Muni Investors Tout Ways to Ease Puerto Rico Pain

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Puerto Rico is getting plenty of free advice from the buy-side community, with $72 billion of debt at stake and restructuring plans expected from the territory's government in coming months.

Some municipal analysts and strategists interviewed in the past week urged the commonwealth to step up pressure on U.S. congress to pass a bill allowing Chapter 9 bankruptcy for the island's public corporations, while others focused on the need for fiscal and economic reforms. These experts, who represent or advise funds that invest in municipal debt from Puerto Rico and elsewhere, also argued that minimizing losses for bondholders is the key to any future recovery plan.

"Judicial decisions that place an overly heavy hand on bond investors will likely discourage future bondholders at a time when they will need them for reinvigorating the island," said Richard Ciccarone president and chief executive officer at Merritt Research Services.

The buy-side discussion comes as debt problems multiply on the island. Following the default on most of a $58 million payment due Aug. 1 from the Puerto Rico Public Finance Corp., the pricing of a $750 million Puerto Rico Aqueduct and Sewer Authority revenue offering, originally planned for last week has been delayed indefinitely due to market uncertainty.

Gov. Alejandro Garcia Padilla in late June declared the commonwealth's $72.2 billion of public debt to be un-payable given its current levels of economic growth, and named a Working Group for the Economic Recovery of Puerto Rico. The group is due to issue fiscal and economic recommendations at the end of this month. Proposals for debt restructuring may come after the legislature acts on the panel's recommendations. The governor has said Puerto Rico would seek a moratorium on payments.

"The most important step forward is for political leaders in Puerto Rico to get behind a concerted effort to urge Congressional Chapter 9 amendment," said David Tawil, president of Maglan Capital. "In the absence of that, there will not be sufficient momentum in Congress, and, as Congress often does, it will not act until the patient is being wheeled on a stretcher into the emergency room.

"At that point, a lot of time will have been wasted and the situation will be a lot worse than it currently is," Tawil said.

Chapter 9 "would provide for the most equitable, efficient and cost contained process," said Jeffrey Lipton, managing director and head of municipal research at Oppenheimer & Co.

"A systematic adjudication of Puerto Rico's affairs before a third-party, impartial judge would also produce a more balanced result," Lipton said. "Although there is growing traction within Congress to amend the bankruptcy code, we do not see sufficient appetite for a Republican-controlled Congress to open up bankruptcy for Puerto Rico."

Tawil said Congress should facilitate extending Chapter 9 of the Bankruptcy Code to the Puerto Rico public corporations, because "the resulting restructuring efforts could lead to considerable balance-sheet relief and possibly aid economic reform."

He said he currently doesn't own any Puerto Rico debt, but may buy island securities again in the future.

"Without a clear legal framework for restructuring, negotiations among the various stakeholders are less likely to lead to concrete results," Tawil added. "If the law is clear, it provides solid boundaries for negotiations to proceed."

Legislative, economic, and regulatory reforms were on the minds of other municipal experts.

In addition to Chapter 9, "I also would hope to see a financial control board, such as was put in place after the New York City crisis in the 1970s, so that there is true oversight of the government," said Alexandra Lebenthal, president and CEO, Lebenthal Holdings.

Ciccarone spoke of the need for Congressional aid in devising incentives to "jump start" Puerto's Rico's economic base and stem the loss of talent, capital, and opportunity in the commonwealth.

"Chapter 9 is not a silver bullet that can resolve the problems facing the island," said Peter Delahunt, managing director at Raymond James & Associates, calling that option "extremely litigious, expensive, and time consuming."

"It simply allows for a process when consensual agreement is unattainable," and lacks an ongoing remedy for the island's underlying problems, he said.

"Each of the issuers on the island has[its] own individual capital structure, expenditures and revenue sources, yet there is quite a tangled web of related recourse," Delahunt said.

Instead of amending the bankruptcy code, Delahunt suggested Congress intervene and offer other long-term options that would help reduce deficits and benefit the island's economic viability.

He said waiving the Jones Act restrictions, which raise the cost of imported goods on the island, and making permanent the Act 154 excise tax credits would be a viable start.

Additionally, regulatory changes would help alleviate constrained resources, he said.

"It has been demonstrated in fact that [the Puerto Rico Electric Power Authority] could meet its debt obligations with a modest increase to its base rate, while consumers would still pay less than they have this past year due to the significant reduction in fuel costs," Delahunt said.

Delahunt said the island should explore these options before bankruptcy.

"Even if the public corporations - PRASA, PREPA and the commonwealth's Highway and Transportation Authority — were granted the option to access Chapter 9, the agencies would face challenges proving insolvency based on the dedicated revenue support, which could be found difficult to impair.

"There are many opportunities and resources here to work with before investors turn west and begin to follow their intrigue with the opening of relations on the neighboring island of Cuba," Delahunt said.

Lipton agreed that Congress should aid the island's recovery.

"While a debt restructuring is critical, a re-engineering of the Commonwealth's economy is an absolute necessity," Lipton added. "While we do not foresee a wholesale bailout by the U.S. government, we believe that economic revitalization requires contributions from the U.S."

His suggestions included reintroducing tax incentives to boost island commerce and competition among corporations, the reintroduction of Section 936 tax benefits afforded to subsidiaries of U.S. companies operating in Puerto Rico - whose elimination had a "devastating" effect on the island's economy — and an evaluation of and possible exemption from the Jones Act and Federal minimum wage requirements.

"Substantial restructuring of debt will be needed, but just a 'scoop and toss' approach won't do because it will only hamper economic growth and development in the long run," Ciccarone said.

Ciccarone agreed that the evaporation of the island's population and economic base seemed to accelerate when the federal government terminated the Section 936 tax subsidy program and said its return would help stoke the economy.

Others, like Michael Comes, vice president of research and portfolio manager at Cumberland Advisors, believe the commonwealth could rely on its stronger credits for the best possible recovery outcome as well as future market access.

He suggests a restructuring will identify a "fulcrum" security that controls the outcome in the event of bankruptcy — and will likely recover more than others.

"Given the level of stagnation and debt unsustainability in this particular instance it is hard to name such securities as an across-the-board impairment seems likely in order to rationalize the commonwealth's expenditures with its revenue base," Comes said.

"We have heard chatter about across-the-board impairments of 30-40%," he said. "Our thoughts are 20% impairment on general obligation bonds, and 30-40% impairment on Puerto Rico public corporation debt," he said.

Comes - whose firm manages $70.1 million of insured Puerto Rico debt — forecasts that insured Puerto Rico bonds will have a higher recovery than other securities in a restructuring and/or bankruptcy. Bond insurers, he said, ultimately control Puerto Rico's access to capital since they have greater negotiating leverage in a recovery.

"We can say with relative certainty that Puerto Rico credits do indeed have recovery value," Lipton said. "Nobody expects to get back zero cents on the dollar, however, the haircuts are likely to be steeper for those credits that are more loosely secured."

The other primary security class that Comes said will play a major role in aiding the recovery process is Puerto Rico Sales Tax Financing Corp., known as COFINA, because it could be preserved and used as a revenue stream for debtor-in-possession financing, he said.

"Not subject to claw-back provisions in the state's constitution, Puerto Rico is likely to rely on this revenue stream for access to capital in the future," Comes said.

Ciccarone, meanwhile, said the protection of bond holders is key in any future recovery plan.

"Restructuring and reform without accountability is a dangerous path to pursue on a long term basis," Ciccarone said. "Any plan put forward will need to keep skin in the game for all parties who either borrow or lend. That means that any federal guarantee programs of future debt shouldn't provide 100% protection, nor should Puerto Rico taxpayers be given a free ride."

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