Puerto Rico Sales-Tax Bonds Decline as Governor Proposes VAT

Prices on some Puerto Rico sales-tax bonds fell to a seven-month low after Standard & Poor’s cut the debt to junk as Governor Alejandro Garcia Padilla proposes replacing the levy with a value-added tax.

The rating company on Thursday lowered the senior-lien sales-tax bonds, called Cofina, by six steps to B, citing questions about the timing of pledged revenue under the governor’s recommended system. Sales taxes back about $15 billion of Puerto Rico municipal debt.

Securities maturing in August 2044 traded Friday at an average of 74.9 cents on the dollar, the lowest since July 15, data compiled by Bloomberg show. The average yield on the tax-free obligations was 8.9 percent.

Garcia Padilla this week proposed a 16 percent VAT that would be applied at each level of production and distribution. It would replace the 7 percent sales tax that the island’s consumers pay on goods and services. Cofina bonds have been a key financing tool for the junk-rated U.S. territory since 2006.

Implementing the VAT has “negative implications” for the sales-tax debt because of “uncertainty over the amount of pledged revenues that would replace the sales tax, and whether the new structure maintains the separation of pledged revenue from what is pledged to the general-obligation bondholders,” David Hitchcock, an S&P analyst, wrote in a report Thursday.

The commonwealth expects revenue to increase with the new tax, Melba Acosta, president of the Government Development Bank, which handles the island’s debt sales, said Thursday in a statement.

“Cofina bonds will continue to receive a pledged portion of the proposed VAT tax, while the structure, security and payment system remain unchanged pursuant to the fulfillment of Cofina obligations,” she said.

S&P now assesses the securities five steps below investment grade. The debt also has junk marks from Fitch Ratings and Moody’s Investors Service.

S&P on Thursday also pushed Puerto Rico general obligations deeper into junk, cutting the rating to B from BB.

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