MBIA, Assured Guaranty, Ambac: What Are We to Make of Report of Potential $2bn Puerto Rico Financing? via Mark Palmer of BTIG
UPDATE 3-Feb-14 8:42am: Puerto Rico Governor Alejandro Garcia Padilla announced today that the Commonwealth will introduce a balanced budget for the 2014-2015 fiscal year “in the coming weeks.”
Puerto Rico previously had a goal of balancing the budget by the 2016 fiscal year. The government said the acceleration would be made possible by reducing the current year fiscal budget by $170mm, reducing the deficit for 2013-2014 to $650mm from $820mm.
We believe Puerto Rico’s accelerated schedule for a balanced budget may be helpful both in terms of addressing the concerns of the rating agencies, which currently have the Commonwealth’s investment grade credit ratings under review for a possible downgrade to junk, and in potentially allowing the Commonwealth to achieve a lower coupon in its anticipated debt offering by providing more comfort to bond investors.
“To balance the budget, we will not need to utilize contingent reserves and additional expenses that were factored into the current budget,” said Carlos Rivas, director of the Puerto Rico Office of Management and Budget. “We have also identified special assignments that agencies can cover on their own or through current budget.
“Finally, we have also adjusted agencies’ operating budgets, including payroll and service contracts, which will be implemented by agency heads by applying discipline, austerity and creative management.”
UPDATE 2-February-14 8:16pm: The Wall Street Journal reported this evening that Puerto Rico is preparing to offer $2mm in debt “in coming weeks,” and that the type of debt to be offered will be chosen during the next few days.
According to the article, “some Puerto Rico officials have come to terms with the likelihood the island may have to pay rates of around 10% to issue debt—more than twice its yields on 10-year debt a year ago—after resisting for several months.” As we state in the blog post below, we believe the coupon on a $2bn Puerto Rico debt offering would be less important than getting the deal done insofar we view a high-coupon issue as the equivalent of a bridge financing that would buy time for the Commonwealth’s government to execute on its plans to boost its economy.
Along those lines, the article quoted Angel Rosa Rodriguez, a Puerto Rico senator and vice president of the senate’s Treasury and Public Finance Committee, as stating that “Puerto Rico officials are also discussing options to help bolster the island’s finances with the U.S. Treasury Department and Congress.” Rosa did not specify what options have been proposed.
In mid-December we began to hear from clients who had been approached by Morgan Stanley about participating in a $1.5bn financing for Puerto Rico that would carry a coupon in the 10% context. Almost as soon as we were told about this development, we also learned that the Puerto Rican government had rejected the proposal.
Last evening, The New York Times’ Dealbook reported that “bankers at Morgan Stanley (NYSE:MS) have been reaching out to about a dozen hedge funds, private equity firms and other large investors to gauge their interest in providing up to $2 billion in financing to Puerto Rico, according to people briefed on the discussions.” According to the article, the coupon on the debt could be as high as 10%.
When we read the Dealbook article, our first thought was that a reporter had heard about the deal that had been bandied about in December and had written about it. However, we have spoken to a couple of clients who say that they were approached about the financing during the past few days.
Dealbook noted that “the people briefed on the proposed financing said Morgan Stanley had not been hired by Puerto Rico to underwrite a deal. Rather, the bankers are acting on their own to put together a proposal to take to Puerto Rican officials.”
So what are we to make of the article, and particularly the reported terms of the deal? While we have already seen a knee-jerk reaction on Twitter and elsewhere to the notion of a coupon in the 10% ballpark, with critics noting the unsustainability of such a high cost of debt, we think such a financing needs to be put into perspective.
We believe a $2bn debt issuance by Puerto Rico with a 10% coupon should be viewed as a bridge financing insofar as it would buy the Commonwealth time to continue to execute on the plans for economic revival and enhanced revenue generation put in place by Governor Alejandro Garcia Padilla. When Puerto Rico’s economy and finances stabilize, it could then refinance the debt at a lower coupon.
And while Puerto Rico officials have stated that the government has sufficient liquidity to last through June 30, a $2bn deal would take the possibility of default off the table for a full two years.
This last point is particularly relevant to investors in buy-rated bond insurers MBIA Inc.(NYSE:MBI), Assured Guaranty Ltd. (NYSE:AGO) and Ambac Financial Group, Inc. (NASDAQ:AMBC), as the potential for a Puerto Rico default has continued to weigh on their shares given their exposures to the Commonwealth’s debt. And insofar as those currently shorting MBI, AGO and AMBC are concerned, the removal of a near-term catalyst for their trade could cause them to throw in the towel.
While 10% is certainly a high price for a municipal issuer to pay for financing, the statements emerging from some corners seem to indicate the belief that such a rate would apply to all of Puerto Rico’s debt, rather than just $2bn of the $70bn in debt it has outstanding. Again, such financing would be a bridge for the Commonwealth not unlike the second- and third-lien financings that Goodyear Tire and other corporations accessed during the past decade to tide them over until they could tap the markets from a position of greater strength.
We also think a deal could silence some of the inanity about Puerto Rico emerging from some members of the financial media, who have not exactly cloaked themselves in glory of late. In a blog post published last Wednesday, we noted how the Financial Times had reported on a meeting between Puerto Rico creditors and restructuring advisors that supposedly demonstrated that the Commonwealth was a step closer to default (or so the article’s headline indicated).
As it turned out, that meeting wasn’t even a meeting – it was a long-since-scheduled panel discussion – followed by cocktails – hosted by a law firm looking to drum up business. But since the FT published that report – the story and headline were subsequently changed more than once – Forbes and Fox Business both reported on the event using the newspaper’s original characterization. Forbes even tweeted out its story this morning as if it was “new news.”
When Puerto Rico’s Government Development Bank addressed the Commonwealth’s liquidity situation in October, one of the financing alternatives it identified was “securing medium-term or long-term private placements with institutional investors.” Another alternative was “accessing, within a short timeframe, a significant amount of the approximately $2.8 billion in unrestricted government deposits in private financial institutions,” an action that the government moved toward earlier this month.
Unlike Detroit and other municipalities that barely put up a fight before filing for bankruptcy protection, Puerto Rico is clearly pulling out all of the stops as it waits for better conditions to return to the U.S. municipal bond market for financing.