Moody’s Investors Service downgraded the Puerto Rico Sales Tax Financing Corporation’s (COFINA) senior sales tax bonds to A2 from Aa3 late on Thursday.
Moody’s affirmed Puerto Rico’s general obligation rating at Baa3. It also affirmed the COFINA junior sales tax bonds at A3.
Moody’s changed its outlook on COFINA debt to negative from stable. The GO outlook remains negative.
The actions affect $6.8 billion of senior COFINA bonds and $9.2 billion of junior COFINA bonds.
There are three main reasons that Moody’s lowered the senior COFINA rating, Moody’s analyst Lisa Heller said.
The commonwealth’s persistently weak economy has constrained growth in sales tax revenues; Moody’s has reassessed the links between the commonwealth’s fundamental credit position and that of its sales tax bonds and concluded that the prior six-rating-notch differential from the GO rating was too great; and because of a sharply escalating debt service schedule, she said.
In Moody’s special tax methodology special tax ratings rarely exceed that of the GO and, when they do, usually by not more than two notches.
It is because Moody’s believes the legal separation between the GO and the COFINA credits is strong that it has kept a four-notch separation, Heller said.
“We also note that steeply escalating debt service schedules will require significant sales tax revenue growth in order to maintain coverage levels consistent with current ratings, even with the addition of new revenues from the recently legislated sales tax expansion,” Heller said.
“We view the sales tax pledge to be insulated from the commonwealth’s broader budget and financial problems. However, as the commonwealth continues to face economic and fiscal stress, we believe that the risk of challenge to this insulation grows.” Heller said.
“With regard to the change in outlook for the COFINA bonds, we are confident that we can demonstrate continued, significant progress on our fiscal and economic development plans,” the Government Development Bank of Puerto Rico and the Puerto Rico Treasury said in a statement. “We are confident in our plans and are proceeding with focus and determination to continue to strengthen the Commonwealth’s financial position and build a solid foundation for economic prosperity and development.
“We are encouraged by Moody’s acknowledgement of the Commonwealth’s stable sales tax collections amid fluctuating economic conditions and enhanced enforcement measures that are expected to significantly reduce non-compliance,” the Puerto Rico agencies said. “Moody’s has also recognized that the Commonwealth’s strong legal structure, broad and diversified economic base, non-impairment covenant and strong annual debt service coverage on first-lien bonds are COFINA’s strengths, and we look forward to keeping them informed of our progress.”
The negative outlook on the COFINA credit reflects Moody’s negative outlook on the commonwealth. If Moody’s lowers the commonwealth it expects it would lower the COFINA rating, Heller said.
Along with affirming the GO rating, Moody’s also affirmed its Baa3 rating of Puerto Rico Highway and Transportation Authority transportation revenue bonds, Puerto Rico Aqueduct and Sewer Authority commonwealth guaranteed bonds, Government Development Bank senior notes and some other island securities. It affirmed at Baa2 the Puerto Rico Highway and Transportation Authority highway revenue bonds. It affirmed the Ba1 rating for the Puerto Rico Aqueduct and Sewer Authority revenue bonds, Puerto Rico Highway and Transportation Authority subordinate transportation revenue bonds and Puerto Rico Public Finance Corporation commonwealth appropriation bonds.
In explaining the affirmation of the GO rating on $39 billion of outstanding debt, Heller noted on the positive side that the commonwealth government has taken major steps to increase revenues for the government and two of its authorities. Also the government has passed a major pension reform of the Employees Retirement System.
On the negative side, the economy is weak. The government has limited liquidity and high and growing debt levels. The government has also had persistent budget deficits financed with deficit financings and debt restructurings. Finally, the government has not yet reformed the Teachers Retirement System.
