Ratings competition is good for muniland

Morningstar Ratings began when it purchased the respected independent rater Realpoint in 2010. Realpoint was only registered to rate structured finance products, and Morningstar has leveraged that authority to begin rating muniland.

Morningstar Ratings, as a Nationally Recognized Statistical Rating Organization (NRSRO), has to do a lot to prove its chops against bigger competitors Fitch, Moody’s and Standard & Poor’s.

I’ve been pushing for more competition among raters since 2003, so I think the entrance of Morningstar and others is fantastic. Markets benefit from more opinions. Shaking up the ratings business is needed for more timely and accurate ratings.

Nowhere is this competition more evident than on the conference call Morningstar held about its research on Puerto Rico. Puerto Rico is the third-largest issuer in muniland, and the most broadly held. Morningstar estimates that 75 percent of U.S. municipal bond funds hold Puerto Rico bonds. The three major raters do a good job covering the commonwealth’s fiscal conditions, credit characteristics and the covenants of various types of municipal bonds. But Morningstar brings a different perspective to evaluating the credit quality, liquidity and priority of various types of Puerto Rico bonds. Here are a few examples.

This chart shows that PR credit spreads have been stressed since 2007. It’s often forgotten in muniland that Puerto Rico has long been considered risky by the market.

Puerto Rico unveils a plan


Puerto Rico’s top public officials held a two-hour conference call on Tuesday that was open to all investors. That may have been a first for the Commonwealth. Previous calls and conferences had been relatively restrictive in who was admitted. The yields on Puerto Rico’s debt have skyrocketed and the Commonwealth’s access into the public debt markets has been basically shut down. The open conference call was a good change of approach.

Bond investors want to hear the facts about Puerto Rico’s fiscal condition and how they will be repaid on their investments. The call made some progress toward that goal.

The economic and fiscal situation in Puerto Rico is still extremely dire. The economy is mired in a six-year malaise that would be worse if the Puerto Rico government had not issued debt to cover government deficits. As the island has moved away from issuing debt to plug holes in the budget, it has simultaneously reduced the amount of fiscal stimulus that has been injected into the economy. The economy shrank 5.4 percent year over year in August. It will likely shrink more as the Commonwealth reduces its deficit financing.

Puerto Rico tax revenues must pick up pace

Puerto Rico announced first quarter general fund revenues for fiscal year 2013/14. As you can see, revenues increased $71 million year over year. But the Puerto Rico budget projected that corporation taxes would increase $775 million for the full year. They need to rapidly increase.

If general fund revenues continue on this pace, they will annualize at around $7.3 billion for the year. Puerto Rico will need a massive surge in the coming quarters to meet the full year budget estimate of $9.7 billion in general fund revenues (page 14).

Puerto Rico’s moral hazard

Puerto Rico’s short term funding needs are sending out warning bells. The Padilla Administration has been pushing the Commonwealth Legislative Assembly to agree to an increase in the Sales Use Tax to 3.5 percent from 2.75 percent. With this diverted revenue, the government could issue a third series of Cofina bonds for approximately $2 billion. This third tranche would be subordinate to the first two series of Cofina bonds, but have higher ratings than PR general obligations bonds and other public authority debt. The additional Cofina debt may be needed for short-term borrowing done through private placements.

El Neuvodia reports on the action in the Legislative Assembly (translated from Spanish):

Although they stressed there is ‘no rush’ to go to the markets, the principal officers of the prosecution team of Alejandro García Padilla administration today defended the move in a joint public hearing of Finance committees in the House and Senate.

What’s with Puerto Rico GDB bonds?


The bonds of Puerto Rico’s fiscal agent, the Government Development Bank, are inexplicably blowing up today. After a trader alerted me to the sell-off I haven’t been able to find any public information that would explain why.

The GDB bond in the graph above is Cusip 745177FN0 due 2019. It was issued in 2012 for $500 million. The bond is taxable and its yield is hovering around 13.2 percent on inter-dealer trades today (trades done between dealers are the sharpest prices in the market).

In contrast, Puerto Rico tax-exempt general obligation bonds of the same maturity are trading at around 6.74 percent, or 11.16 percent on a fully-taxable equivalent basis. Why did the GDB bond move out 2 percent on heavy trading?

Puerto Rico’s borrowing goes private

Barron’s ran a cover story last week and more articles followed in the financial press about the economic disabilities of Puerto Rico. These disabilities have been fueling a sell-off of the commonwealth’s public debt. Here is a chart showing the spread (or extra yield) that Puerto Rico bonds have had over the last three months:

You can see that the 20 and 30-year bond spreads have been rising since early June in a consistent pattern. This may be related to mutual funds selling their long Puerto Rico bonds. Thomson Reuters Municipal Market Data senior analyst Daniel Berger describes the situation:

Because Puerto Rico bonds are triple tax they are widely held by some well-known mutual funds. The wider spreads in these names have lowered prices of these muni mutual funds that rely on Puerto Rico bonds for higher income (very important in a low interest rate environment.)

Puerto Rico issues bonds for energy

Though it has not borrowed in the bond market this year, the Commonwealth of Puerto Rico appears to have started by taking two loans from unnamed banks. Unfortunately we don’t have much information about these transactions, so the amount and purpose are unclear (July 9, July 29). The Puerto Rico Electric Power Authority (PREPA) has filed a bond offering that is expected to come to market on August 5th. Janney Montgomery’s Alan Schankel wrote about the deal:

For the first time in more than a year, we expect to see a new bond issue from Puerto Rico, in the form of $600 million Puerto Rico Electric Power Authority (Baa3/BBB/BBB-) with all three rating agencies affirming outstanding ratings. Pricing is expected next week.

What is PREPA?

The largest public power provider in the US, PREPA depends on fuel oil for 61 percent of its energy production. Although improved from a 73 percent share five years ago, this dependence on high cost fuel has stunted demand. Much of the utility’s capital investment plan, including $2.3 billion in the past 5 years, and $1.5 billion in the coming 5 years, is focused on conversion of energy production to natural gas, with oil projected to account for only 10 percent of fuel by 2017.

Who is the Development Bank of Puerto Rico’s rumored next president?

In the latest sign of Puerto Rico’s perilous financial footing, The Bond Buyer reported that the president of the Government Development Bank of Puerto Rico, Javier Ferrer, announced his resignation on Wednesday.

In this role Ferrer had the leading role overseeing and advising the debt of the Puerto Rico government and public authorities. The bank also lent to the government and authorities.

Puerto Rico Gov. Alejandro García Padilla announced that Joseph Pagan, currently executive vice president of financing at the GDB, will be the interim president.

Puerto Rico tweets about bankruptcy

The twitter handle for Puerto Rico’s executive branch is @fortalezapr. Here are some of the tweets from Thursday:

We are in pretty grim times when an investment grade government is tweeting about bankruptcy to encourage people to approve big tax and fee hikes.

Who is in line to finance the $2 billion for the Highway Authority? Good luck with that.

Is the U.S. Treasury bailing out Puerto Rico?

Puerto Rico budget negotiations for fiscal 2014 are in the final stretch for the year’s July 1 start date. A massive $1.5 billion difference between spending and revenues must be closed. Discussion has included expanding the commonwealth’s sales tax to services and transactions between businesses. Local businesses fought hard against this proposal, and eventually, Governor Garcia Padilla switched focus. Reuters explains:

[Puerto Rico Treasurer Melba] Acosta told reporters that policymakers had agreed to scale back by 73 percent the governor’s proposed sales-tax expansion, which was strongly opposed by local businesses. The expanded sales tax will be levied only on a small group of industries and will raise $287 million during fiscal 2014.

To make up for the lost revenue, the government will assess a business tax on gross sales on a sliding scale, depending on sales volume. It is expected to generate $522 million.

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