RESEARCH: Puerto Rico's projected cash balances are not enough to justify a rally - Analyst Snapshot - Debtwire

RESEARCH: Puerto Rico’s projected cash balances are not enough to justify a rally – Analyst Snapshot

28 March 2018 - 12:00 am

A review of Puerto Rico’s 23 March fiscal plan provides little reason for optimism once the analysis goes beyond the plan’s cash flow summary.
The summary indicates that cash flow surpluses, net of any debt service payments, are to occur in every fiscal year from FY18 through FY23. By the close of FY23, the sum of all these projected surpluses is USD 6bn. The commonwealth’s fiscal year ends on 30 June.
Underlying the fiscal plan and related surpluses, however, is a series of assumed budget actions that are vague and may be difficult to attain. In FY23 alone, these actions are estimated to save the commonwealth USD 3bn.
The largest category of these actions stem from an initiative called the “New Government Model” (NGM), which provides USD 1.445bn of benefit in the FY23 budget. Another category, “Tax Compliance and Fees Enhancement” (Tax Compliance) is to result in an FY23 benefit of USD 1.168bn.
The largest part of the NGM initiative is the Department of Education, which accounts for USD 466m of FY23 NGM savings. These savings will occur, according to the commonwealth, because “by undertaking a comprehensive restructuring initiative, the Department of Education aims to achieve both academic and financial benefits.” Supporting explanations are also vague in that there are plans to improve the student/teacher ratio but no indication of how this will actually be achieved, e.g. through headcount reduction or through attrition.
Similarly, the largest FY23 component (USD 407m) in the Tax Compliance category is tax compliance itself, which in turn includes ideas such as “promoting voluntary compliance program” and “working smarter on tax debt collection…”. There is no information about technological improvements or other details that might be needed to achieve the projected savings.
Analyst Takeaway
As Debtwire Municipals’  Maryellen Tighe and Simone Baribeau reported yesterday, some major types of Puerto Rico bonds have enjoyed a three-month price rally. The graph below illustrates this trend, which is partially in response to commonwealth projections since March 2017 that show increasing levels of operating surpluses.
According to market participants interviewed for yesterday’s article, the 23 March 2018 release of new fiscal plans for various commonwealth entities provided the most recent boost to market values.
In the best of circumstances, it’s difficult for a borrower to accurately predict its financial operations even a year in advance. The situation is compounded the longer the time frame and as assumptions underlying revenues and expenses become more ill-defined, and Puerto Rico has not been known in recent years for the accuracy of its budgeting.
In addition, it’s a challenge to take seriously any long-term projections by Puerto Rico when there’s such an historic lack of unreliable or unavailable information. The commonwealth’s last audited financial statements were prepared for FY14, and commonwealth officials themselves sometimes seem surprised by what they find when they attempt to better understand budgeting and accounting systems.
Unfortunately, the fiscal plan does not provide a necessary level of detail regarding its underlying assumptions, nor does it directly address the need for better accounting systems. More surprises from the commonwealth are likely as a result. 
By Greg Clark