UPDATE 2-Puerto Rico eyes 8 pct coupon on $3 bln bond sale -market source

Mon Mar 10, 2014 4:16pm EDT

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By Steven C. Johnson and Hilary Russ

March 10 (Reuters) - Puerto Rico is offering $3 billion in general obligation bonds with an 8 percent coupon, according to preliminary price talk obtained on Monday by Reuters, a far lower rate than many thought the cash-strapped U.S. territory would have to pay.

The sale, set for Tuesday, will be one of the biggest ever of high-yield municipal debt, and is expected to help keep Puerto Rico's troubled economy afloat for the next two years.

All of the bonds will be offered in a single 2035 term maturity, and possible yields ranged from 8.625 percent to 8.875 percent, the wire indicated.

Many in the $3.7 trillion municipal bond market had thought junk-rated Puerto Rico would have to pay closer to 10 percent or higher to borrow, given its chronically weak economy and fears that it may need to restructure its debt at some point.

"When the deal was developing, some estimates put the potential yield as high as 11 percent," said Matt Fabian, a managing director at Municipal Market Advisors. "The deal became more assured as the underwriters were able to firm up demand in the premarketing period," he said.

A rise in the price of outstanding Puerto Rican debt in the secondary market over the last month has helped, said Michael Comes, a portfolio manager at Cumberland Advisors.

Puerto Rico bonds have rallied in the secondary market over the past month as high-yield and distressed debt funds have snapped them up at a discount on the view that the island's government would continue to press ahead with reforms. Over the last year, it has cut its deficit and passed public pension reforms, though these are still subject to court review.

"Nobody really anticipated how far Puerto Rico would rally. Some of its general obligation debt is trading around 7.25 percent, so they will have to price the new bonds at something of a concession to get people to come in," said Michael Comes, a portfolio manager at Cumberland Advisors.

Tuesday's deal will have a tentative sinking fund schedule beginning in 2022 for bond redemptions.

Hedge funds are expected to dominate the sale, with many traditional, municipal bond institutional investors shut out by restrictions on holding bonds rated below investment grade.

According to a draft deal document released last week, the bonds will be sold in denominations starting at $100,000, a level that would exclude most individual buyers.

The three largest Wall Street ratings agencies cut Puerto Rico to junk status last month, citing worries about the U.S. territory's ailing economy and its ability to finance itself.

The Caribbean island has long struggled with chronic deficits, high joblessness and an economy that has been shrinking almost continuously since 2006. It has about $70 billion of debt outstanding.

The draft offering document also included an unusually lengthy list of risks to the bonds, including a possible restructuring of the commonwealth's entire debt portfolio. Puerto Rico said last week it had hired a restructuring expert as its financial adviser.

The territory cannot file for bankruptcy under U.S. law.

Comes said none of those risks appear to be scaring off potential investors, saying he has heard talk that the deal will be as much as three times oversubscribed.

"Compared to the sovereign debt of some emerging markets in Latin America, these yields are considerably higher, so that's very attractive to distressed debt buyers and various types of non-traditional municipal bond buyers," he said.

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