Puerto Rico Filed for Bankruptcy. Are You Surprised?: Joe Mysak

Millstein Says Title III Was Inevitable for Puerto Rico

When things get insane, municipalities can change the rules.

That’s the lesson to be learned from the Puerto Rico petition for Title III reorganization. It’s a hard one to swallow for a market that until recent years was known as a haven for preservation of capital and tax-free interest income.

The smartest guys in the room, the hedge funds who bought so much Puerto Rico paper at a discount, were fooled. When quizzed as to why they were so confident about full repayment -- until last year, their battle cry was “GOs at par!” and “Cofinas at par!” -- they pointed to the rules that said Puerto Rico wasn’t allowed to file for bankruptcy.

Congress changed all that last year when it approved the Puerto Rico Oversight, Management and Economic Stability Act and set up a federal oversight board, as well as the Title III process, just in case creditors needed a judge to convince them that no, their securities weren’t worth 100 cents on the dollar.

Some investors, maybe most, are still in denial. Anyone with a lick of sense, though, knew that the Puerto Rico’s debt binge wouldn’t end well. 

Back in 1999, I attended the Bond Club of Virginia’s annual outing and remember chatting with George Calvert, then with the Tredegar Trust Co., now chief investment officer of Middleburg Trust Co., all about the situation in Puerto Rico.

He was a little disgusted by the island’s piling on of ever more debt. And back then, according to the 2000 State Debt Median Report by Moody’s Investors Service, Baa1-rated Puerto Rico had $16 billion in net tax-supported debt, not the $55 billion it would run up by 2014.

“I looked at the credit for the first time 40 years ago as a rookie analyst in Virginia as municipal bond shops all over the U.S. used the ‘triple tax-exemption’ to market the bonds, but never thought the bonds were investment grade,” George emailed me today.

The debt median report is put out annually by Moody’s, tracking states and how much they borrow by various measures. Every year they would publish this report, and every year you’d see the list of 50 states and then at the bottom of the column, below the states and on a line all its own, would be Puerto Rico, “not included in any totals, averages, or median calculations but provided for comparison purposes only,” Moody’s said. And every year you would see the Puerto Rico debt figure grow.

I reported in 2004 that Connecticut had the most tax-supported debt per capita at $3,558. And then I wrote, "The actual No. 1 borrower isn’t a state at all. Puerto Rico has $5,758 in net tax-supported debt per capita. That’s a little scary.”

I wish I paid more attention back then.

Incidentally, the 2015 State Debt Medians report, which covers 2014 (the last time the island tapped the municipal market), showed that Connecticut still had the most tax-supported debt per capita, at $5,491, and Puerto Rico’s had grown to $15,637. In terms of net tax-supported debt as a percentage of gross domestic product, Hawaii topped the state list at 9.18 percent. Puerto Rico’s was 53.85 percent.

In other words -- and yes, this is a technical term -- Puerto Rico had gone insane. And now it wants out of its own asylum. “The numbers are staggeringly grim,” the commonwealth says in the Title III petition. Yes, they are: $74 billion in debt and $49 billion in pension liabilities.

After Governor Alejandro Garcia Padilla broke the news in the New York Times in June of 2015 that “the debt is not payable,” I realized that what this really meant, inevitably, was haircuts for all. All the legal security provisions, all the promises in the world, couldn’t trump the economic reality of a small, impoverished Caribbean nation.

I remember tweeting about this in the summer of 2015. What should the haircut be? I saw that Connecticut had a population about the size of Puerto Rico’s, and that it had net tax-supported debt of about $20 billion, and thinking, “Oh, my. That’s quite a haircut." The Twitterverse piled on.

Most investors think in terms of equities, and in equities there are pretty standard rules for when it’s “Game over” for a company. 

The lesson to be learned here is: It’s different in MuniLand, where it’s never game over. States, cities, and island commonwealths go on. And there have been so few occasions of all-out insane fiscal distress, let alone bankruptcy, that the rulebook is really still being written.

Bloomberg clients: We’ll be doing a TOPLive Q&A on Friday, May 5 at noon ET, in which you can ask me questions about the latest with Puerto Rico’s debt. You can watch it here. If you want to ask a question, please send to TOPLive@bloomberg.net .

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