Puerto Rico in Perspective
August 10, 2015
0
Table of Contents
Executive Summary
2
Puerto Rico’s Economy and Debt
3
Puerto Rico’s Debt in Perspective
5
PREPA Can Meet Its Obligations
8
Puerto Rico and Chapter 9
11
National’s Puerto Rico Exposure
13
National’s Financial Strength
16
Conclusion
20
1
Executive Summary
• Puerto Rico’s financial difficulties are the result of a contracting economy following years
of rapidly escalating debt to fund budget deficits
• In our view, the media’s analysis of Puerto Rico’s debt and its impact on monolines has
been incomplete or limited. Common themes: too much debt, legacy monolines are
overexposed to Puerto Rico, legacy monolines are expected to experience significant
claims and losses
• We believe that PREPA’s issues can be resolved quickly and consensually
• Chapter 9 is merely a process, and is not a solution for Puerto Rico's financial difficulties
• National’s capital adequacy and liquidity are extremely strong and it is well-positioned to
meet claims that might arise from its Puerto Rico exposures in a reasonably adverse
scenario
– National estimates it has over $1 billion of excess capital above the S&P Triple-A level
– National has been generating capital as a result of substantial portfolio amortization and lower
new business volume
– National/MBIA has a 40-year history of paying all claims on time and in full
2
The Problem: Puerto Rico’s Economy is Contracting
10.0%
8.0%
GDP Growth in Puerto Rico and the U.S.
Unemployment Rate
18
Puerto Rico
16
6.0%
14
United States
4.0%
12
Puerto Rico
--RECESSION
12.4%
10
2.0%
8
0.0%
6
-2.0%
4
United States
5.7%
2
-4.0%
0
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15
Annual Population Growth in
Puerto Rico and the U.S.
1.5%
United States
1.0%
Puerto Rico
0.0%
Puerto Rico
45.1%
Mississippi
22.7%
New Mexico
Arkansas
0.5%
-0.5%
Poverty Rate
20.4%
19.2%
Louisiana
19.1%
Kentucky
18.8%
Alabama
18.6%
-1.0%
Georgia
18.2%
-1.5%
South Carolina
18.1%
United States
15.4%
• Puerto Rico also suffers from low labor participation rate, 43% compared to 63% for the United States
Source: US Census, Bureau of Labor Statistics, World Bank
3
The Problem: Rapid Growth in Puerto Rico’s Debt
$80
$70
$62.2
$70.0
$70.0
2012
2013
$72.3
$64.3
$58.4
$60
Puerto Rico Debt - $ in billions
$53.4
$50
$37.4
$40
$30
$24.2
$27.6
$30.0
$40.3
$43.1
$46.2
$32.5
$20
$10
$0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2014
Source: Government Development Bank; Debt outstanding as of fiscal year end; excludes accretion of interest on CABS
• By not addressing its economic issues and continuing to borrow, Puerto Rico exacerbated its fiscal and debt
problems
• With a contracting economy, the substantial debt load now needs to be addressed
4
Rhode Island
Massachusetts
Connecticut
New Hampshire
Alaska
New Jersey
Vermont
Hawaii
West Virginia
New York
Maine
Delaware
Illinois
Montana
Kentucky
New Mexico
Wisconsin
Louisiana
South Dakota
South Carolina
Maryland
Washington
Indiana
Pennsylvania
Mississippi
Missouri
Michigan
United States
California
Oregon
Virginia
Idaho
Ohio
Oklahoma
Colorado
Utah
Arizona
Kansas
Alabama
Florida
Minnesota
Iowa
North Carolina
North Dakota
Arkansas
Georgia
Nevada
Wyoming
Texas
Tennessee
Nebraska
Puerto Rico
Debt-to-GDP%
Focus on the Debt Level Oversimplifies the Issue
Typical News Story Debt Comparison - Wall Street Journal, June 29, 2015:
80%
70%
Puerto Rico has a higher Debt to GDP
ratio than all U.S. states
60%
50%
40%
30%
20%
10%
0%
Sources: Government Development Bank, US Census, Bureau of Economic Analysis , World Bank
5
We Believe the Analysis is Incomplete
• The Puerto Rico government is highly centralized by comparison to U.S. states. Many functions typically provided by
local communities or lower levels of government in the states are performed by the central government in Puerto Rico.
‒ Public schools, Public safety, Utilities – electric (PREPA), water and sewer (PRASA)
• In order to adjust for the centralized nature of the Puerto Rican government, we believe one should either roll up
related local debt in every state or eliminate similar debt in Puerto Rico. In our analysis below, we have chosen the
conservative option of eliminating Puerto Rico’s utility debt e.g. PREPA, PRASA, HTA
• Most Puerto Rico residents do not pay federal income taxes. To truly measure the debt burden on taxpayers one should
adjust for the $17 trillion of Federal Debt. We multiplied the Federal Debt Per Capita by the population of each state
and added that to each state’s debt outstanding.
200%
After adjustment Puerto Rico has the
lowest Debt to GDP ratio
180%
160%
Debt-to-GDP %
140%
120%
100%
80%
60%
40%
0%
Mississippi
Idaho
South Carolina
West Virginia
Maine
Montana
Alabama
Arkansas
Kentucky
Arizona
Florida
New Mexico
Vermont
Michigan
Oklahoma
Missouri
Rhode Island
Indiana
Tennessee
Nevada
Utah
Georgia
North Carolina
Louisiana
Wisconsin
South Dakota
Ohio
Kansas
New Hampshire
Pennsylvania
Hawaii
United States
Iowa
Oregon
Virginia
Illinois
Colorado
Maryland
New Jersey
Minnesota
California
Washington
Nebraska
Massachusetts
Texas
Delaware
Connecticut
Alaska
New York
Wyoming
North Dakota
Puerto Rico
20%
Sources: Government Development Bank, US Census, Bureau of Economic Analysis , World Bank, Treasury
6
We Believe the Analysis is Incomplete - Continued
The final step in developing a more appropriate analysis is to compare the debt levels adjusted by income levels. To adjust
for income levels we compared debt per capita (including Federal debt for the states) to income per capita (Debt Per
Capita / Income Per Capita)
300%
Debt per Capita/Income per Capita
250%
Puerto Rico has the lowest debt burden
as a percentage of income per capita
200%
150%
100%
0%
Mississippi
West Virginia
Arkansas
Idaho
Kentucky
New Mexico
South Carolina
Louisiana
Utah
Alabama
Oklahoma
Indiana
Montana
Tennessee
South Dakota
Missouri
Michigan
North Carolina
Arizona
Georgia
Ohio
Maine
Oregon
Texas
Florida
Wisconsin
Kansas
Nevada
Iowa
Rhode Island
Nebraska
United States
Hawaii
Vermont
Pennsylvania
Delaware
Illinois
California
Wyoming
Alaska
North Dakota
Washington
New York
Colorado
Minnesota
New Hampshire
Massachusetts
Virginia
New Jersey
Connecticut
Maryland
Puerto Rico
50%
Source: Government Development Bank, US Census, Bureau of Economic Analysis , World Bank, Treasury
7
PREPA Can Meet its Obligations
• We believe PREPA’s issues can be resolved quickly
− PREPA has failed to set the base rate at a level sufficient to cover its operating expenses and debt service as it is legally
and contractually obligated to do. PREPA could raise its base rate by a modest amount immediately, and consumers
would still pay less than they did six months ago, because fuel costs are down significantly
− PREPA’s business plan identifies $200 million - $400 million annual operational improvements (receivables, labor, fuel
procurement, etc.) that have not yet been implemented
• PREPA’s current problems are long-standing and came about through:
• Operational and Management Failures
− Numerous staffing and operational inefficiencies including non-payment by both residential and government
customers and failure to collect past-due receivables
− Outsized workforce including significant numbers of politically appointed employees
− Politically appointed Board that must cater to continuously shifting political priorities
• Mismanagement of Capital
− Failing to attract and deploy new capital to modernize its generation fleet, PREPA continually directed capital
towards deficits caused by stagnant rates, operational inefficiencies and poor management
• PREPA’s capital structure is sustainable if accompanied by needed operational improvements
− Creditors have been forbearing for a year
− Creditors have demonstrated willingness to provide liquidity and time necessary to complete a restructuring
− Several credible offers have been made to provide PREPA the capital needed to modernize its plants
8
PREPA’s Electric Rates Are Not the Problem
•
•
•
A common complaint and suggested cause of Puerto Rico’s economic difficulties are claims that electric
rates are too high
Evidence suggests this is not true
− Current rates in Puerto Rico are below those of certain states in the U.S.
− Puerto Rico electric rates are consistently below those of other islands
Capacity exists to adopt rates sufficient to meet operating expenses and debt obligations without causing
undue hardship to ratepayers
60
Island Comp Average = 39.0 cents/kWh
*Red denotes US territories and islands
49.5
50
Cents/kWh
44.0
41.0
40
38.00
38.00
Haiti
St. Lucia
32.73
29.73
30
20
19.62
19.72
Alaska
New
Hampshire
20.81
21.07
Puerto Rico
Rhode
Island
21.65
22.22
10
0
Massachusetts Connecticut
Guam
Hawaii
Grenada
Dominica
Virgin
Islands
Sources: Island electricity rates per PA Consulting, Houlihan Lokey analysis, public filings and 2015 Platts Energy Conference. Mainland U.S. April 2015 residential electricity per U.S. Energy Information
Administration. Puerto Rico August 2015 rate per Chief Restructuring Officer/Alix Partners.
9
Failure to Adjust Base Rate
• In direct contravention of its legal and contractual obligations, PREPA has failed to set the base rate at a level
sufficient to cover all operating expenses and debt service even in the face of large oil price declines
− The base rate has not been adjusted since 1989 and has failed to cover total operating expenses and
debt service for over ten years
− As PREPA’s operating expenses continue to increase, the need to increase the base rate has become even
more paramount
• Meanwhile, PREPA’s all-in rates have declined by nearly 7 cents per kWh over the past year, which from
September 2014 to August 2015 has resulted in over $750 million of foregone revenue
Cents per kWh
Historical Base Rates minus Base Expenses
1.00
0.50
0.00
-0.50
-1.00
-1.50
-2.00
-2.50
Cents per kWh
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
(1)
Source: Historical Bond Offering Documents. Expenses and Debt Service to be Covered by Base Rate equal to non-fuel related operating expenses plus debt service divided by total
energy sales. It does not include any bank debt service if applicable in any given year.
10
Chapter 9 is a Process, Not a Solution
"What we are proposing is that those public corporations and municipalities in Puerto Rico be given the same
access to Chapter 9 as any similar entities in the United States"
Senator Richard Blumenthal, July 15, 2015
• Chapter 9 will not solve the Commonwealth’s debt related or economic problems:
– Chapter 9 would not provide a solution for GO or other Commonwealth debt because the
Commonwealth, like the states, would not be covered
– Although Chapter 9 would be statutorily available for public corporations, eligibility would be subject
to challenge and much of the debt in the three major public corporations is special revenue debt
which has protections under Chapter 9
– Chapter 9 does not avoid litigation or guarantee a streamlined process. The only certainty is that
Chapter 9 takes a long time and is very expensive. Detroit paid $178 million in advisor and legal fees
in just 18 months.
– Chapter 9 does not impose the operational solutions that are necessary to rehabilitate the island’s
public corporations
• The Commonwealth specifically excluded the municipalities, COFINA and GDB from its own
Recovery Act, thereby acknowledging that bankruptcy relief would not be helpful or necessary
for these entities
11
Alternatives to Chapter 9
• Congress can assist Puerto Rico without amending the Bankruptcy Code or providing a bail out;
there are a number of meaningful measures that could address some of the island’s economic
problems without the delay, expense and litigation that would occur in Chapter 9 proceedings:
– Create a Fiscal Oversight Board to provide impartial oversight and governance and prudent
management in the development and implementation of a plan to emerge from the current crisis
– Assist in comprehensive tax reform, including the capture of “shadow“ economic activity and the
transition to a VAT system while protecting the rights of sales tax bond creditors
– Provide potential DoE loans on vital PREPA capital projects and EPA waivers on timeline for MATS
compliance
– Consider other proposals including waiver or adjustment of U.S. minimum wage standards; waiver from
Jones Act restrictions; confirm and extend Act 154 excise tax credits and rum subsidy; revise
welfare/entitlement system to make employment more attractive
• Each of the Puerto Rico issuers has a different debt profile and should be addressed separately,
taking into account their individual capital structure, revenue sources and operational needs. A
consensual approach is best.
12
National’s Exposure to Puerto Rico Debt
Gross Par Exposure* as of 7/2/15 ($ in millions)
Puerto Rico Electric Power Authority
PR Commonwealth GO
PR Highway and Transportation Authority: 1998 Resolution Bonds**
Puerto Rico Sales Tax Financing Corporation (COFINA)
PR Government Development Bank GO
PR Highway and Transportation Authority: 1968 Resolution Bonds
University of Puerto Rico
Inter American University of Puerto Rico Inc.
PR Industrial Development Company
Total
$1,354
$985
$784
$684
$267
$87
$89
$28
$13
$4,290
*Exposure amounts exclude interest accretion on capital appreciation bonds (CABs); Total Puerto Rico exposure including interest
accretion on CABs as of 7/2/2015 is approximately $4,692 million. Complete debt service schedule information is available at:
http://www.nationalpfg.com/pdf/SelectedExposure/SelectedExposures.pdf
**Exposure includes $155 million of PRHTA bonds that were bought back by the Issuer who has agreed they must be cancelled in
accordance with the Indenture.
(Amounts may not add due to rounding)
13
Rapid Growth in Total Puerto Rico Debt Corresponds with Decline in
National’s Par Exposure
Debt Outstanding
80
70
60
National PR Par Exposure
National insures approximately 6%
of the Commonwealth's total debt in
2015 versus 16% in 2008
$72.2
$70.0
$53.4
$ in billions
50
$37.4
40
30
$24.2
20
10
$7.5
$9.0
$8.5
$5.4
$4.3
0
Pedro Rossello Gonzalez
1993-2000
Sila Maria Calderon
2001-2004
Anibal Acevedo Vila
2005-2008
Luis G. Fortuno
2009-2012
Alejandro Garcia Padilla
2012-Present
Source: Government Development Bank
Puerto Rico debt outstanding as of FY year end 2000, 2004, 2008, 2012 and 3/31/15; National Par Exposure as of year end 2000, 2004, 2008, 2012 and 7/2/15
Outstanding debt and exposure amounts exclude interest accretion on capital appreciation bonds (CABs)
14
National’s Puerto Rico Exposure Run-off
$10.0
Gross Par
$9.0
Gross Debt Service
in $ billions
$8.0
$7.0
$6.0
$5.0
$4.0
$3.0
$2.0
$1.0
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
$.0
National’s capital
position is expected to
continue to grow as its
insured portfolio
declines; runoff is
expected to outpace
current levels of new
business
Year End
Credits
Government Development Bank
PR Commonwealth GO
Puerto Rico Electric Power Authority
Puerto Rico Highway and Transportation Authority
Puerto Rico Sales Tax Financing Corporation
University of Puerto Rico System
Puerto Rico Industrial Development Company
Inter American University of Puerto Rico
Total
Gross Par %
Runoff - 5 years
100.0%
41.9%
31.9%
11.4%
0.0%
16.2%
100.0%
26.4%
29.3%
Gross Par %
Gross Par %
Runoff - 10 years Runoff - 15 years
N/A
N/A
71.1%
99.8%
64.6%
77.4%
16.4%
29.6%
0.0%
0.0%
55.4%
77.8%
N/A
N/A
59.3%
100.0%
48.7%
63.1%
Final Maturity
Year
2015
2031
2035
2042
2046
2033
2016
2029
2046
As of 6/30/2015
15
National’s Financial Strength
Lower Leverage Post Financial Crisis
Gross Par Outstanding ($ in billions)
U.S. Public Finance
Statutory Capital ($ in millions)
Claims Paying Resources ($ in millions)
Gross Par/Statutory Capital (lower is better)
Gross Par/Claims Paying Resources (lower is better)
National (6/30/15)
MBIA (12/31/07)
$195
100%
$3,341
$4,851
58:1
40:1
$762
60%
$6,382
$14,559
119:1
52:1
110
90
Gross Par/Stat Capital
70
Gross Par/CPR
50
30
MBIA (12/31/05)
MBIA (12/31/06)
MBIA (12/31/07)
National (6/30/15)
National’s leverage, with a 100% municipal-only portfolio, is lower than pre-crisis Triple–A rated MBIA
16
National’s Claims Paying Capacity
• National maintains significant financial flexibility and capital strength to
withstand a variety of stressful loss scenarios
• National estimates it has more than $1 billion in excess capital over the S&P
Triple-A level
• The Triple-A capital level is the amount of capital required to withstand Great
Depression-type losses in S&P’s model
• From a liquidity standpoint, principal and interest payments under National’s
guarantee are only payable when originally due on bonds; payments cannot be
accelerated under National’s guarantee without National’s consent
• Additional financial flexibility resides in National’s earnings stream and highly
liquid investment portfolio
17
Rating Agency Quotes
• S&P - June 29, 2015
– “National’s capital adequacy is extremely strong”
– “The outlook is stable reflecting National’s very strong capital adequacy and prospective strong
competitive position”
– “there would be no change in National’s capital adequacy score if there were a default by multiple
Puerto Rico issuers over a one, two or three year time period”
• KBRA - May 12, 2015
− “National benefits from a seasoned management team with extensive experience in the financial
guaranty market and in credit risk management”
− “KBRA’s financial model test results conclude that the claims paying resources held by National can
cover both annual operating expenses and annual insured portfolio loss assumptions at the AAA
level”
• Moody’s - May 29, 2015
− “Substantial claims-paying resources”
− “ability to generate earnings absent new business flow is a powerful characteristic of the business
model”
18
Other Considerations
• Transparency of National’s Insured Portfolio
– Pre-crisis monoline portfolios were not transparent so investors had a difficult task assessing risk
– National's total insured portfolio is listed on its website, reporting both par and total debt service
exposure; for certain credits, including Puerto Rico, annual amortization of debt service is reported
• Predictable debt service payments
– Vast majority of National's insured credits have defined debt service schedules
– Structured finance exposures often had shorter weighted-average lives and less predictable payment
streams that increased the potential for large, unexpected claims
– Some structured finance exposures could be subject to accelerated payments in certain circumstances.
National’s exposure, including that to Puerto Rico, is not subject to acceleration without National’s consent
• Insurers often realize better recovery rates in muni defaults and Chapter 9 than forecasted by
market participants
– City of Detroit initially proposed $0.10 on the dollar, but National ultimately received $0.74 on Unlimited
Tax General Obligation debt
– Overall loss in Detroit was less than 1% of National’s total Detroit-related exposure
• Ongoing Capital Generation
– Capital generation through portfolio amortization is significant. During 2014, National's insured portfolio
amortization totaled $55 billion, increasing National’s excess capital by $500 million relative to S&P’s
Triple-A requirement
19
Conclusion
• Puerto Rico’s persistent funding of budget deficits with new debt has exacerbated a
strained economy in need of reform and growth
• The individual debt burden for Puerto Ricans is not as dire as is often portrayed in
the media when the Commonwealth’s total debt is adjusted for (a) public authority
debt issuance; and (b) federal debt allocable to individual states
• PREPA’s electricity rates compare favorably to other island economies as well as
many U.S. states - capacity exists to adopt rates sufficient to meet operating
expenses and debt obligations without causing undue hardship to ratepayers
• Chapter 9 is proposed by some as a solution for Puerto Rico’s problems. We
believe Chapter 9 represents a process – not a solution. A consensual process is
best for all parties
• A prompt, sensible resolution of PREPA will help bring market stability throughout
the Commonwealth, instill confidence in capital markets and lay the foundation for
subsequent restructurings across the island
• National is well-positioned to meet claims that might arise from its Puerto Rico
exposures in an adverse scenario
20
Safe Harbor Disclosure
This presentation includes statements that are not historical or current facts and are “forward-looking statements” made pursuant
to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words “believe”, “anticipate”, “project”,
“plan”, “expect”, “estimate”, “intend”, “will likely result”, “looking forward”, or “will continue” and similar expressions identify
forward-looking statements. Readers are cautioned that these statements are not guarantees of future performance or events.
There are a variety of factors, many of which are beyond the control of National Public Finance Guarantee Corporation
(“National”), that could affect the outcome of any events described herein or the operations, performance, business strategy and
results of National and could cause its actual results to differ materially from the expectations and objectives expressed in any
forward-looking statements. Accordingly, readers are cautioned not to place undue reliance on forward-looking statements which
speak only as of the date they are made. National and MBIA Inc. do not undertake to update forward-looking statements to reflect
the impact of circumstances or events that arise after the date the forward-looking statements are made. Information on National
should be read in conjunction with, and is qualified in its entirety by, the information filed by its parent company MBIA Inc. with
the U.S. Securities and Exchange Commission on Forms 10-K, 10-Q and 8-K, in particular with respect to risk factors associated with
National.
This presentation also includes statements of the opinion and belief of National’s management which may be forward-looking
statements subject to the preceding cautionary disclosure. Unless otherwise indicated herein, the basis for each statement of
opinion or belief of National’s management in this presentation is the relevant industry or subject matter experience and views of
certain members of National’s management and their analysis of available information. Accordingly, National cautions readers not
to place undue reliance on any such statements, because like all statements of opinion or belief they are not statements of fact
and may prove to be incorrect. We undertake no obligation to publicly correct or update any statement of opinion or belief if
National later becomes aware that such statement of opinion or belief was not or is not then accurate. In addition, readers are
cautioned that each statement of opinion or belief may be further qualified by disclosures set forth elsewhere in this report or in
other disclosures by National.
All financial information is presented in accordance with statutory accounting principles, unless noted otherwise.
21