Approximately $38 billion of debt affected; outlook is negative
New York, December 13, 2012 -- Moody's Investors Service has downgraded the general obligation rating
of the Commonwealth of Puerto Rico to Baa3 from Baa1. The downgrade
also applies to those ratings that are based on or capped at the G.O.
rating of the commonwealth (see list later in the report). The
outlook is negative.
SUMMARY RATING RATIONALE
The downgrade to Baa3 and the assignment of a negative outlook reflect
four primary rating drivers:
- Economic growth prospects remain weak after six years of recession
and could be further dampened by the commonwealth's efforts to control
spending and reform its retirement system, both of which are needed
to stabilize the commonwealth's financial results. The lack
of significant economic growth drivers and the commonwealth's declining
population have also reduced prospects for a strong economic recovery.
- Debt levels are very high and continue to grow.
- Financial performance has been weak, including lackluster
revenue growth and large structural budget gaps that have led to a persistent
reliance on deficit financings and serial debt restructurings to support
operations in recent years.
- Lack of meaningful pension reform and no clear timetable to do
so. Reform of the commonwealth's severely underfunded retirement
systems is needed to avoid asset depletion and future budget pressure.
CREDIT STRENGTHS
• Politically and economically linked to the US, with benefit
of the nation's strong financial, legal, and regulatory systems
• Large economy, with gross product exceeding that of 15 states
and population exceeding that of 22 states
• Broad legal powers to raise revenues, adjust spending programs,
and employ borrowing in order to maintain fiscal solvency
• Constitutional first priority lien on revenues of the commonwealth
for general obligation and commonwealth-guaranteed debt
CREDIT CHALLENGES
• Very large unfunded pension liability relative to revenues that
we expect will claim an increasing share of the budget over the medium
term
• Very high and growing government debt relative to the size of the
economy, due in part to financing budget deficits
• High unemployment, low workforce participation, and
high poverty levels compared to the US; average income levels remain
well below 50% relative to the US mainland median
• Declining population
• Large size of commonwealth government relative to the economy (although
recent government actions are reducing the size of the government employment
sector)
• Multi-year trend of large General Fund operating deficits,
financed by deficit borrowing
• Local economy that has been in recession since 2006
DETAILED CREDIT DISCUSSION
ECONOMY STILL VERY WEAK WITH NO CLEAR GROWTH DRIVERS
Until the mid-2000s, Puerto Rico's economic growth direction
tended to mirror that of the US. In 2006, however,
Puerto Rico entered recession when the rest of the US was still in full
expansion mode. Since then, the commonwealth has remained
in recession. Some economic indicators, such as retail,
auto and cement sales and the Government Development Bank for Puerto Rico's
Economic Activity Index, have stabilized or are now trending up
for the first time since 2006, but they are improving off a very
low base, and reflect what is still essentially a weak economy that
is not likely to be able to absorb much additional stress. Moreover,
the commonwealth's economy lacks clear growth drivers as its manufacturing
sector continues to see employment reductions. Population declined
by 3% from 2005 to 2011 and slight declines are expected in the
near term. Unemployment has ticked up slightly to 13.8%
after reaching a low of 13.5% versus the US average of 7.8%
at the end of the first quarter of fiscal 2013. Tourism has been
a relatively good performer, but it remains relatively small and
is susceptible to weakness in the larger US economy.
Puerto Rico's weak retirement system funding could also challenge
the commonwealth's finances and economy, as any new money put into
the system would likely come from the government (weakening finances)
or employees (weakening the economy). As the economy and financial
situation are both fragile, this additional challenge will likely
be difficult for the commonwealth to manage. There are approximately
330,000 active and retired members of the commonwealth's two
main pension plans, or 9% of the population.
DEBT LEVELS ARE HIGH AND CONTINUE TO RISE
As reported in our 2012 State Debt Medians Report (published in May 2012),
debt ratios for the commonwealth are very high, with net tax-supported
debt at over $14,000 per capita and approximately 89%
of personal income, significantly higher than any US state and also
reflective of the relatively low per capita incomes in the commonwealth.
Net tax-supported debt as of December 31, 2011 was $51.9
billion reflecting significant new issuance by the commonwealth and Government
Development Bank over the past year. Debt measures are also relatively
high for similarly rated sovereigns and regional governments outside the
US.
REVENUE GROWTH IN FISCAL 2012 DUE TO TEMPORARY EXCISE TAX
The commonwealth's general fund net revenues increased 6.1%,
or $502 million, in fiscal 2012, in line with the commonwealth's
revenue estimates for the year. The increase was mainly due to
a temporary, multi-year excise tax imposed on certain foreign
persons which yielded approximately $1.2 billion in revenue
for the year. Collections from the excise tax, however,
were offset by declines in other sources of revenue, including income
taxes on individuals and corporations, withholding taxes on non-residents,
and property taxes in part due to tax relief provided to individuals and
corporations as part of the commonwealth's tax reform program.
General fund net revenues through October of fiscal year 2013, however,
are down 3.3% or $76 million as compared with the
same period last year and about 3.7% below estimates largely
due to declines in corporate excise taxes, off-shore shipments
of rum and corporate income taxes.
CONTINUED WIDE BUDGET GAPS, RELIANCE ON DEBT RESTRUCTURING AND DEFICIT
FINANCING
The commonwealth's deficit for fiscal year 2012 was approximately
$1.6 billion, or 17% of general fund revenue,
including principal and interest payments on commonwealth general obligation
and other debt that was paid with bond proceeds. This is a considerable
improvement from 2010 when the commonwealth faced a deficit of $3.1
billion including debt restructurings, or 40% of fiscal 2010
general fund revenues. The commonwealth was able to do this through
spending control (reducing spending largely through large government layoffs)
and conservative revenue forecasting. Total payroll expenses have
been reduced by $907 million, or 16%, since
2009.
The budget for fiscal year 2013 is $9.08 billion,
down 2% from the fiscal year 2012 budget and down 11% as
compared with the fiscal year 2010 budget, mostly due to continuing
declines in payroll spending. General fund revenues are projected
to be $8.75 billion, or 0.9% over fiscal
2012, with the shortfall being made up with bond proceeds issued
by the Puerto Rico Sales Tax Financing Corporation (COFINA) and other
sources. Net revenues for fiscal 2012 were $8.66
billion, just slightly above projections of $8.65
billion. The budget gap however, does not include expenditures
for approximately $745 million of debt service payments which are
expected to be refinanced during fiscal 2013. In addition,
the commonwealth recently cut its forecast for economic growth for fiscal
2013 from 1.1% to 0.6% indicating that the
projected deficit for the fiscal year ending June 30th will grow.
LACK OF PROGRESS ON PENSION REFORM TO AVOID ASSET DEPLETION
In 2011, the commonwealth completed a modest first phase of pension
reform (adopting an ascending schedule of future employer contributions
and limiting the size of personal loans available to members), but
did not undertake further meaningful additional reforms. The timetable
for additional reforms remains unclear.
The commonwealth's pension plans that comprise its retirement systems
are far weaker financially when compared to the pension plans of the 50
US states. As of June 30, 2011, the date of the latest
actuarial valuations of the retirement systems, the unfunded actuarial
accrued liability (including basic and system administered benefits) for
the Employees Retirement System (ERS), the Teachers Retirement System
(TRS) and the Judiciary Retirement System was $23.7 billion,
$9.1 billion and $319 million, respectively.
The pension systems' combined unfunded liability of $33 billion
is almost four times the annual budget ($9 billion), a burden
that will exert significant budgetary pressure for many years to come.
Estimated benefit payments from both ERS and TRS exceed incoming employee
and employer contributions by wide margins -- approximately $938
million between the two plans in fiscal 2012- resulting in a projected
rapid depletion of system assets. A $3 billion issue of
pension bonds in 2008 has helped extend the asset life, though these
funds are included in the current depletion forecast.
In addition to low asset levels, ERS commingles the assets of both
its defined benefit and defined contribution members, meaning future
DC payouts must eventually be paid by ERS. No corresponding liabilities
for these eventual payouts have been disclosed.
Without meaningful additional reforms, the commonwealth will be
forced to add direct retirement benefit payments to the budget within
several years. Moody's estimates that in fiscal 2012,
benefit payments for the major systems plus incremental benefits granted
by special laws (currently paid directly from the general fund) plus debt
service on the existing pension bonds, less employee contributions,
together equal nearly 22% of the $8.7 billion in
fiscal 2012 general fund revenues. This is substantially more than
the approximately 9% of general fund revenues currently paid in
employee contributions and indicative of the size of the budgetary burden
of a future "pay-as-you-go" pension structure.
Since the ERS defined benefit plan was closed in 2000, the benefit
amounts will grow relatively slowly over the next few years, reach
a peak benefit level around 2038 and then start to decline. Future
costs for TRS and the System 2000 defined contribution payouts,
however, are unknown.
ACTION AFFECTS MULTIPLE CREDITS
The downgrade and negative outlook affects general obligation bonds of
the commonwealth, and also affects bonds whose ratings are determined
by or linked to that of the commonwealth. Affected credits are
listed below.
DOWNGRADED TO Baa3 FROM Baa1
--General obligation bonds
--Pension funding bonds
--Puerto Rico Infrastructure Finance Authority (PRIFA) Special
Tax Revenue Bonds
--Convention Center District Authority Hotel Occupancy Tax
Revenue Bonds
--Government Development Bank (GDB) Senior Notes
--Municipal Finance Authority (MFA) Bonds
--Puerto Rico Highway and Transportation Authority (PRHTA)
Transportation Revenue Bonds
--Puerto Rico Aqueduct and Sewer Authority (PRASA) Commonwealth
Guaranteed Bonds
DOWNGRADED TO Baa2 FROM A3
--Puerto Rico Highway and Transportation Authority (PRHTA)
Highway Revenue Bonds
DOWNGRADED TO Ba1 FROM Baa2
--Puerto Rico Public Finance Corporation (PRPFC) Commonwealth
Appropriation Bonds
--Puerto Rico Aqueduct and Sewer Authority (PRASA) Revenue
Bonds
--Puerto Rico Highway and Transportation Authority (PRHTA)
Subordinate Transportation Revenue Bonds
Outlook
The rating outlook is negative, reflecting the stress the commonwealth
will face in the next few years as it continues to attempt to address
the underfunding of the retirement system from an already weak financial
and economic position. While the economy has shown some preliminary
signs of stabilizing, the lack of apparent growth drivers,
the commonwealth's rising debt levels and continued reliance on
deficit financing to fund budget gaps continue to pressure the rating.
WHAT COULD MAKE THE RATING GO UP
--Significant improvement in the condition of the commonwealth's
pension system.
--Strong rebound in economic growth leading to improved
and sustained revenue results.
--Spending controls and/or revenue increases that lead to
long-term improved budgetary results and outlook.
--Reversal of General Fund's deficit position.
WHAT COULD MAKE THE RATING GO DOWN
--Lack of liquidity
--Lack of market access
--Indication that total fixed costs, including pension
contributions and debt service on bonded debt, have become unsustainable
or unaffordable.
--Steep growth in structural budget gap and an increase
in GAAP deficits, solved with non-recurring solutions.
--Further recession, resulting in declining revenues,
deficit financing and continued out-migration
--Inability to curtail increase in debt experienced in recent
years.
PRINCIPAL METHODOLOGY
The principal methodology used in rating the Commonwealth of Puerto Rico
was the State Rating Methodology published in November 2004.
The principal methodologies used in rating the Government Development
Bank for Puerto Rico were the Credit Substitution Methodology published
in August 2009 and the State Rating Methodology published in November
2004.
The principal methodology used in rating the Puerto Rico Public Finance
Corporation appropriation debt was the the Fundamentals of Credit Analysis
for Lease Backed Municipal Obligations published in 2011.
The principal methodologies used in rating the Puerto Rico Highway and
Transportation Authority were the Special Tax Methodology published in
March 2012 and the State Rating Methodology published in November 2004.
The principal methodologies used in rating the Puerto Rico Infrastructure
Finance Authority Special Tax Revenue bonds were the Special Tax Methodology
published in March 2012 and the State Rating Methodology published in
November 2004.
The principal methodologies used in rating the Puerto Rico Municipal Finance
Authority were the State Rating Methodology published in November 2004
and a methodology based on evaluating factors we believe are relevant
to the credit profile of the issuer, such as i) the business risk
and competitive position of the issuer versus others within its industry
or sector, ii) the capital structure and financial risk of the issuer,
iii) the projected performance of the issuer over the near to intermediate
term, iv) the issuer's history of achieving consistent operating
performance and meeting budget or financial plan goals, v) the debt
service coverage provided by such revenue stream, vii) the legal
structure that documents the revenue stream and the source of payment,
and viii) the issuer's management and governance structure related to
the payment. These attributes were compared against other issuers
both within and outside of the issuer's core peer group.
The ratings are believed to be comparable to ratings assigned to other
issuers of similar credit risk.
The principal methodology used in rating the Puerto Rico Employees Retirement
System bonds was the State Rating Methodology published in November 2004.
The principal methodologies used in rating the Puerto Rico Convention
Center Authority Hotel Occupancy Tax Revenue Bonds were the Special Tax
Methodology published in March 2012 and the State Rating Methodology published
in November 2004.
The principal methodologies used in rating the Puerto Rico Aqueduct and
Sewer Authority were the Analytical Framework for Water and Sewer System
Ratings published in August, 1999 and the State Rating Methodology
published November 2004.
Please see the Credit Policy page on www.moodys.com for
a copy of these methodologies.
REGULATORY DISCLOSURES
For ratings issued on a program, series or category/class of debt,
this announcement provides certain regulatory disclosures in relation
to each rating of a subsequently issued bond or note of the same series
or category/class of debt or pursuant to a program for which the ratings
are derived exclusively from existing ratings in accordance with Moody's
rating practices. For ratings issued on a support provider,
this announcement provides certain regulatory disclosures in relation
to the rating action on the support provider and in relation to each particular
rating action for securities that derive their credit ratings from the
support provider's credit rating. For provisional ratings,
this announcement provides certain regulatory disclosures in relation
to the provisional rating assigned, and in relation to a definitive
rating that may be assigned subsequent to the final issuance of the debt,
in each case where the transaction structure and terms have not changed
prior to the assignment of the definitive rating in a manner that would
have affected the rating. For further information please see the
ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
Please see the credit ratings tab on the issuer/entity page on www.moodys.com
for additional regulatory disclosures for each credit rating.
Please see the ratings disclosure page on www.moodys.com
for general disclosure on potential conflicts of interests.
Please see the ratings disclosure page on www.moodys.com
for information on (A) MCO's major shareholders (above 5%) and
for (B) further information regarding certain affiliations that may exist
between directors of MCO and rated entities as well as (C) the names of
entities that hold ratings from MIS that have also publicly reported to
the SEC an ownership interest in MCO of more than 5%. A
member of the board of directors of this rated entity may also be a member
of the board of directors of a shareholder of Moody's Corporation;
however, Moody's has not independently verified this matter.
Please see Moody's Rating Symbols and Definitions on the Rating Process
page on www.moodys.com for further information on the meaning
of each rating category and the definition of default and recovery.
Please see ratings tab on the issuer/entity page on www.moodys.com
for the last rating action and the rating history.
The date on which some ratings were first released goes back to a time
before Moody's ratings were fully digitized and accurate data may not
be available. Consequently, Moody's provides a date that
it believes is the most reliable and accurate based on the information
that is available to it. Please see the ratings disclosure page
on our website www.moodys.com for further information.
Please see www.moodys.com for any updates on changes to
the lead rating analyst and to the Moody's legal entity that has issued
the rating.
Lisa Heller
Vice President - Senior Analyst
Public Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653
Emily Raimes
VP - Senior Credit Officer
Public Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653
Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653
Moody's downgrades Puerto Rico general obligation and related bonds to Baa3 from Baa1 and certain notched bonds to Ba1
