March 14 Puerto Rico pulled off a blockbuster of a bond sale this week, sparing it from the threat of imminent default, but few who have followed the Caribbean island's financial troubles doubt that a massive restructuring is in its future.
Not everyone agrees on what such a workout would look like, though. Because the U.S. territory is not eligible for bankruptcy, some think restructuring its $70 billion debt load could look more like the experiences of countries such as Argentina than U.S. cities like Detroit.
The sale of $3.5 billion in new bonds this week delays a financial reckoning, but the island's economic problems still loom large. It has seen a steady exodus of residents to the mainland United States and has been in recession since 2006.
"Short of some economic renaissance in Puerto Rico, you're looking at a restructuring of the debt," predicted portfolio manager Nick Venditti of Thornburg Investment Management in Santa Fe, who said a restructuring might come by year end.
Market reaction after the deal this week was bullish, with the new single-maturity GO rising sharply on Wednesday in heavy volume, according to Municipal Market Data.
The 2035 GO bonds traded on Thursday with an average yield of 8.49 percent, compared to 8.727 at Tuesday's sale.
Some strategists and lawyers said the upbeat market reaction might be because documents authorizing the new bonds give New York courts legal jurisdiction in any disputes.
"To be able to get into U.S. courts and be a squeaky wheel will position the new GO holders," said Suzzanne Uhland, a bankruptcy attorney from O'Melveny & Myers in San Francisco.
Hedge funds dominated this week's sale. Many municipal bond mutual funds stood aside, citing restrictions on holdings of junk-rated debt. Hedge funds tend to have more appetite for risk and boast deep pockets necessary for any extended court battles.
STAYING OUT OF COURT
Some bankruptcy lawyers and investment strategists, however, expect any restructuring of the island's debt will be done outside courts.
Its lawyers could argue its U.S. commonwealth status shelters it from many bondholders' claims, since the 11th amendment of the U.S. constitution grants sovereign immunity from lawsuits in federal courts to state governments and U.S. possessions such as Puerto Rico.
But such a move would threaten to shut the island out of capital markets for years to come.
Instead, the Puerto Rican government will likely try to hammer out revised terms in closed-door bargaining, according to bankruptcy lawyer Edward Tillinghast at Sheppard, Mullin, Richter & Hampton in New York.
As a debtor, Puerto Rico is more a cash-strapped country than Jefferson County, the Alabama local government that last year handed Wall Street banks losses topping $1 billion in a court-approved settlement, Tillinghast said.
Creditor losses in Detroit, the former industrial giant that last July filed for U.S. bankruptcy-court shelter with $18 billion in bonds and other debts, are expected to ultimately dwarf those from Jefferson County.
"When you look at some restructurings in the past, in Argentina and Brazil and other South American and Latin countries, the likelihood is they (Puerto Rico) would try to improve their economy and address their obligations by both improving revenues and restructuring some debt to give them time and relax payments terms," Tillinghast said.
Any restructuring would likely include extending maturities, changes in interest rates, and debt reductions, said Anthony Valeri at LPL Financial in San Diego, who estimated the net $3.2 billion Puerto Rico got from its sale this week would sustain the government for about two years.
Economic revival is key to Puerto Rico paying its debts, investors and analysts said.
Years of deficit spending and under-funded public pensions on the island of 3.67 million have swelled debt levels to some $70 billion, dwarfing that of any U.S. state on a per capita basis.
The government has hiked taxes and pension reform is under court review. But its pledge to close a $650 million budget gap by mid-2015 seems a tall order. Cutting the budget by that much would suck demand from an already sick economy by reducing government spending and aggravating unemployment already more than 15 percent.
Puerto Rico policymakers routinely pledge to honor their debt payments, which Moody's Investors Service in January calculated would total $18.35 billion through 2018 on both tax-supported bonds and those backed by dedicated revenue flows.
But last week they touched off a wave of restructuring worries by hiring workout experts Millco Advisors L.P. to advise the Government Development Bank, the island's fiscal agent whose liquidity levels worry many investors.
Officials in San Juan said the firm was not consulting on restructuring the island's bonds but was evaluating possible funding sources for the government.
Policymakers may choose to target only some of the $70 billion of outstanding bonds issued by the commonwealth and more than a dozen agencies and institutions, lawyers and strategists said. While the island's main GO rating was cut to junk, its COFINA sales tax agency and other issuers are investment grade.
But bankruptcy attorney Uhland said, "We think they are most likely to announce a moratorium on all debt payments and then force a consensual restructuring."
Washington policymakers, who consistently say there are no plans for aid to Puerto Rico, might be open to creating an oversight agency as a possible debt restructuring approaches, according to James Spiotto, managing director of workout consultants Chapman Strategic Advisors LLC in Chicago.
"There are precedents, in New York City in the 1970s, and in DC (District of Columbia)," Spiotto said. "A restructuring just gets you from point A to point B. What they need is a recovery plan that creates jobs and brings people back."
Spiotto said the federal government could take many steps short of a large and politically unpopular bailout of Puerto Rico, such as restoring incentives for mainland companies to invest on the island and guaranteeing payments of island debt.
Indeed, some on the island trace its economic problems to the expiration in 2006 of federal tax breaks for the parent companies of Puerto Rico-based U.S. manufacturers. Puerto Rico entered recession that year and has yet to exit.