The Puerto Rico Electric Power Authority's recent draw on its debt reserve account is a danger sign for its bond-holders, analysts say.
On Thursday the Puerto Rico Electric Power Authority announced that its trustee had made an unscheduled withdrawal of $41.6 million from the debt service reserve, triggering debate among muni professionals over whether the action amounted to a technical default.
The withdrawal was made on or before July 1. On July 1 PREPA made $418 million in debt service payments on its bonds.
"The most important take-away regardless if [the draw's] a technical default or not is that PREPA is extremely tight with cash and has to resort to extremely creative maneuvers in order to avoid outright default on its bonds," said Joan Vidra, managing director of Opportunities Emerging & Frontier Markets Advisory LLC. "It is already restructuring its debt obligations by delaying payments on its credit lines with banks. It smells like bond debt is next."
The rating agencies lowered PREPA bonds to low speculative ratings after Puerto Rico passed a law last month allowing public corporations to restructure their debt. Fitch Ratings said that a default by the power authority was probable. A default by PREPA, with about $8.7 billion of bonds outstanding, would be the biggest in municipal bond history.
Having made its semi-annual bond payment, PREPA is in negotiations with Citibank and a consortium of banks led by Scotiabank about letters of credit due in July and August. On July 7 a spokesperson for Puerto Rico announced that the banks had agreed to a delay on payment for the lines until July 31.
H.J. Sims senior credit analyst Richard Larkin agreed with Vidra, saying that it was irrelevant whether the draw as a technical default. Rather, the important thing is that it "is a sure sign of the potential of imminent default."
David Litvack, head of tax-exempt research and strategy at U.S. Trust said PREPA "appears to be in the midst of a liquidity crisis, and it is likely going to be forced to restructure its obligations. The question is not whether PREPA has already defaulted, but how much are its bonds worth now. That's what is important to its bondholders, as well as the insurers that back its debt."
According to an official statement released with PREPA's August 2013 bond sale, PREPA had $399 million in its reserve account. It also had an additional $16 million in its reserve maintenance fund, $92 million in its self-insurance fund, and $50 million in its capital improvement fund. The official statement says the $158 million would serve additional reserves for debt service payments.
Contacted on Friday, PREPA's trustee, U.S. Bank NA, did not respond to questions.
As for whether PREPA's debt service draw was a technical default, Axios Advisors managing partner Triet Nguyen said it would be conventional to treat it that way. Puerto Rico spokespeople suggested that the 1974 agreement governing the bonds did not indicate this. PREPA spokesman Abimael Lisboa Félix said the draw was not a default, technical or otherwise.
"Given the wording of the event notice, it is hard to argue that they did not miss a covenant," said Joesph Rosenblum, director of municipal credit research at AllianceBernstein. "But because the actual payment was made to bondholders, they are still not in default as we read the Trust Agreement. That would occur if they don't respond within 30 days to a trustee letter requiring them to replenish the reserve to its required level. All this assumes that the draw on the reserve took the balance below its required level, which the wording of the notice does seem to say."
Whether the debt service reserve fund was fully funded prior to this draw is unclear. The fund is normally supposed to have funds equal to 12 months of interest on PREPA's power revenue bonds plus a small amount of additional funds to cover some of PREPA's other debt. After an August 2013 bond sale, PREPA had about $8.7 billion in power revenue bonds outstanding.
PREPA was expected to pay $577 million for debt service in fiscal year 2014, according to Fitch Ratings managing director Denis Pidherny.
A few days after passage of the public corporation restructuring law, Oppenheimer Rochester Funds and Franklin Funds sued Puerto Rico to overturn it.
