How Much Debt Can Puerto Rico Support?

We have heard a lot of news about Puerto Rico's mounting debt but we have not heard much about a sustainable repayment plan. We know Puerto Rico needs restructuring of debt, a bailout, or a combination of both. We know how much debt the island has but how much can it support? 

Step 1: What are sustainable debt levels for US states and territories on average?

The average state spends 5% of its annual revenue on total debt payments and interest to bond holders.

Step 2: What are sustainable debt levels for US states with similar profiles to Puerto Rico?

Hawaii has the most similar debt profile to Puerto Rico at 13% of annual revenue allocated to total debt payments. Puerto Rico is sitting at an unsustainable 36% of revenue going towards debt and interest payments.

Step 3: What is sustainable for Puerto Rico?

Using Hawaii as a benchmark and settling on 15% of annual revenue as a model, Puerto Rico can support 1.7B USD in debt and interest payments per year. Looking at a 30 year horizon and discounting at 5%, at a 1.7 B USD debt service for year, Puerto Rico can sustain a present value debt level of 26.7B USD instead of the current 49B USD of debt. 

This is the formula used to forecast how much debt burden Puerto Rico can support. The next step is to come up with a proposal considering these calculations. 

Ocean Park, San Juan (February 2015)

Puerto Rican Proposal

The Island has made a definitive offer to its creditors: lower debt payments by exchanging debt and separate bond issue based on future growth to make up the difference. This would help reduce approximately 50B of the 70B in debt to 25B. This would leave 50B total on the table. It represents a 30% reduction in overal debt which is a commendable start.

The strategy is brilliant. It is a reverse bailout in the form of debt forgiveness. Adding the sweetener of the bond issue based on future payouts almost forces the hand and gives parties an excuse to let the island off the hook. Well played. 

On the other hand, they are now indebted in the future should the economy grow. They are giving a disincentive for the economy to grow. Parties will argue the payout is proportional to growing and won't hinder it, but that is not realistic. 

There is also the chance that the Federal government will bail them out. In this case the Island might be playing their hand too early. Or maybe the proposal to restructure debt is gesture that can lead to a supplemental, and more reasonable bailout. 

Perhaps, this model of future growth dependent bond issue can serve as a case study for future municipalities.

La Cueva Ventana - Arecibo (October 2014)