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COFINA acceleration option exposes inter-creditor divisions
By Andrew Scurria and Xavira Neggers Crescioni
April 5, 2016
Senior Puerto Rico Sales Tax Financing Corp. (COFINA) bondholders have a
nuclear option to boost their leverage if negotiations with the commonwealth break
down, according to three sources close to the matter, a source familiar and two
municipal traders.
The ad hoc group of senior COFINA bondholders takes the position that they can
accelerate their claims against COFINA, or declare their debts immediately due and
payable, according to the three sources close.
Acceleration has multiple consequences that favor creditors holding the senior tranche
of COFINAs USD 17.4bn debt stack, said the sources close and the additional source
familiar. It lets creditors holding senior, long-dated capital appreciation bonds (CABs)
jump the repayment line ahead of junior bonds with shorter maturities, while cutting off
coupons that would otherwise flow to subordinated current interest bonds (CIBs).
Because acceleration reroutes all COFINA-pledged sales-and-use tax (SUT) revenues
toward retiring senior debt, subordinated bondholders like Franklin Investments and
OppenheimerFunds have every reason to dispute a claim of default, said the first and
second sources close. A spokesperson for Franklin and Oppenheimer declined comment.
What acceleration does is it pushes the subordinated bondholders to the back of the
line until all of the senior debt is paid, said the first source close.
Is there a default?
That would require a colorable default at the credit, and the question of whether default
has occurred could wind up in court, said the second source close. Although COFINA
has never missed a debt service requirement, an 8 February letter from individual
COFINA bondholder Jose F. Rodriguez Perello alleged a default based on the
commonwealths alleged failure to respect COFINAs legal separateness in its debt
restructuring process.
COFINA denied the allegation, but the question of whether the credit is in default may
depend on subsequent events. Senior bondholders case for acceleration would be
stronger if the commonwealth enacts a debt moratorium, according to an additional
source familiar with the matter.
That seems increasing likely with the Government Development Bank for Puerto
Rico now in crisis. The moratorium legislation passed by the Puerto Rico Senate last
night defines COFINA as a government entity eligible for the laws emergency
provisions the same category as 18 other issuers including the commonwealth itself.
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Once the CABs are accelerated, COFINA holders basically own the government of
Puerto Rico, the source familiar said. The people who wrote the COFINA proposal
knew what they were doing and this is their goal to accelerate COFINA and make a lot
of money.
The ad hoc group of senior COFINA bondholders is one of two creditor groups to have
publicly released a restructuring offer to the commonwealth. The proposal is premised
on acceleration coupled with a forbearance that would delay repayment on subordinated
bonds.
They are playing nice with the government because their ultimate goal is default and
acceleration. Its like a person luring a puppy into the wolfs cave, said the source
familiar.
There will be a stronger case for default if general-obligation bondholders sue the
commonwealth to make a grab for SUT revenues and Puerto Rico does not rise to
COFINAs defense, added a municipal trader following the matter.
The voting threshold that senior bondholders need to declare a default against COFINA
rests on the governing bond resolution. There is a contractual restriction that requires
support from creditors holding 25% of all outstanding COFINA bonds to direct the
exercise of remedies, but there is doubt as to whether this provision applies in a default
scenario or if, alternately, only 50% of senior bondholders are needed to impose a
restructuring transaction
Senior CABs would accelerate at their compounded amount as of the acceleration date,
including accreted interest, according to the governing COFINA bond resolution. Senior
CIBs would accelerate in their principal amounts.
Principal on senior lien CIBs plus accreted value on senior lien CABs totaled
approximately USD 7.4bn as of 1 February 2016, according to Debtwire
Municipals calculations. Total senior lien debt at issuance was USD 6.6bn and the
amount at full maturity would be USD 21bn.
The CABs in COFINAs debt stack are concentrated in the senior tranche, as reported.
Senior CABs with different maturities would be paid on a pro rata basis following
acceleration, said the first two sources close. Subordinated creditors have no
acceleration rights until senior bondholders are paid in full, as reported.
The monoline variable
Insurers Ambac Assurance and National Public Finance Guarantee each have
voting power in any workout due to their sizable exposure to the senior COFINA
tranche, and those wrapped CABs cannot be accelerated without the consent of each
monoline, according to the bond resolution.

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Assured Guaranty also has exposure, but to junior CIBs. There is a school of thought
that the insurers would benefit from acceleration, according to the first and third
sources close, insofar as it would mean that their exposure would be retired ahead of the
scheduled debt service schedule.
But that assumes that the pledged SUT keeps flowing to COFINA to pay down those
bonds, when what the commonwealth wants is to divert the SUT for other uses, said a
second trader following the matter. If there is an acceleration and the pledged SUTs are
removed for any reason, the insurers would be left on the hook for the accelerated
amounts, the second trader said.
If you have an obligation thats due in 40 years its a lot easier to manage or to mitigate
through buybacks and commutations, the second trader said. That would mean that
they dont have to have that money for 40 years.
National declined comment. Ambac did not respond to a request for comment.
The upshot for Puerto Rico
Intercreditor issues aside, there is the question of what becomes of the SUT following
acceleration. Bondholders only have a lien on the portion of the SUT that COFINA
collects. The Puerto Rico general fund collects half the 5.5% SUT with COFINA
collecting the other half. COFINA bondholders, in turn, have collateral rights over the
greater of 2.75% of the SUT, or the so-called pledged base tax amount (PBTA), an
annual sum laid out in statute that corresponds to annual debt service.
Since the PBTA is what is currently being collected, there is no pledged excess and
therefore no immediate impact on the commonwealths general fund from
acceleration, said the first source close. Its still going to get the pledged base tax
amount that it always gets.
The FY17 PBTA is USD 712m and eventually tops out at USD 1.85bn, according to the
governing statute. COFINA debt service ramps up over time, but not for more than two
decades in an acceleration scenario would bondholders be collecting more than the
PBTA, said the second source close. The PBTA increases by 4% annually to track debt
service needs.
The benchmark USD 900m tranche of uninsured Series 2009A first subordinate CIBs
maturing in 2042 priced yesterday (4 April) in round lots at 44.15 to yield 14.092,
according to Electronic Municipal Market Access.

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