NEW YORK, Jan 22 (Reuters) - Morgan Stanley, rebuffed late last year by Puerto Rico officials over an offer to arrange a high-cost loan of up to $2 billion for the cash-strapped commonwealth, is now trying to pique investor interest in backing the idea, according to people briefed on the matter.
The investment bank’s pitch, aimed at hedge funds, private equity firms and others with a possible appetite for the U.S. territory’s tax-free and high-yielding debt, comes as Puerto Rico scrambles to retain its investment grade rating against the threat of a downgrade by Moody’s Investors Service, which could trigger further financial pain for the Caribbean island’s government.
“Under discussion is a 10-year deal with a non-call five-year option priced slightly below 10 percent,” said a San Juan-based investment banker and former government official, who has been briefed on the proposal by hedge fund investors.
Morgan Stanley’s discussion with investors follows a pitch directly to Puerto Rico officials in late 2013 for a loan of roughly the same size and cost, according to two people familiar with that proposal. Officials rejected the idea as too costly.
Puerto Rico, battling population decline, chronic recession and perennial budget shortfalls, is under pressure to show it can access the bond market after delaying a debt sale late last year and promising to bring a deal to market by late February. Puerto Rico has around $55 billion of tax-supported debt and another $15 billion supported by other revenue streams, such as water and power rates.
On Wednesday, a spokeswoman for the Obama administration said the White House is not considering a bail out for Puerto Rico. The administration has established a task force to work with Puerto Rico on its economic and fiscal problems, and would prefer to allow that group to do its work.
Unlike Detroit, which filed for the largest U.S. municipal bankruptcy ever last year, Puerto Rico does not have the option to seek a restructuring of its debt under bankruptcy protection.
Last month, Moody’s placed Puerto Rico on notice that it was considering cutting its credit rating to junk status within three months. All three major ratings agencies have assigned the island’s credit their lowest investment-grade ratings. A drop to junk could trigger accelerated repayments of debt and demands for more collateral for interest rate swaps.
Speaking on condition of anonymity, the San Juan banker said the high rates in the Morgan Stanley proposal may put off government officials, who are actively weighing a sale of municipal bonds worth between $500 million and $1.2 billion.
But they may have few other options, given how risky the market believes its debt to be.
“Seeing how the secondary market is trading, it doesn’t seem they would do much better in terms of pricing ...,” the banker said.
Intermediate and near-term Puerto Rico bonds on Tuesday yielded over 9 percent. An eight-year maturity carried a yield of 9.92 percent, even as maturities beyond 20 years yielded less than 9 percent.
A deal worth $2 billion would allow Puerto Rico to demonstrate to markets and ratings agencies that it has enough liquidity for two years, which could translate into tighter spreads on new bonds, the banker said.
The Morgan Stanley financing effort, which was first reported by The New York Times, might also relieve pressure around the possible ratings cut.
Both Moody’s and Fitch Ratings have said that the government needs to demonstrate its ability to sell new bonds if it is to avoid being stuck with junk-bond ratings.
Yields on Puerto Rico’s widely held debt have long been among the highest of big issuers in America’s $3.7 trillion muni market, and shot up in September as worries about its finances intensified, but have inched back from recent highs.
The credit spread for Puerto Rico’s general obligation bonds maturing in 10 years over top-rated municipal bonds, a measure of the risk investors assign to owning its debt, was 680 basis points on Tuesday, according to Municipal Market Data. That spread has tightened since the start of the new year, when it was 710 basis points, but a year ago it was about 300 basis points.
Morgan Stanley is targeting private equity and other large, non-bank investors, according to a Wall Street source. “Banks don’t want to touch this with a 10-foot pole in terms of providing financing,” said the source, who also spoke on condition of anonymity.
Prominent hedge funds that have been active in securities of troubled municipalities, including Stone Lion Capital and Third Point, declined to comment on the Morgan Stanley proposal. A spokesman for the bank declined comment.
Morgan Stanley may also have a hard time getting a go-ahead on a high-interest, $2 billion deal from Puerto Rico officials, who were just stung by a temporary court halt to unpopular reforms of the island’s vastly underfunded teachers pension system.
Some analysts say the government is concerned about some of the provisions being discussed, such as liens on revenue streams, and don’t want to weaken protections that current bondholders enjoy.
“Raising money prior to receiving an official go-ahead from authorities is unique,” co-founder David Tawil of Maglan Capital, a hedge fund that owns Puerto Rico debt, said in an email. “Perhaps Morgan Stanley feels it’s worth putting in the time and effort because Puerto Rico will need to raise funds, and the bank will then be top of mind when it comes time to select an underwriter.”
The effort to stir up investor interest in Puerto Rico’s debt has gathered steam recently. Last week, law firm Jones Day sponsored a meeting attended by as many as 200 potential Puerto Rico investors at its New York offices that featured one of the firm’s top restructuring attorneys as a speaker.