Bloomberg News

Puerto Rico Voting Out Fortuno Drives Debt Cheaper: Muni Credit

November 13, 2012

Investors have pushed Puerto Rico bonds to the cheapest in more than two years after Republican Governor Luis Fortuno, who cut workers and deficits, lost his re-election bid.

Securities of the U.S. commonwealth, which are tax-exempt in all states, are poised to end a three-year run in which they beat the $3.7 trillion municipal market. Now buyers are penalizing the territory. The extra yield on 30-year revenue debt from Puerto Rican issuers relative to top-rated munis reached the widest since 2010 last week, data compiled by Bloomberg show.

Standard & Poor’s laid out the risk to investors Nov. 9, saying it may cut Puerto Rico general-obligation bonds to one level above speculative grade if Democratic Governor-elect Alejandro Garcia Padilla fails to strengthen the pension system. The plan’s funding ratio is weaker than in any U.S. state.

Investors are wondering “will there be the same momentum of fiscal discipline that Fortuno had?” said John Flahive, director of fixed income in Boston at BNY Mellon Wealth Management, which manages $22 billion of munis. “Until we get better clarity on that, I’m not surprised that the market is being cautious.”

One Term

Garcia Padilla, of the Popular Democratic Party, takes office Jan. 2. He beat Fortuno, a member of the pro-statehood New Progressive Party, by 47.8 percent to 47.1 percent Nov. 6 after the one-term governor cut payrolls by 17 percent from when he took office in 2009 to help close spending gaps.

The governor-elect, a member of the commonwealth’s Senate, has said he won’t raise income or business taxes. He said he’d add 50,000 private-industry jobs within 18 months through business-incentive programs. Garcia Padilla, 41, didn’t respond to requests for comment through an aide, Rolando Padua.

Bonds sold in the commonwealth began to slide before the election as polls showed the 52-year-old Fortuno trailing.

Puerto Rico debt has earned about 0.05 percent in the past three months, worse than the 26 states tracked by S&P and below the 2.1 percent gain for the broader muni market.

‘More Risky’

“The market had perceived that Governor Fortuno’s defeat would make Puerto Rico debt a little more risky,” said Guy Davidson, who oversees $31 billion as director of munis at AllianceBernstein LP in New York.

Puerto Rico’s BBB rating from S&P is below that of California and Illinois, which have the weakest marks among states. A downgrade would drop commonwealth debt backed by annual appropriation from the legislature, now rated BBB-, to junk.

Thirty-year revenue debt from commonwealth issuers yields about 5.44 percent, or 2.21 percentage points above benchmark securities, the most since February 2010, Bloomberg data show.

Puerto Rico general-obligations have also weakened since the vote. Bonds due in 2041 traded Nov. 9 with an average yield of 4.97 percent, about 2.2 percentage points above a benchmark index, Bloomberg data show. That difference is 10 percent greater than when the bonds first sold in March.

The commonwealth had $9.8 billion of general-obligation debt as of March 31, in addition to $5.5 billion of bonds sold by government agencies that it guarantees and $3.8 billion of appropriation debt, according to the Government Development Bank for Puerto Rico.

Debt Plan

Officials don’t plan on selling any more debt this year, Juan Carlos Batlle, president of the Government Development Bank, the island’s fiscal agent, said in an e-mail.

“We will be respectful of the incoming administration and work with them so that there is an orderly transition,” said Batlle, a Fortuno appointee.

The tax-exempt market has rallied since Nov. 6 as traders speculated lawmakers will raise levies to help reduce the U.S. federal deficit. Yields on a Bond Buyer index of 20-year general-obligations bonds fell to 3.55 percent last week, the lowest in 45 years.

Puerto Rico has declined enough relative to benchmark debt that Tom Spalding, who helps manage $10 billion of munis in Chicago at Nuveen Investments Inc., said he’s “getting close” to buying.

‘Moving Up’

“Everything else has moved up in price,” Spalding said. “So it becomes more attractive eventually.”

As of June 30, 2011, Puerto Rico’s Employees Retirement System had assets equaling 6.8 percent of estimated retirement payments, making it the worst-funded in the nation. Illinois had a ratio of about 43 percent, the lowest among states, data compiled by Bloomberg show.

If Garcia Padilla delays changes to the retirement system or adopts “a diluted pension reform package that provides only temporary relief,” the commonwealth would face a downgrade, Horacio Aldrete-Sanchez, an S&P analyst, said in a Nov. 9 report. The rating might drop one step in the next few months with the potential for further cuts, he wrote.

The island’s economy grew 0.9 percent in the year ending June 30, the first expansion since 2006, according to projections from the Puerto Rico Planning Board. Still, the September jobless rate was 13.6 percent, higher than in any U.S. state.

Fortuno cut Puerto Rico’s budget deficit to $933 million for the year through June 2013, down from $3.3 billion in 2009.

“Padilla is just going to have to continue to make that kind of progress or certainly the market’s not going to be as accepting of the debt,” Spalding said. “There’s not a lot of backtracking that he can do.”

Following are pending municipal-bond sales:

NEW JERSEY plans to sell $2.6 billion of short-term debt as soon as this week with JPMorgan Securities LLC as underwriter. The state postponed the sale because of Hurricane Sandy. (Updated Nov. 13)

TEXAS MUNICIPAL GAS ACQUISITION & SUPPLY CORP. plans to sell $1 billion of gas-supply revenue bonds as soon as next week, data compiled by Bloomberg show. Proceeds will finance the prepayment of a 20-year supply of natural gas, according to bond documents. (Added Nov. 13)

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

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net


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