Puerto Rico’s $3 billion bond sale scheduled to price this week could represent its last opportunity to stave off default as the debt-addled commonwealth initiates much-needed financial reforms.
Analysts view the sale as a bridge intended to allow Puerto Rico to cross from its current economic crisis to a period hopefully two years from now when fiscal reforms passed recently by the Puerto Rican legislature have had time to take effect.
“You can’t go all the way down into the valley of despair, you need a bridge over it."
- James Spiotto, MD at Chapman Strategic Advisors
If the reforms are unsuccessful and Puerto Rico’s economy continues to spiral out of control, then this week’s debt offering will only exacerbate the Caribbean island’s troubles.
James Spiotto, an expert in municipal bond offerings and managing director at Chicago-based Chapman Strategic Advisors, said that by issuing these bonds, Puerto Rico is hoping to ensure the government has sufficient funds “to complete a process that will end in a recovery plan that works.”
Without the $3 billion, the commonwealth will likely run out money to provide basic services to its citizens and almost certainly be forced to default on its debts, now estimated at $70 billion.
“You can’t go all the way down into the valley of despair, you need a bridge over it,” said Spiotto.
Puerto Rico is aiming to sell the bonds Tuesday at a yield around 8.25%, or the lower end of expectations, according to FOX Business's Charlie Gasparino. The deal will be priced with a 7.5% coupon, Gasparino reported, indicating the bond's price will be discounted to achieve the higher yield. Other reports, citing investors familiar with the deal, said the offering will be priced with a coupon of 8%, with a yield as high as 8.875%.
An Island in Peril
An eight-year recession, high unemployment and a dwindling population have sapped Puerto Rico’s tax revenues, threatening the commonwealth’s ability to pay down its debt.
In February, all three of the major ratings firms slashed the island’s credit to junk status, citing fears that the ongoing recession and rising government expenses – notably soaring pension costs for retired public employees – will make it difficult for Puerto Rico to raise money in the capital markets.
Most of the money raised in the offering is expected to be earmarked for repaying and refinancing outstanding debt.
Moody’s Investors Service has assigned the general obligation bonds a preliminary rating of Ba2, two notches below investment grade. Standard & Poor’s rated the bonds a single notch below investment grade, but put the issue on notice for a possible downgrade.
Puerto Rico Governor Alejandro Garcia Padilla noted how closely the sale was tied to the island’s fiscal reform program in a statement issued last week shortly after signing a bill authorizing the sale.
“I am confident that this bond offering, along with amendments to the budget and our strategies to promote job creation and industrial development, will take Puerto Rico forward in a stronger fashion,” he said.
As Puerto Rico’s fiscal crisis deepened last year, the legislature approved tax hikes, spending cuts and reforms to scale back pension costs.
The risk for investors is that the tax hikes and cuts in government spending chases off existing business and scares off potential new business, leaving the island with even less revenue as it expands its debt load by $3 billion.
So it’s imperative that the funding from the bond sale helps Puerto Rico maintain an environment that is conducive to attracting business, which helps create jobs and expand the island’s economy.
“If you just borrow money unconnected to implementing a recovery plan when you’re in financial distress, then all you’re doing is creating a larger hole to crawl out of. That doesn’t work,” said Spiotto.