Nearly two years after passage of the Puerto Rico Oversight, Management, and Economic Stability Act, bondholders may face two or more additional years before bond payments resume.

At a Dec. 20, 2017 Title III bankruptcy hearing chief mediator Barbara Houser said that her goal was “confirmable plans of adjustment in 2018.” However, on May 23 Oversight Board Executive Director Natalie Jaresko said she expected that it would take 12 to 18 months before the board submitted a plan of adjustment.

Natalie A. Jaresko, executive director, Financial Oversight and Management Board for Puerto Rico.
Last week Oversight Board Executive Director Natalie Jaresko said she expected that it would take 12 to 18 months before the board submitted a plan of adjustment. Aaron Weitzman

Puerto Rico attorney John Mudd, in his Control Board Watch blog, said he expected it would take a year or more for the judge to confirm the plan of adjustment, possibly taking the bond bankruptcy process beyond Puerto Rico’s November 2020 gubernatorial elections.

This delay would add to a process some participants already have found slow.

“The passage of PROMESA two years ago created a framework for restructuring Puerto Rico’s debts and reviving its economy,” said Matt Rodrigue, lead financial advisor for the COFINA Senior Bondholder Group. “Unfortunately, the process has not progressed as quickly as many had expected back when the law was enacted.”

President Barrack Obama signed PROMESA on June 30, 2016. The White House announced membership of the Puerto Rico Oversight Board on Aug. 31, 2017.

The board certified a 10-year fiscal plan for Puerto Rico on March 13, 2017. It put Puerto Rico’s central government into bankruptcy on May 3, 2017. It certified a revised fiscal plan for Puerto Rico through fiscal year 2023 on April 19, 2018.

“There has been limited progress at least from what is available to the public and in some ways, I believe the situation is worse," said Joseph Rosenblum, director of municipal credit research at AllianceBernstein.

“I have no sense of how some of the numbers in the plan were derived; think the board has been somewhat one sided; see no specific steps to economic turnaround (which is fundamental); have seen millions spent on legal fees and more to come; and there have been a few legal decisions that can threaten portions of the muni market,” Rosenblum continued.

Mudd said the Oversight Board has failed to deliver. Since the passage of PROMESA, “little to nothing has been achieved. Congress gave a mandate that the board negotiate a restructuring with bondholders, reform Puerto Rico’ bloated government and return Puerto Rico to market access. None of these three goals have been achieved.”

“Rather, the board and government have played a lot of games around transparency." They have hidden the government’s financial situation and spent a lot of money wastefully on advisers in order to get a federal Community Disaster Loan. Since the government has too much money, this won’t happen, Mudd said.

“They also want to shaft the bondholders so they hide financials,” Mudd added.

The delay on the completing the Title III process, in particular, is key because there’s reason to believe bondholders won’t be paid until it is completed.

Jaresko was asked on May 25, “When does the Oversight Board expect Puerto Rico’s central government to begin to start paying at least some of its debt again?”

She responded, “Negotiations and mediation regarding the creditors is ongoing. Once a plan of adjustment is presented and approved by the court, the debt payments will be set.”

Municipal bankruptcy attorney James Spiotto said unsecured debt generally isn't paid until the confirmed plan of adjustment or court approved settlement. "Public debt that is ‘secured,’ having a pledge of revenues or security for payment such as special revenues or statutory lien, can receive payment during the insolvency proceeding before a confirmed plan or settlement,” he added.

The special revenue bonds are not being paid right now because of rulings from Title III Judge Laura Taylor Swain. This could change if either a higher court overrules Swain or if the board chooses to start paying them. Given Jaresko’s statement, the latter development is unlikely.

If bond payments don’t resume until a plan of adjustment is confirmed, it would leave holders of Puerto Rico bonds in the unusual situation for a municipal bankruptcy of going for perhaps four or more years without debt payments. Puerto Rico stopped paying the Public Finance Corp. debt on Aug. 3, 2015 and it defaulted on its general obligation debt on July 1, 2016.

The four biggest municipal bankruptcies prior to Puerto Rico – Detroit; Jefferson County, Alabama; Orange County, California; and Stockton, California – all took less time than Puerto Rico’s bankruptcy seems destined to take. Detroit took 17 months, Jefferson County lasted 25 months, Orange County was 18 months, and Stockton went on for 32 months.

The process has been slowed, Spiotto said, because of “too much litigation of positions and too little negotiation and resolution of issues so far and that has to change in order to reach a doable plan of recovery.”

Some observers, including Jubilee USA Network executive director Eric LeCompte and Council on Foreign Relation Senior Fellow Brad Setser, said the bankruptcy’s progress was reasonable considering the impact of Hurricanes Irma and Maria.

PROMESA “gave Puerto Rico some breathing space by allowing for a debt payment moratorium and preventing creditor litigation," LeCompte said. "PROMESA allowed Puerto Rico to default and made it disadvantageous for new predatory creditors to buy the debt. Finally, the legislation created a super bankruptcy process that is capable of restructuring all of Puerto Rico’s debt.”

LeCompte said PROMESA is the “first comprehensive debt restructuring process since the 1953 London Accord that restructured all of Germany’s debt.” He explained that by this he meant that it was the first time since the London Accord that both state-level and local government level debt was simultaneously restructured.

Rodrigue, representing the COFINA Seniors, said, “We hope now the tide is finally turning, given widespread recognition that economic activity on the island has materially outperformed projections – even with the devastation caused by Hurricane Maria – and creditors have advanced settlement proposals for COFINA’s Title III case.”

However, several observers said the fiscal plans that ultimately came from PROMESA’s passage were negative. The Oversight Board adopted an earlier version in March 2017 and a substantially modified version in April 2018.

“Unfortunately, the Oversight Board again [with the April 2018 plan] formulated a fiscal plan without appropriate transparency of information and assumptions, and without collaboration with creditors,” said Assured Guaranty Senior Managing Director Robert Tucker. “In addition to violating many of PROMESA’s most significant statutory requirements, the revised fiscal plan violates the U.S. Constitution by substantially impairing the contractual rights of creditors and by depriving them of property without just compensation or due process of law.”

Setser and LeCompte were critical of the plan from a perspective opposite of Assured Guaranty. “The certified fiscal plan is based on quite optimistic assumptions about Puerto Rico’s capacity to continue to grow once federal reconstruction aid tapers off,” Setser said. “There is a substantial risk that austerity will prove more painful than the board forecast, and Puerto Rico’s recovery will be less robust than the fiscal plan forecasts. Any future debt restructuring should account for this risk.”

James Spiotto

Cumberland Advisors Portfolio Manager Shaun Burgess was positive about the fiscal plan.

The “plan proposes some substantive changes which I think the commonwealth desperately needs,” Burgess said. “The biggest challenges are going to be implementation and execution as well as staying on what may be a very unpopular path from a political standpoint.”

The commentators generally said that the most recent fiscal plan’s section on debt won’t be the key to determining how much debt will be paid. This suggested a figure around 19% of central government debt would be paid.

Setser said the plan pointed to Exhibit 82 of the April fiscal plan that projected $1.42 billion of surplus available before the payment of debt in fiscal year 2023. This is the equivalent of 53% of all debt due in the year. He said money available for debt service would likely increase to $2 billion a year. “That kind of primary surplus (funds available for debt service) should be more than sufficient to generate a deal for the tax supported debt.”

LeCompte said he thought that Exhibit 82 of the plan suggested that 40% of the debt due would be paid through fiscal year 2023.

Burgess said that since the holders of Government Development Bank debt had managed to get 55 cents on the dollar in their certified deal, general obligation bond holders should expect something similar. However, he said Swain’s ruling on who owns the sales tax revenue may greatly affect this.

Mudd said that several adversary proceedings in the Title III case may have a decisive impact on the outcome of the case, including those filed by Aurelius, UTIER, Pinto Lugo, and Assured Guaranty.

Observers were also divided on whether the board had taken enough advice from outsiders. Mudd said, “The board did not ask for anyone’s opinion on the first fiscal plan and then when mediators suggested they do, they had a round a discussions for the second fiscal plan but did not act on the suggestions.”

Burgess was more nuanced: “As an outside observer I do not think they have done the best job in taking outside input but they also have to deal with competing interests within the bounds of an incredibly complicated situation.”

The observer furthest from the bondholders, LeCompte, saw things completely differently.

“In many ways the board has tried to solicit input. My concern is that some creditors seem to have too much influence on the process and there has been a failure from the board to truly understand the post hurricane situation on the ground. Because of this lack of understanding, they passed a fiscal plan that fails to put Puerto Rico’s people first.”

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