Fitch Maintains Negative Watch on Puerto Rico Electric Power Auth's Rev Bonds

Fitch Ratings maintains the Rating Watch Negative on $8.7 billion of Puerto Rico Electric Power Authority (PREPA) power revenue bonds. The bonds are rated 'CC'.

SECURITY

The power revenue bonds are secured by a senior lien on net revenues of the electric system.

KEY RATING DRIVERS

RESTRUCTURING OR DEFAULT REMAINS PROBABLE: Maintenance of the current Rating Watch Negative reflects Fitch's view that a restructuring of PREPA's debt obligations remains probable despite recent forbearance agreements between PREPA and certain of its creditors (including bondholders). The agreements, signed on Aug. 14 2014, provide only temporary relief related to the scheduled maturity of PREPA's bank lines of credit, and minimal comfort that long-term financial compliance is sustainable.

TIME FOR NEGOTIATION PROVIDED: Pursuant to the forbearance agreements PREPA's principal creditors have agreed not to exercise any rights or remedies under their respective agreements through March 31, 2015, which allows for continued operations and time for additional negotiations. The maturity dates on PREPA's existing $696 million of bank loans have also been extended to March 31, 2015 (from Aug. 14, 2014).

TERMS POINT TO RESTRUCTURING: Although certain provisions of the agreements appear designed to enhance PREPA's ability to meet near-term operating expenses, other provisions including the required submission of a restructuring plan by March 2, 2015, retention of a chief restructuring officer and the contemplated use of reserve funds for debt service payments support Fitch's view that a financial restructuring remains probable.

CASH FLOW CONCERNS REMAIN: The terms of the forbearance agreements allow for bondholders to be paid scheduled debt service, including payments due Jan. 1, 2015. However, Fitch remains concerned that PREPA's net cash receipts and existing funds on hand are insufficient to meet longer term working capital, debt service and other funding requirements.

FINANCIAL PERFORMANCE REMAINS WEAK: For the 12 months ended June 30, 2014 PREPA reported unaudited earnings before interest and depreciation of $781 million and a net loss of ($267 million). The net loss was well above PREPA's budgeted loss of ($161 million). Poor performance for the fiscal year was further characterized by declining energy sales (3.6% in fiscal 2014), declining customers (1.5%), high concentrations of accounts receivable (25% of revenue), high fuel costs (14.99 cents/kWh) and an unwillingness to increase base electric rates.

RATING SENSITIVITIES

FINANCIAL RESTRUCTURING: Any restructuring that does not result in full and timely payment of the power revenue bonds according to the original terms promised, would likely result in a further downgrade to 'C' upon agreement and 'D' upon execution.

REQUEST FOR RELIEF: Similarly, any request for relief through restructuring by PREPA, or GDB upon the Governor's request, as contemplated in the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (the Act) would result in a further downgrade.

NEGOTIATED RESOLUTION TO CHALLENGES: Any negotiated resolution to the financial challenges and liquidity demands facing PREPA that does not impair bondholders would be evaluated for commercial reasonableness and long-term sustainability, and could lead to consideration of a Stable Outlook and/or higher rating.

CREDIT PROFILE

PREPA is one of the largest public power systems in the U.S., and the sole provider of power to the Commonwealth of Puerto Rico, an island of about 3.6 million people and about 1.49 million electric customers.

DIVERSIFICATION STRATEGY REASONABLE BUT UNCERTAIN

PREPA's concentration of power resources in oil generation exposes the authority to volatile fuel costs and environmental mandates. Fitch views the utility's efforts to diversify its energy mix positively, as the continued reduction in oil generation dependency should alleviate some of the pressure on future financial margins, as well as meet required U.S. Environmental Protection Agency (EPA) mandates.

PREPA has pursued a reasonable strategy to reduce dependency on costly oil-fired generation, completing the conversion of the Costa Sur generating facility to dual-fuel and planning for construction of the Aguirre LNG terminal and conversion of Aguirre generating units. However, PREPA requires additional capital to fully execute this capital plan and access to capital remains questionable.

WATCH RESOLUTION TIED TO RESTRUCTURING PLAN

Fitch expects to resolve the current Rating Watch Negative following review of PREPA's proposed restructuring plan. Fitch downgraded the rating on PREPA's net revenue bonds to 'CC' from 'BB' on June 26, 2014 to reflect its view of a probable restructuring following introduction of the Act. Pursuant to the terms of the forbearance agreements, PREPA is now expected to submit to bondholders an updated business plan by December 15, 2014, and a restructuring plan by March 2, 2015. PREPA recently appointed a chief restructuring officer, consistent with terms of the agreements.

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