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In a recent interview with the Bond Buyer, David Fernandez, shareholder in Buchanan’s public finance practice, discussed how an increase in interest rates will affect the municipal bond market and also described the decisions facing Puerto Rico, which is on the verge of bankruptcy. Puerto Rico has a bond payment due on January 1, and as David described, its decision at that time will help to set the tone for the rest of the year.

“Puerto Rico, when they get to that January 1 payment, has two decisions to make,” explained Fernandez. They have to decide ‘Are we going to pay the debt? Are we going to take from Peter to pay Paul? Are we going to just default on the debt?' And the decision that they make is going to set the stage. Because if they just pay what they can and default on the debt that comes due, you’re going to have those creditors stepping up and trying to accelerate that debt. If they take from Peter to pay Paul, all of the sudden all these other issuances that may not have been in default are now in covenant default, and now you have a lot more disgruntled holders and the negotiating tool becomes even more difficult. On top of that, without having bankruptcy protection, they have to try to go into the courts and try to figure out how to do it.”

Fernandez drew parallels between the bankruptcy situation of New York City in the 1970s and the bankruptcy situation of Puerto Rico, Illinois and California in 2015.

“The difference between New York in the 70s and Puerto Rico in 2015 is Puerto Rico doesn’t have Chapter 9 available to it, Puerto Rico doesn’t have sales tax revenues available to it, Puerto Rico doesn’t have a whole bunch of other avenues that could be used as life rafts to help restructure their debt.”

In another segment of the interview, Fernandez also described how an increase in interest rates might impact the bond market, specifically for municipal bonds.

“For too long, the rates have been so low that the reasons why you want to use the muni market as opposed to going conventional really didn’t exist.”

Even the tax-exempt status and other incentives of municipal bonds did not make it worthwhile when the interest rates of conventional bonds were low, especially because going conventional means there are not as many regulations, obligations and covenants attached to the bonds. As Fernandez explained, the change in interest rates might now increase the volume of tax-exempt bonds, although the change won’t happen right away.

“The rate hike will help the market address projects that may not necessarily been able to avail themselves of financing beforehand,” he said.

Listen to the interview – “What Effect Will Rate Hike Have on Munis, Puerto Rico?” (The Bond Buyer, December 14, 2015)