Dear PGM Capital Blog readers,
In this weekend's blog edition we want to discuss with you the debt situation of our neighbour island Puerto Rico.
Puerto Rico, an American territory, risks a Greek-style bust. With US$72 billion of debt outstanding, which accordance with CIA world Factbook. is 93% of its GDP.
It is more indebted than any of America’s 50 states. (Puerto Rico is not technically a state, but its bonds are treated as if it were.) Yields on its bonds have soared as high as 10%, as investors fret it may be heading for a default.
On June 29th, Puerto Rico's governor, Alejandro García Padilla is warning that the island can't pay its $72 billion public debt, delivering another jolt to the recession-gripped US territory.
Puerto Rico governer Alejandro García Padilla
Governor Alejandro García Padilla is hoping to defer debt payments while negotiating with creditors
On June 30th, 2015, Standard & Poor's Ratings Services lowered its credit rating on Puerto Rico to 'CCC-minus' from 'CCC-plus', hours after Governor Alejandro Garcia Padilla said the U.S. territory needed a period of bankruptcy to restructure its debt.
A default, distressed exchange, or redemption of Puerto Rico's debt within the next six months seems inevitable, S&P said in a statement. It put a negative outlook on the rating.
In a statement S&P said:
"We believe the (Puerto Rico) commonwealth's very weak liquidity and difficulty in obtaining external market access for cash flow financing raises the likelihood of a debt restructuring within the next six months,"
Fitch downgraded Puerto Rico's debt ratings to 'CC' from 'B' with a rating watch negative, saying a default of some kind appeared probable.
Moody's Investor Service said its ratings on Puerto Rico's debt range from 'Caa2-negative' to 'Ca-negative' and are consistent with a high probability of default.
Puerto Rican municipalities and public utilities were for years allowed to issue “triple tax-free” obligations – meaning that lenders’ earnings were exempt from local, state, and federal taxation.
This made Puerto Rican debt an attractive option for investors, whose eagerness to benefit from the tax exemption helped Puerto Rico cover a substantial budget deficit.
But slow economic growth has made it impossible for Puerto Rico to continue servicing its debts while providing basic services to its citizens.
The Island’s governor, Alejandro Garcia Padilla, warned in an interview with The New York Times on June 28.
"The debt is not payable"
"There is no other option. I would love to have an easier option. This is not politics, this is math."
After months of staggering under its US$72 billion debt load, the island is expected to miss a bond payment due Saturday, August 1st, which - despite what some government officials have claimed - means the island is probably heading for default, setting the stage for what could be one of the largest U.S. municipal debt restructuring.
Puerto Rico's government said Friday, July 31st, it would not make a US$58 million bond payment due over the weekend.
The Puerto Rican governor's chief of staff,Victor Suarez, said in an interview on Friday:
"We don't have the money"
He added that the government still hopes to renegotiate its debts with creditors.
A payment due over a weekend can be made by the end of business on Monday. A missed payment would be considered a default by investors.
The bonds are issued by Puerto Rico's Public Finance Corp., which has sold $1 billion of debt.
PGM CAPITAL COMMENTS:
Like Greece, Puerto Rico is a chronically uncompetitive place locked in a currency union with a richer, more productive neighbour.
The island’s economy is also dominated by a vast, inefficient near-Athenian public sector. And, as with Greece, there are fears that a chaotic default could precipitate a far bigger crisis by driving away investors, and pushing up borrowing costs in America’s near US$4 trillion market for state and local bonds.
Below table shows the comparison of Greece and Puerto Rico's debt site by site.
Puerto Rico's governor recently confirmed that he had considered having his government seek permission from the US Congress to declare bankruptcy amid a nearly decade-long economic slump. His administration is pushing for the right for Puerto Rico's public agencies to file for bankruptcy under Chapter 9. Neither the agencies nor the island's government can file for bankruptcy under current US rules.
Puerto Rico's public agencies owe a large portion of the debt, with the power company alone owing some US$9 billion.
García has taken several measures to help generate more government revenue, including signing legislation raising the sales tax to 11.5% and creating a 4% tax on professional services.
Lawmakers in Washington appear to be getting increasingly anxious about the situation in Puerto Rico, which is poised to default on some US$72 billion in debt the island territory has acquired over the past several years. A key concern is the impact such a default could have on U.S. bond markets.
In a letter to Treasury Secretary Jack Lew on Friday, Senate Finance Committee Chairman Orrin Hatch (R-UT) asked the administration about its plans for dealing with the island’s finances, including its opinion on a move being pushed in Congress to allow Puerto Rico’s municipalities and public utilities to file for Chapter 9 bankruptcy.
To make a long story short, we can conclude that, Puerto Rico’s debts have become unsustainable.
As Greece has taught us, slashing government spending and services in order to pay off debt has a way of further beating down growth. The worse the economy gets, the more Puerto Ricans will likely leave the island, which will mean fewer tax revenues and even weaker potential for growth. Governor García Padilla has called it a potential "death spiral."
After reading this blog and governor, Alejandro Garcia Padilla, statement that Puerto Rico's debt is not payable, the island got a new nickname:
The Greece of the Caribbean.
Last but not least it is worth mentioning that, Puerto Rico's failure to pay on debt would be the USA's highest profile since Detroit, which defaulted on US$1.45 billion of insured pension bonds before filing for bankruptcy in 2013.
Until next week.