Saturday, April 20, 2019

FOMB Says PBA Structure a ‘Sham’ to Avoid Debt Limits

By on January 17, 2019

Editor’s note: The following originally appeared in the Jan. 17-23, 2019, issue of Caribbean Business.

In seeking to annul $6 billion in general-obligation (GO) debt from 2012 and 2014 because it allegedly violated constitutional debt limits, the Financial Oversight & Management Board (FOMB) claims the structure for Puerto Rico’s Public Buildings Authority (PBA) is a “sham” used to issue debt that was not in the Commonwealth’s name but payable through general revenues.

This week, the FOMB’s Special Claims Committee sought to annul two 2012 GO bond issuances for $2.3 billion and $415 million, as well as a 2014 GO bond issue for $3.5 billion because they reportedly violated balanced-budget provisions and constitutional debt limits when the debt issuances of the PBA are included in the total debt calculation, which was not done.

The PBA is a public corporation whose bonds are guaranteed by the Constitution’s full faith and credit, and are payable from the rent on facilities used by the agencies. As a result, Puerto Rico officials did not take the PBA’s debt into account when calculating constitutional debt limits because it was understood that no payments under its guarantee were required.

Holders of senior bonds of the P.R. Sales Tax Financing Corp. (Cofina by its Spanish acronym) argued during an adversary proceeding—in a bankruptcy-like case under the P.R. Oversight, Management & Economic Stability Act (Promesa)—that PBA bonds should have been calculated in the debt limit because they are guaranteed by the full faith and credit. Upon seeking annulment of the $6 billion GO debt, the FOMB said the issue is important for debt adjustment. GO bonds have claimed entitlement to government revenues because of the so-called “constitutional priority of payment” but other bondholders disagree.

The debt-service limit in Article VI, Section 2 of the Constitution limits the amount of debt the Commonwealth can issue by limiting the amount of future debt service the Commonwealth can take on relative to its past internal revenues. New debt cannot be issued—when added to any payments by the Commonwealth in the prior fiscal year on account of debt guarantees—if the full faith and credit obligations of the Commonwealth would exceed 15 percent of the Commonwealth’s average internal revenues for the prior two fiscal years. “The invalid GO bonds were issued in violation of the debt-service limit, when properly calculated to include debt service on the PBA bonds,” the FOMB said. Even if the PBA bonds would not have been included in the calculation, the 2014 GO bonds were issued in violation of the debt limit with the inclusion of the interest on the 2014 GO bonds payable from the proceeds of the 2014 GO bonds themselves.

The FOMB went further and contended that the PBA’s structure is a sham used to issue debt. “In form, the PBA bonds are not direct obligations of the Commonwealth subject to the debt-service limit. In economic substance, however, they are exactly that. Simply put, the PBA structure is a sham. It serves no other purpose than to finance the construction and improvement of buildings for the Commonwealth through the issuance of debt that while not in the Commonwealth’s name is payable (directly or indirectly) from the Commonwealth’s general revenues and depends solely on the Commonwealth’s credit,” the FOMB said.

Did government officials know, or should they have known, that the bond issues were illegal? What went wrong?

The Kobre & Kim investigation of the debt said the government followed a robust process to determine constitutional debt limits, a process that included the Treasury secretary, Government Development Bank (GDB), the bond counsel, the underwriter’s counsel and the secretary of Justice. The latter issued an opinion in 2014 stating that bonds are valid Commonwealth obligations. The problem the FOMB asserts is that the Justice secretary did not check debt-limit calculations, deferring those matters to the GDB.

While the court document does not discuss swap termination fee payments, Puerto Rico officials have also interpreted the constitutional debt limit to not require its inclusion, an action that was mentioned in the Kobre & Kim report, because of the full faith and credit guarantee.

A swap is a type of complex financial transaction into which certain issuers enter, that transfers the risk of interest-rate fluctuations between the issuer and its counterparty. “Through Act 39 of Aug. 1, 2005, Puerto Rico pledged the good faith, credit and power to impose taxes of the Commonwealth for amounts payable,” the report said.

The FOMB did not respond to Caribbean Business questions at presstime about whether it would also try to annul swap termination fees.

Judge gives parties objecting annulment of $6 billion of Puerto Rico debt until Jan. 21

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