SLL holds a simple belief: if you spend more than you take in for long enough, you will go broke. Puerto Rico confirms this simple truism. From Michell Kaske at Bloomberg Business via davidstockmanscontracorner.com:
Even if Puerto Rico manages to strike a last-minute deal to defer bond payments due in three days, the commonwealth’s financial collapse is about to enter an unprecedented phase.
Anything short of making the $422 million payment that Puerto Rico says it can’t afford would be considered a technical default. More importantly, it opens the door to larger and more consequential defaults on debt protected by the island’s constitution, and raises the risk of putting efforts to resolve the biggest crisis ever in the $3.7 trillion municipal market into turmoil.
Nearly 10 months after Governor Alejandro Garcia Padilla said the commonwealth was unable to repay all its obligations, Puerto Rico has failed to reach an accord on a broad restructuring deal presented to bondholders. During that time the administration has delayed payments to suppliers, postponed tax refunds, grabbed revenue originally used to repay other bonds and missed payments on smaller agency debt. With its options drying up, no bondholder agreement in sight and Congressional action delayed, defaulting may be the next step for Puerto Rico.
“It’s a game changer because it starts an actual legal process with teeth on both sides that can finally advance settlement negotiations,” said Matt Fabian, a partner at Municipal Market Analytics, a research firm based in Concord, Massachusetts. “Pre-default negotiations are really not going anywhere. Post default might have a better chance.”
Puerto Rico and its agencies racked up $70 billion in debt after years of borrowing to fill budget deficits and pay bills as its economy shrunk and residents left the island for work on the U.S. mainland.
The island’s Government Development Bank, which lent to the commonwealth and its municipalities, is in talks with creditors to avoid defaulting on the $422 million that’s due May 1. The commonwealth may use a new debt moratorium law if it cannot defer that GDB payment, Jesus Manuel Ortiz, a spokesman for Garcia Padilla, said Wednesday during a press conference in San Juan.
While a GDB default would be the largest yet by Puerto Rico, a missed payment on its general obligations would signal to investors that the commonwealth is finally executing on its warnings that it cannot pay its debts. Puerto Rico and its agencies owe $2 billion on July 1, including a $805 million payment on its general-obligation bonds, which are guaranteed under the island’s constitution to be paid before anything else.
To continue reading: Puerto Rico Nearing Historic Default
“Puerto Rico and its agencies racked up $70 billion in debt ” and
“raises the risk of putting efforts to resolve the biggest crisis ever in the $3.7 trillion municipal market into turmoil.”
From the above, I calculate that Puerto Rico has 1.89% of the debt. So is this “biggest crisis ever” due partly to all the derivative action that will unwind, leaving institutions unable to cover(sorry for bad terminology) and/or what else?
No, it’s not derivatives. The problem is that Puerto Rican debt is exempt from federal, state, and local taxes and because it is not a strong credit, it trades with higher yields than most of the municipal market. High yields and the triple exemption means that Puerto Rican debt is owned by many individual investors and mutual funds that cater to them. Municipal bond market makers are a pretty risk averse lot (I used to be a municipal bond market maker) so at the first sign of trouble the bid evaporates and the bond’s price craters. This is what has happened to Puerto Rico’s debt, so a lot of bonds that were bought at close to 100 cents on the dollar are now trading anywhere from 30 to 60 cents on the dollar. That would be roughly a $28 to $49 billion loss if those percentage are applied to all of Puerto Rico’s debt, which would be a huge loss for the municipal market. The overall size of the market is much larger, but municipal investors are used to very low default rates and very high recovery rates on those rare bonds that do default, so this is a shock. Not to pat myself on the back, well, actually I am patting myself on the back, but when I ran a bond desk, I would not trade Puerto Rico bonds and recommended our clients not purchase them.
SLL, Thank you for the information and insight. And you deserve the pat on the back.