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  • Efforts by the U.S.-appointed and unelected fiscal control board to manage the debt crisis have included oppressive austerity measures.

    Efforts by the U.S.-appointed and unelected fiscal control board to manage the debt crisis have included oppressive austerity measures. | Photo: Reuters

Published 28 July 2017

In Puerto Rico, 18 public agencies owe a combined US$120 billion in bond and pension debt.

U.S. mutual funds that held onto Puerto Rican debt could face battles that pit their own investors against each other, as the island navigates the biggest government bankruptcy in the nation's history.

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Reuters reported that the reason for the potential challenge lies in the U.S. territory's Byzantine capital structure, where 18 public agencies owe a combined US$120 billion in bond and pension debt.

Puerto Rico's constitution guarantees the debt of GO, or General Obligation, bondholders, while other debt, known as COFINA, is backed by revenue streams from tax proceeds. But as both sides claim a right to sales tax revenue, COFINA creditors and locked in litigation with holders of GO bonds. 

For Oppenheimer Funds and Franklin Advisers, whose combined US$10.3 billion in Puerto Rican debt makes them among the island's biggest creditors, they held US$3.2 billion of COFINA as of April 30, more than twice their combined GO holdings. Yet at Franklin, six funds held exclusively GO debt, claims worth a combined US$276 million.

Similar clashes exist between senior COFINA holders, who have first claim on the tax revenue, and junior creditors.

Overall, the companies held nearly four times as much junior as senior COFINA debt. Yet Oppenheimer's Rochester Fund Municipals, for example, had US$384 million of senior debt and just US$83 million of the junior tranche.

The funds say cross-holdings give them more of a stake than other creditors in Puerto Rico and reflect a long-term commitment to the island. However, bankruptcy and municipal bond experts said the competing claims raise questions about whether the funds can represent investors' "best interests."

"You run all these funds - which do you side with?" Dawson, a professor at the University of Miami School of Law, said to Reuters. "If I were an investor, I'd be concerned."

Oppenheimer, Franklin and Santander have formed an ad hoc bankruptcy negotiating group to reach a deal. Court documents and public statements from the group suggested it tends to side with classes of debt where its funds have the most exposure to "maximize total returns across portfolios."

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For example, the funds have primarily advocated for the COFINA junior tranche, where they have the greatest exposure, at the expense of senior COFINA and GO creditors.

Tom Metzold, a municipal bond portfolio manager at Eaton Vance, told Reuters the strategy is "sound but risky." By fighting primarily for junior bondholders, the funds raise the odds of reaching a fair deal for everyone, given that senior creditors are already well represented, he said.

Metzold added that the funds would also face growing criticism that they did not fight hard enough for their senior-most holdings. 

"A number of people will be performing autopsies" on whatever decisions the funds make, Metzold said. "I'm glad I'm not in their shoes."

Efforts by the U.S.-appointed and unelected fiscal control board that was established by the Puerto Rico Oversight, Management, and Economic Stability Act, known as PROMESA, to manage the debt crisis have included oppressive austerity measures. Recently the government — under pressure of the fiscal control board — announced education budget cuts amounting to US$450 million by 2021, a move that was met by student protests and strikes.


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