The Puerto Rico Oversight Board rejected Gov. Ricardo Rosselló's proposed budget and certified a consensual agreement for the island's Government Development Bank, as bondholders battled for position in the biggest municipal debt restructuring.

The Oversight Board, using its authority over the budget process to enforce austerity measures that include a reduction in private and public sector labor benefits and public sector pensions, sent the budget back for revisions by Tuesday. The governor, who is resisting the Oversight Board’s plan, had submitted a budget for fiscal 2019 with zero debt payment.

The Oversight Board on Friday certified the Government Development Bank’s amended Restructuring Support Agreement under its Title VI authority. The GDB had $4.2 billion in bond debt outstanding.

The amended agreement results in a simplified structure whereby GDB’s financial creditors will exchange their claims for only one tranche of new bonds at an upfront exchange ratio of 55%, the Oversight Board said. "In addition to the relief provided to the municipalities under the deal, the issuer of the new bonds will receive additional assets in the restructuring," the announcement said.

Patrick Early, managing director and chief municipal analyst for Wells Fargo Advisors
Patrick Early, managing director and chief municipal analyst for Wells Fargo Advisors Brian Tumulty, The Bond Buyer

“Agreement with the Government Development Bank’s creditors is an important accomplishment toward achieving PROMESA’s goals,” Natalie Jaresko, executive director of the oversight board, said in a press statement. “The amended RSA demonstrates the board’s commitment to achieving consensual restructuring agreements where possible.”

The RSA establishes two pools of bond claims, one for claims guaranteed by the Commonwealth and one for non-guaranteed claims, according to the oversight board.

The amended RSA will treat Puerto Rico Municipality Depositors and on-island GDB bondholders equally as general unsecured creditors. It also provides a consensual restructuring of a substantial portion of GDB’s liabilities, including GDB public bonds, deposit claims by municipalities and certain non-public entities and claims under certain GDB-issued letters of credit and guarantees.

The announcement said that “in exchange for releasing GDB from liability relating to these claims, the claim-holders will receive new bonds to be issued by a new entity.”

“GDB will transfer to the issuer its entire municipal loan portfolio, certain real estate assets available for sale, proceeds, among other assets, of certain public entity loans and a certain amount of cash,” the announcement said.

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A key battle that remains unsettled is whether $17.5 billion in bonds issued by the Puerto Rico Sales Tax Finance Corp. and referred to by the Spanish acronym COFINA must be repaid from sales and use tax as originally pledged or can be used for other government purposes.

COFINA is being debated in federal bankruptcy court, where Judge Laura Taylor Swain of the Eastern District of New York heard oral arguments last month.

“There’s the potential for some market disruption depending on what the judge comes up with,” Patrick Early, managing director and chief municipal analyst for Wells Fargo Advisors, said in an interview Friday.

He delivered the same message at the annual meeting of the Government Finance Officers Association in St. Louis several days earlier.

Puerto Rico has a local statute that pledges sale tax revenue as the property of COFINA but the commonwealth’s constitution gives the territorial government a right to all revenue.

“On the one hand, you have this statutory lien that has been enforced in some bankruptcies,” Early said. “This case has the potential to change how a statutory lien is viewed in bankruptcy. That’s the level concern but I’m not sure how many conditions are the same in other places. Where else do you have a constitutional protection and then revenues carved off through a statutory lien? Where else do you have a bankruptcy type process set up through legislation from the U.S. Congress?”

John Hallacy, a contributing editor at The Bond Buyer who spoke on the same panel at GFOA as Early, said that the COFINA case involves “the sanctity of the first lien and pledge concept.”

“The pledge in COFINA was not court tested at inception that is a clear weakness,” Hallacy said. “We do not really desire to devolve into a scenario where all revenue pledges will need to be court tested. The market could not function as smoothly in that scenario and we would be a lot more inefficient. Yields on revenue bonds would need to adjust to clear the market to reflect increased risk either real or perceived.”

Matt Rodrigue, financial advisor to the COFINA Senior Bondholder Coalition at Miller Buckfire & Company, said “the highest recoveries in restructurings typically go to holders of senior secured debt backed by sufficient collateral.”

“If COFINA creditors’ rights are respected, it will help ensure tax-backed, secured municipal financing remains viable for state and local governments,” Rodrigue said. “The alternative may remove a much-needed arrow from their quiver as more municipalities confront fiscal challenges.”

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