Puerto Rico Risking Point of No Return With Debt Payment Default

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Puerto Rico is poised to set in motion a chain of events to force investors into negotiating a restructuring of the island’s $72 billion debt burden.

The commonwealth’s Public Finance Corp. will likely fail to make $58 million in bond payments due Aug. 1, the first default since Puerto Rico was ceded to the U.S. following the Spanish-American War. Government officials say they can’t make the payment because the legislature didn’t appropriate the funds last month for the current fiscal year.

A default would be the biggest salvo yet between creditors and the debt-ridden island since Governor Alejandro Garcia Padilla said in June that Puerto Rico cannot repay its obligations and was seeking to delay debt payments for a number of years. Prices of the securities are tumbling as officials, who are pursuing the use of bankruptcy, prepare to release a debt-restructuring plan by Sept. 1.

“They’re setting up the process of the entire restructuring,” said Lyle Fitterer, who helps oversee $38 billion of municipal securities, including Puerto Rico debt, at Wells Capital Management in Menomonee Falls, Wisconsin. “They’re probably getting advice from someone saying if you’re not going to pay on something, this is what you shouldn’t pay on.”

Moral Obligation

Investors appear to view a default as a sure thing. PFC bonds maturing in 2031 traded at a record low 11.9 cents on the dollar Monday, according to data compiled by Bloomberg. The debt changed hands Thursday at an average of 15.6 cents, for a yield of 36.3 percent.

“This is the first step to showing they’re not really interested in working with bondholders,” said Daniel Solender, who manages $17 billion as head of munis at Lord Abbett & Co. in Jersey City, New Jersey. “It is strange that they’re using a smaller issue to start the problems with bondholders. It’s the first real default if they really do it.”

The risk of default is spreading to other Puerto Rico securities, with subordinated sales-tax backed bonds known as Cofina debt trading at an average 37.1 cents Wednesday to yield about 45 percent.

While the PFC payment is small within the scope of the island’s debt load, it’s the credit with the weakest repayment pledge -- hinging on legislative appropriation. A dedicated revenue stream isn’t tied to the PFC’s $1 billion of outstanding bonds and the commonwealth isn’t obligated to pay off the securities, known as moral obligation debt.

Protest Rally

Some groups are pushing back against bondholders, particularly hedge funds that bought Puerto Rico securities at a discount and may profit from a restructuring.

About 40 people demonstrated outside of BlueMountain Capital Management’s offices Thursday in Manhattan carrying a hand-crafted vulture and carrying a banner that read: Hedge Funds = inequality. The group is against spending reductions that investors and island officials have called for, chanting in Spanish “Puerto Rico is not for sale. Puerto Rico defends itself.”

BlueMountain holds Puerto Rico Electric Power Authority debt and won a lawsuit this month that defeated an island law that would have allowed some agencies to ask investors to take a loss. The power utility should restructure its obligations for long-term solvency by modernizing its facilities, the New York-based firm said in a statement.

Payment Deadline

The Public Finance Corp. has until the end of business on Aug. 3 to make the payment since the first day of August is a Saturday, according to bond documents.

Puerto Rico and its agencies have more debt than any state except California and New York as the island and its localities borrowed to fix multi-year budget deficits. Its largest pension fund may deplete its assets by 2020, according to Moody’s Investors Service. That retirement plan only has 0.7 percent of assets to cover $30.2 billion of projected costs, according to financial documents. It’s the worst-funded among U.S. state retirement plans.

The commonwealth’s economy has declined every year but one since 2006. Its population has shrunk 7 percent in the last decade as people move to the mainland U.S. for jobs. The island’s 12.6 percent June unemployment rate is double the national average.

Available Cash

Other Puerto Rico debt payments due Aug. 1 include $91.5 million of principal and interest on Municipal Finance Agency bonds repaid with payments from San Juan and other towns, and also $252 million of principal and interest on debt backed by the island’s sales-tax levy.

Whether the PFC payment will be made will depend on if the commonwealth has cash available, Victor Suarez, the governor’s chief of staff, told reporters Monday in San Juan. He didn’t say whether the island will be able to do so.

At the same time, officials are working on addressing Government Development Bank bonds also due Aug. 1. The bank, which lends to the commonwealth and its localities, has $140 million of bonds maturing that day and $29 million of interest due, data compiled by Bloomberg show.

“We’re going to do everything possible so that the debt of the Government Development Bank is met,” Suarez said. “To that end, the bank is taking steps to increase its liquidity -- the bank’s liquidity, not the central government’s liquidity, to be clear -- to make this payment.”

Pressure Point

The GDB earlier this month said it may purchase its debt through cash or exchange the securities at less than par. Standard & Poor’s considers such an exchange as a default.

“The failure to pay any Aug. 1 debt service may also serve to pressure the U.S. Congress to more seriously consider extending Chapter 9” to Puerto Rico’s municipalities, Joe Deane, head of munis in New York for Pacific Investment Management Co., which oversees about $40 billion of state and local debt, wrote in a July 27 commentary on Pimco’s website.

A House bill that would enable some commonwealth agencies to file Chapter 9 has failed to gain Republican co-sponsors.

If PFC fails to pay on time, prices on commonwealth debt should fall, said Matt Fabian, a partner at Concord, Massachusetts-based Municipal Market Analytics.

“I would expect a knee-jerk reaction in Puerto Rico bonds because a lot of Puerto Rico bonds are still held in retail accounts on the expectation of full payment,” Fabian said.

Puerto Rico general obligations maturing July 2035 and originally sold at 93 cents on the dollar traded Thursday at an average 69.7 cents, for a yield of 12 percent, data compiled Bloomberg show.

“Everyone knows going in that it’s a possibility and that it’s on the low end of the spectrum,” Solender said about PFC’s potential to default. “But the expectation would be that they would try to work with bondholders before just walking away from the appropriation.”

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