The Barber of San Juan: Creditors Brace for Haircuts
By: Philipe Schoene Roura & Luis J. Valentín
“Debt restructuring”—If there was any logic to the English language, this term would be a four-letter word. In Puerto Rico’s case, there are 18 different credits with varying hierarchies and values—fittingly restructuring has been defined as an exercise steeped in hardship. The two sides—creditors and the commonwealth’s restructuring brigades—have been in a race against time as the deadline for the first big payment of $422 million by the Government Development Bank (GDB) comes due on May 2.
The most recent proposal to restructure Puerto Rico’s debt continues to target some $49 billion across 11 credits in a plan that now respects the hierarchy of constitutionally guaranteed general-obligation bonds (GOs) and sales tax-backed Cofina (Spanish acronym for Sales Tax Financing Corp.) bonds, with a scalable debt-exchange offer. Proposed haircuts include about 16% for commonwealth-guaranteed debt, including GOs, and 43% for Cofina. Less secure paper, such as those for the Highways & Transportation Authority and the GDB, could see cuts to principal of 44% and 64%, respectively, while other credits would fall around the 50% range.
The offer now makes extensive to local bondholders as much as $8 billion in a new type of base bonds, in a par-for-par deal exclusive for them. The revised proposal also replaces what were once growth bonds—repayable only if Puerto Rico’s economy grew—with capital appreciation bonds (CABs). These would accrete at a rate of 5% annually, payable after 40 years, through a 10-year cycle, until 2065.
The Alejandro García Padilla administration’s counterproposal is the product of talks between the commonwealth’s advisers, headed by Millstein & Co. founder Jim Millstein, a former chief restructuring officer for the U.S. Treasury, and teams of lawyers for creditors who are all jockeying for position. Thoroughbred credits—GOs backed by constitutional guarantees and Senior Cofina credits backed by the local sales & use tax (IVU by its Spanish acronym)—are running neck and neck in this race, insisting that their credits be first in line.
Millstein, Richard Cooper of law firm Cleary Gottlieb and the commonwealth’s Chief Financial Officer Melba Acosta looked at a proposal by a group of GO bondholders that offered a five-year holiday on principal payments that would save the island roughly $1.9 billion, while providing $750 million in new money by issuing more GOs.
Puerto Rico’s fiscal team countered that just paying interests and even with the liquidity injection, cash shortfalls would remain, while leaving nothing to pay other credits, including Cofina. It would end up in courts in a fight with other credits, and significant participation would still be required from GO holders outside of the group that made the offer.
A month before the GO offer, a group of senior Cofina bondholders put forth a plan providing debt-service relief under Cofina during the next four years, although extending debt-service payments for a longer time. This way, Puerto Rico would save roughly $2 billion during the next few years, according to the group’s proposal.
But by defaulting on this credit, payments to holders of senior Cofina bonds would be accelerated, with subordinate Cofina bondholders—many of whom are Puerto Rico residents—getting paid after 25 years.
The common thread in both creditor groups—a claim of “just no haircuts”—has now reportedly been tempered to a claim that premium paper be kept premium. The GOs do not want to trade their steel-belted radial credits for other paper. Cofinas want to keep their sales-tax-backed, golden-lockbox structure. They would be willing to take haircuts in an exchange of GOs for GOs, Senior Cofinas for Senior Cofinas.
This is reportedly an option that Millstein says the commonwealth is willing to entertain, so long as the math in the equation provides adequate levels of annual debt service, not exceeding 15% of government revenue in a year. This option also cannot place the burden solely on other credits.
“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.
The so-called “superbond” is still the administration’s only card on the table—a “global” 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 these credits.
Commonwealth advisers believe the superbond provides a stronger, more liquid instrument, while reducing inter-creditor conflicts. They continue to stress that the island cannot afford a partial deal that leaves it in court with billions of dollars of debt.
An offer they might refuse
“It is really more of the same; it has little improvement with the CABs that have some slight initial value and improve the notional recovery, but we don’t see the rationale for this proposal from an absolute or relative basis,” said Nader Tavakoli, CEO of Ambac Assurance, during an exclusive interview with Caribbean Business. Ambac is one of the municipal bond insurers with exposure to Puerto Rico debt.
“It is interesting to see the timing for the release of these proposals, right before or during congressional hearings to give the impression that something is being done—when, in fact, it is not a counterproposal. It was a counterproposal to their own proposal to which no one made a counter,” he added.
Tavakoli is not alone in his allegations. Several Caribbean Business sources have confirmed that there were no constructive meetings in which the commonwealth’s first proposal was rehashed leading to the latest offer. “The new proposal is very much like the first proposal; there is some tinkering around the edges, and some of the securitization structures could possibly be left in place, but it really is not that different,” said one source with knowledge of negotiations taking place between the commonwealth’s advisers and various creditor groups.
“The exchanges are based on market prices and those stronger credits—namely GOs and Senior Cofinas—are not going to agree to a market pricing as a fair value in an exchange program,” the source added.
The market pricing is an issue that seems to be a deal breaker for GO and Cofina credits, which analysts do not see participating in the superbond structure as it currently stands.
Although none of the creditor groups is willing to be the last in line, hedge funds are now snuggling up to a dog of a deal that is starting to look more attractive by the day. Creditors who possess stronger paper have watched in dismay as their assets have tanked over the past several months, thanks largely to actions by the government. In what is being interpreted as scorched-earth policy, the commonwealth’s media tour of the U.S. Congress and Wall Street, more than stressing the impossibility of making the next two big debt-service payment due dates—the GDB’s $422 million on May 2 and some $1.5 billion in July 1, including $780 million for GOs—has served to push the value of Puerto Rico’s bonds to record lows.
Then, the death knell was struck when García Padilla signed into law the Puerto Rico Emergency Moratorium & Financial Rehabilitation Act. At this writing, the once-sterling GO and Cofina bonds were trading at under 50% of their value.
A novel idea
“The problem is that the GOs and the Cofinas both feel that their paper has a superior hierarchy,” said Latin Media House Chairman Miguel Ferrer, a hedge-fund manager who owns a share of Puerto Rico bonds. “It is pari-passu, all things are equal—they are both right.”
Ferrer believes the impasse between the GO and Cofina bondholders could be resolved with an offer that prioritizes stronger paper, made on the basis of three series. Series I, which would have maturities of 7 to 15 years, with 70% of the value of the bonds exchanged and a 3% coupon; Series II, which would have 15- to 30-year maturity, with 85% of the value of bonds exchanged and a 5% coupon payable each year. Series III would contain 30- to 45-year maturities at par value.
“You would prioritize maturities, offer the option of shorter maturities to those bondholders that have the most valuable paper first; in other words, GOs and Cofinas get a first crack at participating in the Series I,” said Ferrer, who believes this offer brings in elements of the “entry point” component of the proposal made earlier in the year by a coalition of local cooperatives and credit unions, seeking a debt-restructuring mechanism based on the price at which each bondholder acquired their respective Puerto Rico bonds.
“You would pay each maturity in the order of priority until each tranche is paid. So again, the stronger credits would get their 70% in year seven, while others would obtain it in year 15. You would go paying creditor by creditor in the tranche. Then the next maturity group would hit,” Ferrer added.
The new Series I bonds would be funded through a securitization mechanism similar to that structured for the Puerto Rico Electric Power Authority (Prepa). The utility’s restructuring support agreement includes a back-stopped liquidity entity funded by a securitization mechanism that will allow Prepa bondholders to trade their paper for investment-grade bonds. Ferrer sees sources of payment coming from unassigned portions of the IVU, as well as the petroleum-products tax, known as la crudita.
Series II, those creditors seeking an 85% exchange rate, would be grouped in maturities extending from year 15 to year 30. Again, Ferrer explained that higher-rated credits exchanging into Series II would be able to get out at year 20, “and so on down the line until you run through the entire tranche.”
Gustavo Vélez, an economist who has taken some high heat for his advocacy of a federal oversight board, believes that an offer like this could entice hedge funds that bought at a discount, while those holding less secure paper could go for the Series I offer. “If we assume that these have 30% of the $49 billion, that represents 25% savings on principal payment of $15 billion ($3.75 billion) and another $300 million annually in interest (a 2% coupon cut),” Vélez said.
Ferrer envisions a scenario whereby the government can save billions of dollars. “Imagine, if you had $20 billion of the $50 billion getting out at 70%, you would have $6 billion in savings alone and imagine that those have a 5% coupon, you would have $300 million in annual savings,” he explained. “Plus you have $14 billion that remain on, which would lower the coupon from 5% to 3%. That’s several $100 million more. It may not achieve the $22 billion that Melba [Acosta] wanted, but it will come close. And it is a more reasonable offer to close the gap between what the creditors want and what they can receive.”
Ferrer believes that hedge funds will jump at the chance to get into Series I because theirs is an issue of timing: They want to get out quick at 70% rather than fighting to obtain par value. “They want their money out now; the sooner, the better option even at 70% is achievable,” he said.
No sympathy for the devil
Because the creditor body is not monolithic—there are creditors who do not care in the short term about payments, but rather owning a piece of paper that trades well—there are creditors that are more dependent on a current income stream.
“Having a choice of different options may be palatable, but the devil really is in the details,” said one lobbyist on the Hill who spoke to Caribbean Business on the condition of anonymity. “It is an interesting idea. Frankly, it sounds a lot like some of the elements that were in a proposal that we saw presented by the Senior Cofina bondholders, in the sense that it offers a mechanism that allows those creditors who want current income to trade at a discount. You would have to see how it is executed; there is a limited amount of money. What happens if everyone goes for Series I? Do you securitize?—That has to be answered.”
Underpinning those questions is a pressing concern over the commonwealth’s delay in presenting updated audited financial statements, which makes many creditors skeptical of new proposals. “There is a general skepticism in the creditor community about possibilities and probabilities because we don’t even have financial statements for these entities. How do we agree to anything until we get a sense of what is really needed,” Ambac’s Tavakoli told Caribbean Business. “We are supportive of Congressman Bishop’s work toward a federal oversight board. We want the oversight board to get down there and assess the situation. And, not presume that there is all of this debt restructuring that needs to happen. We are happy to look at anything that is constructive, but our focus right now is on the congressional bill.”
Ambac is one of the Highways & Transportation Authority’s (HTA) bond insurers, with a total exposure of $493 million of lifetime principal and interest on the authority’s more than $4.5 billion in outstanding debt.
As this newspaper was going to press, there was a protracted fight being waged in the hallowed halls of Congress by lobbyists for GO bondholders who are trying to brand the oversight bill as a bailout. Those bondholders are behind the Super PAC that is funding the advertising campaign running on U.S. networks with the slogan “No Bailouts for Puerto Rico.”
One lobbyist tied to the Democratic Party who has been part of meetings with House Speaker Paul Ryan (R-Wis.) and House Natural Resources Committee Chairman Rob Bishop (R-Utah) told this newspaper that “a lot of the Republicans who are being affected by the ad campaign are much more understanding that Promesa [the acronym for the Economic Stability Act] is not a bailout and that it is headed toward being a responsible bill.”
Some creditors, namely GOs, who prefer regular Chapter 9 bankruptcy since it would exclude them, are against the oversight bill. Other creditors, namely the big bond insurance companies that are on the hook for $16 billion in commonwealth debt, welcome the oversight bill because it would help them to avoid footing the bill for more than $2 billion in defaults that could kick off in this summer of discontent.