Puerto Rico's Dance With Default Embraces A Fickle Partner: Wall Street

WASHINGTON -- Puerto Rico may stave off default by making a last-minute payment to creditors on July 1, but the island’s economic future rests on the whims of Wall Street.

Gov. Alejandro Garcia Padilla threw investors and market-watchers for a loop Sunday when he deemed Puerto Rico “unable” to pay its debts of more than $70 billion. His comments put a spotlight on the island's troubling relationship with investors who own that debt.

“One of the real issues there, and this is going to be the crux of the problem, are not only the [bond] insurers, but also some of the hedge funds that got involved," said Jon Mousseau, executive vice president at Cumberland Advisors, who spoke in Washington on Tuesday during a panel discussion about economic hardships facing Greece and Puerto Rico.

“Most of the hedge funds signed non-disclosure agreements with Puerto Rico so that they can get access to data, and basically bargaining chips in return for loaning them more money," Mousseau said. "That non-disclosure agreement means they more or less have information that we don’t have, and it means that they cannot trade with anybody else other than themselves.”

If Mousseau’s description sounds strange, it’s because it is. As Puerto Rico has piled up debt to cover budget shortfalls, it has increasingly turned to private investors for financing. That makes the debt crisis in Puerto Rico different from the one in Greece, where government debt is mainly in public hands. Puerto Rican administrations have managed to continue their access to private capital by striking deals that include an array of stipulations, including preventing the disclosure of details to potential financial competitors.

“I’m not sure that’s helping them right now, because they’ve actually wanted to go to Puerto Rico and say we will lend you more money if you do A, B, and C," Mousseau added. "Puerto Rico wants none of that. That includes reducing payroll, cutting benefits, et cetera, and they don’t want to do that.”

Garcia Padilla on Monday night defiantly pushed for “shared sacrifice” between Puerto Rico and bondholders -- a position making creditors nervous.

Longtime investors in Puerto Rico, including mutual funds Franklin Templeton Investments and OppenheimerFunds, fought the island’s 2014 efforts to restructure debt. Oppenheimer -- with its $4.5 billion exposure to Puerto Rico, according to Morningstar -- let it be known it’s not thrilled about Garcia Padilla’s new plan to restructure.

“We strongly believe the Commonwealth has the ability to provide essential services to its citizens, grow the economy and repay what bondholders are due,” Oppenheimer said in a statement on its website. “We are disheartened that Governor Padilla, in a public forum, has called for negotiations with other creditors, representing and including the millions of individual Americans that hold Puerto Rico municipal bonds.”

Oppenheimer said it’s “ready to defend” its agreements with the commonwealth.

Other firms with deep ties to the island, including BlueMountain Capital Management, aren’t taking chances, hiring law firms like Gibson, Dunn & Crutcher, known for aggressive litigation against Argentina on behalf of bondholders.

Investors' competing interests have set the tone for handling Puerto Rico's mounting economic woes for the past year. A collective of financial institutions calling itself the Ad Hoc Group, which manages about $410 billion in assets and owns almost $4.2 billion in Puerto Rico debt, a has actively supported congressional action on legislation that would allow Puerto Rico to file Chapter 9 bankruptcy. The group, which includes Fir Tree Partners, Brigade Capital Management and Monarch Alternative Capital, is heavily invested in general obligation bonds.

Bankruptcy legislation would benefit the group's investments. But those invested in Puerto Rico's state-owned power authority, for example, argue that bankruptcy would put their holdings at risk.

Matt Fabian, of Municipal Market Analytics, said Puerto Rico faces tougher odds than debt-burdened cities on the U.S. mainland. The reason, Fabian said, is hedge funds that have “a lot of conflicting positions.”

Fabian characterized Puerto Rico’s situation as “strange,” because investors are more interested in making the value of their holdings increase than in helping the island. Hedge funds are pushing for reforms to help Puerto Rico's economy, Fabian said, but “it doesn’t necessarily mean that it’s advice that’s in the best long-term interest of Puerto Rico. It is troubling.”

CORRECTION: An earlier version of this story misspelled Matt Fabian's last name.



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