Restructuring PREPA’s Debt: Thoughts on the PRSA
Thomas King, President and Founding Director
Borincana Foundation Inc.
August 5, 2018
Progress is progress, and this is progress. But there is ample reason for caution as well.
Like most people in or on the edges of the movable fiasco that is PREPA, I received notification this week from the oversight board that a preliminary agreement had been reached between PREPA, the FOMB, and the ad hoc group of creditors. I was able to read the agreement before the reports on it came out; most missed the deeper questions it raises.
The agreement would give bondholders 67.5 cents on the dollar in the form of 40-year “tranche A” bonds and 10 cents on the dollar in the form of 45-year “tranche B” bonds that would receive excess cash flow once the tranche A bonds are repaid. A Transition Charge (sort of a sales tax) is added to PREPA’s power sales to secure repayment:
The Transition Charge allocable to the outstanding power revenue and revenue refunding bonds issued by PREPA under the 1974 Trust Agreement shall be set at the following levels:
- 2.636 c/kWh for Years 1-5
- 2.729 c/kWh for Years 6-10
- 2.868 c/kWh in Year 11
- Starting year 12, annual 2.500% increases over the prior year’s Transition Charge
The Transition Charge allocable to the outstanding power revenue and revenue refunding bonds issued by PREPA under the 1974 Trust Agreement shall be capped at 4.348 c/kWh.
A lot more detail will need to be worked out.
The structural concept is sound: term out significantly to lower the immediate burden on the defaulting party while writing off less from face value - pleasing creditors and offering the prospect that at some future point they may trade at or over new face value as the utility or its successor recovers. Moreover, the security of the Transition Charges and the operational tax they place on the utility increases the likelihood of a refinancing when the capital markets are accessible once more. Meanwhile, it is unclear from the document but from the context of commentary it appears bondholders will be giving up any general claim on the utility for a specific one on the account into which the Transition Charges are paid. This provides visibility and certainty on the costs to the utility and customers.
Overreactions to the preliminary deal were almost instantaneous. Some PREPA bonds due in 2042 traded above 60 cents on the dollar on Tuesday, up from the mid 40s. This deal is preliminary and given the ongoing uncertainty surrounding PREPA even if it completes as promised the new bonds are unlikely to trade near face value. Also, Oversight board Chairman Jose Carrion called the deal “a milestone” in the debt restructuring process aimed at transforming and privatizing PREPA into “a modern, world-class utility.” More hyperbole, a milestone we hope, but PREPA will never be a modern, world-class utility. PREPA is the walking dead, but Puerto Rico will persevere to have a transformed, modern energy infrastructure system.
As reported by Caribbean Business, Tomás Torres Placa of the ICSE and Rodrigo Masses of the PRMA went on record following the announcement of the preliminary restructuring deal to assert that this was not sufficient to induce investment in a future privatized version of PREPA and called for debt cuts of 50%. They also expressed concern that the Transition Charges would put immediate pressure on PREPA to raise, not lower, rates, and that this did not assuage concern about additional charges that might be levied on behind-the-meter distributed solar and for grid exits to self generation.
In principle, I agree with the position and concerns of Señores Torres Placa y Masses. Deeper cuts now would be better though there is no magic to a 50% reduction headline number. Its main advantage is it is easier to explain to the populace at large. Much or more can be accomplished by pushing out maturity, lowering interest rates, and reducing the Transition Charges. The better the deal, the more likely PREPA and its successors are to succeed and the less likely we will be back into another restructuring discussion in a few years.
Here is the part of this deal we need to keep an eye on:
The Transition Charges are only really predictable assuming PREPA continues to operate as a monopoly utility. It cannot. In fact the crystallization of the added “tax” is likely to accelerate grid defection. The utility will progressively lose sales as it or its successors become more of a system operator rather than a power provider. We have no visibility into whether or how much this was considered in fashioning the deal.
This direct threat to the generation of cash flow for debt service puts pressure on utility, the government, and by extension the regulator to slow or inhibit the transformation of the grid into resilient distributed systems and become a hindrance to the recovery and prosperity of Puerto Rico.
Lest it become “the tail that wags the dog,” the ultimate deal must not in any way infringe upon the utility or the energy infrastructure system to evolve or the government or regulator to act in full discretion for the benefit of Puerto Rico.
Approached thoughtfully now, this doesn’t have to inhibit the growth of distributed nonutility generation and could enhance the certainty for creditors and future system operators alike but it will require more enlightened leadership than has been in any way evident on the ground.
After ‘doing it for themselves’ and learning to come together to save lives and make change in the wake of total disaster, Puerto Rico has a population that is enlightened, motivated, and empowered. Get between them and their local, resilient energy future, continue to support a utility that overcharges and underperforms, do this wrong and it will be torches and pitchforks time. No politician will be safe.