Puerto Rico issues bonds for energy
Though it has not borrowed in the bond market this year, the Commonwealth of Puerto Rico appears to have started by taking two loans from unnamed banks. Unfortunately we don’t have much information about these transactions, so the amount and purpose are unclear (July 9, July 29). The Puerto Rico Electric Power Authority (PREPA) has filed a bond offering that is expected to come to market on August 5th. Janney Montgomery’s Alan Schankel wrote about the deal:
For the first time in more than a year, we expect to see a new bond issue from Puerto Rico, in the form of $600 million Puerto Rico Electric Power Authority (Baa3/BBB/BBB-) with all three rating agencies affirming outstanding ratings. Pricing is expected next week.
What is PREPA?
The largest public power provider in the US, PREPA depends on fuel oil for 61 percent of its energy production. Although improved from a 73 percent share five years ago, this dependence on high cost fuel has stunted demand. Much of the utility’s capital investment plan, including $2.3 billion in the past 5 years, and $1.5 billion in the coming 5 years, is focused on conversion of energy production to natural gas, with oil projected to account for only 10 percent of fuel by 2017.
PREPA has been in a tough spot because it has needed to import the oil to run the generators that produce electricity. Oil prices have been on a roller coaster (mainly up) since 2008. But there is a bigger issue for PREPA. The Puerto Rico economy continues to stall and electricity demand is plummeting:
As S&P noted in its rating report, ‘PREPA’s credit profile is strongly linked to the economy it serves.’ The June release of the island Economic Activity Index indicates a 4.5 percent economic contraction YoY, the sharpest drop in three years, with the electric power generation component of the index falling by 9.1 percent YoY.
The riskiness of bonds is usually evaluated across several metrics. The primary metric is the debt service coverage ratio, which is how much cash flow is available to service the bond and interest payments. It’s similar to the cash you have left after household expenses to cover credit card payments. For PREPA, the coverage ratio is extremely thin.
The 1.37 times principal and interest coverage ratio number for 2013 says that debt service can be paid with a 0.37 percent cushion. Note the 0.81 percent number below, which adjusts the cash flow by subtracting subsidies and power transfers to municipalities. This is essentially what PREPA gives away without receiving revenues. It’s like leakage in a water system. It is draining cash flow from PREPA and it must be covered with more borrowing to sustain debt service. This is a municipal issuer on a downward spiral. Traditionally the Puerto Rico Government Development Bank would loan money for shortfalls to PREPA, but the GDB has severe liquidity and balance sheet issues itself.
The repayment for these bonds is the revenue of the PREPA system. Bond investors should hope that the Puerto Rico economy does not slow any more.
Credit rating agency reports on this bond offering (requires free registration)
S&P – BBB stable
Fitch – BBB- stable
Moody’s – Baa3- negative