4Q2018 Review: Puerto Rico Insured Bond

Author: Shaun Burgess, Post Date: January 3, 2019
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Cumberland Advisors - Shaun Burgess - Portfolio Manager & Fixed Income Analyst

It has been a busy quarter for the Commonwealth of Puerto Rico. Milestones included a conclusion to the Title VI restructuring of the Government Development Bank (GDB) and a plan for the restructuring of the Puerto Rico Sales Tax Financing Corporation’s (COFINA), as well as the continued rebuilding from the damages wrought by Hurricane Maria and a myriad of other developments. The conclusion of the GDB’s restructuring and the plan of adjustment for COFINA represent the most significant developments we have seen thus far in the Commonwealth’s bankruptcy saga.

The restructuring of COFINA’s debt stands as one of the most significant developments to date and will rank among the largest municipal restructurings in history, at a staggering $17.6 billion. The terms of the plan include COFINA and Commonwealth bondholders splitting sales and use tax revenues to the tune of 53.65% and 46.35%, respectively. Senior bondholders are set to receive 93 and subordinate bondholders 56 cents on the dollar, and both will exchange existing bonds for new senior lien securities backed by their respective portion of the 5.5% sales and use tax. Although the plan obviously offers considerably less for subordinate bondholders than it does for senior debt holders, the proposed workout is an equitable resolution in Cumberland’s opinion for both COFINA and Commonwealth creditors and is less likely to face significant legal challenges that could prolong the agency’s restructuring. Judge Swain’s approval of the plan’s disclosure initiated a creditor support voting process which will culminate in a confirmation hearing set for January 16, 2019, with public commentary included in the proceedings. We look forward to this date as it represents another pivotal moment in the restructuring process. Execution risks remain, as further progress will depend on the outcome of creditor votes as well as Judge Swain’s approval.

A milestone no less important was the closure of the Commonwealth’s first court-authorized workout – the Title VI restructuring of the GDB’s approximately $4 billion of debt. Although a small sum in the totality of the burden facing the Commonwealth, the restructuring still represents a significant step forward. It stands as the only Title VI restructuring thus far and the first of many restructurings we will see in the coming months and years. Bondholders received 55 cents on the dollar in new securities paying a coupon of 7.50% and maturing in 2040. Even with the GDB’s debt restructured, the risk of nonpayment at some point in the future remains high; and the market price on the newly issued securities reflects as much, with a valuation currently in the high $60s. The restructuring of the GDB offers an important lesson to bondholders, in that even securities received from a restructuring can trade to levels which could worsen initial “haircuts”.

Looking ahead, 2019 promises to be an even busier year for the Commonwealth, with the restructuring of Commonwealth-guaranteed debt and numerous agencies including the Puerto Rico Highway and Transportation Authority (PRHTA), the Puerto Rico Aqueduct and Sewer Authority (PRASA), and the Puerto Rico Electric Power Authority (PREPA) on the agenda, along with a number of outstanding legal challenges and unfunded pension liabilities still to address. We expect the focus of the Financial Oversight and Management Board (FOMB) to remain the restructuring of COFINA and Commonwealth-guaranteed obligations as these represent the largest portion of the Commonwealth’s total outstanding debt, not including unfunded pension obligations, and smaller easier to restructure agencies.

We have hit some important milestones in 2018 and think that 2019 will bring more. We still believe that carefully selected insured paper can offer terrific value for clients at tax-exempt yields north of 4%. We do not recommend blindly buying insured paper but instead carefully researching individual issues.

Shaun Burgess
Portfolio Manager & Fixed Income Analyst
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