(Adds details, comment, background, updates bond prices)
NEW YORK, May 14 (Reuters) - An offer by Puerto Rico's biggest bondholder groups to settle a dispute covering about half the bankrupt U.S. territory's $71.5 billion in bond debt appeared dead on arrival on Monday, rejected by the island's federal financial oversight board.
The board issued a statement soon after the bondholders offered to give storm-ravaged Puerto Rico $9.7 billion worth of debt relief, calling the settlement offer "completely unaffordable."
It is a sign, though, that mediation to resolve Puerto Ricos debts, and stem costly litigation, may be making headway.
Under the current agreement between general obligation bondholders and so-called COFINA holders, whose debt is backed by sales tax revenue, a new trust would have been created to own Puerto Rico's sales tax.
Puerto Rico owes about $18 billion each in general obligation and COFINA debt, meaning that the groups combined own roughly half of the island's bonds.
COFINA creditors would get certificates in the new trust entitling them to 52.5 percent of the tax revenue, while 46.2 percent would benefit GO holders. The remaining 1.3 percent would go to general unsecured creditors.
The new paper would be structured as current interest bonds with a 6 percent rate, and capital appreciation bonds with a 6.5 percent rate. GO bondholders would also get so-called remainder claims against the trust for amounts not covered by their stake in it.
The deal was aimed at resolving the single biggest dispute in Puerto Rico's massive, $120 billion bankruptcy. For years, GO and COFINA holders have disputed which side is entitled to Puerto Rico's sales tax revenue, and litigation has been working its way through federal court.
The board, appointed by the U.S. Congress in 2016, said the proposed settlement deal did not align with a previously-imposed blueprint for Puerto Rico's fiscal turnaround.
"The economic terms of this creditor proposal were not crafted with any prior input from either the oversight board or the government and are completely unaffordable," the board said in a statement on Monday morning.
The board, which must approve settlements in Puerto Rico's bankruptcy, added that the terms "would create large and recurring structural deficits over the long-run."
Puerto Rico's government also opposed the deal. The island's financial authority, AAFAF, said in a statement that the debt service levels contemplated under the deal "are not sustainable in light of Puerto Ricos projected fiscal and economic situation."
Puerto Rico is battling the twin scourges of fiscal and natural disaster. With $71.5 billion in bond debt and another $50 billion in pension debt, it filed the biggest bankruptcy in U.S. government history last year.
Then, in September, it was hit by Hurricane Maria, which decimated its infrastructure, killed dozens, and sent bond prices plummeting. They have since recovered somewhat.
Statements from the creditor groups suggest the terms of the deal may be re-workable while maintaining the basic structure.
COFINA creditors revealed that in April, they proposed a similarly-structured deal, in which they would have received two-thirds of the proceeds of the new trust, with GO holders getting about 34 percent.
The COFINA group said in a statement on Monday that discussions remain ongoing, adding that they were committed to exploring restructuring solutions.
The GO bondholders said the deal was a way to speed up the bankruptcy process and avoid costly litigation.
"The supporting parties have come together for the first time in years to forge an agreement on a settlement framework that provides for a consensual path to a successful restructuring," the GO creditors said in a statement.
Puerto Rico's defaulted benchmark general obligation debt carrying an 8 percent coupon rose to a high of 46.50 cents on the dollar from Friday's closing price of 41.375, according to Thomson Reuters data.. It currently trades at around 43.25 cents.
Sales tax-backed senior COFINA debt surged up to 72.25 cents on the dollar from Friday's close of 60 cents, while COFINA's junior debt traded up to 35.25 cents from Friday's close of 30.25 cents. (Reporting by Nick Brown; editing by Daniel Bases, Jonathan Oatis and Tom Brown)