August has brought welcome news for the Commonwealth of Puerto Rico and for creditors eager to see a resolution to the bankruptcy process that started more than two years ago with the passage of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA).
There is now a restructuring agreement for Sales Tax (COFINA) bondholders and a court decision validating the powers of the Fiscal Oversight and Management Board (FOMB), as well as a restructuring proposal for the Puerto Rico Electric Power Authority (PREPA), all of which offer reason for optimism. These developments join the restructuring of the Government Development Bank (GDB), along with better-than-expected economic conditions.
When observers look back at the bankruptcy of Puerto Rico, they will point to the restructuring of COFINA as a major milestone. The formal agreement between the FOMB, the government of Puerto Rico, and both senior and junior creditors as well as monoline insurers marks a momentous step forward. It follows months of court-supervised mediation efforts. As part of the arrangement, COFINA bondholders have agreed to give up a portion of sales tax revenues to the Commonwealth: 53.65% of the Pledged Sales Tax Base Amount on a “first-dollar” basis would back new COFINA securities, while 46.35% would flow through to the Commonwealth. The disclosed term would see existing bondholders receive new senior lien bonds secured by the 5.50% sales-and-use tax (SUT), with recoveries of 93% for senior bondholders and 56% for subordinate bondholders. The accrued COFINA interest currently held in escrow will go to COFINA bondholders, with final disbursements between senior and junior bondholders still to be determined. In light of the circumstances, we believe this is a good outcome for bondholders as well as the Commonwealth, as the deal provides approximately $17.5 billion in debt-service savings. Execution risks do remain, and terms can change, so this is still far from a done deal.
In addition to the COFINA agreement there was Judge Swain’s August 7th decision affirming the authority of the FOMB over the Commonwealth’s budget and fiscal plan. The Commonwealth had challenged the powers of the FOMB for a number of reasons, including budgetary actions. As the judge wrote in her decision, “The power bestowed on the oversight board by Section 205(b)(1)(K) of PROMESA allows the oversight board to make binding policy choices for the Commonwealth, notwithstanding the governor’s rejection of Section 205 recommendations.” She held that while the board has the power to implement a budget or policy, it does not have the “power to affirmatively legislate.” The decision is a blow to the Commonwealth that will likely be challenged on appeal. The decision is significant, as it affirms the FOMB’s powers and will hopefully clear the road to the restructuring of the Commonwealth’s general-obligation debt at some point in the future.
Following congressional hearings and well-publicized turmoil involving PREPA’s top post, a tentative deal between the Commonwealth, the FOMB, and creditors holding roughly $3 billion of PREPA debt was also announced. Under the terms, creditors would receive two series of bonds. The first tranche would provide a recovery of 67.5%, and the second tranche would be a “hope” note at a recovery of 10%. Combined, this would be a total recovery of 77.5%, assuming the “hope” notes pay off. While not the 85% recovery outlined by the previous restructuring agreement that the FOMB scuttled, it is at least in the parking lot if not the ballpark. The terms have not been sufficient to entice monoline insurers on board, so we will wait to see how the situation develops.
Prices of both insured and uninsured debt have risen in accordance with these developments. Uninsured debt, specifically that of COFINA, has seen some of the most dramatic price increases. We still believe carefully selected insured paper offers value, and we continue to take advantage. As with most things in Puerto Rico, though, we view new developments with a grain of salt. Execution risks remain, but at least the ball is rolling. The path is now a little clearer, and the end is a little closer, but there is still a long journey ahead.
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