Are Puerto Rico's Coops Vultures?

by: Daniel Irvin


Puerto Rico's 116 saving and credit coops have nearly a million members who indirectly hold Puerto Rico's government bonds.

The vast majority of the Coops' $1.5 billion in negotiable securities are Puerto Rico government bonds including the weakest credits such as PFC bonds (already in default) and GDB bonds.

Shares and deposits held by Coop members totaled $8.09 billion; assets totaled $8.47 billion. A $380 million (25%) loss on $1.5 billion in Coops' bonds would impair member holdings.

To mask this risk to coop members, Puerto Rico's Legislature passed a law that allows coops to change their accounting to amortize a loss on defaulted securities over 15 years.

This kind of legerdemain, could backfire by spooking members and causing a run, which the Commonwealth's deposit insurance fund could prove inadequate to stop.

The Governor of Puerto Rico's well-orchestrated campaign against the Commonwealth's creditors will ultimately impose a harsh punishment on the Island's residents.

The Governor's policies are preventing government agencies from raising capital to fund vital infrastructure. As an example, the Puerto Rico Aqueduct and Sewer Authority has been trying for over a year to raise $750 million to pay past due invoices from contractors and to continue its capital program to improve environmental quality and address challenges created by a lengthy drought.

These policies are also brutalizing the estimated 30% of Puerto Rico's creditors represented by individuals and businesses in Puerto Rico, who put their confidence in the government's promises to pay. While perhaps a third of Puerto Rico's investors comprise hedge funds and other "vultures" the Administration likes to attack, the majority of Puerto Rico's creditors are individual investors or mutual funds who invest on behalf of individuals. These investors' only apparent crime was to have trusted the representations of the government, and they have been punished with severe losses on their holdings.

An interesting case in point are Puerto Rico's 116 cooperativas de ahorra y credito (saving and credit cooperatives or "Coops"). regulated and insured by a government agency known as COSSEC for its Spanish acronym. COSSEC both regulates the Coops and insures the shares and deposits held by Coop members up to $250,000, similar to FDIC.

According to COSSEC's June 30, 2014 financials (the most recent available), this agency had total assets of $241.8 million, liabilities of $32.3 million and a net position of $209.5 million, although press reports have stated that COSSEC's capital available to insure deposits totals $260 million.

COSSEC's most recent statistical analysis of the Coops presents the following information:

  • 961,274 members hold shares and deposits totaling $8.09 billion;
  • Assets total $8.47 billion, so assets exceed shares and deposits by $380 million;
  • Negotiable securities held by the Coops totaled $1.51 billion in September and the vast majority of these securities are reportedly various bonds of the Commonwealth of Puerto Rico and its agencies.

We do not know exactly which bonds and how much of each the Coops hold, but the local press has reported that Coops own a substantial amount of the Public Finance Corporation bonds which the Commonwealth recently defaulted on and bonds of the Government Development Bank that are not guaranteed by the Commonwealth. These are among the weakest credits issued by Puerto Rico's government agencies.

A loss of more than 25% on the Coops' negotiable securities would reduce total assets to below the amount of total member shares and deposits. In an apparent attempt to mask this risk to Coop members, Puerto Rico's Legislature--controlled by the Governor's party--passed, and the Governor signed on December 15th, legislation that changes the accounting for the Coops' holdings to allow them to amortize a loss on defaulted Commonwealth bonds over 15 years rather than recognizing the loss immediately.

This fairly transparent attempt by the current government to fool Coop members could backfire by eroding confidence in the Coops' financial accounting. Whether COSSEC's resources available to honor deposit insurance total $200 million or $260 million, these resources would likely be inadequate in the face of a full scale run by Coop members.

A couple decades ago, Rhode Island faced a similar situation with local banks insured by a state insurance fund, which ultimately required Federal intervention. This situation could provide another challenge to the argument by the current government that all it needs is a change in bankruptcy laws to manage the fiscal crisis by itself.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long bonds of the Commonwealth and various agencies