January 17, 2019

Puerto Rico Update: As COFINA Restructuring Nears Finale, GO Bondholders Fight Amongst Themselves

by Tom Chan.

As we start the New Year, Puerto Rico remains in focus for municipal investors. For Cofina bondholders, recent news has been mostly positive; the restructuring plan is on track to be finalized and the bankruptcy judge is expected to confirm the plan this week – marking a major milestone for the island. Meanwhile GO bondholders are seeing significant volatility. A joint legal motion was filed this week challenging the legality of certain GO bonds issued by the island. The motion was filed by the Financial Oversight and Management Board for the Commonwealth of Puerto Rico and the Official Committee of Unsecured Creditors. More specifically, the motion calls to invalidate GO bonds issued in 2012 and 2014 resulting in a sharp drop in the value of these bonds and diverging from securities issued prior to 2012.

Of the $13 billion of outstanding GO bonds, over $6 billion of bonds are being challenged in the legal motion. Impacted securities include, among others, the $2.3bn of series 2012 and $3.5bn series 2014 GO bonds. The motion argues these bonds were issued in violation of Puerto Rico’s constitutional debt limit and should therefore be invalidated. A key part of the government’s argument is the debt limit threshold would have been exceeded with the inclusion of debt issued by the Puerto Rico Public Buildings Authority (PBA). This is unusual as the PBA debt was not issued as direct obligations of the Commonwealth. Rather, the PBA debt was secured by rent payments made to it for leasing out office space to the island government. The lease payments were paid by and guaranteed by Puerto Rico government. It is argued by the island government, for all practical intents and purposes that debt issued by the PBA should be treated as a direct obligation of Puerto Rico and should be included in the debt limit calculation.

Bond prices for Puerto Rico GO bonds issued prior to 2012 have diverged considerably from bonds issued on and after 2012 (refer to chart below). For the prior several months leading up to January 14, 2019, Puerto Rico GO bonds were trading at similar levels regardless of their year of issuance. Since then, prices of Puerto Rico GOs have diverged with 8s of 2035 issued in 2014 and 5.75s of 2041 issued in 2011 widening by $11. In heavy trading on Tuesday, PR GO 8s of 2035 declined by 10%, while the 5.75s of 2041 traded 10% higher due to optimism that the recovery pool will be larger for these bonds.

The outcome challenging the legitimacy of certain GO bonds is unclear at this time. The motion to invalidate the bonds will certainly receive objections from affected bondholders. The motion will also need to be approved by the bankruptcy judge. Parties looking to invalidate the bonds are seeking to have a hearing on the motion on Jan 30, 2019.

Any decision on the “pre-vs-post” 2012 GO bonds issued by Puerto Rico could have wide ramifications for the broader municipal market. Debt limits are commonly written into state constitutions and local by-laws restricting how much GO and other direct-debt can be issued. The lease appropriation structure is commonly used by state and local governments as a way to bypass these traditional GO debt issuance limits. If lease debt structures become recognized or re-characterized as direct obligations, the entire municipal market would need to reassess the validity of both structures.

Source: Thomson Reuters Pricing Service.

For more information on Puerto Rico’s restructuring plan, see our whitepaper here: Puerto Rico: Light at the End of the COFINA Tunnel

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*This TRPS article does not provide individualized advice or recommendations for any specific subscriber or portfolio and is not intended for decisions relating to investments, legal, compliance or risk.  Investing involves substantial risk.  Neither the editor, the publisher, nor any of their respective affiliates make any guarantee or other promise as to any results that may be obtained from using the information contained herein. While past performance may be mentioned, it should not be considered indicative of future performance. No reader or subscriber should make any investment decision without first consulting his or her own personal financial advisor and conducting his or her own research and due diligence, including carefully reviewing the prospectus and other public filings of the issuer in question.

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