A panel representing all the nation’s muni-bond rating agencies discussed how Puerto Rico’s bankruptcy and resulting court rulings have altered the way they view the municipal bond market throughout the United States.
Speaking at the Puerto Rico Bankruptcy Risk Summit in New York City, the ratings analysts contended that events arising from the territory’s debt crisis will continue to have wide-ranging negative implications for bond investors in other locales.
“For example, with regard to lessons learned, we know that profound economic dislocation is the root of the problems,” said William Cox, senior managing director in public finance at Kroll Bond Rating Agency. “Don’t lend money to people who can’t pay you back or whose ability to pay you back is very tenuous.”
The event led off with reaction to a hot-button topic roiling the muni-bond industry — a ruling last month from the Boston-based First Circuit Court of Appeals which determined that municipalities are not required to make payments on debt secured by special revenues while bankruptcy proceedings are ongoing, although municipalities can voluntarily opt to do so.
Ratings-agency analysts, lawyers and muni investors alike believe that the appellate court ruling — which upheld a federal district-court ruling — is just another example of an unfair shield for debtors and creates uncertainty about full and timely payment of special revenue obligations.
The concern is that, if the ruling stands, it could negatively impact ratings on certain bonds secured by utility, transportation and tax revenue. (The ruling is commonly referred to by those in muni-bond circles as the “HTA decision,” because Puerto Rico’s Highways and Transportation Authority was a party in the case.)
Frank Coughlin, a managing director with bond insurer Assured Guaranty, asked each of the four panelists — representing S&P Global Ratings, Moody’s, Fitch Ratings and Kroll Bond Rating Agency — how the ruling “may be incorporated into your rating analysis of special revenue bonds.”
The responses suggested that the agencies have differing approaches to the issue.
“The ruling does not bring sweeping changes,” said Robin Prunty, managing director and head of analytics and research with S&P Global Ratings. At the same time, she added that the “ruling is unfortunate for our market because many legal issues that have been grounded in many decades of municipal finance are up in the air now.”
S&P’s Prunty said that the ruling has led to ‘’lack of predictability’’ in a distress situation.
“When there is distress, we expect that issuers will be motivated to take all options to minimize their liabilities, including stopping payment on special revenue debt or a special tax obligation,” she added.
In their responses, it became clear that the raters haven’t drastically upended their criteria for rating revenue bonds since the latest court ruling — at least not yet.
Tim Blake, managing director of public finance with Moody’s, pointed out that the title of the panel was “Evaluating the Uncertainty,” and noted that “our rating methodology has always had a healthy respect for uncertainty.”
Kroll’s Cox called the appeals-court ruling an “affront to the municipal bond market,” adding that it “represents a broadside attack on a fundamental tenet of municipal finance — special revenues are special for a reason.’’
Cox added that he hoped that states would adopt new laws that would effectively overturn it. But he said that his agency would not “overreact with sweeping overhauls” to its criteria for rating special revenue bonds. Instead, he added, “we will roll up our sleeves and review all cases on a case-by-case basis.”
The panel was also asked about muni-bond securitizations — an alternative way for municipalities to access the debt markets with a structure that is independent of the general funds of a government. In Puerto Rico, the Puerto Rico Sales Tax Financing Corporation, known by its Spanish acronym, COFINA, issued bonds secured by a true sale from the Commonwealth of sales tax receipts.
Members of the panel were asked about their approach to applying ratings to such deals. Moody’s Blake, for example, said that his firm doesn’t have a special muni-bond securitization methodology. “If the revenue in question is a government tax, we use our special tax methodology” in evaluating the credit, he added.
Amy Laskey, managing director with Fitch Ratings, added that the approach established in Puerto Rico by COFINA isn’t that “relevant” to its analysis of these type of deals throughout the U.S. “Puerto Rico set up for itself a special structure that isn’t used on the mainland.”
The panelists also shared some of the lessons that they have learned from the Puerto Rico crisis — lessons that would have allowed them to perhaps react more quickly with downgrades. They all agreed that a lengthy economic recession, like the one Puerto Rico experienced in the years leading up to its bankruptcy, is a critical warning sign.
“The magnitude and duration of the recession certainly had long lasting implications,” said S&P’s Prunty.