SAN JUAN, April 4 (Reuters) - Despite staunch opposition from labor unions, senators in Puerto Rico passed a bill on Thursday to overhaul the island's public pension system in what could be a first step to soothe investor worries about the U.S. territory's fiscal health.
Lawmakers in the House of Representatives were expected to approve the bill later Thursday and Governor Alejandro Garcia Padilla has said he plans to sign it into law.
The Caribbean island is a leading borrower in the $3.7 trillion U.S. municipal bond market and has seen its credit rating downgraded to near-junk status because of chronic budget deficits, raising concerns investors could unload its widely held debt.
The bill will raise the retirement age for some state workers to age 65, increase worker pensions contributions by nearly 2 percent and lower monthly pensions and benefits for some public workers.
It will also reduce state workers' Christmas bonuses and eliminate summer bonus payments.
"No retirement system in the world is as broken as ours," Senate President Eduardo Bhatia said as debate on the proposed reform opened. "Doing nothing would be the most irresponsible act to the people of Puerto Rico."
Senators voted 14-11 to approve the bill as hundreds of angry public workers protested outside Puerto Rico's Capitol and union leaders went on a last-minute push to persuade lawmakers to vote against the proposed reform.
The pension overhaul is "good news" for Puerto Rico's financial outlook but more needs to be done to convince investors the worst is over, said Peter Hayes, head of the municipal bonds group at BlackRock, with $109 billion in assets.
"We need to see some pretty meaningful reforms" before increasing investment in Puerto Rico's debt, he said, adding concerns remain over Puerto Rico's deficit, which has doubled to $2 billion.
YIELDS UNLIKELY TO FALL SOON
Although the municipal bond market could show some positive reaction to the news, "the bias is toward widening more than narrowing," said Sean Carney, the municipal strategist for BlackRock.
Puerto Rico's yields, which were already the highest of any borrower in the U.S. municipal bond market, have risen in recent weeks. On Thursday, Puerto Rico's 10-year yield spread over triple A bonds ended at a four-year high of 310 basis points, unchanged from Wednesday, Municipal Market Data showed.
The 10-year Puerto Rico yield spread hit a record high at 340 basis points in February 2009 during the financial crisis.
The government's main retirement fund faces an unfunded liability of more than $37 billion. The fund, which serves more than 200,000 current and retired government workers, is only about 7 percent funded and officials have warned it could run out of money by 2018.
Ahead of the vote, Garcia Padilla released a videotaped speech anticipating its approval.
"Together, we have saved the future of thousands of men and women who have built the future of our country. We have saved all existing pensions," Garcia Padilla said.
All three major credit ratings firms have recently downgraded Puerto Rico's bond ratings to just above junk-bond status, pointing to its widening budget deficits as the island struggles with a sputtering economy and a 14.6 percent unemployment rate.
To help the island narrow the budget deficit, top Puerto Rico government officials say they are evaluating new tax hikes and other measures to increase annual revenue by more than $1 billion.