Rum-Tax Bonds Attract $400 Million, Closing U.S. Virgin Islands Budget Gap

The U.S. Virgin Islands will use the proceeds of a $400 million bond sale backed by rum taxes to plug a budget gap following the biggest tourism slump in a decade.

The debt, secured by excise taxes on rum sales in the U.S., will finance a loan to the territorial government, according to preliminary offering documents. A 7.7 percent decline in visitors to the Caribbean islands last year helped push the 2010 budget deficit to $170 million, the documents show.

A new distillery in St. Croix is poised to take over production for the world’s second-most popular rum, Captain Morgan, according to Diageo Plc, the biggest liquor maker. American consumption of rum has risen for 15 consecutive years, the offering documents show.

Rum-backed debt has “been the bulk of their bond issuance,” said Matt Dalton, who oversees $450 million in municipal holdings as chief executive officer of Belle Haven Investments in White Plains, New York. “They were priced to move. We liked it.”

The week’s largest municipal offering came as yields on top-rated tax-exempts due in 10 years fell 1 basis point, or 0.01 percentage point, to 2.94 percent, the lowest on record, according to data from Municipal Mark Advisors going back to January 2001. Yields have fallen for 12 straight days, the longest streak since March 2003, data from Concord, Massachusetts-based MMA show.

The Virgin Islands bonds are rated Baa2 by Moody’s Investors Service and BBB by Standard & Poor’s, both the second- lowest investment grades. Fitch Ratings graded the debt BBB+, one level higher.

Rum-Backed Bonds

Fifteen-year debt sold yesterday was priced to yield 4.92 percent, 24 basis points below comparable BBB general obligations, according to Bloomberg Fair Market Value data. Comparably rated, rum-backed bonds sold in October, maturing in 2025, were priced to yield 4.6 percent, 128 basis points below the index.

“It was attractive,” Dalton said. “You’re looking at choices now that are exempt on a state and federal level anywhere. You don’t get a lot of opportunity.”

The so-called triple-tax-exempt bonds are backed by a $13.50 federal excise tax paid by American consumers on every so-called proof gallon of rum sold in the U.S. The program, dating to 1917, rebates $13.25 to Puerto Rico and the U.S. Virgin Islands. This revenue is split between the territories based on the percentage of rum produced in each.

Captain Morgan

About 84 percent of it is produced in Puerto Rico, mostly by Bermuda-based Bacardi Ltd. and Ponce-based Destileria Serralles Inc., which currently manufactures Captain Morgan. London-based Diageo, the maker of Smirnoff vodka and Guinness beer, will begin moving production of Captain Morgan to its new St. Croix distillery in January.

The facility, under construction since 2009, will have the capacity to make as much as 20 million proof gallons of rum for the Captain Morgan brand per year, generating $130 million in new tax revenue for the territory, Diageo said in a statement June 24.

The expansion comes after total visitors to the Virgin Islands declined 7.7 percent in 2009 to 2.25 million, the lowest since 2000, according to data from the territory’s Bureau of Economic Research. Unemployment this year through April jumped to 7.9 percent from 6.7 percent in 2009, the bureau reported.

Cruzan International, which currently produces all the rum distilled in the U.S. Virgin Islands, was acquired by Fortune Brands Inc., maker of Jim Beam bourbon, in 2008. Cruzan is also increasing its distilling capacity, boosting production 86 percent, preliminary offering documents show.

St. Croix, St. John

The U.S. Virgin Islands, with a population estimated at about 110,000, was purchased from Denmark for $25 million in 1917. The territory, with a total area about twice the size of Washington, D.C., comprises about 50 islands and cays in the Lesser Antilles. The major islands are St. Croix, St. John and St. Thomas.

Diageo rose 24 pence to 1,085 pence yesterday in London trading. Deerfield, Illinois-based Fortune Brands rose 39 cents to $40.16 in New York Stock Exchange composite trading.

Following is a description of a pending sale of municipal debt in the U.S.:

THE PORT OF SEATTLE, which manages the airport, cargo and passenger marine terminals and related real-estate properties, plans to offer about $395 million in bonds for capital improvements and debt refinancing as soon as next week. The securities are rated AA- by S&P, fourth-highest, and one step higher by Moody’s and Fitch. The offering will be marketed by a group led by Morgan Stanley. (Updated July 8)

To contact the reporters on this story: Brendan A. McGrail in New York at bmcgrail@bloomberg.net; Justin Doom in New York at jdoom@bloomberg.net.

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