In March of 2011 I had this to say about Puerto Rico and its muni bonds:
The weather is great. The beaches are beautiful. The food is good and the drinks are better. The bonds, on the other hand, don’t get on my “buy” list.
We damn near had a significant problem with PR – there was a real possibility the Island would have been forced to default a few months ago. That’s not the case any longer. Wall Street (and some deep pocket funds) are going to do a private bailout next week.
$3 ‘Large’ will be the largest muni deal ever. The new bonds will have a coupon that pushes 10% – and they will be priced in the hole to give the big-buck buyers a quick boost (retail investors will not see a dime of these bonds). And the IRS will not see a penny of taxes on the interest paid as these bonds a tax-free.
The underwriters stand to make a quick $40+ million in fees. Come Tuesday night, the Champagne will be flowing….(I think the deal will be a blowout success – the whole $3B was all spoken for as of Friday)
The best part of the deal (for the Street) is that the new bonds will be Senior to most of PR’s other $70B of bonds. That’s because PR got rolled over a barrel and was forced to allow these bonds to be subject to NYS law – meaning that the new bond holders can grab collateral, and force the other creditors to the back of the bus when the SHTF.
In my estimation, the $3B deal will buy PR at least 24 months before the next credit crunch hits. I have little expectation that PR is going to turn things around in that period of time, so the crunch will happen. But that’s so far away that PR, and its financial woes, will fall off the headlines. As that happens, the new bonds are going to rip up in value – a 10% pop in these bonds is a distinct possibility. That would mean that come Tuesday, those who get to play in this sand box stand to rake in an “extra” $300m.
By Christmas, the new PR bonds will have been sold at big premiums over par to yield-hungry retail investors (more Champagne). And the poor retail guys will be wondering what they bought sometime before 2017.
So Hurray for Wall Street and the money-men. The fact that $3b can be raised for a troubled credit (that does not have a rosy future) is a measure of power. WS can do what the IMF can’t – provided it gets paid well for the effort.
My take on this? Puerto Rico bonds might be a trading Buy – but they most certainly are not a Hold. Three years from now I’ll be reminding folks about the warning today. Wall Street can clean up junk well enough, but it can’t make it go away.
My thinking on the economics of this deal:
- The vast majority of this paper will go to “Pro” hands who have access to the Repo market.
- The haircut on the Repo will be 20% (buy $100 for $20 in cash + $80 of debt)
- The Repo cost is near zero thanks to ZIRP.
- The leveraged yield on this is 40+%.
- The bonds will trade to a premium in the secondary market (my guess=+10%).
- The cap gains + leveraged carry will result in a return on equity north of 50%.
This deal will be a huge win for the ‘players’.