Tags: Experts | Puerto | Rico | Bonds

Experts: Sullied Puerto Rico Bonds Offer Good Value

Friday, 11 Oct 2013 05:53 PM

By Dan Weil

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Puerto Rico, burdened with a whopping $87 billion debt, faces a tough road to recovery, but its bonds offer an attractive investment, some experts say.

Puerto Rico is a U.S. territory, and its bonds are U.S. municipal bonds. Some Puerto Rican bonds have dropped in price below 60 cents on the dollar.

But, "if you own Puerto Rican bonds, you'll get your income and your principal back," Dick Larkin, director of credit analysis for HJ Sims in Boca Raton, Fla., told Moneynews. "It won't be pretty, there will be some heavy lifting, but Puerto Rican bonds are sound if you hold them."

Editor’s Note: 5 Reasons Stocks Will Collapse . . .

To Alan Schankel, managing director at Janney Capital Markets in Philadelphia, the issue is how much risk you want to take on. "For you it might be great; for your brother, maybe not," he told Moneynews. Bond prices could fall further before they rebound, Schankel says.

"Valuations are interesting, but only for the most risk tolerant of investors who can absorb an awful lot of volatility," he said. "I think the odds are it will get better. But it's not like Kumbaya. There are a lot of challenges ahead."

Robert Donahue, managing director of Municipal Market Advisors in Concord, Mass., told Moneynews the commonwealth's general obligation bonds "will prove to be a creditworthy investment but could be in for a rough ride."

When it comes to government-agency bonds, he says he's "worried" because the agencies aren't self-supporting and need unpopular rate increases to generate more revenue.

The Caribbean island's financial woes have received a lot of attention recently. Its debt totals $23,000 per capita, not far from Detroit's total of $25,000, according to The New York Times, which notes that ratings agencies have held Puerto Rico’s general-obligation debt just above junk despite the island's worsening problems.While most of Detroit's debt is for pension and healthcare expenses, the bulk of Puerto Rico's debt, $70 billion, is owed to bondholders.

Puerto Rican bonds are attractive to U.S. investors because they are exempt from federal, state and local taxes, unlike most U.S. municipal bonds.

Investors also like Puerto Rican bonds' high yields. Earlier this week, a five-year commonwealth bond yielded 9.4 percent.

About 75 percent of all U.S. municipal-bond mutual funds own Puerto Rican paper, according to Morningstar Inc., The Wall Street Journal reports.

The reason why Puerto Rican bond yields are so high is that the territory's credit rating is only one level above junk. That, of course, stems from the Puerto Rico's bond-issuing binge over the years, which is what created the debt.

Larkin and others say the rating may be cut to junk status. "But I don’t care as long as the commonwealth does the right thing in bailing out the ship of state," he said. "They are raising taxes and doing the right thing, because they want to pay people back."

For now, the government is shut out of the bond market. It is raising money through loans and short-term notes.

Puerto Rico announced a $1.3 billion tax increase for the fiscal year that began July 1. The numbers that have been released so far for the first quarter show revenue came in about as targeted, Schankel says.

"If the budget numbers over the next few weeks match government projections, that could dramatically change the market tone and sentiment," he said. "If they don't come in with good numbers, thing could get worse."

If good news is sustained for a quarter or two, the government may be able to return to the bond market, Schankel says.

He doesn't think Puerto Rico will need to resort to a bond restructuring. "They have cash to get through the short-term. I think they will make it, but it will be close."

In addition, to the tax increase, Puerto Rico is raising utility fees to generate revenue.

"The commonwealth's ability to articulate a message of stability is critical" for the bond market, Donahue said. "They need to communicate that they will make good on their debt obligations."

Puerto Rico must be sensitive to investor concerns, he says. "At times of crisis, credibility is crucial. Puerto Rico has a history of putting a gloss on things that turned out negative. The burden is on them to come clean."

Editor’s Note: 5 Reasons Stocks Will Collapse . . .

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