Sunday, June 9, 2013

A Shelter From Puerto Rico's Storm - WSJ

A Shelter From Puerto Rico's Storm

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The perilous state of Puerto Rico's finances has sowed fears among some municipal-bond investors. But not when it comes to bonds backed by taxes on the sales of bikinis. Or tobacco. Or most other goods sold on the island.
The investors taking the plunge said this type of debt issued by the Puerto Rico Sales Tax Financing Corp., known by its Spanish acronym of CofinaCFN.LB 0.00% is safer than other debt issued by the financially troubled island but still offers an attractive return. Their reasoning: The government isn't allowed to tap the agency's kitty of sales taxes to pay other obligations. Taxes are collected and allocated to pay sales-tax bondholders' principal and interest before the island's general fund is allotted its share.
MLB Photos/Getty Images
The island's sales-tax bonds offer investors higher rates than similarly rated debt. Above, jerseys on sale during the first round of the World Baseball Classic in San Juan, Puerto Rico, last month.
"It's the only credit on the island the Puerto Rico government doesn't have its claws in," said Alex Grant, portfolio manager at RS Investments, who oversees about $750 million of municipal investments and owns Puerto Rico sales-tax bonds even after getting out of some other of the island's debt this year.
Investors have been nervous about Puerto Rico's fiscal health because it has a 14.5% unemployment rate, an expanding budget deficit, and its main pension fund is only about 7% funded. All three major ratings firms have recently downgraded the commonwealth's general obligation debt to the lowest investment-grade rating, just above "junk" level.
Fluctuations in the value of Puerto Rico's debt can cause broad ripples in the U.S. municipal-bond market, as they are widely held by investors hungry for their tax benefits.
The island's $70 billion in outstanding bonds, including those sold by Cofina, are generally exempt from state, federal and local taxes.
The sales-tax bonds have midlevel investment-grade ratings. They offer investors higher rates than similarly rated debt because of their association with Puerto Rico's troubles.
A Puerto Rico sales-tax bond maturing in 28 years offered a yield of 5.03% in late March, according to BarclaysBARC.LN +1.48% while a similarly rated bond on Thomson Reuters Municipal Market Data's municipal-bond benchmark yielded 3.76%. Puerto Rico's general obligation bond yielded 5.73%, while a similarly rated bond yielded 4.37%, according to the Municipal Market Data benchmark.
There are about $16 billion of sales-tax bonds trading in the markets, comprising just over one-fifth of the island's total outstanding debt, according to Puerto Rico's Government Development Bank, the island's finance arm.
After starting off the year on a hot streak, the commonwealth's bond prices declined in March in the wake of downgrades from Standard & Poor's Ratings Services and Fitch Ratings.
At the start of January, if investors bought a Puerto Rico bond maturing in 2041, they would be rewarded with a return of 5.42% that month. If they held it to the end of the quarter, they would be stuck with a loss on their investment of 0.75%, according to Barclays. In contrast, sales-tax bonds with a similar maturity returned 3.66% in January and 0.85% through the end of March.
Kathleen McNamara, municipal-bond strategist at UBS UBSN.VX +3.42% Wealth Management, said the sales-tax bonds have "exhibited the most resiliency" of Puerto Rico's debt.
Still, there are reasons to be cautious about the sales-tax debt.
Puerto Rico's economic growth has stalled, which could constrain the amount of sales-tax revenue it collects. Prices on the sales-tax bonds could also be volatile, especially if there are more downgrades of other Puerto Rico bonds.
Also, the island collects only about 60% of the taxes it could, according to Barclays. Puerto Rican officials have stepped up their enforcement on sales-tax collection, and they are looking for ways to broaden what they tax, the firm said.
Puerto Rico officials didn't respond to requests for comment about the island's tax-collection practices.
Write to Kelly Nolan at and Mike Cherney at
A version of this article appeared April 4, 2013, on page C4 in the U.S. edition of The Wall Street Journal, with the headline: Shelter From Puerto Rico's Storm.

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