Muni Market Set to Welcome Puerto Rico’s Return After Bankruptcy

U.S. District Judge Laura Swain in January confirmed Puerto Rico’s plan of adjustment. The confirmation is the capstone for Puerto Rico’s journey through a new territorial bankruptcy law called PROMESA, and it comes more than six years after the island’s former governor, Alejandro Garcia Padilla, declared the commonwealth’s debts not payable.

The confirmation paves the way for a debt exchange that will bring new Puerto Rico bonds to market. The commonwealth’s bonds were long prized by muni investors because the interest is exempt from federal, state, and local taxes for holders throughout the U.S., and because yields have traditionally been higher than most U.S. munis due to elevated perceived risk.

The painful bankruptcy experience – by far the largest ever in the muni-bond market in terms of the amount of debt affected – may cause some investors to shun the next wave of Puerto Rico issuance. Yet we believe there may be cause to look at the commonwealth’s debt with fresh eyes. Post-bankruptcy credit quality usually improves for muni issuance, with new bonds offering enhanced security and other favorable provisions for investors.

Rebuilding and restructuring

The journey since PROMESA was signed into law by President Barack Obama in 2016 has been complicated by two major hurricanes in 2017 and a global pandemic that restricted travel to an island that has been planning on expanding tourism. Those tragedies ushered in a wave of fiscal support (estimated at about $130 billion, or over 100% of Puerto Rico’s GDP), facilitating an ongoing recovery and rebuilding that will aid the island’s tax collections and economy for years to come.

By 15 March, we expect that about $35 billion of Puerto Rico’s debt and claims will be exchanged into a mix of cash and new debt, including a contingent convertible instrument that is payable to investors if sales tax collections outperform a benchmark in the certified fiscal plan.

The exchange follows prior successful exchanges for the Puerto Rico Sales Tax Financing Corporation (COFINA) and the Government Development Bank (GDB). We anticipate that these various debt proposals in aggregate will likely reduce the stock of Puerto Rico’s debt by about 50%, and that average debt service on government guaranteed obligations will fall by about 60%.