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PUERTO RICO UPDATE COFINA Bonds Rally

Friday, Jan 12, 2018

Seema Balwada, CFA

 Judge Puts Constitutionality of Oversight Board Under Advisement… Federal Rescue Funds Make Headway… Permanent Medicaid Relief Sought… Puerto Rico Fiscal Plan Deadline Extended… Judge Selects More Investor Letters... COFINA Bonds Rally Bondholders Expect Favorable Ruling…

“Extraordinarily Important” Court Hearing… The key component of Puerto Rico’s debt restructuring is the seven-member Oversight Board. The constitutionality of the selection of Board members is now under Court advisement. Bondholders led by hedge fund Aurelius want a new Board appointed by President Trump through Senate confirmation. The U.S. Attorney General and the Island government along with the Oversight Board defended the legality of the Board for over three hours at the “extraordinarily important” January 10 court hearing. Judge Swain asked if Puerto Rico’s Federal Oversight Board is declared unconstitutional, what would that mean for the Island’s effort to restructure its $74 billion of debt? “Every Board decision can potentially be void,” former Solicitor General, Constitutional expert and Aurelius attorney Theodore Olson told Swain about what could happen to the Oversight Board’s actions. “Hopefully Congress will go back and get it right.”

Federal Rescue Funds Make Headway in Puerto Rico… Bond investors expect Congress to enforce more oversight given Puerto Rico’s history of corrupt politicians. To keep a check on the Island’s government spending, the U.S. Treasury is seeking collateral and guarantees on federal funds promised in October, which should be part of the Island’s upcoming Fiscal Plan. Collateral for federal funds would be similar to Puerto Rico’s secured bonds. A host of unencumbered Puerto Rico revenues such as a portion of the Sales and Use Tax not currently allocated to bondholders, which if pledged would validate the COFINA structure, or income, excise or corporate tax could be used as collateral. Governor Rosselló stated that Puerto Rico is calling on the federal government and the Treasury to expedite their internal processes so that they can inform us of the financial terms and guarantees they need to get the assistance approved by Congress and the President. Federal funds are likely to be disbursed to the central government, which with the approval of FEMA will then be distributed to agencies. In October Congress passed legislation enabling a $36.5 billion disaster aid package for hurricane affected states. Of this, $4.7 billion in low interest loans known as Community Disaster Loans go to Puerto Rico; historically FEMA has forgiven 92% of such loans granted to disaster hit areas. 

Permanent Medicaid Relief Sought in Proposed Disaster Relief Legislation… Under a potential deal, the U.S. would completely fund Puerto Rico’s Medicaid program for two years by lifting a federal Medicaid spending cap of $300 million currently in place. Some lawmakers are seeking permanent Medicaid relief. Proposals to add $6 billion are also afloat. Puerto Rico's Medicaid reimbursement rate is capped at 55% despite the Commonwealth's extreme poverty compared with the U.S. overall. States with increasingly high poverty levels receive Medicaid reimbursements at escalating rates, up to 75%. U.S. lawmakers are also eyeing an additional $81 billion, which many lawmakers feel is not enough, for disaster relief throughout the U.S. The amount was approved by the House in December, and is currently in Senate discussions. This relief package among other things could substantially increase federal funding for Puerto Rico’s Medicaid program. 

Puerto Rico Fiscal Plan Deadline Extended… The Oversight Board has provided two additional weeks until January 24, 2018 for Puerto Rico to submit revised 5-year instead of 10-year Fiscal Plans for the central government, PREPA and water utility PRASA. Other planned deadlines are unchanged. Governor Rosselló has requested aid totaling $94.4 billion (close to the Island's entire annual GDP) and also agreed to give FEMA approval power over Puerto Rico's expenditure of federal disaster funds. It remains unclear if the federal government will authorize aid in line with Puerto Rico's request.
 

U.S. Alleges Massive Electric Rebuilding Materials Discovered… On becoming aware of a previously unknown massive store of electric grid rebuilding materials being held by PREPA, the FBI, FEMA and the U.S. Army Corps of Engineers entered a PREPA warehouse to claim and distribute the equipment. The federal government conducted a full inventory and immediately sent out the critical materials. “At a time when it is a priority to restore the electrical system in Puerto Rico why was this material not utilized? Governor Ricardo Rosselló, who states he was unaware of the hoarded materials, referred the U.S. Army Corps of Engineers’ alleged discovery of materials to the local Justice Department. The materials will be used to restore the Island’s electrical grid.

Judge Swain Selects More Letters Written by Puerto Rico Bondholders... Judge Swain continues to select investor letters that do not favor Puerto Rico officials and their actions. “Your Honor, as a holder of Puerto Rico bonds, I expect the law to be respected and for the court to protect my bondholder rights and liens.” “The United States is a country built on laws.” “Both the U.S. and Puerto Rico governments are responsible for the Island’s current financial crisis.” “The U.S. government gave exclusively to Puerto Rico the most attractive feature of any U.S. security…Triple Tax Exemption.” “It is hard to accept that anyone in Congress is not aware of Puerto Rico’s history of corruption.” “Under current conditions how can U.S. and Puerto Rico politicians believe the Island will ever regain market access?” These are just some of the references made in the letters. Judge Swain hand-picked letters addressed to the Court to showcase she is deeply mindful of the importance of issues raised in these unprecedented cases. Letters to Judge Swain can be emailed to: swaindprcorresp@nysd.uscourts.gov

Puerto Rico Bond Prices Rally… Prices on some Puerto Rico bonds have rallied after hitting record lows following Maria’s destruction. GO’s traded this week at an average price over 25 cents on the dollar, the highest since November 14. Sales Tax bonds, albeit at low prices, have surged, up over 40% in 2018, making the securities the most actively traded in the municipal market, according to Bloomberg. If Judge Swain upholds statutory liens Puerto Rico municipal bonds may well be the best performing asset class of 2018. Media headlines have focused on the dire financial conditions of Puerto Rico as told by Puerto Rico politicians. Politicians continue to withhold annual financial reports and other pertinent financial information. The recent discovery of bank accounts holding over $6 billion is reflective of Puerto Rico politicians lack of integrity. Prices on Puerto Rico secured bonds have not yet taken legal liens and potential bondholder recoveries into consideration. Most media stories never mention bondholder rights under the U.S. and Puerto Rico Constitutions nor do they mention the statutory and priority liens that made many Puerto Rico securities marketable. Puerto Rico bondholders face an anomaly: today’s political environment. No one knows how anything related to the Puerto Rico financial debacle will play out.

Why COFINA Bondholders Expect a Favorable Court Ruling… In 2009 the three most recognized and reputable rating agencies issued credit reports on Puerto Rico Sales Tax bonds. These reports influenced institutional investors, bond funds, hedge funds and individual investors to purchase “A” rated Subordinated Sales Tax bonds. The reports reflect “AA” ratings for senior bonds and “A” ratings for subordinated bonds. Moody’s upgraded the subs from “A2” to “A1” and Fitch upgraded the subs from “A” to “A+” in 2010 while S&P maintained the “A+”. Current ratings for both senior and subs, Moody’s “CA”, S&P and Fitch “D”. Since the inception of COFINA, Sales Tax revenues steadily improved as did security for bondholders. Holders of COFINA bonds are astute, well informed investors who believe the laws will prevail. The 2009 credit reports are attached.*

 

If you have any questions or desire updated information contact your GMS Account Executive. Information taken from sources deemed reliable. This update does not purport to include all available information

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