A Short Legal Review of the Latest PREPA RSA

Well, here we go again. Another day, another PREPA RSA.  We’ve had almost a week to digest the RSA and listen to the myriad of press conferences on whether this will or won’t lead to higher electricity prices.

But here is the most important question we should be asking: Will this time be any different than the previous RSAs?

In the almost 2 years since the Oversight Board came into existence and Governor Rosselló walked backed his campaign pledge to do deals, one thing has become patently obvious: the credibility of these parties is as bankrupt as Puerto Rico.

The Oversight Board and Governor Rosselló need to show progress and to regain credibility. They are also worried about federalization.

To start, the agreement is not much different from the RSA previously rejected by the Board in June of 2017. Nothing in this RSA accomplishes the Board’s original vision when they decided to rebuke the will of Congress, and take PREPA to Title III.  This included wiping out PREPA’s lien and erasing the entirety of the contractual debt of PREPA, raising the specter of a Takings Clause claim. With this RSA, none of that gets accomplished and there is no Taking Clause claim.

Whose In, Whose Out

The bondholders that own or control at least 2/3 of the dollar amount of the outstanding non-insured bonds, section 10.02(a)(vi). Hence, the agreement is not with the insurance companies or the fuel line banks. Like the previous RSA’s, its members cannot transfer (sell) their bonds to any other entity than those involved in it, section 5. The agreement, at Section 8, states:

Without limitation to the provisions of the Term Sheet, the reasonable fees and reasonable expenses of the members of the Ad Hoc Group incurred in connection with the RSA, the Definitive Restructuring Support Agreement, and any documents and transactions (including a plan of adjustment) relating to or implementing the foregoing on or after July 23, 2018, limited to one (1) primary law firm, one (1) municipal bond counsel law firm, one (1) Puerto Rico law firm, one (1) financial advisor, and one (1) utility consultant, shall be reimbursed by PREPA on a monthly basis within forty-five (45) days following submission of an invoice and redacted time detail summary to counsel to the FOMB, PREPA and AAFAF.

Section 10 notes that the agreement may be terminated by mutual consent, or by a breach of the agreement. The only remedy for a breach is the termination of the agreement as listed in section 11.13. In addition, section 10.02(b) says the agreement ends on August 27, 2018, at 5 pm, New York City time, but can be renewed through another agreement. Moreover, New York state law on contracts applies and jurisdiction for any disputes is the Title III court, section 11.03, and the parties obligations are several, not joint and several, as stated in section 11.14.

Economic Terms (i.e. – Electricity Prices)

Where things get interesting is in the economic terms of the agreement, which start at page 33 of the PDF file. It states, inter alia:

 The members of the Ad Hoc Group and any other holders of PREPA Bonds subject to the RSA (the “Supporting Holders”) shall commit to exchange all of their uninsured bonds for Securitization Bonds (as defined below) on the terms and in the manner set forth below.

 The Puerto Rico Electric Power Authority Revitalization Corporation or a new bankruptcy-remote special purpose vehicle as may be agreed upon shall issue Tranche A and Tranche B Securitization Bonds, secured by the Transition Charge.

This is the same system of the rejected RSA. The economic agreement also states as to the bonds:

 The Transition Charge allocable to the outstanding power revenue and revenue refunding bonds issued by PREPA under the 1974 Trust Agreement shall be set at the following levels:

– 2.636 c/kWh for Years 1-5

– 2.729 c/kWh for Years 6-10

– 2.868 c/kWh in Year 11

– Starting year 12, annual 2.500% increases over the prior year’s Transition Charge

 The Transition Charge allocable to the outstanding power revenue and revenue refunding bonds issued by PREPA under the 1974 Trust Agreement shall be capped at 4.348 c/kWh

Similar to the previous RSA, there will be an additional charge for consumers but Governor Rosselló and José Ortiz have claimed, and then backed off, that there will be no increase because the switch to gas will lower rates by 6 cents by kWh. This is difficult to believe for the switch to gas will take time. Moreover, if the agreement is approved as part of the plan of adjustment, it would only start next year. The exchange rate will be as follows:

 67.5% of PREPA Bonds to Tranche A Bonds

 10.0% of PREPA Bonds to Tranche B Bonds

 Tranche A Bonds will extend beyond the stated maturity if not paid in full on the stated maturity, until paid in full, including unpaid interest.

 Unpaid interest on the Tranche A Bonds will accrete.

 PIK interest to accrue annually starting in Year 1.

 Tranche B Bonds shall receive 100% of total excess cash flow after repayment of the Tranche A Bonds. Potential recovery on the Tranche B Bonds shall be capped at the exchange amount, plus PIK interest.

 Tranche B Bonds will mature at stated 45 year maturity, and all unpaid debt service will expire unpaid.

 Tranche A Bonds: 40 year stated maturity, subject to early mandatory redemption from sweep of Transition Charge cash flow (35 year expected maturity under Oversight Board’s May 2018 projections, which may change)

 Tranche B Bonds: 45 year stated maturity

 Tranche A Bonds: 5.25% cash interest

 Tranche B Bonds: 7.00% PIK interest / 8.75% PIK interest to the extent the Tranche B Bonds are not tax-exempt (solely for portion that is not tax-exempt)

According to sources I consulted, this deal gives bondholders a 22.5% discount (67.5 + 10), which is 2.25% more than the rejected RSA from last June. It also extends the life of the bond for many years, with Tranche A being further extended if one year’s payment cannot be made in full. Also, the interest rate for Tranche A is competitive with a securitized instrument. Not bad. In addition, the agreement states:

 No default on either Tranche A or Tranche B Bonds for failure to pay scheduled debt service, so long as full amount collected under the Transition Charge (minus administrative fees) is used to pay debt service. Interest shall continue to accrue (and pay-in-kind, as applicable) and accrete at the original Coupon rate.

 The Transition Charge shall extend, and interest shall continue to accrue (and pay-in-kind, as applicable) at the original Coupon rate, until the later of (1) the date necessary to pay the Tranche A Bonds in full, even if past their stated maturity, and (2) the earlier of (i) the stated maturity of the Tranche B Bonds, and (ii) the date on which the Tranche B Bonds are paid in full.

 Remedies will be mutually agreed upon and will include, at a minimum, the right to replace the Transition Charge servicer and the right to enforce the Securitization Bonds’ trust agreement, the servicing agreement, and non-impairment covenants. Requirements for replacement servicer to be mutually agreed upon as part of Definitive Documentation.

Again, not a bad deal for bondholders. Finally, there is a mention of other creditors:

The Ad Hoc Group shall not object if other legacy debt holders (including fuel line lenders) receive the same treatment with the same terms as the Ad Hoc Group is receiving, so long as such treatment does not adversely affect the Ad Hoc Group’s recoveries. Adjustments to coupons and par are authorized, so long as total cash flow payable each year remains the same (with proportional adjustments for the varying claim sizes of varying legacy debt claims), and so long as such treatment shall not adversely affect the Ad Hoc Group’s recoveries.

In other words, the deal for the insured bondholders may be better as long as the amounts to be received by the non-insured’s does not change. That also applies to the fuel line lenders who are owed around $700 million. Hence, the haircut per bond may decrease further, taking it closer to the 20% of the rejected RSA. In addition, the monolines could get other valuable considerations, as Syncora did in the Detroit bankruptcy (i.e., a parking lot concession worth millions). On July 31, Assured Guarantee rejected the agreement, insisting in the previous RSA they claim is grandfathered. Don’t doubt they will insist on getting a better deal than the non-insured.

Reality Setting In

This deal begs the question, what happened?

Up until recently, the Board and the government were claiming that PREPA bondholders only had a net lien, meaning that the utility’s expenses were paid first. If there was anything left over, only then were the bonds paid–hence they had no collateral. Now, it is given new collateral and will increase the rate consumers pay for electricity. What changed? I think the Board and the government are worried about Congress taking over PREPA in one way or another and want to show that they can get the job done in a way that is very similar to the previous RSA, which Chairman Bishop insisted should not have been rejected. With the COFINA deal pending, this would show that the Board and governor are serious about doing deals.

One of the many unanswered questions is whether this deal will make it more difficult to privatize PREPA. I have mentioned before that I don’t think the politicians in the island want to sell it, not even the generation part, but the Board was insistent on it. We will see.

The PREPA unions and the PDP have already voiced opposition to the deal. Very likely they will sue to block it. The next few months are going to be very interesting indeed.