Puerto Rico has once again averted disaster, passing a tax increase that could salvage a funding deal with some of its creditors and keep the government solvent for another year. But the future still looks bleak.
Moody’s downgraded the stricken island’s rating deeper into junk territory last week, arguing that in spite of a likely bond sale backed by a club of hedge funds, Puerto Rico is still likely to default eventually.
Analysts and investors disagree, however, on just how far the rot will reach. What Puerto Rican debts may have to be restructured, and how deep the pain will be, is an extremely complex financial, legal and political calculus that has led big-name investors down differing paths.
The reason for the uncertainty is Puerto Rico’s tortuously tangled $72bn debts, a hodgepodge of direct, indirect and implicit government liabilities of different rankings and legal protections, in some cases with specific — but potentially challengeable — revenue streams pledged to investors.
A group of hedge funds — led by firms including Fir Tree, Perry Capital and Monarch and steeped in experience of distressed countries — is betting that they can keep the government itself out of bankruptcy.
They have herded into the $13bn “general obligation” and $5.5bn Puerto Rico government-guaranteed bonds, on the view that the island’s underlying debt-to-GDP ratio is relatively modest by international standards — especially if some of the non-guaranteed liabilities are shed or restructured.
Moreover, the Puerto Rican constitution stipulates that general obligation bonds should be serviced ahead of all other liabilities, including pay and pensions.
Further down the creditor food chain the outlook is murkier. At the bottom, and most likely to suffer losses, are creditors to state arms like the utilities and transportation and infrastructure authorities, which owe about $24bn in total.
The Puerto Rico Electric Power Authority is already seeking to restructure $9bn of debts, but attempts to do so under the shelter of US “Chapter 9” bankruptcy protection have thus far been stymied by the courts.
Nonetheless, analysts say creditors led by OppenheimerFunds and Franklin Templeton will almost inevitably have to take a hit. Some warn that Puerto Rico’s Highways and Transportation Authority and Aqueduct and Sewer Authority could follow suit on $6.5bn and $4.8bn of debts respectively.
One analyst says that compared with many other parts of the island’s government-controlled entities Prasa is in “pretty good shape”, and more than $1bn of its debts are guaranteed by the commonwealth, complicating any restructuring. But leaving Prasa’s creditors unscathed might be politically unfeasible if the crisis deepens.
In between the riskier and the safer general obligation debt sits a jumble of liabilities including pension bonds, bonds issued by the university of Puerto Rico and a convention centre, and specific revenue-backed bonds, which total almost $30bn. The biggest chunk is $15.2bn worth of “Cofina” bonds backed by the island’s sales tax revenues.
Jeffrey Gundlach, the head of bond fund manager DoubleLine, favours the pension payment-backed bonds, arguing that the government is unlikely to default on these mostly locally-held securities despite their poor legal protection. Even if there is a restructuring, their cheapness — the 2039 pension bond last traded at just 41.5 cents on the dollar — offers some insulation, he told clients.
Some analysts believe the Cofina bonds are the best bet, especially considering the fact that legal opinion currently holds that the government cannot claw back sales tax revenues hived off to service them — even in the case of a wider restructuring.
Yet some money managers are not confident that this will hold up in a courtroom, given the constitutional privilege enjoyed by the government’s direct debt. “General obligation bondholders will go after the Cofinas if they don’t get paid,” warns one senior muni bond trader.
Everything is going to get hit, and hit hard
– Guy Davidson, AllianceBernstein
Optimists argue that Puerto Rico is unlikely to reach the point where bondholders have to scrap for the island’s money in the courts — at least when it comes to the government itself.
They hope that another temporary financing deal with its hedge fund creditors or a banking consortium will give the government time to tackle its deeper economic and financial problems. The government has unveiled a more austere budget for 2016, and Puerto Rican bonds have rallied hard over the last week, anticipating that a financing deal can be done.
But some analysts and investors are increasingly worried that the commonwealth’s debt crisis is too far advanced. Guy Davidson, head of municipal bonds at AllianceBernstein, the asset manager, fears that Puerto Rico has “passed the point of no return” and predicts that the eventual denouement will hit every creditor.
Source: financial Times