Investors of Puerto Rico Sales Tax Financing Corp.'s $2.6 billion of bonds could have less sales tax revenue to depend upon if Puerto Rico Gov. Anibal Acevedo Vila's proposal to eliminate a portion of the commonwealth's sales tax becomes law.
In response to the governor's plan, Standard & Poor's placed the debt on CreditWatch with negative implications and Fitch Ratings placed it on rating watch negative. Both agencies rate the credit A-plus. Moody's Investors Service gives the debt an A1.
Puerto Rico currently allocates the first percentage point of revenue from the island's 7% sales tax and must support the fund each year with a $185 million floor that increases annually at 4%. In addition, the corporation benefits from the ability to tap into 4.5% of sales tax revenue before the central government can access the funds for other programs, even paying off general obligation debt. The remaining 1.5% of sales tax revenues goes to support local governments.
Yet that could change if the Legislature agrees to decrease the sales tax by 4.5%, leaving the island with a 2.5% sales tax - 1% for the debt-service fund and 1.5% for municipalities.
Currently, the 4.5% of additional sales tax returns gives bondholders an added cushion and security for their investment. Even without the 4.5% revenue stream, the corporation will honor its bond coverage with the 1% debt service fund, yet the additional funds give investors additional piece of mind.
"We like more coverage," said Bob MacIntosh, vice president and co-director of Eaton Vance's municipal bond group. "So technically they'd certainly be adhering to what they had promised in the official statement, but it still would be taking away comfort that bondholders thought they had."
Eaton Vance is a "sizeable" holder of the credit's firs-ever $2.6 billion tax-exempt sale, which priced in mid-July.
Acevedo Vila announced his sales-tax reduction proposal during his state of the commonwealth speech Wednesday evening, with the rating agencies responding to the news yesterday. Standard & Poor's and Fitch both cited the governor's plan to reduce the sales tax for placing the credit on watch.
The 4.5% of additional revenue allows the credit to stand on its own, separate from the commonwealth's credit rating, according to analysts. Moody's and Standard & Poor's rate the island Baa3 and BBB-minus, respectively. Fitch does not rate it.
"The A-plus is where it's at today because bondholders had access to the entire 5.5%, which obviously provided a much stronger coverage than the 1% alone," said Horacio Aldrete, a Standard & Poor's analyst. "The 1% alone would have to consistently grow at 4% every year over the next 50 years to meet one times debt service coverage."
If the 4.5% is eliminated, Puerto Rico officials anticipate replacing the revenue stream with another funding source, possibly via the island's excise tax which taxes businesses and not the consumers directly. The commonwealth previously had a 6.6% excise tax but reduced it when the island implemented its first-ever sales tax in November 2006. In his speech Wednesday night, Acevedo Vila said the sales tax has not helped residents with lower prices, as officials had hoped would happen.
"The prices did not descend. The inflation enlarged," Acevedo Vila said in his speech. "Now the large commerce and importers do not pay the tax but you do, when you pay the sales tax. The lack of consumer confidence has affected the economy and particularly the small merchants, and now we have the new threat of an economic recession in the United States."
Meanwhile, bondholders and rating analysts are waiting to see how exactly Puerto Rico will replace the sales tax with a different revenue stream, one that will have the same performance strengths of the sales tax.
"The sales tax itself, while new, was a very broad tax that captured not just traditional sales but also services, so it's kind of hard to see them replacing it with something that's qualitatively as strong," said Rich Raphael, a Fitch analyst. "But we'll look at the amount they replace it with as well as the quality of the revenue stream."
The island generated approximately $848 million of sales tax revenues in 2007, according to Treasury Department documents. q
