January 17, 2016

            The Puerto Rican government officially defaulted on some municipal bond obligations due on January 4, 2016. This is not surprising – the idea of default had been mentioned several times and in particular every time a bond payment became due. The Governor, Alejandro Garcia Padilla, again asked the US Congress to allow Puerto Rico the authority to restructure its debt.

The required payment for all bond obligations was $902 million dollars, and the government paid all but $37.3 million. Bond repayments are subject to a number of constraints – some obligations have higher priorities than others. For example, I believe general obligation bonds are repaid before other types of bond obligations. Governor Garcia Padilla stated the Puerto Rican government would repay the following bond obligations on January 4:

• $328 million of general obligation, of which $163 million comes from transfer from other sources, a process known, rather dramatically, as ‘clawback’,
• $9.9 million owed by the Government Development Bank,
• $15.4 million owed by the Sales and Use Tax Financing Corporation (COFINA) bonds,
• $8.7 million owed by the University of Puerto Rico,
• $9.5 million owed by the Puerto Rico Convention Center District Authority,
• $101 million in bonds from the Highways and Transportation Authority,
• $13.9 million in bonds owed by the Retirement System Administration, and
• $10.1 million owed by the Puerto Rico Industrial Corporation.

Actually, the situation is worse than this repayment suggests. Some payments (e.g., Retirement System) came from monies in their trust fund. Since those funds have been depleted and not replenished, the Retirement System is technically in default, although not yet to its bond holders. All told, the total default was about $174 million.

It seems nothing is easy in Puerto Rican politics. You would think the government would get some credit for producing such a modest default to bondholders, $37.3 million in default versus $902 million owed. Financial analyst Daniel Hanson doesn’t think so. Hanson, who works for Height Securities, in Washington, D.C., said “When a debtor repeatedly claims they have no cash but then pay more than $900 million in debt service, the credibility of the debtor must be called into question. The governor repeatedly blamed the U.S. Congress for PR’s plight during his remarks, but when Congress returns from its recess, the lack of credibility and commitment to reform within the PR government is likely to push Congress closer to imposing a federal control board over the territory.”

I’m not sure of the role of Height Securities in all this. Height Securities apparently specializes in political intelligence as it relates to investments. It is under SEC investigation for allegations of insider trading. It allegedly released information to selected clients, before the official government announcement, about an impending decision regarding health insurance, thus allowing recipients to benefit by investing in the health insurance companies before their stock prices went up.

The debt issue is complex. Bonds have been issued by 17 different issuers; there are thousands of creditors (Conflict of interest statement: I do not think I own any of these bonds. Just in case you were curious). When bonds are issued and sold, there are rules for repayment. There are undoubtedly embedded inter-creditor conflicts throughout the bond debt structure. This is one, perhaps the principal, reason why the Puerto Rican government is seeking from Congress the authority to restructure its debt burden.

Entities that buy large amounts of bonds can purchase insurance. In the event of default, the insurance companies pay the bond holders. As you might suspect, these insurance companies have not been silent. In particular, the Ambac Insurance Corporation, in conjunction with the Financial Guaranty Insurance Company, wrote a letter to Governor Padilla questioning the legality of the ‘clawback’. Last month, Governor Garcia Padilla, in an executive order,directed the Secretary of the Treasury of the Commonwealth to ‘clawback’ revenues pledged to the Puerto Rica Infrastructure Financing Authority (AFI in Spanish).

The two insurance companies have a considerable stake in this – they insure $863 million in bonds issued by AFI. They claim that the AFI enabling act requires the transfer of the Rum Taxes, the most important of the excise taxes here, to AFI before any other entity. That these Rum Taxes were ‘clawed back’, diverted for other uses by the government, is the basis of their claim.

It is, as I have noted before, an interesting time here. But I think I see a way I can help – I’ll drink more rum. Mojitos, here I come!

Sources: This has been distilled (another rum reference) from several articles in the San Juan Star. an English-language daily newspaper here.