Our perspective stands at odds with the rash of negative headlines and articles about Puerto Rico and its economy that have appeared in recent months. The media coverage largely has added very little to the conversation and has, at times, offered up misleading and even erroneous information.
Yes, the Commonwealth of Puerto Rico has struggled to recover from a long and severe
recession, but it is recovering. The government has taken dramatic steps to fix its balance sheet, and we think that forecasts a much brighter future.
NEW INITIATIVES
In the past two years, Puerto Rico and the Government Development Bank have pursued initiatives to shore up the credit quality of all types of on-island borrowers.
For example, they have:
• Decreased their budget deficit and deficit financing significantly to an anticipated shortfall of $800 million in fiscal 2014, from $3.3 billion in fiscal 2009.
• Increased tax revenue by nearly $1.4 billion annually by changing corporate sales and use taxes.
• Strengthened their tax collection processes to the benefit of holders of general-obligation and government appropriation debt. As of July, general-fund revenue was $43 million above budget.
• Improved year-over-year sales tax collections by 8.4% in July, to the benefit of holders of sales-tax-backed bonds.
• Enacted comprehensive and sustainable pension reforms, with measures that eliminate an annual $900 million shortfall, increase the retirement age, require bigger employee contributions, cut bonuses and merit pensions, and convert lump-sum pension payments to annuity payments.
• Raised Puerto Rico Aqueduct and Sewer Authority rates by 60%, which will increase the authority's revenue by nearly $300 million annually after nearly 20 years of flat rates.
Our investment team has researched Puerto Rican credits and invested in the island's muni bonds for decades. The fiscal conditions on the island are better than we have seen in the past six years.
The government has been willing and able to honor its debt consistently, and that has been true no matter which party held power.
Time and again, Puerto Rican officials have given every indication that the word “default” isn't in their vocabulary.
For those not yet ready to ignore the highly negative headlines about Puerto Rican debt, consider these facts:
• The constitution of Puerto Rico protects general-obligation and guaranteed debt issued by the commonwealth with a first lien on revenue. This means that bondholders get paid first, before pensioners and government employees and officials.
• Puerto Rico and its municipalities can't file for Chapter 9 bankruptcy. That option exists only for municipalities located in a state that allows for muni bankruptcy filings. A state can't declare itself bankrupt, and neither can the municipalities of any U.S. territory.
Finally, the fact that bonds issued by Puerto Rico and its authorities are triple tax-exempt — that is, exempt from federal, state and local income taxes — shouldn't be overlooked.
HANDSOME INCOME
In combination, current pricing levels and tax rates are delivering very handsome after-tax income for yield-seeking investors. Those in the nation's highest tax brackets, for example, will pocket twice as much income from their tax-exempt holdings as they will from a taxable investment with the identical yield.
Investors haven't been well-served by all the one-sided, negative and rehashed discussions that we have heard of late. Lost in the noise are the important strides that the commonwealth and the Government Development Bank have taken to ensure their continuing ability to meet their financial obligations.
The commonwealth has never defaulted on the payment of principal or interest on any of its debt, and while past performance doesn't guarantee future results, we don't expect that stellar track record to change in the near or distant future.
These facts should help investors look at both sides of the Puerto Rico debate. Informed decisions require facts and shouldn't be based on negative headlines.
An understanding of the risk/ reward trade-off can help investors decide whether Puerto Rico munis, given their attractive yields and tax advantages, belong in their portfolios.
Dan Loughran is a senior portfolio manager and senior vice president at OppenheimerFunds Inc.
