IEEFA update: The unsustainable debt deal that won’t die

Magical debt thinking persists even with Puerto Rico’s economy declining and PREPA losing money

July’s proposal to pay bondholders 77 cents on the dollar for about a third of the debt of the Puerto Rico Electric Power Authority (PREPA) straggles on, neither approved nor rejected despite deadlines passing.

If the measure of success of a debt settlement is that it offers realistic payouts to bondholders while allowing the debtor the ability to emerge as a going concern, then it’s time to forget about this deal. This proposal doesn’t move PREPA toward a credible solution to its debt problems. PREPA was broke before the announcement of the deal, it remains broke today and it would be worse off if the deal closed.

Let’s start with the fundamentals. PREPA’s future is tightly tied to the future of the Puerto Rican economy. Puerto Rico needs cheap power to recover. PREPA needs a growing economy to have a market for its energy.

The prospects are dim. Moody’s is projecting a 17-19% decline in the economy from 2019 through 2028. The Financial Oversight and Management Board (FOMB) is projecting a decline in the island’s population and reduced sales of electric power.

In order to move the Island’s economy forward, the FOMB certified a fiscal plan for PREPA that supports a long-term power price of 20 cents per kilowatt-hour.

A settlement should aim to solve problems rather than compound them.

But it’s unclear how the goal of low-price power will be achieved under current proposals. The FOMB-certified fiscal plan was out of balance, contained a host of ill-defined savings initiatives, rising fuel costs, and no money for any debt service for five years. The plan projected rates upward of 24 cents per kilowatt-hour by 2023, without including debt service or pension payments. Including full debt repayment, rates would climb to 30 cents per kilowatt-hour

Average electric rates in FY 2018 were 23 cents per kWh. At that rate level, PREPA shows what it calls a decline in its net position (a net operating loss) of $393 million in its unaudited financial statement for the fiscal year ending June 2018. PREPA recently said that in order to kick-start the economy it plans to cut rates. To do this would create even less chance of investor recovery. PREPA also counts among its expenditures $474 million for interest on its debt, an amount that exceeds the decline in its net position.

Despite all the bad fundamentals, investors since the July announcement, apparently seduced by the promise of 77 cents, have bid up prices on the $3 billion of PREPA’s debt covered by the deal from 30 cents on the dollar to more than 60 cents on the dollar. Negotiations continue with other bondholders, insurance companies and creditors on the remainder of PREPA’s $9 billion outstanding debt.

THOSE NEGOTIATING A SETTLEMENT ON PREPA’S DEBT AND THOSE BIDDING UP THE MARKET PRICE OF THE BONDS have lost sight of a fundamental reality. PREPA cannot pay the debt back, not 30% of it, not 40% of it, much less 77% of it. The FOMB briefly accepted this reality in 2017 when it determined that a debt deal requiring 90% repayment could not be supported by the pre-hurricane Puerto Rican economy. Post-hurricane, the inability to support a similarly high level of debt repayment should be even more obvious.

Creditors, Washington influence peddlers, financial consultants, credit agencies, lawyers, accountants, underwriters and Puerto Rico’s elected leaders may agree to yet another unsustainable deal. But if there is no economic basis for the payments, they will have simply consigned Puerto Rico to another round of bankruptcy, wasted time and assured themselves of another round of fee agreements to repair the damage they create.

PREPA, the people of Puerto Rico and even the bondholders deserve a settlement that will actually help solve problems. The question is, why aren’t they getting one?

Tom Sanzillo is IEEFA’s director of finance. Cathy Kunkel is an IEEFA energy analyst.

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