Photo: Puerto Rico Treasury Secretary Melba Acosta (R) and Governor Alejandro Garcia Padilla at a press conference in response to S&P’s downgrade. (Source: Ustream)
Last June, I asked if the U.S. Treasury was bailing out Puerto Rico with an unusual interpretation of the federal tax code. This waiver or exemption allowed U.S. multinationals operating in Puerto Rico to credit taxes that were paid to Puerto Rico on their federal tax bill. The tax, referred to as Act 154, was passed by the Puerto Rico legislature in 2011. It brought in approximately $1.6 billion in 2011.
The condition of Puerto Rico’s economy is a key concern for bond investors and rating agencies. Although its tax revenues have risen sharply as the government has increased various taxes, the economy has been contracting. From a recent Morningstar report:
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 mysterious borrowing undertaken by the Puerto Rico Government Development Bank in the middle of December has been explained. The GDB issued a press release that said that it had “borrowed” $110 million from the state workers insurance fund:
Dear President Dudley:
Although it is a longstanding policy of the Federal Reserve not to intervene in the finances of state and local governments, it may be time to reconsider this policy in the case of Puerto Rico. A member of your board of directors, Richard Carrión the CEO and Chairman of Banco Popular de Puerto Rico, wrote to The Economist about the state of Puerto Rico’s finances:
Justin Vélez-Hagan is the executive director of the National Puerto Rican Chamber of Commerce, a small non-profit not to be mistaken with the much larger Puerto Rico Chamber of Commerce. Vélez-Hagan argues in a recent Forbes opinion piece that Puerto Rico must default on its debt:
@Morgan_03 HFs are the new liquidity providers and it don’t come cheap
— Guillermo (@groditi) November 12, 2013
There are plenty of stories about how hedge funds are being lured into buy Puerto Rico debt by big dealers. The Wall Street Journal wrote about hedge funds buying distressed debt. Bloomberg reported that Morgan Stanley, Citigroup and Lazard are holding information sessions for hedge funds to learn about Puerto Rico debt. A trader passed me the presentation from the Citi meeting. It was a detailed explanation of the seniority of Puerto Rico debt and the legal covenants and trading history of specific Puerto Rico issuers and authorities. I would guess Morgan Stanley and Lazard did an equally good job on the background for their clients.