NEW YORK (The Deal) -- The Commonwealth of Puerto Rico is including some attractive features in the $750 million bond that its water and sewer utility is issuing, but sources say that it lacks one element that would make investors much more comfortable: bond insurance.
The island is tapping debt markets for the first time since its default on a $58 million payment due Aug. 1 to its Public Finance Corp. bondholders.
Puerto Rican government officials have said the water and sewer authority, known as PRASA, should be able to meet its obligations if it can raise enough money, meet its cash flow projections, and raise customers' rates as planned.
But will investors buy in?
Michael Comes, a fixed-income portfolio manager and vice president of research at investment firm Cumberland Advisors Inc., said Thursday that his understanding is that the bond will not be insured, which gives him pause.
A source familiar with the situation understands that at least one of the insurers that covers other Puerto Rican debt, Purchase, N.Y.-based MBIA Inc. (MBI) - Get Report, has decided not to provide any insurance for the $750 million PRASA issuance. That source said it is unlikely that MBIA would consider adding new exposure to Puerto Rican debt in the absence of a comprehensive restructuring plan that would improve the insurer's overall position.
Of the three bond insurers with the most significant exposure to Puerto Rico's debt, an MBIA spokesman declined to comment, an Assured Guaranty Ltd. (AGO) - Get Report spokeswoman declined to comment, and an Ambac Financial Group Inc. (AMBC) - Get Report spokeswoman couldn't be reached.
A Government Development Bank for Puerto Rico spokeswoman had no comment on the issue of PRASA bond insurance.
Comes said he would consider buying insured bonds from Puerto Rican issuers, but would balk at buying uninsured bonds unless the price and structure were very compelling.
He warned that the missed Public Finance Corp. payment was a demonstration of Puerto Rico's willingness to default, and that move could make it more difficult for the commonwealth to get bond insurance for new debt raises.
The PRASA offering documents estimated the bond's yield at around a hefty 10%, and said the bonds would be subject to jurisdiction in New York courts—a feature hedge fund investors asked for, and received, when Puerto Rico raised $3.5 billion in general obligation bonds in March 2014.
Comes nonetheless said the disclosed risks associated with PRASA's new bonds were "pretty ugly."
The documents warned that Puerto Rico's public utilities could potentially win access to Chapter 9 bankruptcy, and Comes said the document didn't include a debt covenant prohibiting a Chapter 9 filing.
Offering documents didn't include information about the bonds' maturity structure.
An ad hoc group of hedge fund investors had previously expressed interest in providing $2.9 billion in new financing through bonds backed by petroleum taxes, but that effort fell through. It remains to be seen whether Puerto Rican officials can structure the PRASA deal in a way that would tempt those hedge fund investors, who can stomach more risk than traditional municipal investment funds. A spokesman for the group didn't respond to requests for comment.
Puerto Rican government officials and their advisers insist PRASA is a safe investment.
Melba Acosta-Febo, the president of Puerto Rico's federal financing arm, the GDB, said in an Aug. 11 statement, that based on cash flow projections, planned rate revisions, and the ability to access a sufficient amount of new financing with reasonable terms, "the GDB currently does not contemplate PRASA necessitating a restructuring of its debt."
Her comments echo financial adviser Jim Millstein of Millstein & Co.'s assurance at a July 13 bondholder meeting that Puerto Rico would take an issuer-by-issuer approach to restructuring. Millstein said PRASA alone should be able to meet its obligations without modifications.
Water is becoming a major issue in Puerto Rico. The commonwealth's drought is so severe that the territory's Resident Commissioner in the U.S. House of Representatives, Pedro Pierluisi, sent a letter to the U.S. Secretary of Defense on Aug. 12 requesting assistance with the water shortage.
Pierluisi noted that the U.S. Secretary of Agriculture has declared 20 of Puerto Rico's 78 municipalities disaster areas due to the drought.
PRASA plans to use proceeds from its bond offering for initiatives such as funding part of its capital improvement program through June 30, 2019, reimbursing itself for certain capital costs incurred during fiscal years 2013, 2014 and 2015, and repaying or refinancing certain outstanding credit facilities provided by local banks and the GDB.