March 4 (Bloomberg) -- The longest rally in Puerto Rico debt in 10 months may push yields on the U.S. commonwealth’s general-obligation deal planned for next week below 10 percent as investors seek riskier debt.
Securities of Puerto Rico and its agencies are extending gains to a fifth straight week, the longest streak since May, according to S&P Dow Jones Indices. The Caribbean island is preparing to sell as much as $3.5 billion, its first general-obligation sale in two years, to balance budgets and refinance debt.
The debt may yield about 9 percent, with investors prepared to submit bids for more than $7 billion, said Michael Walls, who helps manage about $2 billion of high-yield munis at Waddell & Reed Financial Inc. While that interest rate would be below estimates last month of double-digit levels, it would still exceed borrowing costs of comparably rated companies, he said.
“At the end of the day, it’s all a relative deal,” said Walls, whose company is based in Overland Park, Kansas.
Puerto Rico is borrowing after the three largest rating companies cut it to junk starting on Feb. 4, citing limited funds and market access. The island’s finances influence the $3.7 trillion municipal-bond market because 70 percent of U.S. mutual funds that focus on state and local debt hold the securities, which are tax-exempt nationwide.
A 9 percent tax-free yield would be almost double the interest rate on junk-rated corporate debt. That will attract hedge funds and investors who typically buy taxable bonds, Walls said. An index of company debt in the BB ratings tier yielded 4.75 percent as of March 3, according to Bank of America Merrill Lynch indexes.
The general obligations are set to price as soon as March 11, according to a person with knowledge of the sale who requested anonymity because terms of the offering aren’t final.
Proceeds will give the commonwealth sufficient funds through June 2015, according to David Chafey, chairman of the Government Development Bank, which handles the island’s debt transactions.
As it becomes more likely that Puerto Rico will find enough demand for the deal, investors are gaining confidence that the territory will have cash to repay bills in the next 15 months, said Daniel Solender, director of munis at Lord Abbett & Co.
“It gives them liquidity for a while, and so any near-term default scenario or non-payment would be unlikely,” said Solender, whose company is based in Jersey City, New Jersey, and oversees $15.5 billion of munis.
Initial estimates pegged yield levels for the sale in the low double-digits, Matt Fabian, managing director at Concord, Massachusetts-based research firm Municipal Market Advisors, wrote in a Feb. 18 report.
In the event of a default on this deal, bondholders would be able to sue the commonwealth in a New York court, a first for Puerto Rico general obligations, according to preliminary documents for the sale.
The offering documents include 12 pages of “risk factors” for investors. In the commonwealth’s last general-obligation sale in March 2012, sale documents didn’t include a section outlining risks.
Puerto Rico general obligations maturing in July 2041 traded today with an average yield of 7.65 percent, close to the lowest since October.
The self-governing territory’s debt has earned 6.1 percent since the week starting Feb. 3, while the entire market has gained 1.4 percent, S&P data show.
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