Federal officials placed Puerto Rico under bankruptcy protection, setting up a showdown with Wall Street firms owed billions of dollars in the largest-ever U.S. municipal debt restructuring and further complicating the U.S. territory's efforts to pull itself out of a financial mess.
The federal oversight board installed by Congress invoked a quasi-bankruptcy law that puts Puerto Rico's standoff with creditors before a federal judge in San Juan. The judge's decision marks the start to what could be a lengthy legal fight as Wall Street watches closely to see how other indebted municipal governments may fare in confrontations with investors.
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Puerto Rico and its agencies owe $73 billion to creditors, dwarfing the roughly $18 billion owed by the city of Detroit when it entered what was previously the largest municipal bankruptcy in 2013.
Hedge-fund creditors holding defaulted general obligation bonds were on the verge of completing a consensual agreement late Tuesday before the oversight board intervened to stop negotiations, according to people familiar with the matter.
The slide into bankruptcy would mark a new low in Wall Street's relations with Gov. Rosselló, a political newcomer who pledged as a candidate to repay the territory's debts, shrink the government and strengthen ties with the U.S.
Creditors clashed with the previous administration of Alejandro Garcia Padilla but saw Gov. Rosselló as a likely ally in their fight to be repaid, said Chas Tyson, vice president at investment banking firm Keefe, Bruyette & Woods Inc.
"Now it seems like the honeymoon's over," Mr. Tyson said. "It seems that we're back where we used to be."
The action by the board, which creditors lobbied Congress to create, could mean deeper losses on bonds than investors and analysts have anticipated. Puerto Rico will face off against angry hedge funds, mutual funds and bond insurers in the court-supervised proceeding known as Title III, a legal mechanism created by Congress to restructure debts by force if negotiations broke down.
An initial round of restructuring talks failed to deliver an accord between creditors, including rival groups of hedge funds who are battling for priority. Any write-downs also would impact bond insurers Assured Guaranty Ltd., MBIA Inc. and Ambac Financial Group, which have guaranteed billions of dollars of Puerto Rico's bonds.
Negotiations revolved around a board-approved fiscal plan that allocates about $787 million a year to creditors for the next decade, less than a quarter of what they are owed. Creditors called it a slap in the face, saying the board wasn't trying in good faith to reach a consensus and avoid litigation.
The Title III request, while unprecedented, isn't unexpected. The board signaled in negotiations this month it wouldn't consider paying creditors more than the plan allowed, according to people familiar with the matter.
A legal stay protecting Puerto Rico from lawsuits expired Monday night without standstill agreements with creditors in place. Hedge funds holding general obligation and sales-tax bonds filed lawsuits on Tuesday, naming Gov. Rosselló as a defendant.
Because of the impending bankruptcy filing, lawsuits will presumably be frozen, preventing court rulings that favor one creditor group over another.
The board is pushing a combination of debt restructuring and spending cuts in a bid to revive an economy scarred by a 45% poverty rate and a population decline. Puerto Rico, the board decided last week, will raise water rates on consumers, liquidate its decades-old industrial development bank and seek concessions from creditors of additional government agencies.
Puerto Rico has reached one consensual settlement with creditors, a $9 billion deal covering its public electricity monopoly that Gov. Rosselló recently renegotiated to mitigate politically unpopular fee increases on residents.
But the governor remains in a difficult position, trying to balance fiscal belt-tightening with the demands of residents and placating the federal oversight board while campaigning for U.S. statehood ahead of a plebiscite on Puerto Rico's political status.
Creditors, meanwhile, are likely to dispute whether Puerto Rico has met the legal requirements to invoke Title III when the board spent less than a month negotiating to restructure a complex pile of competing bond claims, people familiar with the matter said.
Title III incorporates features of chapter 9, the section of the U.S. bankruptcy code covering insolvent municipal entities. U.S. cities, notably Detroit, have obtained favorable rulings in recent chapter 9 proceedings that helped them chop down obligations to Wall Street. But key provisions of Title III have never been interpreted by the courts, and the law includes protections for creditors that chapter 9 doesn't.
--Matthieu Wirz contributed to this article.
Write to Andrew Scurria at Andrew.Scurria@wsj.com
(END) Dow Jones Newswires
May 03, 2017 12:07 ET (16:07 GMT)