UPDATE 1-Reforming Puerto Rico's public corporations key -NY Fed

Thu Jul 31, 2014 12:33pm EDT

(Adds view of market impact, details of debt growth)

NEW YORK, July 31 (Reuters) - Puerto Rico must reform its indebted public corporations, the New York Federal Reserve said in a report released on Thursday, the same day the island's electric power authority faced a deadline to renew vital loan facilities with banks.

Public corporations were responsible for 85 percent of the U.S. commonwealth's debt growth from 2000 to 2012, the report said. Electric power authority PREPA is expected to restructure some $9 billion of debt under a new law that provides public corporations with a bankruptcy-like process.

PREPA is negotiating with creditors, including Citigroup and a consortium of banks led by Scotiabank, to extend up to $671 million in credit lines. The authority is facing a payment of $146 million to Citigroup on Thursday and the entire amount of the credit line expires through the end of August.

"Key elements of a successful reform strategy should include strengthening the public-sector corporations' financial standing and greatly increasing the efficiency of their operations," the New York Fed said in its report.

Puerto Rico is part of the second district in the Federal Reserve System, which is administered by the New York Fed. The current report is an update to a report the New York Fed produced in 2012. It was prompted by the increased fiscal pressures that the Commonwealth faces.

The New York Fed includes debt securitized against sales taxes, or COFINA bonds, in its measure of public corporation debt. Excluding COFINA bonds, public corporation debt growth has accounted for a third of a 43 percentage point increase in the island's public sector debt-to-GNP ratio between 2000 and 2012.

The report said that the Commonwealth's new restructuring law, passed in late June and known as the Recovery Act, may change investors' perceptions of the relationship between the central government and the public corporations.

"Generally, debts of these public-sector corporations are not legal obligations of the central government, but historically, market participants may have perceived them to be contingent liabilities of the government," the report said.

About $20 billion in public corporation debt is affected by the law out of Puerto Rico's total debt load over $70 billion.

Following a selloff in Puerto Rico's public corporation debt after the Recovery Act was passed, there was no evidence that the worry over Puerto Rico's fiscal situation was affecting other areas of the $3.7 trillion municipal bond market.

"Based on market-based measures of stress such as yield spreads, it does not appear that investor concerns regarding Puerto Rico have spread to other municipal borrowers," the report said. (Reporting by Edward Krudy; Editing by James Dalgleish and David Gregorio)