Puerto Rico Drops to Level Unprecedented for Bonds: Muni Credit

Photographer: Nikki Kahn/The Washington Post via Getty Images Tourists meander through Old San Juan in Puerto Rico.

No state or city with a credit rating as low as Puerto Rico’s has been able to access bond markets since at least 1990, a situation that may cut off the lifeblood of the commonwealth’s finances.

On July 1, Moody’s Investors Service cut the island’s rating to B2, five steps below investment grade. No local government has borrowed at that level, according to data compiled by Bloomberg. Prices on its general-obligation debt yesterday plummeted to record lows.

“They’re done,” said Matt Dalton, chief executive officer of White Plains, New York-based Belle Haven Investments, which oversees $2.1 billion in munis. “They’re not going to be issuing any more debt on the island. I don’t see how they can bring people back to the trough at this point.”

Puerto Rico and its agencies have operated for years on borrowed money — racking up $73 billion, Bloomberg data show — and Wall Street made $910 million since 2000 by structuring its debt sales. If the government can’t sell bonds at affordable rates, it will have to curtail services for its 3.6 million residents, 45 percent of whom live in poverty.

Closed Classrooms

Like U.S. states, Puerto Rico can’t file for bankruptcy protection. Without the ability to issue debt, it will have to limit all spending to preserve money for health, public safety and education, said Sergio Marxuach, policy director at the Center for a New Economy, a research group in San Juan that focuses on economic development.

The commonwealth had already begun closing about 100 schools to help balance the fiscal 2015 budget.

“We need to have guards in prisons,” Marxuach said. “We need to have public-school teachers teaching.”

Anything else, he said, “could be fair game.”

Governor Alejandro Garcia Padilla this week signed the $9.6 billion budget. Education consumes the largest portion, with about $2.1 billion of spending, followed by $885 million for health insurance for the poor, according to the commonwealth’s Office of Management and Budget documents. About $752 million will go toward police.

‘Onerous Terms’

Puerto Rico’s economy has contracted about 11 percent since 2006, according to its Planning Board. The unemployment rate of 13.8 percent is more than double the U.S. average.

Still, returns generated by the island’s risky debt made investors eager to lend and allowed the commonwealth to paper over budget gaps. The securities, which are tax free in all states, are held in two-thirds of muni mutual funds.

Puerto Rico securities lost 3.4 percent yesterday, the biggest one-day drop since Dec. 26, 2008, according to S&P Dow Jones Indices. Included in the decline were general-obligation bonds maturing July 2035. They originally sold at 93 cents on the dollar in March and traded yesterday at an average 84.8 cents, a record low, data compiled by Bloomberg show

Without the ability to borrow easily, Puerto Rico’s headwinds can only increase, said Dan Toboja, senior vice president of municipal trading at Chicago-based Ziegler Capital Markets.

“If you can’t access the capital markets except for the most onerous terms, it’s going to be a challenge that’s going to accelerate problems,” Toboja said.

Going Dark

The commonwealth is trying to put the brakes on. Garcia Padilla last week signed a bill that allows some public corporations to restructure debt outside bankruptcy. While the governor promoted the move as a way to protect general-obligation debt, creditors took it as an affront. Franklin Templeton Investments and Oppenheimer Funds Inc. are challenging the law. The Moody’s downgrade followed.

The Puerto Rico Electric Power Authority, which provides almost all the island’s electricity and is a prime candidate for restructuring, may have to choose between paying bondholders and keeping the lights on, Marxuach said.

The utility, which carries $8.6 billion in debt, paid investors for maturing bonds July 1. It now faces $617 million of bank lines of credit that expire this month and next.

Prepa, as the agency is known, may have to implement rolling blackouts on residential customers so hospitals, schools and businesses can function, Marxuach said.

Live Wires

“That will be a shock to many people,” Marxuach said. “It will bring home to a lot of people the magnitude of the crisis we’re going through.”

Juan Alicea Flores, Prepa’s executive director, said in a prepared statement that officials would evaluate all options.

“Prepa will continue to produce and deliver power, just as it always has,” he said.

The Moody’s downgrade affected $14.4 billion of general-obligation debt. The New York company also dropped sales-tax bonds to junk, cutting senior-lien securities to Ba3, three levels below investment grade, from Baa1. It downgraded subordinate bonds to B1, four steps below investment grade, from Baa2. The change affects $15.6 billion of obligations and strips Puerto Rico of any way to borrow at investment-grade prices.

“Remember that this is the same credit-rating agency that said Enron was AAA,” Garcia Padilla said at a news conference yesterday in San Juan.

Solutions for the crisis on the island, which was ceded to the U.S. in 1898 after the Spanish-American War, aren’t easily forthcoming. In Washington, there is little zeal to help.

Unpromising Situation

Stephen Myrow, managing partner at Beacon Policy Advisors LLC and a former U.S. Treasury Department official, said there is little the agency or the Federal Reserve can do.

“They are looking at the existing programs to figure out what funds are available, but the problem is such funds are far outsized by the actual financing gap,” he said. “The only federal government assistance available and capable of staving off a restructuring in theory would be some special Fed program. But there is no indication that the Fed has any appetite to do that.”

Treasury spokeswoman Brandi Hoffine and National Economic Council spokeswoman Jen Friedman didn’t have immediate comments on the island’s situation.

Futile Pursuit

Any congressional bailout would be difficult because of anger over federal rescues of Wall Street and the U.S. auto industry.

Pedro Pierluisi, the commonwealth’s single non-voting representative in Congress, said he hasn’t asked for one, nor does he plan to.

“I don’t see fertile grounds,” the Democrat said.

Republicans in the House of Representatives and Senate have introduced legislation that would block the Treasury or Fed from bailing out municipalities. They are intended to cover commonwealths, too, said Luke Bolar, a spokesman for Republican Senator David Vitter of Louisiana, who sponsored the measure.

“By no means should the federal government be in the business of bailing out state and local governments that are in the red,” Vitter said on the Senate floor in April. “These governments must make hard choices.”

One choice would be to default on bond payments. Arkansas was the last state to do so, failing to pay in 1933 after taking responsibility for debt from hundreds of road districts before the Great Depression struck.

To contact the reporters on this story: Michelle Kaske in New York at mkaske@bloomberg.net; Brian Chappatta in New York at bchappatta1@bloomberg.net

To contact the editors responsible for this story: Stephen Merelman at smerelman@bloomberg.net Mark Schoifet