It has been more than a year since Puerto Rico first defaulted on its obligations. While there has been a cascade of missed payments and ratings downgrades since last August — including at the start of this month — and a near constant airing of the intensifying fiscal and humanitarian crises, Puerto Rican debt has proved among the best performing within the $3.7tn municipal bond market.
It is somewhat confounding that the US territory — struggling with a near $69bn debt burden and a vastly unfunded pension system — has bubbled to the top of the closely scrutinised performance tables.
The island’s paper has been lifted by the appointment of an oversight board by US President Barack Obama that will have sign-off over its restructuring plans and future budgets as a part of emergency legislation that set out a path for the commonwealth to slash its obligations.
Creditors have widely viewed the seven-person team as technocratic selections, with a deep understanding of both Puerto Rico and insolvency proceedings. It includes Arthur González, the judge who presided over the Enron and WorldCom bankruptcies, and Carlos Garcia, a former head of Puerto Rico’s Government Development Bank. Holders of the debt hope is that the board will not subsume the bonds they own entirely to pensioners, and that recoveries may fare better than in Detroit.
That has enticed asset managers such as BlackRock back to the asset class, who had avoided Puerto Rican debt after Governor Alejandro García Padilla warned it was “not payable” last year, sparking a broad sell-off.
“A significant amount of bad news has been priced into the market and we’ve had a preview of how Puerto Rico thinks of these credits by the interest payments it has or has not been making,” says Peter Hayes, head of BlackRock’s municipal bonds group. “We have started to buy again.”
Investment grade bonds issued by Puerto Rico, worth roughly $8bn, have returned more than 10 per cent this year, according to Barclays. The broad municipal market gauge is up less than 4 per cent by contrast. Junk rated debt sold by the US archipelago have advanced 12.5 per cent over the same period.
Barclays removes bonds from the indices if an issuer defaults, leaving mostly insured debt in its high grade marker. For investors holding that insured paper, companies such as Ambac, Assured Guaranty, and MBIA unit National Public Finance Guarantee have stepped in to cover missed interest payments, propelling a rally in the debt.
General obligation debt insured by National Public Finance traded at 109 cents on the dollar at the start of the week, up from 100 cents one year ago. Insured bonds that don’t pay a coupon and mature in 2044 have advanced 40 per cent since the end of May to trade at 21 cents on the dollar.
“It comes from confidence that people have gained in the insurers after the defaults in January and July,” says Craig Brandon, the co-director of municipal investments at Eaton Vance. “The insurance companies made good on their policies.”
But even for debts that are no longer being serviced by the commonwealth, prices have climbed. Some $3.5bn of debt issued in 2014, in a sale that attracted a wave of hedge funds, has advanced 3 per cent since the oversight board was named. Portfolio managers and strategists say they are betting on what they’ll ultimately recover after a restructuring is agreed.
“It is a recognition that the board will focus on the real causes of the ailment, not the symptoms,” adds Ambac chief executive Nader Tavakoli.
Mr Hayes estimates a haircut of as much as 55 per cent of the $69bn debt burden may be necessary. While sources familiar with negotiations say informal meetings between creditors and advisers to the commonwealth have taken place, substantive talks are not expected until the oversight board gets fully acquainted with the peculiarities and priorities of the different debt-issuing groups on the island. That includes the differences between general obligation debt that is guaranteed by Puerto Rico’s constitution, which it has defaulted on and is considered sacrosanct by investors, and sales-tax backed bonds that it continues to pay.
While Puerto Rico has been something of its own island within the municipal market this year, it has benefited tangentially from the hunt for income, as $12.6tn of sovereign and corporate bonds now trade with a yield below zero. Municipal portfolio managers have been inundated with fresh capital — 48 consecutive weeks of inflows.
“It is a hunt for yield,” says Mr Brandon. “Those [insured] bonds are paying significantly more than the market rate.”