With Puerto Rico missing a payment on a bond overnight "due to non-appropriation of funds" but denying that this constitutes anything close to a default, the territory may be about to retake the limelight as Greece is now "fixed." As MarketWatch reports,
The missed payment could have serious implications for holders of Puerto Rico bonds, “as the signal from breaking a seven-decade streak of bond payments may imply more defaults are looming,” Daniel Hanson, an analyst at Height Securities, said in a note.
Not all Puerto Rican bonds are created equal, being backed by different types of revenues, such as tax revenues, road tolls, electricity bills etc.
The first thing investors should do is “find out what revenue backs their bonds and whether their bonds are insured or not,” said Mary Talbutt, head of fixed income at Bryn Mawr Trust.
Approximately 30% of muni mutual funds have holdings in Puerto Rico, more than half of which are insured, according to a Charles Schwab Investment Management report. As for the revenue that backs the bonds, most exposure is with the sales-tax backed bonds, known as COFINA bonds from their Spanish-language acronym, and the general-obligation bonds, known as G.O. bonds, according to the report.
In that sense, investors that hold the PFC bonds are somewhat in a bind because “the language in PFC bonds makes payment dependent on appropriations from Puerto Rico’s legislature,” Hanson said.
This is the main difference between the PFC bonds and the G.O. bonds. The former require appropriation, while the latter are backed by the full faith and credit of the territory and their repayment is guaranteed by the constitution.
“The language... makes [the PFC bonds] a weaker credit relative to G.O. bonds. But a default is still a default,” said Andrew Gadlin, a research analyst at Odeon Capital Group.
This has investors worried about other types of bonds that face a repayment deadline, most notably those issued by the island’s Government Development Bank (GDB).
“The market is becoming more skeptical of the payments due August 1 on GDB debt, though the budget does set aside funds for paying these obligations,” Gadlin said.
And as Euro Pacific Capital's Peter Schiff explains, this is far from over
- Exempted the Island's government debt from all U.S. taxes in the Jones-Shaforth Act.
- Eliminated U.S. tax breaks for private sector investment with the expiration of section 936 of the U.S. Internal Revenue Code.
- Required the nation to abide by a restrictive trade arrangement.
- Made the Island subject to the U.S. minimum wage.
- Enabled Puerto Rico to offer generous welfare benefits relative to income.
Puerto Rico’s economy and population have been shrinking for almost a decade, and debts have ballooned to about 100 per cent of its gross national product as the government took advantage of the tax exemption enjoyed by US municipal debt.The Puerto Rico Electric Power Authority is already restructuring $9bn of bonds and loans.By September 1 Puerto Rico is expected to deliver a plan for turning round its finances. Officials have called for patience from creditors about how its various bondholders will be treated.
Puerto Rico must be allowed to declare bankruptcy, the Federal incentive for the Puerto Rican government to borrow money must be eliminated, Puerto Rico must be exempted from both the Jones Act and the Federal Minimum wage, and Federal welfare requirements must be reduced. Puerto Rico already has the huge advantages of being exempt from both the Federal Income Tax and Obamacare, so with a fresh start, free from oppressive debt and federal regulations, capitalism could quickly restore the prosperity socialism destroyed.With the current incentives provided by Acts 20 and 22 (which basically exempt Puerto Rico-sourced income for new arrivals from local as well as federal income tax - see my report on America's Tax Free Zone) and with some additional local free market labor reforms, in a generation it's possible that Puerto Ricans could enjoy higher per capita incomes than citizens of any U.S. state.