Puerto Rico will fail to make Aug.1 payment, signaling default

(Reuters) - Puerto Rico will miss a payment on debt due Aug. 1, the governor's chief of staff said on Friday, an event that will be considered a default by investors as the commonwealth lurches towards what could be one of the largest U.S. municipal debt restructurings in history.

The missed payment will mark the first default by the commonwealth and shows the depth of the island's economic and cashflow problems. Puerto Rico Governor Alejandro Garcia Padilla shocked investors in June when he said the island's debt, totaling $72 billion, was unpayable and required restructuring.

According to a 2014 bond offering statement, Puerto Rico has never defaulted on the payment of principal or interest of debt.

"Tomorrow is Aug. 1 and we don't have the money," Victor Suarez, chief of staff for Puerto Rico's governor, told journalists in San Juan, referring to a $58 million payment due on Public Finance Corporation (PFC) bonds.

"The PFC payment will not be made this weekend," Suarez said. "It was not consigned."

The island faces a number of debt payments due Aug. 1 but had signaled in recent weeks that it may miss the PFC payment.

The non-payment would be the most notable since Detroit, which had about $8 billion of bonds, defaulted on $1.45 billion of insured pension bonds before it filed for bankruptcy in 2013.

"What could surprise investors is when they actually hear the word 'default,' and that a default occurred," said Lyle Fitterer, head of tax-exempt fixed income at Wells Capital Management, which holds mostly insured Puerto Rico debt.

"The immediate reaction might be a slight sell-off in the marketplace because I think people will start to anticipate, 'OK, what's the next series of debt they're going to default on?'"

PFC bonds have weaker protections than many other Puerto Rico bonds and the skipped payment had been signaled to investors over the past few weeks. Suarez said on Monday that the commonwealth did not have the current cash flow to pay the PFC bonds.

"I bought my (PFC) bonds with the anticipation of them defaulting," said Ben Eiler, managing partner at First Southern Securities in Puerto Rico, earlier this week. "They're going to restructure in some form or fashion, and I believe that restructure is going to be higher than that level."

However, Puerto Rico is making another debt payment due. The head of its Government Development Bank (GDB), President Melba Acosta, said in a statement released Friday that the bank would make a $169 million payment for the debt service on GDB debt.

"From the perspective of Puerto Rico, it makes the most sense to default on the PFC bonds," said Michael Comes, portfolio manager and vice president of research at Cumberland Advisors in Florida. "There's no recourse back to them if they don’t make the payments."

The looming default also indicates how cash-strapped the government is. Suarez said the government only had enough cash to operate until November if no additional measures are taken to increase cashflow.

The likelihood of a restructuring is leading investors to wonder how Puerto Rico will prioritize debt payments versus citizens' needs.

"We're beginning to discern a ... mindset on the island that the government is weighing the interest of investors against the economic interest of the island," said Thomas McLoughlin, UBS chief investment officer wealth management research, on Thursday.

DEFAULT DEBATE

Suarez told reporters in San Juan on Wednesday that a missed payment would not constitute default. Bond documents state that Puerto Rico's legislature is not legally bound to appropriate the funds for payment.

However, credit rating agency Standard & Poor's said earlier this week it would view non-payment of rated PFC bonds on their due date as a default. Moody's said it would also consider it a default.

"It (would be) the first failure by the government to pay on a debt to public investors and indicates the weakness of the government's ability and willingness to pay," said Timothy Blake, managing director of Moody's Public Finance Group.

A default could open the door to a fight with investors. Daniel Hanson, analyst at Height Securities, said in a research note that market participants would probably file suit in San Juan as soon as Tuesday.

Still, that could be an uphill battle.

"Our reading of the legal documents is that bondholders have very limited remedies," said David Hitchcock, an analyst at S&P. "Puerto Rico could potentially just ignore the bondholders."

Puerto Rico Justice Secretary Cesar Miranda said they had been anticipating "any type of litigation that this situation may cause".

"We have been organizing ourselves, using internal resources when we can, and external ones when necessary, to defend against any claim that is made," Miranda said.

(Reporting by a contributor in San Juan; and Megan Davies and Jessica DiNapoli in New York; Additional reporting by Karen Pierog in Chicago; Editing by Clive McKeef, Dan Grebler and Ken Wills)