The Commonwealth of Puerto Rico threw fuel onto the fire of negotiations over restructuring of its debt last Wednesday by enacting a debt moratorium. Under the legislation, Puerto Rico’s governor may suspend debt service payments on Commonwealth debt through January 2017. The bill was approved in a late night session Tuesday, with votes split along party lines as the opposition expressed concerns over potential negative long-term consequences for the U.S. territory. The legislation was met with swift resistance from many bondholders as well, who we expect to file lawsuits to prevent Puerto Rico from defaulting on its bonds.
The debt moratorium is the Commonwealth’s latest maneuver in its ongoing effort to reduce its debt burden. Not only does the decision come at a time when the Government Development Bank for Puerto Rico (GDB), an instrumentality of the Commonwealth, faces a now daunting $422 million debt service payment on May 1, but also as prior Puerto Rico initiatives to restructure debt are currently in various phases of negotiations, congressional hearings or judicial review.
Stories about Puerto Rico are hitting newswires and blogs on a daily basis. After sorting through all the events, proposals and negotiations, here is what we know now:
Puerto Rico’s fiscal foundation has crumbled under the weight of $72 billion of municipal debt that was used to fund programs and close never-ending budget deficits fueled by a weak economy and underperforming revenues. As investors began to catch on that Puerto Rico’s fiscal structure was unsustainable, the Commonwealth adopted legislation in 2014 that would authorize the restructuring of some Commonwealth debt programs. In essence, the restructuring would redirect revenues so the Commonwealth could have sufficient funds to pay its general obligation bonds and provide services to its residents. As Puerto Rico has not had authorization to file Chapter 9 municipal bankruptcy, it decided to create its own “Chapter 9” through the restructuring legislation. So far, federal courts have sided with bondholders in preventing the legislative debt restructuring, but the case has been appealed, and it is now awaiting a decision from the U.S. Supreme Court where it was recently heard.
Following agreements between Puerto Rico’s insolvent Electric Power Authority (PREPA) and its bondholders to restructure PREPA’s power bonds, a working group of Commonwealth leaders proposed a plan in February to restructure tax-backed Commonwealth bonds. The tax-backed bondholders were asked to take a 46% haircut by exchanging their bonds for new debt and an “opportunity” to recover the remaining principal if future revenues exceeded specified projections. There has been some pushback on the proposal, particularly from holders of bonds that have stronger bond covenants and coverage levels, but General Obligation bondholders have shown a willingness to defer receipt of principal payments. Puerto Rico has been negotiating with the tax-backed bondholders even as it was enacting the debt moratorium, and released a revised restructuring proposal Monday morning. Under the new plan, the amount of debt reduction would be reduced to the benefit of bondholders along with more favorable opportunities to recover the remaining principal.
Puerto Rico has also been lobbying the U.S. Congress for the authority to file Chapter 9 bankruptcy. While members of Congress have been receptive to Puerto Rico’s plight and appear willing to adopt provisions that would provide authorization to restructure commonwealth debt, there are a number of sticking points in the negotiations. On one side, some members of Congress are concerned that bondholders will be forced to accept draconian cuts in the value of their holdings. Conversely, the Commonwealth is opposed to potential legislation that would include a federal control board to oversee Puerto Rico’s finances.
We view the debt moratorium as one more chapter in the Puerto Rico’s ongoing saga of distressed debt. Despite Puerto Rico’s problems, it has continued to pay all but a small fraction of its debt service, and has so far only defaulted on bonds that have weak bondholder protection. As the Commonwealth’s resources continue to be depleted and it continues to raise the stakes in its restructuring initiatives, time may be running out and significant defaults in the Commonwealth debt may begin to occur, even while long-term solutions to Puerto Rico’s problems seem to be so far away.
Sources: Bloomberg News, the Bond Buyer, Reuters