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REUTERS ENGLISH NEWS SERVICE
MOODY'S IMPROVES COMMONWEALTH OF PUERTO RICO'S CREDIT OUTLOOK TO POSITIVE FROM STABLE
Assigns Baa1 rating to upcoming $475 million general obligation bond sale and affirms Baa1 rating on $4.8 billion of outstanding G.O. bonds
March 10, 2000
Copyright © 2000 REUTERS LIMITED. All Rights Reserved.
(Summary and Full Text of press release provided by Moody's Investors Service Inc.)
NEW YORK, March 10, 2000 -- Moody's assigns a Baa1 rating to the Commonwealth of Puerto Rico's general obligation bonds, and changes the rating outlook from stable to to positive. The Commonwealth plans to offer $475 million of bonds via negotiated sale in mid-March, with proceeds to be used to finance a variety of capital improvement projects.
The medium-grade general obligation rating reflects:
The island's established political and economic link with the US, which has been a foundation for economic expansion and consistent growth in real income over the last two decades;
Average resident income levels which nonetheless remain very low relative to the US mainland;
Balanced General Fund operations, offset by large healthcare-related deficits outside of the General Fund in recent years;
Low financial reserves available to cushion the budgetary impact of any unexpected economic slowdown; and
A debt load which remains manageable in terms of annual servicing burden relative to government revenue, but is very high relative to personal income.
The positive rating outlook reflects:
Successful efforts in recent years to reduce the size of government through greater efficiency and use of privatisation; Implementation of a number of important financial reforms, including closure of the loss-making health facilities authority (and incorporation of such entity's remaining expense base within the General Fund budget), a significant increase in tax enforcement and compliance, and launch of a major reform of the public employee retirement system's benefits and funding;
Significant benefits expected to result from last year's sale of a majority stake in the telephone company, which enabled creation of a $1.2 billion "permanent fund" to support water and sewer capital needs, and should also boost private-sector investment in the island's telecommunications infrastructure;
Moody's cautiously optimistic view that the economy is successfully adapting to the phase-out of Section 936 tax benefits available to US corporations operating in Puerto Rico. The ten-year phase-out is currently in its fifth year, and while some US-owned manufacturers have downsized or left the island in recent years, others have continued to invest in and expand their operations by using alternate organisational and tax structures for new business lines. Continuation of this trend is anticipated.
Future rating action, if any, will depend on progress in establishing consistent and fully-balanced government financial operations, improvement in fund balance reserves, evidence that the trend of government structural and financial reforms will continue and yield expected dividends, and further evidence that the economy is successfully adapting to the 936 phase-out. In this regard, the positive outlook is currently intended to cover a time horizon of up to two-to-three years.
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Following Is The Full Text Of Press Release Provided By Moody's Investors Service Inc.
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Puerto Rico GO Bonds Rated Baa1 By Moody's.
Moody's Improves Commonwealth of Puerto rico's Credit Outlook To Positive from Stable
Assigns Baa1 rating to upcoming $475 million general obligation bond sale and affirms Baa1 rating on $4.8 billion of outstanding G.O. bonds
Puerto Rico (Commonwealth of)
State
Puerto Rico
Moody's Rating
Issue Rating
Public Improvement Bonds of 2000 (General Obligation Bonds) Baa1
Sale Amount $475,000,000
Expected Sale Date 03/15/00
Rating Description General Obligation Bonds
NEW YORK, March 10, 2000 -- Moody's assigns a Baa1 rating to the Commonwealth of Puerto Rico's general obligation bonds, and changes the rating outlook from stable to to positive. The Commonwealth plans to offer $475 million of bonds via negotiated sale in mid-March, with proceeds to be used to finance a variety of capital improvement projects.
The medium-grade general obligation rating reflects:
The island's established political and economic link with the US, which has been a foundation for economic expansion and consistent growth in real income over the last two decades;
Average resident income levels which nonetheless remain very low relative to the US mainland;
Balanced General Fund operations, offset by large healthcare-related deficits outside of the General Fund in recent years;
Low financial reserves available to cushion the budgetary impact of any unexpected economic slowdown; and
A debt load which remains manageable in terms of annual servicing burden relative to government revenue, but is very high relative to personal income.
The positive rating outlook reflects:
Successful efforts in recent years to reduce the size of government through greater efficiency and use of privatisation;
Implementation of a number of important financial reforms, including closure of the loss-making health facilities authority (and incorporation of such entity's remaining expense base within the General Fund budget), a significant increase in tax enforcement and compliance, and launch of a major reform of the public employee retirement system's benefits and funding;
Significant benefits expected to result from last year's sale of a majority stake in the telephone company, which enabled creation of a $1.2 billion "permanent fund" to support water and sewer capital needs, and should also boost private-sector investment in the island's telecommunications infrastructure;
Moody's cautiously optimistic view that the economy is successfully adapting to the phase-out of Section 936 tax benefits available to US corporations operating in Puerto Rico. The ten-year phase-out is currently in its fifth year, and while some US-owned manufacturers have downsized or left the island in recent years, others have continued to invest in and expand their operations by using alternate organisational and tax structures for new business lines. Continuation of this trend is anticipated.
Future rating action, if any, will depend on progress in establishing consistent and fully-balanced government financial operations, improvement in fund balance reserves, evidence that the trend of government structural and financial reforms will continue and yield expected dividends, and further evidence that the economy is successfully adapting to the 936 phase-out. In this regard, the positive outlook is currently intended to cover a time horizon of up to two-to-three years.
CONTINUING ECONOMIC GROWTH AND JOB DIVERSIFICATION
Puerto Rico's economy continues its long term trend of growth in real gross product and personal income levels. The island's recent economic momentum has been influenced by a favourable combination of forces, including the robust US mainland economy, generally low oil prices (until recently), and very strong business conditions in the pharmaceuticals industry. In addition, a surge in Commonwealth borrowing to fund infrastructure projects began about three years ago, and continues, and the past year has seen an additional $3 billion infusion of funds from FEMA and private insurers to support rebuilding efforts in the wake of a September 1998 hurricane. As both of these are viewed to be temporary sources of stimulus, a portion of recent strong gains in economic activity, and government tax collections, is unlikely to be sustained. However, the near-term outlook remains favourable for most of the other fundamental economic forces influencing the island.
Despite the continuing expansion, the island has seen a slowdown in the pace of growth in payroll employment over the past two years, with average employment in calendar 1999 up only 1.1% from 1997 (based on recently revised data from BLS, and compared to US growth of 5%). Job growth in the private sector alone over this two-year period, adjusted for the effect of privatisations, is somewhat more favourable at about 2.5%. These trends reflect job losses in the manufacturing sector, as well as down-sizing of Commonwealth government employment as a result of greater efficiency and also privatisation of the telephone company and various health facilities. Overall, the employment base has continued to diversify, as government and manufacturing have declined in share, while construction, trade, and services have increased. Construction employment, up 17% in two years, may to some degree be unsustainable at present levels. However, the sector accounted for just under 7% of total employment in1999, and a substantial amount of the surge in construction activity reflects private investment as opposed to public works projects.
IMPACT OF 936 PHASE-OUT STILL DEVELOPING
To date, the island's economy has shown little evidence of an adverse effect from the 1996 federal legislation phasing-out Section 936 tax benefits available to Puerto Rican subsidiaries of US corporations, other than a moderate loss of manufacturing jobs (approximately 9,500 jobs lost over past two years, a 6% decline). The job losses appear to have been concentrated in relatively low-pay, labour-intensive industries such as apparel and food products, and mirror similar trends in low-wage industries in the US. During this same period, the growth in value of manufacturing output has accelerated (primarily attributable to pharmaceutical products), and growth in private-sector wages and Commonwealth tax revenue has been strong. In addition, while some US-owned manufacturers have downsized or left the island in recent years, others have continued to invest in and expand their operations by using alternate organisational and tax structures for new business lines. For example, to date about 10% of US-owned entities operating on the island have established so-called controlled foreign corporations, or CFCs, providing a US tax status resembling that of other subsidiaries operating in foreign jurisdictions such as Singapore and Ireland. At the same time, new business expansions by these companies are able to benefit from aggressive tax incentives offered by the Commonwealth government. These strategies, while perhaps not as favourable as the old 936 benefits, nonetheless have the potential to mitigate future tax liabilities on corporate income attributable to Puerto Rico, and thus reduce the impact of the 936 termination. The trend is anticipated to continue in coming years, and will be monitored closely by Moody's.
COMMONWEALTH'S HEALTHCARE-RELATED LOSSES EXPECTED TO END IN CURRENT FISCAL YEAR
The Commonwealth's General Fund performance in recent years has been characterised by strong income tax growth, and equally strong increases in spending, mainly for health insurance, public education, and debt service. The net result has been a budgetary-basis cumulative operating surplus of about $100 million over the past three fiscal years (1997-1999), with this attributable to several non-recurring revenue items in fiscal 1998. On a GAAP basis, the cumulative surplus for these years was a narrower $50 million. These General Fund results do not include losses experienced in the Health Facilities and Services Administration (known by its Spanish acronym, AFASS), which was accounted for as an enterprise fund. On a GAAP basis, AFASS experienced a three-year cumulative net loss of $650 million, far exceeding the General Fund surplus and surpluses in other enterprise funds. However, AFASS was closed at the end of fiscal 1999, and its remaining expense base (net of facilities which have been sold to the private sector) was transferred to the General Fund. Commonwealth budget officials report that a planned dramatic reduction of AFASS expenses in the current year is on track, and that the General Fund will be balanced at year-end. Despite the new AFASS expenses, the General Fund's overall rate of spending growth should be less than half the rate of the past two years, a significant accomplishment.
One of the Commonwealth's main policy initiatives over recent years has been a sweeping restructure of the public healthcare system. All healthcare services formerly provided by the government (i.e. through AFASS) are being transferred to the private sector, and the government will instead provide comprehensive insurance coverage for qualifying residents. While the new system has increased the government's overall health expenditures, access to medical services has also increased. To contain costs, the system uses a managed care approach administered by three private insurance companies. The system is still in the implementation stage, however, and budgetary exposure remains to potential future cost inflation and utilization issues. The healthcare reform currently covers all municipalities in the Commonwealth except the largest, San Juan, which will be added during fiscal 2001.
The Commonwealth has accomplished other important financial improvements in recent years, most notably a significant increase in tax enforcement and compliance (with the number of tax returns up at a substantially greater rate than employment growth), and a major reform of the public employee retirement system's benefits and funding. The latter was launched this January, and substitutes a defined contribution-type plan for new employees rather than the old defined benefit plan. In addition, funding will be accelerated for the old plan through greater government contributions as well as a subsidy from a portion of investment earnings under the new plan. These dramatic changes, if adhered to over time, have the potential to eliminate the growth of new unfunded pension liabilities and also steadily reduce the existing unfunded liability.
General Fund cash balances and GAAP-basis fund balances have narrowed since 1995. The year-end cash balance has declined from over $500 million in fiscal 1995 to a $230 million in 1999, representing some 3.4% of revenues. Similarly, the unreserved GAAP fund balance has declined from over $400 million in 1995 to $185 million in 1999. These trends stand in contrast to those in most US states, which have generally added to their cash and fund balances during recent years. The Commonwealth's current balances are also quite slim in light of the likely economic sensitivity of the revenue structure - with two-thirds of revenue coming from income taxes, and much of this levied at high marginal rates on corporations and high-income individuals - and the potential for inflation of health insurance premium costs. We note that additional cash held outside of the General Fund and managed by the GDB, together with GDB's access to the short-term debt market, provides some additional flexibility to the Commonwealth to manage its liquidity position.
HEAVY TAX-SUPPORTED DEBT BURDEN, BUT SLOWER PACE OF GROWTH
The Commonwealth has a heavy tax-supported debt load, reflecting in part its strongly centralized government - with many functions assumed by the Commonwealth which are carried out by localities in most other states - and also the broad scope of the infrastructure development tasks it has undertaken. The current ratio of tax-supported debt to aggregate personal income is almost 48%, about twenty times the level we typically observe among the fifty states, and more than four times as high as the most heavily indebted of the states. The ratio is affected by the low levels of income in Puerto Rico (per capita income is about one-third the US average) and by the large absolute amount of debt. At $16.3 billion with this issue, the Commonwealth government has more outstanding tax-supported debt than all but three of the states.
From the mid-1970s to the mid-1990s, the Commonwealth's debt policy sought to maintain a stable relationship between increases in debt and economic growth, and it largely succeeded in that effort. Since coming into office in 1994, the current administration has implemented a major effort to improve the island's infrastructure, focusing on highways, mass transit, water aqueduct and sewage treatment facilities, and electric power plants. As a result, in the last five years outstanding tax-supported debt has increased by more than $6 billion (as calculated by Moody's, and excluding self-supporting enterprise debt, such as that of the Electric Power Authority). The pace of growth in debt was more than twice the pace of personal income growth, negatively affecting the debt ratio. On the other hand, debt service, while growing as a percentage of the budget, has remained manageable due to the Commonwealth's ability to impose high local tax rates on individual and corporate incomes given the absence of federal income tax on the island. For example, aggregate debt service on G.O. bonds and appropriation bonds amounts to about 13% of General Fund revenue in the current fiscal year.
Furthermore, the recent rate of growth in tax-supported debt, has slowed.
Over the past two years, the debt total increased by about 12%, compared to an increase of almost 40% in the prior two years. Looking forward, the creation of a $1.2 billion infrastructure "permanent fund," with proceeds from last year's sale of a majority stake in the telephone company, potentially reduces the need for future debt to fund crucially important water and sewer improvements.
OUTLOOK:
Moody's outlook for Puerto Rico's credit has improved. The positive outlook reflects a trend of success in reducing government employment and implementing important financial reforms, particularly with respect to health facilities costs, pension liabilities, and tax compliance. In addition, the outlook reflects Moody's cautiously optimistic view that the economy is successfully adapting to the phase-out of Section 936 tax benefits available to US corporations operating in Puerto Rico. The ten-year phase-out is currently in its fifth year, and while some US-owned manufacturers have downsized or left the island in recent years, others have continued to invest in and expand their operations by using alternate organisational and tax structures for new business lines. Continuation of this trend is anticipated.
Future rating action, if any, will depend on progress in establishing consistent and fully-balanced government financial operations, improvement in fund balance reserves, evidence that the trend of government structural and financial reforms will continue and yield expected dividends, and further evidence that the economy is successfully adapting to the 936 phase-out. In this regard, the positive outlook is currently intended to cover a time horizon of up to two-to-three years.
ANALYSTS: Timothy Blake, Analyst, Public Finance Group, Moody's Investors Service Maria Coritsidis, Backup Analyst, Public Finance Group, Moody's Investors Service Renee Boicourt, Director, Public Finance Group, Moody's Investors Service CONTACTS: Journalists: (212) 553-0376 Research Clients: (212) 553-1625 ((--Reuters U.S. Municipal Desk, 212-859-1650; nyc.munis.newsroom@reuters.com)).
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