Puerto Rico officials are working on selling $2 billion of debt to help the commonwealth exit the auction-rate market by June and also generate savings by refunding fixed-rate bonds.
Officials expect to sell $1.1 billion of general obligation, public improvement refunding debt tomorrow or Thursday and another $1 billion of refunding bonds by mid to late June. The two transactions will help refinance and/or convert $634 million of auction-rate securities into fixed-rate mode or variable-rate demand bonds and refund traditional fixed-rate bonds.
UBS Securities LLC will price the debt. Sidley Austin LLP is bond counsel. Standard & Poor's and Moody's Investors Service rate Puerto Rico BBB-minus and Baa3, respectively. Fitch Ratings does not rate the commonwealth.
This week's deal will convert Series 2004 B5-B8 and Series 2007 A6-A9 bonds from auction-rate into variable-rate mode, although officials are considering refinancing a portion of the auction-rate securities into fixed-rate. Wachovia Bank NA and UBS will provide letters of credit on the VRDBs and MBIA Insurance Corp. and Assured Guaranty Corp. will insure the fixed-rate bonds, according to Luis Alfaro, executive vice president and director of financing at the Government Development Bank for Puerto Rico, the commonwealth's financial adviser.
"We're going to use a recycling on some of the insurance," Alfaro said.
Attached to the auction-rate securities are floating-to-fixed rate swap agreements in which the commonwealth pays a synthetic fixed-rate in exchange for a floating London Interbank Offered Rate index, according to the official statements for the bonds. Those documents do not detail the fixed rate that the GDB pays or the percentage of Libor it receives. Counterparties on those swaps include UBS, Lehman Brothers, Morgan Stanley, and Goldman Sachs & Co.
GDB officials declined to specify which fixed-rate bond series may be refinanced but said this week's refunding and the second $1 billion refunding in June will generate $200 million of present-value savings.
"It will be a number of different series," GDB president Jorge Irizarry said. "What we're doing is re-optimizing the debt service structure along with the auction-rate bonds."
Financial Security Assurance will insure the second, $1 billion refunding in mid-June and Dexia SA will provide additional liquidity on the bonds. That transaction will convert auction-rate Series 2004B1--B4 bonds, which are FSA insured, into variable-rate mode or refinance the debt into fixed-rate.
"In this case we're just going to use the same insurance and put liquidity on top of it which will be provided by Dexia," Alfaro said.
Between the insurance providers, the swap agreements, and the auction-rate securities, this week's refinancing and the second refunding in June have several moving parts.
"It's just a combination of the best alternative in each case and it varies from case to case. Some of them have a swap which is not efficient to unwind, some of them have insurance which is not efficient anymore so we have to layer new credit enhancement," Irizarry said. "In the case of FSA, we don't need new credit enhancement but we may need liquidity. Each series, depending on how it's structured, may have a slightly different combination of overlay on it and with some of it the most efficient way is to just convert to a fixed-rate. So, it's a really complicated group of bond series and each one may be restructured slightly differently from the others."
This will be the first GO deal for Puerto Rico following the March 27 indictment of Gov. Anibal Acevedo Vila for alleged illegal campaign financing. In addition, the island faces a $1 billion budget gap for fiscal 2009, which begins July 1, and the governor in February proposed decreasing the island's 7% sales tax to 2.5%. Of the sales-tax revenue stream, 1% backs $2.6 billion of sales-tax revenue bonds.
While the 1% revenue stream would still be in place, the current structure allows officials to tap into additional sales-tax revenues, if need be, to cover debt service costs on the bonds. While bondholders on the investment are not happy about Acevedo Vila's proposal, interest in this week's GO offering still holds strong, according to municipal portfolio managers.
Matt Fabian, managing director at Municipal Market Advisors, agrees and said as long as Puerto Rico holds its triple-tax exemption status, the island will be able to sell what they need to sell. Although, he added, the commonwealth may need to pay more to borrow in current market conditions.
"The spreads, market wide, are fatter from credit, state, term, rating, tax, to any kind of spread you can think of because the market has been relying on retail and traditional investors to move product," Fabian said. "Without a strong [tender-option bond] bid, spreads are wider. So Puerto Rico as a riskier credit on the spectrum should probably pay a little bit more, but most big issuers are going to wind up paying a little more."
The yield on Puerto Rico GO bonds ranges from 2.35% for bonds maturing in 2009 to 5.24% for debt maturing in 2038, according to Thomson Reuters data. According to Monday's Municipal Market Data's triple-A yield curve scale yields ran closest to the curve in 2038, with bonds 65 basis points above and widest to the curve in 2010 and 1011, with yields 110 basis points above.