NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms the ratings of the Puerto Rico Sales Tax Financing Corporation (COFINA) bonds as follows:
--$6.7 billion senior lien sales tax revenue bonds at 'AA-';
--$8.9 billion first subordinate lien sales tax revenue bonds at 'A+'.
The Rating Outlook for both the senior and subordinate lien bonds is Stable.
SECURITY
The bonds have a security interest in and are payable from the commonwealth's 5.5% sales and use tax. COFINA is an independent governmental instrumentality of the commonwealth and affiliate of the Government Development Bank for Puerto Rico (GDB).
KEY RATING DRIVERS
SALES TAX BONDS INSULATED FROM GENERAL OPERATIONS: The ratings on the senior and subordinate lien bonds reflect a structure and revenue pledge that Fitch believes insulate the bonds from the strained general fund operations of the commonwealth. The legal opinions are strong, finding that neither the commonwealth general fund nor commonwealth GO bondholders have a claim on pledged sales tax revenues until COFINA debt service is fully funded each year. Strong non-impairment language provides some additional protection to bondholders.
DIVERSE AND EXPANDED REVENUE BASE: The sales tax base is broad and the retail environment in Puerto Rico has shown resilience even in challenging economic times. The commonwealth broadened the base of the tax as part of the fiscal 2014 budget, meaningfully increasing projected revenues and enhancing the pledged revenue stream. The commonwealth continues to implement measures to improve the weak tax collection rate.
NOMINAL GROWTH REQUIRED THROUGH LIFE OF BONDS: The final maturity of the bonds is very long and the program's rising debt service profile requires some growth in revenues to achieve coverage of later maturities, particularly for the first subordinate lien bonds. Although this is a credit weakness, normal inflationary growth can be expected to support the revenue stream, and Fitch notes that sales tax receipts have grown, but for one year, even during the commonwealth's prolonged economic downturn.
STRONG ANNUAL COVERAGE: Annual debt service coverage by pledged revenues is strong. Based on fiscal 2013 revenues, debt service for the year was covered 5.2x for the senior lien and 1.9x for the first subordinate lien. Fiscal 2013 revenues would be sufficient to fund debt service without growth through 2056 (senior lien) and 2030 (first subordinate lien). Giving credit to half of expected revenues from recent tax base expansion, adjusted fiscal 2013 revenue would cover debt service on the senior lien bonds through maturity with no additional growth required and current revenues would cover the first subordinate bonds through 2033.
WEAK ECONOMIC ENVIRONMENT: While the bonds are well insulated from the commonwealth's fiscal operations, expectations for growth in revenues are dampened by ongoing economic weakness.
FUTURE BORROWING LIMITED TO THIRD LIEN: The senior and first subordinate liens are almost fully leveraged and there are no legislatively authorized uses available for additional issuance. As a result, all future borrowing will take place using the recently authorized third lien.
RATING SENSITIVITIES
Rating stability is sensitive to evidence of continued growth in the pledged sales tax so that coverage of increasing debt service requirements remains satisfactory. Failure to realize materially increased revenues from the recent base expansion and/or weakness in the economy that translates to reduced sales tax revenue expectations and lower projected coverage would lead to downward pressure on the rating.
CREDIT PROFILE
STRONG LEGAL SEGREGATION FROM COMMONWEALTH OPERATIONS
The bonds are secured by the commonwealth's island-wide sales and use tax, which became effective on Nov. 15, 2006. This broad-based tax was instituted as part of Puerto Rico's 2006 tax and fiscal reform. In conjunction with enactment of the new tax, COFINA was created to refinance appropriation debt of the commonwealth and thereby free up general fund resources. The commonwealth expanded leveraging of the revenue stream in 2009 as part of a fiscal and economic package designed to stimulate Puerto Rico's economy and address recurring budget deficits.
The authorizing legislation transferred ownership of the dedicated sales tax fund, including the right to receive future sales and use tax collections, to COFINA. The act states that the sales tax revenues shall not be deposited in the Treasury of Puerto Rico and shall not be considered "available resources" of the commonwealth subject to the clawback provisions of Section 8 of the Puerto Rico Constitution. Bond counsel and the commonwealth Secretary of Justice (Attorney General) also provide legal opinions to this effect.
The tax is currently levied at the rate of 5.5%, with a 1.5% additional municipal option. As originally structured, the commonwealth expected to use 1% for debt service on the senior lien bonds, with the general fund then receiving the remaining 4.5%. At the time of issuance, the pledge for the senior lien sales tax revenue bonds was the greater of collections from the 1% or a base (minimum) amount payable from all commonwealth sales tax revenues each year. Since debt service in any year is capped at the applicable base amount, debt service is covered by pledged revenues as long as collections from the entire commonwealth sales tax, rather than just the 1%, are sufficient to fund the base amount.
Legislation was passed in early 2009 amending the governing resolution and authorizing COFINA to issue subordinate lien bonds expected to be paid from an additional 1.75% of the 5.5% sales tax that had previously been flowing to the general fund. The base amount, which was originally $185 million in fiscal 2008, rising 4% per year thereafter for the senior bonds, was increased to $550 million, also rising 4% per year thereafter up to a maximum of $1.85 billion.
The ratings on the senior and subordinate lien bonds incorporate coverage by the full 5.5% due to the strong flow of funds. At the start of each fiscal year, revenues from the entire commonwealth sales tax flow directly from Banco Popular de Puerto Rico, the collection agent, to the trustee until revenues deposited with the trustee in that year equal the base amount, which is slightly higher than actual aggregate debt service. Only thereafter does the general fund receive its share of collections.
The 2009 legislation strengthened non-impairment language, making it more difficult for the commonwealth to eliminate or divert the sales tax in the future. The revised resolution includes language specifying that only the non-pledged portion of the sales tax may be lowered or abolished and only if it is replaced with a 'like or comparable security'. To do so, the trustee must be provided written ratings confirmation and written opinions from the Secretary of Justice, bond counsel, and other experts concluding that the Puerto Rico Supreme Court would agree that the substituted assets/revenues have been validly imposed by law, validly transferred to COFINA, and do not constitute available resources of the commonwealth subject to the clawback provisions for GO debt in the constitution.
DIVERSE AND EXPANDED SALES TAX BASE
The sales tax base is broad and diversified, with more than half historically derived from retail trade. There is minimal reliance on tourism and automobiles and motor fuel are excluded. Items subject to sales tax include tangible personal property, taxable services, admission fees and bundled transactions. Sales tax collections have proven resilient, increasing since the lowest point in the recession even as the economy has remained weak. Collections fell in only one year during the recession, 4.5% in fiscal 2009. Since then, collections have been increasing, at an improving rate, despite negative economic trends: 0.1% in 2010, 1.4% in 2011, 2.8% in 2012, and 3.3% in FY 2013 to $1.18 billion.
As part of its fiscal 2014 budget balancing measures, the commonwealth expanded the sales tax base to include certain to business to business services that were previously exempt, eliminated exemptions for certain institutions, including universities, and eliminated the reseller certificate, replacing it with a tax credit system. This expansion is projected by the commonwealth to generate an additional $259 million in fiscal 2014 and will benefit existing senior and first subordinate lien bondholders by providing additional debt service coverage.
Through the first four months of fiscal 2014, sales tax collections have increased 6.5% on a year-over-year basis but are 3.4% below estimate. The base expansion has yet to fully be reflected in the tax collection numbers and Fitch will continue to monitor monthly collections to assess the extent to which budget targets are being met.
SOLID ANNUAL COVERAGE, GROWTH NEEDED LONGER TERM
Coverage of annual debt service from current revenues is ample: fiscal 2013 revenues provided 5.2x coverage of senior lien debt service and 1.9x coverage of combined senior and first subordinate lien debt service. However, debt service escalates fairly rapidly and growth in revenues is required to ensure coverage of all requirements through final maturity. The senior lien bonds require only minimal 0.17% annual growth to meet debt service requirements through the life of the bonds; somewhat higher 1.63% annual growth is required to assure 1.0x coverage of combined senior and first subordinate lien debt service.
Even with escalating debt service and the long final maturity of the bonds, achieving this relatively low level of growth in tax revenues appears reasonable. As noted above, the growth rate in tax revenues over the past four years has averaged 1.9% and revenues have been growing at an increasing rate. Further, even absent strong underlying economic growth, price inflation can be expected to bolster the revenue stream. Finally, any increase in revenue derived from the base expansion will ultimately benefit senior and first subordinate lien bondholders through increased coverage and lower required growth rates.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 14, 2012).
--'U.S. State Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015
U.S. State Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=808110
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