Rumpundit

If it looks mad, it is. But it’s the law! Here is Fitch’s ratings of the USVI’s bonds floated to build Diageo’s Capn Morgan Distillery. The rest of the Caribbean should really explore a WTO case…Rumpundit.

September 16, 2009 06:13 PM Eastern Daylight Time
Fitch Rates Virgin Islands Matching Fund Bonds

NEW YORK–(BUSINESS WIRE)–Fitch Ratings assigns the following ratings to approximately $466.8 million in Virgin Islands Public Finance Authority (PFA) revenue and refunding bonds (Virgin Islands matching fund loan notes), consisting of:

–$95,000,000 series 2009A (senior lien/capital projects) ‘BBB’;

–$272,000,000 series 2009B (senior lien/refunding) ‘BBB’;

–$99,770,000 series 2009C (subordinate lien/refunding) ‘BBB-’.

The bonds are expected to sell Sept. 23, 2009 via negotiation. All three series are due Oct. 1, 2010-2029, with optional redemption beginning Oct. 1, 2019. In addition, Fitch affirms the rating on outstanding matching fund bonds issued under the same indenture by the PFA, as detailed at the end of this release. The Rating Outlook is Stable.

Matching fund bonds are special, limited obligations of the PFA, issued periodically under a 1998 senior indenture (1998 indenture) for United State Virgin Island (USVI) capital purposes under both senior and subordinate liens. The ‘BBB’ rating on the senior lien bonds and ‘BBB-’ on the subordinate lien bonds reflect the established nature of the matching fund revenue stream based on federal law and direct payment by the U.S. Treasury to escrow for debt service before any other purpose. These strengths are offset by the ultimate dependence of the revenues on production at a single USVI facility at present to distill rum for export, as well as exposure to longer-term changes in U.S. consumer demand for rum. A debt service reserve funded at maximum annual debt service (MADS) provides additional protection. Coverage of debt service has been adequate, with fiscal 2008 coverage of outstanding senior lien bonds at 2.54 times (x) and aggregate coverage at 1.93x. Including the new senior lien bonds, coverage of senior lien MADS would be 2.15x, with aggregate MADS coverage at 1.69x. The Stable Outlook is based on the expected continuation of matching fund payments by the U.S. government.

Matching funds have been paid annually to the USVI by the U.S. government since 1954 based on sales in the U.S. of USVI rum. Matching fund revenues received by the USVI are tied to the sole existing distillery, Cruzan VIRIL. Construction is underway of a second distillery, for Diageo USVI, the production of which is expected to augment matching fund revenues and coverage of debt service on the current bonds after completion in fall 2010.

The matching fund program is well-established, with a base rate of $10.50 per proof gallon in place since 1954 and with periodic increases in recent years to $13.25 per proof gallon; the present $13.25 rate expires this year, pending renewal of the higher rate. Should periodic increases not be extended or lapse, the rate reverts back to the base rate of $10.50. The annual payment is calculated from projected sales of USVI-produced rum in the U.S. in the following fiscal year, adjusted by an amount reflecting the difference between estimated and actual sales two fiscal years prior. The bonds include a covenant that if matching fund revenues are replaced with another source of federal funds, the USVI will use its best efforts to use the substitute federal revenues for bond repayment. Political risks include drafted U.S. legislation questioning the use by the USVI of matching fund receipts for economic development incentives; passage of such legislation in Fitch’s view is remote. Moreover, continued production at the Cruzan VIRIL facility is tied to continued provision of incentives from the USVI government; a new incentive regime is currently under negotiation. Failure of these negotiations could lead to reduction of Cruzan VIRIL production.

U.S. consumption of distilled spirits, including rum, has grown steadily in recent years based on shifting consumer tastes and the increasing attractiveness of premium products. Rum consumption in the U.S. is subject to broader shifts in consumer demand; average demand declined by approximately 1.5% annually during the 1985-1995 period, but has increased by an average of 2.6% annually since. Under various alternative scenarios analyzed by Fitch projected matching fund revenues remain sound and provide for adequate debt service coverage. Most USVI rum exported to the U.S. is bulk rum, representing approximately 13% of the U.S. market. Planned production at the second distillery of Captain Morgan-branded rum would raise the USVI share of U.S. market to approximately 35%.

All matching funds received from the U.S. Treasury are available first for outstanding senior and subordinate bonds’ debt service under the 1998 indenture. To finance the distillery for Diageo USVI, in July 2009 the PFA established a separate, subordinate indenture (Diageo indenture) and issued $250 million in debt. Future matching fund receipts generated by the new distillery will benefit 1998 indenture bonds first, before excess receipts are made available for coverage of subordinated debt issued under the Diageo indenture. By contrast, excess receipts from Cruzan VIRIL-related matching funds are not available to Diageo indenture bondholders after payment of 1998 indenture bonds.

The additional bonds test (ABT) for the 1998 indenture bonds was revised to prevent dilution of coverage of Diageo indenture bonds. The calculation of the ABT for 1998 indenture bonds now excludes all matching fund receipts associated with the Diageo project that are required to meet debt service, debt service reserve and certain other required payments under the Diageo financing. Other ABT provisions for the 1998 indenture remain unchanged, with new issuance of senior or subordinate bonds required to meet a three-year historical and two-year prospective MADS coverage test at 1.5x debt service for senior lien and 1.25x for subordinate lien, and two-year prospective MADS coverage at 1.1x combined senior and subordinate liens.

Fitch also affirms with a Stable Outlook the ratings of certain other outstanding PFA matching fund bonds as follows:

–Revenue and refunding bonds (Virgin Islands matching fund loan notes) series 1998A at ‘BBB’;

–Revenue bonds (Virgin Islands matching fund loan note) series 2004A at ‘BBB’;

–Revenue and refunding bonds (Virgin Islands matching fund loan notes) series 1998E at ‘BBB-’.

Fitch’s rating definitions and the terms of use of such ratings are available on the agency’s public site, ‘www.fitchratings.com’. Published ratings, criteria and methodologies are available from this site, at all times. Fitch’s code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the ‘Code of Conduct’ section of this site.