Puerto Rico has defaulted on a US$58 million bond payment that is guaranteed by a letter of credit (L/C), the terms of which appear ambiguous.

The default itself is seen as a risky move. It may force creditors to embark on a wide-ranging debt restructuring or it could spook investors to the extent that they seek to exit their positions and make future borrowing for Puerto Rico far more difficult.

Bewildering structure

Puerto Rico's total US$72 billion of bonded debt has been issued by multiple entities, using a bewildering array of terms, conditions, repayment mechanisms and government guarantees.

The bonds that defaulted were sold with a guarantee in the form of an irrevocable L/C issued by the Government Development Bank.

Ambiguous L/C terms

The L/C made the bonds look safer. It appeared to most investors that if the Public Finance Corporation failed to make a payment, a trustee for the bondholders would be able to draw the money owed to them from the Government Development Bank.

But investors have now learned that the bonds' prospectus does not describe the L/C bond enhancement the same way the bonds' indenture does, causing confusion over what conditions are required to activate the L/C or whether the guarantee is actionable at all.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.