Puerto Rico Debt Restructuring Filed in Federal Court as Expected But No Apparent Impact on Overall Muni Market

The financial oversight board overseeing the restructuring of the Commonwealth of Puerto Rico’s municipal bond debt approved the filing of a petition in federal court on Wednesday that would initiate a court-sanctioned restructuring process.  The Puerto Rico Oversight and Management Board was authorized by the federal PROMESA legislation last year to develop a plan to restructure the Commonwealth’s debt, and while it did not authorize Puerto Rico or any other state to file for Chapter 9 bankruptcy protection, it did authorize U.S. territories, including Puerto Rico, to seek similar relief in federal courts, if necessary. Puerto Rico’s filing is the first under the PROMESA legislation.

The filing is one more step in the long process of restructuring Puerto Rico debt, and occurred after the freezing of lawsuits over Puerto Rico debt expired last week. With the expiration of the lawsuit stay, numerous creditor lawsuits have been filed challenging the Board’s approval of a plan in March that would make drastic cuts in the Commonwealth’s debt service payments.  Lawsuits have also been filed challenging the Board’s filing for court protection.

SNW’s exposure to Puerto Rican debt continues to be limited to bonds issued by their Housing Finance Authority, where debt service payments are backed by the U.S. Department of Housing and Urban Development. These bonds continue to carry an investment grade rating and have not seen a material change in price since we initiated the position a few years ago. Principal and interest payments on these bonds are not impacted by the restructuring news. 

The reaction to the filing from Puerto Rico stakeholders has been mixed, falling along lines of who owns what type of Commonwealth debt. Moody’s Puerto Rico analyst feels that the filing was a positive step overall for bondholders as the restructuring process under the federal court’s jurisdiction will be more orderly than having a proliferation of lawsuits from multiple factions.  

While the management of the restructuring process in federal court could be more orderly, Puerto Rico still does not have authority to file Chapter 9.  So instead of being heard under Chapter 9 bankruptcy proceedings, this would be the first case under the PROMESA legislation.  Without legal precedent, there are questions about how the case would proceed, particularly as there are different factions of bondholders who may own debts that appear to have more bondholder protections than others.  The case will become even more complicated with the inclusion of Puerto Rico pension obligations into the process.

The filing was not unexpected by the municipal market, and it did not appear to have an impact on muni pricing.  Bloomberg News also reported that the prices of actively traded Puerto Rico GO bonds were not impacted by the filing.

The SNW investment team will continue to monitor the potential impacts of Puerto Rico’s debt restructuring on the municipal bond market.  We also track other distressed municipal credits, but we believe the applicability of Puerto Rico’s debt restructuring has more limited impacts on credits such as the state of Illinois’ despite comments made by some pundits.  Illinois as with other states still does not have authority to file Ch. 9 bankruptcy protection nor any other mechanisms such as PROMESA to file for bankruptcy-like protection.  Illinois has not repudiated its debt and we don’t believe it is likely to do so.  It also has an economy that is much stronger than Puerto Rico’s, and the state has sufficient resources to maintain solvency once it overcomes its political stalemate.  Even without bankruptcy authorization, there is a possibility that Illinois GO debt could be downgraded to junk status, but we would expect that they would still pay debt service on their debt obligations.

Source:  Bloomberg News, Moody’s, Reuters, Puerto Rico Financial Oversight and Management Board