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Puerto Rico Bob Kurtter, Managing Director Global Interdependence Center New York City January 15, 2014


Puerto Rico Rating History

Date

Action

Rating

August 2010

Change outlook to Negative

A3/Negative

May 2011

Put on Review for Downgrade

A3/RUR down

August 2011

Downgrade and negative outlook

Baa1/Negative

December 2012

Downgrade and negative outlook

Baa3/Negative

December 2013

Review for downgrade

Baa3/RUR

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Puerto Rico Rating Rationale General Obligation Rating

Outlook

Baa3

Review for downgrade

»  Rating is based on the government’s weakening liquidity, increasing reliance on external short-term debt, constrained market access, and uncertain prospects for growth in a persistently sluggish economy »  These risk factors are exacerbating the longstanding financial strain caused by the commonwealth's very high debt load and pension obligations, as well as its chronic budget deficits

3


Economy is still weak »  The economy is more developed than many Caribbean islands, but still narrow –  Large reliance on government employment (29% of employment)

1% 1%

Manufacturing  =   $46.1B Service  =  $43.8B

8%

–  Pharmaceuticals remain a key sector (40% of GDP) but unlikely to return to prior levels –  Tourism approximately 7% - 10% of the economy and continues to be a good performer

2012  GDP  By  Category

46% 44%

Government  =  $8.3B Agriculture  =  $.8B Total =  $100.5B

–  Nascent development of medical devices and “under the flag” sectors

Source: GDB

4


Economy is still weak »  Trends still negative

3,800   In  Thousands

–  Population declined 3% since 2005; continued decline of -0.2% to 0.3% projected annually

Puerto  Rico  Population

3,850  

3,750   3,700   3,650  

–  Weak growth projected for FY14 of 0.2%, could be further revised downward

3,600   3,550  

»  PR economy still correlated to US economy

2000

2002

2004

2006

2008

2010

Population  has  declined  4%  since  2000.

–  Any near-term growth likely to be modest

2012   Q1

PR  Real  GNP  v.  US  Real  GDP  YOY  Change 4

–  High level of US government transfer payments creates some stability

3 2

Percent

1 0

-­‐1 -­‐2 -­‐3 -­‐4 -­‐5 2001

2002

2003

2004

2005

2006

United  States  %  Real  GDP  Change

2007

2008

2009

2010

2011

2012

Puerto  Rico  %  Real  GNP  Change  

5


Finances still weak despite extraordinary measures »  Structural imbalance has declined, but is still significant and will increase again –  Structural gap is 8% of adopted FY14 budget

PR  30y  GO  Spread  &  Trading  Volume 700

600

»  Deficit financing continues

–  $575 million in planned debt service restructuring for FY14 –  FY14 revenues are slightly above expectations, but too early to tell for full year

»  Recent market volatility has narrowed financial flexibility

500

Basis  Points

–  Budgetary gaps addressed with deficit bonds and “scoop and toss” debt restructurings to eliminate paying debt service

300,000

July EAI   released

250,000

400

200,000

Detroit   Bankruptcy   Filing

300

Negative Press

150,000

200

100,000

100

50,000

0

0 6/3

6/10

6/17 6/24

7/1

7/8

7/15

Bloomberg  BBB  GO  30y  Benchmark  Spread  (left)

7/22

7/29

8/5

8/12

PR  GO  30y  Spread  (left)

8/19 8/26

9/2

9/9

9/16

9/23

Volume-­‐ PR  GOs  maturing  2033  and  later  (right)

–  GDB continues to seek liquidity sources –  Private sector lending continues 6

in  Thousands

–  Underpinning economic growth estimate is 0.2% and likely to drop

350,000


Debt and pension metrics very high

Debt Per Capita

Adjusted Net Pension Liability as a Percent of Total Revenues

$16,000 $14,053

$14,000

300%

$12,000

250%

$10,000

268%

200%

$8,000

150%

$6,000

100%

$4,000 $2,000

$1,074

$0

45%

50% 0%

PR

US Median

PR

US Median

Source: Moody’s 2013 State Debt Medians Report, 2011 Pension Medians Report

7


2006 credit comparison »  Since 2006, population and employment have declined, while debt and pension liabilities have increased significantly »  The structural deficit in FY13 was about the same as FY06 »  Legislative measures indicate a significant increase in FY14 general fund revenues Puerto  Rico  Credit  Comparison  

2006  

2012/2013  

Popula9on  

3.8  M    

3.7  M  

1,045,130  

905,700  

Manufacturing  Employment  

109,740  

75,130  

Government  Employment  

300,960  

246,470  

General  Fund  Recurring  Revenues  

$8.4  B    

$7.8  B  

GF  Structural  Deficit  

$2.0  B    

$2.0  B  

Net  Tax  Supported  Debt  

$32.6  B    

$52.9  B  

GNP  

$58  B  

$69  B  

NTSD:GNP  

56%  

77%  

$14.7  B  (FY05)    

$32.8  B  (FY11)  

33.9  

39.4  

Total  Employment  

Unfunded  Pension  Liability   Per  capita  income  as  a  %  of  US  

8


Credit positives support the rating »  Strong political and economic links to the US; benefits from US legal and regulatory systems »  Broad legal powers to raise revenues and adjust spending »  Constitutional first priority lien on revenues of the commonwealth for general obligation and commonwealth-guaranteed debt »  US financial support in the form of transfer payments (social security, nutrition assistance, veterans’ benefits) transportation aid and stimulus funds »  FEMA support for natural disasters »  Residents not subject to US federal income or gas taxes »  Commonwealth has acted to prevent more serious credit deterioration during the extended economic recession –  Created new revenues –  Pension reform –  Maintained positive liquidity position at GDB

9


Bondholder legal framework »  Bond financings governed by Puerto Rico law and US Constitution –  Precedents exist for hearing contractual & constitutional disputes in Federal Court –  Puerto Rico Supreme Court decisions can be appealed directly to US Supreme Court

»  PR Constitution provides first priority lien on “available resources” of the Treasury for the benefit of General Obligation debt service –  Known as “GO claw-back” from perspective of non-GO bonds –  COFINA sales tax property not part of available resources, per opinions of Secretary of Justice and bond counsel

»  PR constitutional amendments (none since 1970) require approval by 2/3 of House and Senate plus a special referendum to the electorate –  Contracts clauses of both PR and US constitutions protect bondholders

»  Puerto Rico, like US states, is prohibited from filing under US bankruptcy law –  PR municipalities and public corporations also prohibited from filing under Chapter 9

»  Payment obligations could still be disrupted by government’s ability to invoke “police powers”, subject to same high bar standard applicable to all US states

10


What are we watching? What are we watching?

What are we seeing/ expecting?

Private sector employment and other trends

Private sector job loss in 2013 of 2-3%; continued decline in pharmaceutical operations; continued population decline

Prospects for widening structural budget gap and greater need for deficit financing

Possible decline in base revenues (vs. modest growth in budget) and shortfalls against new tax estimates, which will widen deficit financing need from budgeted $820 million

GDB net liquidity position (net of restricted funds and short term external debt of GDB, Commonwealth, and Authorities)

GDB net liquidity position has narrowed; GDB pursuing other sources of liquidity

Pension Liabilities

TRS Reforms

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