(GFR Media)

If the Oversight Board had accepted the economic terms of the joint proposal of certain bondholders of the Puerto Rico Sales Tax Financing Corporation (COFINA) and the organized group of bondholders of General Obligations (GOs), Puerto Rico would have reached an agreement with several of its most important creditors. But this would have been done without a budget that could make it feasible, because the proposal does not offer a significant debt cut, while local bondholders would be left with the worst part of the transaction.

At least two separate sources aware of the negotiations regarding the joint proposal and that have examined its terms, assured that the COFINA-GOs offer would allow several hedge funds that bought their discount bonds to virtually recover the total debt issued in COFINA and GOs bonds.

But that benefit for the main COFINA and GOs bondholders would come by "sacrificing" COFINA's subordinated bondholders, mostly individuals, mutual funds, private pension plans, local businesses and cooperatives in Puerto Rico.

"These funds seek to keep what they have not pay at the local bondholder's expense," said one of the sources, who requested anonymity. "The proposal removes ownership rights of COFINA subordinated bondholders, to give it to GOs bondholders that do not have that protection," added the source. 

"(Municipal) insurers would be relieved because they would recover almost at par in COFINA, compensating what they may lose with other loans," explained another source, an investment banker who also requested anonymity. In financial jargon, at par means that bondholders would recover the initial value plus the accrued interest. 

Final blow to subordinated bondholders

These sources’ statements seem to be confirmed with a report by the BTIG firm published this week.

In this report, analysts Mark Palmer and Giuliano Bologna -who follow up the actions of several municipal insurers- cataloged the agreement between certain COFINA and GOs bondholders as "a significant step towards a potential resolution of one of the most critical and complex disputes in the restructuring of Puerto Rico's debt."

"If the agreement were implemented as a whole, COFINA seniors would receive between 93% to 95%, while COFINA subordinates could recover between 42% and 43%," states the analysis conducted by Palmer and Bologna.

Based on Palmer's and Bologna's analysis, COFINA's subordinated bondholders -who according to their contract bonds have the repayment guarantee of the Sales and Use Tax (SUT)- would receive less than than GOs bondholders. According to the analysis, GOs bondholders -whose bonds do not have any specific source of repayment, although they claim to have payment priority under the Constitution- would receive almost 57 centsof every dollar they lent to the government.

The offer -rejected by the Board- also stated that  subordinated bondholders would not even be entitled to receive a portion of SUT collections, guarded by the Bank of New York Mellon, because that item would be distributed among COFINA's and GOs senior creditors.

However, if the proposal had been accepted, it could not be paid starting the next fiscal year, a date recommended by the proponents, unless the Board and the Government make significant cuts for the rest of the creditors and pensioners.

According to the revised budget, which is still being negotiated between the Board and the Government, as of next fiscal year, Puerto Rico would separate $ 2,327 billion to pensions payment and $ 970 million to the payment of the public debt. That last figure would be, in the best case scenario, one quarter of the debt service that Puerto Rico should pay in the following fiscal year.

A message to Swain

"The proposed framework for a resolution shows a degree of unity between creditors on both sides of the dispute that had not been previously seen. We believe that this framework also sends a signal to Judge Laura Taylor Swain," added the analysts, in referring to the judge that presides over the Island's debt restructuring.

On the other hand, according to sources, the best evidence that the idea is not beneficial for Puerto Rican bondholders lies in the lack of support of those institutional funds that have invested in the Island and that have debt with COFINA and GOs, as well as the closed mutual funds of the Island, which have subordinated COFINA debt.

Those mutual funds with COFINA that participate in the Title III litigation under the name of Mutual Fund Group, for example, did not support the proposal. The local firms UBS Financial Services and Santander Asset Management have participated in this group.

But the proposal received the endorsement of Bonistas del Patio (Backyard Bondholders), an organization that even participated in the mediation process, allegedly in representation of local bondholders, revealed this week the Executive Director of the organization, Jorge Irizarry.

El Nuevo Día reported the offer of COFINA-GOs creditors before the Board and the Government rejected it. The Committee of Retirees and the Unsecured Creditors Committee (UCC) also rejected the offer, according to sources.

In contrast, for the proponents the initial agreement is an opportunity for Puerto Rico to end its default pattern, to reduce the debt and end the litigation regarding who owns SUT collections. 

The actors

Last Monday, members of the COFINA Senior Bondholders Coalition and some COFINA subordinated bondholders, as well as members of the Ad Hoc-GO group, announced that they had reached an initial agreement on the parameters that should rule the renegotiation of the Island’s debt. In short, the structure to be created would be a trust fund that would receive 5.5 percent of the SUT. In general terms, COFINA and GOs bondholders would exchange their debt for a new instrument that would be paid from SUT collections during the next 40 years and would receive part of the funds accumulated in that entity´s reserve accounts.

The proposal provides for the exchange of another $ 500 million of unsecured credits.

In addition, the COFINA-GO group announced a monetary offer that, according to creditors, would save approximately $ 10 billion in the Island's public debt.

As stated in the documents revealed by authorization of the mediation team that works with Title III cases, for COFINA, the proponents own approximately 54 percent of the main or senior bonds. These include investment funds, but main bondholders are insurers such as Ambac Assurance Corp.

COFINA subordinated bondholders that subscribe the proposal are the same funds that have senior debt, with the exception of Canyon, and the municipal insurer Assured Guaranty joins them. In total, they barely own 13 percent of the current COFINA subordinated debt.

On the GOs side, seven investment funds subscribe the agreement, as well as the Assured and Ambac insurers, also owners of COFINA bonds. National Public Finance Guarantee and Syncora Guarantee are also included. 

Together, the proponents on the side of the GOs represent 35 percent of the current debt.

Although the documents indicate that "local bondholders" subscribe the agreement, it is not specified how much they own in GOs or COFINA bonds.

Benefits for some

"The resolution agreement, if adopted, could represent a significant positive for AGO (Assured), MBI (the parent company of National Public Finance) and AMBC (Ambac) to the extent that recoveries would be well above the prices in which unsecured bonds are listed, according to the market on Friday and well above market expectations, as reflected in each of the discount values of insurers," said Palmer and Bologna in their analysis, and recommend to buy the three stock titles.

Since the announcement of the joint proposal last Monday and until last Wednesday, Ambac shares grew 13 percent, and reached its highest level in six months. Assured barely moved higher and MBIA (National's parent company) fel by almost 3 percent.

Consequences for the island

Last Monday, the Board rejected the proposal of COFINA-GOs, but left the door open to "any structure" that allows the Island's debt to be renegotiated fast and reasonably.

However, although the resolution framework proposed by COFINA-GOs uses the securitized debt mechanism, the agreement does not represent the end of the litigation that Puerto Rico faces in Court.

For example, the document emphasizes that the calculations made to exchange the existing debt for a new one that will be at "par", that is, its initial value plus the accrued Title III interest.

Puerto Rican taxpayers would also have to pay the lawyers and advisors of these groups of bondholders. Sources assure that only COFINA Coalition expenses are around $ 75 million.

On the other hand, the deal reached by both groups of bondholders establishes that the agreement would be, in essence, separated from the rest of the adjustment plan that Puerto Rico subscribes with its other creditors, which implies leaving government employees and retirees out of the equation, as well as government contractors, who are expected to have  recoveries of just cents. This is because the agreements document say  that executing the transaction "would not be conditioned or tied to the confirmation or effectiveness of an adjustment plan for the Government."

Likewise, according to the proposal, while the Government would reach an agreement with the GOs bondholder who join the agreement, it still would have to structure a solution for the rest of the debt. According to the documents, about $ 7,561 billion of constitutional debt would remain pending negotiation.

"Nothing contained in this draft joint resolution addresses the procedures of Title III and the rights, remedies and objections of all parties regarding the claims made against the Government," states the documents disclosed by COFINA-GO bondholders.

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