Puerto Rico’s Best Start Excludes Development Bank: Muni Credit

Puerto Rico’s Best Start Excludes Development Bank
Puerto Rico is struggling to bolster its economy as it grapples with a pension-funding ratio lower than any state. Photographer: Alfredo Sosa/The Christian Science Monitor via Getty Images

Puerto Rico’s Government Development Bank, with $4.6 billion of municipal debt, is being left out of a rally that has driven the U.S. commonwealth’s bonds to their best annual start since 2010.

Investors are penalizing the bank, rated one step above junk, even as the island’s municipal securities are gaining at three times the rate of the broader $3.7 trillion market. The extra yield investors demand to own some of the lender’s bonds reached the highest in 15 months in April, data compiled by Bloomberg show.

The institution sells bonds and provides loans and financial advice to the commonwealth and its authorities. The bank is “fragile” because of unpaid loans to agencies, its president, Javier Ferrer, said in an interview from San Juan. Loans to the Puerto Rico Highways & Transportation Authority were a record $2.2 billion as of March 31, from $84 million in fiscal 2008.

Any limit on the institution’s ability to support Puerto Rico “would be a big negative,” said Joseph Pangallozzi, managing director at New York-based BlackRock Inc., which oversees $109 billion of munis. It “has been an integral part of providing liquidity, providing loans to the agencies and the commonwealth.”

Risk Calculus

With municipal yields near five-decade lows, investors have taken on added risk to boost returns. The self-governing commonwealth, whose debt is tax-exempt nationwide, has lured buyers even as its general-obligation grade is one step above junk.

Puerto Rico is struggling to bolster its economy as it grapples with a pension-funding ratio lower than any state. The island’s 14.2 percent jobless rate in March, while down from 16.9 percent in 2010, eclipsed the level in all states.

Still, munis from the island of 3.7 million people have gained 3.3 percent this year, beating all states and territories and compared with 1.1 percent for the entire market, Barclays Plc data show.

National and state-specific muni mutual funds favor Puerto Rico for its tax-exempt benefit. Commonwealth general obligations sold last year and due in July 2041 were the most frequently traded muni in 2012, according to the Municipal Securities Rulemaking Board.

Rally Reject

Even with the Puerto Rico rally, the yield penalty has grown on the development bank’s munis, which are federally taxable. The bank is a public corporation formed in 1942 to spur economic growth and finance infrastructure.

Taxable bonds due in February 2019 are valued by BVAL pricing analysis at a yield spread of about 3.9 percentage points above Treasuries. That compares with 3.1 percentage points Dec. 12, the day before Moody’s Investors Service dropped the bank to the lowest investment grade and assigned a negative outlook. The gap reached 4.2 percentage points last month, the highest since the bank sold the debt in February 2012.

Puerto Rico’s government and its agencies owe the bank $6.9 billion as of March 31, with $3.2 billion of that payable from commonwealth revenue or legislative appropriation, Ferrer said.

The highway authority, which oversees roads and bridges, owed almost $2.2 billion as of March 31, the most it has ever borrowed, and amounting to 24 percent of the development bank’s loan portfolio, Ferrer said. The road agency also has $5 billion of munis, Ferrer said.

Capital Preservation

“We need to resolve this situation by June 30,” the last day of the fiscal year, for accounting purposes, Ferrer said. “We want to make sure we preserve our equity, our capital base.”

The bank is discussing revenue options with the highway authority, the legislature and the administration, and plans to announce a strategy “shortly” that will enable the roads agency to issue munis and repay the bank, Ferrer said.

He is scheduled to update investors tomorrow at an annual conference in San Juan on the commonwealth’s finances.

Irma Moyeno, spokeswoman for the highway authority, didn’t respond to e-mails and phone messages.

“The commonwealth has endeavored to maintain GDB’s capital and liquidity position as weaker corporations,” including the highway agency, “lean on it for support,” Moody’s said in a statement yesterday.

‘Vital’ Role

Daniel Solender, who helps manage $19.5 billion of munis at Lord Abbett & Co., said the bank has helped Puerto Rico and its agencies maintain their operations. The commonwealth’s recurring expenditures have exceeded revenue since 2000, according to the bank’s financial audit for the fiscal year that ended June 30.

“There’s definitely a need to have that backing when the revenues aren’t sufficient whether it’s the highways authority or any other agency,” said Solender, who’s based in Jersey City, New Jersey. “So it’s really vital to the credits that the bank is funded sufficiently.”

In the broader market, local-debt is on pace to outperform Treasuries for the second straight month.

At 1.8 percent, yields on benchmark 10-year munis compare with 1.94 percent for similar-maturity Treasuries.

The ratio of the two interest rates, a gauge of relative value, is about 92 percent, close to the lowest since March 11. The lower the figure, the more expensive local-government bonds are when compared with federal securities. The ratio has averaged 92 percent since 2001.

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