Puerto Rico Deal No Reprieve From Record-Low Supply: Muni Credit

Puerto Rico is set to offer the biggest municipal-bond sale in almost two years. The planned $2.86 billion borrowing still won’t be enough to meet the demand of investors amid a historic slump in debt sales.

After the island’s credit rating was cut to junk last month, it will probably tailor the deal to non-traditional muni buyers such as hedge funds, said Chris Mier at Loop Capital Markets, Vikram Rai at Citigroup Inc. and Matt Fabian at Municipal Market Advisors. The commonwealth’s debt has traded at levels consistent with speculative grade since September as officials grapple with a shrinking economy.

That level of risk may not appeal to the individual buyers who own about 60 percent of the market, leaving their appetite unquenched after the slimmest slate of February borrowing on record. Excluding Puerto Rico, localities have scheduled about $5.5 billion of sales in the next 30 days, less than half the level of a year ago, data compiled by Bloomberg show. The issuance slump may prolong a stretch in which munis have beat company bonds and Treasuries.

“Puerto Rico is unique -- the traditional muni buyer probably won’t buy Puerto Rico and will still face the same technical factors of limited supply and continued demand,” said Gary Pollack, who oversees $6 billion of city and state debt as managing director in Deutsche Bank AG’s private-wealth unit in New York.

February Slowdown

After the worst year for the $3.7 trillion municipal market since 2008, investors have returned, adding money to local-debt mutual funds in six of the past eight weeks, Lipper US Fund Flows data show. At the same time, bond sales in February dropped to about $14 billion, the skimpiest tally for the month since at least 2003, when Bloomberg data begin.

With the dearth of supply, state and city debt has gained 3.5 percent this year through Feb. 27, compared with about 2 percent for Treasuries and 2.9 percent for corporate securities, Bank of America Merrill Lynch data show. Benchmark 10-year munis yield 2.49 percent, the lowest since June, Bloomberg data show.

Municipalities typically boost bond sales in March, issuing about $31 billion on average, second only to June’s $32 billion. The supply spike has caused local debt to decline in March for five straight years, the longest streak of losses of any month, Bank of America data show.

Largest Deals

The biggest planned sales this week include a $1.2 billion offering from the Texas Transportation Commission and $741 million of general obligations from Maryland.

Puerto Rico’s general-obligation sale is scheduled for this month, according to Moody’s Investors Service. At the $2.86 billion level that island officials announced last month, the deal would be the biggest since the Michigan Finance Authority issued about $2.9 billion in June 2012, Bloomberg data show.

Commonwealth lawmakers have been working on a bill authorizing as much as $3.5 billion of borrowing. At that size, it would be the largest offering since Illinois sold $3.7 billion of taxable debt in February 2011.

“There’s going to be a lot of crossover support for this deal” from buyers such as hedge funds, said Rai, a fixed-income strategist at Citigroup in New York. “It adds to the total tally of deals, but it’s not going to alleviate the scarcity of supply for the average muni investor.”

Commonwealth Surging

Puerto Rico has led a broad muni rally since commonwealth officials announced the planned offering last month. The bonds have gained 6 percent in 2014, according to Barclays Plc data.

General obligations maturing in July 2041 traded Feb. 28 with an average yield of 7.6 percent, the lowest since October and down from 8.35 percent on Feb. 4, when Standard & Poor’s lowered the island’s grade. The securities yielded about 5.07 percent a year ago.

Puerto Rico’s junk grades prohibit some investment-grade funds from adding debt from the island. OppenheimerFunds Inc., the largest holder of commonwealth securities, said last month that some of its funds have more speculative-grade holdings than prospectuses allow because of the rating cuts.

“The Puerto Rico deal is outside the typical supply-demand dynamic, and you can’t really count it against the rest of muni supply,” said Fabian, a managing director at Concord, Massachusetts-based Municipal Market Advisors. “It’ll help fill high-yield funds, but that’s a much more limited role.”

“This deal is coming through the muni market, but not necessarily to the market,” he said.

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