Puerto Rico's debt is becoming overwhelming to service. A restructuring appears to be inevitable and this will spell disaster for Mom and Pop investors who own the Commonwealth's bonds.
There are pervasive fears across the municipal bond market that a wide array of Puerto Rico bonds could be restructured in the coming weeks and months. In other words, Puerto Rico is facing widely acknowledged cash flow problems and a financial crisis. It will restructure its current debt levels by renegotiating its distressed debts so it can improve its ability to sell more bonds.
Once Puerto Rico has restructured its debt, the owners of the bonds will likely see their value plummet.
As regular readers of this blog well know, the broad economic backdrop for Puerto Rico is grim and this hurts its bonds. Residents are leaving the island in droves, with Bloomberg reporting a 7% decline in residency since 2005. Principal and interest payments alone consume 15% of the budget.
"Puerto Rico and its agencies are staggering under $73 billion of debt, which would rank the territory third among U.S. states," reported Bloomberg's Michelle Kaske. "The island needs to meet revenue targets and get its economy to grow to enable it to provide services to its 3.5 million residents and also repay investors, said Municipal Market Analytics, Inc.'s Bob Donahue.
"The challenges that are coming down the pike here are greater than they've ever been," said Donahue, managing director of the research firm. There's concern that the commonwealth has to pay short-term bills "at the same time as public-safety responsibilities must be met."
Furthermore, Puerto Rico's Government Development Bank, or GDB, is running out of money, according to a recent Reuters report. The GDB, which finances Puerto Rico's official functions, said last week that liquidity fell to $1.09 billion as of the end of December, compared with $1.55 billion a month earlier.
Another bit of awful news, PREPA, the electric power authority, is working on a plan to restructure $8.6 billion of liabilities this year, a move which would be the "largest restructuring ever in the $3.6 trillion municipal market," according to Bloomberg.
A noted analyst on Puerto Rico at Janney Montgomery Scott, starkly stated that "growing debt and a contracting economy (in Puerto Rico) is an unsustainable condition. It seems very unlikely that PREPA will be the last case of restructuring for Puerto Rico issuers."
Apparently, Puerto Rico's only hope is to raise as much as $2.9 billion in a bond sale this quarter, which would be backed by increasing the petroleum tax revenue. According to Moody's, "residents and business pay about twice as much as mainland consumers for power" so the petroleum tax is not likely to be well received.
So much for the falling oil "tax cut" which mainland U.S. consumers are currently enjoying.
Investment fraud attorneys are already representing a multitude of investors who have suffered large losses in holding UBS closed end funds compromised of Puerto Rico bonds. Any restructuring would likely cause these investments to plummet even further in value.
Puerto Rico is a territory, and therefore, cannot file for bankruptcy. That means restructuring appears to be its only possible solution. The new bond offering would pay as high as 9.5% interest, which is a clear reflection of the enormous risk of these "junk bonds" being peddled to investors. This compares with a return of 0.14 % for a benchmark of one-year municipal bonds.
Investors should be aware of these risks and examine their portfolios to see if they hold any Puerto Rico related debt. If you own a municipal bond mutual fund, for example, call your financial advisor right away to check that it has zero or minimal levels of Puerto Rico bonds. When the restructuring hits, you do not want to be caught on the wrong side of this trade.
Zamansky LLC are securities and investment fraud attorneys representing investors in federal and state litigation against financial institutions. For more information about Zamansky LLC, please visit http://www.ubspuertoricofunds.com/.
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. The author has no business relationship with any company whose stock is mentioned in this article.