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Bondholders need to face reality in Puerto Rico power authority privatization plan

  • Puerto Rico's Governor Ricardo Rossello recently revealed a plan to privatize parts of the bankrupt Puerto Rico Electric Power Authority (PREPA) over the next 18-months.
  • Bondholders could well find themselves in the unenviable position of arguing for creditors' rights while, outside the court room, some one million Puerto Rico residents are still without power.

An electrical crew attempts to repair power lines that were knocked over Hurricane Maria passed through on September 27, 2017 in Corozal, Puerto Rico.
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An electrical crew attempts to repair power lines that were knocked over Hurricane Maria passed through on September 27, 2017 in Corozal, Puerto Rico.

Investors are taking a wait-and-see attitude to Puerto Rico's Governor Ricardo Rossello's recent proposal to privatize parts of the bankrupt Puerto Rico Electric Power Authority (PREPA) over the next 18-months.

The wariness is well-deserved. After all, not only is it unclear if the proposal will ultimately come to fruition, but also who knows what it will look like when it does? However, with Puerto Rico's legislature passing an emergency funding measure in late January just to ensure the struggling utility can keep the lights on, the matter is more pressing than ever.

Natalie Jaresko, Executive Director of the Financial Oversight and Management Board for Puerto Rico, has made it clear the Board favors a full operational and financial transformation of PREPA. To assure that, she stated the Board is "considering privatization as one of our options, maybe privatization of the entire system, some select part, or bringing in the private sector to compete."

Having the Board's backing is critical, but before anything can happen, the proposal has to both clear Bankruptcy Court Judge Laura Taylor Swain's approval and get real bidders to actually buy whatever assets the Governor envisions selling off.

As it stands now, neither are particularly good news for bondholders. PREPA has a total of $8.2 billion in public debt outstanding, of which the principal and interest payments on around $4.9 billion are insured by financial guarantors. The bondholders of the uninsured debt have seen a steady decline in value of their investment as problems facing Puerto Rico's power utility deepened.

"Given the support by both the governor, the Oversight Board chair, and nearly all the stakeholders in positions to decide on the matter, privatization, in some form or another, is going to come to pass."

By the time PREPA filed for bankruptcy in July 2017, investors were already down about 38 percent. After the filing, values fell even further. How much further? Based on trade data posted on the Municipal Securities Rulemaking Board's EMMA, Thomson Reuters Pricing Service has seen the values on some PREPA bonds decline by nearly 50 percent since the bankruptcy. Prices have settled in around 35 cents on the dollar.

Between investors seeing a sum total of over $2.14 billion in value evaporate and the bond insurers now shelling out millions out of their own pockets to pay on the defaulted debt, everyone is a little cranky.

Moreover, the economics of privatization doesn't favor debt. Given Puerto Rico's dated energy generation and distribution infrastructure and its long-deferred maintenance, it's pretty clear a complete overhaul is necessary—likely costing billions.

To make privatization work, both the governor and the Oversight Board are aware they need well-capitalized bidders, either domestic or international, to make that kind of a capital commitment.

The more old outstanding debt that needs to be retired or exchanged, in whole or at a discount, the less likely bidders are going to be interested. No bidder wants to be building a new power plant and distribution system while also either saddled with old debt or being forced pay to retire it. You don't have to be Warren Buffett to figure out where that leaves bondholders. Bondholders are going to suffer losses.

Correspondingly, bondholders are in no mood to roll over. Assured Guaranty, a bond insurer that guarantees payment on some $4.9 billion of the PREPA bonds, stated PREPA would have to find a way to settle with creditors—which includes Assured—with either cash or assets. Coming out empty handed was not an option. Other bondholders are threatening litigation to protect creditor's rights and improve their bargaining position in any final resolution.

It might backfire. Bondholders could well find themselves in the unenviable position of arguing for creditors' rights while, outside the court room, some one million Puerto Rico residents are still without power since Hurricane Maria blew through. Creditors' rights are one thing, but public needs are quite another. Creditors' rights don't turn on the lights.

In assessing options, policymakers—Congress, the Oversight Board, the Bankruptcy Court—are going to give greater weight to the pressing current and future humanitarian and economic needs of Puerto Rico. The more vociferously bondholders push for a larger slice of recovery dollars, the more they end up risking looking like uncaring profiteers. No policymaker charged with the oversight of Puerto Rico wants to be perceived as being aligned against the interests of the over 3 million residents whose lives they are responsible to protect.

For all the political posturing and litigation rumblings, one thing remains absolutely certain: the economy of Puerto Rico desperately needs an upgraded and stable power grid. It's very economic life depends on it; lacking that, there is no business, from the corner store to the resorts and cruise ships that can survive.

Moreover, on an island where the stated unemployment is around 10 percent but privately is believed to be much higher, jobs coming from the new construction of as well as ongoing maintenance on the power plants and transmission lines would be greatly welcomed. If privatization is going to restore consistent, reliable power to the island faster and more efficiently, that is the avenue that is going to be pursued.

In the end, the market will provide guidance as to the value of privatization as it works its way through the Oversight Board and the Court. That's going to take time. Given the varied legal, public policy, and economic considerations needing resolution before the court approves executing any privatization proposal, there are likely to be more adjustments and compromises prior to a final plan being enacted.

But make no mistake: it will be finalized. This is no trial balloon. Given the support by both the governor, the Oversight Board chair, and nearly all the stakeholders in positions to decide on the matter, privatization, in some form or another, is going to come to pass.

Understandably bondholders and their surrogates are duty-bound to act to protect their economic interests. However, in this instance, bondholders who try to forge a deal by stoking the fires of controversy are likely to get burned. They could better protect their creditor rights by returning to the negotiating table looking to assist in turning on the lights.

Commentary by Barnet Sherman, head of municipal research for Thomson Reuters Pricing Service.

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