Last month, more than three years after Congress passed the PROMESA act, the oversight board filed the central government’s debt adjustment plan. The adjustment plan is of paramount importance since it is the last step necessary to get the government out of bankruptcy. If approved, it would be the largest debt restructuring in the history of the US municipal bond market. The adjustment plan concerns the General Fund, the main government fund from which all budgetary allocations of agencies and public services come from.
This is the second debt adjustment plan filed by the oversight board. The first was the COFINA plan, which was approved by the federal court last February, and that requires the government of Puerto Rico to pay off restructured COFINA-backed bonds for the next 40 years with the collections of the sales and use tax.
The current debt adjustment plan proposes an 8.5% cut in pensions for retirees that exceed $1200 per month. This means that over 65,000 people would see their pensions cut significantly.
The adjustment plan would require the government to pay off the restructured debt over the next 30 years. Once approved, the adjustment plan would have the weight of federal law. Neither the legislature nor the executive branch could amend it without the consent of the bondholders.
The adjustment plan ensures the payment of bonds that are mostly held by vulture funds. In fact, some of them also made huge profits from their investments in COFINA. These vulture funds continue to profit from the austerity imposed on the country. The more they are paid, the less there will be for essential services.
What is the debt adjustment plan?
The PROMESA act, in addition to imposing an oversight board, also created the legal framework so that Puerto Rico’s central government and its public corporations could declare bankruptcy.
One of the objectives of bankruptcy is to cut debt sufficiently so that the debtor can continue to operate with stability. To meet this purpose, new terms of payment are negotiated with creditors – in this case mainly with bondholders. This is known as a restructuring – that is, a new agreement with the creditors on how much the debt will be reduced and on the new contractual terms for payments on the debt.
The debt adjustment plan is the final step necessary to get out of bankruptcy. If approved, the new agreement is official.
The payment of pensions used to come from trusts with two main sources of income. On the one hand, a fixed amount of 8.2%, which was increased to 10% by Act 3 of 2013 (p. 20), was deducted from public employees’ salaries to contribute to their future retirement (in the case of teachers it was raised from 9% to 10% by Act 160 of 2013 – p.21). On the other hand, the government, as employer, contributed another fixed amount to the retirement funds, as required by law.
According to a report commissioned in 2010 by the Employees’ Retirement System, since the creation of the retirement systems the government has failed to make sufficient contributions to adequately fund those systems. Pension debt grew over the years to reach the current figure of $50 billion.
The 8.5% cuts would apply to pensions over $1200 monthly. This would impact three retirement systems: the central government’s, the teachers’, and the judicial retirement systems. Over 65,000 retirees, two out of five, would see their pensions significantly reduced. The following table shows how these cuts would affect monthly pensions:
|Total Monthly Pension||8.5% Cut||Total|
|Note: Total pension is the sum of the base pension plus the various bonuses (medicines, Christmas, summer, etc.)|
It is important to highlight that before the enactment of PROMESA, retirees already suffered pension cuts. According to a recent report commissioned by the oversight board (page 13), since 2007 most pensions have not had a cost of living adjustment – that is, they have remained fixed even if the cost of living has increased. The oversight board estimates that the purchasing power of the pensions of people who retired in 2007 has decreased by 19%. On the other hand, acts 3 and 160 of 2013 eliminated certain benefits. They changed the defined benefit pensions of active employees to defined contributions pensions. They also eliminated the contribution to the medical plan, to medications, Christmas, and summer bonuses to those who retired after August 2013, and increased the retirement age.
The damage that these cuts would cause is huge. Older adults are one of the most vulnerable sectors of the country. Every day Puerto Rico’s health system deteriorates. Puerto Rico is an increasingly aging country where many of the retirees help their families survive through their pensions. The dire impact on the economy cannot be overlooked, either. Each pension cut results in less money that goes into the local economy, which has been in depression for over 13 years.
In addition to pensions, what are they restructuring?
The new debt adjustment plan filed would restructure a series of other classes of debt. Mainly, it would restructure the central government’s bonds, around $17.8 billion in debt (if we include the Public Buildings Authority, or PBA, bonds). In addition, the plan addresses the money the central government owes to government vendors, and other unsecured claims. This debt totals about $5.5 billion.
Pension bonds, which amount to $3.1 billion, would also be restructured.
Central government bondholders would be paid 64 cents for every dollar they hold, while those of the PBA would be paid 72 cents. Pension bondholders would be paid 12.7 cents for every dollar (page 18 of the plan). However, the extent of these payments will depend on what the Court of Appeals for the First Circuit of Boston decides in terms of the scope of the claims of pension bondholders. It will also depend on the outcome of the lawsuit of the Unsecured Creditors Committee, or UCC (a committee that represents unions and government vendors in the bankruptcy cases), which challenges the validity of these bonds, claiming that they were issued without the necessary legal authorization.
As a reward to the vulture funds that have signed the agreement that serves as the basis for the debt adjustment plan, the oversight board is granting them three bonuses.
First, to cover their expenses related to litigation and negotiations in court, the oversight board granted a reward equal to 1.2% of the bonds owned by the vultures that signed the agreement on May 31, 2019 (according to the bonds they owned that day). Secondly, the oversight board undertook to pay every four months to the vulture funds that signed the agreement before July 31 a bonus equal to 1.5% of all of the bonds they owned at the time the plan’s disclosure statement is approved (p. 40 of the plan). Third, vulture funds will receive $100 million if the agreement is not approved (p.41 of the plan).
Finally, creditors of the central government that are not bondholders, such as government vendors and other unsecured claims, would be taking the worst part. They would be getting only 1.8 cents for every dollar. However, the payment may be less if the oversight board does not win the lawsuits filed last May against bondholders and banks, among others, for allegedly violating the laws of Puerto Rico and the Bankruptcy Code (p.288 of the disclosure statement). Minor creditors, whose claims are ten thousand dollars or less, will see a 100% recovery.
The legality of significant portions of the debt considered in the debt adjustment plan has been questioned in federal court, including by the oversight board itself. Certain central government bond issuances may have violated the constitutional limit, which states that the payment of the debt cannot exceed 15% of government revenues. Both the oversight board and the UCC have challenged over $9 billion of these bonds. Furthermore, the UCC is also challenging the legality of $3.1 billion of pension bonds. However, the debt adjustment plan considers the payment of $10.1 billion of this allegedly illegal debt.
In total, the bonds challenged by the oversight board, the UCC, or both jointly total about $12.1 billion. This represents around 58% of the bonds included in the debt adjustment plan.
If we consider the interest payable on this debt (without being restructured), debt challenged increases to $26 billion.
With the filing of the debt adjustment plan, the oversight board opens the door to pay for debt that it considers to be illegal. The oversight board gives bondholders of challenged debt two options. They can accept the plan and receive a smaller amount of money than the rest of the bondholders. In the case of the central government’s challenged debt, they are being offered 35 to 45 cents for every dollar. In the case of the challenged debt of the PBA, they are being offered 58 cents.
If they don’t accept the plan, bondholders would have to continue litigating the validity of their debt in court. If the federal court declares the debt illegal, they lose everything. If the court declares the debt legal, then bondholders would receive 64 cents for every dollar, the same recovery that the rest of the bondholders received.
In case there are bondholders who decide to continue litigating and the federal court declares their bonds illegal (null), the money recovered from those transactions would be divided between the central government, which would obtain 33% of the proceeds, and the bondholders who accepted the plan, who would obtain 67% of the proceeds.
How is the adjustment plan approved?
To approve the debt adjustment plan the oversight board needs to clear certain hurdles – that is, the oversight board cannot approve the plan by itself but needs other parties.
First, this version of the debt adjustment plan is not the final version. There is currently a mediation ordered by the judge presiding over the bankruptcy court, Laura Taylor Swain, who gave all parties until November 30 to negotiate. Once they have a final version, the plan would have to go through the following process:
- Approval of the legislature: The oversight board needs a bill approved by the legislature to authorize the restructuring. In particular, the adjustment plan requires a law that facilitates a new issuance of restructured bonds, which will replace the old bonds
- Voting by creditors: All creditors of the central government that are impacted by the debt adjustment plan will have the right to vote to approve or reject the plan. However, this vote is far from a democratic referendum. Only creditors impaired by the plan can participate. Thus, to approve or reject this plan, bondholders, as well as pensioners, public sector workers, government vendors, and others with claims may participate.
Creditors will be divided into classes according to the type of debt they own. The plan establishes 39 classes. For the debt adjustment plan to be approved in each class, it has to meet two requirements. First, it has to achieve 50 + 1 of the votes of the group’s claims. Second, it has to be approved by two-thirds of the debt represented in that class (page 86 of the plan).
In the case of retirees, the plan creates a trap for those opposed to the cuts. The definition of percentage reduction (page 31 of the plan) stipulates that the class that votes to reject the plan will then have a 10% cut, 1.5% additional to the 8.5% base cut. In this way the opposition that decides to use the votes to reject the plan is threatened with more cuts.
If only one of those groups votes in favor, Judge Swain can impose the plan on the rest of the groups, in a legal action known in bankruptcy jargon as a “cramdown.” The voting process can last for over one month.
- Court approval: Finally, the debt adjustment plan would be evaluated by Judge Swain. One of the fundamental criteria when examining the viability of the plan is whether it is sustainable – that is, if the payment of the debt is sustainable.
Retirees are at the forefront of this latest chapter in the struggle against the debt, austerity measures, and the oversight board. While cuts to pensions are one of the most significant costs Wall Street and its oversight board are imposing on the people of Puerto Rico, the dispute goes further. There are serious questions about the sustainability of the debt payments resulting from these adjustment plans. Some economists and analysts of Puerto Rico’s restructuring process have pointed out the possibility that the government will fall back into debt default in the near future. Even the oversight board itself recognizes in its fiscal plans that, despite all the austerity measures taken so far, the government budget would fall back into deficit after 2030 (p. 42). It remains, then, the responsibility of the people to exert pressure from the streets to cancel as much debt as possible.
Correction (July 1, 2020): This piece has been corrected to reflect that the June 2019 agreement offered bondholders with unchallenged debt between 35 and 45 cents per dollar. The article originally stated that bondholders with unchallenged debt were offered between 45 and 55 cents per dollar.