The New Pact Between the Oversight Board and the Vulture Funds

Photo: Eric Haver, Flickr

Spanish version here

The Financial Oversight and Management Board (oversight board) created by the Obama administration to oversee the Puerto Rican economy amidst the country’s debt crisis just announced a new agreement with a group of central government bondholders. The agreement, the second that the oversight board has negotiated with these bondholders, increases the payment of possibly illegal debt, offers cash payments with money that could instead be used for hurricane and earthquake recovery efforts, and threatens Puerto Rico’s economic stability, giving way to the possibility of a second bankruptcy in the future.

The agreement would restructure a total of $35 billion in central government debts. It will be part of a new version of the plan of adjustment, which is the last step to restructure the debt and get out of bankruptcy.

The first attempt to approve a central government plan of adjustment failed. On the one hand, most bondholders did not agree with the provisions of the first agreement of June 2019, mainly because it offered much less money to repay bonds whose legality is being challenged in court. On the other hand, pensioners’ organizations managed to get the Legislature to approve resolutions against the plan of adjustment since it included an 8.5% cut in pensions.

The 8.5% cut to the pensions of over 65,000 retirees is still on the table.

The bondholders who signed this agreement are mostly vulture funds, some of which have been significantly increasing their investments in central government bonds since mid-2018. In fact, many of these vulture funds are the same as those participating in the plan of adjustment of COFINA, through which they generated hundreds of millions in profits.

The agreement in the context of bankruptcy

The oversight board has so far filed for bankruptcy of six government entities. They are:

  1. The central government
  2. Sales Tax Financing Corporation (COFINA, by its Spanish acronym)
  3. Puerto Rico Electric Power Authority (PREPA)
  4. Employees’ Retirement Systems (ERS)
  5. Highway and Transportation Authority (HTA)
  6. Public Buildings Authority (PBA)

The bankruptcy of COFINA ended in February 2019, when the federal court approved its plan of adjustment. COFINA’s restructured bonds will be paid for the next 40 years with a portion of the sales and use tax proceeds (SUT). According to our estimates, this plan meant over $1.3 billion in profits for vulture funds.

The agreement just announced by the oversight board seeks to be the basis of the plan of adjustment for three public entities: the central government, the ERS and the PBA. The oversight board says it will seek to file the new version of the plan of adjustment before the end of February.

The oversight board does not have the power to approve the plan of adjustment by itself. For approval, it needs a bill approved by the Legislature (with the signature of the governor), a voting process of all creditors of the central government (including the ERS and the PBA), and, finally, the approval of Judge Laura Taylor Swain.

What is the agreement?

The agreement is so bad that even some members of the oversight board, including David Skeel and Ana Matosantos, voted against it. What does it consist of?

The agreement directly impacts the General Fund, where budget allocations for all government agencies come from. Pension payments also come from the General Fund.

The more money the oversight board saves for the payment of the debt, the less money remains for essential services such as health, education, and housing, among other things.

The main debt of the central government is the bonds, which total around $18.7 billion (general obligation bonds and those of the PBA). The legality of part of this debt, $9 billion, has been challenged in court for its possible violation of Puerto Rico’s constitution for exceeding the constitutional debt limit. The oversight board itself participated in this challenge. If this debt were declared illegal, the government would be released from paying these bonds.

In the June 2019 agreement, the oversight board offered bondholders with challenged debt between 45 and 55 cents per dollar. To bondholders with unchallenged debt it offered between 64 and 72 cents per dollar.

With the new agreement, the oversight board gives up the challenge of the bonds and considerably increases the payment for them. Challenged bonds would receive 65 to 72 cents per dollar, while unchallenged bonds would receive 75 to 77 cents per dollar.

The oversight board promotes the agreement on the grounds that it cuts 70% of the central government’s debt. However, the haircut to these bondholders – who own the main government debt – is only 27% on average. In other words, vulture funds would have an average recovery of 73%.

The duration of this agreement is 20 years, ten years less than the previous agreement. In part this is achieved by cash payments, a total of $3.8 billion, which the oversight board offers to bondholders. The cash would come from the reserve held by Puerto Rico’s Department of the Treasury, where the savings achieved through austerity measures are saved, among others. As of January 31, 2020 this reserve had $9 billion.

The money from this reserve could be used for the reconstruction of the country that is still recovering from Hurricane Maria and, recently, from the earthquake and its aftershocks. However, the oversight board prefers to make cash payments to the vulture funds, billionaire institutions that speculate on the country’s crisis.

The new agreement stipulates that half of the bonds to be restructured will be exchanged for COFINA bonds. To comply with this provision, the oversight board needs the Legislature to approve a bill to transfer to COFINA (and its bondholders) a portion of the sales and use tax (SUT) proceeds that belong to the central government. Thus, bondholders would exchange unsecured bonds for secured bonds with the payment of the SUT.

The weight of the 70% cut falls on three groups of creditors, whose claims together total about $16 billion. On average these creditors will receive a 97% cut.

First, there are the pension bondholders. In 2008, the ERS issued a series of bonds whose source of repayment were the employers’ contributions for the payment of pensions. After a long legal battle, pension bondholders suffered a severe setback when the Court of Appeals for the First Circuit of Boston ruled against it. As a result of this ruling, these bondholders own only the assets that are still in the retirement system. In the first version of the plan of adjustment the oversight board offered them 13 cents per dollar. This agreement remains silent on how much they are currently being offered.

Second, there are the bonds of three agencies, the Convention District Authority, the Highways and Transportation Authority, and the Infrastructure Financing Authority. The sources of repayment of these bonds depend on revenues that are subject to the government taking them for purposes of greater importance, an action known in the legal jargon as a “clawback.” In the first version of the plan of adjustment, the oversight board offered no more than 3 cents per dollar for these bonds.

Finally, there are the unsecured creditors such as the companies that offered their services to the government (mostly local businesses), workers to whom the government owes money, and plaintiffs who have won sentences against the government. In the previous plan of adjustment the oversight board offered them up to 1.8 cents per dollar.

When the oversight board files the second version of the plan of adjustment, which will include the 8.5% cut to pensions, it will likely face a Legislature unwilling to approve the agreement. The ruling party knows the great political cost of a pension cut to one of the most vulnerable sectors in the country in an election year. Pensioners and people in general can take advantage of this conflict to put a stop to the plans of the oversight board.