Friday, February 14, 2014

What Are Puerto Rican Bonds Worth?

How should a straight unenhanced Puerto Rican GO trade? The market says it should trade above sixty cents. I think that is way off and creates a short opportunity for the brave. I say this for three reasons:
1. I expect PR to restructure its debt.
2. I think PR has very limited debt servicing capacity.
3. There is a risk that PR will impose a unilateral resolution on its creditors in the same way that Argentina and other Latin American countries have done.
4. There will be no bailout.

Likelihood of Default
Puerto Rico faces very large cash demands over the next month which can only be met by selling at least $2-3 billion in bonds. I don’t think that this can be done. PR has not sold a bond since last August, and has been trying very hard to go to market without success. The latest round of downgrades makes the task much more difficult. (The webcast for the planned bond issue is on Tuesday.)

Debt Capacity
PR has run large deficits for a long time, financed with debt. That debt now totals $60-70 billion and does not include around $40 billion in unfunded pension obligations. For PR to service its debt without further borrowing would require a level of fiscal adjustment that is politically impossible. PR will have to decide between massive government layoffs and debt reduction. That will not be a difficult decision for the Puerto Rican people to make. Most of PR’s debt will have to be forgiven one way or another.

Enforceability of Debt Claims
As best as I can tell, there is no explicit election of law in PR’s bond indentures. Because of the 11th Amendment, PR cannot be sued in federal court. Therefore it must be sued in Puerto Rico or New York. I expect that the Puerto Rican courts will defer to the legislature with respect to debt restructuring arrangements (notwithstanding the island’s constitution). That leaves New York, where a bondholder could seek a judgement against PR--assuming that the court decides to waive sovereign immunity. What I am unsure about is the enforceability of such a judgement. Would a New York judge impound PR’s deposits in US banks? It seems to me that trying to force PR to pay will be difficult and time-consuming. Therefore I would expect drawn-out and messy resolution process  that takes years to resolve, as in the case of Argentina.

No Bailout
Puerto Ricans are exempt from federal taxation, which makes a federal bailout seem inappropriate. Puerto Rico has no congressional delegation and very little political clout. Given the current fiscal posture of the House of Representatives, support for a federal bailout bill would be very limited and would come mostly from the minority party. I can imagine some degree of federal involvement in the debt resolution process, but not a bailout. I think that any federal involvement will be for the benefit of the Puerto Rican people, and not the bondholders. The future of the Puerto Rican economy is very bleak, and it can't devalue.

What would I pay for a Puerto Rico GO? Not more than thirty cents.

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