By Cate Long
April 29, 2013

Puer­to Rico Gov. Ale­jan­dro Gar­cía Padil­la unveiled a $9.83 bil­lion oper­at­ing bud­get Thurs­day night dur­ing a state of the com­mon­wealth address in which he pledged to reduce crime, cre­ate jobs, boost school atten­dance and expand the U.S. territory’s tourism sec­tor.   The pro­posed spend­ing pack­age is $783 mil­lion more than the cur­rent bud­get, which will be cov­ered by new rev­enue and $200 mil­lion in deficit financ­ing, he said.   Gar­cía Padil­la said that begin­ning in Decem­ber, the sales & use tax (IVU by its Span­ish ini­tials) will be low­ered to 6.5 per­cent from the cur­rent 7 per­cent lev­el, with­out impact­ing bil­lions of dol­lars in out­stand­ing bonds backed by the tax.   The pro­pos­al was being under­tak­en in tan­dem with mea­sures to widen the base of the IVU, elim­i­nat­ing some exemp­tions, which would end up rais­ing addi­tion­al rev­enue. The plan would con­tin­ue to exempt items includ­ing pre­scrip­tion med­i­cine, books and non-processed foods.

Thom­son Reuters Munic­i­pal Mar­ket Data ana­lyst Dan Berg­er wrote this after the bud­get presentation:

In 2012, the commonwealth’s econ­o­my expand­ed for the first time since 2005, but Puer­to Rico’s tepid eco­nom­ic recov­ery now shows sub­stan­tial signs of sput­ter­ing – a turn that wor­ries own­ers of $53 bln of Puer­to Rico munic­i­pal debt.   As Puer­to Rico’s under­ly­ing eco­nom­ic fun­da­men­tals erode, bond investors want to get paid more for the risk of own­ing Puer­to Rico bonds. Dan Berg­er again on the par­tic­u­lars:   Puer­to Rico GO bonds have been among the only cred­it expe­ri­enc­ing an increase in its spreads to MMD’s AAA curve and it pos­sess­es the biggest spread among the issuers active­ly fol­lowed by MMD. Last night the 10yr spread closed at +320bps .The 12-month aver­age is +260bps and the all-time high of +340bps was reached in Feb­ru­ary 2009.

Trans­la­tion: While the entire U.S. fixed income mar­ket expe­ri­ences low­er (tighter) yields, prices of Puer­to Rico bonds are falling and the yields are ris­ing. A 10-year Puer­to Rico bond cur­rent­ly has a yield of 4.89 per­cent, ver­sus a 10-year AAA munic­i­pal bond at 1.69 per­cent. The mar­ket is reflect­ing that Puer­to Rico is a very high risk for investors. But it wants to get paid.

We get a clear pic­ture of mar­ket con­cerns over Puer­to Rico from the bond offer­ing that the Com­mon­wealth is now shop­ping in the mar­ket – $330 mil­lion of Puer­to Rico Sales Tax Financ­ing Cor­po­rate Sales Tax Rev­enue Junior Lien Bond Antic­i­pa­tion Notes- Series A‑144A. It’s dif­fi­cult to under­stand the pur­pose of the bonds from their name and there is no doc­u­men­ta­tion filed at the MSRB, but we do know they are pay­ing an extra­or­di­nar­i­ly high inter­est rate. The notes have a coupon of 1.95 per­cent and are out­stand­ing for 17 months. In con­trast, 2‑year BBB paper (the same rat­ing lev­el as Puer­to Rico) is trad­ing at 1.31 per­cent, accord­ing to MMD. So Puer­to Rico is pay­ing about 50 per­cent to bor­row in the bond mar­ket. The Puer­to Rico notes are 144A, which is a pri­vate place­ment to insti­tu­tion­al investors. This reduces liq­uid­i­ty, but the inter­est rate is real­ly high.

Puer­to Rico has had a con­sis­tent dis­clo­sure prob­lem in muni­land. Mar­ket pro­fes­sion­als are eager­ly await­ing the 2012 Com­pre­hen­sive Annu­al Finan­cial Report, which would pro­vide offi­cial data through June 30, 2012 (almost one year ago). How­ev­er, the Puer­to Rico gov­ern­ment issues bud­get fig­ures and reports only in Span­ish (see the graph­ics for the bud­get pre­sent­ed by the Gov­er­nor). When an issuer has so much low-rat­ed debt out­stand­ing, they need to pro­vide bet­ter disclosure.