The past week saw the formal start of the largest insolvency in the history of the US “muni” market, when the Commonwealth of Puerto Rico (PR) finally ran out of time to reach a settlement with its creditors and filed for the equivalent of bankruptcy. If one takes into account both funded debt and unfunded pensions and similar obligations, the “headline number” could be up to USD 120BN.
We would find it hard to believe that anyone should be surprised at this outcome, as the Commonwealth’s economy has been in recession for years, while it has lost many of its most productive citizens to emigration to the mainland US. Arguments about who is responsible for the “mess” will no doubt continue to rage, but what matters now is to find a mechanism that enables, rather than hinders, an orderly restructuring of PR’s obligations, which are notoriously complex in structure. In this regard, PR has been singularly unfortunate, being “neither fish nor fowl”. As an unincorporated territory of the US, it neither had access to the established Chapter 9 municipal bankruptcy procedures, nor the sovereign ability as a State to default unilaterally. As a result, it has been the victim of an unwieldy political compromise under the so-called PROMESA legislation passed by the US Congress, whose consequences became visible this week, when the PR government, having run out of time under Title VI of PROMESA to negotiate a consensual restructuring, had to resort to Title III and seek restructuring through the Federal Courts- but not the Federal Bankruptcy Courts. As such, there are no precedents for what the outcome may be. The lawyers will get richer, and the final determination will almost certainly be fought all the way to the US Supreme Court.
While there will be furious litigation over the ranking and priority of PR’s General Obligations versus those of government-related bodies such as COFINA and PREPA, the Fiscal Plan approved in March by the Board now overseeing the process, assumes that cash available to service PR’s debt obligations (i.e., ignoring the insolvent pension scheme) will cover less than 30% of the contractual amounts due over the years to 2027. Of course, this is just a forecast, and almost certainly has little basis in reality, given all the other factors that will come into play.
Not surprisingly, the monolines and quasi-monolines who fell over themselves in the past to “wrap” PR’s obligations and, as a result, have billions of dollars of potential exposure (close to USD 30BN in nominal terms for Assured Guaranty, AMBAC and MBIA, according to a CreditSights estimate) are starting to express concern about the fact that there seems to be a “lack of adult supervision” in how matters have been conducted. This is hardly surprising in the context of the scale of their potential exposure, the complete uncertainty over what will happen next, and the Oversight Board’s “ranging shot” on the level of potential haircuts to creditors holding the bonds they have insured.
From Awbury’s point of view, writing multiple policies with large exposures at slender margins on supposed “tail risks” with a single trigger is hardly a rational approach to long-term value creation and sustainability. The recent history of finance is littered with the corpses and casualties of that approach. Rather, we seek those opportunities (and we are able to be patient in the manner of Warren Buffett) where the need is based upon a set of circumstances in which cost is not the consideration, but rather the provision of a carefully-crafted, bespoke solution with proper alignment of interests.
Naturally, we shall continue to follow the PR saga as it unfolds, as there may well be interesting opportunities that result from it.
The Awbury Team