October 30, 2013 3:17 pm

Puerto Rico could duck fight with retail investors, but the damage to its buyer base is done

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Puerto Rico is on the sidelines as retail bond investors go after the banks, financial advisors, and brokers that sold closed-end and other mutual funds with high Puerto Rico bond exposure, said Debra Brewer Hayes, a Reich & Binstock attorney who represents retail investors that suffered losses due to the purchase of Puerto Rico bonds.

That doesn’t mean it won’t get roped in. Banks or brokers may “turn around and point a finger” at the government for inadequacies in its disclosures and financial statements as part of their legal defense, said Hayes.

But even if the government is never implicated in retail losses, all the lawsuits and negative publicity will make it harder for the government to sell any new debt to its traditional buyer base, said a municipal credit analyst. The commonwealth plans to issue Puerto Rico Sales Tax Financing Corporation (COFINA) bonds for USD 500m to USD 1.2bn of debt in 2013, as previously reported.

During the past week, legal firms specializing in investment fraud and based in Puerto Rico, Texas, Florida, Massachusetts, and California have been putting out calls to investors that have suffered losses by purchasing Puerto Rico bonds on the margin or unknowingly buying municipal fixed income funds with Puerto Rico exposure.

As the traditional buyers of Puerto Rico bonds, mainly retail investors, get involved in litigation that emphasizes the distressed condition of the bonds, the government may need to find new investors in the high yield or hedge fund world, said the analyst.

Preparing for a fight

In the retail investors’ ecosystem, where big losses in closed-end funds and margin loans are currently incurred, it is irrelevant whether a bond is general obligation or COFINA, said Jeffrey Erez of Sonn & Erez, a Florida-based law firm representing around 200 investors that suffered losses due to alleged illegal practices around investing on Puerto Rico bonds.

“If you own a closed-end fund and you are being liquidated these distinctions are of marginal importance,” said Erez. “We are being contacted by hundreds of people that all tell the same story. When you look at their portfolio, around 70%-100% of their savings are in Puerto Rico debt and roughly 70% include loans that are secured by the brokerage account,” he added.

Puerto Rico could step back on the COFINA bond depending on market conditions

“The commonwealth’s financial plan for the remainder of the current calendar year includes between USD 500m and USD 1.2bn of debt issuance, which it plans to execute over the coming months. However, the commonwealth has the flexibility to alter such plan to respond to then-prevailing market conditions,” said a spokesperson for the Government Development Bank for Puerto Rico (GDB).

“Puerto Rico does not need to go to the market in FY14 to meet its financing requirements,” he added.

The spokesperson said the government has received the Legislature’s approval for the sale of the new COFINA III bonds, but has not decided whether it will go to the market with it. “We have the flexibility necessary to make adjustments, as appropriate, to account for changing market conditions,” added the spokesperson.

The spokesperson declined to comment on the possibility of the government being looped into the lawsuits against brokers and financial advisors that sold municipal funds with high Puerto Rico exposure to their clients.

A USD 180m tranche of Series 2011A subordinate sales tax revenue bonds, which mature in 2043, last traded on 24 October between at 76.70, yielding 7.15%, up from 75.7 in September, according to Electronic Municipal Market Access.

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