This post continues our expert coverage of the Puerto Rico municipal bond crisis.
Accelerant analyst Jay Dulski has summarized the Standard and Poor's conference call announcing the downgrade of Puerto Rico debt ratings.
On February 4, 2014 Standard and Poor’s made the following downgrades:
- GOs downgraded to BB+ from BBB-
- Commonwealth appropriation secured debt downgraded to BB
- Employee Retirement System (“ERS”) debt downgraded to BB
- Highways and Transportation Authority (“HTA”) bonds downgraded to BB+
- GDB long-term issuer rating downgraded to BB from BBB-
- GDB short-term issuer rating downgraded to B from A-3
Ratings of Puerto Rico Sales Tax Finance Corporation (“COFINA”) bonds remain unchanged. All ratings except COFINA are on a negative CreditWatch, however COFINA has a negative outlook.
See the February 4, 2014 S&P releases below:
Puerto Rico GO Rating Lowered to 'BB+'; Remains on Watch Negative
Research Update: Government Development Bank for Puerto Rico Downgraded to 'BB/B' from 'BBB-/A-3'; Ratings Remain on CreditWatch Negative
On January 28, 2014, in hindsight quite a coincidence, S&P Dow Jones Indices announced their February 2014 rebalancing of the S&P National AMT-Free Municipal Bond Index. Citing a methodology change, all U.S. territories were removed from the index, which had contained extensive Puerto Rico holdings. The change took effect after the close of business on Friday, January 31, 2014. The full index announcement may be found below.
February Rebalancing Results for S&P National AMT-Free Municipal Bond Index Announced by S&P Dow Jones Indices
At 4:00pm EST on February 4, 2014, S&P hosted a webcast regarding the downgrades. The following notes are highlights, and a link to the full webcast may be found below.
Rating Actions on the Commonwealth of Puerto Rico and the Government Development Bank
Webcast: Ratings Actions on the Commonwealth of Puerto Rico and the Government Development Bank
February 4, 2014
Speakers included but were not limited to:
- Horacio Aldrete-Sanchez, Managing Director, Finance Ratings Standard & Poor’s Ratings Services
- David Hitchcock, Senior Director, Public Finance Ratings Standard & Poor’s Ratings Services
- Sunsierre Newsome, Associate Director, Financial Institutions Ratings Standard & Poor’s Ratings Services
-The downgrade reflects the GDB’s ability to provide near term liquidity to the Commonwealth
-The GDB is also on CreditWatch, which S&P expects to be addressed after the downgrade
-S&P expects the downgrade to cost Puerto Rico $940 million in debt accelerations and swap collateral postings
-In any future decisions, S&P will examine the recapitalization of the GDB, which may include a bond sale
-The GDB downgrades reflect S&P’s opinion that the liquidity position has weakened and the deterioration of the Commonwealth’s creditworthiness has hurt GDB’s business position and heightened the risk of their heavy loan portfolio concentration
-Since the GDB may not borrow from the central bank, the ratings reflect S&P’s opinion that the GDB cannot fund the Commonwealth’s liquidity without accessing the markets
-S&P expects that the GDB or the Commonwealth will seek to access the market in the near future
-A $1 billion debt placement by the GDB or the Commonwealth would be viewed as a stabilizing factor by S&P
-The funding and liquidity of the GDB “is not in line with an investment grade rating”
-The ratings also reflect that the GDB operates within a single market and is exposed to significant concentration risk
-S&P views the health of the Commonwealth as important to the GDB and recognizes that the two are closely tied
-The deterioration in the health of the Commonwealth’s financial situation may negatively affect payments for the GDB due to asset concentration in government affiliated entities
-The GDB’s deposits are down while loans up, posting a very high 160% loan to deposit ratio
-Asset quality at the GDB has deteriorated with a significant rise in non-performing assets (“NPAs”)
Question and Answer Session
If Puerto Rico cannot fix their cash flows, how far down would the rating go?
-The credit rating does assume that they will be able to raise additional funding by the end of February
-The CreditWatch reflects the risks that they may not raise significant additional capital
-S&P will continue to evaluate the situation
-For now, at BB+ S&P believes they have adequate liquidity, but they will need to raise additional capital between now and the end of the fiscal year
Regarding the status of rum bonds
-Rum bonds (based on excise taxes) and HTA bonds were taken down to the same rating as GOs because of Article 6 of the Puerto Rican Constitution, which grants priority payment to the GOs
-This diversion to GOs makes the ratings equal, even though their natural ratings may be higher than the GOs
Regarding the impact on COFINAs
-No rating action was taken on COFINAs
-The outlook was changed to a negative outlook a few months ago to reflect economic weakness
-S&P has legal opinions that the GO diversion does not affect COFINA, as it is simply a gross revenue pledge, so no rating action has been taken on COFINA
-COFINA is not currently under review unless there is new information, but nothing is currently pending
Would a yield above 10% represent a lack of market access?
-Market access is an important component of liquidity evaluations
-The question is whether Puerto Rico will be able to bridge the period to budget balance
-Puerto Rico recently announced a balanced budget for FY 2015, which would be the first time in many years
-Such a development could represent some credit improvement
-For now S&P believes that in the near term there are significant liquidity and implementation risks
Regarding the effect on bond insurers
-The rating action does not affect either Assured or National Public Finance (“NPF”) with respect to capital adequacy or financial strength ratings
-S&P believes their capital and liquidity are strong and can absorb higher theoretical losses
-Assured and NPF Each have $5 billion of exposure to various Puerto Rico outstanding obligations
What impact will the Commonwealth’s liquidity issues have on the island’s local banks?
-Depending on legislation, there may be a transfer of public deposits from local banks to the GDB
-S&P does not expect any material effect on banks, since they will still have private deposits and broker deposits
Since a bond offering is expected, why downgrade ahead of GDB?
-S&P will keep the BB+ rating even in the event of a sizeable bond issue in the near term
-S&P had the information and wanted to share it with market
-Again, the bond issue could resolve the CreditWatch, but also could demonstrate some market access risks
-Again, without market access, the rating could be below BB+
-The bond issue will not change the rating, but may resolve CreditWatch
-S&P had expected an issuance in the fall which did not happen, and thus believes that access has been constrained
What is the next step, what can the government do, how long will it take?
-S&P is not prescriptive, only an observer, and has made no suggestions as to what to do
-S&P is rigidly bound by their published criteria
-Short term resolution of liquidity issues could take Puerto Rico off CreditWatch, and if the attempt to balance the budget overcomes implementation risks, that could improve the credit rating
-There have been very significant budget and pension reforms by the Padilla administration, but there other credit factors outside of executive management, such as macroeconomic and market access headwinds
What extent does the coupon level or size of the deal affect CreditWatch status? What’s affordable for the Commonwealth?
-S&P will have to look at the impact on the general fund
-There have been significant deficit cutting efforts and there are prospects for more, which represent long term positive credit factors
Any additional details about the GDB’s asset quality?
-High concentration to the Commonwealth
-NPAs have more than doubled over last few years
-Entities that are non-performing are government related entities that have been struggling
-NPAs ~3% in 2011, FY 2012 at more than 6%
Will the GDB have enough liquidity?
-S&P believes that the GDB will have a limited ability to fund liquidity needs for the government in coming quarters
-But again, failure to access markets in coming quarters would be “very difficult”
-The first concern is concentration in the Commonwealth and government entities
-To be clear, S&P views the GDB as well capitalized, but very concentrated
-S&P is not saying the GDB has problems of big losses, but rather is noting the GDB’s concentration in incrementally deteriorating entities
Comment on the 1-notch difference between GOs and the GDB
-S&P applies government related entity criteria in addition to the stand alone profile of the GDB
-S&P does not feel that Puerto Rico has significant liquidity except through the GDB at this point
Does the current rating assume the teachers’ pension reform will stick?
-The current rating does assume that the teachers’ pension reform, currently in court, will stick
-S&P believes that the issues are very similar to the ERS reforms which the court upheld
-Also, reforms do not go into effect until the beginning of 2015, but a court decision is expected within a few weeks
-If it is ruled invalid S&P expects legislative tinkering, but the rating incorporates an expectation that it will be upheld
What would have to happen to be concerned about bond insurers?
-Last week S&P published a commentary with a stress scenario if Puerto Rico obligations go to single B, and in that scenario both Assured and NPF maintained capital adequacy cushions well above the requirements for their current ratings
-Since we did not get there today, S&P is very comfortable with their ratings and their liquidity positions.
Bond Insurers’ Capital Adequacy is Sufficient to Handle Potential Credit Deterioration in Puerto Rico
What impact will this have on Puerto Rico local banks? [second time this was asked]
-OFG Bancorp (Oriental Bank and Trust) is on CreditWatch with a negative outlook
-Have not stated a resolution timeframe, but did say that S&P could lower the rating on OFG if:
they expect loan performance to weaken materially;
capital is no longer viewed as strong;
the rating on the Commonwealth is lowered;
-No more than a 1-notch downgrade at the bank and a 2-notch downgrade at the holding company are expected
-Other banks’ outlooks include:
Firstbank of Puerto Rico (negative outlook)
Banco Santander Puerto Rico (negative outlook)
Doral Bank (negative outlook)
Banco Popular (stable outlook)
What economic growth forecast are we expecting in the rating?
-S&P does not make an independent forecast but does look at others
-The outlook is for economic weakness, and forecasts are not anticipating any major growth
-The Puerto Rico planning board will issue a new forecast for next fiscal year shortly
-S&P expects to see more of the same
-S&P does feel that the government is taking steps to grow business, including finding native substitutes for agricultural imports
-Problems remain, really since 2006 and the Section 936 phase out, and the economic environment is “very difficult”
Are any resources available from the U.S. federal government for liquidity?
-S&P does not expect support from the federal government
-The current rating does not include any expectation of a federal bailout
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