MuniLand – Implications of Puerto Rico’s Recovery Act

Last week Puerto Rico (PR) proposed legislation that provides a framework for its public enterprises, for example, PR Electric Power Authority (PREPA), to restructure their debt. Subsequently, Fitch downgraded PREPA to CC from BB on liquidity concerns. The new legislation provides a protective moat around direct government obligations and stops general fund transfers to public enterprises. For many years, PR’s public enterprises were subsidized by governmental transfers. In our opinion, the public enterprises were not going concerns without this assistance. This latest move has implications for the nascent economic recovery in the Territory; PREPA will need to raise rates to make up the lost governmental income, which also hampers its ability to supply competitively priced electricity. This will be a drag on the local economy. The primary implication of this legislation revolves around the legal security pledge of revenue bonds. Generally, we like secured revenue pledges of public essential services like airports, wind turbines and toll roads over the full faith and credit pledges of government issuers. In PR, however, the opposite thesis prevails; the full faith and credit pledge and thus the economic ability of the general government are stronger than the essential service enterprises’ own financial wherewithal to repay its outstanding debt.  However, while the security pledge and economic pledge of the PR general government will be stronger after this legislation takes effect, having dropped the requirement to support lagging enterprises, the proposed legislation undermines the assumption that PR will honor its debt obligations no matter the circumstance. Puerto Rico’s proposed Recovery Act legislation is just the beginning of more debt restructuring talk to come. Having highlighted the risk associated with PR’s credits, it is important to note that there are forms of PR debt backed by the United State Department of Housing and Urban Development that we continue to buy. In times of stress there can be opportunities, and we will continue to look through the rubble to find the hidden gems.