Even Buying Puerto Rico Bonds Near Record Lows Isn't a Sure Thing

• Island turning to court to shed some of its $74 billion debt

• Analyst says of outcome: ‘I don’t know how to model it’

Puerto Rico bonds are trading near record lows, but that doesn’t mean they’re not worth even less.

The island triggered the start of the largest U.S. municipal restructuring in history yesterday, nearly two years after it began defaulting on its $74 billion of debt. Puerto Rico has said it can pay less than a quarter of what it owes to creditors over the next ten years, even after it enacts sweeping measures to stabilize the government’s finances.

The prospect of deep losses -- despite vast uncertainty about how large such haircuts will be -- caused some bond prices to tumble in March, as investors sought to gauge how the governor’s fiscal plan would divvy up the island’s scarce cash. Puerto Rico general-obligation bonds due in 2035, one of the most frequently traded securities, sold for an average of 65.2 cents on the dollar Thursday, while sales-tax bonds with the greatest claim on those funds traded at 58.4 cents. Some highway agency debt traded for 23 cents.

"I think there’s a lot of downside risk to these prices," said John Miller, who oversees $120 billion of municipal bonds at Nuveen Asset Management in Chicago, including a small amount of insured Puerto Rico debt. "It’s maybe a message that creditors are not interested in compromise and they want to prove that they are entitled to more of the island’s resources and more of the prioritization scheme."

Miller said even the governor’s plan to pay less than a quarter of the debt service that’s due over the next decade could prove too optimistic, as that relies on the government improving its tax collections by cracking down on scofflaws, something it has struggled to do the past. At the same time, some creditors are more optimistic, insisting that Puerto Rico has the ability to pay more for debt service than it claims.

All of Puerto Rico’s bonds have the three lowest credit ratings from Moody’s Investor Service. The rating agency projects 65 percent to 85 percent recovery rates for bonds such as the general obligations and senior sales-tax debt. It forecasts holders of the Government Development Bank will recover less than 35 percent.

Matt Fabian, a partner with Municipal Market Analytics, said even though he thinks prices will fall further, he doesn’t know how anyone would calculate what final recoveries will be. Municipal bankruptcies are extremely rare, and Puerto Rico’s is rarer still, relying on a special, tailor-made procedure that Congress included in its emergency rescue law.

"I don’t know how to model it. I don’t think that Puerto Rico’s recovery is model-able," Fabian said in a telephone interview. "There’s so much uncertainty over what final recoveries will be, not the least of which is time. Bondholders are likely to be left with certificates when this is done. I don’t know how you price recovery, but based on what the commonwealth believes it can pay, prices are too high."

Not every one is as pessimistic. Peter Hayes, a managing director at BlackRock Inc., said that the current prices probably reflect most of the downside risk going forward as the bad news has already been factored in.

"It’s hard to believe that there will be very big surprises from here that will change the value of the bonds," he said. "With that said, there’s probably not a lot of upside either."