Puerto Rico’s debt overload
If you own bonds issued by the Commonwealth of Puerto Rico or one of its public entities, you need to read the latest report from Alan Schankel of Janney Montgomery Scott. An old-line broker in Philadelphia, Schankel has published the best overview of Puerto Rico debt that I have seen. And the future for most of this debt does not look too bright as Puerto Rico’s economy is barely crawling along.
There is nothing shocking in Schankel’s broad overview:
With outstanding debt in the range of $60 billion, Puerto Rico is one of the more prolific issuers of tax exempt municipal bonds. The fact that interest on island debt is exempt from all state and local income taxes generates particularly strong investor demand for bonds of the Commonwealth’s various issuers.
About half of the debt is general obligation or otherwise tax backed, while most of the remainder is secured by revenues, including electricity sales, water and sewer utility charges and highway tolls, with all bonds to varying degrees dependent on the fortunes and stability of the island’s economy. Puerto Rico’s status as a territory adds unique considerations to credit evaluation.
Here are Schankel’s money quotes:
Current general obligation credit spreads, with yields about 200 basis points above AAA benchmarks, do not reflect bondholder risk.
Translation: An investor is not getting paid enough interest to cover the risk of owning these bonds. Prices need to come down, and yields need to go up.
Investors are cautioned to limit portfolio exposure to Puerto Rico bonds, with 10% concentration a recommended ceiling for risk tolerant investors, and much lower levels appropriate for most.
Translation: It’s unwise to put many of your fixed-income eggs in the Puerto Rico basket.
Elevated debt levels and severely underfunded pension liabilities are a challenge to the achievement of fiscal stability in Puerto Rico.
The Puerto Rico pension fund for general employees was funded at 6.3 percent in 2011. Basically it’s almost out of money for its 113,000 retirees. There could be a huge backlash if retirees’ payments stop and bondholders are paid instead of them.
The pace of debt growth exceeds that of economic growth, an unsustainable proposition.
Translation: This is a death spiral. It’s like increasing the charges on your credit card faster than your income increases.
The stagnant island economy has been in recession for over six years, only recently recovering to neutral territory. Future growth prospects are marginal.
Translation: There’s lots of happy talk about the Puerto Rico economy, but practically no traction for growth.
I have one quibble with Schankel and the broader market in how they view Puerto Rico’s debt and pension liability load. This data is always presented as debt per capita, but I think it’s more realistic to examine debt per worker, since ultimately the debt must be repaid with revenues generated by the state. Debt/pension liability per capita is $13,449, but per worker, the debt/pension liability figure is about $90,000. This is more than triple the average 2010 wage of $26,870. How are the citizens of Puerto Rico ever going to pay back all this debt?
Retail investors and municipal bond mutual funds across America own most of Puerto Rico’s debt. Schankel’s report is the best road map out there to look more deeply into the risks.
Reuters: Puerto Rico asks Moody’s to revisit ratings cut
McClatchy: Puerto Rico governor urges federal help in drug war
Chart from Municipal Market Advisors tweet of June 22, 2012