Welcome to your weekly Title III update for February 12, 2018. This week has been dominated by the PREPA Interim Financing request, but again issues outside the litigation are looming large.

Last Monday, the Board sent the Commonwealth of letter advising it that the Fiscal Plans submitted for the PR Government, PREPA and PRASA did not comply with PROMESA and gave it until, today, February 12 to present compliant ones. There are numerous changes requested by the Board. Here’s a few:

• An emergency reserve of $650 million for the next five years and $1.3 billion for the next ten;
• It “must commit to improving specific World Bank Ease of Doing Business measures in the areas in which Puerto Rico most significantly trails the mainland, in particular the categories of Construction Permits, Registering Property, Paying Taxes, and Getting Electricity;”
• Labor and welfare reform that would mean the end of Law 80, elimination of Christmas bonuses, reduction of vacation time in the Government and adopting Right-to-Work laws;
• Tax reform that is revenue neutral;
• It “must outline a specific capital investment plan at a greater level of specificity than what is currently outlined. This should include: A prioritized list of investments, beyond the reconstruction plan, that addresses key bottlenecks to generate economic growth; framework for reconstruction that does not just build back what existed, but instead incorporates resiliency measures to build to a risk adjusted level; and Sources of funding for all investments;”
• “A strong and independent regulator is crucial to a successful transformation of the power sector, which itself is critical to the Island’s economic recovery. The Board requires that the Proposed Plan contain a plan for a robust and independent energy regulator. Legislation to create this regulatory model should be introduced by this summer. . . [a]t least three but preferably five commissioners, who are selected by the Governor from a candidate list developed by an independent expert panel;”
• “Reduction of municipal subsidies by 80% of current levels by FY22. The Commonwealth should retain 20% of current subsidies to incentivize municipalities to achieve these operating model changes and avoid further fiscal imbalance;”
• A 10% reduction in pensions;
• Detail “projected savings for healthcare” driven by the “New Healthcare Model”;
• “The Proposed Plan for reduction in costs across government agencies relies on an assumption that savings will be driven solely by employee attrition as a result of the Single Employer Model and the Voluntary Transition Program (VTP). Without greater detail on agency-level service eliminations, the Board believes that the Proposed Plan’s attrition-based model overstates the fiscal impact that such an approach will achieve and does not ensure the permanency of fiscal impact. Further, it will not lead to a Government that is rightsized to efficiently meet the key needs of citizens and reflect demographic realities. The Board requires that the Proposed Plan include specific reference to services that can be reduced, eliminated, externalized, or taken over by other entities, as well as which types of employees are currently fulfilling those services. Further, the Proposed Plan must include a specific implementation plan and timeline for such agency rightsizing.”

Clearly, no government can realistically make these changes to a Fiscal Plan in only 7 short days. Moreover, the requirement for reduction in pensions and government employees/furlough, was resisted by the Commonwealth in previous Fiscal Plans and resulted in the Board suing for its compliance. The Commonwealth was saved by the hurricanes and the Board dismissed the lawsuit without prejudice. This is part of the Board’s plan of governing Puerto Rico through the Fiscal Plan. The Commonwealth will counter, saying that the new federal monies make it unnecessary for these changes to be made and will refuse to comply. The Board will then impose its own Fiscal Plan and sue for the Commonwealth’s compliance. All paid by the island’s taxpayers.

However, the budget deal last week in Washington will loom large for the Commonwealth and the Board in the new Fiscal Plan. Will the Governor and Board continue to assign zero funds for debt service? Will the Board acknowledge the $4.8 billion in Medicaid and allow Governor Rosselló’s Mi Salud reforms to progress? Will the Board take into account the monies from the Community Block Development Grants and for PREPA?

Tied to this, in early January, the Wall Street Journal reported that the Board was aware of these accounts since July 2017. I reported about this development in my blog with a link to the internal Rosselló Government log that documents the detailed conversations between the Board and the Governor’s team.

To date, the Board has not denied the accuracy the Wall Street Journal’s article or on my blog; rather, they are simply whitewashing this with the hiring of the forensic audit team. They’re doing this for good reason: The Board told Judge Swain in the summer of 2017 that the Commonwealth’s finances were so bad that it would have to borrow from COFINA by November 2017. Appearing before Congress last November, Executive Director Natalie Jaresko testified that Puerto Rico needed $3.6 billion before the end of the year and between $13-21 billion over next two years. To add insult to injury, sources in Washington are telling me that Jose Carrion in his meetings with Congressional offices is saying the Board was kept in the dark over the secret accounts by none other than Natalie Jaresko. Really?

As to the PREPA, the Board required “a five-year plan for a financially sustainable utility, which is required as a baseline regardless of future transformation plans. The Proposed Plan must also further define realistic measures to reduce costs so that PREPA can continue delivering electric services to the people of Puerto Rico at more affordable rates. The Proposed Plan must also support a transaction by providing a set of targets for a potential bidder to meet or exceed during the bidding process, in line with the Governor’s announced plan to privatize generation and enter into a long-term concession agreement for transmission and distribution.”

The Board applauded the effort to sell PREPA but, “the Proposed Plan must contain much greater detail [of the sale], including specificity regarding ownership models and a timeline towards supporting the proposed transformational transaction. In addition, the Proposed Plan must address steps to improve governance leading up to a transition and describe a strategy for effective governance in a concession or similar arrangement.” Since the bill to allow the sale has not even been presented to the Legislature, and the Title III process is ongoing, this requirement is impossible to achieve, again resulting in the inevitable result: the Board imposing its own Fiscal Plan and directing not only the sale of the utility, but the utility itself.

As to PRASA, the Board, inter alia, requires that “the Proposed Plan forecasts significantly reduced revenues post-Hurricane Maria but does not provide for a commensurate reduction in operating expenses, which results in a significant operating deficit. Similarly, PRASA presently faces a precarious liquidity shortfall and must adopt a cash management program to actively minimize the cash gap.”

Also, “PRASA must exclude uncertain federal funding sources from the Proposed Plan, including removing the Community Disaster Loan ($200M) and 50% of the state revolving funds and rural development funds requests (total $322M).” Moreover, “PRASA must provide a vision for and perspective on potential actions it may take to achieve long-term fiscal sustainability, improved water quality, and greater infrastructure resiliency. The Proposed Plan must include a chapter describing this long-term vision and a prioritized capital plan to achieve it with specific measures around, for example, infrastructure consolidation, modernization, interconnection, and digitalization. The Proposed Plan should propose potential funding sources for the capital plan, including but not limited to federal funding, additional P3s, and concessions.” Not only this is not achievable in the short time given to amend the plan, but it reeks of a Title III filing.

It is unclear what effect the now approved federal funds will have on these requirements, the pensions or the utilities. What we do know is that the Fiscal Plan simply cannot be as stark as the one the Board planned to present. Even if the Fiscal Plan cannot be revised by the Court, and some parties have questioned this Board position, any Plan of Adjustment has to be based on the Fiscal Plan. I cannot see Judge Swain cramming it down if the underlying economic and financial assumptions are patently inaccurate. Let’s see what happens.

In the Court cases, the Board objected to the GO and others having standing to question the PREPA loan. Judge Swain, denied their opposition and stated “In light of preclusive nature of certain relief sought in the proposed order submitted in connection with the Financing Motion, the Court hereby finds that the Movants constitute interested entities and grants the Intervention Motions, to the extent provided herein, pursuant to Federal Rule of Bankruptcy Procedure 2018(a). The Court hereby accepts the substantive briefs submitted by the Movants in response to the Financing Motion, and authorizes the Movants to participate as Opponents in the February 15, 2018, evidentiary hearing on the Financing Motion, subject to the time limitations and consultation requirements established in the Court’s Order.” This order provides for movants and objectors each to have 3 hours, to be distributed internally as they believe best. The hearing is going to be long indeed.

In addition, the Board filed a new proposed order and a new credit agreement. By Friday, several parties filed short supplemental objections to the PREPA loan. Syncora’s objection is that that the loan is an “insider transaction” and hence entitled to heightened scrutiny by the Court and not the Board’s proposed test of “permissible judgement”; that creditors are entitled to information regarding the PREPA-Commonwealth negotiations on the loan and that the Court deny the Board’s request that any “obligations and other financial accommodations under the DIP Facility [be] ‘deemed to have been extended by the Lender in good faith, as that term is used in section 364(e) of the Bankruptcy Code.’”

National also objected to a “permissible judgment” test, insisted that PREPA had not shown the need for the $1.3 billion loan, that the loan is not “fair and reasonable” and that bondholders were not receiving adequate protection. It also wants modifications to the agreement if the Court were to approve the loan.

Assured also claims it needs adequate protection and counters the Board’s argument their lien’s value is zero. It goes further and states “if the value of the lien were zero, then the Commonwealth would not need a priming lien, because a priming lien on valueless collateral would have no value. This is particularly so given that the DIP Facility is subordinate to Current Expenses upon an event of default.”

U.S. Bank National Association, as trustee for the PREPA Bondholders, adopted the objections of other creditors but added some to the document itself. It argues the “Financing Order and Credit Agreement Improperly Delegate Future Priming Loan Approval Authority to Cooperating Insiders,” that it does not solve the problem of material modifications, that it improperly passes through to PREPA unlimited rate increases of the Commonwealth’s financings, that it includes “Improper Provisions Regarding the Application of Proceeds after Acceleration and Current Expenses,” that it should include greater transparency in the transaction, that the scope of the priming lien is unclear, among others.

The Ad Hoc Group of PREPA bondholders also filed an objection. Essentially, it argues that PREPA has not justified that it needs $1.3 billion and that the reason of the cash crisis of PREPA is the Commonwealth and its dependencies not paying their bills. Powerful arguments indeed since, in my opinion, neither the Board nor PREPA have adequately explained why the Commonwealth can lend it $550 million tomorrow but cannot pay over $200 million the utility is owed. Moreover, with the $2 billion in CDBG funds already approved by Congress and signed by President Trump, why is the loan needed at all? I am sure Judge Swain will have these and many other questions for the Board.

Finally, the President of the PR Senate, Tomás Rivera Schatz presented PS 827 to allow holders of bonds of the Government, its instrumentalities and municipalities to use them as collateral in the lease of government property or loans, direct or indirect financing. Although the bill seems to allow local as well as US bondholders to use the bonds in this manner, the foreword of the bill and its declaration of public policy both mention the need to have the $15 billion held by local investors be used for local investment.

Clearly, the purpose of the bill is to benefit local investors over stateside investors, especially when the preamble states that bondholders will not receive neither principal nor interest on their bonds. This bill not only discriminates against those who are not local investors who will do business in PR, but all local investors who do not do business with the Government!

Moreover, the bill is fiscally irresponsible. If for example you use a $1,000,000 PR bond that is worth 15% in the market as a collateral for a loan from the Government for the same amount, in the real world, the loan is undercollaterised for $850,000. This is nothing more than the usual government scheme to help its cronies that put PR in the financial mess it is in now. Wonder whose “close friend” (amigo del alma) the bill wants to benefit?

Surely the Board will oppose this bill, otherwise they will have zero credibility towards their mission to restoring fiscal responsibility and access to capital markets for the island.

This summary is merely what I believe are the more salient motions and decisions in the cases. I receive an average of 20 filings each day so it would be impossible to summarize everything. If you have legal interest in these cases, I urge you to hire an attorney to represent you.