By Nick Timiraos 

WASHINGTON -- Puerto Rico's economic trouble has prompted comparisons to Greece, but a better analogy might be Argentina.

Hedge funds that bought billions of dollars of Puerto Rico's debt two years ago are resisting a broader restructuring in hopes of preserving their rights to be paid off first and in full.

The playbook -- as well as some of the parties and circumstances -- are similar to those that helped a group of holdout bondholders score a big payday in Argentina. In that case, hedge funds used the courts to secure better terms than the government had offered, agreeing in February with Argentina's newly elected government to end the standoff after 15 years.

This time around, the debate is whether the U.S. Congress should pass legislation that would give a federal oversight board the power to help the island balance its budget while authorizing a court-supervised restructuring of its $72 billion in debt. On Tuesday, Treasury Secretary Jacob Lew touted the risk of a long battle with hedge funds as a reason to move quickly on a restructuring.

"As we saw in Argentina, holdouts can drive a process to the brink," he said. "Puerto Rico doesn't have 15 years. If this goes into litigation...there won't be anything left of Puerto Rico."

Conditions are worsening on the island, which has been mired in a recession since 2006. Puerto Rico's Government Development Bank missed most of a $422 million payment on Monday.

Because it is a U.S. territory, it can't file for bankruptcy, an option for municipalities and state agencies, and it can't turn to institutions like the International Monetary Fund for help, because it isn't a country. Its residents are U.S. citizens and have been leaving in droves for the mainland, with tens of thousands departing annually since 2010.

Hedge funds and others said Puerto Rico and its financial advisers have made the island's difficulties worse by threatening to default on debt that under the territory's constitution is to be paid off first. "If they don't honor their own constitution, who's going to lend them money again?" said Hector Negroni, co-founder of hedge fund Fundamental Credit Opportunities, which invests in Puerto Rico's debt.

A default would make it harder to raise new funds in the bond market and would be like removing the steering wheel while driving, said Luis Fortuño, who was Puerto Rico's governor from 2009 until 2013. "You lose control of whatever lies ahead," he said. Mr. Fortuño is now a lawyer at Steptoe & Johnson LLP in Washington, which represents bond guarantors that insure Puerto Rico's debt.

Payments on general obligation bonds enjoy constitutional priority. Separate bonds -- known by their Spanish acronym, "Cofina" -- are backed by sales-tax revenue. If Puerto Rico misses some of a roughly $800 million payment on the general obligation debt in July, those bondholders could challenge the constitutionality of the Cofina debt by arguing that it diverts general fund revenue, sparking a legal battle that could take years to resolve.

The dispute with the hedge funds dates back to March 2014, when they bought much of a $3.5 billion issue of Puerto Rico's general obligation bonds. Three major U.S. credit-rating firms had downgraded Puerto Rico's debt to junk status a month earlier. Given the risks, the bonds carried yields of 8.7%, unusually high for tax-exempt debt. And the territory issued them under New York state law to provide stronger legal protections, just as Argentina had done when it issued bonds in the 1990s.

The bonds have been bought and traded by hedge-fund firms with expertise in distressed debt. They include Aurelius Capital Management LP, which had tangled with Argentina; Brigade Capital Management LP; Perry Capital LLC; Fir Tree Partners and Centerbridge Partners LP.

"Given the choice of emulating" former Argentine Presidents Néstor Kirchner and Cristina Kirchner or current President Mauricio Macri, "the Governor of Puerto Rico, with the blessing of the Treasury Department, has chosen the former," said Mark Brodsky, Aurelius's chairman.

The other funds either declined to comment or didn't respond to requests.

Several financial advisers hired by Puerto Rico's governor have previously advised the government of Argentina.

The hedge funds that hold the debt "are assuming that they can do very well given what happened with Argentina," said Marc Joffe, a former senior director at Moody's Investors Service. "Holders of the 2014 debt are going to be better off, because they're litigating in New York."

One wrinkle is the legislation in Congress, which could undercut the legal protections underlying the funds' assertion of first claims on Puerto Rico's revenue.

Lobbying groups have taken to the airwaves to fight the proposed legislation.

The Center for Individual Freedom, a nonprofit group based in Alexandria, Va., that doesn't have to disclose its donors, had spent more than $2.5 million through mid-April on television and radio ads that call the legislation a bailout, even though it wouldn't spend taxpayer money. Representatives of the group didn't respond to inquiries.

Sen. Bob Corker (R., Tenn.) said at a hearing last week that the ads had prompted constituents in Tennessee to ask him if Congress was planning to bailout Puerto Rico. "It's been pretty shocking to me to see the lengths some hedge funds will go," he said.

A separate group called the 60 Plus Association, a nonprofit conservative senior-citizens advocacy group, has spent heavily on a similar campaign via a coalition it calls Main Street Bondholders.

"Retirees would have their savings wiped out" if Congress passes the debt-restructuring law, Vice President Matthew Kandrach said.

A separate firm, DCI Group, is registered to lobby on behalf of funds that own Puerto Rico's general obligation debt, and it has hired as lobbyists former Republican congressman Connie Mack IV, GOP operative Douglas Davenport and the Raben Group, a firm with ties to Democrats.

All of those lobbyists worked alongside DCI on a group formed in 2009 called American Task Force Argentina, which sought congressional support for full payment on Argentina's debt to American bondholders. DCI didn't respond to a request for comment.

Write to Nick Timiraos at nick.timiraos@wsj.com

(END) Dow Jones Newswires

May 04, 2016 21:29 ET (01:29 GMT)