On Thursday afternoon Fitch Ratings downgraded the Puerto Rico Aqueduct and Sewer Authority’s senior revenue bonds to BBB-minus from BBB. It revised the outlook to negative from stable.

The downgrade affects $3.5 billion of debt.

PRASA supplies water service to nearly the entire island. It provides sewer service to 60% of the island’s residents.

In explaining its action, Fitch managing director Doug Scott said Fitch’s recent downgrade of the commonwealth’s government was key. Fitch downgraded the commonwealth’s general obligation debt to BBB-minus from BBB-plus on March 20.

Scott noted that the commonwealth’s government has provided direct and indirect financial support and influenced its ratemaking decisions. Because of these connections, after the downgrade of the government Fitch believed the authority also should be downgraded.

“While PRASA’s governing body has initiated steps to reach financial independence and self-sufficiency for fiscal 2014 and beyond, until PRASA demonstrates that it is a financially sound and self-sustaining enterprise, its credit quality will be strongly tied to subsequently limited by the commonwealth’s GO rating,” Scott wrote.

The PRASA board has proposed a 67% rate increase. Public hearings will be held on the proposal soon. The board will make the ultimate decision. A rate increase would go into effect sometime from July 1 to August 31.

While this rate increase is a credit positive for PRASA, Scott wrote that Fitch is concerned that the rate increase may increase bad debt rates among PRASA’s customers and may negatively impact the island’s already weak economy.

Additionally, Scott wrote that PRASA’s financial margins were minimal. In fiscal 2011, senior lien debt service from net revenues was 2.5 times based solely on funds from operations. However, for subordinate debt service PRASA relied partially on funds from the government and the Government Development Bank of Puerto Rico.

According to unaudited fiscal 2012 figures, PRASA had senior debt service coverage of 8.1 times and total debt service coverage of 1 time.

Scott also noted the formidable capital needs in PRASA’s near future. The authority’s capital improvement plan anticipates the authority spending $1.5 billion from 2013 to 2017. Further large capital spending is anticipated beyond 2017. PRASA is currently trying to renegotiate consent decrees with regulators to allow PRASA to do the capital spending in a more gradual fashion. Success at these negotiations would be a financial positive for PRASA over the near term, Scott wrote.

PRASA is rated Ba1 by Moody’s Investors Service and BB-plus by Standard & Poor’s.

PRASA is seeking $350 million in loans from four Puerto Rican banks and from Bank of America, PRASA director Efraín Acosta said. This will be enough for the coming year’s capital spending needs, he said. After the authority increases its rates and bond investors take note of this serious action, PRASA will return to the bond market, he said.

The government’s office of the budget and the GDB have told PRASA that it will get no government financial support in the coming fiscal year, which starts July 1, Acosta said.

The rate increase should provide financial stability to PRASA through 2017 or 2018, he said.

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