WASHINGTON – Analysts and bankers questioned the feasibility of a proposal to use a debt exchange to restructure Puerto Rico’s bonds that is under discussion by Treasury Department and territory officials.
The idea would be to persuade holders of the $72 billion of debt of Puerto Rico and its authorities to exchange their bonds, which represent a range of credits, for part of a “superbond” that would be backed a wide array of employment and other taxes Treasury collects for the commonwealth as well as tax revenues collected by the territory.
Treasury would not issue any bonds, provide any direct financial assistance, or offer any guarantees, but instead would act as an intermediary between the commonwealth and its bondholders. Inefficient tax collection has contributed to Puerto Rico’s fiscal crisis, experts have said. Having the federal government step in to hold the tax revenues might provide bondholders with more confidence in getting repaid, even if it is at a negotiated, lower amount, according to proponents.
But Matt Fabian, a partner at Municipal Market Analytics, Inc. said it’s too early to propose such a solution because Puerto Rico still lacks reliable financial and operational projections for investors to consider when assessing its ability to repay debt moving forward. The territory has not filed audited financial statements for the past two years, among other things.
The commonwealth still needs to address internal issues before something like the superbond proposal could work, he said. Even if the solution is workable, Fabian said, it still would have to “get through the serious hurdles in Congress and the Puerto Rican legislature.”
Congress has been reluctant to move forward with companion bills pending in the House and Senate that would extend Chapter 9 bankruptcy protections to Puerto Rico’s municipalities and public authorities. Key Republicans say they lack sufficient financial information from Puerto Rico. Others say their resistance comes from a desire to prevent a federal bailout of the island.
Gordon Gray, director of fiscal policy for American Action Forum, a center-right policy institute that provides data-driven insight on debt, tax and other issues, said the proposal would look like a bailout to lawmakers and others. “It is very difficult to imagine Treasury pursuing what would widely be seen as a bailout,” he said.
The discussion between the Puerto Rico and Treasury officials “went further than reality allowed,” Gray said.
Puerto Rico needs to revise its tax administration and grow its economy before pursuing something like the superbond proposal, he said.
Resident Commissioner Pedro Pierluisi, Puerto Rico’s non-voting member of Congress who introduced the Chapter 9 bill in the House, said “both the territory government and the federal government must take concrete actions to address the crisis.”
“Without commenting on any specific administrative proposal or potential proposal, I support any and all efforts by federal agencies that are designed to help the 3.5 million U.S. citizens of Puerto Rico,” he said.
When the idea was first floated late Wednesday, some sources suggested that Treasury and Puerto Rico officials might be able to move forward with the plan without Congressional approval. But Fabian said it is hard to picture the Obama administration doing that, especially given Congress’ increasing interest in what is happening on the island.
“They would get so much interference on it from Congress that they almost would really need a congressional blessing,” Fabian said. He added that it would be “no small thing” for the Puerto Rico legislature to give up its first claim on taxes.
Other potential problems loom as well, according to Peter Block, managing director of Ramirez & Co.’s municipal credit strategy team.
“The bottom line is there are a lot of unanswered questions in terms of how the different classes of bonds would be treated in an exchange scenario,” Block said. “I think [the superbond] could work, but the hardest question to answer and work out … is deciding the debt exchange ratios.”
The superbond plan would require the officials to deal with the prioritization of revenues from 15 different credits and bring all the bondholders to the table.
Additionally, Block said, Puerto Rico would still have to solve “the fundamental problem” of who would act as the referee in determining the payments different bondholders get.
The referee, which Block said is “ultimately going to have to come from the federal government” under this plan, will have to work with the two different investor classes in Puerto Rico -- retail investors who bought Puerto Rico bonds as long-term investments and institutional distressed investors that bought them for the short-term.
“I think Puerto Rico has been pushing for a resolution to the bankruptcy questions, more so because they believe a referee is best for all parties,” he said. The challenge is going to be to reconcile the two investor classes’ goals and come up with a solution that is workable for everybody, Block said.
The plan would also likely take years to implement and that would not be timely enough to help Puerto Rico, which is expected to run out of money next month.
Fabian urged bondholders to think about the proposal “more as an idea that could aid post-default financial remediation as opposed to pre-default restructuring.”
Meanwhile, Moody’s said in a report on Puerto Rico Thursday that the key factors in the success of the proposal would be the separation of the revenue collection process from the commonwealth’s government and whether the local government would cede control of its tax revenues for an extended period of time. It linked the idea with a federal financial control board, an idea some legislators have floated in Congress.
“If the ‘superbond’ plan came to fruition in conjunction with a federal financial control board, it would formalize the federal government's role as the effective ‘restructurer in chief’ and likely accelerate the restructuring negotiations,” Moody’s said.
