Puerto Rico bonds tumbled for a second day, extending the biggest selloff in at least two decades, after Governor Alejandro Garcia Padilla moved to restructure the junk-rated island’s $72 billion of debt to ease a fiscal crisis.
The commonwealth’s newest general obligations dropped 5 percent Tuesday to the lowest since they were first sold in March 2014. That followed a 6.5 percent decline for Puerto Rico securities Monday, the biggest one-day loss since at least 1998, according to J.R. Rieger, vice president of fixed-income indexes at Standard & Poor’s in New York.
The governor’s statement Monday that Puerto Rico can’t afford to repay all of its debts raised the specter of an unprecedented restructuring in the municipal-bond market. Garcia Padilla’s push to delay some debt bills surprised investors, coming just two months after he said it would be a mistake to default on the commonwealth’s debt.
“A lot of uncertainty and a lot of problems that investors saw longer term have been accelerated,” said Guy Davidson, head of munis in New York at AllianceBernstein LP, which manages about $32 billion in local debt.
The island of 3.5 million people has built up more municipal debt than any U.S. state except California and New York, a result of years of borrowing to paper over budget deficits as the economy struggled to grow. That option has been closing as investors demand increasing yields to lend to the cash-strapped Caribbean government.
The ability to raise money in the financial markets was cast into doubt after Garcia Padilla said his administration will seek to put off some debt payments for “a number of years.” A group of hedge funds that had been prepared to buy a share of a $2.9 billion commonwealth bond issue are now hesitant because of the potential restructuring, according to three people familiar with the matter.
The governor didn’t specify which debt would be affected under such a proposal, which will be developed by Aug. 30. A report prepared for Puerto Rico by former International Monetary Fund officials, which the commonwealth released Monday, said it should convince investors to voluntarily exchange their bonds to delay or reduce interest bills.
OppenheimerFunds Inc., one of Puerto Rico’s biggest bondholders, said it would fight to protect the value of its investments.
“We expect Puerto Rico to act within the tenets of the law, including the Commonwealth’s Constitution, and are ready to defend the previously agreed to terms in each and every bond indenture,” OppenheimerFunds said in a statement Tuesday.
The governor’s effort to get bondholders to share in the island’s sacrifices came as financial markets are preparing for the fallout possibility of a Greek default and exit from the euro zone.
Puerto Rico’s debt lost 8.6 percent this year through Monday, the worst performance for the period since at least 2007, according to S&P Dow Jones Indexes.
Prices on some commonwealth securities continued to fall Tuesday. General-obligation bonds maturing July 2035 traded at an average price of 66 cents on the dollar, the lowest since the bonds were first sold at 93 cents in March 2014. The price has dropped 15 percent since Friday, according to data compiled by Bloomberg.
Puerto Rico’s debt strains aren’t confined to the central government. The island’s main electricity provider, known as Prepa, may default on a $416 million debt payment due Wednesday.
Puerto Rico securities have different repayment pledges, which means investors may be pitted against each other to get whatever money is available. Puerto Rico’s constitution stipulates that the commonwealth must repay general obligations first before other expenses. Other bonds, such as sales-tax debt, are backed by different revenue streams.
The budget for the fiscal year beginning July 1 includes a $300 million fund to repay Government Development Bank debt, although the bank will need additional legislative approval to access most of that money, House Speaker Jaime Perello told reporters in San Juan. The GDB, which lends to the commonwealth and its municipalities, is burning through its cash.
“Given the complexity of the different securities and the uncertainty of the future path of economic growth, we believe the debt restructuring process is likely to be protracted and legally contentious,” Ted Hampton, a Moody’s Investors Service analyst in New York, said in an e-mail.
Standard & Poor’s joined Fitch Ratings Monday in downgrading Puerto Rico, saying that “a default, distressed exchange, or redemption of the commonwealth’s debt appears to be inevitable within the next six months absent unanticipated significantly favorable changes.” S&P cut the commonwealth to CCC-, the same category as Greece.
The governor’s remarks signaled a reversal from his earlier stance to protect Puerto Rico’s direct debt, said Gary Pollack, who manages $6 billion of munis as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. The governor said in his annual speech to the legislature on April 30 that defaulting on the commonwealth’s bonds would be a mistake. He called it “folly” at the time.
Garcia Padilla is now referencing all Puerto Rico debt, “and that’s a scary thing,” Pollack said.