Written by: Michael Joyce
On Monday, the Governor of Puerto Rico, Alejandro Garcia Padilla gave an interview that provided a grim assessment for the finances of the Commonwealth, which in turn, could have negative implications for bondholders of credits in Puerto Rico. Gov. Padilla will be giving a speech today, in which he will propose changes recommended by the Krueger report, which is being released shortly. The Krueger report urges significant structural changes (including labor reforms) but will also call for concessions from bondholders. These concessions and which credits will be impacted are not clear from the report.
What credits will be impacted?
As noted above, this is unclear. Much of the debt in Puerto Rico was issued by their so-called public corporations. One of these public corporations, the Puerto Rico Electric Power Authority, has been in negotiations with major creditors over the past few months. This Authority has a payment coming up that will be difficult to meet without concessions. We think it can be assumed that the other public corporations in Puerto Rico may face similar stress in the near term.
For now, it looks like the Puerto Rico Electric Power Authority is the only credit in Puerto Rico that will not be able to make its near-term interest payments. However, the Krueger report does suggest that even the General Obligation bonds in Puerto Rico should be re-structured. There will certainly be negotiations around any potential re-structuring that will take some time. In the interim (and subject to a lack of negative surprises), we believe that the Commonwealth of Puerto Rico will continue to make payments of principal and interest or face difficulty in future bond sales. There are several maturities that come due on July 1 so we will see the first test shortly. There have not been any defaults on state-issued general obligation bonds in the US since at least the 1930s.
The Krueger report does note that debt relief could be obtained through a voluntary exchange of old bonds for new ones with a later/lower debt service profile. The report does not list the credits that this type of proposal could be offered to bondholders.
How will the Sales Tax Revenue bonds be impacted?
Our clients mainly hold short-term bonds issued and backed by Puerto Rico Sales Tax Revenue. These bonds are not backed by the full, faith, credit and taxing power of the Commonwealth but rather by revenue produced by sales taxes in Puerto Rico. These bonds have significant bondholder-friendly provisions including requirements that keep the revenue from sales taxes segregated from the Commonwealth’s general fund (i.e., bondholders have first lien over the Commonwealth on the revenues produced by sales taxes). There is also statutory protection from “clawbacks” of revenues by the Commonwealth. While we believe that these provisions provide substantial protection for Sales Tax Revenue bonds, we recognize that there still could be a danger that new laws could be passed that could weaken legal provisions in the case of extreme fiscal distress.
There will likely be many developments regarding Puerto Rico debt in the coming days and weeks. We will keep you up to speed.