Puerto Rico Worst-to-First Returns Turning on April: Muni Credit
Puerto Rico debt has soared from worst to first in the $3.7 trillion municipal market as Governor Alejandro Garcia Padilla proposes steps to raise revenue after seven years of budget deficits.
Amid the best month for U.S. local debt since November, obligations of commonwealth issuers earned 2.4 percent in April, beating all 26 states tracked by Standard & Poor’s. The performance by the securities, which are tax-exempt nationwide, follows March’s last-place finish. Garcia Padilla, 41, who took office in January, last week recommended broadening the sales- tax base and increasing levies on top earners.
Puerto Rico bond prices have fluctuated since December as the three major credit-rating companies cut the island’s general-obligation grade to one step above junk, citing pension and budget gaps. Still, investors who stay the course stand to gain, said Scott Cottier, who helps manage $38 billion of munis at OppenheimerFunds Inc. in Rochester, New York.
“If an investor can withstand the potential volatility as a result of changes in ratings and changes in market sentiment, they’ll be very happy with the extra yield that they’re earning on Puerto Rico bonds,” said Cottier, whose holdings include $6 billion of debt from the self-governing commonwealth.
Buyers are hunting for additional yield as the Federal Reserve keeps its benchmark overnight interest rate near zero to bolster the economy. Interest rates on 20-year general- obligations are about 3.9 percent, below the 52-year average of 5.88 percent, according to a Bond Buyer index.
In a sign of demand for lower-rated debt, Iowa Finance Authority sold $1.2 billion of debt yesterday to build a fertilizer plant, the biggest muni junk deal ever.
Investors demand about 2.5 percentage points of extra yield to own Puerto Rico obligations due in July 2041 instead of top- rated bonds, Bloomberg Valuation analysis shows. That spread, while little changed from early December, reached as wide as 2.85 percentage points in January, after Moody’s Investors Service lowered the credit Dec. 13 to Baa3. That’s the lowest investment grade. S&P and Fitch followed in March.
“They’ve certainly stabilized and the selling pressure seems to have abated,” said Tom Spalding, who helps manage $10 billion of munis, including Puerto Rico debt, at Nuveen Investments Inc. in Chicago.
The broader muni market earned about 1 percent in April, keeping pace with a rally in Treasuries, which returned about 1.1 percent, Bank of America Merrill Lynch data show.
Benchmark 10-year munis yield 1.75 percent, compared with 1.67 percent on similar-maturity Treasuries. Local yields have been above their federal counterparts since April 11.
Garcia Padilla, of the Popular Democratic Party, released a $9.8 billion budget for the fiscal year beginning July 1, about 8 percent larger than the current spending plan, according to Robert Donahue, a managing director at Concord Massachusetts- based Municipal Market Advisors.
Assuming the governor’s plan is enacted, the administration projects total sales-tax revenue will grow to $2.2 billion for the coming fiscal year, from $1.2 billion this period, Javier Ferrer, president of the Government Development Bank for Puerto Rico, said in an interview from San Juan.
The governor also plans to reduce reliance on deficit financing, in which it pushes debt payments to future years, by $200 million for fiscal 2014, said Ferrer. The bank is the commonwealth’s fiscal agent.
“We are reducing to $575 million the restructuring of the debt and we are paying down more debt,” Ferrer said.
Donahue questions the governor’s sales-tax revenue estimates because the program doesn’t capture all receipts. The sales-tax system has a historical collection rate of about 60 percent, according to Moody’s.
While the $16 billion of debt repaid with Puerto Rico’s sales-tax revenue should maintain adequate coverage, Garcia Padilla’s plan to increase spending by taxing higher earners is “a little bit of a setback,” Spalding said.
The budget is “going in the wrong direction,” he said.
Garcia Padilla also wants to raise collections through a tax surcharge of 2 percent on self-employed residents who earn $200,000 or more and limiting some mortgage-interest deductions, according to Donahue.
The governor wants to add private jobs as the commonwealth’s unemployment rate in March was 14.2 percent, higher than in any U.S. state. While Puerto Rico’s economy grew in fiscal 2012 for the first time since 2006, officials project that it will contract this year and then grow by 0.2 percent in the period beginning July 1, according to the Puerto Rico Planning Board.
Puerto Rico must repay its general-obligation bonds before directing revenue to other programs and bills, a benefit for investors, said Oppenheimer’s Cottier. When yield spreads on Puerto Rico debt widen, those are buying opportunities, he said.
“The bondholders are No. 1 in line,” Cottier said. “Puerto Rico at these cheapened levels are really a great value.”
In the next two weeks, muni investors get to bid on $3 billion of revenue debt from Grand Parkway Transportation Corp. to finance a toll-road in the Houston area. The offer leads $11.5 billion of scheduled municipal issuance in the next 30 days, data compiled by Bloomberg show. That’s higher than the five-year average of $10.3 billion.
Even with the sales wave, munis may be poised for a better performance in May than in June, UBS AG research shows.
Local debt has earned more in May than the following month in nine of the past 10 years, Bank of America data show.
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