Puerto Rico’s Default Plan May Spread Pain Beyond Utility
The U.S. municipal-bond market begins the week wondering whether the Puerto Rico Electric Power Authority, the commonwealth’s sole provider of electricity, will pay bondholders tomorrow after lawmakers last week enacted debt-restructuring legislation.
If the utility known as Prepa fails to act, the blow would be the latest absorbed by investors buffeted by bankruptcies in Jefferson County, Alabama, and Detroit. The defaults call into question the underpinnings of the $3.7 trillion market.
“Puerto Rico has crossed the Rubicon; it’s crossed the line,” Richard Larkin, director of credit at Fairfield, Connecticut, investment firm Herbert J. Sims & Co., said from his office in Boca Raton, Florida. “This is absolutely a big deal and bigger than Detroit and bigger than Jefferson County because there’s more money involved.”
The bill signed by Governor Alejandro Garcia Padilla allows certain public corporations to restructure debt outside of bankruptcy proceedings. Bondholders have been speculating for months that a Puerto Rico agency would default. Prepa seems poised to be the first to restructure its debt if it can persuade three-quarters of its creditors to agree, and if the commonwealth beats back a lawsuit challenging the law.
The utility, which raided its capital budget last month to buy fuel, has $8.6 billion of debt, with about 70 percent not covered by bond insurance, data compiled by Bloomberg show.
Prepa owes more than the $8 billion of general obligations and water-and-sewer debt in Detroit’s record bankruptcy and the $4.2 billion that led to Jefferson County’s failure. The agency, with the third-lowest speculative grade from Fitch Ratings, is due to make a bond payment tomorrow and about $204 million of its securities mature that day, according to data compiled by Bloomberg.
David Millar, a New York-based spokesman for the Government Development Bank, said the bond trustee has enough money to make the payment. Abimael Lisboa Felix, a Prepa spokesman, didn’t return e-mails seeking comment on its plans.
A restructuring decision would be felt in all corners of the U.S., as the commonwealth’s securities are tax free nationwide and widely held by pensions and mutual funds that invest in the muni market. The commonwealth and its agencies owe $73 billion, with about 66 percent of U.S. muni mutual funds holding the securities, according to Morningstar Inc.
The turning point comes after years of economic anguish. Puerto Rico’s economy has struggled to grow since 2006 and its 13.8 percent unemployment rate is more than double the U.S. average. Yet the competitive advantage afforded by the tax-free bonds made it easy for Puerto Rico and its agencies to sell debt to plug budget deficits and cover operating expenses, the combination that drove New York City to bankruptcy’s brink in the 1970s.
The restructuring measure, sought by Garcia Padilla, would allow some public entities to negotiate to reduce their debt loads. The bill allows public corporations to talk with investors for nine months once 50 percent of bondholders agree to discussions. Any restructuring would require approval of 75 percent of bondholders.
The measure’s effect may extend beyond the corporations. The three largest rating firms cut Puerto Rico to junk beginning in February. The bill excludes general-obligation and sales-tax bonds, but the speculative credit rating may be lowered more, Standard & Poor’s said. The measure may signal “a potential shift in the commonwealth’s historically strong willingness to continue to meet its obligations,” analyst David Hitchcock said in a report.
The governor has said the commonwealth will repay its general obligations. Some have given up on promises.
“I’ve lost all confidence in the collective leadership of Puerto Rico,” Larkin said.
Puerto Rico has 21 days to respond to a lawsuit that San Mateo, California-based Franklin Funds and Oppenheimer Rochester Funds in Rochester, New York, filed on June 28 after the governor signed the debt-restructuring bill.
Franklin Funds, with $907.2 million of Prepa debt, and Oppenheimer, holding $821.4 million, are asking a U.S. District Court in Puerto Rico to declare the new law unconstitutional. The companies argue that Puerto Rico can’t usurp the power of federal courts by enacting what amounts to its own bankruptcy law, according to their filing.
The commonwealth will defend the law, Millar said.
Debt sold in Puerto Rico has been trading at distressed levels since August on concerns that the island of 3.6 million wouldn’t repay its obligations.
Uninsured Prepa bonds maturing July 2040 traded today at 10:00 a.m. at an average 44.5 cents on the dollar, the lowest ever and down from 51.9 cents on June 25, the day that Garcia Padilla filed the restructuring bill. Fitch Ratings last week dropped Prepa to CC, its third-lowest speculative grade. S&P and Moody’s Investors Service also give the utility a junk rating.
Since Puerto Rico’s Senate approved the bill June 25, prices of Prepa bonds maturing within four years have dropped by as much as 40 percent, the investment firms stated in the court filing.
If Prepa or other agencies were to pay creditors less than the bonds’ original prices, insurers such as Assured Guaranty Ltd. (AGO) and MBIA Inc’s National Public Finance Guarantee Corp. would be forced to make up the difference with investors holding insured securities. Other bondholders don’t have that extra security.
Dominic Frederico, chief executive officer of Assured, said in a June 27 meeting with BTIG LLC that the company’s worst-case scenario would be a 20 percent loss on its $852 million exposure to Prepa debt, according to a report by BTIG analyst Mark Palmer.
Assured fell 6.5 percent last week, the most since the week ending Jan. 17, to $24.78.
Along with Prepa, the law enables the Puerto Rico Highways & Transportation Authority to restructure $5.5 billion of debt, and for the Puerto Rico Aqueduct & Sewer Authority to alter its $3.7 billion, according to data compiled by Bloomberg. About 90 percent of the Prasa debt and 40 percent of highway authority bonds aren’t insured.
With 1.48 million customers and $4.94 billion in revenue in 2012, Prepa is the biggest U.S. public power utility, according to the American Public Power Association. The utility took $100 million from its capital budget last month to purchase fuel.
Prepa may offer investors less than 10 cents on the dollar, said Matt Fabian, managing director at Concord, Massachusetts-based research firm Municipal Market Advisors, which may complicate the task of getting three-quarters of creditors to accede. He said that high bar might offer investors comfort.
“That will make consensus even harder to get,” Fabian said.
(A previous version of this story incorrectly stated that 70 percent of the utility bonds were covered by insurance.)
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