“The PR GO curve is inverted and shorter maturity GOs are trading cheap to CCC corporates. Thus, if the Commonwealth is able to access sufficient long-term borrowing in a timely manner, the curve could flatten or even revert to an upward sloping one and GOs will richen vs. comparable maturity distressed corporates.”
“While the Attorney Generals have opined that COFINA’s revenues are not considered available Commonwealth revenues and thus not available for clawback, the Supreme court has not ruled on constitutionality of segregating COFINA revenues as it does not have the jurisdiction to provide advisory rulings…”
– Vikram Rai, Mikhail Foux, George Friedlander, “US Municipal Strategy Special Focus: A SWOT analysis of Puerto Rico's general obligation (GO) debt.” Citi Research. March 4, 2014. (https://ir.citi.com/cMm2h98Rp9tSvpjHgog8JjkvV9nHKabJxXdgP2acTiVJE%2FwBX2m1wA%3D%3D)
We fly to Paris in hours. Our first meeting there is Thursday late morning. Ukraine and the cross border effects on Europe’s banks are a serious issue.
Meanwhile PR is in focus again. The Citi team listed above has issued a superbly done report.
Here are Cumberland’s bullets:
1. It looks as though Puerto Rico will get the new financing done next week. It will be at a high cost with a junk rating. Governance may be NY law, not PR law, for whatever that means if they default down the road. Size is $3 to $3.5 billion. Rate on it will be 8.5% to 9.5% on the low and 10% to 11% on the high end. We think it comes on the low side. Tax-free, PR GO debt with dispute adjudication under NY law. Our best guess is 9% on the longest piece. Remember, the NY law issue is untested for PR debt issuance. There are many theories, but there are zero precedents.
2. It buys Puerto Rico about two years’ time to get their house in order. Will they do it? No one knows. Does the present young Governor Padilla want to? Yes, if he can. Will this be a turning point for PR? Maybe.
3. The new money means cash needs are met for the next two years and no default occurs on most of the present bonds. Be careful here. Most is not all. Some of them are still at risk, and the research needed to sort this out really means getting into the weeds. Remember, this is still a junk credit so undocumented and un-researched assertions and assumptions may be dangerous to an investor’s health.
4. Temporary removal of the default threat temporarily helps bond insurers and most existing PR debt.
5. A MUNI RALLY IS AT HAND. Why? Three reasons. 1.Muni funds hold more than one standard deviation above mean in cash because of the fear of redemptions (source: Ned Davis Research). 2.Detroit is resolving slowly; the losses and haircuts for bondholders are becoming known. 3.PR probably doesn’t default. The long-term muni yield in the highest grade is still higher than the taxable Treasury. This will not last forever. It may change very soon.
6. We think that the muni rally from this level can be fierce. We are very bullish on high-grade US-dollar-denominated tax-free bonds. We are long and stay long. Furthermore, we think the upside yield levels where the highest grade tax-free bond yields more than the taxable treasury is about to reverse. Finally, the partial hedges on long Munis may show results.
7. Additionally, and only for those who have the risk tolerance for exposure to junk rated credits, we are also managing a special type of separate account in only PR debt. It is not high-grade. It is currently positioning. We are long junk credit in PR in these special researched accounts.
I am heading to Paris. À bientôt.
BY David R. Kotok