The Examiners: Prepa Restructuring Requires Time, Liquidity

Puerto Rico’s Prepa utility has until mid-December to come up with a new business plan and early March to propose a debt-restructuring plan. What should these plans consider?

With debt obligations dwarfing those of Detroit, the Puerto Rico debt crisis will soon take center stage in the restructuring world. Much of the early focus will be on the Puerto Rico Electric Power Authority, or Prepa, and its more than $9 billion in debt. With an impending maturity of nearly $700 million in bank loans and litigation over a new restructuring law, Prepa announced in August that it had reached a short-term forbearance agreement with its principal creditors through March 31, 2015. The good news accompanying this relief was that it required Prepa to retain a chief restructuring officer. It did so with the retention of the highly skilled Lisa Donahue. But there was also bad news: Prepa was only given until March 2, 2015, to submit a restructuring plan.

The restructuring of Prepa (like virtually every restructuring) will undoubtedly require a series of deft, short-term economic fixes, and among them will almost certainly be rate costs (that will have to go up), employee costs (that will have to be cut), bondholder recoveries (that will be reduced), and consideration of a change in ownership from the government of Puerto Rico to the private sector. While each is tricky enough in the short term, the heavy influence of the Puerto Rican political environment makes them even more difficult. Moody’s noted that “any restructuring proposal will be influenced, to some degree, by the commonwealth’s politics, particularly given the weakened and lackluster state of the Puerto Rico economy,” which is an understatement, for sure. Both the governor and the commonwealth’s largest union have announced that they will not support rate hikes, employee reduction or a privatization of Prepa, and Prepa’s board has a number of directors who are government appointees.

The stark positions of the government and the powerful unions are obviously unrealistic and will do little to bring bondholders to the table at a time when the financial markets are already discounting the bonds by 20% to 35%. Nonetheless, a concerted effort to transform its financial reporting appears to have begun in restoring confidence in Prepa. In addition, the tensions created by the June enactment of a law allowing the restructuring of Puerto Rico’s public corporation debt appear to have cooled. But this will be short-lived unless greater progress is made. It is therefore critical that Prepa and the CRO begin to obtain at least some necessary concessions from the government and labor on the key economic levers to generate true momentum with the bondholders.

In the end, however, negotiations over these short-term economic issues are only part of the battle, as Prepa must also develop a viable business model for the future. Prepa continues to produce power with high-cost oil and must shift to lower-cost power sources. Ironically, Prepa has been unable to begin this critical shift due its heavy debt burden and steep oil costs. So the restructuring must allow Prepa the time and liquidity necessary to change its business model. If this fails, no matter how “consensual” the current restructuring is, it will be short-lived. Indeed, only a restructuring of Prepa that addresses the short-term economic issues and creates a more viable Prepa for the future will provide the best long term recovery to all of Prepa’s stakeholders.

Richard A. Chesley is the co-chair of DLA Piper’s restructuring practice, focusing on bankruptcy transactions both in the United States and internationally. He is based in Chicago.