Around $600 million of Puerto Rico bonds are coming to the market on Thursday, one day after Standard & Poor’s revised the commonwealth’s outlook to negative.
The Puerto Rico Building Authority, rated the same as the commonwealth, will sell government facilities revenue refunding bonds, structured as both serial and term.
The PRBA is an instrumentality of Puerto Rico that constructs buildings and facilities, including schools, hospitals and prisons, for lease to the government and its agencies.
Goldman, Sachs & Co. is pricing the bonds and Sidley Austin LLP is bond counsel. The Government Development Bank for Puerto Rico serves as the authority’s financial advisor.
“Current market conditions are favorable and we are taking advantage of the low rates to refinance for savings,” said José R. Otero-Freiría, director of financing for the GDB.
Around $336 million of the proceeds will refinance the authority’s Series J bonds that have a mandatory tender on July 1, around $125 million will be issued in an economic refunding for savings, and $154 million will repay a line of credit from the GDB.
Otero said, subject to market conditions, around 5% or more is expected in present-value interest rate savings from the economic refunding portion.
The bonds, which will be subject to redemption, are secured by lease rental payments from government agencies.
They are further secured by the commonwealth’s full-faith-and-credit pledge, which includes a constitutional requirement that provides a first claim on available commonwealth resources.
Standard & Poor’s revised Puerto Rico’s outlook to negative from stable, based on its challenging economic and fiscal environment, which could delay a transition to structurally balanced budgets.
S&P affirmed its BBB rating on the commonwealth’s general obligation bonds. As the PRBA’s bonds are secured by Puerto Rico’s GO pledge, the bonds are assigned the same rating.
“In our opinion, the current administration has taken decisive measures to restore fiscal balance,” said analyst Horacio Aldrete-Sanchez. “However, a steady economic recovery has failed to take hold, which we believe limits the government’s ability to implement additional expenditure cuts and revenue enhancement measures in the near term.”
As of June 30, 2011, the latest actuarial study available, the funded ratio of its defined benefit system was at 6.8%, which is extremely low, according to S&P.
Otero said he doesn’t think the revised outlook will have any significant effect on Thursday’s deal pricing.
“This is nothing new. If anything, we believe things have continued to improve in Puerto Rico,” he said, citing increased fiscal discipline, a reduction in the budget deficit, greater cost control and the implementation of Phase 1 of pension reform. He said they have been working on and will continue to improve the pension system.
Moody’s Investors Service affirmed its Baa1 rating and negative outlook on Puerto Rico’s GOs, assigning the same to the PRBA bonds. “The commonwealth’s general obligation bond rating has been pressured by continued financial deterioration of the severely underfunded retirement systems and weak finances, with a historical trend of funding budget gaps with borrowing,” analysts said.
Moody’s also cited steps taken by the administration, including reducing its structural budget imbalance through strict spending control and conservative revenue forecasting, but said that more reform is needed and will be difficult to achieve.
Fitch Ratings affirmed its BBB-plus rating and stable outlook, saying that recent financial performance has improved, but Puerto Rico’s high debt levels and pension funding remains a challenge.
Duane McAllister, portfolio manager of the BMO intermediate tax-free fund at BMO Funds, said Puerto Rico seems to be moving in the right direction.
“The pluses are that they’ve taken great steps in the last several years to try to balance their budget and eliminate their structural deficit and we give them credit for that,” he said. On the other side, he noted that Puerto Rico is just coming out of a recession and has long-term challenges, including the pension woes.
McAllister said he would look at the bonds, but only with an eye toward the short end of the curve where he can look out a few years, as opposed to decades, and make an assessment of what direction the credit is going.
Puerto Rico bonds have enjoyed high demand from investors despite the credit concerns, given their high yields and exemption from local, state and federal taxes. In April, the Puerto Rico Electric Power Authority upsized an expected $475 million deal to $650 million. Yields ranged from 4% to 5%.
The PBRA last came to market in August, seeing yields ranging from 4.750% in 2022 to almost 6% in 2041.
In today’s market, there continues to be strong demand for higher yielding credits, McAllister said. However, there seems to be some resistance this week.
“Whether it’s just the size of the new issue calendar or rate indigestion, it feels to me like it’s a week in which investors just aren’t certain yet how much capital they want to deploy,” he said.