There is no substitute for sweating the details.
The administration now proposes to refinance the government’s Matching Fund debt thereby lowering the cost of that debt and directing those savings to other essential purpose spending.
On its face, this is a good and recommended course of action.
Thanks to President Donald Trump’s ineptitude in addressing the pandemic the U.S. economy is once again in recession and the cost of money (interest rates) at unprecedented low levels. The Federal Reserve Bank has effectively lowered short-term borrowing costs for banks to zero, is ensuring there are ample funds available to financial institutions for borrowing and by extension allowing even entities with very poor credit to attract investor financing.
This unusual financing environment will not be short-lived. The economy will struggle for several years to generate the same level of employment that existed pre-pandemic, and, until we are clearly beyond this recessionary situation, interest rates will remain at these levels.
Refinancing outstanding debt, whether governmental, business or household, therefore, makes sense in this unprecedented interest rate environment and requires serious evaluation, consideration and timely implementation.
Deciding a debt refinancing should be done, however, does not make for a good refinancing. The devil, as is in most situations, is in the details.
Despite low-interest rates, investors are no more eager to invest in poor or no credit borrowers than they were when the economy was more robust. In fact, there may be a greater hesitancy to do so now. Lower interest rates make less financially viable borrowers look better than they really are. At some point, however, the economy recovers, and interest rates increase. The borrower must be a financially viable entity regardless of the prevailing economic environment.
The Virgin Islands Government created its Public Finance Authority as a public corporation and autonomous governmental instrumentality to aid in the performance of its fiscal duties, to raise capital for essential public projects to support the financing needs of the government and to promote economic recovery and contribute to the stability of the territory’s economy.
This special-purpose government entity was, in large part, created because the government itself could not offer investors the required credibility the PFA could provide. Years of inattention to detail and mismanagement prior to creating the PFA translated into the government’s inability to competitively access the financial markets and obtain the funding required for essential public purposes.
This new refinancing proposal introduced by the governor now creates yet another special-purpose entity to do what the PFA can no longer do.
The very same financial concerns on the part of investors regarding the Government of the Virgin Islands that gave rise to the PFA in 1998 again dog the efficacy of the PFA today. The PFA has had limited influence in spurring the government to embrace sound financial management practices, is unable to provide credit agencies and investors timely and accurate information concerning the government’s financial operations and responsibilities and convince investors that government monies will be sufficient and available to address its financial obligations to investors.
To entice investors to finance this new entity what is proposed is offering investors additional safeguards in the form of a non-government entity that will own the Matching Fund revenues of the Government of the Virgin Islands.
First, the Government of the Virgin Islands will no longer own its Matching Funds revenues. By statute, once sold to the new corporation it is no longer an asset of the Virgin Islands Government until such time as the last borrowing incurred by the new corporation that pledges the Matching Fund revenues to repay the debt is repaid. Second, the new corporate institution will renounce the right to ever seek bankruptcy protection.
The effect of these two features is to insulate investors from any restructuring of the financial operations of the Virgin Islands Government (i.e., think Puerto Rico) that might occur over the life span of the new bonds that might otherwise seek to use the Matching Fund revenues to assist in that restructuring.
And so here we are.
An unwillingness to sweat the details and do what is necessary to be considered a financially responsible borrower now requires consideration of yet another organizational structure and legal framework to allow the V.I. government to borrow monies from investors.
And, what do we achieve for doing this?
The supporting information publicly available explains that the new debt cost will save $85 million per year for three years. What repayment terms will exist, what is the anticipated interest rate on the new bonds, what are the transaction charges for this new financing, what projections underlie the future availability of Matching Fund revenues and what amounts will be available for other uses and not required by the new bond financing, all require an explanation.
What is available as information is there will be less Matching Fund dollars for other uses each year after the initial three years, and by the nineteenth and twentieth years there are negligible Matching Fund dollars available once the debt obligation is paid.
Clearly refunding high-cost debt is a prudent and responsible thing to do in this interest rate environment. Savings from a refinancing should ideally exist not just in the initial years but each succeeding years the new debt is outstanding.
Further financing terms should be more advantageous to the borrower than those which existed at the time the original debt was incurred. In the years between when the old debt was incurred and when it is refunded, there was time to address investor concerns and become a more financially responsible and attractive borrower.
What we see here, however, is that credit concerns surrounding the V.I. government and its PFA are now more onerous and there is less willingness on the part of investors to lend to the PFA.
So, it begs the question. At what stage do we say enough and address the underlying problems associated with the Government of the Virgin Islands credit rather than proposing yet another workaround that comes with a higher cost of implementation, more commitment of Matching Fund revenues to meet repayment obligations over the life of the debt and additional operating restrictions?
This requires sweating the details.
It isn’t as if a solution to this problem does not exist. We need only do what countless other governments, businesses and households do when they are required to improve their financial credit … implement and maintain sound financial practices.
For the Virgin Islands Government, these should include providing government agencies and personnel technical assistance and training that allows the managing of financial operations consistent with the level of responsibility entrusted, ensure there are accurate and timely quarterly and annual financial reports produced, require training across the entire government management structure on the importance of implementing and maintaining best financial management practices, and ensure investors and capital market participants are regularly briefed on ongoing practices, challenges and accomplishments relevant to the economic and financial well-being of the territory.
Making the change will require time. It will be operationally and politically challenging, but we cannot be above embracing the challenge.
The payoff is an end to kicking the proverbial can down the road and opting for a workaround that achieves, only in part, what is in the best interest of the community.
Editor’s note: Justin Moorhead is managing director of Virgin Islands Capital Resources Inc. His articles can be read at www.underthemarkets.com.