Yesterday, Wall Street Journal reporter Andrew Scurria revealed the Commonwealth of PR’s additional terms to the CDL loan. This is only one of the three documents encompassing the loan, the other two being the Promissory Note and the Local Government Resolutions-Collateral Security, which have not been made public yet. Nevertheless, the document is very illuminating.

The amounts to be lent was left blank but it makes clear that the Court may reduce said amount in its authorization for the loan in its “financing order.” The loan will mature, unless the Federal Government (“the Government”) agrees to something different, on the earliest of two dates, (1) the effective date of the confirmation of the Plan of Adjustment or (2) July 1, 2038. More on this later.

The terms state, “Interest will accrue and be payable in accordance with the Interest section herein. Cash payments of interest on the loan shall begin July 1, 2020, with graduated principal amortization payments beginning July 1, 2023, and ending on the maturity date, as specified by the Government in an amortization schedule.” This means that the loan must be repaid, in full, by the time the Plan of Adjustment becomes effective, which considering the Board has said it will be filed this year, would mean that PR believes it can be approved before July of 2020. Interesting.

The next section, “Security and Collateral” is worth a few reads.

“Security and Collateral

The Note is a general obligation of the Borrower secured by the full faith and credit and taxing power of the Borrower.

All amounts owing under this Note shall be secured by and are payable from a perfected first priority priming security interest in all revenues, including but not limited to income taxes, corporate taxes, excise taxes, receipts, and income of the Borrower of every type and description from all sources wherever located and whether now or hereafter existing and whether now owned or hereafter acquired, and whether encumbered or unencumbered, including, but not limited to, any revenues currently or previously used to support or secure repayment of General

Obligation bonds of the Borrower or CO FINA bonds, together with all liens, guarantees, rights, remedies, and privileges pertaining to the foregoing and all accounts or funds in which such revenues are deposited, pursuant to 11 U.S.C. § 364(c)(2) and (d), as applicable in each case, as incorporated into PROMESA under Section 301.

All amounts owing under this Note shall constitute superpriority administrative claims in the Borrower’s Title Ill case pursuant to 11 U.S.C. § 364(c)(l) as incorporated into PROMESA under Section 301, payable in full in cash upon the effective date of a confirmed plan of adjustment of the Borrower.”

The use of the GO language here is very telling. Seems the Federal Government does believe that GO protection is the best. Wonder what COFINA bondholders will say. In addition, the language seems to include any income that may come from the SUT, whether it is pledged to COFINA bondholders or not, it is secured by lien or not, but is subject to the adequate protection and notice and a hearing requirements of 11 U.S.C. §364(d). At the same time, the amounts owed are a superpriority administrative expense, which means that the loan will be paid if the Title III is still ongoing in 2020. Additionally, the Commonwealth cannot lend to any public corporation that is not in Title III. Very possibly we will see PRASA in Title III.

Moreover:

“The Borrower hereby pledges and assigns to the Government and grants the Government a continuing security interest in all right, title, and interest of the Borrower in any bonds, notes, or other evidences of indebtedness or collateral issued by a public corporation to the Borrower to secure on-lending of loan proceeds to such public corporation, in accordance with the terms specified herein.”

Also, the document states that the security interest created in the document “be broadly construed in favor of the Government and the security interests created secure all obligations of the Borrower pursuant to this Note, whether now existing or hereafter arising.” The loan may be drawn up until October 31, 2018, which only gives the Commonwealth six months. The repayment of the loan will be as follows:

“Consistent with the Term and Amortization provisions herein:

• Repayments of principal and interest shall be made semi-annually on July 1 and January 1, and on such other days as may be required in accordance with the terms hereof.

• Repayments shall be applied first to accrued interest and then to outstanding principal.

• Any amounts repaid by the Borrower may not be re-borrowed.

• Any amounts received by the Borrower from a public corporation as repayment of on-lent amounts to such public corporations shall be used exclusively and applied promptly to repay or prepay the Note, in any event within 5 business days of receipt.

• For the period starting on January 1, 2020 and ending on the maturity date, the Borrower shall maintain a segregated non-commingled debt service account and shall deposit into such account on the first business day of each month at least one-sixth of the semi-annual interest and principal due as necessary to ensure the account has sufficient funding to make the semiannual debt payments required hereunder and is replenished for each semi-annual debt payment. Amounts deposited in the debt service account shall be used to make payments on the Note and solely for such purpose.”

The interest rate will be “the current market yields on outstanding marketable obligations of the United States of comparable maturity at such drawdown, as determined by the Secretary of the Treasury.” Many times CDL loan repayment are waived by Federal Government but this does not seem the case here.

The document states that the maximum cash balance for the TSA is $800 million. The document has no date and but its properties show it was created in 4/8/18 and modified in 4/9/18 making it likely it is was created around that date. If it is so recent, why did the Commonwealth say that Treasury had agreed to raise that amount to $1.1 billion? What is the amount? Questions, questions.

Irrespective of the TSA account or the $4.9 billion available for CDL loans, the Government may limit the amounts drawn based on “cash on hand and analysis of expected cash collections and disbursements through the accounts of the Borrower, its component units, and the public corporations.” In addition:

“The Borrower must itemize and certify, to the satisfaction of the Government, the end uses of requested drawdown amounts by the Borrower and the public corporations, based on categories specified by the Government.

The Borrower must certify to the Government its current cash position with each drawdown request. If the purpose of a drawdown is for on-lending to a public corporation, the Borrower also must certify to the Government the cash position of the applicable public corporation. . .

If the purpose of a drawdown is for on-lending to a public corporation, the Borrower must certify to the Government any of such public corporation’s payments, transfers, or deposits made since the last drawdown, regardless of the source of funds, for credits to accrual accounts, reserve funds, trust funds, contingency accounts, and the like that do not represent a cash disbursement to continue current operations.”

The Federal Government wants lot of information from the Commonwealth and this is a theme seen throughout the document.

For what purposes are the loan proceeds to be used? It is not quite clear but:

“Eligible and Ineligible Expenses and Uses of Loan Proceeds for the Borrower and the Public Corporations

Eligible expenses and uses of loan proceeds constituting governmental operations for essential services of the Borrower and the public corporations include:

• Employee payroll and benefits, including pension payments or contributions at rates and levels no higher than those immediately preceding Hurricanes Irma and Maria.

• Facilities maintenance costs that are not capital expenditures or infrastructure improvements

• Normal operational materials, supplies, vendor, and services payments

• In the case of the Borrower, on-lending to the public corporations for the forgoing purposes

Ineligible expenses and uses of loan proceeds that do not constitute governmental operations for essential services of the Borrower and the public corporations include:

• Debt service including but not limited to payment of any indebtedness existing prior to the date of this Note, except as permitted by the terms set forth in the Refinancing of Previous Postpetition Loans section herein.

• Refinancing outstanding debt of the Borrower or a public corporation, except as permitted by the terms set forth in the Refinancing of Previous Postpetition Loans section herein.

• Capital improvements

• Repair or restoration of damaged facilities

• Paying the non-federal share of any Federal program

• Tax refunds

• Lobbying

• Title III costs including but not limited to judgments arising from Title III cases and related cases, and legal or advisory fees

• Deposits, transfers, or payments to accrual accounts, reserve funds, or contingency accounts that do not represent an actual, immediate cash disbursement to continue current government operations for essential services

• Administrative costs of Federal disaster assistance grants and loans

• Disaster related expenditures eligible for reimbursement from the Federal Government

• Any other amounts not constituting current expenses under the trust agreements of the applicable public corporation”

Does this mean that payment of pensions and government employees is an essential service? After reading it several times, it seems to me that pensions and government employees who are essential services are the recipients of said money but that requires the definition of essential services, something PR and the Board have refused to do. Will the Government define them? On the other hand, if all pensions and all public employees are essential services, the amounts paid cannot be higher than the levels preceding Irma and María. Hence, if the Board requires the furlough of employees and reduction of pensions, the Federal Government is ok with that, as well as the Commonwealth funding these as essential services.

The document also allows the Commonwealth to lend to a public corporation for the repayment of a previous loan, but with reporting conditions. Obviously thinking of PREPA.

As mentioned before, there are many reporting requirements. Until December 4, 2018, the Commonwealth “must submit reports on actual and projected cash receipts, cash outlays, restricted and unrestricted cash balances, accounts payable and accounts receivable balances, the waterfall of cash through deposit accounts, and other cash flows, for the Borrower and its component units as specified by the Government, on a weeklybasis and with each drawdown request.” This seems to apply to the Commonwealth whether it takes the loan or not.  Also:

“While the Note is outstanding, the Borrower must submit budget reports on actual and projected revenues and expenditures at least monthly, and must submit a copy of annual audited financial statements within the time period required under 2 CFR 200.512(a)(l) as adopted in 2 CFR 3002.10.”

The first CFR requires that audits be done within the earlier of 30 calendar days after receipt of the auditor‘s report(s), or nine months after the end of the audit period. The second CFR deals with debasement and suspension of federal programs. Hence, if PR does not comply, the Federal Government may not send any more money to the island. Big stick.

Information must also be submitted as to the use of the loan proceeds and nothing can be done that would impede the Government’s ability to verify the use of loans, a clear reference to the Whitefish contract that impeded review by federal authorities. Who said Whitefish was not important?

Budgets must be promptly submitted and any changes must be quickly notified. In addition, “[w]hile the Note is outstanding, and so long as the Financial Oversight and Management Board is in operation, the Borrower must submit status reports at least monthly on any potential or proposed changes to its fiscal plan certified pursuant to PROMESA, and how such changes may

affect the Borrower’s responsibilities and commitments under the Note.” Also, the Commonwealth must promptly submit to the Government any proposed changes to the Fiscal Plan and any certified Fiscal Plan, as well as any insurance payments received.

The same information as to any public corporation that is lent money must be submitted as well as any proposed rates and fee changes of said corporation (PREPA and PRASA come to mind) or if will accept something of value in lieu of said rates or fees. Any default by the public corporation to any loan made with CDL funds must be notified within 5 days.

All these reporting conditions, and others that I will mention infra, put the Government as another overseer of the Commonwealth. It is quite obvious the Government means to keep a close eye on the money it is lending.

In addition, as a condition precedent to the notes effectiveness, a drawdown manager must be appointed by the Commonwealth. More importantly, the Commonwealth must certify “all restricted and unrestricted cash accounts under the custody of the Puerto Rico Treasury and the public corporations, the balances of such accounts, and a narrative statement detailing the waterfall of credits to such accounts for any revenues or income received.” The “discovery” of almost $7 billion in 800 accounts by the Commonwealth has not escaped the scrutiny of the Government. Question is how quickly will this be done when only recently the Commonwealth and the Board hired companies to make a forensic investigation on this subject?

As conditions precedent to the initial funding, the Government requires “receipt of customary certificates and opinions and evidence of all required approvals, consents, and authorizations, including, without limitation, authorization by the Legislature of the Borrower for the incurrence of obligations under the Note as ‘public debt’ of the Borrower and approval by the Financial Oversight and Management Board.” Obviously, the Government wants to take advantage of Article VI, Section 8 of the PR Constitution that puts priority over all else on the payment of the debt. The problem with this is that the Constitutional Convention and the record of the 1961 Amendments to the Constitution make it clear that public debt is not any kind of obligation of the Commonwealth but bond debt in particular and acknowledgement by the Legislature will not make it so. Another issue for Judge Swain to decide.

A financing order by the Court is also required and a certified fiscal plan that reflects said loan are also required as conditions precedent. There cannot be any outstanding notice of non-compliance with the Fiscal Plan by the Board. Clearly another “motivation” for PR to comply with the Board’s orders. Agreement by the public corporation and the Board are also required, as well as the permanence of the Court order as required by the Government. Moreover, “[n]o amounts may be drawn down and on-lent to a public corporation until the Borrower shall have confirmed in writing to the Government the satisfaction of the foregoing conditions precedent to such on-lending.”

There is a list of actions requiring government approval while the note is outstanding. These are:

• “sell, pledge, grant security in or liens on any real property, tangible assets, intangible assets, financial assets, or accounts, or any revenue streams, or incur any debt under any indenture nor resolution, or otherwise borrow money, or

• refinance, prepay, or repay any other indebtedness or borrowings other than pursuant to an effective plan of adjustment confirmed pursuant to a Title III case under PROMESA that provides for the repayment of the Note in full in cash, unless the Government agrees to an alternative treatment in writing, or

• approve any waivers or amendments to any lending agreement between the Borrower and a public corporation, or

• extend any loans, credit support, or otherwise bear credit risk to or for the benefit of any corporate entity, government entity, or other institution.”

Similar limitations are imposed on public corporations that receive the CDL loans. Does this mean that PREPA cannot be sold without the Government’s approval? Any other part of the PR government? What will the Board think of this, especially given what Under Secretary Walker testified before Congress? Questions abound.

The Government may collect on the loan regardless of whether the amounts are due and regardless of a default, including but not limited to the offset (set off in more traditional parlance) as established by 31 U.S.C. § 3716.

As to events of default, there are many. These include, breach of any conditions by the Commonwealth, the payment by the Commonwealth of any principal or interest of any prepetition debt via cash or adequate protection, an order dismissing the Title III or a petition by the Commonwealth to dismiss the Title III or the appointment of a receiver for the Commonwealth (interesting) or a public corporation, a request or an order amending the financing order or violations of said order, failure of Commonwealth authorization to the loan (the Legislature or the Board may do this), any unstayed judgment of $10 million or more, the filing of a Plan of Adjustment that provide for full payment of the loan, failure of the liens to remain in full effect, default by any of the public corporations, failure of PROMESA (the Aurelius litigation or any other constitutional challenge). Any suspected breach must be reported to the Government or it will be a breach.

The default has many remedies. The Government may suspend all or part of the commitment amount, declare all or part of the Note due and payable, increase the interest rate by 50 bps or any other action available under the law. Moreover, once there is a declaration that the note is due and payable, “all revenues and other amounts pledged hereunder shall be applied solely to repay this Note including any interest thereon in full before being used for any other purpose.”

The document also includes some General Covenants which put further supervisory restrictions on the Commonwealth. Some of them are to provide prior notice to the Government of any consensual debt restructuring proposals submitted or reported to other creditors, the Board, or any regulatory agencies, make sure the Fiscal Plans reflect the loan debt, notice of proposed changes to the Fiscal Plan, provide prior notice of all material motions or filings by the Board in the Title III case and maintain the level of insurance. The prior notice requirements mean that the Federal Government wants to know what is going on in the case before all others do. Control anyone? Wonder what the Board will think of this?

As per the agreement, the Commonwealth represents some very interesting things:

“As set forth in more detail below, the Borrower represents and warrants that it has authority to execute the Note and to give full force and effect to, and comply with, all terms and conditions herein.

The Borrower represents and warrants that nothing in its certified fiscal plan pursuant to PROMESA, and in the public corporations’ certified fiscal plans pursuant to PROMESA, is inconsistent with the terms and conditions of this Note.

The Borrower has all requisite governmental power, consents, and authority to execute and deliver this Note and, upon entry of the financing order, shall have all requisite governmental power and consents to perform all obligations hereunder, including, without limitation, the creation of security interests by the Borrower as contemplated hereunder.

The execution and delivery by the Borrower of this Note has been duly authorized by all necessary governmental action and does not, and will not, contravene any law, rule, or regulation of the Borrower, and will not result in the creation or imposition of, or the obligation to create or impose, any encumbrance upon any assets of the Borrower pursuant to any obligation, except  pursuant to this Note.”

This last representation requires some thought. By tapping into what the COFINA bondholders consider their property, this agreement could be considered to be against PR law. By placing the loan as “public debt”, the GO bondholders can claim that the agreement is in violation of the PR Constitution and if the legislature accepts the loan is public debt, they are violating said Constitution. Food for thought.

The terms of this loan are of such nature that would make any government hesitate before accepting them. On the other hand, the Rosselló administration desperately wants extra cash in order to spend its way a 2020 reelection. At the same time, the Executive was not much involved in the Title III since PROMESA did not provide it with a role. Now it wants to know what is going on before at the same time as the Board. Will Governor Rosselló try to play any Federal Government v. Board rivalry to his advantage? In addition, does the Commonwealth TSA account have to get down to $800 million or $1.1 billion in order for the loan to be provided? Even if the TSA account goes down to the required amount, the Government may “cash on hand and analysis of expected cash collections and disbursements through the accounts of the Borrower, its component units, and the public corporations,” and the loan could be denied. Finally, without the missing documents we cannot really understand the full details of the loan but we have gotten a glimpse. More information is needed but neither the Government nor the Commonwealth are transparent. We will to wait.