Moody's: Weak economy and upcoming legal battles increase asset risk at Puerto Rico's banks

Puerto Rico's banks can withstand the island's defaults, but the weak economy and upcoming legal battles will expose them to greater asset risk, said Moody's Investors Service.

In a new report, Moody's said Puerto Rico's continuing economic contraction and fiscal crisis could lead to deteriorating asset quality at the island's banks. Moody's analysts said the banks' consolidated non-performing assets are already extremely high relative to their total gross loans and other real estate owned - currently, 8.7% at Banco Popular de Puerto Rico, 10.3% at Banco Santander Puerto Rico, and 12.4% at FirstBank Puerto Rico.

"Despite their best efforts, the banks in Puerto Rico are still holding a significant number of problem loans in their portfolios," said Moody's Vice President Joseph Pucella. "The longer the island stays in this recession, the higher the chances are that its banks will experience further asset quality deterioration."

On 1 September, Moody's downgraded the standalone baseline credit assessments (BCA) of Banco Santander Puerto Rico (issuer rating Baa2 stable, BCA ba3), Banco Popular de Puerto Rico (issuer rating B2 negative, BCA b1) and FirstBank Puerto Rico (issuer rating Caa1 negative, b3). Moody's said the negative outlooks for Popular and FirstBank reflected their vulnerability to further economic deterioration. While Santander's Puerto Rico unit also shares that vulnerability, the bank's outlook remains stable, benefitting from its connection with Santander's US affiliate, which has a stable outlook.

Though the island's public sector defaults will force its banks to incur sizeable losses, Moody's said these losses will be manageable given their strong capital levels. However, Puerto Rico's attempts to restructure its public debt could bring further challenges for its banks.

While Puerto Rico's recently announced debt restructuring proposal aims to pay down the island's public debt in an orderly fashion and limit damage to the economy, Moody's said the potential for protracted litigation and a deepening recession could have negative credit implications for the island's banks.

"Even with this proposal on the table, it's going to be difficult for Puerto Rico to avoid a long legal battle," said Moody's Vice President Joseph Pucella. "Should the island's financial turmoil spark a deeper recession and higher unemployment, we expect the banks will start taking bigger hits."