Is Puerto Rico The Next Greece?

by: Daniel Irvin

Summary

Puerto Rico's fiscal condition has been compared to Greece's.

This ignores Puerto Rico's credit strengths including debt service under 15% of government revenues.

But what is most misunderstood about all governments' finances is that lack of will, not lack of means, is usually the more serious threat to bondholders.

Puerto Rico's financial condition has often been compared to Greece's. The comparison is not particularly informative and ignores important differences. For example, Greece's debt per GDP was nearly 2x Puerto Rico's at its height. Puerto Rico also has a very manageable debt repayment schedule with annual general obligation (GO) debt service limited by its constitution to less than 15% of government revenues. Viewed through this lens, defaulting on its debt seems hardly worth the distraction. Puerto Rico's constitution also provides strong protection to GO bondholders, including a prior claim on all government revenues, including tax revenues pledged to other credits. Importantly, this "clawback" provision does not apply to revenues of independent agencies such as the Puerto Rico Electric Power Authority or the Puerto Rico Aqueduct and Sewer Authority, which charge fees for service.

To be sure, investors need to understand the credits they are buying, as (for example) some credits such as the Highway bonds are effectively subordinated to the GOs. However, in the end I believe all of Puerto Rico's bonds will be repaid with interest, a view I have held since the "crisis" began (see previous articles here and here).

The revenues stream available to holders of government bonds is far more robust than most observers appreciate. Taxing power and monopolistic enterprises are extraordinarily resilient credits that can recover from extremes of mismanagement.

Despite the long term strength of government revenue streams, governments are often slow to respond to fiscal challenges, and few governments maintain the level of cash reserves, relative to the size of their operations, that a private company would. As a result, lack of near term liquidity is often more of an issue than long term insolvency. While illiquidity can be frightening to analysts at credit rating agencies and investors (particularly short term investors), the experience of investors in downgraded or even defaulted bonds of New York City, Cleveland, Bridgeport, Massachusetts, Orange County, Philadelphia, District of Columbia, California and numerous other credits demonstrates how resilient government finances can be, if the political will exists to address the challenges.

It is now historical fact that Detroit's debt was unsustainable, but is it possible that the difference between Detroit and the examples of fiscal stress listed in the previous paragraph is political will and not fiscal condition or means? When the governor of Michigan appointed a bankruptcy lawyer as Detroit's Emergency Manager, bankruptcy was inevitable. Whether Detroit's operations are reformed in a meaningful way remains to be seen. Repudiating debt certainly seems like a path of less resistance, at least for a skilled professional with significant experience with the bankruptcy process.

If a clear path to bankruptcy existed for Puerto Rico's leadership to follow, it is conceivable that this path of less resistance would be considered. There is some noise about legislators proposing such a path, but it would likely face significant legal challenges.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long bonds of the Commonwealth of Puerto Rico, Puerto Rico Aqueduct and Sewer Authority and the University of Puerto Rico.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.