Two Puerto Ricos on Display in Newest Bond Deal

Puerto Rico’s almost four-year bankruptcy has always been difficult to follow. On Tuesday, something happened that could potentially signal the beginning of the end of this saga that has spanned devastating hurricanes, the Covid-19 pandemic and legal challenges that reached the U.S. Supreme Court.

But you might not have known it at first from reading some headlines.

First, here’s what I consider the correct interpretation, from my colleague Michelle Kaske of Bloomberg News: “Puerto Rico to Slash Bond Debt in New Restructuring Pact.” The deal, which goes beyond an agreement reached about a year ago, sets the commonwealth on the path to receive court approval in the fall and exit bankruptcy by the end of 2021, according to Natalie Jaresko, executive director of the island’s financial oversight board. Here’s a bit more:

While the deal cuts the island’s debt more deeply than the previous agreement, it is supported by owners of more than $11.7 billion of debt, including bond insurers, Aurelius Capital Management, BlackRock Financial Management Inc., Davidson Kempner Capital Management and GoldenTree Asset Management.

The accord, if eventually supported by a sufficient number of creditors and approved in court, promises to help Puerto Rico emerge from a bankruptcy that has cast a shadow over the island since May 2017 by cutting the central government’s bond debt by 61%.

“It’s a fair deal,” David Skeel, the chairman of the oversight board, told reporters Tuesday. “It provides bondholders with payments that we believe that Puerto Rico can afford in the coming years while also lifting a heavy weight off the shoulders of Puerto Rico’s next generation.”

The Associated Press headline gives a vastly different initial impression: “Puerto Rico Rejects Key Deal With Creditors to Reduce Debt.” A quick Google search suggests this was picked up by top newspapers across the country. Here are the first two paragraphs:

Puerto Rico’s governor announced Tuesday that a federal control board reached a key deal that would reduce the U.S. territory’s overall debt by nearly 80%, but that his administration is rejecting it because it would require cuts to the island’s crumbling public pension system.

The impasse between the governor and a board that oversees Puerto Rico’s finances threatens to throw into limbo attempts to end a bankruptcy-like process for a government that six years ago declared unpayable its more than $70 billion public debt load.

What’s going on here? It boils down to who is considered “Puerto Rico” at the end of the day — Governor Pedro Pierluisi or the members of the federal board overseeing the island’s finances. For better or worse, I’d argue it’s the latter.

The website for Puerto Rico’s oversight board strikes a congenial tone, stating that the seven-person group “is tasked with working with the people and Government of Puerto Rico to create the necessary foundation for economic growth and to restore opportunity to the people of Puerto Rico.” Pierluisi is an eighth, nonvoting member.

That kind of description understates the power that the oversight board wields over the bankruptcy process and the future of Puerto Rico’s finances. Supreme Court Justice Sonia Sotomayor wrote last year that even though “Puerto Rico, like a State, is an autonomous political entity,” the board, which was selected at the federal level, has “wide-ranging, veto-free authority over Puerto Rico.” In this context, it’s clear that the board speaks for Puerto Rico in negotiations with creditors and effectively has the final say in how this bankruptcy shakes out.

Pierluisi, a member of Puerto Rico’s pro-statehood party who caucused with Democrats while in the U.S. House, has comparatively little sway in how the bankruptcy progresses, but he does hold the power of the bully pulpit. In a statement, he bemoaned that the board “has not yet abandoned the pension cuts included in the February 2020 plan of adjustment.” Still, he acknowledged that the new deal provides a deep cut to the island’s debt. 

Obviously, the oversight board would prefer to have Pierluisi’s support for the restructuring plan when presenting it to the court. It would fly in the face of the aforementioned mission statement if the governor, elected by the people of Puerto Rico, were staunchly opposed to the resolution. In an extreme scenario, Judge Laura Taylor Swain could make the governor’s approval a condition for signing off on the resolution. But that’s unlikely, given the potential headaches involved and the costs associated with prolonging an already drawn-out bankruptcy.

As it stands, Puerto Rico’s general-obligation bondholders would see their holdings reduced by 27% on average, while those who own buildings authority debt would face a 21% cut, according to the oversight board. Curbing pension benefits is politically unpopular but necessary to put the retirement system on stronger footing and win court approval. The board knows this, and in truth Pierluisi probably does, too — but he needs to at least put up a fight.  

Together, they are the two Puerto Ricos — the cold, calculating oversight board and the governor standing up for public employees over mainland hedge funds. In the end, though, only one has the overarching authority needed to get Puerto Rico to the end of this painful chapter in its history. And it’s slowly but surely making progress.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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