THE BOND BUYER
Government Development Bank: Puerto Ricos Quiet Powerhouse For Bond Business
by Lynn Sherman
May 1, 2000
SAN JUAN, Puerto Rico -- Puerto Rico is building new infrastructure, ending government control of utilities, and trying to become a center of global commerce, trade, and travel.
An island-wide privatization and economic stimulation effort, buttressed by current United States prosperity, prompted Moody's Investors Service earlier this year to raise its two- to three-year outlook on the commonwealth's $4.8 billion of outstanding general obligation debt to positive.
"The positive outlook reflects a trend of success in reducing government employment and implementing important financial reforms," according to a report issued in March by the rating agency.
A major factor in that success, observers say, is the 58-year-old Government Development Bank for Puerto Rico , which is striving to position the commonwealth to compete in the global economy by developing its physical, social, and economic infrastructure.
Central to those efforts is the Golden Triangle project, which has earmarked 110 acres in the San Juan area for development. The project includes the $500 million Puerto Rico Trade and Convention Center District, home to a world trade center, two hotels, stores, restaurants, a movie theater, a children's learning center, and residential property.
The bank -- which acts as the central bank, fiscal agent, and financial adviser for all of the island's government agencies -- has played a key role in Gov. Pedro Rossello's economic reforms.
In the current fiscal year -- which ends June 30 -- the GDB is on track to facilitate issuance of more than $4.3 billion of long-term debt, placing it in the top tier of issuers in the U.S.
The commonwealth's issuer status is enhanced by federal law that goes back to 1917 enabling most Puerto Rico debt to be exempt from all federal, state, and local income taxes. In 1984, Congress required that all Puerto Rico debt must comply with the Internal Revenue Code in order to retain that unique triple tax-exempt status .
One trading professional noted that Puerto Rico 's GO credit trades at the same yield as triple-A rated paper in the national market, and observed that a large percentage of the commonwealth's paper is held by investors in California, New York, and other high-tax states. Buy-siders in those states use Puerto Rico debt to diversify their holdings without diluting their portfolio's tax-advantaged status .
Among the most significant privatizations spearheaded by the bank was the $2.25 billion transaction for the Puerto Rico Telephone Co., which allowed the creation of a $1.2 billion infrastructure development fund that will grow as the government divests its phone company stock.
The head of the bank at that time, Marcos Rodriguez-Ema, also headed the phone company's privatization committee. Despite some bitter opposition when the project was first announced in 1997, the privatization was completed in fiscal 1999.
"The new economic model promotes changing the role of the government from one of provider of most basic services to that of a facilitator for private-sector initiatives," according to information provided by the bank to investors in the commonwealth's securities. It is a very difficult process on many levels -- including politically-- but worth it, according to Susanna Gonzalez, a spokeswoman for the GDB. "You swallow hard and keep moving ahead," she said.
Since its founding in 1942, the bank has been involved in nearly every major project on the island. In recent years, the GDB has assumed the duty of spearheading local privatization initiatives as part of an effort to expand its responsibilities from those of a central bank to those of a development bank.
The GDB acts as the Puerto Rican government's chief investment officer and as the fiscal manager of Puerto Rico 's outstanding debt. In those two distinct functions, the bank evaluates a public entity's overall financial picture and determines whether it can afford to sell debt to fund its plans. Once a financing decision is reached, the bank serves as a "fiscal agent," coordinating the bond issuance.
As fiscal agent, the bank also serves a banking function, albeit a not-for-profit one. With $8.2 billion in assets and a capital position of more than $1.5 billion, the GDB lends money on its own balance sheet with the purpose of furthering economic development rather than generating a profit. One observer described the GDB, which generated net income of $127 million in fiscal 1999, as a bank that has only one client -- the commonwealth.
"They have a dual identity. That is where people get confused," said John Hallacy, managing director for municipal bond research at Merrill Lynch & Co.
"The investment community views the bank as the trustee of Puerto Rico 's economy," a public finance banker who works with the GDB said. "The bank is the primary economic development facilitator."
In fact, the GDB carries its own rating of A-plus from Standard & Poor's, which is stronger than the single-A rating the agency assigns to the Puerto Rican government's GO debt and the Baa1 the commonwealth receives from Moody's. The issuers that sell debt through the GDB, meanwhile, also have distinct ratings.
The key GDB leaders on bond issues, financial advisory work, and economic development are the bank's 15th president, Lourdes M. Rovira, and its executive vice president Carlos A. Colon De Armas. Working with them are Gabriel F. Rivera, vice president and director for public finance, who oversees financing of the public corporations and the central government; Javier Ramos, the adviser to the president on financings who plays a major role in the structuring of deals; and treasurer Jose Casellas, who manages the funds of the bank and the government agencies with which it works, while also having a hand in functions such as negotiating with insurers and government investment contract providers.
Vice president Alexis Rivera manages the New York office and runs the bank's investor relations effort.
The GDB's subsidiaries are the Puerto Rico Tourism Development Fund, Housing Finance Corp., Public Finance Corp., Development Fund, and Capital Fund. Affiliates include the Puerto Rico Infrastructure Financing Authority and Municipal Financing Agency, as well as the Caribbean Basin Projects Financing Authority and the Puerto Rico Industrial, Tourist, Educational, Medical and Environmental Control Facilities Financing Authority, also known as AFICA.
When financing projects at the local level, the bank acts as the lender, executing contracts between the local governments and its Municipal Finance Agency affiliate. The GDB then removes those loans from its books by pooling them to achieve critical mass and selling them in the bond market.
In roughly the last 10 months, the bank has overseen the sale of $530 million of Puerto Rico public improvement new-money and refunding bonds with Goldman, Sachs & Co. as the senior manager, and an $857.7 million Municipal Finance Agency new-money and refunding deal that Merrill Lynch senior managed. On the short-term side, the GDB arranged the issuance of $600 million of commonwealth tax and revenue anticipation notes through Goldman.
The GDB also works with Bear, Stearns & Co., Morgan Stanley Dean Witter, PaineWebber Inc., and Salomon Smith Barney Inc. Though these firms are not on a formal rotation, they are frequently used by the bank.
The forward calendar, meanwhile, holds an $800 million Highway and Transportation Authority deal; a $300 million Puerto Rico Electric Power Authority loan; $700 million of debt for the infrastructure trust fund created by the sale of the phone company; $200 million for the University of Puerto Rico ; $350 million to provide permanent financing for a super-aqueduct in Arecibo; and $400 million for the children's trust fund.
The bank has used some of the more innovative municipal financing techniques seen in the market. Last year, it sold the largest tax-lien securitization in history -- a $228 million taxable deal backed by $323 million in delinquent property taxes and brought to market by PaineWebber. And more recently, the bank -- through Goldman -- was the first issuer to sell a loan entirely over the Internet.
"I want to take advantage of the new technologies," said the GDB's Colon de Armas in an interview. "I think it is important that people know that Puerto Rico is willing to try whatever is out there that is new and beneficial to Puerto Rico ."
To that end, the GDB is enhancing its Web site to provide more information, including presentations, about its bond deals.
SMALL ISLAND, BIG DEBT?
Investors looking for the paper shouldn't have much of a problem finding it. The GDB has worked on the issuance of $18.91 billion of municipal debt since 1993, and, with roughly $16.3 billion of tax-supported debt outstanding, the commonwealth has the dubious distinction of having a higher level of total indebtedness than all but three states.
But those figures are misleading, according to analysts, who say a commonwealth-to-state comparison does not paint an accurate fiscal picture for Puerto Rico , because the commonwealth provides many services to its 3.8 million residents that, in most states, are carried out by local governments.
"The commonwealth has a heavy tax-supported debt load, reflecting, in part, its strongly centralized government," Moody's analysts said in their recent report.
The agency noted that debt service, while growing as a percentage of the budget, remains manageable because of Puerto Rico 's ability to impose high local tax rates, due to the absence of federal income tax on the island.
Another positive for the island is the fact that the 1996 federal legislation phasing out the preferential tax policies available to Puerto Rican subsidiaries of U.S. companies appears to be having only a minimal impact on the island's economy. When it was first passed, MBIA Insurance Corp. thought the legislation was such an economic threat, it temporarily stopped backing deals there. The 10-year phase-out is in its fifth year.
During the 102 years since Puerto Rico became part of the U.S., the island has repeatedly considered and rejected the idea of statehood . However, the effort remains popular among some residents.
Statehood would create several uncertainties, including what role the GDB would play under a state structure. Brad Gewehr, director of municipal research at PaineWebber, suggested that the bank could take on a role similar to that of a state treasurer, but added that its role as an issuer need not change. He also said he believed that many of the roles of the GDB could continue in some form.
What would change, however, is the triple tax-free status the commonwealth's debt currently enjoys. Many professionals believe outstanding debt would maintain its triple-tax exemption should any change occur, but it is unclear how new issues would fare and how a change in Puerto Rico 's political status would alter its tax structure.
"If there is any concern, it has to do with longer-term credit quality, but I don't think it is driving anyone away from the credit," Gewehr said.
That may be in part because of the municipal industry's high regard for the talent at the GDB, he added.
"I think the market recognizes that they have talented people with high professional standards and that there have been improvements in terms of fiscal discipline and reporting that the GDB has been a part of," he said.