Description

On the heels of abcd1234's excellent write-up of Puerto Rico GDB, I wanted to offer my own somewhat off the run play on Puerto Rico. I refer you to the GDB write-up for an overview of the restructuring situation and I don't really have any strong views on recovery values for most entities, but one stands out to me as mispriced.

As mentioned, Puerto Rico has something like ~$73Bn in debt among various issuers/silos.

• $4.3Bn of this was issued by the Puerto Rico Public Buildings Authority ("PBA"). The PBA was created to design and construct office buildings, quarters, courts, warehouses, shops, schools, health facilities, social welfare facilities etc for the Commonwealth. Book value for PBA assets that are currently leased to various municipalities/agencies is ~$4.4Bn. All of the PBA debt is guaranteed by the Commonwealth (and this guarantee is pari to the GO debt (which, it should be noted, trades ~40)
• Of this $4.3Bn in PBA debt, ~$880MM was issued under section 54E and 54F of the Federal Tax Code and designated "Qualified Zone Academy Bonds" or "Qualified School Constructions Bonds" (the designations are similar and I'll just refer to them as Qualified School Construction Bonds/QSCB for ease). But this section of the Code provides for Federal subsidies of interest payments for municipal bonds used to fund school construction (Most of these specific bonds were issued in '09/'10 and in that timeframe, Treasury authorized issuance of $22Bn in total qualified school debt so PR's share is ~3% of the total).
  • Depending on the specific CUSIP, the Federal gov't subsidizes between 82-88% of coupon. Happy to get into mechanics of this, but basically every quarter the PBA requests the subsidy from the Federal Government and notwithstanding some modest delays, the subsidy has been paid during the pendency of the PR debt moratorium.
• PBA (like most PR issuers) is not current on their interest/principal payments. However, the subsidy on the QSCB's has continued to be paid. So these bonds are partially current (note, however, they generally trade flat which makes no sense to me, but I guess that's what you get in an illiquid and opaque market like this).
• NPV of the interest subsidy is ~40 compared with bonds trading ~45. So for 45, you get an interest subsidy worth 40, security from the acutal assets as well as a guarantee from the Commonwealth.

For context, GO's trade ~40. PBA's (which have a bunch of assets and a guarantee from the commonwealth) trade ~42 and these bonds with the PBA assets, GO commonwealth guarantee plus the interest subsidy trade at 45. This says to me the market isn't placing much value in either the commonwealth guarantee or the assets or the interest subsidy. I'm sure there's some really compelling reason why that should be the case-but so far the most likely explanation I can come up with is this is a 1% sliver of the Puerto Rican debt stack, trades very thinly and is simply misunderstood. I think in the most likely scenario, these things should be worth par.

Catalyst

Bonds continue to remain partially current via interest subsidy. Recoveries will eventually come with a resolution of PR restructuring.