Puerto Rico General Obligation and Cofina Creditors Pitch Deal
By Philipe Schoene & Eva Lloréns Velez
Puerto Rico’s debt game is on the verge of its first rook to pawn move with the final tweaks of a deal between the Commonwealth General Obligation (GO) bondholders and the Puerto Rico Sales Tax Financing Corp. (Cofina) creditors about to be sealed.
According to a joint settlement outline obtained by Caribbean Business, the preliminary deal “supported by certain holders or insurers of GO Bonds and certain holders or insurers of Cofina Bonds (Supporting Parties) would settle the Commonwealth-Cofina dispute based on the creation of a trust into which all Cofina Bonds would be contributed and which would make an exchange offer for all GO Bonds and allow general unsecured claims (GUCs). The trust shall be an independent entity employing a lock box mechanism and, to the fullest extent permitted under applicable law, structured as a bankruptcy remote entity, on terms acceptable to the Supporting Parties.”
The documents shared with the Financial Oversight & Management Board (FOMB) and Puerto Rico Fiscal Agency & Financial Advisory Authority (Fafaa) stipulate, “Implementation of the settlement would be that (i) Cofina Bondholders receive 52.5000 percent of Distributable Value, and (ii) the participating GO Bondholders [would] receive 46.2330 percent, and GUCs…1.2670 percent, for an aggregate Commonwealth-side share of 47.5000 percent.”
The so-called Commonwealth-Cofina dispute over who has a priority in debt payments is one of the key areas that needs to be resolved in the government’s Title III bankruptcy process under the Puerto Rico Oversight, Management & Economic Stability Act (Promesa) as it has repercussions in determining how assets will be distributed.
“This is hugely important because, as you know, these are the two creditor constituencies with a claim to priority hierarchies; they are the first groups of creditors that should be resolved so everything else starts to fall into place,” one Wall Street source with knowledge of the matter told Caribbean Business.
“The deal includes a significant number of Cofina bondholders—including seniors, subs and the hedge funds, and a significant number of General Obligation bondholders, which also includes all of the hedge funds.”
The agreement reportedly uses the structure of Cofina—the revenues of the Sales & Use Tax (IVU by its Spanish acronym) as a mechanism to fund the deal. “In essence, they are going to use Cofina revenue to pay the GOs a portion, Cofina Seniors a portion, Cofina Subs a portion. Another set-aside will be made for unsecured creditors and the remainder for the Commonwealth,” the Wall Street source added.
The preliminary agreement, which has been discussed with members of Gov. Ricardo Rosselló’s restructuring brigades and members of the FOMB, is significant because it sets a starting point for consensus in a legal harangue between two Puerto Rico creditor constituencies who believe their paper to be holy. “They have come to a preliminary understanding of the level of haircuts they would be willing to take to drop their legal claims and enter into the structure enabled by this deal,” a second source involved in the negotiations told Caribbean Business. “Cofina remains in place as a very important structure enabling an agreement on how to set up the different tranches and hierarchies with the main creditors being paid with agreed-upon haircuts. It frees up the Commonwealth’s general fund so the government frees itself of the legal claim.”
The Wall Street source confirmed the deal “is going to be an exchange where everyone is going to tender their current bond and they receive back a Cofina bond, which depending on the tranche you are in, will have a particular haircut, coupon and maturity.”
The bond exchange contemplates revenue streams contingent upon certain levels of growth in the economy and the capture of Sales & Use tax. In essence, it stipulates that payment to holder of the new paper is based on the revenue streams achieved by the Cofina structure. “Analysts made their projections based on the forecast for economic growth—they based creditors’ recovery on those expected revenues—if it is more, you get more; if it is less; you will receive less. But it is nonrecourse—so if it is less, you can’t go outside the structure to make a claim. So, the government can say this is what my dedicated revenue stream is going to be. Of course, there are a bunch of hurdles that remain.”
People with knowledge of the matter say that the mediation between lawyers for several creditor constituencies that were at odds with each other have recently made headway as they try attempt to cross T’s and dot the I’s. Yet there are many moving parts that remain, which are tracing mostly to objections by some of the hedge funds owning GO and Cofina debt.
The dispute between the GO and Cofina debtors has been ongoing in the courts for some time, prompting the FOMB to appoint officials to represent each side to resolve the matter. The dispute was part of the adversary proceeding in Official Committee of Unsecured Creditors vs. Bettina Whyte, who is the Cofina bondholders’ representative in the case.
U.S. Judge Laura Taylor Swain last week took under advisement whether to have the Puerto Rico Supreme Court answer questions involving the constitutionality of Cofina and whether the sales & use tax belongs to Cofina or to the island’s general fund.
The issue’s resolution is important because while the Cofina enabling law, or Act 91, says the sales & use tax belongs to Cofina, the law also calls for part of the money to go to the general fund. The Cofina enabling law created a Dedicated Sales Tax Fund, to be held and owned by Cofina separate and apart from the central government’s general fund, and provided, among other things, that each fiscal year the first receipts of the Commonwealth’s Sales & Use Tax, in the amount specified in the law, be deposited in this special Dedicated Fund to pay sales-tax revenues. The rest goes to the general fund.
Supporters of allowing the local Supreme Court to decide the issue contended that it is a matter of pure local law and that the federal court should have a deference to the local courts before declaring a Puerto Rican law unconstitutional. Opponents say the matter was a federal dispute that could be answered by the U.S. District Judge.
The legality of Cofina or the transfer of ownership of the sales & use tax to Cofina has never been interpreted by any court.
Fafaa, FOMB react to the proposed settlement
The Financial Oversight & Management Board (FOMB) said today that the economic terms of the General Obligation-Cofina creditor proposal made public today do not align with the New Fiscal Plan certified on April 19, 2018. The Board stated that it “remains very interested in achieving a broad-based, consensual restructuring of Puerto Rico’s complex and unaffordable debts and is encouraged that our major creditors, even those with competing claims, are working together toward that same goal. However, the economic terms of this creditor proposal were not crafted with any prior input from either the Oversight Board or the government and are completely unaffordable.”
In the Board’s view, the proposed terms would create large and recurring structural deficits over the long run as compared to the long-term primary surpluses projected in the certified New Fiscal Plan, which are highly dependent on the government’s full implementation of the Fiscal Plan, with no aspect as critical to long-term economic growth as prompt enactment of the proposed labor reform.
“The Board welcomes the opportunity to engage with all of Puerto Rico’s creditors toward a consensual and comprehensive debt restructuring that has economic terms that are affordable, sustainable and consistent with the certified New Fiscal Plan over both the short and long terms,” the Board added.
Meanwhile, the Puerto Rico Fiscal Agency & Financial Advisory Authority (Fafaa) announced that after having consulted with its advisers and counsel, as well as the FOMB, has determined the Bondholder-Proposed Settlement terms are not acceptable.
“Fafaa’s decision is based upon the conclusion that the Bondholder-Proposed Settlement debt-service requirements are not sustainable in light of Puerto Rico’s projected fiscal and economic situation, as reflected and explained in the Commonwealth Fiscal Plan submitted to the FOMB”, the financial organism said on behalf of the Government of Puerto Rico.