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Puerto Rico electric power authority debt restructuring: A weak deal plagued by scandal

August 01, 2019
Tom Sanzillo
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Key Findings

In May 2019, FOMB announced that a deal had been reached between AAFAF, the FOMB, a large segment of PREPA’s bondholders, and bond insurer Assured Guaranty, to restructure PREPA’s legacy debt.

In reality, the rate impact will likely be higher than stated in the debt deal, as a result of several hidden costs and fees.

Even if Puerto Rico is able to successfully implement proposed savings and revenue initiatives, the economy will continue to experience flat to declining GDP from FY 2029 to the end of the forecast period.

Executive Summary

The Puerto Rican legislature will soon be asked to approve a debt restructuring agreement for the Puerto Rico Electric Power Authority (PREPA). As detailed in this report, the deal is unaffordable and will jeopardize the financial and physical recovery of the island’s electrical system and economy.

The proposed restructuring agreement fails in five critical areas:

  • The Transition Charge to support the debt raises utility rates by at least 13%. Several additional costs identified in the bond documents ensure that by the time the deal closes the rate increase will be higher.
  • The proposed Transition Charge will grow more rapidly than Puerto Rico’s economic growth. This will impede Puerto Rico’s plans to expand its economy.
  • The Transition Charge places pressure on PREPA’s Fiscal Plan and budget that exacerbates budgetary imbalance.
  • Puerto Rico’s economy is weak and the security protections for investors shaky. The Commonwealth and its advisors have not released any analysis that shows this deal can be rated by credit rating agencies using current methodologies. Comparing PREPA’s proposed deal to a successful securitization agreement, such as the one set up by the Long Island Power Authority, exposes serious weaknesses in PREPA’s plan.
  • Some of PREPA’s debt may have been illegally obtained. Recently, the Puerto Rico Financial Oversight and Management Board (FOMB) stated that PREPA was insolvent in 2011. Two debt issuances occurred after 2011, suggesting a likelihood that the market was misled. A recent lawsuit brought by two bond insurers challenges the legality of an additional $3.7 billion in PREPA debt issued between 2002 and 2007.

Additionally, the debt restructuring agreement cannot be divorced from the ongoing corruption scandals that have created unprecedented political upheaval in Puerto Rico this summer. On July 10, 2019, the U.S. Attorney announced the arrest of the managing partner of BDO Puerto Rico,3 the auditing firm that produced PREPA’s FY 2016 and FY 2017 audited financial statements. BDO was contracted by PREPA: to prepare monthly financial reports, analyze its budgeting and accounts system, draft budget and accounting reports, and other tasks. These accounting tasks are critical to the accurate presentation of PREPA's financial position, which underlies the debt restructuring. The legislature is now being asked to make a judgement on a debt deal whose underlying financial representations are tainted by potential fraud. We also note the particularly troubling implications of the BDO arrest combined with the lack of an internal control certification accompanying its FY 2016 audit. The FY 2016 audit should be redone and several of its findings, particularly related to multibillion dollar financial restatements, probed further.

The FOMB announced in August that it will be investigating the auditing, accounting and other services performed by BDO for Puerto Rican government entities since 2016 to determine whether BDO’s activities were impaired by fraud.

The terms of the agreement are not in the best interest of the people of Puerto Rico.

The testimony presented by the Puerto Rico Fiscal Agency and Financial Advisory Authority (AAFAF) to the bankruptcy court in support of the debt restructuring now also lacks credibility. Puerto Rico’s former Chief Financial Officer Christian Sobrino testified to the court about his key role in negotiating the debt deal on behalf of PREPA in his position as executive director of AAFAF. Sobrino was fired from that position in July 2019 as a result of the chat scandal. Sobrino’s testimony argued that PREPA is on track with reforms to its operations and that its contracting process has sufficient oversight. Both of these claims are dubious in light of the apparently systemic corruption of the administration of former Governor Ricardo Rosselló.

In addition to these significant red flags surrounding the negotiation of the deal, we find that the terms of the agreement are not in the best interest of the people of Puerto Rico, the future financial stability of the electrical system, or future investors in the system.

Press release: IEEFA report: Puerto Rico Electric Power Authority debt deal weak and plagued by scandal

Please view full report PDF for references and sources.

Tom Sanzillo

Tom Sanzillo is Director of Financial Analysis for IEEFA. He has produced influential studies on the oil, gas, petrochemical and coal sectors in the U.S. and internationally, including company and credit analyses, facility development, oil and gas reserves, stock and commodity market analysis, and public and private financial structures. He also examines such areas as community and shareholder activism, institutional investment, public subsidies and Puerto Rico’s energy economics.

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