Rating firm downgrades V.I.'s rum-backed debt
Published: September 3, 2013
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ST. CROIX - A revised calculation that lowers the amount of projected coverover revenue the territory is forecast to receive from Captain Morgan rum sales has prompted Fitch Ratings to downgrade its ratings of V.I. Matching Fund Bonds issued by the V.I. Public Finance Authority.
Fitch's outlook on the bonds remains stable.
Even with the lower ratings by Fitch, the Matching Fund Bonds remain investment grade - although some of the bonds are in the lowest tier of that category.
"We don't expect this is going to have any impact on the saleability of our bonds," said Public Finance Authority Executive Director and V.I. Finance Commissioner Angel Dawson Jr.
The Public Finance Authority is in the process of going to the bond market to restructure and refund approximately $75 million in old Matching Fund bonds, with an eye toward getting a lower interest rate that officials anticipate will save the government approximately $23.9 million in debt service payments for Fiscal Year 2014.
That savings is to be applied toward a projected deficit in the territory's budget for FY 2014.
Early in August, Fitch had affirmed its existing ratings on the Matching Fund Bonds.
However, after receiving new information based on corrected projections by an independent economic forecasting company, Fitch made the decision to downgrade the bond ratings, said Marcy Block, a senior director at Fitch.
Fitch Ratings is one of three global credit rating agencies recognized by the Securities and Exchange Commission.
What the error in the forecast boils down to is this: Captain Morgan rum contains less alcohol than was previously assumed by the independent economic group - IHS Global Insight - that did the forecast for the bond issuance.
Because coverover revenues - the rum tax rebate the territory receives from the federal government when Virgin-Islands produced rum is sold in the United States - are tied to proof gallons, alcohol content matters.
A proof gallon is a standard U.S. gallon of spirits that contains 50 percent alcohol, which is 100 proof. Rum that is bottled at 40 percent alcohol - or 80 proof - would be 0.8 proof gallons per gallon of liquid, according to the U.S. Treasury.
Therefore, the lower the alcohol content in the rum, the more rum it takes to make a proof gallon.
For every proof gallon of Virgin Islands-produced rum exported to the U.S. mainland, the federal government collects $13.50 in excise taxes from the manufacturer. A portion of the excise tax collected is returned to the territory
The base rate for the rum tax rebate - also called the coverover - to the territory is $10.50 per proof gallon, but Congress has temporarily increased the rebate a number of times in recent years to $13.25 per proof gallon. The coverover is currently at the $13.25 rate, set to expire in December unless it again is renewed.
The V.I. Matching Fund Bonds are backed by the territory's revenue stream from future rum tax rebates.
Part of the process that the Public Finance Authority goes through when issuing bonds is hiring an independent economic group to do forecasting, which then becomes part of the documentation for the bond issuance.
Block said that Fitch was contacted last week by IHS Global Insight, which indicated that after speaking with Diageo - the company that produces Captain Morgan rum - recently, it had learned that the alcohol content in Captain Morgan was not as high as it previously had thought, Block said.
Dawson said that IHS Global Insight had been assuming the industry average of 80 proof rum in doing its calculations, when Captain Morgan, at 70 proof, has less alcohol.
Therefore, IHS Global Insight had been using the wrong conversion factor to determine projected coverover revenues for the territory from Diageo, he said. There was no change to the projections for Cruzan Rum.
Dawson said the Public Finance Authority was disappointed in the discovery that the wrong conversion factor had been used in the forecast.
He described IHS Global Insight as a "highly-regarded econometric firm that we, of course, would rely on for the credibility and acumen of the projections."
The IHS Global revised forecast based on the lower alcohol content of Captain Morgan lowered the territory's overall projected coverover revenue during FY 2013 by 13.1 percent, from $271.6 million to $235.9 million, according to the Fitch report.
The coverover revenue had to be revised down in the forecast, based on the different conversion factor, for the life of the bonds.
The lower projected coverover revenue in the forecast is what prompted Fitch to make the downgrade, according to Block.
"We care about the revenue, because that's what pays the debt service," Block said.
Dawson said that the territory bases its annual request for an advance on coverover revenue from the U.S. government on what the territory's two rum manufacturers say their actual production in proof gallons will be that year and not on the type of forecast that goes with a bond issuance.
Based on the revised forecast that is part of the bond issuance, Fitch made the downgrades, which were announced Thursday.
Moody's and Standard & Poor's - the other two global credit rating agencies - also were informed of the revised forecast but did not change their existing ratings, Dawson said.
The new Fitch ratings put the Matching Fund Bonds in these categories:
- $901.1 million in senior lien revenue bonds dropped from "BBB+" to "BBB."
- $177 million in subordinate lien revenue bonds, $250 million in subordinated revenue bonds for the Diageo project series 2009A, and $37.5 million in subordinated revenue bonds for the Cruzan project series 2009A dropped from "BBB" to "BBB-"
According to Fitch, "BBB" ratings are considered good credit quality and "indicate that expectations of default risk are currently low. The capacity for payment of financial commitments is considered adequate, but adverse business or economic conditions are more likely to impair this capacity."
The bond ratings that dropped to "BBB-" are in the lowest tier of investment grade.
Dawson said that the changes Fitch announced last week put Fitch's ratings in line with those of the other two agencies.
He said he does not anticipate any impact on the bond refunding that is in process.
The Public Finance Authority anticipates getting good interest rates and having more demand for the bonds than there are bonds available, according to Dawson.
- Contact Joy Blackburn at 714-9145 or email email@example.com.