Moody's Investors Service has downgraded the rating for Puerto Rico Electric Power Authority's (PREPA) approximately $8.0 billion in Power Revenue Bonds to Ca from Caa3. The outlook remains negative.
The downgrade to Ca from Caa3 reflects PREPA's decision on July 2nd to commence bankruptcy proceedings under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), the July 3rd payment default on PREPA's uninsured debt instruments, and the uncertainty regarding a future debt restructuring plan for PREPA, which has greatly increased and will impact the ultimate recoveries for bondholders.
Today's action affects the ratings on PREPA's uninsured revenue bonds and the underlying ratings on PREPA's insured revenue bonds, which benefit from insurance from one of the monoline insurers.
The decision to file under Title III of PROMESA and to restructure PREPA's debt in a municipal bankruptcy-like proceeding is significant as PREPA had reached an agreement with more than two-thirds of its creditors on a consensual restructuring known as the Restructuring Support Agreement (RSA). Under PROMESA, parties reaching consensual agreements can restructure their financial obligations under Title VI of PROMESA, with the approval of the Financial Oversight and Management Board of Puerto Rico (PROMESA Board), a fiscal oversight board established to review PREPA's and other entities' eventual debt restructuring plans.
Notwithstanding the fact that the RSA was specifically identified as a Pre-existing Voluntary Agreement, the PROMESA Board rejected the RSA on June 27, and a PREPA ultimately filed under Title III of PROMESA on July 2, owing to the fact that the utility had a $447 million debt service payment due the following day. In our view, the PROMESA Board's rejection of the RSA, which followed two years of negotiations, will result in larger losses for bondholders and other financial creditors relative to those suggested under the RSA.
The RSA contemplated bondholders being asked to exchange their bonds for new securitization bonds to be offered at an exchange ratio of 85%, and to defer the repayment of principal and interest, and extend the tenor of the debt. PREPA's prior Caa3 rating, which suggests a recovery range of 65-80%, incorporated these three aspects of the RSA. A key element of the RSA contemplated a special purpose vehicle, separate from PREPA, issuing securitization bonds which would be repaid by a 3.1 cents/kWh surcharge on ratepayers' bills that had been approved by the Puerto Rico Energy Commission in June 2016. Deferring principal and interest and extending the tenor of the debt were other important elements of the RSA given PREPA's capital spending needs over the next five years and the goal to minimize the rate impact on customers. Since the PROMESA Board's rejection of the RSA centered around the ability of the Commonwealth's struggling economy to withstand higher electric rates over the long-term, Moody’s believe that any revised plan which includes a securitization element will have some combination of a lower securitization surcharge, the deferral of scheduled debt service for a longer period, and further extensions of debt maturities. Reducing the surcharge to bring down PREPA's rates will directly affect the amount of debt that can be raised in a securitization, which will lower the exchange ratio and potential recoveries for creditors. Moreover, deferring further scheduled repayment of debt service and the maturity date will also reduce recoveries for creditors. While creditor recoveries will benefit from PREPA's role as a provider of an essential service, Moody’s does believe that any future reorganization will focus more heavily on the impact on customer's electric rates owing to the weak macroeconomics within the Commonwealth. Based on our analysis which centered primarily on a range of possible discounts from the current 3.1 cents/kWh surcharge, Moody’s believes that recoveries for creditors are more likely to fall in the 35-65% range, consistent with the Ca rating.
