Puerto Rico's debt problems aren't going away

Impact of Puerto Rico's debt

It was a week that investors and analysts alike had been eyeing for insight into how Puerto Rico planned to handle its $72 billion debt burden, due to three key deadlines for the financially strapped island.

The way each of these situations played out, though, may leave holders of Puerto Rico's paper with more questions than much-needed answers.

Here is where things stand on the each of the three deadlines that Puerto Rico faced heading into this week:

Sept. 18: Prepa's $8.6 billion bill

Late on Tuesday, the Puerto Rico Electric Power Authority and a large group of its creditors reached a verbal agreement on the framework for a restructuring plan of the utility's $8.6 billion in outstanding debt, narrowly making the Forbearance Agreement deadline that required a term sheet be in place by midnight.

The agreement, which has been in place for more than a year and protected the utility from litigation, was extended through Sept. 18.

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Details of the plan continue to be hammered out between Prepa, one of the largest utilities in the U.S., and the Ad Hoc Group of creditors—comprised of traditional mutual funds and hedge funds including BlueMountain Capital and Knighthead Capital—which holds about 35 percent of the debt outstanding.

Noticeably absent from the new forbearance agreement is MBIA, the largest insurer of Prepa's paper with about $1.4 billion in gross exposure (out of the 30 percent, or $2.6 billion, of Prepa bonds that are insured). Some uncertainty remains around why MBIA chose not to accept the deal; the power authority plans to continue negotiating with MBIA, as well as its other insurers and lenders.

With no money currently being set aside by the utility for future bond payments, a finalized restructuring deal seemingly will have to be signed before Jan. 1, when a $191 million coupon comes due to its bondholders. Investors are focused on this deadline as more than 50 percent of Prepa's bonds are held by U.S.-based mutual funds, including Franklin Templeton and Oppenheimer Funds.

Under the restructuring plan, the Ad Hoc Group will swap the existing revenue bonds for new notes and receive 85 percent of its existing bond claim.

Bondholders will have two options to swap their existing bonds: Option A is a securitization bond that pays cash interest only for the first five years at a rate of 4 percent to 4.75 percent; option B,is a securitization bond that will accrete interest, but not pay cash, at a rate of 4.5 percent to 5.5 percent during the first five years and pay current interest in cash thereafter.

The plan, assuming participation of 75 percent of the uninsured bondholders excluding those in the Ad Hoc Group, is forecast to reduce Prepa's total debt principal to approximately $670 million and save more than $700 million in principal and interest payments over the next five years.

Melba Acosta-Febo, president of the Government Development Bank for Puerto Rico, hopes the deal will set a precedent for the some $60 billion in remaining debt that will likely need to be restructured.

"The economic terms agreed by PREPA and the Ad Hoc Group represent an important step forward in PREPA's restructuring process, and is an example of the promising results that can be achieved when the commonwealth and its creditors work together," Acosta-Feba said in a statement Wednesday following the utility's announcement.

Sept. 15: Prasa's $90 million

People at the beach in San Juan, Puerto Rico.
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The sole provider of public and wastewater services in Puerto Rico, the Puerto Rico Aqueduct and Sewer Authority, was able to secure an extension to repay a $90 million loan originally due on Monday, to its trustee, Banco Popular de Puerto Rico. The new deadline is Sept. 15.

The $90 million loan stems from an agreement Prasa was able to broker with its creditors in late May to avoid a $150 million payment deadline due to Banco Popular and Oriental Bank. The deal was brokered under the assumption the utility would be able to execute a new bond offering prior to the Aug. 31 due date.

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The 15-day extension will allow the water authority to continue the process of issuing $750 million in bonds, according to a statement issued by Alberto Lazaro, Prasa's executive president.

The timing of the debt offering, which would be the first issuance by the U.S. territory since March 2014, is currently on a day-to-day basis.

Despite the island's troubling fiscal situation, some investors see real opportunity, albeit in select securities.

"Smart money sees this as an opportunity to get into some of the credits that have been oversold," said Vasileios Sfyris, managing partner of First Southern Securities, a broker-dealer that owns and advises investors on Puerto Rico muni bonds, "We're in a very stale and illiquid market in some of [the Puerto Rico-issued muni bond] credits, some of the stronger and more patient hands can capitalize on this."

First Southern Securities, a boutique financial services firm based in Alpharetta, Georgia, opened an office in Puerto Rico last year, in order to gain a better understanding of the island's socioeconomic issues.

Sfyris, who has 15-years of experience in high-yield and distressed muni bonds, is eyeing the secondary market as the place to invest in undervalued Puerto Rican credits.

Sept. 8: The Working Group plan

Shortly after June 29, when the governor of Puerto Rico declared that the island's $72 billion in debt was not payable, the Working Group was established to start on a comprehensive fiscal adjustment plan to restructure the U.S. territory's debt.

The group's restructuring plan was due to be delivered to Gov. Alejandro Garcia Padilla for review on Sunday.

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However, according to a statement issued by the governor's chief of staff, Víctor Suarez Melendez, Padilla granted a last-minute extension to the Working Group to present its fiscal adjustment proposal.

"Since the government's efforts in the past days have been focused on preparing for the possible impact of tropical storm Erika, the work of the designated group, the consultant's analysis, and the final drafting of the document have not been completed," the statement said.

The new deadline for the group to deliver the plan to the governor for review will be "on or before Sept. 8, 2015."

Once the proposal has been completed, the intended date the details will be made public is not known; Padilla is to make that decision after he reviews the plan.

The delay was no surprise to many who closely watch Puerto Rico.

"While leaks of information may be forthcoming before this date, the final public release of the report is unlikely to come before September 8," said Daniel Hanson, an analyst at Height Securities, which advises clients with financial interests in the U.S. territory. "It may, in fact, come much later, as the governor and the Working Group may negotiate changes before releasing details to the public."

Hanson also believes that Oct. 1 is likely the more important date to watch, as this is the deadline set by the governor when legislation will need to be filed with the legislature to put the plan into effect.