Puerto Rico Asks For Concessions and Investors Get Ready for More Losses

Puerto Rico Governor Alejandro García Padilla says that the U.S. territory cannot pay back its $72 billion debt without concessions from its creditors, including U.S. mutual funds and hedge funds. According to the Governor, the Commonwealth’s efforts to restructure its debt and cut spending have failed.

Following the Governor’s announcement, credit rater Standard & Poor’s Ratings Services downgraded Puerto Rico’s credit rating from CCC-plus to CCC-minus. The rating covers the island’s entire debt, including the debt of its Employees Retirement System and the Municipal Finance Agency.

García Padilla and Puerto Rico’s government development bank also issued a report backing his statements. The executive summary was written by Anne Krueger, a former World Bank Chief Economist and the International Monetary Fund’s first deputy managing director, as well as Ranjit Teja and Andrew Wolfe, who are both economists.

In their “Krueger Report,” the economists said that they found the territory’s debt to be unsustainable. Based on the report and Puerto Rico’s own analysis, García Padilla wants to defer debts so that Puerto Rico can continue to negotiate with creditors. Some payments could be deferred for up to five years. The Governor said, “This is not politics, this is math.”

Following the Governor’s statements, White House spokesperson Josh Earnest said that while the U.S. government would offer access to resources that already exist, along with financial expertise, it will not be offering Puerto Rico a bailout. Earnest said that the U.S. Treasury Department will provide advice and a task force to help Puerto Rico identify the federal funding and programming it might be able to use.

Because Puerto Rico is a U.S. territory it cannot file for Chapter 9 bankruptcy protection. Moreover, according to its constitution, the Puerto Rican government must pay back its debt first before paying for other government services. This means that right now the latter is also going unpaid. Earnest, however, noted that the White House would like Congress to look at the option of allowing the Commonwealth to use Chapter 9 to continue operations while working out its debt.

In the meantime, investors of Puerto Rico municipal bonds look likely to take another financial hit in the wake of these latest developments. Those affected would include individual investors as well as the hedge funds that last year purchased over half of the territory’s $3.5 billion in junk-rated debt.

Puerto Rico’s bonds were popular among investors for years because of their tax-free status. However, the Commonwealth has been in a deep recession since as early as 2006, with many of its banks failing in the financial crisis and its continued loss of population and resources. As a result, despite their tax implications, Puerto Rican bonds have been a risky investment for almost a decade.

Firms such as UBS Puerto Rico (UBS), Banco Santander (SAN), and Banco Popular came under fire for not just selling these investments but also for marketing them to retail investors, especially retirees for whom they were not appropriate. UBS, in particular, has been accused of encouraging individual investors to borrow so they could invest in the bonds even more.

In addition, UBS, along with Banco Popular, created a series of closed-end funds that used heavy leverage to purchase Puerto Rican bonds and sell to investors as safe investments with a high income. Those funds, because of their leverage and concentration in some of the worst debt the Commonwealth has issued in the last few years, have lost much of their value since the fall of 2013.

In addition to those in Puerto Rico, many individual investors on the US mainland hold Puerto Rico debt-some may not even know it, because the debt is in mutual funds and other investment accounts. According to Morningstar, in 2013, up to 80% of Puerto Rico’s debt could be found in muni-bonds funds here in the United States. Also, said the investment research firm, at least 5% of 180 mutual funds that concentrate on municipal debt own at least some Puerto Rico bonds.

At Shepherd Smith Edwards and Kantas, LTD LLP, our Puerto Rico muni bond fraud lawyers represent investors on the island and the U.S. mainland who are seeking to recover their bond losses. Contact us today.

Puerto Rico urges U.S. to help save it from default, The Washington Post, June 29, 2015

The Krueger Report (PDF)