By Shaun Burgess, Portfolio Manager & Fixed Income Analyst and
John Mousseau, CFA, Executive Vice President & Director of Fixed Income
July 1 was a historic day for the Commonwealth of Puerto Rico and one that will shape the future of the island for years to come. Following President Barack Obama signing the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) on June 30, the island experienced its largest single default to date. Faced with approximately $2 billion in debt payments across a number of differing authorities, the island paid $1.049 billion of $2.008 billion due.
Thus, it defaulted on $800 million of general obligation (GO) debt and Commonwealth-guaranteed debt issued by the Puerto Rico Public Building Authority. This event represents the first default on GO debt (which is constitutionally guaranteed to be paid before all other expenses) and the largest default of island debt to date in the Commonwealth's history.
Default on GO and Commonwealth-guaranteed debt in some form were expected following Governor Alejandro Padilla's statement leading to July 1 and the stay on litigation provided by PROMESA. Default was not isolated to GO debt alone. Individual debt payments per authority can be found below. This list covers the largest individual issuers and is not a complete list of total debt payments scheduled for July 1.
$780 million: General Obligation
Non-payment of principal and interest. Governor Padilla issued, via executive order, the suspension of payments towards general obligations guaranteed by the Commonwealth of Puerto Rico, as well as the obligations of other public agencies, in compliance with the Puerto Rico Debt Moratorium and Financial Recovery Act.
$177 million: Public Building Authority (PBA) *Commonwealth Guaranteed
A partial payment of $152.8 million was made on the $177.3 million due.
$232 million: Puerto Rico Highways and Transportation Authority (PRHTA)
The agency paid $221.4 million to bondholders, including full payments on its 1968 resolution bonds, 1998 senior bonds, and 2003 subordinated bonds. However, PRHTA only put $100,000 towards the $4.5 million due on its Series 2003 subordinated bonds.
$423 million: Puerto Rico Electric Power Authority (PREPA)
PREPA made its full payment of $417.7 million.
$147 million: Puerto Rico Aqueduct and Sewer Authority (PRASA)
PRASA paid $135 million, but did not include $12.7 million due on rural development bonds.
Smaller amounts outstanding and due from various other authorities are not listed. The Government Development Bank for Puerto Rico also made full payment on its $9.8 million in senior notes due, but it defaulted on $11 million it must pay on GO notes it holds.
What can we learn from last week's events? Pledges, whether constitutional or not, are only as dependable as those charged with upholding them. Although Puerto Rico is insulated from the broader municipal market, it does reinforce our preference for revenue debt over GO or moral pledges of repayment. If a municipality has to choose between making a payment in full or police walking the streets or schools staying open, they will do what they feel is in the best interest of those they govern and face the consequences thereafter.
Uncertainty remains, and there is much more of the story yet to play out. We await the appointment of the oversight board by President Obama. The drama will continue as haircuts are shared and recoveries become known.
Insured bondholders were paid in full as promised. Our confidence in those insurers we utilize remains steadfast. Cumberland Advisors manages approximately $105 million in an all-insured Puerto Rico strategy. We started the Puerto Rico Insured strategy in March 2014. Our feeling was that insured Puerto Rico bonds with yields between 6.25% and 6.50% were quite compelling in a universe where long-maturity insured bonds not issued in Puerto Rico were between 4.75% and 5%.
More than two years after the start of this strategy, long-insured Puerto Rico yields are approximately 4.5%, while longer-insured non-Puerto Rico paper is approximately 2.5%. In a universe where municipal bonds are more expensive to US Treasuries on a relative basis and overall yields are at historical lows on a nominal basis, the insured Puerto Rico story still offers value.
