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Puerto Rico risks creditor ire by hijacking income earmarked for bond payments

SAN JUAN/NEW YORK Puerto Rico might have dodged a bullet when it avoided default last week, but its selection to commandeer revenue that was supposed to meet future debt payments will invite creditor pushback and possibly lawsuits.

Creditors have extended criticized Puerto Rico’s spending habits, and could have the ammunition to bring those complaints to court now that the Caribbean island plans to divert funds to cover constitutionally-guaranteed debt and crucial government solutions.

The U.S. territory, which owes creditors $ 72 billion, final Tuesday avoided defaulting on a $ 355 million payment. But it owes yet another such payment on Jan. 1, which can only be produced if revenue that was earmarked to repay and service other debt owed by a variety of government agencies is repurposed, Governor Alejandro Garcia Padilla mentioned.

The island mentioned it also wants to use that income to hold some essential services operating, even though it has not specified which ones. Several creditors mentioned these so-called clawbacks are premature, and question no matter whether they will be utilized on truly important services.

The government hasn’t been particular about the revenue that will be grabbed. Bonds vulnerable to the switch contain $ four.six billion at Puerto Rico’s highway authority (HTA), $ 1.9 billion at its infrastructure authority (PRIFA), and added debt at a public transportation authority and convention center authority, according to an executive order signed by Garcia Padilla.

A single creditor supply with exposure at the affected agencies stated a lawsuit was achievable, insisting that clawbacks had been getting misused below Puerto Rico’s laws and constitution. “They haven’t met the needs to permit a clawback under the constitution … you can assume we’re searching at all the diverse avenues,” said the supply.

Two other sources mentioned that, while lawsuits are an alternative, they were far more inclined to wait to preserve their negotiating capacity.

“There is a really high probability of protracted litigation,” stated Ted Hampton, vice president at Moody’s Investors Service. “It is a bit like a race or some kind of competitors – people are waiting to jump in when the whistle blows.”

Hampton said he expected creditors would at least think about legal action over the clawbacks.

Puerto Rican officials have themselves acknowledged the prospective for lawsuits. Justice Secretary Cesar Miranda said last week that the clawbacks could open the door to litigation since they “could be interpreted as a technical default, in the way that we retain funds destined to eventually spend a debt when due.”

Creditors’ aggravation is likely to only enhance in the next few weeks. For instance, the island by December 20 owes $ 120 million in Christmas bonuses for public sector workers, which are a constitutional requirement in Puerto Rico. Paying them at the expense of bonds would likely irk creditors, however skipping them would outrage labor unions.

BRIDGE LOAN

Exactly how the diverted money is spent will invite investor scrutiny.

A 1980 law in Puerto Rico dictates that any clawbacks ought to be used initial to spend constitutionally backed debt, and then to fund crucial solutions. Puerto Rican officials recommended they program to use them for both purposes at as soon as.

“There is small query that (the clawbacks) are a patent attempt to revise the provisions of the constitution, legislation and contracts with out justification or required method,” stated Nader Tavakoli, interim president and chief executive officer of Ambac Economic (AMBC.O) , which insures about $ 1.1 billion principal of bonds at the affected agencies.

A lawsuit could also challenge the variety of solutions getting funded, particularly if they contain what creditors may claim are discretionary items like Christmas bonuses.

Nonetheless, creditors wary of litigation say they want to be careful not to hurt progress in ongoing talks with the island on a consensual debt restructuring agreement. “We implore the governor to get back to the negotiating table toward consensual options, which are achievable,” Tavakoli added.

Puerto Rico has mentioned it desires to structure a universal exchange offer you, or “superbond,” for creditors across a lot of various debt classes. Litigation would make that approach a lot more tough, mentioned many creditor sources, threatening the anticipated higher ratings of new debt that could attract creditors to an exchange provide in the initial spot.

If creditors can support the island to make its January payment without clawbacks, litigation might be avoided. Its subsequent significant maturity date is in May possibly, when $ 422.8 million is owed on senior Government Improvement Bank notes, according to a source familiar with the scenario. That enables much more time to talk, free of charge from the stress of looming defaults.

An offer you by at least two bond insurers to give a bridge loan to get Puerto Rico via January remains on the table, stated two sources close to the talks.

A lawsuit at this stage may possibly not succeed. With no a missed payment, clawbacks alone may possibly not convince a court of Puerto Rico’s wrongdoing, stated Height Securities Puerto Rico analyst Daniel Hanson. Creditors may possibly fare much better if they delay litigation till an actual default.

(Reporting by Nick Brown in San Juan and Megan Davies in New York Extra reporting by a contributor in San Juan Editing by Martin Howell)