February 11, 2014 / 2:25 PM / 6 years ago

UPDATE 3-Puerto Rico looks to borrow amid financial turbulence

By Kanika Sikka and Lisa Lambert

Feb 11 (Reuters) - Puerto Rico said on Tuesday it plans to issue general obligation bonds to refinance debt and ease its liquidity crunch, but the island did not offer details as to the timing or how much debt it plans to sell.

The U.S. territory, which has $70 billion in tax-free debt outstanding, is mired in a multi-year recession. It has been downgraded to junk status by all three major U.S. credit rating agencies in the last week and is struggling to avoid default.

“We have completed significant measures in the past month to improve our fiscal health and are ready to access the market with a new issuance of GO bonds,” David Chafey, chairman of Government Development Bank for Puerto Rico, said in a statement.

The statement did not specify when Puerto Rico would sell bonds or how much it planned on selling. Barclays, RBC Capital Markets and Morgan Stanley have been named as lead underwriters. The issue would be the first time since August the territory has tapped the municipal market.

A source familiar with the deal said Puerto Rico needs to raise about $2.3 billion, which would allow it to refinance some variable-rate bonds, a $290 million outstanding GO bond, and more than $1 billion in debt service restructuring, as well as borrow $100 million in new money. Hedge funds are expected to show the biggest interest in the deal.

Puerto Rico Governor Alejandro Garcia Padilla said on Monday that he had asked the legislature for approval to borrow up to $3.5 billion in general obligation bonds.

A spokesperson for the territory said specifics of the sale would be announced during its quarterly webcast, which was rescheduled to Feb. 18 from this Wednesday - an indication that the sale will take place toward the end of the month.

A member of the Barclays public finance department was not available for comment.

In January the Government Development Bank of Puerto Rico said it was planning to return to the bond market that month or February, with a deal officials estimated would range from $500 million to $1.2 billion.

The island’s legislature has also authorized more borrowing through the Sales Tax Financing Authority, known by its Spanish acronym, Cofina.

“Should Puerto Rico decide to issue general obligation bonds, we believe they will have to pay a substantial yield premium,” said Morningstar, Inc. in a special municipal research note on Tuesday. “Full details about how Puerto Rico will structure its planned issuance are not yet available, but we expect it to involve some combination of GO, third-lien COFINA, and private placements.”

In recent weeks, financial markets have grown increasingly worried about the fate of the territory, specifically that downgrades could push it toward default.

Fitch Ratings became the final major rating agency to downgrade Puerto Rico’s credit rating, cutting it to “BB” with a negative outlook on Tuesday, citing the island’s large debt levels and pension liabilities. It also cut Puerto Rico’s employees retirement system to “BB” from “BBB”.

Standard & Poor’s slashed Puerto Rico’s rating last week and said the territory could see a further downgrade if it did not raise additional funding by the end of this month. Moody’s Investors Service lowered the commonwealth’s credit rating to junk status two days after S&P and also cut the rating of the Puerto Rico Electric Power Authority on Monday.

The rating changes could force Puerto Rico to pay more than $1 billion on interest rate swaps, collateral, variable-rate bonds and debt acceleration.

The $3.7 trillion municipal market has long priced in the credit risk of Puerto Rico bonds, but the downgrades helped push up yields on the debt in secondary trading over the last week.

As of Monday, 10-year Puerto Rico GO bonds yielded 10.27 percent on Municipal Market Data’s benchmark scale. That was 34 basis points higher than the previous Monday. A year ago, Puerto Rico bonds yielded 4.88 percent, according to MMD, a unit of Thomson Reuters.

Yields frequently topped 20 percent in small trades on Tuesday, with a buildings authority revenue bond that matures this year trading at 25.771 percent in the morning, according to Municipal Securities Rulemaking Board data.

Some large U.S. mutual funds that accumulated large holdings of Puerto Rico debt because of its rich yields and special tax treatment have recently sold off the bonds.

In recent months, the Puerto Rico government has taken steps to put its finances and economy in order, with mixed results. In December, an index tracking its economic activity fell 1 percent, snapping a three-month run of monthly increases. . In January, the commonwealth took in revenue of $664 million, $1 million less than in January 2013, though sales tax collection hit a record high.

The island paid off a $400 million loan to Barclays last year, but still has a second $400 million bond anticipation notes issue with RBC Capital Markets taken out in August.

The Puerto Rico power authority brought a $673.15 million deal to market in August, which was underwritten by Morgan Stanley and had top yields of 7.12 percent for debt maturing in 2043 with a 7 percent coupon.

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