BALTIMORE — It is virtually impossible to predict what would happen if Puerto Rico's financial situation deteriorated to the point where it could no longer repay its debts, experts on distressed municipalities said Thursday.
Several market participants discussed both the financially strained Commonwealth and Detroit's bankruptcy proceedings at The Bond Buyer's Municipal Distress, Recovery, & Financial Sustainability Symposium here.
Panelists noted some similarities between the two localities, including tax bases that have shrunk in recent years and the fluidity of developments that can and have been changing on an almost daily basis as Detroit works toward settling with its bondholders and Puerto Rico tries to take steps to avoid insolvency. But while Detroit's bankruptcy filing has caused some analysts and investors to look more closely at the strength of general obligation pledges, a major credit rating agency analyst told conference attendees Puerto Rico might be an even wilder ride.
"If they decide not to pay their debts, it's really all bets are off," said Emily Raimes, a vice president and senior credit officer at Moody's Investors Service.
Triet Nguyen, a managing director at Axios Advisors LLC, pointed out that there "hasn't been a lot of legal precedent," for how that scenario would play out. There is no provision in federal bankruptcy laws that would allow Puerto Rico to enter a structured bankruptcy process as Detroit has, so there would be questions beyond how much bondholders might recover.
Raimes said it is unclear which court any resulting litigation might even end up in, as judges might be inclined to try to consolidate such cases into a single court.
Nguyen, who in the past has warned against "fear mongering" about Puerto Rico's condition, suggested that the closest applicable example would be Argentina's 2002 default on more than $80 billion of sovereign debt. Argentina restructured its debt at a steep loss to investors, and refused to pay any who resisted the settlement. That led to a nasty international legal battle that is still ongoing. While Puerto Rico is a territory and not a sovereign nation, this is the most analogous recent situation, Nguyen said.
Puerto Rico won praise from analysts — including Raimes and Nguyen — earlier this week for adopting its first balanced budget in two decades. While both commented Thursday on the positives of that development, Raimes said the Puerto Rican government is walking a tight rope as it tries to proceed down a fiscally sustainable path. The island's economy remains weak, she told conference-goers, and the austerity measures it needs are unlikely to help in that regard.
"They have a real balancing act they need to work out there," she said.
Detroit may be fundamentally different from Puerto Rico in many ways, but panelists agreed that the Motor City also has the potential to provide more surprises for investors as its bankruptcy proceeding moves forward. In recent weeks, Detroit has nailed deals with its unlimited-tax general obligation bondholders through the bonds' insurers, and with police, fire and general employees' pension funds. Unlimited-tax GO bondholders would see a 74% recovery though the insurers will make full on-time payments to bondholders.
But settlements have not yet been reached with some stakeholders, including those holding the city's limited-tax GO bonds and its roughly $5.9 billion of junk-rated water and sewer bonds. Detroit emergency manager Kevyn Orr has proposed paying holders of the water and sewer bonds 100% of principal, but eliminating call protection and refinancing the debt in a way that would, among other changes, make debt-service subordinate to an annual lease payment to the city.
If that proposal comes to fruition without bondholder consent, it would mean special revenue bonds aren't as secure as once believed, Fitch Ratings managing director Amy Laskey said.
"It certainly gives us a lot of pause," she said.
John Hallacy, a managing director at insurer Assured Guaranty Municipal, said that even though his company is on the hook for many millions of Detroit's debt, the recent settlements are a win from its perspective. Going forward, there is still a lot to be worked out, he said, adding, "A lot of this is being tested for the first time."
Kate Hackett, a managing director at Kroll Bond Rating Agency, said at an earlier panel that the market is beginning to perceive a "growing divide" between high-quality muni credits and those that carry a lot of risk. While the investors of years past were strongly inclined to believe localities would not default, the attitude has changed in the wake of Detroit and speculation about Puerto Rico, she said.
"We're over that," Hackett said.
The symposium concludes Friday.
