PHOENIX – Investors eager to buy triple tax-exempt debt have been turning to island territories in the Pacific, where limited tax bases and large debt loads create some risks reminiscent of Puerto Rico.
The Guam Waterworks Authority sold $143.3 million of Series 2016 water and wastewater revenue bonds earlier this month.
Those bonds were rated Baa2 by Moody's Investors Service, A-minus by Standard & Poor's, and BB-minus by Fitch Ratings. The bonds were priced as 5s to yield from 1.53% in 2020 to a high of 3.64% in 2046, and Guam officials said demand exceeded supply by 10 times.
The U.S. territories' bonds are attractive because their bond interest isn't taxable by the federal government or by any U.S. state or municipality.
Such triple-tax-exemption for years helped sell Puerto Rico debt, but with the commonwealth sidelined from the new issue market amid a fiscal crisis in which bondholders may find themselves sacrificed, more investors may turn to the Pacific territories.
Triet Nguyen, a managing director at NewOak Capital LLC, said developments in Puerto Rico should change the way analysts view other territorial island debt.
"Bondholder protection has to be viewed as lacking in these credits," he said.
Guam is an island of just over 160,000 people 3,800 miles west of Hawaii and 1,500 miles south of Japan.
In its most recent report on Guam in late 2014, S&P affirmed a speculative-grade BB-minus rating on the island's roughly $1 billion of general obligation debt.
The island's economy is extremely limited, Standard & Poor's noted, with a strong "economic concentration in military and tourism." The U.S. military presence on the island is heavy, with thousands of active-duty personnel stationed there. Guam has very limited fiscal flexibility and has been operating relatively near its legal debt cap.
The waterworks enterprise deal not only offered triple tax-exemption but also investment-grade ratings.
"The sale was a huge success for Guam and is a true testament to the financial strength and stability we have built over the last five years," Guam Gov. Eddie Baza Calvo said in a Feb. 10 statement. "We have been able to share the Guam story with Wall Street and with today's numbers, they are pleased with our progress."
Guam Waterworks Authority chief financial officer Greg Cruz told The Bond Buyer that the authority reached out to investors in San Francisco, New York, and Boston through a combination of one-on one meetings and calls prior to the sale.
"I can state for a fact that the appetite for GWA's bond was incredible when you consider we received approximately $1.5 billion in orders on a $143 million offering," he said in an email.
Guam also saved money late last year by refinancing some $400 million of its junk-rated GO bonds into debt backed by business privilege tax revenue, with bonds rated A-minus by Fitch and A by S&P.
The interest rate dropped from as high as 7.28% for some 2009 GOs to what Guam's governor called the lowest rate for long-term bonds that the Guam government had ever received.
Yields ranged from 1.17% on the 2017 maturity to 4.181% for a 2039 term bond.
Guam has been making progress, Fitch said in a rating report, noting that fiscal 2014 receipts totaled $238 million, up 7.5% year-over-year.
The substitution of the BPT bonds for the GO bonds is expected to save the government approximately $2 million annually in debt service costs, the rating agency noted, and Guam's budget has moved toward balance despite remaining at very high overall debt levels.
High-yield triple-tax-exempt buyers found another outlet last year when American Samoa issued its first tax-exempt debt since Congress passed a law in 2004 to clarify that its debt qualifies for the triple tax-exemption.
When the American Samoa Economic Development Authority sold $44 million of tax-exempt general revenue bonds in 2015, its $38.2 million term bond, with a 2035 maturity, priced at 6.625% - 375 points above the Municipal Market Data triple-A benchmark for the pricing date, and 274 basis points above the triple-B benchmark.
More recently, on January 29, the American Samoa Economic Development Authority priced a taxable, $23 million general revenue bond deal, underwritten by George K. Baum & Co. The single 2024 maturity priced to yield 11.827% on a 10% coupon.
Both deals carried Ba3 ratings from Moody's.
Prior to 2015 American Samoa had no bond debt, according to Moody's, though it had borrowed from its pension system and had two loans from the federal government outstanding, one from the Department of Interior and one from the Federal Emergency Management Agency.
The territory of roughly 55,000 people some 2,700 miles southwest of Hawaii has some economic issues that reflect the junk rating and which analysts have said may make them suitable only for institutional investors.
"Its economy is concentrated almost entirely in government and tuna packing, causing GDP and employment to be highly volatile," Moody's said. Government accounted for 39% of total employment in 2013 versus the US mainland average of 15%. Tuna canneries accounted for 13% of employment and 21% of total private sector employment in 2013.
The territory also recorded a significant operating deficit in 2014 equal to about 13% of revenues, though officials said they expected to get things back on track with improvements to its tax collection system.
The small territory may also have a looming pension issue. American Samoa's pension system was 79.9% funded at the end of 2013, but the funding level dropped to 63.5% with the implementation of new Governmental Accounting Standards Board rules, Moody's said.
Both Guam and American Samoa are much smaller and issue far less debt than Puerto Rico, which along with the U.S. Virgin Islands and the Commonwealth of the Northern Marianas Islands can issue triple tax-exempt debt. But Puerto Rico's continuing downward spiral and inability to meet its long-term obligations have led the territory to push for authorization to restructure the debt of its public authorities under Chapter 9 of the federal bankruptcy laws.
Holders of Puerto Rico debt would almost certainly take a significant haircut under a bankruptcy-like scenario.
U.S. Senate Finance Committee chair Orrin Hatch has demanded that Puerto Rico Gov. Alejandro Garcia Padilla provide detailed financial information by March 1 and said he wants to come up with a plan to help Puerto Rico by the end of that month.
Nguyen said that territories like Guam are likely benefiting from overflow investor demand for triple tax-exempt debt, now that Puerto Rico is no longer acceptable, but that some investors may be ignoring risks in pursuit of the triple-tax benefit.
"I suspect that need is blinding them in some respects," Nguyen said. "Guam, for instance, is completely dependent on U.S. defense spending."
Nguyen said that these risks have always been present in the territorial credits, but that the market has not been focusing on them up until now, similar to the way some of Puerto Rico's risks were largely ignored until the last few years.
"They're going to be much more prominent going forward," he said of those risk considerations.
