Puerto Rico - Pirates Of The Caribbean To Bond Investors - You Get What's Left, If Anything

by: Carl Dincesen

Summary

No other form of central government debt is authorized by the Commonwealth’s Constitution. Had Puerto Rico not circumnavigated its debt limit, as many States do, we would not be having this discussion.

The fact that the Commonwealth has a grossly under used source of revenue that it has chosen to not deploy for purely political reasons, will be an important fact in the courts.

The owners of commercial properties, whose position was that it would better to let bondholders pay than pay themselves, led the politics against the tax increase.

The credibility of the Commonwealth's Governor and Legislature is now zero. That is based on an outline of the restructuring released a few days ago. It is a bizarre plan and nothing else remotely like it has been proposed in the history of American public finance.

The Governor's statements about working together with creditors are disingenuous. How about releasing the "secret" budget, which by law is a public document.

We do not need the Island's Governor to tell us how much debt the central government can afford. The Commonwealth's Constitution, adopted in 1950, tells us clearly: maximum future annual P&I on all outstanding and proposed additional GO bonds may not exceed 15% of the average of general fund revenue in the last two completed fiscal years. All of the States either have a proscribed GO bond limit or require voter approval.

No other form of central government debt is authorized by the Commonwealth's Constitution. Had Puerto Rico not circumnavigated its debt limit, as many States do, we would not be having this discussion. Today there is additional GO bonding authority available under the Constitution, but few would buy them because of the Governor's position and his failure to act in an apolitical manner.

Inclusion of Commonwealth GO bonds in the restructuring plans makes it likely that the NY State Court and, if appealed, the Federal Court will save the government from itself and order full and timely payment of Commonwealth GO bonds with interest on interest if then in arrears. That is because the Island's government agreed to those venues to make the Commonwealth's last issue of GO bonds more attractive to investors.

Why believe they will honor that promise if they are willing to abrogate their Constitution. Because they have no choice. The documents and contracts securing the GO bonds are more than sufficient for bondholders to seek court orders and relief from borrower threats that are causing a diminution of asset value.

The last word on this from the NYS Court of Appeals involved payment default on $1.3 billion NYC general obligation notes in the late 1970s. The Court ruled that the debt moratorium declared for the City of New York was invalid and that all outstanding notes (most had been exchanged for MAC bonds) must be paid immediately, with interest on back interest at the note rate.

The last word on government promises to bond investors from the US Supreme Court involved the Port Authority of NY and NJ, and the Authority's consolidated bond trustee US Trust Co of NY. After financing the NY NJ Path Transit system, the Authority covenanted to bondholders that it would not finance any further mass transit projects. Several years later, the States voided that covenant based on the exercise of State police power. The bond trustee took the Authority to the Supreme Court and won. The covenant remains inforce today.

I would like to know and many others would too, what US courts, including the Supreme Court, would have to say when a state or commonwealth abrogates parts of its own constitution with no current or foreseeable serious threats to public health, welfare or safety present. That is the minimum standard.

The fact that the Commonwealth has a grossly under used source of revenue that it has chosen to not deploy for purely political reasons, will be an important fact in the courts, assuming the Commonwealth seeks appeals.

According to law and as referenced in the above mentioned bond documents, the Commonwealth may levy an Island wide annual real estate tax up to an amount equal to GO bond P&I, or $1.1 billion per year, until all outstanding bonds mature by 2034. By law that tax is not a part of the central government's general fund and can only be used to pay GO P&I.

The Commonwealth's current levy of this tax produces $100 million for GO P&I. An increase to yield an additional $1 billion would surely total well less than one-half of one percent of current market values in addition to local municipal real estate taxes, which are very light since many properties are assessed at unadjusted 1958 values. See Puerto Rico's CRIM agency for more.

The owners of commercial properties, whose position was that it would better to let bondholders pay than pay themselves, led the politics against the tax increase. The Governor, or shall we say emperor of Puerto Rico, given what has been a rubber stamp legislature, apparently agrees.

By not enacting a property tax increase, the general fund will be denied the up to $1.1 billion increase in unencumbered revenue, and GO bonds will likely default, absent court intervention.

From purely a practical point of view, after all this is resolved, what vehicle other than GO Bonds would the Commonwealth have? Will they be viable if the Commonwealth chooses not to pay? It is the wrong plan for the residents of the Island in both the short and long term.

Disclosure: I am/we are long 200K GO BONDS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.