RESEARCH: PREPA bondholders should prepare for more shocks - Analyst Snapshot

26 January 2018
The Puerto Rico Electric Power Authority (PREPA) this week left USD 8.1bn in bondholders with an increasingly unfavorable outlook following Governor Ricardo Rossello’s proposal for partial privatization of the utility.
 
The governor’s 22 January statement was superseded two days later by release of PREPA’s new fiscal plan, which provides more details about the privatization but is a “fiscal plan” in name only. It contains no current year budget or forward-looking financial statements. Commonwealth officials state that “certain challenges” prevent submission of a fiscal plan at this time. Among these challenges are damage from recent hurricanes and uncertainty regarding federal funding.
 
There may be merit to the reasons behind the omissions. But a five-year financial plan, even one that is subject to major revision, is preferable to no plan at all. This is especially so given the financial and capital challenges that PREPA faces and its near-total lack of resources to meet those challenges.
 
But the overall tone of the 24 January plan indicates its intent may be to present a case to the US government that federal assistance is needed to rebuild PREPA. The plan estimates that USD 17.6bn is needed to rebuild the system with sufficient resiliency to withstand major storms, and a declaration that this goal can’t be accomplished without “substantial federal funding”.
 
Nowhere in the plan is any mention of paying debt service to existing lenders, among which are USD 8.1bn worth of bondholders. Similarly, other fiscal plans submitted by the government this week include no provisions for debt service.
 
The graph below shows trading for PREPA’s USD 588m 5.25% Series 2010XX power revenue bonds due 2040 since 1 January 2017. Between then and late September, prices declined slowly to 50 from 60. Even PREPA’s first payment default, which occurred on 3 July 2017, did not cause a steep price drop.
 
The 20-point decline from September and October coincided with Maria’s landfall on the island and with President Trump’s comments regarding Puerto Rico’s debt that “we’re going to have to wipe that out”. The market for the bonds has firmed slightly since this week's announcements.
 
 
Analyst Takeaway
 
Commonwealth officials are well aware of arguments that PREPA bondholders are not legally well-secured. Debt service is payable only from system net revenues. And not only is there no lien on PREPA’s physical assets but there appears to be inadequate protection against asset transfers.
 
The combination of inadequate bondholder security and PREPA’s decrepitude indicate that it won’t be long before commonwealth officials make the case to the Financial and Oversight Management Board that PREPA bondholders should receive even less than the 30 cents on the dollar indicated most recently on the graph. A recommendation by officials that PREPA should be freed from any and all existing debt service payments is not out of the question.
 
Bondholders might eventually benefit from proceeds of any privatization or concession, but a long period of time is expected before any such proceeds are realized. And although the latest fiscal plan may result in additional federal aid, almost every page of it will make private sector bidders think twice about how much they want to pay for PREPA’s generating assets.