My Name Is Bond—SuperBond
Support Building for Puerto Rico Debt Restructuring
Nuveen Agrees That Years of ‘Bitter’ Litigation Will Only Stifle Economic Growth
While the Puerto Rico government has tried mightily, but has so far failed to achieve access to bankruptcy protection, the commonwealth seems to have found an unlikely ally in Nuveen Asset Management, a major fund manager in the municipal bond market.
Nuveen’s recently released February report, “Puerto Rico’s Course Forward,” not only comes out in support of an orderly restructuring process, but also backs a mechanism akin to a Super Chapter 9 in which a broader restructuring regime would encompass the commonwealth’s 18 different issuers that represent a complex web of debt obligations.
Nuveen’s findings are significant because the Chicago-based company has total assets of $225.7 billion, of which $108.4 billion, or 48%, are municipal (i.e. tax exempt) fixed-income assets, according to the company’s website. Puerto Rico issues its debt in this tax-exempt market, of which Nuveen is a major player. However, it was unclear as of presstime how much exposure Nuveen has in terms of Puerto Rico bonds, but its portfolio includes Sales Tax Financing Corp. (Cofina by its Spanish acronym) bonds, among others.
Congress has been evaluating options for Puerto Rico’s fiscal and economic crisis, exacerbated by a $70 billion public debt load and more than $40 billion in unfunded liabilities under its pension systems. In recent months, congressional debate has focused on establishing a federal fiscal-control board for Puerto Rico and whether the commonwealth should be given access to bankruptcy protection, particularly under Chapter 9 of the U.S. Bankruptcy Code.
For its part, the commonwealth government continues to warn Congress against the consequences of not acting when it comes to access to a broad debt-restructuring regime, with years of litigation ahead that would only delay a return to economic growth. Regardless, Democrats on Capitol Hill are solidly in favor of debt restructuring for Puerto Rico, while Republicans are steadfastly against it.
“We believe the final legislation [in Congress] must include a path for Puerto Rico to restructure these liabilities. We don’t advocate for restructuring lightly. As investors, we prefer political solutions that avert restructuring whenever possible,” Nuveen states in its report. “Yet we believe when an issuer reaches the point where debt reduction becomes inevitable, any delay only serves to engage in value destruction through additional unsustainable borrowings, economic contraction and/or population loss due to reduced government services.”
Meanwhile, the U.S. Treasury is also urging Capitol Hill to enact broad debt-restructuring authority for the island, which should be paired with fiscal oversight, a “tried and true combination to resolve debt crises,” Antonio Weiss recently told a handful of Congress members during a House committee hearing. Weiss, a former head of investment at Lazard, is Treasury Secretary Jacob Lew’s lead adviser over Puerto Rico matters.
Instead of recommending Chapter 9, or anything under the U.S. Bankruptcy Code for that matter, the Obama administration is pushing for a “tailored solution” under the U.S. Constitution’s territorial clause—broad enough to cover all Puerto Rico debt obligations and safe enough to protect commonwealth pensioners. It also calls for a temporary stay on creditor lawsuits against the commonwealth.
Both Treasury and Nuveen have indicated that restructuring is better for creditors than the status quo, as the commonwealth would be able to focus on such other key issues as lack of economic growth, loss of population, and bureaucratic and inefficient government. “Thus the restructuring—painful as it may be—provides greater value to creditors than lobbying for maintaining the status quo…. As municipal asset managers and creditors, we are reluctant to support any adjustment of debts by issuers, but we believe it is both inevitable and necessary for Puerto Rico,” Nuveen states.
In the event of a commonwealth debt restructuring, contagion risk is low, Nuveen argues, because Puerto Rico’s case is “unique” and restructuring “will not create widespread negative credit implications for other issuers.” The company also notes that the market already differentiates between Puerto Rico bonds and other high-yield municipal bonds. However, the longer Puerto Rico’s crisis is extended and remains in the news, “market contagion is possible in the form of threats to the municipal bond tax exemption.”
The commonwealth has already put forth a voluntary debt-restructuring offer to its creditors, targeting about $49 billion of its “tax-supported debt,” including general obligations (GOs), Cofina and various other public entities.
The government is seeking to exchange this chunk of its debt for two new securities, with affected creditors facing initial haircuts, or reductions to principal, in the vicinity of 45%, depending on the credit. The government says these losses could be eventually recovered through so-called “growth bonds,” one of the two new securities that would be paid only if sustained economic growth is achieved in the midterm.
But chances to achieve a voluntary agreement without a restructuring regime in place are slim at best, given the complexity of Puerto Rico’s debt web. “Given the wide variety and complexity of Puerto Rico’s debt obligations, the diversity of bondholders and interests involved, and the competing security pledges, realists will acknowledge there is little to no hope of a consensual agreement,” Nuveen states in its report.
“The debt is unusually complex with 18 different issuers and 20 creditor committees with competing claims. There is currently no way to forestall litigation or conclude a voluntary agreement supported by a majority of creditors,” U.S. Treasury’s Weiss stated during last week’s congressional hearing.
So far, a group of Cofina senior bondholders has presented a counterproposal to the government, but although it provides much-needed debt relief in the short term, it would protect these bondholders from haircuts and could impair other credits, including subordinate Cofina bondholders. Moreover, it would place Cofina senior bondholders’ claims on top of the priority ladder, even above GOs.
“The proposal as delivered by the [Cofina] creditors is likely more of a bargaining chip than anything else, designed to paint creditors as reasonable negotiators in advance of congressional action, potential court cases and the hearings concerning the [Puerto Rico Public Corporation Debt Compliance & Recovery Act] at the [U.S.] Supreme Court on March 22. We expect additional creditor proposals to emerge in coming days as creditors jockey to position themselves in the queue for repayment,” said Daniel Hanson, an analyst at Washington, D.C.-based Height Securities. “Just as the commonwealth’s proposal has faced a frosty reception with creditors, we expect preliminary proposals from various creditor groups to face long odds for completion with commonwealth officials.”
Competing interests among creditor classes, such as GOs’ constitutional pledge versus Cofina’s lockbox structure, could prove to be a significant challenge to overcome for a restructuring-regime-strapped commonwealth.
In its report, Nuveen also laid out a strong argument for why a broader restructuring regime is necessary, as these competing interests will likely result in lawsuits. In their view, GOs and guaranteed debt have “first priority” on repayment, while Cofina, which is backed by revenues from the current 11.5% sales & use tax, has second priority.
Meanwhile, the island’s more than 330,000 public pensioners represent yet another competing claim and Nuveen notes that “preserving pension security” is among the top priorities for the Alejandro García Padilla administration. “We believe the government will attempt to keep pensions free from impairment and prioritize these payments above debt service, regardless of current statutes that prioritize debt service ahead of annual pension costs.”
In fact, Treasury’s proposed restructuring plan also seeks to protect payments to pensioners, “a notion which is not likely to make many friends in the Republican-controlled Congress,” Hanson said.
Bringing in the holdouts
For the past few months, both federal and local government officials have been raising their voices on the need for a restructuring mechanism, not only to have a regime to orderly settle intercreditor claims, but also to bind potential “holdouts,” or minority creditors that fail to agree to terms under a restructuring deal struck with a creditor majority.
Meanwhile, another possibility could be the use of collective action clauses (CACs), which have already been brought to the table as yet another alternative to the Puerto Rico debt-restructuring issue, as previously reported by Caribbean Business (Feb. 25). The implementation of CACs could allow the government to bind holdouts if it reaches a debt-restructuring deal with a majority of its creditors.
Sources have said CACs already boost support among various creditor groups, while government officials agree it could help within the holdout creditors’ context, although Plan A continues to be achieving a broad restructuring regime from Congress.
“Without some mechanism to bind holdout creditors, either through some form of bankruptcy or a broader collective action clause that would allow a majority bondholder vote to impose terms on holdouts, Puerto Rico is destined for years of litigation,” Nuveen states in its report.
While pushing for the Obama administration’s territorial-clause bankruptcy regime, Treasury’s Weiss said without access to such restructuring authority “that brings all creditors to the table, it is overwhelmingly likely that holdouts will prevent voluntary negotiations from reaching a successful conclusion.” He added Treasury is indeed worried about the compounding effects of litigation and inability to conclude an agreement, which could turn a voluntary solution into a decade-long crisis.
Yet, many believe potential congressional action could be far away from granting broad restructuring powers to the commonwealth, amid concerns over the Puerto Rico government’s fiscal practices and a lobbying battle among competing interests on Capitol Hill.
“We continue to believe that Puerto Rico gets some bankruptcy protection from Congress, but continued discussions about extraordinary measures—such as collective action clauses, territorial bankruptcy or Super Chapter 9—ought to be viewed as red herrings against the backdrop of what Congress wants to do,” Hanson said.
Resident Commissioner Pedro Pierluisi told Caribbean Business that Congress is looking into a board that would have a role in the commonwealth’s debt restructuring. “But it is clear that it would have to be a restructuring that has the support of a majority of creditors,” he said, adding the board would oversee and mediate in the negotiation process of Puerto Rico and its creditors.
“It is the same as a collective action clause, but through a board, achieving an agreement reached with the majority, and then going to court to make it binding,” Pierluisi said.
When asked if it would cover all Puerto Rico debt, as the García Padilla administration advocates, the resident commissioner believes this needs to be further discussed. “I’m one of those who think that constitutional debt, particularly GOs, should be treated differently. This should be [treated] in a consensual manner, purely based on negotiations,” he told this newspaper following the governor’s recent State of the Commonwealth message.
As House Speaker Paul Ryan’s (R-Wis.) March 31 deadline to act on the Puerto Rico issue quickly approaches and a string of hearings takes place, some GOP members are still mulling when action should be taken and what exactly it should include.
During last week’s House Natural Resources Committee hearing, Puerto Rican Rep. Raúl Labrador (R-Idaho) told Treasury’s Weiss that he didn’t agree “on every one of your solutions,” while adding Congress was leaning more toward implementing fiscal oversight, and not so much toward debt-restructuring powers.
Meanwhile, Chapter 9 won’t cut it for Treasury, as it would only cover public corporations, roughly a third of the island’s $70 billion debt load. While La Fortaleza recently said it still supports Pierluisi’s bill that seeks to include Puerto Rico under Chapter 9, it has been increasingly echoing the broad restructuring-regime discourse. The commonwealth’s voluntary debt-exchange offer also covers GOs, which would fall outside Chapter 9’s scope.
In addition to restructuring authority, Treasury believes a strong, independent oversight board could be established, while simultaneously preserving Puerto Rico’s self-governance.
As for the protection of existing credits’ claims under the Obama administration’s proposed restructuring, Weiss said they “are not advocating a ‘one size fits all’ approach; restructuring legislation can be designed to consider existing priorities and claims.” Moreover, Treasury favors an initial period of voluntary negotiations with creditors, which would be facilitated by the suggested short-term stay on litigation. If talks go south, a court would then come into play to “assure an orderly resolution.”
“The comprehensive restructuring framework proposed by the Treasury Department would be…considerably more stacked against the creditors than in a normal Chapter 9 process,” Hanson said, adding that “Congress is well-aware of these kinds of concerns and is likely to avoid acting in a manner that unduly biases the restructuring process.”
Meanwhile, Nuveen states that swift action from Congress will avoid years of messy litigation, “force” the Puerto Rico government to implement reforms and fiscal discipline and build confidence. “Years of litigation and intercreditor dispute will only stifle economic growth and accelerate outmigration, further diminishing the tax base available to pay off creditors. At present, too many unknowns prevent investors from reaching a reasonable degree of confidence in the territory or any particular security pledge.”
“This lack of certainty will keep Puerto Rico locked out of the market until a path to sustainability and economic growth emerges. We believe this will not happen until Congress enters the void and brings with them a sense of order and path forward for Puerto Rico,” the report further notes.
During last week’s hearing, Rep. Rob Bishop (R-Utah), the committee chairman, asked the Treasury official to describe the commonwealth’s complex debt structure, to which Weiss answered, “Very creative.”
“Well, then we will be very creative when we come up with something here,” Bishop replied, in reference to how they would tackle the Puerto Rico issue.
For his part, Pierluisi believes it is highly likely legislation would be filed soon, which at least should be approved in committees before March 31. As for when it would reach the floor for a vote, “that’s another story. I think we are talking here more toward April,” he said. Amid the uncertainty of how and when Congress could act—if it decides to—the clock continues to tick on the commonwealth as it hits a $2.5 billion debt-service wall beginning May 2, with $422 million owed by its cash-strapped Government Development Bank.
By: Rosario Fajardo & Luis Valentín