Puerto Rico Notes Show Cost of Economy’s Struggle: Muni Credit

A sale of $900 million of notes by Puerto Rico’s Government Development Bank, the first borrowing from the junk-rated island since a debt-restructuring law passed in June, is showing the cost of a deteriorating economy.

The transaction was part of a short-term financing that generated $1.2 billion for the commonwealth. The GDB offering included $700 million of fixed-rate securities due in June 2015 and priced to yield 7.75 percent, according to the bank. Benchmark issuers pay about 0.14 percent to borrow for a year, data compiled by Bloomberg show. When the U.S. territory sold 13-month notes three years ago, the yield was 1 percent.

The restructuring law would allow certain public agencies to ask bondholders to take a loss. The island was cut to speculative grade in February as its leaders struggled to revive the economy and generate enough revenue to pay its debt.

“Your risk is whether their revenues come in where they expect” so they can pay off the notes on time, said Daniel Solender, who oversees $16 billion as director of munis at Jersey City, New Jersey-based Lord Abbett & Co. “It’s just uncertainty about their economy, the revenues and how next year is going to go.”

Distress Call

Puerto Rico’s debt has been trading at distressed levels for about a year on concern that the commonwealth and its agencies won’t be able to repay $73 billion of obligations.

“They needed to be able to eat their next meal,” said Matt Dalton, chief executive officer of White Plains, New York-based Belle Haven Investments, which manages $2.4 billion of munis.“They need any scrap of cash they can get.”

The 7.75 percent tax-free yield is equivalent to 12.8 percent on a taxable basis for top earners, approaching the 15 percent yield on two-year, dollar-denominated bonds of war-torn Ukraine.

Puerto Rico revenue collections for July through September came in $36 million below budgeted estimates, according to Treasury Secretary Melba Acosta. An index that tracks Puerto Rico’s economic activity has shrunk by almost 20 percent since July 2006, according to the GDB.

The bank, which handles the territory’s capital-markets transactions, said it also sold $200 million of floating-rate notes.

Libor Spread

The tax-exempt securities, which mature in June, priced to yield 7.55 percentage points above one-month Libor, or about 7.7 percent, Bloomberg data show.

The GDB said it will use the $900 million to buy an equal amount of tax- and revenue-anticipation notes from the commonwealth. The bank will also purchase an additional $300 million of notes from the territory.

“Today’s transaction is part of the commonwealth’s normal-course financing as it manages the timing difference between ongoing budgetary obligations and the yearly collection of tax revenues in April,” Jose Pagan, the GDB’s interim president, said in a statement.

A group of banks bought the GDB’s $900 million of notes, including JPMorgan Chase & Co., Morgan Stanley, Bank of America Corp., Barclays Plc, Banco Popular de Puerto Rico and Amalgamated Bank, according to the GDB.

Since March

Jessica Francisco, spokeswoman at New York-based JPMorgan, declined to comment on the sale, as did Mark Lane at Barclays in New York, Lauren Bellmare at New York-based Morgan Stanley, Zia Ahmed at Bank of America, headquartered in Charlotte, North Carolina, and Teruca Rullan at San Juan-based Banco Popular.

“We are pleased to have participated in this important loan to continue to help the commonwealth of Puerto Rico during a challenging financial situation and to maintain essential services for its residents,” Samantha Berg, spokeswoman for New York-based Amalgamated, said in an e-mail.

Puerto Rico hasn’t sold long-term debt since March, when it issued $3.5 billion of general obligations maturing in July 2035 at an 8.73 percent yield, or 93 cents on the dollar. Hedge funds bought the bulk of the offering. The debt traded today at an average of about 88 cents.

Moody’s Investors Service rates Puerto Rico B2, five levels below investment grade, while Standard & Poor’s assesses it at BB, the second-highest level of junk. Fitch Ratings gives it a BB-.

The island’s struggles haven’t stopped its debt from outperforming the entire $3.7 trillion municipal market as investors seek out riskier securities with benchmark yields close to generational lows.

Debt from Puerto Rico has earned about 12 percent this year, compared with 8.4 percent for the broader market, Barclays Plc data show.

To contact the reporter on this story: Michelle Kaske in New York at mkaske@bloomberg.net

To contact the editors responsible for this story: Stephen Merelman at smerelman@bloomberg.net Mark Tannenbaum, Alan Goldstein

By Michelle Kaske

Puerto Rico Notes Show Cost of Economy’s Struggle: Muni Credit