Hedge Fund Splitsville Helps Puerto Rico

All’s fair in love and debt restructuring.

In the saga of Puerto Rico, dozens of hedge funds were shaping up as a formidable alliance until it looked as if some stood to gain more than others. Then they became enemies, at least in regard to their competing stake in the island’s $72 billion of debt.

This group’s breakup is a small victory for Puerto Rico, which is quickly running out of cash and needs to pay its workers and retirees while also facing hundreds of millions of dollars of interest payments. Its coffers may be empty as soon as November.

Here’s why the group fizzled: the effort, which once included more than three dozen firms, had lost its purpose as it became increasingly clear that the island had no intention of negotiating with them.

Their main argument was that Puerto Rico could manage all its obligations if it just cut spending and raised taxes. To show their faith, the funds agreed to lend even more money to the cash-strapped island in return for certain concessions. It was an attempt to gain power in a negotiation in which, ultimately, they’re somewhat powerless.

Cracks in the group began deepening in June after Governor Alejandro Garcia Padilla said that the island’s debts were “not payable.” Some funds began splitting off, preparing for the all-but-inevitable restructuring.

Then, a Puerto Rico agency defaulted for the first time in August and paved the way for a battle that would inevitably leave the island paying some some bondholders at the expense of others. Puerto Rico said last Thursday that its restructuring would take into account the constitutional priority given to the $13 billion of its outstanding general-obligation debt. That may have been the last straw. A day later, Laura Keller of Bloomberg News reported that the group had finally disbanded in favor of smaller groups.

That’s good news for Puerto Rico, which will face a less-unified group of bondholders to fight its restructuring proposals. For its part, the island can use all the help it can get. It is firing teachers and paying less to pensioners. Its population has dropped by 7 percent in the past decade, and it expects another 245,000 to leave by 2025. It can’t keep incurring more debt forever as its economy shrinks.

More important, because of its status as a commonwealth, Puerto Rico has no ability to restructure its debt in bankruptcy, and Washington has indicated no willingness to change that anytime soon. That leaves it in free-for-all negotiations with its creditors and no clear template for exiting its fiscal mess.

Make no mistake, Puerto Rico faces herculean challenges. But this divide-and-conquer outcome, whether by choice or circumstance, gives it some bargaining room.

(For more Market Line insights, see NI MKTLINE.)
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