Luis Dávila Colón: PR default is imminent

The prominent Puerto Rican journalist and attorney Luis Dávila Colón said last Thursday he believes there will be a default on Puerto Rico’s Government Development Bank bond payment of $354 million due on December 1, 2015.

In an interview recorded with PRNewsRoundup.com’s Cate Long (@cate_long) and Gil Hall (@gillamhall), Dávila Colón (@davilacolon) said that

 government officials “have decided not to pay–even the GOs–and they’re going to have a party with the money…”

Citing documents he provided to PRNewsroundup, Dávila Colón indicated that over $650 million in funds that had been allocated for the general obligation (GO) payments–not only the January 1st payment, but future payments as well–would be used to fund research and development at the University of Puerto Rico (UPR).

The documents, which appear to be minutes of a meeting of the UPR Board of Directors, lay out “basic rules” that are very much at odds with bond holder’s expectationstranslations of upr docs from Luis Davila Colon 201511.001 translations of upr docs from Luis Davila Colon 201511.002

Background

Geographically, politically, and socially isolated from the US mainland–PR has its own unique culture, speaks Spanish, and is run by two political parties that have no US equivalents. The island has accrued debt of $72 billion over the last three decades. PR’s economy, always anemic, has stagnated dramatically over the last 10 years. Costs for goods and services have risen rapidly (they consistently exceed the mainland’s costs), and, last year alone, 80,000 citizens left the island in search of better opportunities.

This perfect storm has challenged the provision of many core governmental services like healthcare and education. Other factors that exacerbate the problem include: a poverty rate that approaches 50% and ~ 40% labor participation rate.

Dávila Colón says it’s not just a matter of whether PR can pay the amount due in December, it’s that there is an intention not to do so:

“It is clear from what they’ve stated, from the governor on down … that they’re not going to pay. That’s their intention. They have expressed it, verbalized it, stated it.”

PR’s governor, Alejandro García Padilla, said in an interview with the New York Times in June 2015 that he regards the debt as it is currently structure as not able to be repaid.

PR’s debt is the most complex municipal debt under United States jurisdiction: a mix of many different financial instruments with different degrees of protection for bondholders, different source of revenue from repayment and subject to interpretation under different legal frameworks.

Months of inconclusive debt negotiations

Failure on the part of PR to pay the $397 million due on December 1st would almost certainly end what has been months of speculation.

National Public Finance (NYSE MBI) insures $247 million of the December 1st payment and would likely seek immediate redress in PR and/or Federal courts in the event of default.

In the intervening five months since García Padilla’s declaration that the debt was not payable, his economic team, led by the Government Development Bank’s director Melba Acosta Febo, has put out feelers to try to determine how bondholders–and the municipal bond market as a whole–might react to various scenarios. Although PR has not engaged in substantive debt negotiations outside of the efforts for  Prepa, PR’s public electric utility.

Many analysts believe the failure to make the relatively small $58 million bond payment in August 2015 was part of a strategy to drive down bond prices across all classes of debt. Crucially, the August default is a bond that belongs to a class of appropriated debt which is considered the weakest in protection. There has been no litigation related to the August default.

Over the last year bondholder groups from all classes of debt have formed, dissolved, and reformed alliances to advocate privately and publicly for the full payment of the different debts they hold. Mutual funds Franklin and Oppenheimer and hedge fund BlueMountain successfully challenged the locally legislated framework for the restructuring of debts of PR public corporations in federal courts. That decision was appealed by the Puerto Rico government and the U.S. Supreme Court is considering whether they will accept the government’s appeal this week.

Puerto Rico’s Resident Commissioner to the U.S. Congress has filed legislation with the support of Democratic leadership to extend the federal bankruptcy code to include PR. Generally Republicans have been lukewarm to extending Chapter 9, the portion of the bankruptcy code for municipal entities, to PR. Some have fought the PR government’s assertion that it be allowed access to federal chapter 9 bankruptcy protection. PR was removed from the federal law that permits chapter 9 in the mid 1980s for unknown reasons.

Cate Long, co-host of the PRNewsRoundup.com podcast and a longtime municipal market analyst, said during the call with Dávila Colón that she is not convinced that a default is imminent.

“He [the governor] has some control in terms of whether these debts get paid, but there are a lot of other forces at play here.”

When asked what the reaction of the markets might be to a non-payment, Long was sanguine.

“I think bond prices would go down a bit. But all the bad news is basically priced into the market.”

Long shared many of Dávila Colón’s criticisms of island officials:

“PR has never shown a willingness to be on fair and good terms with bondholders. The number one thing is the financials, the 2014 financials. That to me is the perfect indicator that the government has very little control of what’s happening, and is also possibly hiding some very serious things.”

PR has not released audited financials for 1.5 years even though annual reports are legally required. While PR has experienced delays in the last ten years, a year and a half is far longer than previous years.

Dávila Colón’s comments were harsher still.

The “cooking up the books is very close to fraud. It’s very very close to a violation of all everything that has to do with financial values. … This is a major, major major scandal.”

University of Puerto Rico documents

If the documents provided by Luis Dávila Colón are accurate–the context from the short excerpts is not clear–presumably the funds $660 million would be in addition to the roughly $850 million in annual funding the university receives from the island’s general fund.

Luis Dávila Colón criticized not only the allocation but also the performance and efficiency of the university:

“At UPR we have the lowest tuition in the nation, yet we have one of the most expensive university systems in the world. Our universities are so bad that they [almost] do not appear in the top 1000 list of the world. Only Mayagüez [campus], which has engineering, appears at like 966 or 967.”

Federal action

In light of the US Senate hearing scheduled for the 1st of December–the same day the large bond payment is due– Dávila Colón observed that it was not a coincidence: “It will not be [PR] government officials [that are testifying]. It will be the other side of the story. … It will be people who represent [bond]holders. But the important thing is that if PR defaults on GOs, which are constitutionally guaranteed, we are talking about a violation of constitutional rights, of taking of property without due process of law.”

Dávila Colón was similarly skeptical of the ability of the government–any island government, not just the government in power–to right the ship.

“How does the song Hotel California go? You can check in but never check out. … Listen to the lyrics. Puerto Rico is like the Hotel CA… As long as it’s local politicians and the press is left wing, you will never get the political will to do change. Not matter who the governor is.”

 

Postscript:

The UPR documents in the original Spanish.

IMG_1557 IMG_1556

About Gil Hall

Currently writing book on PR crises. Working title: “Los Pertrechos: the Story of an Economy”. Polyglot prone to prolixity in English, German &, Spanish. Based between San Juan and North Carolina. MBA/MHA.