Puerto Rico Is Greece, & These 5 States Are Next To Go

Tyler Durden's picture

As Wilbur Ross so eloquently noted, for Puerto Rico "it's the end of the beginning... and the beginning of the end," as he explained "Puerto Rico is the US version of Greece." However, as JPMorgan explains, for some states the pain is really just beginning as Municipal bond risk will only become more important over time, as assets of some severely underfunded plans are gradually depleted.

Wilbur Ross discusses Puerto Rico's debt struggles and where it goes from here...

 

But, as JPMorgan details, Muni risk is on the rise for US states, but broad generalizations do not apply (in other words, these five states are 'screwed')...

The direct indebtedness of US states (excluding revenue bonds) is $500 billion.  However, bonds are just one part of the picture: states have another trillion in future obligations related to pension and retiree healthcare.  In the summer of 2014, we conducted a deep-dive analysis of US states, incorporating bonds, pension obligations and retiree healthcare obligations.  After reviewing over 300 Comprehensive Annual Financial Reports from different states, we pulled together an assessment of each state’s total debt service relative to its tax collections, incorporating the need to pay down underfunded pension and retiree healthcare obligations. 

While there are five states with significant challenges (Illinois, Connecticut, Hawaii, New Jersey, and Kentucky) , the majority of states have debt service-to-revenue ratios that are more manageable.

As a brief summary, we computed the ratio of debt, pension and retiree healthcare payments to state revenues.  The blue bars show what states are currently paying.  The orange bars show this ratio assuming that states pay what they owe on a full-accrual basis, assuming a 30-year term for amortizing unfunded pension and retiree healthcare obligations, and assuming a 6% return on pension plan assets.  States below the green bar are spending less than 15% of total revenues on debt, which seems manageable from an economic and political perspective.  When this ratio rises above 15%, harder discussions in the state legislature about difficult choices begin.  

 

 

It would take a long time for underfunded pension plans (e.g., 60% funded) to run out of cash, given the long duration of plan liabilities.  But as investors learned in Puerto Rico and Greece, bond markets can drift along unconcerned with mounting fundamental problems, only to experience a rapid repricing at times that cannot be predicted.  As a reminder, this analysis applies to states and not to city, county and other in-state issuers.