Clients May Want Another Look at Puerto Rican Bonds After the Dust Settles

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With Puerto Rico’s financial future still uncertain, some members of the buy side community say they see potential investment opportunities in the event of a comprehensive debt restructuring.

That may be welcome news for advisors whose clients have suffered losses from their investments in Puerto Rico debt. Among the most impacted are UBS clients, who have sought to recoup on their investments since the market for the island's municipal bonds suffered steep price declines in 2013.

David Tawil, president of Maglan Capital, who stopped investing in the island commonwealth about two years ago, said opportunity could arise from the ashes of the current debt debacle if investors see balance sheet relief and improved liquidity.

“When it’s all said and done, if there is a restructuring, people will be able to invest in it,” the manager of the $80 million hedge fund said on Thursday. “It might be a high coupon, and it might be high yield, but I would go back if the fundamentals are sound enough.”

Tawil said time is of the essence for the island, because it needs to secure a restructuring plan before the Federal Reserve Board decides to continue its rate hike cycle.

“In this environment, people are going to flock to 8% or 9% yields, and the island could create a sound business plan to shoulder that type of debt at those types of rates” versus issuing double-digit bonds, Tawil said.


“They should move as fast as they can because once the Fed continues to move on interest rates this will become an increasingly difficult situation,” he said. “Getting [a restructuring] done now is really imperative.”

Others, meanwhile, are still investing in the commonwealth’s debt, albeit selectively, as they await the outcome of the island’s potential restructuring plan.

Shawn Burgess, portfolio manager and fixed income analyst at Cumberland Advisors in Sarasota, Fla., said he continues to purchase insured Puerto Rico paper for his $100 million Cumberland Specialized Insured Puerto Rico Strategy while anticipating a possibility of a restructuring, as well as federal intervention.

Both are inevitable, he said, to help cure the systemic fiscal problems that have resulted after decades of filling deficits with more debt.

With market access “deservedly” limited, the island will have to rely on intervention and aid under a restructuring plan to help calm its rough fiscal waters, according to Burgess.

“They have come to a point where they are going to have to restructure for the benefit of the island and their own people,” he said. “That’s where the ship is headed.”


Others, like Guy Davidson, director of municipal bonds at Alliance Bernstein, said the island’s debt load and contracting economy argue against investment in the commonwealth.

He is among investors erring on the side of caution and avoiding the island’s debt, even as they support a potential restructuring, along with federal aid and intervention.

Buy side analysts and managers said decades of poor borrowing patterns led to the commonwealth’s fiscal instability in recent years.

Their comments come as House members consider legislation to create a federal oversight board that would be responsible for restructuring and prioritizing Puerto Rico’s debt obligations and pension payments.

Davidson, who is steering clear of Puerto Rico debt, said the impact on the broader municipal market of a default and the restructuring are likely to be “negligible” based on recent data and pricing patterns.

“We believe that any contagion impact on the general muni market from a Puerto Rico default would be short-lived because of the limited supply of municipal bonds,” Davidson said in the report, “Puerto Rico: Restructure Needed,” he wrote with municipal credit analyst John Ceffalio.

Bonds issued by Puerto Rico only represent 2% of the municipal debt outstanding, and prices of Puerto Rico paper have moved independently from other non-island bonds over the past few years, Davidson said in a report this month.

“After largely moving in line with other municipal bonds through the financial crisis, an index of Puerto Rico bonds started to decline in 2013, while most municipals continued to gain,” Davidson wrote.

Given the island’s unsustainable debt load, and decade-long recession, the island faces a liquidity crisis that will force widespread defaults in coming months, according to Davidson.


“These defaults will trigger a myriad of new lawsuits, because Puerto Rico has no legal means to restructure,” he said. “The lawsuits would take years to resolve, creating more uncertainty, impeding economic recovery, and accelerating Puerto Rico’s debt spiral.”

The commonwealth’s nearly $70 billion debt on top of $44 million unfunded pension liabilities continues to weigh on a $69 billion economy. Its economy has shrunk nearly 14% since then and population declined nearly 9%.

The solution, he said, is for “issuers and creditors to have a define process for determining a timely – and ideally equitable – resolution.”

Congress could pass legislation that either grants or denies Puerto Rico, or its authorities, bankruptcy protection under Chapter 9. That measure would supersede any ruling by the Supreme Court, which last week heard arguments over a federal appeals court’s ruling striking down Puerto Rico’s debt recovery law for utilities.

“At this point, without further financial aid or some federal intervention federally or some other means to correct these systemic problems on the island, they will end up floating in the same sea” of choppy fiscal waters, Burgess of Cumberland said.

A restructuring, he said, seems inevitable because of the “forgone conclusion” of a future default.

“In our view you’re going to see further defaults either on those that already defaulted or other credits, Burgess said.

A restructuring, he said, provides the best outcome and influence on the island’s management and budgetary practices.

“The island has a long history of filling deficits with more debt and for decades investors have gladly bought their bonds,” he said.

Burgess says his insured Puerto Rico portfolio doesn’t own any uninsured island debt and has benefited from associated risk and negative headlines about the commonwealth.

He said the bonds in the portfolio, including COFINA, highways, and GO debt, have price stability and the insured paper has held steady.

His sights, he said, are on the future outcome of the restructuring.

Davidson of Alliance agrees. Puerto Rico and its creditors should support pending Congressional legislation, which includes imposing the financial control board and giving the island an avenue for restructuring, he said.

“Better financial controls and economic policies should be part of the solution too,” Davidson wrote. “The human and financial costs for Puerto Rico will likely escalate unless the situation is remedied.”

Serious reform, Tawil said, would offer new opportunities to rescue the struggling island from what he called an “abyss” and a “humanitarian crisis.”

“It’s possible to pull this out from the depths of where it is right now, but the situation needs movement and right now there is zero,” Tawil said. “Things are very difficult politically and legally and it is not served well or easily, so it becomes clear there’s no way the commonwealth can go forward without a massive restructuring.”

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