Puerto Rico Electric Cheap to Detroit at Record Low: Muni Credit

Puerto Rico’s electric agency is set to pay record-high yields after Detroit’s bankruptcy helped drive a cash exodus from the municipal market. OppenheimerFunds Inc. and Janney Montgomery Scott say now’s the time to buy as the commonwealth moves to mend its economy.

Puerto Rico Electric Power Authority, which serves the most customers among U.S. public-power systems, plans to sell $675 million of revenue bonds as soon as today, up from the $600 million originally planned. It’s the first muni offer in eight months from the island. In a sign of stress facing lower-rated issuers in the $3.7 trillion market, investors are demanding loftier yields on the Puerto Rico agency’s debt than on some bonds of bankrupt Detroit’s water utility, with a credit rating four steps lower.

Tax-exempt bonds of the electric agency that mature in 27 years and are rated one level above junk by Moody’s Investors Service traded last week at 7.1 percent, the highest since their March 2010 issue, according to data compiled by Bloomberg for sales of at least $1 million. The 2.7 percentage points of extra yield over benchmark munis was the most since at least May.

“Puerto Rico debt is a phenomenal opportunity,” said Michael Camarella, who helps manage $33 billion of munis at OppenheimerFunds in New York, including almost $6 billion of Puerto Rico securities.

“People are unaware of all the positives out of Puerto Rico and all they hear are the negative headlines,” he said.

Fleeing Funds

The utility is selling less than three weeks after Detroit entered the nation’s biggest municipal bankruptcy. The move by Michigan’s biggest city and bets that the Federal Reserve will reduce its bond buying led individuals, who own about 70 percent of local debt, to pull $4.86 billion from muni mutual funds in the four weeks through July 24, the most since February 2011, Lipper US Fund Flows data show. The exiting cash helped push muni yields to a two-year high.

Debt of Puerto Rico tends to offer extra yield because the three major credit-rating companies give the commonwealth the lowest investment grade, with a negative outlook, as the island’s leaders struggle with a shrinking economy and one of the nation’s weakest pension systems. The securities draw demand because they are tax-free in all U.S. states, allowing state-specific muni mutual funds to hold them.

Trailing Junk

The electric agency’s debt is cheaper than Detroit’s water bonds even though Moody’s rates the water utility four levels below investment grade.

In trades of at least $1 million, Detroit water bonds due in July 2041 sold July 29 with an average yield of 5.89 percent, or 0.6 percentage point less than similar-maturity Puerto Rico electric debt, data compiled by Bloomberg show.

The Puerto Rico yield jump was also caused by money managers holding off on buying until the new deal came to market, said Alan Schankel, head of fixed-income research in Philadelphia at Janney.

“The spreads now are pretty attractive and it’s probably the right time to be getting involved with Puerto Rico,” Schankel said.

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 Puerto Rico’s Government Development Bank. The bank handles the island’s capital-markets transactions. Lawmakers this year raised the retirement age and increased employee contributions to the pension fund.

Governor’s Steps

Garcia Padilla, a member of the Popular Democratic Party, “has shown to the rating agencies that he’s doing what needs to get done,” Camarella said.

While the island’s 13.2 percent June unemployment rate is the lowest in five years, it’s higher than in any state. The commonwealth’s economy contracted 4.5 percent in the year through June, the steepest reduction since 2010, according to the development bank. Net tax-supported debt of $14,053 per capita last year was more than in any state, according to Moody’s.

The development bank declined to comment on the electric utility’s offer because the bonds haven’t priced yet, the bank said in an e-mail through Joele Frank, a New York communications firm.

All Alone

The power agency is the sole provider of electricity on the island of 3.7 million, with the most clients and revenue among U.S. public-power utilities, according to bond documents. Proceeds will finance capital projects. The authority had about $8.1 billion of debt as of June 30, bond documents show.

To cut costs, the agency plans to reduce its use of oil to 2 percent of energy production in 2017 from 61 percent in 2012 by converting facilities to run on natural gas, according to a presentation by Juan Alicea Flores, its executive director, at the commonwealth’s annual credit conference in May.

The increase in yield “has been a little bit overdone,” Schankel said. “We’ll see some stability once we get this deal behind us.”

The agency plans to sell debt due in as long as 30 years with a preliminary yield of 7.15 percent, according to three people familiar with the deal who requested anonymity before prices are final.

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