Puerto Rico's resistance to the Oversight Board is high on the list of potential hurdles as the territory's debt restructuring enters its third full year.
Analysts and participants in the biggest-ever municipal restructuring expect Gov. Ricardo Rosselló to continue to resist austerity measures, though some dismiss his rhetoric as mere political posturing. The economy, the pace of the distribution of disaster money following 2017's hurricanes, and pending court rulings may be more significant factors in bondholders' eventual recovery on more than $70 billion of debt.
Puerto Rico Attorney John Mudd said in an article on his professional website that in May or June, he expected “another titanic struggle will arise between the board and the government on pensions” when the board will insist on a 10% cut to funding for government pensions.
The governor has repeatedly stated he will not cut workers’ pensions. “The problem is that the government is paying $2.25 billion every year for pensions because the fund ran out and these are unsecured creditors,” Mudd said.
One Puerto Rico bondholder sees relations between the governor and the board differently, however. Looking at precedent and the coming year, “the takeaway is that the passivity of the Oversight Board, the mediation team, the judge, the Congress and [the] administration is simply coddling the rogue Rosselló administration," the bondholder said. The administration "is far more interested in political patronage towards reelection than restoring [the] credibility of Puerto Rico and its drain on the federal coffers.”
Analysts disagree about where the island’s economy will go this year.
The bondholder said “the fundamental economic conditions are undeniably positive [in comparison] to bond prices” and “the local economy continues to outperform the made-up fiscal plan.”
On the other hand, Advantage Business Consulting President Vicente Feliciano said, “The most important subjects going into 2019 are the slowdown in the Puerto Rico economy at the tail end of 2018 and the slow pace of the federal disaster recovery transfers.” The transfers are happening slower than the Oversight Board had projected, he said.
“Therefore, expect the economy to contract over the first quarter of 2019,” Feliciano said. “As to the rest of 2019, the economy should stabilize as federal transfers for permanent work begin to flow.”
With federal transfers expected to level off beyond 2020, “any growth in the Puerto Rico economy beyond 2019 would have to rely on structural reforms such as the privatization of PREPA. This is critical in terms of Puerto Rico’s debt capacity.”
Another analyst pointed to the importance of the United States economy. Thanks to FEMA aid Puerto Rico could weather a mild recession in the mainland, said Axios Advisors managing partner Triet Nguyen. “We believe the control board’s fiscal plan is already based on very, if not overly, conservative economic growth assumptions.”
While several above-mentioned analysts spoke of the positive role of the federal government, through its post-hurricane aid, in 2019, Evercore Director of Municipal Bond Research Howard Cure worried about shifts in Congressional opinion. Among the new House of Representatives Democratic leadership, “Questions have arisen about whether austerity measures exacerbate Puerto Rico’s economic malaise.” The U.S. House Natural Resources Committee could have hearing on the issue, he said.
Cure made clear that he supports the board-supported budgetary austerity.
Tom Sanzillo, director of finance with the Institute for Energy Economics and Financial Analysis, also emphasized the importance of management. “There is a high risk of slippage in Puerto Rico’s fiscal plan as competent professional staff is in short supply and political hirings remain unacceptably high.”
About 21 months after the board filed for Title III bankruptcy for the central Puerto Rican government, the legal process for many of the Puerto Rican debts is either nearing conclusion, nearing a beginning, or approaching decisive turning points.
Rulings are expected in the next few months for two cases that could upend the bankruptcy process. Investment firm Aurelius is arguing that the steps by which the U.S. Congress and President selected the Oversight Board members were contrary to the U.S. Constitution. While Title III Judge Laura Taylor Swain ruled against the firm, it appealed the decision to the U.S. Court of Appeals.
When the appeals court judges heard arguments in December, observers said they seemed inclined to overturn Swain’s ruling.
The appeals court may release a decision in January or February. A decision for Aurelius could simply lead to a delay in the bankruptcies or it could mean the undoing of all the board’s actions, including the apparently settled Government Development Bank restructuring and nearly settled Puerto Rico Sales Tax Financing Corp. (COFINA) restructuring. Or it could lead to some intermediate result.
Hedge fund Altair has filed a claim in the U.S. Court of Federal Claims that the federal government is responsible for reimbursing investors for any cuts to the bond values resulting from the Puerto Rico Oversight, Management, and Economic Stability Act. The judge has indicated her sympathy for the position but hasn’t yet ruled on the matter. This ruling may also come this winter.
Analysts disagreed on the likelihood that the plaintiffs would prevail in these cases.
Mudd said he thought the appeals court would reverse Swain’s Aurelius opinion. If that were to happen, the board would seek the U.S. Supreme Court’s review of the case. If the court were to review the case, “we would have PROMESA essentially paralyzed until June 2019,” Mudd said in his website post.
As for the Altair case, “I think plaintiffs have a very valid point and the U.S. may end up paying whatever Puerto Rico does not pay,” Mudd said in an email.
The above-mentioned bondholder disagreed. “No one believes the federal government will be found responsible for any impairments to contracts — whether to pensions or bondholders — and, should Aurelius prevail, the board will simply be reconstituted in a compliant manner and re-validate the board’s previous decisions,” he said.
Unless the Aurelius case leads to a freezing or upending of all the bankruptcies, there will be a variety of important legal advancements for the bankruptcies in the coming year. Nearest and perhaps most important, Swain is scheduled to hold a hearing on the COFINA plan of adjustment on Jan. 16. As of Jan. 3 six parties had filed objections to the plan.
Sanzillo said creditors and interest groups have taken actions leading to too much conflict and division and not enough consensus. The Altair and Aurelius cases make this point, he said. “Even if successful, both suits would simply create legal victories that could never be financed by the government. Federal funds or forfeited bond principal need to be put to work to reinvest in Puerto Rico. The private and public sector can work together going forward but not if current resources and future profits are dedicated to pay past debt.”
The U.S. government had filed a statement of its intention to file an objection but requested more time. Swain gave the U.S. until Jan. 4, two days beyond the normal deadline. She may extend the U.S. deadline.
The board has said it may file bankruptcies for the Puerto Rico Aqueduct and Sewer Authority and University of Puerto Rico this summer.
Sean Burgess, portfolio manager at Cumberland Advisors, said in a post on Jan. 3 that along with PRASA, he expected restructurings of the Puerto Rico Highway and Transportation Authority and Puerto Rico Electric Power Authority debts. Cumberland owns insured Puerto Rico debt. Burgess said despite these developments, he expected the board to focus on restructuring the central government and COFINA debt.
Some bond insurers have filed an adversary complaint seeking the power to appoint a receiver for PREPA.
“Contrary to the previous time that the board was clear in its opposition, [the board] has said nothing,” Mudd said on his site. “I think it is negotiating with [the Fiscal Agency and Financial Management Authority] and the bondholders to give them more money in an attempt to reach agreements with them to be able to establish an adjustment plan for PREPA. However, there are rumors that the board is seriously considering the appointment of this ‘receiver’ given the mismanagement in the PREPA.”
Nguyen said, “Looking ahead to 2019, we expect the valuation of Puerto Rico debt to continue to converge toward ultimate recovery values, as the debt restructuring process continues to move along.”
Mudd said that the board has until May 2019 to file suit against entities that have broken laws or regulations connected with debt issuance or otherwise. The board has hired outside counsel to possibly file cases.
In August outside firm Kobre & Kim submitted a report to the board on the history of the island’s debt problem. The report indicated that statutes of limitations may be major problems for the filing of cases against private firms or government entities.
