NEW YORK (Reuters) - Puerto Rico’s debt-ridden power authority PREPA is expected to ask bondholders to take some pain as part of a turnaround plan it will present to creditors on Monday, kicking off what could be heated negotiations over terms, sources familiar with the situation said.
PREPA and its creditors must reach agreement quickly or risk hurting the Caribbean island’s broader efforts to climb out of a $73 billion debt hole. Not all creditors are in step, with some more willing to compromise by accepting payment deferrals, those sources say.
The PREPA talks are seen as a critical forerunner of whether the U.S. territory can overcome political and other challenges in fixing broken public entities. With Puerto Rico itself facing a June 30 deadline to approve a new budget and under pressure to raise capital, time is running short as it seeks to persuade investors that it can right the ship.
PREPA on Monday faces a deadline to present creditors with a proposed framework for turning around its business and tackling $9 billion in debt.
“If they fail to resolve PREPA, Puerto Rico is in trouble,” said David Tawil, president of New York-based hedge fund Maglan Capital, which sold its Puerto Rico exposure about a year ago.
The island’s 3.5 million residents rely on PREPA for electricity. Outdated plants and an inability or unwillingness to collect bills or raise rates have contributed to its troubles.
According to several sources close to the matter, Monday’s proposal from PREPA is likely to include some financial engineering that could mean sacrifices by creditors, such as extending maturities or forgoing interest payments. PREPA may make some broad elements of the plan public, sources say.
Creditors want PREPA to invest new capital and provide other protections in return for their cooperation, but some are against adjustments in the terms of their debt outright, the sources said. None are willing to accept cuts to principal, they said.
In a statement, PREPA Governing Board President Harry Rodriguez said the agency is continuing discussions with creditors and would not comment “until it has had a chance to discuss” the recovery plan with them.
“PREPA is aware that the June 1st deadline is of high interest to the people of Puerto Rico,” Rodriguez said.
PREPA may want to take a hard line on bondholders to avoid any perception that it is favoring New York hedge funds at the expense of Puerto Rico’s people. Census data shows that 45 percent of the population lives below the poverty line.
At the same time, the two sides need to reach a resolution quickly. If investors see PREPA as likely to miss a roughly $400 million interest payment on July 1, the island could be hard pressed to persuade investors to lend it the additional capital it will need in any recovery.
A forbearance agreement between PREPA and its creditors, which protects the agency from default while a fix is sought, sets Monday’s deadline for a restructuring framework to be presented.
Parties to the deal include bank lenders and an ad-hoc bondholder group comprised of both hedge funds like Appaloosa and institutional investors like OppenheimerFunds and Franklin Advisers. Bond insurers include Assured Guaranty and National Public Finance Guarantee.
While creditors consider debt cuts off the table, some would be responsive to extending maturities or skipping interest payments in exchange for other protections and for the right to have a greater say in PREPA’s future through new investments, sources say.
Other creditors take a harder-line approach, demanding PREPA fix its problems through rate hikes for customers and cuts elsewhere. “They have a vision of shared pain, but the pain sharing seems to be by creditors, not pensions, not employees,” and not the island’s government, said one person in the discussions.
Creditors could have competing interests. Risk-minded hedge funds who buy debt at discounts may cut deals that net them profits. Insurers who guarantee the debt can be more motivated to enforce contractual terms.
Puerto Rico’s power revenue bonds maturing 2043 were trading around 58 cents on the dollar on Friday.
PREPA’s immediate needs for debt concessions have lessened because of the sharp drop in oil and gas prices. Still, credit analysts and lawyers consider restructuring likely.
“I have a hard time seeing how they solve PREPA without at least a debt deferral,” said bankruptcy attorney Suzzanne Uhland, a municipal finance expert.
A March proposal by the ad-hoc group to backstop a $2 billion investment package was not well received by PREPA, which said it underestimated costs.
A separate consortium, including York Capital Management, NRG Energy and ITC Holdings on Thursday proposed investing up to $3.5 billion in the island’s infrastructure.
Oppenheimer, Franklin and Appaloosa did not immediately respond to requests for comment. Assured and MBIA, NPFG’s parent, declined to comment.
PREPA is “a test case for how things could be resolved on the island,” said one person involved in the talks. Not only will it give creditors insight into how the Puerto Rican government plans to approach restructuring discussions, it will signal to investors whether Puerto Rico’s problems are starting to get fixed.
Puerto Rico’s struggles have threatened to shut down the government. Governor Alejandro Garcia Padilla averted that threat by signing a tax plan to enable a crucial $2.95 billion financing, but the island faces other key deadlines, including the June 30 budget date and a $655 million payment on general obligation debt on July 1.
The negotiations are complicated by the lack of a municipal insolvency framework in Puerto Rico: U.S. law forbids the island’s government entities from restructuring under Chapter 9 of the U.S. bankruptcy code, which was used for Detroit’s 2013 bankruptcy. Puerto Rico’s U.S. Congressman, Pedro Pierluisi, is fighting in Washington to extend Chapter 9 to Puerto Rican public entities.
A so-called Recovery Act was last year passed, making some of the island’s agencies eligible for court-supervised debt restructuring, PREPA included. But the law was voided by a court in February and Puerto Rico is appealing the ruling.
The legal uncertainty makes it difficult to predict bondholder recoveries.
“It’s a wild card because we don’t even know what the framework for settling these disputes will be,” said Fitch analyst Dennis Pidherny. “Until that first question is answered, it’s very hard for investors to determine” recovery prospects. (Additional reporting by a contributor in San Juan)