Puerto Rico Yields Above Venezuela’s in Worst Rout: Muni Credit

Puerto Rico’s borrowing costs are at a record high as the self-governing commonwealth’s revenue trails forecasts, calling into question the island’s ability to tackle a debt load greater than that of all but two U.S. states.

Investors in the $3.7 trillion municipal market are punishing Puerto Rico even after the nine-month-old administration of Governor Alejandro Garcia Padilla boosted pension contributions and raised taxes to keep the territory’s obligations from being cut to junk. His challenge is compounded by a shrinking local economy.

The island’s financial health is a concern for the U.S. fixed-income market because about 77 percent of municipal-bond mutual funds hold Puerto Rico debt, which is tax-exempt nationwide, according to Morningstar Inc. The commonwealth of 3.7 million people has about $58 billion of gross tax-supported debt, trailing only California and New York, Moody’s Investors Service data show.

“We’ve heard the government of Puerto Rico talk about achieving budget balance in a short time frame and that seems to always be missed,” said Joseph Rosenblum, director of municipal credit research in New York at AllianceBernstein LP, which manages $31 billion of local bonds, including some from the island. “There is a huge amount of debt, which worries a lot of people.”

Governor’s Pitch

Garcia Padilla, 42, of the Popular Democratic Party, took office in January. He traveled to New York this week to discuss his fiscal and economic initiatives with ratings companies. Puerto Rico is graded one step above junk by the three major rating firms, with a negative outlook, and is preparing to borrow as much as $1.2 billion by year-end to balance budgets.

Officials plan to use debt backed by sales-tax revenue for the financing, because the securities are graded three to four levels above the island’s general obligations. Even the sales-tax bonds, which Moody’s Investors Service cut to A2 this month, sixth-highest, trade at historically high yields.

“This administration has implemented a number of very significant measures to support sustainable economic growth through job creation and continued progress towards a balanced budget,” commonwealth Treasury Secretary Melba Acosta and Jose Pagan, interim president of the Government Development Bank, said in a statement after the sales-tax bonds’ rating was cut.

The bank plans a webcast for investors on Oct. 15.

Worse Off

Debt of Puerto Rico is faring even worse than the broader municipal market, which is headed for its worst year since 2008.

Puerto Rico obligations have lost 19.1 percent in 2013, on pace for the steepest drop since at least 2000, Standard & Poor’s data show. The declines deepened in the past few months after Detroit filed a record U.S. municipal bankruptcy in July, and as investors bet the Federal Reserve would curb its bond-buying program.

Unlike the former auto-industry capital, Puerto Rico isn’t legally capable of filing for bankruptcy, Luis Sanchez Betances, the island’s attorney general, said in an e-mail through his spokesman, Miguel Pereira.

This week, investors demanded as much as 4.8 percentage points of extra yield to own commonwealth general-obligation bonds maturing in July 2041, data compiled by Bloomberg show. That was the biggest yield spread since the debt’s issue 19 months ago.

Exceeding Venezuela

Ten-year Puerto Rico debt yields about 7.94 percent, according to BVAL data. That’s 13.1 percent on a taxable basis for investors in the top federal income bracket.

The level exceeds the 12.6 percent interest rate on similar-maturity U.S. dollar debt of Venezuela. That country’s borrowing costs have surged since the death of former President Hugo Chavez in March, as signs of economic distress and government rhetoric against perceived opponents raise concern over the country’s ability and willingness to pay creditors.

Garcia Padilla has moved to end recurring budget deficits while also reviving a struggling economy.

An index that measures the commonwealth’s economy fell 5.4 percent in August from a year earlier, the biggest drop since 2010, according to Puerto Rico’s Government Development Bank, which handles the island’s capital-market transactions.

Garcia Padilla has enacted laws that boost the retirement age and workers’ contributions to Puerto Rico’s pension system, which has a funding level below that of any U.S. state.

The governor also implemented a new corporate tax and expanded the sales levy to more transactions to help balance a $9.77 billion budget for the fiscal year that began July 1.

‘Significant’ Steps

Moody’s affirmed the commonwealth’s Baa3 general-obligation rating Oct. 3, calling the administration’s fiscal steps “significant.”

Puerto Rico has done more than any U.S. state in the past few years to implement pension changes, raise revenue and reduce budget shortfalls, said Rosenblum and Alan Schankel, managing director at Janney Montgomery Scott LLC in Philadelphia.

“They stand well above actions taken by any state,” Schankel said. “They are in worse shape than any state, so they needed to take those actions, but I thought it was impressive that they took the actions that they did. It was very socially and politically difficult and challenging for the legislators and the administration.”

Yet more than $1 billion of Garcia Padilla’s spending plan relies on new tax measures.

Preliminary net revenue collections for the first quarter tallied $1.68 billion, or $7 million less than budgeted estimates, according to Acosta. That’s still $70 million more than the same period last year.

Revenue Concern

“There’s some concern about revenue performance -- were they too optimistic in terms of their projections?” Rosenblum said. “And these series of tax increases are complex and still need to be implemented.”

Garcia Padilla wants to make some agencies operate without assistance from the central government, reducing one strain on the island’s budget.

Puerto Rico’s Aqueduct & Sewer Authority, which serves about 1.3 million customers, increased water rates this year to generate $300 million of revenue to help wean the agency from government financing. Meanwhile, higher petroleum taxes and motor-vehicle fees will add $276 million to the Highways & Transportation Authority’s operations.

Localities nationwide have scheduled about $8.3 billion of borrowing in the next 30 days, or 12 percent below this year’s average, as the federal government shutdown extends to a second week.

Market Week

Top-rated 10-year munis yield 2.72 percent, close to a three-month low, and compared with 2.63 percent for similar-maturity Treasuries.

The ratio of the yields, a gauge of relative value, is about 103 percent, where the average has been 93 percent since 2001. The higher the figure, the cheaper munis are compared with federal securities.

Following is a pending sale:

The Cook County, Illinois, district that operates seven City Colleges of Chicago plans to sell $250 million in federally tax-exempt bonds this week. The proceeds will finance work such as a health facility and a transportation hub, according to S&P, which rates District 508’s debt AA, third-highest.

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