An Open Letter About Treasury's Proposal for Puerto Rico from Dominic Frederico

December 11, 2015

Counselor Antonio Weiss
US Treasury Department

Dear Mr. Weiss,

I read with great disappointment your remarks on December 9 at the Peterson Institute attempting to justify the US Treasury’s insistence that the way to assist Puerto Rico is to dramatically and retroactively alter the rule of law and impose a potentially unconstitutional federal restructuring regime for the entirety of the Commonwealth of Puerto Rico’s debt.  Rather than encourage the island’s government to make a good-faith effort to curb expenses and corruption and work with creditors on a long-term solution benefiting the people of Puerto Rico, your comments represent the latest attempt to unnecessarily politicize the issue with the specter of a Congressional bailout funded by the U.S. taxpayer.

When you incorrectly state that a federally legislated restructuring regime would cost taxpayers “nothing,” you are conveniently ignoring the impact on holders of $70+ billion of Puerto Rico municipal debt who will be unlawfully and materially damaged through a failure by Puerto Rico to put its obligations above its short term political motivations.  These holders of debt are US taxpayers including individual “mom and pop” retail investors who likely outnumber (and include members of) the population of Puerto Rico, mutual funds, pension funds, corporations, insurance companies, and more.

The Treasury and some Puerto Rico officials advocate a retroactive change in the law that, if enacted, would allow an unprecedented bankruptcy regime.  Had Puerto Rico been eligible to file under Chapter 9 at the time these bonds were issued, investors would have priced that risk into the bonds, and Puerto Rico would have had to pay higher interest rates.  Instead, at issuance, Puerto Rico issuers enjoyed broader distribution, possibly greater proceeds and the immediate benefit of a lower cost of funds.  There is no justification for initiatives that would retroactively undermine the Puerto Rican Constitution and the legal rights and remedies that were the basis on which bondholders agreed to provide financing for the island’s development.

While there are many statements in your speech that merit correction, I want to focus on your attempt to use the “cautionary tale” of the PREPA restructuring talks as evidence that a federally legislated restructuring regime is an essential step toward Puerto Rico’s financial stability.  I strongly disagree with both your characterization of the negotiations and your suggestion that the PREPA experience suggests that bankruptcy would help Puerto Rico.  The true tale is rather one of politics overriding the moral responsibility of government representatives to respect their obligations, the long term best interests of their citizens, and the rule of law.

First, your statement implies support for the Puerto Rico government’s rhetoric that the failure to reach a consensual restructuring rests upon the creditor group.  For anyone to say that bankruptcy is needed to bring creditors to the table simply does not reflect reality.  PREPA’s monoline insurance creditors and an ad-hoc group of bondholders have been negotiating with PREPA in good faith since 2014.  After numerous creditor proposals to PREPA offering at varying times liquidity funding, refinancing capacity, new capital for modernization, technical expertise and concessions on existing debt terms, in September of this year the ad-hoc bondholders reached agreement with PREPA on a consensual solution for their debt.  By November 25, 2015, negotiations with the two primary monolines also resulted in a framework business agreement approved by officials and advisors of PREPA and the Government Development Bank of Puerto Rico (“GDB”) with regular updates to, and input from, members of the PREPA board of directors.  The agreement included commitments for additional financing from monoline creditors, increasing PREPA’s liquidity and putting it on a path towards modernization and efficiency.

This agreement was reached despite PREPA’s willful refusal to meet its legal obligations and bond covenants, and the Puerto Rico Energy Commission’s refusal to fulfill its responsibilities under law to review PREPA’s electricity rates and expenses. Moreover, it was reached in an environment of dramatically falling oil prices which provided a windfall of opportunity to PREPA, setting the stage for it to meet absolutely all of its obligations without the need for the significant concessions consensually agreed to by monolines and other creditors.

Notwithstanding that together the parties  secured a favorable framework agreement for PREPA (that could have been a template for resolving many other credits), during the December 1, 2015 Judiciary Committee hearing, PREPA and the Commonwealth of Puerto Rico declined to acknowledge this concrete progress when speaking publicly and appearing before Congress.  Now, in your recent remarks, it seems that the US Treasury is promoting this Commonwealth storyline, arguing that bankruptcy will be better for Puerto Rico than allowing the parties to resolve these matters contractually, on a negotiated and consensual basis.  As a direct result, we believe, of these sustained hopes for bankruptcy in Puerto Rico, PREPA and GDB representatives have since re-opened negotiation on what they had previously labeled as a “Final” term sheet agreement.

To embrace the Commonwealth’s narrative suggests an irrational preference for harming creditors at the expense of the welfare of Puerto Rico and a long-term solution to bolster the island’s economy to the benefit of its people.  Creditors, we might add, most of which have been partners with Puerto Rico for many decades, helping the island to build its roads, airports, hospitals, schools and other infrastructure.

It takes two to consent and two to be constructive.  I agree wholeheartedly with a number of  recent statements by people familiar with the negotiations that the key issues here are willingness more than inability to meet obligations, and perhaps more importantly, a crisis of credibility with Puerto Rico leaders and representatives.  The task of municipal leaders in distressed fiscal situations throughout this country’s history has been to operate efficiently and responsibly, and to figure out how to best meet as many of their obligations as possible.  Here this task has been converted into one aimed at how to meet as few contractual obligations as possible.  This is against a backdrop of third party advisors and representatives, primarily bankruptcy professionals, who will continue billing Puerto Rico’s government to the tune of tens of millions of dollars in fees as any crisis is prolonged.

Not only is PREPA not a cautionary tale, but the real cautionary truth is that Chapter 9 is messy, expensive and unpredictable.  Detroit’s bankruptcy cost the city roughly $180 million in bankruptcy professionals’ fees to achieve a restructuring result that could very well have been averted using traditional tools of distressed fiscal management and municipal finance.

Even in the case of a Chapter 9 restructuring of PREPA, experts already know that there are two very critical hurdles that would have to be litigated if the Commonwealth attempts to impose creditor haircuts.  First, PREPA should not meet the insolvency test that will allow it to declare bankruptcy, as historically low oil prices and a refusal to appropriately set electricity rates and government employment levels show a clear unwillingness rather than inability to pay creditors.  Second, PREPA bonds will receive revenue bond treatment under Chapter 9, which provides preferential rights for creditors under the law.

Beyond the PREPA agreements, Assured Guaranty has remained committed and supportive as we continue to discuss and negotiate broader island wide solutions as well.  However, as circumstances continue to change and the Commonwealth and its bankruptcy advisors choose swords over pens, consensual deals with the current Commonwealth administration become fragile.

As you and your staff are aware, Assured Guaranty has been constructively negotiating in good faith with PREPA management, the Commonwealth and the GDB for over 18 months.  On July 1st of this year, we and other creditors consensually provided a new bridge financing to help enhance PREPA’s liquidity. On November 30th, Assured Guaranty and another creditor also offered additional bridge financing to help the GDB with its liquidity for debt service obligations.  Government officials chose to reject our offer and instead institute unnecessary and potentially illegal “clawbacks” of bonded revenues in contradiction to the priorities of its own Constitution. The next day they pushed forward with a crisis narrative before Senate hearings in order to hold political sway in Washington, relaying again that they needed help getting creditors to the table. To portray any creditors as “unyielding” in order to help the Puerto Rico Governor gain support for a destructive super Chapter 9 tool is inaccurate and counterproductive.

Furthermore, it is unreasonable to label as a “myth” the need for the federal government and other stakeholders to receive accurate, transparent and legally required financial information from Puerto Rico before determining whether its debt is sustainable and making a retroactive change to the rule of law.  In his December 1 Congressional testimony, the governor asserted that the Puerto Rico government has a history “to hide information to the market so they were able to have more access to the market.”

Such unconscionable behavior goes hand in hand with the widespread corruption described in a report of the Puerto Rico Civil Rights Commission released in July. This report enumerates many problems that are both serious and widespread.  For example, it asserts that almost half the money collected by merchants for the sales and use tax is not remitted to the Department of Treasury of Puerto Rico. Additionally, more than 200,000 water consumers do not pay for it. This is obviously one reason that the Puerto Rico Aqueduct and Sewer Authority estimated in its August 2015 Preliminary Official Statement that almost 60% of the water it produces provides no revenue.

The Commonwealth government cannot wash its hands of this history by blaming it on prior administrations, because the problems still exist today and the current administration itself has serious credibility problems.  On December 2, 2015 the FBI issued a release stating ten Puerto Rico businessmen and government officials have been indicted for their alleged participation in several schemes to corruptly give things of value to public officials within the government of the Commonwealth of Puerto Rico in exchange for favorable treatment and awarding of government contracts to various corporations.

Similarly, it is no “myth” that the broader U.S. municipal market would react negatively to Congress permitting a wholesale abrogation of contracts, many of which are constitutionally protected, or that decades of municipal investors concerned about “changing the rules in the middle of the game” were sufficiently put on “notice” because one limited 2014 bond offering, sold to non-traditional investors, stated so.  Such congressional action would alarm not only the market for Puerto Rico debt but the entire municipal bond market.  Investors would no longer be able to trust constitutionally protected promises to pay debt, and the cost of borrowing for states would almost certainly increase because it would no longer be certain that they could never declare bankruptcy. Some states might demand the same rights to impair obligations that are proposed for Puerto Rico, further harming the other states that have taken responsible steps to manage their fiscal affairs.

Access to finance in the capital markets is the lifeblood of thousands of debt issuing municipalities and authorities around the nation.  Assured Guaranty’s business is to help these entities raise capital at the lowest cost possible, and we routinely work with them in constructive ways when times are difficult. Look no further than some cities and communities in Michigan, Illinois or California to understand how precarious the situation can be, and how sensitive the mainland municipal landscape could be to irresponsible actions in Puerto Rico.

Instead of advocating for a destructive option for Puerto Rico, Treasury should work with Congress to find ways to help the Commonwealth regain credibility in the market to set the island on a long-term path to economic growth.  Puerto Rico must be discouraged from failing to consummate negotiations in the vain hope that a Congressional bailout will provide the island with a simple tool to cram down losses on investors, including many “main street” investors that have pledged a long-term investment in Puerto Rico and the future of its people.

In summary, the destruction that could be caused by your misdirected efforts, could forever impact the financing capabilities and the financial stability of Puerto Rico, its citizens and potentially the $3 trillion municipal market.  By ignoring legal rights, by not recognizing what full faith and credit means, by acting without sufficient facts, and in light of the current accusations of widespread corruption, by allowing willingness to pay to outweigh ability or responsibility to pay, by wrongly using political power to eradicate a sovereign constitution and by harming US residents who would be negatively impacted by such a betrayal of faith and law, you will do more harm to Puerto Rico and its people than any other actions imaginable.

Yours truly,

Dominic J. Frederico
President and Chief Executive Officer

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