Governor Alejandro Garcia Padilla warned that Puerto Rico bond investors face a cascade of defaults starting in July unless Congress passes legislation that facilitates a restructuring of the commonwealth’s debt.
The exhortation made Monday in San Juan came a day after Garcia Padilla announced a moratorium on the payment of $400 million in Government Development Bank debt that matured Sunday. The governor said he was choosing to focus on providing essential services as the commonwealth’s financial crisis worsens, rather then to pay creditors. The default is the biggest yet by the island.
The missed payment opens the door to larger and more consequential defaults on general-obligation bonds, which are protected by the island’s constitution. Puerto Rico and its agencies owe $2 billion on July 1, including $805 million in GOs. It also could affect slow-moving efforts by U.S. lawmakers to resolve the biggest crisis ever in the municipal bond market.
“The really bigger deadline is the one the market’s more worried about, the July 1 payment,” Peter Hayes, who oversees $110 billion of state and local debt as the head of BlackRock Inc.’s muni group, said during an interview on Bloomberg Television. The May 1 payment “has been widely expected, generally known.”
After announcing the default, the GDB said it reached a tentative agreement with a group of hedge funds who hold $900 million of its debt under which creditors would accept a potential haircut, leaving them 47 cents on the dollar of the face value of their original securities. The parties agreed to keep discussions out of court while they continue to negotiate. It reached a similar agreement Friday with credit unions holding about $33 million in debt.
Even with the debt-deferral agreements, credit-rating companies said a default was inevitable. Moody’s Investors Service analysts said last week that any non-payment, even if creditors agree to it, constitutes a default in their eyes. S&P Global Ratings said a distressed debt exchange or temporarily withholding interest is synonymous to default.
A default on the general-obligation bonds would be the first by a state-level borrower since Arkansas missed payments on its debt in 1933. That would likely trigger a restructuring of the commonwealth’s $13 billion of general obligations, which would be the largest-ever in the tax-exempt market.
Not everyone is convinced it will reach that point. Daniel Hanson, an analyst at Height Securities, wrote in a note that April tax collections may show that Puerto Rico is taking in enough revenue to be able to meet its July payments. The island’s Treasury Department will release April collections next week.
Even so, the non-payment by the GDB alone will push the amount of outstanding munis in default up by 44 percent, to $23.6 billion from $16.4 billion, according to a tally from Municipal Market Analytics. That would make 0.64 percent of the $3.7 trillion market in default, up from 0.44 percent.
Puerto Rico racked up $70 billion of debt across more than a dozen issuers as it borrowed to paper over budget deficits. Garcia Padilla said 10 months ago that the obligations were unpayable. Yet, up until now, the commonwealth only missed $143 million of payments on appropriation bonds from the Public Finance Corp. and rum-tax securities from the Infrastructure Financing Authority.
The development bank, in contrast to those borrowers, is a prominent, visible and well-known Puerto Rico entity set up after the Great Depression to chart a course out of poverty. It’s the fiscal agent of the commonwealth, lending to the island government and localities. For the past few weeks it has operated under a state of emergency to preserve cash.
The lender was designed to promote business investment with a long-term horizon, but in recent years politicians turned it into a piggy-bank that lent to the government and its agencies, helping keep them afloat as the island’s economy shrunk every year but one since 2006. About 45 percent of residents live in poverty. Puerto Ricans have been fleeing the island at record rates for work on the U.S. mainland.
The default comes as the House Natural Resources Committee is working on a bill that would establish a federal oversight board to manage any debt restructurings and weigh in on spending plans. It’s set to file a new draft after lawmakers return from recess on May 10. The committee last month postponed a vote on the measure as lawmakers from both sides and the U.S. Treasury Department sought to make changes to the bill.
“Unless Congress passes legislation that includes appropriate restructuring and oversight tools, a taxpayer‑funded bailout may become the only legislative course available to address an escalating crisis,” Treasury Secretary Jacob Lew said in a letter to Congress posted Monday on the Treasury department’s website. “Congress must work quickly to resolve the few outstanding issues on the proposed legislation to help Puerto Rico.”
The island owed $470 million in total to bond investors in May, including a $1.6 million general-obligation payment. Puerto Rico will pay everything Monday except for the GDB principal, according to Barbara Morgan, a spokeswoman for the GDB at SKDKnickerbocker in New York.
The GDB bond in question, which matured May 1, is a $400 million taxable security issued in 2011 with a 4.7 percent interest rate. The $22 million in interest will be paid, the commonwealth said. It last traded in March at about 32 cents on the dollar.
Those with the largest positions, according to the latest disclosure filings compiled by Bloomberg: Thompson Investment Management, $24 million; Frost Investment Advisors, $11.2 million; Baird Financial Group, $5.1 million; Texas Mutual Insurance Co., $2 million; Merchants Mutual Group, $1.5 million; and UBS Asset Managers of Puerto Rico, $1 million.
The tentative accord with investors holding $900 million of debt involves bondholders swapping their securities in the near term at a 56.25 percent recovery rate, the bank said in a statement. If Puerto Rico at a later date reduces most of its debts through a broader restructuring, then the final recovery rate on GDB bonds would be 47 percent of the original value. The GDB will pay May 1 interest on the bonds in full.
Members of the so-called Ad Hoc Group of bondholders include Avenue Capital Management, Brigade Capital Management, Claren Road Asset Management, Fir Tree Partners, Fore Research & Management and Solus Alternative Asset Management.
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