Puerto Rico Puts Forth New Deal for Creditors
SAN JUAN — Higher recovery rates and a debt instrument tailored for local bondholders are among the changes to the Puerto Rico government’s recently revised debt-restructuring proposal, which was presented to creditors on March 23 and released publicly Monday. Negotiations between the commonwealth and its creditors are slated to continue this week.
Targeting roughly $49 billion of Puerto Rico’s tax-supported debt, the commonwealth first proposed to creditors in January an exchange offer with two types of instruments: a mandatorily payable base bond; and a growth bond to be paid only if the island achieved economic recovery. Cuts to principal, or haircuts, hovered around 45%, and only $1.75 billion of government revenue would be available each year for debt service.
This amount now increases to $1.85 billion, allowing the U.S. territory to offer more base bonds — and higher recovery rates — under the revised proposal. The larger margin is a result of using projected government revenue for fiscal year 2021, instead of fiscal 2016, as the basis for the restructuring team’s 15% debt-service target as a percentage of annual revenue.
Growth bonds have been replaced with capital appreciation bonds (CABs), which are repaid in full upon maturity as they accrete value — at 5% annually over a 49-year period under the commonwealth’s most recent offer. CABs would ensure creditors fully recover initial losses, only if they hold onto these until maturity. In any case, commonwealth advisers believe this instrument will eventually become highly tradable as the island recovers its creditworthiness along the way.
As for Puerto Rico residents, who happen to mostly own the island’s less-secured debt, they could now choose a par-for-par exchange, instead of taking discounted base bonds. These par bonds would mean a longer maturity for local bondholders, while receiving 2% interest payments for more than 50 years beginning in January 2017.
“Feedback from the mainland creditors is that they are OK with that,” said Jim Millstein, founder of Millstein & Co., lead restructuring advisers for the Puerto Rico government. He discussed the new offer with local press during a recent roundtable that also featured the Alejandro García Padilla administration’s entire fiscal team.
“Our proposal is fair to the extent we could do so, and tries to equitably give something to everyone within constitutional limits,” Government Development Bank (GDB) President & Chairwoman Melba Acosta said.
Under the new offer, the amount of base bonds could reach as much as $27.8 billion, depending on the participation of Puerto Rico residents on the local instrument, while roughly $1.75 billion in CABs and up to $8 billion in local holder bonds would also be issued.
While seeking a leveled debt-service schedule, the commonwealth’s most recent offer would translate into a longer debt-repayment calendar. No principal payments until fiscal 2021 are still contemplated, but interest payments would now be paid current, scaling up until reaching 5% annually by fiscal 2021. The local bond option would always be paid a 2% annual interest during its life.
“Future administrations wouldn’t be facing a new wall of maturities like we are facing today, which we can’t pay. If you can handle [debt service] this year, you will be able to handle it next year, because it is leveled,” Millstein said.
Proposed haircuts include about 16% for commonwealth-guaranteed debt, including general obligations (GOs), and 43% for Sales Tax Financing Corp. (Cofina by its Spanish acronym) bonds. Less-secured paper, such as the Highways & Transportation Authority and the GDB’s, could see cuts to principal of 44% and 64%, respectively, while other credits end up in the 50% range.
If the commonwealth fails to obtain a legal mechanism by which to bind holdouts or if the federal government significantly reduces financial support to the island, the terms of the exchange offer would have to be revised, which could mean larger haircuts for creditors.
“We need a way to achieve finality. If we are going to start a restructuring procedure, we have to make sure that we have an ability to get to the end,” Millstein said, noting the importance of achieving mechanisms that could bind all creditors, thus avoiding a holdout problem.
Judging by the feedback to date, Millstein believes the island is on the right path following the latest revisions. While some creditor groups have suggested that the commonwealth government has dragged its feet in restructuring talks, he said this is far from the truth.
“There are many lawyers and bankers with whom we have been talking about the original proposal…both individually and collectively,” Millstein stressed. “This is a negotiation. We have elicited from them counterproposals.”
At least three different creditor groups have countered with their own offers. These include constitutionally guaranteed GOs; sales tax-backed, lockbox-structured Cofina; and a group of local cooperatives and credit unions that mostly own less-secured paper.
For the administration, the creditors’ proposed fixes fell short, often solving only part of the problem and placing an unfair burden on less-protected credits. None of the counteroffers would deal with the government bank’s debt woes. None would contemplate cuts to principal.
“We needed the moratorium [law] to address that [May 2] payment,” Acosta said in reference to the recently enacted Puerto Rico Emergency Moratorium & Financial Rehabilitation Act. “It is not correct to say these proposals would have made approving the moratorium law unnecessary.”
In fact, the island’s recent fiscal developments, including the moratorium legislation and the executive order that followed to address the GDB’s fiscal woes, have prompted various creditors to sit down at the negotiating table, Acosta said.
Nondisclosure agreements have been signed by advisers for all sides, and the commonwealth government will now be looking to engage holders directly, explained Richard Cooper, a partner at Cleary Gottlieb, lead legal advisers for the island. If progress is made, creditors would be asked to enter into short-term confidentiality agreements.
“It is easier to negotiate this in private, if possible, than to do it publicly,” Cooper noted.
So far, creditors have sought more government revenue dedicated to debt service, less impairment and higher recoveries. Commonwealth advisers recognize there is a tug of war over the administration’s 15% target of annual government revenues destined to debt service, and has said the idea is to make it the least painful possible to creditors. “But there is going to be some pain,” Millstein conceded.
“This is going to take time, but [the revised offer] is designed to give us a stable and sustainable debt structure, with predictable debt service levels that do not crowd out public investment,” Millstein said. “If we get an agreement on the economics, the structure would solve itself.”
DEFINING THE STRUCTURE
Still pushing for a “global deal” anchored on the so-called “superbond” — a structure whereby the island’s different credits are streamlined into a single “currency” by pooling in the various revenue sources that secure the repayment of existing credits.
Puerto Rico’s fiscal team is looking to stave off calls to implement an entity-by-entity approach in debt-restructuring efforts. They believe the superbond provides a stronger, more liquid instrument, while reducing inter-creditor conflicts, while arguing that the island can’t afford a partial deal that leaves it in court with billions of dollars of debt.
But GOs and Cofina Senior creditors would rather do a GO-for-GO/Cofina-for-Cofina swap instead of the government’s proposed debt-exchange structure. “We have no religion on this. We think everyone is better off being in one big superbond. But if the economics work…we are prepared to consider that,” Millstein said.
“We can fashion a baby superbond for the other guys,” he added, while noting that the rest of the island’s creditors have expressed interest in taking part of the superbond structure.
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