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Puerto Rico Readies $1.4 Billion Sales Tax Deal

The Puerto Rico Sales Tax Financing Corp. Wednesday plans to sell $1.4 billion of subordinate sales-tax bonds that will finance the commonwealth’s stabilization fund and help balance the current fiscal 2010 budget.

This will be Puerto Rico’s second subordinate sales-tax deal after the corporation sold $4.1 billion of subordinate bonds in early June. Like last year’s transaction, Puerto Rico will offer two days of retail pricing, beginning today, with institutional sales set for Wednesday.

Citi is the senior manager of the subordinate deal. Nixon Peabody LLP is bond counsel. The Government Development Bank for Puerto Rico, the commonwealth’s fiscal agent, will hold an investor call this afternoon regarding the bond sale.

Fernando Batlle, executive vice president of financing and treasury at the GDB, said market participants are expecting strong retail demand along with the usual traditional bond funds on the institutional side looking for the commonwealth’s triple-tax exemption.

“We’ll probably get some of the insurance companies — we’ll probably get a little bit of everything — but it will mostly be on the traditional institutional base that buys muni paper from Puerto Rico,” Batlle said.

The transaction includes current interest bonds maturing annually from 2015 through 2030, with two term bonds in 2039 and 2042, according to the preliminary official statement. The deal will also offer capital appreciation bonds maturing from 2031 through 2037 and convertible capital appreciation bonds.

Batlle said the structure is based upon a set cash flow that grows at 4% annually. Puerto Rico’s sales-tax credit, known as COFINA by its Spanish acronym, is backed by a 2.75% sales-tax dedication or a pledged base amount, whichever is greater. The pledged base amount for fiscal 2010 is $550 million, with that amount increasing to a capped allocation of $1.85 billion in 2041. It will stay at $1.85 billion thereafter.

COFINA receives the base amount regardless of how the island’s 7% sales tax performs.

“There is a particular debt service structure and you have to fit maturities as you have cash flow available, so it becomes an issue,” Batlle said. “That’s one of your constraints as you put together the structure — what term bonds you can offer, and what convertible CABs you can offer, and how much CABs you can offer. So it’s all kind of an optimization game in terms of where you put what bonds.”

Moody’s Investors Service and Fitch Ratings rate the deal A2 and A, respectively. Standard & Poor’s assigns its A-plus rating to the transaction.

Bond proceeds will help meet operational expenses in fiscal 2010, including incentives to help laid-off public employees find employment and business opportunities in the private sector. The deal will also pay off a $500 million loan that First Bank extended to the commonwealth last year, Batlle said.

In looking at sales-tax revenue performance, receipts July through November total $436 million. That’s $6.85 million below the same five months in fiscal 2009. Officials estimate sales tax receipts to total $1.21 billion for fiscal 2010, which ends June 30. December revenue collections — which would include consumer spending during the holiday season — are not included in the POS, and Batlle said the Treasury Department was still gathering December sales-tax revenue.

While the sales tax in fiscal 2010 is underperforming last year’s collections so far, analysts say the revenue stream is stronger than sales-tax programs in the continental U.S. Many of those sales-tax revenues are down by more than 10% over last year’s collections while Puerto Rico’s fiscal 2010 sales tax receipts have dipped by 2.8% compared to the previous year, according to Horacio Aldrete, an analyst at Standard & Poor’s.

He and other analysts cite the credit’s broad base, which includes many products and services. In addition, the government has ramped up its collection process to improve its low 60% collection rate and that may have helped offset a decrease in consumer spending due to Puerto Rico’s 15% unemployment rate.

“Even if people are spending less, the fact that the commonwealth has been cracking down on tax evasion has given them some resiliency and some stability in collections,” Aldrete said.

Looking ahead, COFINA has two forward-starting, floating-to-fixed-rate swaps totaling $907 million that will begin Feb. 1 2012, according to the POS. In those swap agreements, Depfa Bank PLC and Morgan Stanley will pay 67% of the three-month London Interbank Offered Rate to COFINA and in return, the corporation will pay a fixed rate of 3.95%. The current mark-to-market value of the derivatives is $85 million, according to Standard & Poor’s.

Batlle said COFINA is still analyzing whether to terminate the derivatives, or pair up the swaps with an issuance of new-money variable-rate debt or refinance existing fixed-rate bonds into floating-rate mode.

COFINA has $5.2 billion of outstanding senior-lien sales tax bonds and $4.6 billion of outstanding subordinate sales-tax debt. The corporation has about $700 million of bonding capacity under its senior-lien credit, according to Aldrete, and another $800 million of subordinate bonding capacity after this week’s $1.4 billion sale. That capacity could grow if lawmakers increase the dedication, the sales tax rate, or if collections were to improve greatly.

The commonwealth has used its sales tax credit as a leveraging tool to help meet operating expenses, and pay down loans that the GDB has extended to the government in the past. In addition, sales-tax bond revenues have helped finance the government’s $2.5 billion fiscal stabilization initiative. One aspect of that program is to help transition public-sector employees into the private sector and reduce Puerto Rico’s overall workforce.

Officials have identified $1.2 billion of savings in fiscal 2010 to help reduce a $2 billion structural deficit.

“It is our understanding and it is our view that [COFINA] is a tool to be used on a temporary basis in order for them to go through the process of re-balancing their budgets,” Aldrete said. “It’s definitely, in our view, not a tool that can be used  — at least not to a great extent — over a long period of time to fund ongoing recurring deficits.”

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