Fitch Downgrades Puerto Rico GO and Related Debt Ratings to 'BB'; Outlook Negative
NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the ratings for the following Commonwealth of Puerto Rico debt to 'BB' from 'BBB-':
--Commonwealth general obligation (GO) bonds;
--Puerto Rico Public Building Authority government facilities revenue bonds guaranteed by the commonwealth;
--Puerto Rico Aqueduct and Sewer Authority (PRASA) commonwealth guaranty revenue bonds;
--Employees Retirement System of the Commonwealth of Puerto Rico pension funding bonds.
The ratings have been removed from Rating Watch Negative; however, the Rating Outlook, which indicates the direction the ratings are likely to move over a one- to two-year period, is Negative.
The current action does not affect the ratings that Fitch assigns to bonds issued by the Puerto Rico Sales Tax Financing Corporation (COFINA). Those bonds are secured by the commonwealth's sales and use tax and insulated from the commonwealth's general credit strain. Their ratings are driven by economic and revenue performance.
The GO bonds are a full faith and credit obligation of the Commonwealth of Puerto Rico that benefit from a constitutional first claim on commonwealth revenues. The ratings on the public building authority and PRASA bonds reflect the guaranty of the commonwealth's full faith, credit, and taxing power. The pension funding bonds are payable from and secured by a pledge of statutorily required employer contributions to the system; the commonwealth is the largest contributor.
KEY RATINGS DRIVERS
REDUCED FINANCIAL FLEXIBILITY PROMPTS DOWNGRADE: Fitch placed the GO and related ratings on Negative Watch in November 2013, citing the challenge facing the commonwealth in maintaining financial flexibility in light of the deterioration in capital markets access. Recent downgrades have triggered new liquidity requirements and lowered expectations for the market available for the commonwealth's debt going forward, though there have been no significant negative developments regarding the commonwealth's finances or economy since November. In the context of other credit challenges related to a weak economy and elevated liability levels, Fitch believes that these additional hurdles preclude the commonwealth maintaining an investment-grade credit profile.
FISCAL MANAGEMENT EFFECTIVE AND COMMITTED: The commonwealth's management has responded quickly and decisively to challenges that have arisen in recent years and the current administration has made significant progress in addressing longstanding credit issues. Fitch believes the commitment of management to achieving fiscal balance and honoring commitments to bondholders remains strong, and the governor recently announced a plan to balance the budget next year, one year earlier than previously expected.
ECONOMIC PERFORMANCE THE KEY FACTOR: The commonwealth's economy has been in recession since 2006. Initial signs of recovery in 2012 appear to have been more a reflection of economic stimulus than underlying growth and subsequent economic performance has been weak. Although some recent information suggests nascent improvement, results are mixed and it is too soon to tell whether the economy will stabilize this year. Fitch believes that the ultimate success of efforts to put the commonwealth's finances on a sustainable path will be dictated by the performance of the economy.
DEBT AND RETIREE BENEFIT LIABILITIES HIGH: Puerto Rico's bonded debt levels and unfunded pension liabilities are very high relative to U.S. states, with a large amount of outstanding debt issued for deficit financing purposes. This has created spending pressures and limited the commonwealth's ability to use additional leveraging. Pension funding will remain exceptionally low even with the significant pension reform effort undertaken by the current administration.
MARKET ACCESS IMPAIRED: The commonwealth's capital markets access deteriorated steeply in 2013 despite the action taken to address longstanding credit challenges. Reliable external market access in line with market norms is important to long-term stability.
GO PLEDGE STRONG: Puerto Rico's GO pledge is unusually strong, providing a constitutional first claim on commonwealth revenues. The commonwealth cannot file for bankruptcy.
MARKET ACCESS: The current rating assumes that the commonwealth will be able to execute a sizable transaction in the near term to bolster liquidity. An inability to access the market would be a significant credit concern and cause for a downgrade.
EVIDENCE OF ECONOMIC STABILIZATION: Maintenance of the current rating will require stabilization in economic performance and emergence from the long recessionary period.
ACHIEVABILITY OF BUDGET TARGETS: Failure to show continued progress toward structural balance would pressure the rating.
Puerto Rico's current management has repeatedly shown its ability and willingness to take quick action to address financial challenges and external market concerns, much of which has required legislative action. However, underlying the need for these measures is the very difficult economic, financial, and market situation that management continues to confront.
Fitch downgraded Puerto Rico's GO debt rating to 'BBB-' with a Negative Outlook in March 2013, reflecting economic and revenue underperformance that significantly increased the size of the operating imbalance for the then-current fiscal year and the gap presented to the commonwealth as it developed a budget for fiscal 2014.
The commonwealth subsequently took numerous measures to bolster finances and strengthen fundamental credit factors. However, in the same period, the capital markets environment for the commonwealth's debt deteriorated considerably. In addition, economic indicators continued to show material weakness, and the commonwealth reduced its forecast for economic performance. In November 2013, Fitch placed the commonwealth's GO and related ratings on Rating Watch Negative, primarily reflecting the new risk of constrained market access.
Since that time, the administration has taken additional steps to support the credit, including enactment of teachers' pension reform, various measures to improve GDB liquidity, and numerous economic development initiatives. Spending is reportedly under budget, and the commonwealth recently announced a reduction in the deficit forecast for the current and coming fiscal years. On the downside, the sales tax changes included in the current-year budget have failed to produce the expected additional revenues. The January 2014 revenue forecast revision, while unchanged in aggregate, reflects an even larger reliance than previously budgeted on corporate taxes, which are currently overperforming estimates.
Last week's downgrades have triggered potential new liquidity demands of about $1 billion; although Fitch expects that the commonwealth will be able to meaningfully lower this amount through negotiations with relevant counterparties, such demands will still consume some of the commonwealth's limited current market capacity in the near term. Just as importantly, Fitch believes that the non-investment-grade ratings will reduce the market available for the commonwealth's debt going forward, thereby diminishing financial flexibility as the administration moves forward with its fiscal stabilization efforts. The commonwealth has announced plans to come to market with a sizable transaction in the coming weeks that is expected to be sold primarily to non-traditional investors.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Fitch Places Puerto GO and Related Debt Ratings on Rating Watch Negative' (Nov. 14, 2013);
--'Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'U.S. State Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. State Government Tax-Supported Rating Criteria