Millstein: After Restructuring, Debt Service-to-Revenue Ratio Will be Higher than in most Indebted State
SAN JUAN – Under the most recent voluntary debt exchange proposal that would facilitate a restructuring of the island’s debt, the commonwealth’s debt service-to-revenue ratio would be significantly reduced, but would still remain at levels above the most indebted U.S. states.
As the island’s debt is unsustainable, it would need a broad restructuring mechanism that goes beyond the Chapter 9 bankruptcy procedure.
The remarks were made by Jim Millstein, the commonwealth’s lead debt restructuring adviser, at a recent Economic Transformation and Restructuring Conference organized by the Consejo Empresarial de América Latina.
The commonwealth’s debt is significantly worse than any of the U.S. states. Hawaii, which has the highest debt, has a 13% debt service-to-revenue ratio, whereas Puerto Rico has 36% ratio. After the restructuring, it may be 15%, he said.
Puerto Rico faces $69 billion in total debt and a shrinking population, all of which threaten to collapse its economy. It defaulted on around $400 million on May 1 and is expected to default on another $1.5 billion in debt payments on July 1.
Based on the commonwealth’s current fiscal policies, growth trends and existing debt service schedule, Millstein says the island projects a cumulative fiscal deficit of $63.4 billion over the next 10 years.
To address this deficit, the government developed extensive revenue and expense measures, projected to result in approximately $20.6 billion and $13.8 billion of benefits, respectively, which would reduce the fiscal deficit to approximately $34 billion, before considering any incremental economic growth benefits, he said in the presentation.
With approximately $33 billion of scheduled principal and interest payments due over the next 10 years, a substantial restructuring of the commonwealth’s existing debt is required to allow the commonwealth to bring its fiscal accounts into balance, to give it time and the financial flexibility to implement structural reforms and growth initiatives, he said.
The island’s adviser explained that Chapter 9 would not address $60 billion in commonwealth obligations, including $43 billion of unfunded pension obligations.
He said there was no way to pursue multiple Chapter 9 proceedings simultaneously while there is an ongoing disorderly default, with litigation pending at the commonwealth level. In any event, he said there is a need for some mechanism to bind holdout creditors at the commonwealth level.
Another problem with the mechanism is that holders of approximately $15.2 billion of Sales Tax Financing Corp. (Cofina by its Spanish acronym) debt will argue the agency is not eligible for Chapter 9. “In any event, since COFINA has no operations or assets to satisfy creditor claims other than tax revenues that General Obligation creditors have claimed is illegal and subject to clawback, a Chapter 9 filing would not address those disputes and/or could lead to billions in claims against the Commonwealth,” he said.
The Puerto Rico Electric Power Authority (Prepa), with approximately $8.8 billion in debt, and the Aqueduct and Sewer Authority (Prasa), with approximately $4 billion in debt, rely on payments from the commonwealth government, as primary customer. He said they likely will be unable to successfully restructure and issue debt going forward without simultaneous relief for the commonwealth
He also noted that Chapter 9 eligibility standards will invite damaging, dilatory litigation because proving “municipality” status requires a multi-pronged and fact-specific analysis under the case law.
The entity must be found to be insolvent; it must show it negotiated unsuccessfully with creditors or that negotiation was impracticable; and creditors may still yet move to dismiss a Chapter 9 petition as having been filed in bad faith.
“All of this will require months of litigation and millions of dollars of fees that will delay focus on the substance of a restructuring,” he said.
The government this year made two voluntary debt exchange proposals to creditors.
On Feb. 1, the commonwealth published a voluntary exchange proposal to facilitate an orderly restructuring of its $49.3 billion of tax-supported debt.
The original proposal contemplated that creditors would exchange their existing securities for two new securities such as a “Base Bond,” with fixed payment terms (principal and interest) that the commonwealth would be obligated to meet, and a “Growth Bond” with a principal balance equal to the difference between the Base Bond amount and Current Par that would be payable only if the commonwealth’s revenues exceeded certain levels
The Original Proposal significantly reduced the principal amount of the commonwealth’s mandatorily payable debt by approximately $22.7 billion and would have protected the commonwealth against having to make payments on the Growth Bond in the event economic growth did not exceed the projected rate of inflation, he said.
Following creditors concerns, the government made a second proposal that called for a debt service increase to $1.85 billion. The new proposal would reduce a $49 billion chunk of the debt to between $32.6 billion and $37.4 billion by exchanging existing debt for two classes of new bonds, a base bond and a capital appreciation bond.
“Since the publication of the counterproposal, the Commonwealth has received proposals from certain holders of Puerto Rico’s largest credits…. All proposals submitted to date require significant additional consideration than contemplated in the Counterproposal,” he said.
The GDB reached an agreement with some of its creditors last week.