MuniLand: Rocky Horror Puerto Rico Show

Puerto Rico’s economy is flagging. Its unemployment rate remains in the low double digits. Its population is falling. Its government debt is growing. And now, no one will lend it money. Last Monday, Puerto Rico’s governor, in a televised address, acknowledged that its debts could not be paid and that a moratorium on debt payments will be needed while structural reforms are implemented to grow its economy and reduce its structurally imbalanced budget. News reports have been fluid since Governor Alejandro Garcia Padilla’s speech, so let’s review what is known.

  • Former International Monetary Fund analysts published a report titled “A Way Forward,” laying out a case for debt restructuring and economic reforms. Puerto Rico’s governor referenced the report frequently in his speech.
  • The PR Legislature passed a fiscal year 2016 budget with very little appropriation for non-general obligation debt, decreased its operating budget by 3% and increased the sales tax to 11.5% (up 7.5%).
  • There was much trepidation about whether June 30th and July 1st debt payments would be made. Surprisingly, the payments were made on time.
  • Internal Government disclosures point to September as the date that may be the start of bond defaults.
  • All of the NRSROs lowered their rating on PR general government and financing authority debt to the low “C” rating category. 
  • The public municipal insurance companies MBIA and AMBAC’s equity prices traded down about 35% and 30%, respectively.

What is SNWAM doing, and do our clients have exposure to PR?

  • Yes, our clients do have exposure to a specific type of PR debt, and we are actively adding to our position as the bonds become available.
  • The PR debt we own supports affordable housing units in the territory, but does not have direct exposure to PR’s balance sheet. The backing for the bonds comes from the U.S. Department of Housing and Urban Development (HUD). HUD provides grant support for a national affordable housing program across all states and territories. The structure of the bonds is important because PR does not report the HUD grants on its B/S or income statement. 
  • In fact, the PR HUD bonds are so unique in structure that the debt payments are sent directly from the HUD to the bond trustee (US Bank) and then on to the bondholder. These bonds are implicitly backed by the U.S. Treasury (since the HUD is a US Agency), but earn the 3x (Federal, State and Local) tax-exemption status. Furthermore, the debt payments do not touch PR operations, so there is no risk of the funds being transferred or impacted by any potential PR budgetary shenanigans.

Sources: Bloomberg News, Caribbean Business News, Fidelity, Barclays, Citi and SNWAM Research