Puerto Rico bondholders mobilize; some hedge funds tap Morrison & Foerster

by by Seth Brumby, Jon Berke and Maryellen Tighe

[Subsequent to the publication of this report, Aurelius contacted this news service to say the firm has maintained a positive dialog with the Commonwealth and with like-minded bondholders, with the hope of restoring the Commonwealth to financial health and helping to finance its needs.]

After months of presentations and marketing, The Public Corporation Debt Enforcement and Recovery Act finally catalyzed the organization of Puerto Rico’s bondholders. First, Oppenheimer Rochester Funds and Franklin Funds, long-time investors in commonwealth debt, enlisted Kramer Levin Naftalis & Frankel to sue the government in federal court in Puerto Rico over the legality of the Recovery Act.

Now, hedge funds have begun to coalesce around their own legal experts and have hired Morrison & Foerster, said two sources familiar with the matter and a bondholder.

Monarch Alternative Capital, Fir Tree Partners, Brigade Capital Management and Perry Capital Management are spearheading the ad hoc group, said the first source familiar with the matter and a bondholder. The group is looking to hire a financial advisor and will hear pitches from advisors this week, said the two sources familiar.

Meanwhile, other bondholders, including Aurelius Capital Management, Mackay Shields, Apollo Global Management and Fortress Investment Group are looking to take on a more activist role as the island’s restructuring heats up, said two restructuring lawyers looking to get involved in the situation. Whether the bondholders consolidate into one group remains to be seen.

Initial organization efforts point to differing motivations between the hedge funds and the island’s traditional investors. While Oppenheimer and Franklin have a clear intention in blocking the island’s attempts to restructure its public corporations through the Recovery Act, the crossover buyers are not so certain that fighting the Recovery Act is the best way to embark on a restructuring, said the first restructuring lawyer.

The hedge funds have north of USD 3bn in holdings across the island, notably in the island’s general obligation debt, debt issued by the Sales Tax Financing Corporation (COFINA), the Public Building Authority (PBA), and the Government Development Bank of Puerto Rico, said the two sources familiar and the bondholder.

Debt issued by these entities is not affected by the Recovery Act, according to the text of the legislation. That means the commonwealth is not intent on impairing tax-backed debt through the Recovery Act. The hedge funds are supportive of the island’s focus on restructuring the public corporation debt and are available to provide private capital, said the second source familiar.

Restructuring the island’s public corporations, like the Puerto Rico Electric Power Authority (PREPA) and Highways and Transportation Authority (HTA), might actually be a boon for holders of the commonwealth’s tax-backed debt, said the first restructuring lawyer and a trader.

“If you take a reduction in your PREPA debt, [general obligation] holdings should rally,” said the trader.

The commonwealth has not yet responded to the Kramer Levin complaint, which was filed on 28 June. It executed a summons on 30 June for the government to respond. The government could have anywhere from 21 to 60 days to respond to the complaint – depending on whether it considers itself a US agency or affiliate, according to court documents. That means the market might not see or hear anything from the commonwealth on the lawsuit until Labor Day.

Calls to the aforementioned hedge funds were not returned. Morrison & Foerster declined to comment.

The commonwealth’s benchmark USD 3.5bn 8% Series 2014 general obligation bond due 2035 traded heavily this morning, up slightly to 87.5 to yield 9.4% from 86.5 to yield 9.6% yesterday, according to Electronic Municipal Market Access (EMMA).

Meanwhile, its USD 900m 6% Series 2009 COFINA subordinate bond due 2042 traded yesterday in round lots at 72 to yield 9%, up from round lots at 69 to yield 9.4% on 10 July, according to EMMA.

PREPA, which the market largely considers the most at risk of a restructuring via the Recovery Act, has taken a nose dive since late June. It’s USD 358m 5% Series 2012A power revenue bond due 2042 traded today at 42 to yield 12.3%, slightly more firm than round lots at 33 that yielded 15.2% on 2 July, according to EMMA.

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