Yields on Puerto Rico Debt Hit High - WSJ

CREDIT MARKETS
Yields on Puerto Rico Debt Hit High
By AL YOON And MIKE CHERNEY
Jan. 1, 2014 6:06 p.m. ET
Puerto Rico is struggling to convince investors and credit-rating firms that it is on the path to financial health amid rising borrowing costs and fears over a potential downgrade of its debt.

Yields on Puerto Rico's $70 billion worth of debt, which is held by many small investors through mutual funds, ended 2013 at record highs, raising questions over the commonwealth's ability to tap credit markets to bolster its finances.

The average yield on Puerto Rico's 10-year bonds hit 9.87% on Friday and hovered there through Tuesday, the last trading day of 2013. That was the highest ever in Thomson Reuters Municipal Market Data records going back to 1997. Yields, which move in the opposite direction of prices, more than doubled in 2013.

The coming months are shaping up to be a test for Puerto Rico. The island's beleaguered economy makes it more difficult for Puerto Rico to juggle its budget deficit as well as its debt load, which weighs in at nearly 70% of GDP according to the Center for Economic and Policy Research.

Moody's Investors Service and Fitch Ratings have warned of potential downgrades of Puerto Rico debt to "junk" status, citing the borrower's growing challenge in tapping debt markets.

"The hole they are in is pretty big," said Hugh McGuirk, a portfolio manager at T. Rowe Price, a $614 billion asset manager which has pared its Puerto Rico holdings over the past two years. A public bond deal would be "a pretty tough sell."

Investors in Puerto Rican debt have endured a brutal 2013. The S&P Municipal Bond Puerto Rico Index—which measures the performance of bonds issued within Puerto Rico—fell 20.47% last year, the worst annual performance since its launch in 2000.

Puerto Rico debt has lured investors in past years with its "triple-tax-exempt" status, which makes the interest free of all city, state and federal taxes.

A successful public bond sale would give Puerto Rico more time to get its finances in order and reassure investors. Plans to issue bonds by the end of 2013 were delayed to avoid paying high interest rates, according to a person familiar with the matter.

Puerto Rico officials declined to comment for this article but local media reports have quoted officials as saying that the commonwealth plans to return to the bond market in early 2014.

Lately, the island has turned to short-term bank loans for funding, balking at the high yields demanded by bond investors, said people familiar with the thinking of Puerto Rico's finance officials.

Last week, the Government Development Bank for Puerto Rico, which serves as the island's fiscal agent, said it placed $110 million of notes yielding 8% with the Puerto Rico State Insurance Fund Corp., a government-owned entity.

In a news release, José Pagán Beauchamp, interim president of the development bank, said the transaction "reflects another step in improving the commonwealth's near-term economic situation and long-term economic outlook."

Before repaying a $400 million loan taken from Barclays PLC in December and last week's notes placement, the Government Development Bank had about $2.1 billion that could be tapped for short-term needs until the end of this fiscal year in June.

The next phase bond investors are anticipating is the start of budget negotiations.

Some investors expect Puerto Rico will attempt to sell bonds before June to show that it will be able to fund itself through fiscal 2015.

Municipal-bond investors, traditionally a conservative bunch, have become more cautious about holding the debt of troubled borrowers since Detroit filed for bankruptcy protection last July.

In recent months, Puerto Rican officials have gone on the offensive. They have taken frequent trips to New York and other cities to meet with investors and members of the media. During these presentations, they have emphasized steps taken to overhaul the pension system and raise taxes.

To be sure, some investors are taking heed, and dipping into the debt to take advantage of the higher yields.

"The trends over the past two to three years have been positive," said Philip Condon, head of U.S. Fixed Income and Municipal Bonds at Deutsche Asset & Wealth Management, part of Deutsche Bank AG and manager of $101.4 billion in U.S retail and retirement assets.

Mr. Condon said his funds did buy some Puerto Rico bonds with longer-term maturities since the summer, but he added that he will wait for more signs of fiscal improvement before taking larger bets.

Deutsche's DWS municipal-bond funds have reduced holdings of Puerto Rico debt in the past couple of years, to 5% or less of their total assets.