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June 2 (Bloomberg) -- Puerto Rico is staging its longest rally in a year as the struggling U.S. territory’s speculative- grade bonds lure investors escaping from tumbling yields.
Debt from the self-governing commonwealth has gained for six straight weeks for the first time since May 2013, according to S&P Dow Jones Indices. Three months after the island was cut to junk, it’s delivering better returns than any state. Puerto Rico debt, which is tax-exempt nationwide, has earned 10.6 percent this year, leading the high-yield charge and beating the broader municipal market’s 6.2 percent advance.
Investors are buying Puerto Rico even as revenue trails projections by $356 million for the fiscal year through June, signaling a possible budget gap that officials would need to fill this month. With benchmark muni yields at one-year lows and the Federal Reserve holding its overnight rate near zero, the draw of extra income is outweighing the island’s financial challenges, said Dan Toboja at Ziegler Capital Markets.
The appetite for yield is “overwhelming any kind of concerns about Puerto Rico right now,” said Toboja, vice president of muni trading in Chicago.
The commonwealth’s bond performance is a reversal from 2013, when yields soared to records as the fiscal strains cast doubt on the ability of Puerto Rico and its agencies to repay $73 billion of debt. Puerto Rico obligations lost 20.5 percent last year, the steepest drop since at least 1999, S&P data show.
The entire $3.7 trillion municipal market is seeing an unexpected rally after year-end predictions from Morgan Stanley and Barclays Plc that tax-exempt debt would lose value in 2014. Issuance is down 26 percent this year through May 23 from the same period in 2013, buoying state and local debt.
Asset managers are looking beyond Puerto Rico for opportunities in high-yield munis of hospitals and real-estate developments. They have plenty of money on hand. Investors have added cash to U.S. high-yield muni mutual funds for 21 straight weeks, the longest stretch since 2012, Lipper US Fund Flows data show.
High-yield munis, those ranked below Baa3 by Moody’s Investors Service or lower than BBB- by Standard & Poor’s and Fitch Ratings, have gained about 10 percent this year. That compares with the 4.7 percent earned by high-yield company debt, S&P data show.
Puerto Rico, which lost its investment grades in February, procured enough cash to last through June 2015 by selling $3.5 billion of tax-exempt general obligations on March 11. It was a record speculative-grade muni borrowing.
That sale and Governor Alejandro Garcia Padilla’s plan to balance the budget for next fiscal year without proceeds from future debt sales allayed some concern, said Robert Amodeo, head of munis in New York for Western Asset Management Co., which oversees $28 billion in munis. Investors are also less concerned that Detroit’s historic bankruptcy filing in July would be a precursor to widespread defaults, he said.
“As people are looking for income and some of the high profile credit stresses recede from the headlines, investors feel more comfortable owning those types of portfolios,” Amodeo said.
Buyers of speculative-grade munis have had less debt to choose from.
Not including Puerto Rico’s March sale, localities this year have sold about $800 million of long-term, fixed-rate munis rated below investment grade, less than half the volume from the same period last year, according to data compiled by Bloomberg. The tally excludes the Puerto Rico sale, which was tailored to nontraditional muni buyers such as hedge funds.
“Some of these high-yield participants just have plenty of cash to put to work and, frankly, no huge deals in the near term,” Toboja said.
Benchmark 20-year munis yield about 3.1 percent, close to the lowest since June.
General obligations from Puerto Rico’s March sale that mature in July 2035 traded last week with an average yield of about 9.1 percent, which for top earners is equivalent to a taxable yield of 15.1 percent.
“As Puerto Rico continues to pay their debt on time and when due, the yields that these securities are offering are attractive,” Amodeo said.