Moody's Investors Service said it has downgraded the rating for Puerto Rico Electric Power Authority's (PREPA) $8.8 billion of power revenue bonds to Caa3 from Caa2.
This rating action concludes the rating review that Moody's initiated on July 1, 2014.
PREPA's rating outlook is negative.
Separately, Moody's said it has confirmed ratings on the Puerto Rico Highway and Transportation Authority (PRHTA), the Puerto Rico Aqueduct and Sewer Authority (PRASA), and the Puerto Rico Convention Center District Authority (CCDA), concluding a review for possible downgrade that began July 1.
The ratings have been confirmed at Caa1, except for PRHTA subordinate-lien bonds, which are confirmed at Caa2. The outlooks are negative, in line with the commonwealth of Puerto Rico (B2, negative).
The downgrade considers the uncertainty that persists regarding the details of the expected restructuring plan by PREPA, the implementation risk that continues regarding PREPA's ability to execute on its multi-year fuel conversion plan and any such debt restructuring will involve some degree of impairment for bondholders.
The downgrade to Caa3 further incorporates a belief that the expected recovery rate could approximate 65% to 80% in the event of a default, which is highly likely. While the recently entered Forbearance Agreement provides time for parties to work on a consensual restructuring plan, any restructuring proposal will be influenced, to some degree, by the commonwealth's politics, particularly given the weakened and lackluster state of the Puerto Rico economy.
Implementation risk is high with respect to completing the multi-year fuel conversion plan, an important element for PREPA, and portions of this risk are outside of the PREPA's management control. The extensions of PREPA bank lines to March 31, 2015, and the Forbearance Agreement addressed immediate issues, but longer-term structural and liquidity issues remain.
PREPA's financial condition remains fragile, as bondholder debt service due January 1, 2015 is expected to be satisfied by draws against various reserve accounts held by a trustee, and as part of the Forbearance Agreement, liquidity needs can be satisfied by draws under the construction account reserve. In the end, the ability of the Forbearance Agreement to remain in place depends upon the progress towards completing a complex restructuring plan.
For example, PREPA could fall behind on its milestones and jeopardize the forbearance. The Ad Hoc group of bondholders may be working constructively with each other now, but this could change. There is also the possibility of political interference on the part of the Commonwealth government. While the existence of the Forbearance Agreement and the September 4th appointment of a Chief Restructuring Officer are constructive data points, Moody's said it cannot rule out the possibility that efforts to restructure could be derailed resulting in the Forbearance Agreement being terminated and PREPA moving to restructure under the newly enacted Debt Enforcement and Recovery Act (Recovery Act).
During the period of the forbearance, PREPA will make required payments on the bonds as stipulated in the Forbearance Agreement while it works on a restructuring plan, which is to be completed by March 2, 2015. The stipulated payments are to be put into a separate Specified Period Defeasance Fund with the Trustee, sufficient to enable PREPA to make its next scheduled interest payment on the bonds of $214 million.
Also during the period of the forbearance, PREPA must continue to pay interest on the outstanding bank lines. Failure to comply with the terms of any forbearance agreement will cause an early termination of that forbearance agreement and will cross-terminate to the other forbearance agreements.
If PREPA were to fail to make its required payments or to meet the milestones, the forbearance would unravel, and bondholders will be free to exercise their remedies and take other legal action.
A restructuring is most likely in the early part of 2015, and the timeline and milestones spelled out in the Forbearance Agreement support this. However, there is the possibility that a restructuring announcement could happen sooner and PREPA could avail itself of the new Recovery Act if negotiations among bondholders, PREPA and the government break down.
The Caa3 rating and the negative outlook incorporate this uncertainty.
The negative outlook also considers the uncertainty and obstacles to executing on a complex restructuring plan as well as the long-term capital investment program focused on converting oil-based power generation to natural gas in the face of a very challenging economic environment within the Commonwealth.
