Event

After years of ever-deepening fiscal trouble, a default on Puerto Rican public debt obligations now looks imminent. Even Alejandro García Padilla, the governor of the US commonwealth who has persistently attempted at austerity-driven fiscal consolidation ever since taking office in January 2013, has recently announced that the island’s public debt load is ‘not payable’ under current economic conditions. The picture is grim indeed, with Puerto Rico having suffered terrible economic times (GDP has virtually declined every year since 2005 and the unemployment rate stands at more than twice the US national average) and being vastly more indebted than any US state (its liabilities amount to about 70% of GDP). Cash flows pressures have been building up since July 2013, when the city of Detroit filed for bankruptcy and financing conditions in the US subsovereign debt market abruptly deteriorated as a result. Increased investor scrutiny raised doubts over Puerto Rican solvency and borrowing costs soared. This dynamic was further reinforced when all three major credit rating agencies downgraded Puerto Rican public debt from investment grade to junk in early 2014. As things stand, the public sector of Puerto Rico is effectively shut out from capital markets and will be unable to stay current on its debt servicing obligations. Indeed, on 1 August, the island seems to have missed a USD 58 million due payment on bonds issued by its Public Finance Corporation.

Impact on country risk

Considering its debt stock of around USD 72 billion, a default by Puerto Rico would constitute the largest one in the history of the US subsovereign market. And crucially, the ensuing legal mess would be severely aggravated by the island’s political status. Not a state, it is excluded from the ‘Chapter 9’ bankruptcy protection that Detroit enjoyed. Not a sovereign nation, bailout negotiations with the IMF are not an option. The lender of last resort in the case of Puerto Rico is the US federal government. But given the partisan divide in US politics, a significant intervention seems highly unlikely. The Puerto Rican government solvency and cash flow problem along with the expectation of a messy default evidently have a negative impact on the non-payment risk by public buyers. Note that in anticipation of the adverse evolution, Credendo Group has been off cover for MLT transactions with public sector debtors in Puerto Rico since April 2014.

Analyst: Sebastian Vanderlinden, s.vanderlinden@credendogroup.com