Seema Balwada, CFA / November 1, 2017
Judge Showcases an Investor’s Case for COFINA Bonds
On October 27, 2017, in an unprecedented action Judge Swain handpicked a letter from a COFINA investor, Mark Elliot, CEO Elliot Asset Management to showcase. The letter was part of a Court filing in which the Judge stated “the Court is deeply mindful of the impact of the fiscal crisis on lives, institutions, and expectations, and of the importance of the issues that are raised in these unprecedented cases.”
The Crux of the COFINA Investor’s Letter Focused on the Writer’s Assertion that Honoring the COFINA Statutory Lien/Pledged Asset is Legally Correct and in the Best Interest of Puerto Rico…
Mark Elliot pleaded, “I urge you, your honor, to err on the side of protecting the Constitution not a far-fetched plan by a lazy political class not interested in meaningful reform. Puerto Rico Politicians seem ready to resort to private property grabs using any far-fetched excuse they can dream up.”
This article condenses, paraphrases and quotes the key points of Mark Elliot’s letter to Judge Swain. Among other items the 13-page letter focused on protecting the COFINA legal structure, with which Puerto Rico could access credit immediately at attractive rates. With reaffirmed ratings on COFINA senior and sub bonds, a lower rated third lien COFINA bond could restore capital access, offer economic stimulus and improve recovery rates on all Puerto Rico bonds. After all, COFINA was used to finance fiscal shortfalls when created.
“There is a way the debt can be restructured in a manner that will leave Puerto Rico stronger while asserting property rights that will allow access to needed capital.” This investor, who purchased his bonds at a discount, suggests COFINA bondholders consider a settlement less than 100% recovery. However, bondholders who believe the statutory lien must be honored and paid 100 for their bonds may feel differently.
A universal truth is that the protection of private property rights including investor rights is vital for productive economies. The government cannot pledge assets to private investors at one time then take away those pledged assets at a later time. To do so would turn the financial markets on their head.
It cannot be overstated that when issued COFINA bond rates were low compared to other Puerto Rico issuers. Also, the bond ratings were high because of the universal acceptance that COFINA bonds were insulated from the challenges faced by the Puerto Rico Commonwealth. COFINA allowed a lifeline that Puerto Rico wasted. For ten years, no one challenged the constitutionality of COFINA bonds. For years, ALL BOND INDENTURES for Puerto Rico general obligation (GO) debt (including the latest 2014 GO bond issue that paid investors a 8.60% current return tax-free) clearly stated in the indenture that pledged COFINA revenue is “NOT AVAILA-BLE RESOURCES to the Commonwealth, GO debt or other obligations”. Allowing Puerto Rico to breach the U.S. Constitution for the short-term benefit of Puerto Rico could prove myopic. Communist regimes such as Venezuela which expropriated private property for the “public good” only created bigger problems. Taking private assets to make up for poor governance is no solution, it chills private investment.
Puerto Rico’s bloated bureaucracy and deeply entrenched political class is responsible for the crisis because such a large number of islanders rely on government “jobs” and welfare. Putting the entire burden of govern-ment mismanagement on those who lent in good faith to prop up the Island cannot be the solution.
When Congress enacted PROMESA, an independent, supposedly apolitical Oversight Board was to steer the Island’s finances. “Unfortunately, rather than tackling the difficult issues that elected officials never addressed, the PROMESA Federal Board members did not take a balanced and holistic approach to solving the crisis. Instead taking the easy road of past Puerto Rico elected officials they punted the problem further down the road. They sought out ANY revenue to continue support for Puerto Rico’s outsized government. And that is when the raiding of COFINA’s previ-ously unquestionable statutory lien on a legally pledged asset was proposed.”
“It seems quite backward that the Oversight Board felt the best way to ensure capital market access was to collecti-vize properly hypothecated assets”. The COFINA investor makes a strong case against the Federal Board’s illegal actions. COFINA pledged assets warranted a high investment grade rating of “AA-” for senior COFINA bonds and “A+” for subordinate COFINA Bonds at issuance. At that same time period, Puerto Rico GO bonds were relegated the lowest investment grade rating “BBB-” just a hair away from junk or speculative grade. The markets priced the risk of the two highly contrasting credits, COFINA and Puerto Rico GO, accordingly. Thus GO bonds had to be offered at considerably higher interest rates than COFINA bonds to compensate investors for the extra risk.
COFINA, the Spanish acronym for “Corporación del Fondo de Interés Apremiante de Puerto Rico” translates to “Emergency Interest/Lending Corporation”. The name, COFINA, speaks volumes as to its legislated purpose: to get Puerto Rico access to capital markets at affordable rates when it was excluded from capital markets during its last fiscal crisis in 2006. For this reason, Puerto Rico legislature provided strong lockbox mechanisms for the pledged sales tax. The laws and statutory lien provided ratings agencies, bond counsels and Supreme Court Jus-tices extreme confidence about the legality of the pledged asset. The COFINA investor conveyed to the Judge that “COFINA investors relied on the rule of law, a statutory lien and the Constitution of the United States of America to protect them”.
PROMESA Section 303(3) provides that “unlawful executive orders that alter, amend, or modify rights of holders of any debt of the territory or territorial instrumentality, or that diverts funds from one territorial instrumentality to another or to the territory, shall be preempted by this Act.”
COFINA investors are not vultures. Approximately 75% of bonds issued by Puerto Rico issuers are held by indi-viduals. Many are Puerto Ricans, others are U.S. residents of modest means in need of investment income for a living, and some are high net worth individuals. The cloud over private property rights of COFINA investors causes more damage the longer it goes unchecked.
The COFINA Investor highlighted to Judge Swain the broad importance of doing the right thing. “Take the correct and just measure of protecting the Constitution and rights of private property owners to not have their assets unjustly seized after they were clearly pledged by all players with strong approval and clear legislative intent to lure private investment at attractive rates. To take that away would not only serve to freeze Puerto Rico out of credit markets, it would lead investors to look at every other U.S. government entity and wonder if their mortgages, toll highway liens, and other pledges can simply be wiped out when things get tough.”
Judge Swain turned an ear to COFINA bondholders by recognizing this COFINA investor’s letter. The broader message is to both the Commonwealth and its GO bondholders. Their appeals have flooded the Court. However, Judge Swain’s decision to incorporate and file a COFINA investor’s appeal into the official Court record, alerts all parties that the Court recognizes legal differences between secured and unsecured credits. It suggests that the Commonwealth and GO bondholders be realistic and attempt to negotiate a consensual settlement prior to a court ruling.
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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