Puerto Rico Proposes Debt Cut

Bloomberg

Puerto Rico Faces Hurdles Seeking a 46% Cut in Debt - Puerto Rico’s debt restructuring plan unveiled today is unlikely to get much traction from bondholder groups because it would require them to accept big losses on debt.

Puerto Rico proposed to cut its $49.2 billion of tax-supported debt by 46% to $26.5 billion as part of a broad plan to put the financially beleaguered island on a stronger footing.

There has been a mild negative reaction in the market as Puerto Rico’s benchmark 8% general-obligation bond is down about 1.5 points to 70.625 in afternoon trading, for a yield of 11.9%.

The problem with the proposal is that key groups of bondholders, notably those holding GO debt and senior sales-tax revenue bonds (COFINA), believe they have strong constitutional and legal protections and probably aren’t going to accept the hits of the magnitude that the commonwealth is proposing today.

As one muni portfolio manager told Barron’s, Puerto Rico will need to gain access to municipal bankruptcy protection through Chapter 9 in order to force a plan on creditors because bondholders are unlikely to agree to any plan along the lines of the one proposed today. Puerto Rico now doesn’t have access to Chapter 9 – Congress has refused so far to grant it such authority – and is seeking a consensual agreement with creditors.

Another manager says that this amounts to an opening, hardball proposal from Puerto Rico that likely will have to be modified significantly to have any chance of getting serious consideration by bondholders.

The island proposes to give bondholders two securities: a so-called base bond that it says has an effective yield of 5% and a so-called growth bond that is payable only if the commonwealth revenues exceed certain levels in the coming years. The base bond is the only security to which investors are willing to accord value now given all the uncertainties with the growth bond.

Holders of $17 billion of GO bonds would get 71 cents on the dollar of base bonds, while those holding $17 billion of COFINA first-lien debt would get about 49 cents on the dollar of base bonds and holders of $15 billion of less secure debt would get just 39 cents on the dollar of base bonds.

However, the base bonds, which are designed to have a 5% “required yield” – it’s not clear what that phrase means – likely wouldn’t trade at par, or face value. Investors tell Barron’s that a new 5% Puerto Rican bond due in 2051 (the base bonds) initially might carry a 7% yield, meaning a 5% security would have to trade around 75 cents on the dollar. This means that GO holders would get 71 cents of a security that might trade for 75 cents on the dollar, for a value of around 53 cents on the dollar (0.75 times 0.71).

That’s not an appetizing deal for GO holders who believe they are constitutionally protected and deserve full payment or something close to that. The base bonds wouldn’t pay interest until 2018 and then would pay a rate of just 3% for the first two years. With long-term Puerto Rico GOs now trading at 60 to 70 cents on the dollar, investors are anticipating some haircut but not as much as the commonwealth is seeking today.

The GO holders also would get a sizable amount of growth bonds to theoretically make them whole but those bonds would trade at a huge discount from face value, giving them very little current value. Muni managers are according the growth bonds almost no value.

Likewise, senior COFINA holders believe they have a lien on sales tax revenues and wouldn’t be happy with a package of base bonds that could be worth less than 40 cents on the dollar (0.49 times 0.75). Senior long-term COFINA debt now trades below 60 cents on the dollar.

All this suggests that the Puerto Rican debt restructuring plan may not go anywhere. The commonwealth may need Chapter 9 or similar legal authority to force a proposal on reluctant bondholders in order to get the debt relief that it says it needs.