Benefit cuts and bondholder disappointment both expected as result of the recovery plan
A fiscal recovery plan for Puerto Rico that is scheduled to be certified April 20 by its oversight board is expected to bring pension cuts, reduced payments to bondholders and even more legal and political skirmishing that will test the board's mettle.
Taking heat from all sides are members of the federal Financial Oversight and Management Board, which was created in June 2016 under the Puerto Rico Oversight, Management and Economic Stability Act. PROMESA calls for fiscal reforms that would also improve access to capital markets after the commonwealth racked up as much as $120 billion in outstanding debt, including $50 billion or more in unfunded pension liability. Title III of PROMESA created an avenue for Puerto Rico to file for bankruptcy in May 2017 amid competing claims from bondholders, retirees, insurers and others in what is one of the largest bankruptcies in American history.
PROMESA also gave the oversight board authority to certify and enforce a fiscal plan.
This will be the oversight board's second fiscal plan. The first, certified in 2017, was derailed by two hurricanes that further harmed the commonwealth's finances.
In a final version submitted to the board on April 5, Puerto Rico Gov. Ricardo Rossello said the commonwealth and the board "have made good progress" toward consensus, and are now only $100 million apart on projected annual savings from $1.5 billion in budget cuts sought by the board.
Getting consensus on pension reform is another matter, with the governor repeatedly and publicly refusing to consider it.
Pension fund freeze
Oversight board documents call for freezing pension benefit accruals by July 1, 2019, and enrolling all government employees in defined contribution plans. Benefits would be reduced progressively to an average cut of 10%, with no cuts for participants whose combined pension and Social Security benefits are below the poverty level of $1,000 per month. Police, teachers and judges younger than 40 would be enrolled in Social Security. (Employees in those groups are not currently in the Social Security system.)
The governor's fiscal plan does not include those pension reforms, and in a letter to oversight board Chairman Jose B. Carrion III, Mr. Rossello disputed the board's authority to unilaterally reduce pension benefits, which he said are recognized property rights under Puerto Rican law.
Oversight board officials and legal experts say the bankruptcy proceeding provisions in PROMESA supersede local law, similar to situations experienced by Detroit and Stockton, Calif.
Among the many lawsuits filed against the commonwealth and the oversight board is one filed by public employees to stop the pension cuts.
Before those claims can be addressed in bankruptcy proceedings, the first step is having a fiscal plan in place to determine how much money might be available to pay debtholders and retirees. PROMESA sets certain requirements for the fiscal plan, such as funding essential services, eliminating structural deficits, improving governance, achieving fiscal targets, providing debt-sustainability analysis, respecting liens and lawful priorities, as well as adequate funding of public pensions.
Puerto Rico's main retirement fund for government employees, the Employees Retirement System, Hato Rey, covers 245,000 participants. It ran out of assets in July 2017 and has been paying benefits out of commonwealth revenues and asset sales. The pension fund also had $3 billion in pension bonds outstanding as of December 2017. The Teachers Retirement System, with 80,000 participants, and Judicial Retirement System with 840 participants, are close to insolvent as well. Together, the three pension funds have combined liabilities of $55 billion and a combined funded ratio of 8%.
U.S. House Natural Resources Committee Chairman Rob Bishop, R-Utah, who oversaw passage of PROMESA and retains oversight authority of the fiscal recovery process, wants the board to be more aggressive about striking a fiscal plan and begin making PROMESA-mandated structural reforms. Those must "provide adequate funding for public pension systems," he told Mr. Carrion in a letter.
Mr. Bishop also expressed frustration with the oversight board's "inability and unwillingness to reach consensual restructuring agreements with holders of Puerto Rico's debt," and warned of budget reductions for Puerto Rico if the government interferes with the oversight board's role as the sole representative of the commonwealth's debtors.
His committee will hold a hearing later this year to measure progress made by the commonwealth and the board.
An independent investigator retained by the oversight board to look into factors behind Puerto Rico's debt crisis also plans to issue a final report this summer. The Miami-based investigative team from law firm Kobre & Kim LLP, which specializes in disputes and investigations, has talked with more than 100 people involved in the issuance of debt securities in Puerto Rico over the past 20 years, including issuers, underwriters, advisers, rating agencies and other stakeholders, to understand management and bond issuance practices of public corporations and the pension system. Rather than finger-pointing, the report is aimed at restoring Puerto Rico's access to the capital markets and restructuring its finances to avoid another financial crisis.
Once finalized, the fiscal plan will be used to work out restructuring deals with bondholders, although the board might be forced to go to court to have it enforced if the governor declines to cooperate. In that case, the law requires commonwealth officials to explain to the U.S. Congress and the White House why they are not enforcing deals.
Without a fiscal plan and a budget for implementing it, the oversight board has exclusive authority to work on a debt adjustment plan. With that plan, all debt could be subject to an embargo, legal experts said. The board is focusing on a fiscal plan first.
For now, all eyes are on April 20, when the oversight board certifies a fiscal plan. "That's when the fireworks will start," said federal litigation expert John Mudd, of the Law Offices of John E. Mudd, San Juan.
"It's clear to everybody that whatever is written in the fiscal plan, good or bad, the board has control. It's just a matter of delaying the inevitable."