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Bates Research  |  10-10-14

More Detail on New Puerto Rico Debt

Additional details on Puerto Rico's planned debt issuance came out this past week. Previously, we reported that Puerto Rico would enter markets within the next month and issue $900 million in Tax and Revenue Anticipation Notes (TRANs). On Monday, Puerto Rico's Senate voted to allow the sale of $1.2 billion in TRANs, a measure which had previously passed the House and is now at the Governor for approval. The amount is higher than we initially thought (though the Government Development Bank in Puerto Rico will purchase the extra $300 million), and while the vehicle will still be TRANs, there are some other key differences from our initial expectations.

Readers of our previous post will recall we speculated that hedge funds would once again be primary purchasers of any new issuance, but it looks like they won't have that opportunity. Under the new debt agreements, banks (JPMorgan, Morgan Stanley, Barclays, Bank of America, etc.) will be the sole buyers of the new debt. Normally these entities would then sell the debt to other market participants, but in this case they have agreed to hold the debt until maturity in June 2015. For keeping the debt on their books, they will be paid a coupon rate of 7.75%, which may explain why the banks are willing to hold the below-investment-grade debt on their balance sheets (something they would normally be reluctant to do because of regulatory capital requirements). The banks may also be hoping to earn underwriting opportunities on future Puerto Rican debt issuance via goodwill for participating in this deal. We were correct in anticipating that the bonds would once again be governed by New York state law, just like the previous issuance, affording investors some additional comfort in the case of a default event.

The unusual deal structure is an attempt by Puerto Rico to avoid the heavy churn in their issuance they experienced the last time they raised debt in March. Those bonds traded hands approximately 2,600 times over the next month, a much higher rate than a California bond sale that same month which only traded about 700 times. The heavy volume drove prices down, which then recovered over the next couple of months. So far the announcement of the TRANs deal has not sent Puerto Rico's GO bond prices down.

Separately, this week also brought about new developments for existing Puerto Rico debt. As a result of the Puerto Rico Recovery Act, some public entities will now have access to a bankruptcy-like process. Of those that have access to this new process, the Puerto Rico Electric Power Authority (PREPA) has gotten the most attention. PREPA previously selected Lisa Donahue of AlixPartners as its chief restructuring officer, charging her with creating a turnaround plan for the utility and negotiating with its current creditors. After the hire was announced, PREPA bonds were downgraded to Caa3 from Caa2 by Moody's, citing uncertainty of the restructuring plan and doubt as to whether it could keep acquiring temporary forbearance from its creditors. Long-dated PREPA bonds fell to an average of 59 cents on the dollar, with final recovery rates estimated at somewhere between 65 and 80 cents. PREPA has until mid-December to come up with a new business plan, and until March 2015 to come up with a complete debt restructuring plan.

A clear direction for Puerto Rico debt is still emerging, as the future state of the economy (and certain public entities) remains uncertain. While that uncertainty is beginning to weigh on bond prices, so far the island has been able to find new money in order to buy its economic plans time to gain traction. This latest deal will help them to diversify their funding base away from a hedge-fund-only audience (who have been problem creditors for Argentina), but it only raises enough capital to close funding needs for expenses due this year.