Second, an eight member Economic Task Force has been given the mandate to understand the Puerto Rican economy and to come up with policy recommendations that will attract investment, people, and stimulate growth.

Both of these Boards have enormous jobs that will require cooperation and accurate information from the Puerto Rican government. If Congress and the President choose motivated Board members that are truly interested in fixing Puerto Rico's problems then this bill will likely result in solutions that are meaningful. Its a start!!