PHOENIX - Investors are stepping up due diligence on triple tax-exempt bonds issued by U.S. territories, intrigued by the yields but wary of financial risk after the Puerto Rico debacle.
While the federal government is reportedly working on an analysis of the fiscal situations of U.S. debt-issuing territories other than Puerto Rico, investors and analysts are already mindful of the lessons of that island's financial distress as they chase higher yields and the benefits of interest payments that aren't taxable by the federal government or by any U.S. state or municipality. Guam, Northern Mariana Islands, the U.S. Virgin Islands, and American Samoa have the potential for similar concerns, investors and analysts said, but each is a unique story.
"What Puerto Rico has gone through has opened people's eyes," said Christopher Brigati, head of municipal trading at Advisors Asset Management. "It has definitely caused people to be more thoughtful."
Guam, a Pacific island with a population of about 160,000, has the most debt of any of the non-Puerto Rico territories. Guam's fiscal year 2015 annual report, the most recent filed with the Municipal Securities Rulemaking Board, lists $63.8 million of general obligation debt outstanding for the territory and its authorities. It listed $1.06 billion of limited obligation bonds and $1.49 billion of revenue bonds, for a total indebtedness of about $2.6 billion. The GO bonds carry a BB-minus rating from S&P Global Ratings, and its miscellaneous tax bonds carry a BBB-plus rating from the same agency.
Fitch Ratings in December cut $763.3 million of Guam's revenue bonds to non-investment grade BB from A-minus based on the federal passage of the Puerto Rico Oversight, Management, and Economic Stability Act and concerns that its precedent could apply in Guam.
The U.S. military presence on the island is heavy, with thousands of active-duty personnel stationed there and paying income taxes that S&P said account for some 95% of bond payment revenues. Analysts have expressed some concern about the reliance on the military, which is subject to federal policy changes, as well as the risk that Guam may reach its debt limit. At the same time, Guam's relative stability and the investment grade ratings on much of its debt set it apart from other U.S. territories.
American Samoa had no bond debt prior to 2015, although it had borrowed from its pension system. It issued bonds in 2015, and its $78 million outstanding of debt carry a speculative Ba3 rating from Moody's Investors Service, which also has the bonds on negative outlook. American Samoa's economy is also narrowly-focused, with the population of around 55,000 largely sustained by the tuna canning industry. Moody's moved the outlook to negative from stable due to the recent closure of one of those tuna packing plants.
The U.S. Virgin Islands is heavily leveraged, with a debt per capita ratio worse than Puerto Rico's, and has struggled to access the market. In January Moody's downgraded the ratings on the USVI's four liens of matching fund revenue bonds, nearly $1.2 billion of debt. The rating agency cut the senior and subordinate lien debt deep into speculative grade, to Caa1 from B1.
The USVI's rum tax bonds were dropped to Caa2 from B2. Moody's also downgraded about $200 million of speculative grade USVI Water and Power Authority Bonds around the same time. Net tax supported debt totaled $1.97 billion, Moody's said, for the territory of around 100,000 inhabitants. USVI is also facing a massive pension crisis, with an unfunded liability exceeding $2.5 billion as of fiscal 2015.
Earlier this year the U.S. Virgin Islands attempted to sell about $219 million in matching fund revenue bonds to fund operating deficits through fiscal 2018, but canceled the sale. Fitch then downgraded the island. The governor said the territory couldn't find buyers, because investors were insisting on revenue reforms that the legislature had not shown much appetite for.
The Commonwealth of the Northern Mariana Islands had about $85 million of unrated long-term debt outstanding at the end of fiscal 2015, and its Port Authority had some $22 million outstanding. The government reported a total deficit net position of $215.4 million in its fiscal 2015 report.
David Tawil, president of Maglan Capital, said the outcome in Puerto Rico will ultimately weigh on the bonds of the other territories.
"If Puerto Rico's restructuring ends with a major cut to bondholders, the bonds of the territories should come under considerable pressure, on the fear that they could face a similar outcome," Tawil said. "In addition, if the Federal government continues to resist financially the territories in a meaningful way, as is currently the case with Puerto Rico, the prospects for the other territories will dim."
Tawil said that traditional high yield investors normally don't have munis in their portfolios, though some high yield funds have gotten some muni exposure through distressed large issuers such as Detroit.
"I still don't think that we're at a point that munis is a regular part of high-yield generally," Tawil said.
Brigati said though investors are interested in other territorial debt as an alternative to Puerto Rico paper, and that many are "kicking tires" on it, there just isn't very much of it out there given the relatively low issuance by most of the territories.
"The biggest hindrance continues to be the relative lack of debt available," Brigati said. "You could wait quite a while before you're able to actually execute on it."