Popular because of its triple tax-free status, Puerto Rico's
outstanding debt totals $70 billion, or nearly four times the $18
billion owed by bankrupt Detroit. Some 70 percent of mutual funds
dedicated to tax-free bonds own Puerto Rico bonds, according to
But the ratings cut by S&P, which came in the closing minutes of
trading on Tuesday, could sap investor interest, despite the high
yields offered by Puerto Rican bonds.
"The island will need to borrow relatively soon to meet its
obligations, and it may well find it difficult or impossible to
access the market for financing," said Peter Hayes, head of
BlackRock's Municipal Bonds Group.
Puerto Rico officials said after the ratings cut, which opens the
government to as much as $940 million in penalties tied to swaps and
other securities, that they are studying financing options and
instituting cost savings.
In San Juan, Puerto Rican Governor Alejandro García Padilla said on
Wednesday he would seek to renegotiate swaps agreements and other
loans that will require accelerated payments.
The island last sold bonds in August and has, according to sources,
considered a possible $2 billion financing by institutional
investors organized by Morgan Stanley, bond deals and loans by banks
on the island.
The downgrade "calls into question whether they'll be able to bring
those offerings to the market," said Dan Heckman, senior fixed
income strategist at U.S. Bank Wealth Management. "It just continues
to drive their interest expense higher and higher."
Some of Puerto Rico's bond yields now top 10 percent in secondary
Puerto Rico is not likely to get much help from Washington; the
White House reiterated on Wednesday that it was not considering a
bailout for the cash-strapped commonwealth.
Bill Delahunty, director of municipal bond research at Eaton Vance
Corp, said there are many questions that still need to be answered
before Puerto Rico can come to market. For example, investors will
key on the bonds' interest rates and credit ratings before deciding
if they will be buyers.
Likely buyers were high-yield funds with little or no current
exposure and hedge funds, Delahunty said. He declined to discuss his
firm's investment strategy, but said that mutual funds and other
traditional buyers were unlikely to be able to absorb all of the
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Lyle Fitterer, municipal bond fund manager at Wells Capital
Management, said he would be reluctant to participate in a bond sale
if and when Puerto Rico comes to market.
"At the general obligation (GO) basis we would not unless there is
some sort of specific revenue pledge that would come with the
structure or some security package that would go above and beyond
the GO pledge and assign some sort of ... tax."
Even so, he said that investors who were inclined to buy new Puerto
Rico debt would be little influenced by S&P's downgrade.
"Most people consider it to be a non-investment grade credit, and I
think at this point, if you're buying it, you better be putting it
in a place that takes non-investment grade risk," Fitterer said.
A big investor in Puerto Rico that now looks like an unlikely buyer
of the commonwealth's debt would be the Franklin Double-Tax Free
Income Fund, run by Franklin Resources Inc. Last year, the fund's
exposure to Puerto Rico topped 60 percent, according to Lipper Inc
Since the end of July 2012, the fund's net assets have shrunk to
$363 million from nearly $900 million. Franklin Resources was not
available for comment.
S&P's rating announcement, which may be followed by similar
downgrades by Moody's Investor Service and Fitch Ratings, had muted
and mixed effects on Puerto Rico bond prices Wednesday despite fears
of heavy selling on a downgrade.
"Puerto Rico's bonds have been already trading in distressed
territory since August 2013," Citigroup Markets analysts said in a
commentary. "The downgrade seemed to have been largely priced in."
(Additional reporting by Karen Pierog in
Chicago, Tim McLaughlin in Boston, Lisa Lambert in Washington,
Hilary Russ and Edward Krudy in New York, and a Reuters
correspondent in San Juan; editing by Leslie Adler)
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