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Muni Week Review / Preview 5/04/2017

Thursday, May 04, 2017


Puerto Rico Bondholders in for Bumpy Ride

MONEY NEWS / Thu May 4, 2017 By Nick Brown

    If Puerto Rico’s record-setting bankruptcy follows the template of other municipal restructurings, general obligation bondholders may be in for a long ride, despite constitutional guarantees on their debt.

   The federal financial oversight board for Puerto Rico on Wednesday pushed the U.S. commonwealth into a court-sanctioned restructuring process akin to U.S. bankruptcy, known as Title III. Similar filings for the island’s public agencies could be coming soon. Puerto Rico will use the court processes to restructure much of its $70 billion debt load and $49 billion in pension liabilities. This dwarfs Detroit’s 2013 filing, which at $18 billion in bond and pension debt was until now the largest-ever U.S. municipal bankruptcy.

   The island's constitution guarantees the debt of GO, or General Obligation, bondholders, while other debt, known as COFINA, is backed by revenue streams from tax proceeds. But in past bankruptcies, that has not meant much.

   In five of six recent public bankruptcies in which the debtor defaulted on bonds, pensioners walked away with full recovery, while bondholders took haircuts, according to data from Moody’s Investors Service. Among those settlements, Harrisburg, Pennsylvania, bondholders took a reduction in the value of their investments by an average of about 25 cents on the dollar, according to Moody's, while in Stockton, California, the haircut was 50%.

   Even in Detroit, where pensioners suffered losses of about 18%, bondholders on average took home only 25 cents on the dollar, the Moody’s data shows.

   “If the market hasn’t taken this dynamic into account by now, you can imagine they will after Puerto Rico, given its enormous scale,” said bankruptcy expert Drew Dawson, a professor at the University of Miami School of Law.

   Among Puerto Rico creditors, GO and COFINA debt are viewed as the two safest bets for decent recoveries.

   GO holders seemed to have an advantage out of court, where constitutional debt is seen as sacrosanct. Puerto Rico offered a restructuring that favored GO bonds over COFINAs.

   But the opposite may be true in bankruptcy, which prioritizes debt backed by a revenue stream, like COFINA, ahead of unsecured debt.

   “Bankruptcy totally changes the priority for those two bonds,” said George Schultze, hedge fund manager and head of Schultze Asset Management, which does not hold Puerto Rican debt.

   Moody’s has rated the commonwealth's GO and COFINA debt on equal footing, forecasting recoveries for both between 65 and 80 cents on the dollar, and ahead of debt from Puerto Rican agencies like the Government Development Bank, which it sees as recovering less than 35 cents.

  “There is no precedent to really resolve which one is the stronger between GO and COFINA,” said Tim Blake, a managing director at Moody’s, noting that Title III was uniquely created under last year’s Puerto Rico rescue law, PROMESA.  Dawson said it is a tough call, but negotiating leverage “seems to have shifted, in the context of bankruptcy, to favor COFINA.”

  GO holders, to be sure, could try to challenge the legality of COFINA’s lien on the tax revenues. But contrasting statements between COFINA and GO holders may give a sense of each side’s confidence in the bankruptcy process.

  Susheel Kirpalani, a lawyer for a COFINA investor group, on Wednesday called the filing “sound public policy.” All along, COFINA holders have favored the bankruptcy route. But Andrew Rosenberg, a lawyer for a GO bond group, said “the economy of Puerto Rico will be put on hold for years” in a bankruptcy.


  Creditors may have some leverage to petition a judge to toss the case, arguing that the oversight board did not meet PROMESA’s requirements to file a Title III.

  PROMESA requires good-faith negotiations toward an out-of-court deal before any filing, as well as to establish “procedures necessary to deliver” audited financial statements for any entity entering bankruptcy.

  Some Puerto Rican agencies still have not published such statements, and creditors have griped for months that the oversight board has not done enough to encourage compromises outside of court.“We would agree there is a case to be made here” for dismissing the case, Keefe Bruyette & Woods analyst Chas Tyson told investors in a note on Wednesday.

  Rosenberg said the oversight board blocked his group’s last-minute restructuring deal with the island in order to push it into bankruptcy, a claim a board spokesman quickly denied.

  Another key issue that remains in limbo for debt holders is what the island defines as an "essential service." Under Puerto Rico's constitution, it cannot cut repayments to GO creditors except to maintain essential services.

  All told, “this will be a field day for litigation, including over who has priority and whether the bankruptcy is even authorized,” said Schultze. “It could even go to the Supreme Court.”

GMS Comment:

  The Title III designation can benefit creditors. Creditors can now dispute the Certified Fiscal Plan which is currently the basis for recovery values. The Certified Fiscal Plan funnels all revenues regardless of priority liens and dedicated revenue pledges into the General Fund. It also pays all government operational expenses before considering debt obligations. The Oversight Board acknowledges the plan does not respect constitutional or contractual rights of bondholders, which is a requirement of the PROMESA law.

  Should the presiding judge deem the Fiscal Plan does not comply with PROMESA the plan would need to be modified. If the plan is modified creditors with strong security provisions would see better recoveries. A court, unlike the Puerto Rico government and Oversight Board, cannot dismiss bondholder rights and liens when elevating government operations and essential services above debt obligation payments. In cases where consensual agreements cannot be achieved the presiding judge will determine bondholder recoveries based on legal provisions and money available.

Information obtained from sources deemed reliable; GMS does not purport Review/Preview contains all available information.