Puerto Rico Debt Update

Over the past several months, three potential solutions have taken shape to help deal directly with Puerto Rico’s US $72 billion debt crisis. First, Governor Alejandro García Padilla established an internal working group to negotiate directly with creditors, which has made modest progress. Second, U.S. Congress drafted a bill that would set up a seven-member control board and give it the authority to oversee a reduction in the commonwealth’s debt. Third, the U.S. Supreme Court heard arguments made by Puerto Rico in support of a local 2014 law that would give it some access to its own version of Bankruptcy legislation, given that the island does not qualify for Chapter 9 protection. While there is debate among debtors and creditors as to which is the preferred method to restructure the debt, one thing remains clear, if no action is taken, Puerto Rico will experience further economic uncertainty.

On April 11th, the working group established by Gov. García Padilla (Working Group for the Fiscal and Economic Recovery of Puerto Rico) unveiled an improved plan to creditors to restructure approximately US $49 billion of Puerto Rico’s total debt. The new plan calls for creditors to accept US $32 billion to US $37 billion up front by exchanging existing bonds for two classes of new bonds, a base bond and a capital appreciation bond. The proposal is up from a previous offer of US $26.5 billion. Negotiations are ongoing.

Also in the works, is a draft bill proposed by the U.S. House of Representatives Committee on Natural Resources (which has jurisdiction over federal territories) that would allow for debt restructuring under the supervision of a federal control board. If implemented, the board must seek consensual negotiations with stakeholders before entering into any kind of forced restructuring process. After recent revisions, the Committee is scheduled to hold a hearing on April 13th regarding the draft legislation, followed by a two-day markup.

Puerto Rico is also hopeful that their initial 2014 effort to establish an option similar to Chapter 9 bankruptcy (the Puerto Rico Public Corporation Debt Compliance & Recovery Act) will receive a favorable ruling from the U.S. Supreme Court, where it heard arguments after being overturned by federal district and appellate courts. The U.S. Supreme Court is now reviewing that local law’s validity, with a decision expected by June.

While all three options attempt to address Puerto Rico’s highly over-levered situation, they may not come soon enough to prevent additional short-term liquidity problems. Indeed, the Government Development Bank (GDB) has debt payments of US $422 million due May 1st, which it has already said it cannot afford. Moreover, the island and its many issuers face additional US $2.0 billion in principal and interest payments on July 1st. The government has already defaulted on over US $220 million in debt, prompting some creditors to file suit in San Juan federal court.

In an effort to prevent further deterioration, Gov. García Padilla signed an executive order declaring a moratorium on the commonwealth’s debt service. The order restricts the GDB’s outflow of cash to stabilize its dwindling liquidity levels, which stood at roughly US $560 million as of April 1st.

Standard & Poor’s (S&P) currently rates all Puerto Rico tax-backed debt at ‘CC’, except for Puerto Rico Public Finance Corp. (PFC) and Puerto Rico Infrastructure Financing Authority (PRIFA) federal rum excise tax-secured debt, which are currently in default and rated ‘D’. The outlook is negative, reflecting S&P’s view that default is a virtual certainty, especially given the impact of recent debt moratorium legislation. Limited liquidity through June 2016 and the likelihood of another operating deficit in the current fiscal year also contribute to the outlook.

It could take years to fix the current solvency crisis. The US $72 billion debt load is unsustainable and weighing heavily on Puerto Rico’s US $69 billion domestic economy. Over the next ten years, the island projects it will have to make over US $34 billion in debt-service payments with limited liquidity and an unstable economy. While active dialogue among commonwealth officials, creditors and Washington is taking place, restoring growth will ultimately require fiscal, political and economic reform.

Authored by: Raymond Perez and Alex Trueba

Sources: Bloomberg, CaribbeanBusiness, FocusEconomics, Miami Herald, NYT, S&P, Reuters, WSJ, YahooNews