Guam Bonds Attain Year's Best Muni Return as Puerto Rico Falters

2014-12-18 01:00:00.0 GMT
By Brian Chappatta

(Bloomberg) -- Bonds from Guam are delivering the best returns in the U.S. municipal market, and may gain again in 2015 as investors seek tax-exempt debt while steering clear of flailing Puerto Rico.

Obligations of the Pacific territory have earned 17.2 percent this year, compared with 9.1 percent for all munis, Barclays Plc data show. At this pace, it would be the largest outperformance in at least 13 years. The securities are also set to beat Puerto Rico's for an unprecedented third straight year.

With municipal interest rates close to generational lows, Guam offers extra yield while boasting fiscal gains that separate it from Puerto Rico and the U.S. Virgin Islands. The three territories' debt is tax-free nationwide. The Pacific island saw its second straight year of economic growth in 2013 and won its highest rating in a decade from Standard & Poor's, though the rank remains below investment grade.

"Guam's credit fundamentals look like they're still trending positive," said John Miller, co-head of fixed income in Chicago at Nuveen Asset Management, which oversees about $100 billion of munis. "Since it's a good story and it's tax-exempt across the United States, spreads could continue to narrow."

Borrowing Contrast

Investors' enthusiasm about Guam contrasts with their take on Puerto Rico. The Caribbean commonwealth and its agencies are grappling with $73 billion of debt and soaring borrowing costs.

The island had its bond ratings cut this year to speculative grade, and its main indicator of economic health is close to the lowest level in two decades.

By comparison, Guam's issuers have about $2.6 billion of debt, and its ratings are increasing, data compiled by Bloomberg show. S&P, while calling the debt burden "extremely high," raised Guam in October 2013 to BB-, three steps below investment grade. The company upgraded bonds backed by hotel taxes last month to A-, four steps above junk.

Guam, with about 160,000 residents, attracted a record 1.3 million tourists in fiscal 2013 and expects the number to keep climbing, budget documents show.

The territory may log its third consecutive fiscal year with a fund surplus, S&P said.

'Exercise Restraint'

"The fact that government finances are better than they've been in two decades is cause for celebration," Governor Eddie Calvo, who won re-election in November, wrote in a forward to the 2015 budget, which took effect Oct. 1. "But, we must exercise restraint through our excitement."

Challenges include reliance on one-time revenue to bolster its finances and dependence on travelers from Japan, according to S&P.

Guam's real gross domestic product grew 0.6 percent in 2013, slowing from 1.7 percent in 2012, U.S. Bureau of Economic Analysis data show.

Business spending on construction and equipment boosted growth, surging 34.3 percent on building of the island's first private hospital, the Guam Regional Medical City, and a luxury hotel, the 419-room Dusit Thani Guam Resort, BEA data show.

Dollar Drag

The strengthening dollar is a drag on tourism, which along with federal outlays account for the biggest contributions to the economy. The island hosts military outposts, including Andersen Air Force Base and Naval Base Guam.

Japanese are the most plentiful tourists, according to budget documents. At almost 119 yen, the U.S. currency has gained about 13 percent this year, making the island costlier for voyagers from Japan. The number of Japanese visitors sank 9.5 percent in fiscal 2014, according to S&P.

Decreased borrowing is another way Guam is diverging from Puerto Rico. The island and its agencies have sold $162 million of bonds this year, the least since 2008, Bloomberg data show.

Puerto Rico's legislature passed a $2.9 billion borrowing measure last week that would repay money owed to the Government Development Bank and fund public transportation.

"Guam hasn't had to clear the market with any large issues," said Dan Solender, who helps manage $16 billion as director of munis at Lord Abbett & Co. in Jersey City, New Jersey. "Given that Puerto Rico is struggling, this is another example of a triple tax-exemption that can work in a variety of funds."

Record Price

Some Guam bonds with higher interest rates may outperform next year if interest rates climb, Solender said.

Ten-year Treasury yields will reach 3.01 percent at this time in 2015, about 0.9 percentage point above current levels, according to the median forecast of 72 analysts in a Bloomberg survey.

Guam general obligations maturing in November 2039 traded Dec. 4 at 117.6 cents on the dollar, for a 3.12 percent yield.

That's the highest price on record, and the yield spread of 1.93 percentage points above benchmark munis is the narrowest yet, Bloomberg data show.

The elevated price cushions holders if interest rates rise, said Solender, who owns some of the securities.

Nuveen is the largest holder of the biggest portions of debt issued by Guam, its waterworks authority and its power agency, Bloomberg data show. The company has some in its Kansas, Louisiana, Nebraska and Wisconsin funds, all of which have beaten at least 80 percent of peers this year.

"We've been cautious about putting too much territorial debt in a state fund, and we've been negative on Puerto Rico's credit trajectory," Miller said. "We're trying to add things where we're positive, and Guam is one that fits."