On July 25, 1898, during the Spanish-American War, the U.S. invaded Puerto Rico with a landing at Guánica. As an outcome of the war, Spain ceded Puerto Rico, the Philippines and Guam (which were then under Spanish sovereignty) to the U.S. under the Treaty of Paris.

Why do I lead with this bit of history? As has been very well documented and publicly discussed, the financial fortunes of the Commonwealth of Puerto Rico have for nearly 117 years been both indirectly and directly tied to the United States. Despite legislative initiatives from the U.S. Congress to stimulate economic activity and significant tax benefits for accessing the capital markets, the Commonwealth today finds itself hard pressed to find ways to stimulate its economy and extricate itself from over $70 billion in debt it needs to honor.

As of this writing, most of the debt resides at the lower end of non-investment grade. While private equity and hedge fund investors have taken the lead in terms of outstanding bonds held, discussions and negotiations with the Commonwealth have yet to generate a solution that leads away from a transformational restructuring of the debt. Bonds continue to trade in the marketplace, evidencing some measure of liquidity and perhaps expectations that a solution will soon be reached.

Moody’s Investors Service, however, just released a report on May 4 (titled Commonwealth of Puerto Rico – U.S. State Governments: Legislature’s Rejection of Tax Overhaul Plan Casts Doubt on Financing Plans), which suggests that the recent legislative rejection of the governor’s value added tax (VAT) proposal is “negative for the U.S. territory because it delays efforts to issue more than $2 billion of bonds to restore cash for operations and debt service. Without the bond sale or another infusion of cash, Puerto Rico will face increasingly difficult choices, including potential government shutdowns.”

Moody’s went on to say that U.S. Secretary of the Treasury Jack Lew has been in contact with Puerto Rico’s governor, urging him to find a solution, noting that federal intervention, “would be unprecedented, and our ratings for U.S. state and local governments do not assume the national government will provide financial support in such situations.”

We continue to monitor developments, both with interest and concern, as the potential impact to the municipal marketplace of a negative outcome would be meaningful.

Gradations of creditworthiness are indicated by rating symbols, with each symbol representing a group in which the credit characteristics are broadly the same. The symbols that are used by Moody’s to designate least credit risk to that denoting greatest credit risk: Aaa, Aa, A, Baa, Ba, B, Caa, Ca, and C. Ratings from Ba to Caa are below investment grade (non-investment grade) or speculative grade.