NEW YORK--(BUSINESS WIRE)--Fitch Ratings has placed the 'BBB-' ratings of the following Commonwealth of Puerto Rico debt on Rating Watch Negative:
--Commonwealth general obligation (GO) bonds;
--Puerto Rico 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.
SECURITY
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 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
RATING WATCH NEGATIVE: Fitch recognizes the significant progress made by the commonwealth in addressing several of its credit challenges and believes the commitment of management to achieving fiscal balance and honoring its commitments to bondholders remains strong. The Rating Watch Negative, however, reflects the challenge being faced by the commonwealth in maintaining its financial flexibility in light of unexpected deterioration in its capital market access. Fitch believes the commonwealth's liquidity through GDB is adequate to address fiscal 2014 financing needs; however, reliable market access in line with market norms is important to the long-term stability of the rating.
NEAR-TERM LIQUIDITY RISK MITIGATED: The commonwealth has $1.46 billion in combined near-term maturities and financing needs for the current fiscal year. Fitch believes that the GDB can provide liquidity if there is insufficient access to other liquidity resources; however, doing so would leave the commonwealth with reduced remaining flexibility.
STEPS TOWARD FISCAL BALANCE: The commonwealth closed a large budget gap that developed during fiscal 2013 through the use of several one-time revenues, including borrowing both as a budgetary solution and to refinance maturing debt. The enacted 2014 budget significantly increased taxes but continues to require borrowing to achieve balance. Future credit direction will reflect the extent to which budget targets are met and progress toward structural balance is achieved.
STRUCTURAL BALANCE REMAINS ELUSIVE: Structural budget balance has not yet been reached despite several years of fiscal restructuring measures. The commonwealth has made significant progress in reducing the deficit from 47% of general fund revenues in fiscal 2009 to an estimated 8.6% in fiscal 2014. Fitch believes meeting the goal of structural balance over the course of the next two fiscal years will remain challenging.
WEAK ECONOMIC PERFORMANCE: Longer-term structural budget balance and island stability require sustained real economic growth. Initial signs of recovery from the long local recession appear to have been more a reflection of economic stimulus than underlying growth and recent economic performance has been weak.
VERY HIGH LIABILITIES: Puerto Rico's bonded debt levels and unfunded pension liabilities are exceptionally high relative to U.S. states, which limits Puerto Rico's ability to use additional leveraging for capital improvements or as a budget solution and creates spending pressures that will be challenging to absorb within slowly growing revenues.
STRONG GO PLEDGE: GO bonds have a constitutional first claim on commonwealth revenues, including transportation-related and rum excise tax revenues dedicated to specific authorities/bonds. The commonwealth cannot file for bankruptcy protection.
RATING SENSITIVITIES
Fitch expects to resolve the Rating Watch Negative by the end of the current fiscal year, taking into account ongoing issues related to the commonwealth economy and budget performance, but also the manner in which the commonwealth addresses its liquidity needs. Continued lack of reasonable external market access would be considered a material reduction in financial flexibility and cause for a downgrade.
Credit direction in the Watch period will also reflect the extent to which budget targets for the current fiscal year are met and management takes further steps toward structural balance in the budget for fiscal year 2015. Credit direction will also consider the extent to which the economy begins to stabilize as improved economic performance will be critical in all of these efforts.
CREDIT PROFILE
Since Fitch downgraded Puerto Rico's GO debt rating to 'BBB-' with a Negative Outlook on March 20, 2013, the commonwealth has taken numerous measures to bolster finances and address longstanding credit challenges. In the same period, the capital markets environment for the commonwealth's debt has deteriorated considerably. This is significant because the commonwealth had planned to issue long-term debt to both take out short-term borrowings that funded last year's operating deficit and fund the smaller deficit in the current year's budget, a total of $1.46 billion in combined near-term maturities and financing needs for the current fiscal year.
With a confluence of negative events, related to both the commonwealth specifically and the municipal market in general, Puerto Rico's market access has become limited, at least temporarily. As a result, the commonwealth has become more reliant on relatively short-term, privately placed borrowing to meet its funding requirements. This, in turn, creates its own liquidity pressure and potential negative impact on Puerto Rico's operations and credit quality.
The commonwealth needs to address $785 million in upcoming maturities (in December 2013 and January 2014) of privately placed bonds and notes that were issued to refinance fiscal 2013 GO bond maturities and $145 million of the total $575 million in debt service refinancing assumed in the fiscal 2014 enacted budget. The budget also included $245 million in deficit funding. The commonwealth has been funding the remaining $430 million of the budgeted $575 million fiscal 2014 GO debt refinancing through a GDB line of credit, as it did in fiscal 2013 prior to entering into various loan participation agreements with local banks (the refinancing of which is included in the upcoming December and January maturities).
The commonwealth continues to assess the ability to execute its plan to refinance these obligations through a new third lien under its stronger sales tax backed security (issued by COFINA, senior and first subordinate lien bonds rated 'AA-'/'A+' by Fitch) that has been approved by the legislature. In addition to potentially coming to market with the third lien sales tax bonds, the GDB continues to explore private placement options and Fitch believes it has sufficient capacity to provide liquidity support to the commonwealth through the fiscal year. Although Fitch believes that the GDB could provide this liquidity if there is insufficient access to other liquidity resources, the need to do so, and the resulting reduction in the support that GDB could provide going forward in the event of unexpected budget underperformance, would be material to Fitch's assessment of the commonwealth's financial flexibility.
Fitch has recognized that Puerto Rico's high level of bonded debt limits its ability to use additional leveraging for capital improvements or as a budget solution; however, the challenge the commonwealth is now facing in borrowing even under the COFINA sales tax credit, which Fitch believes to be materially stronger than the GO, is a significant new negative credit factor.
In addition to the short-term borrowings discussed above, the commonwealth has $1.2 billion in outstanding short-term tax and revenue anticipate notes (TRANs) for fiscal 2014, $900 million of which were privately placed with banks with the remaining $300 million provided by the GDB through a revolving line of credit. Unlike the other short-term borrowings, the existence of these notes is not a key credit concern for Fitch, as they represent more traditional cashflow borrowing and are budgeted to be repaid from general fund resources by the end of the fiscal year.
At the time of the March 2013 downgrade, Fitch stated that stabilization of the GO rating at the 'BBB-' level would be based on substantial progress toward budgetary balance that does not rely on debt restructuring for fiscal relief. Fitch also noted that the ultimate test of the success of future policy would be whether or not Puerto Rico is able to find a sustainable path to the economic growth that is necessary to support high debt levels and other long-term liabilities, as well as to achieve and maintain a structurally balanced budget.
Since that time, the commonwealth has made substantial progress in addressing several of its credit challenges and Fitch believes the commitment of management to achieving fiscal balance and honoring its commitments to bondholders remains strong. The administration took steps to close a significant budget gap in fiscal 2013, raised taxes to support a fiscal 2014 budget that reduces the size of the operating gap while increasing funding for pensions, and passed significant pension reform that was validated by the commonwealth supreme court, removing the uncertainty of potential litigation.
Apart from these positive management developments, it is clear that the commonwealth's economic performance continues to be a drag on the credit. Most recently, the Puerto Rico Planning Board announced that it expected the economy to contract by 0.8% in fiscal 2014, compared to the 0.2% growth that had been forecast in April of this year. The board announced at the same time that real GDP had fallen 0.3% in fiscal 2013; the prior estimate was a decline of 0.4%.
Monthly economic numbers have been weak this year after signs of recovery in 2012; however, given that the 2012 economic performance was bolstered by significant election-year stimulus spending, it is too soon to tell whether the economic trend will continue in a negative direction or improve after the effect of the stimulus comes out of the base performance numbers. It is similarly too early to assess whether the tax increases enacted as part of the fiscal 2014 budget gap closing measures have a dampening effect on economic performance.
Despite the recent reduction in economic expectations for the current fiscal year, revenues through October are up year-over-year and are exceeding budgetary targets in the aggregate, reflecting in part the tax policy changes. Expenditures are reportedly also generally in line with forecast year-to-date. Trend analysis for the commonwealth's tax revenues is challenging given frequent and significant tax policy changes in recent years, making it difficult to judge the degree of the relationship between particular economic and revenue results.
Puerto Rico's debt levels are very high, and have increased as the commonwealth has relied, for many years, on borrowing to fund operations and refinance debt for current-year budget savings. Although the commonwealth has substantially reduced the size of its operating deficit, the remaining structural budget gap requires continued use of deficit borrowing. Fitch has noted this trend and the risk to the commonwealth of potential disruptions in market access.
Additional information is available at www.fitchratings.com.
Applicable Criteria and Related Research:
--'Fitch Affirms Puerto
Rico's Sales Tax Rev Bond Ratings; Outlook Stable' (Nov. 13, 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
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015
U.S.
State Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=808111
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