On July 1, 2016, the day following a debt moratorium declared by the Governor of Puerto Rico, the commonwealth defaulted on the payment of approximately $900 million of the $2 billion of scheduled principal and interest due. This is not the commonwealth’s first default. Over the past year, Puerto Rico has defaulted on smaller amounts of non-general obligation principal and interest.
This time, however, the defaulted debt included $790 million of general obligation principal and interest. This is the first state-level default on general obligation debt since 1933. Unlike states, federal bankruptcy law does not allow the Commonwealth of Puerto Rico nor any of its governmental entities, including its public utilities, to seek relief through Chapter 9 of the bankruptcy code.
While unable to avoid the default, President Obama recently signed into law a bill that will provide a path towards economic and fiscal stability, including the ability to restructure their $72 billion in outstanding debt. Key parts of the legislation include:
- The creation of a seven member Oversight Board appointed by Congress and the President that will work with the commonwealth’s elected officials to develop budgets focused on continuing to fund public services while addressing the pension and debt obligations. The Oversight Board will have final approval of all fiscal plans and budgets. They will also have the ability to require the commonwealth to reduce expenditures or take other actions to address any budget shortfalls.
- Providing the Oversight Board with the authority to negotiate with creditors to address the debt challenges and requires the Oversight Board to provide the final approval of all debt restructuring agreements. The legislation also provides the Oversight Board with the ability to seek injunctive relief, including a stay of litigation through the federal court system.
- Temporarily reducing the minimum wage for some younger workers. This reduction will sunset with the disbanding of the control board.
The use of an oversight or control board is not unprecedented. For example, in 1995, Congress created the District of Columbia Responsibility and Management Assistance Authority to oversee the finances of Washington with budgetary and fiscal planning responsibilities similar to Puerto Rico’s Oversight Board. The entity was disbanded in 2001 after Washington, D.C. achieved its fourth consecutive balanced budget. Additionally, many states have similar laws to provide oversight or control of financially struggling municipalities or government entities within their respective states.
The BMO Tax-Exempt Funds have minimal exposure to the debt of the Commonwealth of Puerto Rico or its governmental entities or public utilities. What limited exposure the Funds have is pre-refunded, with the bond principal and interest paid from an escrow of U.S. Government securities, or supported by bond insurance issued by investment grade rated municipal bond insurers. It is expected that these bond insurers will honor their commitment to make timely principal and interest payments to the extent that there is a shortfall in the Commonwealth’s principal and interest payments.
1 Berkshire Hathaway Assurance Company, Assured Guaranty, and National Public Finance Guarantee Corporation