Trials and Tribulations in Puerto Rico
Much has been said about Puerto Rican debt. The commonwealth has attracted investors from all U.S. states, as the income from their bonds is tax free at the federal, state and local levels. However, as some have peeled the onion back further, they are mired with the reality that the commonwealth has a tax supported debt load in excess of $53 billion, has been in a recession for the better part of six years and is yet to cure its ailing budget deficits. While the worst may yet be ahead, the administration of Governor Alejandro Garcia Padilla has made many difficult decisions which could help put Puerto Rico’s finances on a better path moving forward.
As a whole, Puerto Rico bonds have declined by approximately 20% year-to-date. Beyond the broader increase in interest rates over the past seven months, many factors have contributed to the price declines; some with merit, some arguably without. In the past fiscal year, the commonwealth spent approximately $10 billion, and ran a $2.2 billion budget deficit. On a year-over-year basis, the Puerto Rico Economic Activity Index has declined by 5%. Depending on the actuarial rate used, some have estimated that the commonwealth’s pensions are underfunded by as much as $35 billion. Pundits have taken these economic realities and have created sensational headlines which have contributed to somewhat of a panic among investors; much like Meredith Whitney did less than three years ago. Some investors have been learning their state specific municipal bond funds are wrought with Puerto Rico debt, exacerbating the panic. All combined, sellers have exceeded buyers, and prices have fallen.
The administration’s efforts to right the ship have been significant. Pension reform has been a key component, as worker contributions have been increased, the retirement age has been raised, and they are transitioning from a defined benefit to a defined contribution system. Revenue is likely to increase through modifications to the tax code, and through increases in corporate, petroleum and excise taxes. A critical factor to the long term success of the commonwealth will be to stimulate the economy. Pharmaceutical manufacturing has been a growing sector of the economy, and they are working to incentivize manufacturers to expand into generics and medical devices. Tourism has been among the largest economic drivers, but is inherently volatile, thus they are looking to expand airplane access, and promote niche markets such as ecology, culture, and culinary arts. All said, the administration is projecting an $800 million deficit for the upcoming fiscal year, with revenues currently lagging forecasts by a modest 0.4%.
January will be a telling time for Puerto Rico debt. The commonwealth is scheduled to sell between $500 million and $1.2 billion of their sales and use tax supported bonds (COFINA), depending on market conditions. The COFINA bonds are among the higher credit quality of the Puerto Rico issues, though carry a negative outlook. A ratings downgrade could exacerbate the negativity of the existing situation. Investors in Puerto Rico debt should be mindful that further price declines are quite possible. Likewise, some market experts are predicting a restructuring of Puerto Rico debt which could result in realized losses for investors. Despite the concerns and warnings, some market participants feel the prices have fallen too far too fast, and present a compelling investment for speculative investors. Most importantly, it is critical for investors to understand the security behind their specific issue, and to have the essential information to assess if the risk is in line with their tolerance levels.
This report is prepared for informational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument or service. Market prices and other data may be obtained from outside sources and is not warranted as to completeness or accuracy. Any comments, statements and/or recommendations made herein are subject to change without notice, and may not necessarily reflect those of Alamo Capital. Past performance does not guarantee future results. Alamo Capital has no affiliation with any political party. Investing involves risk. Consult with a Financial Professional for additional information to determine the suitability of this or any other financial product or issue as it relates to your particular situation.