Todd L. Hagerman and Robert Greene of Sterne Agee, analyze the latest news about Puerto Rico in a new research note. Below is their latest commentary (also check out Cate Long’s comments for some always great analysis on munis).
The Puerto Rico Government is in the final stages of closing a record $3B general obligation bond issue in line with investor expectations. While the deal is not without material risks, our sense is the principal structure of the deal, including an estimated two-year fiscal funding buffer, and the scarcity of high-yield debt issuance from the Commonwealth will likely fuel excess demand from investors. Accordingly, this is expected to allay investor fears surrounding the Commonwealth’s fiscal woes, which, in turn, should drive investors back into the heavily discounted banks on the island.
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The pending ~$3B general obligation (GO) Puerto Rico bond issue is in line with investor expectations and is expected to provide at least a two-year funding/liquidity backstop as part of the government’s planned closure of the budget gap in fiscal ’15, one year ahead of plan. Given expectations for high investor demand, the attached yield has reportedly dropped below double digits into the +8% area–still attractive by any means. We note, however, an important provision that may influence the final pricing of the deal: a potential “claw-back” provision if the Commonwealth’s financial condition does not improve. As a result, the remedies/related actions are generally tied to either potential bankruptcy proceedings and/or legal action against the Commonwealth’s Treasury Secretary. This falls under a new provision that provides for the laws of New York to govern any action tied to the bonds. Accordingly, this would potentially affect the enforceability of the Commonwealth to make payments on the bonds. That said, it remains unclear how a New York court would rule on a Commonwealth of the U.S. The transaction is expected to price shortly and close the week of March 17.
Our review of the preliminary Puerto Rico prospectus notes both potential positives and negatives. While the potential risks are blanketed with standard caveats surrounding the uncertainty of the underlying economy, necessary liquidity, budget projections, and potential future funding needs, there are positives. These include a detailed liquidity and cash flow report dated March 5 which provides a comprehensive overview of the GDB’s current and forecast liquidity position. The forecast includes plans to repay 17%, or $1.7B, of outstanding debt of the Commonwealth (deficit financing) and Public Buildings Authority made by the GDB. Importantly, the budget assumes that no additional deficit funding is required in fiscal ’15 as the balanced budget is achieved under the current proposal.
Potential negatives include 11 pages of potential risks: potential issues tied to ’15 budget needs (fiscal gap assumptions), potential restrictions on government guarantees, required pension funding, and a concentration of a small number of corporate taxpayers that provide a significant amount of the Commonwealth’s tax revenues. Conversely, the prospective issue is not expected to have any bearing on the rights and obligations of current outstanding bond obligations of the Commonwealth.
On balance, the pending bond issue removes pressure from rating agencies and allows additional time to demonstrate sustained improvement in the Puerto Rico economy as well as the timely closure of the outstanding budget deficit. Moreover, while the deal is not without material risks, the bond issue (de facto bailout) will likely allay investor fears surrounding the Commonwealth’s fiscal challenges. To that end, as government fiscal concerns are addressed, individual catalysts are likely to accelerate for each of the banks. We remain buyers of each of the Puerto Rico banks including Popular Inc (NASDAQ:BPOP) , First Bancorp (NYSE:FBP) and OFG Bancorp (NYSE:OFG).
