Key Implications of Puerto Rico Restructuring

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Summary:

There has been no systemic spillover effect of the crisis in Puerto Rico to the broader municipal bond market (see chart below).

The most important factor in determining the credit quality of an issuer is the underlying credit fundamentals (economy and operating entity), with covenants offering potentially less protection under stressful conditions.

The Puerto Rico situation bears watching closely for an additional takeaway: How will bondholder and pensioner rights be enforced, given the unique and extreme nature of the Commonwealth’s financial and economic impairment? (i.e., general obligation (GO) bondholders vs. pensioners; GO bonds vs. revenue bonds). Will the sanctity of the special revenue pledge be preserved, as has been the enduring precedent?

Standish Outlook:

Regarding the Title III process, there is no concrete precedent to determine how the judge will treat the various stakeholder groups.

There is a strong possibility that Puerto Rico residents, including pensioners, will receive favorable treatment at the expense of general obligation bondholders.

It is not clear that historical bankruptcy precedence will be applied to the Puerto Rico revenue bond issues. Recently, in Detroit MI, Stockton CA, and Vallejo CA, the special revenue security provisions protected the revenue bondholders from impairment.

The restructuring process is likely to endure for years, and may only be the first step towards permanent financial stability. Absent meaningful fiscal and economic reforms, Puerto Rico is likely to continue its negative trajectory.

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