Lorie Shaull (Flickr)
The Financial Oversight and Management Board (Oversight Board) imposed by the United States Congress to reorganize Puerto Rico’s government finances recently filed its new plan of adjustment to restructure the central government’s debt. The plan of adjustment impacts around $35 billion in debt and over $50 billion in pension obligations. It is the largest debt restructuring in the history of the US municipal bond markets.
The source of repayment of this debt comes from the General Fund, the government’s main fund that is the source for budgetary allocations of all the agencies.
With the filing of the plan of adjustment, the second amendment to the plan that the Board has filed since the beginning of the bankruptcy, the vulture funds are once again placed in the position of profiting from the austerity measures imposed in Puerto Rico, as happened with the restructuring of COFINA. The Public Accountability Initiative estimates that, in that restructuring, the vulture funds made $1.1 billion in profits.
The plan of adjustment includes cash payments of $7 billion for vulture funds.
The plan also contains a pension cut of 8.5% to all those retirees whose monthly pension exceeds $1,500. However, if the pension cuts and the freezing of all benefits enjoyed by both pensioners and active employees are added, the adjustment plan would imply a total cut of 19.3%.
To carry out the plan of adjustment, the Board needs the Legislature to pass a bill that makes the restructuring feasible. The plan would then go to a vote in which all central government creditors who are impacted will participate. Potential voters include bondholders, pensioners, public sector workers, utility companies, and others with claims against the government.
The Pierluisi administration has said it will not endorse any adjustment plan that includes cuts to pensions.
The new version of the plan of adjustment still includes a pension cut of 8.5%. The cut affects three retirement systems: the Teachers’ Retirement System, the Judicial Retirement System, and the Employees’ Retirement System. In the previous adjustment plans, the 8.5% cut was for all pensions of $1,200 or more; that is, no cut could lead to a pension falling below $1,200 per month. Now the cuts would be for all pensions of $1,500 a month or more.
However, if we add the pension cuts and the freezing of all benefits enjoyed by both retirees and active employees, in 40 years the cut will total $12.5 billion, equivalent to a 19.3% pension cut.
If imposed, this cut would be another of a series of cuts that pensioners have suffered since before the imposition of PROMESA. An analysis of the retirement systems commissioned by the Oversight Board found that most pensions have not had a cost of living adjustment; that is, they have remained fixed despite the increase in the cost of living, effectively lowering their real value. The study estimated that the purchasing power of pensions has dropped by 19% since 2007.
The approval of the plan of adjustment requires, in addition to a bill approved by the Legislature, a vote with the participation of all creditors impacted by the plan. Creditors are divided into classes according to the type of claim they have. In total, the Board divided the creditors into 66 different classes, with pensioners being one of these classes.
Pensioners will have the power to vote against the adjustment plan. However, the plan includes a trap for the opposition: The class that votes to reject the plan will then have a 10% cut – instead of the base cut of 8.5% (p. 40 of the plan). In this way, any decision by opponents of the plan to reject it with their votes will bring about even greater cuts.
Pensioner organizations have been able to get the Legislature to stand firm against pension cuts. The House of Representatives recently approved, without opposition, the Ley de retiro digno (Law for a Dignified Retirement), which establishes as public policy the rejection of any pension cuts. The Board opposes the bill. However, since the Board needs a bill approved by the Legislature to move forward, the issue of pensions could jeopardize the approval of the plan of adjustment.
Central government bondholders and creditors
According to the Board, the plan of adjustment reduces debt in central government bonds (general obligation plus Public Buildings Authority bonds) by 61%, from $18.8 billion to $7.4 billion. However, if the $7 billion in cash that the Board would give to the bondholders is taken into account, the reduction of this debt would be only 23%.
When we compare the terms of the past two plans of adjustment, we note that, despite the numbers’ game, the debt reduction accepted by the vulture funds has not dropped.
|Plan of adjustments|
|Deal terms||September 2019||February 2020||March 2021|
|Cash + new bonds||$14.7||$14.2||$14.4|
|% Cut (not including cash)||37%||45%||61%|
|% Cut (including cash)||22%||24%||23%|
As can be seen in the table, if we include cash payments, the debt reduction has remained more or less the same in all three agreements. What has changed are the terms, with the Board offering more cash, to the point of offering $7 billion, a figure that represents 70% of the government’s operational budget.
Part of the cash included in the plan comes from the austerity measures imposed by the Board in the past years. Each budget cut generated savings that will now be used to pay bondholders.
The repayment of this debt will come from the General Fund, the source for budgetary allocations for the government. In addition, the plan of adjustment stipulates that 1.03% of the property tax collections taken in by the Municipal Revenue Collection Center (CRIM, by its Spanish acronym) will be paid to the bondholders (p. 89 of the plan). This is not the first time that CRIM’s collections are part of the source of repayment in a restructuring agreement. In the Government Development Bank’s restructuring, property taxes collected by the CRIM constituted a substantial part of the source of repayment for bondholders.
All the discussion about the illegality of parts of the debt has been dropped out of this plan. The Board desisted from challenging the $6 billion in general obligation bonds whose legality it had questioned in court.
As part of the plan of adjustment, the bonded debt of the Employees’ Retirement System (ERS), one of the most disputed debts in the bankruptcy process, would also be cut.
On the one hand, the bondholders tried to demonstrate that their claims were secured with the payment of employer contributions to the ERS. In other words, the bondholders, mainly vulture funds, argued that future employer contributions belonged to them up to the amounts necessary to cover debt service. The Court of Appeals for the First Circuit in Boston ruled against the bondholders. On the other hand, the legality of these bonds has been questioned on the grounds that the ERS did not have the legal authority to issue bonds.
The Board offered in this plan a recovery of 8.7% to the ERS bondholders. If they do not accept the agreement and continue with the litigation, the bondholders risk losing everything if their bonds are declared invalid by the court. However, with the signing of a stipulation between the Board and the vulture funds, it seems that they are on the verge of reaching an agreement. The stipulation establishes cash payments of $373 million to $448 million, which would imply a debt reduction between 85.9% and 88.3%.
The worst cut in the plan of adjustment falls on unsecured creditors who are neither bondholders nor pensioners. These creditors include government vendors, public sector workers, and individuals with rulings against the state. The cut is estimated to be 99.3%, or less than a penny for every dollar.
Contingent value instrument
The adjustment plan includes a contingent value instrument (CVI) that could further increase the income of central government bondholders. CVI payments would be activated in the coming years if the sales and use tax (SUT) collections exceed the projections established in the fiscal plan. In other words, if Puerto Rico’s economy improves in the future and the government’s SUT collections exceed the Board’s projections, then the bondholders would obtain payments in addition to the agreed fixed payments.
According to the plan, 50% of the surplus that exceeds the projected SUT collections would be paid to the bondholders (p. 90 of the plan). Payments through the CVI would have at least two caps: Annual payments could be up to a maximum of $200 million to $400 million and all payments over the life of the bonds (22 years) cannot exceed $3.5 billion. In that sense, the 23% cut could be much smaller.
The plan of adjustment has been denounced for its unsustainability. As outlined in the May 2020 fiscal plan, the government budget would again fall into deficit as early as 2029, even if the Board’s proposed structural reforms are imposed and generate the projected savings. To rephrase this: despite the cuts suffered by the people of Puerto Rico and the reorganization of the public finances carried out by the Board, the government could fall into a new debt crisis in ten years.