| DOWNGRADE STANDARD & POOR’S FEBRUARY 4, 2014 | DOWNGRADE FEBRUARY 7, 2014 MOODY’S | DOWNGRADE FITCH, FEBRUARY 11, 2014; KEY RATINGS DRIVERS |
| ECONOMIC PROFILERecent economic news is mixed. The U.S. Bureau of Labor Statistics released preliminary data showing December 2013 total employment was down slightly, nonfarm wage and salary employment was up slightly, and the preliminary December unemployment rate had risen to 15.4%. The GDB economic activity index was up for three consecutive months through November 2013, although down year over year. On a yearly basis, the Commonwealth has suffered economic contraction for every year except one since 2006. Income levels are well below U.S. state averages, although good compared to some Caribbean island nations. | CREDIT CHALLENGES | REDUCED FINANCIAL FLEXIBILITY PROMPTS DOWNGRADE: Fitch placed the GO and related ratings on Negative Watch in November 2013, citing the challenge facing the commonwealth in maintaining financial flexibility in light of the deterioration in capital markets access. Recent downgrades have triggered new liquidity requirements and lowered expectations for the market available for the commonwealth’s debt going forward, though there have been no significant negative developments regarding the commonwealth’s finances or economy since November. In the context of other credit challenges related to a weak economy and elevated liability levels, Fitch believes that these additional hurdles preclude the commonwealth maintaining an investment-grade credit profile. |
| Puerto Rico recently enacted various reforms to the Teachers Retirement System similar to the ERS reforms. This sparked a two-day teacher strike and a court stay of implementation while union litigationis resolved. Puerto Rico expects the Teachers Retirement System litigation to be resolved by the end of February, well before implementation of the important part of the legislation on July 1, which would be positive from a credit standpoint. The ERS reform significantly reduced future benefit disbursements, but requires a $140 million higher general fund contribution in fiscal 2014 and afterward to forestall much higher contributions that were projected by 2020 when the pension system would otherwise have exhausted its cash and reverted to a pay-as-you-go system. All active employees are now in a defined contribution retirement system.
Combined, the employees, teachers, and judicial pension systems had what we consider a large unfunded actuarial liability of $37.0 billion, and a combined funded ratio of 8.4% at their June 30, 2012, actuarial valuation date. The ERS alone had a 4.5% funded ratio. The unfunded pension liability amounts to about $10,240 per capita. The Commonwealth’s unfunded other postemployment liability is not as large, but also significant in our opinion at $2.9 billion, or about $809 per capita. |
Very large unfunded pension liabilities relative to revenues, even after major reforms to two main plans that helped reduce cash-flow pressure | DEBT AND RETIREE BENEFIT LIABILITIES HIGH: Puerto Rico’s bonded debt levels and unfunded pension liabilities are very high relative to U.S. states, with a large amount of outstanding debt issued for deficit financing purposes. This has created spending pressures and limited the commonwealth’s ability to use additional leveraging. Pension funding will remain exceptionally low even with the significant pension reform effort undertaken by the current administration. |
| Very high government debt, equal to more than 50% of gross domestic product | ECONOMIC PERFORMANCE THE KEY FACTOR: The commonwealth’s economy has been in recession since 2006. Initial signs of recovery in 2012 appear to have been more a reflection of economic stimulus than underlying growth and subsequent economic performance has been weak. Although some recent information suggests nascent improvement, results are mixed and it is too soon to tell whether the economy will stabilize this year. Fitch believes that the ultimate success of efforts to put the commonwealth’s finances on a sustainable path will be dictated by the performance of the economy. | |
| Deficit financing has been the primary reason for the recent increase in Puerto Rico’s tax-supported debt levels in our view. We calculate that since 2009, the Commonwealth’s tax-supported debt has risen by $12.7 billion, or 49.2% at fiscal end 2013. Our calculation of tax-supported debt includes $10.6 billion of GO debt, $4.0 billion of appropriation and tax-supported debt, $2.9 billion of pension bonds, $15.2 billion COFINA sales tax debt, and $5.6 billion of guaranteed debt, totaling $38.4 billion of total tax-supported debt at June 30, 2013. The majority of this increase ($8.9 billion) is attributable to debt issued by COFINA, whose corporate purpose was to fund the identified accumulated deficits through fiscal 2012, but whose authority to issue debt has just been expanded for fiscal 2014.Our calculation of the Commonwealth’s current tax-supported debt level of approximately $38.4 billion at fiscal year end June 30, 2013, or $10,635 per capita and 38% of GDP, are significantly higher than the median for the states of $1,036 per capita and 2.3% of gross state product. Total public sector debt is much larger, and includes $25.6 billion of revenue debt issued by the Commonwealth’s public corporations and agencies (some of which previously received support from the general fund). This debt calculation does not include the potential for additional tax-backed debt expected to be sold shortly, or the pending expansion of a Commonwealth GO guarantee to GDB debt to $2.0 billion from $500 million. | Ongoing economic weakness due to long-term decline in dominant manufacturing sector, decreased competitiveness as a result of expired federal tax benefits, and high energy costs | |
| Dependence on capital markets financing to fund operating expenses and debt service during period of increased risk of reduced market access | ||
| Multi-year trend of large general fund operating deficits relative to revenues, financed by deficit borrowing | ||
| WHAT COULD MAKE THE RATING GO UP | ||
| Strong rebound in economic growth leading to improved and sustained financial performance | EVIDENCE OF ECONOMIC STABILIZATION: Maintenance of the current rating will require stabilization in economic performance and emergence from the long recessionary period. | |
| A trend of declining debt | ACHIEVABILITY OF BUDGET TARGETS: Failure to show continued progress toward structural balance would pressure the rating | |
| WHAT COULD MAKE THE RATING GO DOWN | ||
| Evidence of further constraints on market access or significant further weakening of GDB liquidity | ||
| The ratings remain on CreditWatch with negative implications. The current pressures on funding access heighten our concern about the Commonwealth’s overall liquidity profile and the timing and magnitude of potential contingent liquidity requirements that may develop. Our ratings reflect an expectation that either the Commonwealth or GDB will access the market in the near future, while the CreditWatch reflects the risk Puerto Rico may not be able to access the market in a manner to maintain sufficient liquidity on a timely basis. We would view a debt placement by either GDB or the Commonwealth sufficient to cover potential near-term liquidity and contingent risks, currently estimated around $1 billion or more, as an important credit stabilizing factor—the Commonwealth is currently contemplating a sizeable bond sale in the near future. The ratings could be further lowered if there is an inability to raise funding in the next few months or to otherwise improve cash flows. We expect to resolve or address the CreditWatch within the next couple of months. | MARKET ACCESS IMPAIRED: The commonwealth’s capital markets access deteriorated steeply in 2013 despite the action taken to address longstanding credit challenges. Reliable external market access in line with market norms is important to long-term stability.MARKET ACCESS: The current rating assumes that the commonwealth will be able to execute a sizable transaction in the near term to bolster liquidity. An inability to access the market would be a significant credit concern and cause for a downgrade. | |
| Indication that total fixed costs, including pension contributions and debt service on bonded debt, have become unaffordable | ||
| Steep growth in structural budget gap and an increase in GAAP deficits, solved with non-recurring solutions | ||
| Economic weakness resulting in declining revenues and continued out-migration | ||
| Reacceleration of growth in government debt |
Como verán, las acreditadoras no clasifican sus razones para la degradación de la misma manera pero hay temas recurrentes; los retiros sin fondos suficientes, préstamos, acceso al Mercado, gobierno ineficiente y en negación que necesitan despedir empleados, entre otras. Estamos bien mal y no va a mejorar mientras el equipo económico del gobernador siga con su mensaje de reelección.
muddlaw 