Commonwealth Shuffles Options as Summer Debt Cliff Looms
Collective Action Clauses Present a new Alternative
The clock continues to tick on a Puerto Rico government that is quickly approaching its fiscal “D-Day” early this summer.
The debate remains open on what exactly the “D” stands for in the context of World War II, but for Puerto Rico, it could very well stand for debt or default, beginning on May 2, when roughly $422 million is owed by the financially battered Government Development Bank (GDB).
The Alejandro García Padilla administration has already anticipated that additional emergency measures, which could affect creditors’ rights, are in the cards, as the island hits a $2 billion-plus debt-service wall this summer. There is simply not enough cash to pay this amount in full and there are no more fiscal tricks to pull out of the hat, according to the commonwealth government.
The administration continues to push for congressional action over access to a debt-restructuring mechanism, preferably a regime broader than Chapter 9 of the U.S. Bankruptcy Code, which would only cover public corporations’ debt. Yet, intense lobbying by competing interests has resulted so far in a stalemate on Capitol Hill, as Congress continues to be divided on how to act over the Puerto Rico issue.
Nevertheless, two sources confirmed to Caribbean Business that another possibility—the use of collective action clauses (CACs) to bind holdout creditors—has been brought to the table and is being discussed in Washington, D.C., as another alternative to solve the island’s debt crisis.
House Speaker Paul Ryan (R-Wis.) has said the lower chamber aims to come up with a solution to the Puerto Rico issue before the end of March, but Republicans in the upper chamber have yet to commit to a similar deadline, although some majority senators have said they are moving forward on several initiatives. The majority GOP in Congress continues to lean toward greater federal fiscal oversight and less debt-restructuring powers, if any.
Collective action clauses
CACs allow majority creditors to agree to a debt-restructuring plan that would become binding on all creditors, eliminating potential “holdouts.” While sources added that sides are willing to entertain the idea, legislation would be required to retroactively place CACs into existing Puerto Rico bond documents.
Puerto Rico has already presented creditors a comprehensive debt-restructuring proposal—a voluntary debt-exchange offer that impacts roughly $49 billion of the island’s $70 billion debt, and initially calls for “haircuts,” or reductions to principal, in the vicinity of 45%, depending on the credit.
“I think we will achieve a consensual offer with the majority of creditors. But we need a mechanism to bind holdouts,” Jim Millstein, the commonwealth’s lead restructuring adviser, recently said during a panel discussion at the Puerto Rico Investment Summit.
The implementation of CACs could allow the government to bind holdouts if it reaches a voluntary debt-restructuring deal with a majority of its creditors. Moreover, the Puerto Rico Electric Power Authority would be able to bring the 30% of its creditors that are still not part of the utility’s debt-restructuring deal.
One of the sources added that the government’s Plan A continues to be achieving a broad restructuring regime from Congress, although commonwealth advisers have been presented with the possibility of using CACs, which already enjoy support from some creditor groups, in a bid to avoid the possibility of providing Puerto Rico greater bankruptcy powers.
Potential debt moratorium
Declaring a debt moratorium and even seeking relief under existing receivership laws for some public entities have been mentioned among the range of emergency measures that the government could implement if the island fails to promptly solve its fiscal woes.
For instance, La Fortaleza confirmed last week that local legislation to declare a moratorium on the payment of future debt service is already in the works, and would be presented if needed.
Following the GDB’s $422 million payment in May, the commonwealth faces a $780 million payment on its general obligations (GOs) on July 1. Back in December, García Padilla ordered the use of clawback clauses, which allowed the government to redirect previously pledged revenues to pay for its GO debt. But even with the clawbacks, the commonwealth expects it will not have sufficient funds to meet this payment, according to a recently released draft of fiscal 2014 financial statements.
Meanwhile, payments under the Highways & Transportation, Infrastructure Financing and Convention Center District authorities could also be facing potential defaults on their debt-service payments due July 1. Revenues pledged to these entities were subject to the governor’s clawback order.
GDB on brink of insolvency
The GDB continues to see its fiscal health quickly deteriorating, while it is dangerously running out of liquidity, hindering its day-to-day operations. What’s more, liquidity levels during the final stretch of fiscal 2016, which ends June 30, “may be insufficient to operate in the ordinary course and honor its depositary and financial obligations in full,” according to the draft of the financial report.
“If [the] GDB were to be placed in receivership or if its liquidity falls below a level necessary to operate in the ordinary course, the Commonwealth and its instrumentalities may have limited access to their funds deposited at [the] GDB, which could in turn affect the provision of essential government services,” the document notes.
Because of the importance of the bank for the commonwealth government, the administration said it “may amend the Organic Act of [the] GDB or enact new emergency legislation (subject to applicable constitutional limitations), which could include a moratorium” on its future debt payments.
The recently released 370-page draft of Puerto Rico’s financial statements for fiscal year 2014 reiterates the doomsday scenario for the island if it fails to promptly restructure a large chunk of its $70 billion debt. The latter figure tops more than $110 billion when taking into consideration the estimated $40 billion in unfunded liabilities of the commonwealth’s pension systems.
Amid a severe cash crunch, the bank could be unable to comply with its legal reserves before the end of the fiscal year. The GDB must maintain reserves equal to 20% of its demand deposits. This scenario could prompt a request to the Puerto Rico Treasury secretary for a three-month waiver to these requirements. On Dec. 1, 2015, the GDB board had authorized management to request the waiver, if needed.