Puerto Rico – Fourth Quarter 2017 Review

The Commonwealth of Puerto Rico entered the fourth quarter having suffered one of the most devastating natural disasters in the island’s history. Hurricane Maria left billions of dollars in damage in its wake, including both infrastructure damage and economic losses. The human costs have been equally terrible, with millions of US citizens suffering.

Three months later and the lights are still out – only 70% of power has been restored.  Many businesses remain closed due to the lack of electricity and the high costs of using diesel generators. An estimated 20%-30% of the island’s 65,000 businesses may close permanently. Residents have fled to the mainland in the wake of the hurricanes. According to a study by the Center for Puerto Rican Studies at Hunter College in New York, the island’s population is expected to decrease by 14% to 2.9 million people by 2019, as residents flee the devastation. Whether they return remains questionable. The deeper the roots they establish on the mainland, the less likely they are to return home. Hurricane Maria has magnified an already exceedingly complex situation. Rebuilding will take months, a full recovery, years.

Fortunately, bipartisan support for the Commonwealth remains strong. Many millions of dollars have already been spent on recovery and rebuilding and they are set to receive a share of the multi- billion dollar disaster aid package currently making its way through the Senate. How much the island ultimately receives remains to be seen; but whatever the amount turns out to be, it should help with their long-term financial health. The influx of federal dollars is indeed a benefit to bond insurers, even in light of the rhetoric that creditors should not benefit from the destruction, as previously dilapidated infrastructure is rebuilt to a more resilient form.

The island’s electric grid will be modernized and resistant to future hurricanes according to FEMA officials. That’s welcome news: Maria will not be the last to strike. Our hope is that they will use this ‘Hurricane Andrew moment’ to look closely at how they build on the island.

On the legal front, court proceedings are again underway following a delay due to the storms. The Commonwealth, COFINA, Employees Retirement System (ERS), Highway Authority (HTA), and Electric Authority (PREPA) are currently restructuring their debt under Title III of the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA). The Aqueduct and Sewer Authority (PRASA) may also eventually follow this path due to damages sustained during Hurricane Maria. The restructuring of the Government Development Bank for Puerto Rico remains the only Title VI restructuring currently underway.

We await the Commonwealth’s new five-year fiscal plan, which will incorporate storm related damages and economic losses. The fiscal plan will likely contain no debt service payments for the five-year term. How the fiscal plan accounts for federal dollars and treats creditors remains to be seen. Additional court decisions expected in 2018 should give welcome clarity and a clear direction to the Title III cases highlighted above.

If Hurricane Maria was a left hook, then the Tax Cuts and Jobs Act may be the overhand right that knocks the island to its knees. Congress is set to end one of the Commonwealth’s few competitive advantages that helped to make it a medical manufacturing hub at a time when billions in taxpayer dollars are expected to be spent on recovery and rebuilding. The legislation includes a tax on intangible property of controlled foreign corporations (CFC), including those operating on the island. This tax would essentially treat Puerto Rico and other US territories as foreign countries.

Congress’s well intended attempt to protect American jobs with this new tax may have the unintended consequence of doing the exact opposite in Puerto Rico, where roughly 235,000 US citizens are employed in the manufacturing sector. This would not be the first time the island’s future has been directly impacted by the United States government. It was the phase-out of section 936, signed by then-president Bill Clinton, as well as their own inability to adapt, that marked the beginning of the end. The problems they face require long-term reforms that spur economic growth. We hope that future legislation addresses those needs.

Uninsured debt traded lower in price in response to the hurricanes, driven by the expectation of a reduction in economic activity and the possibility for lower recoveries. Insured debt has been driven to higher yields because of uncertainty and tax-loss selling pressure. With the entire picture in view, we think that carefully selected insured debt can still offer an attractive opportunity. As such, we remain buyers. Cumberland Advisors’ Puerto Rico Insured strategy does not include uninsured debt from any island authority but focuses instead on the headline-driven opportunity in carefully selected insured debt.

Shaun Burgess
Portfolio Manager & Fixed Income Analyst
Email | Bio


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Puerto Rico and Recurring Hurricanes

Last Monday, November 6th, I was privileged to serve on a panel discussion at the American Enterprise Institute in Washington DC, where the topic was Puerto Rico after Hurricane Maria. The discussion covered a wide range in topics that included the damage to Puerto Rico as well as issues of finance, law, and markets.   The proposed solutions to the problems ranged from a Marshall Plan-type of approach to direct Federal oversight.  Included in the discussion were the social issues that are also affecting Puerto Rico and in some cases are obstacles to progress.  The link to see this panel discussion is here:

http://www.cumber.com/john-mousseau-panelist-at-american-enterprise-institute-puerto-rico-discussion/

One of the panelists at AEI was Alex Pollock. Alex is a distinguished fellow at the Washington-based R Street Institute, where he provides thoughts and policy leadership on financial issues.  Here is the link to his bio:

http://www.rstreet.org/people/alex-j-pollock/

Alex has written a terrific piece on the meteorological conditions that affect Puerto Rico, and hurricanes in particular. His analysis has implications for the rebuilding of Puerto Rico near-term, as well as longer term-implications on issues running from federal intervention to possible future statehood.  With Alex’s permission we present it here.

John R. Mousseau, CFA
Executive Vice President & Director of Fixed Income
Email | Bio

 


Puerto Rico has a long history of many disastrous hurricanes, as once again this year with the devastating Hurricane Maria.  These disasters recur frequently, historically speaking, in an island located “in the heart of hurricane territory.”   Some notable examples follow, along with descriptions excerpted from various accounts of them.

-In 1867, “Hurricane San Narciso devastated the island.”  (Before reaching Puerto Rico, it caused “600 deaths by drowning and 50 ships sunk” in St. Thomas.)

-In 1899, Hurricane San Ciriaco “leveled the island” and killed 3,369 people, including 1,294 drowned.

-In 1928, “Hurricane San Felipe…devastated the island”–“the loss caused by the San Filipe hurricane was incredible.  Hundreds of thousands of homes were destroyed.  Towns near the eye of the storm were leveled,” with “catastrophic destruction all around Puerto Rico.”

-In 1932, Hurricane San Ciprian “caused the death of hundreds of people”—“damage was extensive all across the island” and “many of the deaths were caused by the collapse of buildings or flying debris.”

-In 1970, Tropical Depression Fifteen dumped an amazing 41.7 inches of rain on Puerto Rico, setting the record for the wettest tropical cyclone in its history.

-In 1989, Hurricane Hugo caused “terrible damage.  Banana and coffee crops were obliterated and tens of thousands of homes were destroyed.”

-In 1998 came Hurricane Georges–“its path across the entirety of the island and its torrential rainfall made it one of the worst natural disasters in Puerto Rico’s history”—“Three-quarters of the island lost potable water”– “Nearly the entire electric grid failed”—“28,005 houses were completely destroyed.”

-In 2004, Hurricane Jeanne caused “severe flooding along many rivers,” “produced mudslides and landslides,” “fallen trees, landslides and debris closed 302 roads,” and “left most of the island without power or water.”

-And in 2017, as we know, there was Hurricane Maria (closely following Hurricane Irma), with huge destruction in its wake.

These are some of the worst cases.  On this list, there are nine of them in 150 years.  That is, on average, one every 17 years or so.

All in all, if we look at the 150 year record from 1867 to now, Puerto Rico has experienced 42 officially defined “major hurricanes”—those of category 3  or worse.  Category 3 means “Devastating damage will occur.”  Category 4 means “Catastrophic damage will occur.”  And Category 5’s catastrophic damage further entails “A high percentage of framed homes will be destroyed…Power outages will last for weeks to possibly months.  Most of the area will be uninhabitable for weeks or months.”

Of the 42 major hurricanes since 1867 in Puerto Rico, 16 were Category 3, 17 were Category 4, and 9 were Category 5, according to the official Atlantic hurricane database.

Doing the arithmetic (150 years divided by 42), we see that there is on average a major hurricane on Puerto Rico about every 3 ½ years.

There is a Category 4 or 5 hurricane every 5.8 years, on average.

And Category 5 hurricanes occur on average about every 17 years.

There are multiple challenging dimensions to these dismaying frequencies–humanitarian, political, engineering, financial.  To conclude with the financial question:

-How can the repetitive rebuilding of such frequent destruction be financed?  Thinking about it in the most abstract way, somewhere savings have to be built up.  This may be either by self-insurance or by the accumulation of sufficiently large premiums paid for insurance bought from somebody else.  Self-insurance can include the cost of superior, storm resistant construction.  Or funds could be borrowed for reconstruction, but have to be quite rapidly amortized before the next hurricane arrives.  Or somebody else’s savings have to be taken in size to subsidize the recoveries from the recurring disasters.

Is it possible for Puerto Rico to have a long-term strategy for financing the recurring costs of predictably being in the way of frequent hurricanes, other than using somebody else’s savings?


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John Mousseau Panelist at American Enterprise Institute Puerto Rico Discussion

Hurricane Maria delivered a serious body blow to the Puerto Rican economy by severely damaging much of the island’s infrastructure. This raises the prospect of a humanitarian crisis on the island and a mass wave of migration to the mainland.

John Mousseau of Cumberland Advisors joined other panelists during a seminar at the American Enterprise Institute that took stock of Puerto Rico’s post-hurricane economic prospects.

John Mousseau Panelist at American Enterprise Institute Puerto Rico Discussion

Having occurred Monday, November 6, 2017 between 2:00 pm & 4:00 pm, it also explored the appropriate policy response from Washington to the Puerto Rican crisis and the issue of how the island’s debt might be restructured. A livestream of the event was generated from AEI’s  YouTube page.

Panelists & Participants:
-Andrew Biggs, AEI
-Jose Carrion, Financial Oversight and Management Board for Puerto Rico
-Anne Krueger, Paul H. Nitze School of Advanced International Studies
-Desmond Lachman, AEI
-John Mousseau, Cumberland Advisors
-Alex J. Pollock, R Street Institute
-Antonio Weiss, Harvard Kennedy School

Join the conversation on social media by following @AEI and @AEIecon on Twitter and Facebook.

Watch the recorded video of this engaging panel talk below:

Learn more about John Mousseau here: http://www.cumber.com/team/john-r-mousseau/


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Puerto Rico Needs a Plan

Excerpt below:

President Donald Trump suggested last week that Puerto Rico’s $74 billion in debt would be wiped out. In response, Puerto Rico’s bonds, which had been surprisingly resilient up until Maria hit, plummeted.

Even some insured municipal bonds fell, after initially trading above par post-Maria. Yields, which move inversely to prices, rose from about 4.1% to 4.75%, and then fell back to 4.3%. “That’s a lot of gyrations off of one statement that didn’t mean anything,” says John Mousseau, director of fixed income at Cumberland Advisors. His firm owns insured Puerto Rico debt and bought more during the panic.

What’s next? Puerto Rico needs emergency aid—whether in the form of grants or very low-cost loans—and Congress has no choice but to step up. After that, a comprehensive plan to rebuild and modernize its infrastructure is needed. That could halt the dire problem of outmigration by creating new jobs and boost the economy by allowing tourism to flourish, says Mousseau.

Read the full article here: http://www.barrons.com/articles/puerto-rico-needs-a-plan-1507351565




Trump sends Puerto Rico bonds reeling

The stock market has gotten pretty good at discounting some of President Trump’s more freewheeling rhetoric on North Korea, taxes and other issues. But the bond market had no idea what to make of Trump’s comments late Tuesday that the U.S. might have to wipe out Puerto Rico’s $74 billion in publicly held debt.

Cumberland Advisors’ David Kotok emails on Trump: “No idea what he means. It certainly threw a curve at markets. There is a federal oversight system already in place. The pre-hurricane debt needs restructuring and this is widely known. Trump is an enigma.”

Read the full article here: http://www.politico.com/tipsheets/morning-money/2017/10/05/trump-sends-puerto-rico-bonds-reeling-222655


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President Trump’s Puerto Rican Debt Comments Have Spooked Investors

Excerpt below:

“The biggest risk for Puerto Rico and the creditors is that the rebuilding of basic infrastructure takes so long that the out-migration worsens, and you see people put roots down in other places,” said Jim Millstein, CEO of financial advisory firm Millstein & Co. Millstein recently advised Puerto Rico on managing its debt.

So far, the emigration is already happening. An estimated 7,000 people have already left via the Luis Munoz Marin International Airport, with “tens of thousands more” likely to follow, a recent Municipal Market Analytics note read. But on a more optimistic note, investors such as John Mousseau, the director of fixed income at Cumberland Advisors, says he waiting for financial aid from the federal government to help rebuild and strengthen Puerto Rico’s economy.

“If you get this rebuilding underway, you start seeing Puerto Rico turning the other way,” he told Fortune in late September.

Read the full article here: http://fortune.com/2017/10/04/puerto-rico-donald-trump-debt-bankruptcy


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