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A Puerto Rican default: Its effect on the municipal bond market

Part 5
A Puerto Rican default: Its effect on the municipal bond market (Part 5 of 9)

The Puerto Rican downgrade: What doesn’t meet the eye?

While Puerto Rico’s mounting fiscal deficit is the main cause of the ratings downgrade of its $70 billion public debt, the current state of the island is characterized by high unemployment, rising cost of living, pervasive crime, crumbling schools, and an exodus of professionals to Texas and Florida in search of better jobs (or just jobs, for that matter).

Puerto Rico’s Public Bonds Capital StructureEnlarge Graph

At a time when Puerto Rico stands on the verge of defaulting on its obligation, investors in the Puerto Rican debt can ask for nothing more but more transparency and realistic tax revenue projections from the government. As the current law makers in the territory talk about improving the fiscal deficit situation of the island by raising taxes and rebalancing pensions, the net effect of such tax increases, especially the corporate tax, should be calculated and viewed more judicially.

Unemployment

With the government fiscal budget of $10 billion a year for a territory like Puerto Rico with a population of 3.6 million people, one would expect the place to have a single digit unemployment rate.

However, for the last seven years, Puerto Rico has been in recession 95% of the time, and has consistently had its unemployment rate ranging from 13% to 16%, during that period.

The U.S. government is still providing funding to the island in the name of a social program, to the tune of $6.2 billion a year. This, of course, is over and above the money that has been flowing from the U.S. to Puerto Rico as debt. The U.S. taxpayer’s money seems to have found “a route of no return” to this place.

Water Issue

While the U.S.’s water utilities industry average for water loss is close to 12%, Puerto Rico stands tall at a 60%. With a territory, crumbling under rising costs, and lost jobs, over 60% of water is lost through thefts or leakages. Consequently, to make up for the loss, bills have tripled from $50 to $150 a month over the last six years, adding to the common man’s woes. The delinquency rates have shot up to 25% already.

The decline or recovery of a municipality is directly reflected in the performance of funds that are invested into it. The iShares National AMT-Free Muni Bond ETF (MUB) tracks the performance of the investment grade segment of the U.S. municipal bond market through its underlying index. One may also want to compare the performance of municipal funds vis-à-vis corporate bond funds like the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), which tracks the performance of 600 highly liquid investment grade corporate bonds, including General Electric (GE), Verizon Communications (VZ), and Apple (AAPL).

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