Thursday, June 30, 2016

Puerto Rico Says It Will Default Even With Congressional Aid
June 29, 2016 — 4:23 PM EDT

Two days before a potential historical default, Puerto Rico Governor Alejandro Garcia Padilla made it clear that the commonwealth won’t pay bondholders even as Congress votes on a bill allowing the island to restructure its $70 billion in debt.

“On July 1, 2016, Puerto Rico will default on more than $1 billion in general obligation bonds, the island’s senior credits protected by a constitutional lien on revenues,” Garcia Padilla wrote in a editorial posted on a CNBC website.

The lapse will mark the first time the U.S. territory has failed to pay what it owes on general-obligation debt, a $13 billion swath that its constitution says has the top claim to the government’s funds. Garcia Padilla previously said the commonwealth couldn’t raise enough to cover what’s owed to bondholders even if he shut down the government. The island has about $2 billion in principal and interest payments due Friday.

“All the efforts up until now have already damaged relations with investors,” said Daniel Solender, who oversees $19 billion, including Puerto Rico securities, as head of municipals at Lord Abbett & Co. in Jersey City, New Jersey. “By taking a step to break the constitution, it makes it more definitive.”

The default signals the depths of the crisis on the island, which had been tapping whatever funds it could to avoid missing payments on securities backed by the strongest legal pledge. The escalating strain prompted Congress to create a bill that would give Puerto Rico the ability to cut its debt and put a hold on bondholder lawsuits that could jeopardized its ability to pay for schools, police officers and health care. The Senate voted 68-32 Wednesday morning on the measure, setting up a final-passage vote as soon as this evening.

Some Puerto Rico securities traded up in price even after the governor’s comments because the Puerto Rico bill advanced in the Senate, said Daniel Hanson, an analyst at Height Securities, a Washington-based broker dealer. General obligations with an 8 percent coupon and maturing 2035 changed hands at an average price of 66.6 cents on the dollar, up from 65.2 cents on Tuesday, according to data compiled by Bloomberg.

It would be the first payment failure from a state-level borrower on debt backed by the full power to raise taxes since Arkansas’s in 1933. Since August, Puerto Rico had already defaulted on debt issued by three agencies, including the Government Development Bank, though creditors were left with little recourse because the securities were backed by weaker legal safeguards.

Revenue Collections

While Garcia Padilla has said the commonwealth doesn’t have enough money to pay investors on Friday and continue essential services, its revenue collections, which were revised last year, are on target. The island collected $8.69 billion of general-fund revenue from July through May, $15 million above revised budgeted estimates, according to Puerto Rico’s Treasury Department.

Along with missing smaller payments on agency debt with weaker repayment pledges, Puerto Rico owes contractors and suppliers $2 billion.

“They’ve had a relatively strong tax year and yet still find themselves not paying bills,” Hanson said.

“It’s totally unclear why.”

Spanish-American War

Puerto Rico, which became a territory in 1898 following the Spanish-American War, stopped paying bondholders so it can maintain essential services for its 3.5 million residents, nearly half of whom live in poverty. With more debt than any state but California and New York and a shrinking economy, Garcia Padilla said a year ago that the commonwealth couldn’t repay all that it has borrowed and he has unsuccessfully sought to persuade investors to accept less than they’re owed.

The crisis hasn’t triggered any broader contagion in the U.S. municipal-bond market because investors view Puerto Rico’s problems as unique. The yield on an index of top-rated 10-year munis was 1.34 percent, up from 1.3 percent Monday, the lowest level since at least 2009, Bloomberg data show.

Without the ability to file for bankruptcy protection as cities including Detroit have done, Puerto Rico pushed Congress to give it legal tools to force creditors to the bargaining table and prevent an onslaught of lawsuits. The legislation will establish a federal control board with the power to oversee the budget and a debt restructuring in court if needed. President Barack Obama’s administration lobbied for the legislation.

While the bill gives Puerto Rico the ability to reduce its debt load, investors will seek spending cuts and government efficiency, Hanson said.

“Creditors are now going to get a court or the control board to come together and force the Puerto Rican government into some kind of austerity plan,” Hanson said.

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