Puerto Rico debt process can impact your hometown
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As Puerto Rico’s fiscal crisis begins to play out in court, the stakes loom large for America’s $3.8-trillion municipal debt market. If you think this is hyperbole, just ask one of the 50,000 issuers in the marketplace.  

One of the main conflicts at the heart of Puerto Rico’s restructuring is the prioritization of its competing creditors and stakeholders: The beleaguered territory has 18 public agencies that collectively owe nearly $125 billion in debt and pension obligations.

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To help facilitate an orderly restructuring, Congress passed the Puerto Rico, Oversight, Management, and Economic Stability Act last year. The bill allows the territory to file bankruptcy-like cases under Title III of the law. 

 

Absent a consensual settlement between the island’s two largest creditors, the Title III proceedings will determine if secured bondholders with a U.S. constitutionally-protected lien on sales tax revenues take precedence over unsecured bondholders with territorial “constitutional priority.”

While many of Puerto Rico’s creditors continue to claim superiority, the highest recoveries in debt restructurings typically go to holders of senior secured debt backed by sufficient collateral. This is a long-standing precedent that many muni-market investors have come to count on and an increasing number of state and local government issuers greatly benefit from in good times as well as challenging ones. 

Just this month, Chicago Mayor Rahm Emanuel shared his city’s plan to securitize sales taxes to issue higher-rated debt at lower borrowing rates. This followed the Illinois General Assembly passing legislation that enables municipalities to isolate and securitize dedicated revenue streams to raise debt.

The Emanuel administration has stated that the capital raised through a tax-backed secured bond issuance will be 200 to 300 basis points cheaper than Chicago’s current general obligation debt, potentially unlocking up to $100 million in annual savings. 

Financially-strained issuers, including Chicago, are only able to rely on secured debt issuances to the extent they provide creditors confidence of repayment. Investors in these structures trust that in exchange for accepting lower interest payments, they receive secured property interest in specific collateral, such as sales tax revenues. This property interest remains intact following a default or even a bankruptcy filing. 

Detroit’s 2014 plan of adjustment under Chapter 9 of the U.S. Bankruptcy Code did not impair secured bonds backed by pledged revenue streams. Similarly, resolutions of the fiscal crises in the District of Columbia and New York City respected secured creditors’ rights.

Not surprisingly, all three cities used tax-backed secured debt offerings to raise affordable capital during their turnarounds. The absence of such an important policy option may have rendered each recovery impossible, or required it to occur at a higher cost to the people living in each jurisdiction. This was fortunately not the case thanks to investors’ faith that their collateral would be protected under state and federal law.

Puerto Rico’s largest debt issuance, known by the Spanish acronym COFINA, is a $17.6-billion securitization with a lawful lien and property interest in a portion of the island’s sales tax. The bipartisan legislation that established COFINA in 2006 stipulates that a set percentage of collected sales tax flows to a lockbox — separate from the commonwealth’s general fund — before going to pay bondholders. 

Today, approximately half of the outstanding debt issued by U.S. municipalities is secured by some type of collateral or property. In the face of tightening budgets and rising deficits, an increasing number of elected officials understand that the use of secured debt represents sound public policy. They appreciate that these issuances make it possible to obtain attractive borrowing by simplifying the underwriting process and instilling confidence in ratings agencies and investors.

This is why Puerto Rico’s Title III proceedings should be watched as closely on Main Street as on Wall Street and in Washington. 

If COFINA creditors’ rights are respected in the island’s court-supervised restructuring, it will help ensure tax-backed, secured municipal financing remains viable for state and local governments. The alternative may remove a much-needed arrow from their quiver as they confront inevitable fiscal challenges on the horizon.  

Matt Rodrigue is a managing director of Miller Buckfire & Company, which serves as financial advisor to a coalition of asset managers and retail investors holding more than $2.6 billion of COFINA senior bonds.


The views expressed by contributors are their own and not the views of The Hill.