A Ramble on PR

Bruce Krasting's picture

 

To me, the big, big, big Macro economic factor is population growth (or the lack of it). Coupled with population growth is the rate of aging within the population. I don't care what the Fed and all the other CB's do to push back on the deflationary consequences of demographics. Those forces of will trump the CB's efforts, it's just a matter of when.

Japan is the poster child for this issue. Zero immigration and a declining indigenous population will overwhelm Abenomics. Europe has the same problem, it's about 10 years behind Japan.

And then there is the USA - we are about 20 years behind Japan. The forces of an aging population are already being felt. In March, Social Security paid out a record $70B. It took three years for SS to go from $60B to $70B a month. In about 18 months we will hit $80B, in March of 2022 the nut will be $120B.

 

I've been having deep thoughts on population because I've been watching Puerto Rico and its bond market. PR did a mega bond deal ($3.5B) a few weeks back . Before the issue was floated I wrote about it (Link) and suggested that the deal would be a big success - (the price of the bonds would rally post issue). And that's exactly what happened. In a matter of days the bonds rose 7%, bringing a paper gain of $200+m for the fat cat hedge funds that cornered the deal.

Then someone hit the 'sell button' (PR hired some restructuring lawyers and everyone freaked out). There has not been a solid bid for weeks. This dog is now trading at 87.50 - plunging below the the issue price of 93 - the yield is pushing 9.5%. There is no real exit for the holders of these bonds. There is no new money chasing after the high yield as the bonds can't be sold to retail investors. So the current holders of this swill are also the future owners. In between, it's just passing the trash.

If I was stuck with these bonds I would be worried. This bond issue looks like the Facebook IPO - investors loved it in the first hour, and then hated it for a year. If things get sloppy, and some hedgies are forced to vote with their feet (AKA-Vomit) where might this bond trade? How about 12%?

Finish this circle with PR's population status. This slide looks at the data from 2000 - 2010:

Screen Shot 2014-04-15 at 9.48.59 AM 1

Total population for the island was down 100K (dispora of 1.2m - 30%!). Since 2010 the population has declined by an additional 110k.

 

census#2

 

PR is also aging rapidly. The natural demographics are exaggerated by the fact that PR's young go to NYC for employment.

The CIA (link) has the Median age for Puerto Rico at 39. Japan is at the extreme at 46. But the median age in the USA is only 37.6 years, younger than PR. France's Median age is 41, not far from PR. The median age in Mexico=27, Columbia=29, Panama=28. Pretty much anyway you look at it, PR is old.

So, if you believe as I do, that population is the horse, and everything else is the cart, then don't buy PR bonds just yet. And if you're the fixed income guy at a hedge fund that is stuffed to the gills with this problem deal, well there's always the next job...

My concern is that some guys do get forced to sell, and the bonds go bid-less for awhile. I'm not worried about the hedge funds, but if there's blood in the $3.5B special deal, then it's going to leak into the $70B PR Muni market. That $70B is largely held by retail. A bust up in PR munis would be a mini-crisis that would require Treasury to get involved. (Treasury's is already worried: WSJ Link). So there is plenty of headline risk in this story. (Question: Did the lawyers who dreamed up the retail exclusion in the PR deal really believe it would work? Do they not understand markets?)

On 3/9 I opined that the $3.5B deal would buy PR a year or so of market peace. I believed that the bond deal created enough cash to payoff maturing debt and fund the government (I was not alone in that bit of wisdom). It appears that I was absolutely dead wrong on that. This is looking more like a here-and-now problem. I think a lot of folks are surprised by that.

 

 

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