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Prasa’s Labyrinth

By on February 25, 2016

Securitization Essential for Market Access

Prasa Maneuvers Through Revitalization Maze

Management Touts Securitization as Essential to Avoid Rate Hike in July

Every Dec. 15, the governing board of the Puerto Rico Aqueduct & Sewer Authority (Prasa) revises its financial projections for the following year, and if needed, comes up with a plan to cover any operational deficits that may show up.

However, this was not the case last December. “Given how many pieces are moving at the same time, we haven’t been able to complete that process, which in a normal situation would have been already done with relative easiness,” Prasa Executive President Alberto Lázaro conceded to a handful of reporters, just after a meeting of the utility’s board last week. Kenneth Rivera, Prasa’s board chairman, and Mariana Bartok, deputy finance manager, joined him in the roundtable discussion.

Puerto Rico’s water utility, with almost $4 billion in debt, is no stranger to the island’s larger fiscal crisis. Prasa owes roughly $150 million to its suppliers and contractors, many of which are local companies struggling to stay afloat amid the island’s decade-long economic free fall. With no money to pay for much-needed upgrades, Prasa has stopped its capital improvement program—the utility’s five-year plan to invest in its infrastructure—which was approved in 2015 to the tune of more than $1 billion.

The utility will finish the fiscal year, which ends June 30, with a $45 million to $50 million deficit. “Why? We had a drought worth $70 million,” Lázaro explained, adding that Prasa has reduced its spending by about $20 million to ease the red ink.

During last week’s meeting, the utility’s board approved an action plan that establishes how Prasa would act under several different scenarios that could lie ahead.Alberto Lázaro, Prasa president

“We need help,” said Lázaro, while making reference to a one-page flow chart that outlines the plan, and perhaps more importantly, the timing of a water-rate hike that could come as soon as this summer or as late as 2018 under the best-case scenario.

In fact, Prasa needs help from the central government, which would have to pay roughly $35 million of the $60 million it owes the utility, while also staying current with its water bills. Prasa also needs help from the Government Development Bank (GDB) to extend a much-needed line of credit set to expire this summer, which would support Prasa’s plans to avoid a rate hike this year. The utility also needs a hand from credit-rating agencies, bondholders and even federal agencies.

And they need help from the local Legislature, which after narrowly approving the Puerto Rico Electric Power Authority (Prepa) Revitalization Act, is now evaluating the Prasa Revitalization Act—a bill that would pledge a portion of the water rate charged to clients to pay for servicing new debt through a process known as securitization.

Despite not being initially requested by Prasa, the proposed legislation now presents the best way forward for the utility, according to its management, particularly to avoid a rate hike in July, which could very well reach double digits.

Got to be startin’ somethin’

Right off the bat, Prasa will no longer set aside money to service about $1.1 billion of its junior debt, most of which is guaranteed by the central government and includes federal loans made by the U.S. Department of Agriculture’s (USDA) Rural Development, which is owed $390 million, and the Environmental Protection Agency (EPA), owed $550 million.

“That doesn’t mean we aren’t going to pay,” Lázaro quickly pointed out about the suspended set-asides.

As for the cash-strapped central government, Prasa is asking it to stay current with at least 96% of its billing, in addition to paying within the next few months about $35 million of the $60 million it owes the utility, a debt that does not include municipalities.

Prasa’s management will reconvene by April to see what has happened with the central government and the securitization bill. If the latter is approved by that time, the utility would have about three months to find money that could avoid a rate hike come July 1. That cash would also allow Prasa to pay its suppliers, reactivate the infrastructure program and meet existing debt service as scheduled.

Getting the bill approved and, along with it, obtaining external financing could push the rate hike to at least the summer of 2017, when fiscal 2018 kicks off and right about the time Prasa had originally anticipated a review of its rate. Last revised in 2013, the utility had projected a 4.5% increase to its current rate during fiscal 2018.

Looming debt obligations

On the other side of the coin, without the bill or financing, Prasa would not pay about $35 million of the roughly $166 million due July 1 on its debt service. What’s more, the central government could end up with an $18 million tab in its lap since it guarantees a portion of this debt payment—unless Prasa convinces two federal agencies, the USDA and the EPA, to agree to “a different payment plan,” Lázaro said.

Remember the monthly set-asides the utility is not doing as part of its action plan? Under this scenario, that is the money that would have been used to cover the July 1 payment on its so-called junior debt, but the utility would rather use these funds to cover other obligations, such as beginning to pay its suppliers. So, the plan is to have Prasa sit down and negotiate with these agencies, while avoiding slapping the commonwealth with an $18 million bill on July 1.(Centro) Director de la AAA Alberto Lázaro

Junior debt includes loans with the USDA, EPA and GDB, as well as debt corresponding to the Superaqueduct water system. Unlike the island’s electric utility, Prasa operates under a “gross revenue pledge”—meaning revenues go first to a trust, from which senior bonds are paid first, followed by operational costs and then the juniors.

The utility’s management has already held informal talks with the two federal agencies, in an effort to negotiate the July 1 payment. Has this ever been done before? Lázaro briefly recalled a precedent in New York with the EPA, while adding they are still working on the USDA’s Rural Development case.

Prasa also has a $90 million payment due Feb. 29 on short-term loans, of which it was able to prepay $15 million that was owed to Banco Popular. “The other investors—their lawyers, really—decided they would rather wait [to get paid],” Prasa’s chief said. Patiently waiting until the end of the month would give these investors an additional $600,000 in interest.

To pay the $90 million, Prasa is siphoning its Rate Stabilization Fund (RSF), which was established to prevent a sooner-than-projected rate hike. “Since next fiscal year’s budget has no deficit, the rate covenant [that calls for a rate hike] is not triggered. So, if I have the money in the RSF to pay this debt, I would rather pay it and not keep paying interest of $600,000 a month,” Lázaro explained.

Meanwhile, the rest of the July 1 debt-service tab, or $135 million corresponding to senior and refunding bonds, should be met without much trouble given Prasa’s gross revenue pledge. This debt includes roughly $1.5 billion in refunding bonds the utility issued in 2008, which established a reserve that requires three months’ worth of operational spending, or about $180 million. A line of credit has covered this obligation, and when asked who provides it, Lázaro said the GDB.

Credit (life)line

“You may think what is its worth, but we have it…we have the signed paper,” Prasa’s chief quickly added about the GDB’s $180 million line of credit.

However, there’s a bit of a problem. The credit line expires June 30 and the financially battered bank has already said it would not extend it, according to Lázaro. “But let’s see how this goes until then,” he added, showing some optimism.

However, it is well-known that the GDB has been running dangerously low on cash for months and its liquidity issues are already threatening its ability to pay for its debt service and keep operations afloat if its fiscal health does not improve in the immediate future.

In a written statement to Caribbean Business, the GDB said that at this moment, it is “in no position to evaluate an extension to the operational reserve’s $180 million line of credit.” The bank added it seeks to continue working with Prasa to evaluate the different options available.

What happens if the reserve is not covered? “If that line is not extended, we would have to fund the $180 million on July 1, and that would trigger a rate hike,” Bartok said. Lázaro acknowledged the utility will not be able to fund the reserve at once, so they will ask credit-rating agencies in New York to amend bond documents to allow Prasa to fund the reserve gradually, over a five-year period.

In a nutshell, if Prasa needs to immediately fund the $180 million operational reserve, either because the GDB does not extend the line of credit or credit-rating agencies do not agree with the five-year gradual funding, a rate hike would follow—unless Prasa finally achieves external financing that would help it cover this reserve.

Searching every nook & cranny for financing

During past years, the utility’s board has decided to finance most of its infrastructure projects by issuing debt, rather than using its revenues. However, for the past 18 months, Prasa has been unable to go to market.

Lázaro surely has a host of “external reasons” why this has not been possible: the priority the GDB has placed on Prasa to go to market, the discussion over Puerto Rico’s access to Chapter 9 of the U.S. Bankruptcy Code and the legal dispute over the Puerto Rico Public Corporation Debt Compliance & Recovery Act. The truth of the matter is that the utility has been unable to finance its capital improvement program with its current revenue. After all, it was never meant to foot the improvement bill.Melba Acosta Febo (GDB) Government Development Bank President & Chief Financial Officer of the Government_ANA_5531

Since 2014, no stone has been left unturned in Prasa’s quest for financing: from traditional investors and private banks, to hedge funds and even municipalities. San Sebastián just loaned the utility some money—at a 6% interest rate—so Prasa could finish an upgrade of one of its plants in this town, after the contractor stopped showing up because the utility was not paying him.

Most recently, talks resumed once again between Prasa and a group of hedge funds, the same group who was willing to come on board the utility’s failed transaction last August.

“We were very close,” said Lázaro, in reference to Prasa’s previous attempt to access capital markets in August. The utility was able to issue a preliminary offering statement, but the deal quickly went south amid the onerous terms being asked by potential investors. These terms were called by the GDB as “unprecedented,” and it would have made it the most expensive bond issue ever at pricing.

As for potential demand if Prasa is able to return to the market following the approval of the securitization mechanism, Lázaro believes this will not be a problem. “I believe there will be a market for Prasa. Obviously, this would all depend on credit-rating agencies giving a good grade, and it remains to be seen how they see a securitization within the Puerto Rico context. That grade will determine the type of investor and at what cost,” he said.

North Carolina-based Raftelis Financial Consultants, which specializes in water utilities, has been retained for almost $1 million to conduct an evaluation of Prasa’s operations, including its long-term infrastructure plan. Raftelis is expected to deliver its report within the next weeks, according to Prasa’s chief. Bringing in the external consultants, at the recommendation of the GDB, is part of efforts to provide more security to potential investors, if Prasa is able to regain access to capital markets.

A very important bill

Having extinguished all possibilities to achieve external financing to date, Lázaro said that in addition to the rate hike, the only remaining option is the Prasa securitization bill.

House Bill 2786 would establish the Prasa Revitalization Act, whereby a new corporation would be created with the sole purpose of issuing new debt for the utility, backed by a portion of water bills that would be pledged to cover this new debt service. It basically seeks to provide investors more security than they will be repaid. “It is a very, very important bill,” board chairman Rivera said.

“I think the market is waiting for this [bill], they already know this is coming,” Lázaro added. While it can take up to four months to establish the mechanism following the bill’s enactment into law, it still puts the utility in a better position at achieving interim financing that avoids a rate hike this year, according to Prasa’s chief.

untitledPopular Democratic Party Rep. Rafael Hernández, co-author of the bill and chair of the House Treasury Committee, has placed high priority on the matter, aiming to move the measure as quickly as possible. But although the GDB supports establishing a securitization mechanism at Prasa, it has called for changes to the bill to ensure the utility’s clients are not the only ones footing the bill.

What’s more, the island’s fiscal agent believes a long-term strategic plan should first be reached with stakeholders to develop infrastructure projects, implement operational improvements and elevate service standards. This plan should serve as the starting point toward Prasa’s securitization.

When asked by this newspaper about Prasa’s securitization bill, the GDB stated it continues to support the utility “in the structuring of a strategy that achieves the stabilization and financial sustainability of the utility, both in the short and long term.” For the bank, this needs to include future discussions among Prasa’s stakeholders, including its management, consultants, lawmakers and creditors.

While Lázaro acknowledged Prasa would need to eventually sit down with creditors, the utility is perhaps following a different path than Prepa, the electric utility. For instance, most of the money that would be sought, once the securitization is in place, would be invested in the utility’s infrastructure, and not as part of a larger debt-restructuring process like Prepa’s, he explained.

“In our case, as in any bond issue, it would allow for refinancing—you can call it restructuring. At the end of the day, you are taking existing debt and transforming it into new debt, under different terms,” Prasa’s chief conceded.

“If we approve the bill and get the financing, whether interim or with the final securitization, the outlook is good,” said Lázaro, while going back to the one-page flow chart. “We end up here, in this box that reads, ‘Prasa Revitalization.’ We can pay contractors, reactivate the infrastructure program, pay the [junior] guaranteed debt and Prasa heads toward financial sustainability. There would be no need to increase water bills, maybe even after 2018, it would all depend on the refinancing scenario resulting from the [securitization] bill.”

One could talk numbers all day, but the reality is that some people who are paying their monthly water bills are not receiving the service because Prasa simply does not have the cash to pay for the needed repairs needed, and some of this could have been avoided if the infrastructure program were running smoothly.

Moreover, given the island’s current state of affairs and Prasa’s long “help” list, it would be no small feat to accomplish what officials are banking on to avoid a rate hike this year. For his part, Lázaro feels “more optimistic today than how I felt yesterday.”

One must also ask how optimistic Prasa’s most important stakeholders—Puerto Rico residents—are feeling.

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