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Puerto Rico Initial Bond Market Reaction

Monday, Apr 16, 2018

Initial Bond Market Reaction Appears  to Indicate the April 10th Commonwealth vs COFINA Court Hearing Leaned Toward COFINA Bondholders… Judge Addresses Debt Limit… COFINA Defendants’ Offer Straight-Forward Conclusive Argument… Judge Swain Appears Focused on Law…Record High $20 billion Federal Housing Funds Brings Economic Impact… Puerto Rico Designated “Opportunity Zone” For Tax-Favored Investments… Stronger Island Electric Grid Plan By Mid-Year…Puerto Rico Bonds Best-Performing Fixed Income Investment in 2018…

Based on market reaction COFINA defendants appeared to have had a good day in Court as both sides made their final arguments to settle the key legal question: Who has the right to Puerto Rico’s pledged sales tax revenue? Puerto Rico’s ability to borrow money in the foreseeable future may hinge on a favorable COFINA ruling in the Commonwealth-COFINA dispute. Judge Swain is expected to issue a written ruling as she put a stop to trial preparation. Judge Swain’s cross-examination echoed COFINA bondholders’ concerns. Judge Swain seemed to have a clear objective for the hearing. She wanted to showcase the differences in bond security between revenue secured bonds and full faith and credit general obligation bonds. Judge Swain wanted to deal with the text of the COFINA statute and did not want the Court to be dragged into political functions. Judge Swain called on the Commonwealth to adhere to PROMESA which orders respect of territory law. Taking great pains to clarify a revenue secured bond to the Commonwealth side, Judge Swain leaned on an illustration of airport revenue bonds offered by COFINA defendants to explain the significance of revenue secured bonds in the municipal bond market. Judge Swain’s pointed questions echo COFINA bondholders concerns: Her questions reveal that the Court has been listening carefully to both sides. In light of the the importance of the ruling and the April 25 court hearing which will include constitutional issues and whether to allow the Puerto Rico Supreme Court to certify the COFINA legislation, a relative early resolution is anticipated by some market participants 

Judge Addresses Debt Limit… Judge Swain initially focused on Puerto Rico’s debt limit, which was cited as a cause for the dispute in the Commonwealth’s complaint. Why is it the right result that the Commonwealth get the benefit of its old debt being paid off with the proceeds of the COFINA debt offerings and the COFINA bondholders who bought something they thought was secure should be the ones to take the hit? Judge Laura Taylor Swain also asked the Commonwealth that even if the Commonwealth overstepped its bounds why should COFINA bondholders suffer? Swain went on to correct the Commonwealth’s argument on Puerto Rico constitutional debt limits. The Puerto Rico Constitution doesn’t say all commitments made for debt are to be included in the debt limit. It says all commitments made for direct obligations of the Commonwealth backed by the full faith and credit of the Commonwealth make up the debt limit. The Constitution could have been written to say all debt, but it wasn’t written that way. Judge Swain indicated that general obligation bondholders who bought after COFINA was in existence bought under documentation that said, by the way, this pledged COFINA money is not going to be available to you. The COFINA statute not only doesn’t say full faith and credit, there is no commitment to use the Commonwealth full faith and credit taxing powers to replace sales tax revenues if they are taken off the table; it says you look to a particular body of revenues. The COFINA people focused on it not being full faith and credit, not being a direct obligation and not affecting the debt limit, Judge Swain’s remarks showed that not all Puerto Rico debt is equal in the eyes of the Court.

COFINA Defendants’ Straight-Forward Conclusive Argument... The Commonwealth received $16 billion in COFINA bond proceeds secured by pledged sales taxes and now the Commonwealth wants the pledged sales tax revenue too, this simple statement is the crux of COFINA’s opposition to the Commonwealth’s claim for COFINA pledged sales tax. The COFINA defendants asked the Court, as articulated by the U.S. Supreme Court, to interpret and enforce the plain meaning of the statutory language of the COFINA Enabling Act. When Judge Swain asked if non-recourse debt without full faith and credit has constitutional debt limits, COFINA defendant answered conclusively that there is no constitutional prohibition on nonrecourse debt issued at market terms through a democratic process. The COFINA defendant asked that the Court, given the undeniable textual clarity of the statute, materials outside the statute should not be considered by the Court and the Court’s decision should only be on the statutory text. The COFINA defendants offered robust, straight forward and conclusive answers to Judge Swain that received little cross-questioning. 

Judge Swain Appears Focused on Law…Judge Swain asked, “Isn’t it a fundamental political function of elected leaders to determine what resources are prioritized, those are important political distinctions.” Trying to obscure the plain meaning of the COFINA statute, the Commonwealth defendant dragged in the drafting history of the statute and made the language of the Puerto Rico Constitution an issue. Judge Swain asked the Commonwealth the following question showing empathy for COFINA bondholders, “Why can’t there be an absolute transfer of the right to revenue and, in addition, a payment consideration for some contractual undertaking of the Commonwealth without committing its full faith and credit.” An April 25 court hearing on constitutional issues and COFINA certification by the Puerto Rico Supreme Court is on the calendar. At the hearing the Judge could hand out further court orders or set a ruling date. 

Record High $20 billion Federal Housing Funds Brings Economic Impact…“It’s a historical assignment,” Governor Rosselló termed U.S. Department of Housing and Urban Development’s $20 billion allocation for Puerto Rico housing reconstruction “the largest allocation in the history of the United States.” So far, close to $32 billion of federal funds have been allocated through various U.S. Agencies such as FEMA, Army Corps of Engineers, HUD and others. Disbursement will not be immediate as federal compliance and monitoring guidelines develop. HUD’s $20 billion federal fund allocation for rebuilding includes $18.5 billion from the Community Development Block Program approved this year and $1.5 billion approved in 2017. Applauding the confidence of the U.S. government, Rosselló stated, “We are going to make the recovery process more transparent. We are going to have a digital framework to see the projects that are being carried out, how much money is being allocated and to see the progress in such a way that the citizens and the whole world can see how the project is progressing. Puerto Rico’s Resident Commissioner is seeking additional allocations in the near future. Including private insurance proceeds of about $15.7 billion, Puerto Rico is expected to receive close to $50 billion in recovery funding, most of which be funded in the early years. Federal recovery funds are expected to have the most economic impact. A U.S. agency official said, “This money should leverage, along with other funds, the economy of Puerto Rico.”

Puerto Rico Designated “Qualified Opportunity Zone” For Tax-Favored Investments… The U.S. Treasury Department and IRS designated Puerto Rico “Qualified Opportunity Zone” under the recently enacted Federal Tax Cuts and Jobs Act to bring capital to distressed communities. “New investments in Opportunity Zones can receive preferential tax treatment, which will, in turn be a boost to our economy,” Governor Rosselló said. Investors can defer tax for ten years even on prior gains reinvested in a Qualified Opportunity Fund. U.S. Treasury Secretary Steve Mnuchin “I am very excited about the prospects for Opportunity Zones”

Stronger Island Electric Grid Plan By Mid-Year… A new electric grid likely to cost about $18 billion could be funded almost entirely by federal moneys. FEMA will fund 90% of the rebuild and HUD’s $18.5 billion disaster recovery grant approved this week allocates $2 billion towards the electric grid. U.S. Dept. of Energy officials are looking at integrating renewable energy sources and building micro grids around industrial sites. At this week’s House Subcommittee on Oversight and Investigations hearing, energy experts recommended installing underground power lines, relocating high-voltage transmission lines along existing highways instead of hard-to-reach terrain and installing flood barriers at substations. Puerto Rico is heavily dependent on imported fuel and manufacturing accounts for nearly 50% of its economy. Federal officials told U.S. lawmakers that a plan to strengthen and stabilize Puerto Rico’s electric grid is expected by June.

Puerto Rico Bonds Best-Performing Fixed Income Investment in 2018… Much of Puerto Rico’s recovery is premised on federal aid. The recent Fiscal Plan, not certified by the Oversight Board, boosts the Island’s surplus to $6.3 billion before paying bondholders. PIMCO funds boosted its holdings of Puerto Rico bonds in December after federal disaster aid hit home. The large rally in Puerto Rico bonds stands out. “Some Puerto Rico bonds went up about 100%,” said PIMCO Chief Investment Officer. Puerto Rico bonds have been the best-performing fixed income investment thus far in 2018. The Board is expected to certify its Fiscal Plan by April 20, 2018.

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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