Puerto Rico is desperately trying to reorganize its $72 billion debt, but it faces a unique hurdle…
You see, it's an unincorporated territory, not a state. It can't actually declare Chapter 9 bankruptcy.
Without those legal protections, the Caribbean island is clearly sunk.
What isn't so clear now is the risk to mainland investors. There will be losses either way, but it's too early to say how big they'll be and how hard they'll hit.
Whatever happens there, we'll do well. The strategy I'm going to show you today offers protection and the potential for big profits as Puerto Rico's economy circles the drain…
There's Bad News… and There's Really Bad News
Puerto Rico's public debt load is $72 billion and rising.
Most of the municipal debt was issued by the Government Development Bank's subsidiary, the Public Finance Corporation (PFC). Utility, infrastructure, civic projects, and tax financing bonds were issued as revenue bonds, general obligation bonds, and moral obligation bonds.
Puerto Rico has been keeping up with most of its debts so far – but on Aug. 4, 2015, it paid only $658,000 out of a required $58 million payment due on some moral obligation bonds.
On the face of it, the Commonwealth breached its moral obligation to make timely payments on its debt.
Not making a full-interest or principal payment constitutes a default under most standard bond indentures. But the Commonwealth said it hadn't technically defaulted because moral obligation bonds issued by the PFC are paid by "appropriation of monies legislated by government," and there simply hadn't been enough money appropriated.
The rationale put forward was that in the future, sufficient monies could be appropriated and payments made.
Technicalities aside, Puerto Rico Gov. Alejandro Garcia Padilla said in June the debts are "not payable" and the island is in a "death spiral."
And its chances of getting bankruptcy protection are slim…
This is where Pedro Pierluisi comes in. He's Puerto Rico's Resident Commissioner to the House of Representatives. He can vote in committee but has no say whatsoever in what happens on the floor – that's down to the nature of the territory's constitutional relationship to the United States.
But Puerto Rico's situation is desperate, so Pierluisi is making a heavy back-channel push on other Representatives to get H.R. 870 passed – the bill that would allow Puerto Rico to declare bankruptcy. Senators Chuck Schumer (D-NY) and Richard Blumenthal (D-CT) introduced a companion bill in the Senate.
Proponents of the bill say it would allow the island to adopt U.S. bankruptcy laws and offer the island's municipal bond issuers an orderly restructuring process.
But big mutual fund companies, like Massachusetts' Mutual Financial Group, which owns Oppenheimer Funds and holds about $4.5 billion of Puerto Rico's paper in almost 20 different funds, are lobbying hard against Puerto Rico's effort to gain access to bankruptcy protections. So are other investment and hedge funds.
These opponents say the haircuts imposed in a Chapter 9 reorganization leave creditors exposed to substantial losses – just like those suffered by creditors in the bankruptcies of Detroit and Stockton, Calif.
What those opponents want is to let existing covenants in existing bond documents govern any post-default process. Currently, that process calls for the creation of a receivership at the request of bondholders. The court appoints a receiver who would have the power to fix utility rates so creditors could get paid back while services continue.
Under Chapter 9, courts don't have the same power to affect rates and can force creditors to take substantial losses in a plan to pay back some of the outstanding debt.
Here's How Regular Investors Get Hurt
About the Author
Shah Gilani is the Event Trading Specialist for Money Map Press. In Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.