* Hedge funds, others made $16 bln in bids
* Deal carries yield under 9 percent tax free
* New bond prices rise in secondary trade
By Michael Connor
NEW YORK, March 11 Puerto Rico on Tuesday sold
$3.5 billion of junk-rated bonds at a surprisingly low tax-free
interest rate under 9 percent, but investor demand outstripped
supply despite the Caribbean island's difficult cash position.
The sale, considered crucial for financial reforms in the
U.S. territory, which has $70 billion of outstanding debt, was
priced in a single 2035 maturity with an 8 percent coupon and an
approximate yield of 8.727 percent.
Bigger than an initially planned $3 billion, the sale was
oversubscribed, attracting orders worth more than $16 billion
from 270 different accounts, according to the island's Treasury.
It drew scores of hedge funds and other non-traditional buyers
eyeing fat yields and possible trading gains.
"At least for the time being, they found the right
combination of product structure to entice" investors, said
James Colby, a municipal strategist at Van Eck Global, an
operator of two high-yield bond funds that bid on the Puerto
The new bonds were freed to trade late on Tuesday, and they
immediately began to rise in price. Yields hovered around 8.4
percent and 8.5 percent, with the lowest reaching 8.352 percent,
according to Municipal Securities Rulemaking Board data.
The price Puerto Rico paid to borrow was well below the
expectations of 10 percent or higher that prevailed in the
market just a few weeks ago.
Still, the rate was enough to attract interest in the bond
market, where similarly rated junk corporate bonds yield around
Hedge funds favoring riskier investments had been expected
to dominate the sale, with many traditional institutional
investors shut out by restrictions on holding municipal bonds
rated below investment grade.
The deal was oversubscribed partly because new deals in
America's $3.7 trillion muni market have been scarce and the new
bonds promise hedge funds liquidity and price movements, said
John Mousseau, director of fixed income at Cumberland Advisors
in Vineland, New Jersey.
But worries linger about Puerto Rico's economy, which has
been shrinking nearly non-stop since 2006. Puerto Rico suffers
from a dwindling population and has unemployment topping 15
percent along with chronic government budget deficits.
"The deal buys Puerto Rico time to do what they have been
doing: lowering deficits, improving business conditions,
reforming taxes," Mousseau said. "But it doesn't improve the
In San Juan, Puerto Rico finance officials said the
commonwealth expected net proceeds from the sale of $3.2 billion
would be used to refinance $900 million of short-term
obligations and swap agreements.
The bulk would be used to refinance other debts and raise
liquidity by $1.9 billion at the island's Government Development
Bank, a key lender and adviser to Puerto Rico bond issuers that
some analysts and portfolio managers say may be over stretched.
Puerto Rico's governor, Alejandro Garcia Padilla, said the
bond sale was just one step toward bettering the island's
finances and said he would announce cost-cutting measures in
coming weeks. The governor has promised a balanced fiscal 2015
"Together we will achieve Puerto Rico's recovery," Padilla
said in a statement.
Puerto Rico's government debt dwarfs that of any U.S. state
on a per capita basis, but has long been popular among mainland
investors for high yields that are free of state, local and
federal income taxes.
Puerto Rico had warned in an unusually lengthy list of
investment risks published ahead of the offering that it may
have to eventually restructure the commonwealth's entire debt
portfolio. Last week Puerto Rico hired a restructuring expert as
its financial adviser.
The territory cannot file for bankruptcy under U.S. law.
Puerto Rico, whose officials said they still have authority
to issue as much as another $900 million in general obligation
bonds, will likely be back to the market soon, according to Nick
Venditti, a portfolio manager at Thornburg Investment Management
in Santa Fe, New Mexico, who did not participate in the sale.
Puerto Rico remains a weak credit, as illustrated by a
provision in the deal that allows investors to sue the
commonwealth in New York courts, Venditti said.
"The question becomes, If these investors needed a
super-senior structure to buy $3.5 billion, what is the next
round of investors going to need?" Venditti said, adding that
the government's fiscal reforms have been too weak and saying a
future restructuring was "almost a certainty."
Not all were so pessimistic. Dan Hickman, a senior
fixed-income strategist at U.S. Bank Wealth Management, said the
deal probably buys Puerto Rico about two years of breathing
"It just kicks the can down the road," he said, "but it
kicks it pretty far."