Moody's Cuts Puerto Rico Rating to Junk on Default Worries
Following the Standard & Poor's junk rating on Puerto Rico on Feb 12, Moody's Corporation (MCO - Analyst Report) downgraded the rating on the island’s $48 billion debt issues. The company lowered Puerto Rico’s general obligation (GO) rating to Caa1 from B2 on Feb 19.
In addition, the credit rating agency downgraded Puerto Rico’s Sales Tax Financing Corp. (COFINA) to B3 from Ba3 and subordinate bonds to Caa1 from B3. Overall, Moody’s maintains a negative outlook on Puerto Rico's all governmental and public corporation debt with most of the security issues rated as junk. This signifies that the country is likely to bear significantly higher cost of debt to access capital markets.
Puerto Rico’s Rating Trend So Far
For a long time, credit rating agencies, including Moody's and S&P, have been maintaining a negative stance on Puerto Rico. Last year, in July, Moody's Investors Service downgraded the Commonwealth of Puerto Rico to B2 from Ba2 that hit the economy’s $14.4 billion outstanding GO bonds. This followed the S&P’s decision on Feb 4, 2014 to lower its credit rating on the country from BBB- to BB+ affecting its $70 billion tax-free debt.
Why the Negative Outlook?
One of the primary reasons behind the persistent downgrade of this cash-strapped economy is its capacity to meet the existing debt obligation and ability to access capital markets. The country has been recording negative gross domestic product (GDP) growth over the past nine years. Inefficient public corporations and increased spending significantly increased the country’s debt position, which is equivalent to approximately 70% of the annual product of this region.
Puerto Rico’s debt has long been a staple for the American municipal-bonds, and now the hedge funds have become interested in it given the high risk and large returns.
However, rating agencies are concerned about the country’s persistent economic weakness that has resulted in liquidity constraints. The economy has a long history of budget gaps — the primary reason behind the Standard & Poor's GO credit rating downgrade to BBB- in 2013. Further, the country is marred by double-digit unemployment rate, which stood at 13.7% as of Dec 2014.
Further, tax reforms, effective on or after Apr 1, 2015, are not likely to address the structural problems that the country is currently facing. The latest tax reform involves the substitution of the existing sales and use tax system (SUT) with value added tax (VAT) system (effective Dec 31, 2015) and focus on increasing capital gain and dividend tax rates. This is done in order to reduce the economy’s dependence on direct income tax collection while bringing more unrecorded economic activity under the tax radar.
However, credit rating agencies believe that the recent tax reform is unlikely to improve the current status of the country’s approximately $70 billion junk bonds. Personal and corporate taxes account for the majority of the Puerto Rico General fund revenues. But, the new tax rule is expected to eliminate corporate tax for Puerto Rico’s major economic entities, leading to the country’s revenue shortfall in the near term.
In addition, the country’s proposed Recovery Act failed to impress bond holders as was deemed to be in violation of the U.S. Constitution by allowing a state government to modify municipal debt. This resulted in the recent court ruling against the enactment of the Act, a plan for debt restructuring of some of the countries government agencies, which irked large debt holders. However, the Puerto Rican government is appealing against the ruling, leading to further uncertainty regarding lenders’ money.
Conclusion
Despite several market researchers considering Puerto Rico’s debt crisis a short-term concern, which is likely to be mitigated by remedial actions undertaken by its government, the outlook remains disappointing. Further, the tax reforms, though beneficial over the long haul, are not likely to aid the financial health of the economy in the short term.
Rating agencies point out that there is no hint of any possible revival in the current condition of the economy, thus indicating continued pressure on the country’s credit position. In the coming days, rating agencies apprehend more government corporations to default debt payment, aggravating the risk of default on central GO bonds.
However, risk seekers may watch out for the rising yield on Puerto Rico bonds in the coming days, which is only expected to move up from an already sky rocketing mark. According to reports, yields on 30-year GO debt have risen 36 basis points in a month to approximately 8.06%.
Moody’s currently has a Zacks Rank #3 (Hold). Other stocks in this sector include Blackhawk Network Holdings, Inc. (HAWKB), General Finance Corp. (GFN - Snapshot Report) and Ladder Capital Corp. (LADR - Snapshot Report). All the stocks sport a Zacks Rank #1 (Strong Buy).
Moody's Cuts Puerto Rico Rating to Junk on Default Worries
In addition, the credit rating agency downgraded Puerto Rico’s Sales Tax Financing Corp. (COFINA) to B3 from Ba3 and subordinate bonds to Caa1 from B3. Overall, Moody’s maintains a negative outlook on Puerto Rico's all governmental and public corporation debt with most of the security issues rated as junk. This signifies that the country is likely to bear significantly higher cost of debt to access capital markets.
Puerto Rico’s Rating Trend So Far
For a long time, credit rating agencies, including Moody's and S&P, have been maintaining a negative stance on Puerto Rico. Last year, in July, Moody's Investors Service downgraded the Commonwealth of Puerto Rico to B2 from Ba2 that hit the economy’s $14.4 billion outstanding GO bonds. This followed the S&P’s decision on Feb 4, 2014 to lower its credit rating on the country from BBB- to BB+ affecting its $70 billion tax-free debt.
Why the Negative Outlook?
One of the primary reasons behind the persistent downgrade of this cash-strapped economy is its capacity to meet the existing debt obligation and ability to access capital markets. The country has been recording negative gross domestic product (GDP) growth over the past nine years. Inefficient public corporations and increased spending significantly increased the country’s debt position, which is equivalent to approximately 70% of the annual product of this region.
Puerto Rico’s debt has long been a staple for the American municipal-bonds, and now the hedge funds have become interested in it given the high risk and large returns.
However, rating agencies are concerned about the country’s persistent economic weakness that has resulted in liquidity constraints. The economy has a long history of budget gaps — the primary reason behind the Standard & Poor's GO credit rating downgrade to BBB- in 2013. Further, the country is marred by double-digit unemployment rate, which stood at 13.7% as of Dec 2014.
Further, tax reforms, effective on or after Apr 1, 2015, are not likely to address the structural problems that the country is currently facing. The latest tax reform involves the substitution of the existing sales and use tax system (SUT) with value added tax (VAT) system (effective Dec 31, 2015) and focus on increasing capital gain and dividend tax rates. This is done in order to reduce the economy’s dependence on direct income tax collection while bringing more unrecorded economic activity under the tax radar.
However, credit rating agencies believe that the recent tax reform is unlikely to improve the current status of the country’s approximately $70 billion junk bonds. Personal and corporate taxes account for the majority of the Puerto Rico General fund revenues. But, the new tax rule is expected to eliminate corporate tax for Puerto Rico’s major economic entities, leading to the country’s revenue shortfall in the near term.
In addition, the country’s proposed Recovery Act failed to impress bond holders as was deemed to be in violation of the U.S. Constitution by allowing a state government to modify municipal debt. This resulted in the recent court ruling against the enactment of the Act, a plan for debt restructuring of some of the countries government agencies, which irked large debt holders. However, the Puerto Rican government is appealing against the ruling, leading to further uncertainty regarding lenders’ money.
Conclusion
Despite several market researchers considering Puerto Rico’s debt crisis a short-term concern, which is likely to be mitigated by remedial actions undertaken by its government, the outlook remains disappointing. Further, the tax reforms, though beneficial over the long haul, are not likely to aid the financial health of the economy in the short term.
Rating agencies point out that there is no hint of any possible revival in the current condition of the economy, thus indicating continued pressure on the country’s credit position. In the coming days, rating agencies apprehend more government corporations to default debt payment, aggravating the risk of default on central GO bonds.
However, risk seekers may watch out for the rising yield on Puerto Rico bonds in the coming days, which is only expected to move up from an already sky rocketing mark. According to reports, yields on 30-year GO debt have risen 36 basis points in a month to approximately 8.06%.
Moody’s currently has a Zacks Rank #3 (Hold). Other stocks in this sector include Blackhawk Network Holdings, Inc. (HAWKB), General Finance Corp. (GFN - Snapshot Report) and Ladder Capital Corp. (LADR - Snapshot Report). All the stocks sport a Zacks Rank #1 (Strong Buy).
Moody's Cuts Puerto Rico Rating to Junk on Default Worries
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