Will Puerto Rico sell general obligation bonds?

January 23, 2014

The New York Times reported that Morgan Stanley is shopping a potential $2 billion general obligation bond deal for Puerto Rico. Bloomberg followed up with a story that had a few more details about the offering that Puerto Rico supposedly has not authorized. According to Bloomberg the possible deal terms are:

The taxable general-obligation deal said to be under discussion would have maturities of at least five to seven years. The funds [hedge funds and distressed debt buyers] would assist the commonwealth as it struggles to turn around its shrinking economy. The discussions have cited possible yields of about 10 percent, the people said.

Let’s break this proposed issue into several pieces:

Taxable: Issuing taxable municipal bonds makes sense because it attracts a broader base of investors (including hedge funds, commercial banks and some insurance firms) outside of muniland that don’t take advantage of the municipal bond tax exemption. But the extremely high interest rate is a signal to any bond investor that the security has very high risk, regardless of its investment-grade rating from the three major raters. So we can rule out banks and insurance companies as buyers.

5 to 7 year maturities: It’s interesting that Morgan Stanley would focus on a shorter issuance for this proposed offering. Puerto Rico’s debt service schedule has approximately $8.88 billion maturing in 5 to 10 years, or about $1.77 billion per year, on average. Adding another $2 billion in that period, plus the ongoing interest payments, would put a heavy burden on the general fund. It assumes that Puerto Rico will have better access to markets to roll the debt in the years ahead.

Taxable yield of 10 percent: In the maturity range being proposed (5-7 years) tax exempt general obligations bonds are trading at 9.03 percent to 9.67 percent in the secondary market. The small proposed yield premium would likely lock out any tax-exempt buyers, because their tax-equivalent yield would be higher on the current outstanding tax-exempt bonds (14.95 to 16 percent).

There are deeper issues about Puerto Rico issuing new debt. What happened to the discussion of issuing a third lien Cofina (“Sales Use Tax”) bond? Has this been abandoned because SUT/Cofina revenues have not been coming in is as projected? I suggested this when I wrote two weeks ago:

Puerto Rico has announced it intends to sell a Cofina 3.0 bond in January or February. The most important question is whether there are sufficient new Cofina tax collections to support it. Will Puerto Rico be willing to pay market rates above 8.5 percent to sell Cofina 3.0?

I don’t think Cofina revenues were sufficient to support a third lien issue. I wonder if Puerto Rico has enough room under its constitutional debt limit to issue $2 billion more in general obligations.

According to a sell-side report, Puerto Rico has approximately $1.26 billion of bonds and letters of credit that must be refinanced or come due before June 2014. Combined with an estimated $800 million deficit for 2014, it needs $2 billion in new money. Will a yield of 10 percent on 5-7 year paper be enough to attract investors? Will Puerto Rico deny the story that Morgan Stanley is offering bonds on its behalf, just like it shot down the story of Jones, Day holding a creditor meeting about a possible restructuring of Puerto Rico debt? Stay tuned.

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