Financial Times recently reported that investors in Puerto Rico’s debt, including hedge funds, met with restructuring experts in New York as the likelihood increases for a moratorium on payments for $70 billion in public sector debt and an additional $40 billion of unfunded pension liabilities. Puerto Rico’s debt service burden requires it to pay between $3.4bn and $3.8bn each year for the next four years, reported Financial Times.
“The numbers are untenable,” said one restructuring adviser, according to Financial Times. “To issue new debt the yield would have to rise and where they can’t raise new money they will have to stop paying.”
Because Puerto Rico is an unincorporated territory, not a municipality, it is ineligible for Chapter 9 bankruptcy protection, like that sought by Detroit in July 2013. Financial Times reported that just 25-50% of the total issuance of Puerto Rico debt is estimated to be insured. If Puerto Rico were to stop paying on its debt, it would impact the entire municipal bond market. At the same time, further raising taxes appears impossible given Puerto Rico’s already high per capita debt, compared to low per capita income and unemployment of approximately 14%, as reported by Financial Times.
The current quagmire stems from Congressional action taken in the mid-1970s when Puerto Rico was struggling with high unemployment and increasing oil prices, as explained by Financial Times. In an effort to bolster Puerto Rico, the US Congress granted the territory special status, which allowed American companies to expand manufacturing operations in Puerto Rico without being taxed on the profits earned there. As a result, manufacturers, including pharmaceutical giants Abbott Laboratories, Eli Lilly, Merck, Pfizer, and Johnson & Johnson, came to Puerto Rico and created jobs. The incentives driving this growth, however, were phased out by 2006. Accordingly, Puerto Rico became less competitive, and companies scaled back. At the same time, rising costs for water and electricity, coupled with the US financial crisis, drove Puerto Rico into recession, while its debt and unemployment grew.
Despite this, one bright spot remained: US municipal bonds. By virtue of its unique status as an unincorporated territory of the US, Puerto Rico bond are exempt from federal, state, and local taxes. Thus, notwithstanding its fiscal troubles, Puerto Rico attracted US investors with its “triple tax free” status. The influx of investment funds carried Puerto Rico through several years of economic troubles. Eventually, the music stopped.
“As the economy started to decline, we borrowed more,” says Antonio Sosa, a managing director at financial advisory firm REOF Capital in San Juan, reported Financial Times. “And soon, instead of borrowing to finance productive capital expenditures and investment, Puerto Rico was borrowing to fund mainly its own deficit.”
Puerto Rico’s tax free bonds have declined sharply in Fall 2013 due to concerns about the island’s sluggish economy and large debt, which led several US money managers to sell off the bonds at a loss in September. The downturn has been exacerbated by investors who purchased Puerto Rico tax free bond using margin or other loans, which forced investors to sell their holdings and lock in losses. UBS and Wells Fargo cautioned their brokers not to recommend Puerto Rico debt to clients, according to The New York Times. While yields on some Puerto Rico bonds have risen to record highs, prices remain low, and the three big credit rating agencies have cut Puerto Rico’s status to one notch above junk, signaling possible future downgrades.
If you invested in Puerto Rico debt and have experienced investment losses, please call us at 844-689-5754 or complete our “contact form.” Sonn Law Group is a nationally recognized law firm representing individuals, trusts, corporations and institutions in claims against brokerage firms, banks and insurance companies.