Recently there has been much talk about the high level of Puerto Rico bond debt and the associated financial deficit for 2012. In the past, there has generally been demand for Puerto Rico Bonds because they are 1) triple tax free to investors in all 50 states, 2) they provide financial and geographic diversification and 3) they have rich yields compared to similar bonds. This last point means that the marketplace is literally suggesting that Puerto Rico Bonds have more risk as measured in cheaper prices and higher yields. For example, here is a list of the most recent trades of high yielding Puerto Rico Bonds.
We have seen 1st hand that Puerto Rico bonds have been some of the 1st to to drop in value during recent downturns with some essential service bonds loosing as much as 40% on the dollar.
To drill down deeper into this issue, we turned the really smart folks at The Center for the New Economy who did a revealing look at Puerto Rico’s deficit issues. We provide a summary below:
For purposes of this analysis we adopt the definition of structural deficit used by the rating agencies. Under that definition we estimate the Commonwealth’s deficit for fiscal year 2012 to be at least $1.449 billion. Our analysis is based on the government’s recent disclosure to its bondholders. In the Preliminary Official Statement for its recent offering of $1,500,000,000 of Commonwealth of Puerto Rico Public Improvement Refunding Bonds, Series 2012 A (General Obligation Bonds), the government of Puerto Rico makes the following disclosure:
“The deficit for fiscal year 2012 is projected to be approximately $610 million, excluding approximately $685.2 million of principal and interest payments on Commonwealth general obligation bonds that were refinanced through GDB financings (the “GDB Lines of Credit”), which financings are expected to be repaid from the proceeds of the Bonds and the Series B Bonds, and $154 million of interest payments on Commonwealth guaranteed Public Building Authority Bonds that were refinanced through GDB financings, which financings are expected to be repaid from the proceeds of the issuance of Public Building Authority Bonds. In addition, the Office of Management and Budget (“OMB”) has indicated that the sectors of health and public safety carry the risk of budget overruns for fiscal year 2012 as they are undergoing operational changes that were not considered during the preparation of the 2012 budget.”
In our view, debt service is a recurring expenditure. Therefore, the difference between general fund recurring revenues and recurring spending for fiscal year 2012 is at least $1.449 billion ($610 million + $685.2 million + $154 million) plus any budget overruns in the public health and safety sectors.
The municipal bond analysts at UBS Wealth Management Research based in New York seem to agree. In their most recent analysis of the Commonwealth’s finances (dated January 11, 2012) they estimate the Commonwealth’s structural deficit at $1.429 billion.
According to UBS’s analysts, “as UBS WMR defines a structural budget deficit as the excess of recurring expenditures over recurring revenues and views debt service as a recurring expenditure, we feel that the representation shown in Table 7 –Budget deficit (December 2011) is more appropriate from an analytical perspective.”
In sum, it appears to us that given (1) the government’s own disclosures and (2) the financial analysts’ definition and use of the term “structural deficit”, it is difficult for the administration in Puerto Rico to claim that the deficit for fiscal year 2012 is only $610 million. Intellectual honesty demands that the people in charge of our public finances be consistent, they cannot use one budget deficit figure for bondholders and another one in Puerto Rico.