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If next Tuesday, Judge Laura Taylor Swain concludes that the Board and the administration of Ricardo Rosselló complied with all the requirements of PROMESA and the applicable provisions of the Bankruptcy Code, then Puerto Rico will enter the final stage of the modification of the Sales Tax Financing Corporation (Cofina, Spanish acronym) debt.

But, according to the considerations of several creditors and a recent analysis by Nobel Prize-winning economist Joseph Stiglitz, the proposed renegotiation for Cofina will not be so favorable for Puerto Rico.

In addition, according to the objections filed in court, the adjustment plan will grant almost all the payment to Cofina senior bondholders, causing losses to subordinate creditors, many of them, residents of Puerto Rico.

In that sense,  Cofina bondholders will have days, or, at most, a few weeks during the holiday season to decide if the adjustment plan - an extensive and very complex document, full of warnings and risks that few or none will presumably read - suits them.

What will happen on Tuesday?

Next Tuesday, Swain will have the opportunity to hear the arguments for and against the Cofina adjustment plan and will examine the disclosure statement submitted by the Board. Broadly speaking, it is a 621-page document, divided into several sections or chapters. The document includes the Cofina fiscal plan, as well as details of the agreement signed by the Unsecured Creditors Committee (UCC) and agent Bettina M. Whyte on behalf of Cofina, which put an end to the controversy regarding the Sales and Use Tax (SUT). 

In addition, the document includes the PSA to modify the debt of Cofina and amortization for the debt renegotiated debt within a 40-years period.

At full speed

The agreement is the result of the mediation process encouraged by Swain and which ended the dispute over the SUT.

According to the file, there is a rush to renegotiate the main debt of the government of Puerto Rico.

The main legal advisor of the Board, Martin Bienenstock, told Swain earlier this month that the entity expects to achieve the approval of the adjustment plan by next January, that is, just as the US Congress changes hands after mid-term elections.

Furthermore, unless objections prevail or Swain determines that the plan is not reasonable according to PROMESA, the voting process of the adjustment plan will be, in essence, academic because the disclosure statement established that "the parties, as described in the PSA, will have to vote to accept the Cofina plan."

On the other hand, Judge Swain denied a motion from the Official Committee of Retired Employees (COR, Spanish acronym), a group that requested to extend the deadlines to file objections to the current proposal.

Constitutional margin

Last Friday, the COR warned Swain that the agreement submitted will affect the future of Puerto Rico. Specifically, the COR said that in the first agreement the parties agreed that in the future, when Cofina issues debt again, it will have to be calculated within the 15 percent loan margin as stipulated by the Puerto Rican Constitution.

"Neither the agreement nor the Title III adjustment plan includes this safeguard," warned the COR, through his attorney, Robert D. Gordon, who added that allowing the agreement without such a restriction is a "dangerously short-term" position.

The consideration is not to be taken lightly, since one of the findings of the special investigator, Kobre & Kim, on the reasons for the island´s fiscal collapse was not counting multiple debt transactions in the analysis of the constitutional margin.

According to the Board

Sources assure that the Board does not fully agree with the terms reached with Cofina bondholders. But faced with the possibility that the dispute over the SUT took years and the government would have to spend hundreds of millions of dollars on lawyers, the Board agreed to the pact between the UCC and Whyte, on behalf of Cofina.

In short, the UCC and Whyte agreed to split up the pledged portion of the SUT - that is, 5.5 percent of the total 11.5 percent that is the current rate.- between Cofina and the General Fund. 

The agreement would allow the government to save about $ 17 billion in annual payments over the life of Cofina's renegotiated debt.

According to the Cofina fiscal plan - on page 10 - and the PSA, Puerto Rico will only cut some $ 4,700 billion of the current Cofina´s principal that has been calculated at about $ 16,700 billion.

Another argument in favor of the agreement, according to the Board, is that it is an settlement signed by some major Cofina creditors, municipal insurers and investment funds that hold General Obligation bonds (GOs) and that would have objected to the plan if they had not been compensated through Cofina.

In addition and as reported by El Nuevo Día, those who sat at the negotiating table with the Board and the government will receive $ 332 million, funds that are in the Bank of New York Mellon -the custodian of Cofina- and that should have been used to pay the bondholders.

A 621-page "farce" 

Stephen T. Mangiaracina, a lawyer and subordinate or "junior" Cofina bondholder is among those bondholders who will not receive a penny of that compensation. He has labelled the process followed in Cofina as "a farce."

For the lawyer, the whole document that the Board submitted before the court seems tos kip the “due process of law” that protects bondholders.

"I will not be at the hearing on November 20, 2018. I live in South Carolina. That's two days before Thanksgiving. I would have to pay an exhorbitant amount of monet for an air ticket, accomodation, meals and local transportation. My family and I cannot afford to have a New York firm representing us in court that day," said the lawyer.

The COR, Mangiaracina, four savings and credit cooperatives have asked Swain not to give way to the Cofina agreement.

“It is unreasonable for creditors to vote on the acceptances or rejections on a Plan which based on the numbers assigned to the appearing creditors proofs of claims entails no less than 45,000 claims and debts

outstanding as of May 4, 2017 of $17,637 Million,” argued the savings and loans cooperatives de Rincón, Manuel Zeno Gandía, del Valenciano and de Juana Díaz.

Among other things, Cofina's adjustment plan divides Cofina's creditors into 10 groups or classes. But nowhere in the document they explained how much Cofina owes to each class or “what can be expected to be received per each defined class,” the credit unions stated. 

On the other hand, the document also makes multiple technical warnings such as the fact that Cofina renegotiation includes exchanging tax-exempt debt for taxable and that the adjustment plan could be changed at any time. If this were the case, the Board would notify it -at least- 15 days before the voting deadline.

The document also warns that if a bondholder receives a check for the claim and does not cash it within six months, he will not be able to file any further claim or request for payment.

The history of SUT

In dollars and cents, as of fiscal year 2020, Puerto Rico would separate approximately $ 814.5 million for the payment of Cofina and other obligations in the General Fund. The figure would increase to $ 1.85 billion by fiscal year 2041. In total, after 40 years, and considering the cut of the principal provided by the PSA, Puerto Rico will pay Cofina bondholders approximately $ 32.3 billion.

Beyond the complexities of the disclosure statement, the debt exchanged and issued by Cofina´s successor, seems to rest on the premises that were questioned before PROMESA Title III was invoked.

When, under the administration of Luis G. Fortuño, Cofina subordinated series were conceived, bondholders were told that SUT revenues would increase every year at a 4 percent rate.

Although the fiscal plan states that the population of Puerto Rico and therefore, the number of consumers will decrease, the amortization sheet of the new Cofina bonds establishes, precisely, that from fiscal year 2020 to fiscal year 2041, SUT revenues will grow 4 percent.

However, since SUT was adopted in 2006, the story has been is a different one.

The disclosure statement says that the SUT has raised about $ 17.457 billion between 2006 and fiscal year 2018. This would mean an average annual growth of 14 percent. When analyzing the performance of the SUT year by year, volatility reigns in this source of revenues.

In 2009, for example, instead of increasing, the SUT fell 13 percent year-on-year. To counterbalance that, the Treasury promoted the SUT-Loto and ordered oversight in sale points. After that move, between fiscal years 2011 and 2013, SUT revenues only increased between 1 and 3 percent. At that time, the government legislated to collect SUT on online sales.

Two years later, a 4 percent SUT was applied to professional services, which contributed to raising collections by 14 percent. A year later, the SUT went over the $ 2 billion mark in collections because the applicable rate was increased to 11.5 percent.

The Stiglitz analysis

"Sadly, the opportunity to right Puerto Rico’s fiscal ship has not been seized," Nobel Prize-winning economist Joseph Stiglitz wrote in the Project Syndicate magazine last week.

According to Stiglitz, instead of rewriting a “flawed” plan, after the opportunity created by the devastation caused by Hurricane María, the Cofina agreement could put put Puerto Rico "in a debt straitjacket indefinitely."

"The terms of the restructuring do not provide enough relief for Puerto Rico to be able to achieve future growth," Stiglitz explained, noting that when the agreement is analyzed, in the aggregate, senior and subordinated bondholders will receive almost 76 cents.

When it is segmented, senior bondholders would be almost 93 cents and subordinates, 54 cents.

"If such a deal were to be implemented, there would be virtually nothing left for the other categories of bonds," the economist warned.


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