Virgin Islands Echoes Puerto Rico Gains Amid Stress: Muni CreditBrian Chappatta
Buyers of tax-free municipal bonds aren’t stressing about fiscal distress in the U.S.’s Caribbean territories.
Debt from the U.S. Virgin Islands, where the budget deficit has grown to about twice its 2009 level, has gained 10.2 percent this year, Barclays Plc data show. Securities of Puerto Rico, the junk-rated commonwealth 40 miles (64 kilometers) west in the Caribbean, have rallied 9.7 percent. The returns are the third-and fourth-best among states and territories.
Investors have favored riskier debt this year with muni yields close to the lowest since the 1960s. Puerto Rico is luring buyers even after it lost its investment grades this year amid a struggling economy. The Virgin Islands, with less than 5 percent of Puerto Rico’s population, is also hooked on debt to cover deficits, said David Ashley at Thornburg Investment Management in Santa Fe, New Mexico.
“They parallel Puerto Rico to a certain extent,” said Ashley, a money manager who helps oversee $10 billion of munis. “They’re constantly borrowing each year to make up for the shortfall in their revenues and expenses.”
Investors in the $3.7 trillion municipal market have looked to pad returns with territorial bonds, which are tax-exempt nationwide. Yet the fiscal stress in Puerto Rico, which combined with its agencies has $73 billion of debt, has also raised awareness of the risks. Thornburg, for one, shuns Puerto Rico.
The Virgin Islands, purchased from Denmark for $25 million in gold in 1917, has $2.4 billion of bonds, data compiled by Bloomberg show. With about 105,700 residents, the territory has more debt per person than its neighbor of 3.6 million. It borrowed $50 million last week through its public-finance authority to pay for operating expenses. Standard & Poor’s rates the securities BBB+, three levels above junk.
In offering documents, the government says debt-service costs are contributing to budget gaps, which in turn require issuing more bonds. The cumulative shortfall through September 2013 was $1.4 billion, up from $737 million in 2009.
“We’re monitoring our cash and expenditures closely,” Debra Gottlieb, the territory’s director of management and budget, said in a telephone interview. “Unfortunately, this year, like previous years, there will be some appropriations that we’re not in a position to allot because of our cash resources. But the sale of this last bond issue will bring some much-needed relief.”
Last week’s deal included debt maturing in October 2024 that priced to yield 3.4 percent, or about 1.2 percentage points more than AAA munis, Bloomberg data show.
Offering documents say Chapter 9 bankruptcy is “inapplicable” to the territory and the agency that issued last week. Yet the documents reference the Puerto Rico Public Corporation Debt Enforcement and Recovery Act, which was passed in June and spurred downgrades for some Puerto Rican issuers.
“There can be no assurances given that the legislature will not enact similar or even broader legislation in the future that could entitle the government or the authority to seek the protection of a statute providing for restructuring, moratorium and similar laws affecting creditors’ rights,” according to bond offering documents.
As in Puerto Rico, the Virgin Islands’ fiscal strains extend to its public corporations. Bondholders are watching for a restructuring from the Puerto Rico Electric Power Authority, which took $100 million from its capital budget in May to purchase fuel. Yet electricity costs for customers of the Virgin Islands Water & Power Authority are almost double those in Puerto Rico, according to a July report from UBS Wealth Management.
The Virgin Islands agency, which has some debt with junk grades from the three biggest credit raters, wants to cut its reliance on oil by 60 percent over the next decade by using natural gas. Yet its population is shrinking and it barely has enough money to cover debt service, making it “a speculative investment destined for further downgrades,” UBS analysts led by Thomas McLoughlin wrote.
The island’s economy is still recovering from a setback in 2012, when the 350,000-barrel-a-day Hovensa LLC oil refinery shut, leaving more than 2,000 workers without jobs. The St. Croix facility, the area’s biggest private employer, was a partnership between Hess Corp. and Petroleos de Venezuela SA.
The Virgin Islands unemployment rate jumped to 13.4 percent in 2013 from 8.9 percent in 2011. The U.S. figure ended last year at 6.7 percent, down from 10 percent in 2009.
“The Virgin Islands economy is having a lot of problems,” said Justin Land, who helps manage $3.5 billion of munis at Naples, Florida-based Wasmer, Schroeder & Co. “Their economy is shrinking pretty significantly.”
Without Hovensa, the Virgin Islands rely on tourism, which has rebounded since the recession. Hotel occupancy taxes rose to $21.7 million last year from $15.5 million in 2009 as visitors grew to 2.7 million from 2.2 million.
The territory also leans on rum. A Diageo Plc distillery that moved to St. Croix from Puerto Rico produces the rum used in Captain Morgan products sold in the U.S. The public-finance agency issued $250 million of debt in 2009 to help London-based Diageo finance the venture. The Virgin Islands also assisted Cruzan International Inc. in constructing a rum distillery.
Diageo production has more than doubled the amount of money the Virgin Islands get from the U.S. Department of the Interior based on federal excise taxes on rum exports, collecting $256 million in 2013, offering documents show.
“We were very grateful that when the Captain Morgan folks were looking for a new home, they selected the Virgin Islands,” Gottlieb said. Bonds backed by rum taxes, such as the 2009 debt, “are one of our strongest credits,” she said.
As Puerto Rico has shown, credit strength can change. Fitch Ratings in July cut the island’s sales-tax debt, known as Cofina, by nine levels to BB-, citing the restructuring law.
With a government pension system that faces insolvency by 2025, a growing debt load and a declining population, the Virgin Islands could follow the same path as Puerto Rico, according to UBS.
“Expect the Virgin Islands to face more hurdles,” McLoughlin said. “Diversifying portfolios away from concentrated exposure to Virgin Islands credits is advisable.”