LOS ANGELES — Investors should sell off Virgin Island and Guam bonds if Puerto Rico's restructuring act is allowed to stand, according to Municipal Market Advisors.
The precedent set by the act could enable other U.S. territories to unilaterally change bond provisions, MMA said in its weekly outlook.
The law, approved in late June, allows Puerto Rico's public corporations to restructure their debt.
Matt Fabian, an MMA managing director, said his report wasn't an indictment of the Virgin Islands or Guam, but merely recognition of the potential for change in the risk profile of U.S. territories.
Fabian called the advice given in his investment report a trading strategy.
Investment managers have to look at the change in the structure of the security, he said, because if the law stands it increases the risk and makes the territories' municipal bonds more equivalent to sovereigns, which can unilaterally change the structure of bond agreements.
"I actually like Guam as a credit," Fabian said in an interview. "They are doing better. The Navy presence is increasing. And I doubt that Guam is even following anything with respect to Puerto Rico."
But he advised in the MMA outlook piece that current long-term holders of Guam and Virgin Islands paper strongly consider taking gains immediately, before there is a greater appreciation of the related risk to their credit profiles.
"Should PR's Restructuring Act be validated by the courts, all U.S. Territories - and not just PR - will have effectively been awarded the right to unilaterally adjust their contracts with bondholders in a manner unconnected to Federal legal precedents," Fabian wrote. "In effect, Territory bonds may need to be treated and priced like Tribal financings and perhaps ultimately moved away from a traditional, municipal market borrowing context (into emerging markets?)."
Guam and the Virgin Islands are often compared to Puerto Rico, because their territorial status makes interest on the bonds exempt from state and local income tax in every state.
"This follows the theory that, if PR's restructuring law is ultimately allowed to stand, other territories have similar rights to set their own bankruptcy provisions and unilaterally amend contractual expectations," Fabian wrote.
"There are not other municipal market issuers who can exchange the terms for their bonds," Fabian said. "It is similar to emerging markets, because sovereigns can do that.
"It draws parallels to different segments of the market and isn't a typical muni risk," he said.
"With recent trading well above par, it may be a good time for accounts with long related positions to either take partial gains to sell entirely in expectation of cheaper prices in the next few weeks or months," he wrote.
Fabian said he doesn't think Guam or the Virgin Islands are headed for default.
"I think they are still very good long-term viable credits," Fabian said. "In particular with Puerto Rico struggling, in theory, the Virgin Islands and Guam should become more appealing to investors looking for triple tax exemption in addition to Puerto Rico."
He also acknowledged that the Puerto Rico law faces a legal challenge, so it could be a long time before the laws is validated by judge, if it ever is.
Oppenheimer Rochester Funds and Franklin Funds filed suit against Puerto Rico in U.S. District Court on June 29 seeking to overturn the public corporation debt restructuring bill Gov. Alejandro García Padilla signed the day before.
In Fabian's analysis, the Puerto Rico law signals to investors that statutes can be changed heightening risk for investors.
Moody's Investors Service analysts view the question more cautiously.
"We don't see any direct implications from this," said Ted Hampton, Moody's senior analyst for Puerto Rico. "One should bear in mind, for starters, that Guam and other territories have yet to pass similar legislation."
Even if it reached that point, Hampton said, "we would review and try to discern the credit implications, but for now we don't see any rating consequences for other territories."
The amount of Puerto Rico debt held in the muni markets so outstrips the debt held for other territories that it is not really an apples-to-apples comparison, said Emily Raimes, a Moody's analyst.
Guam has $1.07 billion in municipal bond debt, while Puerto Rico has $70 billion.
"We should also remember that any municipality or other issuer in the bond market can default at any time," Hampton said. "It doesn't need a construct like PR debt restructuring or Chapter 9 to do that."
