Puerto Rico’s fiscal crisis is spreading the wealth around Wall Street.
The commonwealth, grappling with a shrinking economy, paid banks led by Barclays Plc (BARC), Morgan Stanley and RBC Capital Markets $28.1 million in underwriting fees when it sold $3.5 billion of bonds on March 11, according to documents filed with regulators and released today. That’s $8.04 for every $1,000 of securities, up 27 percent from when Puerto Rico last sold bonds two years ago and still had an investment-grade credit rating.
Initial investors, including hedge funds that bought most of the tax-exempt bonds, saw gains of as much as 7.5 percent during the first two trading days. Puerto Rico used $90 million in proceeds from the sale to pay Bank of America Corp., Morgan Stanley and other banks for breaking derivatives contracts.
The figures show how banks and investors are profiting from the financial distress of the island of 3.6 million people. Puerto Rico, which has had persistent budget deficits, raised taxes, fired workers and had its credit rating cut to junk.
“Puerto Rico’s ability to push off default and multiple ratings downgrades hinged entirely on this transaction,” said Matt Fabian, an analyst for Municipal Market Advisors, the Concord, Massachusetts-based research company. “I can’t remember an issue when an issuer’s credit rating hinged so exclusively on a single deal.”
The underwriting fees reflect increased risk to the banks handling the sale, including the possibility that they could have been stuck with bonds if they couldn’t sell them.
“Puerto Rico as an issuer is just a magnet for bad news,” Fabian said. “This was a very high risk transaction.”
The sale gives Puerto Rico enough money to pay bills through June 2015, easing speculation about its solvency that helped fuel losses in the municipal market last year. As a result, Standard & Poor’s today removed Puerto Rico from its list of borrowers at risk for an imminent cut to their credit ratings.
“The sale will relieve near-term liquidity pressure,” said David Hitchcock, an S&P analyst, in a statement.
The bonds priced to yield 8.73 percent, twice as high as top-rated municipal securities.
The increase in underwriting fees contrasts with the rest of the municipal market, where those costs have fallen amid competition from banks. Even so, Puerto Rico paid less than other low-rated borrowers. The average fee for junk-ranked municipal debt is $13.83 per $1,000 so far this year, according to data compiled by Bloomberg.
Mark Lane, a spokesman for London-based Barclays, declined to comment. Mark Lake, a spokesman for New York-based Morgan Stanley (MS), and Sanam Heidary, a spokeswoman for RBC, a unit of Toronto-based Royal Bank of Canada, both declined to comment ahead of the filing and didn’t immediately return calls seeking comment today.
The underwriters marketed the securities to non-traditional buyers of municipal bonds, including hedge funds.
Underwriters raised the size of the sale by $500 million after receiving orders for about $16 billion of bonds, about five times what were initially offered. The yields were also lower than the expectations of some investors, who last month speculated that Puerto Rico would have to pay yields of 10 percent or more to attract buyers willing to take on the risk.
“The pricing became a lot better than what maybe the talk was some time ago,” said David Chafey, chairman of the Government Development Bank. “Puerto Rico is saving quite a bit of money with the improvement of price in the last few weeks.”
The cash infusion hasn’t ended Puerto Rico’s financial struggles.
Governor Alejandro Garcia Padilla, who oversees a $9.8 billion budget, may need to cut spending by $1.5 billion or more in the next budget year, according to bond documents. Last year, he increased the retirement age to save on pension spending, froze benefits and required employees to increase their contributions.
Fabian said the borrowing buys Puerto Rico some time to seek ways to fix its long-running budget shortfalls.
“They have stepped out of the woods, but they could easily be dragged back in,” he said.
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