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HJ Sims Special Report on Puerto Rico Bonds by Dick Larkin
by Richard Larkin
Published June 26, 2014
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Governor’s Support for Debt Restructuring Law is a Game Changer

June 25, 2014: The Puerto Rico Public Company Debt Enforcement and Recovery Act
In the last 2 days, Governor Padilla introduced this law, which was passed by the Legislature and signed by the Governor. As stated in public documents from the Governor’s office and the Commonwealth’s Government Development Bank (GDB), the Act ensures “that vital public services such as the delivery of electricity, gas and clean water are not interrupted…(and) the jobs of the thousands of hard-working employees… are sustained in the long-term.” If there’s not enough money, essential services and employees will be paid before bondholders.

The public documents also state that that the act will give “public corporations a controlled, orderly way to negotiate with creditors to lower debt”. In simple layman’s terms, this means the Act will legally permit and allow bond defaults as one of its major goals. This is a major departure from past government statements supporting the full and complete payment on Puerto Rico debt.

Governor Padilla closed his public statement with the comment that “…..The Recovery Act is not related to the Commonwealth’s general obligations to creditors. We will continue to honor our obligations to the Commonwealth’s creditors.” In my opinion, this is a superficial statement of fiscal responsibility. Puerto Rico’s electric, water/sewer and highway utilities have long been supported by the Commonwealth during tough fiscal periods. While it is abundantly clear that bond documents for those utilities contain no financial guarantees by the general government of Puerto Rico, they are still organizations whose management is appointed by the Commonwealth, and whose financial operations have long been supported by the general government as well as the GDB.

The GDB not only serves as Puerto Rico’s financial advisor, but is also charged with providing financial support to Puerto Rico and its operating organizations. The GDB’s own mission statement says that it exists to “…..safeguard the fiscal stability of Puerto Rico and ….serve as a bank, fiscal agent and financial advisor for the Commonwealth of Puerto Rico, and its instrumentalities.” The GDB has been a key entity that has provided needed liquidity to the Commonwealth and its utilities for decades. That support now appears to have disappeared, which raises the question as to whether there continues to be a need for the GDB. With the GDB’s support of the Act, which will legalize defaults on Puerto Rico debt, it appears to me that it is failing in its mission to “safeguard the fiscal stability of Puerto Rico”.

There is an old saying by municipal bond professionals that full debt payment by a government depends on the “ability & willingness” of the government to honor its debts. It is clear that Puerto Rico’s economic and financial ability to repay bonds has been severely challenged, but until now, its “willingness” has been extraordinary: documented by the tough tax and spending decisions that needed to be made over the last several years. With the Governor’s proposal of this Act to allow defaults, Puerto Rico’s “willingness to pay” has been compromised. And its effect on the municipal market’s acceptance of Puerto Rico debt will be felt for years, if not decades.

Is This Law Beneficial To Bond Investors, As The GDB Has Stated?

This law is today the law of the land in Puerto Rico. The possibility of the law being rejected by the legislature is now in the past, and the damage to Puerto Rico’s name in the municipal debt market is real.

David Chafey, the President of the GDB’s Board of Directors, has been quoted as saying that “…many investors will see this (restructuring bill) positively because it creates a judicial framework…”. This will not comfort individual retail investors who bought Puerto Rico debt with the belief that the Government would support full debt repayment, even from subsidiary authorities whose management was appointed by elected government officials. I can see, however, how large institutional investors that have been buying large lots of bonds on speculation would see a debt restructuring law as positive, especially if the bonds were purchased at depressed prices driven by speculation in the last year. While those wealthy institutions may own a majority of Puerto Rico debt, their number is probably quite small compared to the many thousands of individual and family retail bond investors. Retail investors have little or no access to officials making decisions which will hurt their investments in Puerto Rico debt. The future market for Puerto Rico debt may well be dominated by aggressive investors and speculators as opposed to the steady retail buyers. Remember, right now aggressive investors are looking for easy prey because of headline fear.

There is still fundamental value for Puerto Rico bonds because of the government’s ability to tax and its authorities’ legal monopoly over its service areas for water, sewer and electric facilities. In my opinion, the need for this equivalent of bankruptcy law could have been averted by better management and control over the operating authorities. It is foolish and naïve for someone to think that Puerto Rico bonds will lose all their value. Even if this law reduces bond payment obligations through negotiation or legal mandate, it is very possible that a bondholder would do better under a “bankruptcy” type settlement than to sell bonds at today’s fire-sale prices. I would encourage investors to contact their HJ Sims financial advisor if they have any questions on these recent events or their Puerto Rico debt investments.

The material presented here is for information purposes only and is not to be considered an offer to buy or sell any security. This report was prepared from sources believed to be reliable but it is not guaranteed as to accuracy and it is not a complete summary of statement of all available data. Information and opinions are current up to the date of publication and are subject to change without notice. The purchase and sale of securities should be conducted on an individual basis considering the risk tolerance and investment objective of each investor and with the advice and counsel of a professional advisor.
The opinions expressed by Mr. Larkin are strictly his own and do not necessarily reflect those of Herbert J. Sims & Co., Inc. or their affiliates. This is not a solicitation to buy or an offer to sell any particular investment. All investment involves risk and may result in a loss of principal. Investors should carefully consider their own circumstances before making any investment decision.