S&P cuts Puerto Rico credit to junk

Cites inability to raise funds in capital markets, keeps on watch with negative implications

Feb 5, 2014 @ 12:28 pm

Puerto Rico's general-obligation bonds have been cut one step to speculative grade by Standard & Poor's, which cited the U.S. commonwealth's limited ability to raise funds in the capital markets.

S&P lowered the island to BB+ from BBB- and kept it on watch with negative implications, signaling the potential for further cuts, according to a statement Tuesday.

Investors in the $3.7 trillion municipal market had anticipated such a move for months from the major rating firms. Bond buyers pushed yields on commonwealth securities to speculative-grade levels last year as officials struggled to revive the Caribbean getaway's shrinking economy. Island officials plan to sell bonds as soon as this month to raise funds and plug deficits.

“It's all about them finding liquidity,” said Robert Amodeo, head of munis for Western Asset Management Co., which oversees $28 billion in munis. If they do, “it will relieve some pressures in the immediate future,” he said.

GOVERNOR'S STEPS

The territory of 3.6 million people failed to stave off a downgrade to junk even after lawmakers reduced pension benefits, increased taxes and trimmed budget gaps.

Gov. Alejandro Garcia Padilla, who took office in January 2013, said in the past week that he would release a budget for next fiscal year that doesn't rely on deficit borrowing, ending a practice used in every spending plan since at least 2000.

“Decades of fiscal irresponsibility can't be fixed in 12 months,” Mr. Garcia Padilla said at a press conference in San Juan after the S&P announcement. “We did everything we could.”

The commonwealth and its agencies have about $70 billion of debt, about $16 billion of which is backed by Puerto Rico's full faith and credit, according to figures as of June 30 from the Government Development Bank, which handles the island's debt transactions. The GDB was dropped two levels to BB.

As is the case with bonds from U.S. territories such as Guam, Puerto Rico's securities are tax-exempt nationwide, making its offerings popular among mainland mutual funds. About 70% of U.S. municipal mutual funds own Puerto Rico debt, according to Morningstar Inc.

“The commonwealth's access to liquidity either through the GDB or other means will remain constrained in the medium term, even in the event of a potential issuance of debt,” David Hitchcock, an S&P analyst, wrote in a report released Tuesday. “These liquidity constraints do not warrant an investment-grade rating.”

Moody's Investors Service and Fitch Ratings have given Puerto Rico the lowest investment grade. Moody's on Dec. 11 threatened to cut Puerto Rico to junk within 90 days if it is unable to access capital markets. Fitch may lower it to junk by June 30, the firm said on Nov. 14.

The speculative rating from S&P may limit buyers for commonwealth debt because some mutual funds require managers to purchase only securities with investment grades. Puerto Rico officials plan to sell long-term debt this month after soaring interest rates last year halted issuance of as much as $1.2 billion of sales-tax bonds.

'IN DISCUSSIONS'

S&P hasn't lowered the sales-tax bonds, known as Cofinas, analysts at the company said in a webcast Tuesday. A bond offering could remove the commonwealth from CreditWatch, the analysts said.

“We are confident that we have the liquidity on hand to satisfy all liquidity needs until the end of the fiscal year, including any cash needs resulting from today's decision,” according to a statement Tuesday from GDB Chairman David Chafey and Treasury Secretary Melba Acosta.

The bank and the commonwealth “have been in discussions with parties that have expressed an interest in arranging additional liquidity,” according to the statement.

The GDB will hold a webcast for investors on Feb. 12, according to the release.

Investors have been valuing Puerto Rico bonds at junk levels since at least September amid mounting speculation the island would struggle to repay its obligations, S&P data show.

Puerto Rico securities lost 20.5% in 2013, the steepest drop since at least 1999 and about eight times more than the loss for the entire municipal market, according to S&P data.

Tax-exempt general obligations maturing in July 2041 traded Tuesday with an average yield of about 8.34%, or 4.5 percentage points above benchmark munis, data compiled by Bloomberg show. That's down from Monday's average yield of 8.45% and spread of 4.59 percentage points.

A year ago, the debt traded with interest rates of about 5%, and investors only demanded about 2.5 percentage points of extra yield.

A cut to speculative grade means Puerto Rico will have to pay as much as $1 billion for collateral and accelerated payments on swaps and other financings, Lisa Heller, a Moody's analyst, said in a Dec. 11 report.

Puerto Rico's budget is on track this year through December. For the first six months of fiscal 2014, which ends June 30, revenue collections were $93 million above budgeted estimates, according Ms. Acosta. At the same time, expenditures for July through November were $135 million below appropriations, according to Carlos Rivas, director of Office of Management and Budget.

ECONOMY CHALLENGE

The commonwealth's fiscal challenges are compounded by its struggling economy.

An index tracking the island's economic activity has contracted in six of the last seven fiscal years, according to the GDB. The 15.4% jobless rate in December was the highest in two years.

In its report, S&P also cited the island's ties to the U.S. economy and the trade that relationship generates.

The federal government hasn't offered additional funds and Puerto Rico hasn't requested such aid, Ms. Acosta said Jan. 24 in an interview on CNBC.

“The federal government has offered technical assistance, and that's what we're getting,” Ms. Acosta said.

Interest rates on benchmark munis rose after the downgrade, pushing yields on 10-year maturities to 2.65%, the highest since Jan. 23, Bloomberg data show.

(Bloomberg News)

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