San Juan, Puerto Rico, to make standalone muni market debut
Bloomberg News
San Juan, Puerto Rico’s plan to bring $122.2 million of municipal bonds to the market Tuesday is generating interest among some but also doubts among others.
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San Juan, the capital city of Puerto Rico, will be the second Puerto Rico government entity to sell government bonds since the passage of
San Juan plans to sell $112.6 million of triple tax-exempt bonds — interest is exempt from state and local income taxes in addition to federal taxes —and $9.6 million of federally taxable but Puerto Rico tax-exempt bonds. The triple tax-exempt bonds will have serial maturities 2027 to 2046 and a term maturity in 2051. The federally taxable bonds will mature in 2031.
The bonds will be the general obligation of San Juan secured by ad valorem taxation on real and personal property in the municipality, called the CAE for Contribución Adicional Especial or special additional tax.
RBC Capital Markets is the underwriter on the deal.
The bonds are rated Baa3 by Moody’s Ratings and BBB-plus by Fitch Ratings, both with stable outlooks.
The tax-exempt bonds will be subject to optional redemption prior to maturity after 10 years. The federally taxable bonds will be subject to a make-whole call.
In late June, San Juan refinanced $232.7 million of GO bonds, notes and other debt with a bank loan to Banco Popular. The seven year loan has a 6.35% interest rate.
A few days before the loan, the Puerto Rico Oversight Board
“Investor reception to the San Juan transaction has been very encouraging ahead of our August 4th pricing,” said Carlos Piniero, managing director at RBC.
“We’re fielding inquiries from a wide range of institutional buyers, from dedicated municipal bond funds to insurance companies and relative value accounts, with interest coming from investors across the mainland U.S. as well as Puerto Rico,” he said.
“Over the past several years, the Municipality of San Juan has pursued disciplined financial strategy focused on balanced budget, strengthening liquidity, rebuilding financial reserves, and maintaining prudent fiscal management,” Mayor Miguel Romero Lugo told The Bond Buyer.
“As a result, San Juan is now able to access the U.S. municipal bond market directly on its own credit rather than through an intermediary,” the mayor said.
“I’d expect that this new San Juan offering will price at spreads wider than its ratings would imply,” said Justin Marlowe, research professor at University of Chicago Harris School of Public Policy, where he is director of the Center for Municipal Finance.
San Juan and the territory’s other municipalities
Marlowe said the rating agencies have gone to great lengths to separate San Juan’s credit from that of the territory’s government. Investors may think differently.
“We have seen investors price Puerto Rico debt more holistically and in ways that conflate local, territorial and other credit risks. After all, the central government does have a GO default and PREPA remains unresolved,” Marlowe said.
“When San Juan comes to market, it is hard to escape the patina of doubt that the Puerto Rico insolvency brings to the financing,” said John Mousseau, executive vice president and chief investment officer at Cumberland Advisors. “A good analogy is the W
Marlowe said the city’s climate risk concerns are real “even if they’re not fully reflected in the credit ratings…. Puerto Rico also has a unique set of political norms, including and especially that San Juan’s local politics are connected to the central government’s political environment in ways that don’t really apply to other municipalities.”
John Hallacy, president of John Hallacy Consulting, said, “Hurricanes will always be an exposure. Any reserves and self insurance would be called upon. FEMA is an unknown at this point.”
Municipal Market Analytics President Matt Fabian said, “potential bondholders should be prepared for outsize valuation volatility because of headline risks.” The Puerto Rico Oversight Board will end oversight of the territory at some point, “which has highly uncertain implications for what the commonwealth government will look like.
“The commonwealth itself could very easily be back into a fiscal crisis in the long term,” he said.
“The economic headwinds across the island are also real, especially now that the federal reconstruction dollars are all but spent and the Trump administration has been openly hostile toward the island generally,” Marlowe said.
Hallacy said tourism is strong but agreed Puerto Rico’s economy is likely to have limited growth in the next 10 to 20 years.
San Juan gets about $100 million a year in CAE property tax revenue each year. The Banco Popular loan will absorb roughly 25% of that from 2027 to 2032. The loan culminates in a $149 million balloon maturity in July 1, 2033, according to the preliminary official statement.
The 2033 term payment “is deferring financial pressure into the future,” Mousseau said. “Certainly, the city believes they will be able to refinance this. For now, it’s an incremental risk because they are not amortizing the debt over the next seven years.”
An enthusiastic purchaser of the bond will be PRMF Fund LLC, which was formed about three years ago to purchase bonds from smaller or medium-sized Puerto Rico cities. When Puerto Rico’s largest city, San Juan, decided to sell bonds, the fund decided to buy, said Francisco De Armas, co-founder and managing member of PRMF.
Under Puerto Rico law, De Armas said, Puerto Rico residents get significant tax benefits when they purchase Puerto Rico municipal bonds. The fund is in conversation with other municipalities and it expects at least one of them will sell bonds in the next few months.
An oddity of the bonds is that they are funded from assessed real property values based on the replacement cost value of properties as if they were built in 1957. Property values have not been reassessed since then. Since construction costs were lower in 1957 than current costs, the nominal property rates are higher. San Juan and the Municipal Revenue Collection Center (CRIM, for its Spanish acronym) are working to reassess properties.
Personal property is “self-assessed annually based on current values,” said Romero Lugo.
In explaining its Baa3 rating of San Juan, Moody’s pointed to a strong available fund balance and liquidity. The city also benefits from a recent record of operating surpluses.
Municipality of San Juan
The municipality has a manageable long-term liability burden and fixed-cost profile, stemming from the closure of a defined benefit plan, Moody’s said. Its 329,000 residents have a high level of educational attainment and the city economy is balanced across many sectors.
For negatives, Moody’s mentioned a low full real estate value per capita and resident income levels well below other triple-B-rated cities. The city also has lagging economic growth.
The city’s revenue-raising control is limited by a centralized Puerto Rico commonwealth framework, Moody’s said.
Finally, the city has elevated environmental and social risks, Moody’s said. Emigration to the continental United States has eased some in recent years but could be revived, it said. The city has an aging population, elevated poverty and low workforce participation.
Fitch pointed to many of the same factors in explaining its BBB-plus rating. It said its model-implied rating was A but that it was notched down two notches by an exceptionally weak population trend and low median household income.
Proceeds from the bonds will be used for improvements to the San Juan municipal hospital, United School of San Juan, an animal protection and adoption center, a facility providing services to the homeless and other at-risk populations, and several streets and parks.
Ankura Consulting Group is the municipal advisor for the deal. Ad Astra Solutions is the financial advisor. Norton Rose Fulbright is the legal counsel.
This will be the first time San Juan directly offers a bond to the municipal market. Historically, Puerto Rico municipalities, through the Government Development Bank for Puerto Rico and the Municipal Finance Authority, have issued bonds that pooled municipal borrowings. San Juan last participated in one of these in 2005.
