Puerto Rico Creditors Said Drawing Battle Lines as Default Looms

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Puerto Rico Governor: Economy in Death Spiral

A group of more than 35 hedge funds has gone from standing ready to pour more than a billion dollars into cash-strapped Puerto Rico to preparing for battle against the island territory -- and one another -- in a default.

Governor Alejandro Garcia Padilla triggered the unraveling of a potential $2.9 billion oil-tax bond deal for Puerto Rico’s Government Development Bank by signaling his desire to restructure the island’s debt rather than raise new capital, according to three people with direct knowledge of the matter.

The hedge funds that were preparing to fund the bulk of that deal are now focusing on ways to protect their stakes, including through litigation, said one of the people, who didn’t want to be named because the talks are private. Some creditors are also in talks to break off into new groups, the person said.

“You are going to see additional creditor organization efforts, new groups form, and perhaps existing groups splinter,” Aaron Rosen, a principal at Archview Investment Group, a Stamford, Connecticut-based hedge-fund that manages about $900 million, said by telephone. “Bondholders are going to have to check their specific exposures and see which groups they should be in and which ones they shouldn’t be in.”

Budget Passed

Garcia Padilla has turned the island’s rescue efforts on their head. In a televised speech Monday, the governor said he will seek to delay payments on the island’s $72 billion in debt for “a number of years,” and he called on officials to come up with a debt restructuring plan by Aug. 30.

His comments sent the prices on some Puerto Rico bonds tumbling to all-time lows, while both Standard & Poor’s and Fitch Ratings cut the commonwealth’s ratings deeper into junk. With traditional municipal-debt investors shunning its bonds, the island faces a stultifying cash crunch and the government expects its development bank to run out of capital by Sept. 30.

Puerto Rico’s new fiscal year starts July 1 and lawmakers Monday night passed a budget that would enable it to make payments on central-government debt. The U.S. territory of 3.5 million people is grappling with a jobless rate double the national average and a debt load bigger than every U.S. state except California and New York.

The creditors own about $4.5 billion of Puerto Rico’s debt and are led by Fir Tree Partners and Monarch Alternative Capital. They had been proposing terms for the bond deal since at least February, people with knowledge of the matter told Bloomberg last week. It would siphon money to the GDB, which handles the island’s debt transactions and lends to the commonwealth and its agencies, by repaying debt owed by its highway authority.

Investor Sacrifices

The decision by investors to quit the deal and focus on other remedies comes after Garcia Padilla said in an interview with the New York Times published Sunday that investors should be prepared to sacrifice if they want the island’s economy to grow. He said in a televised speech Monday that Puerto Rico’s debt is unpayable and needs a complete restructuring.

Russ Grote, a spokesman for the hedge funds at Hamilton Place Strategies in Washington, and David Millar, a spokesman for the GDB at Sard Verbinnen & Co. in New York, declined to comment.

Prices on Puerto Rico general obligation bonds maturing July 2035 fell to as low as 68.3 cents on the dollar from 76.8 cents on Friday, data compiled by Bloomberg show. Puerto Rico’s debt is spread across multiple issuers, including the public electric utility, and some bonds are secured by specific tax receipts from revenue streams such as taxes on rum.

Legal Battle

Restructuring Puerto Rico’s debt “is likely to be protracted and legally contentious” because of the “complexity” of the commonwealth’s securities and “the uncertainty of the future path of economic growth,” Ted Hampton, lead analyst for the commonwealth at Moody’s Investors Service, said in an e-mailed statement.

Fitch cut the island’s debt rating to CC, a level that indicates the credit grader sees some kind of default as probable, while S&P cut its ranking two steps to CCC-.

The hedge-fund investor group has already begun preparing itself for a legal fight. It hired Washington-based law firm Robbins, Russell, Englert, Orseck, Untereiner & Sauber LLP to handle its litigation matters, people with knowledge of the hire told Bloomberg in May. The firm represented hedge fund Aurelius Capital Management in its fight to get paid back after Argentina defaulted, according to court documents.

“Sparring between creditors and against Puerto Rico ‘‘will necessarily increase’’ because the governor’s comments upend the top-ranked hierarchy the island’s constitution gives its general obligation bonds over other types of bonds, Andrew Gadlin, an analyst at broker Odeon Capital Group, said Monday in a telephone interview.

‘‘We’re now expecting every single credit is going to face a haircut,” Gadlin said. “We never expected that before.”

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