Puerto Rico debt crisis headed for U.S.-style bankruptcy resolution

Wed Jul 23, 2014 2:22pm EDT
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By Nick Brown and Tom Hals

(Reuters) - Momentum is building toward a deal that would make painful losses inevitable for investors holding about $20 billion in bonds issued by Puerto Rico's highway, water and electricity authorities even as some big U.S. mutual funds launch a legal battle to squelch a new law that authorizes a restructuring.

The Puerto Rican government and most of its creditors have hired U.S.-based bankruptcy experts to advise them through the Caribbean island’s efforts to solve its debt problem, and the resolution figures to look a lot like a U.S.-style bankruptcy.

The crisis came to a head late last month when Governor Alejandro Garcia Padilla pushed through the Public Corporations Debt Enforcement and Recovery Act to create a bankruptcy-like process for restructuring the debt of commonwealth-run corporations. That’s caused prices on some of the bonds of the electric utility, known as PREPA, to fall to 40 cents on the dollar or below. PREPA is widely viewed to be in the weakest condition of the agencies.

Municipal bond mutual funds including Oppenheimer & Co. and Franklin Templeton sued to block the law. Some of their funds have suffered negative returns since the Recovery Act triggered the decline in Puerto Rico bonds, a long-time favorite among fund managers thanks to their triple tax-free status and fat yields. Supporting the law is a group of distressed debt investors who bought more than $3 billion of Puerto Rico’s general obligation (GO) and governmental development bank (GDB) bonds, which can't be restructured under the law.

Padilla is trying to protect the commonwealth’s ability to make payments on about $52 billion of bonds not subject to the law by restructuring the debt of agencies like PREPA and the sewer and water authority known as PRASA, said Suzzanne Uhland, a lawyer and municipal insolvency expert at O'Melveny & Myers in San Francisco.

"What the commonwealth is trying to signal is that they are going to let PREPA and PRASA go under but they will stand behind the GO and GDB bonds," she said.

Late last week, the distressed debt investors who bought the GO and GDB bonds said they had formed a committee in support of the new law. The formation of such groups, which are a staple in big bankruptcy cases that involve disparate creditor factions, is an indication of a restructuring in its infancy, restructuring specialists said.

One key role for the committee in Puerto Rico, which includes Fir Tree Partners and Aurelius Capital Management, among others, could be to finance a restructuring for PREPA through a so-called debtor-in-possession, or DIP, loan.   Continued...

Puerto Rico's governor Alejandro Garcia Padilla addresses the legislature about a billion-dollar cut in public spending and his new economic initiatives, in San Juan April 29, 2014. REUTERS/Ana Martinez-Santiago