Industry hails PREPA court decision as win for bondholders, revenue bond pledges

The public finance community hailed Wednesday’s First Circuit Court of Appeals ruling that Puerto Rico Electric Power Authority bondholders had a lien on net revenues.

Observers say the decision sends a message that the municipal revenue bond pledge is strong, the Oversight Board’s plan of adjustment for PREPA as it currently is proposed is unlikely to stand, and the court understood and properly interpreted Congress’ narrow intent with the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA).

Assured Guaranty, one of the key players who had filed the appeal, said it was “pleased that the court vindicated PREPA bondholders’ rights yesterday, holding that bondholders have a claim against PREPA for the full principal amount of the bonds, plus matured interest, and that claim is secured by PREPA’s net revenues, including future net revenues.”

Assured said the decision is “not only important to the PREPA bondholders, but also to the municipal revenue bond market as a whole, as the court confirmed the ability of municipal issuers to create liens on both current and future project revenues, a fundamental security provision that is essential to the proper functioning of the revenue bond market.”

The panel of appeals court judges ruled unanimously that PREPA bondholders had a perfected lien on the authority’s net revenues as well money in the authority’s sinking and subordinate funds, and that their claim was on the bonds’ principal and matured interest, a total of $8.5 billion.

Kent Hiteshew, a former U.S. Treasury official who worked to pass PROMESA, said, the law “was designed to narrowly and uniquely resolve [the debt and fiscal] crises within Puerto Rico while avoiding or minimizing any broader impact on the legal foundations of the $4 trillion municipal bond market.”

Hiteshew said the board’s PREPA litigation and the Title III Court’s lien rulings “threatened this careful compromise and the First Circuit’s decision restores Congress’ intended balance.”

Municipal Market Analytics, Inc. Managing Partner Matt Fabian agreed the ruling had an important impact on both the bondholders and the muni market generally.

“The circuit judges push back on the Title III [bankruptcy] court’s very narrow, very specific reading of the trust indenture’s wording to use a broader argument: in part, that it’s not reasonable to assume investors would have loaned PREPA all that money if they were to be secured only with money already in the debt service funds,” Fabian said. “This is good for PREPA’s bondholders, which now have a larger, face value claim for repayment, even if the assets by which PREPA will repay them are no bigger, better, or less broken. And how or if this fundamentally changes any potential PREPA debt restructurings remains to be seen.”

The more important impact, though, is for municipal revenue bondholders generally, he said.

“By looking to intentions vs ‘magic words,’ the court’s opinion at least partially beats back the erosion of municipal security pledges that has become commonplace in large federal bankruptcies in the last decade,” Fabian said. “It’s a rare win for municipal investor expectations.”

The decision should provide the bondholders “with strong arguments that the plan of adjustment cannot be confirmed as currently formulated,” said Bill Kannell, member of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo. “I am especially intrigued to see what the bondholders do with the claim for an accounting that they may now make.”

“Obviously, it’s great to see the rebuke of the [Puerto Rico Oversight] Board’s ridiculously narrow characterization of bondholders’ rights by recognizing creditors’ security interest in all current and future net revenues,” said Hector Negroni, founder and CEO of Foundation Credit. “Now the [board] will not only have to defend their fictitious fiscal plan and its deeply flawed affordability assumption, but they will also find themselves accountable for their misuse of prior revenues which were due to bondholders.”

On the X platform, former Oversight Board member Justin Peterson wrote, “Today’s ruling by the First Circuit is a total and complete defeat of the [board] and a repudiation of its discriminatory treatment of PREPA creditors. It’s great to see justice prevail.” 

John Hallacy, principal of John Hallacy Consulting LLC, said that having a net revenue lien on the revenue stream “should have been self-evident from the start.”

“The documents are unequivocal on this point,” he said. “Why upend 160 plus years of public finance practice? Revenue bonds and the respective pledges constitute one of the bedrocks of the municipal bond market.”

From a technical standpoint, Phillip Escoriza, senior counsel with Feldesman Leifer LLP, said in an email the appeals court decision means several things, including that bondholders, as secured creditors, stand to receive priority treatment in any distribution of the utility’s assets as may be ordered in the Title III process and “the share of the pie available to those secured creditors extends to future revenue streams.”

“The PREPA bondholders have, thanks to this ruling, greater bargaining power in any future efforts to resolve PREPA’s bankruptcy through consensus or in a final debt adjustment plan,” Escoriza said. He cautioned, however, that this latest decision could be appealed to the entire bench of circuit judges or to the Supreme Court.

he Title III [bankruptcy] court’s very narrow, very specific reading of the trust indenture’s wording

Puerto Rico Clearinghouse Principal Cate Long said she believes the decision means the proposed plan of adjustment needs to be thrown out.

“Since the circuit says the bonds are secured they now have priority over the fuel lenders, Unsecured Creditors Committee and other unsecured creditors,” she said.

“The fight will now move to when any security interest cuts off, GoldenTree’s renewed motion for a receiver, which is currently scheduled to be heard at the July 31 omnibus hearing, and the GoldenTree motion for payment of debt service since the petition was filed (which GoldenTree estimates at about $4 billion of matured interest),” Long said.

GoldenTree, which has remained opposed to the proposed plan of adjustment, said the PREPA Bondholders “remain hopeful” the Puerto Rico government and the Oversight Board “will engage in a constructive fashion to reach a fair resolution of the PREPA restructuring that allows the Commonwealth to move past its bankruptcy proceedings and focus its efforts on providing services to the island’s citizens.”

“A consensual emergence from bankruptcy will best position the people of Puerto Rico for economic success and allow the island to achieve its goal of re-accessing the capital markets as an investment grade issuer, and the PREPA Bondholders remain ready to engage,” GoldenTree’s statement read.

Not everyone was happy with the ruling. “The blackouts Puerto Rico is experiencing right now, and since Hurricane Maria in 2017, will be more frequent and longer if the bondholders get what they are demanding,” said Tom Sanzillo, director of financial analysis at Institute for Energy Economics and Financial Analysis.

While the ruling largely sided with the bondholders, the Oversight Board may still exercise a great deal of influence on the future of the restructuring. After the ruling it said it was reviewing it on the “extent of the bondholders’ collateral and recourse claim” against PREPA and it was also analyzing the impact, “if any, of the ruling on PREPA’s proposed plan of adjustment.”

“PREPA does not generate any net revenues unless and until electricity rates are increased,” the board said. “Under bankruptcy law, the court must determine the value of the bondholders’ collateral on the confirmation date, which is prior to any rate increase. Therefore, the implications of the First Circuit decision and the value of the bondholders’ collateral will depend on careful consideration and additional determinations by the U.S. District Court.”

Long said it appears the Oversight Board plans to “fall back to their defense” that nothing can be paid until the Energy Bureau raises rates.

“The simple rebuttal is that PROMESA can preempt that requirement and bondholders can be paid with rates that remain affordable for unsubsidized customers (the middle class and higher),” Long said.

“Also note the Oversight Board is likely to file cert at the U.S. Supreme Court on the lien decision.”

Long said SCOTUS won’t take it up “because there is not a conflict between circuits on revenue bonds being secured.”

Puerto Rico’s local government was also generally on the losing side of Wednesday’s decision but is also likely to influence the restructuring’s future.

“The government continues to analyze the court’s decision and the next steps in the PREPA Title III [bankruptcy] case, including the impact of the decision on PREPA’s debt adjustment process and the proposed adjustment plan,” Puerto Rico Fiscal Agency and Financial Advisory Authority Executive Director Omar Marrero said Thursday.

“The government is committed to working constructively to resolve PREPA’s obligations without imposing additional burdens on PREPA customers with unaffordable rates,” Marrero said. “The government also recognizes and respects the role of the Energy Bureau in the rate review process.

“The administration will continue to insist on its position that the restructuring of PREPA’s debt and the transformation of the energy system will promote fiscal stability and economic growth in Puerto Rico, to the benefit of PREPA’s subscribers,” Marrero said.

Joseph Krist, publisher of Muni Credit News, said, “The establishment of the size of the claim and the ability to get paid from revenues should stimulate more serious negotiations. Do I believe that there will be a full recovery for bondholders over time? No. The system’s operating difficulties and the weak revenue base provided by the economy make that unlikely.

“As always, the politics of the commonwealth remain a huge hurdle,” Krist continued. “The court order doesn’t change the political realities in the commonwealth where populism still reigns as the biggest hurdle to funding PREPA.”