PREPA lien ruling could impact revenue bond market, AGs say

If bondholders are not allowed a lien on Puerto Rico Electric Power Authority revenues, it could “threaten the continued viability of the primary revenue stream for vast swaths of municipal public works projects,” 14 attorneys general and the Securities Industry and Financial Markets Association said in friend of the court filings with the First Circuit Court of Appeals.

In November, several bond parties filed an appeal of the U.S. District Court’s March opinion they didn’t have a lien on PREPA’s revenues.

“If this [appeals] court affirms the district court’s decision, it will call into question the security and predictability of the municipal revenue bond market,” the attorneys general wrote. “Doing so would harm the market and its participants — including the states, municipalities, and investors — and threaten the continued viability of the primary revenue stream for vast swaths of municipal public works projects.” 

Municipal Market Advisors Partner Matt Fabian said PREPA case should remind investors to be exceedingly careful about “distinguishing credit differences between a sponsor government and its revenue bonds.”

The attorneys general, all Republican, represent Virginia, Alabama, Georgia, Kansas, Nebraska, Oklahoma, Texas, West Virginia, Florida, Iowa, Montana, Ohio, South Carolina, and Utah.

In their filing, they took issue with the determination that PREPA’s future revenue was a “mere expectancy” rather than property and therefore could not be a security interest under federal bankruptcy law. They said Congress rewrote federal bankruptcy law in the late 1970s and 1980s to ensure municipalities could pledge future revenues for bonds.  

“The district court’s interpretation would, if adopted more broadly, run roughshod over state and local laws that embody the consensus that revenue bonds are secured by a pledge of future revenue,” the attorneys general said, and “will have severe consequences for the municipal revenue bond market,” and add to borrowing costs.

What the AGs said makes “sense,” according to Municipal Market Advisors Partner Matt Fabian. “Recent rulings in the PREPA case communicate clearly that investors should be very, very careful when distinguishing credit differences between a sponsor government and its revenue bonds,” he said. “Investors need to look at the legal documents, the specific terms used, and how those terms compare with recent bankruptcy court precedents.”

Fabian noted the AGs would like their own definitioning to matter more: “if they choose to segregate a revenue security from the state’s general obligation, they want that difference to be real and enduring, if only to protect the state’s primary ratings,” he said. “Because, as modern analysts and portfolio managers increasingly roll revenue bonds up onto state balance sheets (in part because of the precedents in Puerto Rico), either state GO ratings become more vulnerable to downgrade as borrowing needs rise or the states choose to borrow with even more remote (and thus costly) security pledges to protect their GO ratings.”

The Puerto Rico Oversight Board released a statement noting, “PREPA’s bond agreements date back decades,” and today’s revenue bond indentures “are written very differently and generally include valid liens. The [District] court’s decision did not apply any bankruptcy’s law to limit the bondholders’ security interest. It simply read the security provisions the same as they would be read outside bankruptcy.”

In its brief, SIFMA said the District Court judge’s rejection of a bondholder lien on PREPA’s revenues “grossly misreads the underlying bond documents.”

The ruling that bondholders had a lien only on funds deposited into a fund at PREPA “invite creditor subversion: they enable debtors to deprive bondholders of pledged revenues by diverting those revenues from the specified accounts and potentially making such revenues available for the general use of the municipality,” SIFMA said.

“Municipalities may have to pay bondholders for perceived risk caused by the [District Court’s PREPA] lien and estimation decisions where before they would not, and it will be the municipalities in most need of financing that will feel those effects the hardest,” SIFMA said.

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