Wednesday, June 26, 2019

Swain’s World: Cofina Plan of Adjustment One Step Closer to Reality

By on November 19, 2018

Editor’s note: The following originally appeared in the Nov. 8-14, 2018, issue of Caribbean Business.

The controversy around the Cofina deal continues. On Nov. 20, Judge Laura Taylor Swain is slated to determine the adequacy of the information in the disclosure statement from the Puerto Rico Sales Tax Financing Corp., known as Cofina by its Spanish acronym. This preliminary step would lead to approval early next year of Cofina’s plan of adjustment and settlement of the Commonwealth-Cofina dispute over ownership of the revenues from the sales & use tax (known as IVU by its Spanish acronym).

However, numerous questions still remain unanswered. The restructuring of Cofina’s $17 billion debt comprises what appears to be two agreements. The first is one in which holders of commonwealth debt and Cofina bondholders will decide how they will distribute the 5.5 percent sales & use tax revenue, with Cofina taking 53.65 percent of the tax each year and the remaining 46.35 percent going to the commonwealth. The second question involves the restructuring of Cofina securities. Cofina senior and junior bondholders would exchange their current bonds for new bonds. In that deal, senior bondholders would get 93 percent of the value of their bonds while junior bondholders would get 56.4 percent. The IVU tax will continue to be collected over the next 40 years and all parties agree not to challenge the deal in court.

However, retail Cofina bondholders have pointed out certain irregularities. Seema Balwada, a Cofina junior bondholder, pointed to the fact that hedge funds have not only acquired senior bonds but are also holders of a significant portion of junior Cofina bonds, which influenced the negotiations to the detriment of those who only hold junior bonds.

Balwada pointed to court documents that show the Senior Cofina Bondholders’ Coalition, comprising investment advisers or managers of funds, held $2 billion in senior bonds and $616.4 million in junior bonds in August 2017. By August 2018, the Senior Cofina Bondholders Coalition held $2.6 billion in senior Cofina bonds and $1.7 billion in junior bonds. The agreement lists numerous hedge funds holding both senior and junior Cofina bonds. Many of them also hold general-obligation (GO) bonds, so it is a win-win situation for them.

Balwada, a financial analyst, told Caribbean Business via email that the agreement seems to cast away the property rights of retail-held junior Cofina bondholders, which were unrepresented in the mediation. “It is difficult for conflicts of interest not to arise when some mediating team members carry both senior and junior Cofina and GO bonds. When hedge funds that are part of the mediation dispute are also trading disputed bonds, it creates suspicions of manipulation. It raises questions whether the seemingly low-ball 56 percent recovery on junior Cofina bonds is an outcome of mediating team members’ profit motives,” he told Caribbean Business.

The agreement also appears to unfairly compensate mediating team members by providing them a $332 million distribution from the Cofina Bond Trustee-held funds and an additional $620 million to senior Cofina bonds, he said. Not only are junior Cofina bondholders being forced to accept a 44 percent haircut, but they are also left out of the Cofina Bond Trustee funds, he added.

Puerto Rican Independence Party Rep. Denis Márquez reiterated that the deal is a negative for Puerto Rico. The deal calls for Cofina legislation, which was recently approved, that would create a new Cofina corporation that will not be subject to constitutional debt limits. These Cofina funds are not considered part of the commonwealth’s available resources but are separate. Any savings in the sales & use tax will have to go to pay debt. “The sales & use tax is compromised for the next 40 years…. For us, there is a reality that the Financial Oversight & Management Board is pushing for this deal and they are here because of our colonial status,” he said.

Meanwhile, the Bank of New York Mellon (BNY Mellon), which is the Cofina trustee, expressed reservations about Cofina’s disclosure statement, which Judge Laura Taylor Swain must evaluate.

“The plan provides that certain institutional holders of beneficial interests in the existing securities, which participated in the mediation process and executed the plan’s support agreement, receive additional compensation over and above that provided to other holders in the same class. This payment is to be made from all holders’ shared collateral. The disclosure statement describes this payment, in the aggregate amount of about $332 million, as compensation for the costs of negotiation, confirmation and consummation of the term sheet and the plan,” the BNY Mellon says.

In its role as trustee for all existing securities, BNY Mellon said it seeks to ensure that holders who did not participate in the mediation process receive disclosure necessary for them to make an informed, intelligent decision with regard to the plan. “The disclosure statement does not explain the basis under Promesa [the P.R. Oversight, Management & Economic Stability Act] and applicable provisions of the Bankruptcy Code for making this payment from holders’ shared collateral to selected institutional holders generally and, more specifically, in the amount of $332 million,” the bank said.

Lehman Bros. also raised issues about the disclosure statement for various reasons, including the fact that the BNY Mellon is released from claims Lehman may have against it. Lehman also says the disclosure agreement fails to say what causes of action Cofina may have, including avoidance actions.

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