Puerto Rico Investors Sue to Stop Development Bank Payments

  • Hedge funds say ailing bank is making preferential payments
  • Bank hid information as condition worsened, creditors say

Hedge funds holding debt in Puerto Rico’s Government Development Bank sued to stop the island’s key fiscal entity from making payments to local government agencies as it faces a growing cash shortage and the prospect of insolvency.

The funds, which include affiliates of Brigade Capital Management, Claren Road Asset Management and Solus Alternative Asset Management, accused the bank in a lawsuit filed Monday in San Juan federal court of seeking to “prop up” local agencies at the expense of other creditors. The situation may imperil restructuring efforts for the bank, which its regulator says is facing a cash shortfall of as much as $1.3 billion in June.

Puerto Rico, which is negotiating with creditors to reduce a $70 billion debt load, has “had every incentive to cannibalize” the bank to “meet its own liquidity needs through preferential transfers even if such transfers make it impossible to restructure” the bank, the hedge funds said in the complaint. “The unfortunate depositors and bondholders left behind in GDB will be left to bear amplified losses.”

Dual Purpose

The Government Development Bank serves the dual purpose of providing financial support to local governments and acting as a financial adviser to the commonwealth. The funds, which say they hold a “substantial amount” of almost $3.75 billion in the bank’s outstanding debt, blamed the entity’s deteriorating condition on a “hopeless conflict” between loyalties to Puerto Rico and to creditors.

The bank owes investors a $422 million bond payment May 1 that Governor Alejandro Garcia Padilla has said can’t be paid. If the GDB skips that payment, it would be the first major default by a commonwealth entity after two agencies have missed smaller debt payments.

Along with receiving financing from the bank, local agencies and municipalities also hold deposits there. The hedge funds are trying to stop the withdrawal of those deposits as the bank’s finances worsen and the agencies “race for the exits,” according to the complaint.

Preferential Transfer

In another example of a preferential transfer, the bank allowed hundreds of millions of dollars of assets to be moved into a trust for the benefit of the Municipal Revenue Collection Center, a tax-collecting agency known by its Spanish acronym Crim, according to the lawsuit.

The funds also complained the GDB has continued to make loans to Puerto Rico and its agencies even though the commonwealth won’t be able to pay back the loans.

The hedge funds also allege the bank kept “creditors in the dark” about its predicament and the scope of preferential payments. The bank’s “failure to disclose such essential information and frankly acknowledge and face its own financial problems has delayed it from developing plans to restore GDB’s solvency and restructure its debts,” the funds alleged.

The GDB currently has about $700 million of liquidity, the bank’s president, Melba Acosta, said in a local radio interview last week. That’s down from about $1.1 billion on March 31, 2015, according to GDB documents.

It had $10.7 billion of total assets -- including loans to public corporations -- and $8.8 billion of total liabilities, as of June 30, 2015, according to the commonwealth’s latest financial data. The bank held $3.9 billion in deposits from public agencies as of Sept. 30.

‘False’ Claims

Acosta said in a statement Monday that the hedge funds’ claims are “wholly false and without basis in fact” and that the bank will “respond to the complaint in full through proper legal means.”

The bank will continue to negotiate with its creditors, including the hedge funds, she said.

“GDB -- like all agencies of the commonwealth -- is faced with extremely difficult choices, and it is our responsibility to evaluate all options that may protect creditors’ ability to be repaid while ensuring that GDB keeps its doors open,” she said.

The hedge funds that sued the development bank were part of a seven-member bondholder group that tried last year to negotiate a plan to restructure the GDB’s roughly $5 billion of debt and inject it with fresh capital, people with knowledge of the matter said at the time. A month later, the creditors warned they would take steps to install a receiver and freeze the bank’s assets if they suspected it was being run improperly, people familiar with the matter said then.

Long Dispute

Puerto Rico has been quarreling with hedge-fund creditors over how to restructure commonwealth debt since at least February 2015. Some of the proposals that have been lobbed back and forth would’ve helped inject capital into the struggling development bank, which is central to Puerto Rico’s financial apparatus because it lends to the government and its localities. The island is running out of cash to service its mountain of debt after job-creating tax incentives were ended in 2006, sending the economy into a tailspin.

The hedge funds seek the suspension of payments by GDB, except for withdrawals needed to maintain essential public services or to pay the ordinary operating expenses such as utilities, rent and employee wages.

The case is Brigade Leveraged Capital Structure Fund Ltd. v. Government Development Bank of Puerto Rico, 3:16-cv-1610, U.S. District Court, District of Puerto Rico (San Juan).

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