Time to Renegotiate Prepa Deal
BY VICENTE FELICIANO
Agreements reached under duress come undone when the power of one party to impose the deal subsides. The agreement between the Puerto Rico Electric Power Authority (Prepa) and its bondholders was reached when there was no legal framework to restructure debt. The Puerto Rico Oversight, Management & Economic Stability Act (Promesa) now brings this legal framework and Prepa should force a renegotiation with bondholders of what is at present a bad deal for Puerto Rico.
The Prepa deal establishes that the majority of bondholders will be paid in full, 100 cents on the dollar. A minority of bondholders will be paid 85 cents on the dollar. This is outrageous in light of the expected discounts on principal on other bonds, the expected fiscal adjustments on the people of Puerto Rico, the expected losses to credit unions and the expected cuts in pensions of government retirees.
On July 1, 2016, general-obligation bonds, guaranteed by the Puerto Rico Constitution went unpaid, both principal and interest. However, Prepa bondholders were paid. The Puerto Rico Sales Tax Financing Corp. (Cofina by its Spanish acronym) debt, collateralized with the sales & use tax, or IVU in Spanish, is trading at some 40% discount because this is the discount that the market expects the bonds to take as a result of debt restructuring, but the majority of Prepa bondholders will be paid 100 cents on the dollar.
In order to pay Prepa bondholders, the majority at 100 cents on the dollar, there would have to be a surcharge of 4.4 cents per kilowatt-hour (kWh), or some $750 million per year. This is the equivalent of almost a 3.5 percentage point increase in the IVU. Proposing such a huge tax increase on a weakened economy beset by emigration should bring howls of protest and indignation. However, the Prepa surcharge is discussed as if it would have no impact on the rest of the economy. This is not correct.
The Puerto Rico Manufacturers Association strenuously opposes the surcharge. They argue that you cannot have a new beginning at Prepa carrying a legacy of $9 billion in debt. The increase in electricity rates would hamper the competitiveness of the island and negatively impact existing businesses, not only in manufacturing but also in tourism. These are operations that compete globally with other businesses that are not seeing an increase of 4.4 cents per kWh. For example, hotels in neither Florida nor the Dominican Republic are seeing an electricity rate increase in the near future.
Nevertheless, the main impact is not on existing businesses but on the ones that will never come to life. Take generic/bioequivalent pharmaceutical manufacturing. This is the fastest growing segment of pharmaceutics, already accounting for some 90% of the number (although not the value) of prescriptions in the United States. This is an industry where tax incentives are secondary because margins are thin. The key is to generate a profit. Partly because of high electricity rates, there is already little production of generics in Puerto Rico. As a result of the planned rate increase, Puerto Rico would be further hampered in its efforts to compete in this fast growing segment of the market.
Perhaps Lisa Donahue, Prepa’s chief restructuring officer, gets a “success” bonus if she closes the restructuring deal, despite committing to pay 100 cents on the dollar to the majority of the utility’s creditors. If this is the case, her contract must be amended.
The restructuring of Puerto Rico’s debt will require sacrifices by all stakeholders. It would be outrageous if the majority of Prepa bondholders were to be paid 100 cents on the dollar while others face cuts, some of them quite big.
—Vicente Feliciano is the founder & president of Advantage Business Consulting. He holds a bachelor’s degree in economics, cum laude, from Harvard University and an M.B.A. from Switzerland’s IMD, one of the world’s top business schools. His consulting practice has included advising clients in New Mexico and the U.S. Virgin Islands, as well as the Puerto Rico government, hospitals and clinics, and financial institutions.