Puerto Rico Debt Donnybrook Kicks Off With Default Squabble (1)

Emma Orr, Steven Church and Michelle KaskeMay 11, 2017 9:31 am ET

(Bloomberg) -- Dealing with Puerto Rico’s crushing debt has started to resemble a circular firing squad.

Simply put, the bankrupt island can’t pay everything it owes, so creditors are taking aim at each other as they squabble over who will get what’s left. But the debt’s size and the tangled process invented to rescue Puerto Rico mean there’s no established rule book to shape what comes next.

Holders of general-obligation debt have declared their right to be paid first, owners of sales-tax bonds are squabbling with one another over who deserves priority, and they’re all up against the commonwealth’s leaders, who want the cash for essential services. Amid this melee, Puerto Rico’s federal overseers will have to choose between paying U.S. hedge funds everything they’re owed or keeping schools, water and electricity running.

“There just isn’t enough money,” said Matt Fabian, a partner with Municipal Market Analytics Inc. in Concord, Massachusetts, who foresees a chaotic brew of lawsuits, federal interventions and politics. “Nobody has any idea what’s going to happen.”

All told, Puerto Rico has about $74 billion in debt and $49 billion in pension liabilities. Hedge funds holding $1.4 billion of general-obligation bonds, including Aurelius Capital Management and Monarch Alternative Capital, have already sued to get overdue principal and interest. On the other side, owners of $17 billion in sales-tax bonds, including Tilden Park Capital Management and GoldenTree Asset Management, have entered the fray. They’ll meet for the first time in court on May 17 in San Juan.

Default Notice

The dispute over the sales-tax bonds, named Cofinas after the agency that issued them, began in earnest May 4. That’s when the trustee, Bank of New York Mellon Corp., sent a notice of default to the authority that sold the bonds. The object was to keep the government from diverting the sales-tax revenue to other purposes before it pays what it owes to investors.

The New York-based bank acted after weeks of pressure from senior bond owners who urged the trustee to safeguard their claims. In the process, junior bondholders were irked because the default notice could mean no payments for them until the senior bondholders are paid in full. The notice sets a 30-day deadline for a response from Puerto Rico, which is supposed to pay about $256 million of principal and interest on Aug. 1, according to data compiled by Bloomberg. 

Puerto Rico’s status as a commonwealth means it’s not subject to traditional bankruptcy laws. Instead, the island filed for the next best thing to deflect claims, called Title III. It’s an in-court restructuring based on the U.S. bankruptcy code that was created under Puerto Rico’s Promesa law last year. But it’s never been used before, which means any cuts imposed by U.S. District Court Judge Laura Taylor Swain will be more likely to face years of appeals than a typical case.

Delayed Filing

Puerto Rico’s initial Title III filing on May 3 didn’t include Cofina. If it had, BNY Mellon may have been prohibited from sending its May 4 default notice. But the oversight and management board didn’t file its separate Title III action for Cofina until May 5, giving the bank a window to declare the default.

The delay means it’s unclear whether the Title III filing voids BNY Mellon’s default notice, as well as a separate default notice sent by Ambac Assurance Corp. on May 1. Regardless, BNY Mellon and senior creditors are prepared contest a court’s decision if it’s not in their favor, according to a person familiar with the matter, who asked not to be identified discussing private information. The government hasn’t said how it will respond.

“As a public policy, legal defense strategies are not discussed until they are presented in judicial forums,” Yennifer Alvarez, a spokeswoman for Governor Ricardo Rossello, wrote in an emailed comment.

The senior bondholder group, which controls about one-third of the senior Cofina bonds, is led by hedge funds Whitebox Advisors, Tilden Park Capital Management, GoldenTree Asset Management and Merced Capital, according to Susheel Kirpalani, a lawyer at Quinn Emanuel Urquhart & Sullivan who represents the group.

Debt Due

For investors, there’s a lot at stake. Cofina holders are owed more than $8 billion in debt service through 2026, with $704 million in payments due in the next fiscal year, which starts in July, according to the commonwealth’s fiscal plan.

The territory owes all bondholders $33.4 billion in debt payments between now and 2026, according to the plan, but it proposes to pay only about $8 billion. The government hasn’t said how bondholders should divide those payments, or which group is first in line.

“This is a government restructuring, not a court one, so the government will be in the driver’s seat,” Fabian said. “Creditors will not be heard to the extent they’re saying, ‘let’s do it a different way.’ Those arguments won’t have any standing in a court.”

Owners of junior Cofinas could be left vulnerable. BNY Mellon holds a trustee reserve fund of sales-tax revenue with about $400 million, more than enough to handle the upcoming August payment, according to people familiar with the matter.

But because of the default notice, junior bondholders are unlikely to be paid, in order to safeguard claims of the senior Cofinas, said the people, who asked not to be identified discussing private transactions. Given the limited funds available for debt repayment, there’s a chance the subordinated holders could get little or no recovery. A representative for BNY Mellon declined to comment.

What’s more, general-obligation bondholders claim that the entire Cofina structure violates the island’s constitution, and all the sales-tax revenue is owed to them. If the general-obligation claims are supported in court, all of the Cofina debt could be ruled invalid and investors could receive nothing at all.

(Updates with BNY Mellon location in seventh paragraph.)

--With assistance from Rebecca Spalding

©2017 Bloomberg L.P.

Chicago Public Schools May Fall Short on Upcoming Pension Payment

by Tribune News Service | May 10, 2017

By Juan Perez Jr. and Hal Dardick

Chicago Public Schools has enough cash to complete the school year but the system is still short hundreds of millions of dollars needed to make a pension payment due at the end of June, Mayor Rahm Emanuel's top finance official said Tuesday.

CPS and city officials say that's because the state still owes CPS about $467 million in aid that has been held up by Illinois' budget impasse.

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While still trying to come up with a plan to keep the district from running out of cash, CPS and Chicago Chief Financial Officer Carole Brown used the state aid shortfall as the latest salvo in an ongoing battle with Republican Gov. Bruce Rauner's administration over funding.

"We're in this horrible, horrible position because the state's not doing its job," Brown said. "And the thing we hope people will do is encourage and push the state to pass a budget and pass a budget that has adequate funding for schools."

The state disputes the amount owed the district and blames the issue on a failure by Democratic state Comptroller Susana Mendoza, an Emanuel ally and Rauner critic, to make payments.

Officials say that without short-term borrowing or some other rapid infusion of money, the district will fall far short of making a $700 million-plus contribution to the Chicago Teachers' Pension Fund. Making a late or incomplete pension payment could violate state law and prompt a negative response from bankers the district needs to stay afloat.

"This is clearly a bad option," pension fund Executive Director Chuck Burbridge said Tuesday.

"I don't think the rating agencies would respond well to them missing the pension payment," Burbridge said. "Everybody knows where that gets you."

Brown on Tuesday acknowledged officials have discussed withholding the pension payment as they test ideas with bond rating agencies to see which would do the least additional harm to the district and the city's already low bond ratings.

"It's an option that we've talked about, but it's not an option that anybody's concluded is something that's viable, or an option that anyone's concluded is the preferred course of action," she told the Tribune.

Brown's comments reflect an ongoing debate within city government over how Emanuel can craft a CPS financial rescue that would likely also have to address another looming budget mess next school year.

Brown said CPS funding options include short-term borrowing, a loan from the city's tax increment finance districts and delaying payments to vendors that provide services to the district.

She declined to rule out reinstating a so-called head tax on jobs at large firms that Emanuel eliminated with much fanfare in his first term but which some aldermen and the Chicago Teachers Union have proposed resurrecting.

"I don't have the luxury of telling you we definitely aren't doing anything," Brown said.

The district began this budget year counting on $215 million from the state to help pay for teacher pensions. But Rauner vetoed the funding measure because he said legislators didn't tie it to broader pension reform.

CPS proceeded to cut school budgets and filed a lawsuit challenging state education funding. District CEO Forrest Claypool warned that Rauner's veto would force schools to close almost three weeks early. But after a Cook County judge rejected the district's lawsuit in April, Emanuel quickly staged a news conference to say the school year would go on as scheduled.

The district said it reduced its budget gap after Rauner's veto to $129 million, but it has regularly declined to acknowledge whether it had enough cash to pay the bills.

The $467 million in state funds that CPS says it is owed are separate from the $215 million in pension assistance from the state that the district had counted on. The money represents education grants that are part of regularly scheduled aid payments distributed to school districts across the state.

State government distributes general aid to school districts as well as grants that finance specific programs but are ultimately swallowed up and used for expenses in the district's multibillion-dollar operating budget. The budget impasse has delayed the distribution of more than $1 billion of that grant aid to schools across the state, a Wall Street ratings agency concluded last month.

Illinois State Board of Education records indicate CPS is owed roughly $324 million in grants that have yet to be processed by Mendoza's office. The district maintains that doesn't cover the full total owed by the state.

Rauner's office said Mendoza's office can send the money awaiting processing to Chicago at any time. Mendoza's office says there's no money to cut those checks without a state budget.

As of Tuesday, the teachers pension fund said CPS owed it about $716 million. The fund said it expects CPS to pay about $470 million of that tab by June 30, with the rest payable after a quarter-billion dollars in revenue arrives later in the summer from a new property tax devoted to teacher pensions.

Burbridge said the pension fund's outlook changes if the city falls short on its payments for less predictable reasons, such as a lack of state aid.

"The critical thing for us is being able to plan so we can structure our investments appropriately to both make the pension payments that are certain and take advantage of markets and the compounding impact of interest and dividends," he said.

Emanuel's administration told aldermen this week the issue is "extremely complex" while delaying an update on district finances. The solution will hold consequences not only for students, parents and teachers, but for the district's reputation with financial markets.

"The district doesn't have any good choices," said Matt Fabian, a partner at Concord, Mass.-based Municipal Market Analytics.

"Arguably, their biggest problem this year was relying on the state to help them in any way," Fabian said. "Their fundamental problem is they spend too much money they don't have, but really in fiscal year 2017, it's been relying on the state to fill that gap."

___

(c)2017 the Chicago Tribune

Puerto Rico's Bankruptcy a 'Dramatic Reshaping' of Muni Risk

The muni market hasn't posted much reaction to Puerto Rico's mammoth bankruptcy filing this week. The iShares S&P National AMT-Free Municipal Bond Fund  (MUB) stayed right around $109, roughly where it has been for the past three months.

But that doesn't mean muni investors should be shrugging off the largest bankruptcy filing in U.S. history.

Municipal Market Analytics' Matt Fabian puts it in pretty start terms in his Default Trends report Friday. Here's his summary of his report:

Assuming all remaining Puerto Rico bonds end up in payment default, as now appears likely, the municipal market's total for bonds in default will have roughly doubled to $74B, with Puerto Rico issuers accounting for 85% of that total. This would also roughly double the municipal market's current default rate from 1.02% to 1.93% (versus 0.30% excluding Puerto Rico bonds). This is a dramatic reshaping of the industry's overall risk profile and will doubtless drive at least somewhat more conservative investor behavior in the future, in particular as regards large distressed governments like IL, NJ, CT, KY, and Chicagoland credits.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Puerto Rico Declares “Bankruptcy” Due to $123 Billion in Debts

The island owes $74 billion in bond debts and $49 billion in pension payments.

Earlier this week, Puerto Rico, an American territory, sought “bankruptcy” protection after years of economic downfalls and facing $123 billion in bond and pension debts. So why did it take over two years for the island to address these problems?

First off, it’s not exactly bankruptcy since Puerto Rico is only a territory and the island cannot receive the same Chapter 9 protections like the states. Second, it was not until last year that Congress passed the Puerto Rico Debt Relief Bill:

The legislation would create a federal oversight board, appointed by Washington, with power to restructure Puerto Rico’s unmanageable debt load.

The bill provides for a stay, or halt, to any litigation brought against the Puerto Rican government and its debt issuing agencies that is retroactive to December. This provides breathing room for the board to start the process of restructuring and oversee a sustainable budget process.

The Puerto Rico Financial Oversight and Management Board

This committee invoked that law passed by D.C. in June of last year. This means that the island’s “standoff with creditors” will now go “before a federal judge in San Juan in a restructuring process known as Title III.” Supreme Court Justice John Roberts will select a judge to hear the case. He may choose any federal judge he wishes.

The Wall Street Journal explained how this will work out:

Chapter 9, which the city of Detroit used to obtain $7 billion in debt relief, relies on elected officials to negotiate with creditors and design repayment schemes. Under Title III, the federal board overseeing Puerto Rico’s finances is responsible for restructuring negotiations. The board, comprised of appointed technocrats, was designed to take local politics out of the equation. “Unlike chapter 9, a Title III case is not led by elected officials,” said Susheel Kirpalani, a lawyer for sales-tax bondholders. “That is a critical point to depoliticize the government’s restructuring and hopefully will lead to fairer outcomes for creditors.”

—

Settlement talks haven’t produced an agreement so far, but the board said it still wants to strike deals. If it can’t find takers, however, it can ask a judge to approve a plan over the objections of creditors, as in chapter 9. The board is required to “respect” creditor liens and priorities, but no one knows if that gives creditors real ammunition to resist forcible write-downs.

The court filing listed these problems. From NPR:

Puerto Rico’s labor participation rate is only about two-thirds that of the U.S. mainland.

The territory’s population has dropped by 10 percent since 2007.

Nearly half of Puerto Rico’s residents live below the federal poverty level.

How Did Puerto Rico Get In This Mess?

This did not happen overnight. In fact, it started decades ago. As of right now, Puerto Rico has “$74 billion in bond debt and $49 billion in unfunded pension obligations.”

The island has struggled to create jobs since Congress ended the federal tax credits it enjoyed. The local leaders tried to “cut spending and boost tax collections,” but they decided to take the borrowing route:

For over a decade, Puerto Rico’s government and its municipal corporations borrowed more to buy time to stave off deeper economic overhauls. With government payrolls down over the past decade, pension funds have fewer workers contributing and the plans are now underfunded by an estimated $45 billion.

The investors decided to ignore the financial problems:

For years, investors overlooked these fiscal and demographic problems because Puerto Rico’s bonds offered high yields and because they believed the island’s economy would eventually recover. Puerto Rico can issue debt exempt from federal, state and local taxes, unlike U.S. states, which made these bonds attractive to many mutual-fund investors and more recently, hedge funds.

But Puerto Rico began to lose access to the credit markets three years ago, when its ratings were downgraded. The door closed for good in 2015 when the island’s governor declared the debts unpayable.

Investors

Reality? The investors will probably not receive as much money as they want. USA Today points out that if the investors “hold secured bonds, they might get paid in full.” Without secured bonds, they “could suffer significant cuts, depending on which types of debt the judge determines to be vulnerable.” The main fight comes from two bondholders: Confina bonds and GO bondholders. From NASDAQ:

The Cofina camp argues that its claims on tax revenue are protected by the bond indentures and should not be used to pay holders of the island’s general obligation bonds.

The GO bondholders meanwhile have seen Puerto Rico default on their payments while staying current on the Cofina debt, because the taxes have already been remitted to the trustee.

Before Puerto Rico declared bankruptcy, these bondholders tried to work out “a deal with the government that would have valued their debt at 70 cents on the dollar.” But now the bonds have started to trade “around 66 cents on the dollar.”

Honestly, no one knows for sure what will happen next because this has never happened before. But these bondholders believe their should receive money first.

Pensions

The creditors believe they deserve money first, but what about those who have retired and need to receive pensions? The law Congress passed last year demanded that Puerto Rico “provide adequate funding for public pension systems.”

When Detroit sought protection, the retirees accepted “cuts after a judge ruled that their pensions could be cut in municipal bankruptcy.” Yet, under bankruptcy, the protections given to pensioners could collapse.

However, as Municipal Market Analytics analyst Matt Fabian said, the pensioners could “still fare better than investors” since they “are more politically empathetic than Wall Street creditors and bond insurers.”

Message of Puerto Rico debt crisis: Easy bets sometimes lose

When some of Wall Street's savviest hedge funds piled into Puerto Rico's debt in 2014, it seemed like an easy bet: Buy up the island's bonds at a discount, pocket the high interest and persuade politicians to make decisions that would raise the value of their investments.

Even if Puerto Rico's economy collapsed and its government unraveled, the investment funds figured they had an ace in hand. Puerto Rico was a United States commonwealth, and thus — like the 50 states — legally barred from declaring bankruptcy as a way to shed its debts.

But that safeguard was all but wiped out this week. On Wednesday, Puerto Rico essentially filed for bankruptcy in federal court, under a law Congress passed last summer to help the island cut its debt and escape financial calamity.

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In taking this drastic step, Puerto Rico asserted that it had no way to pay the $123 billion in bonds and pension debt it owes.

The unprecedented legal filing came only a few days after hedge funds and other holders of Puerto Rico's general obligation debt thought they had cut a deal with the government to avoid bankruptcy.

The move represented one of the lowest points in Wall Street's long, torturous history of investing in Puerto Rico's bonds. The hedge funds have been battling to protect their investments through the administrations of two Puerto Rico governors and across Capitol Hill, keeping an army of lawyers, consultants and operatives gainfully employed.

"I don't think anyone bargained for this," said David D. Tawil, a co-founder of Maglan Capital, a New York hedge fund that had at one point invested in Puerto Rico's debt. "I think most funds expected there would have been a consensual agreement by now."

It does not take long to see why a solution to Puerto Rico's debt problem has eluded the hedge funds and other investment firms that own the island's bonds: Many of the creditors think they are, or should be, first in line for the money. But the island also has to keep paying its police officers and its teachers while it struggles to raise revenue.

Two bondholder groups in particular — owners of general-obligation bonds and owners of Cofina bonds, which are backed by sales tax revenue — are at odds. Each of those types of bonds, their investors argue, carries protections that put those bondholders at the top of the pecking order after a default.

Puerto Rico's general-obligation bonds are backed by a provision in the island's constitution that promises that if there is not enough money in the general fund for all planned expenditures, general-obligation bonds will be paid off before anything else.

That sounds good, but investors in the Cofinas say they have an even better claim because they have a dedicated repayment stream in sales tax revenue.

The money goes straight from the merchants to a trust — not to Puerto Rico's treasury — so the government cannot lay claim to it and use it for anything else, such as paying the general-obligation bondholders.

With both the general obligation bondholders and the Cofina bondholders claiming dibs, it will very likely take a judge to force a resolution.

A law passed last summer under the Obama administration, called Promesa, was designed specifically to address Puerto Rico's predicament. It created a bankruptcy-like process that the island and other United States territories could use to restructure their debts.

Bondholders fought vigorously on Capitol Hill to derail the legislation but lost. They did win a few concessions in the makeup of the fiscal oversight board that would oversee the government's attempts to cut expenses. For instance, it would have to include three members from a list of people picked by Democrats and four picked by Republicans. That way, some bondholders figured, they could expect a more creditor-friendly approach.

But the bill that was finally enacted had many elements that could harm bondholders, including a "cramdown" provision, which gives a bankrupt government the power to force a deal on an unwilling creditor.

To investors — who bought the bonds assuming their legal protections were ironclad — it seems as though the governments in San Juan and Washington are constantly moving the goal posts.

Hector Negroni, co-chief executive of FCO Advisors, which is invested in Puerto Rico bonds, said the oversight board had failed to honor constitutional protections for bondholders and to carry out its duty to force the government to tighten spending.

The board's actions, he said, are hurting not only bondholders, but also the people of Puerto Rico, because the island's access to the debt markets would be indefinitely frozen.

"We were promised Promesa wouldn't change the rules against creditors," Mr. Negroni said. "Here we find ourselves with a board that has attempted to force a solution on us that does the exact opposite."

Do not count the hedge funds out just yet. Puerto Rico may have veered from Wall Street's preferred playbook, but some of these hedge funds employ skilled dealmakers and relentless litigators.

Those firms include Aurelius Capital, which was among the firms that fought Argentina in court for years over its sovereign debt default and succeeded in pressuring the government there to pay back its debt. But the legal issues may prove even more vexing in Puerto Rico.

The hedge funds are not the only investors in Puerto Rico's $74 billion in bonds. Those bonds had been a staple of retirement funds across the United States, generating hefty yields for mom-and-pop investors at a time of low interest rates.

Those retirement funds had been assured that Puerto Rico had little choice but to honor its debts — even as the island's pension costs swelled and its tax revenue ebbed. Mutual fund managers like Oppenheimer and Franklin Templeton are now fighting for repayment alongside the hedge funds.

It is too early to say whether the hedge funds will end up losing money on their investments, as they bought many of them at a discount.

Before the bankruptcy filing, general obligation bondholders were close to a deal with the government that would have valued their debt at 70 cents on the dollar, according to people briefed on the matter.

On Thursday, many of those bonds were trading around 66 cents on the dollar, according to Municipal Market Analytics.

Mr. Tawil of Maglan Capital said many investors had made the mistake of comparing Puerto Rico to an insolvent nation. But nations are typically bailed out by the International Monetary Fund before they collapse totally.

No such bailout has come for Puerto Rico. As a commonwealth of the United States, Puerto Rico does not qualify for I.M.F. assistance, and there was little appetite in Congress for a wholesale federal rescue. For months, investors and residents have been in a "five-ring circus," as Mr. Tawil put it, where bondholders are fighting with the government, the control board and one another.

Even so, Mr. Tawil is considering investing in the debt again. "We are in this unknown territory," he said. "How this all ends is unclear."

Why you can't ignore Puerto Rico's bankruptcy

Puerto Rico's bankruptcy is poised to threaten the livelihood of American citizens who planned their retirement on the island's promises, bludgeon investors and undermine state governments.

The bankruptcy may also provide hope of fiscal sustainability and improved services for Puerto Rico, as the U.S. territory attempts to dig out of $74 billion in debt and $49 billion in pension promises.

But the ripple effects remain shrouded in uncertainty as the U.S. judicial system runs, for the first time, a debt-cutting legal process known as Title III of a 2016 law dubbed the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA).

"Nobody really knows exactly what’s going to happen," S&P Global Ratings credit analyst David Hitchcock said in an interview. "It’s highly uncertain."

To be sure, the legal process is similar to the Chapter 9 municipal bankruptcies of Detroit in 2013 or Orange County, Calif., in 1994.

An oversight board governing Puerto Rico will aim to negotiate debt-cutting deals with creditors with the goal of achieving a viable "plan of adjustment" that a federal judge deems reasonable and fair.

But previous municipal bankruptcies have demonstrated that the clash between Wall Street creditors, mom-and-pop vendors, retirees, politicians, union officials and special interests is a recipe for inertia.

"I don’t know that a dawn is coming, but it’s going to get darker," Municipal Market Analytics analyst Matt Fabian said in an interview.

What's clear, however, is that in the absence of action, Puerto Rico's downward spiral will continue, as the island's economy remains distressed and as thousands of people flee to the mainland.

© THAIS LLORCA, EPA People face off with police during the general strike against austerity measures, which coincides with the International Workers Day, in San Juan, Puerto Rico, on May 1.

To many Americans, Puerto Rico is a vacation spot and nothing more. But this bankruptcy could hit closer to home than they realize. Here's why.

Fellow American citizens could continue to suffer.

Puerto Ricans are American citizens. Their home is our home, and ours is theirs. They are suffering under the weight of heavy debt, government bureaucracy, high taxes and poor access to economic opportunity. 

This bankruptcy may lead to their pensions and health care insurance taking hits, while services could also suffer cuts. Fabian estimated that some pensioners may get cuts of up to 20%.

But that may be necessary to help stabilize the island. Puerto Rico has lost 20% of its jobs since 2007 and 10% of its population, sparking an economic crisis that worsens by the day.

Still, without action to improve services such as public safety, health and education, the island's population loss could continue or even accelerate.

Your retirement investments may take a hit.

Since Congress voted 100 years ago to exempt Puerto Rican bonds from federal, state and local taxes, those investments have attracted many people seeking tax-free retirement income.

Despite years of trouble, more than 40% of U.S. municipal bond funds still have exposure to Puerto Rico debt, totaling $7.82 billion in holdings, according to Morningstar data provided to USA TODAY.

What's more, U.S. mutual funds hold about $8.38 billion in Puerto Rico debt, according to Morningstar.

Those bonds could be subject to steep cuts in bankruptcy, and while insurance may cover some of those losses, anyone who bet their portfolio on Puerto Rico should be nervous.

The bankruptcy "could have the advantage of a potentially global solution that might arrive more quickly and with lower legal costs, but it also strengthens Puerto Rico's protection against legal claims," Hitchcock said in a research bulletin.

It might be more expensive for your state to borrow.

Puerto Rico's crisis shows that large governments can reach a point of no return, endangering investment principal.

That may give investors pause before they acquire debt from cash-strapped states and cities, Fabian said. That could increase borrowing costs for state and local governments, which must cut spending or raise taxes to make up the difference.

"I think it will make life more difficult in places like Illinois and New Jersey and Connecticut, where investors are already reluctant to loan the government money," Fabian said. "It’s going to increase investor trepidation."

The case could lead to a political eruption in Washington.

Although Washington's response to Puerto Rico's action was largely muted Wednesday — it was, after all, not unexpected — the unintended consequences of PROMESA may soon trigger a political firestorm.

If and when discussion of pension cuts heats up, expect angry missives from members of Congress — perhaps even from lawmakers who voted to create this debt-cutting process in the first place. Others may be upset about bondholders taking cuts.

"Members of Congress have a variety of interests in what sacrifices are made in this restructuring," said Melissa Jacoby, a University of North Carolina professor and expert on municipal bankruptcy.

But don't expect a bailout anytime soon. President Trump has blasted the possibility of rescuing Puerto Rico, and it's highly unlikely Republicans on Capitol Hill will show any interest.

Even Buying Puerto Rico Bonds Near Record Lows Isn't a Sure Thing

• Island turning to court to shed some of its $74 billion debt

• Analyst says of outcome: ‘I don’t know how to model it’

Puerto Rico bonds are trading near record lows, but that doesn’t mean they’re not worth even less.

The island triggered the start of the largest U.S. municipal restructuring in history yesterday, nearly two years after it began defaulting on its $74 billion of debt. Puerto Rico has said it can pay less than a quarter of what it owes to creditors over the next ten years, even after it enacts sweeping measures to stabilize the government’s finances.

The prospect of deep losses -- despite vast uncertainty about how large such haircuts will be -- caused some bond prices to tumble in March, as investors sought to gauge how the governor’s fiscal plan would divvy up the island’s scarce cash. Puerto Rico general-obligation bonds due in 2035, one of the most frequently traded securities, sold for an average of 65.2 cents on the dollar Thursday, while sales-tax bonds with the greatest claim on those funds traded at 58.4 cents. Some highway agency debt traded for 23 cents.

"I think there’s a lot of downside risk to these prices," said John Miller, who oversees $120 billion of municipal bonds at Nuveen Asset Management in Chicago, including a small amount of insured Puerto Rico debt. "It’s maybe a message that creditors are not interested in compromise and they want to prove that they are entitled to more of the island’s resources and more of the prioritization scheme."

Miller said even the governor’s plan to pay less than a quarter of the debt service that’s due over the next decade could prove too optimistic, as that relies on the government improving its tax collections by cracking down on scofflaws, something it has struggled to do the past. At the same time, some creditors are more optimistic, insisting that Puerto Rico has the ability to pay more for debt service than it claims.

All of Puerto Rico’s bonds have the three lowest credit ratings from Moody’s Investor Service. The rating agency projects 65 percent to 85 percent recovery rates for bonds such as the general obligations and senior sales-tax debt. It forecasts holders of the Government Development Bank will recover less than 35 percent.

Matt Fabian, a partner with Municipal Market Analytics, said even though he thinks prices will fall further, he doesn’t know how anyone would calculate what final recoveries will be. Municipal bankruptcies are extremely rare, and Puerto Rico’s is rarer still, relying on a special, tailor-made procedure that Congress included in its emergency rescue law.

"I don’t know how to model it. I don’t think that Puerto Rico’s recovery is model-able," Fabian said in a telephone interview. "There’s so much uncertainty over what final recoveries will be, not the least of which is time. Bondholders are likely to be left with certificates when this is done. I don’t know how you price recovery, but based on what the commonwealth believes it can pay, prices are too high."

Not every one is as pessimistic. Peter Hayes, a managing director at BlackRock Inc., said that the current prices probably reflect most of the downside risk going forward as the bad news has already been factored in.

"It’s hard to believe that there will be very big surprises from here that will change the value of the bonds," he said. "With that said, there’s probably not a lot of upside either."

Puerto Rico Collapse Shows Debts Seen as Ironclad May Not Be (2)

(Bloomberg) -- Puerto Rico’s decision to use a U.S. court to escape from its debts cast few ripples in the state and local bond market, where prices rose Wednesday. But the action -- once inconceivable for a territory that didn’t have authority to file for bankruptcy -- sets a precedent that could resonate with struggling states in the decades ahead.

The island was extended the bankruptcy-like powers by Congress as a way to end an intractable crisis, despite the assurance once given to investors that it couldn’t be done. While state finances are largely on the mend and officials have dismissed any suggestion they would ever push lawmakers for the same legal recourse, the path ceded to Puerto Rico has fostered speculation it may one day look attractive to governments at the end of their financial ropes.

“There’s a cautionary tale here across the board,” said Jim Millstein, founder of Millstein & Co., which served as financial adviser to Puerto Rico under former Governor Alejandro Garcia Padilla. “Municipal debt, state debt, federal debt, sovereign debt is not without risk. The truth is that bondholders get paid based on the health of the economy of the issuer.”

Puerto Rico’s restructuring will be the biggest in municipal-bond market history, vastly larger than Detroit’s $18 billion record bankruptcy, and will mark the first time a state-level issuer has had debt written off in federal court. It comes after years of borrowing to pay bills as the economy shrank and residents left for the U.S. mainland, leaving the government without enough revenue to repay what it owes.

The island had been expected to resort to such a step ever since Congress enacted legislation last year that allowed for it. There was no discernibly negative impact from the news on the financial markets, with yields on an index of top-rated 10-year municipals slipping to 2.15 percent. Nor did it have a big effect on Puerto Rico bonds: a commonwealth general obligation with an 8 percent coupon, one of the island’s most-actively traded securities, changed hands for an average of 65.2 cents on the dollar Thursday, up from 64.7 cents on Tuesday, ahead of the court filing.

“Puerto Rico’s just been in the news for so long we know it’s in default,” said Matt Dalton, chief executive officer of Rye Brook, New York-based Belle Haven Investments, which oversees $5.7 billion of municipal bonds, including insured Puerto Rico debt. “We know it’s a problem.”

Municipal bankruptcies are rare, given that governments have the power to raise taxes to satisfy their debts. Even after the Great Recession, only a few local governments did so. And the scale of Puerto Rico’s debts is far larger than any other major American government, exceeded only by those of the more populated and wealthier New York, California and Massachusetts.

While some issuers can solve their fiscal challenges over time, investors will be watching states and localities with mounting financial problems, said Robert Amodeo, head of municipals in New York for Western Asset Management Company.

“Each issuer faces different circumstances, and some can fix their imbalances over time, but new negative information will heighten concerns for any one of them,” Amodeo said.

Pension Woes

Puerto Rico’s collapse also shows the pressure than can emerge when retirement systems run out of cash. States such as Illinois and New Jersey are under increasing fiscal strain as their unfunded retirement liabilities grow. The gap between U.S. state pension assets and benefits promised to public employees climbed to $1.1 trillion in 2015, Pew Charitable Trusts said in a report last month.

Illinois is grappling with more than $129 billion of retirement debt, leaving the state with the worst credit rating in the nation. Efforts to shore up its retirement systems have fallen victim to partisan gridlock as Republican Governor Bruce Rauner and the Democrat-led legislature have failed to agree on a spending plan for almost two years.

Even so, the possibility of petitioning Congress to allow for bankruptcy isn’t being discussed, and Democrats have roundly ruled out allowing even the Chicago school district to do so. The idea for opening bankruptcy to states was briefly raised in the Republican-led U.S. House of Representatives after the recession, only to be dismissed by governors who said it would cause investors to demand higher yields on their bonds.

Nobody should assume that a Puerto Rico-type restructuring could be applied to U.S. states: Territories and states are distinct under the U.S. Constitution, and the Tenth Amendment limits the federal government’s ability to legislate for the states, according to lawyers and legal scholars.

Virgin Islands

“If Congress acting under Article I powers were to amend the bankruptcy code to allow either voluntary or involuntary debt adjustment for U.S. states, very serious questions would be raised about unconstitutionality,” wrote Fordham University School of Law Professor Andrew Kent in a April 20, 2016 letter to the congressional committee that drafted Puerto Rico’s oversight law.

The events in Puerto Rico may have more immediate relevance to the U.S. Virgin Islands, its smaller Caribbean neighbor. Debt sold by the island is junk-rated, it faces population decline, large unfunded retirement liabilities and has a history of borrowing to fill budget gaps.

“If Puerto Rico can achieve this level of debt relief through Promesa as the initial plan suggested, it will only make sense for Virgin Islands to attempt the same,” said Matt Fabian, a partner with Municipal Market Analytics.

(Adds comment from former adviser in the fourth paragraph.)

--With assistance from Elizabeth Campbell

©2017 Bloomberg L.P.

Puerto Rico declares bankruptcy. Here's how it's going to unfold

Facing mountainous debt and population loss, the board overseeing Puerto Rico filed Wednesday for the equivalent of bankruptcy protection in a historic move that's sure to trigger a fierce legal battle with the fate of the island's citizens, creditors and workers at stake.

The oversight board appointed to lead the U.S. territory back to fiscal sustainability declared in a court filing that it is "unable to provide its citizens effective services," crushed by $74 billion in debts and $49 billion in pension liabilities.

The filing casts a shadow of uncertainty over the future of Puerto Rico pensioners, American retirees who own the island's debt, institutional investors who backed the island in good times and businesses with lucrative contracts.

But it could also provide hope to residents seeking to preserve access to basic services such as public safety and health care, while also offering a potential route to economic stability for an island that has been suffering for years. Puerto Rico officials have complained that their debt crisis has cut off funds needed to pay doctors and run schools.

Puerto Rico has lost 20% of its jobs since 2007 and 10% of its population, sparking an economic crisis that worsens by the day.

The island's response has worsened matters. Politicians raised taxes, allowed governmental bureaucracy to balloon, borrowed to pay the bills and promised pensions that the island could not afford.

"The result is that Puerto Rico can no longer fully pay its debt and pay for government services," the oversight board said in the court filing. "Nor can Puerto Rico refinance its debt — it no longer has access to the capital markets. In short, Puerto Rico’s crisis has reached a breaking point."

The island's slumping economy was, perhaps, the final straw. Some six in 10 Puerto Ricans are unemployed or not interested in working, and nearly half are enrolled in Medicaid.

Puerto Ricans are U.S. citizens and can move to the mainland at any time, draining the island's tax base. Tens of thousands have streamed into Florida.

The legal case is not technically considered a bankruptcy filing under the federal code that governs municipal cases, but it's similar. Instead, it was filed through a bankruptcy-like mechanism dubbed Title III of legislation authorized by Congress and signed into law by President Obama in 2016.

Here are key questions:

What happens next?

U.S. Supreme Court Chief Justice John Roberts will appoint a life-tenured judge, likely a U.S. District Court judge, to oversee the case, said Melissa Jacoby, a University of North Carolina law professor and expert on municipal bankruptcy.

That's different than Chapter 9 municipal bankruptcy cases, where a bankruptcy judge controls the process.

The person appointed to oversee the case will have significant power over how it unfolds.

This particular debt-cutting process has never occurred, so the lack of legal precedent could leave the judge with much sway over the future of Puerto Rico.

What does the oversight board do?

The oversight board will aim to negotiate debt cuts with creditors, after which it will propose a plan of adjustment. The judge will decide whether to authorize the plan, which could lead to massive debt cuts.

How will investors be treated?

They're in trouble.

To be sure, it depends on the status of their debt. If they hold secured bonds, they might get paid in full. But unsecured bondholders could suffer significant cuts, depending on which types of debt the judge determines to be vulnerable.

Financial creditors, including major investors that had bet on Puerto Rico bonds that were exempt from federal, state and local taxes, argue that their investments were made when the island was not eligible for bankruptcy.

But Congress passed the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA) specifically to create a process that allows the island's numerous debt-saddled governmental entities to achieve debt relief.

Complicating matters is the various governmental entities included in the bankruptcy filing, each of which has its own investors and creditors wanting to be paid.

"It really isn’t clear how creditors stack up against each other," Jacoby said.

Moody's Investor Service Vice President Ted Hampton concluded Wednesday that the bankruptcy filing is actually "a positive step for bondholders overall" because it will bring about "orderly process that should be better for creditors in the aggregate than a chaotic and uncertain period involving proliferating lawsuits."

What happens to Puerto Rico pensioners?

They might face cuts because Puerto Rico has run out of pension funds.

In the Chapter 9 bankruptcy of Detroit, retirees agreed to accept cuts after a federal judge ruled that their pensions could be cut in municipal bankruptcy. That could pave the way for a similar ruling in Puerto Rico.

The PROMESA law states that the oversight board must identify a fiscal plan that will "provide adequate funding for public pension systems."

Puerto Rico pensioners also have certain legal protections, but inside of bankruptcy those protections can collapse. That's exactly what happened in Detroit.

That's why pension cuts and reductions to health care insurance could be in the cards.

But pensioners may still fare better than investors, Municipal Market Analytics analyst Matt Fabian suggested Tuesday in a research note. That's because pensioners are more politically empathetic than Wall Street creditors and bond insurers.

Could Puerto Rico sell off assets to pay some debts?

That's possible. In Detroit, which had $18 billion in debt, the city faced pressure from creditors and pensioners to consider selling off the city-owned Detroit Institute of Arts. The city instead negotiated a deal to avoid liquidating art and collected an infusion of cash from private donors and the state of Michigan.

The city could not be forced to sell assets because Chapter 9 bankruptcy prevents federal judges from ordering municipalities to take such actions.

Similarly, PROMESA dictates that the court may not "interfere with" the island's "property or revenues," without the oversight board's consent.

So a judge may not be able to order the island to sell off beachfront property.

But that doesn't mean creditors won't try to pressure the island into it.

"I wouldn’t be surprised because we’ve seen it in other contexts," Jacoby said.

© 2017 USATODAY.COM

Stakes are high in Puerto Rico’s ‘bankruptcy’

Ripples will extend far beyond its shores

“Puerto Rico can no longer fully pay its debt and pay for government services.” Oversight board

Facing mountainous debt and population loss, the board overseeing Puerto Rico filed Wednesday for the equivalent of bankruptcy protection in a historic move that’s sure to trigger a fierce legal battle with the fate of the island’s citizens, creditors and workers at stake.

THAIS LLORCA, EUROPEAN PRESSPHOTO AGENCY People face off with police during a strike against austerity measures, in San Juan, Puerto Rico, on Monday.

The oversight board appointed to lead the U.S. territory back to fiscal sustainability declared in a court filing that it is “unable to provide its citizens effective services,” crushed by $74 billion in debts and $49 billion in pension liabilities.

The filing casts a shadow of uncertainty over the future of Puerto Rico pensioners, American retirees who own the island’s debt, institutional investors who backed the island in good times and businesses with lucrative contracts.

Puerto Ricans are U.S. citizens and can move to the mainland at any time, draining the island’s tax base. Tens of thousands have streamed into Florida.

Wednesday’s actions also could also provide hope to residents seeking to preserve access to basic services such as public safety and health care, while also offering a potential route to economic stability for an island that has been suffering for years. Puerto Rico officials have complained that their debt crisis has cut off funds needed to pay doctors and run schools.

Puerto Rico has lost 20% of its jobs since 2007 and 10% of its population, sparking an economic crisis that worsens by the day.

The island’s response has worsened matters. Politicians raised taxes, allowed governmental bureaucracy to balloon, borrowed to pay the bills and promised pensions that the island could not afford.

“The result is that Puerto Rico can no longer fully pay its debt and pay for government services,” the oversight board said in the court filing. “Nor can Puerto Rico refinance its debt — it no longer has access to the capital markets. In short, Puerto Rico’s crisis has reached a breaking point.”

The island’s slumping economy was, perhaps, the final straw. Some six in 10 Puerto Ricans are unemployed or not interested in working, and nearly half are enrolled in Medicaid.

The legal case is not technically considered a bankruptcy filing under the federal code that governs municipal cases, but it’s similar.

Instead, it was filed through a bankruptcy-like mechanism dubbed Title III of legislation authorized by Congress and signed into law by President Obama in 2016.

Here are key questions:

WHAT HAPPENS NEXT?

U.S. Supreme Court Chief Justice John Roberts will appoint a lifetenured judge, probably a U.S. District Court judge, to oversee the case, said Melissa Jacoby, a University of North Carolina law professor and expert on municipal bankruptcy.

That’s different than Chapter 9 municipal bankruptcy cases, where a bankruptcy judge controls the process.

WHAT DOES THE OVERSIGHT BOARD DO?

The oversight board will try to negotiate debt cuts with creditors, after which it will propose a plan of adjustment. The judge will decide whether to authorize the plan, which could lead to massive debt cuts.

HOW WILL INVESTORS BE TREATED?

They’re in trouble.

It depends on the status of their debt.

If they hold secured bonds, they might get paid in full. Unsecured bondholders could suffer significant cuts, depending on which types of debt the judge determines to be vulnerable.

Financial creditors, including major investors that had bet on Puerto Rico bonds that were exempt from federal, state and local taxes, argue that their investments were made when the island was not eligible for bankruptcy.

WHAT HAPPENS TO PUERTO RICO PENSIONERS?

They might face cuts because Puerto Rico has run out of pension funds.

In the Chapter 9 bankruptcy of Detroit, retirees agreed to accept cuts after a federal judge ruled that their pensions could be cut in municipal bankruptcy. That could pave the way for a similar ruling in Puerto Rico.

Pensioners may still fare better than investors, Municipal Market Analytics analyst Matt Fabian suggested Tuesday in a research note. That’s because pensioners are more politically empathetic than creditors and bond insurers.

Hedge Funds That Flocked to Puerto Rico Bonds Face Long Road Out

Michelle KaskeApr 24, 2017 9:20 am ET

(Bloomberg) -- Hedge funds first starting buying Puerto Rico debt in the summer of 2013 because they liked what they saw: A government that was paying high, tax-free yields that couldn’t go bankrupt.

Nearly four years later, the Caribbean island has defaulted on most of its bonds and Governor Ricardo Rossello, who took office in January, says it can pay less than a quarter of what’s owed over the next decade, assuming he can slash the budget and increase the island’s revenue. Some of the securities are trading near record lows. And, thanks to the U.S. Congress, Puerto Rico and its federal overseers can use bankruptcy-like proceedings to have some of its $70 billion debt written off in court, something investors once assumed it couldn’t ever do.

“It’s been a really long trade,” said David Tawil, president and co-founder of Maglan Capital LP, who bought Puerto Rico bonds in 2013 but has since sold them. “I don’t think when they first got into this they bargained for this type of length of trade. There’s been a lot more twists and turns and not to any substantial progress point between then and now.”

Puerto Rico investors holding general-obligation bonds and sales-tax debt and insurance companies are negotiating through mediation on a restructuring deal, the largest ever in the $3.8 trillion municipal-bond market. There isn’t much time: The commonwealth faces a fresh hurdle on May 1, when a temporary hold that’s sheltered it from the impact of creditor lawsuits is set to expire. If Puerto Rico fails to strike a deal with its creditors or gets bogged down in a legal morass, it can seek to reduce its obligations through a court -- an avenue that analysts say looks increasingly likely.

“We’re at the very beginning of a process that will likely take years,” said Matt Fabian, partner at Concord, Massachusetts-based Municipal Market Analytics Inc.
 

Hedge funds, which hold about one-third of Puerto Rico’s debt, started buying in 2013, after the island’s long-running recession and unremitting budget shortfalls caused other investors to flee. The distressed-debt buyers scooped up the bonds as traditional municipal-bond investors dumped their holdings and prices fell. An index of Puerto Rico bonds plunged nearly 10 percent in August 2013, the biggest monthly decline since the index’s inception in 1999.

The size of Puerto Rico’s outstanding debt made it easy to take large positions and the discounted value left open the chance of a price rebound -- dangling an opportunity for speculative gains rarely seen in the municipal market, where few borrowers default. Distressed debt was scarce at that time and the island’s bonds were one of the few places to buy cheap securities, Tawil said.

“This was the first real distressed opportunity in U.S. municipals,” Tawil said. “It’s a gigantic capital structure so all of the big distressed guys can go ahead and look at this and say ‘I could put a couple hundred million to work here, no problem.”’

Hedge funds wagered that investors would ultimately allow the island to push out maturities if the commonwealth did its part to cut the government’s spending, Tawil said. Instead, by 2015, Puerto Rico started defaulting on bonds to avoid potentially devastating budget cuts.

“There’s just not enough money,” Fabian said. “We have a basic problem of where do municipal-bond payments fit as far as the priority of payment? GO and Cofina believe that they’re at the top and the board believes they’re at the bottom.”

While Puerto Rico’s debts include a web of obligations sold by different government entities with various repayment pledges, investors are now fighting over an average $787 million that Rossello says he has each year to pay principal and interest over the next decade. One key issue is what will receive a better recovery -- the $12.5 billion of general obligations or the $17.3 billion of sales-tax bonds.

Puerto Rico’s constitution states the island’s general obligations are to be paid before other expenses, while sales-tax bonds have a claim on that revenue before the commonwealth can use it for other expenses. The government hasn’t missed payments on its sales-tax bonds.

Moody’s Investors Service estimates the general obligations and senior Cofinas, which get first claim on the sales-tax receipts, will receive 65 cents to 80 cents on the dollar in a restructuring deal. MMA’s Fabian doubts the recovery rates will be that high because Puerto Rico’s outcome is unpredictable. Securities with even weaker repayment pledges may receive less than 10 cents on the dollar, he said.

Some bonds are trading below the projected recovery rates. General obligations with an 8 percent coupon and maturing in 2035, the island’s most-actively traded, fell to as little as an average 61.8 cents on the dollar on March 30, the lowest since they were first sold in 2014 at 93 cents, data compiled by Bloomberg show. The debt traded at an average 63.1 cents on Friday.

Cofinas with 6.05 percent coupon and maturing in 2036 traded at an average 60.8 cents Friday after falling to 58.7 cents on April 12, the lowest in nearly a year, Bloomberg data show.

Analysts say Puerto Rico’s debt crisis will ultimately be resolved in court, given the long odds of convincing creditors -- some of whom have already taken opposing sides in lawsuits -- to voluntarily accept steep losses, despite whatever legal claims they have on the government’s cash.

“It’s hard to see how mediation could succeed theoretically,” Fabian said. “There are fundamental points like the constitutional prioritization of GOs and the purported segregation of Cofina that need a court to decide their staying power.”