One of the most interesting points that Puerto Rico Governor Alejandro Garcia Padilla made in a speech on Monday after the credit rating downgrades by Standard & Poor’s and Moody’s (Fitch has since also downgraded Puerto Rico to speculative grade) is related to the restructuring of Puerto Rico’s tax code. He said:
In less than a year, propose a new tax structure allowing the best balance between all sectors of the country and promote economic development. These studies include the revaluation of the SUT to explore if it is the best alternative for all, taking into account the debt issued against that source.
SUT is the “sales use tax” that is the repayment source for $15.5 billion of Cofina debt. This debt is generally considered highly secure because of the legislative pledge of SUT revenues.
There had been discussion of Puerto Rico issuing another tranche of Cofina bonds that would have a third lien on SUT revenues, but SUT revenues have been coming in lower than projected as the economy contracts. I’ve questioned if there were sufficient revenues to leverage another bond offering on this revenue source. Puerto Rico has since announced it would switch and bring a general obligation bond to market rather than a Cofina offering.
A general obligation offering presents its own problems.
The primary problem is the Constitutional limit on the amount of general obligation debt that can be issued. The Government Development Bank (GDB) describes how Section 2 of Article VI of the Puerto Rico Constitution says debt cannot be issued if the payment of principal and interest on “direct obligations of the Commonwealth” exceeds 15 percent of “average annual revenues raised under the provisions of Commonwealth legislation” for the two previous fiscal years. “Direct obligations of the Commonwealth” are the $11.5 billion in general obligation debt of Puerto Rico.