For the Commonwealth of Puerto Rico, 2017 was a particularly stormy year. On the heels of Hurricane Irma, Hurricane Maria battered the island, causing extensive structural damage. At year-end, many of the Commonwealth’s residents were still without power and/or potable water.

Scores of U.S. military and medical personnel were deployed to deal with the territory’s immediate needs. Government officials, already under scrutiny because of decisions regarding Puerto Rico’s debt, were soon embroiled in new controversies: Why was a $300 million contract awarded to Whitefish Energy Holdings, a small Montana-based company that was deemed ill-equipped to restore electricity? Was Gov. Ricardo Rosselló Nevares’s request for $94.4 billion in federal hurricane relief realistic?

Even as the Rosselló administration voiced concerns about the Commonwealth’s weakening cash position, an offer designed to provide immediate financial relief to PREPA (Puerto Rico’s electric utility authority) and help it qualify for matching funds from FEMA (the Federal Emergency Management Agency) was rejected. The offer – from a creditors’ group that included Oppenheimer Rochester – would have given PREPA a loan of $1 billion in the form of debtor in possession notes (DIPs). In addition, creditors would have had the right to exchange up to $1 billion of existing bonds for $850 million of additional DIP notes, enabling PREPA to cancel up to $150 million of existing debt. “We sincerely believed our loan would have helped PREPA finance its recovery and rebuilding efforts as quickly as possible,” the bondholders’ financial advisor said at the time.

Before the hurricanes struck, Puerto Rico’s ongoing financial woes were already adversely affecting the Commonwealth’s debt. The leading credit rating agencies began downgrading some Puerto Rico debt in early 2014, but Puerto Rico holdings – a long-time source of highly attractive levels of tax free-income – continued to contribute favorably to the positive total returns of the Rochester funds that had held them in 2014 and 2016. In 2015, most of our funds produced positive annual total returns despite declining prices on many Puerto Rico bonds.

In 2017, Puerto Rico’s failure to meet some of its debt-service obligations again fostered price declines. As NAV pressure mounted, the funds’ Puerto Rico holdings, in aggregate, detracted from performance.

To be clear, several Puerto Rico issuers remained current in their payments during the year: PRASA (Puerto Rico’s aqueduct and sewer authority), the University of Puerto Rico, the Municipal Finance Agency, and the Children’s Trust, which is responsible for payments on the tobacco bonds backed by Puerto Rico’s share of the proceeds from the 1998 Master Settlement Agreement.

However, general obligation (G.O.) securities, which first defaulted in 2016, continued to miss their debt payments, despite a requirement in the Commonwealth’s Constitution that general fund revenues be used to pay G.O. debt service ahead of any other government expense. The legal protections for our G.O. holdings have not yet been tested before a court.

Bonds backed by the sales and use tax – known as COFINAs – made their February 1 payments, but Judge Laura Taylor Swain in May suspended COFINA debt payments in response to a motion filed in U.S. District Court by the COFINA bond trustee, pending resolution of the proper application of funds among COFINA bondholders. (In December, the COFINA trustee reported that the bonds’ debt-service account held nearly $904 million, more than the bonds’ annual debt-service obligation; this revelation, we believe, gives credence to the senior COFINA bondholders’ claim that the payments on their bonds should not have been suspended.)

Also in May, the Financial Oversight and Management Board (“Oversight Board”) established under the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”) initiated Title III proceedings for four issuers: the Commonwealth, COFINA (the Sales Tax Financing Corporation), PRHTA (Puerto Rico’s highway and transportation authority), and the Employee Retirement System; Title III proceedings under PROMESA are similar to a Chapter 9 municipal bankruptcy.1 In Title III, the unresolved issues among debtors and creditors proceed along separate tracks: mediation and litigation. Protracted litigation remains a very real possibility.

For many years, our portfolio management team has been trying to reach negotiated settlements with various Puerto Rico issuers. PREPA and its forbearing bondholders, including Oppenheimer Rochester, continued to work in 2017 to finalize a restructuring support agreement (RSA), the terms of which were agreed on in September 2015. On July 2, 2017, the Oversight Board voted against the RSA and commenced PREPA’s Title III proceeding; subsequently, the utility did not make its scheduled payments of principal and interest on July 3.

The work of the Oversight Board and Title III proceedings were temporarily halted in September while the government of Puerto Rico rightly focused on its immediate needs in the aftermath of Hurricane Maria.

Throughout the fourth quarter of 2017, the Oversight Board, the Rosselló administration, and owners of Puerto Rico debt remained at odds about the extent of the Oversight Board’s authority. One particularly contentious issue had to do with PREPA leadership. Bondholders, believing that the utility would benefit from sound professional management, advocated for an independent receiver. The Oversight Board meanwhile wanted to appoint Noel Zamot, a retired U.S. Air Force colonel, as PREPA’s chief transformation officer, but Judge Swain ruled that the Oversight Board lacked the authority to do so. PREPA’s executive director Ricardo Ramos then resigned, and the governor recommended that the PREPA board appoint Justo González, a long-time PREPA engineer, as interim director.

Representatives of the Oversight Board, the government and the bondholders also appeared at Congressional hearings during the fourth quarter. In response to one such hearing, Gov. Rosselló released a statement asserting that the Oversight Board presented “incorrect figures.”  

Bondholders, among others, have been seeking accurate figures from the government for several years. As of December 31, 2017, the government of Puerto Rico had not provided audited financial results for fiscal years 2015, 2016, or 2017.

In late December, Gov. Rosselló explained that results had not been published because the auditors “did not have access to the information and were not willing to put their signature on something that was simply something that some agency director or document told them.”

Also in late December, Puerto Rico announced that it had found an additional $5 billion deposited in more than 800 government accounts, bringing the total to nearly $6.9 billion. At one point, the government said it would run out of money by December 1; on that date, however, it reported a cash position of $1.73 billion.

While the filing of the Title III proceedings has temporary halted litigation against some Puerto Rican issuers, Aurelius Capital, an investment firm, has challenged PROMESA itself, specifically the process by which Oversight Board members were appointed. Additionally, various parties have criticized the Oversight Board’s decision to apply Title III to PREPA, the slow speed with which the Oversight Board has worked, its relationship with the government, and its inconsistent adherence to the tenets of PROMESA.

In other news, the governor swore in a seven-member Puerto Rico Statehood Commission in mid-August. The Commission will seek, among other things, that its members be seated in the U.S. Congress as the Commonwealth’s representatives. We do not believe it likely that the delegation or the push for statehood will gain significant traction in the near term.

The Oversight Board’s deadline for approving new fiscal plans has been extended into 2018 as it awaits revised reports that take into account the impact of the hurricanes. Several Puerto Rico entities had submitted their reports earlier in the year. The deadline for providing information to the Oversight Board has also been extended into the New Year.

The new plans will replace fiscal plans that were approved in Spring 2017, despite having what creditors, including Oppenheimer Rochester, believe to be several shortcomings and egregious omissions. To cite just one of the creditors’ numerous concerns, the Spring 2017 plans excluded the sizable Medicaid allocations from the federal government, even though there is no indication that these allocations will be curtailed.

The Rochester team is committed to working constructively with a range of stakeholders to maximize value on the bonds held by our funds. The situation became increasingly challenging in 2017, but our resolve to reach positive outcomes that are in the best interests of our investors remains strong.

For more on the municipal bond market and the Rochester Way, read the 2017 Annual Overview.

Follow @RochesterFunds for more news and commentary.

 
  1. ^According to PROMESA, the government of Puerto Rico must develop a new fiscal plan that includes methods to access capital markets; develop and enact budgets and legislation that conform to the fiscal plan; and deliver audited financial results in a timely fashion in order to take advantage of certain of the law’s provisions.