The PREPA Debt Deal and the Future of Puerto Rico Creditworthiness
There are no free lunches, an eternal truth that does not bode well for the years-long efforts of public officials in Puerto Rico to avoid the realities attendant upon the commonwealth’s staggering public debt of over $70 billion. The $9 billion debt of the Puerto Rico Electric Power Authority (PREPA) remains one of the largest of the commonwealth’s unrestructured obligations despite the availability of a restructuring agreement that eliminates billions in payments to creditors and that supports a set of reforms needed urgently.
Decades of mismanagement, poor preparation for inevitable hurricanes, and the short-term political objective of subsidizing current constituencies by suppressing rates--- while kicking the desperately-needed reform can down the road---pushed PREPA into bankruptcy in 2017. Everyone understands that the PREPA debt will not be repaid in full.
But a restoration of access to capital markets needed for investments to modernize the system and to improve poor service reliability---an absolute requirement for recovery from the economic downturn attendant upon the COVID-19 pandemic---is being stifled by foot-dragging on debt restructuring on the part of many local officials.
The incentives of local officials to focus on the next election led to a 2016 compromise between Congress and the Obama administration: the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA), which created an oversight board empowered to restructure debt, and which established a formal legal process to deal with emerging disputes between the creditors and the commonwealth debtors.
Unsurprisingly, the board has exhibited its own severe divisions---it is, after all, a political body---resulting in a prolongation of both PREPA’s long bankruptcy and the poor physical condition of the electric grid. There finally emerged in 2017 a restructuring agreement after negotiations with two different commonwealth administrations. It provided debt relief of $1.7 billion over the first five years, and at least $2 billion in the first ten years. Three years in the making, the agreement in the end was scuttled by the oversight board itself, which at the time feared the implications of even modestly higher electricity rates. Commonwealth officials more generally also did not perceive a political advantage in a compromise that would require businesses and consumers to pay rates marginally higher but stabilized.
PREPA then filed for bankruptcy in July 2017, after which Congress passed a broad disaster relief bill that included billions in federal aid for Puerto Rico. Whatever the merits of that legislation, it represented a bailout; and bailouts do not strengthen incentives for seriousness. And so after the demise of the 2017 agreement, it was back to the negotiation table, the result of which was a new debt restructuring deal last year, which would allow PREPA to reduce its debt service payments by about $3 billion over the next decade.
Bondholders would exchange their PREPA bonds for new “Tranche A” bonds at 67.5 cents on the dollar, and new “Tranche B” bonds at 10 cents on the dollar. Payment of the Tranche B bonds would depend on full payment of the Tranche A bonds and on future electricity sales on the island. The new bonds would be paid off through an additional charge imposed upon commonwealth power consumers, beginning at about 1 cent per kilowatt-hour (kWh), increasing to 2.768 cents per kWh and then 4.552 cents per kWh for the expected 40-year terms of the new bonds.
Which brings us to the here and now: “Political leaders including Puerto Rico Gov. Wanda Vázquez and Senate President Thomas Rivera Schatz have all but vetoed the proposed deal and taken an increasingly populist stance against debt repayment. They said they wouldn’t accept any hikes in electricity rates.”
Wow. Does the commonwealth’s political leadership believe that the creditors are the ones at fault? PREPA has been mismanaged for decades. Its accounts receivables practices are acknowledged widely to be dismal: PREPA gives vast amounts of power to local government agencies and other entities essentially at no charge, yielding enormous waste and upward pressure on rates for the remaining ratepayers. After Hurricane Maria wreaked havoc on the system, the creditorsoffered a $1 billion loan in exchange for some assurance that a portion of the outstanding debt would be paid---how such a promise would be enforced was never clear---an offer rejected by the Puerto Rico government. In the end the government gave PREPA a low-interest loan, which for the future is not an option likely to prove viable.
The adverse effects of political myopia are obvious. PREPA faces massive capital needs for investment in new generating plants, modernized transmission and distribution systems, and improvements needed to satisfy tightened environmental requirements. A continuation in bankruptcy is inconsistent with acquisition of the resources needed to effect such improvements; for how long must the island’s residents endure service reliability among the worst in the industry? It does not take much imagination to realize that the greater the efforts of commonwealth officials to impose losses upon the existing creditors, the higher the interest rates that the capital market will demand for new lending to PREPA. Precisely how will future ratepayers---and the commonwealth economy more generally---benefit from that outcome?
Sacrifice cannot be a one-way street: Sooner or later PREPA ratepayers will feel some pain from past borrowing decisions, and a hope that only “Wall Street” will endure losses will come a cropper. The same is likely to be true for hopes for more aid from the federal government while PREPA remains in bankruptcy, due to the economic problems caused by the COVID-19 pandemic and the massive stimulus spending enacted to address it. “Wall Street” includes municipal bond funds that invest individuals’ retirement assets in PREPA bonds, representing the future financial security of many ordinary people, including thousands of investors living on the island. Perhaps Vázquez and Rivera Schatz and others should think of them also.