Bonds

Governor: Puerto Rico will default in January or May

Puerto Rico's governor says that the island will default on its debt in January or May.

The announcement comes a day after a provision that would have granted Puerto Rico access to Chapter 9 bankruptcy laws was left off the U.S. omnibus spending bill.

"There is no money to pay essential services and pay the creditors," said Gov. Alejandro Garcia Padilla at the National Press Club luncheon. "The time will come very soon, and will probably be on Jan. 1, that I will not have money to do both things and if they make me choose between Puerto Ricans and creditors, I will choose Puerto Ricans, always."

Puerto Rico Gov. Alejandro Garcia Padilla delivers his state of the Commonwealth address at the Capitol building in San Juan on April 30, 2015.
Puerto Rico Gov. Alejandro Garcia Padilla delivers his state of the Commonwealth address at the Capitol building in San Juan on April 30, 2015.

On Jan. 1, the commonwealth faces nearly $1 billion in interest payments on more than half a dozen bonds. If Puerto Rico is able to clear this financial hurdle, the next major debt deadline would be on May 1, when approximately $422 million is due to bondholders of the Government Development Bank.

Puerto Rico's situation is unique because it is a territory of the United States and despite previously being legally afforded the rights to access bankruptcy laws; in 1984 the commonwealth was inexplicably removed from legislation that granted debt restructuring protections under U.S. Laws.

Complicating matters further is the complexity of Puerto Rico's debt structure. There are 18 unique bonds issued by Puerto Rican government entities, all with varying degrees of solvency and protections under the law.

At the top of the bond hierarchy, are the general obligation (GO) bonds that have constitutional provisions that give these bondholders the right to sue the commonwealth, if necessary, to apply any available resources to pay GO debt service. A separate constitutional provision gives GO bondholders a first claim on the government's available resources.

Jan. 1 is the next scheduled GO debt payment, when $332 million in interest is due to bondholders.

In order to try to preserve liquidity, the Puerto Rican government decided in July to stop making the required monthly set-asides for this payment, so the governor signed an unprecedented executive order on Dec. 1 to implement a "clawback" mechanism to redirect money pledged to other bonds in order to meet the GO obligation.

On the other end of the spectrum are appropriated bonds, such as the Public Finance Corp. (PFC), a subsidiary of the Government Development Bank, which defaulted on its debt in August when it failed to make the full $58 million payment due to bondholders. Since that historic default, the PFC has missed every monthly payment due to bondholders.

As the countdown to the $1 billion debt deadline continues, the governor restated that the island is out of money, and faces a serious humanitarian crisis absent help from the U.S. government.

"Hedge funds proved more persuasive over Congress than the well being of 3.5 million American citizens living in Puerto Rico," said Garcia Padilla, referring to the key provision left off the omnibus bill that would have allowed PR to restructure its debt.

"They won this round," he said about the hedge funds that hold the island's debt, "but we will fight back."