The Securities Litigation Expert Blog

PREPA Restructuring?

Posted by Jack Duval

Dec 24, 2015 10:33:59 AM

PREPA announced a restructuring last night that puts it squarely in the realm of Ponzi finance. The Puerto Rico utility will issue $115M of new debt in order to pay interest on existing debt. As Hyman Minsky taught us, this is the definition of Ponzi finance (the last phase of the financial fragility cycle).

The new debt is to be purchased by two of the largest PREPA bond insurers: Assured Guaranty and National Public Finance Guarantee ($50M) and the Ad Hoc Group of hedge funds which own the majority of Puerto Rico municipal Bonds ($65M).[1]

In theory, there will eventually be a restructuring that will give PREPA $700M in interest rate relief over the next five years and a permanent haircut of $600M.[2] This would be accomplished through a debt exchange where the old bonds were exchanged for the new (haircut) bonds that would have an investment grade credit rating. The new bonds would be credit enhanced by surety of the bond insurers.

There’s only one problem with all this. PREPA is still losing money and the debt exchange will require increasing power rates by adding a surcharge that flows directly to the bond trustee.[3]

Chart One: PREPA Financials[4]

 PREPA_Financials.jpg

The High Cost of Restructuring

Allow me an anecdote: in a recent case in which I was engaged, a Puerto Rico resident who lived in a modest house, well outside of San Juan, was paying $1,000 per month to PREPA for power. Such high rates are an incredible drag on the economy. Higher rates will further depress the economy. Also, the restructuring is contingent on the rate surcharge, which will have to be passed after numerous other tax increases in the past two years and, more importantly, in an election year.

 In Order to Save the GDB, We had to Destroy It

In the Byzantine system of Puerto Rico debt payment priorities it is not clear how this works out. The Government Development Bank (“GDB”) balance sheet has been taking body blows. Over 21 percent of GDB assets are in Highway and Transportation Authority (“HTA”) bonds which are currently trading around 42.[5] The Governor has already enacted clawback provisions in the HTA bonds to meet principal and interest payments that were due on December 1 for (I kid you not) GDB debt.[6] Thus, in order to meet the GDB’s debt obligations, the Governor had to destroy the GDB’s balance sheet.

Chart Two: Puerto Rico Highway and Transportation Authority Bond[7]

  HTA.jpg

The GDB has at least $740M exposure to PREPA.[8] Coupled with their $2B exposure to HTA, their bonds have been getting crushed.

Chart Three: Puerto Rico Government Development Bank Bond[9]

 GDB.jpg

Stay tuned, this is far from over.  If a Chapter 9 bankruptcy becomes available to the Commonwealth's agencies, all bets are off, including the proposed Superbond.

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Notes:

[1]                 Mary Williams Walsh, The New York Times, “Puerto Rico Utility Reaches Deal with Bond Insurers in Effort to Avoid Default”. Available at: http://www.nytimes.com/2015/12/24/business/puerto-rico-utility-reaches-deal-with-bond-insurers-in-effort-to-avoid-default.html?_r=0; Accessed December 24, 2015.

[2]                 Id.

[3]                 Bloomberg; “Puerto Rico Electric Wins Debt-Restructuring Deal with Creditors; December 24, 2015.

[4]                 Source: Bloomberg

[5]                 GDB Liquidity Update; October 17, 2014; 6.

[6]                 Michelle Kaske; Bloomberg; “Puerto Rico Avoids Default by Redirecting Revenue From Bonds; December 1, 2015.

[7]                 Source: Bloomberg

[8]                 See Supra note 5.

[9]                 Source: Bloomberg

For information about securities expert Jack Duval, click here.

For my previous coverage of the Puerto Rico municipal bond crisis, see this.

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Topics: municipal bond crisis, Puerto Rico, UBS, securities litigation, GDB, Restructuring, PREPA, HTA

Puerto Rico Superbonds:  GOs Drink Agency Milkshakes

Posted by Jack Duval

Nov 30, 2015 7:48:00 AM

The hedge funds that constitute a large portion of Puerto Rico municipal bond holders are signaling initial acceptance for a restructuring of the island's debts.  Last week, The New York Times reported the following:

... the exchange would involve rolling up most of the island's current debt and restructuring it into a new "superbond," according to people briefed on the plan.  As part of that new bond, general obligation holders would have the first claim on government revenues, giving them the highest priority in the superbond structure.  Holders of other forms of the government's debt would have lower priority.

 

 

 

 

 

Puerto_Rico_GOs_Drink_Agency_Milkshakes.jpg

General Obligation Bonds Drink Your Milkshake

General Obligation bonds were always going to come out ahead in any restructuring because they are constitutionally protected and they have first claim on many of the revenue streams that support various Puerto Rico agencies.

Most noteable are the Highway Transportation Authority bonds, of which there are roughly $6.5B outstanding.  Infrastructure Funding revenues are also pledged to support GOs.

It is not clear if the superbond structure would broaden these claims to other agency revenues not currently pledged to support Commonwealth GOs.  However, don't be surprised if additional straws appear.

Puerto Rico CDO

In effect, the superbond debt restructuring would create a Puerto Rico CDO with GO bonds as the super senior tranche, and many equity tranches (all named after various Puerto Rico agencies).  It could look something like the chart below.

Chart 1:  Potential Puerto Rico "Superbond" CDO Structure

Puerto_Rico_Superbond_CDO.jpg

For a higher resolution version of this chart, click here.

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For information about securities expert Jack Duval, click here.

For my previous coverage of the Puerto Rico municipal bond crisis, see this.

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Topics: municipal bond crisis, Puerto Rico, UBS, securities litigation, CDO

FINRA: Santander Failed to Update Risk on Puerto Rico Munis - See Our Suitability Matrix

Posted by Jack Duval

Oct 14, 2015 10:37:00 AM

santander

Yesterday FINRA announced a $6.4 million fine and Acceptance, Waiver and Consent by Santander for sales practice and supervisory violations at its Puerto Rico offices.  (FINRA Press Release and Santander AWC - search under Case Number: 2014041355501)

The AWC and sanctions revolve around a number of failures to supervise the sales of Puerto Rico municipal bonds and closed-end funds.  The AWC highlights a number of supervisory failures, including:

  • The failure of Santander to update its proprietary risk-classification tool for the unique and changing risks of Puerto Rico municipal bonds; (See our Suitability Matrix, below.)
  • The failure to monitor for the use of margin in connection with the purchase of Puerto Rico municipal bonds;
  • The failure to monitor for over-concentrated positions in Puerto Rico municipal bonds and closed-end funds;
  • The failure to monitor for Registered Representatives selling personal Puerto Rico municipal bond holdings to their clients. 

The "Securities Master"

Santander used a proprietary risk-classification tool that categorized securities into three risk levels: low, moderate, and high.  The AWC noted the "vast majority of Santander's clients were moderate-risk investors" and that almost all the Puerto Rico municipal bonds sold to their clients were coded moderate-risk.  However, Santander did not update the Securities Master to reflect the dramatically increasing risks in the Puerto Rico municipal bond market.

The FINRA press release stated:

Santander did not review or assess the tool's Puerto Rico municipal bond risk classifications following significant market events such as the December 13, 2012, Moody's downgrade of certain (bonds) to one level above junk.

Santander and its Registered Representatives Sold Their Puerto Rico Municipal Bonds While Customers Held or Purchased Them

While Santander was holding its moderate risk classification steady for Puerto Rico municipal bonds, it was reducing it's trading desk inventory.  The AWC states:

On November 29, 2012, Santander began reducing its Puerto Rico municipal bond inventory.  (The December 13, 2012 Moody's downgrade) acceleranted the Firm's efforts to reduce its inventory of Puerto Rico municipal bonds, reflecting Santander's concerns about changed risks in the market for Puerto Rico municpial bonds and Santander's exposure to those risks.

The next day, on December 14, 2012, Santander closed its Puerto Rico trading desk to any new purchases of Puerto Rico municipal bonds... The Firm, however, continued to reduce its market exposure and entirely eliminated its inventory of Puerto Rico municipal bonds by October 2013.

... employees sold securities directly from their accounts to customer accounts.

Sanctions

FINRAs sanctions include:

  • A centure;
  • A fine of $2 million;
  • Restitution of approximately $4.3 million.

Analysis

The most significant finding in the AWC is that Santander failed to update it's risk-classification for Puerto Rico municipal bonds in the face of overwhelming evidence that the economy had been in a long-term decline, and the fact that the bonds had been downgraded a number of times.  (Puerto Rico GO bonds were downgraded on 8/8/11, 12/13/12, and 3/13/13.)

These increasing risks made the bonds less and less suitable for investors going back to the beginning of the economic decline in 2006.

The Accelerant Puerto Rico Municipal Bond Suitability Matrix

Accelerant has created a suitability matrix showing how Puerto Rico municipal bonds became more risky and less suitable over time.  It provides a framework for evaluating the suitability of client positions in Puerto Rico municipal bonds, by level of client account concentration. Key features:

  • Identifies three distinct phases of increasing risks in Puerto Rico municipal bonds;
  • Highlights two milestones where continuing to hold the bonds required higher risk tolerances or lower allocations;
  • Provides a clear and consistent method for evaluating damage claims.

For a high resolution version of the Suitability Matrix, go here.

The_Accelerant_Puerto_Rico_Changing_Suitability_Matrix

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For information about Puerto Rico municipal bonds expert Jack Duval, click here.

For my previous coverage of the Puerto Rico municipal bond crisis, see this.

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Topics: municipal bond crisis, FINRA, closed-end funds, Puerto Rico, UBS, supervision, securities litigation, Compliance, Santander

UBS Hit with $34 Million in Fines over Puerto Rico Funds

Posted by Jack Duval

Sep 29, 2015 4:29:00 PM

UBS_Puerto_Rico

FINRA and the SEC just announced a $34 million fine against UBS for its Puerto Rico funds.  You can find the announcement here.

For the full AWC, see this.

We will have more analysis later.

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For information about Puerto Rico municipal bonds expert Jack Duval, click here.

For my previous coverage of the Puerto Rico municipal bond crisis, see this.

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Topics: municipal bond crisis, FINRA, closed-end funds, Puerto Rico, UBS, SEC, securities litigation

Puerto Rico Debt Crisis Puts Focus on Insurers

Posted by Jack Duval

Jul 14, 2015 10:02:00 AM

To access our analysis of Puerto Rico bonds by insurer, see this.

PR_Bond_Image

 

The July 28th, 2015 Puerto Rico debt restructuring announcement by Governor Padilla should have come as a surprise to no one.  However, the stocks of the insurers standing behind more than $11.8 billion of Puerto Rico municipal bonds have declined significantly since then.

We have analyzed the bonds of the largest Puerto Rico bond issuers and compared the prices of similar issues with different insurers.  The difference is striking.  National, Assured, and AMBAC appear to have the market's confidence, while CIFG, XLCA, and FGIC do not.

Simply put, the market appears to be pricing in the certainty of a restructuring/reorganization/default and is looking through the bonds to the insurers.

You can access our analysis here.

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For information about securities expert Jack Duval, click here.

For my previous coverage of the Puerto Rico municipal bond crisis, see this.

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Topics: municipal bond crisis, closed-end funds, Puerto Rico, UBS, securities litigation, municipal bond insurance

Accelerant Publishes Guide to Puerto Rico Capital Structure

Posted by Jack Duval

Jul 1, 2015 11:29:00 AM

Accelerant has published a guide to the Puerto Rico municipal bond capital structure.  The guide covers:

  • The largest Puerto Rico issuers;
  • Amount outstanding;
  • Primary security source;
  • Government backing;
  • If "local" bonds have been issued;
  • Taxation to U.S. and P.R. residents;
  • Insurance;
  • Ratings;
  • The price on or before June 26, 2015.

To access the guide, please click here.

This guide is designed to help market participants and securities litigators better understand the outstanding debt of the Commonwealth, its agencies, and other issuers.

Chart of Puerto Rico General Obligation Bond (trading at 55.375)

Puero_Rico_GO_Municipal_Bond

 

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For information about securities expert Jack Duval, click here.

For my previous coverage of the Puerto Rico municipal bond crisis, see this.

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Topics: municipal bond crisis, closed-end funds, Puerto Rico, UBS, securities litigation, Puerto Rico Municipal Bond Capital Structure

Puerto Rico to Default/Reorg/Restructure Municipal Bond Debt

Posted by Jack Duval

Jun 28, 2015 9:15:00 PM

Puerto Rico Governor Garcia Padilla today admitted what has been obvious for years:  the Commonwealth cannot pay its debts and will look to reorganize, restructure, or default on some or all of its $72 billion in outstanding municipal bonds (including general obligation bonds).  The Governor will release an IMF Stability Anaysis tomorrow and will make a televised speech about the fiscal crisis at night.

As we have covered extensively, this outcome was inevitable, and obvious.  This is good news for the island economy as it will allow it to hit the "reset" button.  In the near term, the economic pain will continue, but in the long term, the dead wood will be cleared and new growth will emerge.

This is not good news for owners of Puerto Rico municipal bonds, many of whom own the debt directly, and others who own it indirectly, through open and closed-end municipal bonds funds.  Almost any scenario will most likely invovle severe haircuts on the amount owed (i.e. your $1,000 face value bond is now a $400 face value bond) and/or payment extensions (i.e. your five year bond is now a 20 year bond).

With Greece closing its banks and stock market and imposing other capital controls tomorrow, it looks to be an interesting day for the markets.

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For information about securities expert Jack Duval, click here.

For my previous coverage of the Puerto Rico municipal bond crisis, see this.

 

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Topics: municipal bond crisis, closed-end funds, Puerto Rico, UBS, securities litigation

Former Brokers Sue UBS of Puerto Rico

Posted by Jack Duval

Apr 16, 2015 7:26:00 AM

UBS

Two former UBS brokers, George and Tresa Bravo, are suing UBS Puerto Rico for "deceiving employees and customers about closed-end mutual funds".  (Emphasis added. My paraphrasing of the google translation from Sincommillas.com.)

The brokers, who have 30 years of industry experience and managed over $120 million of client assets, are alleging that UBS "threatened, deceived, and coerced" them regarding UBS's proprietary municipal bond closed-end funds, most of which used leverage.

If true, it would appear that it is another case of brokerage firms selling complex products that are not properly understood by the firm's management, salesmen, or clients.  I have examined this phenomenon at length in my white paper: Complexity Risk: A New Risk Category.

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For information about securities expert Jack Duval, click here.

For my previous coverage of the Puerto Rico municipal bond crisis, see this.

 

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Topics: municipal bond crisis, closed-end funds, Puerto Rico, UBS, securities litigation, Complex Investments, Complexity Risk

Fitch Downgrades Puerto Rico GO Debt to B - Watch Negative

Posted by Jack Duval

Mar 26, 2015 3:09:00 PM

fitchratings

Yahoo! News reports the following affected credits:

With today's action, Fitch has downgraded and placed on Rating Watch Negative all of the following ratings:

--$13 billion Commonwealth of Puerto Rico GO bonds, downgraded to 'B' from 'BB-'

--$6.7 billion Puerto Rico Sales Tax Financing Corporation (COFINA) senior lien sales tax revenue bonds and $8.5 billion COFINA first subordinate lien sales tax revenue bonds, downgraded to 'B' from 'BB-'

COFINA bonds have a security interest in and are payable from the Commonwealth's sales and use tax. COFINA is an independent governmental instrumentality of the Commonwealth and affiliate of the GDB established by specific legislation. The COFINA bonds are rated at the level of the Commonwealth's general credit. Although COFINA bonds were specifically excluded in the Public Corporation Debt Enforcement and Recovery Act, the passage of the Act substantially increased Fitch's assessment of the risk that the Commonwealth may take steps to the detriment of COFINA bondholders if the Commonwealth considered that a fiscal emergency and its need to provide essential services required legislative action limiting revenues available to COFINA. Fitch does not place COFINA debt below the Commonwealth's GO as the agency believes that if circumstances warranted a shift in COFINA revenues to fund the general government, the GO bonds would be equally likely to default. There is no rating distinction between the senior and subordinate COFINA liens, as the legal security of each would warrant a higher rating in the absence of Commonwealth risk factors.

--$2.9 billion Employees Retirement System of the Commonwealth of Puerto Rico (ERS) pension funding bonds, downgraded to 'B' from 'BB-'

The ERS bonds are a limited, non-recourse obligation of the pension system, payable from and secured by a pledge of statutorily required employer contributions to the system. The rating on the ERS bonds is the same as that assigned to the Commonwealth's GO bonds, as the Commonwealth is the largest employer contributor and contributions have a strong legal priority. Given that GO bondholders have a legal claim on Commonwealth revenues senior to contributions due to the pension systems, the rating on the ERS bonds can be no higher than the Commonwealth GO rating.

--$1.4 billion Puerto Rico Public Building Authority (PBA) government facilities revenue bonds guaranteed by the Commonwealth and rated by Fitch and $658 million PRASA Commonwealth guaranty revenue bonds, downgraded to 'B' from 'BB-'

Bonds of the PBA and PRASA that are guaranteed by the Commonwealth are backed by the Commonwealth's commitment to draw from any funds available in the treasury. The good faith and credit of the Commonwealth is pledged to any such deficiency payments, resulting in a rating that is the same as the Commonwealth's GO bonds.

--$3.4 billion PRASA senior lien revenue bonds, downgraded to 'B' from 'B+', Rating Watch Negative maintained

PRASA's revenue bonds likely will be influenced by movement of the Commonwealth general obligation rating for the foreseeable future given the Commonwealth's historical actions and ability to expose PRASA to potential fiscal and operational challenges.

Fitch does not rate any other appropriation- or special tax-secured debt of the Commonwealth.

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For information about securities expert Jack Duval, click here.

For my previous coverage of the Puerto Rico municipal bond crisis, see this.

 

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Topics: municipal bond crisis, closed-end funds, Puerto Rico, UBS, securities litigation

Jack Duval Publishes Company Town Investing White Paper

Posted by Jack Duval

Mar 11, 2015 4:33:37 PM

I am pleased to announce the publishing of a new white paper: "Company Town Investing: The Case of Puerto Rico."

PuertoRicoMuniBondCrisis

This paper examines a risk that is commonly missed by financial advisors: that of common exposures across an investor’s total wealth.  I call this phenomenon "Company Town" risk, harkening back to the small towns that sprang up around a local mill, mine, or factory.  As those who have lived in Detroit could attest, the company town exists today.

In this paper, I use Puerto Rico as an exemplar of the modern company town.  I show how the island became dependant upon the Section 936 U.S. tax incentive, and how it's expiration sent Puerto Rico into a brutal secular decline.

Furthermore, I show that if Puerto Rico residents had been diversified away from Puerto Rico exposed investments, they would have done very well through the economic decline.  This will be of particular interest to those attorneys with municipal bond cases in Puerto Rico.

Paper sections include:

  • Puerto Rico - A Company Town with One Large Exposure
  • Section 262 and 936 Tax Incentives
  • Statistical Evidence of Section 936 Impact on Puerto Rico Growth
  • Correlations of Puerto Rico Total Wealth
  • Investing for Company Town Residents

Click to Download: Company Town Investing - The Case of Puerto Rico

To learn more about author Jack Duval, click here.

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Topics: municipal bond crisis, closed-end funds, Puerto Rico, UBS, securities litigation, Company Town, Total Wealth Diversification

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