October 4, 2018 Read More →

IEEFA op-ed: Conflicted consultants prove costly for Puerto Rico

Millions of dollars squandered on rejected restructuring plans, and a $1.1 billion loss on risky interest rate bets

Overreliance on outside consultants with conflicts of interest and the failure to invest in a competent workforce have imposed huge costs on and severely weakened the Puerto Rico Electric Power Authority (PREPA) and other Puerto Rico government agencies. That’s one of many important lessons from the investigation of Puerto Rico’s debt crisis recently published by the Financial Oversight and Management Board (FOMB).

The report includes an entire chapter just on interest rate swap agreements, a complicated and high-risk investment that cost Puerto Rican government entities nearly $1.1 billion when they repeatedly bet the wrong way on interest rate movements. Instead of these investments reducing Puerto Rico’s debt, government entities, including PREPA, had to take on more debt to pay for the losses.

It was the Government Development Bank (GDB) of Puerto Rico that made these interest rate bets. The report explains that many of the GDB Board members who were required to approve the swap transactions, “were not familiar with the mechanics and risks associated with swaps. Many told us outright they could not describe how a swap worked. Instead, the GDB Board members told us they relied on the advice presented to them by the swap advisor,” an external consultant.

Calamitous results orchestrated by high-priced off-island experts.

In other words, the GDB board members effectively ceded control over their investments in these very risky financial instruments to a third-party swap advisor that earned fees for as long as the government of Puerto Rico continued to invest in the swaps, regardless of the outcome, in this case, huge losses.

The report also shows that more generally, as the financial condition of Puerto Rico deteriorated, the deals became more complex and less transparent.

This situation appears similar to PREPA’s overreliance on an outside restructuring advisor, AlixPartners, to lead PREPA’s debt restructuring negotiations with bondholders, as well as developing PREPA’s business plan and savings initiatives. This process resulted in PREPA paying $45 million in fees to AlixPartners for a debt restructuring deal that was ultimately rejected by the Financial Oversight and Management Board for Puerto Rico, who judged that the deal called for PREPA to pay more debt than the economy of Puerto Rico could support.

The Puerto Rico Energy Commission found that there was not appropriate due diligence over the ongoing fees for legal counsel, financial advisors and underwriters that would have accrued had the PREPA restructuring deal moved forward.

Specifically, the commission noted that the restructuring team charged with ensuring the reasonableness of advisor fees “includes the very advisors whose fees are in question … that is not the arm’s-length relationship necessary to protect consumers from excess fees.”

PREPA also relied on an outside consultant to completely produce its long-term integrated resource plan (IRP) with a bad result. In 2015-16, PREPA paid $2.1 million to Siemens for an IRP that did not comply with Puerto Rico Energy Commission regulations and was ultimately rejected by the Commission.

This theme was also picked up last week in a New York Times exposé of McKinsey’s role as consultants to the Financial Oversight and Management Board. McKinsey has received over $50 million in fees from the Board and is in charge of putting together financial projections for the island that will inform decisions on how much debt the Puerto Rico government must repay. McKinsey, the New York Times article revealed, also holds Puerto Rican bonds.

WE DO NOT TAKE ISSUE WITH THE USE OF THIRD-PARTY CONSULTANTS PER SE, BUT RATHER WITH THE FACT that in many of the above examples, core operational functions and decision-making of Puerto Rico agencies, including PREPA, have been handed over to consultants. When no staff or employee of the Puerto Rico government has control over a $72 billion bond portfolio, the results can only be calamitous for the government. Too often, consultants have been found to have conflicts of interest and there are many unanswered questions about how they were selected. In the debt swap and PREPA restructuring deals, the consultants clearly did not act in the public interest. 

This overreliance on consultants goes hand-in-hand with a failure to invest in the technical capacity and expertise of government staff. As noted by the Kobre & Kim report prepared for the FOMB, PREPA has suffered over the years from a high degree of political interference, including the appointment of hundreds of political appointees to managerial and technical positions without regard for qualifications. This has weakened the managerial competence of the agency.

However, instead of recognizing this reality and implementing labor reforms designed to dramatically reduce the influence of political appointees within the agency, the Financial Oversight and Management Board has sought an across-the-board salary freeze and benefit cuts. Although the Board recognizes that PREPA has lost 30% of its workforce since 2012 and has severe shortages of skilled workers in key areas, it has developed no plan for workforce training and development.

This would seem to force PREPA to continue to depend on consultants, rather than its own expertise. Little else will be gotten right so long as this remains wrong.

Tom Sanzillo is IEEFA’s director of finance.  He can be reached at tsanzillo@yahoo.com. This column first appeared today in The Bond Buyer.


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