Winners and Losers

The moment we have been waiting for us finally here. Puerto Rico has officially defaulted on part of its debt obligations. The island will still make payments to finance its general obligation fund but will not be able to fulfill other bond payment obligations.

The government and the markets are entering unchartered waters due to the unique nature of the island territory to the United States. Bondholders will be sitting on the edge of there seats waiting to see if they are the chosen few that will actually receive payment. This uncertainty will not have a positive impact on the markets. What will other US municipalities do? Detroit, Orange County, and other municipalities facing the same dilemmas now and in the past do not have the luxury to selectively make bond payments. The nature of credit markets is "all or none". Either you pay your bills or you don't. This is a very interesting case study. 

Institutional funds and other investors  will be left holding the bag at the whim of Puerto Rican legislators. Puerto Rico is actually the winner in this situation. How do you squeeze blood from a stone? You can't. Will Puerto Rico be able to borrow money? No. Will the US let one of its territories fall into a humanitarian crisis? Probably not.

Castillo San Felipe del Morro 2014

Common Sense Proposals

Finally! After months, US lawmakers have compromised to take a more rational approach to solving Puerto Ricos debt crisis. House Speaker Paul Ryan directed financial committees to take a common sense approach to preventing Puerto Rico from defaulting on January (or May) debt payments.

One approach will be allowing Puerto Ricans to qualify for the Earned Income Tax Credit currently available to citizens living in the States. This is a step in the right direction. Congress may not be able to legally allow the Island to default but they can even the laying field for its residents. Medicaid is another area where the government can help alleviate financial pressure.

Puerto Rico's position has not changed although policiticians are becoming more anxious that default is inevitable. There is no question about it. Puerto Rico will default. The impact on the people of the Island will be a directly proportional to the governments ability to toe the line of default to maximize negotiations between the municipalities and debt holders. 

Rising interest rates should also throw a wrench into the equation. Let's see what happens.

Palmas Del Mar (October 2014)

Where Are We Going?

We still don't know what the future holds for Puerto Rico. There have been numerous studies and articles describing the situation and desperate and possibly, as Forbes described, leading to a humanitarian crisis. We know what the problem is but what are the possible solutions. Remember the game of Battleship where you would call out your opponents position in an attempt to sink their ships? We can describe the situation between Puerto Rico and bond holders in his manner.

Goal = Balanced Budget

Possible Solutions:

1) Raise Revenue to balance budget

The government can raise revenue by increasing the amount of taxes collected. There are a variety of ways to do this but almost all will lead to an exodus of residents from the island. An eroding tax base will lead to an incurable problem. Raising taxes is not a long term solution to the problem.

2) The budget can be balanced by increasing revenues, reducing costs, and usually the combination of both. Cost cutting is the best way for Puerto Rico to balance the budget and pay bond holders. Since the government has already increased taxes, witnessed an erosion of tax base, they should cut costs to demonstrate government austerity and restore confidence to all involved. 

Governor Padilla has atleast taken a realistic approach that the debt cannot be paid and unless restructuring occurs there will not be a meeting of obligations. He had also increased taxes and reduced some government services in an effort to balance the budget.

Opportunities: Padilla had already ordered an end to marajuana related prosecutions stating it was costing the territory millions a year in administration. This can also be a revenue producer for the island should the laws become favorable to the medical marajuana industry. This kind of cost cutting is a good example of measures that can be taken. Any unnecessary cost should be cut if there is not a clear positive benefit.

If the territory makes an effort to increase economic efficiency then bond holders may be able to compromise. For example of the government shows austerity by changing the laws of the general obligation fund GOF to meet financial obligations they are showing a real desire to balance the budget.

Certain agencies are already facing pay freezes for the uncertain future. Given that the entry level salary is almost minimum wage and dramatically increases in years 2-4, this had a dramatic impact on the population. Unfortunately, this is a step in the right direction.

Palmas Del Mar (October 2014)

Puerto Rico Walks Away From Talks With Bondholders

Today, 21st of October, Puerto Rico walked away from the table with bond holders. That must be nice. We all knew this was bound to happen. It was a game of brinksmanship that had already been decided long ago. The only difference is the number of sunk ships was yet to be determined. The only reason both sides kept slow playing is because the bond holders wanted to lose the fewest ships.

So, what next? Well, I don't know. If Puerto Rico loses it's credit rating, they have no ability to borrow money and restructure debt. They also have no incentive to pay back debt since it's so insurmountable it would be like putting out a forest fire with a single bucket. The next thing that is likely is a series of judgements which should prove interesting given the jurisdiction of the island and the mainland.

But as always, I see an opportunity to buy real estate. Why not? The value is intrinsic to the value of the land itself. The land sells itself. Those looking for good long term investments should still consider buying land and holding for a horizon no less than 20 years. There are many hot spots around the island. Anything close to the close will be hard to mess up.

Palmas Del Mar (October 2014)

The Good, The Bad, and The Ugly

Let's start off with The Ugly.

The current drought and water rationing scenario in Puerto Rico demonstrates a lack of planning and foresight by those in charge. With only a 3 month supply of water in reserve, many municipalities are left with water 1/3 days. Of course, in the tourist areas, this policy doesn't apply. 

The sad part is that with a little capital investment, the whole problem could be avoided. Yes, the carribean is experiencing its worst hurricane and rainfall drought in 9 years, but that doesn't excuse the island from only capturing 20% of rainwater. International reports indicate a strategically placed dam would alleviate the island of its water shortage problem. The project would cost upwards of 350 MM USD and obviously PR lacks the fuss to engage such a capital intensive project.

The Bad

It's official. Moodys has downgraded the island and labeled them as default on their obligations. Now what? More people are going to leave for th mainland. The tax base will continue to erode. The underground economy will continue to grow as a result of fewer industry level jobs. The government will be in a worse position to negotiate debt. The only answer is foreign direct investment, whether it be mainland US or elsewhere.

The Good

Tourism. Luckily the island is still flush with tourists. Real estate opportunities are increasing as people have to leave their homes and move to where the jobs are. Acquiring a distressed asset in Condado is my best bet. You can always rent it out to tourists of the rest of th island is a ghost town. 

Puerto Rican Debt: Now What?

The island was able to meet its debt obligation over the past week but it's a small victory in the big picture. Governor Padilla already stated the debt is "unpayable". These statements already put investors and creditors in a tailspin. The advantage of a good credit rating is that you can borrow at favorable rates. After saying the debt isn't payable, how favorable of a rate is possible? 

I understand Padilla is meeting the problem head-on with the statement but he is not leaving himself room to negotiate. Creditors will likely allow for a restructuring of payments but the terms will be less favorable given the Governor had already shown his hand. How is Puerto Rico expected to pay off the debt with a shrinking tax base? As more people leave the island, the tax base shrinks. The current state is only encouraging a larger and more drastic exodus. Creditors also realize the impact of this scenario. 

Act 20/22 were supposed to help alleviate the problem but it's a case of too little too late. The tax benefits largely only benefit the Americans moving to Puerto Rico to take advantage of them. The island was supposed to experience the secondary effect of increased consumption from the 20/22 participants 

Where do the opportunities lie? Land! Property! Real estate! These assets will become distressed as the island navigates the debt fiasco. Given the relationship with the U.S., it is highly likely that actions and regulations will be favorable for Puerto Rico. Relief in the form of direct investment, favorable legislative actions to promote American business, or bailout will all promote a recovery in Puerto Rican hard assets. When will it happen and timeline? Considering the layers of uncertainty, only long term plays are viable. 

Impact of New Marijuana Legislation

The Governor of Puerto Rico issued an executive order on May 4, 2015 granting the legal use of marijuana for medical purposes. This legislation poses an interesting scenario when paired with the Act 20/22 laws of 2012. Legal medical marijuana is nothing new for the United States and its territories. Twenty-three states along with Guam and the US Virgin Islands have already outlined legislation to legalize marijuana for medical use but Puerto Rico is a special case.

Puerto Rico holds the trump card in the medical marijuana game. The US began adopting the legalization and regulation of marijuana for the obvious reason of trying increase tax base. What would happen to this tax base if US marijuana startups began moving to Puerto Rico to conduct business? Would these companies be exempt from State and Federal income taxes? What if only the downstream (end product) component was outsourced to Puerto Rico. What would the implications be?

Given Puerto Rico is an island of approximately 360 square miles, there is limited space to grow and cultivate the product in the upstream supply chain. However, as was seen in the 1990s, pharmaceutical companies are no stranger to the island and opportunities may exist to manufacture an end product here with great tax advantages. There is a great amount of uncertainty regarding how this will all play out but I have presented just one scenario to think about. It will be interesting to see how this all plays out in the coming months. It will all depend on how well Puerto Rico adopts and embraces the idea of medical marijuana. The regulations regarding growing, distribution, and sale of the product will be integral in determining Puerto Rico's role in the US scheme.