Standard & Poor's Ratings Services lowered its ratings on the Commonwealth of Puerto Rico's tax-backed debt to 'CC' from 'CCC-' and removed the ratings from CreditWatch, where they had been placed with negative implications July 20. The outlook is negative.
These rating actions follow the Sept. 9 release by the Working Group for the Fiscal and Economic Recovery of Puerto Rico (a special commission recently appointed by the governor) of a special fiscal commission report (the report) recommending restructuring all tax-backed debt, including general obligation (GO) and Puerto Rico Sales Tax Financing Corp. (COFINA) sales tax debt.
We believe a default or restructuring is highly likely and could take the form of either a missed debt service payment or a distressed exchange that we would characterize as a default. In a follow-up address to the commonwealth, Gov. Alejandro Garcia Padilla stated that if creditors are not willing to partake in restructuring negotiations, the government would have no alternative but to proceed without them even if it involved "years of litigation and defaults."
We rate debt 'CC' when we expect default to be a virtual certainty, regardless of the anticipated time to default. In our view, all of Puerto Rico's tax-backed debt is highly vulnerable to nonpayment.
In his television address, Gov. Padilla announced the appointment of a team of debt restructuring experts to negotiate with creditors. Although at this point the report is technically only a recommendation, the report specifically references measures to address all of Puerto Rico's tax-backed debt obligations, including GO and COFINA sales tax debt.
The report projects Puerto Rico's treasury will exhaust its liquidity in November 2015, even after undertaking extraordinary measures to preserve cash, while the Puerto Rico Government Development Bank (GDB) is projected to exhaust its liquidity before the end of calendar 2015. It projects Puerto Rico will not have fully sufficient resources in fiscal 2016 to make payment on its scheduled tax-supported debt, including GO debt. The report further forecasts a total central government deficit as a whole, including the general fund, GDB net revenue, COFINA, federal programs, and Puerto Rico Highways & Transportation Authority (HTA) net revenue, in fiscal 2016 of $3.2 billion, or about 16% of expenditures, including payment of debt service. The report projects only a $924 million surplus available before payment of debt service--insufficient, in our view, to pay $1.8 billion of GO and GO-guaranteed debt service (GO debt service alone is $1.2 billion), much less total central government debt service, including GO debt, of $4.1 billion.
We rate all Puerto Rico tax-backed debt at the same 'CC' level, except for Puerto Rico Public Finance Corp. (PFC) debt, which is currently in default and rated 'D', reflecting the report's projection of limited liquidity to meet all debt service before the end of calendar 2015, including GO debt service, and the report's recommendation to enter restructuring discussions with all tax-backed debt holders.
The report also makes various other revenue and expenditure recommendations, although the governor stated in his follow-up address that he does not expect to make any further reductions to the number of commonwealth employees. In addition, the report recommends that the governor establish a five-member financial control board with oversight authority over most governmental entities, including the commonwealth, GDB, and the public corporations except Puerto Rico Aqueduct & Sewer Authority (PRASA) and Puerto Rico Electric Power Authority. Creating such a board would, however, that would require new legislation. In our view, it may be difficult for the governor to obtain the requisite legislative approval to cede significant fiscal power to a financial control board. The report also anticipates the provision of additional federal health care funding not in current law and other U.S. actions in future years that might not materialize.
