Investors Eager for Puerto Rico’s $70 Billion Debt?

By Fernando Langa

The Puerto Rican economy has significantly suffered because of the territory’s $70 billion debt.  The debt has constrained the island, which has been in recession since 2006, crimping tax revenue and pushing the jobless rate well into double digits.

Rating agencies have reacted to the territory’s economic crisis.  On February 2014, Standard & Poor, Moody’s, and Fitch downgraded Puerto Rico’s debt to junk status.  Standard & Poor believed that liquidity constraints did not warrant an investment grade rating.  Puerto Rican officials and market analysts believed that Puerto Rico would face significant challenges in obtaining any type of investments because of the economy’s inability to portray any type of recovery.

However, on March 11, 2014, Puerto Rico issued $3.5 billion of general-obligation bonds and received more than $16 billion in orders.  Hedge fund managers who received half the amount they requested considered themselves lucky.  Market advisors believe that the fears of widespread default are misplaced.  Moreover, these bonds are tax-exempt and are yielding at 8.73%, which is double the rate of general municipal bonds. Since the last quarter of 2013, Puerto Rico has implemented measures that have already had an impact on the economy: increasing retirement age, raising taxes, and cutting bonuses for public officials.

FINRA is currently examining the trading and demand for these bonds.  The prospectus for the bonds states that the debt would be issued in minimum denominations of $100,000 unless Puerto Rico’s credit rating was upgraded.  However, recent activity shows that the bonds are trading in denominations as low as $5,000.  FINRA fears that these bonds, which are junk-rated, are currently being sold to individual investors as safe, conservative investments (which they are not).

Because Puerto Rico is relying on the credibility and success of these bonds to improve its credit rating and attract investors to its territory, it will be quite unfortunate if FINRA finds some type of violation in the trading of these bonds.