(Bloomberg) -- Puerto Rico’s bankruptcy created some debt securities that don’t pay interest, but still managed to deliver an almost $400 million windfall to investors this month.
Called contingent-value instruments, or CVIs, they’re what investors received in March 2022 as part of a debt restructuring deal that cut $22 billion of the commonwealth’s outstanding bonds down to $7.4 billion.
The CVIs are taxable securities that resemble zero-coupon bonds — except they do offer investors a chance to collect interest-like payments before the debt expires. This is because they include a provision that calls for holders to receive a payout in November if sales-tax collections for the prior fiscal year surpass projections. So far they have: CVI holders received $362 million in 2022 and $388.7 million on Nov. 1.
Some bondholders view the CVIs as a long-term investment. But others see them as trading vehicles, looking to take advantage of price movements because their longer duration makes them more sensitive to interest rates and susceptible to swings, said Daniel Solender, head of municipal debt at Lord Abbett & Co, which holds some of Puerto Rico’s CVIs.
“The underlying value is based upon the tax payments, but since the prices move so much in the market, there are a lot of people using it for speculation too,” Solender said. “It’s a liquid market. You can get in and out of it and make a trade.”
The CVIs are benefiting from billions of federal cash flowing to Puerto Rico after Hurricane Maria made a direct hit in 2017, which devastated the power grid and left most of the island without electricity for almost a year. The federal funds are helping to boost the commonwealth’s economy, which means stronger-than-budgeted sales-tax collections.
The $8 billion of outstanding CVIs are backed by 5.5% of the island’s sales-tax levy. If collections surpass a baseline for the fiscal year ending June 30, then investors receive a portion of that excess revenue on Nov 1. The 5.5% pledge brought in $1.75 billion in revenue in the fiscal year that ended June 30, $474 million above the $1.28 billion baseline for that year.
“The economy there is getting a tremendous amount of government support,” Solender said. “So a lot of money’s going into it and the economy’s doing well and people are traveling.” Holders of Puerto Rico’s CVIs include Allianz, BlackRock Financial Management, Invesco, Nuveen Asset Management and AllianceBernstein, data compiled by Bloomberg show.
Puerto Rico also has about $12.7 billion of outstanding sales-tax bonds, according to the securities’ most recent audited statement, which are repaid before the CVIs. Sales-tax collections tend to cover the debt’s annual principal and interest payments about 100 days after the start of the fiscal year.
Puerto Rico’s most actively-traded CVI matures in 2043. It last changed hands Monday at an average 49.8 cents on the dollar, according to data compiled by Bloomberg. While prices on the security have rallied from the start of 2023, they’re still below the average 57 cents the CVI offered when it first traded in the secondary market on March 15, 2022.
Prices on that 2043 CVI are higher than on a commonwealth zero-coupon sales-tax bond that matures in 2046 and is tax-exempt. That bond traded Monday at an average 26.8 cents on the dollar, data compiled by Bloomberg show.
The commonwealth’s interest-bearing bonds are more expensive. A tax-exempt Puerto Rico sales-tax bond with a 4.3% coupon and maturing 2040 traded on Monday at an average price of 90.8 cents, the data show.
The possibility of a slowdown in Puerto Rico’s economy and its sales-tax collections are a risk for the CVIs. The commonwealth’s bankruptcy began in 2017 after years of economic decline. Puerto Rico’s financial oversight board has warned that economic activity on the island is dependent on federal cash. The board projects the island’s gross national product will decline by 1.6% in 2024 and 1% in 2025, when taking into account structural reforms to generate savings. It also anticipates that Puerto Rico’s population will continue to decline through fiscal year 2051.
Investors will be watching Puerto Rico’s economy and its tax collections, Solender said.
“If things slow, it wouldn’t do as well,” he said about the CVI’s ability to repay.
Puerto Rico’s restructuring gave investors the CVIs, a $7 billion cash payment and $7.4 billion of new general obligation bonds.
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