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Puerto Rico Debt Poised for Worst Year Since 2000: Muni Credit

Governor Alejandro Garcia Padilla
Governor Alejandro Garcia Padilla enacted a budget for the fiscal year that began July 1 that uses $750 million of deficit financing, the smallest amount since at least 2009, according to the Development Bank. Photographer: GDA via AP Images

Municipal debt from Puerto Rico is poised for its worst year since at least 2000 as the U.S. commonwealth prepares to sell its first general-obligation bonds in 18 months.

Securities from the island have lost 16.3 percent this year, more than three times the decline of the $3.7 trillion municipal market, Standard & Poor’s data show. Borrowings of the territory and its local agencies haven’t had an annual drop that steep since at least 2000. Puerto Rico is on the brink of speculative grade amid recurring budget deficits and a pension system that has a lower funding level than any U.S. state.

The $600 million general-obligation refinancing sale planned for September will repay loans used to balance the budget for the fiscal year that ended June 30, Jose Pagan, interim president of the Government Development Bank for Puerto Rico, said last month. Investors demanded 2.76 percentage points of extra yield as of Aug. 28 to buy 30-year commonwealth general obligations rather than top-rated munis, the most since January, data compiled by Bloomberg show.

“Individuals are running scared on Puerto Rico right now,” said Matt Dalton, who manages $1.6 billion of munis at Belle Haven Investments Inc. in White Plains, New York. “There’s a good chance that it will be the underperformer for 2013.”

Island Punished

Bond buyers are punishing Puerto Rico as they favor higher-rated securities during the biggest wave of withdrawals from municipal debt since 2011. As investors bet a growing economy will lead the Federal Reserve to curtail its bond buying, the muni market has lost 5 percent this year, according to S&P.

While benchmark muni yields reached a two-year high this month, Puerto Rico debt fared worse. Individual investors, who own about 70 percent of the municipal market, are “spooked” by the drop in prices on the territory’s bonds and are selling, Dalton said.

Puerto Rico debt is tax-exempt nationwide, allowing state-specific muni mutual funds to buy the securities. Investors have pulled $5.9 billion this year from U.S. muni mutual funds focusing on lower-rated and non-investment-grade munis, according to Lipper US Fund Flows data through Aug. 28. That’s the most since 2011.

Shrinking Economy

The island of 3.7 million people had an unemployment rate of 13.5 percent in July, compared with 7.4 percent nationwide. Puerto Rico’s economy shrank 4.5 percent in the year through June, the steepest contraction since 2010, according to the Development Bank.

Governor Alejandro Garcia Padilla, 42, who took office in January, enacted a budget for the fiscal year that began July 1 that uses $750 million of deficit financing, the smallest amount since at least 2009, according to the Development Bank. The governor, a member of the Popular Democratic Party, has raised taxes to help balance the budget.

Lawmakers this year also boosted the retirement age and increased employee retirement contributions.

While reducing budget gaps and enacting pension changes are supportive, “what investors are nervous about, though, is the volume of debt on an economy that doesn’t appear to be growing,” said Guy Davidson, who helps manage $31 billion as director of munis at AllianceBernstein LP in New York. “They’ve bought themselves some time, but Puerto Rico needs to grow.”

Debt Load

The commonwealth had about $70 billion of public-sector debt as of June 30, according to the Development Bank, which handles the island’s capital-market transactions. Net tax-supported debt of $14,053 per capita last year was more than in any state, according to Moody’s Investors Service.

Puerto Rico’s last general-obligation sale was a $2.7 billion refunding deal in March 2012, Bloomberg data show.

Debt from that sale that matures in July 2041 traded yesterday at an average yield of 8.13 percent, the highest since its issue, Bloomberg data show.

The Development Bank declined to say if it will postpone the general-obligation deal or a planned borrowing of $750 million to $1 billion for the Puerto Rico Highways & Transportation Authority.

The commonwealth refinancing and the highway agency sale will repay two $400 million bond-anticipation-note deals. The GDB said in a release yesterday that it had closed those loans.

``The successful placement of these securities demonstrates the confidence the financial community has'' in the commonwealth, the roads authority and the GDB, Pagan said in a statement.

Financing Plan

“We continue to work on our financing plan and are re-evaluating our alternatives based on market conditions,” Betsy Nazario, a spokeswoman for the bank, said via e-mail before the note sale announcement.

Losses on Puerto Rico accelerated after Barron’s published an article in its Aug. 26 issue on the commonwealth’s fiscal challenges.

The value of the island’s debt may drop even further as the commonwealth borrows in the next couple of months, Dalton said.

“It’s going to make it awfully difficult to bring another deal into the market right now, which puts pressure on them once again,” he said.

In the nationwide market for new issues, municipalities from New Jersey to Oregon plan to offer about $2 billion of long-term debt next week, which will be shortened by the Sept. 2 Labor Day holiday. It will be the slowest holiday week since January.

At 3.1 percent, yields on benchmark 10-year munis are close to the highest since April 2011, and compare with about 2.76 percent for similar-maturity Treasuries.

The ratio of the yields is about 112 percent, after reaching the highest since July 2012 this week. The greater the figure, the cheaper munis are relative to Treasuries.

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