Puerto Rico: How To Play Hardball With Bondholders

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How much of its more than $8 billion in debt can the essentially bankrupt Puerto Rico Electric Power Authority pay back?

A federal oversight board appointed four months ago to supervise debt restructuring for the entire Puerto Rican government offered up an indication last week. The board, empaneled in October under the auspices of the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA) and tasked with helping Puerto Rico address its deepening financial crisis, posted a letter to Gov. Gov. Ricardo Rosselló that sketches a broad path toward fiscal stability for the commonwealth.

One blunt takeaway: Puerto Rican government debt is worth about 21 cents on the dollar.

In a briefing memo we published this morning, we key in on the board’s finding that in fiscal year 2019 (which begins in October), Puerto Rico’s taxpayers can afford to pay perhaps $800 million in debt service on the government’s $64 billion in outstanding debt. That $800 million amounts to about 21 percent of the $3.9 billion that the commonwealth is supposed to pay over that time span.

By framing the debate over Puerto Rico’s financial problems in so realistic a way, the oversight board is only doing its job. This contrasts with the proposed PREPA debt-restructuring deal put together last year by fee-driven consultants, an inattentive board, an overwhelmed staff, and a public service commission hamstrung by legislation. That proposal—not to put too fine a point on it—stands to protect and enrich bondholders at the expense of Puerto Ricans.

Puerto Rico is in no position to do what is solely in the interest of creditors, however. The commonwealth’s economy is expected to continue to shrink, declining by 1.1 percent annually over the next decade.

Contrary to this stark reality, PREPA’s proposed debt deal assumes that Puerto Rico’s ratepayers can afford to pay nearly $940 million in annual debt service on a debt load of just over $8 billion. Ratepayers are being told, in other words, they must shoulder the full cost of indebtedness—while other government debt is worth only 21 percent of face value.

The oversight board, by contrast, has considered Puerto Rico’s baseline needs for schools, hospitals and other public services. It has looked at its revenues (a combination of local taxes and federal revenue) and concluded that the government’s annual operations deficit is $3.7 billion. It has addressed that gap with proposed austerity savings and revenue increases worth $4.5 billion. This is where the $800 million “implied surplus” for debt service comes from. Note that the oversight board cautions that the figure may be overly optimistic

PREPA, by contrast, has decided bondholders come first, and it has set aside $940 billion from its $3.7 billion budget for debt service. The recent order  granting PREPA a rate increase shows that the agency has done very little to determine its actual needs, and the order states bluntly that information provided by PREPA is largely unsupported by documentation.

 WHITE PREPA INSISTS THAT IT HAS WRUNG ALL CONCESSIONS POSSIBLE OUT OF CREDITORS, THE OVERSIGHT BOARD’S APPROACH SUGGEST OTHERWISE. By saying up front that Puerto Rico is broke and can afford only to pay perhaps 21 percent of what it owes, the board is making clear that the settlement of Puerto Rican government and PREPA debt obligations will be occur through negotiation.

Discussions will not be driven by supposed jurisprudence, fears for future bond market access, regional pride or plays on morality.

PREPA failed at the outset by proposing a budget that did not consider either customers’ ability to pay or the pressing needs of the island’s electricity system. It went in too gently and gave up too easily. We have pointed out that PREPA’s proposal will have it making payments on debt levels that by its own admission are higher than the market value of that debt. We’ve pointed out also that an audit that if used correctly can lower PREPA’s liability and that Moody’s Investors Service has stated PREPA’s bondholder debt recovery should be in the range of 65 percent to 80 percent—not 100 percent (although we think it should be less that what Moody’s says).

The oversight board’s budget methodology and its opening gambit show that there are ways to relieve PREPA’s debt burden.

While the board has not taken a position on the PREPA refinancing deal in deference to a review by the newly elected Rosselló, it is arranging an independent accounting into the true scope of Puerto Rico’s debt burden. We note that the governor in his response to the board acknowledges that an average 79 percent bondholder haircut is in play in his budget considerations.

These steps, pursued collectively, will allow for a meeting of the minds around a sensible, uniform debt strategy that will help the badly damaged Puerto Rican economy recover.

A deal must—and will—be hammered out by the federal government, the commonwealth government, and the investment houses that hold the highest stakes.

Tom Sanzillo is IEEFA’s director of finance.


IEEFA Puerto Rico: PREPA Would Starve Its Electric Grid to Pay Its Bondholders

IEEFA Puerto Rico Report: Debt Restructuring Deal for Commonwealth’s Electric Company Only Makes Matters Worse

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