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Bates Research  |  07-11-14

PREPA and Puerto Rico

Note: If you missed our interim post last Wednesday on recent developments in Puerto Rico, it can be found here. Please take a moment to review it before reading the updates below.

So far, 2014 has been a good year for municipal investors, who are up 5.6% year-to-date, compared to investors in high-rated corporate debt (4.8%) and Treasuries (2.1%). However, the situation in Puerto Rico could mark a dramatic turn for municipal investors, who must once again face declining price pressure on the island's bonds.  Prior to the announcement of the Recovery Act, the price return on Puerto Rico bonds had made them the strongest performing component within municipal markets, a trend which may now take a turn back toward 2013 levels, when Puerto Rico debt struggled.

Puerto Rico Electric Power Authority (PREPA) bonds traded at record low ranges, from 37-41 cents on the dollar, indicating strong concerns as to whether they will continue to make debt payments rather than using the newly available restructuring options. The situation intensified for PREPA as it negotiated an extension on $800 million in credit lines with Citigroup and other lenders. According to a PREPA statement, its lenders have "have agreed to not exercise remedies as a result of credit downgrades and other events,” as well as extending currently due payments to July 31. While the extension is good news for PREPA's ongoing operations, markets have been unimpressed by the modest amount of additional time given to the company. Fitch and Moody's previously downgraded PREPA to CC and Caa2 (from BB and Ba2 respectively) in the wake of the Recovery Act announcement, but the latest news caused S&P to drop PREPA from BB to B-, a four notch move. Fitch has also responded, but has made a stronger statement, downgrading Puerto Rico to BB- rather than lowering PREPA's rating further.

Losses for mutual fund investors continued as well; the Franklin Double Tax-Free Income Fund (FPRTX) traded down to $9.10, the lowest level since its creation in 1985. There have been no new developments in the lawsuit filed by Franklin and Oppenheimer Funds since we blogged about it last week.