Puerto Rico Yield Above Greece Fuels Longest Rally: Muni Credit
Puerto Rico bonds are staging their longest rally in two months after prices plummeted about 40 percent this year and yields soared above those on Greek debt.
Interest rates on tax-exempt Puerto Rico general obligations that mature in July 2041 and are rated one step above junk climbed to a record 9.29 percent last week, data compiled by Bloomberg show. That compares with about 9 percent on 30-year securities of Greece, which is graded six levels lower and has received billions of euros of rescue funds.
For Mikhail Foux at Citigroup Inc. and Alan Schankel at Janney Montgomery Scott LLC, the yield surge wasn’t a result of any new deterioration in the commonwealth’s credit. Governor Alejandro Garcia Padilla is tackling recurring budget shortfalls and has bolstered a pension system with a weaker funding level than any U.S. state as he works to preserve the island’s investment grade.
Puerto Rico securities were “unfairly punished over just the last several weeks,” said Foux, a muni analyst in New York. If fund withdrawals wane, “you could effectively see people looking at Puerto Rico as a value story,” he said.
Puerto Rican debt is tax-exempt in all U.S. states, making it attractive to managers of national and state-specific mutual funds. Losses on the island’s bonds outpaced declines in the rest of the $3.7 trillion municipal market in the past few months amid speculation that an expanding U.S. economy would lead the Federal Reserve to decide as soon as this week to reduce its monthly bond purchases.
In a reversal, Puerto Rico has gained the past six trading sessions, the longest streak since July. The municipal market is on pace to advance this month for the first time since April, Standard & Poor’s data show.
The bonds due in 2041 plunged to a record low 57.6 cents on the dollar Sept. 11, from 99.31 cents Feb. 4, a 42 percent drop, according to Bloomberg data.
For investors in the top federal income bracket, last week’s peak yield was equivalent to 15.4 percent on a taxable basis, about 6 percentage points above Greek debt.
Even hedge funds and buyers who typically purchase Treasuries and corporate debt have been buying commonwealth securities, Schankel said.
Greece is in the sixth year of a recession that has been deepened by austerity measures linked to a 240 billion euro ($320 billion) bailout from the euro area and International Monetary Fund. Yields on 10-year Greek bonds eclipsed 20 percent a year ago.
“While we continue to tackle our economic challenges, it should be noted that Puerto Rico’s capacity to service its public debt is being unfairly compared to Greece,” Puerto Rico’s Government Development Bank, which handles the commonwealth’s capital-market transactions, said in a statement.
The island’s economy shrank by 5 percent in July compared with the same month in 2012, the steepest contraction since 2010, according to the Development Bank. While Puerto Rico’s 13.5 percent July unemployment rate was down from 16.9 percent in May 2010, the highest since at least 2003, it still exceeds the level in any U.S. state.
This year’s Puerto Rico sell-off has hurt even the commonwealth’s strongest credit, the Sales Tax Financing Corp., the issuer through which the island sells bonds backed by sales taxes. The debt is rated three levels below benchmark munis.
Yields on senior-lien sales-tax bonds maturing in August 2040 reached an average 6.35 percent Sept. 11, the highest since the debt was first sold in 2011, and up from the 2013 low of 3.6 percent in February. The bonds rebounded to trade with a 6.14 percent yield Sept. 16.
Puerto Rico credits “are all being grouped in together,” said Daniel Solender, who helps manage $19.5 billion of munis at Lord Abbett & Co. in Jersey City, New Jersey. “And if they’re all getting caught up in the same movement, then there’s definitely value in the different selections.”
Gary Pollack, who oversees $6 billion of munis as managing director in Deutsche Bank AG’s private-wealth unit in New York, has been buying some Puerto Rico debt this year after shunning the securities.
“Just be discriminating in which credits you buy,” John Taft, chief executive officer of RBC Wealth Management USA, said in an interview on Bloomberg Surveillance. “There’s a huge difference between the best bonds, like sales-tax bonds, and the worst bonds that they issue.”
Investors are watching Puerto Rico’s revenue collections as more than $1 billion of Garcia Padilla’s $9.77 billion budget for the fiscal year beginning July 1 relies on new tax measures. The island collected $495 million of net general-fund revenue in July, $43 million more than budgeted, according to Treasury Secretary Melba Acosta.
Meeting or surpassing revenue projections will help avert a rating cut, said Schankel, head of fixed-income research at Janney Montgomery Scott in Philadelphia. All three major credit-rating companies grade the commonwealth one level above junk, with a negative outlook.
“They’re likely to make it through this calendar year,” without a rating cut, Schankel said. “And then the chances in early next year begin to rise depending on how their revenues come in.”
Garcia Padilla, 42, a member of the Popular Democratic Party who took office in January, has moved to strengthen Puerto Rico’s finances. In one step, he pushed through laws to boost the retirement age and require public workers to contribute more to their pensions.
Muni mutual funds may still be forced to sell Puerto Rico debt this year if investors drain more cash from the portfolios, Solender said. At the same time, investors face the prospect of diminished supply of new debt from the island.
As yield climbed, the Development Bank said last week it would reduce its financing plan for 2013, capping new issues from Puerto Rico and its agencies at $1.2 billion through Dec. 31.
In this week’s nationwide local-debt market, localities are set to sell about $4.1 billion in long-term debt at the lowest interest rates in a month.
Benchmark 10-year munis yield 2.96 percent, compared with 2.85 percent for similar-maturity Treasuries. The ratio of the yields, a measure of relative value, is about 104 percent, compared with an average of 93 percent since 2001. The higher the figure, the cheaper munis are in comparison.
Following is a pending sale:
The University of California Regents are set to sell about $2.6 billion of revenue bonds as soon Sept. 25, according to state Treasurer Bill Lockyer’s website.
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