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.




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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cfosnock's picture

Great post, and the only reason you misjudged the timing of the problem is that you did not take into account the greed and corruption of the government. IE they will not use it to pay off debt, or fund the government, they will either steal it, or they will use it to replace stolen money. The only fault I can find with the article is that Puerto Ricans are flooding Central Florida (Orlando), not New York

John Law Lives's picture

"There is no real exit for the holders of these bonds." - Bruce Krasting

Okay, Bruce.  Unless you believe the issuer of these bond will default and the bondholders will take it on the chin, what is wrong with holding the paper and collecting interest payments until the bonds are called (assuming they are callable) or until they mature (at which time the bonds should be redeemed at par)?

Bruce Krasting's picture

John Law - What rock you living under?

Hedge funds don't buy bonds with cash and then sit back and clip coupons, that investment strategy is for widows and orphans. No juice in that!

Hedge funds use LEVERAGE, to make bond plays. To buy this bond all a hedgie had to do was put up 20%, the other 80% is borrowed via the repo market.

So if you bought this crap, and it is now 8% below issue, what is your mark to market loss?? 8/20 or 40%. The hedgies put up $700m and borrowed $2.8B for the deal. Now they are underwater by the 40% so that means $280,000,000 of imbedded losses (and margin calls). Ouch!!

The question is who pukes first, not who holds the longest.


PS: To call a bond, you gotta have the cash to call it. PR has no cash (or borrowing capacity), so forget about any call provisions.


John Law Lives's picture

"John Law - What rock you living under?" - bk

bk, no need for ad hominem here.  It is beneath the process of civil exchange.

"Hedge funds don't buy bonds with cash and then sit back and clip coupons, that investment strategy is for widows and orphans. No juice in that!" - bk

Perhaps I was not being clear enough here.  I was not specifically referring to hedge funds as holders.  Frankly, I don't particularly care much if a few hedge funds take one on the chin from time to time.  I was referring to individual investors who do elect to purchase munis as a long-term investment in their portfolios.  As far as holding bonds and clipping coupons, that investment strategy worked exceedingly well for me (i.e. I have not lost a single penny in principal EVER to a muni default in 30+ years).  Buying munis also worked out quite well for investors like... Ross Perot (for example). Since I live in Texas (no state income tax), 100% of my interest income from munis is tax free (state and federal).  Pretty nice tax-free return.  As I am neither a widow or an orphan, I would humbly suggest you rephrase your characterization of those of us who do reap steady tax-free returns from munis.


Bruce Krasting's picture

Well, you're making an argument for an individual investor who wants to clip coupons. I'm telling you that is not how this deal works. Individual investors were largely excluded from buying these bonds.

The minimum denomination is $100,000 AND the buyer must be a "Sophisticated Investor". That is a legal term established in the 33 Act. Today, a Sophisticated Investor is defined as someone with a minimum invest-able cash of $5,000,000, they must also have previously demonstrated their ability to understand complex risks. To buy these bonds you have to meet those requirements, sign a form for the SEC, and then you have to pass muster at the compliance department of one of the big Wall Street firms.

So no small players at this table.


This deal was "bought" by hedge funds (trust me). They bought it with leverage. The objective was to make a leveraged return in the 30-40% range.This was a bet, and so far it is not working out.

I'm happy you're making 4% after tax on your investments. But that has nothing to do with what this deal is about. This was a junk deal for pros. Different sandbox entirely.


A discussion of the deal and the role of the hedge funds:



John Law Lives's picture

Thanks for the additional information.  It was not abundantly clear (to me) from your original article that individuals were largely excluded from this deal.  Let the hedge funds take one on the chin if they elect to speculate in such a fashion.  I don't trade muni bonds... ever.  I buy and clip coupons... along with those widows and orphans... and Ross Perot.

"I'm happy you're making 4% after tax on your investments."

That is a tad low.  Face value of the munis in my portfolio averages closer to 4.5%, and the tax advantages are (effectively) additive to the total return of the assets.  Alas, it seems to make both of us happy.


DR's picture

Great post!

The 'new normal' is simply a reflection of the aging OECD countries. Investors who keep looking for interest rates to normalize back to the 90s/2000s heyday when the developed world was in the the sweet spot of the demographic dividend will be repeatedly disappointed.

BTW, is that a photo taken of Yellen, Lew and Obama from the latest economic meeting?

new game's picture

maybe it is worse than i thought:) a great barometer of understanding(if you are old enough) is to think as if it was twenty years ago, then think about what i just read...

the grateful unemployed's picture

don't worry as I understand it there is a buyer ready to step in through a Belgium clearing house.

NoTTD's picture

Gee, Doug Casey want me to move my business there.

Fuh Querada's picture

Peter Schiff, Alex Daley and Louis James (latter 2 from Casey Research) were lauding the fantastic tax breaks on PR and claimed they were moving there

no mention of the likely bond defaults

cfosnock's picture

No mention of a lot of negative things, I give them 3 years before "Island Living" forces them back to the mainland. It makes you wonder how much they were paid for their infomercials.

DOT's picture

Just add PR to NYC as a new borough.

Bienvenido a Nuevo York !

Milestones's picture

Bruce, loved your being there to catch their photo,s as they mask their suprise!!

Have some interesting things surrounding the Bundy ranch insidencent and some further things that are coming down here in Colorado. This is going to get much bigger in the coming weeks that are outside the Bundy ranch which is apparantly happening in N.M. and possibly Texas as I write.

If you can give me an e-mail address i'll send you what is happening right now in your home state. Like i said, we will see over the next few months this gets some legs or not. The item now is or can be quite explosive, literly not figurgitavly (sp) ( for NSA sakes)


Rainman's picture

Puerto Rico is a USA territory we " won " as war booty from the Spanish in 1898. Island residents pay no federal income tax. So why should Treasury bail out their bonds ? Give it all back to insolvent Spain.. the sooner the better. Let Draghi bail them out.

cfosnock's picture

Because the residents don't want to go back to Spain, using your logic we should give California back to Mexico. If you want them to pay taxes, just give them the right to vote, and give them representation in Congress. No taxation without representation was one of the founding principles of this county

kaiserhoff's picture

Great pic Bruce.  Thanks for fessing up on this one.

What concerned me about your original post, is that the generous terms on these bonds immediately subordinate the other 70 billion of debt and reset the valuation on those.  Has that happened?  Not many of us are bond Dudes, so we just don't follow this.

PR is old because all the young ones have moved to Orlando, and it hasn't done the place any good, to put it mildly.

edit:  Saw your statement in the next to last paragraph.  Guess we a still in the Twilight Zone.  Gawdhelpus.

Bruce Krasting's picture

These are three Executive VPs at major hedge funds. They are responsible for all fixed income investment and trading for their fund. Losses from their investment activity affect the bottom line of the fund, and also their bonus payouts. They are looking at a Bloomberg terminal and watching the price action in the $3.5B PR deal. This is the selfie that was taken when the bond cruised through 88.00 on the downside.

This is what you look like when Buy-Buy becomes Bye-Bye.

Cognitive Dissonance's picture

Welcome to the new global normal. Us old farts are clogging up the pipes. Time to float off into oblivion on a piece of ice Eskimo style?

<Bruce, I love the selfie at the end of your piece. Who are your comrades on either side?> ;)

Ms No's picture

You "old farts" desperately need to take your health into your own hands and out of this predatory slash, burn and empoverish medical system anyway.  I have been meddling with alternative medicine for 15 years and can nearly cure myself of anything now.  I figure if I can't cure it it may be my time.  If it becomes my time pain medications will be the only money they get from me ( ;  Here is just one example of things that can be done and it is just short of miraculous.  Don't scoff until you read it all at least it may save your life.  This is FOOD GRADE peroxide from your healthfood store only.



kaiserhoff's picture

HH and I agree with you.

Medical "Doctahs" do more harm than good.  Caveat emptor.

Comte d&#039;herblay's picture

Why on Kalki's green earth would you post an 85 page document???

Too many notes.  Take some out. 

Got any spare heart valves for the guy who comes down with endocarditis from filling his own teeth?

max2205's picture

...dead till Yellin is told to do the right thing