Puerto Rico Swap at Record Cost as Investors Await Payment

Jul 01, 2014 11:40 am ET

(Updates with bond pricing in second and 13th paragraphs.)

July 1 (Bloomberg) -- Investor confidence in Puerto Rico’s ability to repay debt is sinking as the cost to protect commonwealth bonds against default has more than doubled since June 12 to the highest ever.

Puerto Rico Electric Power Authority bondholders are awaiting payment today on maturing debt after legislators last week enacted a law meant to allow some government entities to restructure outside bankruptcy. A revision of Prepa’s $8.6 billion in debt would be the largest ever in the $3.7 trillion municipal-bond market. Prices on some Prepa bonds increased today, data compiled by Bloomberg show.

Prepa’s trustee, U.S. Bancorp, has the money for today’s payment on $204 million in bonds, David Millar, a New York-based spokesman for the Government Development Bank, the commonwealth’s financial agent, wrote in an e-mail this week. He didn’t return an e-mail and a phone call today. Juan Alicea- Flores, Prepa’s executive director, didn’t immediately return an e-mail and phone call seeking comment on any payment.

Even with the money, the trustee can withhold funds if it believes Prepa needs them for legal fees or other expenses, said Lyle Fitterer, who helps manage $33 billion of munis at Wells Capital in Menomonee Falls, Wisconsin, among them some of the bonds due today.

“As the trustee in a distressed situation, they can make a decision whether it’s prudent to pay it out or not,” Fitterer said.

Swaps Surge

The market reflects the uncertainty. It costs about $1.5 million annually, the most ever, to protect $10 million of commonwealth debt for 10 years through credit-default swaps, according to data provider CMA, which is owned by McGraw Hill Financial Inc.

The crisis reflects a broader malaise in the island commonwealth, whose tax-free debt is held in 66 percent of U.S. muni mutual funds. Puerto Rico’s economy has struggled to grow since 2006 and its unemployment rate of 13.8 percent is more than double the U.S. average. About 45 percent of its residents are in poverty, according to U.S. Census data. The commonwealth for years has borrowed to keep its government functioning, and investors hungry for the rewards of risky debt kept lending.

Legal Challenge

Puerto Rico has a grade of Ba2 from Moody’s Investors Service, two steps into speculative territory.

The utility must file a nonpayment notice with the Municipal Securities Rulemaking Board, a self-regulatory organization that monitors the market, “in a timely manner,” according to bond documents. Abimael Lisboa Felix, a Prepa spokesman, didn’t return e-mails seeking comment on its plans.

Teri Charest, a spokeswoman for Minneapolis-based U.S. Bancorp, and Bari Trontz, spokeswoman at New York’s Depository Trust & Clearing Corp, which transfers payments from bond trustees to bondholders, declined to comment on the payment.

The commonwealth’s sole electricity provider has a rating of Ba3 from Moody’s. Of Prepa’s debt, 70 percent isn’t covered by bond insurance, data compiled by Bloomberg show. Prepa owes more than the $8 billion of general obligations and water-and- sewer debt in Detroit’s record bankruptcy and the $4.2 billion that led to the failure of Jefferson County, Alabama.

Bonds Rise

Governor Alejandro Garcia Padilla signed the debt- restructuring bill June 28. It allows certain public corporations to negotiate with bondholders to lower debt loads. San Mateo, California-based Franklin Funds and Oppenheimer Rochester Funds in Rochester, New York, filed suit after the governor signed the bill. Puerto Rico has 21 days to respond.

Prices on some Prepa debt increased today after falling in the past week. Uninsured Prepa bonds maturing July 2040 traded today at 11:10 a.m. at an average 44.1 cents on the dollar, up from 41.4 cents yesterday and down from 51.9 cents on June 25, the day that Garcia Padilla filed the restructuring bill.

Fitch Ratings last week dropped Prepa to CC, its third- lowest speculative grade. S&P and Moody’s also give the utility a junk rating.

The restructuring legislation “may be the best path for Puerto Rico leadership to pursue since there is little sign of the economic growth necessary for Puerto Rico to work its way through its mountain of debt,” Alan Schankel, managing director at Janney Montgomery Scott LLC in Philadelphia, wrote in a June 30 report. “And Prepa’s severe liquidity problems create an urgency which must be addressed.”