Nov 14 (Reuters) - Fitch Ratings said on Thursday it may soon strip heavily indebted Puerto Rico of its investment grade credit rating, threatening to tag the U.S. territory as the largest municipal bond issuer to date to tumble into junk bond territory.
A leading Wall Street credit ratings group, Fitch said it had placed the Caribbean island's BBB-minus general obligation bond rating on negative watch and expected to clarify the status of its rating by the end of June.
Fitch and two other U.S. ratings agencies - Moody's and Standard & Poor's - currently rate Puerto Rico's GO debt at the bottom of the investment grade scale. Moody's and S&P also have negative outlooks on Puerto Rico, which already sports the lowest ratings of any state or U.S. territory.
A cut in Fitch's rating to junk would be widely felt in America's $3.7 trillion municipal bond market, where Puerto Rico's $70 billion of high yielding debt is held by many mutual funds and other institutional investors.
Interest rates on Puerto Rico debt have shot up in recent months amid worries about its finances and a sputtering economy, which appears to be tumbling back into recession.
The cost to insure Puerto Rico debt against default has rocketed recently in the credit default swaps market.
On Thursday, a contract to insure $100 million of Puerto Rico bonds for five years closed at about 799 basis points, not far below a record high of 816 basis points in late October, plus an upfront cost of 20.4 percent of the insured amount.
That means it would cost about $2 million per quarter over five years, plus a one-time payment upfront of $20.4 million, to insure $100 million of the island's bonds.
Fitch said in a news release it worried that the island's ability to issue bonds had become limited and weighed on the government's overall liquidity, which the agency said could be bolstered by the Government Development Bank of Puerto Rico.
Fitch said the negative ratings outlook also applied to Puerto Rico Building Authority government facilities revenue bonds guaranteed by the commonwealth, Puerto Rico Aqueduct and Sewer Authority commonwealth guaranty revenue bonds and pension funding debt issued by the Employees Retirement System of the Commonwealth of Puerto Rico.
Fitch, which also affirmed its AA-minus and A-plus ratings on $15.6 billion of Puerto Rico sales-tax bonds, praised financial and pension reforms taken by the island's government, but described as "challenging" the prospects of ending Puerto Rico's chronic budget deficits in the next two fiscal years.
The island's government is benefiting from new tax hikes, with tax revenues for September and October coming in stronger than a year earlier, GDB Interim President José Pagán Beauchamp said in a news release.
"Our administration continues its focus on creating sustainable economic growth through job creation, making ongoing progress towards our goal of a structural budget balance by fiscal 2016, and strengthening our credit profile, market access and liquidity," he said.