July 31 (Reuters) - A preliminary deal with owners of more than $3 billion of Puerto Rico Electric Power Authority (PREPA) bonds, announced late on Monday, puts the bankrupt utility on a tentative path toward transformation and privatization, but more challenges remain.
The restructuring agreement announced by a bondholders group largely made up of mutual funds and the utility would exchange existing bonds for new debt and link future payments to the island's economic recovery.
The deal marks a major development in the government-owned utility's four-year effort to restructure its debt. That process produced multiple proposals that were ultimately stymied, including one that was rejected by Puerto Rico's federal oversight board last year.
Monday's deal sent prices on some PREPA bonds higher in secondary market trading.
Governor Ricardo Rossello's office estimated the tentative agreement would result in more than $3 billion in debt service cost savings over 20 years.
Oversight board Chairman Jose Carrion called the deal "a milestone" in the debt restructuring process aimed at transforming and privatizing PREPA into "a modern, world-class utility."
Sinking under a debt load of $9 billion, PREPA filed for bankruptcy in July 2017. Its financial and operational problems were compounded by Hurricane Maria, which slammed into the island in September, decimating an electric grid already struggling due to poor rate collection, heavy management turnover and lack of maintenance.
Unlike previous proposed deals with creditors, the new agreement links future debt payments to Puerto Rico's economic recovery and minimizes risk to rate payers by setting a fixed annual transition charge, according to the territory's oversight board, which was also part of the agreement. That board was created by the U.S. Congress under the so-called PROMESA Act.
James Spiotto, a municipal bankruptcy expert at Chapman Strategic Advisors, said on Tuesday the deal shows progress toward a consensual resolution.
"It's a very positive step," he said in an interview. "Is it done? No."
The agreement would give bondholders 67.5 cents on the dollar in the form of 40-year "tranche A" bonds and 10 cents on the dollar in the form of 45-year "tranche B" bonds that would receive excess cash flow once the tranche A bonds are repaid.
"This negotiated agreement, the first of its kind in the commonwealth's restructuring, is a significant positive achievement for all parties involved," the Ad Hoc Group of PREPA bondholders said in a statement.
Some PREPA bonds due in 2042 traded at 61 cents on the dollar on Tuesday, up from 45 cents on the dollar earlier this month.
The preliminary agreement lays out several potential events that could result in its termination, including the dismissal of the bankruptcy case.
Not included in the preliminary deal are PREPA bonds backed by insurance companies that guarantee debt payments. Assured Guaranty, a bond insurer, said on Tuesday it will continue "to vigorously enforce our property rights as a secured creditor" in PREPA's bankruptcy case, while also seeking to consensually resolve matters.
The oversight board said that in addition to finalizing the deal, it seeks to reach debt restructuring agreements with insurers and fuel line lenders.
Rossello in January announced a plan to privatize the crippled utility, which recently experienced management changes that led to a congressional oversight hearing last week.
(Reporting by Karen Pierog in Chicago Additional reporting by Nick Brown in New York Editing by David Gaffen and Matthew Lewis)