BASED ON PUBLIC INFORMATION

For Puerto Rico, There is a Better Way

A Second Look at the Commonwealths Finances and Options Going Forward

Authored by Jose Fajgenbaum, Jorge Guzman, and Claudio Loser

July 2015

BASED ON PUBLIC INFORMATION

Disclaimer

This presentation has been prepared by Centennial Group International (Centennial) for the exclusive use of the party to whom
Centennial delivers this presentation, using information made publicly available by the entities that are the subject of such presentation
(together with its subsidiaries and affiliates, the "Commonwealth") and other publicly available information. Centennial has not
independently verified the information contained herein, nor does Centennial make any representation or warranty, either express or
implied, as to the accuracy, completeness or reliability of the information contained in this presentation. Any estimates or projections as
to events that may occur in the future (including projections of revenue, expense, and net income) are based upon the best judgment of
Centennial from information made publicly available by the Commonwealth (including its advisors and representatives) and other
publicly available information as of the date of this presentation. There is no guarantee that any of these estimates or projections will be
achieved. Actual results will vary from the projections and such variations may be material. Nothing contained herein is, or shall be relied
upon as, a promise or representation as to the past or future. Centennial is not undertaking to provide any legal, regulatory, accounting,
insurance, tax or other similar professional advice in this presentation. Nothing contained herein is, or shall be relied upon as, such
advice. Centennial and its affiliates expressly disclaim any and all liability relating or resulting from the use of this presentation.
This presentation has been prepared solely for informational purposes and is not to be construed as a solicitation or an offer to buy or
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financial, accounting or other advice to you or any other party.
This material must not be copied, reproduced, distributed or passed to others at any time without the prior written consent of
Centennial.

BASED ON PUBLIC INFORMATION

Bios
Jose Fajgenbaum is Director of Centennial Group Latin America. Prior to joining the Centennial Group, he worked at
the IMF for more than 30 years, where he advanced from economist to Deputy Director. His key role included leading
missions to surveillance countries, such as Brazil, Israel, Russia and South Africa, as well as to countries with economic
countries supported by the IMF, such as Brazil in the early 1990s, the Dominican Republic, Kenya, Malawi, Peru and
Trinidad and Tobago. He holds a BA from the National University of Cuyo, an MA in economics from the University
of Chicago, and completed his Doctoral studies in economics at the University of Chicago.
Jorge Guzman is a consultant for Centennial Group Latin America. He worked at the IMF for 27 years as a
macroeconomist, including as mission leader to countries with IMF-supported structural adjustment programs in
Latin America and the Caribbean. He holds a B.S. in Electrical Engineering from the U.S. Military Academy (West
Point) and a Ph.D. in Economics from Georgetown University.
Claudio Loser is Founding Director and Chief Executive Officer of Centennial Latin America. He is a well-known
authority on Latin American economies and institutions. During his career at the International Monetary Fund he held
many senior positions, including Director of the Western Hemisphere Department. Under his leadership, the
Department was actively involved in a wide range of surveillance, technical assistance, and research activities. Recently
he has worked closely with the G-24, the Andean Finance Corporation (CAF), the Rio Group of Latin American
Cooperation, and with a number of other financial corporations, dealing with developments in Latin America and the
evolving relations between these countries and the IMF. He is a Senior Fellow at the Inter-American Dialogue, a
Washington-based forum for opinion leaders and policymakers on Western Hemisphere affairs. He teaches
international economics and finance at the George Washington University. He has published in many journals, mostly
on Latin American economic issues. He graduated from the University of Cuyo, Argentina and received his Masters of
Arts and PhD from the University of Chicago in 1967 and 1971, respectively.

BASED ON PUBLIC INFORMATION

Executive summary
Puerto Rico can avoid a costly default even after consideration of the Krueger Report (the
Report)
Puerto Rico has a deficit problem, not a debt problem
Deficit is fixable and extensive history exists of other governments that made similar or greater fiscal adjustments
and subsequently grew their economies
Path laid out by the Governor has significant risks and is not the answer to Puerto Ricos deficit problem
Ignores legal limitations and the priority granted to GO and Commonwealth guaranteed debt by the Puerto
Rico Constitution
Ignores large and long lasting economic costs
Ignores significant costs to on-island retail and institutional investors who hold substantial amounts of the
Commonwealths obligations
Puerto Rico has ~18 different debt issuing entities that make up the $72 billion of outstanding debt. Each entity
has its own legal particularities and financial capacities and thus each should be considered individually

BASED ON PUBLIC INFORMATION

Puerto Rico government has begun to make a fiscal adjustment

Puerto Ricos true deficit has been shrinking
Deficit estimated to be only 1.3% of GNP in FY2015

Central Government Overall Balance and GNP Growth

0

1.2%
FY2014

FY2015P
1.0%

($500)
1.0%

0.8%
($1,000)

(932)
0.6%
0.6%

($1,500)

0.4%

GNP Growth

Central Government Overall Balance ($US Millions)

FY2013

($2,000)
0.2%

(2,066)
($2,500)

0.0%

(2,580)
($3,000)

0.0%
-0.2%

Source: Puerto Rico A Way Forward - 7/13/2015

BASED ON PUBLIC INFORMATION

Krueger Report shows path forward without need for a default

Report demonstrates the ability of Puerto Rico to generate a growing surplus
Report suggests several measures for both fiscal and structural reform
Fiscal reform measures
Revenue increases of $3 billion per year by 2020, $4 billion per year by 2025
Adoption of increased SUT
Income tax surcharge on corporations receiving exemptions, eventual move to flat rate
Step up in property taxes (real property values were last assessed in 1958)
Increased individual income taxes from higher labor participation
Expense cuts of $2 billion per year by 2020, $2.5 billion by 2025
Freeze formula-based General Fund appropriations
Reduce number of teachers to fit the size of the student population
Reduce subsidy to University of Puerto Rico
Cut excess Medicaid benefits
Structural reform measures
Amend local labor laws regarding overtime, vacation time, mandatory bonuses, and others
Make welfare benefits consistent with local labor market conditions
Reduce transportation costs by seeking Jones Act exemption
Reduce energy costs via PREPA reform
Modernize / improve processes to facilitate new business startups in Puerto Rico
Specifically, property registrations, new business permits and tax collections
Source: Commonwealth reports

BASED ON PUBLIC INFORMATION

Krueger Report shows path forward without need for a default (continued)
Report includes reform measures that can lead the Commonwealth to fiscal surpluses
Below chart shows central government overall balance after including revenue and expenditure reforms and the
GNP effects of such reform as included in the Report
Assumes status quo with respect to ACA and Act 154
Financing should be utilized to provide bridge to implement reform measures
Central Government Overall Balance After Reform Measures
$5,000

Overall Balance After Reform Measures ($US Millions)

4,303
3,860

$4,000
3,355

Positive overall
balances (i.e.
FY2017 and
later) allow debt
levels to be paid
down

2,947

$3,000

2,519
2,311
1,814

$2,000

Transition to fiscal
surplus, after
payment of interest,
by FY2017

1,250

$1,000
379
0
(519)
($1,000)

FY2016

FY2017

FY2018

FY2019

FY2020

FY2021

FY2022

FY2023

FY2024

FY2025

Source: Puerto Rico A Way Forward - 7/13/2015

BASED ON PUBLIC INFORMATION

Puerto Rico has room to increase revenues

Puerto Ricos federal and state tax collections are low compared to US states
Commonwealth has opportunity to increase revenue while maintaining tax levels inline with the US states
Below chart shows state and federal taxes as a percent of GDP for the US states, Puerto Rico is shown both as a
percent of GNP and GDP

State and Federal Tax Collections as a % of GDP/GNP (1)

40%
35%
30%
25%
20%
15%
10%
5%
Puerto Rico (GDP)
New Mexico
South Carolina
Oregon
West Virginia
Mississippi
Wyoming
South Dakota
Alabama
Utah
Montana
Nevada
Puerto Rico (GNP)
Hawaii
Alaska
Iowa
Arizona
New Hampshire
North Carolina
Maine
Washington
Idaho
Louisiana
Colorado
Texas
Virginia
Georgia
Kentucky
Indiana
California
Oklahoma
Michigan
Florida
Maryland
Wisconsin
Kansas
Tennessee
North Dakota
Vermont
New York
Missouri
Pennsylvania
Illinois
Massachusetts
Nebraska
Ohio
Connecticut
New Jersey
Rhode Island
Arkansas
Minnesota
Delaware

0%

Sources: Commonwealth reports, IRS and US Bureau of Economic Analysis

Notes:
(1) For FY2013.

BASED ON PUBLIC INFORMATION

Puerto Rico has room to increase revenues (continued)

Improve tax collection rates
Estimated that Puerto Rico sales tax compliance is 56% (1) compared with an average of 83% (2) in the 50 states
Extrapolation would suggest an incremental $1.1(3) billion available if Puerto Rico sales tax collection rates
could be improved to the 50 state average
Sales tax is only a small part of the broader tax collections
An increase in compliance rates would provide additional revenue to the government without increasing the
burden on the existing tax base
Increased fiscal flexibility associated with improved tax compliance can be used to facilitate further GNP growth
in the medium-term

Source: Commonwealth reports , KPMG and IRS

Notes:
(1) KPMG - Commonwealth of Puerto Rico Tax Reform Assessment Project Unified Tax Code of Puerto Rico: Tax Policy Implementation Options General Explanation of Principal Options 10/31/2014.
(2) IRS gross tax compliance rate.
(3) $1.1 billion equals difference between the 10.5% SUT collected at 56% and 83% compliance levels assuming ~$40.3 billion in tax base.

BASED ON PUBLIC INFORMATION

Puerto Rico has room to lower expenses

Total governmental expenditures increased 29% or $4.4 billion in the past decade while
population declined 6%
Government expenditures have not been adjusted to reflect Commonwealths current situation

Total Governmental Expenditures and Population (1)

3,900

$20

3,827

$19.6

3,850

3,800

$19

$18

3,750

$17

3,700

$16

3,650

Population (in Thousands)

Governmental Expenditures ($US Billions)

$21

3,615

$15.2
$15

3,600
FY2004

FY2005

FY2006

FY2007

FY2008

FY2009

Total Governmental Expenditures

FY2010

FY2011

FY2012

FY2013

Population

Sources: Commonwealth reports

Notes:
(1) Total governmental expenditures equal to Governmental Funds total expenditures as reported in the Commonwealths annual audited financials.

BASED ON PUBLIC INFORMATION

Puerto Rico has room to lower expenses (continued)

Education expenditures increased 39% or $1.4 billion in the past decade while total school
enrollment declined ~25%
Education Expenditures and School Enrollment (1) (2)
764,861

$5.0

750,000

700,000
$4.5

650,000

School Enrollment

Education Expenditures ($US Billions)

$4.8

$4.0
600,000

$3.5

573,494

$3.5

550,000
FY2004

FY2005

FY2006

FY2007

FY2008

FY2009

Education Expenditures

FY2010

FY2011

FY2012

FY2013

School Enrollment

Sources: Commonwealth reports

Notes:
(1) Education expenditures equal to Governmental Funds education expenditures as reported in the Commonwealths annual audited financials.
(2) FY2004 FY2012 school enrollment per the Commonwealths 6/30/2012 audited financials, FY2013 total enrollment unavailable and estimated based on historical growth rates, i.e. 573,494 =
588,384 * (100% 2.5%).

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BASED ON PUBLIC INFORMATION

Puerto Rico has other additional opportunities to improve liquidity

Public private partnerships and real estate value
Commonwealth should consider the successful public private partnership precedents set by PR-22/PR-5, the
Luiz Munoz Marin International Airport, and the Teodoro Moscoso Bridge as a roadmap for additional PPPs
Government real estate such as buildings and ports has the potential for billions in additional revenue
PBA, PRCCDA, and PRIDCO owned buildings total ~$4.1 billion in carrying value
Ports Authority and Port Authority of the Americas capital assets not already under a concession agreement
total ~$1.0 billion

$6.0
$5.1
$5.0

$US Billions

$4.0
$3.0

$2.5

$2.0
$1.0
0
FY2016 Financing Gap

Potential Value of Real Estate

Source: Commonwealth reports and press reports

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BASED ON PUBLIC INFORMATION

Puerto Rico can make a fiscal adjustment and grow

Countries in comparable situations have grown after fiscal adjustment
Contrary to conventional wisdom that fiscal adjustment programs cause recessions and political costs to
governments, the Independent Evaluation Office of the IMF found that the average growth rate in the first
program year improved over the previous year and in the second year improved further, surpassing the average
of the pre-program decade
Based on a review of 133 programs with an average targeted fiscal adjustment of 2% of GDP over two years
IMF has found that
Fiscal adjustment programs generally have had a positive effect on GDP growth
Fiscal balances in program countries improved substantially faster than in the non-program countries
Puerto Rico should eliminate its fiscal deficit in order to regain normal market access
Given lack of economic growth, Puerto Rico must bring the Governmental Funds into full balance using
fiscal adjustment measures
Recent and proposed measures, if implemented, would allow Puerto Rico to obtain fiscal surpluses

Source: IMF and Commonwealth reports

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BASED ON PUBLIC INFORMATION

Puerto Rico can make a fiscal adjustment and grow (continued)

Below examples show that deficit reductions of ~2% of GDP can be accompanied with
strong positive economic growth
All countries included in the chart below made a fiscal adjustment without recourse to debt restructuring

Improvements in GDP Growth and Fiscal Performance (1) (2)

12.0%
10.1%
10.0%
8.9%

8.0%

6.0%

5.4%

5.3%

4.8%

4.2%

4.0%
4.0%

2.5%

2.0%

1.4%

1.5%

1.7%

3.4%
2.4%

2.1%

2.4%

2.4%

1.5%

1.3%
0.5%

0.4%

2.3%

2.1%

1.1%
0.5%

0.3%

3.3%

2.8%

1.5%

1.3%

0.5%

0.0%

Brazil
1998

Brazil
2002

Colombia Croatia
2000
2001

El
Honduras Ireland
Salvador
2004
2011
2009

Mexico
2004

Panama Paraguay
2005
2006

Peru
2002

Poland
2004

Spain
2012

Turkey
2002

Uruguay
2002

Change in Annual GDP Growth (%)

Cummulative Improvement in Fiscal Balance (% GDP)
Sources: IMF and J.P. Morgan
Notes:
(1) Shows cumulative improvement in fiscal balance from year prior to program to year after program and improvement in average GDP growth before and after program.
(2) Paraguay had an initial fiscal surplus position. Panama, Poland and Spain did not have programs with the IMF when they engaged in their adjustment effort.

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BASED ON PUBLIC INFORMATION

Path laid out by the Governor has significant costs and risks
An attempt to impair GO bonds would be costly and unsuccessful
GO constitutional priority
Puerto Ricos Constitution provides that GO and Commonwealth guaranteed debt service shall be paid first before
other expenditures
Priority granted by Article VI of the Puerto Rico Constitution
No state in recent history has defaulted on its GO bonds
Disregards ability to clawback ~$1.0 billion of revenues annually
Revenue currently appropriated to HTA, PFC, PRCCDA and PRIFA totals ~$1.0 billion annually
Commonwealth obligated to redirect revenue for payment of GO debt service
Clawback-able revenues could cover the vast majority of the ~$1.2 billion in annual GO debt service
$1.5
$1.2
$1.0

$US Billions

$1.0

$0.5

0
Clawback-able Revenues

FY2016 GO Debt Service

Source: Commonwealth reports, Bloomberg and EMMA

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BASED ON PUBLIC INFORMATION

Costs of default will be high

Restructuring will come at the expense of the Commonwealth and its people
Argentina, as a result of its fight with creditors and ensuing uncertainty regarding economic policy in the country has
seen foreign direct investment collapse and large capital flight of well over $150 billion
Locked out of international capital markets after pursuing a unilateral restructuring and as a result still cannot
obtain foreign financing at reasonable interest rates
Only financing by China at undisclosed rates is preventing a sharp decline in international reserves
Combination of non-market and non-creditor friendly policies has resulted in a collapse in confidence and economic
recession
Detroits bankruptcy fees totaled ~$180 million or 17% of FY2013 general fund revenue
Costs to Puerto Rico expected to be much higher due to larger, more complex capital structure, lack of established
bankruptcy process, and GO and Commonwealth guaranteed constitutional protections
Puerto Rico has ~18 different debt issuing entities each with different complexities and structural issues
Three major banks, Banco Popular, First BanCorp and Oriental, lost $900 million in combined market cap in the week
following the Governors announcement
Stocks were down 10%, 26% and 31% respectively in four days following the Governors speech
Creditors that may be impacted by the Governors plan are largely on-island, and include many retail holders
Local investor who bought GDB bonds worth $10,000 has seen the value of those holdings shrink to ~$4,000
Local investor who bought GO bonds worth $10,000 has seen the value of those holdings shrink to ~$6,500
Reported that UBS no longer allows clients to use Puerto Rico bond funds or closed-end fund shares as collateral
Significant amount of these clients are on-island
Source: City of Detroit financials, press reports, Bloomberg, and EMMA

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BASED ON PUBLIC INFORMATION

Government should take the initiative to create a better Puerto Rico

Reforms should be coupled with measures to grow the economy
Government has opportunity to consolidate entities, improve IT systems, and strengthen controls and
accounting
Additionally the government can focus on growing underutilized parts of the economy and improving areas the
World Bank Doing Business profile (1) cites as opportunities to enhance competiveness
Tourism industry
Growth in tourism has lagged many Caribbean peers and Puerto Ricos status affords it large advantages
over other destinations that require a passport to travel to
Agriculture industry
Agriculture represents 1% of GNP currently and opportunity exists to replace the large amount of imported
food consumed with food grown/raised on-island
Potential to generate billions in local revenue by utilizing greater amount of farmland

Existing port infrastructure

Puerto Rico has one of the largest port systems in the Caribbean
Infrastructure exists to receive Post-Panamax size ships
Source: Commonwealth reports and press reports
Note:
(1) http://www.doingbusiness.org/data/exploreeconomies/puerto-rico/~/media/giawb/doing%20business/documents/profiles/country/PRI.pdf

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http://www.centennial-group.com/

Washington, DC:
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Washington, DC 20037
202-393-6663

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