Puerto Rico stumbles on tax collections
Puerto Rico’s April tax collections suffered a big collapse. The projections were missed by 27 percent, or $442 million. The data was released last Friday. The April shortfall, caused mostly by reduced corporate income taxes, imperils year-end budget figures. It also jeopardizes the recently proposed fiscal year 2015 budget that was proposed by Puerto Rico Governor Alejandro García Padilla.
If tax collections continue to taper, either substantial additional taxes must be levied or cuts larger than the anticipated $1.5 billion will need to be made for the 2015 budget to be balanced. Bondholders have been promised that the 2015 budget will be balanced and that it will not rely on debt borrowing to fill budget shortfalls. April’s tax collections, if not made up in May and June, will make this promise hard to keep.
According to Morningstar, 67 percent of U.S. municipal bond funds (as of March 31) have exposure to Puerto Rico general obligation and agency debt. The gross market value holdings of Puerto Rico bonds held by 486 U.S. municipal bond funds increased to $12.69 billion as of March 31, from $12.51 billion on December 31.
Overall, the number of securities held by municipal funds likely decreased as the market value of Puerto Rico bonds increased an average of 7 percent, according to the S&P Municipal Bond Puerto Rico Index.
While mutual funds have been reducing or maintaining their exposure to Puerto Rico debt, 12 Oppenheimer municipal bond funds and one Eaton Vance bond fund have increased their holdings. These funds held $2.69 billion of Puerto Rico bonds as of December 31, which increased to $3 billion as of March 31, 2014:
It is unclear where new demand for Puerto Rico bonds will come from to support these prices. Banks and insurance firms are unlikely to own junk-rated Puerto Rico debt (tax supported COFINA bonds currently remain investment grade) due to regulatory constraints. Some large brokerage houses are requiring their sales representatives and customers to sign waiver documents before buying Puerto Rico bonds, just as they would with any junk-rated debt.
The local Puerto Rico retail investment market was decimated by the implosion of UBS mutual funds, which are currently the subject of FINRA arbitration.
Hedge fund holdings are not publicly available. Yields on Puerto Rico general obligation debt are trading higher than most countries except for Ukraine, Venezuela and Argentina. The yield curve remains inverted as of May 7, according to Thomson Reuters Municipal Market Data:
The less-than expected tax revenues is devastating for Puerto Rico. Now a fear that massive tax increases from last year will slow the economy may be realized as corporate tax revenues fall. The near term outlook for Puerto Rico is getting dark.