Introduction

Puerto Rico's public debts, which totaled just over $70 billion when the Puerto Rico Oversight, Management, and Economic Stability Act (P.L. 114-187; PROMESA) became law on June 30, 2016, are now in the midst of one of the largest restructurings of public debt in U.S. history. Puerto Rico's fiscal troubles fell under national scrutiny during summer 2013, after the City of Detroit's bankruptcy filing reminded investors that municipal bonds are not risk free, and after the financial press noted the precarious state of Puerto Rico's public finances.¹ The City of Detroit, by way of comparison, had about $18 billion in debt when it entered bankruptcy in 2013.² Puerto Rico's public debts, which in 2016 totaled over $70 billion before including unfunded pension liabilities, were about four times larger than that sum. Puerto Rico could also become one of the most expensive restructurings ever, with professional fees that might exceed $1.4 billion.³

PROMESA, among other provisions, created two paths for debt restructuring: one that draws on the Bankruptcy Code and another that is similar to some sovereign debt procedures. It also established a Financial Oversight and Management Board (FOMB; Oversight Board) and empowered it to represent the Puerto Rican government in those debt restructuring processes. Those processes have included extensive litigation and negotiations with the Puerto Rican government, hedge funds, bond insurers, and other creditors. The restructuring of Puerto Rico's public debts, some contend, could inform future federal responses to fiscal strains faced by some state and local governments.⁴

Disputes over the relative priority of general obligation (GO) debt claims and claims of sales-and-use-tax-backed debt were a central point of contention in the debt restructuring process. The Oversight Board decided to first restructure the sales-tax-backed bonds—known as COFINA bonds after their Spanish acronym.⁵ After delays due to gubernatorial turnover in January 2017 and the destruction caused by Hurricanes Irma and María in September 2017, in August 2018 the Oversight Board reached an agreement with COFINA bondholders on a split of sales tax revenues between COFINA debt service and Puerto Rico's central government, the Commonwealth of Puerto Rico (CPR). On February 4, 2019, a federal district court judge confirmed a plan based on that agreement, clearing the way to a restructuring of Puerto Rico's COFINA debt. At that time, COFINA bonds represented nearly one-quarter of the island's outstanding public debt.⁶ Bonds with a par value of $17.6 billion were then exchanged for $12 billion in new bonds.⁷

On February 23, 2021, the Oversight Board pivoted toward restructuring the island's GO bonds and certain other central government debts by announcing an agreement with "certain bondholders" on a revised restructuring plan.⁸ The Board filed a disclosure statement describing the amended plan of adjustment with the Title III court on March 8, 2021.⁹ After a series of hearings on the adequacy of plan disclosures in July 2021,¹⁰ on August 2, 2021, the Title III court approved a disclosure statement and scheduled hearings on confirmation of the plan.¹¹

As 2021 progressed, several key creditor groups came to support the plan once modifications had been agreed to in negotiations. Compromises with the Commonwealth government and legislature led to enactment of legislation to enable issuance of new debt securities and some changes in public pensions.¹² On January 18, 2022, the Title III court confirmed the plan of adjustment to restructure debts of the Commonwealth of Puerto Rico and certain closely linked public authorities, as well as modified pension plans for teachers, public employees, and judges.¹³ The confirmation resolves various legal disputes, albeit subject to appeals. That plan of adjustment was consummated on March 15, 2022.¹⁴ A later section of this report discusses events that led to the confirmation order in more detail.

PROMESA conditions the Oversight Board's termination on Puerto Rico's ability to access "short-term and long-term credit markets at reasonable interest rates."¹⁵ Finishing the restructuring of the island's debts into a fiscally sustainable form is a likely prerequisite to that access.

This report outlines the accumulation of Puerto Rico's debt and the restructuring of the island's public debt through processes established by PROMESA. Acute fiscal crises in 2006-2007 and 2013-2016 resulted in debt levels that could neither be sustained nor addressed through the Bankruptcy Code, which led to PROMESA's enactment.

This report focuses on the largest portions of the island's public debt. For brevity's sake, it omits discussion of pensions and the restructuring of public corporations, such as the Puerto Rico Electric Power Authority (PREPA)¹⁶, the Highways and Transportation Authority (HTA), and smaller entities. Also, the Puerto Rico Aqueduct and Sewer Authority's (PRASA's) somewhat stronger financial position has enabled it to avoid the need to seek a restructuring of its bonds.¹⁷

The report's Appendices include a summary of the structure of Puerto Rico's pre-restructuring public debts, an analysis of the evolution of prices and trading volumes of selected bonds during the restructuring process, a chronology of selected events, and a glossary of abbreviations in English and Spanish.

The Long Build-Up to Puerto Rico's Debt Crisis

Over the past few decades, Puerto Rico's government has struggled to collect sufficient revenues to cover outlays, which led to rising public debt levels and growing unfunded pension liabilities.¹⁸

Postwar Development Strategy Made Puerto Rico a Model

From the onset of World War II in 1939 until the 1973 energy crisis, Puerto Rico had been put forth as a model for economic development through industrialization supported by generous tax incentives.¹⁹ That energy crisis, along with broader changes in the global economy including heightened trade competition from middle-income countries, brought Puerto Rico's postwar era of rapid economic progress to an end.²⁰

During the 20^th century, Puerto Rico closed much of the gap with the mainland in per capita income, literacy, and health status.²¹ Nonetheless, by the 1970s Puerto Rico was still far poorer, in terms of median household income, than the poorest mainland state. Since then, that income gap has narrowed more slowly.²² Despite the economic slowdown in the 1970s, public debt levels remained nearly steady before increasing in the mid-1980s, as shown in Figure 1. By 2014, the island's public debt reached a level roughly equivalent to its gross national product (GNP).²³

Figure 1. Puerto Rico's Public Debt, 1960-2017 In billions of constant (FY2017) dollars

Source: Statistical Appendix (Apéndice Estadístico), various years; available at https://web.archive.org/web/20160831062749/http://www.jp.gobierno.pr/Portal_JP/Default.aspx?tabid=184. Notes: Data represent gross public debt of Puerto Rico as of June 30 of each year, provided by the Government Development Bank of Puerto Rico. Figures for 1989 and 2014 were preliminary estimates. HTA and the University of Puerto Rico are included in the Commonwealth Government subtotal. The U.S. GDP price index is used to adjust levels for inflation. Recent Apéndices Estadístico omit debt data.

Public corporations, which provide electricity, water, transportation, and other publicly provided services, accounted for much of that accumulation of debt. Puerto Rico's central government, whose budgets were considered separate from its public corporations, kept revenues and outlays roughly in balance until 2000, when outlays began to consistently outpace revenues.²⁴

The 2006 Budgetary Crisis

In 2006, the Puerto Rican legislature and then-Governor Aníbal Acevedo Vilá reached an impasse on a budget and how to address looming fiscal challenges. By late 2006, after credit rating agencies downgraded the island's GO bonds nearly to junk status, island officials and their financial advisors soon came to view bonds backed by sales tax revenues as one way to manage fiscal challenges.

Tax-Backed COFINA Bonds Provided Stop-Gap Financing

Seeking to pay off old debts incurred without a clear means of repayment, the island's legislature and governor enacted measures in the second half of 2006 that set up a securitization of a new 5.5% sales and use tax, which replaced an excise tax.²⁵ The tax-backed bonds were able to obtain a high credit rating, and thus could be issued with a lower yield, reducing debt service costs to the Puerto Rican government.

COFINA was established as a public corporation controlled by the Government Development Bank (GDB) to issue bonds backed by half of the proceeds of the new tax, which were divided between senior bonds carrying stronger investor protections and junior (subordinate) bonds. COFINA provided funds to the Puerto Rican government and helped service its debts, but its proceeds were not tied to infrastructure projects. Instead, funds covered past debts and continuing operating budget deficits—a process termed "scoop and toss."²⁶ The legal status of COFINA and its relation to fiscal provisions in the Puerto Rican Constitution later became a central point of contention in debt restructuring litigation and negotiations, as subsequent sections will discuss.

As the Great Recession of 2007-2009 strained Puerto Rico's economy and public finances, more COFINA bonds were issued. Those bonds were viewed as a more favorable financing option because they carried better credit ratings than CPR GO debt and thus could be issued with a lower yield. The last COFINA bonds were issued in 2011.²⁷ From 2009 through 2011, former Oversight Board member Carlos García held senior posts in GDB, including serving as its president. From 2001 through 2006, García worked at Banco Santander, which helped place Puerto Rico's pension bonds and which accumulated large holdings of COFINA bonds.²⁸

Experiences with Pension Obligation Bonds

The Great Recession and ongoing budgetary pressures also affected Puerto Rico's three public pension systems, which had been severely underfunded. Unfunded obligations of Puerto Rico's public pension systems were estimated at over $40 billion in 2016. Many beneficiaries of Puerto Rico's public pensions were ineligible for the federal Social Security program, leaving them dependent on systems with few remaining assets and uncertain financial prospects.

In 2006, Merrill Lynch advisors suggested that the Puerto Rico Employee Retirement System (ERS) and Merrill Lynch issue at least $7 billion in pension obligation bonds (POBs). Merrill Lynch was unable to place those bonds with investors because the bonds were ineligible for a federal tax exemption.

Other jurisdictions have issued POBs in the hope that returns on investments funded by bond proceeds would cover principal and interest payments plus the forgone investment earnings that could have been made using contributions pledged to back the bonds—an approach known as an arbitrage strategy.²⁹ That strategy might conceivably reduce unfunded pension liabilities were investment yields sufficiently high, if fees and other costs were low, and if bond proceeds were not diverted to cover other liabilities. Low yields or losses would expand pension liabilities.

In 2008, UBS (Union Bank of Switzerland)—which had also advised island officials on the structure of the bonds—underwrote three rounds of POBs. UBS's own proprietary funds—largely closed-end mutual funds marketed to Puerto Rico residents—bought 41% of the first POB issue, 89% of the second issue, and 38% of the third. Santander and Banco Popular, two of the largest banks in Puerto Rico, apparently bought nearly all of the remaining bonds in the second issue.³⁰

The Puerto Rico POBs incurred substantial losses and raised serious questions regarding the judgement of ERS board members, the island government's financial advisors, and investment banks involved in implementing the bond sales. A 2010 analysis of the ERS POBs' issuance by financial analysis firm Conway MacKenzie was sharply critical of responsible officials.³¹ The underlying bonds' poor performance and the use of leverage resulted in substantial losses for retail investors who held those UBS mutual funds.³² A Puerto Rico subsidiary of UBS agreed to pay $34 million to settle claims regarding marketing of its closed-end bond funds with the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) in September 2015. One UBS financial advisor pleaded guilty to criminal fraud charges in November 2018.³³

2013-2015: Fiscal Pressures Intensify

The island's fiscal condition began to raise widespread concerns in financial markets and among policymakers in mid-2013, after Detroit filed for municipal bankruptcy and a business magazine criticized Puerto Rico's fiscal condition.⁴¹ Then-Governor Alejandro García Padilla, who was inaugurated in January 2013, hired a team of debt restructuring advisors in early 2014.⁴²

Ratings on the island's public debt—which had reached a level roughly equivalent to the island's gross national product (GNP)⁴³—were downgraded in February 2014.⁴⁴ Following enactment of a local bankruptcy law, another round of downgrades put several of the debt ratings for the island's public corporations below investment grade. Ratings for COFINA and GO bonds were also downgraded.⁴⁵ The downgrades and the state of Puerto Rico's public finances ended the island's access to capital markets.⁴⁶

Last GO Bonds Sold Directly to Hedge Funds in March 2014

Lacking access to normal channels of municipal finance, the island's government issued $3.5 billion in GO bonds to a syndicate of hedge funds⁴⁷ in March 2014—a month after the credit ratings on the island's GO bonds had been downgraded to junk status.⁴⁸ The bonds carried an 8.6% yield, well above usual rates in the municipal finance market.⁴⁹ The 2014 GO bonds were issued with a provision that New York State law would govern disputes, then viewed as a significant investor protection. Moreover, the Puerto Rico Constitution sets debt service as a top priority, before other public outlays.

About $900 million of the bond proceeds went to pay off bank loans, including to banks involved in underwriting the issue.⁵⁰ SEC staff reportedly recommended actions against bankers involved in the deal, including former GDB head Jorge Irizarry, who later led a coalition said to represent local junior COFINA bondholders.⁵¹ The SEC declined to pursue those charges.⁵² Investment funds Paulson & Company, Och-Ziff Capital,⁵³ Fir Tree Partners, Perry Capital, and Brigade Capital reportedly each bought more than $100 million of the issue.⁵⁴

After the 2014 GO issuance, hedge funds expanded their involvement in Puerto Rico, both in purchases of bonds as well as contact with officials and policymakers. The ratings agency Fitch, according to reports, found that some 60 hedge funds held about $16 billion of Puerto Rico's public debt, about 22% of the total amount, by fall 2014.⁵⁵ In addition, the investment bank Goldman Sachs's holdings of Puerto Rican debt increased to a reported $1.3 billion in 2014.⁵⁶

Federal Courts Strike Down Local Bankruptcy Law

The Puerto Rican government lost access to Chapter 9 of the U.S. Bankruptcy Code, which governs the adjustment of municipal debts, in 1984.⁵⁷ Lacking that access and with major public corporations facing severe liquidity challenges, island policymakers sought to create a path to restructuring debts through local laws. In particular, the deterioration of PREPA's finances and operations became evident in spring 2014.⁵⁸ In August 2014, PREPA, unable to afford fuel, signed a restructuring support agreement (RSA) with its creditors, which included appointment of an outside chief restructuring officer.⁵⁹

In June 2014, Puerto Rico enacted a local bankruptcy law, which heightened concerns of default risks.⁶⁰ The hedge fund Blue Mountain Capital Management, along with the Oppenheimer and Franklin mutual fund groups, challenged the law.⁶¹ Other hedge funds reportedly supported the law, which would enhance CPR's ability to pay GO debt by allowing cramdowns of public corporations' debt.⁶² The Supreme Court struck down the local bankruptcy law,⁶³ holding that, although the Bankruptcy Code prevents municipalities in Puerto Rico from seeking relief under Chapter 9, the code nonetheless preempted Puerto Rico's Recovery Act, and thus barred the CPR from enacting its own municipal bankruptcy scheme to restructure debt.⁶⁴

Governor García Padilla Calls Debt "Unpayable," Declares Fiscal Emergency

Then-Governor García Padilla called Puerto Rico's public debts "unpayable" at the end of June 2015.⁶⁵ In the following year, the governor took a series of actions to conserve the government's liquidity in the face of mounting fiscal pressures. At the beginning of August 2015, three small public bond issues were in default.⁶⁶ At the end of November 2015, Governor Padilla signed an executive order authorizing a clawback of balances and revenues from transportation and infrastructure entities.⁶⁷ In April 2016, he signed into law Act 21-2016, which declared that a debt service moratorium could be invoked to preserve funding for essential public services.⁶⁸ As Puerto Rico's defaults widened, Congress considered measures to address the island's fiscal crisis, which culminated in PROMESA's enactment.

On June 29, 2016—two days before a $780 million GO debt service payment was due—Governor Padilla suspended payments on GO and Commonwealth-guaranteed bonds, leading to the first defaults on CPR debt.⁶⁹ The following day, June 30, 2016, PROMESA was signed into law by President Obama to address Puerto Rico's debts and finances. Before describing provisions of PROMESA, the next section analyzes the structure of Puerto Rico's debt stack.

Predefault Structure of Puerto Rico's Public Debts

Puerto Rico's fiscal crisis and its accumulations of debt are intertwined with the structure of its public sector. This section surveys Puerto Rico's public debts and briefly discusses how they were accumulated. The Puerto Rican government includes a central government—the Commonwealth of Puerto Rico (CPR)—as well as some 50 public corporations.⁷⁰ These public corporations have a wide range of responsibilities, including providing electricity, water and sewer service, social services, health care, and maintenance of ports and parks. The island's public debt, issued by 18 distinct public entities, presents an unusually complex debt structure. Transfers and cross-subsidies among different public agencies and corporations, often routed through the former Government Development Bank, added to that complexity.⁷¹

Government Development Bank as Fiscal Agent and Financial Advisor

The GDB—the CPR's former fiscal agent and financial advisor to each governor's administration—had a central role in Puerto Rico's debt crisis. In postwar decades, it supported the island's industrialization strategy and served a mix of public and private clients. A GDB head in 2015 described its role as "really a combination of things that the Treasury, the New York Fed and a development bank like the Inter-American Development Bank do."⁷² In particular, the GDB controlled debt issuance and negotiated with investment banks. The GDB defaulted on bond payments in May 2016. In 2017, the newly formed Fiscal Agency and Financial Advisory Authority (FAFAA) assumed most of GDB's functions.⁷³

Categories of Public Debt

Restructuring Puerto Rico's finances has involved complex disputes among bondholders invested in different types of Puerto Rico's public debt. This section outlines the structure of the island's public debts. Since Puerto Rico lost access to credit markets in late 2014, its current debt structure has been largely unchanged, aside from the runoff of short-term notes, the 2018 wind-down of the GDB, and the 2019 restructuring of sales-tax-backed COFINA bonds (COFINA—an acronym for the Corporación del Fondo de Interés Apremiante—is also known as the Puerto Rico Sales Tax Financing Corporation). Figure 2 and Table A-1 show debt levels as of the end of July 2016.

Unfunded obligations of Puerto Rico's pension systems, which were estimated at $49 billion as of June 2015, are not included.⁷⁴ Puerto Rico's public debt, after adjustments to avoid double-counting, totaled $68.7 billion at the end of July 2016.⁷⁵

These debts can be divided by the source of funds used to repay them,⁷⁶ namely

• 1. the Commonwealth's General Fund;
• 2. the sales & use tax or other specific revenue sources;
• 3. public corporations' revenues;
• 4. other debts, including local governments (municipios) and nonrecourse debt.⁷⁷

By July 2016, the category of debt repaid through the General Fund included $12.7 billion in GO debt backed by the good faith, credit, and taxing power of the Commonwealth, as well as $4.2 billion in Public Building Authority debt, most of which carried a CPR guarantee. Another $25.5 billion of Puerto Rico's public sector debt was payable from selected tax receipts, including $17.3 billion in COFINA bonds. An additional $11.5 billion was payable through Commonwealth appropriations. Outstanding bonds for the island's largest public corporations, PREPA ($9.0 billion) and PRASA ($4.6 billion), are mostly repaid through utility charges.

Figure 2. Puerto Rico's Public Debt as of July 31, 2016, in $Billions

Source: CRS calculations based on Commonwealth Statement, December 18, 2016, https://web.archive.org/web/20170101045953/http://bgfpr.com/documents/CommonwealthofPuertoRicoFinancialInfoFY201612-18-16.pdf. Notes: Some items may not sum to totals due to rounding. This figure excludes debt of the Government Development Bank to minimize double counting. See source document for other important notes and caveats.

Public Debt and the Puerto Rico Constitution

The Puerto Rican Constitution's provisions related to budgets and debt have played a central role in the process of restructuring the island's public debts.⁷⁸ Puerto Rico treated public corporations as legally separate from the island's central government,⁷⁹ although in practice governors largely have controlled them indirectly via appointments of those corporations' boards.⁸⁰ Debts of most public corporations were also considered as separate from debts of the central (CPR) government.

Five key fiscal policy clauses in the Puerto Rico Constitution are

• a balanced budget requirement that appropriations (asignaciones aprobadas) not exceed available resources (los recursos disponibles) (Article VI, Section 8);
• a priority for payment of interest and principal for securities backed by the "full faith and credit" of the Puerto Rico government in the case of a budgetary shortfall (Article VI, Section 8);
• a "clawback" provision, mandating the reapplication of revenues to debt service of full faith and credit pledges (Article VI Section 2);
• a prohibition on issuance of new GO debt if average debt service costs over the two preceding fiscal years equaled or exceeded 15% of the average of total revenues for those two years (Article VI Section 2);⁸¹ and
• a 30-year limit on GO bond maturities, except for housing bonds, which were permitted maturities of up to 40 years (Article VI, Section 2).

The stringency of those provisions, however, was loosened in several ways. A 1974 Puerto Rico Attorney General's opinion held that bond proceeds counted as "available resources," thus relaxing the balanced budget requirement.⁸² The 15% limit and the 30-year maturity limit were considered to apply only to central government GO debt, not to so-called "extraconstitutional" debt of public corporations and COFINA. The GDB, by serving as a conduit for transferring resources between the central government and other public entities, also weakened the effective distinction between "constitutional" and "extraconstitutional" debt.⁸³ Moreover, some have contested whether some post-2012 debt issues conformed to the 15% limit, as well as the reach of clawback measures used to bolster resources for payment of GO debt. Interpretations of those constitutional limits have shaped much of the island's public finance policy as well as PROMESA Title III litigation, which later sections describe.⁸⁴

PROMESA Enacted in 2016 to Address the Crisis

PROMESA (P.L. 114-187), as noted above, established two debt adjustment processes and a Financial Oversight and Management Board for Puerto Rico, among other provisions.⁸⁵ Title II of PROMESA endowed the FOMB with wide authorities, while the governor and legislature of Puerto Rico retained substantial control over public priorities, within the constraints of Board-certified fiscal plans and other PROMESA provisions.

Oversight Board Appointments and Organization

The Oversight Board plays a central role in the restructuring process. At the end of August 2016, President Obama appointed six members from nomination lists compiled by congressional leaders and a seventh of his own choosing.⁸⁶ The Puerto Rico governor was empowered to appoint a nonvoting representative to the Board. The Board chose José B. Carrión, an island insurance broker, as chair.⁸⁷

Litigation questioning the Board's compliance with the U.S. Constitution's Appointments Clause delayed the renomination or replacement of the original members, whose three-year terms expired in August 2019. The Supreme Court rejected those challenges in June 2020, clearing the way for new nominations and appointments.⁸⁸

The Oversight Board chooses which instrumentalities will be "covered."⁸⁹ The Board can require the CPR government and covered instrumentalities to submit fiscal plans and budgets, which are subject to Board approval. In September 2016, the Oversight Board listed the CPR government as a covered territory and 62 public corporations and other entities as covered instrumentalities.⁹⁰ The Board also represents covered entities in debt restructuring processes set up by PROMESA.

PROMESA Established Two Paths to Restructure Debt

PROMESA's Title III establishes a debt restructuring process that draws on Chapters 9 and 11 of the U.S. Bankruptcy Code.⁹¹ Title VI establishes a debt restructuring process for voluntary collective action agreements, similar to procedures used in some sovereign debt negotiations. Chief Justice John Roberts selected U.S. District Court Judge Laura Taylor Swain to oversee PROMESA Title III processes in proceedings in San Juan and New York.

Restructuring COFINA and GO Bonds

Disputes over the legal and constitutional foundation for tax-backed bonds and for certain other bonds have played a central role in Puerto Rico's debt restructuring, even before PROMESA's enactment. In particular, controversies over the relative priority of GO debt claims and claims of sales-and-use-tax-backed COFINA debt split investor groups.

Some suspected that issuing COFINA bonds sidestepped a limitation on debt issuance in the Puerto Rico Constitution, an accusation denied by others.¹⁰⁷ COFINA bonds were sold as "extraconstitutional" debt, meaning that bond proceeds and tax revenues supporting debt service were not to be considered as "available resources" to the CPR. Bond documents asserted that COFINA proceeds were therefore protected from "clawback," that is, the invocation of a provision of the Puerto Rican Constitution prioritizing payment of GO debt service.¹⁰⁸ While the Puerto Rican government obtained opinions from mainland law firms and the Puerto Rican Attorney General that COFINA funds would not be subject to clawback, at least one mainland law firm partner expressed doubt that a court would bar clawback of COFINA funds—an opinion not shared with investors.¹⁰⁹ In 2009, bond filings began to note, in general terms, the potential legal risks presented by COFINA's structure.¹¹⁰

Some major mutual funds, which had bought Puerto Rico securities at par when issued before the island's fiscal challenges became evident, sharply reduced their holdings of the island's public debt in late 2013 and 2014, prompting sharp drops in bond prices.¹¹¹ A significant portion of those sales were to hedge funds with a stronger appetite for complex debt restructuring processes.¹¹²

Many GO bondholders believed that restructuring the island's public corporations' debts or clawing back COFINA revenues could help the government meet GO bond obligations, prompting contention with COFINA bondholder groups.¹¹³ Conflicts also emerged between senior COFINA bondholders, which included several mainland financial institutions and hedge funds, and junior COFINA bondholders, who tended to be individual residents of Puerto Rico.¹¹⁴

Much of the COFINA-GO litigation included coalitions of major bondholders, such as the Ad Hoc Group of Puerto Rico GO Bondholders, the COFINA Senior Bondholders Coalition, and the Bonistas del Patio, a group claiming to represent island-based junior COFINA bondholders.¹¹⁵ Three bond insurers (Ambac, National Public Finance, and Assured Guaranty), also known as monolines, also participated actively in negotiations and litigation.¹¹⁶ These groups played a role in congressional deliberations that led to PROMESA's enactment.

The constitutional fiscal provisions became more salient as the prospect of a default of Puerto Rico's government loomed, triggering heightened tensions among bondholders. In July 2016, a group of GO bondholders sued then-Governor García Padilla to demand a clawback of COFINA-pledged revenues. In April 2017, a federal appeals court held that PROMESA stay provisions applied.¹¹⁷ That suit and other litigation, however, convinced the Oversight Board that the GO-COFINA dispute needed to be resolved through the PROMESA Title III process.¹¹⁸

New Governor Inaugurated in January 2017

In January 2017, Governor Ricardo Rosselló Nevares succeeded Governor García Padilla, who did not seek reelection.¹¹⁹ The new governor took steps to restructure the island government, including setting up FAFAA,¹²⁰ which took over financial management roles from the GDB. Rothschild & Co. were brought in to replace previous restructuring advisors.¹²¹ The new governor abandoned the PREPA RSA and revamped PREPA's governance by letting the chief restructuring officer's contract lapse and replacing the PREPA board appointed in 2017 with his own appointees.¹²² Rosselló Nevares also disbanded a commission set up by his predecessor to audit the island's public debts.¹²³

Oversight Board Files PROMESA Title III Petitions in May 2017

PROMESA required the Oversight Board to take several steps to restructure debts. In an initial step, as noted above, the Board listed the CPR and the bulk of the island's public corporations as covered instrumentalities under terms of PROMESA.¹²⁴ That designation required the governor to draft fiscal plans for the CPR and covered instrumentalities, whether or not the instrumentalities' debts were to be restructured. Fiscal plans and budgets are subject to certification by the Board, which can impose its own plan if the governor's draft is deemed inadequate.

Where the Board viewed debt restructuring as necessary, the next step was to petition a federal district court to initiate PROMESA Title III proceedings. The subsequent steps that put the GO-COFINA dispute into the Title III court followed in rapid succession in late April and early May 2017. Puerto Rico enacted a measure to claw back COFINA funds to the general fund,¹²⁵ triggering a default declaration on COFINA bonds on May 4, 2017.¹²⁶ A day before, on May 3, 2017, the FOMB filed a petition to restructure CPR's obligations under Title III of PROMESA.¹²⁷ On May 5, 2017, the Board then filed a Title III petition for COFINA,¹²⁸ and on May 21, 2017, it filed a petition for HTA.¹²⁹ The Board also initiated a Title III process for PREPA on July 2, 2017, and thus rejected the previous RSA framework.¹³⁰

The Board also used PROMESA Title VI, which sets out a different procedure, to settle debts and operations of the GDB. The Board approved the GDB's restructuring petition in July 2017, and the bank was dissolved in November 2018.¹³¹ Most of its functions, as noted above, were taken over by the FAFAA.

Judge Swain then directed the Oversight Board to resolve disputes among GO and COFINA creditors through confidential mediation overseen by a senior bankruptcy judge. On August 10, 2017, Judge Swain appointed the Unsecured Creditors Committee (UCC) to represent Commonwealth interests and Bettina Whyte to represent COFINA interests.¹³² Negotiations were surrounded by a cascade of litigation by various interested parties.¹³³

Hurricanes Irma and María Hit Puerto Rico in September 2017

Two Category 5 hurricanes soon stalled progress in those negotiations. In September 2017, Hurricane Irma skirted the northern edge of Puerto Rico, and two weeks later, Hurricane María passed over the whole island, leaving major damage in its wake.¹³⁴ The hurricanes affected the debt restructuring process in several ways. First, the island's electrical grid was disabled, which crippled many water and sewer facilities, as well as most manufacturing facilities and transportation systems. Health, housing, and incomes also were affected. Second, the disaster responses commanded the attention of public officials and others. The hurricanes' damage to public infrastructure, including the island's electrical grid, and to private businesses, including most manufacturing facilities, prompted the Oversight Board to revise the Commonwealth's fiscal plan to reflect reduced economic activity and tax revenues. The Board anticipated that federal disaster recovery funding—which it estimated would total $82 billion—would enhance the ability to repay creditors in future years.¹³⁵ Much of that funding, however, has been slow in coming.¹³⁶

Settling the COFINA/GO Dispute

The COFINA Senior Bondholders Coalition, a coalition of hedge funds and investment groups, played a central role in negotiations that led to a settlement of the COFINA/GO dispute over payment priority. The coalition controlled about a third of outstanding senior COFINA debt and substantial amounts of COFINA subordinate (junior) bonds. In June 2015, the coalition retained the law firm Quinn Emanuel and lead counsel Susheel Kirpalani.¹³⁷

After selling off about half of their COFINA junior bonds after Hurricane María hit, the coalition increased its holdings of those bonds from $709 million in October 2017 to $2.222 billion at the end of October 2018, as shown in Figure 3.¹³⁸ Over that interval—October 2017 to October 2018—the price of COFINA senior bonds rose from about 35% to over 80% of par, and junior bonds rose from about 10% of par to about 50% of par.

On May 14, 2018, the COFINA Senior Bondholders Coalition proposed a framework to settle the GO/COFINA dispute,¹³⁹ which the Oversight Board reportedly rejected as offering the CPR no "meaningful debt relief."¹⁴⁰ Further negotiations led to an agreement in principle, announced on June 5, 2018, that would allocate 53.65% of the Pledged Sales Tax Base Amount—set at 5.5% of the 10.5% Sales & Use Tax—to COFINA.¹⁴¹ Judge Swain, according to media reports, viewed the draft agreement favorably, as it could sidestep calls to rule on the validity of COFINA's legal structure under the Puerto Rico Constitution.¹⁴²

Under the proposed framework, existing COFINA bonds would be exchanged for new securities designed to reduce debt service obligations over the next decade, but carrying stronger investor protections. Certain COFINA creditors were to collect about $1.2 billion held in escrow.¹⁴³ The reduction in COFINA claims allowed the CPR government a greater share of sales and use tax revenues, which, in principle, would benefit GO bondholders. Island taxpayers also appear to have benefited from a reduction of certain tax rates enacted in December 2018.¹⁴⁴

Figure 3. COFINA Holdings of Senior COFINA Bondholders Coalition

Source: CRS calculations using Rule 2019 filings on the COFINA docket. Notes: Baupost, headed by Seth Klarman, controls the investment vehicles named Decagon Holdings. See David Dayen, "We Can Finally Identify One of the Largest Holders of Puerto Rican Debt," Intercept, October 3, 2017, https://theintercept.com/2017/10/03/we-can-finally-identify-one-of-the-largest-holders-of-puerto-rican-debt/.

The Oversight Board announced a deal with major COFINA creditors in August 2018.¹⁴⁵ Once the Puerto Rican government enacted conforming legislation,¹⁴⁶ the Oversight Board certified a revised COFINA fiscal plan.¹⁴⁷ On October 18, 2018, the Board filed a disclosure statement that detailed the proposed restructuring of COFINA debt.¹⁴⁸ On November 27, 2018, the Title III court approved¹⁴⁹ a revised disclosure statement,¹⁵⁰ clearing the way for a vote among classes of COFINA bondholders for approval.¹⁵¹ The UCC, representing the interests of Commonwealth creditors, conditionally approved the agreement in early November 2018 after having complained about the settlement.¹⁵²

Many junior COFINA bondholders contended the settlement was unfair. Some alleged that key Senior COFINA Bondholders Coalition members had purchased enough junior bonds to attain a decisive position in settlement negotiations, to the advantage of senior COFINA bondholders and the detriment of junior COFINA bondholders.¹⁵³ Small investors also complained about $332 million in consummation costs awarded to major investors involved in negotiations.¹⁵⁴ Several small COFINA bondholder suits were dismissed by the Title III court. The U.S. Court of Appeals for the First Circuit upheld those dismissals on February 8, 2021.¹⁵⁵ In a separate case, that court upheld on March 2, 2021, the dismissal of claims of Puerto Rico credit unions—called cooperativas—who contended they were pressured to buy COFINA junior bonds.¹⁵⁶

Oversight Board, Title III Court Move to Wrap Up COFINA Restructuring

Arthur González, a member of the FOMB, argued that the proposed COFINA agreement was a prudent compromise, which avoided litigation that could end with a judgement that

would either find that COFINA and its bondholders own the island's sales tax revenues, which would sharply reduce the funds available for other constituencies, or that the Commonwealth has the right to claw them back. A loss for the Commonwealth would be a particularly devastating setback, costing the local government billions of dollars in reduced debt and recouped revenue over the coming decades.¹⁵⁷

Natalie Jaresko, executive director of the Oversight Board, stated in a court filing that the

alternative to the Plan is protracted litigation . . . which could lead to an all-or-nothing recovery for holders of either Commonwealth claims or COFINA's Existing Securities.¹⁵⁸

Court Approves Restructuring and Bond Exchange in February 2019

On February 4, 2019, as noted above, Judge Swain approved the COFINA settlement and confirmed its restructuring plan,¹⁵⁹ marking one of the largest municipal bond restructurings in U.S. history and thus resolving the GO-COFINA dispute.¹⁶⁰ On February 12, 2019, old COFINA debt with a par value of $17.6 billion was exchanged for $12 billion in new COFINA bonds, which were divided into several current-interest-bearing bonds (CIBs; i.e., normal bonds) and capital appreciation bonds (CABs), for which balloon payments would be due in future decades, the last ones ending in 2058.¹⁶¹

Concerns over COFINA Settlement and Ethical Conflicts

Some investment firms reported significant gains from holdings of Puerto Rican public debt and in particular, COFINA bonds.¹⁶² A group of hedge funds, which acquired COFINA bonds at distressed prices and then spearheaded creditor negotiations, reportedly made "hundreds of millions of dollars" in profits.¹⁶³ Some smaller-scale bondholders complained that the exchange was mishandled and that their interests were not protected in negotiations, from which they were excluded.¹⁶⁴ For instance, rounding protocols, according to some, disadvantaged investors with smaller holdings and advantaged those who held major positions.¹⁶⁵ Judge Swain dismissed objections that small holders were excluded from mediation, stating that individual investors were not prevented "from advocating their positions and seeking to participate in negotiations," that investors were "welcome to reach out to the mediation team," and that investors could object to proposals resulting from mediation and other negotiations.¹⁶⁶

Some contend that links among the Whitebox investment fund, a member of the Senior COFINA Bondholders Coalition; the Compass funds; and McKinsey, the main consultant to the Oversight Board, posed conflicts of interest that were not properly disclosed.¹⁶⁷ The Board commissioned a review that asserted that McKinsey's investments posed no conflict, although they "could create the appearance of a potential conflict."¹⁶⁸ The following day, McKinsey paid $15 million to settle claims that it failed to disclose conflicts of interest in 14 other bankruptcy cases.¹⁶⁹ In November 2021, the Securities and Exchange Commission (SEC) levied a $19 million fine on MIO Partners, a subsidiary of McKinsey.¹⁷⁰

Board Pivots to GO Restructuring in 2019

The resolution—apart from certain appeals—of the COFINA restructuring cleared a path to address restructuring of GO bonds and debts of other entities closely tied to the island government, such as the Employee Retirement System (ERS) and the Public Building Authority (PBA). The PBA constructs buildings that are leased to agencies of the island government.

On January 14, 2019, the Oversight Board, in conjunction with its special claims committee and the UCC, challenged the validity of $6 billion (at par value) of GO bonds issued after 2011—referred to as "late vintage GO"—such as the $3.5 billion 2014 issue placed with hedge funds, allegedly issued in violation of a constitutional debt limitation.¹⁷¹ In May 2019, the Oversight Board and the UCC filed over 250 avoidance action suits¹⁷² and sued bankers involved in the 2014 GO bond issue.¹⁷³ Avoidance actions allow a trustee to challenge transactions involving debtors before the filing of a bankruptcy petition.¹⁷⁴

The Board did not explain why it chose to challenge GO bonds backed by a constitutional guarantee, but did not challenge the legal and constitutional basis of COFINA bonds. One investment analyst concluded "[t]he tacit support [by U.S. District Court Judge Swain] for the securitized structure represented by COFINA should be a welcome development for a municipal market that has been transitioning away from full faith and credit GO pledges and toward dedicated revenue pledges with perfected liens."¹⁷⁵ A coalition of bond insurers and bondholders filed a motion defending the validity of the GO bonds on March 21, 2019.¹⁷⁶

2020: Oversight Board, Hedge Funds Negotiate Over GO Bonds

On May 31, 2019, after negotiations with creditors, the Oversight Board announced a Plan Support Agreement (PSA) for GO bonds and debt issued by ERS and PBA. The PSA was supported by the Lawful Constitutional Debt Coalition (LCDC); some other hedge funds, including some members of the COFINA Senior Bondholders Coalition; and some retiree and labor groups.¹⁷⁷

The Oversight Board released an amended PSA on February 9, 2020, claiming to have the backing of holders of $10 billion in GO and Public Building Authority bonds,¹⁷⁸ followed by a draft disclosure statement on February 28, 2020.¹⁷⁹ The Oversight Board claimed that holders of 58% of outstanding GO and PBA debt had signed onto the PSA.¹⁸⁰ The new PSA offered slightly better terms for holders of GO and guaranteed debt, but worse terms for junior bonds.¹⁸¹ Future debt service would fall from levels that fluctuate around $3 billion to $1.5 billion per year.

In contrast to the wrap-up of the COFINA case, the GO bond case has been delayed by a series of obstacles. On March 27, 2020, the Title III court, at the request of the Oversight Board, suspended consideration of the adequacy of the disclosure statement covering the proposed restructuring of GO, PBA, and ERS debt due to the effects of the Coronavirus Disease 2019 (COVID-19) pandemic.¹⁸² The Board has filed regular status reports on its activities relevant to that case and on effects of the pandemic.¹⁸³ The Board, in its December 2020 report, stated that negotiations continue, but declined to offer details due to confidentiality restrictions.

Accusations of Insider Trading in the GO Restructuring Process

On February 25, 2020, the Title III Court received allegations of insider trading by coalitions of hedge funds involved in GO restructuring mediation and negotiations. On the same date, the UCC called for more specific disclosures of holdings by participants in the GO mediation. For instance, previous disclosure filings reported aggregate holdings that combined GO debt with a full faith and credit pledge and PBA bonds that carried a CPR guarantee, distinctions that potentially translated into different treatment in restructuring plans. On June 8, 2020, Judge Swain ordered that creditor disclosures fully conform to Federal Rule of Bankruptcy Procedure 2019(b) standards.¹⁸⁴

One analysis of changes in mediation participants' holdings as reported in amended disclosure filings asserted that LCDC members had increased holdings of GO bonds issued after 2011—referred to as late vintage GO bonds—while in an overlapping time period the LCDC and the Oversight Board had sought to invalidate the late vintage bonds.¹⁸⁵ That analysis also pointed to bond price changes that appeared to coincide with confidential mediation sessions in mid-January 2020. Hedge funds and other institutional investors denied that their members had either traded during restricted periods or traded on nonpublic information.¹⁸⁶

Calls for Investigations of Alleged Insider Trading

In June 2020, Oversight Board Executive Director Natalie Jaresko testified that she was aware of insider trading allegations, but considered those a matter for law enforcement.¹⁸⁷ On August 5, 2020, five House Members sent a letter to the New York State Attorney General requesting an investigation into possible violations of that state's Martin Act, which covers a broad range of securities dealings.¹⁸⁸ Resident Commissioner Jenniffer González asked the U.S. Securities and Exchange Commission to consider whether securities laws were violated.

On October 5, 2020, House Committee on Natural Resources Chair Raúl Grijalva and other Members sent the Oversight Board a letter requesting an investigation into those allegations.¹⁸⁹ On the same day, a bond insurer, National Public Finance, asked the Title III Court to investigate insider trading and related allegations.¹⁹⁰ Both requests were declined. The Oversight Board demurred on an investigation, but pledged to contact the U.S. Department of Justice, explaining that

given the investigative resources available to Department and its expertise in investigating the conduct at issue, the Oversight Board believes the Department is better suited than the Oversight Board to evaluate the evidence and to determine whether federal laws have been violated. This approach will also avoid saddling the Commonwealth with a potentially expansive and expensive investigation.¹⁹¹

Judge Swain declined bond insurer National Public Finance's motion to direct the U.S. Trustee or another entity to conduct an investigation, writing that "neither PROMESA nor any provision of the Bankruptcy Code that is incorporated into Title III explicitly authorizes this Court to initiate an independent investigation along the lines of the investigation sought by National in its Motion."¹⁹² Moreover, Judge Swain found that "National ha[d] not proffered evidence sufficient to support a reasonable inference that any participant in the Mediation has traded on inside information to the detriment of counterparties or the bond market, much less to the detriment of the Title III and Mediation processes."

Restructuring on Hold in 2020

The final resolution to the Title III case for GO bonds and related debts was in limbo for much of 2020 for several reasons. First, the COVID-19 pandemic, as elsewhere, has disrupted normal operations and cast in doubt previous projections of Puerto Rico's economic and fiscal future. A series of earthquakes hit the southwest of Puerto Rico in early 2020, further disrupting operations.

Second, allegations that hedge funds involved in negotiations had traded bonds using nonpublic information prompted Judge Swain to order more detailed disclosures, which in turn has prompted further litigation. Third, former Resident Commissioner Pedro Pierluisi Urrutia was inaugurated as governor in January 2021. Changes in the governor's office have typically led to major staffing changes in island agencies and public corporations.¹⁹³ Fourth, some of the original Oversight Board members have stepped down and the process of appointing new members or extending appointments of current members remains unfinished. Until the reappointment process had concluded, the Board's composition and priorities were unclear. Fifth, the pace of disaster recovery funding, which was expected to bolster the island's economy—and thus its ability to service debts—in the medium term has been slow and uncertain.¹⁹⁴ The Biden Administration has released some of those recovery funds.¹⁹⁵

The Oversight Board discussed proposals to revise the plan of adjustment to reflect effects of the COVID-19 pandemic on the island economy at its October 30, 2020, public meeting. A newly appointed member, Justin Peterson, left the online meeting, blocking a vote to modify the plan.¹⁹⁶

Oversight Board Announces Revised GO PSA in February 2021

On October 29, 2020, Judge Swain ordered the Oversight Board to present "an informative motion presenting a term sheet disclosing the material economic and structural features of an amended plan of adjustment that the Oversight Board intends to propose for confirmation" by February 10, 2021, which would cover GO debt, as well as debts of the Public Building Authority.¹⁹⁷ On that date, the Oversight Board announced that it had reached an agreement in principle with several major bondholders. Two weeks later it released the proposed amended plan support agreement (PSA), which it filed with the Title III court on March 8, 2021.¹⁹⁸ Table 1 compares terms of the February 2021 PSA with those of a plan discussed by the Oversight Board in October 2020.

Although the total recovery value of the GO settlement proposed in February 2021 would have been higher than the plan outlined by the Board in October 2020,¹⁹⁹ it would have been well below that of the plan of adjustment filed in February 2020 ($15.2 billion) or the creditors' counterproposal of August 2020 ($15.3 billion), in part reflecting effects of the COVID-19 pandemic.²⁰⁰

If the terms of that PSA were implemented, existing bonds covered by the agreement would have been exchanged for cash, new GO bonds, capital appreciation bonds (with interest only payable in future years), and contingent valuation instruments (CVIs) that would have paid creditors extra amounts if the island's economic growth exceeded Oversight Board projections. The mix of new assets received would have differed for each old bond, with estimated recovery rates ranging from 67.7% for the 2014 GO bond to 80.3% for pre-2011 PBA bonds, excluding CVI payments.²⁰¹ Certain creditor groups were to receive "consummation cost" payments in cash.²⁰² Those recovery rates were well above what market prices indicated were expected recovery rates for much of the period of the debt restructuring, as a later section discusses.

The Oversight Board chairman claimed the proposed plan aimed at consensual agreement; that it reflected harm to the island from hurricanes, the COVID-19 pandemic, and other natural disasters; that it was a fair deal for creditors; and that it would be a "once and done deal."²⁰³ The plan also included reductions of 2%-3% in some pension payments above certain thresholds, which the Board contended would protect most pensioners from those reductions.²⁰⁴ Pension reductions, creditor concerns, and macroeconomic uncertainties, among other considerations, have spurred opposition to the Board's plan.²⁰⁵

Governor Pedro Pierluisi was quoted as stating that the agreement was a "step forward," although he vowed to oppose any plan that would result in reductions in public pension payments to retirees.²⁰⁶

Further Negotiations with Bond Insurers and Other Creditors

On April 12, 2021, the Oversight Board announced an agreement in principle with two bond insurers, Assured Guaranty and National Public Finance Guarantee, regarding convention center and Highway and Transportation Authority bonds.²⁰⁷ A plan support agreement announced on May 5, 2021, involved treatment of the CPR clawback of revenues from certain public corporations.²⁰⁸ In mid-July 2021, the Board reached agreement with the Unsecured Creditors Coalition (UCC), which (as noted above) played a major role in debt negotiations.²⁰⁹ Later that month, the two remaining bond insurers reached an agreement with the Board on their claims, which include bonds backed by rum taxes.²¹⁰

As more creditors signed onto plan support agreements, the Title III court took additional steps to advance the process of restructuring of CPR and related debts. On May 11, 2021, the Title III court scheduled hearings in July 2021 to assess the adequacy of the proposed disclosure statement describing terms of the plan.²¹¹ On August 2, 2021, the court approved a disclosure statement and scheduled hearings on confirmation of the plan.²¹² An approval vote was also set with an October 4, 2021, deadline for return of ballots. The plan was approved by 47 out of 61 creditor classes, including 90% of the bondholder classes.²¹³

On October 26, 2021, the Puerto Rican legislature approved legislation to issue new bonds,²¹⁴ albeit after the island's senate balked at passing the measure.²¹⁵ The measure was enacted after parties agreed to further negotiations over provisions concerning public pensions and funding for the University of Puerto Rico.²¹⁶

Judge Swain held eight days of hearings on the confirmation of the plan of adjustment in November 2021.²¹⁷ Each day was structured to consider specific issues and hear from representatives for major creditor groups, the Oversight Board, some members of the public, and a few individual creditors.²¹⁸ On January 18, 2022, Judge Swain confirmed the plan, clearing the way for an exchange of new bonds for old. The confirmed plan preempted dozens of Puerto Rican laws and Article VI of the Puerto Rico Constitution, dismissed litigation related to clawback claims and pension bonds, and restructured public pension systems. Older public employees were transferred from a defined benefit system to a defined contribution system, while younger workers were slated to join the U.S. Social Security system. Puerto Rico policymakers had opposed reducing pension benefits, while the Oversight Board noted that existing pension funds lacked assets to pay those benefits. The plan preserves pension benefit levels to retirees receiving $1,500 per month or less.

A Puerto Rican teachers' association appealed the confirmation of the CPR plan. The 1^st Circuit Court of Appeals declined to stay consummation of the plan,²¹⁹ but heard arguments on the case on March 9, 2022.²²⁰ The doctrine of equitable mootness complicates efforts to reverse provisions of a consummated debt restructuring.²²¹

Apparently Conflicting Claims on Recovery Rates

The Board claimed that creditors would recover on average 69% of their claims, although for some creditor classes the reductions in bond values were as low as 10%.²²² In February 2022, Governor Pedro Pierluisi Urrutia testified that the plan will reduce the central government's debt from $34 billion to $7.4 billion, a 78% reduction. A third-party estimate,²²³ however, put recovery rates for older GO bonds at 95% and at 83% for 2014 GO bonds sold to hedge funds.²²⁴ Bond prices, as shown in the next section, largely align with that estimate.

The divergence between claims of drastic reductions in debt levels and more modest reductions implied by the high recovery rates noted above appears to result from other features of the debt restructuring. Many creditor classes received cash payouts, long-term bonds with balloon-payment features (capital appreciation bonds; CABs), consummation cash payments used to help reach various agreements, and contingent valuation instruments (CVIs) tied to the island's economic growth, which raise recovery rates. Moreover, new bonds carry interest rates higher than most other municipal bonds. Investors may note that after the termination of the Oversight Board, Puerto Rico would again lack a clear path to access federal bankruptcy processes.

Market Perspectives on Debt Restructuring

Trends in bond prices provide a window on investors' views of the restructuring process and proposals as they proceed through the events described in previous sections. Figure 4 shows bond prices as a percentage of par from 2013 through February 2022 for selected issues of GO bonds; COFINA bonds; and bonds of the three largest Puerto Rican public corporations: PREPA, PRASA, and HTA.

Figure 4. Price Trends for Selected Puerto Rico Bonds: January 2013-February 2022

Source: CRS calculations based on the Municipal Securities Rulemaking Board EMMA site: https://emma.msrb.org/. Notes: All prices quoted as percentage of par value. CUSIPS (codes used to identify issuers and financial securities) are 2006A (74514LHN0), 2009B (74514LVW4), 2011A GO (74514LYW1), 2012A (74514LA98), 2014A NY Law GO (74514LE86), PREPA (74526QVX7), PRASA (745160QF1), HTA (745181K97), COFINA Subordinated (74529JHN8), and COFINA Senior (74529JNX9). The first vertical grey line indicates the release of the August 2013 Barron's article; the second is the introduction of a local bankruptcy measure. COFINA bonds were exchanged for new bonds on February 12, 2019. Values interpolated between trade dates.

Bond prices, according to finance theory, reveal market expectations of the probability of default and recovery rates—that is, the value of what bondholders would receive after default and restructuring.²²⁵ Once the prospect of default became a certainty, bond prices then reflected market expectations of recovery rates. Appendix B presents data on bond prices and trading volumes for a narrower time period. Appendix C lists key dates with links to key documents.

Bond prices have changed dramatically over the course of the debt restructuring process.²²⁶ Many Puerto Rican bonds traded above par before mid-2013. All of these bond prices fell sharply in 2013, reacting to the Detroit bankruptcy filing and a business press article on Puerto Rico's fiscal distress.²²⁷ The introduction of a local bankruptcy measure in June 2014 and the announcement by Puerto Rico's governor a year later that the island's debts were "unpayable" also pushed bond prices down.

Not all categories of debt moved to the same extent. For instance, COFINA subordinate bond prices reacted more sharply to events of 2015 than GO bond prices, although they recovered more ground than other bonds in the lead-up to the enactment of PROMESA at the end of June 2016. The COFINA default in May 2017 depressed senior and especially subordinate COFINA bonds.

The devastation left by Hurricanes Irma and María in September 2017 severely depressed almost all Puerto Rico bond prices.²²⁸ GO bonds then traded at a quarter of par or less, while COFINA subordinates briefly traded at about 10% of par. Prices began to recover in 2018, with the February enactment of the Balanced Budget Act of 2018 (BBA 2018; P.L. 115-123), which appropriated disaster relief funds for Puerto Rico and other affected areas. Prices also responded to Oversight Board proposals in April 2018 that combined calls for fiscal austerity with relatively optimistic macroeconomic forecasts.

In January 2018, the Oversight Board called for invalidating late vintage GO issues, causing the older GOs to trade at a premium to the 2014 issue. The 2014 GO issue had traded above older GO issues until Hurricane María, reflecting the New York law provision. Some of the allegations of insider trading—discussed in "Accusations of Insider Trading in the GO Restructuring Process," above—center on divergences between earlier and late vintage GO bonds. Those differences narrowed after the Oversight Board announced an Amended Plan Support Agreement for the CPR, ERS, and PBA in February 2020.

The relationship between bond prices and estimated recovery rates in the consummated COFINA plan and the plan support agreements for restructuring GO and related debts has attracted some attention. Several activists assert that the marked recovery of bond prices after some of those prices reached extremely low levels in fall 2017 implies that investors took advantage of island residents. The recovery of those prices, per se, need not imply any misbehavior on the part of investors, but could reflect a transfer of bond holdings to investors and funds more willing to tolerate risk, or less adverse to litigation, or better informed about long-term prospects.

Bond prices after confirmation of the CPR plan of adjustment in January 2022, as noted above, suggest a market assessment that the plan delivered high recovery rates for many GO bonds. All GO bonds shown in Figure 4 had prices near 90% of par in February 2022. The Highway and Transportation Authority (HTA) shown in Figure 4 traded above par since spring 2021. Negotiations over the restructuring of PREPA debt remain in progress. Market pricing data suggest that investors anticipate a high recovery rate for PREPA bonds as well.

The shift in holdings from smaller bondholders to hedge funds acting within coalitions may also play a role. Hedge funds, some contend, can serve to mitigate collection action challenges to enforcing creditor interests facing dispersed investors.²²⁹ The leverage hedge funds can bring to bear in complex negotiations may also result in dissimilar treatment for different classes of investors.

What Can Puerto Rico Afford to Pay?

A "once and done deal," as the Oversight Board chair put it, would require a manageable future debt service burden. Capacity to service public debt depends on growth in the tax base—largely proxied by growth of the island's economy—as well as the efficiency of tax administration and the willingness to keep tax rates in proportion to expenditures. In other terms, debt service capacity rests on a government's ability to run primary surpluses; that is, having receipts running sufficiently above non-debt-service outlays to meet debt service obligations. For each component of debt service capacity—economic growth, tax administration, willingness to tax, and fiscal constraint—reasons for both optimism and concern may exist.

Puerto Rico's Economy Expected to Shrink

In recent decades economic growth in Puerto Rico has been uneven, if not stagnant.²³⁰ Recovery from the 2017 Hurricanes Irma and María has been slow. Earthquakes in late 2019 and early 2020, along with the COVID-19 pandemic, also hindered economic activity. The island's economy, according to April 2021 Oversight Board estimates, shrank by 3.0% in 2020.²³¹

The Board projects negligible economic growth over the next five years, as shown in Figure 5.²³² The 2021 CPR Fiscal Plan projects somewhat more growth than plans from recent past years. Growth projections that adjust for income increases due to federal COVID-19 relief measures show stronger growth in 2021 (3.8%) and 2022 (1.5%), but weaker growth for later years. Puerto Rico's projected economic growth trajectory, according to Oversight Board projections, will be well below growth rates expected for the U.S. economy for the years 2021-2024, although it would nearly match the projected U.S. growth rate in 2025.

Figure 5. Projected Puerto Rican and U.S. Economic Growth Rates, 2020-2025

Source: Oversight Board, Fiscal Plan Macroeconomic Overview and Fiscal Plan, August 18, 2020; and Oversight Board, Certified 2021 Fiscal Plan, April 23, 2021. Notes: Puerto Rico projections use GNP, which avoids distortions in GDP measures related to tax avoidance strategies of multinational firms with Puerto Rican subsidiaries. Puerto Rican growth rates are for the CPR fiscal year, which starts on July 1.

The 2021 CPR Fiscal Plan anticipates that Puerto Rico will receive $110 billion in federal funds over the coming decade, although mainland firms or contractors would receive some of that amount. Federal and private disaster assistance is estimated to drop from $8.1 billion in 2019 to $2.3 billion in 2020, and to rise in following years as Community Development Block Grant Disaster Recovery (CDBG-DR), Federal Emergency Management Agency (FEMA) permanent public assistance, and certain other federal program funds are disbursed.²³³

The island's shrinking population, due to continuing net outmigration to the mainland and low birth rates, also affects its growth prospects.²³⁴ The U.S. Census Bureau estimates that the island's population fell from 3.73 million in 2010 to 3.16 million in 2020, a decrease of 15%.²³⁵ The Oversight Board projects that its population will decline to 2.76 million by 2026.²³⁶

The FOMB has been optimistic that structural reforms, such as changes in the island's labor laws to encourage higher labor participation rates and to loosen employment law restrictions and protections, would accelerate economic growth.²³⁷

Some economists have viewed Oversight Board projections of Puerto Rico's growth prospects and its capacity to service debt as overly optimistic²³⁸ and note that fiscal austerity could restrain economic growth enough to outweigh gains from proposed structural and labor market reforms.²³⁹ Although low labor participation rates have been a persistent issue in Puerto Rico,²⁴⁰ recent IMF research suggests projections of faster economic growth through structural changes are often unfulfilled.²⁴¹

Effects of the 2017 hurricanes, the 2020 earthquakes, and the COVID-19 pandemic all complicate the island's fiscal prospects. Despite the catastrophic damage endured by the island, Executive Director Jaresko stated that federal disaster recovery funds and insurance proceeds would promote economic growth and raise tax collections, which would increase Puerto Rico's ability to repay its debt,²⁴² in particular through the rebuilding of the island's electric grid and generating fleet, in part to be supported through Community Development Block Grant disaster recovery funds. Federal outlays on permanent disaster recovery projects had been slow relative to mainland standards, although the Biden Administration has lifted holds on those funds.²⁴³ Restructuring of Puerto Rico's energy sector, however, is subject to substantial implementation, operational, and financial risks.²⁴⁴

Contingent valuation instruments (CVIs) added into the amended plan of adjustment proposed by the Oversight Board in February 2021, if implemented, would provide creditors with additional payments if Puerto Rico's economy grew faster than the Board's projections.

Revenue Growth and Tax Policy

Recent tax collections have exceeded projections. CPR-source revenue rose from $10.1 billion in FY2018 to a projected $12.3 billion in FY2019. Federal-source income also rose by $3.6 billion between those years.²⁴⁵ Revenues for the last half of calendar 2020 were stronger than expected.²⁴⁶

Other concerns persist. Recent changes in federal tax laws regarding treatment of intellectual property and corporate taxation could present challenges to Puerto Rico's economic development strategies, which historically have relied heavily on advantageous tax treatment of corporate income.²⁴⁷ Those tax incentives have led some to term Puerto Rico a tax haven.²⁴⁸ In July 2019, Puerto Rico enacted a law that consolidated many of its tax incentives.²⁴⁹ The Oversight Board has expressed concerns about how the CPR has awarded tax credits and incentives.²⁵⁰ The Puerto Rico Treasury Department has promised to tighten controls on tax fraud.²⁵¹

About one-fifth of the CPR's revenue stems from Act 154 taxes on transactions between multinational corporation subsidiaries based in Puerto Rico and the mainland, which often can be credited against federal tax liabilities. In September 2019, then-Treasury Secretary Mnuchin had pushed to phase out Act 154 taxes.²⁵²

Comparison with Heavily Indebted States

A comparison with per capita debt levels of state governments is one benchmark of Puerto Rico's capacity to repay debt. Puerto Rico's post-restructuring public debts—if recent plans and proposals go through—would leave it with per capita debt burdens somewhat above the most highly indebted state governments. Puerto Rico's per capita income levels, however, are well below those of mainland states.²⁵³ The Oversight Board, in a presentation outlining its March 2021 restructuring plan, contends that those proposals would significantly reduce Puerto Rico's public debt in comparison to the most heavily indebted mainland states.²⁵⁴

Issues for Congress

Puerto Rico's debt restructuring processes may present policy issues concerning not only the island, its debts, and its creditors, but also municipal finance markets more broadly. Congress therefore might consider legislative and oversight initiatives focused not only on Puerto Rico, but also on the wider municipal securities market.

As Puerto Rico's public debt comprises about 2% of overall municipal debt, the consequences of debt restructurings will affect or have affected a significant number of investors. Many investors held Puerto Rican public debt through mutual funds, which generally bought bonds near or at par when issued, and then were left with realized losses after those funds sold off those holdings.²⁵⁵ Judicial decisions in Puerto Rico cases could shape case law, thus affecting the future disposition of mainland municipal debtors.

In the case of Puerto Rico, issues with federal tax exemptions, alleged violations of securities laws, and the interpretation of provisions of the Bankruptcy Code incorporated into PROMESA Titles III and VI may provide lessons for policymakers.

More generally, many have complained that the restructuring process has taken too long to complete.²⁵⁶ Moreover, the costs of litigation, which the Oversight Board has called "extraordinarily expensive," have been higher than expected.²⁵⁷ Costs of the Oversight Board's operations and litigation are borne by island taxpayers and residents.²⁵⁸

Federalism and Municipal Debt Markets

The federal government has three main instruments to shape municipal bond markets: tax policies, securities laws, and bankruptcy laws. Requirements for exemptions from federal income taxation play a fundamental role in municipal finance because marketing bonds without that exemption is more difficult.²⁵⁹ Securities laws that mandate disclosure requirements help investors make informed choices so that financial resources and risk-bearing can be allocated in an efficient way.

The federal government, to a large extent, has exercised light oversight of municipal bond markets, which provide state and local governments with lower-cost access to capital to build roads, schools, public buildings, and water and sewer systems, among other ends, as well as to help manage cash flows to match revenues and outlays.²⁶⁰ This reflects a division of responsibilities between the federal government and states, which have the flexibility to accommodate policies to local conditions. Congress, however, has greater authority to oversee territories through its Article IV powers.

Great Depression-era securities laws were not considered to apply to municipal securities until the early 1970s, when questionable practices by some municipal finance specialty firms and New York City's fiscal crisis prompted federal responses.²⁶¹ The Securities Acts Amendments of 1975 (P.L. 94-29) extended the reach of federal regulations to the municipal securities market, established the Municipal Securities Rulemaking Board (MSRB), and imposed certain antifraud provisions.²⁶² The act also included a provision known as the Tower Amendment that barred the MSRB and SEC from requiring that municipal issuers file pre-sale financial statements.²⁶³ Some have questioned those limits on federal regulation of municipal finance,²⁶⁴ although others point to more active federal enforcement of disclosure violations.²⁶⁵

A 2012 SEC report included some legislative proposals for enhancing disclosure in the municipal bond market, although it did not call for removing Tower Amendment restrictions.²⁶⁶ A 2020 SEC advisory panel discussed various means to improve the timeliness and usefulness of disclosures, although some warned of imposing new disclosure requirements that would burden small public issuers.²⁶⁷ H.R. 4476, introduced September 24, 2019, during the 116^th Congress, would have set data standards for financial disclosure, although it would not have imposed new disclosure standards.

The scale of Puerto Rico's debt restructuring could conceivably lead to other modifications of municipal finance practice. Federal bankruptcy law, which during the Great Depression was extended to cover instrumentalities of state governments such as cities and public authorities, also plays a role in how municipal bond contracts are structured and how investors and creditors share risks. Past municipal bond defaults have affected how municipal bond markets operate. New York City's financial crisis in the mid-1970s led to stronger investor disclosure requirements, and the early 1980s defaults of the Washington Public Power Supply System (WPPSS) led to the expansion of bond insurance.²⁶⁸ In general, however, municipal defaults have been much less frequent than corporate or individual defaults.²⁶⁹

Congress controls tax policy and the tax treatment of municipal securities more directly. Modifications of the federal tax treatment of municipal securities could lead to significant changes in government finance because of the importance that tax advantages play in marketing those securities. For instance, in 2006, Merrill Lynch advisors suggested that ERS and Merrill Lynch issue at least $7 billion in pension obligation bonds (POBs). Because those bonds were ineligible for federal tax exemptions, Merrill Lynch was unable to place those bonds. UBS then sold less than half that amount, as noted above, largely purchased through its own proprietary accounts.²⁷⁰ Had a larger amount of bonds been issued, the island government's finances would have been in even worse shape. Thus, lack of federal tax exemption helped constrain the extent of a strategy that an independent review concluded "was so badly structured that, rather than yielding profits, it resulted in tremendous losses that have accelerated the demise of [the] Retirement System."²⁷¹ Modifying federal tax exemption requirements or limiting the amount of certain types of bonds might restrain issues of debt that could create serious fiscal risks. Congress has also limited tax exemptions on some types of municipal bonds on other grounds.²⁷²

Federal Policies and Municipal Debt Structures

Federal tax and bankruptcy law help shape financial decisions of state, local, and territorial governments on how they structure their debts. For instance, federal tax law constraints on issuance of tax-advantaged private activity bonds (PABs) and on advance refundings of municipal bonds have changed the "muni" markets. Congress may consider how the different treatment of municipal bonds in federal bankruptcy law might affect how local governments approach municipal finance decisions.

In municipal finance, GO bonds are typically used to support publicly provided services and infrastructure, such as streets, schools, and other public buildings, and are backed by a jurisdiction's commitment to collect sufficient tax revenues. GO bonds, backed by the full faith and credit of a jurisdiction, have the advantage of being supported by a broad set of budgetary resources, without a specific lien on revenues. The experience of restructuring Puerto Rico's public debts could affect how future municipal finance arrangements are made.

Revenue bonds have typically been used to finance infrastructure to supply services that generate their own revenue through fees or charges, such as electric power, toll roads, water and sewers, and airports, often administered through authorities with some measure of independence from elected governments.²⁷³ If a project or authority failed to generate revenues sufficient to cover debt service, revenue bondholders generally could not obtain support from other revenue sources, such as general tax revenues. Although revenue bonds are backed by more narrowly defined cash flows, they carry the advantage that liens could be applied to a stream of fees and charges.

In 1988, Congress enacted bankruptcy legislation that included particular protections for bondholders' interests in pledged fees and charges backing certain revenue bonds.²⁷⁴ The 1988 act added Section 928 to the Bankruptcy Code, which states "special revenues acquired by the debtor after the commencement of the case shall remain subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case."²⁷⁵ Without that exception, special revenues collected by a debtor would not be subject to lien.²⁷⁶ Litigation regarding the restructuring of the Puerto Rico Highways and Transportation Authority (PRHTA) has raised questions about the treatment of revenue bonds and special revenues.²⁷⁷ Congress could consider modifying Section 928 of the Bankruptcy Code to clarify those issues. Some have contended a clearer treatment of special revenue bonds would lower financing costs for local governments.²⁷⁸

Ultra-Long-Term and Exotic Debt

Mutual funds provide small investors with the advantages of diversification by pooling large numbers of securities. Expecting those investors, however, to monitor hundreds or thousands of issuers, some of which may employ complex securities, may be unrealistic. A 1993 SEC staff report found that larger numbers of unsophisticated individual investors were buying municipal securities and that governments had come to rely on increasingly complex structured securities and derivatives.²⁷⁹ The onset of the financial crisis in mid-2007 led to the failure of exotic forms of municipal debt widely marketed to individual investors.²⁸⁰ The underwriting and marketing of POBs to retail investors in Puerto Rico has raised concerns.²⁸¹

Congress passed PROMESA, among other ends, to create a debt restructuring process that would put Puerto Rico's public finances on a sustainable basis, which could then anchor a healthier economic climate.²⁸² Risks due to uncertainties in future economic growth and population trends could compound potential challenges embedded in the use of COFINA CABs. Some analysts have noted that the use of financial instruments or public-private partnership agreements that provide governments with up-front proceeds may yield few benefits in later years and may shift fiscal burdens to future generations that may have benefited little from the use of those proceeds.²⁸³

Congress could consider changes in requirements for federal tax exemptions for municipal bonds to encourage issuers to rely on securities that avoid exotic structures or ultra-long maturities.

Bankruptcy Procedures, Disclosure, and Potential Conflicts of Interest

Congress could consider measures to protect the interests of a wider set of investors in complex bankruptcy cases, such as by strengthening or clarifying disclosure requirements. The COFINA restructuring raised concerns that hedge funds and institutional investors involved in settlement negotiations were treated more favorably than individual investors.

Congress could consider bolstering disclosure requirements for officials and professionals engaged in the debt restructuring processes. In the case of those engaged in procedures established by PROMESA, the House unanimously passed H.R. 1192 (Puerto Rico Recovery Accuracy in Disclosures Act of 2021; PRRADA) on February 24, 2021, two days after it was introduced. A companion bill was introduced in the Senate on February 23, 2021, and passed in amended form on December 18, 2021.²⁸⁴ After a resolution of differences, the measure (P.L. 117-82) was signed into law on January 20, 2022.

The act requires professionals engaged in PROMESA Title III actions to file a disclosure statement under Section 2014(a) of the Federal Rules of Bankruptcy Procedure before being compensated. In particular, professionals would have to set forth their connections with those on a list of materially interested entities compiled by the Oversight Board.

In the 116^th Congress, the House passed a similar measure (H.R. 683) on December 8, 2020. A companion bill (S. 1675) had been introduced in the Senate on May 23, 2019.

Hedge funds have played a central role in Puerto Rico's debt restructuring, as well as in other complex bankruptcy cases, in which debt and other claims are increasingly treated as liquid assets.²⁸⁵ Hedge funds, through the scale of their investments, may enhance market efficiency by overcoming collective action challenges facing smaller or more traditional investors, as noted above. Hedge funds and similar funds, acting either singly or in concert, however, may disadvantage other claimants.²⁸⁶ Conflicts of interest may be particularly salient in bankruptcy and debt restructuring processes because major cases have involved a relatively narrow set of professionals.²⁸⁷ In particular, the extensive and ongoing relationships among McKinsey—the Oversight Board's main contractor—and firms working on major bankruptcy cases have raised concerns.²⁸⁸

Stronger disclosure requirements on holdings of debt instruments and on potential conflicts of interest may help level the playing field, an issue that Congress has addressed in the past. One legal scholar argued that Congress crafted provisions of the 1934 Bankruptcy Act to curtail opportunities for collusion among insiders to the disadvantage of other parties.²⁸⁹ Another scholar argues that requiring investors to disclose "material rights against or affecting distressed firms, whether direct or derivative, and whether held singly or collectively, in real time, using online market portals or similar information systems" would curtail potential abuses by unregulated private investors such as hedge funds.²⁹⁰ Research on other asset-trading disclosure requirements suggests that they limit insiders' excess gains.²⁹¹ According to economic theory, reducing insiders' excess gains would enhance assets' attractiveness to rational small investors.

An Audit of Puerto Rico's Public Debt

H.R. 6975, introduced on May 22, 2020, would have established a commission to audit all public debt issued by Puerto Rico since 1972.²⁹² The measure would also have allowed discharge of some unsecured debts, applied certain ethics requirements to the Oversight Board, provided federal funding for Board activities, and commissioned a Government Accountability Office (GAO) report on the Board's spending and activities, among other provisions.

This proposal to audit the island's public debt followed other initiatives. In July 2015, the Puerto Rico legislature enacted Act 97-2015, which, among other provisions, established a Commission for a Comprehensive Audit of Public Credit.²⁹³ The act's preamble²⁹⁴ stated

As one of the necessary mechanisms to proceed towards a broad fiscal and financial restructuring, this Legislative Assembly recognizes as prudent and necessary the creation of an independent commission composed of members from the public sector and private citizens, drawn from diverse strategic sectors of civil society, entrusted with the responsibility to audit the totality of Puerto Rico's public debt. The commission will operate in an autonomous manner and will have the necessary authority to evaluate all government transactions pertinent to the tasks assigned by this law.

Governor Rosselló Nevares disbanded the commission after he took office in 2017.²⁹⁵ Volunteer citizen efforts have attempted to continue the former commission's work, although without formal investigative powers.²⁹⁶ For instance, one citizen group in January 2019 issued a report challenging the legal basis of COFINA debt.²⁹⁷

The Oversight Board commissioned an investigation of Puerto Rico's debt by the law firm Kobre & Kim, which produced a 608-page final investigative report in August 2018.²⁹⁸ Although the Kobre & Kim report was extensive, some contended that key points were less than fully investigated.²⁹⁹ Some of those concerns overlapped with concerns regarding gaps in the reporting of possible conflicts of interest among those involved in debt restructuring in various roles. The UCC has also sought to obtain documents and other evidence in PROMESA Title III litigation.³⁰⁰ The Oversight Board, as noted above, challenged certain debts. Oversight Board Executive Director Natalie Jaresko, responding to congressional questions in an October 2019 hearing, opposed a new effort to audit Puerto Rico's public debts, which, in her view, would delay restructuring processes underway and the resolution of PROMESA Title III litigation.³⁰¹

A bill was introduced in the Puerto Rican Senate on February 25, 2021, that would again establish a commission to audit the island's public debts.³⁰² The Oversight Board contended that such a commission would duplicate work done by Kobre & Kim and suggested the Puerto Rican Senate modify the bill.³⁰³

Constitutional Restraints May Be an Ineffective Substitute for Prudent Budgeting

Some economists have called for imposing constitutional restrictions on government finances, such as on outlays, revenues, or debt. The Puerto Rican Constitution, as discussed above, includes a balanced budget requirement and various constraints on public debt. Those provisions, however, did not appear to set an effective constraint on levels of indebtedness. In the 1840s, when several states had defaulted on or repudiated public debts, other states in similar fiscal straits managed to avoid default, apparently motivated by a desire to maintain good credit. Those examples might motivate federal policymakers to reassess the utility of constitutional or legal mechanisms to ensure sustainable fiscal policies relative to other ways of establishing fiscal balance. Sound fiscal policies may provide a better bulwark against default.

Appendix A. Details of Puerto Rico's Public Debt

Table A-1 presents data underlying Figure 2, which provides a breakdown of Puerto Rico's public debts at the end of July 2016, shortly before the PROMESA debt restructuring process commenced. One column shows indebtedness to the GDB (GDB Loan), which had been the Puerto Rican government's fiscal agent and advisor. Public agencies and corporations deposited funds in GDB accounts, and the GDB extended loans to some public corporations as an alternative to issuing bonds to the municipal finance market. GDB bonds are excluded from Figure 2 to minimize double counting.

Appendix B. Price Trends and Trading Volumes for Selected Bonds

Prices of Puerto Rico's bonds have experienced wide swings since the island's fiscal precarity became more widely known in 2013. Prices reveal market views of the value of future cash flows, which in the case of Puerto Rico's public bonds will be determined in large part by the debt restructuring processes created by PROMESA.

Some in Congress have expressed concerns that some investors may have traded on nonpublic information obtained in the course of PROMESA Title III negotiations among creditors, the Oversight Board, and representatives of Puerto Rico's government. Charts shown below depict price trajectories and trading volumes for selected bonds. CRS chose specific bonds either because the U.S. Treasury had identified them as representative in materials distributed in the legislative deliberations that led to PROMESA or because they were larger issues that would likely be more liquid than smaller issues. CRS also chose bonds that would have been affected by initiatives by the Oversight Board and the UCC to invalidate certain GO and PBA bonds.

Some 18 entities issued public debt on behalf of Puerto Rico, which added to the complexity of the island's debt structure. In addition, most bond issuances were divided into multiple subissues. Therefore, the figures below give a partial view of trading activity.³⁰⁴

The charts also show, by means of vertical lines, some key events in the restructuring processes. Those key dates, and other events, are listed in Table C-1, with links to related documents. Rational investors trade when they have new information, when assets' risk characteristics are perceived to have shifted, or due to liquidity needs.

COFINA Prices and Volumes

Figure B-1 shows the evolution of prices and trading volumes for senior and subordinate (junior) COFINA bonds from 2016 through February 2019, when old COFINA bonds were exchanged for new ones. Trading amounts are aggregated by week, with bars centered on Mondays.³⁰⁵ Trade volumes are typically larger for junior bonds, which was a larger issue, but also may reflect strategic purchases, as described in a previous section. Other things equal, larger bond issues are more liquid and trade more frequently.

Trades in junior bonds picked up after PROMESA's enactment, but those volumes were dwarfed by some large trades after COFINA defaulted and before the Title III court appointed representatives for the debt negotiations. Prices for COFINA junior bonds fell to nearly 10% of par after Hurricane María, but both senior and junior bond prices began to recover at the end of 2017, and especially after the February 2018 passage of the Balanced Budget Act of 2018 (BBA 2018; P.L. 115-123), which provided funds for Puerto Rico. Those prices jumped sharply after an agreement on a split of COFINA revenues was announced in June 2018 and, to a lesser extent, once the Oversight Board announced details of the final COFINA deal.

Figure B-1. Trading Volumes for COFINA Bonds, 2016-2019

Source: CRS calculations based on Municipal Securities Rulemaking Board EMMA data: https://emma.msrb.org/. CUSIPs are COFINA Subordinated (74529JHN8), and COFINA Senior (74529JNX9). Notes: Trade volume aggregated by week, centered on Mondays. See text and Table C-1 for information on key events. Vertical scales differ. Volumes include inter-dealer transactions used to execute block trades.

GO and PBA Bond Prices and Trading Volumes

Figure B-2 shows prices and trading volumes for selected GO bonds from 2018 through 2020. Figure B-3 shows that information for selected Public Building Authority (PBA) bonds. These charts, as noted elsewhere, provide a partial view of the price and trading of GO and PBA bonds due to the degree of fragmentation of Puerto Rico's debt structure.

From the time of their issuance until around the time that Hurricane María hit Puerto Rico, the 2014 GO bonds, issued with a provision to be governed by New York law, traded at a premium to other GO bonds. After María, that premium vanished and GO bonds traded at similar prices, just above 20% of par (as shown in Figure 4). During 2018, those bonds' prices rose to about 50% of par, with marked increases after enactment of the Balanced Budget Act of 2018 (P.L. 115-123) in February, the April release of Oversight Board proposals for pension reductions and other changes, and the Board's announcement of a framework for a COFINA settlement in August.³⁰⁶

GO bond prices began to diverge in January 2019, when the Oversight Board and the UCC challenged the validity of late vintage GO bonds and PBA bonds. The 2014 GO bonds began to trade at lower prices than earlier vintage GO bonds. That gap increased after GO/PBA PSA negotiations began in April 2019. Sculptor Capital, a hedge fund member of the Lawful Constitutional Debt Coalition, outlined four no-trade periods, beginning with the start of the PSA negotiations, and claimed that its trades of relevant bonds took place outside of those periods (Table B-1). Some large trades in 2011 GO bonds, however, took place during the first no-trade period, although whether those traders possessed nonpublic information is unclear. Many trades also occurred soon after the end of those periods. As those periods ended when previously private information became public, one would expect markets to react.

GO bond spreads narrowed after the fourth no-trade period ended with the Oversight Board PSA announcement. GO and PBA bond prices dipped in spring 2020, but stabilized after May 2020, when the Title III court required detailed Rule 2019(b) disclosures.

Figure B-2. Price Trends and Trading Volumes for Selected GO Bonds, 2018-2022

Source: CRS calculations based on the Municipal Securities Rulemaking Board EMMA site: https://emma.msrb.org/. CUSIPs are 2006A (74514LHN0), 2009B (74514LVW4), 2011A GO (74514LYW1), 2012A (74514LA98), and 2014A NY Law GO (74514LE86). Notes: See text and Table C-1 for information on key events. Trade volumes are summed by week, centered on Mondays. Vertical scales differ. Light grey areas denote no-trade periods as described by Sculptor Capital. Volumes include inter-dealer transactions used to execute block trades.

Figure B-3. Selected Puerto Rico Building Authority Bond Price Trends and Trading Volumes, 2018-2020

Source: CRS calculations based on the Municipal Securities Rulemaking Board EMMA site: https://emma.msrb.org/. Notes: See text and Table C-1 for information on key events. Trade volumes are summed by week, centered on Mondays. Vertical scales differ. Light grey areas denote no-trade periods as described by Sculptor Capital. Volumes include interdealer transactions used to execute block trades.

Appendix C. Chronology of Selected Events

Table C-1 lists many key events in the restructuring of Puerto Rico's public debts.

Appendix D. Table of Common Acronyms