NEW YORK (The Deal) -- After weeks of speculation, Standard & Poor's has downgraded the Commonwealth of Puerto Rico's general obligation debt to a junk rating ahead of the island's planned debt offering, but municipal investment sources said this development is neither a surprise nor a big deal.
"All this means is that mutual funds won't be able to buy into the new offering, and they were unlikely to be big buyers in the first place," said Jon Schotz, managing partner at Los Angeles-based alternative investment firm Kayne Anderson Capital Advisors' Kayne Saybrook Municipal Opportunity Funds.
Many mutual funds are not allowed to purchase below-investment-grade credits. However, it is not common for mutual funds to require divestments of existing holdings that lose their investment grade ratings, so this shouldn't trigger a major sell-off, although some funds may want to reduce their Puerto Rico holdings in order to respond to investor concerns about Puerto Rico's credit risk, sources said.
However, S&P did raise the stakes for the commonwealth's planned debt financing deal.
S&P analyst David Hitchcock said in a Feb. 4 webcast that a successful debt raise was factored into the downgrade of the GO debt to BB+ on watch with negative implications from BBB-, adding that a failure to raise at least $1 billion by the end of February could result in a further downgrade.
The commonwealth, which together with its major public agencies has over $71 billion in debt, said last month that it would launch a debt offering in late January or in February, and the timing has some muni investors scratching their heads.