Hedge funds holding debt in Puerto Rico’s Government Development Bank sued to stop the island’s key fiscal entity from making payments to local government agencies as it faces a growing cash shortage and the prospect of insolvency.
The funds, which include affiliates of Brigade Capital Management, Claren Road Asset Management and Solus Alternative Asset Management, accused the bank in a lawsuit filed Monday in San Juan federal court of seeking to “prop up” local agencies at the expense of other creditors. The situation may imperil restructuring efforts for the bank, which its regulator says is facing a cash shortfall of as much as $1.3 billion in June.
Puerto Rico, which is negotiating with creditors to reduce a $70 billion debt load, has “had every incentive to cannibalize” the bank to “meet its own liquidity needs through preferential transfers even if such transfers make it impossible to restructure” the bank, the hedge funds said in the complaint. “The unfortunate depositors and bondholders left behind in GDB will be left to bear amplified losses.”
The Government Development Bank serves the dual purpose of providing financial support to local governments and serving as a financial adviser to the commonwealth. The funds, which say they hold a “substantial amount” of almost $3.75 billion in the bank’s outstanding debt, blamed the entity’s deteriorating condition on a “hopeless conflict” between loyalties to Puerto Rico and to creditors.
The bank owes investors a $422 million bond payment May 1 that Gov. Alejandro Garcia Padilla has said can’t be paid. If the GDB skips that payment, it would be the first major default by a commonwealth entity after two agencies have missed smaller debt payments.
The hedge funds also allege the bank kept “creditors in the dark” about the scope of preferential payments.
Along with receiving financing from the bank, local agencies and municipalities also hold deposits there. The hedge funds are trying to stop the repayment of those deposits as the bank’s finances worsen and the agencies “race for the exits,” according to the complaint.
The GDB currently has about $700 million of liquidity, the bank’s president, Melba Acosta, said in a local radio interview last week. It had $10.7 billion of total assets — including loans to public corporations — and $8.8 billion of total liabilities, as of June 30, 2015, according to the commonwealth’s latest financial data. The bank held $3.9 billion in deposits from public agencies, as of Sept. 30.
Barbara Morgan, a spokeswoman at SKDKnickerbocker in New York who represents the GDB, and Betsy Nazario, a spokeswoman at the GDB in San Juan, didn’t have an immediate comment on the lawsuit.
The hedge funds that sued the development bank were part of a seven-member bondholder group that tried last year to negotiate a plan to restructure the GDB’s roughly $5 billion of debt and inject it with fresh capital, people with knowledge of the matter said at the time. A month later, the creditors warned they would take steps to install a receiver and freeze the bank’s assets if they suspected it was being run improperly, people familiar with the matter said then.
Puerto Rico has been quarreling with hedge-fund creditors over how to restructure commonwealth debt since at least last February. Some of the proposals that have been lobbed back and forth would’ve helped inject capital into the struggling development bank, which is central to Puerto Rico’s financial apparatus because it lends to the government and its localities. The island is running out of cash to service its mountain of debt after job-creating tax incentives were ended in 2006, sending the economy into a tailspin.
The hedge funds seek the suspension of payments by GDB, except for withdrawals needed to maintain essential public services or to pay the ordinary operating expenses such as utilities, rent and employee wages.
The case is Brigade Leveraged Capital Structure Fund Ltd. v. Government Development Bank of Puerto Rico, 3:16-cv-1610, U.S. District Court, District of Puerto Rico (San Juan).