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Analysis: Puerto Rico Bondholders Are In for a Bumpy Bankruptcy Ride

If Puerto Rico’s record-setting bankruptcy follows the template of other municipal restructurings, general obligation bondholders may be in for a long ride, despite constitutional guarantees on their debt, according to an analysis in Reuters today. The federal financial oversight board for Puerto Rico yesterday pushed the U.S. commonwealth into a court-sanctioned restructuring process (Title III), and similar filings for the island’s public agencies could be coming soon. The island's constitution guarantees the debt of GO, or general obligation, bondholders, while other debt, known as COFINA, is backed by revenue streams from tax proceeds. But in past bankruptcies, that has not meant much. In five of six recent public bankruptcies in which the debtor defaulted on bonds, pensioners walked away with full recovery while bondholders took haircuts, according to data from Moody’s Investors Service. “If the market hasn’t taken this dynamic into account by now, you can imagine they will after Puerto Rico, given its enormous scale,” said bankruptcy expert and ABI Resident Scholar Drew Dawson, a professor at the University of Miami School of Law. Moody’s has rated the commonwealth's GO and COFINA debt on equal footing, forecasting recoveries for both of between 65 and 80 cents on the dollar, and ahead of debt from Puerto Rican agencies like the Government Development Bank, which it sees as recovering less than 35 cents. Susheel Kirpalani, a lawyer for a COFINA investor group, on Wednesday called the filing “sound public policy.” All along, COFINA holders have favored the bankruptcy route. But Andrew Rosenberg, a lawyer for a GO bond group, said “the economy of Puerto Rico will be put on hold for years” in a bankruptcy.

Op-Ed: Puerto Rican Bankruptcy: Better Late than Never

Wednesday's application by Puerto Rican Governor Ricardo Rosselló for bankruptcy protection for the island under the provisions of the PROMESA Act underlines the dictum that if a debt cannot be repaid, it will not be repaid, according to an op-ed in The Hill today. One must now hope that wise use will be made of the forthcoming bankruptcy process not only to ensure that a fair deal is secured for both Puerto Rico and its creditors, but also to put the Puerto Rican economy back on an economic growth path that might restore prosperity to the island. It was always fanciful to think that Puerto Rico could either repay or engineer a voluntary restructuring of its public-debt mountain, according to the op-ed, but the island has no fewer than 18 separate bond issues, each of which has different legal protections or claims to different streams of government revenues. In light of the island’s highly compromised public finances, one should not have been surprised by Wednesday’s request by Governor Rosselló for bankruptcy protection. After all, the island was being hit by a slew of damaging creditor lawsuits in the immediate wake of the May 1 expiry of the temporary stay against such litigation. Rather, one should have been surprised that the governor waited until after the lawsuits had been filed before he sought such protection, given how inevitable bankruptcy for the island seemed to be. One must welcome Governor Rosselló’s decision now to seek bankruptcy protection, according to the op-ed. This should provide the framework for an orderly and fair restructuring of the island’s debt without rancorous and economically damaging creditor lawsuits. The orderly restructuring of Puerto Rico’s debt should also be seen as a necessary, but far from sufficient, condition for its economic revival.

House Panel Approves Plan to Undo Parts of Dodd-Frank Financial Law

The House Financial Services Committee voted 34-26 along party lines today to approve the first comprehensive congressional plan to undo Obama-era financial regulations, the Wall Street Journal reported today. The committee sent the Financial Choice Act, a bill by the panel’s chairman that unwinds significant parts of the 2010 Dodd-Frank law approved after the financial crisis, to the full House, where it will likely get a vote in the coming weeks. The legislation eases regulations and some capital requirements for healthy firms, forces failing firms to go through bankruptcy and restructures the Consumer Financial Protection Bureau. “Our plan replaces Dodd-Frank’s growth-strangling regulations on small banks and credit unions with reforms that expand access to capital so small businesses on Main Street can grow and create jobs,” said House Financial Services Committee Chairman Jeb Hensarling (R-Texas). Democrats relentlessly fought to stop the bill’s first passage over three days of committee debate by proposing nearly two dozen amendments, many of which would have preserved components of the law Republicans want to eliminate. All of the Democratic amendments were rejected. But some of the issues, such as narrowing the CFPB’s powers and the process for unwinding a failed financial firm, will come up again as debate over changing Dodd-Frank moves through Congress.

Interest Rates Remain Unchanged; Fed Notes Softness in Economy

The Federal Reserve’s Open Market Committee’s decision about raising interest rates was a no go, Forbes reported Wednesday. That likely doesn’t surprise market-watchers who have been following the CME’s FedWatch Tool, which has been predicting with a 95 percent probability for some time now that Wednesday’s Fed decision would be a nondecision. Could there be a step-up by June? Hard to say, based on the Central Bank’s statement. Sticking with the “gradual pace” of tightening that Fed Chair Janet Yellen has advocated for some time, the Fed statement noted softness in the economy and a slowdown in household spending, but signaled a stay-the-course position on monetary policy. “The committee views the slowing in growth during the first quarter as likely to be transitory and continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, labor market conditions will strengthen somewhat further, and inflation will stabilize around 2 percent over the medium term,” according to the Central Bank’s statement. The statement failed to give any clear hints about when the Fed might raise interest rates next, noting that it believes that “economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate” and adding that “the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”

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Op-Ed: Puerto Rico Needs Bankruptcy Protection. Now.

The last thing that Puerto Rico needs now is yet another shock to its very troubled economy. Yet, that is precisely what the island should be bracing itself for once the temporary stay that the U.S. Congress afforded it last year from creditor lawsuits expires on May 1, according to an OpEd in The Hill today. It is difficult to understand why Puerto Rico’s governor and its Oversight Board have not already availed themselves of the island’s right to file for bankruptcy protection that was made possible under last year’s PROMESA Act of Congress. It is also difficult to overstate how desperate the present state of the Puerto Rican economy is. Even before the slew of costly and disruptive creditor lawsuits that will almost surely follow the expiry of the U.S. Congress’ temporary stay on such suits next week, the island’s economic outlook was nothing short of grim. According to the Puerto Rican government’s own 10-year budget plan, which was approved by its Oversight Board, the island’s economy is projected to decline by more than 3 percent a year in 2018 and 2019 and by around 10 percent over the next five years. In these dire circumstances, one would think that it would be in the island’s best interest to secure as soon as possible an orderly restructuring of its public debt mountain. If such a restructuring were quickly done in the context of a far-reaching structural economic reform program, especially one that included reforms to its archaic labor laws, the island would have a chance to at last begin recovering from its deep economic depression. By orderly restructuring its debt, the island would reduce the investor uncertainty from which it now suffers as a result of a debt level that everyone knows it cannot afford to pay.

Commentary: A Better Idea for Bankrupt Big Banks

The most significant Wall Street reform in nearly a decade may soon become law, according to a commentary in Monday’s Wall Street Journal. Last Friday, President Trump directed Treasury Secretary Steven Mnuchin to review Title II of the 2010 Dodd-Frank Act, which gives the federal government authority to wind down involuntarily failing financial institutions. Treasury is to issue a report that considers whether changing the U.S. Bankruptcy Code “would be a superior method of resolution for financial companies” while preventing bailouts. Congress is already moving in that direction. The Financial Institution Bankruptcy Act (FIBA) passed the House earlier this month with wide bipartisan support. FIBA would amend the Bankruptcy Code to streamline chapter 11 cases of “systemically important financial institutions,” or SIFIs, while minimizing disruptions to the rest of the economy. By endorsing FIBA, Treasury could bring the administration a key legislative victory. FIBA builds upon existing Bankruptcy Code protections but would work more quickly, leave operating subsidiaries outside chapter 11, and assign bankruptcy court judges preselected by the chief justice for their expertise in financial markets. FIBA would enable a quick separation of “good” and “bad” SIFI assets through the rapid post-petition transfer of the good assets to a newly formed bridge company that is not in bankruptcy. The bridge company would be capitalized by leaving behind unsecured debt, and creditors would pursue their claims in the chapter 11 case. Prior Senate versions of these reforms also included a provision to repeal Title II, which FIBA does not. But debate over Title II should not impede the prospects for FIBA’s prompt enactment, according to the commentary.

Analysis: TBTF: Is More Capital Really the Best Way Forward?

The use of the term “too-big-to-fail” (TBTF) found its way into the lexicon of finance after the global financial crisis of 2007-09, and it continues to be redefined and argued: Which financial institutions should be so identified, and have current regulations resolved the problems of the financial crisis? According to an analysis in The Hill yesterday, the TBTF business model proved faulty, not because it was wrong to be big, global and diversified, but because the capability for seeing into these financial behemoths was missing. Regulators needed a blueprint and a plan to fix long-overdue data standards, legacy systems, risk-data aggregation issues and infrastructure problems. Without these improvements, TBTF CEOs and their regulators could not — and still cannot — see risk exposures building up in a single TBTF institution nor across multiply interconnected ones. With these improvements, TBTF institutions and their regulators will be better able to determine and monitor their risk, according to the analysis. They can then be rewarded with less capital, not more. The issue of TBTF has revolved around whether more capital (the equivalent of saving more for a rainy day) will support the systemic impact of another financial crisis. However, capital was then and is still now a measure with which to count down to failure. Even with mandates for more capital, higher-quality capital and more-liquid capital, capital will be depleted as before. More capital will buy a bit more time, but not the time needed to successfully unwind a TBTF financial institution nor even a modestly sized, globally interconnected one.

Analysis: Startups Rarely File for Bankruptcy, but Could That Change?

Plastc, a company that raised millions from crowdfunders with the promise of revolutionizing payments, has shut down. On its own, this is not notable, but this firm isn’t just ceasing operations. A notice posted to the company’s website said that it is “exploring options” to file for bankruptcy. According to an analysis in Forbes Monday, there is an increasing willingness of venture-backed companies to go through bankruptcy. Normally when startups shut down, bankruptcy is pointless for a few reasons. With young software companies, there are usually no assets to reorganize. What’s more, venture backers and founders would rather not glorify their failure with an embarrassing public auction. Lastly, bankruptcy is expensive. If the company is truly out of money, who will pay for it? “Their muscle memory is to avoid chapter 11 at all costs,” says Jeffrey L. Cohen, a partner at Lowenstein Sandler LLP. “It’s pretty taboo in the Valley to use the term ‘chapter 11.’” But bankruptcy is becoming more appealing for startups for two reasons: the increased number of asset-based lenders, and the fact that, for many, their assets have become more valuable.

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