Probe reveals questionable aspects of PREPA bond issue
A pre-audit survey report released Monday by the Commission for the Comprehensive Audit of the Public Credit of Puerto Rico analyzing a $673 million bond issue by the Puerto Rico Electric Power Authority has raised a number of questionable aspects of the transaction completed in 2013.
For one, the audit findings showed that the Power Revenue Bonds Series 2013 sold at a 7 percent yield came with a PREPA forecast of sales increases over the next five years that the corporation stated without any kind of support, said Katja Litz, who along with Ricardo Puga y Vidals — students of the Hertie School of Governance in Berlin — prepared the study while participating in an internship program at the Puerto Rico Institute of Statistics this past summer.
“Did PREPA use assumptions that were too optimistic and insufficiently documented at the time of the issuance of its debt in 2013?” the study posed, paving the way for the Commission to answer in a full forensic study based on the findings.
Furthermore, the interest rate and other terms obtained by PREPA in its 2013 debt issuance appear to be less favorable than those obtained by emissions from similar debts of other entities that occurred at about the same time, the study showed.
“This suggests one of the following two scenarios: a) the crediting agencies improperly awarded an investment grade rating to the issuance of debt or b) the bond market excessively rationed what it was willing to lend to PREPA, which negatively affected PREPA and its customers,” she said.
“An audit of the 2013 PREPA debt issuance could assess which of these hypotheses is correct. Did PREPA obtain an interest rate that was consistent with the investment‐grade rating granted to PREPA by crediting agencies?” the researchers questioned.
According to the pre-audit, PREPA appears to have artificially inflated its forecasted net revenues in to comply with the provisions of its Trust Agreement with creditors to ensure proceeds that are at least 120 percent of its debt payments (interest plus principal.)
“When uncollected revenues are excluded, [PREPA] complied with the 120 percent requirement in only 1 of the 10 years between 2009 and 2018,” Litz noted, confirming that PREPA only complied with the requirement in 2010. “Should the Commission evaluate whether this constitutes a violation of the Trust Agreement between PREPA and its creditors?”
According to the bond indenture, PREPA stated it would use the proceeds for its capital improvements program that required $1.6 billion in investments from 2013 to 2018.
“The amount issued in 2013 was not enough to finance the program. There was $1.1 billion outstanding. So they didn’t have enough, and they didn’t explain how they were going to get the money to repay the debt,” Litz said. “That puts into questions the expressions made in the offering statement.”
Second pre-audit aids Commission
The student project was to review the public documents associated with the 2013 PREPA debt issuance with the goal of developing a list of observations and questions intended to help the Commission determine the methodology and scope of its audit, to be performed as soon as the body gets the budget allocations needed to hire staff, Commission Chairman Roberto Pagán said.
“This second exercise in pre‐auditing reiterates the importance of getting started with the official audit,” he said, confirming that Attorney Alvin Velázquez has been hired as the Commission’s executive coordinator.
“The serious findings in this report, together with the findings of the first report released last May, raise questions for which Puerto Rico needs clear responses urgently,” he said referring to the report analyzing the last General Obligation bond issue by the Commonwealth through which it raised $3.5 billion in debt in 2013.
Meanwhile, the study uncovered that PREPA has used URS Corporation as its performance auditor and engineering consultant for more than 65 years, and hired it to work on the sale of the 2013 PREPA bonds, specifically in the commodification process.
“Although the Sarbanes‐Oxley Act does not apply to PREPA [being a public entity,] this Act applies to certain private electric power providers and requires a minimum five‐year rotation for auditors and it prohibits an auditor from providing additional services not related to the audit, such as the commodification of bonds,” the study stated.
“Did [PREPA] and its advisers take sufficient steps to ensure the independence of its auditors in order to protect the people and the institutions that lent it money?” the research questioned.
The study also raised concerns about the lack of citizen participation in PREPA’s decision-making, as well as the lack of independence from political influence evidenced by the corporation’s board of directors, as well as of the Puerto Rico Government Development Bank, which influences the public corporation.
“Do the dual roles of the GDB as an advisor to PREPA and as its lender constitute a conflict of interest? Are the interests of the people of Puerto Rico sufficiently represented on the Board of PREPA? Did the Boards of Directors of PREPA and of the GDB fail to protect the public corporation, its customers and its bondholders when issuing debt in 2013?,” the study questioned.
“We see that PREPA’s board is connected to the Commonwealth’s political administration. That also means that when the government changes, there’s a possibility that so will the members of the board. That can cause a loss of expertise these members have gained and also affect PREPA’s management,” Litz said.
Meanwhile, Puga y Vidals noted that when it came to granting the bond issue a BBB rating, the ratings agencies — Moody’s Investors Service, Fitch and S&P — seemingly ignored that PREPA lacked the revenue to repay the new debt.
“PREPA was in a difficult situation and we saw that they lacked liquidity in their finances. They were nearly insolvent, which was evidenced 10 months after the issue, when there was a technical pause applied to the debt,” Litz said, noting that PREPA was unable to meet its debt obligations in October 2013.
“PREPA was in near insolvency, but its financial auditors did not report any going concern matter of emphasis,” she said. “PREPA obtained a BBB rating. We question how consistent that investment grade is given PREPA’s limited capacity to repay its bonds.”
The Hertie School of Governance is one of the leading universities in Germany and a center for teaching and research of international excellence that prepares exceptional students for leadership positions in government, business, and civil society.
The students who prepared the pre-audit confirmed they developed an interest in Puerto Rico’s financial challenges given the island’s “unique” nature as a Commonwealth, “which is unlike anything else in the world,” said Litz.
Mario Marazzi, a member of the Commission and executive director of the Puerto Rico Institute of Statistics, said Monday the student’s work represented a cost of $8,000, or the budget that covered the internship period from early June to mid-August.
“As is well‐known, the Puerto Rico Institute of Statistics has very few resources to operate. However, we are pleased to have been able to make available to the Commission the work of two students from our internship program,” Marazzi said. “We’re extremely proud that the work of these two students has been put to good use by the Commission for the purposes of planning the audit that should start soon.