Puerto Rico's Bonds On the Brink, Payment Missed on $58 Million

From the smiling faces and tanned bodies of the tourists lounging at posh seaside resorts sipping ice cold rum drinks, you would hardly notice that Puerto Rico is entering the dangerous unchartered waters of default.  

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The government failed to transfer millions of dollars necessary to make a $58 million payment on its outstanding Public Finance Corporation (PFC) bonds, according to a statement from   Government Development Bank for Puerto Rico (“GDB”) President Melba Acosta Febo.And investors worry it’s the first of many still to come. 

Ben Eiler is a Managing Partner of Municipal Trading at First Southern Securities.  Eiler says the government is, "...strategically defaulting on specific bond payments they perceive have less priority and so what you're going to see happen is the lawsuits coming in and that's going to force investors to come to the table and negotiate."  

Eiler, whose firm owns Puerto Rican bonds, lives with his family just outside San Juan, Puerto Rico's capitol. With more defaults looming, he expects life to get a little more difficult for the 3.5 million who live in the commonwealth. That means longer lines at government offices and more headaches to conduct official business.  

Puerto Rico has an almost $28 billion consolidated annual budget and more than $5 billion in debt service payments due in 2016.  The governor, Alejandro Garcia Padilla, rocked the muni bond world in late June when he announced Puerto Rico could not pay its debts.  His Chief of Staff, Victor Suarez told reporters here on the island that even with the missed PFC payment, the government faces a liquidity crunch come November 1st but the next test for the commonwealth hits much sooner.

Come September 1, Puerto Rico owes $350 million on its Highway Transportation Authority (PRHTA) Bonds and investors are betting they may be the next to go into default.  The highway bonds were trading Monday at roughly 20 cents on the dollar.  At the beginning of the year they were trading at 49 cents on the dollar.  Nobody knows if Puerto Rico will target those bonds for what Eiler and other traders believe is a strategy to drive investors to the negotiating table to restructure $73 billion dollars of debt.   

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"I don't think restructuring is necessary on some of the others, but the PFCs for example it’s going to have to happen. The revenues are just not there to make the money and they are going to have some sort of forum, they can call it bankruptcy or not, but they are going to have some sort of forum to have a meaningful negotiation."  

Pressure is building on the Puerto Rican Government too.  The default is driving up the cost of future borrowing just as Puerto Rico needs to borrow more money.  The current budget is running with a $703 million dollar deficit.  Fitch, which does not rate the PFC bonds, issued a note Monday which suggests Puerto Rico will face higher borrowing costs. "Fitch rates the commonwealth's General Obligation (GO) and related debt 'CC' ; Rating Watch Negative, which indicates Fitch's belief that default of some kind appears probable. "

But Eiler thinks Puerto Rico can still have a bright future.  He believes the government will cut services in an attempt to convince investors to take haircuts on the bonds they hold.  He also thinks most Americans fail to realize the opportunities that life in Puerto Rico can offer. "A lot of people think it is a third world type economy and they don't realize how nice it really is and what great people these folks really are" he said.


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