Puerto Rico and Others Respond to Fitch Downgrades

Fitch Ratings drew objections from Puerto Rico's government and mixed opinions from analysts for downgrading a wide array of the island's bonds.

Fitch's downgrades on Wednesday evening were generally not as severe as those from Moody's Investors Service on July 1. Whereas Moody's dropped Puerto Rico's general obligation bond to B2 from Ba2, Fitch dropped it to BB-minus from BB. BB-minus is two notches above the rating equivalent to B2.

Moody's now has the bonds of the Puerto Rico Aqueduct and Sewer Authority at Caa1, three notches lower than the B-plus that Fitch assigns them, though Fitch has them on ratings watch negative. Moody's has Employment Retirement System bonds at B3, three notches lower than Fitch's BB-minus rating.

An exception to this pattern is the Puerto Rico Electric Power Authority. Fitch rates it CC, two notches below Moody's Caa2. Fitch announced its PREPA rating in late June.

Many observers were struck by Fitch's nine notch downgrade Wednesday of the Puerto Rico Sales Tax Financing Corp. (COFINA) bonds to BB-minus from AA-minus. Fitch is rating both the first-lien and subordinate lien sales tax revenue bonds at BB-minus.

"Although COFINA bonds are specifically excluded in the Public Corporation Debt Enforcement and Recovery Act, the passage of the act has substantially increased Fitch's assessment of the risk that the commonwealth may take steps to the detriment of COFINA bondholders," Fitch managing directors Laura Porter and Doug Scott wrote.

"We are disappointed by Fitch's erroneous interpretation that the recent passage of the Recovery Act suggests Puerto Rico may take actions in the future to the detriment of the COFINA credit," Puerto Rico Treasurer Melba Acosta Febo and Government Development Bank of Puerto Rico Chairman David Chafey wrote in response. "As Fitch has acknowledged, COFINA is explicitly insulated from the Recovery Act."

"All the steps taken since the beginning of [the Gov. Alejandro García Padilla] administration have been consistent and aligned towards the same goal: to strengthen the General Fund and COFINA while ensuring the self-sufficiency of public corporations that provide essential services to island residents," Chafey and Melba Acosta said. "Towards this objective, during the past 18 months this administration has (i) increased the COFINA base rate from 2.75% to 3.50%, (ii) pledged an additional 0.5% of the sale and use tax to COFINA, (iii) expanded the sales tax base in the fiscal year 2014 budget and for the fiscal year 2015 budget, and (iv) pledged to begin charging the sales and use tax at the commonwealth's ports."

The measures have increased COFINA's debt capacity, Chafey and Melba Acosta said, improved coverage ratios and break-even growth rate scenarios, and boostedsales and use tax growth.

In a separate statement on Wednesday, the Treasury and GDB denied the new law signaled any change in the commonwealth's commitment to honor its obligations.

"To the contrary, the explicit aim of the Recovery Act is to protect and strengthen the General Fund, our GO credit, and the GDB by giving public corporations the opportunity to address their financial challenges once and for all without being a drain on the General Fund," they said in the statement. "The Recovery Act specifically excludes the commonwealth, all of its municipalities, the GDB and COFINA and in no way alters our commitments to honor our GO, COFINA and other related credits."

The Puerto Rico agencies cited actions including: elimination of the commonwealth's $2.2 billion budget deficit; pension reform; passage of the Fiscal Sustainability Act, which cut operating costs at the central government; a successful sale of $3.5 billion of general obligation bonds in March; passage of an act that barred the GDB from extending credit to public corporations without an identifiable source of repayment and elimination of tax loopholes.

Axios Advisors managing partner Triet Nguyen said he disagreed with Moody's and Fitch that COFINA should be considered a speculative grade debt. He approvingly quoted Chafey and Acosta Febo's defense of COFINA in a column in MuniNetGuide.com.

Nevertheless, Nguyen said it was significant that two of the three major ratings agencies now have COFINA bonds at a speculative grade. This will prevent investment grade mutual funds and exchange traded funds from buying the debt, he said.

The Fitch and Moody's downgrades "could create a self-fulfilling prophesy further weakening the credit fundamentals," said Joan Vidra, managing director of Opportunities Emerging & Frontier Markets Advisory LLC.

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