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Commonwealth’s credit rating drops

S&P and Moody’s share many concerns over local government’s credit quality


June 3, 2005
Copyright © 2005 CARIBBEAN BUSINESS. All Rights Reserved.

The bad news for the Commonwealth’s credit keeps on coming. In less than a week, a series of five reports prepared by Moody’s Investors Service and Standard & Poor’s (S&P) were made public, all coinciding with their concerns over the island’s fiscal deficit and the high levels of government spending. In February, CARIBBEAN BUSINESS predicted the large deficit left by the Sila Calderón administration (estimated as high as $2 billion), huge levels of debt, and the unfunded government’s pension plan, would result in a drop in the Commonwealth’s credit rating (CB, Feb. 24).

S&P lowered the credit rating for the Commonwealth of Puerto Rico’s long-term general obligation (GO) bonds to BBB from A-. "The rating change reflects the fact that the Commonwealth’s structural imbalance continues due to the combination of disappointing expenditure controls, particularly in the areas of education, public safety, health and human services, and the inability to achieve previously planned revenue control," commented analyst Kenneth Gear.

The S&P report listed a series of other factors that affected the rating such as, thin financial reserves, continued use of nonrecurring revenues in the form of short-term loans from the Government Development Bank (GDB), failure to adopt a multiannual financial plan leading the Commonwealth to structural balance, an inability to achieve consensus on the adoption of the fiscal 2006 budget and specifics related to tax reform, and the increasing burden of a weakly funded pension system.

The report indicated the outlook remains negative and S&P specified that failure to develop and implement a financial plan that effectively addresses the causes of the Commonwealth’s structural imbalance could lead to further weakening of credit quality.

In a separate report that was simultaneously made public, S&P lowered GDB’s rating to BBB+/A-2 from A/A-, and its CP rating to A-2 from A-1. The downgrade was attributed mostly to the downgrade of the Commonwealth of Puerto Rico. "The ratings and negative outlook assigned to the GDB are because of the close business ties it has to the Commonwealth," explained analyst Victoria Wagner.

S&P goes on to explain that the rating reflects the governments continued dependence on GDB loans as a financial resource to manage the overall financial business of the Commonwealth and the integration of the two entities.

On a positive note, S&P points out that GDB’s financial profile includes good liquidity and a strong capital position that provides it with financial flexibility to manage potential business or economic disruptions.

GDB’s rating was given a negative outlook as a consequence of the outlook assigned to the Commonwealth of Puerto Rico, which was also negative. It also mentions the 2002 passage of Act 82, which instituted annual dividend contributions from the GDB to the Commonwealth’s General Fund, further linking both entities.

Moody’s credit rating

On May 19, Moody’s made public their report downgrading the GO bonds to Baa2 from Baa1. Apart from the same factors pointed out in the S&P report, Moody’s also mentioned the lack of economic growth on the island and the high rate of government payroll as factors of concern. The outlook for future ratings changes was also negative.

On May 23, Moody’s made public another report concerning the assignment of a Baa2 rating for $520 million special tax revenue bonds for the Infrastructure Financing Authority (AFI by its Spanish acronym). The last time Moody’s assigned a rating to an AFI bond issue of $1.1 billion was on Sept. 21, 2000, and the rating had been Aaa. The outlook for the current bond issue was also negative.

On May 24, Moody’s prepared another report on the University of Puerto Rico’s (UPR) bond rating. The $440 million bond issue was put on ‘Watchlist’ for a possible downgrade from its current A3 rating. Another series of UPR bonds, totaling $86 billion, that have a Baa1 rating, were also placed on ‘Watchlist.’ Moody’s believes, since UPR depends on the Commonwealth for more than 70% of its revenue, the institution may suffer revenue cuts, as the Commonwealth’s own fiscal situation tightens.

GDB’s close government ties raise concerns

GDB President William Lockwood explained to CARIBBEAN BUSINESS the significance of having both agencies echo many concerns about the Commonwealth’s situation. "Having both agencies [saying the same thing] proves even more strongly the need to take adequate measures immediately," commented Lockwood.

In relation to the concerns of the close ties between the government and the GDB, Lockwood pointed out that this year there are more members of the private sector than the public sector on the board of directors of the bank. Although he couldn’t confirm if this was designed in order to separate the GDB from the government, he believes it marks a departure from the traditional publicly dominated board.

Lockwood also mentioned the bank has already identified a series of measures to increment its liquidity by over $2.5 billion. Among the measures the reimbursement to the GDB of the issues programmed before year-end, such as AFI, Municipal Financing Authority, the Convention Center District, and the Coliseum of Puerto Rico, for an income of over $1 billion. There is also a sale of medium-term notes, the increment of deposits at the bank, and other transactions related to government loans if necessary, which would generate over $1.5 billion. Lockwood also pointed out that the bank will be much more selective with the projects they finance.

When asked the consequences the downgrades have for bond holders, Lockwood explained the bonds have protection of repayment priority under the Constitution and the trust agreements are very strong granting further safeguard of repayment to bond holders. "Typically bond holders retain bonds until they expire on account of the triple exemption. We hope they continue acting this way," commented the GDB president.

In terms of the potential for a positive shift in the ratings ladder, Moody’s anticipates achieving the required progress in the Commonwealth may take several years. In the meantime, many things need to happen in Puerto Rico in terms of balancing the budget, government structure, tax reform, and economic environment, for the sake of the Commonwealth’s credit and future stability. These challenges may open a window of opportunity for Puerto Rico as it focuses on fortifying the areas that need attention in order to regain a positive outlook for the island’s future well being.

This Caribbean Business article appears courtesy of Casiano Communications.
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