PREVIEW-Puerto Rico to test shaky bond market with new offering
* Puerto Rico comes back to muni market with Prepa bonds
Prepa officials court investors in New York
* Ten-year yields on Puerto Rico GO bonds at 5.9 percent
By Edward Krudy
NEW YORK, Aug 2 (Reuters) - Puerto Rico is turning to investors for the first time in more than year next week, but a shaky U.S. municipal bond market plagued by months of outflows could prove a tough customer for the fiscally troubled island.
The U.S. Commonwealth, whose shaky finances have led to the highest borrowing costs amongst the largest municipal borrowers, has not sold bonds in the $3.7 trillion U.S. muni market since July, 2012.
Now, Puerto Rico Electric Power Authority (Prepa) is aiming to sell a $600 million deal to fund power plant and transmission network improvements across its facilities. It will be the first test for a series of financings. Island issuers have plans to refinance more than $3 billion of debt by the end of this year.
The sale could be any day next week.
Puerto Rico and Prepa officials have been in New York this week hawking the new bonds, hoping that an overhaul of its underfunded public pension system approved earlier this year has put its budget on a stable enough footing to entice investors to buy its debt again.
"Unfortunately for them the market for credit in munis right now is rather soft, primarily because you continue to see outflows from the longer-term funds and your high-yield funds so that is going to put the wind in their face," said Lyle Fitterer, a fund manager at Wells Capital Management.
Fitterer says he is looking at the deal but has not yet made a decision on whether to participate.
Municipal bonds have sold off sharply since the start of the year, a move accelerated by expectations the Federal Reserve will curtail its bond buying program later this year as well as Detroit's bankruptcy filing last month.
Municipal bond funds have seen weekly outflows for most of the last five months, with a record of $4.5 billion in one week in June.
The market has been punishing lower-grade issuers more severely. The S&P Municipal Bond Puerto Rico Index fell over 4.1 percent in July compared to a drop of 1.1 percent for investment grade bonds, according to S&P Dow Jones Indexes.
It is not only the current bond market that will be a headwind for Prepa. Its credit rating was downgraded by Moody's in June to Baa3 from Baa2, one step above junk. In addition, Fitch downgraded Prepa in July to BBB minus.
DEAL QUESTIONED BY LAWMAKERS
The deal has also raised eyebrows in Puerto Rico where lawmakers have questioned the wisdom of borrowing that is expected to increase Prepa's debt servicing costs by tens of millions of dollars.
"How do you plan on paying back these bonds?" Eduardo Bhatia, president of Puerto Rico's Senate, asked Prepa officials at a hearing before the Senate Treasury and Public Finance Committee on Wednesday.
Bhatia pointed to Prepa's estimate of a $283 million operating loss during fiscal year 2013, which ended in June.
"In Puerto Rico, there has developed a culture of taking out loans and not paying them back. That has ended," said Bhatia.
The bonds could add about $35 million to $38 million a year to Prepa's debt service costs, said Jesus Garcia, vice president of the Government Development Bank, at Wednesday's hearing.
Prepa says it is the largest government-owned utility company in the United States with 1.5 million customers. It is still small, however, compared to big U.S. private sector utilities such as ConEdison, which delivers electricity to 3.3 million customers in New York.
PUERTO RICO BONDS MIXED
Puerto Rico policymakers agreed in early June to hike taxes by $1.5 billion as part of a budget that is key to the Caribbean island avoiding a Wall Street downgrade of its massive debts to junk-bond status. Moody's welcomed the tax increases but highlighted collection risks.
Still, the yields on Puerto Rico's bonds tell a mixed story of how investors view the debt.
The premium that Puerto Rico pays on its 10-year general obligation debt over top-rated AAA municipal bonds has risen to 320 basis points compared to 290 basis points at the start of year. The premium on 30-year debt, however, has fallen to 255 basis points from 275 basis points, according to Municipal Market Data, a unit of Thomson Reuters.
Puerto Rico's 10-year debt currently carries a yield of 5.9 percent. The 30-year bond yields 6.7 percent.
Puerto Rico expects to follow the Prepa deal by refinancing some $3.38 billion in existing debt this year. The deals depend on Puerto Rico filing the commonwealth government's Comprehensive Annual Financial Report (CAFR) for fiscal year 2012, which officials say will be completed this month.
The Prepa bonds will be used to convert eight oil-fired power generating units at the San Juan and Aguirre power plants to natural gas and improve Prepa's transmission and distribution systems.
The projects are aimed at lowering the cost of electricity in Puerto Rico and cutting plant emissions so that Prepa can comply with strict new Environmental Protection Agency regulations taking effect in 2015.
Prepa planning director Sonia Miranda defended Prepa's financial projections and listed a number of steps it is taking to lower operational costs, including cracking down on electric theft, reducing the workforce through attrition and cutting back on overtime and outside contractors.
(Additional reporting by a Reuters correspondent in San Juan; Editing by Tiziana Barghini and Eric Walsh)