What is Puerto Rico’s Problem?

CFAP Downtown Luncheon

Wednesday, March 23, 2016

Agenda

• Panel Discussion (12:30 – 1:15) – Speaker introductions

– An overview of Puerto Rico’s problem

– Why investors should care about Puerto Rico

– Upcoming dates & events related to Puerto Rico

– How the problem might be solved

• Audience Q&A (1:15 – 1:30)

• Networking (1:30 – 1:45)

David Hitchcock

• Standard & Poor’s, Senior Director, State Ratings Group

• EF Hutton, Municipal Bond Research • Municipal Analysts Group of New York,

Past Chairman • National Federation of Municipal

Analysts, Past Board Member and Recipient of Meritorious Service Award

• Smith’s Research and Ratings Review All-Star Municipal Analyst, multiple years

• Williams College, BA in Physics

John Mousseau, CFA

• Cumberland Advisors, Municipal Bond PM, Executive VP, Director of Fixed Income

• Lord Abbett, Director of Municipal Bond Investments • Lehman Brothers • EF Hutton • Member of several industry groups including PCBE,

NFMA, NABE, WAMM, NEC • NYSSA, Past Chair of the Municipal Bond Buyers

Conference, Member of High Net Worth Investors Committee

• Instructor, New York Institute of Finance & Bond Market Association

• Brown University, MA Economics • Georgetown University, BA in Economics

Alan Schankel

• Janney Mongtomery Scott, Managing Director, Municipal Bond Strategist

• FINRA, Fixed Income Committee & Arbitrator for Dispute Resolution

• The Bond Club of Philadelphia, Past President

• Municipal Bond Club of Philadelphia, Past President

• Wharton School of the University of Pennylvania

• Postgraduate work at University of Pennslyvania, Temple University & Rutgers

• Increasing Debt Service Schedule– sales tax bond debt service (COFINA) increases about 3% per year

• Operating deficits-- Still occurring, although lowered. There has been political opposition to recent sharp tax hikes, imposition of a VAT, and to potential spending cuts

• Stagnant Economic Performance-- in part the result of the final phase out in 2006 of federal tax breaks for manufacturers

6

Puerto Rico Key Pressure Points

Source: Standard and Poor’s Puerto Rico rationale published March 22, 2016

Overview

Overview

Public Financing Corp.: ‘D’ in default. Secured only by general fund appropriations.

PRIFA Rum tax secured bonds: ‘D’ in default. These bonds have adequate pledged revenue coverage, but Puerto Rico has diverted pledged revenue to payment of GO bonds

Highways and Transportation Authority: ‘CC/Negative’ These bonds have adequate pledged revenue coverage, but Puerto Rico is diverting gas and petroleum tax revenue to GO debt service, although not toll road revenue

Convention Center District hotel tax backed bonds: ‘CC/Negative’ These bonds have adequate pledged revenue coverage, but Puerto Rico is diverting pledged revenue to pay GO debt service.

9

Selected Non-GO ratings

Source: Standard and Poor’s Puerto Rico rationale published March 22, 2016

GO: 28% haircut

COFINA: 51% haircut

Highways Authority, CCD, PFC, GDB, ‘everything else’ combined: 61% haircut

10

Puerto Rico Restructuring Proposal

Source: Working Group for the Fiscal and Economic Recovery of Puerto Rico– Puerto’s Fiscal and Economic Crisis presentation, March 1, 2016; S&P calculations

11

Puerto Rico Projected Cash Flow (Jan. 18 projection)

Source: Working Group for the Fiscal and Economic Recovery of Puerto Rico-- Puerto Rico Fiscal and Economic Growth Plan updated presentation, Jan. 18, 2016

Overview

Source: Bureau of Labor Statistics

Disclaimer: Puerto Rico and Greece are rated using different criteria

• Puerto Rico (‘CC/Negative’)– rated under our State Rating Methodology published Jan. 3, 2011, and our ‘CC’ Criteria published Oct. 1, 2012

• Greece (‘B-/Stable’)– rated under our Sovereign Rating Methodology published Dec. 23, 2014

13

Puerto Rico and Greece

Points of Comparison

Puerto Rico Greece

Real GDP Annual Growth

2010-2014

(3.6%), (1.8%), +0.7%, (0.2%), (0.9%)

respectively

(5.5%), (9.1%), (7.3%), (3.2%),

+0.7% respectively

Debt/ GDP 44.7% (2014 tax-backed debt

supported by the Commonwealth-

does not include underlying municipal

debt or federal debt– including all

underlying municipal debt and public

authorities it would be 68.9%)

171.1% (2014 Net general

government debt/GDP)

Current GDP Per Capita $28,900 (2014 preliminary) $21,200 (2014)

Impact of a Debt Default Puerto Rico bonds were widely sold

throughout the U.S. municipal market

Potentially lighter impact on

eurozone government bonds

14

Puerto Rico and Greece

Sources: Puerto Rico Planning Board, Puerto Rico Nov. 6, 2015 disclosure statement, Standard and Poor’s Puerto Rico rationale published March 22, 2016, Standard and Poor’s Greece

rationale published Jan. 22, 2016

Points of Comparison

Puerto Rico Greece

Sovereign Status A U.S. territory– only has non-

voting representation in

Congress

Full member of the euro area

Labor Mobility Full mobility within the U.S. Full mobility within the EU

Control of Its Own Currency No control Representation at ECB, but Greek

economy not well synchronized with

euro area as a whole

Fiscal Transfers High level of fiscal transfers from

the U.S. government (about 24%

of island personal income)–

primarily social security, but also

Medicare, Medicaid, food

stamps, and veteran’s benefits

Customs transfers, which are

relatively minor

15

Puerto Rico and Greece

Sources: Puerto Rico Planning Board, Puerto Rico Nov. 6, 2015 disclosure statement, Standard and Poor’s Puerto Rico rationale published March 22, 2016, Standard and Poor’s Greece

rationale published Jan. 22, 2016

©Copyright 2016 Cumberland Advisors®. Further distribution prohibited without prior permission. 16

PR: Uninsured vs. Insured

3

4

5

6

7

8

9

10

Puerto Rico Uninsured vs Insured

Uninsured Puerto Rico Insured Puerto Rico

5.00% Due 7/1/41

Call: 7/1/22 Dated: 4/3/2012

5.00% Due 7/1/35

Call: 7/1/22 Dated: 4/3/2012

Source: Bloomberg

©Copyright 2016 Cumberland Advisors®. Further distribution prohibited without prior permission. 17

PR GO: 8% due 2035

March 11, 2014:

Puerto Rico issues $3.5 bn

of general obligation debt,

drawing hedge funds

interest

August 1, 2015:

Partial default of debt

owed by the Public

Finance Corp. (PFC)

January 1, 2016:

Commonwealth defaults

on Puerto Rico

Infrastructure Finance

Authority (PRIFA) debt

February 16, 2016:

Governor signs the Puerto

Rico Electric Power

Authority (PREPA)

Revitalization Act

8

9

10

11

12

13

The Bellwether

Source: Bloomberg

Why care?

4,832

1,648

994

367

289

274 230 217

171

169

60,809

Oppenheimer

Franklin Advisers

Goldman

Franklin Resources

Nuveen

Lord Abbett

Eaton Vance

Capital Research & Management

Wells Fargo

Invesco

Other

Bondholders as of July 1, 2015

Source: Bloomberg 9/15

Why Care?

• In 1945, there was less than $20B of municipal debt outstanding

• In 1960, there was $66B

• In 1981, $361B

• TODAY, $3.7 TRILLION

• 8% CAGR over 71 years

• Puerto Rico represents <2%

Source: SEC.gov

Why Care?

Gross

Potential

Puerto Rico Total Shareholders'

Exposure Assets Equity

Insurer ($MM) ($MM) ($MM)

AMBC 9,863 23,728 1,958

MBI 8,989 14,855 3,729

AGO 8,597 14,544 6,063

Source: Company filings

SUMMARY OF INSURERS'

EXPOSURE TO PUERTO RICO

©Copyright 2016 Cumberland Advisors®. Further distribution prohibited without prior permission. 21

PR: Uninsured vs. Insured

3

4

5

6

7

8

9

10

Puerto Rico Uninsured vs Insured

Uninsured Puerto Rico Insured Puerto Rico

5.00% Due 7/1/41

Call: 7/1/22 Dated: 4/3/2012

5.00% Due 7/1/35

Call: 7/1/22 Dated: 4/3/2012

Source: Bloomberg

©Copyright 2016 Cumberland Advisors®. Further distribution prohibited without prior permission. 22

CHI BoE: Uninsured vs. Insured

1.5

2.5

3.5

4.5

5.5

6.5

7.5

Insured Chicago A Buy?

10YR MMA Uninsured Chicago BoE Insured Chicago BoE - AGMSource: Bloomberg

Upcoming Dates & Events

• Potential defaults in April, May, July 2016 and/or January, 2017

• Timeline for evaluating 2/1/16 restructuring proposal?

• Timeline for evaluating PREPA’s restructuring plan?

• Potential Federal Action via Control Board or Bankruptcy

• Supreme Court review of Puerto Rico’s 7/14 restructuring law

Potential Solutions?

• Tax haven?

• Economic stimulus?

• Debt repudiation?

Contact Us!

• David Hitchcock, david.hitchcock@standardandpoors.com

• John Mousseau, CFA, john.mousseau@cumber.com

• Alan Schankel, aschankel@janney.com

• Sean Heberling, CFA, sean@valdesmoreno.com