Puerto Rico default highlights liquidity strain and government priorities

New York, USA — According to Fitch Ratings agency, Puerto Rico’s decision to miss an August 1 debt service payment on appropriation-backed debt due on Monday is consistent with both the commonwealth’s stated intent to restructure its debt and its current liquidity pressures.

Fitch rates the commonwealth’s General Obligation (GO) and related debt ‘CC’; Rating Watch Negative, which indicates Fitch’s belief that default of some kind appears probable. The payment default on appropriation-backed debt has no direct effect on Fitch’s commonwealth ratings, but does highlight the factors that underpin the Negative Watch.

As the commonwealth’s restructuring plans become clearer, a downgrade to ‘C’ would be triggered on a security-specific basis at the point that default appears inevitable. The commonwealth has declared its debt unpayable in aggregate without distinction among its numerous securities.

Therefore, at this stage Fitch does not believe that there is sufficient information available to consider default of any of the specific credits that Fitch rates to be inevitable. Fitch’s public finance ratings do not address the loss given default of the rated liability.

Although Fitch does not rate appropriation-supported debt of the commonwealth, its rating methodology recognizes the weaker security provided to holders of appropriation debt and a higher risk of default on such debt relative to GO and dedicated tax-secured debt. Repayment of this debt is contingent on appropriation by the governing body, which is not a requirement for GO and dedicated tax debt.

From a legal perspective, the contrast is particularly stark in Puerto Rico, where GO debt has been promised a constitutional first-claim on revenues. Fitch notes that the commonwealth reportedly is making payment on other debt as due.