Puerto Rico Closing In on Record Speculative-Grade Muni DealBrian Chappatta and Michelle Kaske
Puerto Rico is closing in on what may be a record sale of junk-rated municipal bonds as the struggling U.S. commonwealth plans to issue debt to allay Wall Street doubts that it can access capital markets.
The general-obligation deal will take place by mid-March, Government Development Bank Chairman David Chafey said today in an interview in San Juan. The sale, through Barclays Plc, Morgan Stanley and RBC Capital Markets, will refinance debt and raise cash, according to the GDB. Officials plan to borrow $2 billion through bonds, though lawmakers are working on a bill authorizing as much as $3.5 billion of general obligations, according to General Assembly Representative Rafael Hernandez.
If the deal exceeds $1.2 billion, it would be a record junk borrowing in the $3.7 trillion municipal market, eclipsing an offer last year from the Iowa Finance Authority. Standard & Poor’s, Moody’s Investors Service and Fitch Ratings cut the island to speculative grade in the past week, citing limited access to bond markets and an economy that has contracted in six of the past seven years.
After the rating reductions, “you have the loss of investment-grade mutual funds and the question becomes where demand comes from,” said Matt Fabian, a managing director at Concord, Massachusetts-based research firm Municipal Market Advisors. “You’re relying on opportunistic investors and high-yield funds.”
The island of 3.6 million people has an outsized impact on the municipal market because 70 percent of local-debt mutual funds own commonwealth securities, which are tax-exempt nationwide, Morningstar Inc. data show. Commonwealth securities have traded at yields consistent with speculative-grade bonds since at least September, luring buyers such as hedge funds.
The rating cuts may block investment-grade funds from adding the territory’s bonds, even as Puerto Rico lawmakers have reduced pension benefits, increased taxes and trimmed budget gaps in attempts to stave off downgrades.
“We have completed significant measures in the past month to improve our fiscal health and are ready to access the market with a new issuance of G.O. bonds,” Chafey said in a statement today. The bank will hold a webcast with investors on Feb. 18.
Governor Alejandro Garcia Padilla, 42, who took office in January 2013, said he would release a budget for next fiscal year that doesn’t rely on deficit borrowing, ending a practice used in every spending plan since at least 2000.
Puerto Rico’s debt load doubled from 2003 to 2012 as it borrowed to fill deficits, GDB data show.
“Decades of fiscal irresponsibility can’t be fixed in 12 months,” Garcia Padilla said at a press conference in San Juan last week after the S&P cut. “We did everything we could.”
Fitch acknowledged the efforts in its decision today to cut the rating.
“Puerto Rico’s G.O. pledge is unusually strong,” Fitch said in its report. “Current management has repeatedly shown its ability and willingness to take quick action to address financial challenges and external market concerns.”
Bill Black, who runs Invesco Ltd.’s $5.9 billion high-yield muni fund from Downers Grove, Illinois, said he’s interested. Dan Solender, director of munis at Lord Abbett & Co., and Chad Farrington, head of muni research at Columbia Management Investment Advisors, also said they would consider buying.
“We are on the list of potential buyers,” Black said at a breakfast with reporters today in New York.
The rating companies dropped the commonwealth’s grade because of concern that the island’s economy couldn’t grow fast enough to cover a debt burden totaling $70 billion. In a 2013 Moody’s study of state debt loads, only California and New York had more gross tax-supported obligations.
Puerto Rico securities lost about 20 percent last year, the most since at least 1999, and about eight times more than the decline for the entire market, S&P data show.
S&P on Feb. 4 lowered Puerto Rico’s general obligations one level to BB+, the highest speculative grade. Moody’s and Fitch followed, cutting the debt two steps below investment grade.
The downgrades are poised to realign $13 billion of debt in Barclays indexes that serve as benchmarks for most muni mutual funds. Puerto Rico will comprise 21 percent of Barclays’ high-yield index, up from 5 percent, the company said in a report last week.
The planned general-obligation deal will be Puerto Rico’s first since a 2012 offer of about $2.7 billion, data compiled by Bloomberg show. The island’s electric power authority was the only issuer to borrow last year.
High-yield bonds have beaten the broader market this year, returning 3.1 percent to the 2.3 percent gain for all munis, S&P data show. Puerto Rico debt has advanced 1.9 percent.
Some of its general obligations have joined in the high-yield rally since the downgrades began.
Bonds maturing in July 2041 traded today with an average yield of 8.15 percent, down from 8.45 percent on Feb. 3 and close to the lowest since November, Bloomberg data show. The bonds yielded about 5 percent a year ago.
The new obligations would probably have to yield from 8 percent to 9 percent to attract enough buyers, said Black, Farrington and Solender. All three oversee high-yield funds.
Puerto Rico had considered other ways to access the market, such as creating a new segment of bonds issued through its Sales Tax Financing Corp., known by the Spanish acronym Cofina.
Using that debt may have lowered borrowing costs, said Solender, who oversees $15.5 billion of munis. It also could have delayed a deal because investors would need more time to understand the pledge backing the bonds, he said.
While a bond sale may prove that the island can finance itself through capital markets, officials still face the challenge of reviving a shrinking economy.
An index tracking the island’s economic activity has contracted in six of the last seven fiscal years, according to the GDB. The 15.4 percent jobless rate in December was a two-year high, and exceeded the level in all U.S. states.
Brandon Ashcraft, a spokesman at Barclays in New York, declined to comment, as did Lauren Bellmare, a spokeswoman at New York-based Morgan Stanley. Sanam Heidary, a spokeswoman at RBC Capital, didn’t return an e-mail seeking comment on the offering.