In what many thought was a miracle of modern money-printing-driven yield-chasing, Puerto Rico managed to get $3.5 billion of bonds off last week with no problem (albeit at a 8.73% yield). The issue (while perhaps not as surprising as the low yield issues of Uganda we have reflected on previously) raised some eyebrows and in the trading since its release, FINRA noticed something concerning. The bonds, as Bloomberg reports, are supposed to 'minimum denomination $100,000' blocks and yet 75 trades this week have been for no more than $25,000 violating regulations which deem these for "institutional purchasers" and strongly suggesting the heavy hedge fund demand was nothing more than a pump-and-dump scheme to unsophisticated retail investors. PR bonds have plunged from par to $92 this week.
- *PUERTO RICO SOLD $3.5 BLN OF GENERAL-OBLIGATION DEBT MARCH 11
- *FINRA SAYS IT’S EXAMINING TRADING IN NEW PUERTO RICO BONDS
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Puerto Rico borrowed $3.5 billion at 8.73% yield maturing in 2035 - funding itself through June 2015 and staving off imminent default risk with the biggest ever high-yield muni offering! As Bloomberg notes,
Hedge funds made up the majority of buyers in the tax-exempt deal, according to David Chafey, chairman of the island’s Government Development Bank.
Sale documents stipulate that “the bonds shall be issued in the minimum denomination of $100,000 and any integral multiple of $5,000 in excess thereof,” unless one of the three largest rating companies raise Puerto Rico to investment grade.
However, once the bonds were free to trade March 11, things changed...
Since then, they changed hands in at least 75 transactions less than $100,000, data compiled by Bloomberg show. The bonds’ highest price, 100 cents on the dollar, was for a $25,000 trade at 10:47 a.m. in New York on March 12.
This is a problem that FINRA is looking into...
Trades below the minimum amount for investors that don’t already own at least $100,000 of the debt violate the Municipal Securities Rulemaking Board’s Rule G-15 subsection F, said Martha Haines.
The rule Haines referenced states that brokers and dealers can’t execute a trade of a municipal security that’s below the minimum denomination of the issue, according to the MSRB’s website.
“These are intended for institutional purchasers, or at least for people that can afford the risk by making it a minimum denomination of $100,000,” said Haines, who teaches municipal finance at the Maurer School of Law at Indiana University in Bloomington.
A glance at the chart shows both the illiquidity in the market (huge bid-offers) and the major drop on Friday as FINRA unveiled its probe (suggesting those wanting to get rid - hoping to find greater fools - dumped them fast).
However,
Given the commonwealth’s challenges, the debt should be held by investors who are aware of the possibility of default, said Sean Carney, a municipal strategist for New York-based BlackRock Inc., the world’s largest asset manager.
"It’s irresponsible,” Carney said about trades below $100,000. “It’s not what the deal was meant to do -- to keep the risk with those who understand it.”
Of course, this could be merely splitting across accounts (or smal lupsizing from already $100,000 accounts) and all be a big misunderstanding... you decide which is more likely.