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WRAPUP 1-US municipal market on edge over Puerto Rico power authority payment

WASHINGTON, July 1 (Reuters) - Moody's pushed its rating on Puerto Rico's debt deeper into junk territory on Tuesday and prices of the island's troubled electric authority's bonds plunged as investors awaited word on whether they would receive a scheduled payment on the securities.

The ratings cut and the fall in Puerto Rico Electric Power Authority, or PREPA, bonds comes just days after the territory cut assistance to its public corporations and created a bankruptcy-like process for restructuring their debts.

The developments kept the $3.7 trillion U.S. municipal market on edge because Puerto Rico bonds are widely held thanks to their tax exemption in every state and their high yields, making them a tempting asset despite the U.S. commonwealth's struggles to cope with a shrinking economy, chronic budget deficits and a $73 billion debt load.

Regardless of the payment, PREPA faces other financial obstacles in coming days from expiring lines of credit and limited cash for fuel purchases. Prices of its junk-rated bonds plummeted to 38.625 cents on the dollar, or a yield 14.243 percent, which was close to the record-low 36.875 cents reached on Monday.

The flight to Puerto Rico's $3.5 billion junk general obligation bonds ended as well - with prices falling to 85 cents or a 9.684 percent yield.

The funds to cover the PREPA payment were delivered to the bond trustee, U.S. Bancorp, said Government Development Bank spokeswoman, Betsy Nazario. Approximately $204 million in principal and $179 million in interest is due.

But on Tuesday, rumors whipped through the municipal market that bondholders may not receive any money.

The bond trustee is allowed to hold onto funds if it foresees large expenses looming, and Puerto Rico's new law allowing public corporations to restructure already threatens to rack up costs for PREPA. The authority is considered the most likely corporation to restructure, which could generate legal bills, and on Sunday mutual funds sued saying the law was unconstitutional.

"You can see in their monthly cash flow statements they've been making payments to the trustee," said Shawn O'Leary, senior vice president at Nuveen Asset Management, which holds $80.6 million of bonds that could be subject to the legislation.

"The question then becomes: Will the trustee turn over the funds in the high likelihood that PREPA will be the first to test this law?"

U.S. Bancorp did not respond to questions about its intentions.

The fear is that PREPA is the first domino toward the restructuring of Puerto Rico's debts, a move akin to filing for bankruptcy, which the territory cannot do. The law passed last week excludes Puerto Rico and the GDB.

Puerto Rico has been fighting hard this year to pull its finances together, after years of population and economic declines led its revenues to shrink. Late on Monday, it passed a scaled-down budget for the fiscal year starting on Tuesday, but recent measures may not be enough to fix its economy.

Meanwhile, Moody's Investors Service cut the island's general obligation bonds to B2 from Ba2.

PREPA's $250 million line of credit from Citibank has already expired. On July 3, PREPA is required to pay the bank $10 million. It must turn over $146 million to the bank through the end of August. Likewise its $550 million line of credit from ScotiaBank de Puerto Rico expires next month, putting it on the hook for $525 million.

PREPA is currently negotiating extensions of the lines. Still, it also must find cash to pay a recent internal loan for buying fuel and then cover future fuel purchases.

In the past the GDB has stepped in to prop up the perennially struggling PREPA but now, dealing with its own liquidity worries, it is staying away. Meanwhile, Governor Alejandro Garcia Padilla has repeatedly said public corporations must become self-reliant.

"They're a cash-poor entity and have been for a long time," said O'Leary. "The difference now is that the central government and the GDB said, 'We're no longer floating you loans'."

(Additional reporting by Reuters in San Juan and the Bangalore newsroom; Editing by Tom Brown)