In a long expected move, Standard & Poor’s (“S&P”) announced that it has downgraded general obligation municipal bonds issued by Puerto Rico to speculative grade or junk status. Many are now expecting a similar credit downgrade by ratings services Fitch and Moody’s.
In its announcement, S&P stated that its decision is partially based on Puerto Rico’s apparent impaired ability to raise much needed funds in the capital markets. The S&P kept Puerto Rico general obligation debt on watch status with negative implications, evidence that additional downgrades may be forthcoming. To date, S&P has not lowered the rating of Puerto Rico’s sales-tax bonds, also known as Cofinas.
According to Puerto Rico’s governor, he will release a budget for the next fiscal year that is not reliant upon deficit borrowing. InvestmentNews reports that, since at least 2000, every budget of the commonwealth has relied on deficit borrowing. In the past year, Puerto Rico’s lawmakers have reduced pension benefits, increased taxes, and pared budget gaps, but were unable to prevent the rating downgrade.
According to figures released by the Government Development Bank, Puerto Rico had roughly $70 billion in debt as of June 30, 2013. Moody’s Rating Service estimated in December 2013 that a drop to junk status would mean the commonwealth could have to pay up to $1 billion for collateral and accelerated payments on swaps and other financing.
As of December 2013, Puerto Rico’s unemployment rate was 15.4%, its highest level in two years.
Like all U.S. territories, Puerto Rico’s municipal bonds are tax-exempt regardless of the location of the investor. This tax-free status has traditionally made Puerto Rico municipal debt attractive to mainland U.S. mutual fund managers. Morningstar estimates that approximately 70% of U.S. municipal bond funds contain Puerto Rico municipal bonds. However, some mutual funds are precluded from holding below-investment grade bonds which could push increased sales of Puerto Rico debt by bond holders.
Some of the mutual funds that are most highly concentrated in Puerto Rico municipal bonds are the UBS Puerto Rico Family of Funds that were offered exclusively to Puerto Rico residents. The UBS closed-end funds have lost 50-60% since September 2013 according to Forbes.
Investors who have lost money in Puerto Rico municipal bonds or mutual funds containing Puerto Rico debt can click here to read more about the securities arbitration attorneys at McCabe Rabin.