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Analysis: Puerto Rico Bondholders Are In for a Bumpy Bankruptcy Ride


May 4, 2017

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ABI Bankruptcy Brief

Analysis: Puerto Rico Bondholders Are In for a Bumpy Bankruptcy Ride

If Puerto Rico’s record-setting bankruptcy follows the template of other municipal restructurings, general obligation bondholders may be in for a long ride, despite constitutional guarantees on their debt, according to an analysis in Reuters today. The federal financial oversight board for Puerto Rico yesterday pushed the U.S. commonwealth into a court-sanctioned restructuring process (Title III), and similar filings for the island’s public agencies could be coming soon. The island's constitution guarantees the debt of GO, or general obligation, bondholders, while other debt, known as COFINA, is backed by revenue streams from tax proceeds. But in past bankruptcies, that has not meant much. In five of six recent public bankruptcies in which the debtor defaulted on bonds, pensioners walked away with full recovery while bondholders took haircuts, according to data from Moody’s Investors Service. “If the market hasn’t taken this dynamic into account by now, you can imagine they will after Puerto Rico, given its enormous scale,” said bankruptcy expert and ABI Resident Scholar Drew Dawson, a professor at the University of Miami School of Law. Moody’s has rated the commonwealth's GO and COFINA debt on equal footing, forecasting recoveries for both of between 65 and 80 cents on the dollar, and ahead of debt from Puerto Rican agencies like the Government Development Bank, which it sees as recovering less than 35 cents. Susheel Kirpalani, a lawyer for a COFINA investor group, on Wednesday called the filing “sound public policy.” All along, COFINA holders have favored the bankruptcy route. But Andrew Rosenberg, a lawyer for a GO bond group, said “the economy of Puerto Rico will be put on hold for years” in a bankruptcy.
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Op-Ed: Puerto Rican Bankruptcy: Better Late than Never

Wednesday's application by Puerto Rican Governor Ricardo Rosselló for bankruptcy protection for the island under the provisions of the PROMESA Act underlines the dictum that if a debt cannot be repaid, it will not be repaid, according to an op-ed in The Hill today. One must now hope that wise use will be made of the forthcoming bankruptcy process not only to ensure that a fair deal is secured for both Puerto Rico and its creditors, but also to put the Puerto Rican economy back on an economic growth path that might restore prosperity to the island. It was always fanciful to think that Puerto Rico could either repay or engineer a voluntary restructuring of its public-debt mountain, according to the op-ed, but the island has no fewer than 18 separate bond issues, each of which has different legal protections or claims to different streams of government revenues. In light of the island’s highly compromised public finances, one should not have been surprised by Wednesday’s request by Governor Rosselló for bankruptcy protection. After all, the island was being hit by a slew of damaging creditor lawsuits in the immediate wake of the May 1 expiry of the temporary stay against such litigation. Rather, one should have been surprised that the governor waited until after the lawsuits had been filed before he sought such protection, given how inevitable bankruptcy for the island seemed to be. One must welcome Governor Rosselló’s decision now to seek bankruptcy protection, according to the op-ed. This should provide the framework for an orderly and fair restructuring of the island’s debt without rancorous and economically damaging creditor lawsuits. The orderly restructuring of Puerto Rico’s debt should also be seen as a necessary, but far from sufficient, condition for its economic revival.
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House Panel Approves Plan to Undo Parts of Dodd-Frank Financial Law

The House Financial Services Committee voted 34-26 along party lines today to approve the first comprehensive congressional plan to undo Obama-era financial regulations, the Wall Street Journal reported today. The committee sent the Financial Choice Act, a bill by the panel’s chairman that unwinds significant parts of the 2010 Dodd-Frank law approved after the financial crisis, to the full House, where it will likely get a vote in the coming weeks. The legislation eases regulations and some capital requirements for healthy firms, forces failing firms to go through bankruptcy and restructures the Consumer Financial Protection Bureau. “Our plan replaces Dodd-Frank’s growth-strangling regulations on small banks and credit unions with reforms that expand access to capital so small businesses on Main Street can grow and create jobs,” said House Financial Services Committee Chairman Jeb Hensarling (R-Texas). Democrats relentlessly fought to stop the bill’s first passage over three days of committee debate by proposing nearly two dozen amendments, many of which would have preserved components of the law Republicans want to eliminate. All of the Democratic amendments were rejected. But some of the issues, such as narrowing the CFPB’s powers and the process for unwinding a failed financial firm, will come up again as debate over changing Dodd-Frank moves through Congress.
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Interest Rates Remain Unchanged; Fed Notes Softness in Economy

The Federal Reserve’s Open Market Committee’s decision about raising interest rates was a no go, Forbes reported Wednesday. That likely doesn’t surprise market-watchers who have been following the CME’s FedWatch Tool, which has been predicting with a 95 percent probability for some time now that Wednesday’s Fed decision would be a nondecision. Could there be a step-up by June? Hard to say, based on the Central Bank’s statement. Sticking with the “gradual pace” of tightening that Fed Chair Janet Yellen has advocated for some time, the Fed statement noted softness in the economy and a slowdown in household spending, but signaled a stay-the-course position on monetary policy. “The committee views the slowing in growth during the first quarter as likely to be transitory and continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, labor market conditions will strengthen somewhat further, and inflation will stabilize around 2 percent over the medium term,” according to the Central Bank’s statement. The statement failed to give any clear hints about when the Fed might raise interest rates next, noting that it believes that “economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate” and adding that “the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”
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New on ABI’s Bankruptcy Blog Exchange: How Ending the FDIC's Resolution Powers Would Hurt Americans

The full-scale attack on the “orderly liquidation authority,” the Dodd-Frank Act provision authorizing the government to manage wind-downs of failed companies, is unfortunate, according to a recent blog post.

To read more on this blog and all others on the ABI Blog Exchange, please click here.