Could a Puerto Rico Default Hammer the $3.7 Trillion US Muni-Bond Market in 2014?

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1/03/2014 @ 12:29PM |31,369 views

Could a Puerto Rico Default Hammer the $3.7 Trillion US Muni-Bond Market in 2014?

A democracy will continue to exist up until the time that voters discover they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy, which is always followed by a dictatorship.

Alexis de Tocqueville 1835

As we head into 2014, you may be asking why we are concerned about a small island located in the Caribbean Sea, about a thousand miles southeast of Miami. Geographically, it is a mere speck on the map… practically irrelevant. In fact, 70 islands the size of Puerto Rico could fit comfortably into the state of Texas. However, the debt burden currently burying this economy may eventually send nasty tremors into the United States’ municipal bond market.

Surprisingly, of all the US muni bond funds, a staggering 75% of them are lending money to Puerto Rico, leaving millions of US investors and a large portion of US brokerage accounts exposed to this beleaguered little island. We suspect Puerto Rico will become America’s Greece. If swans could fly this far south, they would without question, be the color of night.

2014 Tail Risk

Texas’s state government debt is relatively modest, near $40 billion, or $1,577 per resident.  Puerto Rico’s public debt of $53 billion is nearly $15,000 per person, but when we add inter-governmental debt the mountain rises to $70 billion, or $17,500 per person.  Throw in a violently under-funded pension and healthcare obligations, the noose approaches $160 billion. That’s $46,000 per person, enough to make one think about trying a swim for Miami.

Quantitative Easing: Deadly Side Effects

Puerto Rico, a mere rectangle 100 miles long by 35 miles wide, the smallest and most eastern island of the Greater Antilles, is the 3rd largest municipal bond issuer after California and New York. That is a mind-blowing statistic. But Puerto Rican bonds are free from all State, Federal and local taxes, a very attractive investment for US investors with a thirst for yield.  This is one side effect of low interest rates and quantitative easing coming out of the Federal Reserve; American investors have become this island’s great enabler from the north.  Similar to 2007, when investors were reaching for yield in toxic subprime mortgage CDOs, today this song is playing again.  This time in Spanish.  A colossal reach for yield has enabled politicians in Puerto Rico to run up a dangerous bill, and the music is about to stop.

States with the Most Public Debt vs their Size of Population

California $99B vs 38 million people

New York $62B vs 19 million people

Puerto Rico $52B vs 3.6 million people

Credit Contagion; Toxic Side Effects

A default in Puerto Rico would re-price the entire $3.7 trillion US Municipal bond market, costing states and counties across America billions in additional interest rate charges. Once investor confidence is lost, it’s like losing personal trust, and becomes almost impossible to get back.  So far Puerto Rico’s $52 billion pile of bonds were off 20 points in 2013, already costing US investors nearly $10 billion.

An unsustainable, systemic risk debt bomb has been formed.  If there was a picture of moral hazard in the dictionary, Puerto Rico’s image would be right there next to Fannie and Freddie, the US government sponsored entities that already received a $180 billion bailout from taxpayers.
The Great Enabler
Why is Greece being forced by the heavy hand of the market to get its financial house in order, while Puerto Rico continues to walk down this reckless road to fiscal destruction?  There’s only one reason. The US Congress is their great enabler. In Europe, Germany, as well as the bond market, has had enough with Greece living beyond their means.

Lehman Like Financial Transparency

Politicians can only promise so many goodies as they try to get elected, but in the end somebody has to pay the bill. Why would you lend money to any person, organization or country that doesn’t provide timely information of their finances?  There’s less transparency on Puerto Rico’s true financial health than there was coming out of Lehman Brothers in 2008.  As someone who wrote the New York Times bestseller on Lehman’s demise, I’m here to tell you, Puerto Rico’s accounting smells to high heaven. Audited financials for the fiscal year ending June 2012 only became available to investors a year and a half late, finally arriving in September 2013. Five years after Lehman, this is outrageous.

One would think a government that spends $10 billion a year on 3.6 million people in such a small place would have low, single digit unemployment figures. Think again.  For the last 7 years, 95% of the time Puerto Rico has been in recession.  This petri dish of American Socialism is consistently producing 13% – 15% unemployment. With all this «stimulus,» as President Obama likes to call it, the latest jobless figures for October came in at 14.7%, up from August’s 13.9%.  How these horrible statistics are allowed to march on is the question no one in Washington is prepared to answer.  On top of all the debt, the US taxpayer is sending Puerto Rico $6.2 billion a year in social program funding and has very little to show for it.

300% Water Inflation

It’s hard to believe, over 60% of the Commonwealth’s water is lost through theft or leaks, staring down at the US’s 12% industry average among water utilities. Bills have tripled from $50 a month to $150 over the last 6 years, there’s a growing 25% delinquency rate.   In jeopardy on the rise, this cash flow is the life blood traveling to the US in interest for municipal bond investors.

Stopped Looking for Work?

Entitlements and transfer payments from Uncle Sam make up some 40% of total Puerto Rican personal income, with 27% of the citizens on food stamps.  Recently, much has been made about the US’s labor force participation rate in free fall at 63%, down from nearly 68% in 2007.   It’s a day at the beach in Puerto Rico, with a appalling rate of 41%, many people simply prefer not to work.  With a welfare state this big, why even try?

A recent Manpower Employer Outlook Survey reports Puerto Rico’s employers on average do not plan to increase hiring during the first quarter of 2014.  By contrast, a net of 16% of US States plan to expand payrolls.  The country’s main economic activity index has been in decline for 11 years in a row. In 2013, it is down 5.4% – a whopping 25% off 2005 levels.

Ironically, consumer spending has increased 5% to 6% a year through 7 years of recession.  Similar to Greece, 30-40% of the Puerto Rican economy is underground, making tax collection the biggest challenge. Puerto Rico’s fiscal deficit was $2.2 billion in the year ending in June, just a slight miss compared to the $300 million projection the government shared with investors last year.  If a publicly owned corporation had these kinds of consistent earnings misses, management would be thrown out of the office, probably to face a firing squad!

Investors need transparency and realistic tax revenue projections from bond issuers.  In Puerto Rico, Detroit and Greece, investors have been taken to the cleaners, with promises nobody can keep, but merely hyperbole to sell the next pile of debt to bond buyers in search of income and to keep the dream alive.

The new deficit forecast for the year ending June 2014 is $850 million. Puerto Rico’s government is losing credibility by the day.

Deficit

2014 $850 Mln (Est)

2013 $2.2 Bln

2012 $1.7 Bln

2011 $2 bln

2010 $3 bln

2009 $3.2 bln

Rising Tensions between Washington and San Juan

In June of 2013, there were $300 million US Medicaid funds to be paid to the citizens of Puerto Rico, but for the first time the payment was delayed.  Why?  The Puerto Rican Government, with one hand in Uncle Sam’s pocket, changed their nationally sponsored insurance carrier without getting approval from the US Health and Human Services Department.  We’re told the US Treasury is investigating, which caused the delayed the payment.

Buyers Strike

Puerto Rico has lost access to the US capital markets, which is a fancy way of saying most investors have stopped buying the country’s bonds.  Now the government is heavily relying on regional bank financing.  New private and bank financing in the 5-10 year range is running up at 9%, similar to Greece in 2010, levels which will prove to be unsustainable.

As the government is leaning on the regional banks for financing, the FDIC is creating a possible black hole for themselves, which so far has them on the hook for another $2-3 billion.  We’re told in recent weeks they have a SWAT team in San Juan, searching under the hoods of these banks.

As with all distressed situations, we’re keeping an eye on near term debt maturities.  Puerto Rico has $507 million of bonds coming due in the next 3 months, and another $700 million that needs to be repaid by June 2014.

The Government Development Bank (GDB) recently repaid Barclays $400 million it had borrowed on a short-term basis when the GDB «planned» to go back to the capital markets.  It has to pay another bank another $400 million in December, and another debt of $300 million early in 2014.  Even with expected revenues, the payments and others will very much narrow the GDB’s liquidity, according to an official.

Cyprus Replay?

In a client recent note, my colleague Robbert van Batenberg of Newedge made an interesting observation.  «The Puerto Rican banks are also sensitive to the island’s tenuous fiscal situation. Popular Bank (BPOB) for example has $1.4bl of exposure to the government, of a total loan book of $30bl and First BanCorp (FBP) and OFG Bancorp (OFG) have both about $990ml of total exposure over an $11bl loan and a $6.8bl loan book respectively.»

Puerto Rico’s deficit is $890 million annually, and needs to be brought down to $250 million in order for the Commonwealth to regain access to the municipal bond market.  Just like Greece and Portugal, they are shut off, and trust has been broken.

A Fatal Blow

Ultimately, the fatal blow will likely come from the commonwealth’s colossal underfunded pension obligation.  At $36 billion, according to Moody’s, is 235% of the tax revenues.   This leaves Puerto Rico with an embarrassing 11.2% funding ratio, the worst of all US municipalities.  Similar to Fannie and Freddie in 2008, how this situation has been able to go on for so long lies in the dirty hands of politics. For further political risk market updates on these matters, go tolawrencegmcdonald.com.

Puerto Rico’s Public Bonds

Capital Structure

AA- / AA3 Cofina (Sales Tax Backed) $15.3 Bln

BBB / Baa3 Highway and Transportation $4.7 Bln

BBB / Baa3 Electric Power Authority $9.2 Bln

BBB-/Baa3 General Obligation $10.8 Bln

BB+ / BA1 Aqueduct and Sewer $4.7 Bln

Bloomberg Data

Greece Like Forbearance is Likely in the Cards

The likely outcome will be Greece like forbearance agreement forced on bond holders.  In other words, with the approval of Uncle Sam, Puerto Rico lowers the coupon on their debt load to say 3% and extends maturities out to 2030 through 2050.  It’s a technical default because when this is put into practice, bond prices drop like a stone.  Greece bonds which traded at 100 in 2008, touched 18 cents on the dollar in 2011.  The pain for investors could be severe without another bailout from US taxpayers.  It’s simple math.  Mathematics is not Republican nor Democrat it’s the lurking sword which has no friends, especially in Greece. A 9% interest rate on $70 billion of debt is over $6 billion a year of interest expense for a country with a $10 billion annual budget.  Even at 4.5% that’s $3 billion of interest costs, or 30% of the budget without even entertaining the thought of Pension and Healthcare obligations.

Soak the Rich

The territory needs to dramatically cut spending and unrealistic promises, but their solution of choice has been tax hikes in order to close these fiscal gaps. Last year, it raised the top marginal rate from 30% to 39%. The next victim is likely to be the corporate tax rate for multinational companies, which have been lured into Puerto Rico due to its favorable corporate tax rate.  Some say raising taxes here is killing the goose that laid the golden egg.

Corporate tax rates going from 4% to 6% will generate an additional $1 billion or 13% more in tax revenues. Some of the multinationals with significant assets in Puerto Rico are Johnson & Johnson (JNJ), Abbott (ABT) and Medtronic (MDT).

On average, these companies were able to reduce their tax rate by 150bp through their presence in Puerto Rico.  The corporate tax elasticity in reaction to another hike in the rate is the key to Puerto Rico’s survival.  Many US companies have spent millions building an infrastructure on the island, but might be inclined to move if the hikes are too harsh.

Demographic Dead Zones

In the 1990s there were 240,000 Puerto Rican citizens were living in Florida, today that number is over 1 million.  In 2000, the commonwealth’s population was 3.8 million, thirteen years later that number in 3.6 million.  Nothing like rising taxes and an out of control welfare state to drive people to the exits, deja vu Detroit.  The Hispanic population of Puerto Rican origin in the US 50 states and D.C. increased from 3.4 million in 2000 to nearly 5 million in 2013.  It now surpasses Puerto Rico’s total population by 30%.  Nearly a third of Puerto Rican Hispanics now living in mainland US were born in Puerto Rico, according an analysis of by the Pew Hispanic Center.

Nearly 200 Years Later, these Words Endure

The frustration among the taxpayers has nearly reached a 15 year high, so Puerto Rico must tread carefully in these simmering waters. If they press too hard, could Puerto Rico be on the precipice of destruction the French historian, Alexis de Tocqueville, first wrote about nearly two hundred years ago. To quote him accurately, «the American Republic will endure until the day Congress discovers that it can bribe the public with the public’s money.» Surely, Puerto Rico is much farther along this road than the United States of America. Let’s just hope the possible contagion from this Caribbean chaos stays well clear of American shores.  The delicate US bond market, is in no shape for this shock.

Special thanks to the writing talents of James Robinson and the team at McDonald Advisory for their assistance in this post.

http://www.forbes.com/sites/larrymcdonald/2014/01/03/puerto-rico-default-to-re-price-the-3-7-trillion-municipal-bond-market-in-2014/print/

http://www.theprovince.com/business/Puerto+Rico+investigate+nearly+awarded+government+bonuses/9347671/story.html

Puerto Rico to investigate nearly $34M awarded in government bonuses
By The Associated Press

January 3, 2014 2:02 PM

SAN JUAN, Puerto Rico – The president of Puerto Rico’s Senate is requesting that legislators investigate why the state-owned power company recently awarded nearly $34 million in bonuses amid an economic crisis.

Eduardo Bhatia said Friday that he regrets public funds were used for what he called unjustified bonuses.

The push for an investigation comes as the government prepares to overhaul the power company amid corruption allegations and complaints that bills are on average more than twice that of the U.S. mainland.

Puerto Rico depends on oil to generate nearly 70 per cent of its power.

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Bhatia ordena investigar la AEE

Por bonos de Navidad concedidos a los empleados

Por ELNUEVODIA.COM

Según información que trascendió hoy, los empleados de la AEE cobraron cerca de $34 millones de bonos en Navidad. (Archivo)

El presidente del Senado, Eduardo A. Bhatia, ordenó al presidente de Comisión de Asuntos Energéticos y de Agua, Ramón Luis Nieves, que investigue las bonificaciones que concedió la Autoridad de Energía Eléctrica (AEE) durante el 2013 a sus empleados.

“Las bonificaciones y salarios excesivos no se justifican en una realidad económica como la nuestra. Mucho menos se justifican dentro de una corporación que ha sido incapaz de reducir el costo de energía eléctrica y que mantiene como rehén al consumidor puertorriqueño. La austeridad que estamos haciendo como país nos incluye a todos. La Autoridad no es una excepción al sacrificio colectivo”, expresó Bhatia en declaraciones escritas.

Según información que trascendió hoy, los empleados de la AEE cobraron cerca de $34 millones de bonos en Navidad. De esa cifra, los unionados de la Unión de Trabajadores de la Industria Eléctrica y Riego (UTIER) recibieron $17 millones por concepto de bonos.

“Le he solicitado al senador Ramón Luis Nieves, quien preside la comisión senatorial de Asuntos Energéticos y de Agua a que inicie una investigación y cite a la Autoridad para que ésta rinda cuentas sobre las razones o justificaciones para emitir esa cantidad de dinero en bonos”, sostuvo Bhatia.

“Es increíble y hasta inmoral que una suma significativa del dinero de los consumidores se utilice para pagar bonos, mientras el costo de luz sigue siendo un obstáculo para todas las familias puertorriqueñas y para los comerciantes del país. Una vez más, el monopolio del estado tiene que terminar ya y los consumidores tienen que poder decidir sobre su inversión”, agregó.

Por otra parte, Bhatia recordó que el plan de Alivio Energético, que incluye diez medidas legislativas de su autoría y que presentó  en noviembre pasado, será evaluado en vistas públicas durante las próximas semanas de enero.

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 LA según The Economist

Caerá el PIB del ELA según The Economist

Por Carlos Antonio Otero, EL VOCERO

Puerto Rico quedó por debajo de Venezuela como los países que mayor caída registrarán en su PIB este año.

A nivel global, Puerto Rico se proyecta como uno de los tres países con el peor retroceso en su Producto Interno Bruto (PIB) para este año 2014, en comparación con el año previo, según muestra una gráfica de The Economist Intelligence Unit, en la publicación The Economist.

En su edición de hoy sábado, en una tabla comparativa sobre los datos más relevantes del PIB a nivel global, The Economist colocó a la Isla en la tercera peor posición, solamente precedida por Libia y Cyprus.

Puerto Rico quedó por debajo de Venezuela como los países que mayor caída registrarán en su PIB este año. La quinta posición la ocupa Eslovenia y le sigue Barbados. Aun Grecia, como espejo del colapso económico de un país, está en la séptima posición, lo cual ubica a Puerto Rico en un escalón menos privilegiado.

Por el contrario, los países que comparativamente mejores avances proyectarán en su PIB este 2014, incluyen a Mongolia, Macau y Sierra Leona.

El PIB se refiere a la producción total de riquezas de un país en bienes y servicios.

Mientras, el Producto Nacional Bruto (PNB), representa el valor en el mercado de la producción económica originada por los residentes del País.

 

Puerto Rico, al entrar en el octavo año de recesión, continúa sin registrar avances significativos en su economía y la información publicada por The Economist se presenta en consonancia con los más recientes indicadores económicos de la Isla, con números a la baja de -5.7% en el Índice de Actividad Económica, y con la proyección –también hacia abajo- que en noviembre pasado realizó la Junta de Planificación (JP) sobre la economía local.

La JP proyectó una reducción de -0.8% en el PNB real para 2014, tras revisar el estimado previo de un crecimiento de 0.2%. También bajó entonces el PNB para 2013 a -0.03%.

La revisión se debió principalmente ¨al margen de incertidumbre creado por las políticas fiscales y los diferentes acontecimientos exógenos¨ y a la posposición de los proyectos de inversión para este año fiscal 2014 que culmina en junio 30, entre otros factores, según la JP. Además, dicha agencia planteó que la considerable migración hacia Estados Unidos provoca un impacto negativo en el consumo, y por ende en los recaudos de Hacienda por concepto del Impuesto de Ventas y Uso (IVU).

Para el año fiscal 2012, el PNB totalizó $69,461.6 millones a precios corrientes. Mientras, a precios constantes o reales, el valor fue $6,442.0 millones, para un aumento de 0.1 por ciento, respecto al año fiscal 2011. Según datos del Banco Gubernamental de Fomento (BGF), ¨durante los años fiscales 2010 y 2011, esta misma variable registró bajas de 3.6 y 1.6 por ciento, respectivamente¨.

http://elvocero.com/caera-el-pib-del-ela-segun-the-economist/

Retreating U.S. stimulus poses risk to world recovery

BY ROBIN EMMOTT

BRUSSELS Sat Jan 4, 2014 2:04pm EST

The facade of the U.S. Federal Reserve building is reflected on wet marble during the early morning hours in Washington, July 31, 2013.

CREDIT: REUTERS/JONATHAN ERNST

 (Reuters) – The world economy should finally overcome its hangover from the global financial crisis this year as growth picks up and house prices rise, but reduced U.S. monetary stimulus will pose a challenge.

After months of angst, investors will see how the U.S. Federal Reserve handles its decision to curtail its policy of easy money, starting from this month.

U.S. jobs data on Friday will give markets a sense of the pace at which the Fed plans to pare back its bond-buying program, while minutes on Wednesday from its December 18 meeting will throw light on the central bank’s thinking.

«The United States will be the main focus given the Fed has finally started to taper its asset purchases,» said James Knightley, a senior economist at ING in London, referring to what economists call the «tapering» of U.S. stimulus.

«Nonetheless, the Fed has made it clear that it will not be looking to run down the size of its balance sheet anytime soon, while rate hikes remain some way off,» he said.

The Fed’s stimulus revived the U.S. economy after the biggest crisis since the Great Depression and the U.S. economy is leading the global recovery. The United States could grow by up to 3 percent this year, helping the global economy to expand by almost 4 percent, according to the International Monetary Fund.

The delicate job of bringing the $85 billion-a-month program gradually to an end will almost certainly fall to Janet Yellen, whose candidacy as the next Fed chair will be voted on by the U.S. Senate on Monday.

Yellen, who would become the first woman to chair the U.S. central bank, would take the reins on February 1, the day after Ben Bernanke ends his two-term stint.

CURRENCY CONCERNS

For emerging markets – major beneficiaries of cheap money unleashed by Fed stimulus – a scaling back of the program will prompt investors to reduce their holdings of stocks andbonds. Short-term economic growth could suffer due to a failure to reform during the years of easy money.

Turkey is one country that relies on foreign capital to plug holes in its balance of payments and the country will be in focus again in the week ahead, not least because Ankara faces its greatest period of political instability in a decade.

Markets have calmed since the last week of 2013, when Prime Minister Tayyip Erdogan dismissed police officers involved in a corruption investigation that has dragged in relatives of ministers and others with close links to the government.

But a falling lira is saddling companies with higher payments on foreign loans and pushing up inflation.

Indonesia, also vulnerable in the face of reduced U.S. stimulus due to its sizeable current account deficit, has been at the centre of the sell-off in emerging currencies and will hold a central bank policy meeting with the Fed firmly in mind.

Emerging markets are becoming more of a concern for the global economy as the rich world recovers from the 2008/2009 financial crisis, while China’s slowing economy, which generates more than a third of global growth, has added to the unease.

The world’s second-largest economy releases business surveys, trade, inflation and lending figures in the week ahead.

NO CELEBRATION

Europe offers good news for a change and U.S. Treasury Secretary Jack Lew should hear some of that in a visit to Berlin, Paris and Lisbon for talks with senior officials.

The single currency area is forecast to return to growth in 2014 after two years of contraction and Greece, at the centre of the bloc’s crippling banking and debt crisis, expects its first economic expansion in six years.

Still, European Central Bank President Mario Draghi will be in no mood for celebrating when the bank’s Governing Council meets on Thursday. He faces the difficult task of supporting growth with limited tools in a region still facing record unemployment and high public and private debt levels.

The ECB is banned from buying bonds directly from governments and cannot emulate the Fed, although it can find ways to purchase bonds from banks on the secondary market.

Draghi said last week he saw «no need for immediate action» after cutting interest rates to a record low of 0.25 percent in November, and sees signs of a gradual economic recovery.

«Draghi will merely emphasize once again that the ECB is ready to act,» said Michael Schubert, an economist at Commerzbank in Frankfurt.

Before the ECB meets, euro zone inflation data on Tuesday will show how consumer prices are holding up despite deflationary risks in some of the weaker economies.

Surveys of the euro zone’s service sector are likely to show the currency bloc ended the year on a reasonably robust note, even if France’s tepid performance is a concern.

Outside the euro zone, Britain is in a different position, with growth picking up, unemployment falling and house prices rising, leading to talk of the need for a rate rise sooner rather than later to avoid a real estate bubble.

The Bank of England also holds its meeting on Thursday but no one expects a change in monetary policy this month. For the time being, the consensus remains that rates will rise from their record low of 0.5 percent in 2015.