On December 24th, Puerto Rico, creditors, and the bond insurers’ came to an agreement to restructure the debt of the island’s electric utility PREPA. PREPA has about $8.2 billion in debt in total, a significant chunk of the island’s roughly $70 billion in debt. Basically the creditors are taking a 15% hit on their bonds, but are exchanging the previous bonds with new ones that have additional legal and financial security. Puerto Rico is saving about $700MM in debt service payments, which can be used to modernize its facilities. Fortunately for us and far better than my optimistic expectations, the bond insurers’ don’t have to take that 15% hit. Instead, the bond insurers’ MBIA and Assured Guaranty, are providing a surety bond of as much as $462MM that will guarantee repayment in the event of a default on a securitization of restructured bonds. They are also agreeing to refinance a portion of PREPA’s January debt payment. Puerto Rico needs access to capital markets and the only real way for them to get that is either through government intervention, or through the bond insurance companies, which is why they didn’t have to take the hit. Bond insurers provide tremendous value and this has been proven time and again. The deal is contingent upon Puerto Rico passing legislation that allows for revenue from a customer surcharge to flow directly to the bond trustee. Puerto Rico actually was obligated to raise rates to meet its debt service payments but due to the poor financial health of the island, this restructuring was the best solution for all parties. This removes a huge amount of uncertainty for them and sets a clear path forward.
This deal is the largest municipal restructuring in American history and is important for a variety of reasons. First of all PREPA was the biggest problem in terms of Puerto Rico’s debt issues. Many prognosticators expected losses to be 50% or greater and now look very foolish for doing so. Second of all it proves that there is a path forward in which creditors and Puerto Rico can reach mutually beneficial agreements to restructure the island’s other debt issues. Puerto Rico has been engaged in an exhausting political campaign to get access to Chapter 9 bankruptcy, which is prohibited from States and the Commonwealth. Chapter 9 is simply a process and not a solution, and it is a very expensive process at that. The final results are not likely to be much different either way but retroactively allowing Chapter 9 bankruptcy would be an incredibly dangerous precedent, which could lead to other financially irresponsible states to seek Chapter 9 as a way to attempt to cut debt, without making the important fiscal decisions to rationalize government spending. The fact that a deal was reached on PREPA would seem to indicate that the need for Chapter 9 is not nearly as important as what the island has been saying it was.
Not all debt is created equal. While Puerto Rico has about $72 billion in debt in total, the vast majority of debt that the bond insurers insure are either revenue bonds, or general obligation bonds. Revenue bonds have specific revenues associated with them, which provides far greater security than most types of bond issues. Not all of the revenue bonds will be restructured in my opinion and historically the ones that have been restructured, have averaged recoveries of between 80-85%. It seems to me on any revenue bonds that are restructured, the PREPA template would make a lot of sense as a basis for discussions. Assured Guaranty has already been reserving substantially for Puerto Rico and I believe this result continues to show that management is inherently conservative in its accounting. The general obligation bonds are prioritized by the Puerto Rican constitution over any other payment including employee salaries. They are not eligible for Chapter 9 and I find it difficult to believe that a Republican congress would allow them to create this dangerous precedent, which could raise costs for all municipalities in the future. On December 20th, Puerto Rico paid $120MM in employee Christmas bonuses despite the constant complaints of having no money, while being unable to provide current financial statements. Puerto Rico has over ten billion of debt with far less security than these insured bonds, which are likely to take much more severe hits. This situation will remain fluid. There is and will remain to be a great deal of noise surrounding Puerto Rico as it has become increasingly political. This is really the only significant issue holding Assured Guaranty back right now. The operating book value is around $42 per share and the adjusted book value is about $60 per share. The company has amply reserved for these exposures and while we might see some minor additions as things develop, overall this looks extremely manageable. MBIA and Ambac both have a little more hair on them than Assured does, but they all are in strong financial condition with huge upside. MBIA for instance has an adjusted book value of $30 per share, with the stock trading at less than $7 per share. I’ll continue to keep you posted but this was an extremely positive development for the island, creditors, and the bond insurance companies.