Illinois GO decision has little bearing on Puerto Rico GO challenge

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A court decision rejecting a bid to declare Illinois general obligations invalid may have little bearing on the outcome of Puerto Rico Oversight Board's challenge to bonds on the debt strapped island, analysts said.

While the lawsuit subject to Thursday's ruling by Illinois Associate Circuit Judge Jack Davis II was seen as similar to the Puerto Rico case, the reasons given to justify invalidating the state's debt were different. The Oversight Board, seeking to lower Puerto Rico's debt burden as it seeks to revive the economy, has argued almost $7 billion of bonds should be declared invalid because they exceeded a debt limit in the territory's constitution.

In Illinois, the petitioners, John Tillman and Warlander Asset Management, were seeking to improve prospects of repayment of their bonds by declaring the bonds issued in 2003 and 2017. They argued that the Illinois Constitution would bar the sale because the legislation authorizing the bonds failed to give a specific purpose for the debt.

Davis agreed that the state constitution would bar such a sale, but said that the legislation authorizing the bonds in question had given clear purposes for use of the debt proceeds.

Tillman had also said that the bonds had violated the state’s balanced budget amendment.

Responding to this, Davis said: “Tillman asks this court to address a non-justiciable political question and substitute its judgment for the Illinois legislature some two decades after it occurred. To do so would be improper and would violate the separation of powers.”

Matt Fabian, partner at Municipal Market Analytics, said the two cases were “totally unrelated.” The Illinois plaintiffs had a weak case and the judge recognized this. In Puerto Rico, the issues are different and the board’s case isn’t trivial, he said.

In its filing in the Title III bankruptcy action in federal court, the Puerto Rico Oversight Board in January challenged the validity of over $6 billion in Puerto Rico general obligation bonds. It then extended its challenge to include recently issued Public Building Authority bonds, bringing its total challenge to $6.8 billion.

The board argues that the GO and PBA bonds issued from 2012 onward were issued contrary to the Puerto Rico Constitution’s debt limits. The original bond documents treated the authority as being independent from the commonwealth government and thus its debt wasn’t the debt of that government. The board has said that this was a fiction and that when the PBA debt is added to the central government’s debt, one finds that Puerto Rico was already over its debt limit when it sold bonds from mid-2012 and after.

Accordingly, the board has asked the Title III judge to declare the relevant bonds invalid and to allow the board to claw-back larger-sized payments to bondholders.

Some market participants drew parallels to the Puerto Rico case with the Tillman suit, which was filed July 1.

In the Illinois case Judge Davis said Illinois borrowed the money and it should pay it back, said James Spiotto, Chapman Strategic Advisors managing director. The decision will enhance Illinois’ ability to borrow money, despite its large unfunded pension liability, Spiotto said.

By contrast, the Puerto Rico board’s effort to invalidate past bonds will harm the commonwealth’s ability to borrow in the future. It runs counter to the stated goal of the Puerto Rico Oversight, Management, and Economic Stability Act, that the board’s purpose was to seek to “achieve fiscal responsibility and access to the capital markets.”

If you’re trying to regain access to the capital markets the last thing you should do is try to invalidate debt, Spiotto said. If you try this, one won’t gain the confidence of the market.

Instead, the board should be saying Puerto Rico doesn’t have the ability to pay and then trying to negotiate a consensual solution to its debt problem.

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PROMESA Commonwealth of Puerto Rico Puerto Rico Public Buildings Authority Puerto Rico Illinois