Puerto Rico signaled it's giving some debts priority over others, as it began clawing back revenue from certain non-general obligation bonds while avoiding default on $355 million of Government Development Bank notes.
"Starting today the commonwealth will have to claw back revenues pledged to certain bond issues in order to maintain essential public services," Gov. Alejandro García Padilla said Tuesday in prepared comments for a hearing of the U.S. Senate Judiciary Committee.
In written testimony he added, "In light of the rapidly deteriorating revenue situation, in accordance with Article 6, Section 8 of the constitution of the Commonwealth of Puerto Rico, I ordered the 'claw back' of revenues assigned to certain instrumentalities of the commonwealth for the repayment of their debts. Together these instrumentalities have approximately $7 billion in bonds outstanding. In simple terms, we have begun to default on our debt in an effort to attempt to repay bonds issued with the full faith and credit of the commonwealth and secure sufficient resources to protect the life, health, safety and welfare of the people of Puerto Rico."
His comments came just before the Government Development Bank for Puerto Rico said it had paid all $355 million in debt service due on its notes. Puerto Rico is trying to restructure about $70 billion of public sector bond debt, which the governor says is un-payable unless the economy improves.
The governor's office indicated that revenues were being diverted from the Puerto Rico Highways and Transportation Authority, the Infrastructure and Finance Authority, the Metropolitan Bus Authority, the Integrated Transportation Authority, and the Convention District Authority.
García Padilla said that he had tried to negotiate with the insurers of some of Puerto Rico's debt maturing on Tuesday but no agreement was reached, according to a written statement from the governor's office. The statement didn't specify which debt he was referring to. "The administration's priority has always been and will always be the welfare of Puerto Ricans, so while we tried to negotiate with the insurers of our bonds to refinance the payment that was due today, the terms and conditions that they wanted to impose on us were unacceptable to the government," Puerto Rico chief of staff Victor Suárez Melendez said.
García Padilla told members of the Judiciary Committee that the "magnitude of the fiscal and economic problems bearing down on Puerto Rico are simply too large," and that with default imminent, there was a need to choose between paying back creditors and providing essential government services. Without an orderly restructuring process in place, García Padilla said it is necessary to take the kinds of steps taken by the GDB.
"Commencing today, the commonwealth will have to claw back other income sources in order to maintain essential public services. We have taken this step in the trust that Congress will act," he said. "But do not be misled. We have no resources left. Puerto Rico cannot keep this up longer."
Melba Acosta, the GDB's president, said the debt service payment on Dec. 1 reflects the GDB's commitment to honor its obligations even with the extreme fiscal challenges the island faces.
The GDB's decision to honor its obligation may be a step toward showing creditors that they will stand by possible forbearance and debt exchange agreements in the future, said Matt Fabian, a partner at Municipal Market Analytics.
The claw-back solution will give "short-term breathing room" for the payments on the GO bonds, but it does not mean those bonds will not be in danger in the near future, he said.
Moody's Investors Service, which had predicted at least a partial default on the GDB notes due Tuesday, issued a release from its vice president Ted Hampton stating the payment "indicates the commonwealth is making an effort to avoid litigation and prevent further deterioration in relations with its creditors." Hampton added that the payment does not change Moody's ratings or outlooks ahead on Puerto Rico's $945 million of total bond payments coming due on Jan. 1.
Senators and others speaking at the Judiciary Committee hearing also moved beyond direct discussion of the GDB bonds to discuss what broader fixes are necessary for Puerto Rico. Both García Padilla and Pedro Pierluisi, Puerto Rico's representative in Congress, urged Congress to give the commonwealth a structured process to resolve its debts through Chapter 9 bankruptcy protections for the island's public authorities. Pierluisi also renewed calls for federal aid through improvements to Medicaid coverage on the island and an extension of the Earned Income Tax Credit to residents.
Pierluisi said if Congress passes a package of bills that give Puerto Rico the ability to restructure its debt and also provide improved healthcare and tax credit practices, he will accept federal oversight – a concept that has been met with contempt from Puerto Rico officials.
Committee members didn't question Pierluisi and García Padilla. A second panel featured five experts with varied views on Puerto Rico, ranging from calling for a Chapter 9 regime that would apply to all of the commonwealth's debt to focusing only on stimulating economic growth.
Carlos Col-n de Armas, a professor of finance at the University of Puerto Rico, said the best way to fix the ongoing problem is for the Puerto Rico government to cut spending and focus on restoring access to financial markets. Throughout the hearing, he said much of the data people are using to show Puerto Rico is insolvent is actually flawed. He claimed Puerto Rico has the money to honor its debt commitment as originally contracted.
Stephen Spencer, who represents funds like OppenheimerFunds and Franklin Advisors in negotiations over the Puerto Rico Electric Power Authority debt, strongly opposed Chapter 9 as harmful to the many retail investors both in Puerto Rico and the mainland U.S. that have holdings in Puerto Rico debt. He also pointed to Detroit as proof that a Chapter 9 solution can make the market jaded toward future bond offerings from an issuer that uses bankruptcy. Detroit "wasn't a bankruptcy, it was a stickup," he said.
The remaining three speakers each called for either a Chapter 9 or a control board solution.
Alex Pollack, a resident fellow with the American Enterprise Institute, said the best solution would be an emergency federal control board and cited as examples previous control boards in Washington and New York. Richard Ravitch, a former lieutenant governor of New York, told the committee the best solution would be a bankruptcy regime that would apply to the entire commonwealth. And Richard Carri-n, executive chairman of Banco Popular in San Juan, laid out a three-part plan that would include bankruptcy, a control board, and some type of stimulus for the economy.
"I don't think they could ask for something [from Congress] without putting something on the table first," Dick Larkin, senior vice president and director of credit analysis at Herbert J. Sims & Co., told The Bond Buyer on Tuesday shortly after it was announced that P.R. made its bond payments.
"If you pay your bills today, it looks a lot better," he added.
"But if they made the payment, it's basically window dressing to make sure the elected official of Puerto Rico are going to Congress with at least a relatively clean slate and they are paying their bills," he continued.
"Now we have the government making some hard decisions on what gets highest priority and to them it is constitutionally protected debt and essential services," said AllianceBernstein director of municipal credit research Joseph Rosenblum, in an email. "I had been under the impression that claw backed revenues were only available for general obligation and guaranteed debt and that may be an issue that will be litigated especially by holders of highway bonds who may challenge the loss of their security for payment of services (forgetting the argument over what constitutes essential services)."
Triet Nguyen, managing director of NewOak Fundamental Credit, told The Bond Buyer that "In effect, the default process has already started on the bonds that are secured by the revenues being diverted or clawed back.
"At the end of the day, the market should take some degree of comfort in the fact that the commonwealth continues to respect the priority claim status of GOs and 'constitutional priority' debt, at least for the time being," Nguyen said.
"We also note that COFINA bonds have been left out of the $7 billion that may be affected by the revenue claw backs," Nguyen added, referring to Puerto Sales Tax Corp. bonds.
