Puerto Rico Draft Exposes Faultlines Among Creditors

Puerto Rico’s debt crisis has pitted Republicans against Democrats, Puerto Rican elected officials against some of their counterparts in Washington, and even bondholders against bondholders.
The various factions of creditors are at odds about whether a legislative aid package for the island should force debt restructuring even if all the parties can’t come to an agreement on a fair deal. Everyone will lose some money in the process. The only question is who takes the biggest hit.
By now, the story is familiar. Puerto Rico for decades boasted a burgeoning municipal bond market before it began facing a macroeconomic collapse that contributed to the erosion of its tax base, inflated public costs and a vortex of debt obligations totaling $72 billion. Interest on most of San Juan’s bonds is exempt from federal, state and local taxes, leading major firms and hedge funds to take out billions in Puerto Rico bonds.
Many of those firms now are refusing to accept a cut on those bonds as part of restructuring legislation. Among them are the general obligation bonds, which Puerto Rico’s government has issued for decades.
The island’s public utilities, such as the public power utility PREPA, have also faced well-documented financial troubles with their own debt service payments, and some have been engaged in talks with creditors.
About a quarter of San Juan’s bonds are in a class of their own. Known by their Spanish-language acronym COFINA, they are backed by a special sales tax that Puerto Rico’s government instituted in 2006, around the same time the island’s financial crisis began. They are safer, by far, than the general obligation or PREPA bonds.
For that reason, COFINA bondholders hold a much different perspective on how Congress could help the commonwealth resolve its debt crisis. They generally approve of the House Republicans’ restructuring plan. The general obligation bondholders, meanwhile, have opposed the initial draft legislation.
The discussion draft’s language is still in a state of flux and will likely change between now and the formal introduction of a bill scheduled for mid-April. Susheel Kirpalani, who represents a group of senior COFINA bondholders, said in an interview that the current version represents an “excellent, responsible first step” for dealing with the crisis.
Kirpalani said the draft language, though far from complete, contains logical elements of bankruptcy laws that are nearly a century old, a point reinforced by senior COFINA creditors themselves.
“It is particularly encouraging to see they have incorporated battle-tested restructuring precedents that balance the needs of the Puerto Rican people, defend against litigious hold-outs, and provide for the ‘fair and equitable treatment’ of creditors,” these creditors said in a March 30 statement.
“If Puerto Rico is given tools to bind all creditors and vendors based on their respective legal rights, all parties should reach outcomes that properly satisfy private and public interests,” the statement said.
That’s a stark difference from other bondholder groups that blasted the discussion draft as soon as it left the gate.
Stephen Spencer, who represents some of Puerto Rico’s major creditors, said in a recent statement that the discussion draft is “fiscally irresponsible” and contains a “cram-down” mechanism he says is unfair to creditors.  That cram-down mechanism refers to language in the debt restructuring title that could force restructuring on creditors even if they don’t like the agreement.
“Most troubling, by including the broad ‘cram down’ provision sought by the Obama Administration, the bill would retroactively eliminate an important investor protection relied upon by millions of individual investors throughout the U.S. mainland and Puerto Rico,” Spencer said. “As a result, the bill would transfer billions of dollars from retail investors and retirees to pay for Puerto Rico’s mismanagement and reckless spending.”
The Main Street Bondholders, a coalition of self-described “small” bondholders on the island, also blasted the House restructuring plan for similar reasons.
All of this opposition is having the intended affect of influencing the congressional debate, especially among Republicans. On Wednesday, Rep. Bill Flores of Texas, chairman of the 170-member conservative Republican Study Committee, announced his opposition to the current form of the legislation because of its “forced restructuring” language.
His comments came in the wake of positive comments from Speaker Paul Ryan (R-Wis.), who called the bill “thoughtful, comprehensive legislation.”
However, not everyone thinks the final deal, when it comes out, will be too hard on the general obligation bondholders. According to Daniel Hanson, an analyst with the advisory firm Height Securities, the legislation specifically creates a process that “insulates creditors – especially in ‘good’ credits – from bankruptcy.”
“We continue to believe this legislation represents a positive event for General Obligation (GO) bondholders, despite some appearances to the contrary,” Hanson said in a March 31 analysis.

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