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[Enterprising Investor]

Puerto Rican Debt Crisis Is Coming to a Head (5/07/16)

Congress is under pressure to create a financial control board that could restructure the island’s $72 billion of debt and maybe impose a settlement on bondholders.

As Congress weighs legislation to permit Puerto Rico to restructure its $72 billion of debt, the commonwealth’s bonds are languishing at or near record lows. Investors fear an unfavorable deal could be forced on them by an as-yet-to-be-created financial control board.

Puerto Rico’s benchmark 8% general-obligation bonds, due in 2035, traded Friday around 64, down from 73 at the start of the year and 93 when the $3.5 billion issue was sold in March 2014. Other GO debt changes hands in the mid-50s. Puerto Rico’s long-term senior Cofina bonds, backed by sales-tax revenue, trade around 57, and junior Cofina debt, near 40. The GOs and GO-supported debt total about $17 billion (face value), and a similar amount of Cofina debt is outstanding.

The U.S. House of Representatives soon is expected to resume work on legislation to let Puerto Rico restructure its debt and create a financial control board. The board could oversee the island’s finances and possibly force a restructuring deal on recalcitrant bondholders.

Congress is likely to enact legislation before midyear, when Puerto Rico faces $2 billion of bond interest and principal payments. Puerto Rico now lacks access to the bankruptcy code’s Chapter 9, which lets local governments, but not states, restructure debt. Barron’s was among the first to call attention to Puerto Rico’s financial plight in an Aug. 24, 2013, cover story.

Puerto Rico’s Government Development Bank, which plays a key role in the island’s finances, defaulted on $3.9 billion of debt last week, while working out a deal with about 25% of creditors that would pay them around 47 cents on the dollar.

“Most everyone agrees that Congress needs to act to create an oversight board that gives Puerto Rico the regulatory and legal framework to restructure its debts and put the economy on a more sustainable path,” says John Loffredo, co-head of investor MacKay Municipal Managers. Without a powerful board, it will be tough to achieve a comprehensive restructuring.

GO holders say their claims are protected by the Puerto Rican constitution, while senior Cofina holders take comfort from that debt’s dedicated revenue stream.

Muni-bond managers Franklin Templeton and Oppenheimer, the largest holders of junior Cofina debt, are resisting any deal that would impose a harsh settlement on them. For risk-takers, the best Puerto Rican bet probably is the GO bonds, because they have protection from the Puerto Rican constitution. While it’s unlikely that they’d pay 100% in a restructuring, they may get more than the current market price.

One sizable Puerto Rico bondholder fears a powerful control board would impose an onerous settlement on investors. Puerto Rico’s government wants maximum debt relief. In such situations, political forces can trump financial interests.

Among the things to watch is whether any restructuring involves creating a Puerto Rican “super-bond,” backed by a dedicated revenue stream, and whether Puerto Rico’s pension plan, which has $43 billion in unfunded liabilities, is untouched or minimally affected. Pensions were favored over bondholders in the Detroit and General Motors (ticker: GM) bankruptcies.

Cofina bonds could be dicey because the agency was created to enable Puerto Rico to get around legal restrictions on GO issuance. In Detroit’s bankruptcy, similarly structured debt was treated harshly.

Puerto Rico Gov. Alejandro Padilla has denounced “vulture investors,” including some hedge funds, for trying to profit at the expense of ordinary Puerto Ricans. However, the hedge funds, big buyers of Puerto Rico’s $3.5 billion GO issue in 2014, now have paper losses of 30%.

Puerto Rico debt insured by the likes of Assured Guaranty is holding up well, as investors anticipate that the insurers will make good on their guarantees.

The only certainty: There will be plenty of drama in coming months as Puerto Rico moves to a likely restructuring of its onerous obligations.

-- Andrew Bary

http://www.barrons.com/articles/puerto-rican-debt-crisis-is-coming-to-a-head-1462593795?tesla=y&mod=BOL_archive_twm_dept