Puerto Rico Is a Financial Disaster

Puerto Rico has recently been the unfortunate target of Hurricane Maria, and over 80% are still without power. This strong hurricane is only the latest blow in what has been a steady slog into economic oblivion for the island.  Puerto Rico’s bonds, which had been in moderate free-fall, have now taken a steep dive lower with their general obligation debt now trading at only 35% of where they were initially issued and where they traded just half a dozen years ago.

In 2013 I first wrote about Puerto Rico’s extremely risky municipal bonds and suggested that investors avoid them. In 2015, I published another commentary with the same message. The territory’s economic fundamentals flashed a red warning sign then and the situation has only worsened.

The population in Puerto Rico has been declining since the early 2000s, and that population decline has only accelerated in recent years. More worrisome is that the population decline is concentrated among those that are younger and better educated and can therefore more easily move to the US mainland. Thus, the residual population is less able to contribute financially to the growing economic burden and the existing $70B+ in debt is spread over fewer people with even less financial strength. With the recent destruction from Maria, the population decline is likely to accelerate further as many leave to avoid the challenging conditions that are likely to persist for months, if not years. This drain will continue to pull those from the territory that it most needs to retain.

Employment in Puerto Rico will also weaken further in the aftermath of the Maria. This is challenging for a territory where the unemployment rate is already more than double the rate of the US national average and almost double the level of every state except Alaska.

Despite the weakness in most parts of the Puerto Rican economy over the past few years, Puerto Rico could still count on a healthy and growing level of tourism which accounted for nearly 7% of the island’s GNP. However, with the destruction from the hurricane, the country no longer has this desperately needed area of strength. The tourist infrastructure may be restored within the next year, but the likely shortfall in visits during the rebuilding phase will pressure the territory’s limited financial resources further.

More concerning longer term, over a quarter of the island is employed by the government, the very body whose balance sheet is now in trouble—and will likely worsen as the government seeks to aid the utilities and other quasi-government entities with stretched balance sheets. In comparison, on the US mainland only about 15% of those employed work for the state or federal government.

The owners of the municipal bonds of Puerto Rico have finally been forced to come to the realization that these bonds are not likely to rebound, if they even survive. Many have held out hope that the bonds would not be permitted to default, a notion that is no longer widely held.

Puerto Rico is now in economic freefall, and with nothing to support it in the form of a larger outside government, there is little to indicate the municipal bonds are worth considering at this time. The bonds are nothing more than the riskiest level of speculative junk and don’t warrant a position in most portfolios. We haven’t owned them in years and will continue to avoid them.

Advisors Capital Management, LLC is an investment advisor registered with the United States Securities and Exchange Commission. Registration does not imply any degree of skill or training. All investing carries risk, including the potential for the loss of principal and past performance is no guarantee of future results. This content is for informational purposes only, can change at any time without notice, and is not investment advice or a recommendation to trade any security. Indices are not available for direct investment. We only provide services in jurisdictions where we are registered. Our disclosure brochure (ADV Part 2A) and customer relationship summary (ADV Part 3) are available at https://adviserinfo.sec.gov and upon request.