Swain’s World: Cofina Deal ‘Federalized’
Besides federalizing the Cofina debt adjustment plan, whose fine print will have consequences for Puerto Rico, U.S. District Court Judge Laura Taylor Swain this week approved a series of guidelines for the procedures that will be followed in the island’s attempts to annul $6 billion in general-obligation (GO) debt issued in 2012 and 2014.
Through the guidelines, Judge Swain seeks to ensure GO bondholders have participation in the process to avoid the problems that happened before the court approved the Cofina deal. Many Cofina bondholders claimed they were blocked from intervening in that process.
The judge stressed that for the GO case, the government must meet and confer with the objecting parties. She said the proposed procedures must be written with an eye for clarity for retail-level bondholders. The parties must have 60 days to file notices of participation. The procedures must contain the consequences for failure to file a timely notice of participation. She also stressed that the procedures must be written in Spanish.
On the other hand, the court finally approved the Cofina debt adjustment plan that allows the island to restructure 25 percent of its total debt after nearly two years of negotiations. The restructuring of Cofina’s debt has two parts. In the first, commonwealth and Cofina bondholders settled their dispute over ownership of the sales & use tax (IVU by its Spanish acronym) by agreeing to divide the 5.5 percent portion of the 11.5 percent sales & use tax. From the 5.5 percent portion, Cofina will keep 53.6 percent and the commonwealth receives the rest. According to court documents, the split will result in the commonwealth receiving about $400 million a year from the sales & use tax over the next 40 years. Secondly, under the debt plan, Cofina bondholders will exchange their current bonds for new bonds whose value is being cut. Cofina senior bondholders will recover 93 percent of the value of their original bonds and junior bondholders 53 percent.
“After considering the applicable legal standards and evidence, the court is persuaded that the Cofina Plan is a necessary and legally compliant component of Puerto Rico’s recovery efforts and is essential to ensure Puerto Rico is on a path that will restore its access to financial markets as it builds a stronger economy,” Judge Swain said when approving the deal. “It is important for all to bear in mind that the plan before the court addresses only Cofina’s assets and liabilities. It does not map the way forward for the Commonwealth of Puerto Rico.”
Upon review of the argument raised by certain public participants at the confirmation hearing, as well as by citizens of Puerto Rico who have written numerous letters to the court, that a comprehensive audit of Puerto Rico’s financial circumstances should be conducted before confirmation of the Cofina Plan, she said the plan’s approval does not foreclose continuing an investigation.
However, it is the fine print contained in the deal that raises some concerns. The amount at issue in the Commonwealth-Cofina dispute, for instance, is significant—about $783 million in the current fiscal year alone, which grows at four percent annually until it reaches $1.85 billion in fiscal year 2041 and remains fixed at that amount until Cofina’s existing securities are repaid.
However, she said the debt is sustainable. The central component of the agreement in principle—the 53.65 percent/46.35 percent allocation of the disputed sales & use tax revenue between Cofina and the Commonwealth, respectively—was a fair and reasonable settlement, she said.
Citi helped negotiate the terms of the plan so the debt service on Cofina bonds is slightly below 53.65 percent of the pledged sales tax base amount, virtually identical to the amount contemplated by the Cofina fiscal plan. The Cofina revenues comprise the first collections of the 5.5 percent IVU in each fiscal year. Thus, the debt service on the Cofina bonds is backed by the entire amount of the 5.5 percent IVU because a shortfall will only exist in the event that the entire amount of the 5.5 percent IVU generated in a fiscal year is less than 53.65 percent of the pledged sales tax base amount.
Citi’s analysis of Cofina’s fiscal plan showed that stimulus from disaster funds, structural and fiscal reforms of the Puerto Rico economy, and improvements in tax collection methods will maintain a robust amount of personal consumption in the commonwealth. However, lately, there have been delays in the disbursement of the funds, which is something the plan did not take into account.
On the other hand, Judge Swain approved dispositions in the plan that make it final, conclusive and binding, and “shall not be the subject of collateral attack.”
The deal was virtually federalized by the judge because any claims under the deal will be handled through Promesa and the Bankruptcy Act, and only by commonwealth laws that are not incompatible with the first two. All legal claims that took place before the deal have to be dismissed. Only Whitebox and Ambac retain their claims of fraud against the Bank of New York Mellon, which is Cofina’s trustee.
“[A]ll entities who have held, hold or may hold claims or any other debt or liability that is discharged or released pursuant to Section 30.2 of the plan are permanently enjoined, from and after the effective date, from (a) commencing or continuing, directly or indirectly, in any manner, any action or other proceeding (including, without limitation, any judicial, arbitral, administrative or other proceeding) of any kind on any such claim…,” the plan reads.
The individuals involved in the settlement are exempted from lawsuits. “Each of the Cofina and Reorganized Cofina, the disbursing agent and each of Cofina’s and Reorganized Cofina’s related persons (other than any former elected or appointed officials, directors or officers of any of the government parties and the Commonwealth, in each case acting in his or her capacity as such prior to Jan. 1, 2017) shall be deemed to have and hereby does irrevocably and unconditionally, fully, finally and forever waive, release, acquit and discharge the released parties from any and all claims,” the plan says.
Similarly, the Oversight Board, the Commonwealth, Aafaf, Cofina, the commonwealth agent releasees, and each of their respective related persons, including monoline bond insurers and “Bonistas,” are also exempted from liability.