PREPA Prices Trail Other Issuers That Tapped Reserves

Puerto Rico Electric Power Authority bonds are trading at low prices compared with the bonds of other issuers that have drawn on their debt service reserves, as investors weigh risks that range from the island's public corporation debt restructuring act to political pressure to restrain power prices.

PREPA, as the power authority is known, drew $42 million from its reserve to make a $418 million bond payment on June 31. Its bond maturing in 2015 traded at 40 cents on the dollar on July 15, according to Municipal Market Advisors. On Monday, a customer bought $2.12 million of PREPA bonds maturing in 2042 for 46.75 cents on the dollar, accoring to the Municipal Securities Rulemaking Board's EMMA website.

By comparison, a review of three recent issues of Municipal Market Advisors Default Trends publication showed only one of the 37 municipal bond issuers that had drawn on emergency support through tapping their debt reserves was trading at fewer cents to the dollar than the PREPA bond.

Of the 90 issuers that had already defaulted on payments, Default Trends showed 49 had no trades reported and 18 were trading at values above 40 cents on the dollar. Many in the latter category were trading well above 40 cents on the dollar.

For example, in the July 16 Default Trends, a defaulted assisted living center/nursing home was listed as trading at 52 cents on the dollar and a hospital in default was shown at 59 cents on the dollar.

Municipal Market Advisors managing director Robert Donahue said with a hospital, there is a reasonable chance of recovery. With PREPA, which has $8.7 billion in debt, recovery is in doubt for several reasons, he said.

First, there is concern that the future for the power authority may include a receivership, restructuring, or even Chapter 9 bankruptcy filing if Puerto Rico's resident commissioner in the United States House of Representatives, Pedro Pierluisi, gets his way. How and even when the courts will rule on the recently enacted "Recovery Act" with regards to PREPA is another source of uncertainty for investors

The rapid approval and lack of debate as the Puerto Rico government introduced and adopted the restructuring act upset investors, Donahue said.

The law firms and restructuring experts that put together the restructuring act may have anticipated that the bond prices would go down on the secondary market so that when PREPA makes its actual offer it will be acceptable. It is common in sovereign debt restructurings that some of the negotiators want the secondary market's bond prices as low as possible so that the prices can serve as starting points for negotiations, Donahue said.

In classic bankruptcy scenarios the creditors evaluate the market value of assets versus the value of liabilities, as well as the present value of anticipated cash flows. It is even less clear what PREPA's assets are given the obsolescence of its assets, cost of environmental remediation and need to convert some of its facilities to natural gas.

If PREPA goes through a Recovery Act restructuring act in chapter 3, as Donahue thinks likely, a Puerto Rico judge would oversee the restructuring process. The court hearings would be in Spanish and far more likely to be politically influenced.

Finally, PREPA and Puerto Rico's government are eager for PREPA to lower its costs for producing its electricity so as to allow PREPA to lower its electricity prices, helping the economy, Donahue said. Even if PREPA defaults it may believe it will be able to borrow in the next few years from lenders outside the traditional municipal market.

Joan Vidra, managing director of Opportunities Emerging & Frontier Markets Advisory, LLC, said the market's pricing of PREPA bonds has to do with expected recovery value, expectations of price recovery, and the maturity of securities and repayment schedule.

According to Reuters, 18 hedge funds have banded together to form an "Ad Hoc Group" favoring the restructuring law for public corporations. Together they hold $4.2 billion in Puerto Rico government debt, all or nearly all of it outside the public corporations.

"What is interesting also is the impact this growing hedge fund group of supporters has on the market for [debt of] the public companies covered under the debt restructuring law," Vila said. "On the one hand, it makes the scenario for ring-fencing [the Puerto Rico government debt] way more plausible… On the other hand, it means the pain won't be distributed 'broadly' so debt holders of companies targeted for debt restructurings will be hit harder."

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