June 28 (Bloomberg) -- Debt from Puerto Rico, with a credit rating lower than any U.S. state, is set for the worst month in almost five years. The losses signal a potential rebound as rising interest rates lure back investors.
In a sign that demand is already returning to the riskiest local bonds, Illinois had to spurn buyers at an offer of $1.3 billion of general obligations this week, even as the state faces the nation’s biggest pension liability.
Puerto Rico securities are tax-exempt nationwide. That status underscored the appeal as yields on its debt reached 5.22 percent on June 24, the highest since at least 2011 and about 8.6 percent on a taxable basis for top earners, Standard & Poor’s data show. Commonwealth bonds have still lost 5.3 percent this month, the most since September 2008, according to S&P. Munis have joined broader fixed-income declines on bets the Federal Reserve will slow its bond purchases as the economy improves.
“Our retail clients have certainly been interested in the higher yields that Puerto Rico’s been offering,” said Alan Schankel, head of fixed-income research in Philadelphia at Janney Montgomery Scott.
The island’s debt is held by bond funds across the U.S. because of its tax-free status. The self-governing commonwealth of 3.7 million people had $53 billion of net tax-supported debt in 2012, more than all but two states -- California and New York -- according to Moody’s Investors Service. The debt load is a reason the three major credit rating agencies grade Puerto Rico one level above junk, with a negative outlook.
Prices of Puerto Rico obligations are stabilizing as lawmakers this week are poised to pass a budget for the fiscal year beginning July 1, Maria Martinez, spokeswoman for senate President Eduardo Bhatia, said by telephone. The commonwealth also enacted higher taxes on petroleum products that will help the Puerto Rico Highways & Transportation Authority repay $2.2 billion to the Government Development Bank, which handles the island’s capital-markets transactions.
“There’s been some good news in Puerto Rico,” Schankel said. Puerto Rico debt will also benefit as the broader tax-exempt market has begun to rebound, Schankel said.
Yields on benchmark 10-year munis fell 0.12 percentage point yesterday to 2.8 percent, the biggest drop since May 2009, and dropped again today, data compiled by Bloomberg show. Also this week, an index of Puerto Rico yields fell the most since at least 2011.
Individuals buying Puerto Rico bonds through a broker increased their purchases as muni trades set a daily record this week, said John Bagley, president of New York-based BondDesk Trading, a platform for transactions in munis and other fixed-income securities.
The system recorded 11,590 muni trades on June 25, a record, Bagley said. The platform began trading munis in 2002. While in early June sales of commonwealth bonds matched the amount purchased, that dynamic has shifted, Bagley said.
“At the end of June in Puerto Rico, it was really like two-thirds of the business was buying and one-third was selling,” Bagley said.
The volatility hasn’t changed Puerto Rico’s borrowing plans. It is set to refinance commonwealth debt and highway authority bonds in the next three months, the GDB said in an e-mail through Joele Frank, a New York communications firm.
Puerto Rico still faces hurdles. An index measuring its economy dropped 3.5 percent in April compared with a year earlier, according to the GDB. The island’s jobless rate was 13.4 percent in May, higher than in any state.
“Puerto Rico’s economy is not faring well at all,” William C. Dudley, president of the Federal Reserve Bank of New York, said at a press briefing in New York this week.
While the island’s spending plan is balanced through a new business tax and an expanded sales levy, achieving its targets will be a challenge, said Joseph Pangallozzi, managing director at New York-based BlackRock Inc., which oversees $114 billion of munis.
“They have to meet those revenue targets,” he said by phone. “They have to stay within their spending projections.”
For some buyers, the risk is worth it. The 5.03 percent yield on Puerto Rico bonds due in 18 years is 1.33 percentage points more than benchmark munis.
The rebound of the past few days wasn’t enough to prevent historic outflows from municipal-bond funds. Investors withdrew $4.5 billion for the week through June 26, the most since at least 1992, when Lipper US Fund Flows began tracking the data.
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