The second quarter of 2019 has been a busy one for the Commonwealth of Puerto Rico. Milestones mired in controversy, optimism dampened by frustration, and increasing uncertainty have all been part of the experience.
In what may be one of the most significant milestones to date, an agreement was unveiled between the Federal Oversight and Management Board (FOMB) and creditors holding $3 billion of uncontested debt. The $35 billion restructuring agreement encapsulates $18 billion in general-obligation and Commonwealth-guaranteed debt and $16 billion in unsecured creditor claims. Although very tentative and likely to go nowhere, the agreement does provide a starting point in what are sure to be very contentious negotiations. Pushback against the plan has been fierce, with claims of inadequate recoveries and a disparate treatment of creditors. Few apart from the FOMB and the negotiating creditors support the agreement. Recoveries range between 23 to 73 cents on the dollar, depending on the issuing authority and the date debt was issued. One of the most interesting points of the plan is that it provides recoveries on debts the FOMB has claimed are invalid and that it is therefore under no obligation to pay. The catch, though, is that creditors must sign on now or risk a court fight where they may receive nothing. We initially viewed the attempted invalidation of what is now $15 billion of outstanding debt as a negotiating tactic. This restructuring agreement validates that view and is tantamount to forcing creditors to negotiate with a gun to their heads.
On a more positive note, the Puerto Rico Industrial Development Company (PRIDCO) reached an agreement in their Title VI restructuring, and the Title III restructuring of the Puerto Rico Electric Power Authority (PREPA) has seen significant advances, with a restructuring agreement reached between the FOMB and a majority of bondholders, including Assured Guaranty. Whether there is enough support for the plan to move forward is questionable, as MBIA remains a holdout. Any plan will almost certainly have to include MBIA, as it holds a significant portion of the utility’s outstanding debt. An approval by the courts and eventual exit from Title III would be a welcome end to what has been a very long fight.
For all the improving economic metrics and progress we have seen, tremendous uncertainties remain. The US Supreme Court has agreed to hear the FOMB’s case seeking to overturn an earlier appeals court ruling that board members were unconstitutionally appointed and to determine whether any decisions FOMB makes until 15 July can stand. Readers may remember that an appeals court found FOMB members to be federal officials and therefore subject to the Appointments Clause of the US Constitution. The FOMB and federal government seek to have the high court validate their status as territorial officials who are therefore appropriately appointed. An unfavorable outcome would mean that progress becomes murky and mired in litigation. A conclusion to the restructuring of the Commonwealth’s outstanding debt has likely been pushed into 2020.
Because of the risks of acceleration, insured Puerto Rican bonds have lagged the tremendous performance experienced in the broader municipal market. We still believe insured bonds can offer value when you do your homework and pick appropriate structures. We continue to find value opportunistically when supply is available. It remains increasingly important to know what you are buying and to understand the risks of debt acceleration within the insured space.