Puerto Rico’s bond rally and economic contraction

By Cate Long
February 25, 2014

Reuters and others have reported on the recent rally in Puerto Rico bonds.

The S&P Municipal Bond Puerto Rico Index is up 4.94 percent so far this year, with most of that increase happening in February. That same index fell more than 20 percent in 2013, when net outflows in Puerto Rico-oriented funds totaled $20.2 billion, or 28 percent of $83.4 billion in assets under management, according to Lipper data.

The primary spur for the February rally in Puerto Rico bonds was the investor call held by the Government Development Bank on February 18. The GDB had held its previous investor call on October 15, 2013 and it hadn’t issued any financial information in the  four months between calls. Investors were starved for information aside from the monthly Economic Activity Index data issued by the GDB.

Looking back over my previous writing, another big movement in Puerto Rico bond prices caught my attention. This was the violent 40 percent spread widening of Puerto Rico general obligation bonds that happened between August 28 and September 3 last year:

The late August spike in yields dwarfs the recent rally. Was there an unknown credit event for Puerto Rico in late August? Actually that is when Puerto Rico did a massive amount of borrowing, mostly away from the public markets (only the August 29 highway deal was done as a public offering).

 

In the three-week period after the Puerto Rico borrowed at least $1.34 billion, the commonwealth’s spreads blew out 40 percent. I assume that some investors that were privy to those deals had up-to-date financials. Since it’s difficult to short bonds in muniland, I assume that investors either dumped their current holdings to invest in the new offerings or didn’t like what they saw on Puerto Rico’s financial statements and sold their holdings to reduce exposure. The price moves of late August to early September dwarf the recent February rally in size.

Two new pieces of data for Puerto Rico point to continued economic contraction. Sincomillas.com reports that the asset base of Puerto Rico banks continues to shrink:

[Puerto Rico] bank assets declined 5.3 percent between 2012 and 2013, a drop of $3.5 billion in 12 months, according to the Office of the Commissioner of Financial Institutions (FICO). The assets have not grown since 2008. Total assets of commercial banks decreased from $66.8 billion in 2012 to $63.3 billion in 2013.

Sincomillas.com also reported that the firm Technical Studies, Inc. wrote in a quarterly publication that Puerto Rico would suffer three years of economic contraction through 2016.  This varies substantially from the government’s economic projections and is important for estimating tax revenues for upcoming years.

Political opposition is growing against the waiver of sovereign immunity in the $3 billion general obligation bond offering. Former GDB president and head of economic development Ramon Cantero Frau wrote an OpEd urging the governor not to sign legislation that would authorize the immunity waive. Cantero Frau writes:

Already outraged, the core problem is that a year from now, we will be worse because the debt will be higher. And then what do we do? With all due respect to Alberto Bacus, I can only say that I do not share your optimism about the economy. Why? Because the ideas presented about the situation and the economic development of the country do not offset the accelerating deterioration of the economy. The massive cuts that have to happen to balance the budget logically have an impact on economic actors and economic decline will become more acute.

Having gained $1.400 billion in taxes in early 2013, when we compare the revenues of January 2014 to January 2013, we see that down by $1 million. Without fear, I dare to bet that this trend will continue. The negative impact of these taxes on the economy has not yet fully manifested.

So the question arises: How and what do we pay the debt that will mature next year?

Off the record I’m hearing that the Puerto Rico Senate still lacks the votes to approve the House Bill granting the sovereign waiver. Stay tuned.

5 comments

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They are smart not to waive their immunity. Repudiation must remain on the table as a policy option.

Posted by nixonfan | Report as abusive

Not sure what the poor PR has done to you, Cate, since you are so much into digging for negatives about it. There must be some personal history here. But frankly, I do not care, and neither should other investors. Complain all you want, while we are making profits: the bond price index is +6.78% YTD.

Posted by CraigL | Report as abusive