Moody’s Corporation (NYSE:MCO) Investors Service has put Puerto Rico’s general obligation rating, currently at Baaa3, on a review that may lead to a downgrade.  The ratings agency cited “weakening liquidity, increasing reliance on external short-term debt, and constrained market access, within the context of a weakened and now sluggish economy.”

Puerto Rico Muni

On course for junk?

The commonwealth has already been facing severe financial difficulties because of budget deficits and a crushing debt burden.

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Puerto Rico’s rating of Baaa3 is the lowest investment grade rating, and a downgrade by Moody’s Corporation (NYSE:MCO) would take the island’s credit worthiness into junk rating status.

Puerto Rico’s bond market out of bounds

Because of its financial difficulties, yields on Puerto Rico’s bonds have shot up making it uneconomical for it to access the bond market for financing. Turmoil in the muni bonds market earlier this year, and the Detroit bankruptcy made matters more difficult for Puerto Rico.

As a result, the Government Development Bank has postponed plans to raise debt of between $500 million and $1.2 billion. The commonwealth had in fact to take recourse to a $400M financing from Barclays PLC (NYSE:BCS) (LON:BARC) in the form of bond anticipation notes in the interim. This short-term loan has since been paid.

Plans for bonds in 2014

However, Treasury Secretary Melba Acosta says, “We have been preparing to go return to the bond market and we expect to do so early next year.” Puerto Rico needs to refinance debt of about $1.2B stemming from 2013 and $800M relating to the current year.

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“While Moody’s Corporation (NYSE:MCO) has placed our general obligation and related bonds on review, we are pleased that they have identified that economic indicators may point to the start of economic stabilization for the commonwealth,” Treasury Secretary Melba Acosta Febo and Government Development Bank Chairman David H. Chafey said in a joint statement, and referring to comments made by other analysts in the Ratings Report.

But Moody’s recent review may put a spanner in the works if it leads to a junk rating, pushing up the yields further.

Impact on bond insurers

MBIA Inc. (NYSE:MBI) and Assured Guaranty Ltd. (NYSE:AGO) are likely to incur capital charges of about $65M each in case S&P decides to downgrade Puerto Rico debt, according to an analysis by BTIG’s Mark Palmer.