For Puerto Rico, a New Picture Emerges After Maria
For the people of Puerto Rico and its bondholders, many of whom are Puerto Rican, 2018 ended on much better note than 2017.

In the aftermath of Hurricane Maria, help arrived in the form of federal aid and boots on the ground. The disaster also served to shed more light on the Commonwealth’s largely pre-existing headaches, many of which have worsened in recent years.

In 2018, billions of dollars in federal aid were spent to help those in Puerto Rico deal with the challenges wrought by Hurricane Maria, and the ensuing blackout gave Puerto Rico a distinction that no one coveted: It was the longest U.S. blackout and the second longest worldwide. According to the Rhodium Group, a research organization with energy-market expertise, the Commonwealth lost nearly 4 billion hours of electricity, more than 1,000 hours per resident.

Throughout 2018, medical and military personnel worked side by side with outside contractors and islanders to repair the damage and, as a result of these rebuilding efforts, many economic indicators improved.

Coupled with announcements related to various debt restructuring agreements, these developments bolstered the performance of securities issued by Puerto Rico.

Overall, Puerto Rico securities provided a total return of 6.0%, according to the Bloomberg Barclays Municipal index of Commonwealth debt, and high-yield bonds issued by Puerto Rico performed far better, offering a total return of 36.4%.1 (Debt issued by the U.S. Virgin Islands was the second strongest in 2018, with a total return of 5.6%; the next best U.S. municipalities were New Hampshire and Wyoming, each with an annual total return of 2.2%, according to Bloomberg Barclays.)

Securities issued by Puerto Rico were the No. 1 driver of 2018 annual total return for the Rochester complex overall and for each of the 10 Rochester funds that hold these types of securities.2

At year-end, our funds’ investments in a diverse set of securities issued by Puerto Rico and its instrumentalities contributed favorably to 5-year total returns complex-wide.

Help Arrives

Puerto Rico is expected to receive at least $82 billion in disaster relief funds, according to Axios, a new mobile media platform. Given that losses have been estimated at $37 billion, the balance of the relief money represents a sizable boost to Puerto Rico’s economy.

Puerto Rico also received more than $37.2 billion in prime awards from the federal government during 2018, an increase of nearly 60%, according to USAspending.gov.3

The Federal Emergency Management Agency (FEMA), which at one point had 19,000 disaster relief workers on the ground, has given $4 billion to residents of Puerto Rico, The Economist reported in November. Additionally, as of mid-December 2018, according to El Vocero de Puerto Rico, FEMA’s community disaster loan program had approved more than $294 million for 75 municipalities in Puerto Rico, and many loan applications were still pending.

Meanwhile, Gov. Ricardo Rosselló Nevares believes that the Commonwealth needs outside funding of $139.1 billion over the next 10 years, with the most of it to be provided by the U.S. government. Of the total, according to the 531-page economic and disaster recovery plan he released in August, approximately $69 billion is “known to be available” and $45 billion is “funding that will have to be sought out.”4

Signs of Improvement

Despite Puerto Rico’s sense that it is in dire straits, the Treasury Department has accumulated a significant reserve. At year-end, the Puerto Rico Treasury Department reported a bank cash position of $3.646 billion versus $1.695 billion on December 31, 2017.

Other positive developments include:

The unemployment rate reached a record low 7.7% in November 2018, according to the U.S. Bureau of Labor Statistics’ employee survey. The bureau also reported that the number of employed people rose to its highest level since 2013.

In the first 7 months of 2018, corporate investments totaling more than $350 million had been announced, wildly overshadowing the $48 million that companies had planned to spend in all of 2017, according to a November report in The Economist.Job creation rose more than 450% over the same time periods, and per capita personal income increased by more than 25% between 2008 and 2017.

Sales and use tax (SUT) collections were down a mere 1% in fiscal 2018 (which ended June 30), much less than anticipated. Although Maria had an adverse effect on fiscal 2018’s economy, retail sales have increased and the Puerto Rico Economic Activity Index rose to an all-time, year-over-year high of 15.5% in October 2018.5

Revenues are running ahead of government projections and contributing to a surplus that the government expects will total $6.7 billion over the next 6 years (before debt payments) and $30 billion over the next 15 years. We continue to believe that the revenue projections in the fiscal plans, which have been certified by the Federal Oversight and Management Board, are highly suspect.6

Investors should note that the Commonwealth has not released audited financial results for fiscal years 2016, 2017, or 2018. Consolidated financial statements for fiscal 2015 results were released in 2018, but the external auditor, KPMG, said it would not attest to the reliability of the information it had received. Citing evidence of spending overdrafts and non-compliance with accounting standards, among other issues, the audit included qualified opinions, adverse opinions, and warnings or disclaimers pertaining to various government agencies and instrumentalities.

While officials continue to lament conditions on Puerto Rico, our sense is that the future economic well-being of the Commonwealth has been and continues to be stymied by years of mismanagement and insufficient transparency and accountability.

Status of Debt

In 2018, several Puerto Rico issuers continued to remain current in their debt payments, including PRASA, the Commonwealth’s aqueduct and sewer authority; the University of Puerto Rico; the Municipal Finance Agency, and the Children’s Trust, which handles payments on the tobacco bonds backed by Puerto Rico’s share of the proceeds from the 1998 Master Settlement Agreement. A restructuring plan between the Government Development Bank of Puerto Rico (the GDB) and its bondholders was approved this year; the Rochester complex was not invested in GDB debt at year-end.

Puerto Rico has not honored the debt-service obligations on its general obligation (G.O.) securities since 2016. The Commonwealth’s cash position, we contend, absolutely undercuts the government’s ongoing assertion that it cannot make these debt payments.

Debt restructuring agreements related to approximately $9.0 billion of PREPA debt and $17.6 billion of COFINA debt were announced in 2018; PREPA debt is issued by Puerto Rico’s electric utility authority and COFINA debt is backed by SUT collections. The COFINA agreement gained the support of bondholders, insurers, and the Puerto Rico Legislature by early November and, assuming it is approved by U.S. District Court Judge Laura Taylor Swain, will become effective in early 2019. Investors should note that details of the PREPA restructuring have not been hammered out, and absolute recoveries will depend on a variety of factors.

Despite the Commonwealth’s refusal to honor debt-service obligations, the government has enacted tax measures that are expected to reduce collections by nearly $2 billion over the next 5 years and has continued to distribute Christmas bonuses to public sector employees. The Oversight Board, among others, has doubts that these moves will be revenue neutral, as Gov. Rosselló has said. We see little evidence of belt-tightening, which is expected in any bankruptcy.

The relationship between the Oversight Board and the governor remained tense and litigious throughout 2018 with clashes about fiscal plans, budgets, and data. Additionally, an appellate court heard arguments in early December about whether the means by which Oversight Board members were appointed violated the U.S. Constitution.

As long-time investors know, our funds’ holdings in securities issued by Puerto Rico have delivered significant shareholder value over the years. The Rochester team has worked constructively with a range of stakeholders for many years to maximize the value of the funds’ investments, and we believe the improvements in current valuations signal that much of the hard work is already underway. We will continue to work constructively with all parties involved as we seek the best overall return for our shareholders and a sustainable path forward for Puerto Rico.

For more on the municipal bond market and the Rochester Way, read the 2018 Annual Overview.

 
  1. ^Bloomberg Barclays indices are unmanaged and cannot be purchased by investors. Our funds’ investments are not limited to the investments comprising these indices. Index performance – which includes reinvestment of income, but does not reflect transaction costs, fees, expenses, or taxes – is provided for illustrative purposes only.
  2. ^Oppenheimer Rochester offers three funds that cannot invest in the securities issued by Puerto Rico or other U.S. territories: Oppenheimer Short Term Municipal Fund, Oppenheimer Intermediate Term Municipal Fund, and Oppenheimer Municipal Fund.
  3. ^Prime awards are the amounts paid by the federal government to non-federal entities that carry out federal programs.
  4. ^“Transformation and Innovation in the Wake of Devastation” is a sharp report chock-full of detailed text, explanatory graphics, and stunning photographs, the first of which is a portrait of the governor.
  5. ^The monthly index reflects the results of four economic indicators: total non-farm payroll employment, cement sales, gasoline consumption, and electric power generation. According to TradingEconomics.com, which relies on official data sources, the index averaged 0.49% from 1981 until 2018.
  6. ^The Federal Oversight and Management Board, which was established under the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”), first met in September 2016. Its purpose, according to PROMESA, “is to provide a method for a covered territory [Puerto Rico] to achieve fiscal responsibility and access to the capital markets.” The Oversight Board is authorized to certify the government’s budgets and fiscal plans, among other responsibilities.