President Obama signed into law on Thursday a bill designed to rescue Puerto Rico’s economy and restructure its staggering debt burden.
Nonetheless, in order to maintain essential services, Puerto Rico’s government defaulted on roughly $1 billion of debt payments that came due Friday in one of the largest ever municipal bond defaults.
“The fiscal situation of the Commonwealth on the last day of fiscal year 2016 is dire,” the government said in a release Friday morning.
Meanwhile, the island’s state-owned electric utility said it had reached a deal with its biggest creditors to avert a default for the time being — although it would mean as much as 24 percent hikes in electricity rates by early next year.
Although the Senate on Wednesday approved legislation to set up a federally appointed oversight board designed to bring balance to Puerto Rico’s budget and manage its debts, the island still faced about $2 billion of debt payments due Friday and more in the months ahead while the oversight board gets up and running.
“It’s not going to be an easy period,” Treasury Secretary Jack Lew said. He added that although the legislation includes a temporary stay on bondholder lawsuits, Puerto Rico would have to negotiate lasting restructuring terms with its creditors on a voluntary basis.
“The bill doesn’t solve any problems. It gives you a framework,” said another person involved in negotiations who spoke on the condition of anonymity to protect his business relationships.
The Puerto Rico Electric Power Authority (PREPA) said Thursday that it would make Friday’s payments by tapping cash on hand and floating $264 million worth of new bonds at high interest rates. The bonds will pay an average of 8.46 percent and help the power authority make a total of $417 million in payments while leaving some money for capital improvements and operations.
The agreement was joined by the holders of 70 percent of PREPA’s debts and included Syncora Guarantee, one of the firms insuring a portion of the utility’s bonds. That put PREPA over the two-thirds mark needed to appeal to the oversight board to enforce a deal even if some creditors remain opposed to it.
PREPA has also obtained permission from the island’s energy commission to make two series of electricity rate increases that would total 4.4 cents a kilowatt hour, roughly a 24 percent jump in rates that are already among the highest in the nation. A person involved in the talks said that because the utility generates electricity by burning oil, the rates had fallen over the past two years because of lower oil prices. Rates had peaked earlier at 28 cents a kilowatt hour.
Puerto Rico’s government said it simply did not have the $780 million needed to meet interest costs and the repayment of general obligation bonds due Friday, even though the general obligation bonds are supposed to be backed by the full taxing authority of the commonwealth.
The Commonwealth said it expected to end the month of June with approximately $200 million of cash in its operating account and about $150 million more in funds that were clawed back from state-owned corporations.
Puerto Rico’s governor, Alejandro García Padilla, issued two executive orders Thursday evening blocking the transfer of tax revenues to half a dozen other agencies with payments due Friday, thus forcing defaults by the Metropolitan Bus Authority, the Public Buildings Authority, Convention Center District Authority, the Puerto Rico Industrial Development Company, the Commonwealth’s Employee Retirement System, and the University of Puerto Rico.
García Padilla has said that the territory must first pay for essential services — education, police, sanitation, among them.
In a lawsuit filed June 21, a group of hedge funds led by Jacana Holdings argued that the general obligation bonds must be paid first. “The Puerto Rico Constitution explicitly guarantees that the Constitutional Debt will be paid first, on time, and in full from all of the Commonwealth’s available resources — ahead of any and all other expenditures,” the filing said.
But the congressional legislation, known as PROMESA, retroactively issues a stay on such lawsuits, rendering the hedge fund filing moot for now. The stay expires in February 2017.
In the meantime, it makes little sense for the Puerto Rican government to make partial payments.
“In a restructuring, the first rule is ‘Cash is king,’ ” said Susheel Kirpalani, a partner at Quinn Emanuel Urquhart & Sullivan, representing bondholders in COFINA, a financing arm of the Puerto Rican government. “To pay interest would be 180 degrees opposite of restructuring 101.”
Kirpalani said that COFINA bonds are backed by the island’s sales tax and that $400 million of those revenues have been placed into an account at the Bank of New York Mellon.
The Puerto Rican highway authority also has enough money in a reserve account to meet Friday’s payments.
The Puerto Rican government said that even after taking extraordinary measures, the balance in the Treasury’s account is projected to fall below approximately $95 million later this year, “a dangerously low cash position for a government that funds services to millions of Puerto Ricans.”
“It kind of reminds me of an International Monetary Fund program for Puerto Rico — without the funding,” said Sarah Glendon, senior vice president and head of sovereign research at Gramercy, a hedge fund that does not currently hold any Puerto Rico securities. “Usually, the IMF gives funding and then says you have to do all these structural reforms. PROMESA is not giving any funding but simply a framework for getting the economy back on track.”
Lew said that one of the long-term issues that concerned him was the fate of Puerto Rico’s pension plans, which currently have a $43 billion shortfall in funding. Under current law in Puerto Rico, pensioners there had virtually no protections. Ideally, he said, they would be on equal footing with bondholders and other creditors. The PROMESA bill instructs the oversight board to make sure pensions are adequately funded, though what that means is not clear.