Puerto Rico Debt Bill Sends Yields to Record Highs: Muni Credit

Jun 26, 2014 2:27 pm ET

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June 26 (Bloomberg) -- Yields on Puerto Rico electric bonds soared to record highs after Governor Alejandro Garcia Padilla filed legislation yesterday enabling debt restructuring of some public corporations.

Puerto Rico Electric Power Authority securities maturing July 2017 traded at an unprecedented average yield of 20.6 percent, equivalent to 66.4 cents on the dollar and up from 12 percent when they last changed hands in April, according to data compiled by Bloomberg. Prepa, struggling with $10 billion of debt, is seeking to extend lines of credit with banks and could be one of the first borrowers to rely on the plan.

The proposal would allow public utilities such as Prepa and the Puerto Rico Aqueduct and Sewer Authority to negotiate with bondholders to reduce their debt loads. While the bill excludes general-obligation bonds and debt backed by sales-tax revenue, those securities may also face restructuring if Puerto Rico’s economy fails to improve, said Shawn O’Leary of Nuveen Asset Management, which oversees $92 billion of munis.

“If you’ve been bullish on Puerto Rico up to this point, part of your thesis has been that they have a strong willingness to pay their debt,” O’Leary, a senior research analyst in Chicago, said in a telephone interview. “Clearly today’s legislation proves otherwise.”

Struggling Economy

Debt sold in Puerto Rico lost 0.37 percent yesterday, compared with a 0.15 percent gain for the broader muni market, according to S&P Dow Jones Indices.

Puerto Rico, with an economy that’s struggled to grow for eight years, and its agencies owe $73 billion of debt, with about 66 percent of U.S. muni mutual funds holding the securities, according to Morningstar Inc. The debt is so widely held because it’s tax-exempt nationwide.

The three largest ratings companies cut the commonwealth’s general-obligation bonds to speculative grade beginning in February and followed with similar downgrades to its utilities.

Investors have been anticipating a potential debt restructuring since August on concern that the island of 3.6 million would be unable to repay its obligations. Its unemployment rate of 13.8 percent is more than double the U.S. average.

‘Desperation Move’

While Garcia Padilla has said his administration will pay off its $10 billion of general obligations on time and in full, O’Leary said investors should be wary that the scope of a restructuring may extend beyond the public corporations because of the depths of the island’s economic challenges.

“This is a desperation move,” O’Leary said. “What it signals is that when they get into trouble, they may not honor all their obligations.”

The legislature is set to pass the measure within the next few days, David Chafey, chairman of the Government Development Bank, which works on the commonwealth’s debt sales, said in a conference call with reporters. He declined to say which government entity is most in need of changing its debt structure.

The bill allows public corporations to negotiate with investors for a period of nine months once 50 percent of bondholders agree to begin discussions about debt changes, Treasury Secretary Melba Acosta said during the call. Any restructuring would require approval of 75 percent of bondholders, she said.

Prasa’s Debt

If the parties fail to reach an agreement within that timeframe, a Puerto Rico court would then oversee the process, Acosta said.

The legislation allows public entities that are in financial stress to continue providing core services to Puerto Rico residents while addressing debt loads, Chafey said.

“It provides a clear legislative framework for certain public corporations that are experiencing severe financial stress to work on their financial obstacles so they may continue providing essential services ensuring the health, safety and welfare of Puerto Rico,” Chafey said.

Prasa, the water and sewer agency, has about $4.5 billion of debt and Puerto Rico Highways & Transportation Authority has $7 billion, Chafey said.

Garcia Padilla, who took office in January 2013, has been pushing for Prepa and other public agencies to become self- sufficient and not rely on the commonwealth’s operating budget, which has struggled with deficits for years.

‘Ring Fence’

Even if Puerto Rico’s public corporations reduce their debt levels and operate without subsidies from the government, the commonwealth and its agencies still face the challenge that the island’s economy needs to grow substantially to help alleviate its fiscal stresses, said Joseph Rosenblum, director of municipal credit research in New York at AllianceBernstein LP, which manages about $30 billion of munis.

“Even though they’re trying to sort of ring-fence these public corporations, there is still overlapping relationships,” Rosenblum said in a telephone interview.

The exclusion of general obligations and sales-tax debt from the measure “affirms the relative strengths of those credits and the market’s acting accordingly,” said Chad Farrington, head of municipal research in Boston at Columbia Management Investment Advisors, which oversees $30 billion of munis.

Puerto Rico general obligations sold in March and maturing July 2035 traded yesterday at an average price of 88.1 cents on the dollar, up from 86.4 cents the day before, Bloomberg data show.

Gains in Puerto Rico’s general obligations may not last considering the governor’s bill would force investors to accept lower payments as part of their contribution to the island’s recovery, John Miller, co-head of fixed income at Nuveen, said in a telephone interview.

“They have financial problems and they’re saying bondholders are going to be part of the solution--not getting paid in full,” Miller said.