Joe Deane, bond fund PIMCO‘s head of municipal bond portfolio management, Dave Hammer, municipal portfolio manager, and Sean McCarthy, the head of municipal credit research, sat down last week to discuss the evolving Puerto Rican debt crisis.

The first thing the PIMCO execs did in the piece was to toot their own horn a bit. They noted the firm exited Puerto Rico all the way back in 2013 when they saw the handwriting on the wall.

“We have long viewed the challenge facing Puerto Rico (PR) as a debt sustainability issue. This led us to sell the last position in PR debt in our dedicated municipal portfolios in the first quarter of 2013 at a premium dollar price. And today, firm wide, we maintain zero exposure to Puerto Rico credit risk. PIMCO’s rigorous top-down, bottom-up investment process confirmed our suspicions and informed our decision. Our credit research team’s analysis of PR’s capital structure has been extensive and exhaustive. When we weighed the economic, demographic, political and financial makeup of the island against the sheer amount of liabilities outstanding – $73 billion of bonded debt and around $30 billion of unfunded pension liabilities – it led us to conclude that the Commonwealth would face significant challenges making creditors whole on those obligations.”

PIMCO's Take On Puerto Rico's Debt Crisis
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PIMCO On why Puerto Rico debt is setting new lows today

Deane, Hammer and McCarthy highlight that until recently the market consensus was that Puerto Rico’s general obligation debt was senior to other debt and liabilities because of a constitutionally protected claim on the Commonwealth’s assets. This bubble has been burst over the last couple of months with the release of a report by a former deputy managing director at the IMF, and statements from PR Governor Alejandro García Padilla.

The report notes the Commonwealth’s large and growing cash needs. The PIMCO tean suggests this means the “need for a “comprehensive solution” entailing broader debt relief that would affect most parts of the PR capital structure, including GO bonds.”

The fact that PR has hired Steven Rhodes, the ex- U.S. federal bankruptcy judge who presided over Detroit’s bankruptcy case, as a consultant is also telling Rhodes told Reuters in an ionterview that “the parallels between Detroit and Puerto Rico are strong enough that I think any of the public corporations or the Commonwealth itself could take advantage of the same kind of process that we used in Detroit.”

Of note, pensioners did much better than GO bondholders in the Detroit bankruptcy. There, pensioners received 75 cents to 90 cents on the dollar, while GO holders were only repaid 20 cents to 75 cents per dollar. Deane, Hammer and McCarthy point out that if Puerto Rico is restructured in a manner similar to Detroit, it will result in recoveries much lower than those implied in current bond trading levels.

Puerto Rico Debt Crisis

Puerto Rico’s plan

The governor of PR has established the “Working Group for the Economic Recovery of Puerto Rico,” which will provide legislators with recommendations for economic reforms and fiscal adjustments by the fall. According to Governor Padilla, the goals of the group include a negotiated agreement with bondholders to reschedule debt payments for several years. A comprehensive educational and lobbying campaign will be launched to back the working group’s recommendations.

Two weeks ago, PR Government Development Bank President Melba Acosta and a number of advisers held a meeting with creditors. Sources noted that the advisers avoided questions about specific plans to restructure public deb during the meeting. They stated that the commonwealth plans to renegotiate its capital structure on a case-by-case basis with creditor committees over a several month period.