Saturday, September 05, 2015

Will Puerto Rico Sales Tax Bonds And PREPA 'Securitization' Be Subordinated To GOs?

Summary

  • Puerto Rico's Constitution gives General Obligation bonds a first lien on Commonwealth revenues.
  • To subvert the intent of this provision, the sales tax revenues were "securitized", but the Territory's supreme court has never ruled on the validity of this structure.
  • If the GOs are impaired, an obvious challenge by the holders would be to argue that the sales tax must be used first to pay the GO bonds.
  • This vulnerability has potential implications for the securitization of a new charge on utility customers that supports the tentative deal announced between PREPA and some of its bondholders.
Fundamental to the security of Puerto Rico's general obligation bonds (GOs) is this provision in the Commonwealth's constitution:



Section 8. In case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid, and other disbursements shall thereafter be made in accordance with the order of priorities established by law.

In its threats to default on GOs, the Padilla Administration has made the same argument that New York City made and ultimately failed to win when it declared a debt moratorium in the 1970s: that provisions like this are qualified by the government's obligations to provide services to its citizens. However, even if we ignore the trade off among government budget cuts, tax increases and payment of debt service, there is a question of which bonds get paid first from whatever revenue is available for debt service.

The constitution limits the term of GO bonds to 30 years and prohibits the issuance of additional GOs if debt service exceeds 15% of the average of the past two years' revenues. Had Puerto Rico's governments adhered to these limitations, the Commonwealth would not have a serious debt problem. But, over the years with the help of lawyers and bankers, Puerto Rico's governments proliferated structures that pledged various commonwealth revenue streams to bonds which are not GOs and therefore not subject to these debt limitations.

No comments: