Defaulting on bond payments isn’t just for Europe anymore. Detroit and several cities in California have defaulted on bond payments. Now Puerto Rico may be in trouble, as its bonds are trading as if they are going to default.
This week, the yield on Puerto Rico’s general obligation bonds (PR G.O.) pushed up over 10%. That led the Government Development Bank on Tuesday to announce that it would scale back bond sales for the rest of 2013.
Puerto Rico’s bonds offer a double tax advantage, which should help hold their yield down. Yet when considered on a tax-equivalent basis, PR G.O. yields this week exceeded CCC corporate yields, based on the Merrill CCC Index YTW.
Puerto Rico’s junk bond status reflects a weak economy, but it also signals that the island is in deep financial trouble. And the problems extend beyond Puerto Rico, given that it is part of a growing list of state and local governments with financial troubles.
Defaulted debt in the U.S. municipal bond market reached $6.96 billion in the first half of 2013, according to the Distressed Debt Securities Newsletter, which easily surpasses the national total of $4.8 billion for all of 2012.
Considered as a whole, the United States is still not Europe, but a worrisome picture is beginning to develop.
Maybe Meredith Whitney Was Right
In a 2010 interview on “60 Minutes,” banking analyst Meredith Whitney predicted a financial meltdown of state and municipal governments and said, “next to housing, this is the single most important issue in the United States and certainly the largest threat to the U.S. economy.”
The “60 Minutes” segment focused on debt in Arizona, which sold off state buildings to raise cash and now leases them to their new owner; Illinois, which has a reputation as a “deadbeat” state for not paying its bills, and New Jersey, which had billions in debt even after severe cutbacks by Governor Chris Christie.
Because of their tax benefits, many high-net-worth investors hold municipal bonds, but they typically hold them in their individual or trust accounts at brokerage firms, where their bonds are not monitored.
They typically sit in a laddered portfolio for years, receiving little or no attention. What happens when the state or municipality defaults? That’s a question that anyone who owns munis should start asking.