Puerto Rico Default: More Political Fallout Than Market Impact

Flag of Puerto Rico

Officials in Washington, D.C., and San Juan have expected for some time that Puerto Rico would default Monday on debt owed by its Government Development Bank. When it finally happened, the impact on the markets was muted, which means there may be less urgency to resolve a standoff in Congress over debt restructuring legislation.

The commonwealth made its default on the debt official over the weekend when Gov. Alejandro García Padilla declared a moratorium on the GDB debt payment and addressed the 3.5 million people of Puerto Rico on television.

Importantly, the island did not default on all of the $422 million it owed to GDB creditors. An ad hoc group of creditors negotiated with the San Juan government before the default to allow some of its payment to be delayed. Under the plan, as described by the D.C.-based broker-dealer Height Securities LLC, Puerto Rico will hold off some payment to these creditors, meaning the unpaid amount comes to about $270 million in GDB debt.

Daniel Hanson, an analyst for Height Securities, told Morning Consult that the current default likely won’t have a major effect on the municipal bond market because its effects were already “priced in” ahead of time.

Instead, the most likely near-term effect is that default could compromise the commonwealth’s liquidity. GDB acts as the main thoroughfare for liquidity from Puerto Rico’s government deposits. If the fund demonstrates insolvency, as it did Monday, it is required under the law to be placed into receivership. The island’s Treasury secretary is supposed to make this determination, but Hanson said it’s unclear that he’ll do so.

If that doesn’t happen, creditors could sue. Again Hanson predicted it’s also unlikely they’ll do that, since many of them have either entered into forbearance agreements with the government, like the ad hoc group. Other creditors have little incentive to pay the millions in legal fees such a suit could entail.

Gov. García has framed the moratorium, over the objections of creditors, as a way for San Juan to ensure that it will continue to provide public services to its people.

That message, combined with the success of the independent GDB-creditor talks, may not offer the emergency punch needed to unstick the barriers in Congress to passing a bill to help San Juan work though its debt issues.

Last month, as it became clear that a GDB default was imminent, key lawmakers such as House Natural Resources Committee Chairman Rob Bishop (R-Utah) insisted that “Armageddon will not hit on May 2” if Congress didn’t act to pass its bill, H.R. 4900, before then.

But Bishop also has posited that the GDB default could give Congress more impetus to find a solution because of negative economic effects. The successful creditor talks, combined with the lack of a tangible market effect, is challenging that notion. 

In addition to many Republicans, Democrats and the administration still want Congress to act. They reacted to the default with a tone that reflected their increasing impatience on a bill.

In a letter sent Monday to House Speaker Paul Ryan (R-Wis.), Treasury Secretary Jack Lew noted that the deal to restructure some of the GDB’s payments “effectively would be conditioned on federal legislation providing a restructuring authority.”

Lew also warned that, absent federal debt restructuring legislation, “Puerto Rico will face a series of cascading defaults.”

“In the coming days, it is important to keep in mind that further inaction only gives those seeking to deter Congress from passing a bill more time to continue making inaccurate and misleading claims about the legislation,” Lew wrote. “Absent enactment of a workable framework for restructuring Puerto Rico’s debts, bondholders will experience a lengthy, disorderly, and chaotic unwinding, with non-payment for many a real possibility.”

Earlier in the day, the White House similarly called for quicker congressional action.

“I sure hope it creates a new sense of urgency for members of Congress to address this situation,” White House Press Secretary Josh Earnest told reporters Monday afternoon.

Even Hillary Clinton weighed in with a personally authored tweet calling out congressional “inaction.”

Resident Commissioner Pedro Pierluisi, who is running to replace the departing García as the island’s chief executive, is attempting to distance himself from the current commonwealth administration. He serves as Puerto Rico’s non-voting representative in Congress and said in a statement that the “current administration in San Juan has done a tremendous disservice to the people of Puerto Rico, blaming everyone but itself for the island’s problems.”

“With today’s default by the Government Development Bank, the number of government entities in Puerto Rico that have missed scheduled payments to bondholders has now increased to three,” Pierluisi said. “Further defaults would be devastating to Puerto Rico’s economy.”

Morning Consult