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Puerto Rico Downgrade Was Expected And Priced In

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Ratings agency Standard & Poor’s downgraded Puerto Rico’s debt to BB+ from BBB- citing liquidity concerns that could force the commonwealth to resort to heavy expenditure cuts or raise revenues sharply. The downgrade pushed Puerto Rico’s credit rating from investment grade to junk grade. Worse, S&P had its debt on a negative watch, signifying that further downgrades were possible.

Puerto Rico Downgrade

The downgrade could in fact exacerbate the island’s cash crunch, considering a lot of its debt is issued with a rider that triggers payments in cash should its rating degenerate below investment grade. Other ratings agencies could now take similar steps. However, the island authorities put on a brave face and announced they were talking to unidentified parties to ensure adequate cash was on hand.

“Standard and Poor’s Downgrade of Puerto Rico General Obligation Debt to BB+ from BBB- comes as little surprise given concerns surrounding the Commonwealth’s liquidity position and speculation surrounding the government’s access to the long-term capital markets,” said Sterne Agee analysts Todd L Hagerman and Robert Greene in their research note issued yesterday. “To be sure, much of the negative news has long been priced into the stocks with the ramifications of the downgrade considered more of a long-term negative vs. short-term.”

Mark Palmer of BTIG agrees with the analysts from Sterne. In a research report this morning Palmer asked:

“Did S&P’s downgrade increase the price of a potential deal? We’re not so sure, especially in light of the stability of yields on Puerto Rico’s outstanding debt following the announcement.

Did the downgrade change investors’ perceptions of the Commonwealth’s various issuing entities? Only if they hadn’t been paying attention to the situation.”

Hedge funds and PE firms may throw a $2B lifeline

Last month a media report said that Morgan Stanley was trying to cobble together a $2B funding package for Puerto Rico from hedge funds, alternative asset investors and PE players. However, this was likely to be at a very high cost – with yield as high as 10% – and still under discussions which were fluid.

The Sterne Agee analysts point out that the commonwealth’s municipal debt yields are already trading at 7-8%, and these developments indicate that the market had likely already priced in the deterioration in ratings.

Impact on Puerto Rico banks limited

“We would expect the tangible economic impact of the downgrade to be limited given the relatively small securities exposure held by the Puerto Rico banks, with the bulk of Government-tied exposure in the form of direct credit to the Government, Public Corporations and Municipalities vs. General Obligation debt,” says Sterne Agee.

Over the long term, however, the rating action by S&P could impact Puerto Rico’s fiscal reforms, worsen its liquidity situation and push interest rates higher.

Sterne Agee currently has a Buy rating on Puerto Rico banks Popular Inc (NASDAQ:BPOP), First Bancorp (NYSE:FBP) and OFG Bancorp (NYSE:OFG).

First Bancorp (FBP)

Sterne Agee made the following observations on the bank’s 4Q13 earnings:

  • FBP’s 4Q13 earnings results marked two consecutive quarters of positive GAAP earnings.
  • Credit quality improvement slowed in the quarter. On Puerto Rico exposure, Sterne Agee comment, “We view the total government-related exposure as manageable given the relative strength of the credits, including the underlying collateral (as 43% of FBP’s exposure is directly to the municipalities, which we view as stronger credits).”


  • Loan growth turns positive in the quarter.
  • With profitability emerging and capital levels improving, FBP continued to deliver on its strategic objectives. “We believe FBP is potentially positioned to exit its regulatory Orders within the next several quarters. Although financial market turmoil has likely pushed back any immediate plans for the U.S. Treasury to draw down its ownership stake from 9.5%, continued positive underlying earnings results provide a solid foothold for FBP’s valuation.”

Price performance

Sterne Agee has a price target of $9.00 on First Bancorp (NYSE:FBP).


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