GO-Cofina Bondholder Sides Head for Shootout
Editor’s note: This article first appeared in the June 12-18 print issue of Caribbean Business.
A settlement between bondholders of the Sales Tax Financing Corp. (Cofina) and the commonwealth of Puerto Rico in the dispute over ownership of 5.5 percent in sales & use tax (IVU by its Spanish acronym) revenues may be reached before the Aug. 4 deadline imposed by Judge Laura Taylor Swain, despite objections from a group of general obligation (GO) bondholders.
The GOs are objecting to a deal being negotiated by agents representing Cofina and the commonwealth mainly because it prevents them from legally challenging the Cofina structure if it is approved in court. Cofina bondholders, on the other hand, say the deal will be good for Puerto Rico and GO bondholders because the portion of the sales & use tax revenue that goes to the commonwealth will be ensured.
While agents for Cofina and the commonwealth could seek an extension to the Aug. 4 deadline, they could ultimately reach an agreement that would be binding for all sides. The deal would become Cofina’s plan of adjustment and Taylor Swain would have to decide if it is valid.
“Ultimately, the agents have the power to bind the two houses…. We don’t need them [GOs],” a source in the Cofina group said on condition of anonymity because of nondisclosure agreements imposed on the parties.
After Title III bankruptcy proceedings began, the Financial Oversight & Management Board (FOMB) delegated two agents to the negotiations process to settle the dispute between the commonwealth and Cofina bondholders over ownership of sales & use tax revenues because the FOMB was representing both parties in the bankruptcy.
The court agreed with the proposed protocol to settle the dispute over the 5.5 percent sales & use tax. The designated Cofina agent is Bettina Whyte and the commonwealth agent is Luc Despins, who represents the Unsecured Creditors Committee (UCC) in Title III proceedings, of which GO bondholders are members.
Settling the dispute over ownership of the sales & use tax is an important step to determine the distribution of assets as part of the Title III bankruptcy case filed under Promesa and is the matter that is holding up debt adjustments, say observers who see a deal as a move that would open further negotiations among other creditor constituencies.
While agents were negotiating a settlement to the dispute, creditors from Cofina and the GOs revealed on May 14 details of a separate proposed creditor settlement to the dispute, which the island’s FOMB rejected, contending it was too expensive because it did not offer the commonwealth any “meaningful debt relief,” sources said.
The creditors’ agreement contemplated retention of the 5.5 percent sales & use tax through a newly formed securitization trust, which would have taken ownership of the IVU through the effective date of the Cofina plan of adjustment plus 40 years. Under the defunct proposal, Cofina bondholders would have received trust certificates entitling them to 52.5 percent of IVU cash flows plus 52.5 percent of the cash held by Bank of New York Mellon. Participating GO bondholders would have received 46.2 percent of IVU cash flows plus 46.2 percent of Bank of New York Mellon cash. Meanwhile, holders of other commonwealth general unsecured claims, up to an allowed claim amount of $500 million, would have had the right to tender their claims to the trust and receive up to 1.3 percent of future 5.5 percent sales & use cash flows and 1.3 percent of Bank of New York Mellon cash.
While other sources Caribbean Business consulted said the oversight board privately hailed the deal, others said the FOMB rejected it because, as a necessary condition to the deal, the GOs still wanted to keep a claim against the commonwealth for the revenues that went to Cofina even after the deal is approved. So, “the board asked what exactly are we negotiating here?” sources close to the negotiations said.
While the GOs supported the creditors’ deal, they did not have the power to impose it because they are just one group among the diverse commonwealth creditors on equal footing.
“Unlike Cofina, the commonwealth side is a lot more diverse and there is no contractual senior-sub relationship among commonwealth creditors…. In the end, senior Cofina bondholders can cram down the subs [Cofina junior bondholders] and can force them to take a deal. That relationship does not exist on the commonwealth side. The GOs could not implement anything without the commonwealth agent…. The GOs need the commonwealth agent,” the Cofina source said.
The deal, however, gave the parties an overview about what each side was willing to negotiate. It was a starting point to show what is acceptable to each side.
In early June, agents representing the commonwealth, including GO and Cofina bondholders, asked Judge Swain to refrain from making a decision related to their dispute over Cofina’s legality for 60 days because they may have reached an agreement in principle on how to split the 5.5 percent sales & use tax revenue. That 60-day period is slated to end in August.
The most recent deal being negotiated between Whyte and Despins came after lawyers for Cofina pushed Judge Swain to certify questions to the commonwealth Supreme Court over Cofina’s legality. “If Cofina were to have been declared legal, the GOs would have gotten zero Cofina money,” the source said. That prompted GO bondholders to approach Cofina in an attempt to settle the dispute.
While Swain ended up rejecting the idea of having the local Supreme Court analyze Cofina’s legality, contending there were federal issues involved, sources opined that Swain, in reality, wants parties in the dispute to settle the matter because “she does not want to decide on the legality of Cofina.”
“Swain does not want to rule on the legality of Cofina…. Swain does not want to rule on the constitutionality of Cofina. Swain does not want to rule on priority of Cofina debt over GO debt. If the parties settle, she does not have to rule on any of that,” a Wall Street source said.
As part of the preliminary agent agreement, Cofina bondholders would receive all $1.2 billion in sales-tax revenue sitting in a reserve account. Once sales-tax bondholders are repaid each year, revenue would then flow into an escrow account for the commonwealth to repay creditors, including GO bondholders, and to cover essential services.
However, the GOs are not happy with the agreement currently being negotiated by agents because it provides Cofina recovery on first dollars, virtually risk-free, leaving the commonwealth and its stakeholders to bear the entire risk of any economic underperformance. The agents’ deal, the GOs say, provides that the portion of the commonwealth’s sales & use tax allocated to Cofina “would be the first dollars of the 5.5 percent IVU distributed each year,” and would remain untouched. The agents’ deal offers billions of dollars of “additional value to Cofina over and above the creditor-initiated settlement framework [in the May agreement],” said a source with knowledge of GO bondholder perspective.
To the Cofinas, the dissatisfaction of the GOs is that “the share carved out to Cofina is not going to them.” The deal gives Cofina bondholders just over half of the future sales-tax revenue they’re currently entitled to each year. About 46 percent of the 5.5 percent in sales tax under dispute would go to the commonwealth, including the GOs.
Cofina sources disputed GOs claims of economic underperformance by Cofina because studies have shown that will not be the case, especially after a U.S. Supreme Court ruling that would allow Puerto Rico to collect sales tax on online sales.
“Today, who does the IVU’s 5.5 percent belong to? It belongs to us. The portion of the IVU that goes to the commonwealth will continue to go to the commonwealth after this deal. Only the 5.5 percent is in dispute…. They already have the risk,” a Cofina source said.
Cofina bondholders have always said they would participate in a deal as long as they take the first dollars. While the GOs say payment of their GO bonds is guaranteed by the Constitution, a Cofina source said “all they have is a priority payment. Priority means that before paying for schools, they have to pay them…. We do have a guaranteed payment,” the Cofina source said, noting that GOs belong to the UCC, which represents creditors whose claims are unsecured.
After the deal is completed on paper, the parties need to convince Judge Swain that it is “reasonable” under the bankruptcy law. “It will be tough to argue that it is not…. Best evidence is that two entities divorced from these say this is the way to resolve it,” the Wall Street source said.
However, not everything is “coming up roses” with the Cofinas because there are disputes between Cofina senior and junior bondholders. GOs say the deal will destroy Cofina sub bondholders because they get less value in the disputed asset.
Cofinas argued that agents cannot negotiate anything related to a senior-sub split because that would be part of Cofina’s debt adjustment. “The senior-sub split is not part of the deal…. That is being negotiated separately…. This deal is a dispute on the division of the 5.5 percent,” the source said.
The settlement also does not determine the distribution of the 46 percent of the 5.5 percent of the sales & use tax among commonwealth creditors. “It does not say the GOs will get paid first and we will not pay police or teachers…,” the Cofina bondholders say.
Although Cofina bondholders will be giving up a huge portion of their 5.5 percent share to the commonwealth, they say they are inclined toward the deal because it will allow them to continue trading bonds, assure a return on their investment and end costly litigation.
What the GOs are saying
Sources close to the GOs say chances are that the agents will ask Swain for an extension on the 60 days to negotiate the dispute because they are certain more people are unhappy than happy with the deal. Some GOs are very dissatisfied with the job that the commonwealth agent is doing in negotiations.
They say the deal is bad for four reasons. First, the government will be giving up its sovereign powers because it will not be able to raise or lower the sales & use tax in perpetuity.
They object to the fact that Cofina is getting the first dollars and will be sharing the rest, which will also be distributed for essential services, when the FOMB has not defined exactly what essential services are.
“The third thing is that Cofina will be getting more than par [value],” the GO bondholder said.
As part of the deal, the government will not be able to use Cofina funds to borrow money but only to pay debt. “Promesa says Puerto Rico has to regain access to the markets. This deal goes against Promesa,” the source said.
Cofina bondholders agree that once the deal is in place, the government will not be able to alter it, but they noted it will get Cofina out of bankruptcy. They noted that the move is needed to ensure future governments do not repeal Cofina or try to change the deal.
“Because this is not a deal in which creditors will be paid tomorrow, they do not want somebody coming down the line and saying repeal that,” the Cofina creditors said.
The current Cofina statute, however, says that if it is repealed, bondholders have to be given a substitute payment.
The GOs say they are ready to prove to Judge Swain that the deal is unreasonable. “Everyone is getting paid except bondholders…. We were the ones who financed construction,” the source said. But the Cofina bondholders noted that the GOs are not the only creditor constituency within the commonwealth. “They [GO bondholders] want to give the impression that they could blow this [deal] up. I don’t think so,” the Cofinas said.