Moody’s Downgrades Puerto Rico Bonds to Junk; US Investor Funds Sell Off Puerto Rico Debt to Meet Investor Redemption Demands

Following close on the heels of a downgrade by Standard & Poor’s, Moody’s Investors Services became the second rating agency in a week to cut Puerto Rico’s general obligation debt rating to junk status due to concerns about Puerto Rico’s weak economy and debt. Moody’s now rates Puerto Rico’s general obligation bonds at Ba2, two notches below investment grade and one step lower than Standard & Poor’s.

A recently issued UBS analyst report predicts that the probability of a downgrade of Puerto Rico’s general obligation and related bond ratings by all three rating agencies into the non-investment-grade category by the end of the June 30 fiscal year is “very high,” according to Bloomberg. UBS Puerto Rico was the primary underwriter of 23 closed-end funds with a total market capitalization of more than $5 billion. UBS dominated the island’s tax free bond market, and sold more than $10 billion of the funds through the end of 2012.

“While some economic indicators point to a preliminary stabilisation, we do not see evidence of economic growth sufficient to reverse the commonwealth’s negative financial trends,” Moody’s said, reported Financial Times.

Puerto Rico has $70 billion of tax-free debt, nearly four times the $18 billion owed by Detroit, reported Financial Times. Because Puerto Rico is an unincorporated territory, not a municipality, it is ineligible for Chapter 9 bankruptcy protection, like that sought by Detroit in July 2013.

Much of that $70 billion debt is held in US mutual funds, reported The Washington Post. Puerto Rico bonds are tax-free at the federal, state and local levels, thus attracting a broad spectrum of investors. The downgrades could limit demand for Puerto Rico debt, because some money managers are unable to buy securities rated below investment grade. U.S. mutual funds with significant exposure to Puerto Rico Bonds have sold off some of the debt to meet investor redemption demands, including OppenheimerFunds, according to CNBC.

Puerto Rico bonds have been paying increasing yields as the island’s debt increases. In fact, investors have been valuing Puerto Rico bonds at junk levels since July 2013 due to concerns that the island would be unable to meet its obligations on time and in full, according to Bloomberg.

“The problems that confront the commonwealth are many years in the making, and include years of deficit financing, pension underfunding, and budgetary imbalance, along with seven years of economic recession,” Moody’s said, reported CNBC.

Puerto Rico Governor Alejandro García Padilla criticized Moody’s action. “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,” Governor Padilla said, according to Financial Times.

Puerto Rico’s tax free bonds declined sharply in Fall 2013 due to concerns about the island’s sluggish economy and large debt, which led several US money managers to sell off the bonds at a loss in September. The downturn has been exacerbated by investors who purchased Puerto Rico tax free bond using margin or other loans, which forced investors to sell their holdings and lock in losses. UBS and Wells Fargo cautioned their brokers not to recommend Puerto Rico debt to clients, according to The New York Times.

If you invested in Puerto Rico debt and have experienced investment losses, please call us at 844-689-5754 or complete our“contact form.” Sonn Law Group is a nationally recognized law firm representing individuals, trusts, corporations and institutions in claims against brokerage firms, banks and insurance companies.