Bates Research - 12-05-14

FBI Raids Puerto Rico Agency

In a surprise raid on the offices of the Puerto Rico Highway Transportation Authority this Wednesday, the FBI arrested Treasurer Silvino Cepeda-Ortiz. Cepeda-Ortiz was arrested on bribery charges, having allegedly solicited a $10,000 bribe in order to authorize payment on a $1.98 million invoice at the HTA. Federal prosecutors in San Juan will be handling the case, and the raid itself was an extension of additional investigations into Puerto Rico agencies that had led to a previous raid on the Puerto Rico Aqueduct and Sewer Authority on November 25th. The HTA has suspended the arrested treasurer indefinitely.

This is yet another messy situation for Puerto Rico debt holders. The HTA is responsible for about $6.8 billion in debt and is eligible to enter bankruptcy, per Puerto Rico's previous announcements. Concerns about corruption within the organization will certainly not help to convince investors that their debt holdings are secure. PREPA, another troubled Puerto Rico agency, is expected to begin default on $9 billion in debt sometime around March 2015. Puerto Rico debt holders met difficult conditions in 2014, but early 2015 is shaping up to be even more volatile.

Further complicating matters, the HTA was already at the center of a controversial new tax hike. A tax increase on oil was previously proposed by Governor Padilla, raising the current tax per barrel of $9.25 to $15.50. The measure met sharp resistance and was expected to be pushed into 2015 after a debate in late November, wherein the Governor threatened to shut down public transportation services. $2.2 billion of the sought revenue is needed to repay money that the HTA owes to the Government Development Bank (GDB). The bill finally passed the Puerto Rico House of Representatives the day before the FBI's raid. It's unclear if public sentiment, which was already against the new tax increase, will lead to even more outrage given the current allegations surrounding HTA.

With only $1.7 billion in liquidity left, the GDB could certainly use the money it is owed: that $2.2 billion represents about a fifth of the outstanding debts owed to the bank. Investors responded very negatively in the aftermath of the raid, sending HTA bond prices down in excess of 7%. Markets have previously supported Puerto Rico bonds due in large part to the perception that the government (and Governor) strongly supported protecting creditors’ rights. That confidence was undermined by Padilla's latest public remarks in which he stated: "We are now confronting the consequences of the irresponsibility of these loans that were taken, situations so serious that it threatens to shut the operations of the HTA and important public works projects." His use of the phrase "irresponsible" has been taken by some market participants as an indication that the political will to pursue repayment is beginning to diminish on the island.

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