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Debt Audit Commission Raises Flags in New Report

By on September 29, 2016

SAN JUAN — A new preliminary report issued by the Puerto Rico Commission for the Comprehensive Audit of the Public Credit raises serious questions about the $673 million in debt issued by the Electric Power Authority (Prepa) on Aug. 21, 2013.

It questions whether the authority, its auditors and advisers—including the Government Development Bank (GDB) as fiscal agent—and the underwriters involved in the transaction adequately protected both the public interest and Prepa’s investors. The commission identifies several areas that should be further analyzed once the audit of Puerto Rico’s debt begins formally.

The Puerto Rico Electric Power Authority (PREPA) logo is displayed in San Juan, Puerto Rico, on Friday, April 29, 2016. The indebted Caribbean island, home to 3.5 million U.S. citizens, has juggled dwindling resources from one hand to another for months now, to keep creditors at bay. The crisis is set to tip into a new phase this weekend when $422 million of payments are due and, as things stand, unlikely to be made in full -- threatening the biggest default yet. Photographer: Erika Rodriguez/Bloomberg via Getty Images

Photographer: Erika Rodriguez/Bloomberg via Getty Images

The 34-page document details how the utility carried out the issuance, which seems to have had less-favorable terms when compared with similar transactions made at that time, according to the report.

Although the commission approved the document during a meeting Wednesday, it was ready since last month. However, the lack of quorum in four previous meetings and opposition among some of the commission members delayed its approval, sources told Caribbean Business.

The group also approved Wednesday the nomination of Alvin Velázquez as executive coordinator of the commission. Velázquez currently works as an attorney for the Service Employees International Union (SEIU).

This is the second pre-audit report released by the commission, which comprises 17 members representing the public and private sectors, academia and organized labor. It first assessed the $3.5 billion in general obligation bonds issued by the Puerto Rico government in 2014, and the tax revenue anticipation notes, or TRANs, sold in 2015.

Optimistic projections

Among its findings, the report establishes that the official statement of the 2013 transaction shows that Prepa’s projections were not in line with the fiscal and economic conditions of both the public corporation and the island. It is “indicative of unduly optimistic and insufficiently documented assumptions with respect to Prepa’s ability to raise an additional $1.1 billion to complete its five-year $1.6 billion capital improvement program,” and repay its creditors, according to the preaudit report.

URS Corp., Prepa’s consulting engineers since 1945, and the GDB in its role as fiscal agent “attested to the reasonableness” of the authority’s plans and projections.

The report also notes how during the past 10 years, Prepa had been “artificially inflating its debt coverage ratio,” by recording higher revenues than it actually generated. This would have enabled it to meet its debt-coverage requirements, which called for its annual net revenues to be 120% of what the utility had to pay in debt service the following year.

“However, when Prepa’s method of artificial inflation is not used, the requirement of at least 120% was reached only once in the same ten years,” the document reads.

As for the recent restructuring efforts at the public corporation, the report warns that the $162 million in recurring savings achieved so far would not be sufficient to modernize its infrastructure, unless greater debt relief is achieved from its creditors.

Audit processes

The preaudit document also questions why Prepa’s independent auditors, Ernst & Young, didn’t emphasize the serious liquidity problems the corporation already faced in the utility’s fiscal 2012 audited statements. According to the commission, the auditors didn’t address the matter as a “going concern” in its opinion.

Moreover, Prepa failed to take the necessary steps to that would have accounted for in its 2012 statements the roughly $1 billion the utility needed to invest in its infrastructure, particularly in its generation component, so it could comply with certain environmental regulations.

The preliminary report also raises concerns over compliance with federal regulations and laws in the utility’s auditing and disclosure processes. For instance, the commission highlights the role played by the consulting engineers in “the commodification process” of Prepa’s power revenue bonds. “This created an environment in which the income earned by the URS Corporation was directly tied to the outcome of the sale of the financial instruments of the corporation (PREPA) that it was contracted to analyze,” the document reads.

It also questions whether the GDB’s dual role as financial adviser and lender to the authority constitutes a conflict of interest and whether the governance structures at both public entities adequately protects the public interest.

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