Puerto Rico default nears as debt deadline looms

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Fear that Puerto Rico will default on some of its bonds builds as a major debt service deadline edges closer.

Money managers, value investors, and analysts are all eyeing Dec. 1, when $355 million of notes issued by the Government Development Bank come due, as a litmus test of sorts, to see if the island is willing to make difficult decisions to avoid default on some of its most senior and constitutionally protected bonds.

The GDB, which is Puerto Rico's financing arm, recently released an update on its finance that showed the bank's net liquidity was approximately $875 million as of Sept. 30. The statement also disclosed that the bank's cash resources "may be depleted before the end of the calendar year 2015 in the absence of market access, other financing alternatives (including agreements with GDB's creditors) or emergency liquidity measures."

Moody's Investors Service believes that Puerto Rico will likely default on at least a portion of its debt obligations in the coming weeks, which would be the second default by Puerto Rico to date.

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"The GDB has less incentive to make a payment of $81.4 million om debt service on non-general obligation-backed debt, as the payment pledge does not benefit from constitutional protections," Moody's said in a note issued last week. "However, given the already severe and growing liquidity challenges facing the commonwealth, it may be forced to default also on the $273.3 million of GDB notes that are backed by the commonwealth's general obligation (GO) guarantee."

Puerto Rico has insufficient funds to meet all of its maturing obligations, which amount to more than $1 billion, due in the next few weeks, and will have to decide which debts to pay, and on which debts to default.

"Everyone can speculate, but if you look at the market, it believes that the GO bonds due in January will get paid," said Vasileios Sfyris, managing partner of First Southern Securities, a broker-dealer that owns and advises clients with financial interests in Puerto Rico muni bonds.

Deal still faces hurdles

In addition to the GDB's woes, Puerto Rico debt watchers are also eyeing the ongoing negotiations between Puerto Rico's Electric Power Authority and a key group of its creditors, the monoline insurers — MBIA, Assured Guaranty and Syncora.

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Following extensive negotiations, a deal to restructure the approximate $8.2 billion in PREPA's outstanding debt, was finalized on Nov. 5 between the government-owned electricity provider and three of its creditor groups — PREPA's fuel line lenders, the Government Development Bank for Puerto Rico, and the Ad Hoc Group, which holds more than 35 percent of PREPA's outstanding power revenue and refunding bonds.

Under the terms of the agreement, holders of PREPA's paper will take a 15 percent haircut on the principal of their existing bonds in exchange for new notes with better terms.

However, the agreement is contingent on the buy-in from the monoline insurers, and requires the Puerto Rican legislature to pass the PREPA Revitalization Act, which was unveiled by Gov. Alejandro Garcia Padilla earlier this month.

It's very hard to see what other alternative solution is going to work without an intervention by the U.S. government.
Ted Palatucci
partner, Andres Capital

With a Friday deadline looming for both consents, some experts believe the focus should not be on the dates, but rather on probability of whether the deal will get finalized.

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"The Revitalization Act will pass at some point (so) the focus on a specific date for any legislative vote, or any other issue is not important," MKM Partners analyst Harry Fong said in a note issued Monday. "There is no 'drop dead' date for anything, even a debt service payment. The key item in the insurers' willingness to continue to hold discussions with PREPA (and Puerto Rico in general) is their belief that a resolution of the financial crisis is possible."

Veteran investor Ted Palatucci, a partner at Andres Capital and former managing director of Merrill Lynch's municipal bond division, believes the ultimate solution for Puerto Rico's crisis lies in Washington, D.C.

"This problem is so big and there's so many interested parties that the referee is going to have to have a very big whistle," said Palatucci, who has closely followed Puerto Rico's debt situation for more than 30 years. "It's very hard to see what other alternative solution is going to work without an intervention by the U.S. government."

Palatucci, who is also a portfolio manager at Andres Capital, which launched in June and now has close to $700 million in assets under management, thinks the best solution now to help Puerto Rico dig out from under its massive $70 billion debt load is to give the island access to bankruptcy restructuring.

The next opportunity for Puerto Rico's top officials to plead their case for access to Chapter 9 will be December, when the U.S. Senate Judiciary Committee — which has jurisdiction over bankruptcy policy — will hold a hearing to discuss what's currently being done about Puerto Rico's fiscal problems and consider what options are available to help the U.S. territory get itself out of the present situation.