MuniLand

Puerto Rico’s whirling inferno of news

By Cate Long
July 1, 2014

The news flow from Puerto Rico has become a whirling inferno since the government passed legislation last week to allow some of the Commonwealth’s public corporations to default.

Here are four important points for investors in Puerto Rico bonds:

1. The market is awaiting official confirmation that Puerto Rico’s teetering electric utility PREPA has made its $204 million bond payment due July 1. If made, it will relieve short-term pressure on Puerto Rico, but the intentions for restructuring are still unknown. Attention will turn to PREPA’s $660 million outstanding lines of credit with Citibank and Scotiabank that need to be renewed.

2. The credit rating agencies are finally catching up with the market and have been raining downgrades and watch alerts on Puerto Rico and its public corporations. At this point these downgrades are somewhat irrelevant, since Puerto Rico bonds are selling at junk yields and investors are more interested in possible recovery values.

3. Puerto Rico’s Secretary of the Treasury Melba Acosta Febo wrote an op-ed that ran in El Nuevo Dia. It is the clearest statement of the government’s intent to restructure PREPA’s debt yet.

One critical piece of the debt puzzle is the amount owned by Puerto Rico’s public corporations – the essential structures that provide vital services to the citizens and businesses of the island. Just three of the island’s many public corporations account for more than 30 percent of the government’s billions of dollars in total debt. By addressing the public corporation issue, Puerto Rico takes a giant step toward freeing future generations from an immense financial burden.

Currently, these essential businesses cannot use Chapter 11 of the Bankruptcy Code because they are not private corporations, nor can they use Chapter 9 because they are not municipalities of States. The Recovery Act fixes this by giving public corporations a controlled, orderly way to negotiate with creditors to lower crippling debt.

4. Will Puerto Rico’s intent to restructure public corporation debt spread to the general obligations of the Commonwealth? Shawn O’Leary of investment management firm Nuveen believes that it will. He writes that Puerto Rico will default on its public corporation debt in an attempt to preserve the liquidity of the Government Development Bank (GDB):

We believe that the move to restructure the debt and operations of Puerto Rico’s public corporations is about preserving liquidity at the GDB for the benefit of the central government. In years past the GDB would provide interim financing to the public corporations – as well as the Commonwealth government – to cover operations and debt service. These loans would later be repaid from the proceeds of long term debt sales either by the public corporations or through general obligation or COFINA bonds.

As the buyer base for Puerto Rico debt has narrowed over the last year and its cost of financing has increased markedly, we believe the Commonwealth government now views the public corporations as competitors for scarce liquidity at the GDB. Preserving GDB liquidity for the benefit of the Commonwealth government may be beneficial to government over the short run, but the strategy’s success will turn on the government’s ability to maintain market access at affordable rates over the long term.

O’Leary goes further and says that Puerto Rico will likely default on its general obligation debt, even after public corporation debt is restructured and the general fund is relieved of subsidizing approximately $800 million a year.

Barring a sudden and lasting reversal in Puerto Rico’s economic trajectory, we expect the Commonwealth will continue to struggle to meet its general obligation debt service even after shedding any additional future subsidies to the public corporations.

Given passage of debt restructuring legislation as well as the trajectory of the economy, scheduled escalation of General Fund debt service, expected pension cost increases and possible reductions in revenue moving forward, we believe Puerto Rico’s assertions it will honor its general obligation debt should be met with a healthy dose of skepticism by investors. Puerto Rico once claimed its unwavering commitment to repay all of its debts, yet today says the debt of its public corporations and instrumentalities is subject to default and restructuring. Investors seeing relative safety in Puerto Rico’s general obligation bonds today may well be viewing a mirage.

This is just the beginning of bondholder troubles for muniland’s third-largest debt issuer. Buckle up.

Comments
2 comments so far | RSS Comments RSS

Does anybody know when and where PREPA will make bond payment??

Posted by NMM | Report as abusive
 

NMM: “Government Development Bank Chairman David Chafey said in a statement that all general obligation, Prepa and Highways & Transportation Authority bond payments maturing Tuesday were made: $721.9 million to service GO bonds and $417.5 million to service Prepa bonds.”

Posted by CraigL | Report as abusive
 

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