Fitch response to Puerto Rico ruling will affect fewer than 20 ratings

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Fitch Ratings has responded to investor inquiries by providing a new explanation, slated for Wednesday release, of its proposal to impose a six-notch cap on its ratings of tax-supported bonds issued by municipal entities eligible to file for bankruptcy protection.

The proposed criteria changes announced last month were in response to a March 2019 ruling by the U.S. Court of Appeals for the First Circuit involving the Puerto Rico Highways & Transportation Authority.

The appeals court affirmed a ruling by U.S. District Court Judge Laura Taylor Swain, who is overseeing Puerto Rico's bankruptcy. Swain dismissed a lawsuit by bond insurance companies claiming that payments on the debt from pledged toll and other revenue should not be halted during the bankruptcy.

The appellate court ruling is expected to have an impact on local government bondholder protections provided by special revenue debt issuances in future cases involving municipal governments seeking Chapter 9 protection under the federal bankruptcy code.

“It’s a change for us in response to the court decision which was not consistent with what we had previously thought,” Laura Porter, managing director and head of U.S. Public Finance for Fitch Ratings, said in an interview Tuesday. “We felt that the court case was a surprise in terms of what special revenue protections get you. We felt like we needed to respond to that in our criteria.”

Porter said her firm believed the protections afforded by special revenue status had been a settled matter prior to the court ruling.

Previously, the Fitch rating for a special revenue bond was not limited by the rating for the issuer even though Fitch rarely rated special revenue bonds above the issuer rating.

But in some cases it did.

As a result of the March 23 appellate court ruling, Fitch announced on April 11 it has put seven bond issuances on negative ratings watch.

One of the seven — senior lien Chicago water revenue bonds rated AA while the city was rated BBB/stable — has since been removed from the watch list because the bonds were paid off.

The six remaining are: limited ad valorem Chicago Board of Education A-rated tax revenue bonds; Maricopa County Special Healthcare District AAA-rated limited tax general obligation bonds; Oakland Unified School District AAA-rated unlimited tax-dedicated general obligation bonds; Palomar Health AAA-rated unlimited tax-dedicated general obligation bonds; Sacramento City Unified School District AAA-rated unlimited tax-dedicated general obligation bonds; and Sweetwater Union High School District AAA-rated unlimited tax-dedicated general obligation bonds.

Fitch estimates its new criteria will affect fewer than 20 ratings, including the six already put on rating watch.

“The reason why the number is relatively low, is because issuer ratings are generally quite high,” Porter said. “Our average issuer rating for municipals and states is in the double A category.”

There are, in fact, only two notches above double-A — double-A plus and triple-A.

The only real impact of the criteria change is for communities below double-A minus, according to Porter.

Fitch plans to post the comments it has received on its proposal after the October deadline.

In a new document released this week, Fitch is responding to investor questions it received earlier this month during a webinar on the proposed change in ratings criteria.

Fitch said the changes will not alter its fundamental methodology for rating local government debt.

Instead, it will limit how much higher a security rating can be than the related municipality’s Issuer Default Rating (IDR).

State governments are not affected by the change because they are not eligible for Chapter 9 bankruptcy.

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