This weekly report presents insights from our Global Investment Management team.
The Commonwealth of Puerto Rico has seen its share of adversities, but perhaps none so devastating as where it finds itself today.
The island’s economy has seen negative economic growth since 2006, bankruptcy seems to be looming just around the corner, political fractures between the U.S. administration and the Puerto Rican local government have risen, and to top it off, it took the full brunt of a category 5 storm when Hurricane Maria ravaged the island. Citizens as well as the Puerto Rico governor’s director of safety and public protection described the storm and its effects as “everything collapsing simultaneously,” as reported by the Washington Post. This seems to be true for both the storm and for the near-term economic future of the island.
Moody’s Analytics estimates the hurricane-related damage caused by Maria is close to $95 billion and, after nearly a decade of decline in its financial coffers, Puerto Rico will likely need to heavily rely on U.S. government aid – and therein lies the problem. However, this wasn’t always the case. Back in 1976, the federal government granted tax incentives to corporations doing business in Puerto Rico in an attempt to further the industrialization and economic advancement of the island. However, in 1996 Congress repealed this part of the tax code after a ten year phase out period and by 2006 the commonwealth began its downward economic spiral. Without the incentive, corporations fled the island leaving a wake of unemployment. The Puerto Rican government estimated that over 100,000 individuals were employed by those corporations directly and another 200,000 indirectly employed, which was close to 23% of the total Puerto Rican workforce in 2012. Consequently, Puerto Rico suffered its first default back in 2015, and has seen its debt trade at lower and lower prices throughout the years, with its 2035 general obligation maturity now trading at 35 cents on the dollar as of today.
Currently with approximately $74 billion in municipal debt, Puerto Rico has more outstanding debt than all but three U.S. states (California, New York, and Massachusetts), according to Bloomberg. However, the island produces GDP of only $131 billion, which would rank it ahead of only 17 states, just past Nebraska and Arkansas. Many investors bought this debt due to its dual tax advantages, especially as yields were sometimes higher than their individual state rates. The people of Puerto Rico are in a dire situation in the aftermath of the hurricane damage, but budgetary conflicts between the federal government and the commonwealth along with its own debt burdens will play a major role in the overall health of the island for years to come. For now we caution investors until further clarity can be reached but more importantly pray for the livelihoods of the Puerto Rican people and hope resolution can come to them as soon as possible.
Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.
Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.
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