Standard & Poor cut Puerto Rico’s credit rating to junk status today, a move that had been anticipated by market watchers.

Puerto Rico Muni

S&P had placed Puerto Rico’s rating on downgrade notice last month and today it moved the rating to BB+ which is one level below investment grade.  Previously it was rated BBB-.

“The downgrades follow our evaluation of liquidity for the Commonwealth,” an S&P press release stated. Concerns are that political and government leaders will be placed in a difficult position of dramatically reducing spending or somehow raising revenue to fill the gap. As reported in ValueWalk two days ago, Puerto Rico Governor Alejandro Garcia Padilla announced the Commonwealth will introduce a balanced budget for the 2014-2015 fiscal year “in the coming weeks.”  Puerto Rico previously had a goal of balancing the budget by the 2016 fiscal year, but that timeline appears hastened now.

S&P not swayed by politician’s promises

“We believe Puerto Rico’s accelerated schedule for a balanced budget may be helpful both in terms of addressing the concerns of the rating agencies, which currently have the Commonwealth’s investment grade credit ratings under review for a possible downgrade to junk,” the governor said two days ago, comments that apparently did not sway S&P.

Puerto Rico’s Treasury Secretary and Government Development Bank tried to put an optimistic face on what they considered S&P’s disappointing decision.  “We are confident that we have the liquidity on hand to satisfy all liquidity needs until the end of the fiscal year, including any cash needs resulting from today’s decision,” a press statement said. “The GDB and the Commonwealth of Puerto Rico have been in discussions with parties that have expressed an interest in arranging additional liquidity for the Commonwealth, and the Commonwealth continues to explore such options, including obtaining additional funding, as necessary.”

Reports note the ratings downgrade raises concerns first expressed in a December 23 Moody’s Corporation(NYSE:MCO) report that Puerto Rico could face up to $1 billion in collateral demands from creditors, which could be triggered by a one notch downgrade.  Approximately 70 percent of U.S. municipal mutual funds hold Puerto Rico tax exempt securities, according to Morningstar. 

Compounding difficult problems

Downgrading its debt to junk may compound Puerto Rico’s already difficult problems, because many investment managers are prohibited from holding securities rated below investment grade.  With mainstream investment funds unable to purchase Puerto Rican debt, it may be forced to raise already high interest payments to attract lenders.

Puerto Rico general obligation debt maturing in July 2041 was generating a 8.51% return on January 30, 2014 according to a Bloomberg report.  This was 4.61 percent higher than the benchmark for municipal bonds of a similar maturation date.

In late January UBS Wealth Management had predicted today’s action.  “Given the myriad obstacles facing Puerto Rico, we believe that at least one rating agency will take such an action within the next 30 days,” said analysts Thomas McLoughlin and Kristin Stephens at UBS Wealth Management in New York wrote in the report.