July 29 (Bloomberg) -- Puerto Rico debt is rallying the most this year as lawmakers of the self-governing commonwealth shrink its chronic budget deficits and take steps to bolster one of the nation’s weakest pension systems.
As investors prepare for next week’s $600 million bond sale by the island’s electric agency, the first of 2013 from the commonwealth, the extra yield buyers demand on Puerto Rico debt is close to the smallest since at least January, data compiled by Bloomberg show.
The island’s securities are tax-exempt nationwide, drawing demand even as Puerto Rico’s fiscal challenges have pushed it to the brink of speculative grade. The bonds are rebounding from the worst monthly loss in five years after legislators reduced the budget gap to the least since 2009 and moved to trim pension costs, said Joseph Rosenblum, director of municipal credit research at AllianceBernstein LP in New York.
“They’re in a better position than January,” said Rosenblum, whose company manages $31 billion of local debt, including Puerto Rico bonds. “They are certainly addressing many of the issues that were cited against them” by ratings companies, he said.
Puerto Rico securities lost about 5 percent in June, the worst performance since 2008, Standard & Poor’s data show. The $3.7 trillion municipal market fell 3 percent, part of broader fixed-income declines amid bets that the Federal Reserve would scale back its bond purchases.
“We’re definitely taking a look given where the yields have backed up to,” said Daniel Solender, who helps manage $19.5 billion of local debt, including Puerto Rico, at Lord Abbett & Co. in Jersey City, New Jersey.
The island of 3.7 million people tends to have higher interest rates than U.S. states because the major credit-rating companies grade the commonwealth one step above junk with a negative outlook.
The extra yield buyers demand on 30-year Puerto Rico bonds was 2.12 percentage points July 25, near a 2013 low of 2 percentage points set July 18. The gap is still down 28 percent from the start of the year even as Puerto Rico 10-year yields are coming off their second-biggest weekly increase this year.
“There are investors on the sidelines who will buy on cheapness,” said Tom Weyl, director of muni research at Barclays Capital Inc. in New York. “Puerto Rico has positive credit news. They should be stable for a while.”
Governor Alejandro Garcia Padilla, 41, who took office in January, signed a budget last month for the fiscal year that began July 1 that uses $750 million of deficit financing, the smallest gap since at least 2009, according to the Government Development Bank for Puerto Rico. Lawmakers this year boosted the retirement age and increased public workers’ pension contributions.
The Puerto Rico Electric Power Authority, operator of the largest U.S. public power system, plans to sell debt three weeks after Detroit filed a record municipal bankruptcy and as muni mutual funds have seen nine straight weeks of withdrawals.
Detroit’s bankruptcy shouldn’t affect the bond deal because investors have already digested the filing, Jose Pagan, interim president at the Development Bank, said from San Juan.
“There’s been no contagion in terms of Detroit,” he said. “We’re going to time our entry into the market and make sure that it’s the most efficient. We don’t foresee any major issues.”
The Puerto Rico authority is rated one step above junk by Moody’s Investors Service. It’s the biggest commonwealth sale in almost 16 months, Bloomberg data show.
Agency bonds maturing in July 2026 traded July 25 with an average yield spread of 2.6 percentage points, the smallest since July 17.
The island’s leaders still face the challenge of bringing down a jobless rate that was 13.2 percent in June, higher than in any state. Also, Puerto Rico’s pension liability as a percentage of revenue is about 234 percent, more than 49 states, according to Moody’s. Only Connecticut has a higher ratio.
The performance of Puerto Rico debt in the next few months will depend on demand across the municipal market as supply of commonwealth bonds is set to increase, Rosenblum said.
Along with the electric agency sale, Puerto Rico is poised to refinance about $600 million of general obligations as soon as September. The Puerto Rico Highways & Transportation Authority plans to borrow from $750 million to $1 billion about 30 days after the general-obligation sale, Pagan said. Those deals will repay two $400 million loans from U.S. banks, said Pagan, who declined to identify the institutions.
Localities from California to Massachusetts are set to borrow $4.6 billion of debt this week, the slowest non-holiday week since June, as municipal borrowing costs rise.
At 2.93 percent, 10-year benchmark muni yields are near the highest April 2011. That compares with 2.56 percent for similar-maturity Treasuries.
The ratio of the yields, a measure of relative value, is 114 percent, compared with a five-year average of about 100 percent. The higher the ratio, the cheaper municipal securities are against federal debt.
The municipal market has lost about 1.6 percent this month, compared with a 0.3 percent decline for Treasuries, Bank of America Merrill Lynch data show.
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