Puerto Rico Restructuring Hire

Puerto Rico made headlines again this week when it confirmed the hiring of noted debt restructuring firm Cleary Gottlieb Steen & Hamilton.  While the government denies that the hire is connected to possible restructuring plans, the news has still ruffled feathers in municipal markets.  Prior to the island's $3.5 billion debt sale in March of this year, the government had also contracted Millco Advisors, whose founder James Millstein previously helped devise the U.S. government's plan for AIG.  Cleary Gottlieb partners have previously handled high profile sovereign restructurings for Argentina and Greece.

Despite assurances from officials that restructuring is not being considered, bonds issued in March have begun to drop in price.  One interesting aspect of these bonds, noted previously in this post, is that "...the laws of the State of New York shall apply to any action or proceeding arising out of the Bonds...".  This feature has made them more attractive to certain types of investors.  One of the concerns going into March's debt issuance was that Puerto Rico would default on this debt, even though it was issued as General Obligation, because the sheer amount of debt ($70 billion) that the island had issued would leave it no choice but to default on payments to all securities.  Since the Federal Bankruptcy Code does not allow states or U.S. territories like Puerto Rico to use bankruptcy to reorganize their debts, the notion of seniority carries less weight, meaning that investors could not have been enticed by promises of 'super-seniority'.  Having debt that is subject to New York law makes this somewhat possible.  Greece defaulted on its domestic debt, while maintaining payments on its debt under London law, setting a precedent for this type of selective default behavior.  As long as the debt is a fairly small portion of the overall debt (in this case about 5% of Puerto Rico total debt), it is easier to continue payment rather than get tied up in a foreign court.  That bit of additional incentive against defaulting may explain why prices have begun to drop, but have not yet experienced dramatic declines.    

The situation in Puerto Rico is a fluid one, and while the debt issuance in March was a success in terms of both demand and ultimate yields, markets remain sensitive to any signs of trouble.