Puerto Rico’s General Obligation Rating is Downgraded to CCC+

Standard & Poor’s (“S&P”) has just downgraded the general obligation rating of Puerto Rico from a rating of B to a rating of CCC +. The ratings agency said the downgrade was because the market access prospects for the U.S. territory have weakened even further and Puerto Rico’s ability to fulfill its financial commitments is becoming more and more linked to the economic and business conditions in the Commonwealth, which are not strong.

The credit rater is also putting the general obligation rating on CreditWatch negative, which means the rating could go even lower into junk bond status and closer to a default. S&P lowered its ratings on the first-lien and second-lien sales tax bonds of the Puerto Rico Sales Tax Financing Corp. from B to CCC + as well. The bonds of the Puerto Rico Employees Retirement System and the Puerto Rico Municipal Finance Agency also received downgrades with a negative outlook.

S&P says that unless the conditions in Puerto Rico get better, the territory won’t be able to sustain its financial commitments. The ratings agency said there was not currently a consensus on key aspects of the 2016 budget and that this could make fiscal pressure and liquidity worse. In a letter from Puerto Rico’s Government Development Bank to its governor, there were concerns about liquidity problems unless the government starts tax reform and enacts a budget. S&P stated that if the budget is delayed or flawed there might be an even further ratings downgrades.

Governor Alejandro Garcia Padilla had proposed a VAT initiative that would supposedly reduce tax rates for 800,000 small businesses and persons. The tax would be determined by consumption of certain necessities. Garcia had hoped to increase revenue and deal with Puerto Rico’s public debt with a 16% VAT that would compel manufactures to pay taxes on raw materials, which would be included in the price of a product when sold to retailers. Now, the governor is willing to consider a lower 14% rate that is currently up for debate at Puerto Rico’s House of Representatives.

If approved, this could lead to a rise in the sales tax from 7% to 10% . There would then be a 14% goods-and-services tax next year. Tax breaks would also be provided for lower income persons as early as July of net year. Such changes could generate $900 million in new revenue starting July. More importantly, these changes could allow for a $2.9 billion bond sale to help alleviate the territory’s debt.

Until the issue is resolved, Puerto Rico remains burdened with $73 billion of debt. Investors who sustained major losses from municipal bond funds linked to the island are still trying to recoup their losses. Many of these investors were persuaded by financial firms such as UBS (UBS), Banco Popular, and Banco Santander (SAN) to invest in Puerto Rico municipal bonds, even though they were high risk. When the bonds dropped significantly in value beginning in the Fall of 2013, investors suffered.

The U.S. treasury department has started to increase its involvement in Puerto Rico. High ranking officials have been traveling between the island and Washington DC to offer advice to Commonwealth officials to try assisting with bringing stability to the territory’s financial situation.

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Treasury Officials Increase Efforts With Finances of Puerto Rico, New York Times, April 13, 2015

Puerto Rico downgraded to CCC+ from B, with negative outlook, by S&P, CNBC, April 27, 2015

Puerto Rico proposes plan to go after commercial tax evaders, spiraling debt, Fox News, March 8, 2015

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