Our Blog Apr 06, 2017
Puerto Rico has been an exception to the normally reliable muni bond market. Here is what you should know about its debt restructuring process.
Following last summer’s default on general obligation debt and the subsequent passage of the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA) by the U.S. Congress, Puerto Rico has started a debt restructuring process. With that work underway, here are three things to know about the future of Puerto Rico municipal bonds:
1. Repayment funds are limited.
The PROMESA’s oversight board has approved Governor Ricardo Rosello’s amended Fiscal and Economic Growth Plan (FEGP), but it indicates that funds available to repay Puerto Rico’s debt are limited. The governor’s initial plan was slightly more favorable for bondholders, but the oversight board didn’t believe it provided enough relief for Puerto Rico.
2. No Puerto Rico government bond will be safe from debt-restructuring.
The FEGP allocates a mere $800 million annually, or $7.8 billion cumulatively, to the payment of debt service, which is equal to only 24% of debt service due in the projection period.
To put this in perspective, $7.8 billion would only be enough to cover 76% of scheduled debt service on general obligation bonds even if no other bonds, including securitized sales-tax bonds, are paid. The plan is silent on which types of bonds may be favored, but different bonds will likely receive different recoveries. In any case, the severity of the total cut indicates that no Puerto Rico government bond is safe from restructuring.
3. The set of reasonable outcomes for bondholders is at best, uncertain, and at worst, well below current market prices.
FEGP is a negotiation tool between Puerto Rico and bond holders, and therefore represents a first (and perhaps lowball) offer to bondholders. But this negotiation is different than most in that if an agreement is not reached, the Congressionally empowered oversight board can cut debt under Title III of PROMESA, provided it demonstrates “good faith” negotiations with bondholders. This is similar to what might be seen in a corporate bankruptcy proceeding. With this dynamic in mind, the set of reasonable outcomes for bondholders is at best, uncertain, and at worst, well below current market prices.
Investors with large exposures to Puerto Rico are likely to realize significant losses, but throughout the extended default saga the larger municipal market has proved its resiliency. Puerto Rico has been an exception to the rule of reliability that municipal bonds generally offer.