An announcement by Moody’s Investors Service states that Puerto Rico’s general obligation rating has been placed on review for possible downgrade. A downgrade in Puerto Rico’s general obligation rating would result in a change of the rating of Puerto Rico’s municipal bonds to non-investment grade. According to Caribbean Business, the review also covers government debt linked to the general obligation credit, mostly through guarantees, such as public corporation bonds which account for approximately $52 billion of outstanding debt.
Rating service, Fitch Ratings, announced a similar plan to consider whether to downgrade Puerto Rico municipal bonds to junk status by mid-2014.
Moody’s stated that its move stems from Puerto Rico’s weakening liquidity, escalating dependence on external short-term debt, and restricted market access. Moody’s went on to state that this issues are all exacerbated by Puerto Rico’s exorbitant debts, severely underfunded pension obligations, and lingering budget shortfalls.
According to Moody’s, some things that could keep Puerto Rico bonds from declining to junk status are:
- Puerto Rico’s willingness to access long-term capital markets;
- Improved employment data;
- Improved retail sales;
- Positive financial performance, including December revenues;
- Legislative action to address its pension obligations, improve liquidity or preserve fiscal stability; and
- Puerto Rico’s proposed 2015 budget.
Conversely, the rating could be downgraded if the following occurs:
- Puerto Rico’s government fails to commit to long-term borrowing;
- A decline in liquidity;
- Disappointing financial performance in coming months;
- Puerto Rico’s government does not address the reforms needed concerning government pension obligations.
Puerto Rico’s municipal bonds have long been favored by fixed income portfolio managers because of their tax exempt status. If Puerto Rico municipal bonds are downgraded to below investment grade, portfolio managers who are prohibited from holding non-investment grade fixed income investments will look to liquidate the debt at a loss. In addition, investors may seek to exit municipal bond funds holding Puerto Rico municipal debt. Due to the increasing liquidity problems currently facing Puerto Rico municipal bonds, bond fund managers may need to sell the higher quality bonds in order to meet withdrawal demands, thereby decreasing the overall credit quality of the bond funds even further.
Additional information on the Puerto Rico municipal bond market may be obtained here.