Puerto Rico Tobacco Bonds Cut to Junk by S&P on Debt Moratorium

  • Debt was among the last on the island with investment grades
  • Bond payments `could potentially be interrupted,' analysts say

Puerto Rico tobacco bonds issued by Children’s Trust were cut to junk by Standard & Poor’s because of the agency’s inclusion in the island’s debt moratorium law.

Securities maturing in 2033 and 2039 had their ratings cut three and two steps, respectively, to BB, two levels below investment grade, S&P said Monday in a report. The credit rater put a negative watch on the two portions, as well as another already-junk segment due in 2043, signaling the chance of more downgrades in the coming months.

Children’s Trust is a not-for-profit entity created by Puerto Rico to issue debt backed by legal-settlement money that U.S. states and localities receive from cigarette companies. Its inclusion in the commonwealth’s debt moratorium law passed this month was seen as puzzling because the cash that pays investors was considered out of the government’s reach.

“While the enforceability of certain provisions in the legislation is subject to interpretation, if the governor were to exercise his powers under the legislation and place the Children’s Trust tobacco settlement asset bonds into the moratorium, payments to the bondholders could potentially be interrupted,” S&P analysts Jayashree Subramanian and Kate Scanlin said in the report.

Governor Alejandro Garcia Padilla has yet to halt any debt payments under the law. It’s unclear whether he can stop debt service on the tobacco securities because the funds are supposed to flow directly from the master settlement agreement escrow agent to the bond trustee.

“The inclusion of an entity, like the Children’s Trust, in the act does not automatically mean these tools will be applied to that entity,” Barbara Morgan, a representative at SKDKnickerbocker in New York who represents the commonwealth’s Government Development Bank, said last week in an e-mail.

This month, $70 million was funneled into an escrow account to make payments due on May 15 and Nov. 15, according to S&P. The securities also have a liquidity reserve of $83 million to cover collection shortfalls.

S&P said it will determine its next move based on confirmation that payments next month take place as promised and other developments in Puerto Rico.

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