Puerto Rico Says It Will Default on Some Bonds.

Puerto Rico will default on nearly $174 million in principal and interest payments on bonds on Friday, the first day of 2016, the governor said on Wednesday, increasing the likelihood that the island will face lawsuits from an array of creditors.

In a briefing for journalists, Gov. Alejandro García Padilla said only some of the payments would be halted immediately. They include $35.9 million due to holders of bonds issued by its Infrastructure Financing Authority, and $1.4 million due to holders of its Public Finance Corporation’s bonds.

In a stark example of the financial version of musical chairs that has been playing out on the island in recent months, the government will divert a total of $174 million from lower-grade bonds to pay holders of the legally protected general obligation bonds. That diversion, known as a “clawback,” technically amounts to a default even though some of those creditors will not see a difference in their payments on Jan. 1.

General obligation bonds have a top priority under Puerto Rico’s Constitution, and defaulting on them outside an official bankruptcy proceeding could set off a constitutional crisis, making the island’s problems even worse than they already are.

As a result of the shuffle, the general obligation bondholders will receive on Friday the entire $328.7 million they are owed, said the governor, who referred to those top-ranked bondholders as participants in “vulture funds.”

At a news conference later in the day in San Juan, the island’s capital, he accused the general obligation bondholders — who have resisted efforts to cut back their payments — of caring more about their financial interests than the well-being of Puerto Rico’s residents.

“We know that our creditors have spent a fortune lobbying against the people of Puerto Rico,” Mr. García Padilla said, according to an unofficial English transcript of the event, which was conducted in Spanish. The bondholders, he said, were “willing and anxious to initiate costly and disruptive litigation against the commonwealth, and attempt to attach and seize the little cash left in our accounts to obstruct our ability to provide essential services to our people.”

“My administration has the obligation to protect the people of Puerto Rico against the grave consequences of a disruption in essential services and a government shutdown, which would result from a wider default,” he added.

Melba Acosta Febo, the head of Puerto Rico’s Government Development Bank, told journalists that the clawback of certain bond money was legal in Puerto Rico. She said that the possibility of such a step had been disclosed in the marketing materials for the affected bonds.

The development bank, which orchestrates most of Puerto Rico’s debt, issued a statement on Wednesday, saying that it intended to make separate principal and interest payments of about $10 million due on Friday.

In his briefing, the governor said that some of the investors whose bonds are part of the clawback would still receive the full amounts they expected on Friday. That is because Puerto Rico had previously sent enough money to bond trustees to cover the most imminent payments. Once money has been sent to a trustee, it cannot be clawed back.

Even though the bondholders in this group will not feel any immediate difference, their bonds will still be considered in default, Mr. García Padilla said, because their prepaid reserves are now being depleted and the flow of additional funds to the trustees has ceased. That means the number of bondholders who are left unpaid is likely to grow, as more payments are due in the coming months.

Investors in this group include those who hold bonds issued by the Puerto Rico Highways and Transportation Authority, and its Convention Center District Authority.

In a hint at the extremely complex structure of Puerto Rico’s total debt, the governor pointed out that not all of the Infrastructure Financing Authority bonds would be in default on Jan. 1 because, much like the general obligation bonds, some of them also carry a governmental guarantee.

In effect, one group of Infrastructure Authority investors — those without the guarantee — are having their money clawed back to pay another group of Infrastructure Authority investors whose bonds are guaranteed. This is something few ordinary investors are likely to have understood when they first decided to invest in Puerto Rico’s bonds.

The bonds are widely held across the United States mainland, because they offer better-than-usual tax preferences and a higher yield than most municipal bonds. In the past, Puerto Rican debt was a popular addition to mutual fund portfolios because it increased the overall yield.

When asked how he expected the rising tide of defaults to affect the broad restructuring talks that Puerto Rico has been calling for, Mr. García Padilla said he thought it would make them harder. Some investors will now be forced to make unexpected sacrifices that help other investors, a situation that the governor said could not be good for anyone in the long run.

Mr. García Padilla said that he had been forced to claw back money from the lower-ranked bondholders because the island had practically run out of cash and Congress had so far failed to respond to its pleas for help. He said he needed to save at least some money to keep paying nurses in hospitals, police officers and teachers.

At least two types of Puerto Rican bonds remained outside the line of fire, the governor said. One is a type of bond backed by dedicated sales taxes through the Puerto Rico Sales Tax Financing Corporation, known by its Spanish acronym, Cofina. The other is a type of bond issued by the Puerto Rico Electric Power Authority, or Prepa.

For months, Puerto Rican officials have been urging Congress to amend the federal bankruptcy code to eliminate an exclusion that currently bars any branch of the Puerto Rican government from restructuring in Chapter 9 municipal bankruptcy.

The Republican senators who chair the relevant committees have expressed concern for the island’s predicament but have said so far that they could not consider such an amendment until more was known about why Puerto Rico had fallen into such distress and what could be done to address the systemic causes. 

Legislative efforts were expected to resume when Congress returns in January.

The Treasury said in a statement on Wednesday that Puerto Rico’s default “demonstrates the gravity of the commonwealth’s fiscal crisis and the need for Congress to act now.”

The statement continued: “Puerto Rico is at a dead end, shifting funds from one creditor to pay another and diverting money from already-depleted pension funds to pay both current bills and debt service. This increasingly urgent situation demands swift congressional action to give Puerto Rico access to an orderly restructuring regime paired with independent oversight.” 

By: Mary Williams Walsh. 


Review: Emerging Market Formulations & Research Unit, Flagship Records.
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