The Puerto Rico Electric Power Authority, which put off a day of reckoning in an agreement with creditors announced Thursday, still may be headed for what would be the largest municipal bond default in U.S. history.
PREPA announced a debt forbearance agreement with holders of more than 60% of its bonds, banks holding lines of credit, and the Government Development Bank of Puerto Rico, to which it owes loans, and said it will deliver a debt restructuring plan by March 2.
Should that restructuring impair holders of the public corporation's $8.5 billion of revenue bonds, the default would outpace the previous record set by Detroit last year.
"The hardest work remains ahead," said Municipal Market Advisors Managing Director Robert Donahue. "Specifically, the agreement only delays bondholder haircuts which we believe are likely in the ultimate restructuring."
The agreement will let PREPA delay payment of $671 million for letters of credit, delay repayments of loans to the GDB, use its debt service reserve account to make its Jan. 1, 2015 bond payment, and use its $280 million construction fund to pay for operating and capital expenses. These conditions are expected to continue to the end of the forbearance agreement on March 31, 2015.
In July the GDB said that PREPA owed it $40 million. It is not clear if all of this is due by March 31, 2015.
In exchange for these financial advantages, PREPA said it will give a $1.4 million forbearance fee to bondholders who agreed to the forbearance agreement.
PREPA also promised to increase its disclosure of financial information through March.
It said it will make interest payments of an alternate base rate plus 4% to the banks holding the letters. The alternate base rate is generally defined as the greatest of the prime rate, the federal funds rate plus 50 basis points, or LIBOR plus 100 basis points, according to Reuters.
PREPA also promised to complete a five-year business plan by Dec. 15 and committed to hire a chief restructuring officer by Sept. 8. Along with suggesting improved business practices, the officer is to contribute to creating a debt restructuring plan.
"Today's agreements give PREPA the additional time and financial resources we need to reach a comprehensive solution that ensures our ability to provide a safe, reliable and efficient power supply to all Puerto Ricans for many years to come," PREPA Executive Director Juan Alicea Flores said in a statement.
OppenheimerFunds is the parent company of one of the two firms suing to challenge Puerto Rico's recently adopted public corporation debt restructuring law, which is expected to be a major factor in any PREPA restructuring.
"We strongly believe the forbearance agreement provides PREPA both the time and liquidity needed to begin to modernize its operations and streamline expenses while providing bondholders with additional protections and input in PREPA's restructuring process," the firm said in a statement.
"Although the forbearance agreement is a positive development, it didn't eliminate the recently passed Recovery Act [that allows the restructuring of public corporation debt], which we continue to believe threatens the rights of bondholders and is unlawful," said Kaitlyn Downing, spokeswoman for OppenheimerFunds. "We intend to aggressively pursue our lawsuit against PREPA and the commonwealth until the act is overturned."
According to PREPA, as of Feb. 28 it had $11.3 billion in liabilities, including the $8.5 billion for power revenue bonds.
The new agreement directs the bond trustee to make five $34 million transfers from the bond reserve account to a fund for the bond payment due Jan. 1. PREPA owes $205 million in interest payment on Jan. 1, according to a Puerto Rico government source. It owes no principal on that date. The government source said the interest payment would be made from a draw on the debt service reserves.
"We believe that this bond forbearance agreement provides time for major stakeholders to adapt to the changing reality of PREPA," said Antonio Sosa Pascual, managing director of REOF Capital, a Puerto Rico firm that conducts financial analysis. It doesn't own any PREPA bonds or other PREPA debt.
"PREPA did not move fast enough to anticipate the variables in their new scenario - they have been given a second chance to do so," Pascual said. " This agreement provides much needed transparency, predictability and visibility to investors on what to expect in the coming months while also protecting bondholders from potential and unanticipated administrative or legislative changes. All in all, we think that it is a positive for all stakeholders, including PREPA customers."
Municipal Market Advisors' Donahue said, "MMA agrees with GDB's statement that the agreements 'provide PREPA with a consensual path forward and time to develop a restructuring plan.' These temporary measures, if implemented, provide liquidity at a critical time and mark a major step in the right direction toward long overdue management reforms at PREPA."
PREPA's 1974 trust agreement allows for the agreement to be amended by the decision of more than 60% of the bondholders. The forbearance agreement includes an amendment allowing the draw on the construction fund for general and capital purposes and the draw on the reserve fund for debt service payment. Because of this, the remaining bondholders cannot challenge them, a Puerto Rico government source said.
"The restructuring plan will also require negotiations with PREPA's largest union, UTIER, now the focus of reform efforts," Donahue said. "The union, which reportedly barricaded doors outside PREPA headquarters as this agreement was being negotiated, will resist payroll reductions and layoffs. Finally, reducing the cost of energy by diversifying fuel sources will require new capital and receptivity of innovative technologies and approaches. Over years, Puerto Rico's leaders have resisted or failed to embrace alternative approaches, including privatization, but this crisis creates an opportunity to not only shed liabilities but improve operations."
In its filing with EMMA, PREPA said as of Aug. 8 there was $412 million in the bond service, redemption and sinking fund reserve account, $96 million in the self-insurance fund, $279 million in the capital improvement fund, and $16 million in the maintenance reserve fund. Finally, there is $87 million in its general fund.
