Puerto Rico Cries Wolf (Again)

by: Wall Street Daily

By Shelley Goldberg

The island's taxpayers are on the hook to pay back a whopping $49.2 billion in debt.

Actually, Puerto Rico has about $73 billion in debt - but a big slice of the debt pie belongs to its troubled utility company, as well as other government entities.

Thus, the island's obligated bond payments continue to swell.

Puerto Rico

Currently, around 36% of Puerto Rico's revenue services its debt payments (versus 7% in the United States), but the island says it can't afford to pay more than 15%.

In a meeting with lawmakers in Washington, Governor Padilla said the island is in a "death spiral" and that "the U.S. faces a humanitarian crisis under its own flag if Congress does not act soon."

Recently, Puerto Rico has been moving money from one pocket just to pay another, something Padilla blatantly admitted when he said that the government has "paid their creditors up to now with 'fiscal gymnastics' but we have no more tricks."

Kicking the Can

Padilla, who has repeatedly stated that Puerto Rico can't pay back all of the debt it owes to creditors, has now proposed cutting that debt by almost half, to $26.5 billion.

In its proposal, Puerto Rico asks creditors to voluntarily exchange their current bond for two new ones in a restructuring deal involving a 46% reduction of debt.

That means the $49.2 billion the island owes will be split into two tranches. The first $26.4 billion "base" bond will pay guaranteed interest while the $22.7 billion "growth" bond only pays out if it meets its revenue and growth threshold.

But Puerto Rico is so short of funds that it has already defaulted twice before, in August and early January, and now it's trying to kick the can even further down the debt road.

Puerto Rico's government argues that by not having to pay existing creditors now, it can trim the debt, pay school teachers and police, and get the economy growing again.

But that may be tough to do, especially because Puerto Rico is facing a serious "brain drain." Many Puerto Ricans are migrating to the mainland United States in search of better opportunities and economic conditions.

Today, over 700,000 Puerto Ricans live in New York City - almost twice as many as in San Juan. Padilla stated in a tone of desperation, "This is mathematical - this is not politics, this is a real crisis."

But Wait, There's More…

Yet the situation is indeed highly political - especially since it's an election year in the United States.

The democrats favor Chapter 9 bankruptcy law, but Republicans have another agenda. Senate Finance Committee Chair Orrin Hatch (R-Utah) along with Sens. Chuck Grassley (R-Iowa) and Lisa Murkowski (R-Alaska) introduced their own legislation to address Puerto Rico's debt and economy without allowing bankruptcy.

There's one big road block, however, in the Republican debt path: Some lawmakers would require financial statements prior to providing assistance, and Puerto Rico has been delinquent in producing them.

Meanwhile, Senator Elizabeth Warren (D-MA) pejoratively called those entities holding Puerto Rican debt "Vulture Funds," even though the debt is widespread and held by many creditor pools.

Some of the debt is owned by hedge funds, but a lot is held by individual investors who bought the bonds, are invested in funds holding Puerto Rican debt, or own it through their pension funds.

Mutual funds such as Franklin Templeton and Oppenheimer Funds hold substantial amounts of the Puerto Rico Electric Power Authority's debt. Fund investors have lobbied against Chapter 9, believing that it would retroactively violate the terms of the prospectus, and their portfolios would take a hit.

No Mambo, No Cha-Cha-Cha

Ultimately, no one will be dancing until this crisis is resolved, and it's likely to end up in a lengthy court battle unless Washington politicians step in and negotiate.

Of course, if there's not enough money to eventually pay off the debt, then we're simply delaying Puerto Rico's day of reckoning.

In fact, the aforementioned "growth" bond has been coined the "hope" bond due to the skepticism surrounding debt payment. As we all know, hope isn't a strategy, and calling it a "wishful thinking" bond doesn't bode well for institutional bond dealers.

Unfortunately for debt holders, this situation is worlds apart from Detroit, where $0.20 on the dollar eventually turned into $0.74. In fact, Puerto Rico is looking less like Detroit and more like Greece, particularly because it's faced with an ugly 60% tax evasion rate.

Investors that are already in should sit tight and, believe it or not, be hopeful. But for everyone else, it will likely pay to wait before diving in with the vultures.

Good investing,

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