While lawmakers in the junk-rated commonwealth plan a sale of as much as $2.9 billion of bonds backed by petroleum taxes to boost cash, investors say a spiral of fiscal strains may halt the bond gains. Debt service consumes 15 percent of the budget, triple the median for U.S. states, and the pension system has only 3 percent of the assets needed to pay current and future retirees.
Securities from the Caribbean island, which are tax-exempt nationwide, have earned 9.8 percent this year, the most for the period since 2009, according to S&P Dow Jones Indices. The gain follows a 20 percent drop in 2013, and investors anticipate renewed volatility if the Electric Power Authority renegotiates its $8.6 billion of debt in March. It would be a record restructuring for the municipal market.
“That’s going to affect all Puerto Rico bonds and then the gains that they’ve made this year will get washed away,” said Matt Dalton, chief executive officer of White Plains, New York-based Belle Haven Investments, which manages $2.4 billion of munis.
Island’s Burden
Commonwealth debt has traded at distressed levels for more than a year as investors speculate that Puerto Rico and its agencies will fail to repay $73 billion of bonds. Only California and New York have larger debt burdens among U.S. states.The economy has shrunk about 19 percent since July 2005, according to the Government Development Bank, which handles the island’s bond sales. Compounding the slide, the population has declined for eight straight years as residents moved to the U.S. mainland, according to Census data.
Puerto Rico and its agencies have a history of using deficit financing to balance budgets, and bond sales to repay bank loans and short-term debt. A $3.5 billion general-obligation sale in March, the biggest junk-rated muni deal ever, and a $1.2 billion short-term borrowing in October generated cash. Yet the deals underscored that the island depends on capital markets to maintain services.
‘Musical Chairs’
In the latest plan, the Infrastructure Financing Authority, which borrows for capital projects, would sell bonds backed by petroleum taxes. Proceeds would repay $2.3 billion of Highways & Transportation Authority obligations, most of which is owed to the GDB. Governor Alejandro Garcia Padilla plans to call lawmakers back for a special session to work on the deal.“It’s a game of musical chairs,” said Sergio Marxuach, public-policy director at the Center for a New Economy, a research group in San Juan that focuses on economic development. “What you’re essentially doing is shifting it from the GDB to another agency.”
Puerto Rico securities have gained this year as investors seek lower-rated credits for higher yields with interest rates close to generational lows. The advance surpasses the gains in the debt of all U.S. states but Alabama, Colorado and Iowa, Standard & Poor’s data show.
General obligations sold at 93 cents on the dollar in March and maturing in July 2035 demonstrate the volatility in Puerto Rico. The bonds traded today at about 87.3 cents on the dollar, up from 83.5 cents July 8, the lowest this year, data compiled by Bloomberg show.
Bond Cycle
While Garcia Padilla, who took office in January 2013, has reduced deficit financing, the island hasn’t abandoned the maneuver: $344 million from bond sales in 2012 and 2014 went toward balancing the fiscal 2015 budget, according to GDB data. The commonwealth also reduced its contribution to the pension system to cut expenses.Escaping the borrowing cycle will require stronger economic growth, Dalton and Marxuach said. S&P has threatened to lower Puerto Rico’s rating deeper into speculative grade if economic declines widen budget gaps, said David Hitchcock, an analyst in New York. The company ranks Puerto Rico BB, two steps below investment grade, with a negative outlook.
“It really boils down to getting whatever gross-domestic-product growth back on the island so that they can break that cycle,” said Bill Black, who manages Invesco Ltd’s $7.3 billion High Yield Municipal Fund in Downers Grove, Illinois.
Growth Lacking
The fiscal 2015 budget assumes economic growth of 0.2 percent, according to S&P.That’s not enough to tackle the island’s mounting obligations, Hitchcock said. The retirement system’s 3 percent funding level as of June 30, 2013, was lower than any U.S. state. The territory also faces an estimated $1.8 billion shortfall in fiscal 2018 in its health-insurance program, and a $287 million increase in principal and interest payments on debt in fiscal 2016.
“To comfortably cover some of these liabilities -- some of which will increase in the short-run, some in the long-run -- they’re going to need real economic growth,” Hitchcock said.
The fiscal 2015 general fund directs $1.45 billion toward principal and interest on general obligations, Public Buildings Authority bonds and other government debt, consuming 15 percent of the $9.56 billion budget. In comparison, U.S. states devoted a median of 5.1 percent of 2013 operating revenue to paying tax-supported debt, according to Moody’s Investors Service.
Job Cuts
To get Puerto Rico’s finances back on track, the governor has cut 12,500 jobs payable from the general fund, a 12 percent drop, while boosting the retirement age and worker pension contributions. His administration estimates private businesses will create more than 90,000 jobs by the beginning of 2016.The governor also wants authorities and utilities to operate without subsidies. He signed legislation in June allowing certain agencies to negotiate with bondholders to reduce debt. The Electric Power Authority, called Prepa, is set to release a debt-restructuring plan by March that would ask investors to take a loss.
A revamp of Prepa obligations would cheapen commonwealth securities and spur investors to withdraw cash from muni mutual funds, said Tom Metzold, co-director of munis in Boston at Eaton Vance Management, which oversees about $27 billion of local bonds. About 57 percent of muni mutual funds held Puerto Rico securities as of September, down from 77 percent in October 2013, according to Morningstar Inc.
“This is going to be the next draw-down event only because Puerto Rico is still owned by a lot of individuals,” he said.
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, Mark Schoifet
Puerto Rico Rally at Risk With Rising Debt Expenses: Muni Credit
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