Puerto Rico’s huge debt became the center of an intense dispute since 2014, when the commonwealth credit was downgraded. There are two visions about the debt dilemma. The outgoing administration stated that the outstanding debt of $70 billion is not payable, while creditors and others analysts argued that indeed the debt is payable.
The fact is that Puerto Rico’s total public debt is divided in 15 non-related issuers with different financial and legal structures. In this article, I analyze the General Obligation Bonds (GO), that has an outstanding debt of $13,883 million.
Without any doubt, the GO is the most important issuer. From the legal standpoint, GO’s are protected by the Constitution of the Commonwealth, and are backed by the General Fund revenues. Historically, the local government has used the GO as an instrument to finance the development of infrastructure. Moreover, this bond was widely respected in the municipal market, where other states, cities and utilities, raise capital. The muni market is valued in $3.7 trillion.
For many decades, the GO issued by the Commonwealth was highly respected by the investor community, due to its high credit rating, and the financial guarantees provided by the Constitution. Specifically, the constitution established “When resources for a given year, are no sufficient to cover financial assignments to the same fiscal year, in first term the administration must pay interests and amortization of the public debt, and then, other payments have to be done in accordance established by law” (if you have English version of the constitution include the wording).
This constitutional protection, provided the GO within the financial community a unique strength and high credibility. The guarantee provided by the Commonwealth and the triple tax exemption, positioned the GO as unique instrument and provided Puerto Rico with unlimited access to the bond market. The downgrade of 2014 and the recent defaults, including the GO, despite the constitutional protection, have the effect of closing the bond market to the Commonwealth. Puerto Ricans have not fully understood the negative impact of the decisions taken by the outgoing the administration in the financial community.
The impact of PROMESA
The approval of PROMESA and the implementation of the “stay” complicated the scenario even more for the constitutional debt (GO). Under this legal protection, government ceased interest payments for all bonds, except for bonds issued by COFINA. These bonds are backed by the sales and use tax collections, created by Act 91 of 2006.
The legal and financial structure allow that SUT collections during the first half of every fiscal year, goes to directly to a private trust under COFINA to pay the debt annual debt service estimated in $623 million.
COFINA’s original intention, was to provide a source of payment to $7,000 million debt (unconstitutional debt), but since its approval in 2006, total debt increased to $15,223 million. This action reduced disposable resources to the general funds, thus affecting the central government liquidity.
Recently, it has been challenged the legality of the allocation of tax revenues to a private trust. The constitution establish that the Treasury Department has a preeminence over any tax collections. Since the approval of PROMESA, the legal debate has increased, since COFINA bond holders are receiving their interest payments, while GO bond holders are not.
Is the debt payable?
In addition to the legal debate, there is another question, is the constitutional debt payable? The outgoing government position is that the GO debt service ($1,300 million) cannot be made without affecting essential services. Debt service represents 14% of the current fiscal year budget (general fund).
In fact, this impasse and the potential default, accelerated the approval of PROMESA by Congress. Nevertheless, this argument is challenged for several reasons. The administration has failed to implement fiscal reforms and there are not financial statements for fiscal years 2015 and 2016. Without reliable data, nobody knows if the government is insolvent and unable to pay its financial obligations, including the GO.
However, if debt restructuring is the final option, there are different models under COFINA and GO creditors, could work together in a collaborative way for the best interest of the government and the people of Puerto Rico.
