Puerto Rico- Distressed Debt Strategy. Duke GS Trade Pitch Competition

Puerto Rico- Distressed Debt Strategy. Duke GS Trade Pitch Competition

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  Sponsored by Puerto Rico DistressedDebt Strategy Goldman Sachs FEP Competition FTB CAPITAL MANAGEMENT Julio Cesar, Matt Ochs, Repton Salisbury
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  Recommendation: Sell 21yrGO Current Price: 88.75 / Target Price: 82.75 Distressed Debt Triggers: •Highest coupon payment ever demanded by investors for a 1year TRANs note for Puerto Rico. This points towards a possible inversion of an already flat yield curve. •Market has underpriced default probability of Puerto Rico’s Highway and Transportation Authority (PRHTA) •Bloomberg’s statistical Municipal Credit Risk (MRSK) model assessed a higher credit spread than the adjusted market spread is currently traded at. Trade Thesis Capital Market Access PRHTA Default Credit Risk Yield Curve Risk Return Overall Assessment: Bearish on creditworthiness of Puerto Rican government $88.75 $30.71 GO Bond Price Time Series vs. High Yield Benchmark Source: Bloomberg Terminal 1
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  ● Municipal FinanceCorporation Act (Jan. 2014) ● General Obligation Bond Issuance (Mar. 2014) ● Puerto Rico Public Corporation Debt Enforcement & Recovery Act (Jun. 2014) ● TRANs 1 yr. Issuance (Oct. 2014) ○ $1.2 billion in TRANs notes to be issued in October (Maturity- June 2015) ○ Coupon rate 7.75% ○ Underwritters including JP Morgan, Bank of America and Morgan Stanley won’t sell the debt and have agreed to hold until maturity Relevant Legislation “A major difference between Puerto Rico’s balance sheet and those of the states is the presence of large, heavily indebted, corporate-like entities that continue to lose money and increase borrowing. For any financial reform agenda to be successful, it must confront this issue head on” FOMC Vice-Chairman William Dudley Unsettled Legal Disputes with Investors ● U.S. Solicitor General Theodore Olson has been hired by hedge fund (with large holding in PREPA debt) to fight recent restructuring law. ● Doral Bank has an ongoing $229 million tax refund dispute with Treasury. The PR Supreme Court is expected to rule on the lawsuit this month (October 2014). Trade Thesis Capital Market Access PRHTA Default Credit Risk Yield Curve Risk Return 2
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  0 10000 20000 30000 40000 50000 60000 70000 2 0 02 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 2 0 0 7 2 0 0 8 2 0 0 9 2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 TOLLGATE TAX REVENUEDistressed Debt Trigger: ● PRHTA credit rating downgraded from Ba3 to Caa2 in July 2014 (Moody’s) ● PRHTA issued bonds are secured in part by ● Tollgate revenues of the Authority’s traffic facilities ● Excisetaxes levied on specific petroleum commodities ● 1968 Resolution Revenue Fund ● Total debt outstanding $4.6 billion ● Constitutional claw back provision: all tax revenues of PRHTA (excluding tollgatetaxes) are firstavailable to the Treasury for Commonwealth GO debt servicepayments Source: Government DevelopmentBank of Puerto Rico Trade Thesis Capital Market Access PRHTA Default Credit Risk Yield Curve Risk Return 3
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  • The issuanceof GO bonds underscores Puerto Rico’s dependency on continued access to capital markets for plugging budget deficits and gaining operational short-term liquidity • $14.2 billion of GO bonds outstanding Intent of GO Issuance: TRANs:Tax and RevenueAnticipated Notes Source: BloombergTerminal Credit Risk: GO Performance after TRANs Issuance 10/07/2014 $88.75 • GO bonds are only secured by the good faith, credit and taxing power of Puerto Rico • Total GO debt cannot exceed 15% of the average annual revenues in the two fiscal years preceding the current fiscal year. • As of now, total GO bonds outstanding have reached 12.44% of the average annual revenues in 2012 and 2013 Trade Thesis Capital Market Access PRHTA Default Credit Risk Yield Curve Risk Return 4
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  Bloomberg Municipal CreditRisk (MRSK) Model Credit Risk DS5 Model Spread 847.53 Adjusted Market Spread 798.45 Market Risk DS5 Model Inputs (USD) Total Assets 2,771 MM Total Liabilities 44,724 MM Excess Rev over Exp 1,347 MM Other Sources of Funds 504 MM Property Tax Revenues 58 MM Building Permits 474 House Price Index 136 Median Income 19,183 Non-farm Employment 904 Unemployment 13.50% 847.53 bp Source: BloombergTerminal Trade Thesis Capital Market Access PRHTA Default Credit Risk Yield Curve Risk Return 5
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  Island’s Political Outlook 9.225% 9.98% 7.75% 8.422% 0 2 4 6 8 10 12 14 16 18 20 1year 21 year • Fed short term rate hike before April 2015 can lead to an inversion of borrowing costs. (i.e. next short-term TRANs coupon rate rises at a faster pace than the 21 yr. GO bond “The time is right to make some of the tough decisions. You can be in a much better place even six months or a year from now” FOMC Vice-Chairman Dudley • Privatization of currently held public utility companies could inject medium to long term liquidity into Treasury • Our political outlook until the next general election in 2016 is that structural reforms are highly unlikely. Labor unions have stronghold on the ruling party’s voter base TRANs note vs. GO bond borrowing costs Global Interest Rate Risk Overall Hedge: Sell Interest Rate Swap (if political outlook changes on the ground) Trade Thesis Capital Market Access PRHTA Default Credit Risk Yield Curve Risk Return 6
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  Bond Price ExpectedReturn 82.75 6.76% Expected GO Bond Yield 9.983% Returns to Maturity Principal 1,000,000.00 MM Coupon Price 1,680,000.00 MM Reinvest@ 9.23% 3,717,369.05 MM Total Income 6,397,368.05 MM Expected Return on PRHTA default Before April 2015 GO Performance after PREPA imminent default GO Bond Price Time Series PREPA: Puerto Rico Energy Power Authority Source: Bloomberg Terminal $83.50 $89.875 Trade Thesis Capital Market Access PRHTA Default Credit Risk Yield Curve Risk Return 7