Puerto Rico’s latest debt effort

July 11, 2014

 

Puerto Rico

The struggling Puerto Rico government was sideswiped when reports emerged that the island’s Resident Commissioner Pedro Pierluisi had asked the U.S. Congress to consider amending the federal bankruptcy code.

Pierluisi wants to give Puerto Rico public corporations the right to seek protection to reorganize in federal court under Chapter 9 of the bankruptcy code, rather than use the island’s newly passed Public Corporation Debt Enforcement and Recovery Act.

The Puerto Rico government reacted with faint praise, but it failed to point out that Pierluisi’s plan, if executed, would deny Puerto Rico’s electric utitlity [PREPA] the right to haircut bondholders. This is because Prepa issues revenue bonds that are protected by Chapter 9 in the bankruptcy process. Pierluisi’s approach would handcuff the Puerto Rico government in their effort to restructure Prepa’s debt.

Pierluisi has since quietly backed off his suggestion. In addition to haircutting debts, Puerto Rico needs to revamp employee headcounts and benefits at Prepa and other public corporations.

After successive rating downgrades of all of Puerto Rico’s debt this week, the government has taken up a bullhorn to try and persuade investors that they truly intend to ring-fence public corporation debt. Axios Investors’ Triet Nguyen thinks raters went too far. Nguyen writes:

The rating agencies’ sweeping downgrades of the PR public corporation issues were certainly justified by the passage of the Public Corporation Debt Enforcement and Recovery Act. Unfortunately, the Commonwealth’s concurrent attempt to ‘ring-fence’ its G.O. and Cofina credits appears to have backfired, at least for the time being.

Investors were most rattled by Moody’s downgrade of Cofina, whose senior lien bonds are arguably one of the best, if not the best-secured credit in the PR debt complex. Because Cofina bonds tend to reside in more conservatively-managed portfolios, unlike the public corporation debt which is owned by more high yield accounts, Moody’s (and, as of last night, Fitch) potentially hit a broader swath of the market when it took the sales tax-backed bonds to ‘junk’ levels. For the record, we believe such a drastic move is wholly unwarranted at this time. If the agencies have truly lost confidence in the Commonwealth’s ‘willingness to pay,’ why not rate everything ‘CCC’ and be done with it?

The Puerto Rico government announced early in the week that it had stayed lines of credit with Citibank and Scotiabank that were being used by Prepa to buy fuel. The terms and seniority of the lending are unknown, but both banks had previously expressed unwillingness to extend them.

On July 10th Prepa made a delayed disclosure to the MSRB’s EMMA system that it had drawn down $41 million of its debt service reserve fund to make its July 1 bond payment of $417 million. Nguyen argues that this is a technical default on bondholders, although it can be cured if the debt service reserve is replenished. There are still possible collateral calls that swap counterparties Deutsche Bank, JPMorgan Chase and UBS AG could make on Prepa.

Market perception is that Prepa remains the most likely candidate for restructuring under the new law. Caribbean Business reported:

Another reason that both Prasa [water monopoly] and the HTA [highway administration] aren’t yet bad off enough to undergo debt restructuring is that they could still raise rates if they run into trouble and confront future financial difficulties. For example, a 4¢-a-liter gas tax could bring in about $175 million a year. Although the recent Prasa water-rate hikes hit large users and businesses harder than residential consumers, most experts believe there is still room to revise the basic rate in the future if Prasa had to do so.

In contrast, Prepa doesn’t have these same options. In fact, the high price of electricity, more than twice the U.S. average, is already one of the most significant barriers to economic development and investment on the island, and there is no room to raise rates more. At this point, if oil prices increase because of the Iraq- Iran tensions in the Middle East, it would be a devastating blow to consumers on the island.

Puerto Rico officials stated again that their intention is to focus restructuring on public corporation debt. Reuters reported:

Puerto Rico has struggled to counter the negative sentiment that engulfed its bonds following the passage of the [restructuring] law in late June. What was supposed to be a law aimed solely at the island electric power authority PREPA has been unfairly extrapolated to all the island’s $70 billion debt, the officials said…

…’We are talking about the passage of a law, and until now, no entity has taken advantage of it. They conclude that if a public corporation does file under this law, then at the end of the road the entire government will take advantage of its provisions and we believe the opposite. It isolates the problems in the public corporations,’ [Treasury Secretary Melba Acosta] said.

Puerto Rico officials say that they will hold an investor call and make their argument why the island’s general obligation and Cofina debts will be paid on time and in full. Meanwhile investors should be concerned as fiscal 2014 ended with tax collection about $488 million or 5 percent short of projections.

Puerto Rico

The debt structure and finances of Puerto Rico are complex. There is little room for error in executing a balanced budget and restructuring debt.

2 comments

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Government Development Bank for Puerto Rico (GDB) will host a webcast on July 17th at 2:30PM EST to update the investor community

Posted by Cate_Long | Report as abusive

A smart man would buy PR protection in CDS. Big arbitrage with retail ignorance.

Posted by nixonfan | Report as abusive