Monday Update – May 14, 2018

Welcome to your weekly Title III update for May 14, 2018. Once more, the news outside the Court overshadowed the activity inside the Court.

Today a settlement between various COFINA and GO bondholders and insurers was announced. Exhibit B breaks it down this way:

“A proposed settlement of the Commonwealth

COFINA dispute based on the retention of 5.5% Sales and Use Tax (“SUT”) by a newly formed PR Securitization Trust (the “Trust”)

The Trust would take ownership of the 5.5% SUT through the effective date of COFINA plan of adjustment plus 40 years (or such later date as of which the new trust certificates are paid in full)

COFINA bondholders would receive Trust certificates entitling them to: 52.5% of future 5.5% SUT cash flows and 52.5% of Bank of New York Mellon cash To be structured with 1.2x debt service coverage into Current Interest Bonds (“CIBs”) with a 6.0% interest rate and Capital Appreciation Bonds (“CABs”) with a 6.5% interest rate along with a pro rata interest in the residual cash flows of the 5.5% SUT that remain after payment of interest and principal on the CIBs and CABs (the “Residual,” which has been valued using a 15% discount rate)

Participating GO bondholders would tender their bonds into the Trust and receive: 46.2% of future 5.5% SUT cash flows and 46.2% of Bank of New York Mellon cash. To be structured with 1.2x debt service coverage into CIBs with a 6.0% interest rate and CABs with a 6.5% interest rate along with the Residual Commonwealth/GO remainder claim certificates would be supported by the remainder of GO claims, as of the effective date (assumed to be 7/1/18), in the Commonwealth Title III (as calculated by taking par plus accrued claim amount less the distributable value received by GO bondholders)

Participating Commonwealth General Unsecured Claims (“CW GUCs”) up to an allowed claim amount of $500 MM would have the right to tender their claims to the Trust and receive: 1.3% of future 5.5% SUT cash flows and 1.3% of Bank of New York Mellon cash. To be structured with 1.2x debt service coverage into CIBs with a 6.0% interest rate and CABs with a 6.5% interest rate along with the Residual.”

The agreement would provide recoveries of 58.6% to GO’s, 58.6% to General Unsecured Debt, 64.5% in general for COFINA, broken down to between 93-95% to COFINA senior and 42.2-43.2% to COFINA subordinate. All this would be paid from the 5.5 SUT which would be surrendered to a trustee. What about the Commonwealth and COFINA agents position? The agreement states:

“Pursuant to the Stipulation, in order to settle the Commonwealth-COFINA Dispute, the two agents appointed by the Oversight Board would need to support the Joint Settlement Outline: (i) the official committee of unsecured creditors appointed in the Commonwealth’s Title III case (the “Commonwealth Agent”) and (ii) Bettina Whyte (the “COFINA Agent”).

While the COFINA Agent supported the allocation of the Pledged Sales Tax between the Commonwealth and COFINA, the Commonwealth Agent did not support any portion of the Joint Settlement Outline.”

Unfortunately, the Board and AFFAF quickly rejected the agreement stating that it was contrary to the certified fiscal plan. Whether that is true or not, the agreement is an important milestone. It is the first time the possibility of a path to exit Title 3 and return Puerto Rico to the capital markets has been presented in black and white. Moreover, the agreement was driven by creditors with extremely divergent interests, rather than by the Board or the Commonwealth, who have done very little to advance consensual negotiations or a settlement. More importantly, the fact that their first move was to immediately denounce the deal raises substantial questions as to their true interest in securing a consensual deal. It really feels like more of the same. It is almost like they really prefer a cramdown of a Plan of Adjustment with over 70% cuts for bondholders. If the Board and AFFAF actually pull this off, who will lend to Puerto Rico in the foreseeable future?

On May 8, 2018, the Senate’s Committee on Energy and Natural Resources held a hearing on “The Current Status of Puerto Rico’s Electric Grid and Proposals for the Future Operation of the Grid.” The witness list included Bruce Walker Assistant Secretary, Office of Electricity Delivery and Energy Reliability, U.S. Department of Energy (DOE) and Charles R. Alexander, Jr., Director, Contingency Operations and Homeland Security U.S. Army Corps of Engineers for the Federal Government. From Puerto Rico, Christian Sobrino-Vega, President of the Government Development Bank and Chairman of the Board of the Fiscal Agency & Financial Advisory Authority, Government of Puerto Rico; Mr. Walter Higgins, Chief Executive Officer Puerto Rico Electric Power Authority; Mr. José H. Román Morales, PE Acting Associate Commissioner for the Puerto Rico Energy Board and Mr. Rodrigo Masses, President Puerto Rico Manufacturers Association. Maybe during this hearing we will know who will actually be in charge of planning the PREPA electric grid and the utilities sale, and understanding some more about the recent blackouts.

Senator Murkowski from the start asked very important questions:

“[G]oing forward, who is in charge of the grid? Who is providing the vision for the future of the grid and who should outside parties be in contact with to help fulfill that vision?
Is it the Governor’s office, which is promoting legislation to sell off some of PREPA’s assets and contract with a third party to operate the transmission and distribution lines?
Is it the Financial Oversight and Management Board, which recently certified a new fiscal plan for PREPA that includes a process for privatization?
Or is it PREPA, which has a relatively new Board of Directors, and a new CEO, but could be completely upended by these other plans?
Or is it the PREC, which claims responsibility for setting the overall policy direction for the grid, yet could be dissolved under the Governor’s reorganization plan?
And then how do the Department of Energy and the Army Corps of Engineers fit into this hierarchy? And of course, what about the creditors?”

Unfortunately, no one, not even the Government’s representatives, gave a clear answer. Mr. Walker from the DOE stated:

“Another DOE effort is through grid modeling to support the rebuilding of a more resilient electric power grid system in Puerto Rico. This endeavor will develop a near real time dynamic model of the Puerto Rico power system that will not only be used as an operational tool but for planning purposes as well. This modeling effort will provide technical insight into the resiliency objectives, allowing for coordination and communication of potential solutions across stakeholder groups. Working in partnership with FEMA and the U.S. Department of Housing and Urban Development (HUD), DOE seeks to facilitate collaboration with PREPA as they plan future investments and determine where financial resources will be most beneficial in strengthening Puerto Rico’s grid and increasing its resilience. . .
The Southern States Energy Board (SSEB), in association with DOE, is working in coordination with the governor and legislature of Puerto Rico to establish a reliable, affordable, and sustainable electric energy grid system, and to develop a policy and legal framework to provide a regulatory process for possible privatization efforts. Working in collaboration, SSEB will present Puerto Rico with various options and recommendations for the electricity and other utility sectors. . .
Although some of the additional analysis necessary to support those resilience principles is underway, recommendations that can be acted on today to improve the performance of the system ahead of the 2018 hurricane season are as follows:
1. The Governor and PREPA should immediately ensure that updated, effective mutual aid agreements are primed to quickly provide support during the next event.
2. The Incident Command System should be trained and utilized during a response.
3. The Puerto Rico Energy Commission (PREC) should coordinate a joint study with the Puerto Rico Telecommunications Board to determine and enforce safe loading requirements of distribution poles carrying both electric and telecommunications infrastructure.
4. Electricity transmission towers installed specifically for temporary emergency restoration should be considered for replacement, potentially by monopoles; many of the round monopole structures survived the 2017 storms.
5. The PREC should finalize microgrid regulations, and establish effective and efficient interconnection requirements and wheeling regulations with PREPA. These regulations will allow customers to design their systems to add reliability and resilience to PREPA’s system.
6. The Commonwealth Energy Public Policy Office, in coordination with other appropriate Commonwealth agencies, should consider drafting an updated Energy Assurance Plan, which will provide for an Incident Management Team as well as other important components. Besides preparing for the next hurricane season, acting immediately will allow for leveraging the presence of Federal staff in the Joint Field Office and the Federal data collection efforts that have been underway since September. Finally, the SSEB may be able to facilitate peer-to-peer information sharing and lessons learned among Puerto Rico’s neighboring governments and utilities.”

Mr. Higgins, the new PREPA executive director, also failed to say who was in charge and made it clear that he did not make public policy, but only executed it. Moreover, he stated:

“Since it received the loan, PREPA has consistently collected slightly more than $50 million of accounts receivable per week, and it projects collections to remain near that level through the end of PREPA’s fiscal year on June 30, 2018. PREPA currently believes that these weekly collections, coupled with the loan, will permit PREPA to continue to operate under current conditions without the assistance of additional financing through the end of the current fiscal year and into Fiscal Year 2019. It is worth noting that the continuity of restoration and mitigation/hardening work on the grid is dependent on the continuing receipt of federal funding, which is being closely coordinated with FEMA.”

Again we see that the Board and AFFAF overestimated PREPA’s need for a loan and Judge Swain was correct in denying said loan. Moreover, it is clear that PREPA is able to continue with reconstruction efforts due to federal funding.

Mr. Sobrino, the Governor’s representative before the Board, had this to say:

“Governor Rosselló has set forth a three-phase plan for the transformation of the electric sector. The first phase will define the framework for the transformation through legislation. The second phase will involve marketing, receiving offers from interested parties, and evaluating the technical, economic, and financial capabilities of offerors. In the final phase, the terms of awarding and hiring the selected parties that meet the requirements for the transformation and modernization of our energy system will be negotiated, finalized, and approved. . .

The assumed “base case” for the contemplated transformation involves (i) private ownership and/or operation of all generation assets and a development of greenfield generation projects with a focus on a diversified fuel mix and clean energy and (ii) a private operator of the transmission and distribution system through a concession model, which leaves the ownership of the assets in public hands under the operation of a private operator. I anticipate this “base case” will be subjected to a market test in order to determine the extent of investor interest and whether higher values and/or better transaction terms can be achieved by using an alternative structure. I anticipate the timeline to run the competitive process for the transformation will be at least 12 to 18 months.”

The problem with this is that the legislation for the sale of PREPA is anything but transparent and it does not say how the sale will be done. Moreover, Mr. Higgins and Mr. Sobrino both repeat the mantra of the last 12-18 months, which is what the Governor said in January of 2018, only the House has approved the sale legislation. Seems to me politicians do not want to sell the crown jewel of political patronage and makes me wonder if it would be better for the federal government to handle the sale.

Also during the hearing, Mr. Sobrino tried to blame the federal government for the delay in bringing back electricity to Puerto Rico, implying that the Corps of Engineers had told the Governor it would be done in 40 days. When Sec. Walker demurred, Sobrino said “I was there,” and Walker retorted “So was I.” There is a fine line between being assertive and irritating those whose help you need. I suspect this will not be the last we hear about the Corps of Engineers vs. PREPA fight. Food for thought.

The PREPA loan is not the only area where the Board’s projections were wrong. In the certified Fiscal Plan of the Commonwealth, the Board mentions in footnote 9, a projection of outmigration by a part-time blogging self-taught demographer who is actually a full-time cotton economist at the U.S. Department of Agriculture. The idea is that the Puerto Rican population left in droves due to Hurricane María and will continue to leave, especially this coming summer. A recent study, however, puts these dire predictions into question using data from people’s phones, showing that most of the population that left after María hav returned to Puerto Rico. The Court lacks jurisdiction to review the Fiscal Plan, PROMESA section 106(e), but it can do so in the context of the Plan of Adjustment. We shouldn’t be surprised for one second when all creditors cite this new finding, and ask the Board and Commonwealth to back up their migration claims. Food for thought.

This is just another example of the Board hiding relevant information like it hides the Commonwealth’s financial information to make things look worse than they are in order to convince Judge Swain to impose the cramdown it desires. Given the discovery that will continue in this case pursuant to Bankruptcy Rule 2004, I doubt this strategy will prevail. Moreover, as Judge Swain has stated, she will review the fiscal plan at the plan of adjustment stage. I take this to mean that if the information contained in them is incorrect, there will be no cramdown.

Last week Congressman Bishop attended a fundraiser that was supposedly not a fundraiser, but most likely was a fundraiser (I don’t understand either) and our own José Carrión was the man of the night. So the godfather of PROMESA and the President of Board were schmoozing at a dinner and no one has asked whether this is legal, ethical or right? Mr. Carrión says in the article “I do not think there were conflicts of interest at the dinner . . . My political contributions are well known and of the public record. Everyone in Puerto Rico knows I am a Republican.” I’m also told that Carrión’s firm, CLC, hosted Congressman Bishop for a private luncheon with their clients. Why is it that the Board can investigate any possible pay-for-play with the Commonwealth advisors and lawyers but we have to take their word that nothing wrong is happening in the Bishop-Carrión affair or in Matosantos case? Where are the ethical analysis of these cases? Don’t the Puerto Rico taxpayers have a right to know? The Board’s lack of transparency on these two cases leaves a lot to be desired.

As I reported, on May 4, the Commonwealth handed the Board its proposed budget as was required and on May 8, the Board notified the Governor that it was in violation of PROMESA. The Commonwealth has until May 5, 2018 to provide with a conforming budget. As to be expected, the inclusion of Christmas Bonuses and additional funds for Municipalities did not set well with the Board. In addition, the Commonwealth must:

“Provide a detailed budget of expenses for FY19 that is consistent with the trajectory for the primary fiscal balance in the Fiscal Plan, using the same basis of accounting used to prepare the Fiscal Plan (modified accrual basis of accounting) and in accordance with the accounting policies used to prepare the audited financial statements of the Commonwealth. If the basis of accounting is different than modified accrual, please confirm the basis of accounting being used.

Provide a reconciliation of the budget to the Fiscal Plan for expenditures with explanations of any variance. However, it is not expected that total expenditures would deviate from Fiscal Plan submitted and approved. To the extent the budget changes after May 4, provide the updated reconciliation in excel within five business days of the update and no later than eight business days before certification of the FY19 budget. . .

Where available, provide a comparison of expenditures to prior two budgets and to prior two years of actuals (where available) and latest twelve (“LTM”) months ending December 31, 2017 of actuals and explain key differences. If the actuals for the prior two years or LTM period, are just draft versions, indicate so when providing the information.”

Also, as for public corporations in the Commonwealth Budget, it must:

“Provide a detailed budget of total expenditures defined in this document to include operating expenses and separately capital improvement plan (“CIP”) expenditures for FY19 that is consistent with the trajectory in the Fiscal Plan covers transactions conducted by all subsidiaries. There should be a detailed breakout of operating expenses

Provide a reconciliation of the budget to the Fiscal Plan with explanations of any variance. However, total expenditures should not deviate from the Fiscal Plan operating expenses and CIP submitted and approved. To the extent the budget changes after May 4, 2018 based upon specific information not known at that time, provide the updated reconciliation in excel within five business days of the update and no later than eight business days before certification of the FY19 budget.

Provide a comparison of expenditures to the prior two budgets (FY17 and FY18) and to the prior two years (FY16 and FY17) and year-to-date (“YTD”) from July 1, 2017 through March 31, 2018 of actuals versus July 1, 2016 through March 31, 2017. Explain key differences by both $ and % differences for any variance over 10%. If the actuals for the prior two years or YTD period are draft versions, indicate so when providing the information.”

This is only a small scope of the things that were “requested” from the Commonwealth, making it impossible to comply. Moreover, Mr. Sobrino reacted by saying that some changes would be made to the budget but that Puerto Rico would not increase the Board’s budget, include the labor reform or cut the Christmas bonuses. Ms. Jaresko, however, made it clear that the Commonwealth must comply with the budget order. Eventually, all this will land on Judge Swain’s desk and the people of Puerto Rico will pay for both the Board and AFFAF’s lawyers to determine who is in charge of the Government. A total waste of resources. Oh, well.

This is only the beginning of a long process. Section 202 of PROMESA requires the Board to give the Governor some time (not specified) to correct any errors in the budget. It not corrected, the Board will impose their own budget and send it to the Legislature and the Governor. If the Legislature does not approve a conforming budget, the Board must again give the Legislature time to correct the errors and if not done, section 202(e)(3) specifies:

“If the Governor and the Legislature fail to develop and approve a Territory Budget that is a compliant budget by the day before the first day of the fiscal year for which the Territory Budget is being developed, the Oversight Board shall submit a Budget to the Governor and the Legislature (including any revision to the Territory Budget made by the Oversight Board pursuant to subsection (d)(2)) and such Budget shall be—
(A) deemed to be approved by the Governor and the Legislature;
(B) the subject of a compliance certification issued by the Oversight Board to the Governor and the Legislature; and
(C) in full force and effect beginning on the first day of the applicable fiscal year.”

This belies arguments by the politicians in the Legislature that if they do not approve the budget, last year’s budget will go into effect as per the Puerto Rico Constitution. The devil is in the details.

Last week, the Government Accountability Office issued a report entitled “Factors Contributing to the Debt Crisis and Potential Federal Actions to Address Them” and determined this as causes:

“The Puerto Rico government’s inadequate financial management and oversight practices. For example, the Puerto Rico government frequently overestimated the amount of revenue it would collect and Puerto Rico’s agencies regularly spent more than the amounts Puerto Rico’s legislature appropriated for a given fiscal year.
Policy decisions by Puerto Rico’s government. For example, Puerto Rico borrowed funds to balance budgets and insufficiently addressed public pension funding shortfalls.
Puerto Rico’s prolonged economic contraction. Examples of factors contributing to the contraction include outmigration and the resulting diminished labor force, and the high cost of importing goods and energy.”

The report recommended the following:

“Modify the tax exempt status for Puerto Rico municipal debt. Making interest income from Puerto Rico bonds earned by investors residing outside of Puerto Rico subject to applicable state and local taxes could lower demand for Puerto Rico debt. However, reduced demand could hinder Puerto Rico’s ability to borrow funds for capital investments or liquidity.

Apply federal investor protection laws to Puerto Rico. Requiring Puerto Rico investment companies to disclose risks with Puerto Rico bonds and adhere to other requirements could lower demand for the bonds. However, this action could also limit Puerto Rico’s ability to borrow funds.

Modify the Securities and Exchange Commission’s (SEC) authority over municipal bond disclosure requirements. SEC could be allowed to require timely disclosure of materials—such as audited financial statements—associated with municipal bonds. Over the past decade, Puerto Rico often failed to provide timely audited financial statements related to its municipal bonds. Timely disclosure could help investors make informed decisions about investing in municipal bonds. However, a broad requirement could place additional burdens on all U.S. municipal issuers, such as the costs of standardizing reporting.”

Faced with a report saying the triple tax exemption on bonds, possible only for a territory, would be accepted with open arms by a pro-statehood administration. Not so. In a letter from Carlos Mercader, Executive Director of the Puerto Rico Federal Affairs Administration, said that the Government of Puerto Rico was strongly opposed to the elimination of the triple exemption since it was crucial to its efforts to solve the current financial crisis. In other words, although the Government admits that the triple exemption facilitated the financial crisis it is in, it hopes to use it get further loans but claims that statehood is the solution to its problems. Oh, and sans paying the debt. Quixotic, don’t you think?

On the legal front, Judge Swain heard the oral argument on the COFINA motion to certify the Commonwealth v. COFINA question to the Puerto Rico Supreme Court. She took the controversy under advisement and as with the Aurelius, ERS and other controversies, we will have to wait. Seems Judge Swain is taking a page from Judge Rhodes’ book in hopes of solving everything in mediation. Unfortunately, I find this highly unlikely, even with today’s encouraging news from the Commonwealth’s largest creditors.

The Asociación de Profesoras y Profesores del Recinto Universitario de Mayagüez, Inc. has sued the Board and the Commonwealth challenging the UPR certified fiscal plan. The case had been stayed until the new fiscal plan for the UPR was approved and this week the complaint was amended and surprise, surprise, this claim was ditched and now plaintiff requests:

“a. An order declaring that the fiscal plans of the Commonwealth and the UPR are not legislative acts and could not be implemented without the enactments of the necessary laws after the process established by Article III, Section 17 of the Constitution of the Commonwealth of Puerto Rico.

b. An order declaring that the budgets certified by the Oversight Board for the Commonwealth and the UPR could not be implemented without the enactments of the necessary laws after the process established by Article III, Section 17 of the Constitution of the Commonwealth of Puerto Rico.

c. An order declaring that the fiscal plans and budgets certified by the Oversight Board for the Commonwealth and the UPR could not impose budgetary cut that are contrary to Act 3-2017.

d. An order Defendants enjoining and staying from implementing budgetary cuts to the UPR in the fiscal year 2017-2018 neither in the fiscal year 2018-2019, that are not compliant with Act 3-2017.”

It is doubtful this group has standing in this case. Moreover, it is more than likely that PROMESA supersedes the Constitution of Puerto Rico as to these issues. Irrespective of my view, this group is actively challenging the Board’s actions whereas in cases 17-242 and 17-243, the American Federation of State County and Municipal Employees, who also sued to set aside the fiscal plan, the cases remain dormant.

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.