Home Politics Puerto Rico Bonds: Put Your Money Elsewhere

Puerto Rico Bonds: Put Your Money Elsewhere

When you purchase through our sponsored links, we may earn a commission. By using this website you agree to our T&Cs.

Puerto Rico Bonds: Put Your Money Elsewhere

Puerto Rico is facing well-publicized financial stress. Despite a recent rally, bond prices have declined over the last year and yields have jumped. Is it time to buy Puerto Rico’s bonds? Our answer is no.

A Budget in Sight

Puerto Rico now confronts an estimated deficit of approximately $1.5 billion in its next fiscal year on a general fund budget of less than $10 billion. A big chunk of the shortfall is due to increased annual debt service payments. To solve the problem, the Commonwealth’s House and Senate just passed legislation that will increase the sales tax from 7% to 11.5% on July 1, the start of its new fiscal year, and then replace it with a value-added tax (VAT) on goods and services by April 1, 2016. The move to a VAT should improve tax-collection compliance. These tax changes, coupled with cuts in government spending, should largely address next year’s budget shortfall.

Immediate Liquidity Needs

Despite having raised more than $3 billion last year by selling bonds, Puerto Rico is running out of money quickly and has stated it may need to implement” a moratorium on the payment of debt service or debt adjustment.” With a budget in sight, and many investors willing to extend Puerto Rico credit, albeit at high rates, we expect their current liquidity crisis to be averted. But their financial and economic struggles will continue.

Economy in Recession

Puerto Rico has many strengths: an educated workforce, an established legal system, and financial support from the US in the form of Social Security, Medicare and Medicaid. But its economy has been in recession since 2006, when US tax breaks for US companies located in Puerto Rico expired. Manufacturing still represents half of the Puerto Rico economy, but the sector is in decline.

Nearly a quarter of those employed in the Commonwealth work for the government—another sector that will likely shrink as spending is cut to help balance the budget. And while the small tourism industry is growing, at just 8% of the economy, it can’t grow quickly enough to offset the economic decline in other areas, at least not in the short-to-intermediate term.

Puerto Rico’s unemployment rate is 12% and almost half of the population is living below the poverty line. So it’s not surprising that Puerto Rico’s citizens are looking for better opportunities elsewhere—the population has declined an average of 0.8% per year over the last decade. A shrinking population limits potential economic growth and increases the debt burden per person.

Financial Problems Ahead

Raising taxes, cutting spending and adding expensive new debt to its balance sheet are Puerto Rico’s only options to avoid default in the short run. But these actions will bring disaster over the longer term unless the Commonwealth finds a way to jump-start its economy.

Unfortunately, we don’t see any engine of growth; what we do see are its growing financial commitments to health-care, pensions and debt service. In fact, when a one-time federal appropriation for health-care expenses is exhausted in fiscal year 2018, our projection of Puerto Rico’s budget deficit quickly exceeds the level of its debt service for all forms of government debt by fiscal year 2019. Thus, recovery rates for bondholders are likely to be lower than current prices suggest, and the loss in price could be greater, in our view, than the coupon income earned over the period.

Avoid at Current Prices

Could the federal government provide more money to help Puerto Rico balance its budget and pay its debts? Yes, but it’s not likely. Rather, the US Congress is considering a bill that would allow Puerto Rico’s government agencies to file for municipal bankruptcy.

For all the above reasons, we absolutely do not believe Puerto Rico debt belongs in investment grade portfolios. And we expect prices to begin to decline again. At significantly lower prices, the expected returns of the Commonwealth’s debt would turn positive, in our estimation. And, at that time, Puerto Rico bonds could be a buy for high-yield investors.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

Puerto Rico Bonds
Puerto Rico Bonds

Our Editorial Standards

At ValueWalk, we’re committed to providing accurate, research-backed information. Our editors go above and beyond to ensure our content is trustworthy and transparent.

Alliance Bernstein

Want Financial Guidance Sent Straight to You?

  • Pop your email in the box, and you'll receive bi-weekly emails from ValueWalk.
  • We never send spam — only the latest financial news and guides to help you take charge of your financial future.