Puerto Rico Municipal Bonds – How Bad are They?March 26th, 2012 by David Waring
If Puerto Rico was an official state of the United States, Puerto Rico would rank 51st (dead last) when comparing the size of their debt to their Gross Domestic Product. It would be the only state rated below A by the three major credit rating agencies.
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There is still enormous demand for the debt of Puerto Rico however, for four reasons:
- With yields hovering around 4% for 10 year maturity dates, the yield is high compared to other states, which offer around 2%.
- Income from Puerto Rican Bonds is triple tax free regardless of what state you reside. While a New Yorker might have to pay state and city income taxes on a municipal bond issued in Texas, they do not on Puerto Rican debt. This feature greatly increases the tax-equivalent yield of Puerto Rican bonds.
- The constitution of Puerto Rico requires that debt holders be paid before any other expenditures. In theory, bondholders get precedence over paying government workers and pensioners. I don’t think this has every been tested in practice.
- There is a notion that the Federal government would step in to make payments, if the the government of Puerto Rico could not. However, when major municipal governments faced loan defaults in the past like the City of New York, no federal aid was forthcoming.
There have been a number of great articles written recently which dive deeper into the numbers which I have included links to at the bottom of this article. I would also like to highlight 3 facts that I think deserve particular attention from investors.
- Puerto Rico is running a budget deficit (the difference between revenues and expenditures) of around $1.5 billion dollars per year. The government disputes this number. They argue the number is closer to $600 Million, once you take out one time items like refinancing maturing debt.
- Puerto Rico has amassed about $50 billion in debt and forward obligations (pension liabilities) which is over 100% of the state’s Gross National Product (GNP). This is over 5 times the amount of most states. If every dollar of state government revenue went to repaying debt, and the state did have any expenses, it would take over 8 years to repay the debt, and that doesn’t even include interest costs.
- The economy of Puerto Rico is stagnant. They are not on path to eliminate the budget deficit which will continue to add to their debt burdon.
Puerto Rico is completely dependent on the continued willingness of investors to lend it more and more money every year. At some point, the appetite of investors will turn away from their bonds, which become increasingly more risky every year as their debt load increases. Until then, investors will enjoy after tax yields that are over twice as much as other Municipal bonds.
Relevant Articles on Puerto Rico’s Finances:
While slightly dated, the following infographic for Credit Loan gives a great sense of the relative debt burdens of states (not including PR) based on debt to GDP. Puerto Rico’s Debt to GDP is the neighborhood of 67%.