A better-than-expected result from Puerto Rico's
highway concession and strong performance of the novel contingent value instruments, or CVIs, issued under the
commonwealth plan of adjustment in March 2022, are raising investor confidence that Puerto Rico can regain market access - a key goal of the PROMESA law and a condition to end the PROMESA oversight board’s supervision of island finances, according to market sources.
The sources caution that Puerto Rico’s market access still depends on a successful restructuring of the more than $8 billion debt of the Puerto Rico Electric Power Authority, or PREPA. The
confirmation process for the oversight board’s contested plan of adjustment will extend into next year and is expected to be subject to legal appeals by creditors who oppose the plan. A hearing to consider approval of the
disclosure statement for the oversight board’s latest plan of adjustment for PREPA is scheduled for Tuesday, Nov. 14.
The financial close of the $2.85 billion Puerto Rico Highway and Transportation Authority, or HTA, public-private partnership with Spain-based Abertis Infraestructuras SA is expected as soon as December, and the commonwealth is expected to move forward with a redemption of $1.245 billion of restructured HTA bonds issued under the
HTA plan of adjustment, which took effect in December 2022. One source said they expect the redemption notification process to take place in December, and another source says the P3 transaction’s close could extend into the first quarter of 2024 or beyond, given the complexity of the deal.
Puerto Rico Fiscal Agency and Financial Advisory Authority, or AAFAF, Executive Director Omar Marrero told Reorg today that the HTA bond redemption would not require a tender offer process. Upon the financial closing of the transaction, HTA would deposit sufficient funds with the trustee to redeem the bonds on the redemption date. The date will depend on when the toll road P3 closes and requires a 30-day conditional redemption notice, Marrero added.
The HTA’s $600 million 5% Series 2022A restructured toll revenue bond due 2062 most recently traded in size on Nov 2 at 98.75 to yield 5.074%, up from the issue price of 93.9 to yield 5.3% in December 2022, according to secondary trading data on
EMMA. The call provisions provide for pay par plus accrued interest and include no redemption premiums. Nevertheless, the concession agreement comes within one year after HTA issued $1.2 billion of new bonds.
“This follow through on HTA, and earlier than people had anticipated, gives the market confidence that it can trust the island,” said one trader. “The market wants more of these kinds of opportunities and follow through.”
Market sources agree that the P3 transaction was announced sooner than expected and provided a larger-than-expected payout, which is bolstering market confidence regarding Puerto Rico’s ability to deliver on market opportunities. In calling the P3 transaction a “big win” for the commonwealth, the oversight board
noted that the agreement provided “considerably more” cash than the minimum that Puerto Rico had required to close the transaction and would provide proceeds to not only defease HTA bonds but also repay a plan-related $362 million loan from the commonwealth and provide an additional $1.1 billion for HTA, which the oversight board said should be used to support road maintenance and other long-term transportation projects and transactions.
Meanwhile, the CVIs issued under the
commonwealth plan of adjustment, with an aggregate original notional amount of $3.5 billion of GO CVIs and an aggregate original notional amount of $5.2 billion of clawback CVIs, have been delivering outperformance distributions to holders during the past two years; the most recent annual payment occurred on Nov. 1, with $211.8 million going to GO CVI holders and $176.9 million to clawback CVI holders. The CVIs use the 5.5% portion of Puerto Rico sales-and-use tax and rum excise tax collections as the the metrics to determine the annual payments to GO and clawback CVI holders, which are premised upon sharing of any outperformance between the creditors and the commonwealth.
After the distributions, there is $3.107 billion outstanding on the GO CVIs, which have a maturity date of July 1, 2043, and a final redemption date of Nov. 1, 2043, and $4.88 billion outstanding on clawback CVIs, which have a maturity date of July 1, 2051, and a final redemption payment date of Nov. 1, 2051.
Given the strong performance, CVI holders and some investment banks have been discussing the potential for a CVI tender offer, which would be well received by the market and could provide the commonwealth with some future debt service savings, according to three sources familiar with the matter. The transaction would be especially compelling for the market, because the commonwealth is “flush” with cash and the fiscal plan on which the CVI outperformance is based “grossly” underestimates the tax revenue, one of the sources added.
However, in a statement to Reorg, AAFAF said it is not actively working on a transaction currently, citing market conditions. “In our role as fiscal agent and financial advisor to the Government of Puerto Rico, its agencies, municipalities and public corporations, we are continuously monitoring market conditions and evaluating debt optimization strategies and opportunities that may result in debt service savings. However, given current market conditions, at this time we are not actively working on any specific transaction,” according to the statement. AAFAF
held meetings with credit ratings agencies last month; officials said this is part of a long-term effort to attain an investment-grade credit rating.
Two of the sources familiar with the matter pointed to several obstacles to any potential CVI tender transaction, including current market conditions. The sources said that the oversight board would have to approve any such transaction and that it is not clear what funding the commonwealth would use to finance the transaction. One of the sources also said that CVI holders would also have to want to sell the securities for the transaction to be successful.
Because of the novel nature of the CVI debt, the distributions have been taxable, according to market sources, and it is not clear whether the securities would qualify for tax-exempt status, given the need to get an Internal Revenue Service ruling.
Marrero told Reorg today that the commonwealth has not requested an IRS ruling on the tax-exempt nature of the CVI instruments, but Puerto Rico finance officials
have said that the commonwealth will take the position with the IRS that the CVIs should be tax exempt both locally and on the federal level because there is no exception to the inclusion of a tax-exempt status as a result of issuing a security on a contingent basis. They acknowledged the determination is “complex” and would likely set a precedent on the use of CVIs elsewhere. An initial
issue is to get CVIs recognized as debt, according to the oversight board. One of the sources familiar with the matter said that some of the market figures pushing for a potential CVI tender transaction believe the securities could get tax-exempt status because the outperformance distributions are so likely to happen, given the underestimation of the baseline performance targets.
During a May
investment conference, investment bank executives highlighted the potential of CVIs, saying that because they are likely undervalued, the CVIs could represent the most attractive part of the commonwealth's capital structure. Given their “equity like” features, CVIs will probably be more favored by hedge funds than traditional municipal investors, and achieving the CVI's tax-exempt status would improve their potential, according to the executives.
The commonwealth’s $708.8 million Series 2022A-1 general obligation restructured bonds due 2046 traded on $1.1 million in volume on Nov. 8 at 76.9 to yield 5.85%, which was 171 bps above the benchmark scale and firmer than yields on Nov. 7 at 5.95%, said a trader.
The Puerto Rico Sales Tax Financing Corp., or COFINA, has also rallied since the Oct. 17 announcement. Its $3.5 billion 5% Series 2018A-1 restructured bonds due 2058 traded at 93 to yield 5.5% to 5.49%, up from 5.58% to 5.56% on Wednesday, which is 122 bps above the benchmark AAA MMD, according to a trader. That’s tighter than the 190 bps spread earlier in May when the island hosted a conference for investors in New York City,
as reported, and up from 89 to yield 5.73% in institutional-size trading on Oct 16, according to
EMMA.