S&P revises outlook on Puerto Rico COFINA bonds
Basing its assessment on Puerto Rico’s declining economy and population, Standard & Poor’s Ratings Services revised Monday its outlook on Puerto Rico Sales Tax Financing Corp.’s (known as COFINA) first- and second-lien bonds to negative from stable.
At the same time, the credit ratings agency affirmed its ‘AA-‘ rating on COFINA’s senior (first-lien) sales tax revenue bonds and its ‘A+’ rating on the first subordinate (second-lien) sales tax revenue bonds outstanding.
“We base the outlook revision on what we view as Puerto Rico’s current declining economic and population trends,” said S&P’s credit analyst David Hitchcock.
Although annual debt service coverage remains strong for both first- and second-lien sales tax-secured debt, particularly after a recent legislated expansion of the sales tax base that has raised annual coverage in the short-term, growth in sales tax is still needed to maintain high annual debt service coverage for first-lien bonds, and to cover combined first- and second-lien maximum annual debt service (MADS) occurring in 2041.
“If we were to lower the rating on the bonds, we believe it would likely be limited to one notch, reflecting gradual economic trends that have seen steady declines in population and economic gross product,” said Hitchcock.
The ‘AA-‘ rating on the first-lien bonds and ‘A+’ rating on the second-lien bonds reflect S&P’s opinion of:
- A large tax base of 3.7 million, which receives substantial federal income transfer payments, and a sales and use tax (SUT) that excludes volatile sectors such as automobile sales and hotel occupancy, and has shown recent trends of increasing tax collections, despite commonwealth economic contraction;
- Very strong current annual debt service coverage on first-lien bonds and adequate historical coverage of first-lien MADS;
- Strong annual coverage on the second-lien bonds;
- A strong legal structure that separates the revenue stream securing the bonds from the Commonwealth of Puerto Rico (‘BBB-/Negative’ general obligation rating);
- COFINA’s access, on a priority basis, to the entire 5.5 percent SUT currently collected to pay debt service for first- and second-lien SUT-secured debt; and
- A recent expansion of the sales tax base to business services, projected by the commonwealth to increase sales tax collections by 28.7 percent as budgeted in fiscal 2014, 2.4 percent annual growth in SUT between fiscal 2010-2013, and a commonwealth projection that only an annual growth rate of 1.1 percent will be needed to achieve coverage of second-lien MADS in 2041.
Offsetting factors include:
- The inability to completely isolate credit quality from the commonwealth’s financial and economic condition; and,
- The need to have revenue growth continue to meet second-lien MADS occurring in 2041, and to preserve strong annual debt service coverage of first-lien bonds.
Commonwealth officials have announced plans to potentially issue new third-lien secured sales tax bonds. The rating affirmation and outlook revision on the first- and second-lien sales tax debt reflect S&P’s view of the current economic climate and is not related to the potential for additional leverage, the agency said Monday.
“The negative outlook on the bonds reflects Standard & Poor’s expectation that if current negative economic trends persist there is at least a one-in-three chance that we could lower the ratings over our two-year outlook horizon,” Hitchcock said.
“We believe such a downgrade would likely be limited to one notch, reflecting gradual economic trends that have seen steady declines in population and economic gross product. Although sales tax has increased during this period, we don’t believe sales tax can remain wholly immune to economic trends,” he said.
P.R. government reacts
S&P’s determination drew swift reaction from Treasury Secretary Melba Acosta and Government Development Bank Interim President José V. Pagán, who said to be “pleased” and “encouraged.”
“We are pleased that S&P has reaffirmed its ratings on the COFINAI and COFINA II bonds. We are also encouraged by S&P’s focus on COFINA’s strengths, such as a large and stable tax base, a robust legal structure designed to protect bondholders and strong historical coverage levels, as well as their recognition of the positive impact the recent expansion of the SUT base will have on the credit,” the government officials said in a joint statement.
The SUT remains an important source of revenue for the Commonwealth, with SUT proceeds growing at an average annual rate of 2.4 percent over the past four years and expected to grow significantly in FY 2014 once the 28.7 percent expansion of its tax base is fully implemented, the two said.
“With regard to the change in outlook, we are confident that we can make continued, significant progress on our fiscal and economic development plans within S&P’s two-year horizon,” Acosta and Pagán said.
Meanwhile, Acosta went on to outline the actions taken by the Gov. Alejandro García-Padilla administration to “strengthen Puerto Rico’s fiscal situation, including an unprecedented reform of our pension system, measures to create self-sufficiency at our public corporations, and increased tax revenues.”
These actions support sustainable economic growth through job creation and continued progress toward a balanced budget, Acosta said.
Among other steps, Acosta listed the proposal to expand COFINA’s capacity to issue bonds, unveiled late last month; the plan to attract capital investment to the island by supporting the pharmaceutical, biotechnology and medical devices sectors, and attracting other industries such as infrastructure, aerospace, business services and information technology; revamping the island’s infrastructure including diversifying energy sources; the Employee Retirement System reform earlier this year; and, steps taken to strengthen the operations of its public corporations, such as the Puerto Rico Aqueduct and Sewers Authority, the Highway and Transportation Authority, and the Puerto Rico Ports Authority.
“We believe these measures, along with additional measures that are in the process of implementation, will spur economic growth as Puerto Rico moves forward with its robust plan to cut its budget deficit in half by 2015 and achieve a fully balanced budget by 2016,” Pagán said.
The GDB is working to complete its financing plan, which has been adjusted to account for ongoing market fluctuations and the private liquidity of recently completed transactions, he said.
This plan contemplates a possible COFINA III bond issue later this year, pending market conditions.
“We currently have a range of additional liquidity options. Banks and other financial institutions continue to lend to the Commonwealth, as evidenced by a $125 million Tax and Revenue Anticipation Note closed with Bank of America on Sept. 27,” he said.