The Puerto Rican government has filed for a form of bankruptcy protection after a new wave of litigation from bondholders seeking payment on defaulted loans.
The island, which has suffered from a decade-long recession, has accumulated more than $70 billion in outstanding debt after financing its fiscal deficits by issuing loans that it is now unable to pay back.
Although U.S. territories like Puerto Rico are barred from traditional bankruptcy proceedings, the Puerto Rico Oversight, Management, and Economic Stability Act, enacted last year and known as PROMESA, made it possible for the island to pursue a similar in-court debt restructuring process under a section called Title III. Puerto Rico’s financial oversight board filed Wednesday to begin these proceedings after a federal stay on litigation ended Monday, unleashing new lawsuits on the island.
According to the filing, a “lack of financial transparency, excessive borrowing, management inefficiencies, and a severe economic decline” has made it impossible for the Puerto Rican government to satisfy its $74 billion debt burden and $49 billion in pension liabilities, causing the territory to reach a “breaking point.”
Puerto Rican debt was popular with fund managers, particularly mutual funds and hedge funds, and bond insurers because it offered high yields and because they had confidence the debt would be repaid. Speaking at the Delivering Alpha conference in 2015, Perry Capital founder Richard Perry argued that Puerto Rico was “the 51st state“ and said there were constitutional guarantees ensuring that its debt would be repaid.
Some asset managers observe that the situation has been deteriorating for some time and that bondholders have had time to shed their holdings. “Puerto Rico has been a long slow burn,” says Karen McQuiston, head of institutional advisory and solutions at PGIM, the investment management business of Prudential Financial. “It’s a theme that applies to political risks in general. We’ve seen the fiscal situation. We’ve seen the external debt, but there has been time to get out.”
Marina Gross, executive vice president of the portfolio research and consulting group at Natixis Global Asset Management, adds that the municipal bond market priced in a bankruptcy for Puerto Rico 24 months ago. “The market has dealt with it a while back,” she says.
Ellen Ellison, CIO of the University of Illinois Foundation, adds, “My hedge funds have done the analytical work on Puerto Rico. But distressed investors loves a fast train wreck, this has been a slow train wreck.”
Some $10 billion of Puerto Rico’s debt is held by mutual funds, with two fund firms, OppenheimerFunds and Franklin Templeton Investments, holding the bulk of that amount, according to a Wall Street Journal report, citing Morningstar figures. OppenheimerFunds could not be reached by press time. Franklin Templeton declined to comment.
Litigants who sued Tuesday include bondholder and hedge fund Aurelius Capital Management, as well as Ambac Financial Group, an insurer of debt issued by Puerto Rico.
