“Progress is not an illusion, it happens, but it is slow and invariably disappointing.” – George Orwell
For the holders of uninsured Puerto Rican debt, the words of Mr. Orwell are strikingly poignant. The first quarter of 2017 has seen continued defaults across island credits, a possible Puerto Rico Electric Power Authority (PREPA) renegotiation, and a fiscal growth plan that was disappointing to say the least. March saw the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) Board approve the governor’s fiscal economic growth plan which, among other things, identified just $7.873 billion to cover $35.158 billion in debt obligations over the next ten years. This amount equates to an average annual payout rate of just 22.39 cents on the dollar over the ten-year period. This is, in our view, the first salvo in what will be a long and contentious restructuring. The likelihood of a consensual restructuring has been diminished by the starting point set out in the fiscal plan. The likelihood of a Title III restructuring, or bankruptcy-like process, grows. It is important to keep in mind that recoveries could be much higher, depending on issuing authorities and creditors’ positions in the overall debt stack. A lesson to take away from Detroit’s recent bankruptcy is that initial offerings can be much different than eventual outcomes. The initial offer to general-obligation bondholders in Detroit’s case was 20 cents on the dollar, which was then lowered to 15 cents, but the eventual outcome was 74 cents. We would not hang our hat on that outcome; instead, we recommend that uninsured debt be avoided, as eventual recoveries are guestimates at best and risks remain significant. The market response to the governor’s plan for uninsured debt was decidedly negative, with prices down 5 to 10 points across various issuing authorities.
Most concerning among recent developments has been the intrusion and attempted renegotiation of PREPA’s current restructuring support agreement (RSA) by Governor Ricardo Rosello. The governor, who many viewed initially as bondholder-friendly and cognizant of the importance of market access for the Commonwealth’s future, has adopted a decidedly different tone with his actions. Since Rosello took office, the Puerto Rico Fiscal Agency & Financial Advisory Authority (FAFAA) has taken over negotiations from the electric authority and failed to extend the contract of PREPA’s Chief Restructuring Officer Lisa Donahue of AlixPartners. The administration’s proposed RSA, which has not been well received by creditors, includes lengthening maturities, reducing debt service reserves, and eliminating the $464 million surety bond funded by the monoline insurers. The governor is likely seeking further concessions from bondholders, including the insurers who took no impairment due to their funding of the current RSA’s surety bond. The governor’s interference is troubling as the restructuring of PREPA remains, for the time being, the best example for future consensual negotiations.
Litigation between general-obligation and sales-tax bondholders continued in the first quarter until March 20, when Chief Appellate Judge Jeffrey Howard ordered all proceedings in the district court stayed “until further notice,” since continued litigation might hinder any consensual negotiations under Title IV. The outcome of this case remains a pivotal piece in future restructurings for both general-obligation and COFINA debt holders. Cumberland maintains our view that the COFINA structure remains pivotal to the Commonwealth in any future attempts to tap debt markets.
We expect defaults to continue across island authorities and the process of renegotiating the Commonwealth’s debt to be complicated and drawn out.
We come away from recent developments confident in two things: The insurers will work feverishly to protect their interests, and remain money good. Cumberland does a tremendous amount of work examining the insurers we utilize, focusing on their ability to meet obligations of principal and interest when due. Insured bonds, after briefly trading off on the negative news, have rebounded and continue to offer an attractive value proposition. With insured yields at 4.5% or better, we continue to believe that Assured Guaranty and MBIA insured bonds offer an attractive opportunity for investors.
Cumberland Advisors’ Puerto Rico Insured strategy does not include uninsured debt from any island authority but focuses instead on the headline-driven opportunity in carefully selected insured debt. It is critical to examine the details of each bond indenture and the terms of each insurance contract. Blindly buying insured bonds is not a strategy we recommend.
