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Aug. 1 (Bloomberg) -- The Federal Reserve Bank of New York says Puerto Rico needs to cut its debt to levels from 2000. The burden isn’t stopping buyers of distressed assets from driving the island’s obligations to their longest rally since May.
Hedge funds and nontraditional municipal-bond buyers are purchasing junk-rated commonwealth securities as the obligations are on pace to gain for a fourth straight week, according to S&P Dow Jones indices.
The debt is rebounding from record low prices set after lawmakers approved a law in June that would let certain public corporations restructure their debt. Yesterday, the island’s delegate in the U.S. House of Representatives proposed a bill letting some agencies file for bankruptcy protection. Buyers with a stomach for risk see opportunity at these distressed levels, said Dan Toboja, senior vice president of muni trading at Ziegler Capital Markets in Chicago.
“People think that even if there’s a restructuring, those bonds are still probably going to have some sort of profit in them,” Toboja said.
Puerto Rico officials are struggling to revive the island’s economy while digging out from under $73 billion of debt and tackling a jobless rate that’s more than double the U.S. average. The population of the self-governing island of 3.6 million has shrunk for eight consecutive years as residents flee to the U.S. mainland, according to Census data.
The island should lower the ratio of public debt to its gross national product to 60 percent -- the level of 14 years ago -- from 100 percent last year, the New York Fed said yesterday in its first report in two years on Puerto Rico, which is part of its district. The ratio and the commonwealth’s speculative-grade ratings raise borrowing costs, which the report said can impede economic growth.
“While these adjustments can be difficult, the experience of New York City suggests that it is possible to tackle fiscal pressures head on and come out stronger,” William Dudley, president of the New York Fed, wrote in a foreword. “Puerto Rico clearly has the assets and attributes to do so.”
Reducing the island’s debt load will take time, said Matt Dalton, chief executive officer of White Plains, New-York based Belle Haven Investments, which oversees $2.2 billion of munis.
“If your credit card debt is as much as you make, how do you fix that problem? There’s not an obvious fix,” Dalton said.
Puerto Rico and its agencies, including the Electric Power Authority and the Highways & Transportation Authority, have borrowed over the years to help balance budgets. The commonwealth is the third-largest municipal debtor behind California and New York. The bulk of its obligations are tax- free nationwide, leading 66 percent of U.S municipal mutual funds to hold the securities.
Prepa, as the electric agency is known, may be the first to use the new debt-restructuring law. It faces $671 million of bank loans that it must repay Aug. 14 after extending the lines of credit.
Uninsured Prepa bonds maturing July 2042 traded yesterday at an average price of 48.11 cents on the dollar, the highest since June 26, the day after Governor Alejandro Garcia Padilla proposed the debt-restructuring bill, data compiled by Bloomberg show. The bonds fell to about 38.50 cents July 2, the lowest ever.
After losses in early July, Puerto Rico securities have recovered as investors absorbed the significance of the debt- restructuring law, Dalton said.
“That initial cannon fire over the bow, everybody just goes to the worst-case scenario of what they perceive it to be,” Dalton said.
Borrowing by public corporations accounted for almost 85 percent of the increase in the island’s debt ratio, according to the New York Fed report.
While those agencies have benefited from Puerto Rico’s ability to borrow through capital markets, “they have now harmed that access, threatening the delivery of the commonwealth’s core public services,” according to the report.
In response to the report, Garcia Padilla, who took office in January 2013, said his administration has reduced deficits, attracted businesses and created 50,000 jobs.
“There is more work to be done, and we continue to execute on a comprehensive plan to drive economic growth and fiscal stability,” he said in a statement.
Puerto Rico’s utilities need to improve their finances and become more efficient, and may benefit from changes in “governance and ownership structures, including implementing selective privatization,” according to the report.
Lawmakers in June approved a measure allowing certain public corporations to negotiate with bondholders to reduce their debt.
Puerto Rico needs to eliminate budget deficits and implement multiyear spending plans, build reserves against economic shocks and improve its financial reporting, according to the New York Fed, whose markets desk implements monetary policy and monitors financial conditions.
“It takes money to make all that happen and they don’t have it,” Dalton said. “They’re desperate for cash.”
The report also suggests expanding Puerto Rico’s tax base and reducing rates across a range of levies to stimulate growth.
Pedro Pierluisi, a Democrat who can propose legislation but can’t vote on it, yesterday introduced a measure that would let agencies restructure debt in court. They don’t have that option, unlike cities including Detroit and Stockton, California, that have done so to escape financial burdens they could no longer afford.
--With assistance from William Selway and Derek Wallbank in Washington.