Wed 06/12/2024 18:19 PM
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It was supposed to be Fed day for the bond market, but today’s opinion from the U.S. Court of Appeals for First Circuit shook muniland with big implications for the bondholders of the Puerto Rico Electric Power Authority, or PREPA, said market participants.

The opinion affirms that PREPA bondholders have a “non-recourse claim on PREPA’s estate for the principal amount of the bonds, plus mature interest” and that the claim “is secured by PREPA’s Net Revenues - as that term is defined by the underlying bond agreement - and by liens on certain funds carted by that bond agreement.” Reorg’s legal analysis of the opinion is HERE.

Undoubtedly a positive ruling for bondholders, trading was confined to one CUSIP - the $204.3 million 5.5% coupon due July 1, 2038 - which jumped today on $2 million in volume at 35 cents, up roughly 10 bps from the last institutional trade of $6 million at 24.75 cents on Jan. 6, according to EMMA. A wide gap emerged between bids and offers at 35/47, suggesting that sellers believe in future gains.

"Anybody who bought bonds in the 20s isn’t selling anytime soon,” said one trader. Another noted the same and said that the ruling is obviously positive for the bondholders because it does not restrict them to just what’s available in some specific fund.

The ruling is the latest development in a restructuring that has baffled and frustrated investors and lawyers for years. The appeal was set in motion following a summary judgment ruling on March 22, 2023, which established that bondholders’ security and liens only applied to a sinking fund that had a balance of only $16 million.

At the time, Judge Laura Taylor Swain also ruled that bondholders had an unsecured deficiency claim in the form of an unsecured net revenue claim. In a June 26, 2023, opinion and order, Judge Swain estimated that the unsecured net revenue claim totaled $2.388 billion, which was much lower than the $8.5 billion secured claim that bondholders had asserted.

Today’s ruling from the First Circuit concluded that the proper amount of the bondholders’ claim is “roughly” $8.5 billion, representing principal plus the matured interest of the bonds. However, the court also made clear that “this is not to say that the Bondholders must be paid $8.5 billion” but instead to say that the bondholders’ allowed claim on PREPA’s estate “is on the order of $8.5 billion” and only secured to the extent of the value of the bondholders’ interest in PREPA’s net revenues and the sinking and subordinate funds. The appellate court’s conclusion that bondholders have a lien on all net revenues is obviously positive for them because it does not restrict them to just what is available in a specific fund.

The opinion could also spark additional litigation, as the First Circuit observed: “Taken together, the Trust Agreement and Authority Act appear to permit the Bondholders to bring an equitable action for Net Revenues wrongly diverted from debt service. Indeed, in their brief, the Bondholders suggest that PREPA has spent Net Revenues on unreasonable Current Expenses, thereby starving the Sinking and Subordinate Funds of cash and slowing debt payments to the Bondholders.”

The ruling also raises whether the oversight board or the Puerto Rico Energy Bureau, or PREB, would move to raise rates to boost bondholder recoveries. Luma Energy, the private operator of PREPA’s transmission and distribution system and spearhead of PREPA’s budgets and integrated resource plans, has told the regulator that current rates are inadequate to support growth, maintenance and repair, and modernization required to effectively transform the electric system.

Other emergent issues concern the impending ruling on confirmation from Judge Swain on PREPA’s plan of debt adjustment, the trial for which concluded on March 18, as reported. The three-day confirmation trial over the modified fourth amended Title III plan pit supporters of the plan, which include the PROMESA oversight board, the UCC, National, a monoline that had insured certain of the PREPA bonds, fuel line lenders, a majority member PREPA ad hoc group and AAFAF against opponents of the plan. Opponents include Assured Guaranty, which also insured other PREPA bonds, the PREPA ad hoc group, the bond trustee and PREPA’s unions.

While Judge Swain has yet to submit her ruling on confirmation, the opponents’ successful challenge to her earlier rulings concerning liens and the value of those liens could disrupt the confirmation process, said market participants. One advisor source close to the matter described the First Circuit ruling as a “pretty big monkey wrench” thrown into the PREPA plan of adjustment, but the source said analysis of the opinion’s financial and legal ramifications were still being parsed.

“There are many scenarios that could unfold from here,” said another trader, and the outcomes are “hard to quantify.”
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