Puerto Rico after the storm: an island on edge

As President Donald Trump touched down at San Juan airport last week, 36-year-old Tanya Diaz was heading in the opposite direction. Although she has no job to go to Ms Diaz, her two sons and grandmother flew to California to escape the aftermath of Hurricane Maria — the strongest storm to hit Puerto Rico in nearly a century.

Some estimates suggest that more than 400,000 of the country’s 3.4m population will follow Ms Diaz in the coming years as the Caribbean island, which has already defaulted on its debt obligations, now confronts something that could be even more devastating to its economic recovery — losing thousands of its most talented people.

“It was hard to find food and water,” says Ms Diaz, a resident of Corozal, a municipality 20 miles from the capital San Juan. “We waited for four hours for gas. The kids don’t have school.” Ms Diaz is following a well-trodden path. Hundreds of thousands have left the island since 2010 as economic activity slumped and manufacturers moved offshore, taking well-paying Puerto Rican jobs with them. The departures have left fewer people to shoulder Puerto Rico’s debt and pension obligations of more than $120bn. Ultimately, they could help push the island into insolvency.

“Emigration is a painful process, but for many on the island that may be the best option,” says Barry Bosworth, a senior fellow at the Brookings Institution in Washington, who estimates that the population could drop below 3m within a few years as annual migration doubles. “The economic problems are becoming increasingly evident.”

Ricardo Rosselló, the island’s governor, puts it in even starker terms: “You will not only be getting hundreds of thousands moving to the US, you will get millions, creating a devastating demographic shift in Puerto Rico . . . a brain drain”. Some may dismiss his warning as scaremongering, part of an effort to secure multibillion-dollar aid commitments from Washington. But flights out of Puerto Rico in the aftermath of the storm — which left at least 34 dead and 11,000 homeless — were fully booked.

The scale of migration envisioned by Mr Rosselló would cause a severe economic shock on the island and potentially weigh on the finances of US cities from Florida to New York that are most likely to receive the new arrivals.

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Gerardo Portela Franco, who heads Puerto Rico’s fiscal agency, says the island, part of the US since 1898, could need between $50bn and $60bn to rebuild. The money is critical for the island to restore its electricity grid, which completely failed in the 155mph winds, replace collapsed bridges and rebuild a communication network that was knocked out.

Yet Raúl Maldonado-Gautier, the treasury secretary, says that even “before the hurricane . . . our worst problem in Puerto Rico was emigration because my tax base is being reduced and many of the people who went to the US are professionals and merchants”.

Across the island the devastation is evident. Aluminum roofs have been twisted beyond recognition, bamboo trees lining the mountain roads now resemble split toothpicks and paint has been peeled off houses by gale-force winds that pummelled walls with salt water.

Mr Rosselló expects the vast majority of the island to remain off the electricity grid for the rest of October as the Puerto Rico Electric Power Authority slowly restores services. This lack of power is expected to be the biggest impediment to the island’s immediate economic prospects amid fears that large manufacturers could begin to relocate, although several are importing industrial-scale generators to restart their operations.

Clearing up a Puerto Rican road damaged by Hurricane Maria © AFP

Tourism, which accounts for more than 5 per cent of the economy, is at a standstill and affected workers will have little alternative but to seek employment off the island — at least in the short term.

“My sister in Washington wants us to go but I have to stay for the moment,” says Laura Perez, 32, who lives in Utuado, a city that has been without clean water since Maria made landfall on September 20. “Maybe in a week I’ll go.”

Ms Perez counts herself among the lucky ones. Mudslides wiped homes off the sides of mountains in this central region, where the dirt is still a deep vermilion hue from all the rain. The landslips ripped away bridges as whole chunks of the mountain dislodged and came crashing down.

“The long-run outlook for the Puerto Rican economy was discouraging before the hurricane,” says Mr Bosworth, “now it seems much more of an immediate crisis.”

Demonstrators hold signs during a protest against austerity measures in San Juan in August © Bloomberg

There will be an instant budget gap that the government is unlikely to be able to fill as tax collection grinds to a halt. Mr Rosselló has warned the territory could run out of cash later this month, which would force it to cut police, fire and other emergency services and put pension payments to retirees at risk.

Brad Setser, who worked on the US Treasury department’s response to Puerto Rico’s fiscal crisis in 2015, expects the economic damage done by the storm to intensify the fight between major bondholders, including hedge funds such as Aurelius Capital and Baupost, and mutual funds such as Franklin Templeton and Oppenheimer over how much each competing class of bondholder should be paid.

Puerto Rico borrowed heavily after 2006 in a bid to stimulate growth following the phasing out of federal tax cuts that had attracted multinationals like Merck and Pfizer to the island. Some manufacturers left after the tax incentives were revoked, taking hundreds of thousands of jobs with them.

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Alongside borrowings from the electric and water utilities, creditors pumped money into two financial vehicles that Puerto Rico had relied on to close yawning budget gaps each year. The first — general obligation bonds — are backed by the Puerto Rican constitution. Within the $3.8tn US municipal bond market, this type of debt is seen as among the safest a city or state can issue. Those creditors have been pitted against bondholders who bought notes backed by sales taxes collected by the island and known by the Spanish acronym Cofina. They were created in 2006 to help Puerto Rico borrow billions more.

The two account for $31bn of Puerto Rico’s $74bn of bond obligations that will fall due over the next four decades.

Those debts were sent into a tailspin last week after Mr Trump said the US government would have to look at the island’s entire debt structure and “work something out. They owe a lot of money to your friends on Wall Street and we’re going to have to wipe that out,” he said in an interview on Fox News. “You can say goodbye to that.”

The White House said on Wednesday that those comments should not be taken “word for word”, and that the federal government was “not going to pay off those debts . . . We are not going to bail out those bondholders.”

Holding out hope: Donald Trump during his visit to Puerto Rico last week when he hinted at a debt write-off © Reuters

Nonetheless, the value of benchmark general obligation debt maturing in 2035 tumbled to a record intraday low of 30 cents on the dollar on Wednesday, before rebounding. It has fallen by roughly a third since the hurricane struck. The Cofina debts have also come under pressure, with bonds due in 2036 down 28 per cent to 45 cents on the dollar over the same period.

What bondholders are paid will come down to a fiscal plan conceived by a federal oversight board installed by Congress last year as part of a rescue plan to help the island restructure its debts. Territories like Puerto Rico do not have access to bankruptcy protection like US cities and public corporations. The legislation, known as Promesa, was crafted to allow the island to cut its obligations through federal courts, as one option.

A judge has to approve a fiscal plan, which must include how much the board believes the territory should earmark for annual creditor payments. Earlier this year it forecast that Puerto Rico would only be able to afford a quarter of its debt obligations over the next decade. The projection was based on a forecast of declining economic activity until 2019 followed by what it characterised as “steady, minimal growth” until 2026. The storm has shredded those forecasts.

The back-story

Puerto Rico’s road to ruin

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In May, the board filed for relief under Promesa, writing that the territory was “unable to provide its citizens effective services” because of its “excessive borrowing”. The oversight board’s plan will now have to be revised, according to one person familiar with the restructuring. They cautioned that after the storm there was no accurate way to forecast how much Puerto Rico could afford to pay its bondholders.

“Cash flows over the next few years will be very low,” Mr Setser says. “Both the general obligation and Cofina [bondholders] will be working even harder to secure their claim of what now looks like a much smaller, much reduced fiscal capacity. With a smaller pie, the fights over the distribution of the pie will get more intense.” Creditors have already proved litigious, claiming the board sought to “sabotage consensual negotiations”, and will probably ramp up lobbying efforts if a large-scale write-off of Puerto Rico’s debts is proposed. Earlier this year, hedge funds contested the legality of the oversight board. They are now involved in a number of inter-creditor fights to determine who has the best claim on the payments the island will one day make.

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“Before the hurricane, Puerto Rico had a massive and unsustainable debt overhang and was a strong candidate for a 70 or 80 per cent debt write-off,” says Lawrence Summers, former US Treasury secretary. “Public rebuilding after the hurricane will be in the same general range of its indebtedness. If the right thing before was an 80 per cent debt write-off, it’s hard to say that’s not 100 per cent today.”

The storm could force Washington’s hand, with policymakers travelling to San Juan and beyond to see the damage and offer support. The Rosselló administration is expected to leverage that goodwill as it lobbies for an aid package, with one congressional aide saying a first tranche covering the financial costs of all three recent storms, Harvey, Irma and Maria, could add up to $29bn.

Mr Trump’s comments in Puerto Rico — where he implied that Hurricane Maria was not “a real catastrophe like Katrina” — were met with incredulity and disgust by some islanders. Many were still seething from the slow initial response by the administration and Mr Trump’s attacks on the island’s leaders.

Yet cities in Florida, New York and California are bracing for an influx of people to the US mainland, where more than 5.4m Puerto Ricans already live. While they hold full citizenship, the new arrivals will gain additional rights, including a vote in presidential elections, after they make the move.

Ms Diaz says her family will decide whether to come back “when Puerto Rico gets on its feet again”. Some in San Juan are already preparing for that day. At the airport, volunteers wearing red shirts emblazoned with the phrase Puerto Rico Se Levanta (“Puerto Rico Rises”) are taking delivery of diesel generators. At present there is more hope than reality in the message.

Puerto Rico governor Ricardo Rosselló speaks during a news conference on September 30 in San Juan after Hurricane Maria © Reuters

Bondholders: Optimism gives way to anxiety as loss

Puerto Rico’s bondholders have suffered billions of dollars in losses this year, with the US territory’s debt prices tumbling first on plans that showed the island could afford to repay even less than previously thought and then again by Hurricane Maria.

At the start of the year the mood had been very different. Bondholders had favoured the election of governor Ricardo Rosselló, who replaced Alejandro García Padilla in January. Mr Rosselló, right, promised a “philosophical shift” from the previous administration that he said would underline the commonwealth’s “willingness to pay” its debts. He swiftly parted company with Millstein & Co and Cleary Gottlieb, which were advising the previous administration on the island’s restructuring but were generally unpopular with bondholders. Creditors believed they could get a better deal.

Benchmark general obligation debt, worth $3.5bn and maturing in 2035, is among the most actively traded of the US territory’s $74bn of bond obligations. It rallied during the campaign and hit an eight-month high in the immediate aftermath of Mr Rosselló’s election.

What followed rattled investors. In January, the Congressionally installed fiscal control board estimated the island could afford roughly $800m by the fiscal year 2019 when it was meant to have balanced its budget. Less than a year earlier bondholders had rejected a deal that offered as much as $1.85bn annually in debt service.

The significant drop in prices of bonds sold by debt-issuing entities after the hurricane suggests the oversight board will return with a far lower offer. At issue is just how much lower the $800m figure will fall.

“It is a binary outcome,” says Julio Bonilla, a portfolio manager at Schroders. “You are either going to get nothing or a very small amount. There is no way bondholders can benefit from this in any shape or form.”

This post originally appeared on Financial Times

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