By Aaron Kuriloff
Investors in Puerto Rico's bonds braced for losses as soon as
this week, after the U.S. commonwealth said it can't pay its debts
as it works to stave off a cash crunch and rebuild its ailing
economy.
The price of some Puerto Rico bonds sold last year touched
record lows at about 68 cents on the dollar Monday after the
government released a report by former International Monetary Fund
officials calling for talks with bondholders about taking losses,
including extending the time frame of some debt and lowering
payments.
The announcement brought into relief the consequences of
long-running financial difficulties on the island, which has about
$72 billion in debt outstanding, a greater sum per capita than any
U.S. state. Analysts said the central government may run out of
cash within a month, which could lead to a government shutdown,
employee furloughs and other emergency measures.
In a speech Monday, Gov. Alejandro Garcia Padilla called Puerto
Rico's debts "unpayable."
"Let me be clear: This is not about politics. This is about
math," he said. "The only way that we can climb out of this mire is
if we come together and are willing--bondholders included--to
assume shared sacrifices today, so that tomorrow we may all share
the benefits of a growing economy."
Many investors stand to lose money, from individuals in mutual
funds attracted to Puerto Rico bonds' tax-free status to hedge
funds that last year bought more than half of the island's sale of
$3.5 billion in junk-rated debt. A group of 35 creditors holding
about $4.5 billion in Puerto Rico debt, including Brigade Capital
Management LP, Centerbridge Partners LP and Monarch Alternative
Capital LP, have proposed financing terms to the government and
said in a letter last week that they had been rebuffed. A spokesman
for the group declined to comment Monday.
Puerto Rico's move also heightened concerns that the
commonwealth's problems could affect the greater $3.7 trillion
market for debt sold by U.S. state and local governments. A broad
restructuring of Puerto Rico would be a new test for the
municipal-bond market amid investor worries about the willingness
of distressed governments to repay debt in the wake of Detroit's
record bankruptcy. Proceeds from the sale of municipal bonds
typically are used to build roads, schools and other public
infrastructure.
Meanwhile, a White House spokesman Monday said that the federal
government would provide expertise and access to existing resources
but no bailout. The administration said Congress should consider
legislation introduced last year that would allow the
commonwealth's public corporations the same right to seek
bankruptcy protection that already exists in the 50 U.S.
states.
Even if officials in Washington were willing to reconsider
providing some kind of lifeline to the island, "it would come at a
significant cost to Puerto Rico," said Sergio Marxuach, policy
director at the Center for a New Economy in San Juan, Puerto
Rico.
Some Puerto Rico creditors already are facing potential losses.
The Puerto Rico Electric Power Authority is in talks with
creditors, including banks, bondholders and bond insurers, to avoid
default on a $416 million payment due Wednesday. The publicly owned
utility has about $9 billion in debt outstanding; it would be one
of the largest restructurings in municipal-bond history.
Monday's report also highlighted the breadth of creditor
exposure, with even general-obligation bonds, backed not by
specific assets but by the government's taxing power, also
potentially at risk.
Moody's Investors Service said Monday that the report and recent
comments by the governor "suggest a rising probability that the
commonwealth will move to restructure the bulk of its bonded debt,
even including those that are guarded by the strongest legal
protections--primarily the central government's general obligation
bonds."
"I think this is a turning point in the strategy from the
commonwealth itself," said John Miller, co-head of fixed income at
Chicago-based Nuveen Asset Management LLC, which manages about $100
billion in municipal debt, including some from Puerto Rico. "For 20
years now, it's been about protecting market access and borrowing
more if there's a gap in the budget.
That strategy became unsustainable about a year ago and was not
acknowledged as such perhaps until now."
Gov. Garcia Padilla said: "We must make difficult decisions to
meet the challenges we now know are ahead, and I intend to do
everything in my power to lead us through this time."
Puerto Rico's problems trace back to the early 1990s, when the
U.S. began closing military bases on the island, whose residents
have U.S. citizenship but don't pay federal tax on local income.
The expiration of corporate tax breaks in 2006 prompted
manufacturing and pharmaceutical businesses to leave, putting the
island into a deep recession. As the economy worsened, migration to
the U.S. mainland accelerated and shrank the island's tax base.
While Puerto Rico's territorial status leaves the commonwealth
with few structural tools to fix its debt, the economy itself faces
deep challenges, including rampant tax evasion, poor business
investment, a bloated welfare state and high unemployment. Puerto
Rico's unemployment rate, 12.4% in May, is more than double that of
the rate for the 50 U.S. states, at 5.5%
The weak economy has prompted many workers to leave the island
in search for better work in the U.S. Puerto Rico's population fell
by 5.5% from 2004 to 2013 and was projected to fall another 0.7%
last year, which would be the seventh-largest decline in the world,
according to a report last year from the Federal Reserve Bank of
New York.
"These are problems that built up over decades," Mr. Marxuach
said. Many of the island's economic problems, including large
unfunded pension liabilities, draw legitimate parallels to Greece,
he said, where the Mediterranean country's debt crisis also is
escalating. But even Greece has options to restructure its debt and
seek emergency assistance from the IMF that isn't available to
Puerto Rico. "We don't even have that card," said Mr. Marxuach.
Several analysts criticized the report. Carlos Colon de Armas, a
finance professor at the University of Puerto Rico, said the study
lacked independent verification of financial data and came to a
"predictable but incorrect" conclusion that default or
restructuring was the answer. He said Puerto Rico must address
bloated public spending, particularly in municipal subsidies and
education, to free cash and pay debt.
"What they are going to do is use the report to force
bondholders to take a hit," Mr. Colon de Armas said. "It would be a
monumental mistake."
Nick Timiraos and Valerie Bauerlein contributed to this
article.
Write to Aaron Kuriloff at aaron.kuriloff@wsj.com