212-373-3158

212-373-2122

arosenberg@paulweiss.com

April 27, 2017

Senator Thom Tillis

185 Dirksen Senate Office Building
Washington, DC 20510

Senator Tom Cotton

124 Russell Senate Office Building
Washington, DC 20510

Re: Puerto Rico Oversight Board

Dear Senator Tillis and Senator Cotton:

The Ad Hoc Group of Puerto Rico GO Bondholders (GO Group) appreciates

your continued interest in the Fiscal Plan for Puerto Rico that the Oversight Board
certified on March 13, 2017. We have carefully reviewed your letter to the Oversight
Board, dated April 7, 2017, as well as the Oversight Boards response, dated April 25,
2017.

Unfortunately, the Oversight Boards response fails to address the core questions
you raised on April 7th concerning the Fiscal Plans compliance with PROMESA, and
instead confirms that the Oversight Board has little interest in following the law as
 2

Congress intended. In particular, the Oversight Board asserts that it does not have to
respect the priorities and liens set forth in Puerto Ricos Constitution on the theory that
Congress only required that the Board respect priorities and liens. According to the
Board, that allows it significant flexibility to payin clear violation of Puerto Ricos
Constitutionlower priority creditors in full while proposing substantial cuts to more
senior creditors. The Oversight Boards theory is squarely at odds with Congress stated
intent. According to Congress itself:

Section 201(b)(1)(N) was added to ensure fiscal plans keep intact the
structural hierarchy of prioritized debt; 1 and

Section 201(b)(1) should not be interpreted to reprioritize pension

liabilities ahead of the lawful priorities or liens of bondholders as
established under the territorys constitution, laws, or other agreements. 2

The Boards response to your letter is a direct rebuke of the plain language of PROMESA
and the clear legislative intent of Congress.

Moreover, the Oversight Board wrongly asserts that the Commonwealth cannot
allocate more than $787 million annually (roughly 6% of its local revenues) to payment
of debt service. As set forth below, that is incorrect on a macro-level when considering
that Puerto Rico is presently enjoying record high tax collections and nominal GNP, and
when compared to the percentage of revenues that other sovereigns allocate to debt
service. The Boards position is also incorrect on a micro-level when considering the
numerous flaws in the Fiscal Plan, most notably a $618 million annual cushion ($6.2
billion over the Fiscal Plans 10-year term) for unidentified expenses based on the
assumption that Puerto Rico will not adhere to its (Oversight Board certified) budget.

Creditors have identified serious errors with the Fiscal Plan, including many that
plainly violate the plain language of PROMESA. The Boards suggestion that creditors
are only unhappy because the pie is not larger is disingenuous, at best. Creditors are
dissatisfied because the Oversight Board ignored all input from creditors before it
certified the Fiscal Plan, and now, when asked by your offices to explain how the Fiscal
Plan complies with PROMESA, the Board offers faint lip service but nothing more.

1
Memorandum of the Full Committee Markup of H.R. 5278 Before the H. Comm. on Nat. Res., 114th
Cong. (2016), http://naturalresources.house.gov/uploadedfiles/markup_memo_--
_h.r._5278_05.24.16__05.25.16.pdf.
2
H.R. Rep. No. 114-602, pt. 1, at 45 (2016).
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Unanswered Questions

You asked the Oversight Board to provide in detail how the Fiscal Plan
complies with several requirements of PROMESA. In particular, you requested an
explanation of (i) how the Fiscal Plan respect[s] the relative lawful priorities in Puerto
Ricos Constitution, as required under Section 201(b)(1)(N) of PROMESA, and (ii) why
the Fiscal Plan fails to differentiate between essential and non-essential expenditures.
The Board either did not provide coherent responses to these questions or did not address
them at all.

Respect for Priorities in Puerto Ricos Constitution

Section 201(b)(1)(N) of PROMESAwhich sets forth one of the requirements

of any fiscal planprovides that the Fiscal Plan shall respect the relative lawful
priorities or lawful liens, as may be applicable, in the constitution, other laws, or
agreements of Puerto Rico. It is no accident that Congress referenced priorities and
liens in the constitution: Puerto Ricos Constitution requires that when available
resources are insufficient to cover all of the Commonwealths obligations, Constitutional
Debt 3 shall be paid first. (P.R. Const. Art. VI, Sec. 8.) None of Puerto Ricos other
obligations (whether for funded debt or otherwise) enjoy any priority or lien under Puerto
Ricos Constitution. The Constitutional priority and lien afforded Constitutional Debt is
unquestionably lawful, and is further codified in Puerto Ricos Management and
Budget Office Organic Act, 23 L.P.R.A. 104(c). That Act recognizes that payment on
Constitutional Debt shall come first, and specifies that payments or disbursements related
to contracts, public health, safety, education, welfare, pensions, and capital works and
improvements shall only be made after payments on Constitutional Debt.

The Fiscal Plan the Oversight Board certified disregards Puerto Ricos
Constitution and its laws, and therefore also disregards Section 201(b)(1)(N) of
PROMESA. The Fiscal Plan plainly provides, in the first instance, for payments or
disbursements of lower-priority expenses, while treating Constitutional Debt as among
the very last expenses to be paid, lumped together with other non-Constitutional Debt.
The Oversight Board admits this in its Letter by stating that the Fiscal Plan first computes
all revenues and expenditures and then computes the funds available for debt service.
(Apr. 25th Letter at 3.) But even a cursory review of the Fiscal Plan confirms that debt
service is the very last line item, comprising any revenues remaining after all other
expenses are paid. (Fiscal Plan at 29.)

The Oversight Boards justification for how the Fiscal Plan respects the priorities
set forth in Puerto Ricos Constitution and therefore meets the requirement of Section

3
The term Constitutional Debt refers to bonds issued or guaranteed by the Commonwealth of Puerto
Rico that are backed by a pledge of its good faith, credit, and taxing power and are accordingly entitled
under Puerto Ricos Constitution to a first-priority claim to and lien on all of the Commonwealths
available resources.
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201(b)(1)(N) of PROMESA cannot be taken seriously. First, the Oversight Board says
that the Fiscal Plan respects priorities by increasing revenues, cutting expenses and
reallocating tax revenues to the Commonwealth. That is no answer at all. While the
Oversight Board should seek to increase revenues and cut expenses, these actions have
nothing to do with how the Commonwealth chooses to spend its resources. Its
Constitution, on the other hand, dictates the priority of expenditures, and provides that
Constitutional Debt should be paid first. The Fiscal Plan does not respect this
Constitutional priority; instead, it contemplates that the Commonwealth will, in fiscal
year 2018, first spend approximately $11.7 billion of local revenues on non-debt
expenditures, and then allocate the remaining $400 million in projected surplus for all
debt service. Simply put, raising revenues and reducing expenses, while necessary, have
nothing to do with the requirement of Section 201(b)(1)(N) that the Fiscal Plan respect
constitutional priorities and liens.

Second, the Oversight Board says that the word respect was intended to
provide[] flexibility and is different from other words in Section 201(b)(1) such as
ensure or provide. In essence, the Oversight Board takes the position that they can
ignore section 201(b)(1)(N) entirely because they perceive a semantic difference between
the words respect and comply. Of course, the Oversight Board does not tell you
what they think the word respect means. That might require consulting a dictionary
and recognizing that respect means, for example, to avoid violation of or interference
with: respect the law (American Heritage College Dictionary, 3rd Ed.).

Whatever dictionary it consults, the Oversight Board has made clear that it has no
intention of respecting the priorities or liens in Puerto Ricos Constitution or laws.
Rather, it believes it has the flexibility to completely ignore these laws. Congress need
look no further than the drastic difference in how the Fiscal Plan treats debt service and
pensions. For debt service, the Fiscal Plan provides annually an average of $787 million,
compared to the $3.51 billion average Puerto Rico owes bondholders annually. This
represents a 78% reduction in debt payments. In contrast, the Fiscal Plan contemplates
only a 10% reduction in pension expenses, resulting in the Commonwealth paying nearly
$2 billion annually in pension contributions. It bears repeating that under Puerto Ricos
Constitution and its Management and Budget Office Organic Act, Constitutional Debt
must be paid first, and public welfare and contributions to retirement systems and
payment of pensions shall be paid third. The Oversight Board, in blatant disregard of
Section 201(b)(1)(N), simply thumbs its nose at Congress:

[Section 201(b)(1)] should not be interpreted to

reprioritize pension liabilities ahead of the lawful priorities
or liens of bondholders as established under the territorys
constitution, laws, or other agreements. While this language
seeks to provide an adequate level of funding for pension
systems, it does not allow for pensions to be unduly
favored over other indebtedness in a restructuring.
 5

See H.R. Rep. No. 114-602, pt. 1, at 45 (2016). The Oversight Board clearly believes
otherwise, and Congress should use all powers at its disposal to prevent such shameless
disregard of the law.

Essential vs. Non-Essential Expenditures

Your April 7th Letter also raised concerns that the Fiscal Plan fails to differentiate
between non-essential and essential spending. While the Oversight Board acknowledges
this concern in their response, it does not provide any explanation. To be sure, the Fiscal
Plan does not distinguish between essential and non-essential expenses. Rather, the
Fiscal Plan presumes that all Commonwealth (and in certain cases, component unit and
public corporation) non-debt expenses are paid before any payments are made on debt
service. The Fiscal Plan therefore provides approximately $18 billion in average annual
expenses, and asks Congress and creditors to presume that every last penny is necessary
to maintain an essential service. Section 201(b)(1)(B) provides that a Fiscal Plan should
ensure the funding of essential public services, but it is impossible for the Oversight
Board to meet this standard without first delineating what services are essential and what
services are not.

The underlying failure of the Oversight Board to consider what expenses are
essential further undermines the Boards repeated assertions that the Fiscal Plan cuts
expenses to the maximum. How can the Oversight Board possibly know if this
statement is true if it cannot first tell you what services are essential and what services are
not essential?

Oversight Boards Purported Inability to Enlarge the Pie

Rather than provide direct answers to your questions, the Oversight Board instead
lays out its case that Puerto Rico is in fiscal crisis, the Boards debt sustainability
analysis does not permit any additional funds for debt service, the Board has already
made significant expense cuts, and any additional expense reductions will reduce growth.
As set forth below, these characterizations are riddled with material misrepresentations
and errors.

The Current State of Puerto Ricos Economy

The Commonwealth economy has grown steadily for several decades, with
average annual nominal GDP growth of 5.2% over 30 years, and 1.8% growth over the
past 10 years. Even in recent years, both nominal GDP and GNP have continued to post
year-over-year increases and, in fact, are at all-time highs.

These trends continue to this day: through March 31, 2017, government revenues
are approximately 2.5% higher than revenues over the same period in 2016, and revenues
for fiscal year 2016 were 2.4% higher than revenues in fiscal year 2015. Not only are
revenues higher than 2016, they are significantly higher than Puerto Rico projected for
 6

fiscal year 2017. Through March 31, 2017, government revenues are $250 million (or
4.1%) higher than initially forecasted. Critically, the Fiscal Plan takes fiscal year 2017
projections as the base for all future years, and those projections are already proving to
inaccurately understate resources available to the Commonwealth.

The Oversight Boards Flawed Debt Sustainability Analysis

The Oversight Board argues that the Commonwealth cannot devote additional
funds to debt service because doing so would be inconsistent with the Boards debt
sustainability analysis. The Boards analysis, however, consists of nothing more than
projecting future revenues and expenses, and assuming that whatever surplus remains
after all non-debt expenses are paid constitutes a sustainable debt burden. This top-
down approach has no intellectual rigor and bears no resemblance to the formal debt
sustainability analysis framework traditionally used in sovereign restructurings. 4

Had the Oversight Board conducted a true debt sustainability analysis, it would
conclude that Puerto Rico is capable of sustaining more than $787 million annually in
debt service. The Fiscal Plan contemplates that, in fiscal year 2018, Puerto Rico will
devote only 3.3% of local revenues (after measures) to debt service. Over the next 10
years, despite projecting average annual local revenues (after measures) of $12.3 billion,
the Oversight Board has allocated only $787 million to average annual debt service (for
all debt), or 6.4% of local revenues (7.0% of adjusted General Fund revenues). 5 As a
percentage of General Fund revenues, this is significantly lower than U.S. states with
comparable populations. For example, the ratio of general obligation debt service (i.e.,
excluding other types of debt) to net revenues is 12% in Connecticut and 15% in Utah.
Moreover, the Puerto Rico Constitution itself reflects the judgment that 15% of revenues
is a sustainable debt burden for Constitutional Debt. 6 And total debt service as a
percentage of total revenues is 10% in Mexico, 14% in Costa Rica and Panama, 17% in
El Salvador, and 29% in the Dominican Republic and Jamaica.

Relatedly, joint World Bank/International Monetary Fund guidelines provide that,

even for low income countries (i.e., the poorest countries in the world, whose
economies are not as developed as Puerto Ricos), 18% to 22% of government revenues
constitutes a sustainable debt service burden. 7 Assuming (for illustration only) that this

4
See International Monetary Fund, Debt Sustainability Analysis (November 2013),
https://www.imf.org/external/pubs/ft/dsa/
5
Adjusted General Fund revenues adjusted to include SUT revenues purportedly assigned to COFINA,
claw-back revenues, pledged property tax revenues, and the estimated portion of revenue measures
attributable to the General Fund.
6
See P.R. Const. art. VI, 2 (tying limits on issuance of new Constitutional Debt to 15% of the
Commonwealths average annual revenues over the preceding two years).
7
See International Monetary Fund, Factsheet: The Joint World Bank-IMF Debt Sustainability
Framework for Low-Income Countries 2 (March 2016),
 7

formula applied to Puerto Rico, and utilizing the revised Fiscal Plan revenues (excluding
federal transfers), the Commonwealth could devote approximately $2.1 billion to $2.9
billion annually to debt service. Accordingly, it is not credible that the Commonwealth
can devote only 6.4% of its total local revenues (after measures) to debt service.

The Oversight Board Has Not Cut Expenses to the Maximum

The Oversight Board incorrectly suggests that the Fiscal Plan reflects a 34%
overall savings compared to the structural budget but the actual expense numbers tell
a vastly different story. Under the Fiscal Planafter taking into account the Boards
proposed reformsCommonwealth expenditures actually increase from fiscal year 2017
to 2026. In fiscal year 2017, the Commonwealth is expected to spend (after measures)
approximately $18.1 billion, and by fiscal year 2026 expenditures are estimated to
increase (after measures) to total $18.4 billion. The overall savings only materialize
when compared to a phantom structural budget that assumes $4.5 billion in annual
spending above the Commonwealths current spending levels.

Putting aside the Oversight Boards non-existent 34% cut, the Fiscal Plan contains
numerous other items which demonstrate that the Board is not focused on cutting
expenses.

The Reconciliation Adjustment

Most notably, the Fiscal Plan includes an incremental $6.2 billion Reconciliation
Adjustment, based upon the assumption that the Commonwealth will not adhere to its
budget (which will be approved by the Oversight Board) and therefore will need
approximately $600 million per year to pay for unidentified expenses. In its April 25th
Letter, the Oversight Board described this as an additional cash need, but notes that the
Fiscal Plan adopts a variety of stringent measures to fill the gaps created by the fiscal
cliffs and understatement of expenses. (Apr. 25th Letter at 7.)

While a limited reconciliation adjustment might arguably be appropriate for fiscal

year 2017 while the Oversight Board continues to gain a better understanding of Puerto
Ricos financials, the Oversight Board projects that this cushion for unidentified
expenses will actually grow every year for the next 10 years, notwithstanding the
stringent measures adopted by the Oversight Board. Thus, although the Board will
have been in place for a decade, it nonetheless projects that Puerto Rico will miss its
budget by $657 million in 2026 and therefore includes a reconciliation adjustment of
an equal amount to pay for such non-budgeted expenses.

http://www.imf.org/external/np/exr/facts/pdf/jdsf.pdf. For market access countries, which have

stronger economies than low income countries, the IMF considers gross financing needs within
15% to 20% of GDP to constitute a sustainable debt burden. See Staff Guidance for Public Debt
Sustainability Analysis in Market-Access Countries (May 2013),
https://www.imf.org/external/np/pp/eng/2013/050913.pdf.
 8

This expense not only can be cut (because the very purpose of the Oversight
Board is to introduce fiscal discipline) but, according to PROMESA, must be cut.
Section 203 requires the Commonwealth to submit quarterly reports to the Oversight
Board detailing whether the Commonwealth is in compliance with its approved budget.
In the event that the Commonwealth was not in compliance with its approved budget, the
Oversight Board shall make appropriate reductions in nondebt expenditures to ensure
that the actual quarterly revenues and expenditures for the territorial government are in
compliance with the applicable certified Territory Budget. (PROMESA 203(d)(1)
(emphasis added).) The Fiscal Plan turns this requirement on its head by permitting the
Commonwealth to build in a significant cushion upfront (a reserve nearly equal to the
annual amount dedicated to debt service), and thereby reduce funds available for debt
service, when Congress clearly stated that budgetary adjustments should be made from
nondebt expenditures.

Other Expense Growth

The Fiscal Plan that the Oversight Board certified on March 13th substantially
increased expenses compared to the fiscal plan originally proposed by the Governor. In
contrast to the February 28th Fiscal Plan, the Fiscal Plan that the Oversight Board
certified increased payroll expenses by more than $1.5 billion and increased operational
expenses by more than $400 million over ten years.

The Fiscal Plan also includes expenditures that are not related to the general fund
or services provided by the central government of Puerto Rico (and therefore are
presumably non-essential). In particular, the Fiscal Plan includes $7.4 billion in non-
enterprise expenses including ASEM, ASES, ADEA, PRCCDA, PRIDCO, PRITA,
Tourism, and UPR deficits. (Fiscal Plan at 14.) In all, deficits at component units and
other non-General Fund entities have likewise increased by $715 million over 10 years
compared to the February 28th Fiscal Plan proposed by the Governor. Moreover, the
Fiscal Plan assumes a compound annual growth rate of approximately 10% for such
expenses.

Further Expense Reductions Will Not Prevent Future Growth

It is undeniable that the Oversight Board does not fully understand Puerto Ricos
expenses, has not conducted a true bottoms-up analysis, and has not conducted a
traditional debt sustainability analysis. That is evident by the fact that the Oversight
Board includes over $6 billion in non-budgeted expenses because, according to the
Board, expenditures could be understated, (Apr. 25th Letter at 7 (emphasis added)), and
that the Board cannot distinguish between essential and non-essential expenses.

Undaunted, the Board claimsabsolutelythat further material annual cuts

would prevent growth and create minimally larger short term savings at the expense
of a significantly lower resource envelope over the medium and long-term. (Id. at 2.)
 9

The Oversight Board would have you believe that cutting $6 billion in unidentified and
non-budgeted expenses will somehow negatively affect growth. But setting aside the
Boards justification for saying this, their argument rests on the false premise that
government spending is the only input that affects growth, while ignoring the private
sector all together.

The Oversight Board Misrepresents the Extent of Negotiations

The Oversight Board devotes much of its April 25th Letter defending its desire to
negotiate with creditors, and characterizing creditors positions as unreasonable. Neither
characterization is accurate.

Notwithstanding the number of meetings the Oversight Board may have had
with creditors, you will not find any group of creditors who will agree that the Oversight
Board engaged in any type of meaningful negotiations prior to your April 7th Letter. As
the Board itself acknowledges, it only undertook efforts to formulate proposals after the
Fiscal Plan was certified on March 13th. (Apr. 25th Letter at 9-10.) While the Oversight
Board surely has many explanations for its timing, its worth repeating that the Oversight
Board was fully appointed on August 31, 2016 and held its first public meeting on
September 30, 2016.

For its part, the GO Group sent a detailed 10-page letter to the Oversight Board on
March 22, 2017 requesting that the Board make itself available during the week of March
27th-March 31st to discuss the Fiscal Plan and begin engaging in negotiations. Rather
than respond to the letter, the Board ultimately decided to conduct a formal mediation,
which did not commence until almost a month later, on April 13, 2017 (three weeks
before the stay was set to expire).

The Oversight Board also suggests that creditors have been unwilling to engage in
negotiations unless the Board first certify a new fiscal plan with more frothy and
optimistic assumptions. (Id. at 10.) This sentiment reflects a fundamental
misconception of the Oversight Board. Creditors are not demanding that the Board
adopt frothy assumptions that would enlarge the pie. Rather, creditors are
demanding that the Oversight Board justifybased on the revenue assumptions
contained in the Fiscal Planhow the Board has allocated the existing pie. Since
September 2016, creditors (including the GO Group) have provided repeated comments
on drafts of the fiscal plan, including that the Board had failed to respect lawful priorities
and liens, failed to identify essential services, failed to control expenditures, etc. The
Oversight Board never responded to these comments before it certified the Fiscal Plan,
and instead ignored them.

While creditors may have valid arguments for why revenues are being understated
(for example, the fact the Commonwealth continues to exceed its estimates), creditors are
more than willing to negotiate based on the revenue assumptions in the current Fiscal
PAUL, W E I S S , R I F K I N D , W H A R T O N & G A R R I S O N LLP

10

Plan. The question is not whether the Board must adopt "frothy" assumptions, but rather
(among others):

Whether it's appropriate to allocate only 6% of local

revenues to debt service, when comparable sovereigns
routinely devote 15% or more of revenues to debt service;

Whether it's appropriate to completely disregard the

priorities and liens set forth in Puerto Rico's Constitution
based on the Oversight Board's theory that when Congress
required priorities to be "respected," it actually intended to
grant the Oversight Board "flexibility" to pay creditors
whatever it deems appropriate;

Whether it's appropriate to cut debt by approximately 80%

while proposing cuts of less than 10% to pensions and other
politically favored creditors; and

Whether it's appropriate to include a $6 billion cushion for

non-budgeted expenses when the very purpose of
PROMESA is to instill fiscal discipline and budgetary
compliance.

These are legitimate questions that, to date, the Board has been unwilling to seriously
entertain. It is disingenuous for the Board to dismiss these concerns as creditors simply
demanding that the pie be increased by using unrealistic assumptions.

We hope you will continue to use all available tools at your disposal (including
Congressional hearings, if necessary) to ensure that PROMESA remains on track to
achieve Congress' goal of restoring fiscal responsibility and returning the
Commonwealth to the capital markets. The GO Group and its advisors are available at
your convenience to discuss these important issues.

Very truly yours.

Andrew Rosenberg