The Puerto Rico Electric Power Authority has reached a deal with forbearing bondholders to reduce its $9 billion in debt by swapping outstanding bonds for one of two kinds of securitizations, receiving 85% of their existing claims.

These new bonds would be supported by an adjustable charge imposed on the utility’s customers with semi-annual "true-ups," or adjustments reflecting financial conditions.

The deal, which was announced by PREPA Wednesday morning, was reached with bondholders holding around $2.9 billion.

Moody’s Investors Service and Standard & Poor’s have classified the deal as a distressed exchange, which they both consider to be an event of default.

If it goes forward it would constitute the largest bond default in U.S. municipal history. By comparison, by an expansive definition of monetary default, Detroit's bankruptcy affected $7.9 billion of bond debt.

One of the securitization options is current interest bonds, the other capital appreciation bonds. In either case, no principal would be paid for the first five years. For the current interest bonds, interest would be paid for the first five years and thereafter both interest and principal would be paid. The convertible capital appreciation bonds would pay nothing in the first five years (though interest would accrete) and would pay interest only thereafter.

Both versions would have a scheduled maturity in 2043 and a legal maturity at least two years later.

The new bonds would have to carry an investment grade from at least one of the three major rating agencies. Depending on the exact rating, the current interest bonds would have an interest rate from 4% to 4.75% and the convertible capital appreciation bonds would have an interest rate from 4.5% to 5.5%.

The current interest bonds would be callable at par after 10 years and thereafter. The convertible capital appreciation bonds would become callable 10 years after conversion, callable at par thereafter.

Both bonds would have a debt service reserve of up to 10%, the amount to be determined by what is necessary to receive an investment grade.

Non-forbearing uninsured bondholders would have the option to pick either of these two options, to tender their bonds at a price still to be determined, or to simply sit on their existing bonds. However, for the agreement to go into effect, no more than $700 million of the legacy unwrapped revenue bonds can remain outstanding, though the authority may alter this maximum if conditions warrant.

For the agreement to be consummated, Puerto Rico's government must approve the securitization and must make PREPA more politically independent.

The bondholder group reached a "term sheet agreement" with PREPA on Tuesday specifying the basic terms of the deal. The detailed agreement, called the recovery and support agreement, is to be signed by Sept. 18, the date to which the forbearance has been extended.

"Today's announcement represents a significant positive step for all stakeholders involved - including the people of Puerto Rico - and we are pleased to have reached this agreement with PREPA," said Stephen Spencer of Houlihan Lokey, the PREPA Bondholder Group's financial advisor, in a written statement. "We believe it provides PREPA with a fresh start and financial flexibility, with bondholders providing meaningful sacrifices to make that happen. We are committed to working with PREPA to finalize these steps and complete the transaction as quickly as possible."

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