Puerto Rico Climbs Most in Year as Redemptions Rise: Muni Credit

Puerto Rico debt, rated one step above junk, is rallying the most in a year as a strengthening national economy helps lure investors to bet on the commonwealth.

The gains in the island’s bonds, which are tax-exempt in all U.S. states, greeted Governor Alejandro Garcia Padilla as he took office Jan. 2. The 41-year-old Democrat faces a pension system that’s able to meet less than 7 percent of promised obligations and a history of borrowing to balance budgets, a scenario that led Moody’s Investors Service to downgrade Puerto Rico in December.

Still, debt of commonwealth issuers earned 2.8 percent in January, the best in a year, Barclays Plc data show. The island’s bonds, which yield more than any state, attracted some of the $32 billion of principal and interest distributed to muni debt-holders last month for reinvestment. It was one of the year’s four busiest redemption months, according to Bank of America Merrill Lynch.

“People were putting money to work in January, and there were new buyers or buyers who could still own these downgraded credits,” said Mark Paris, who helps oversee about $7.4 billion of munis, including Puerto Rico bonds, at Invesco Ltd. in New York.

Island Comeback

Demand for commonwealth securities is rebounding after a selloff sparked by the Dec. 13 Moody’s rating cut. The gain is getting added impetus as signs of an improving U.S. economy bolster investor confidence in riskier, higher-yielding debt as municipal interest rates remain close to 47-year lows.

Nationwide, hiring rose in January after gaining more than previously estimated at the end of 2012, Labor Department data showed last week. Payrolls rose by 157,000 after a revised 196,000 jump in December and a 247,000 surge in November.

Investors should brace for volatility in the commonwealth’s debt this year as the new governor works to repair the island’s finances, Paris said. The commonwealth still has a negative outlook from Moody’s.

The administration plans to file legislation by early March to strengthen the pension, Javier Ferrer, president of the Government Development Bank for Puerto Rico, said in an interview from San Juan. The bank is the commonwealth’s fiscal agent. He declined to give specifics.

Confronting Challenges

“We understand the challenges that need to be tackled swiftly,” said Ferrer, 51, a former corporate lawyer. “Those include addressing the retirement-system situation, addressing the general fund structural imbalance and creating sustainable economic activity in Puerto Rico.”

As Puerto Rico rallied this month, general obligations maturing in July 2041 traded yesterday with an average yield of about 5.1 percent, data compiled by Bloomberg show. That was about 2.2 percentage points above a benchmark index, down from 2.6 percentage points Dec. 14.

Invesco’s Paris said he bought Puerto Rico Aqueduct & Sewer Authority debt below par in late December and sold other bonds of the agency at a profit. BlackRock Inc., the world’s largest money manager, also bought and sold Puerto Rico credits in December and January as yield spreads widened after the downgrade, said Jim Schwartz, head of the firm’s muni research in Princeton, New Jersey.

‘Attractive’ Destination

Nuveen Investments Inc. and Lord Abbett & Co. are also watching for buying opportunities.

“We see Puerto Rico as very attractive,” particularly in seven- to 10-year maturities, said Tom Spalding, who helps manage $10 billion of munis, including Puerto Rico debt, at Nuveen in Chicago.

Puerto Rico’s pension assets were 6.8 percent of what it owes in retirement payments as of June 30, 2011, according to the commonwealth. In comparison, Illinois had a funding ratio of about 43 percent, lowest among U.S. states, data compiled by Bloomberg show.

The commonwealth also had $51.9 billion of net tax-supported debt last year, or $14,004 per capita, about 10 times the U.S. average, according to Moody’s.

The budget for this fiscal year relies on selling about $775 million of debt by June 30 to push principal and interest payments to future years, Ferrer said. Ferrer said he will move forward with that transaction after the administration announces its pension changes.

Credit Risk

“This governor quickly has to come to terms with some pension-reform package that is viable and realistic or you could see continual downgrades,” said Joseph Pangallozzi, a managing director at BlackRock in Princeton.

Garcia Padilla is working to raise revenue for the commonwealth’s general fund. The administration this week filed legislation to increase the excise tax on manufacturers not based in the commonwealth to 4 percent through Dec. 31, 2017, Ferrer said. The levy is currently 2.75 percent.

The governor, a member of the Popular Democratic Party, is set to release his budget for the fiscal year starting July 1 in April or May, Ferrer said. While the administration will try to avoid borrowing to help balance that spending plan, such deficit financing “is a possibility,” he said.

In trading yesterday, yields on benchmark munis due in 10 years were little changed at 1.84 percent, close to the highest since August, Bloomberg Valuation data show.

Following is a pending sale:

SAN FRANCISCO’S PUBLIC UTILITIES COMMISSION plans to issue about $335 million of wastewater revenue bonds as soon as Feb. 12 through competitive bid, data compiled by Bloomberg show. Proceeds will finance capital projects, according to bond documents. (Added Feb. 6)

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