Bond Exchange Seeks to Trade Value for Shared Pain
The bond exchange the Puerto Rico government is proposing to holders of $49.2 billion of debt will have an impact on local bondholders who have a nominal value of around $15 billion in bonds.
Economist Vicente Feliciano said a restructuring will not alter the portfolio value of the bonds, but it will change the amount the bondholders receive in interest. He said that in a restructuring process, the nominal value, or face value, of the bonds is changed.
For example, if an investor buys $10,000 in Government Development Bank (GDB) bonds, the nominal price is $10,000, but if these same bonds were later trading at 28 cents to the dollar, then the market value of the bonds is $2,800 and the investor has lost $7,200, he indicated.
As long as a particular bond issuer does not default or a bond is not restructured, the interest paid by the issuer (as in the example of the GDB) is on the nominal value of the bonds and not on the market price.
“Investors will be paid less in interest, but there will not be a significant reduction in the value of the portfolio compared with present market value,” said Feliciano, who is the president of Advantage Business Consulting.
To facilitate an orderly restructuring of its debt, the commonwealth government has designed an exchange offer to holders of its $49.2 billion of tax-supported debt. The restructuring contemplates that creditors will agree to exchange their 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 if the commonwealth’s revenues exceed certain levels. Under this proposal, the $49.2 billion of tax-supported debt would be exchanged for $26.5 billion of new mandatorily payable “base bonds” and $22.7 billion of growth bonds.
The “haircut” for affected creditors could be in the vicinity of 45%, according to estimates. According to government documents, the proposed structure contemplates no interest payments until fiscal year 2018 and no principal payments until fiscal 2021, which would provide the commonwealth with the necessary debt-service relief to be able to continue providing essential services to residents, pay stretched suppliers and taxpayers, rebuild depleted cash resources and properly fund the retirement systems.
Additionally, the new securities are projected to provide the commonwealth with a sustainable level of debt service over the long term, as total debt service will only increase to the extent that the commonwealth’s revenues grow, the document reads.
To ensure Puerto Rico’s compliance with an agreed upon and approved exchange plan, as well as the government’s Fiscal & Economic Growth Plan (FEGP), the commonwealth has passed legislation establishing a local fiscal-control board that would ensure implementation of its commitments embedded in the restructuring plan and the FEGP.
However, to the extent a broad federal restructuring regime is made available, then oversight may be enhanced through a federal fiscal-control board. This issue is now under discussion in the U.S. Congress.
The new securities in the Puerto Rico government’s exchange offer are slated to provide creditors with improved credit protections such as statutory liens and pledges on certain revenues and a commonwealth guarantee. Further, the structure provides creditors with the opportunity to recover the full face amount of their bonds if the commonwealth’s revenues appreciate as a result of real growth in the Puerto Rico economy. Creditor recoveries on the growth bond will depend on the growth rate of Puerto Rico’s revenue collections—if the commonwealth economy achieves long-term economic-growth rates.