Puerto Rico Faces $940 Million Bill as Debt Is Cut to Junk

S&P dropped the territory to BB+, the highest speculative grade, on Feb. 4 because of limited access to capital markets as officials struggle to revive a shrinking economy. Moody’s today lowered it to Ba2, one step below S&P’s score. The moves trigger accelerated payments on debt and calls for increased collateral on swaps. Almost half may need to be arranged within 30 days, said David Hitchcock, an S&P analyst.

While S&P said its new rating reflects the assessment that Puerto Rico can handle its immediate cash needs, the island may have to pay the full amount out of a $9.77 billion budget already in deficit if it can’t alter the terms of the swaps agreements or refinance the debt. Officials are trying to renegotiate the transactions and also sell the first bonds from the commonwealth since August, Governor Alejandro Garcia Padilla said on Feb. 5.

“If we don’t have access to the markets or if we can only borrow at very high yields, then we may have to make the payments,” said Sergio Marxuach, policy director at Center for a New Economy, a not-for-profit research group in San Juan that focuses on economic development. “We may not have the option of rolling over the debt,” he said in an interview from the island’s capital.

Borrowing Plan

Even before the downgrades, the island of 3.6 million residents planned to sell debt this month to balance budgets. S&P warned this week that Puerto Rico must raise funds in the next few months or risk further rating cuts. Yields on commonwealth securities have traded at speculative-grade levels since at least September, luring buyers such as hedge funds and investors in distressed debt.

Moody’s move affected $55 billion of debt. The firm also cut the island’s sales-tax bonds, known as Cofinas, two levels. Senior-lien Cofinas were lowered to Baa1, three steps above junk, and subordinate Cofinas were cut to Baa2.

Access Question

Puerto Rico’s “debt load and fixed costs are high, its liquidity is narrow, and its market access has become constrained,” Emily Raimes, a Moody’s analyst, wrote in a report released today.

The Caribbean island’s finances affect the $3.7 trillion municipal market because about 70 percent of U.S. mutual funds that focus on state and city debt hold the securities, which are tax-exempt nationwide.

The Government Development Bank, which handles the commonwealth’s debt transactions, declined to comment or to provide information on the $940 million, including payment dates and swaps counterparties, Alix Anfang, a bank spokeswoman, said in an e-mail.

After S&P’s cut, the governor directed agencies to lower spending by 2 percent as part of a plan to balance budgets. Garcia Padilla wants to shrink the deficit by $170 million, to $650 million, and end deficit borrowing in the fiscal year beginning July 1.

Contraction Call

Reducing spending will strain the island’s economy, which has shrunk by 14 percent since 2006, Marxuach said.

“There’s going to be more contraction,” he said.

The economy depends on the local government. It’s the largest employer on the island, with 256,067 local and federal public workers in fiscal 2013, more than double the level in the education and health industries, the next-biggest group, according to the GDB.

“Although they say that they intend to balance the budget, there’s a lot of implementation risks,” Hitchcock said. “It will be a very difficult thing to actually accomplish.”

Of the $940 million, $832 million applies to variable-rate debt, more than half of which Puerto Rico must pay within 30 days unless bondholders work with officials to change the terms or the territory refinances the securities, Hitchcock said.

Before the downgrades, officials were working on refinancing debt originally due in May and June, Hitchcock said.

Highway Agency

Puerto Rico must pay $39 million of swap collateral payments on contracts it backs with its general obligation, and $69 million on swaps the Highways & Transportation Authority entered into, according to S&P.

Hitchcock declined to say when the payments are due or which banks are swap counterparties because the transactions are private.

The commonwealth had $1.86 billion of general-obligation derivatives with 10 unidentified counterparties as of June 30, according to the GDB. That’s double the five counterparties —Goldman Sachs (GS) Capital Markets, Morgan Stanley (MS) Capital Services Inc., Bank of New York, Depfa Bank Plc and Merrill Lynch Capital Services Inc. — listed in the commonwealth’s annual financial report for the year ending June 30, 2012.

The highways agency had $637 million of derivatives, with Citibank N.A., Morgan Stanley Capital Services and UBS Financial Services as counterparties, as of June 30, 2012.

S&P expects Puerto Rico will be able to address its immediate cash needs, Hitchcock said.

Ratings Reflection

“If we didn’t think that they could cover something in the next 30 days, we’d be talking about a much lower rating,” he said.

Investors are watching to see if the commonwealth will be able to address the $940 million and how much of a strain it may cause, said Shawn O’Leary, senior research analyst in Chicago for Nuveen Asset Management, which oversees about $90 billion of munis. The GDB needs to give more information on how much cash the bank has, O’Leary and Marxuach said.

“It’s very difficult to be confident in Puerto Rico’s ability to meet these challenges when they’re less than clear as to the state of their liquidity,” O’Leary said.

Following Moody’s cut, GDB Chairman David Chafey and Treasury Secretary Melba Acosta said the commonwealth has enough funds through June 30, including cash needs resulting from the downgrades. The officials said they’re in talks to arrange financing.

“Discussions with parties that have expressed an interest in arranging additional liquidity for the commonwealth are ongoing, including new funding or extensions of existing agreements,” the officials said in an e-mailed statement.

Government Deposits

The GDB has a more than $2 billion investment pool of high-grade securities and could withdraw $2.9 billion of government deposits from local financial institutions, Chafey said in November at a Bloomberg Link conference in New York.

The bank plans to hold an investor webcast Feb. 12 to discuss its fiscal and borrowing plans.

Scott Helfman, a Citigroup spokesman; Michael DuVally of Goldman Sachs; Lauren Bellmare at Morgan Stanley; Gregg Rosenberg at UBS and Bill Halldin at Bank of America Corp. (BAC)declined to comment.

Mike Dunn and Susan Rivers at Bank of New York Mellon Corp.; and Walter Allwicher, a spokesman for Hypo Real Estate Holding AG, parent of Dublin-based Depfa, didn’t respond to e-mails requesting comment.


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