Analysts Weigh PREPA's Fate

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The spotlight is on the Puerto Rico Electric Power Authority as it faces a July 31 deadline to make already delayed payments to Citigroup and perhaps other banks for letters of credit.

Many analysts say that PREPA is probably near defaulting on its bond debt. They diverge on what form this default will take, when it will happen, and what impact it might have on Puerto Rico's other government entities.

PREPA has $8.7 billion in bonds outstanding, setting the stage for what would be the biggest municipal bond default in United States history.

If PREPA were to clearly default on paying the letters of credit, it would not constitute a bond default, but might presage a bond default, analysts said. And one analyst said that a PREPA bond default could trigger other defaults in Puerto Rico's $73 billion portfolio of bond debt.

PREPA's immediate challenge is to deal with the letters of credit. According to Standard & Poor's, PREPA owes Citibank $146 million for a line of credit. PREPA also owes a consortium of banks led by Scotiabank $525 million. According to Moody's, the other two banks in this group are Banco Popular de Puerto Rico and Oriental Bank.

In early July the banks agreed to extend the due dates for repayment of the letters to July 31.

Michael Ginestro, director of municipal research at Bel Air Investment Advisors, said he thinks the banks will not give another extension.

H. J. Sims senior credit analyst Richard Larkin believes they probably will.

If the banks call the letters it would be like "slitting their own throats," he said, because PREPA would turn to the commonwealth's new restructuring law. In that case the banks would get equal treatment to the bondholders. Instead, the banks will continue to seek changes from PREPA, Larkin said.

On Thursday Banco Popular said that its exposure to PREPA was $75 million, or just 1.6% of its Tier 1 Capital. Because Citibank and Scotiabank are large banks, problems with PREPA's letters should not affect them, Ginestro said.

Whatever happens with the negotiations on the letters of credit, the analysts generally expected PREPA to default on its bonds, though their scenarios diverged.

PREPA said its next bond payment is due January 1, 2015.

Joan Vidra, managing director of Opportunities Emerging & Frontier Markets Advisory, LLC said PREPA has little cash on hand and the Government Development Bank of Puerto Rico will not help out since it must preserve its liquidity for the commonwealth government. By Jan. 1 PREPA will likely have filed for bankruptcy under one of the two chapters of Puerto Rico's new public corporation restructuring law, she said.

AllianceBernstein senior vice president Joseph Rosenblum said that he was unsure if the January payment will be made. There should be enough money in the debt service reserve with the trustee to make the payment. It is possible that PREPA will try to get the trustee to not use the debt service reserve for the payment, Rosenblum said.

Municipal Market Advisors Managing Director Robert Donahue wrote that the trustee might withhold the payment on its own initiative.

"With the reserve containing only one year of scheduled interest expense - and now depleted by approximately 10% -- we expect the bond trustee is unlikely to make any more distributions to bondholders, reserving cash for likely litigation expenses," he wrote in MMA's Weekly Outlook. PREPA's trustee, U.S. Trust, did not respond to an inquiry about Donahue's statement.

Rosenblum said a bond restructuring could be announced far before the start of 2015. PREPA did not make its scheduled bond payment to its trustee on June 25, he said.

According to the agreement governing the bonds, the trustee should have notified bondholders of this lack of payment on the date. This notification has not been mentioned by participants. Assuming it was made, PREPA has 30 days, or until July 25, to refill the withdrawal from its debt service fund or there is a technical default, Rosenblum said on July 24.

If the technical default occurs, bondholders could direct the trustee to take actions that could lead bondholders to ultimately have a receiver appointed who would control PREPA in their interests, Rosenblum said. Puerto Rico's government does not want this to happen and would use the recently passed restructuring act to block this.

The restructuring act would supersede the current agreement governing the PREPA bonds.

As of July 24, Rosenblum said he expected PREPA to either have its debt restructured or to turn to some sort of alternative financing. The latter might be in the form of lending from hedge funds or from banks that demand a prime position for their loans.

PREPA is struggling with the need to repay its letters of credit, pay for oil for its electrical generators, finance plans to convert its plants to less expensive natural gas, and cover other expenses, Rosenblum said.

PREPA already charges high electricity rates compared to those on the mainland and Puerto Rico's government does not want to raise them further, fearing the impact on its economy, Rosenblum said.

Rosenblum said PREPA could use the restructuring law, enter receivership, or go into Chapter 9 bankruptcy if the United States Congress extends its coverage to Puerto Rico's public corporations, as Puerto Rico's resident commissioner is now seeking. Any of these options would involve a default, he noted.

In mid-July a source close to Gov. Alejandro García Padilla said PREPA leaders were meeting daily with GDB officials to figure out what to do with the authority's finances. She said she expected the PREPA leaders to come up with a plan without the governor's input. Only if PREPA cannot develop its own plan would the governor develop a plan.

Ginestro said he thought PREPA would soon pursue a restructuring under one of the two routes found in the recently passed Recovery Act. However, "they've pulled things out of their hat in the past," he said.

Perhaps it will avoid a restructuring through some sort of external financing or a revenue anticipation note with the central government, he said.

Any problems at PREPA are unlikely to be contained within the authority, Larkin said.

"If PREPA blows up, everything in Puerto Rico blows up," he said. "All of these entities are interconnected."

That's not a certainty. A few moment later, Larkin said, "I really think there's a chance that all of this will work out."

Other analysts said any PREPA default or restructuring would have a more limited impact on other Puerto Rico government entities.

"If market participants have confidence such a restructuring would be isolated then other government entities - likely not public utilities - will have market access, although given uncertainties this would be costly," Vidra said. "It can be argued - and this is probably the argument of the government - that restructuring these credits helps loosen the noose around the government's neck, and hence is credit positive."

Puerto Rico may have a balanced budget in the current fiscal year, Vidra said. While this is positive, to help manage its debt and to make payments palatable to its voters, Puerto Rico will have to start generating real economic growth, she said.

A PREPA default would limit other Puerto Rico government entities' ability to borrow for the next couple of years, Ginestro said. But this would not force the other entities to default in the next year or two, he said.

The Puerto Rico Aqueduct and Sewer Authority can survive without borrowing for a while. The commonwealth government can avoid borrowing for a year or maybe two years, Ginestro said. But there are challenges further out for the central government including an increase in scheduled debt service in fiscal 2016.

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