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Puerto Rico Agency Poised to Default on $58 Million Payment

By Michelle Kaske, Alexander Lopez

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A Puerto Rico agency is poised to default on bonds for the first time Monday, initiating a clash with creditors as the struggling commonwealth seeks to renegotiate its $72 billion debt load.

The government doesn’t have the money for the $58 million of principal and interest due on Public Finance Corp. bonds, Victor Suarez, the chief of staff for Governor Alejandro Garcia Padilla, said during a press conference July 31 in San Juan.

The default promises to escalate the debt crisis racking the island, where officials are pushing for what may be the biggest restructuring ever in the municipal market. Puerto Rico bond prices have tumbled amid speculation that the island won’t be able to repay what it owes as its economy stagnates and residents leave for the U.S. mainland. It has about $5 billion of principal and interest due over the next 12 months, according to data compiled by Bloomberg.

“An event like this is significant enough that it could hurt prices for Puerto Rico bonds,” said Richard Larkin, director of credit analysis at Herbert J Sims & Co. in Boca Raton, Florida. “I can’t believe a default on debt with Puerto Rico’s name will go unnoticed.”

The lapse, which Puerto Rico officials had telegraphed in advance, didn’t have any immediate impact on the price of the island’s other securities. Puerto Rico general-obligation bonds maturing in 2037, which are given priority under the commonwealth’s constitution, traded for about 61 cents on the dollar Monday, up from 59 cents Friday.

Debts Paid

The Finance Corp. bonds represent a small share of Puerto Rico’s debt load, and the island isn’t defaulting on interest and principal payments due on other securities. Government Development Bank President Melba Acosta said in a statement July 31 that a separate $169 million debt-service payment for the bank’s bonds will be made.

The Finance Corp., which has borrowed to help balance the government’s budget, has about $1 billion of debt. The securities are paid for with money appropriated by the legislature, unlike other bonds with a claim on tax money. That leaves bondholders with little recourse because the commonwealth hasn’t guaranteed repayment and the legislature isn’t obligated to allocate the funds.

Faced with a budget shortfall, lawmakers didn’t provide the money when they passed the annual spending plan. Island officials said that Puerto Rico’s available cash was limited to funding essential services such as health and safety.

Liquidity Pressure

The decision to skip the payment is “consistent with both the commonwealth’s stated intent to restructure its debt and its current liquidity pressures,” Fitch Ratings said in a statement Monday.

Garcia Padilla said in June that the commonwealth cannot pay all of its obligations, following years of borrowing to paper over budget shortfalls, and that bondholders need to share in the sacrifice to help steady the island’s finances. Officials plan to draft a debt-restructuring plan by Sept. 1.

It’s too soon to say how particular bonds will be affected because there isn’t “sufficient information available to consider default of any of the specific credits that Fitch rates to be inevitable,” the rating company said. The governor has drawn opposition from investors including OppenheimerFunds Inc., which said it will fight to ensure that the commonwealth repays its debt. A report by three former International Monetary Fund economists, which was commissioned by a group of hedge funds, said the island can balance the budget without a broad debt restructuring.

Problem’s Roots

Puerto Rico’s economy has contracted every year but one since 2006 and is projected to decline by 1.2 percent this year. The island’s population shrunk 7 percent in the past decade. An additional 245,000 residents are estimated to leave by 2025 as they seek employment on the U.S. mainland. Puerto Rico’s June jobless rate of 12.6 percent is more than double the level in the U.S.

“The essential problem in Puerto Rico is the economy and the outmigration of individuals,” said Phil Fischer, head of municipal research at Bank of America Corp. in New York. “And neither of those seems to be improving.”

While Garcia Padilla surprised investors by pushing for a restructuring, two months after he said it would be a mistake to default, the island’s worsening debt crisis hasn’t rippled through the municipal-bond market. Munis in July had their strongest return since January as investors recognized that Puerto Rico’s problems are unique.

The commonwealth’s securities have traded at distressed levels for two years. Puerto Rico debt has lost 10.8 percent this year through July 31, the worst for the period since at least 2007, S&P Dow Jones Indices show.

— Check out Puerto Rico Bonds May Be Hiding in Your Clients’ Portfolios on ThinkAdvisor.

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