Monday, March 3, 2014
Friday, February 14, 2014
Puerto Rico Perspective From Alpine Fund Management
By Steven Shachat, Alpine Funds
In recent weeks, Puerto Rico’s economic and financial challenges have been discussed extensively in media headlines. The negative articles have created heightened awareness of the challenges facing some Puerto Rico issuers and this has contributed to Puerto Rico bond prices declining to historically low levels as investors consider the possibility of default.
Historically, Puerto Rico has had considerable economic and financial challenges. These challenges were intensified by the expiration of certain federal tax benefits for manufacturers in 2006 and the global recession in 2008/09, which hit the island harder than the mainland. As a result, the territory has been in recession for several years and has issued debt to fund its operating deficits over the last half-decade through COFINA sales tax issuances. Moody’s provides a general obligation rating of Baa3 to the Commonwealth and in October, Moody’s downgraded Puerto Rican senior sales tax bonds from Aa3 to A2 which, while downgrades, are still investment grade ratings.
Puerto Rico bond prices appear to have gained some stability in mid-October after an investor conference call hosted by the Commonwealth’s Governor and senior administration officials. Puerto Rico officials discussed favorable Commonwealth Q1 2014 financial performance, highlighting slightly better than budgeted revenues and expenditures as well as enumerating additional fiscal and economic measures the Commonwealth is implementing.
Based on information provided from the Puerto Rican government, we recap key initiatives that the Puerto Rican government presented that they believe will drive improvement in Puerto Rico's fiscal standing—and in the prospects for its municipal debt.
Puerto Rico’s financial position:
Since fiscal 2009, the Commonwealth’s general fund financial position has demonstrated some improvement. Puerto Rico’s budget gap has been steadily reduced from a $2.9 billion deficit in 2009 to $1.3 billion by the end of the prior Governor’s tenure in FY2013. The budgetary reductions were derived largely through cutting government payrolls by 40,000 employees during that period. New Initiatives
Since January 2013, recently elected Governor Padilla has implemented several initiatives that seek to improve the financial position of the Commonwealth and its agencies. Alpine has been closely following these credit milestones. The Governor’s FY2014 budget, which began on July 1, 2013, projects an $820 million operating deficit, reducing the prior year’s deficit by half. As indicated earlier, unaudited Q1 2014 financial results indicate the Commonwealth is slightly (favorably) ahead of revenue and expenditure budget targets.
Shortly after taking office, Governor Padilla reformed the Commonwealth’s largest pension fund, increasing the retirement age and reducing certain benefits. He has also committed his administration to reform the smaller Teacher’s Retirement System by December 2013. These measures are designed to reduce fixed costs to future general fund budgets. Additionally, the Governor has raised taxes and certain fees by $1.3 billion in FY2014, in an effort to increase recurring revenues by 10% of the budget.
Commonwealth officials have also increased water and sewer authority (PRASA) rates by over 60% (about $20 per household), which are projected to generate over $300 million of new revenues making the utility self-supporting and potentially eliminating the need for Commonwealth annual subsidies. The current administration also expects the fiscal 2015 budget to further reduce the budget deficit to below $400 million and expects to provide a balanced budget by fiscal 2016.
During the balance of the fiscal year, the willingness of Puerto Rico officials to correct any material FY 2014 budgetary overages on the expenditure side or revenue shortfalls will be key to it maintaining its general obligation investment grade ratings and moving toward fiscal stability.
None of Puerto Rico’s securities are in default and the Commonwealth has not expressed any desire to default on any of its obligations. Furthermore, the Commonwealth has demonstrated a very strong willingness to pay its debt obligations in a timely manner. Puerto Rico’s continued fiscal discipline and the implementation of a long-term economic plan to grow the island economy will be critical to the long-term success of the Commonwealth. Going forward we believe there will continue to be volatility in both directions as the fiscal situation in Puerto Rico continues to evolve.
|The views expressed are as of the date specified and are subject to change based on changes in market, economic and other conditions. These opinions are not intended to be a forecast of future events, a guarantee of future results, or legal, tax or investment advice. All data referenced are from sources believed to be reliable but cannot be guaranteed. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. Forecasts and model results are inherently limited and should not be relied upon as indicators of future performance. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional.|
The value of investments in debt securities will fluctuate in response to market movements. When interest rates rise, the prices of debt securities are likely to decline, and when interest rates fall, the prices of debt securities tend to rise. A portion of the income derived from a municipal bond may be subject to the alternative minimum tax. Any capital gains realized may be subject to taxation. Federal, state, and local taxes may apply. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Investments in Puerto Rico and other U.S. territories, commonwealths, and possessions may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems. No investing strategy can overcome all market volatility or guarantee future results.
Investment Grade: Securities rated AAA to BBB are considered to be investment grade. A bond is considered investment grade if its credit rating is BBB- or higher by Standard & Poor's or Baa3 by Moody's. Ratings based on corporate bond model. The higher the rating, the more likely the bond is to pay back at par/$100 cents on the dollar. AAA is considered the highest quality and the lowest degree of risk. They are considered to be extremely stable and dependable.
Monday, February 3, 2014
After one month and one day of trading in 2014 each of the major stock market indexes are lower by more than 5%. Here are a few noteworthy comments about the bond market, which has nudged higher so far this year.
Following the global financial crisis of 2007–08 the Federal Reserve used massive bond purchases to depress interest rates spur the U.S. economy. Six years later the economy is now showing some level of improvement and the Fed is expected to scale back its bond buying program. In anticipation of higher interest rates, the market has already re-priced the 10-year Treasury yield to 3% from 1.8%. Subsequently, many bond mutual funds, which move opposite direction as interest rates, declined during 2013. Longer-term issues tumbled the most. For example, last year the values of 20-year Treasury and municipal bond funds were lower by over 10% and 8%, respectively. Corporate bonds were also re-priced lower. However, this is not as problematic for investors that hold these issues until maturity.
Bond mutual funds witnessed huge outflows as the result of panicked investors. According to investment researcher Morningstar, June experienced the first monthly net outflow of money from bond mutual funds in nearly two years as $68 billion headed for the doors. Another $8 billion exited funds in July. In the fourth quarter, interest rates stabilized as Washington’s circus featured a government shut-down and the abysmal launch of Obamacare. These events dashed any predictions that the Federal Reserve will completely take the training wheels off the U.S. economy in early 2014.
The chart below shows a sample of fixed income investment returns and why it is important to balance both “Term & Risk”.
January 2014 Bond Rates
Approximate data from TD Ameritrade Bond Offerings