Puerto Rico Yields at Record High as Setbacks Mount: Muni Credit

By Michelle Kaske

(Bloomberg) -- Puerto Rico officials’ challenges are mounting as they seek to revive a struggling economy and reassure investors that the junk-rated island can pay its debts.

Yields on some commonwealth bonds climbed to records Monday after a judge threw out a debt-restructuring law that lawmakers passed last year. The steepening borrowing costs come at a crucial time for the U.S. territory: Officials want to sell $2 billion of petroleum tax-backed debt to pump cash into the Government Development Bank, which lends to the island and its localities.

Puerto Rico and its agencies have $73 billion of debt, more than all U.S. states but California and New York. Most of the securities are tax-free nationwide and held by investors around the country. General obligations maturing in July 2035 traded with average yields above 10 percent for a second straight day, the highest since they were issued in March 2014, data compiled by Bloomberg show. The securities changed hands for as low as 81 cents on the dollar.

The selloff is “putting pressure on liquidity for the commonwealth, which has implications for just about everything they do,” said Bill Black, who helps manage Invesco Ltd.’s $7.5 billion High Yield Municipal Fund in Downers Grove, Illinois.

Conflict Finding

U.S. District Judge Francisco A. Besosa ruled Feb. 6 that the restructuring law that Governor Alejandro Garcia Padilla signed in June would take away protections provided under federal bankruptcy code, presenting an “irreconcilable conflict.”

Puerto Rico plans to appeal the ruling, Secretary of Justice Cesar Miranda said in a statement Monday. The law would have allowed certain Puerto Rico agencies, such as its power utility, to negotiate with bondholders to reduce their debt. By strengthening the hand of those investors, the decision may leave less cash available for Puerto Rico general obligations, said Black at Invesco, which owns some of the utility debt.

“It is important that the commonwealth’s creditors, other constituents of political entities and the public interest that these entities serve, benefit from mechanisms necessary to adjust their debts in an orderly manner at an economic cost that is prudent and in the best interests of the commonwealth,” Melba Acosta, president of the GDB, said in a statement.

Bondholder Sway

Throwing out the law restores bondholders’ ability to force Puerto Rico and its agencies to raise taxes or electricity rates, cut staff and negotiate fuel contracts, said Daniel Hanson, an analyst at Height Securities LLC, a Washington-based broker-dealer.

“Puerto Rico is now in a meaningful position of weakness with respect to its bondholders,” Hanson said. “It forces the government’s hand in public-policy questions. They either make decisions that are bond-friendly or they’re forced to make decisions later on by courts.”

The Electric Power Authority, called Prepa, and a majority of its creditors signed an agreement in August that put off payment of bank loans and required the utility to file a debt-restructuring plan by next month. That contract ends March 31 and the agency has asked for a new June 30 deadline, according to two people with knowledge of the request.

The utility may default this year “because its financial position and liquidity remain very weak,” Moody’s Investors Service analysts wrote in a Feb. 9 report.

$8.6 Billion

Prepa, with $8.6 billion of debt, owes bondholders $400 million in principal and interest July 1, according to Janney Montgomery Scott LLC. A restructuring by the agency would be the largest ever in the $3.6 trillion municipal market.

The general-obligation yields above 10 percent reflect the risk that Puerto Rico might direct money to the agency to help resolve investor negotiations, leaving less for its general obligations, Black said.

“There’s only so much money to either go into the pockets of general-obligation holders or Prepa holders or other constituents of the commonwealth,” Black said.

The island’s securities have traded at distressed levels for more than a year as the flailing economy added to fiscal strains. An index tracking economic activity on the island has shrunk by 19 percent since 2006, according to the GDB. The jobless rate, at 13.7 percent in December, was more than double the national average.

Bankruptcy Bill

Pedro Pierluisi, Puerto Rico’s delegate in the U.S. House of Representatives, said in a statement Monday that the Garcia Padilla administration should work to give Puerto Rico agencies access to Chapter 9 of the U.S. Bankruptcy Code. Pierluisi, who can propose laws but can’t vote on them, filed a bill in July that would give commonwealth agencies that ability.

Puerto Rico needs to replenish the GDB’s balance sheet. The bank said it had about $1.1 billion of net liquidity as of Dec.

31. That’s 17 percent below its October projection, according to Moody’s Investors Service.

Proceeds from the petroleum-tax bond sale, which would carry Puerto Rico’s general-obligation pledge, would repay debt the Highways & Transportation Authority owes the GDB.

While commonwealth general obligations declined Monday, Prepa bonds gained, reflecting the increased leverage of those bondholders after the judge’s ruling.

Prepa bonds maturing in July 2040 traded at an average of 58.05 cents on the dollar, the highest since May.

“It definitely does shift the balance of power,” Black said.

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