Nearly a year has passed since Hurricane Maria devastated Puerto Rico, and more than two years have passed since President Obama appointed seven people to the Oversight Board that was established by PROMESA (the Puerto Rico Oversight, Management and Economic Stability Act). It has also been more than five years since Puerto Rico’s financial issues started making headlines.

Post-Maria recovery efforts have made significant progress of late – electricity has largely been restored to pre-storm levels, except in the most remote areas of the island – but the Oversight Board, the government, and its agencies and instrumentalities continue to tussle and point fingers.

While the situation continues to be dynamic, recent developments have driven strong improvements in the performance of securities issued by the Commonwealth of Puerto. High yield Puerto Rico bonds are up 32.9% for the eight months ended August 31, according to Bloomberg Barclays, versus 4.9% improvement in its high yield muni index. By way of comparison, the Bloomberg Barclays Municipal Bond Index, which measures the performance of the overall muni market, was up 0.25% for the time period, the Bloomberg Barclays’ California muni index was up 0.65%, and its New York muni index lost 0.07%.

Investors in the Rochester municipal funds, most of which have sizable investments in Puerto Rico securities, have been handsomely rewarded during the first eight months of 2018.

The civilian labor force has increased on a seasonally adjusted basis, and the unemployment rate in July fell to 9.1%. While still high relative to the country’s overall unemployment rate, the rate in Puerto Rico has not been this low since at least 1975, according to the U.S. Bureau of Labor Statistics. Puerto Rico’s Department of Labor and Human Resources, meanwhile, says the annual rate is the lowest since at least the early 1940s.

The central government reported a cash position of $3.28 billion as of August 17, 2018. This balance exceeds the highest cash position of fiscal 2018 (ended June 30) by more than $100 million.

Retail sales are on the rise, driven by significant year-over-year increases in sales by small and midsize businesses (SMBs), according to Puerto Rico’s Trade & Export Co. In April 2018, the overall year-over-year sales increase was 16.9%, according to figures released in July, with SMBs achieving year-over-year sales growth of 33%.  Not surprisingly, the sectors showing the greatest sales growth included hardware stores and home improvement supplies, motor vehicles, and gas stations.

Hurricane Maria, as anticipated, had an adverse impact on sales and use tax (SUT) collections during fiscal year 2018, but the final tally was far better than the dire predictions had been. At $2.52 billion for the fiscal year, SUT collections were just 1.2% lower than in the previous fiscal year. Puerto Rico’s Treasury Department estimates that collections will increase by about $40 million as a result of the U.S. Supreme Court’s ruling in South Dakota vs. Wayfair requiring certain online retailers to collect and remit sales taxes.

In the past 12 months, the federal government awarded Puerto Rico more than $34 billion in recovery aid, according to USAspending.gov.  In early August, the governor requested an additional $139 billion in outside funding over the next 10 years, with the majority of this assistance aid to come from the federal government.

Bond prices on many securities issued in Puerto Rico have improved in recent months, driven in part by these fiscal developments as well as by a modicum of progress regarding debt restructuring. Agreements related to PREPA and COFINA debt – that is, the securities issued by Puerto Rico’s electric utilities authority and securities backed by sales tax revenue, respectively – have been announced, though investors should note that details have not been hammered out, let alone finalized, and many hurdles remain.

PREPA bonds rallied on the announcement at the end of July that bondholders had reached an agreement on the economic terms of a restructuring of the debt with the Oversight Board, the government, and PREPA. Key terms of the agreement are that existing PREPA bonds would be exchanged for two new long-dated securities. Tranche A securities would be exchanged at a ratio of 67.5% of par of existing PREPA bonds, carry a 5.25% coupon, and mature in 40 years. Tranche B securities would be exchanged at a ratio of up to 10% of par of existing PREPA bonds, effectively function as zero-coupon bonds, and mature in 45 years. Absolute recoveries will ultimately be dictated by several mitigating variables.

COFINAs rallied on the news, announced August 8, that bondholders had reached an agreement on the economic terms for restructuring the COFINA debt with the Oversight Board, the government and the Puerto Rico Urgent Interest Fund Corporation (issuers of COFINA securities); the bonds had also rallied in June after a preliminary agreement between an agent of the Commonwealth of Puerto Rico and an agent of the COFINA bondholders was announced.  Key terms of the August agreement are that existing COFINA bonds (senior liens and subordinate liens) would be exchanged for new long-dated securities at a ratio of roughly 93% of par of the existing senior lien bonds, and roughly 53.4% of par of the existing subordinate lien bonds, with the possibility of an additional commitment fee of at least 2% of principal. As with the PREPA agreement, absolute recoveries will ultimately be dictated by several mitigating variables.

If consummated, the deal is expected to reduce COFINA debt by more than 32%. Judge Laura Taylor Swain, the federal judge overseeing this process, has approved the segregating SUT collections going forward after July 1 into two  separate pools, as stipulated in the agreement. Among other provisions, the agreement calls for bondholders to receive the $1.2 billion in unpaid debt service that the Bank of New York-Mellon, the COFINA trustee, has amassed through June 30, 2018.

As for Puerto Rico’s general obligation (G.O.) bonds, the Commonwealth has not been making debt payments, despite a requirement in the Commonwealth’s Constitution that general fund revenues be used to pay G.O. debt service ahead of any other government expense. The legal protections for our G.O. holdings have not yet been tested before a court.

Many other developments have made headlines in recent months:

  • A July decision by Gov. Ricardo Rosselló Nevares to appoint Rafael Diaz-Granados as PREPA’s new executive director led to a board shakeup. Diaz-Granados quit after one day over a pay dispute, and four other board members resigned in protest. Jose Ortiz, who had previously led PRASA, the Commonwealth’s aqueduct and sewer authority, returned to PREPA; he had been the board’s chairman from 2011 to 2013. Ortiz, who became the fifth person to lead PREPA since the hurricane hit, has expressed interest in selling some of PREPA’s power plants.
  • The Oversight Board certified a budget for Puerto Rico on June 30, allocating $8.76 billion for the general fund and $20.7 billion for the consolidated budget, but the governor and legislative leaders filed lawsuits claiming that the oversight board was overstepping its authority.
  • Also early August, Judge Swain ruled that the Oversight Board could include binding policy decisions in its fiscal plans, which led to to following response from the governor: “We are adamantly opposed and will not comply with the decision.”  At the end of August, the Oversight Board sent an 8-page letter to the governor commending Puerto Rico for making “substantial updates” in its latest fiscal plan proposal but also indicating that it “has determined that the proposed plan requires certain revisions before the Oversight Board can certify it as compliant with the requirements of PROMESA.”  
  • Meanwhile, the Oversight Board released an investigative report into factors contributing to Puerto Rico’s fiscal crisis and its decisions related to the issuance of debt. Its 608 pages provide wide-ranging recommendations, including many about Puerto Rico’s need for improved budgeting and accounting processes and systems, but also indicated that it was likely too late to punish any individual, government, or institution for Puerto Rico’s current debt situation.

Clearly, the situation remains dynamic. Our team continues to believe that the best interests of all stakeholders can be met through negotiated settlements that offer Puerto Rico a path forward, strengthen its economy and improve the quality of life of its residents while providing investors with an appropriate return.