Bond traders and ratings agencies are growing increasingly alarmed that the billions of dollars in debt incurred by Puerto Rico and its public corporations could go unpaid, after the commonwealth passed a measure in June that would allow entities to restructure debt.
Within the next 30 days, the Puerto Rico Electric Power Authority (PREPA) will have to pay back more than $650 million to two big banks. On July 31, a $145 million line of credit with Citibank comes due; on Aug. 14, PREPA must pay back a $525 million line of credit to a group of financial institutions headed by Scotia Bank.
Those loans would ordinarily be covered by Puerto Rico’s government. But a new law signed in June by Gov. Alejandro Garcia Padilla, of the Popular Democratic Party, would allow public corporations to restructure its debt — in effect, to default. That has investors worried that billions of dollars in loans to the U.S. territory could become worthless. It also has some economists worried that Puerto Rico could lose access to the bond market, on which it relies to finance ongoing government operations.
Padilla proposed the new rules and the legislature passed them in a single day.
“There was no time for comment, no hearings, no nothing,” said Arturo Porzecanski, director of the International Economic Relations Program at American University’s School of International Service. “It was interpreted by many as a statement of unwillingness to stand by the legal commitments of the commonwealth.”
The public corporations that have incurred so much debt are a relic of the World War II era, when Gov. Rexford Tugwell, appointed by President Franklin D. Roosevelt, created the government-run companies to help Puerto Rico evolve from an agrarian society to an industrialized one. The corporations helped Puerto Rico’s economy evolve, but they didn’t evolve themselves: PREPA still generates about two-thirds of its power from oil, at an extraordinarily high cost. Power companies in the continental United States generate only about 1 percent of their power from oil.
Investors believe the Debt Enforcement and Recovery Act is a prelude to imminent action by PREPA and several other public corporations, which carry a combined $19.4 billion in outstanding bonds, according to Moody’s Investors Service. Any restructuring of that debt — which Moody’s and other ratings agencies see as a default — would cost bondholders money.
“Any restructuring that involves extension of maturities or reduces value of bonds is de facto default,” said Ted Hampton, a Puerto Rico analyst at Moody’s. “You’re not, as a bondholder, getting your principle and interest as you had anticipated.”
Soon after the Debt Enforcement and Recovery Act passed, OppenheimerFunds and Franklin Templeton Investments filed suit to stop the law. The firms, which hold more than $1 billion in PREPA bonds, said only Congress has the right to change bankruptcy laws. Moody’s downgraded 16 types of Puerto Rico debt to below investment-grade levels, meaning the commonwealth must now pay much higher rates to borrow from investors.
Puerto Rico officials have moved to dismiss the suit [pdf], saying the Supreme Court has ruled that state and local governments can pass laws governing debt restructuring. In a statement, Secretary of Justice Cesar Miranda Rodriguez said the new law is “designed to protect the creditors’ collective interests through an orderly procedure for adjustment of a public corporation’s obligations while enabling it to continue providing critical services to Puerto Rico’s residents and businesses.”
Puerto Rico’s financial crisis has been mounting for years. Because of its status as a U.S. territory, the island of about 3.6 million residents doesn’t get the same level of financial support from the federal government. But the commonwealth’s government has tried to provide the same benefits every other U.S. citizen receives, levying a heavy cost on the state.
Puerto Rico’s government financed that spending through bonds; and while the commonwealth used bond money to build infrastructure in the 1990s, it began floating bonds to pay for recurring expenses beginning in 2000, a risky way to finance ongoing government operations. Today, the commonwealth carries more debt, an estimated $73 billion, than every U.S. state other than California and New York.
Still, Puerto Rican bonds remain enticing to investors because of their tax status. The commonwealth’s bonds are triple exempt from taxes — that is, owners of Puerto Rican bonds do not pay federal, state or local taxes on interest. Puerto Rican bonds can make up a third of tax-free municipal bond packages put together by big Wall Street investment firms.
But the future looks grim. PREPA’s revenue has declined precipitously in recent years as oil prices skyrocket and as residents leave for the U.S. mainland; about 100 Puerto Ricans move to the mainland every day. If the economy had rebounded as quickly in Puerto Rico as it had elsewhere, the power agency might have been able to grow its way out of debt.
The economic recession hit the island especially hard. Even before the recession, unemployment rates have been above 10 percent for more than a decade. It spiked to 16.5 percent in March and April 2011, and has fallen to 13.1 percent today, according to the Bureau of Labor Statistics.
Some economists compare Puerto Rico’s financial condition today with that of Southern European countries that have been forced to pursue bailouts over the last several years.
“The level of the recession in Puerto Rico is similar, perhaps greater than it was in Greece,” said Charles Blitzer, a former IMF official. “Unlike Greece, there is no easy way to get a bailout to make adjustment less painful for the Puerto Rican government and the Puerto Rican people. There is no IMF available. There is no E.U. bailout fund available.”
And thanks to a quirk in U.S. bankruptcy law, Puerto Rico and its public corporations don’t have the same protections as other governments. Cities like Detroit can file for Chapter 9 bankruptcy, so long as the filings are approved by the state of Michigan; the 1978 law that reformed the bankruptcy system didn’t cover governments not under state control — like Puerto Rico and the District of Columbia.
PREPA’s debts are only the most immediate concern investors face. In total, there are 17 agencies in Puerto Rico that issue bonds. The government owes $14 billion in general obligation bonds; PREPA owes $8.8 billion; the Government Development Bank owes $5.5 billion; and the state Sales Tax Financing Corporation owes another $6.3 billion.
Puerto Rico’s representative to Congress, Resident Commissioner Pedro Pierluisi, is urging Congress to change U.S. bankruptcy laws to allow the commonwealth’s government to authorize a public corporation — like PREPA — to file for bankruptcy. Pierluisi has spoken with House Judiciary Committee Chairman Bob Goodlatte (R-Va.), although election year atmospherics and the condensed congressional calendar make any change in the near future unlikely.
Sources familiar with the new Puerto Rico law, speaking on condition of anonymity to avoid angering either side, say the banks have few options. The law allows the government to ask for an extension of credit lines; without an extension, PREPA will default, and the banks risk being sent to the back of the line, behind other creditors.
And the government will feel pressure, too: Friday is Constitution Day, an annual holiday that serves as a de facto celebration of Padilla’s Popular Democratic Party. Unions representing government workers, including those at PREPA, have threatened to disrupt public rallies.