Puerto Rico Outlines 46% Haircut Proposal

Puerto Rico released details of a proposal to restructure the commonwealth's debt that would reduce the burden by 46 percent under a bond exchange, making negotiations with creditors public as it seeks to convince U.S. lawmakers that its obligations are unsustainable.

The commonwealth's tax-supported debt would be reduced to $26.5 billion from $49.2 billion and annual debt payments would be capped at 15 percent of government revenue, according to a statement Monday from officials of the island. Creditors would also get the opportunity to recover the principal amount of their investments under the proposal.

"Ultimately you've got to believe that there's compromise somewhere between 46 percent and something less than that," said Matt Dalton, chief executive officer of Rye Brook, New York- based Belle Haven Investments, which oversees $3.8 billion of municipal bonds, including Puerto Rico securities. "They've put the offer out there, now it's time to work it up from there."

Puerto Rico and its agencies piled on debt by borrowing for years to fill budget deficits. Governor Alejandro Garcia Padilla in June said he would seek to reduce the island's obligations by asking investors to take losses on their securities or wait longer to be repaid. A Puerto Rico authority defaulted for the first time in August and the administration in December began redirecting revenue used to repay agency debt to instead pay general-obligation bonds, forcing a second authority to default Jan 4.

Garcia Padilla has asked that the commonwealth and its agencies be given access to bank protection so that officials may reorganize its debt. Republicans in the U.S. House of Representatives are holding a hearing Tuesday to explore the case for setting up a Puerto Rico financial control authority.

Restructuring Proposal

Puerto Rico's benchmark general obligations with an 8 percent coupon due in July 2035 changed hands Monday at 71.1 cents on the dollar, down from 72.1 cents on the dollar on Jan. 29, data compiled by Bloomberg show.

The restructuring proposal asks that creditors exchange existing securities for two new securities: a "Base Bond," with a fixed rate of interest and amortization schedule, and a "Growth Bond," which is payable only if the commonwealth's revenue exceeds certain levels. The new securities would also provide creditors with enhanced credit protections, such as a commonwealth guarantee and statutory liens and pledges with respect to certain revenue.

The $49.2 billion of tax-supported debt would be exchanged into $26.5 billion of "Base Bonds" and $22.7 billion of "Growth Bonds." Interest payments on the Base Bonds would begin in January 2018, rising to 5 percent per year by 2021, when principal payments would begin. The Growth Bonds would be payable only to the extent the commonwealth's revenue exceeds its current baseline projections as a result of real economic growth on the island.

Growth Bonds

By sharing in the island's economic recovery, creditors would have the opportunity to recoup the principal amount of their investments, the commonwealth said in the statement. The first payments, if any, would be made beginning in the 10th year after the close of the exchange offer. In any given year in which the Growth Bond would be payable, creditors would receive payment of up to 25 percent of such revenue.

The exchange offer is predicated upon a number of key assumptions, including very high participation levels from the creditor groups as well as the federal government maintaining at least its current percentage levels of support for the commonwealth, according to the statement. If very high participation levels cannot be achieved or the federal government allows the level of support for Puerto Rico to materially decline, then the terms of the exchange offer will have to be revisited and creditor recoveries adjusted accordingly, the commonwealth said.

Bloomberg News
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