Puerto Rico's Own Deficit Forecast Seen High by Morgan Stanley

The Controversy Behind Puerto Rico's Debt Problems
  • Debt trading team sees lower deficit than 2 official forecasts
  • Creditors would fare worse from higher deficit estimate

Puerto Rico officials have overestimated the U.S. territory’s anticipated budget deficit over the next five years by about 60 percent, according to an analysis by Morgan Stanley’s debt-trading team.

Puerto Rico will be confronted with a $5.57 billion financing gap through its fiscal year in 2020, according to a report distributed Sept. 11 by Ryan Brady, an analyst on Morgan Stanley municipal-debt trading desk in New York. That’s less than the $14 billion shortfall the Puerto Rico government estimated in its banner restructuring and economic plan released this week.

Puerto Rico’s government has sanctioned two different deficit figures for between 2016 and 2020. Former International Monetary Fund economists led by Anne Krueger concluded in a study commissioned by the U.S. territory that the financing gap would be $9.6 billion. And a day before Brady released his report, Morgan Stanley’s research analysts led by Michael Zezas, who work separately from the trading desk, put out a note stating that “we could not patch together a budget baseline with a strong enough degree of confidence.”

The gap between the estimates is particularly important to Puerto Rico bond investors because the deficit will help define how aggressive the government can be in seeking concessions in debt-restructuring talks. Governor Alejandro Garcia Padilla said in a Sept. 9 speech that he expects creditors to “share these sacrifices” so “Puerto Rico can return to a sustainable path of economic growth.”

Seeking Ammunition

As the island prepares to enter multiple negotiations to restructure its $72 billion of debt, the more dire the deficit appears to be, the stronger the ammunition for Puerto Rico’s negotiators. Officials are targeting the Government Development Bank as the place to begin talks. Citigroup Inc., which is helping oversee the financial restructuring, has been preparing to enter into confidential discussions with holders of that agency’s debt, people with knowledge of the matter said last week.

Lauren Bellmare, a spokeswoman for Morgan Stanley, declined to comment on the investment bank’s trading desk analysis. And Scott Helfman, a spokesman for Citigroup, declined to comment last week on the GDB negotiations.

Brady’s report, which was distributed privately to institutional investors and Morgan Stanley clients and was obtained by Bloomberg, challenges some core assumptions Puerto Rico officials have used in calculating the depth of their debt dilemma. It says the island’s deficit would be lowered by increasing the government’s expected efficiency in collecting taxes, restoring funds collected under an excise tax known as Act 154, and reducing the impact of the loss of Affordable Care Act funding from the U.S. federal government.

The analysis also reduces Puerto Rico’s cash burn by accounting for fewer payments to public agencies and extending payback dates on some cash reserve accounts.

The island’s 8 percent general obligation bond maturing July 2035 rose about 0.8 cent Tuesday to an average of 73.3 cents on the dollar, according to data compiled by Bloomberg. The average yield was 11.4 percent.

The most actively traded Government Development Bank security, the 4.375 percent notes maturing February 2019, climbed 0.1 cent Tuesday to an average of 40.1 cents on the dollar, according to data compiled by Bloomberg. The notes traded at 32.8 cents a week ago on Sept. 8, the data show.

(An earlier version of this story corrected the distribution date of the trading desk report in the second paragraph.)

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