Comisión para la Auditoría Integral de la Deuda Pública de Puerto Rico, informe preliminar, agosto 2016

 Executive Summary:

Law 97 of 2015 created the Commission for the Comprehensive Audit of Puerto Rico’s Public Credit (“Commission”).  The Commission is comprised of 17 members selected from civil society stakeholders including:  elected officials, representatives of financial institutions, credit unions, academics, and organized labor.  The Commission requested that the Methodology Committee of the Commission conduct a pre-audit survey to obtain a basic understanding of the debt and the legal norms applicable to Puerto Rico’s debt. The Commission also asked it to provide a factual basis for continued study.  The scope of this pre-audit report was limited to a review of documentation produced by the Government Development Bank associated with the two most recent full faith and credit debt issues of the Commonwealth; those being the 2014 $3.5 billion general obligation bond offering and the 2015 issue of tax and revenue anticipation notes, as well as associated independent economic, legal, and accounting research.  The review was limited due to the fact that the Commission has yet to receive funds to commence its work.

As a result of this research, the Commission has decided to further study the following questions:

1.Has Puerto Rico violated the constitution’s balanced budget requirement by using debt to finance deficits? Puerto Rico issued the 2014 GO bonds in order to finance prior deficits.  Puerto Rico’s Constitution requires that the Commonwealth maintain a balanced budget, and thus prohibits the government from borrowing to cover budget deficits.  Nonetheless, Puerto Rico has borrowed over $30 billion to finance deficits.  Puerto Rico has been borrowing to cover deficits since as early as 1979.  If Puerto Rico borrowed without authorization to do so, then a court may bar it from issuing further debt in the future to finance deficits, force a raise in taxes, or alternatively, declare the debt unpayable for lack of authorization.

2.Has Puerto Rico violated the constitutional debt limit? Puerto Rico is spending anywhere between 14% and 25% of internal revenues on debt. Puerto Rico’s Constitution states that Puerto Rico cannot take out any debt that would make it spend more than 15% of internal revenues in its Treasury on General Obligation debt.  If the audit demonstrates that Puerto Rico has been spending more than 15% of internal revenues on debt, then a court could, under U.S. Supreme Court case precedent, rule that the debt may not be payable.  The Commission will have to determine what debt counts toward that limit, and which debt does not, and then determine whether the Commonwealth went over that limit.

3.Does Puerto Rico’s use of “scoop and toss” practices violate the constitutions prohibition against issuing notes lasting more than 30 years? The Commonwealth has engaged in a long time pattern of “scoop and toss”.  That means anytime a debt is about to come due, rather than pay it, the Commonwealth took out another loan and refinanced the debt.  For example, the 2014 debt repaid a debt from 2003, but that was refinancing a debt from 1987.  The Constitution explicitly states that Puerto Rico cannot issue any loans for more than 30 years.  While this practice may not be fiscally wise, Commission will have to determine whether scooping and tossing debt violates the Constitutional prohibition.

4.What effect did the Commonwealth’s use of Capital Appreciation Bonds have on the total debt amount? Puerto Rico has approximately $37 billion in Capital Appreciation Bonds (CAB’s) outstanding.  CABs are an unusual type of debt in which the borrower does not pay interest or principal until the bond comes due.  Interest continues to accrue even though the borrower does not have to pay until the debt is due.  In Puerto Rico’s case, one of the bonds that the Commonwealth must pay on July 1, 2016 was a CABs issued in 1998 for $14.15 million, and that the Commonwealth must now pay $38.3 million on.

 5.Did the Commonwealth, and or its advisors and underwriters, comply with relevant SEC laws concerning disclosure? SEC Rule 15 c2-12 bars underwriters from selling debt unless they have determined that the issuer will provide to the Municipal Rulemaking Board (“MSRB”) annual financial statements or audited financials in a timely manner.  The Commonwealth issued the 2014 GO bond on March 17, 2014.  However, only six weeks later, on April 30, 2014, the Commonwealth filed a notice that it would miss its continuing disclosure obligation to provide its FY 2013 audited financials.  Furthermore, the 2014 bond offering says very little about the fact that Puerto Rico’s constitution may not allow using debt to cover deficits.  The Commission plans on investigating whether the underwriters, which used the proceeds from the debt to retire some of its holdings, knew, or should have known, that the Commonwealth would not meet its continuing disclosure requirements six weeks later.

6.At what point did the debt stop being productive and contributing to economic growth?  Puerto Rico has a debt to GDP ratio of 96%.  Economic literature suggests that borrowing is correlated to possible negative economic growth once the GDP to debt ratio goes over 95%.  The Commonwealth has increased debt usage in recent years, but has failed to realize any sustained economic growth in that period.   As deficits increased, the amount of “unproductive debt”, debt used to finance deficits increased and the amount of productive debt decreased.  The Commission plans to study the economic impact of Puerto Rico’s debt issuances.

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