In August 2015, two municipal issuers tested the financial markets: The city of Detroit and the Puerto Rico government-owned Puerto Rico Aqueduct and Sewer Authority (PRASA). Detroit filed for bankruptcy in 2013, its bondholders taking deep discounts. PRASA has always met its credit obligations. Detroit easily placed its debt at 4.5 percent, while PRASA had difficulty in placing debt at more than 9 percent. Meanwhile, the government-owned Puerto Rico Electric Power Authority (PREPA) is shut out of the capital markets.
Chapter 9 of the U.S. Bankruptcy Code protects a political subdivision, public agency or instrumentality of a state. In 2013, Detroit filed for a debt restructuring under Chapter 9, which gave the city the possibilities for a new beginning. The results thus far are promising. The law applies to the 50 states, but not to Puerto Rico.
Congress has been unwilling to extend Chapter 9 protection to the territory. The result is difficult negotiations between bondholders demanding pounds of flesh and Puerto Rico government instrumentalities. Puerto Rico is unable to use the possibility of filing bankruptcy as leverage to reach reasonable agreements. Negotiations could drag on for a long time, becoming an impediment to Puerto Rico's economic recovery.
The negotiations between the bondholders and PREPA are a case in point. The bondholders shared a proposal with the press in July 2015 that would have a negative impact on the island because it would increase electricity rates. Given the present dire state of the Puerto Rico economy, such an increase would imply further economic contraction and continuing emigration.
According to bondholders, the electricity rate would decline from the 28 cents per kilowatt-hour a year ago, August 2014, to something in the vicinity of 24 cents per kilowatt-hour. However, this implies an increase from the present 21 cents per kilowatt-hour even if the bondholders' projections pan out. As stated by Stephen Spencer in a previous contribution to The Hill: "Our proposal would result in Puerto Rican electricity rates being roughly 15 percent lower than PREPA's 'status quo' rate. We used the average August 2014 electricity rate because this was when we started negotiations, so it's the benchmark we have been using throughout this process."
The July proposal also included Capital Appreciation Bonds (CAB). These involve no disbursement by PREPA over 20 years because even after the rate increase, cash flow would not be enough to pay these bonds. Therefore, the bonds would accrue interest over 20 years at S&P AAA Municipal Bond Yield plus 200 basis points. Then, starting in 2035, somehow, PREPA and its Puerto Rico clients are supposed to come up with more than $5 billion.
Detroit was able to spread out the pain of debt restructuring among residents, pensioners, public-sector workers and bondholders. Today, Detroit is coming back as a city. Puerto Rico instrumentalities would be able to spread the pain if Chapter 9 was available to them. Even in the absence of Chapter 9, Puerto Rico should still strive to restructure debt in a fair way.
References to the disbursement of Capital Appreciation Bonds have been corrected.
Feliciano is an economist and president of Advantage Business Consulting.
By Vicente FelicianoChapter 9 of the U.S. Bankruptcy Code protects a political subdivision, public agency or instrumentality of a state. In 2013, Detroit filed for a debt restructuring under Chapter 9, which gave the city the possibilities for a new beginning. The results thus far are promising. The law applies to the 50 states, but not to Puerto Rico.
Congress has been unwilling to extend Chapter 9 protection to the territory. The result is difficult negotiations between bondholders demanding pounds of flesh and Puerto Rico government instrumentalities. Puerto Rico is unable to use the possibility of filing bankruptcy as leverage to reach reasonable agreements. Negotiations could drag on for a long time, becoming an impediment to Puerto Rico's economic recovery.
The negotiations between the bondholders and PREPA are a case in point. The bondholders shared a proposal with the press in July 2015 that would have a negative impact on the island because it would increase electricity rates. Given the present dire state of the Puerto Rico economy, such an increase would imply further economic contraction and continuing emigration.
According to bondholders, the electricity rate would decline from the 28 cents per kilowatt-hour a year ago, August 2014, to something in the vicinity of 24 cents per kilowatt-hour. However, this implies an increase from the present 21 cents per kilowatt-hour even if the bondholders' projections pan out. As stated by Stephen Spencer in a previous contribution to The Hill: "Our proposal would result in Puerto Rican electricity rates being roughly 15 percent lower than PREPA's 'status quo' rate. We used the average August 2014 electricity rate because this was when we started negotiations, so it's the benchmark we have been using throughout this process."
The July proposal also included Capital Appreciation Bonds (CAB). These involve no disbursement by PREPA over 20 years because even after the rate increase, cash flow would not be enough to pay these bonds. Therefore, the bonds would accrue interest over 20 years at S&P AAA Municipal Bond Yield plus 200 basis points. Then, starting in 2035, somehow, PREPA and its Puerto Rico clients are supposed to come up with more than $5 billion.
Detroit was able to spread out the pain of debt restructuring among residents, pensioners, public-sector workers and bondholders. Today, Detroit is coming back as a city. Puerto Rico instrumentalities would be able to spread the pain if Chapter 9 was available to them. Even in the absence of Chapter 9, Puerto Rico should still strive to restructure debt in a fair way.
References to the disbursement of Capital Appreciation Bonds have been corrected.
Feliciano is an economist and president of Advantage Business Consulting.
Detroit and Puerto Rico, a tale of two issuers
No comments:
Post a Comment