Puerto Rico Default Matters Little With Reputation in Ruin

  • Bonds trade well below commonwealth’s proposed recovery rates
  • Garcia Padilla likey to enact moratorium without bill passage

Regardless of whether Puerto Rico goes through with a historic default in four days, owners of the commonwealth’s bonds are saying the damage is already done.

Almost a year to the day since Governor Alejandro Garcia Padilla warned that the island couldn’t afford to pay its bills, the price of the securities are trading at levels that suggest investors have all but given up on full repayment.  In a sign of worsening relations, the commonwealth announced last week that the latest round of restructuring negotiations had collapsed. Some holders were quick to file a lawsuit to prevent the implementation of a debt moratorium that would allow the governor to skip the payments.

“I don’t think it changes anything for them,” said Matt Dalton, chief executive officer of Rye Brook, New York-based Belle Haven Investments, which oversees $5 billion of municipal bonds, including insured Puerto Rico securities. “Their reputation is already butchered. Whether they do or don’t pay at this point, it’s too late. The perception has turned into reality.”

If Puerto Rico defaults on the $805 million in general obligations, it would be the first by a state-level borrower since Arkansas missed debt-service bills in 1933. Since August, three Puerto Rico agencies, including the Government Development Bank which served as the island’s fiscal adviser, have defaulted on smaller payments.

In the end, it may not matter. The Senate is set to take up a bill this week that’s been tagged as Promesa, which means promise in Spanish, that would allow Puerto Rico to restructure its debt through a federal control board that would also oversee the island’s budgets. The legislation would also shield the commonwealth from lawsuits that were filed as far back as December and future legal claims the island may face. The House approved the bill earlier this month.

Bonds Rally

“It is essential that the Senate acts on Promesa so that the commonwealth can get access to a framework to restructure its debts, comply with its financial responsibilities, and find a sustainable path forward,” Victor Suarez, Puerto Rico’s fiscal agent, said in a statement.

While commonwealth bonds have rallied as the bill gained support, prices are still well below the recovery levels that Puerto Rico has offered investors.

A debt-exchange proposal made by the commonwealth on June 17 said general-obligation holders would receive 83.5 percent of their holdings through new restructuring bonds with a 5 percent interest rate. General obligations with a 5 percent coupon and maturing July 2041 traded Monday at an average price of 61.8 cents on the dollar, to yield 8.8 percent, according to data compiled by Bloomberg.

“The bonds are waiting for a road map out of Congress as to what’s going to happen,” Dalton said. “If you really believe that they’re going to get something done and they offered you 90 cents on the dollar, then the bonds should be trading at 88 cents on the dollar.”

Redirecting Revenue

Investors have yet to file suit over the smaller defaults on agency debt as those securities have no dedicated revenue streams or are repaid only if the legislature appropriates the funds. That may change if the Promesa bill isn’t approved by July 1 and if Puerto Rico defaults on its general obligations.

“It’s a big deal,” said Daniel Solender, who oversees $19 billion, including Puerto Rico securities, as head of municipals at Lord Abbett & Co. in Jersey City, New Jersey. “When you break a constitution, there has to be action by investors to protect their investments. I assume there’s going to be legal action taken.”

Since the governor’s restructuring announcement a year ago, Puerto Rico has repaid general-obligation investors at the expense of other bonds with weaker pledges by redirecting money originally used to repay those securities. Comments by Garcia Padilla during a panel discussion Thursday in Washington indicate his options are running out.

“It’s just a reality. We do not have the money,” Garcia Padilla said about the July 1 deadline. “That’s why we’ve been saying that we will default on July 1.”

Water Utility

Even though Garcia Padilla has warned for months that the island’s ability to pay on July 1 is uncertain, a general-obligation default would still prompt selling of commonwealth debt, said Matt Fabian, a partner at Concord, Massachusetts-based Municipal Market Analytics.

“There will be selling of Puerto Rico securities because nothing is ever baked into the muni market,” Fabian said. “The market typically waits for the rake to hit you in the face before you step aside.”

The effects will likely be long lasting. A general-obligation default would force the commonwealth to pay higher borrowing costs in the future, even on agency debt backed by dedicated revenue, Solender said.

While Congress is considering the broader debt restructuring process, Puerto Rico lawmakers are working on a bill that would allow its main water agency, the Puerto Rico Aqueduct and Sewer Authority, to raise money through a bond offering for needed infrastructure improvements and to repay suppliers.

“For their future, they’re going to need to access the markets,” Solender said. “If they don’t make the payment, why would anyone believe that the contract on the Aqueduct and Sewer Authority is any different?”

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