Standard & Poor’s Downgrades Puerto Rico Bonds to Junk; UBS Report Anticipates Other Downgrades to Follow

Standard & Poor’s downgraded Puerto Rico’s general obligation bonds one level from the lowest investment-grade status of triple-B-minus to double-B-plus on February 4, 2014. The downgrade to junk levels will make it more expensive for Puerto Rico to raise much-needed funds. S&P stated that Puerto Rico’s ratings could be lowered again in the next “couple of months” if the island is unable to raise funds or “otherwise improve cash flows,” according to The Wall Street Journal.

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.

Puerto Rico bonds are tax-free at the federal, state and local levels, thus attracting a broad spectrum of investors. Morningstar research shows that almost 70% of U.S. munipal bond funds hold Puerto Rico securities, reported The Washington Post. A downgrade to junk could limit demand for Puerto Rico debt, because some money managers are unable to buy securities rated below investment grade.

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.

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. The island’s leaders have undertaken significant austerity measures, including raising taxes and cutting pensions, but default remains a looming concern as indicated by the S&P downgrade.

“While we are disappointed with Standard & Poor’s decision, we remain committed to the implementation of our fiscal and economic development plans. We believe the investment community will recognize the positive impact of the reforms that the [Gov. Alejandro Javier] Garcia Padilla Administration has enacted in due course,” Treasury Secretary Melba Acosta Febo and David H. Chafey, president of the island’s Government Development Bank, said in a written statement reported by The Washington Post.

If Puerto Rico were to stop paying on its debt, it would impact the entire municipal bond market. For example, although the S&P downgrade was expected, once announced, the $835 million Market Vectors High-Yield Municipal Index ETF, which holds some Puerto Rico debt, dropped 1.2% on the day, according to The Wall Street Journal. Puerto Rico must come to market in the near future to borrow money to fill accumulated budget deficits, thus revealing more of how the downgrade impacts the market.

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.