Puerto Rico Proposal Would Provide Debt Relief for the Commonwealth

On Monday, February 1, the Working Group for the Fiscal and Economic Recovery of Puerto Rico (the “Working Group”) introduced a plan intended to help provide economic stability and increased fiscal flexibility for the Commonwealth of Puerto Rico by reducing its debt obligations. Under the plan, current bondholders would voluntarily exchange $49.2 billion of tax-backed commonwealth debt for two new types of debt. In essence, bondholders would take a 46% haircut by receiving $26.5 billion of “Base Bonds,” secured by existing tax revenues and a new tax on petroleum products. Bondholders could recover the remaining amount of their principal if revenues backing the second type of debt, “Growth Bonds,” exceed projections.

In addition to the reduced amount of principal, the Commonwealth’s debt payments would also be reduced, as principal payments would be deferred until 2021, and total debt service under the plan would be capped at 15% of government revenues. The plan would impact only the commonwealth’s tax-backed debt, including general obligation and pension bonds, specified debt of the Government Development Bank, COFINA sales tax bonds and debt of the Highway and Transportation Authority. The plan excludes bonds issued by the Puerto Rico Housing Finance Agency, amongst other non-tax backed debt.

We expect that many bondholders will balk at the Working Group’s proposal. In particular, COFINA sales tax bonds have had a high level of coverage and strong bondholder protections, including provisions that exempt pledged sales tax revenues from any diversions to pay commonwealth general obligation bonds. The proposed exchange would fly in the face of existing debt agreements, as general obligation bondholders would receive 72% of their current holdings in Base Bonds, while COFINA bondholders would receive only 49%.
While we expect that there will be restructuring of Puerto Rico’s debt obligations, we believe there will be a lengthy period of negotiations before a plan is finalized. We also believe that other types of reforms or programs will need to be implemented to provide stimulus to an anemic Puerto Rico economy.

Sources: Bloomberg, Working Group for Fiscal and Economic Recovery of Puerto Rico