The U.S. Treasury is no longer skimming money from federal grant payments backing Puerto Rico’s grant anticipation revenue vehicle bonds, Puerto Rico disclosed to investors Wednesday, the same day Moody’s Investors Service placed the Garvees on notice for a possible downgrade.

The disclosure was made in an event notice filed with the Municipal Securities Rulemaking Board’s EMMA system.

Treasury had withheld about $158 million in federal funds that Puerto Rico was counting on to pay debt service on its remaining Garvee debt. The commonwealth issued almost $140 million of the bonds in 2004.

The debt was backed by federal gas tax money. Puerto Rico knew the U.S. Army Corps of Engineers had referred it to the Treasury offset program in order to settle a $214 million debt owed to the USACE for work on dam and reservoir projects. Puerto Rico officials said the specific funds that would be offset were not identified, forcing them to withdraw $231,236 in reserve funds to pay investors, which ultimately led Moody’s to issue its notice.

When the debt service on the Garvees was due and the expected money was not there, Puerto Rico officials initially believed the federal grant payment had incorrectly been made to the wrong account and that the Federal Highway Administration would correct the error and soon transfer the money back.

Upon discussing the situation with the FHWA, however, they learned that the payment was not made because it, along with other federal funds due to the commonwealth and its instrumentalities, were being offset to make up for the debt owed to the USACE. The situation resulted in a debt service payment on the Garvees that was two days late.

The Government Development Bank for Puerto Rico issued a statement on the latest developments, also posted to EMMA, explaining that Puerto Rico officials are negotiating repayment terms and that further funds will not be withheld under the Treasury Offset Program in the meantime.

“The secretary of the Treasury of the Commonwealth is in the process of negotiating a final debt agreement with the USACE and the United States Department of Justice to achieve more manageable repayment terms and to avoid further offsets of federal payments due to the commonwealth and/or its instrumentalities,” the bank said. “As part of such negotiations, the commonwealth has requested that certain amounts constituting penalty interest be forgiven.”

Jeffrey Schramek, assistant commissioner of debt management services at the Treasury’s bureau of the fiscal service, said an entity referred to the offset program can avoid further offsets as long as the agency the debt is owed to agrees to new repayment terms or the debt is paid in full. “Generally, they want something that is very iron-clad,” Schramek said. He added that a situation like Puerto Rico’s is quiet rare.

Municipal Market Advisors earlier this week urged Garvee holders to evaluate their own potential offset risk.

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