On December 1, Puerto Rico governor Alejandro Garcia Padilla was staring down a $354 million debt payment he couldn’t make.
If the commonwealth defaulted on the GO portion, a cascade of messy litigation would follow and the island’s reputation with creditors would suffer irreparable harm.
That afternoon, on the heels of a visit to Capitol Hill where the governor attempted to explain to Congress why Puerto Rico should be allowed to take advantage of bankruptcy laws, the island made the payment, avoiding default.
Padilla “found” the money by using what we called an “absurd” revenue clawback mechanism.
Essentially, Puerto Rico diverted money earmarked for non-GO creditors and used it to pay the island’s GO bonds. As you can imagine, the bond insurers for the debt involved in the clawback were not happy. Ambac, for instance, called the clawback “illegal” and claimed that Padilla actually began siphoning funds well before the December 1 payment, a charge the governor denied.
On January 1, Puerto Rico defaulted on some $36 million in Prifa bonds.
Now, Ambac, along with Assured Guaranty, are suing. “Insurance companies that guarantee Puerto Rico municipal debt filed a lawsuit challenging the commonwealth’s decision to divert revenue designated for some bonds to pay other creditors,” Bloomberg reports, adding that the monolines “said the clawback of revenue pledged to bond issues violates the U.S. Constitution by interfering with debt-holders’ contractual rights.” Here’s more:
The suit filed in U.S. District Court in Puerto Rico seeks to have the clawback declared unlawful and asks the court to issue an injunction against implementation, according to a statement.
“The commonwealth has committed itself to a ‘scorched earth’ strategy of blaming its fiscal and structural problems on lenders, Congress and others, in an effort to deflect responsibility and obtain retroactive application of bankruptcy laws,” Nader Tavakoli, chief executive officer of Ambac, said in the statement late Thursday.
The insurers are the first to sue over the diversion. They claim a clawback can only be implemented if the commonwealth’s funds are insufficient to cover general-obligation debt service. Puerto Rico estimates approximately $9 billion of available resources in the fiscal year ending June 30, 2016, which vastly exceeds debt service on the public debt of approximately $1.85 billion, according to Ambac.
So, while bondholders may have little in the way of recourse, the monolines are taking this lying down and that means a protracted battle among stakeholders for limited cash is about to ensue. "The lawsuit is an opening salvo in what could be a long and expensive court fight over Puerto Rico's efforts to restructure its debt," Reuters wrote on Friday. "They also said Puerto Rico is wrongfully using clawbacks to fund government services, and is diverting bondholders' collateral in violation of the Takings and Due Process clauses of the U.S. constitution."
In other words, the insurers don't think Padilla should have the option of choosing to provide public services over paying creditors. We predicted as much back in Novermber when we said the following:
Ultimately, the decision will be between paying bondholders and ensuring that the government can continue to provide public services, and just as Greece prioritized pensions over IMF payments last summer, Padilla isn’t likely to sacrifice the public interest at the altar of the island’s creditors.
The lawsuit comes just weeks after MBIA and Assured Guaranty struck a deal with the commonwealth to restructure $8.2 billion in PREPA debt.
That agreement marked the largest ever muni restructuring and raised questions as to Padilla's contention that bankruptcy is the only way for the island to efficiently get out of trouble. Padilla contends that restructuring the rest of Puerto Rico's debt will be far more difficult. "The vast number of creditors with differing interests across all issuing entities would result in negotiations that are lengthy, costly and chaotic. Access to legal, broad restructuring authority would allow us to undertake these in an orderly manner," he said last month.
PREPA isn't subject to the clawback, but the Prifa default has Assured Guaranty on edge. “These actions stand in contrast to the consensual agreement that we and other creditors recently reached with Puerto Rico’s electric utility, Prepa," Dominic Frederico, Assured Guaranty’s president and chief executive officer, said in a statement Thursday.
As you can see, this is about to get very messy, very quickly and the angrier the monolines get, the more difficult it will be for the island to restructure its obligations (recall that it was the insurers who held up the PREPA deal).
But don't worry, the holiday bonuses aren't in jeopardy - yet.
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Full Ambac statement
Ambac Financial Group, Inc. (Nasdaq:AMBC) ("Ambac"), a holding company whose subsidiaries, including Ambac Assurance Corporation ("Ambac Assurance"), provide financial guarantees and other financial services, today announced that Ambac Assurance has filed a lawsuit to protect its rights against the illegal clawback of certain revenue by the Commonwealth of Puerto Rico. The Complaint for Declaratory and Injunctive Relief was filed in U.S. District Court, District of Puerto Rico, with co-plaintiffs Assured Guaranty Corp. and Assured Guaranty Municipal Corp.
In December 2015, the Commonwealth of Puerto Rico announced that it would clawback revenues pledged to other bonds to fund obligations to its general obligation ("GO") bonds. Although the Commonwealth of Puerto Rico, under its constitution, has the right to clawback certain revenues to service its GO bond payments, that right is subject to important preconditions. One key precondition is that the revenues can only be clawed back if no other revenues or moneys are available to pay the GO bond payments. For fiscal year 2016, the Commonwealth forecasts approximately $9.0 billion of available resources, which vastly exceeds debt service on the public debt of approximately $1.85 billion.
The targeted clawback revenues include those of Puerto Rico Highways and Transportation Authority ("HTA"), the Puerto Rico Convention Center District Authority ("PRCCDA") and the Puerto Rico Infrastructure Financing Authority ("PRIFA"). The implementation of the clawback contributed to the government's default on January 1, 2016 on $36 million of interest on PRIFA bonds, and will eventually cause a default on HTA and PRCCDA bonds. Ambac Assurance satisfied its obligation to make timely payment on approximately $10 million of claims related to PRIFA bonds it insures.
Commenting on today's announcement, Nader Tavakoli, President and Chief Executive Officer of Ambac said, "Over the last several months, we have attempted to engage the Commonwealth in consensual conversations toward finding amicable solutions for their asserted liquidity issues, only to be rebuffed. Instead the Commonwealth has committed itself to a ‘scorched earth' strategy of blaming its fiscal and structural problems on lenders, Congressand others, in an effort to deflect responsibility and obtain retroactive application of bankruptcy laws. Serious issues have been raised by the Governor himself as to whether the Commonwealth historically misrepresented its financial condition to fool the very lenders it now seeks to punish."
Mr. Tavakoli continued, "Most recently, the Commonwealth unlawfully diverted tax revenues collected by the U.S. government, which are collected for the specific purpose of supporting PRIFA bonds, in order to finance the government's general accounts. We remain hopeful that the Commonwealth will abandon these illegal tactics, and turn instead toward good faith negotiations aimed at solutions instead of confrontation. While we are optimistic that the government of Puerto Rico will begin to act responsibly, at this time we have no choice but to protect our stakeholders through judicial recourse."
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