Puerto Rico’s Debt Crisis Deepens as Government Misses Payment
Risk of cascading missed payments turns up heat as Congress weighs legislation on a restructuring
Puerto Rico missed a debt payment on Monday. The White House is calling on Congress to step in and help the U.S. territory avoid financial disaster. How did the island get into this situation? WSJ’s Jason Bellini has #TheShortAnswer. Photo: Erika P. Rodriguez/Bloomberg
Puerto Rico’s debt crisis moved into a more perilous phase for residents, lawmakers and bondholders Monday after the Government Development Bank failed to repay almost $400 million.
The missed principal payment, the largest so far by the island, is widely viewed on Wall Street as foreshadowing additional defaults this summer, when more than $2 billion in bills are due.
Together with the spread of the Zika virus, the risk of cascading defaults is putting new urgency on bipartisan negotiations in Washington over legislation granting the U.S. territory new powers to restructure more than $70 billion in debt. The Centers for Disease Control and Prevention reported last week the first U.S. death related to the mosquito-borne Zika virus—a Puerto Rican man in his 70s who died in late February.
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In a letter to Congress, Treasury Secretary Jacob Lew warned on Monday that a U.S. “taxpayer-funded bailout may become the only legislative course available” if the proposed restructuring legislation isn’t approved.
The island’s debt is held by mutual funds, hedge funds, bond insurers and individual investors, who were attracted in part by tax benefits and high yields. The default Monday casts serious doubt on the commonwealth’s ability to make other future payments, which “means that other defaults are very likely on other Puerto Rico credits,” said Paul Mansour, head of the municipal credit research group at investment management firm Conning.
Monday’s developments are the latest sign that a long-running economic crisis has reached an acute stage, embroiling financial markets and Congress. Benchmark Puerto Rican bond prices fell to near record lows Monday, with some investors paying less than 65 cents on the dollar for general obligation bonds maturing in 2035, an unusually low price.
Just two years ago, investors snapped up $3.5 billion of those bonds, which carry an interest rate of 8%.
While Monday’s default had been expected, it creates new complications for the local government. Its agencies maintain their bank accounts at the GDB, which serves as the government’s fiscal agent and financial adviser and backs loans to private enterprises. The government had already passed legislation to limit withdrawals from the agency to avoid a potential bank run, and the commonwealth’s treasurer last month began opening accounts at private banks.
Puerto Rican Gov. Alejandro García Padilla said in a televised address Sunday that the island was struggling to pay for such basic goods as fuel for police cars.
The default could mark a turning point after weeks of negotiations on Capitol Hill. House Republicans are completing legislation to create a federal oversight board for Puerto Rico with the power to sign off on local budgets and to authorize a court-supervised debt restructuring. The bill wouldn’t commit U.S. taxpayer funds, but some creditors have described it as a bailout because they say it might violate existing contracts.
House Speaker Paul Ryan (R., Wis.) has forcefully rallied Republicans to back the legislation, the product of unusually bipartisan discussions with the Treasury Department. Mr. Ryan is warning colleagues that, if the local government can’t manage the crisis, calls for actual taxpayer assistance will mount.
“The longer this goes on, the more likely there will have to be a federal bailout,” said Marc Joffe, a former senior director at Moody’s Investors Service who is now principal consultant at Public Sector Credit Solutions, a research group.
Puerto Rico, whose residents are U.S. citizens, has been mired in recession for a decade and borrowed heavily to balance budgets. Despite the shaky economy, investors snapped up its debt for years thanks to generous tax incentives. The borrowing spree, however, did little to create economic opportunity on the island, and residents have steadily left for employment on the U.S. mainland, eroding Puerto Rico’s tax base.
On Monday, Puerto Rico was supposed to make a $422 million debt payment. The government paid $22 million in interest, a spokeswoman for the development bank said, but it missed a $367 million principal payment. The government earlier swapped $33 million worth of debt coming due Monday for new debt with later maturities, the spokeswoman said.
A provisional deal announced Monday with hedge funds holding about $900 million of Government Development Bank, or GDB, bonds showed the lengths that Puerto Rico’s leaders must go to as they wait for Congress to establish a legal framework for a broader restructuring. Under the proposed swap, bondholders would accept new GDB bonds worth about 56% of their original claims. They would exchange that debt yet again, and take a bigger loss, if the island achieves a broader restructuring.
Puerto Rico’s debt crisis isn’t seen as likely to spill into the U.S. economy or the broader $3.7 trillion municipal bond market because the island’s troubles make it something of an outlier.
John Miller, co-head of fixed income at Nuveen Asset Management LLC, which sometimes invests in distressed municipal debt, said the measure empowering Puerto Rico’s governor to suspend debt payments became law almost a month ago “and munis have had a really strong April.”
Congress is considering legislation because the commonwealth’s public institutions don’t have access to federal bankruptcy courts, unlike municipalities in U.S. states. Because Puerto Rico isn’t a country, it can’t turn to the International Monetary Fund for assistance.
The battle in Congress boils down to one about leverage. The Treasury and Puerto Rico want a process that makes it easier to restructure debts because this will give the island’s financial advisers more leverage in negotiations with bondholders. Creditors want one that makes it impossible to forcibly restructure debts or void contracts because this preserves their leverage.
Mr. Ryan is caught in the middle. As bondholder advocates lobby against the bill, he risks losing Republicans. This would force him to choose whether to push through a bill with predominantly Democratic support.
The Treasury says a broad restructuring regime is needed in part to avoid litigation between creditors who hold debt with differing security pledges and who are likely to sue each other to make claims on the island’s dwindling revenues. Creditor battles, officials say, could prolong the crisis for years and chill private investment in Puerto Rico.
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