IEEFA: Oversight Board warns Puerto Rico bonds could be worthless
Creditors who loaned money to the bankrupt Puerto Rico Electric Power Authority (PREPA) risk recovering none of it, wrote Tom Sanzillo, director of the Institute for Energy Economics and Financial Analysis (IEEFA) in a piece published on the nonprofit’s website regarding a recent filing by the federal panel that oversees the island’s finances.
“For the first time since the Financial Oversight and Management Board for Puerto Rico was established in 2016, it has officially acknowledged that using reasonable budget assumptions, there is no money to pay back more than $11 billion in outstanding electrical system debt,” he said.
In July 2017, the oversight board rejected a debt agreement for PREPA, explaining that the deal was not in the best interests of Puerto Rico. The entity said the agreement failed to meet the twin goals of an affordable and reliable system and would not ensure economic growth.
The rejected plan offered a recovery rate of 85% for the bondholders. It also called for an increase in the use of natural gas and renewable energy. In the wake of the rejection, the utility’s chief financial adviser was replaced.
“Various post-mortems on the process and orders from the utility regulators raised concerns about conflicts of interest, and about high fees for the law firms and financial advisors who had negotiated and would implement the deal,” said Sanzillo in a lengthy analysis of the status of the PREPA bankruptcy.
In August 2019, Moody’s Investors Service estimated potential recovery rates would be less than 35%. A slightly more optimistic second oversight board proposal was floated in 2022 that would have increased customer rates to cover $5.68 billion in debt but still estimated a recovery rate of approximately 57% for the creditors.
A June 2023 amended plan cut the payout to $2.5 billion — about a 25% recovery rate for bondholders — and offered a new rate structure to support the legacy debt, as well as maximizing renewable energy.
During the deliberations on the new 25% recovery rate, the board, McKinsey & Co., and legal advisers produced an analysis that reviewed the recoveries available to PREPA bondholders if the bankruptcy proceeding failed to produce a result.
“The Oversight Board analysis applied various debt stacking, expense payment and revenue assumptions as if a court were adjudicating how PREPA should be managed. The analysis showed that debt recoveries ranged from zero to approximately $2.6 billion, with the variation reflecting different assumptions about future PREPA sales,” he said. “In short, creditors are being told that a court might award them zero — nothing.”
“This is the first time that the [board] or any official source has raised the possibility that the level of fiscal distress at PREPA means that the utility doesn’t have the money to pay its debts,” he added.
“Some creditors have argued that there is plenty of money available at PREPA to pay off the debt. But the [board] filing with the bankruptcy court makes the implicit argument that it is in the best interest of the creditors to take the current bond deal. Rejecting it and relying on a potential court-imposed settlement under existing non-bankruptcy rules is likely to yield lower recovery rate than being offered in the current proposed deal and could result in zero,” he said.
Another set of voices that are not usually heard in a bankruptcy proceeding are the customers and employees/retirees of the company involved. Recently, the court has received almost 800 motions from PREPA customers and retirees expressing concern about rate increases on the one hand and losing pension benefits on the other, the IEEFA official added.
Adding to the list of concerned individual customers are several business associations, including the Puerto Rico Manufacturers Association (PRMA), United Retailers Association (CUD, in Spanish), the Gasoline Retailers Association, the Community Pharmacies Association, the Puerto Rico Builders Association, and the League of Cooperatives.
“All see rate increases causing smaller profit margins and less likelihood that businesses can survive. To stakeholders who are bondholders, the issue is how the losses in Puerto Rico will affect their diverse portfolios. Stakeholders that are businesses in Puerto Rico are more likely to be concerned with whether monthly incomes can be stretched to meet rising prices,” he said.
Revenue for debt service should be zero
IEEFA’s findings from its analyses over seven years conclude that the revenue available for debt service should be zero, he said.
However, the solution that IEEFA proposed would not result in zero recoveries for the bondholders and other claimants, Sanzillo said. It would require underwriters, lawyers, accountants, engineers and all other diligence providers to establish a fund to settle the various creditors’ claims — bondholders, unsecured creditors and pensions included.
“As we have stated, the diligence providers collectively have at least $12 trillion in assets under management. Establishing a pool to satisfy claims can go a long way to settling PREPA’s debt situation and putting it on a path to fiscal solvency,” Sanzillo assured.
“The negligence of the diligence providers leading up to the bankruptcy has been amply documented. The abusive pattern of setting consultant fees is a diligence question that extends beyond the bankruptcy declaration. This issue has been raised by both the utility regulator and the bankruptcy court’s fee examiner,” he added.
Affordable electricity is a “key goal for the economic growth of the commonwealth,” he emphasized. “So is reliable electricity.” An unsustainable debt settlement that increases utility rates is counter to these goals, he said, outlining steps IEEFA believes are necessary to achieve that:
- Establish a pool to be used to settle all claims.
- Require insurers to cover their obligations.
- Pursue criminal prosecutions.
- Establish an independent private sector inspector general to oversee utility financial management more closely.
- Provide resources to fully compensate the lost value for on-island, small bondholders.
“The Oversight Board submission to the bankruptcy court concluded that creditors may end up with zero from a court-ordered, non-bankruptcy settlement because they estimate that PREPA’s expenses exceed revenues,” he said.
“This solution gives PREPA an opportunity to move forward with a balanced budget. If PREPA emerges from bankruptcy freed from legacy debt, their fiscal condition will remain stressed for a period,” said Sanzillo. “With proper deployment of federal resources, significant improvement in the grid should occur.”
The analyst added that concerns about a low or zero recovery rate preventing PREPA from participating in the bond markets should consider that any new debt issuance will be by a utility with a new grid, a balanced budget and no debt obligations.
“Such a scenario should prompt investors to participate in a new issuance, even if the system lacks a history of solid operational performance and that history is marred by the taint of negligence,” he said.
“At this level, a fulsome commitment of all stakeholders working together and setting PREPA on a path to fiscal solvency while providing the commonwealth with a tool to grow its economy should help to allay market concerns,” he added.
“There’s a choice to be made here by the bondholders and underwriters: Work together or face a possible future where judicial intervention leaves them with nothing,” Sanzillo concluded.
