After a round of holiday hellos during dinner with a group of friends, the conversation turned to Puerto Rico and its financial distress. One gentleman at the table has a lot of his 401(k) account invested in municipal bonds, including a hefty allocation to Puerto Rico. Naturally he is nervously watching events and hoping for the best. From his perch, he finds it incomprehensible that retirees would be left holding the proverbial bag and strongly believes that his Puerto Rico investments are safe.
Although the situation is fluid and therefore subject to change, the essence is that this U.S. territory is facing a severe cash crisis and may need to restructure its estimated $70 billion in debt. Filing for Chapter 9 protection from creditors will depend in part on U.S. Congressional approval. Creditors are not happy and likely to be less so if attempts to seek redress (if they don’t get paid on time) in court are thwarted. See “Bills Halting Litigation Over Puerto Rico Debt Raise Legal Issues” (Lynn Hume, The Bond Buyer, December 23, 2015).
Some believe that allowing a bankruptcy filing is neither necessary nor helpful. According to “Puerto Rico’s utility reaches tentative agreement to restructure $8.2B debt” (Robert Walton, Utility Drive, December 21, 2015), MBIA Inc. and Assured Guaranty Ltd. are willing “to take a 15% loss on what they are owed.” If approved, this arrangement would free up resources to modernize the power infrastructure in Puerto Rico and demonstrate that negotiations are possible. In his piece for Forbes, energy consultant Steven Fetter predicts three adverse outcomes should Puerto Rico file for bankruptcy protection. They are as follows: (1) reduced access to capital (2) higher costs of borrowing required by those lenders who are willing to take the exposure and (3) greater difficulty for retail investors to recoup principal and interest. See “Filing For Bankruptcy Isn’t The Right Solution For Puerto Rico” (November 29, 2015).
Regular readers of Good Risk Governance Pays know that my other analyses about municipal bond investing have focused on unfunded liabilities, disclosures and liquidity. As I wrote in “Muni Bonds, Pension Liabilities and Investment Due Diligence” with Dr. Israel Shaked and Mr. Brad Orelowitz, having sufficient information about a municipal bond structure is so important that the U.S. Securities and Exchange Commission (“SEC”) has ratcheted up its enforcement efforts in this area. Co-presenting with senior attorney Elaine Greenberg as part of an educational program for the Practising Law Institute, I put forth a long (but not exhaustive) list of “must know” items that an investor would reasonably require before purchasing a particular municipal bond or municipal bond fund. When contract terms or economic circumstances change, an investor wants to know how he or she is likely to be affected so that a decision can be made to buy or, if possible, sell.
One change that worries some Puerto Rico bondholders is whether they are subsidizing payoffs made to others at their own expense. In his December 27, 2015 piece, Wall Street Journal reporter Aaron Kuriloff describes how sales tax revenue that has been earmarked to pay off IOUs issued by the Puerto Rico Sales Tax Financing Corp.(“COFINA”) may instead be diverted to pay holders of Puerto Rico’s general-obligation debt on January 1. Click to read “‘Safe’ Puerto Rican Debt Stirs Worries.” As CNBC’s Dawn Giel points out, there are serious questions about whether this kind of clawback is permitted. See “Puerto Rico takes dramatic step to avoid default” (December 1, 2015).
As this crisis unfolds, there are lots of questions that need answers. A few are listed below.
- How did investors reevaluate credit risk each time that Moody’s Investors Service downgraded Puerto Rico general obligations bonds to below investment grade?
- What information was disclosed to investors by issuers and when?
- Will the value of bond insurance be degraded as part of any restructuring?
- What is the market for uninsured bonds such as the $750 million that was issued by the Puerto Rico Aqueduct and Sewer Authority (“PRASA“) earlier this year?
- How will the presence of large mutual fund and hedge fund bondholders such as Oppenheimer Funds, Franklin Templeton, Perry Capital and Monarch Alternative Capital influence the restructuring discussions?
The next repayment date is right around the corner. Stay tuned.