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Puerto Rico set to register largest default to date

Puerto Rico is set to register its largest default to date on Friday as $2 billion in debt payments are due to the financially strapped island's creditors.

The payments include more than $1 billion in general obligation bonds, the island's highest tiered credit that carries a constitutional lien on revenues.

The largest default prior to this was on May 2 when the Government Development Bank, which formerly acted as the island's primary fiscal agent and lender of last resort, defaulted on $367 million due to its bondholders.

Governor Alejandro Garcia Padilla issued two executive orders Thursday suspending payments on the general obligation bonds and declaring a state of emergency at several of the island's agencies in order "to ensure the residents of Puerto Rico continue to receive essential services while the Commonwealth continues to face a delicate financial situation," according to a statement issued by the Governor's office.

The executive orders were issued around the same time President Obama was signing a bipartisan bill—The Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA—into law that the U.S. Senate had scrambled to pass ahead of the looming July 1 debt deadline.

PROMESA is designed to help create a path for the commonwealth and its creditors to achieve an orderly restructuring of the island's massive $70 billion debt burden—the bill also creates an immediate stay on litigation, providing the government protection from bondholder lawsuits.

The defaults that are set to occur on Friday will not be the first for the beleaguered U.S. Territory—Moody's estimates that the island has defaulted on $562 million of debt service payments since August—however, a missed or partial payment on the GO bonds will be the first default on a security that carries the highest priority of repayment under Puerto Rico's constitution.

Which is why bondholders, analysts, investors and insurers of Puerto Rico's paper had all been closely watching and speculating how the government would handle the July GO payment—with many believing that at the very least the interest would be paid.

This, despite Gov. Garcia Padilla publicly stating multiple times in the past month that the government simply did not have the money to make the payments coming due, and disclosed this week in an op-ed penned for CNBC that "Puerto Rico will default on more than $1 billion in general obligation bonds".

The defaults will leave the three largest insurers of Puerto Rico's bonds on the hook for payments on the various securities they back. Assured Guaranty, Ambac and National, a wholly owned subsidiary of MBIA, collectively have more than $800 million in exposure to the total payments due Friday. The predominant exposure for two of the insurers is to the GO bonds—with Assured Guaranty and MBIA backing $196.5 million and $173 million, respectively.

Ambac's largest exposures are $41.7 million to PR's rum tax bonds and $38.6 million on the Public Building Authority GO-guaranteed securities.

Of the thirteen agencies that have payments scheduled for tomorrow, at least one, Puerto Rico Electric Power Authority, or PREPA, will make its full principal and interest payment of $417.5 million from available funds due Friday, according to S&P Global Ratings. However, this payment came with a caveat that caused the ratings agency to downgrade PREPA to 'D' from 'CC' on Thursday.

"We further understand that on June 30, 2016, certain of PREPA's forbearing creditors and monoline insurers loaned PREPA approximately $263.8 million at 8.46% interest, with repayment due in three tranches at an average maturity of 3.5 years. In our opinion, were it not for the loan, PREPA would not have made the payment, and that the creditor loans were a necessary condition for PREPA to make the debt service payment."

S&P believes that the "payment/re-lending" constitutes a distressed exchange restructuring, which is "tantamount to default" under their criteria.

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