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Independent investigator: Flaws in constitutional limits led to Puerto Rico’s $74 billion debt

By on August 22, 2018

SAN JUAN – Did Puerto Rico violate article 6, section 2, of the commonwealth Constitution, which limits the amount of debt Puerto Rico may issue in bonds for which it has pledged its full faith and credit?

That depends on how it is calculated. The independent investigator that probed the island’s $74 billion debt, Kobre & Kim, said Puerto Rico used a “robust process” to make the debt limit calculations. The investigator did not find evidence that Puerto Rico government officials believed their interpretation of the constitutional debt limit was wrong.

However, the calculation includes only debt backed by the full faith and credit of the commonwealth, such as general obligation bonds, and does not include debt issued by public corporations. More importantly, the calculation is not based on the total amount of the debt, which is currently $74 billion, but on how much the government will pay in yearly debt service.

The dispute is important because holders of Sales Tax Financing Corp., or Cofina, senior bonds have argued in one of the adversary proceedings–in the bankruptcy-like case under the Puerto Rico Oversight, Management and Economic Stability Act (Promesa)–that bonds issued by the Public Buildings Authority (PBA) should have been calculated in the debt limit.

PBA is a public corporation but Puerto Rico has not only guaranteed PBA bonds with a pledge of its full faith and credit but the bonds themselves are payable from rental payments on facilities rented to agencies, and Puerto Rico has backed those rental payments with a pledge of its full faith, credit and taxing power. As a result, certain Cofina bondholders say the debt should have been included in the debt limit.

The Puerto Rico Constitution establishes that general obligation debt, such as bonds or notes backed by the commonwealth’s full faith and credit, may not be issued if it will cause a certain calculation to exceed 15% of its average annual internal revenues.

To arrive at the calculation, officials must figure the sum of the maximum future annual debt service, including principal and interest on all outstanding general obligation debt plus any amounts Puerto Rico has paid in the previous fiscal year on account of any bonds or notes it guaranteed. Then, officials have to ensure the resulting sum does not exceed 15% of Puerto Rico’s average annual internal revenue, based on averaging the prior two fiscal years.

The sum does not include debt issued by public corporations, which according to the investigator could help explain the reason why Puerto Rico’s debt reached $74 billion.

On the other hand, the investigator noted that the calculation is based on future debt service and prior-year guarantee payments and not on the total amount of debt issued or guaranteed. The interpretation allowed government officials to play with numbers.

“Because the Debt Limit Calculation includes future annual debt service payments, Puerto Rico could attempt to avoid a violation by structuring the servicing payments in a certain way. For example, a longer maturity on a bond being issued could result in lower annual payments so as to fit the issuance within the 15% limit. According to multiple witnesses, GDB [Government Development Bank] historically worked with the underwriters to manage the debt and structure the service payments to avoid a violation. Based on our investigation, it appears this interpretation was shared among the participants responsible for ensuring compliance with the Constitutional Debt Limit and that the practice of managing debt to avoid a violation was understood to be permissible,” the investigator’s report reads.

The report includes the suggestion that courts review the constitutional debt limit.

“Nevertheless, in light of Puerto Rico’s debt crisis, Puerto Rico should consider whether it may be worthwhile for its judiciary to review the meaning of Section 2 of Article VI of the Puerto Rico Constitution, as well as the methods pursuant to which Puerto Rico determines the types of debt servicing payments to be included within the Debt Limit Calculation. Significantly, the Constitutional Debt Limit did not prevent the issuance of legal, but ultimately unsustainable, amounts of public debt,” the report concluded.

Among Puerto Rico debt investigator’s recommendations: debt-issuance validations to regain investor confidence

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