GDB chief Melba Acosta leads restructuring efforts with banks and Wall Street
Government Development Bank (GDB) President Melba Acosta has been traveling a lot lately, as she heads Gov. Alejandro García Padilla's administration efforts to put out financial fires wherever they erupt, whether it is the global oil-price meltdown that has muddied the market for Puerto Rico bonds, or proposed federal legislation that could kill the island's main investment lure.
She has been meeting with Wall Street investors about structuring a $3 billion bond deal before the end of this fiscal year on June 30, when the GDB and the wider commonwealth government will run perilously low on cash. At the same time, she has been keeping tabs on the restructuring process now underway at the Puerto Rico Electric Power Authority (Prepa), which is widely expected to default on its $9 billion debt load.
Also on Acosta's agenda is keeping the administration of President Barack Obama up-to-date on the commonwealth government's financial situation, while talking to U.S. Treasury Department officials and members of Congress about ways to support Puerto Rico's critical but shrinking manufacturing base. In fact, she has spent the past two weeks traveling to Washington, D.C., and New York to meet with all concerned parties.
Meanwhile, the former Treasury secretary continues to play a central role in the rollout of the administration's tax reform, while instituting long-term budget analysis that will enable the government to better control its finances and plan for the future. The government needs to raise an additional $1.5 billion in annual revenue, according to CARIBBEAN BUSINESS sources. However, last week, a federal judge ruled the Puerto Rico Public Corporation Debt Compliance & Recovery Act (Recovery Act) unconstitutional, which will further complicate efforts to strengthen public finances. The law outlines a bankruptcy-like procedure for most public corporations to restructure their debts.
Throughout it all, Acosta said she remains focused on her most important role: to deliver the ultimate solution to Puerto Rico's problems by bringing sustained economic development and job creation back to the island.
"We have to move toward economic development, and if there is no job creation, there is no economic development," Acosta told CARIBBEAN BUSINESS in an exclusive interview. "Economic development is very important. We have had so many crises since we came into office, but we are moving in the direction of economic development." Government officials have said that if Puerto Rico doesn't create more jobs, it can't expect consumers to help move the economy forward. Consumers are the ones who drive 70% of an economy.
While Puerto Rico is passing through a tough adjustment period, Acosta sees better days ahead. She said people shouldn't expect the problems, which have been building for many years, would be resolved in two years, pointing to places such as Ireland, which has taken seven years to resolve its financial crisis.
But while a return to boom times may not get here as fast as anyone would like, including Acosta, the administration is taking the right steps to assure economic development will again take root in Puerto Rico.
"Puerto Rico is passing through an adjustment period, something which has happened or is happening in other countries. We are working on our five-year fiscal adjustment plan, and we are following it," Acosta said.
"Now we are passing through the bonanza of the drop in oil prices. This is helping the economy greatly. We are on the path to tax reform that will put more money in people's pockets. We have a plan to continue improving government finances; although it will take some time, we are making the decisions that must be taken to raise ourselves up," she added.
THE IMPORTANCE OF RETURNING TO MARKET
One of the most pressing issues on Acosta's full agenda is arranging a mega-bond deal of up to $2.95 billion to refinance old debts and return liquidity to the GDB, the commonwealth government's lender of last resort.
The GDB's largest outstanding loan is a monster $2.2 billion line of credit to the troubled Highways & Transportation Authority (HTA), which has been sitting on its books since the administration of former Gov. Luis Fortuño.Acosta has been warning about the importance of the deal since last fall. The loan must be paid back or the GDB will have to reserve the loan as a loss, a move that would sink the GDB, leaving the bank completely decapitalized.
"There is no drop-dead date, but we need to go to market soon because market conditions are certainly becoming more difficult, and the GDB needs liquidity," she said.
The GDB is already making contingency plans to reserve its cash, freezing all new loan applications and taking other measures, noted Acosta, who said that nevertheless, a deal will get done before the end of the fiscal year.
Lawmakers initially resisted approving a petroleum-tax hike that would back the deal, and when they finally approved it in January, they placed conditions on the deal that are making it difficult to market.
The final version of legislation authorizing the bond deal and a petroleum-tax hike to back the issue didn't tie the increase to an automatic inflation index. This means that the revenue stream in the future will fail to provide enough coverage for a $2.95 billion issue as originally planned, and will only be enough to cover about $2 billion. Another provision caps the interest rate on the deal at 8.5% and the discount at 93 cents on the dollar, which apply to the "weighted average of the deal."
The interest rate and discount provisions mean the bond deal can't be sold at rates higher than a 9.2% yield, which isn't sufficient in current market conditions. Acosta pointed to last year's $3.5 billion general-obligation (GO) bond issue, which offers investors the full faith GO guarantee. Those bonds are now trading at a 9.7% yield.
"If you are an investor and you can buy GOs at a 9.7% yield, which is the best debt the commonwealth has to offer, why would you go buy a new bond issue that is lower in credit quality and pays a yield of 9.2%," Acosta said.
"The GDB doesn't want to issue debt at 10% or 9%. We are going to do everything within our means to reduce that interest rate the most that we possibly can, but going to market is almost like going to war, and imposing these kinds of limitations is like sending a soldier into battle with one arm tied behind the back," she added.
One way around the cap is to insure up to $500 million in bonds, which could be sold at a lower rate. That would allow the rest of the deal to be sold at a 9% interest rate, with yields around 10%, while keeping within the letter of the law authorizing the deal.
However, Acosta said the negotiations have been tough because insurance companies have also insured Prepa bonds, and they face serious potential losses in the restructuring process now underway. Despite months of negotiations, there are no firm commitments from insurers.
The GDB has also been meeting in New York to discuss alternate financing structures, including short-and long-term guaranteed notes, but Acosta said the different financing scenarios all have their legal risks.
"There are options, but there is no best option. The best option is to try to amend the law. Things have changed. The market today is very different than it was in December. We have been discussing this matter with lawmakers in the House and Senate, and I believe they now have the knowledge and understanding about why we should amend the law, and they have an interest in amending it," she said.
CARIBBEAN BUSINESS investment industry sources say amending the law to index the petroleum-tax hike to inflation is essential to getting the deal done. Investors want the GDB to undertake a larger issue so that they get enough cash to last for the next two years, which will help strengthen the security of the new bonds. It isn't clear whether lawmakers will agree to lift the caps on interest and discount rates, and Acosta noted there was some resistance to tying the petroleum-tax hike to an inflation index.At press time, lawmakers were taking initial steps to granting more flexibility in arranging a deal.
Indexing the petroleum-tax increase will provide further incentive for insurers to participate in the deal, and there are other ways to market a $500 million portion of the deal that would enable the rest to be sold at higher rates, the sources added.
The deal hikes the petroleum tax from $9.25 to $15.50 a barrel, and transfers the GDB's $2.2 billion HTA loan to the Puerto Rico Infrastructure Financing Authority, along with the means to pay for it via revenue produced by hikes in the petroleum tax. The bill also provides extra funding to cover operational budget gaps at the HTA, including its mass-transit assets that are being spun off into a new public corporation.
On paper, Puerto Rico has enough money to make it through the end of fiscal 2015, which ends June 30, but officials say boosting GDB liquidity is essential so Puerto Rico can use the extra cash to plug any fiscal holes in this year's budget and cover other emergency situations.
A GDB report, which showed its liquidity at $1.09 billion as of Dec. 31, 2014, representing a drop of nearly $1 billion over a six-week period, also shows that GDB finances are at a critical state, with its cash and bank deposits dropping to $332.61 million at year-end.
The GDB must make payments of about $600 million before June 30, and in fiscal 2016, it faces some $800 million in principal payments. Of particular concern are five-year notes purchased last term by the GDB, which are now coming due.
"The HTA was supposed to pay back the GDB, which would allow the bank to repay its debts and keep lending. If this circle isn't completed, there are problems. In this case, the circle was never completed. The money was never paid back, and now the notes are coming due," Acosta said.
"We are going to do everything in our power to reduce the interest on the HTA issue—we are doing all the due diligence and giving out all the information possible. If we can also achieve some sort of wrap, we will try, but there are other options," she added.
RESTRUCTURING UNDERWAY AT PREPA
Nobody knows the seriousness of Puerto Rico's financial problems better than Acosta, but she is quick to shoot down much of the press coverage as "sensationalist."
"I read all these things about how we should be restructuring, and this process is already underway in Prepa's case," she said. "We are negotiating. With restructuring, there are various flavors and colors. In some cases, you can extend the maturity and make some rate adjustments. These processes are healthy; they don't necessarily have to be a process of suffering."
Prepa has already technically defaulted on its $671 million in bank loans and has been in talks with its creditors since last summer.
Because Puerto Rico's public corporations can't file for Chapter 9 under the U.S. Bankruptcy Code, the commonwealth government drew up its own law, the controversial Recovery Act, which was passed last June. It was aimed at pushing Prepa into talks with its creditors when it became clear it lacked the cash to pay the maturing loans. Now that the Recovery Act has been declared unconstitutional, analysts told CARIBBEAN BUSINESS the decision would embolden creditors to Puerto Rico's detriment, as the commonwealth could no longer invoke the law as a bargaining chip.
"The law took a lot of time to develop. I have to laugh when people say that no one has taken advantage of the law. It's true that nobody has invoked the law, but the process going on with Prepa [and its lenders] wouldn't be happening without this law. That is how we got into talks with Prepa bondholders and creditors. The law allowed us to say, 'listen, sirs, we have a situation at Prepa and you have to acknowledge it,'" she said.
Acosta added that the administration fully supports efforts to amend Chapter 9 to include public corporations, but explained they had to move on their own given the uncertain political will to make the changes in Washington, D.C., or the time it would take for such a change to take place. Resident Commissioner Pedro Pierluisi has filed legislation to amend Chapter 9 so that Puerto Rico public corporations could seek bankruptcy protection under the U.S. Bankruptcy Code.
Acosta joined Prepa officials, led by Chief Restructuring Officer Lisa Donahue, in a meeting with bondholders last month in which Prepa's "status quo" was laid out.
"Prepa needs $3 billion to $4 billion to operate in the coming years, and its creditors need to understand that. If you are going to negotiate, they need to know what is your starting point," Acosta said.
Donahue, of Alix Partners in New York, has to submit a restructuring plan by March, according to the forbearance agreement reached with Prepa creditors. That deadline is expected to be pushed back until June, according to CARIBBEAN BUSINESS sources.
"Obviously, the work at Prepa is very big; it's about trying to understand the whole company, the entire operation. Sometimes people lose focus as if this is all about rates, but you have to look beyond that and see the whole company, everything Prepa does: generation, transmission and distribution. Is the way in which Prepa currently operates the best? We need to consider whether the private sector can help in certain areas. All of this analysis is underway," she said.
"When one talks about tariffs, people get scared, but what I hear is the current tariff system has many problems and many holes. Prepa provides backup power to many companies and it doesn't charge for that, for example. There are entities that don't pay Prepa, and there are municipalities that have for-profit enterprises. Why shouldn't they pay for their electricity like private companies. So, when you hear about electricity rates, you have to see the entire concept. It isn't a question of increasing or decreasing rates. What does Prepa charge for? What doesn't it charge for? That is what we have to look at," she added.
RESTRUCTURING BEYOND PREPA
The administration's main fiscal strategy is to protect the central government and GO bonds from the financial problems at Puerto Rico's public corporations.
"We told all public corporations: 'You have to stand on your own two feet. Here are the tools, now you have to deal with it. The central government and the GDB won't continue subsidizing you,'" Acosta said.
While Puerto Rico was punished by a series of credit downgrades that affected GO and Sales Tax Financing Corp. (Cofina by its Spanish acronym) bonds as well, Acosta said Puerto Rico continues to stick to the plan.
At the same time, while the island's debt load is more than $70 billion, Acosta said one has to look at each entity that has issued the debt.
"You can't talk about restructuring everything. You need to look at each entity, each issue, to judge the fiscal situation. Yes, we have a high debt. Yes, no one here doubts that. But we have public corporations, the central government, municipalities, Cofina, the Children's Trust. We have a whole lot of issuers, and we have to look at each of them before we talk about restructuring," she said.
In the past, Acosta and GDB Chairman David Chafey have insisted that only Prepa would be restructured, but the GDB chief said the evaluation of other public corporations continues.
"Right now, it's Prepa, but obviously, we continue to evaluate the rest," she said, adding that the petroleum- tax hike should help the HTA, while the Puerto Rico Aqueduct & Sewer Authority has raised rates to improve its finances and will return to market soon.
"There are many forms, many ways of restructuring," Acosta said, adding that rate adjustments or extension of maturities are commonly done. "The most terrible form is to cut principal."
ON TO JOB CREATION
As a member of Gov. García Padilla's economic team dating back to her days as Treasury secretary, a post she held before taking on her current role as GDB president, Acosta took on the task of putting in place an austerity plan together with then-Office of Management & Budget (OMB) Director Carlos Rivas. Together, the two put in place measures aimed at achieving a structurally balanced budget.
Achieving structural balance has been an exercise steeped in hardship as revenue projected by Treasury fell short of the mark in the second quarter of 2014.
Armed with the informed perspective of a broad plan that includes fiscal adjustment and much-needed economic development, Acosta is on to the next step—economic development—in a five-year plan."In two years, we have dealt with the problems that were generated in the past—who knows how many years," Acosta said, in reference to her many meetings addressing the fiscal austerity sought by investors on Wall Street. "This doesn't have party colors—we are all responsible. This isn't going to be resolved in two years."
Acosta is the first to recognize that investors on Wall Street are looking for economic development where there is very little to be had. In fact, Puerto Rico is down 79,000 net jobs in the past 24 months.
Her plan is to see the GDB become a true financial adviser and fiscal entity, tasked with lending for economic development rather than deficit financing. "We became a financer of debt and that isn't the bank's role," Acosta said, alluding to the $9 billion in loans the GDB has secured to help cover deficits. "Imagine what we could do with $9 billion in loans for economic development and infrastructure works."
While the GDB is heading the effort to obtain the financing to keep Puerto Rico's government operating beyond the end of fiscal 2015, Acosta has been working in tandem with Treasury and the OMB on the fiscal adjustment plan, which spans five years. "That means we are working on five-year budgets, five-year projections," she added. "We have to snap out of that tendency to look at ourselves from year to year. Obviously, to complete those projections, we have to take a look at the final version of tax reform."
SWEEPING TAX REFORM ON THE WAY
Government officials, lawmakers and special-interest groups spent last week wrangling over the final details of tax-reform legislation that will be presented this week, take 12 to 18 months to fully implement and comes with growing pains.
At the heart of the sweeping tax reform, proposed by KPMG—the consultants hired by La Fortaleza— is a 16% broad-based value-added tax (VAT, or IVA by its Spanish acronym), which will replace the current 7% sales & use tax (IVU by its Spanish acronym). The VAT would be placed on all goods and services,with few exemptions, such as those on housing, electricity, water and fuel. (See related story on page 8.)
"You don't just turn on a switch and turn off another. What we want to look at, in the long term when everything is implemented, is that this will be positive for the economy. This will be something that will push economic growth and employment," Acosta said. "The reform is a complete change of the system— stop taxing productivity and begin taxing consumption. It's a change of philosophy: Let's not tax productivity. Let's leave the money to the people, so they can decide whether they create more jobs, etc., and let's tax consumption. Let people decide whether they are going to consume more or less."
Tax reform is the final phase of the complete overhaul of the commonwealth's finances that began with increasing government revenue with such things as the Act 154 excise tax—whose $2 billion in annual revenue has literally propped up government operations since 2010—and decreasing public spending. Getting Puerto Rico's fiscal house in order has topped commonwealth officials' agenda ever since credit-rating agencies downgraded commonwealth & public corporations debt to junk in February 2014, threatening access to capital for public works.
"The KPMG model used to develop the system not only tells us how much revenue we are going to generate, but also how we are going to affect the economy with these changes. So, we are changing things that will promote positive growth. The model projects that taxing consumption and not productivity is one of the ways to help the economy grow. In that sense, tax reform is a very important economic-development tool because you are telling businesspeople: 'Keep your money and grow,'" Acosta said. "The good thing about the model is that you can project positive or negative growth. The changes project that the economy will grow. "The governor is deciding whether more exemptions are added. The Legislature has already said the fewer the exemptions, the better. Whether they have the political will to stick to that, we will see as the legislative process moves forward," Acosta said.
"Yes, I believe there will be changes made. The more things that are exempt, the less you have to give back. It's all related. If you exempt food, medicine and other certain things, you won't have to reimburse as much. The basic things are being exempted, and the same applies to lowering individual tax rates," Acosta added. "The KPMG report says the best VAT systems in the world—and the best is New Zealand's—are the ones that are the purest, the ones with the least number of tax exemptions. Are we ready for that here in Puerto Rico? I don't know."
Overhauling the commonwealth's tax system and government finances is a work in progress that will be accompanied by growing pains of a "dislocation of government revenue," Acosta said, especially if lawmakers eliminate certain taxes, such as the 4% tax on gross receipts or the patente nacional. Eliminating this tax before implementing tax reform will result in a $200 million shortfall in this year's budget, she added.
Other issues that need to be addressed are implementing new structures for property taxes and transfer pricing for multinational firms operating here.
A Treasury study of the entire database for Puerto Rico's taxpayers showed companies with billion-dollar annual sales paying $50,000 in taxes. "That is a factor in low tax collections that traces to issues beyond technology that has to do with legal loopholes," Acosta said. "So, yes, there are administrative issues, but existing legal loopholes promote a very fragile tax base. That is why we are making a change.
"The KPMG study mentions that Acts 20/22 [on tax incentives on investment income and service income] should be tied to specific job-creation benchmarks. And I think that is a good recommendation," Acosta added.
"An economist said to [Treasury Secretary Juan] Zaragoza the other day, this is the country that has taken the longest to implement a VAT. We began in 2006, and in 2015, we are still at it. The reality is, and for all practical purposes, when we began collecting IVU at ports in August, for the goods, it's a VAT," Acosta said, adding that she expects the tax reform to be implemented this year. "I don't know if it will be complete or in phases. We are having this discussion with the Treasury secretary."
—Senior reporter José Carmona and Chief Copy Editor Rosario Fajardo contributed to this story.
The crusade in Washington, D.C.
Government Development Bank (GDB) President Melba Acosta said that since the administration has taken office in 2013, she has kept in constant contact with the federal government, particularly members of the White House, U.S. Treasury Department and key members of Congress.
"We have had constant conversations since I have arrived in office and it has been very useful in different ways," she said, explaining how those meetings ultimately addressed concerns about Puerto Rico's lack of economic development shared by all observers in Washington, D.C., and on Wall Street.
A key finding in a recently released KPMG report on tax reform points to the lack of economic development in Puerto Rico, a prevailing issue in the many webcasts Acosta has headed with investors on Wall Street during the past two years. Economic development— lack of job creation—has put added pressure on Acosta in her pursuit to keep the pillars of Puerto Rico's fragile manufacturing industry in place as a handful of companies contemplate their exodus from Puerto Rico.There are a handful of companies— seven to be exact—that represent nearly $2 billion in taxes for the island's base that are concerned about the uncertainty surrounding Act 154's creditability. At this point, there is no certainty that in the future the companies will be able to offset the local 4% excise tax against federal income taxes that was allowed with a notice that the IRS issued in 2010.
"Most of my meetings in Washington, D.C., were with the U.S. Treasury Department to try to obtain a permanent ruling on the creditability of Act 154," Acosta explained.
The GDB chief said the companies want certainty on two issues. "They want a final ruling on the notice by the IRS,' Acosta said, "and they want to be certain what will happen in 2017, when there is a change in the computation of the tax whereby the modified source-income rule changes through a formula that compares variables in a global context—considering costs for their Puerto Rico operations versus the company's global operations. They want to know if the formula gives them more or less what they are receiving now. That is a difficult question to answer because we don't have the numbers for their global operations and they are secretive about that data."
The uncertainty is causing tangible harm, Acosta said. "One firm with 48% excess capacity at a local plant won't move another shift here because of the Act 154 situation. The uncertainty around the tax prompted another firm to build a new plant in Singapore despite having a large presence here."
Puerto Rico wants to be competitive in this area, Acosta emphasized. "We are passing through difficult times and we are doing all we can do to lift ourselves up. With this tool, you can help us," she said of her message to concerned parties stateside.
Acosta has been forced to push for the permanence of Act 154 against the backdrop of a U.S. Congress vehemently opposed to laws that allow U.S. companies to skirt their tax obligations. "When we are asking them to consider the ruling on Act 154, they look at Puerto Rico's competitiveness and they look at us as a part of the U.S., which we are," she said. "It's the same argument that we used when members of Congress targeted Puerto Rico's foreign controlled corporations [CFCs]."
OBAMA'S CORPORATE TAX PLAN
As part of his proposed budget, President Barack Obama has unveiled a corporate tax plan that would undercut the effectiveness of the industrial tax-exemption program that Puerto Rico has relied upon for more than half a century to attract offshore investment.
The plan, which is very similar to one drafted by former House Ways & Means Committee Chairman Dave Camp (R-Mich.), would tax a company on its foreign as well as U.S. income. The Obama plan would slash the corporate tax rate to 28%, while slapping a 19% tax on a U.S. firm's foreign earnings. Although taxes paid to a foreign jurisdiction could be credited toward the 19%, it would dampen the appeal of low-tax jurisdictions such as Puerto Rico, where multinational pharmaceuticals pay an effective tax rate as low as 2%. U.S. House Ways & Means Committee Chairman Paul Ryan, Wisconsin's Republican point man on tax reform, said he would look for common ground with the Obama administration to revamp corporate taxes. He is expected to use the Camp proposal as a starting point for a wider reform.
"We have had several meetings with members of Congress and the Obama administration. We told them if you treat all CFCs in foreign countries equally, you are putting Puerto Rico at a disadvantage because you are treating Singapore, Ireland and Puerto Rico the same. So, Puerto Rico is foreign for tax purposes, but we really aren't," Acosta said. "All federal tax legislation applies to Puerto Rico—we have the minimum wage, the Jones Act. We have all these federal laws that apply to us and put us at a disadvantage with Singapore. So, our request wasn't for Puerto Rico alone, but rather for all the territories," she added.
"You need to understand that when you say, 'bring back jobs to America,' Puerto Rico is America. We shouldn't be saying take the jobs out of Puerto Rico and send them to America. Puerto Rico is America. When Obama says bring back dividends to America, Puerto Rico is America. They can't see us as Africa. We are a part of America, with a strange and complicated situation, but we are a part of America," she emphasized.
GDB chief Melba Acosta leads restructuring efforts with banks and Wall Street
Comments