Puerto Rico Gets a Break With Rates on Its Bonds

Puerto Rico is expected to sell roughly $3 billion in bonds on Tuesday at interest rates that are considerably lower than many investors in the municipal market had expected, providing a rare bright spot for the cash-squeezed island.

The lower yields, investors say, are being driven by a combination of factors, including a recent flow of investments in mutual funds that are large buyers of municipal bonds, Puerto Rico’s progress in closing its chronic budget gap, its improved financial disclosures and a general sense of relief that the commonwealth still has access to the debt market.

“There’s a very explicit, almost to the point of jarring, acknowledgment of many problems,” said Robert Donahue, a managing director at Municipal Market Advisors, referring to a long-sought liquidity report issued last week by the Puerto Rican government. “Now the commonwealth has opened the curtain.”

But the commonwealth’s fiscal agent, the Government Development Bank, also has hired an affiliate of a well-known restructuring firm, raising concerns among some investors that Puerto Rico is weighing a revamping of its existing debt load, even as it prepares to raise fresh funds.

“I have to say it lends an element of discomfort as you look at the new deal,” Joseph Rosenblum, director of municipal credit research at AllianceBernstein, said of the hiring of the restructuring firm Millco Advisers, an affiliate of Millstein & Company. The firm’s founder is James E. Millstein, a former Treasury Department official who oversaw the government’s revamping of the bailed-out insurance giant American International Group after the inancial crisis.

At the moment, plenty of investors appear to be willing to look past the specter of a revamping as well as Puerto Rico’s current liquidity issues. They are betting that the $3 billion in new debt â€" one of the commonwealth’s largest bond sales in recent memory â€" will buy Puerto Rico the time it needs to turn around an economy that has been in a painful recession since 2006.

The tax-exempt debt is expected to be sold with yields from 8.62 to 8.87 percent, according to preliminary pricing documents circulated in the bond market on Monday. Those rates would prove far less expensive for the government than predictions ranging in the low double digits.

Many investors are calculating that any future losses from a revamping could be made up on the high yields that they can collect from the bonds, which will carry the commonwealth’s general obligation pledge. That pledge is stronger than usual when it comes from Puerto Rico because the commonwealth’s constitution states that all the island’s available resources will be used to make investors whole.

The Government Development Bank has not said whether a revamping is under consideration. The agency says that Millco was hired as a financial adviser to help it analyze the size and timing of coming cash requirements and to evaluate financing options.

Mr. Rosenblum of AllianceBernstein said he feared a repeat of what occurred in Detroit, when Kevyn Orr, a bankruptcy expert from the law firm Jones Day, was hired as the city’s emergency manager. It turned out to be a prelude to Detroit’s bankruptcy filing in July 2013.

Like Detroit, Puerto Rico has been losing population, which can hamper economic growth and leave a smaller and poorer group of people responsible for repaying the debt.

“I am not disregarding the progress that they have made in terms of the budget, but the situation continues to be challenged,” Mr. Rosenblum said.

As a United States territory, Puerto Rico cannot file bankruptcy under any existing chapter of the federal bankruptcy code, but many investors expect that the government may have to reduce some of its debt, dealing losses to investors.

Doubts about the credibility of Puerto Rico’s general obligation bonds have been growing, especially since Detroit has proposed resolving its bankruptcy by sharply reducing its payments on such bonds. The Puerto Rican secretaries of the treasury and justice have added an unusual provision to their bond resolution, requiring that any legal disputes be settled in federal court in New York, rather than in Puerto Rico.

The provision, described in materials circulated by the Wall Street banks selling the bonds, is meant to reassure investors who believe they would find a more creditor-friendly judge in New York than in Puerto Rico, people briefed on the sale said. The offering circular notes that a New York judge would still have the power to send any bondholder complaints to a Puerto Rican venue if that would be “more suitable on grounds of judicial fairness to the parties involved.”

For all investors’ concerns about Puerto Rico’s liquidity, many say they are heartened by the commonwealth’s success at cutting its pension expenses and reducing its budget shortfalls.

Some of this optimism is reflected in a recent rally in Puerto Rico bond prices. Yields on Puerto Rico general obligation bonds have fallen to 7.54 percent from 8.9 percent at the start of the year, according to Thomson Reuters data.

Still, Puerto Rico’s financial problems are complex and are not always immediately apparent â€" the result of multiple debt obligations of many government agencies. Sorting out those complexities will be a delicate task for Mr. Millstein and Millco.

Mr. Millstein was the architect of a complicated series of transactions that paid back the Federal Reserve Bank of New York for its initial bailout loans to A.I.G., which were extended before the Treasury got involved through TARP. Finding enough cash within A.I.G. to repay the loans, and separating A.I.G.’s various operating units from each other were operations that took months, and may prove relevant to Puerto Rico.

Since striking out on his own, Mr. Millstein has landed assignments like advising the merger of US Airways with the once-bankrupt American Airlines and some big creditors of Energy Future Holdings, the troubled Texas utility.

A.I.G. had to be revamped outside of bankruptcy, and A.I.G.’s operating units were woven together in ways that made them hard to separate without causing insurance insolvencies.

The Government Development Bank said Millco would also help it analyze the commonwealth’s capital structure, including the relationships between the bank itself, the central government and various public corporations, “including understanding all direct and contingent liabilities.”