Joseph Krist

Municipal Credit Consultant

NEW PLAN FROM PR

On Monday, Puerto Rico said it had found a way to make debt payments of $1.85 billion a year, compared with the $1.7 billion a year it had offered before. The new restructuring plan covers $49.3 billion of Puerto Rico’s total debt, most of which is in the form of municipal bonds. The larger margin is a result of using projected government revenue for fiscal year 2021, instead of fiscal 2016, as the basis for the restructuring team’s 15% debt-service target as a percentage of annual revenue.

It calls for creditors to exchange existing bonds for two new classes of bonds. The offer is up from a previous offer of $26.5 billion. Puerto Rico has taken the position that all types of creditors must sacrifice, however. The new offer announced on Monday reflects that position. General obligation bonds held by investors who do not live on the island would get a recovery rate of 74 percent under the new proposal. Holders of sales-tax-backed bonds would get 57 percent; and holders of bonds issued by the Government Development Bank would get just 36 percent.

The first type would be a “base bond” with a total face value ranging from $32.6 billion to $37.4 billion, depending on whether bondholders in Puerto Rico opted in or took advantage of the special offer available to them alone. The new base bonds would start out paying 1.1 percent interest for the coming fiscal year. (Under Puerto Rico’s previous offer, interest payments would not have started until a year later.) The interest rate would then rise gradually to 5 percent in 2021, the same year principal repayments would start. Bondholders living in Puerto Rico would, however, have the chance to recover more of their initial investment if they were willing to wait. Instead of trading in their holdings for the regular base bonds, they could opt for “local holder base bonds,” which would have a value equal to the face amount of the bonds being handed over. The local holder base bonds would pay a fixed, 2 percent rate of interest over a longer period of time.

For investors not living in Puerto Rico, there would be only a chance of getting a full recovery. In addition to their base bonds, they would get a second type, called “capital appreciation bonds,” which would not offer any cash payments until after the base bonds had been fully repaid and it was clear how much of a loss each type of bondholder had suffered. The CABs would be repaid in full upon maturity as they accrete value — at 5% annually over a 49-year period under the commonwealth’s most recent offer. CABs would ensure creditors fully recover initial losses, only if they hold onto these until maturity.

The higher recovery rates and a debt instrument tailored for local bondholders are the  major changes in the government’s revised debt-restructuring proposal, which was presented to creditors on March 23 before it was released publicly Monday. Negotiations between the commonwealth and its creditors are slated to continue this week. The commonwealth first proposed to creditors in January an exchange offer with two types of instruments: a mandatorily payable base bond; and a growth bond to be paid only if the island achieved economic recovery. Cuts to principal, or haircuts, hovered around 45%, and only $1.75 billion of government revenue would be available each year for debt service. This amount now increases to $1.85 billion, allowing the U.S. territory to offer more base bonds — and higher recovery rates — under the revised proposal. The larger margin is a result of using projected government revenue for fiscal year 2021, instead of  fiscal 2016, as the basis for the restructuring  team’s 15% debt-service target as a percentage of annual revenue.

Growth bonds would be replaced with capital appreciation bonds (CABs), which are repaid in full upon maturity as they accrete value — at 5% annually over a 49-year period under the commonwealth’s most recent offer. CABs would ensure creditors fully recover initial losses, only if they hold onto these until maturity. The commonwealth’s advisers believe this instrument will eventually become highly tradable as the island recovers its creditworthiness along the way.

Puerto Rico residents, who happen to mostly own the island’s less-secured debt, could now choose a par-for-par exchange, instead of taking discounted base bonds. These par bonds would mean a longer maturity for local bondholders, while receiving 2% interest payments for more than 50 years beginning in January 2017. Under the new offer, the amount of base bonds could reach as much as $27.8 billion, depending on the participation of Puerto Rico residents on the local instrument, while roughly $1.75 billion in CABs  and up to $8 billion in local holder bonds would also be issued. While seeking a leveled debt-service schedule, the commonwealth’s most recent offer would translate into a longer debt-repayment calendar. No principal payments until fiscal 2021 are still contemplated, but interest payments would now be paid current, scaling up until reaching 5% annually by fiscal 2021. The local bond option would always be paid a 2% annual interest during its life.

Proposed haircuts include about 16% for commonwealth-guaranteed debt, including general obligations (GOs), and 43% for Sales Tax Financing Corp. (Cofina) bonds. Less-secured paper, such as the Highways & Transportation Authority and the GDB’s, could see cuts to principal of 44% and 64%, respectively, while other credits end up in the 50% range. If the commonwealth fails to obtain a legal mechanism by which to bind holdouts or if the federal government significantly reduces financial support to the island, the terms of the exchange offer would have to be revised, which could mean larger haircuts for creditors.

At least three different creditor groups have countered with their own offers. These include constitutionally guaranteed GOs; sales tax-backed, lockbox-structured Cofina; and a group of local cooperatives and credit unions that mostly own less-secured paper.

For the administration, the creditors’ proposed fixes fell short, often solving only part of the problem and placing an unfair burden on less-protected credits. None of the counteroffers would deal with the government bank’s debt woes. None would contemplate cuts to principal.

So far, creditors have sought more government revenue dedicated to debt service, less impairment and higher recoveries. Commonwealth advisers recognize there is a tug of war over the administration’s 15% target of annual government revenues destined to debt service, and has said the idea is to make it the least painful possible to creditors.

PREPA

The passage of the debt moratorium legislation has created much uncertainty as to its impact on the existing agreement framework for a restructuring of Puerto Rico electric Power Authority’s outstanding debt. In a report issued late Friday, Moody’s weighed in with its opinion. “The moratorium law could also create complications for negotiations between the Puerto Rico Electric Power Authority (PREPA – Caa3/negative) and its lenders, which have been underway for 18 months and appear to be approaching a resolution. The law encompasses the commonwealth’s numerous debt-issuing entities including PREPA and gives Puerto Rico’s governor the power to invoke a state of emergency with respect to PREPA (or any other government agency), thereby beginning a moratorium. However, the law does not include the PREPA Revitalization Corp., the special purpose vehicle that is expected to issue securitization bonds to complete the restructuring of PREPA’s $9 billion of debt. We continue to believe that PREPA and its creditors are working constructively toward a consensual agreement.”

The next turn in the PREPA restructuring process will come when the utility will obtain a ruling on its securitization charges within the next 87 days, followed by a validation process. In parallel, PREPA’s restructuring team will be making its case before the credit rating agencies, which will ultimately decide if the new securitization bonds are worthy of investment grade.

AND IN CONGRESS

The House Natural Resources Committee had been expected to release a revised version of its Puerto Rico bill early this week, including a modification designed to avoid a constitutional challenge if the legislation is enacted. Some have warned the bill would violate the Uniformity Clause of the U.S. Constitution. That clause, in Article 1, Section 8, says, “Congress shall have power … to establish … uniform laws on the subject of bankruptcies throughout the United States.”

The bill would be revised to permit the other four U.S. territories, should their financial situations plummet, to opt into its provisions. The territory’s Governors would have to sign them. As a result, Guam, the U.S. Virgin Islands, America Samoa, and the Northern Mariana Islands could opt for the creation of an oversight board that would have the sole ability to file a petition for debt restructuring.

Under the bill, debtors could not have a proposed financial control board file a petition for restructuring on their behalf until they have released their most recent audited financial report and engaged in voluntary debt restructuring discussions with creditors. The bill borrows from Chapter 9 of the U.S. Bankruptcy Code but explicitly avoids amending that statute and instead uses the Territorial Clause of the Constitution as the basis for its debt restructuring provisions. The other territories don’t want to be in the measure.

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