Sobrino Stares Down Debt
“This is a revolution—we’re back in 1776,” so begins the allocution of Christian Sobrino, who holds the thankless job of heading the Fiscal Agency & Financial Advisory Authority (Fafaa, or Aafaf by its Spanish acronym) and is the Puerto Rico government’s ex-officio representative on the Financial Oversight & Management Board (FOMB). That entity is a creature of the U.S. Congress, created under the Puerto Rico Oversight, Management & Economic Stability Act (Promesa) to oversee the island’s financial and fiscal affairs as a condition to enable the law, which includes a provision, Title III, for bankruptcy-like proceedings. Puerto Rico was stripped of its ability to file for bankruptcy in 1984.
Upon enabling the federal law, Congress set in motion an experiment that has seen Puerto Rico’s government and the oversight board clashing over directives issued by the panel that are often ignored or fought on grounds, says the Rosselló administration, that the board is overstepping its bounds. Those dustups—refusal by the Rosselló administration to implement a two-day monthly furlough for government employees and reneging on the FOMB order to suspend the granting of Christmas bonuses to public employees—have bolstered claims by critics who allege Promesa is a flimsy law with many gray areas. Sobrino disagrees.
“I don’t think the law is flimsy; we just have to administer it correctly,” Sobrino said during an interview that took place in the boardroom on the fourth floor of Aafaf’s headquarters, which once was home to the Government Development Bank (GDB), the former fiscal agent for Puerto Rico that was liquidated as part of a debt-restructuring strategy set in motion in the final two years of the Alejandro García Padilla administration.
The writing on the wall
Sobrino, who was a young attorney in the days when the “good bank, bad bank” ploy was being concocted by Puerto Rico’s financial advisers at Cleary Gottlieb and Millco, saw the writing on the wall well before the death knell.
“I started to think the end was near for the GDB in 2013,” said Sobrino, who was a young attorney in private practice at the time. “We were working on the Comprehensive Cancer Center financing—a $200 million loan. And I was thinking why are you taking such a forward hit; you have liquidity issues and you are hiring people to deal with this—right? People forget that people like Millstein and Proskauer, Cooper—all of those guys came at the end of 2013, the beginning of 2014 to help the GDB.
“To be honest, I had concerns even when Carlos [García] was here—me being a young attorney and seeing what was happening—how the economic situation started to deteriorate even with stimulus programs like ARRA [American Recovery & Reinvestment Act] going on. And I questioned if this model worked—where you took your general fund and your operating accounts for each of the government entities and essentially turned it into an investment vehicle for development purposes. I think that worked great for a long time. It still works great in North Dakota and it works in some other states.”
Sadly, the government’s fiscal agent jumped off the rails more than 10 years ago—when short-term debt was ratcheted up to fund public corporations and the central government’s unbalanced budgets, a practice known as deficit financing. The bank veered from its role as the lender for infrastructure works and as the fiscal agent responsible for economic policy to become a bankrupt lender of last resort. The numbers are ominous indicators of the GDB’s inevitable insolvency.
“Liquidity dropped from $5 billion in 1989 to less than $500 million in 2016, while at the same time the portfolio of loans jumped from $1 billion to $8.3 billion,” former GDB President Melba Acosta told Caribbean Business during an exit interview in 2016.
“I thought the GDB was a great concept, but it wasn’t there. We didn’t have the culture that was implemented in the beginning,” Sobrino says with a hint of nostalgia coloring the sound of his voice. “When it was created in the 1940s, the original purpose was to turn your general fund into an investment vehicle for infrastructure and economic development, much the same way that North Dakota did with its Agriculture Bank. And that worked great, if you think about it, we are surrounded by the GDB’s legacy—the Museum, Hotel La Concha, the Vanderbilt, the Highways. I don’t think people appreciate what we lost last year when it closed; we lost something great. We lost an institution that formed generations of lawyers, of bankers, of accountants, of economists. And we don’t have anything nearly ready to take its place yet. We should work on getting that; developing an institution that trains people to be leaders and professionals in society.”
Can Aafaf be something like that? “I think Aafaf is an intermediate institution; it reflects what we need now for certain transactions and work,” Sobrino replied. “I think Aafaf and other agencies will eventually merge and evolve into something that could be that. I am not sure yet; I am not clairvoyant. But we need something like that.”
For now, Sobrino’s time is occupied trying to secure consensus in public policy that is being dictated by an oversight board that was imposed on Puerto Rico as a condition for the passage of Promesa. Think of him as a goalie attempting to defend Puerto Rico’s goal with one arm tied behind his back. As the ex-officio representative on the FOMB, his role is pro forma—he delivers reports, answers questions and the seven members of the control board tell him what fiscal measures they expect of the Rosselló administration.
Meanwhile, professional and financial advisers in this legal jamboree under Promesa’s Title III bankruptcy proceedings have racked up more than $300 million in legal and advisory fees in the two years since the inception of Promesa in June 2016. Those overblown costs led to the appointment of Brady Williamson as fee examiner in October 2017 to rein in those rampant fees. Sobrino said that when it has come to the consultants working for Aafaf, who are subject to the fee examiner, the entity has been fair in its observations. “I do have some issues with the amounts that some consultants on the other side charge and my perception of their value. I like flat-fee arrangements. They are productive but my consultants on flat fees have to keep time sheets. That is a standard in the accounting world. Keeping time sheets is good for managing the contract,” Sobrino said, adding that companies that charge a lot of money to the island should “at least set up shop here.”
Sobrino took pride in the fact that his consultants have not increased their fees as others have done because “I crack the whip and my consultants know what they have to do.”
Regarding the conflict of interest by McKinsey & Co., which advises the island on its debt, but also owns Puerto Rico bonds, Sobrino said the matter should be investigated aggressively. “It would not have been tolerated had it been a government consultant. I am looking forward to what the independent investigator will publish,” he said. Sobrino declined to say whether he told the board [FOMB] to cancel the contract, merely saying, “They hear my opinions about every consultant.”
In his role as director of Aafaf, Sobrino is keeping his eyes peeled on negotiations between the Rosselló administration and the diverse creditor constituencies in restructuring Puerto Rico’s more than $70 billion debt.
Caribbean Business inquired about what Puerto Rico should expect regarding the restructuring of commonwealth agencies, in general. Sobrino said he does not agree with the theory that after the Puerto Rico Sales Tax Financing Corp. (Cofina) restructures its $17 billion debt, other agencies will follow suit in a domino effect because of the complications with each type of debt. Each debt is being worked upon on a credit-by-credit basis.
“I don’t see the dominoes. Everyone expected it to be very orderly. They would first see GO [general-obligation bonds] then Cofina and you would follow the stack down. But there is a much more complicated scenario and you have to take each credit on its own terms,” he said.
Aafaf is trying to find credits in which the parties, legal advisers and economic situation lend themselves to “good restructuring” at a given time. If that does not work, Promesa’s provisions allow for a “cramdown,” or forced restructuring. “I don’t think there is a domino effect and we proved that with the GDB. Everyone thought the GDB could not be closed until we closed GO and Cofina, but we showed that it could be done,” he said.
In that regard, Sobrino did not expect the $9 billion restructuring of the Puerto Rico Electric Power Authority (Prepa) to move forward any time this year because a group of monoline bond insurers are currently in court seeking a receiver for the power utility in an effort to hike up rates and pay debt. “That does not lend itself to a positive negotiation process. I would love to sit down with them and see if we can negotiate something, but if that is the position, then we have to unfortunately fight it out,” he said. Monolines, he added, are refusing to negotiate because they benefit from the delay.
Sobrino said there will never be a receiver in Prepa and opined that monolines refuse to negotiate a debt settlement because they get unfair advantage through a delay. “I am going to privatize Prepa first because there is never [going to be] a receiver,” he said.
Right now, there are five companies vying to take over Prepa’s transmission and distribution system, including consortiums. All are from the United States. “They are all serious players and are all involved in the energy sector,” he said.
While Sobrino assured everything is on schedule to announce the name of the company that will lease Prepa’s transmission and distribution system, Prepa’s executive director, José Ortiz, said in a radio interview that the entire privatization process may be delayed because of the partial shutdown of the federal government and the energy agencies that are helping Prepa are not working.
Meanwhile, the government is developing a new energy policy, Senate Bill 1121, which calls for the island to use 100 percent renewables by 2050. Sobrino says the government is trying to clarify the language to establish the exact jurisdiction for the Energy Bureau and provide it discretion to implement the reforms and causes of action that could arise, “[so] there is a clear mandate over who is responsible to impose those policy directives,” he said about the requested amendments, denying that the government wants language to ensure it can control the composition of the Energy Bureau.
Another entity that for the past few years has said it is close to restructuring is the Puerto Rico Aqueduct & Sewer Authority (Prasa), which has a $4 billion debt. Sobrino said he expected the water utility to announce a debt deal “in the coming months.”
However, Prasa recently paid about $1.6 million of debt and announced it will continue to pay debt while negotiate its restructuring. “Prasa has not failed to make a payment on its senior bonds. It is working on its negotiations with the EPA [U.S. Environmental Protection Agency] and with the USDA [U.S. Department of Agriculture] on the federal part of the debt stack. A very critical component included refunding the revolving fund,” he said.
While Prasa is “a very good entity,” Sobrino said the issue with the debt is having the ability to implement a capital improvement plan for its infrastructure.
Agents of change?
On the other hand, Sobrino said he expects Judge Laura Taylor Swain to approve the plan of adjustment to restructure the $17 billion debt of the Puerto Rico Sales Tax Financing Corp. (Cofina), which was approved by a majority of the bondholders in a preliminary plan. The terms, however, have been objected to because these could lead to another default and result in stringent austerity measures to be able to pay the debt. Junior Cofina bondholders have also raised objections about their low recovery in a proposed bond exchange.
“A lot of the opposition to the Cofina deal is ideological or is pursuing the economic interests of other parties,” he said.
One of the objections to the Cofina deal argues that the oversight board manipulated the negotiations because it has control over the commonwealth side of the dispute, as well as Cofina, in a conflict of interest. The FOMB, however, delegated the negotiations toward the debt deal to two independent agents.
“I was not in favor of the agent structure then, and I still don’t agree that it was the best procedural structure, but I am happy with the results. We would have been able to do it without the agents,” Sobrino said.
The government, he noted, does not favor the view that the island’s debt should be wiped out but restructured according to the island’s condition. “A more moderate approach, in which you recognize that Puerto Rico’s debt needs restructuring, is better. Otherwise it does not work,” he said.
Regarding allegations that Cofina may have fraudulently filed for bankruptcy because the government has failed to submit audited financial statements since 2015, Sobrino replied that the process of doing the audits for 2016 and 2017 has been difficult because of the complexities with the island’s fiscal state. “It is easier said than done,” he said.
He said he was surprised the oversight board recently published a letter chastising the government over delays with audited financial statements because they have been kept informed about the problems and complexities to finish them.
He dismissed claims Cofina may have fraudulently filed for bankruptcy by saying, “The people who have said that are now parties to this deal…. That is not true at all.”
Claims to fame
Sobrino also rejected allegations Puerto Rico can pay its debt because it has billions of dollars or nearly $4 billion in its Treasury Single Account (TSA). Aafaf publishes weekly reports on the level of funds in its TSA. What should people understand about the TSA?
Sobrino said allegations that Puerto Rico is being dishonest about its liquidity is a “misreading of the facts…. How can you be dishonest when you are the one publishing the reports?”
He noted that while it may seem like Puerto Rico does not have liquidity problems, it does have solvency problems and has yet to determine the impact of the Pay-Go provisions (pay-as-you-go) on the fiscal state of its retirement systems. “The reason it has accumulated so much cash is because we are operating under a budget that we think cuts too [much]. [The TSA] is high but I would not generate a false sense of security because, while it may appear Puerto Rico does not have a liquidity problem, it does have a solvency crisis. It is there and may turn into a liquidity problem,” he said.
May is the deadline for avoidance of claims. Can you tell us something about actions or claims that may have been unjustified? Sobrino said he does not participate on the board’s Special Claims Committee but noted the group was taking its job very seriously. This week, the Special Claims Committee virtually said that bond debt incurred by the island after 2012 was illegal because it exceeded the island’s constitutional debt limits. The committee sought to annul $6 billion of total debt from two bond issuances, one for $2.3 billion and the other for $415 million, issued in 2012, and one done in 2014 for $3.5 billion, contending they were illegal. “All claims were based on invalid GO bonds that should be disallowed because the bonds were issued in violation of the debt-service limit and, in the committee’s view, the balanced budget clause, and, therefore, the bonds are null and void and the holders of such bonds have no remedy against the commonwealth,” the committee said.
Sobrino said that with the situation in Puerto Rico, it is easier to say something illegal happened but “a lot of this is structural in how some institutions were working…. I am sure corruption happens, but I would not say Puerto Rico’s entire fiscal situation is that. What we are facing in Puerto Rico is much larger,” he said.
Asked what he thought caused Puerto Rico’s fiscal crisis after reading the debt investigation completed by Kobre & Kim, he said: “I think a lot of the issues were due in part because people were forgetting that the GDB was not a piggy bank and a lot of pressure was put on its debt and that pressure was transferred to the general fund…. But it is much more complicated than that,” he said.
While this year, President Trump and Congress are slated to change the composition of the oversight board, Sobrino said he can work with whatever he has. He also considers the federal Promesa law, which rules the island’s bankruptcy process, does not need to be amended. “When the law is administered correctly, it can work. I don’t think it has that many gray areas. If it is administered properly, it can work,” he said.