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Moody's Downgrades Puerto Rico to Just Above Junk - UPDATED

DEC 13, 2012 4:06pm ET
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Moody’s Investors Service downgraded the commonwealth’s general obligation debt to Baa3 from Baa1 on Thursday. About $15.5 billion in GO debt was affected, a Moody’s spokesman said.

The Baa3 is Moody’s lowest investment grade rating. Moody’s retained a negative outlook on the debt.

Also part of the downgrade, Moody’s lowered Puerto Rico conduit debt to below investment grade. Specifically, the Public Finance Corporation, certain of Puerto Rico’s Highways and Transportation Authority’s subordinate bonds, and the bonds of the Puerto Rico Aqueduct and Sewer Authority were dropped to Ba1 from Baa2. Ba1 is Moody’s highest speculative grade rating. A total of about $5 billion has been moved to Ba1, a Moody’s spokesman said.

In addition to the GO bonds, other Puerto Rico credits that Moody’s downgraded to Baa3 from Baa1 were: pension funding bonds, Puerto Rico infrastructure finance authority special tax revenue bonds, convention center district authority hotel occupancy tax revenue bonds, Government Development Bank senior notes, Municipal Finance Authority bonds, Puerto Rico Highway and Transportation Authority transportation revenue bonds, Puerto Rico Aquaduct and Sewer Authority commonwealth guaranteed bonds.

Moody’s downgraded the Puerto Rico Highway and Transportation Authority highway revenue bonds to Baa2 from A3.

Moody’s explained its downgrade of the GO debt to Baa3 by pointing to four factors:

•       “Economic growth prospects remain weak after six years of recession and could be further dampened by the commonwealth’s efforts to control spending and reform its retirement system, both of which are needed to stabilize the commonwealth’s financial results. The lack of significant economic growth drivers and the commonwealth’s declining population have also reduced prospects for a strong economic recovery.

•       Debt levels are very high and continue to grow.

•       Financial performance has been weak, including lackluster revenue growth and large structural budget gaps that have led to a persistent reliance on deficit financings and serial debt restructurings to support operations in recent years.

•       Lack of meaningful pension reform and no clear timetable to do so. Reform of the commonwealth’s severely underfunded retirement systems is needed to avoid asset depletion and future budget pressure.”

“The economy has shown some preliminary signs of stabilizing,” Moody’s wrote. However, it remains weak with unemployment at 13.8%.

Due to investor concerns about Puerto Rico, credit spreads above the triple-A benchmark have widened over the last four months.

Standard & Poor’s rates the island’s GO debt BBB and Fitch Ratings gives it a BBB-plus.

“Obviously, we are not pleased with Moody’s action today, and we disagree with the fact that they did not give the incoming [gubernatorial] administration more time to introduce its fiscal team and their work plan to address these issues,” Government Development Bank President Juan Carlos Batlle said. Most of Puerto Rico’s debt is issued through this bank and authorities connected to the bank. “Moreover, we disagree with Moody’s interpretation of many aspects of the government’s present fiscal situation. But, in essence, the report validates what we have been saying the past months: first, that in the last years considerable progress has been made in economic and fiscal matters; second, that this progress is not enough and we have to do more; and third, that there is no time to lose, that the new administration needs to move quickly to submit its plan to continue addressing the economic and fiscal situation,” he pointed out.

Moody’s had Puerto Rico’s GOs at Baa3 in 2008 until upgrading them in 2009. On Aug. 8, 2011, Moody’s downgraded the rating to Baa1 from A3. Moody’s has since had a negative outlook on the bond but had not placed it on review for a downgrade.

The downgrade of the GO debt may lead to some selling of the credit, said Municipal Market Advisors managing director Robert Donahue. However, for the most part investors had already expected the downgrade and had priced it in.

Newly elected Puerto Rico governor Alejandro Garcia Padilla will be sworn into office on January 2. Donahue said he was optimistic about the new administration. He pointed to the appointments of Javier Ferrer Fernandez as administration’s new president, and David Chafey as the new chairman, of the Government Development Bank. The appointments become effective January 2.

Donahue said he respected both Ferrer Fernandez and Chafey and expected that Garcia Padilla made his seriousness about dealing with Puerto Rico’s economic and financial condition clear to Chafey before he accepted the position. Otherwise, Chafey would not have accepted the position, Donahue said.

The three Puerto Rico entities that Moody’s downgraded to Ba1 do not have to sell bonds for some time, Donahue said. However, Puerto Rico’s government will have to sell $770 million in bonds by June.

If Garcia Padilla is to succeed in that bond sale, when he comes into office he will have to explain his vision for balancing the budget, Donahue said. The debt could be sold as GOs or as COFINA sales tax bonds, he said.

Moody’s rates the Puerto Rico senior sales tax revenue bonds at Aa3. Their rating was not affected by Moody’s Thursday’s action.

A spokesman for Garcia Padilla did not return a call for this story.

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We are surpised about the drop in rating of the gross revenue secured Aquaduct and Sewer Authority bonds. Strahsmeier Securities Co
Posted by frankstra | Friday, December 14 2012 at 11:10AM ET
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