Puerto Rico’s Debt-Relief Gambit

As Puerto Rico sinks under the weight of $73 billion in government and agency debt—not to mention billions more in unfunded pension and health-care liabilities—its political class is looking for an escape hatch.

This isn’t about wiping the slate clean. But if a bankruptcy judge approved the write-down of, say, half the municipal debt, it would reduce the fiscal pressure.

There’s an app for that. The trouble for Puerto Rico is that getting it requires a retroactive change in U.S. law. If Congress cares about the future of Puerto Rico or the hundreds of thousands of Americans who hold Puerto Rican debt, it will just say no.

More than half of the outstanding Puerto Rico debt is triple tax-exempt revenue bonds issued by government-owned corporations. Unlike public corporations and municipalities in the 50 states, these enterprises do not have access to Chapter 9 bankruptcy protection under the U.S. code. If they fail to meet their loan obligations, they face receivership.

Last June Puerto Rico enacted a law to allow its government corporations to declare bankruptcy. But in February, a U.S. federal judge in San Juan struck down that law on grounds that the federal bankruptcy code supersedes it.

Now Pedro Pierluisi, who represents Puerto Rico as a nonvoting member of the U.S. House of Representatives, is sponsoring legislation to extend Chapter 9 bankruptcy protection to the island. Allowing U.S. states that route and not Puerto Rico is “illogical and unfair” his office told me in an email last week.

There may be good reason to make this change if it applies to new bond issues, and if the government wants to pay the higher risk premium that bankruptcy court implies. But as House Judiciary chairman Bob Goodlatte (R., Va.) warned at a subcommittee hearing in February, Mr. Pierluisi’s bill is not “merely a technical ‘fix’ to the bankruptcy code.”

Each one of Puerto Rico’s government-owned corporations “has issued billions of dollars in municipal bond debt,” Mr. Goodlatte noted. If only one of them filed for Chapter 9 “it would rank among the largest municipal bankruptcies in our country’s history.”

When the bonds were issued, both parties to the contract knew the corporations had no access to Chapter 9. This means, Mr. Goodlatte said, that “proposals to retroactively impact investors’ rights should be reviewed with care and caution.”

The owners of almost $9 billion in troubled Puerto Rico Electric Power Authority (Prepa) bonds seem to agree. Total outstanding Prepa bonds are nearly four times the size of the $2.2 billion munis that Detroit targeted for impairment when it filed for Chapter 9 in 2013.

Under the terms of Prepa’s bond contracts, holders of at least 60% of the value of the outstanding debt can agree to abridge the terms to give the company limited relief from debt service. That minimum of creditors has granted the company forbearance until June 4. Prepa says it’s working on a recovery plan to present to creditors on June 1. If they cannot reach a negotiated solution, Prepa could face receivership.

Mr. Pierluisi’s office told me there is wide support among bondholders for granting Chapter 9 to Puerto Rico. But much of that support, as cited by his office, seems to come from holders of general-obligation bonds who would benefit from a reduction in Puerto Rico’s huge overall debt burden.

Last year Gov. Alejandro García Padilla suggested that write-downs of public-corporation debt are necessary to preserve public services. Another line of thinking holds that it’s a way to lower electricity rates and stimulate the economy. And if I don’t pay my Amex bill I can do the same for New York City next month.

But there’s no evidence that Prepa creditors are hankering for the haircut they could expect under Chapter 9. Or even that they want to put the company in receivership.

A group of institutional bondholders—including Franklin Advisors and Oppenheimer Funds—representing 40% of the outstanding bonds and more than 500,000 individual bondholders have offered the company a restructuring plan to avoid receivership. It includes a new, $2 billion capital commitment to modernize power-generation equipment and cut costs. If Prepa can improve its operational efficiency, the group believes that its proposal can lower the electricity rate to the range of 22 cents per kilowatt-hour from the 28-cent range of recent years.

This intervention is unlikely to appeal to Puerto Rico’s political class, which uses Prepa as a populist honey pot. The company has a dismal collection record and one of the most notorious deadbeats is the government. A Nov. 15, 2014, report by FTI Capital Advisors found that the company had “over $200 million in accounts receivable from public corporations, of which approximately 70% is over 120 days old.”

Prepa can pay its creditors. Shielding it from a restructuring and simply wiping out the bondholders is neither fair nor logical.

Write to O’Grady@wsj.com

Puerto Rico’s nonvoting member of the U.S. Congress, Pedro Pierluisi, at a news conference in San Juan, April 30. PHOTO: RICARDO ARDUENGO/ASSOCIATED PRESS

By Mary Anastasia O’Grady

Puerto Rico’s Debt-Relief Gambit