Debt Strikes at Midnight

On July 1, the Puerto Rico government could be paying a large chunk of the roughly $1.9 billion it owes to its creditors. However, it would be a last-minute decision, as the Alejandro García Padilla administration and its advisers evaluate how much should be paid, according to sources.

Moreover, sources added that La Fortaleza would be announcing on Thursday the executive order that authorizes the Puerto Rico government to miss its constitutionally guaranteed debt obligations to protect essential services to citizens, as allowed by the local debt-moratorium statute enacted earlier this year. However, the government could still decide to make partial payments due July 1 on this debt.

Officials declined to confirm how much it would finally pay, or default, come Friday.

At risk is the roughly $958 million due on constitutionally guaranteed debt, as well as some $87 million tied to the Infrastructure Financing Authority (AFI by its Spanish acronym). The government defaulted earlier this year on AFI debt, and the entity is already operating under a moratorium executive order.

According to market filings, municipal bond-insurance companies cover many of the payments that could be missed, meaning these would need to pick up the tab for any defaulted debt they insure.

Early this week, Government Development Bank (GDB) President & Chairwoman Melba Acosta stressed to this newspaper this factor would not play into the government’s payment decisions. She noted the important role these companies play as creditors in debt-restructuring talks.

Meanwhile, the Puerto Rico Electric Power Authority (Prepa) reached a deal with its creditors on Thursday over how it would fund its $417 million payment due on July 1. The utility also extended until Dec. 15 an initial debt-restructuring agreement struck with a majority of its creditors, while updating some of the milestones that need to be achieved for the deal to run its course.

The rest of the debt-service tab corresponds to public entities that were already expected to meet their payments in full, although some would do so by tapping into their debt-service reserves.

Friday’s potential default could mark the first time Puerto Rico fails to pays its constitutionally protected debt.

To try to soften the blow, the administration was leaning to use “clawed back” revenues, or monies taken from some of the island’s public entities since late last year, one source said. However, some officials within the administration would be pushing for not using these funds to pay for debt, another source added.

Government officials declined once again to comment on the whereabouts and potential uses of the redirected funds, which previously paid for debt issued by certain public entities. Less than two months ago, Treasury Secretary Juan Zaragoza said that about $140 million in such funds should be available by June 30, in line with initial estimates given when the measure was first announced.

With some creditors already suing the Puerto Rico government over its latest fiscal maneuvers, officials demanded swift enactment of the Puerto Rico Oversight, Management & Economic Stability Act, or Promesa, before July 1. They believe it would give the island the legal protections it needs in the face of a default.

On Wednesday, the bill cleared Congress with bipartisan support, and is on its way to President Barack Obama for its signing.

An eventful week
Any dodged debt payments on July 1 would become part of yet-another eventful week for Puerto Rico. Meanwhile, prices of commonwealth bonds remain in a frenzy, as the market continues to soak in events related to the island’s fiscal and economic crisis.

In addition to Promesa’s passage, La Fortaleza would be making public the executive order that paves the way for any nonpayment call on Friday. Officials and advisers have been putting the final touches on the document since late last week, sources said.

The governor had previously expanded AFI’s state of emergency, allowing a moratorium on the entity’s looming debt obligations.

Long-awaited audited financial statements for fiscal year 2014—due for over a year—are also expected to be finally unveiled “within the next days,” according to García Padilla administration officials.

On the legislative front, Puerto Rico lawmakers end the session on June 30—the only one of the year because of November’s general elections—with the government’s fiscal 2017 budget plans taking center stage. Failure to have a budget in place by July 1 would cause the current one to remain in place, and only the governor can call a special session after Thursday.

Despite the bumps in the road and continuing rough days ahead, Acosta told this newspaper she remains confident debt-restructuring talks will continue. Moreover, the GDB chief believes Promesa would go to great lengths in spurring negotiations with Puerto Rico’s creditors.

Talks among advisers for the government and certain creditor groups recently came to a halt after failing to strike a deal over a plan to restructure about $50 billion of Puerto Rico’s $70 billion public debt.

Acosta recently noted how some of the creditor groups did not want to extend the confidentiality period under which negotiations were taking place. Nondisclosure agreements (NDAs) were signed four days before talks were put on hold.

Sources told Caribbean Business a slight rally in bond prices following Promesa’s passage in the House had some of the negotiating creditors eager to exit the NDAs’ confines so as not to miss out on the occasion. Creditors who are under NDAs cannot trade the Puerto Rico bonds they own, as they are sharing confidential information not available to the rest of the market.

“There is no mechanism to bind holdouts, there is no mechanism to force agreement with any single class of creditor,” said Antonio Weiss, an adviser to U.S. Treasury Secretary Jacob Lew, who noted how Promesa would help on this front.

Run-up to July 1
Many of the July 1 payments correspond to debt issued to refinance old debt. Along the way, “underwriting discount, legal, printing and other financing expenses” were also paid out from the proceeds of each transaction.

For months, the García Padilla administration has warned that the island lacks the cash to pay for its payroll and services, while meeting its full debt obligations. “Even if I shut down the government on July 1, I will not have enough money to pay [for debt],” the governor said last week.

Although the public discourse has been somewhat geared toward “a $2 billion payment default,” a large number of Puerto Rico issuers are expected to meet their obligations.

Such entities as the P.R. Aqueduct & Sewer Authority ($147 million), Municipal Financing Authority ($7.5 million), Highways & Transportation Authority ($221 million), Convention Center District Authority ($20 million), Employees Retirement System ($14 million), P.R. Industrial, Tourist, Educational, Medical & Environmental Control Facilities Financing Authority [Afica by its Spanish acronym] ($4 million) and the P.R. Industrial Development Co. ($13 million) should be meeting in full their debt-service payments, barring any last-minute setback.

At Prepa, talks with its creditors resulted in Thursday’s deal, whereby a group of monolines and other creditors will provide about $260 million to the utility to help it fund its $417 million payment due July 1.

Meanwhile, the $958 million due July 1 carrying Puerto Rico’s full faith and credit is split roughly in half between principal and interest.

As for clawed-back revenues, La Fortaleza has remained mum for quite some time over these monies, which the government has been collecting now for several months. It is still unclear whether the government will finally use these funds to cover part of the constitutionally protected debt owed on July 1.

After triggering the clawbacks on Nov. 30, the administration used about $160 million of these revenues to meet more than $400 million in payments due on Jan. 2 on commonwealth-guaranteed debt. Puerto Rico, under its constitution, could take control of previously pledged revenues, but only to service its constitutionally guaranteed debt if no other monies are available.

However, Justice Secretary César Miranda has argued that a court could allow Puerto Rico, under its constitutional police power, to prioritize essential services to residents.

“But if you ask me at this moment and I’m pressed to give you an answer, I would have to say those monies [clawbacks] would need to go to pay constitutional debt,” he conceded to Caribbean Business a few months ago.

At the end of the day, even if the administration uses these monies for such purposes, it would not be sufficient to cover what it owes on general-obligation bonds come July 1. Affected creditors could then ask a court to embargo the Puerto Rico government’s accounts, officials warn, thus the need to have Promesa in place by then.

Calls for Promesa
There are 14 lawsuits in different jurisdictions already, according to Weiss. These include challenges to the García Padilla administration’s use of the clawback measure and debt moratorium law.

“They should be trying to find a way for Puerto Rico to walk out of this and not to add obstacles in this race,” the governor said during a forum held last week in Washington, D.C.

Despite weeks of demanding changes to its proposed fiscal board’s powers, García Padilla called for Promesa’s swift passage.

“Congress must act before July 1. Creditors are hoping to gain the protection of legal judgments as quickly as possible,” Lew wrote early this week to U.S. senators.

But what if Congress had taken longer to clear the bill?

In his letter, Lew warns that “a judge could immediately order Puerto Rico to pay creditors over essential services,” if a default materializes without Promesa in place. “Even a retroactive stay on litigation passed by Congress a few days later would not reverse such a court order,” he added.

Yet, there are those who say that even if Promesa was not approved before July 1, the retroactive nature of its legal protections offsets most of the default consequences, including potential lawsuits.

For his part, Héctor Negroni, Co-CEO of Fundamental Advisors, called the stay mechanism “a fairy tale,” while adding he may challenge it in court. Along with his firm, he has been involved in debt-restructuring talks with the Puerto Rico government.

Promesa establishes a financial control board, charged with bringing back access to capital markets for Puerto Rico. It would oversee the island’s budgets, fiscal plans and debt-restructuring efforts.

The legislation also temporarily shields Puerto Rico against creditors’ lawsuits, during which time the board determines if the local government can at least make interest payments. Yet it is unclear what happens in the time before the board is constituted.

Promesa grants certain debt-restructuring tools, which will be administered by the oversight entity. Its Title VI allows for collective-action clauses, seeking to facilitate the adoption of debt-restructuring plans consented to by a majority of creditors within a class; Title III establishes a bankruptcy-like process if negotiations between the commonwealth and its creditors are unsuccessful.

With Promesa, the federal government believes it is “safeguarding the economy” and “the people of Puerto Rico with a financial control board that “is designed to go away,” Weiss said. For the U.S. Treasury official, this is the only solution on the table, and no one should rally behind alternatives that simply do not exist.

Gov. García Padilla considers this to be the largest debt crisis in U.S. history, and Friday’s looming default would be the island’s fourth in less than a year, joining those by the Public Finance Corp., AFI and the GDB.

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