By Steven C. Johnson
NEW YORK Feb 7 Moody's Investors Service on
Friday became the second ratings agency this week to cut Puerto
Rico's credit rating to junk, citing concern about the
cash-strapped U.S. territory's weak economy and its ability to
Reaction in the $3.7 trillion municipal bond market was
somewhat muted as the move was widely expected, though a few
wild odd-lot trades, while tiny, indicated growing concern about
the Caribbean island's ability to meet its obligations.
Moody's said it now rates the commonwealth's general
obligation bonds at Ba2, two notches below investment grade and
one step deeper into junk territory than Standard & Poor's,
which cut the Caribbean island's rating to junk on Tuesday.
With some $70 billion of tax-free debt - nearly four times
the $18 billion owed by bankrupt Detroit - Puerto Rico has long
been mired in recession and has for months been under threat of
a ratings downgrade by all three U.S. credit ratings agencies.
Moody's praised the government's recent attempts to cut
spending, reform its pension system and boost growth, but said
they are not enough.
"While some economic indicators point to a preliminary
stabilization, we do not see evidence of economic growth
sufficient to reverse the commonwealth's negative financial
trends," Moody's said.
In the municipal bond market, investors said they were not
surprised by the downgrade. But a spike in the yields in a few
odd-lot trades indicated that some bondholders were demanding
greater compensation due to a perception of increased risk.
"You knew it had to happen. We were waiting for this shoe to
drop," said Marilyn Cohen, president of Envision Capital
Management in Los Angeles. "Now we have to see what mutual funds
are not going to be able to hold these bonds now that more than
one rating agency has downgraded them."
The yield on a Puerto Rico tax-exempt public improvement
refunding general obligation bond maturing on July 1 topped
28.75 percent, compared with 5.48 percent on its most recent
previous trading day in late January.
A similar bond maturing this summer carried a yield of over
34 percent in one late trade on Friday, though even at that
rate, it was still priced at about 90 cents on the dollar.
Bonds coming due soon are at the "most risk of some kind of
potential disruption of payment or restructuring," said Daniel
Berger, a senior market strategist at Municipal Market Data, a
unit of Thomson Reuters
Fear of an imminent default, as measured by Puerto Rico's
one-year credit default swap, remained high.
As of Friday afternoon, it cost more than $22,000 to insure
$100,000 of Puerto Rico bonds against default for one year. That
was more than it cost to buy five- or 10-year insurance.
The top 10 U.S. mutual funds with the greatest exposure to
Puerto Rico have been hit with nearly $3 billion in net outflows
over the past year, according to Morningstar, amounting to about
a quarter of the funds' combined net assets.
The U.S. territory is not eligible to file for Chapter 9
municipal bankruptcy protection, and the White House has said it
is not considering a bailout.
HIGH STAKES DEBT SALE
The island of 3.62 million people is facing a steadily
declining population and has large unfunded pension liabilities,
which have raised doubt about its ability to sell more debt.
Emily Raimes, Moody's lead analyst on Puerto Rico, told
Reuters that the commonwealth's failure to sell bonds late last
year or so far this year had heightened concerns about its
The government plans to sell up to $2 billion in debt this
month, its first foray into the bond market since August.
"There will be people who simply can't participate," said
Barry HoAire, a portfolio manager at Bel Air Investment Advisors
in Los Angeles, adding that hedge funds that specialize in
distressed debt may still be willing to lend to the island.
Puerto Rico bonds are popular with U.S. investors because
they are tax-free in all 50 states.
The downgrade could also cost the commonwealth more than $1
billion in penalties and other costs tied to variable rate
demand obligations and other securities, Raimes said.
Puerto Rico Governor Alejandro García Padilla said earlier
this week he would seek to renegotiate swaps agreements and
other loans that will require accelerated payments.
In a joint statement, Treasury Secretary Melba Acosta Febo
and the chairman of the Government Development Bank for Puerto
Rico, David Chafey, said they "strongly disagree" with Moody's
decision and were "confident" about meeting obligations until
the end of the fiscal year.
Padilla also criticized the action, citing the recent
passage of sweeping pension reforms and other measures that
Moody's called for last year.
"It's evident that Moody's Investors Service has abandoned
its fundamental role of providing an analysis without prejudice
to its clients and has become locked in a game of appearances
with its competitors," he said.
Moody's also cut the island's sales-tax supported bonds to
the lower investment-grade level of Baa1 from A2.
These securities, issued by COFINA, the Spanish acronym for
Puerto Rico's Sales Tax Financing Corp, are viewed as more
secure as they are backed by more reliable income streams.
A 2041 maturity COFINA bond with a 5.25 percent coupon from
COFINA fell to 65.7 cents on the dollar from as much as 69.4
cents before the ratings cut.
S&P did not cut its rating on COFINA, which is expected to
be a primary vehicle for any subsequent bond market sales.
The COFINA bonds have "held up better than most," Envision
Capital's Cohen said. "But investors are worried....It's not
like sales taxes are booming in an economy on its tush."