Municipal bonds weakened Tuesday as concern over Puerto Rico credits gripped the market.
Yields rose across the curve, increasing by two basis points for five to seven year maturities and for 17 to 30 year maturities, and by one basis point for bonds maturing in 8 to 11-years and 14 to 16-years, according to Municipal Market Data's triple-A scale. Yields on the 10-and 30-year rose by one basis point to 2.36% and 3.52% respectively, and the two-year held steady at 0.32%, according to Municipal Market Advisors' data.
"Puerto Rico selling is causing munis to weaken across the board," a trader in New York said. "We're not following treasuries anymore, we're being pulled by that island."
Treasuries strengthened, with the 30-year yield falling six basis points to 3.38% and the 10-year by five basis point to 2.56%. The two-year note held steady at 0.52%.
Puerto Rico bonds began selling off after the weekend of June 28 when Puerto Rico Gov. Alejandro García Padilla passed a new law for the commonwealth that allowed its public corporations to restructure their debts. Soon after the law was enacted Moody's Investors Service downgraded Puerto Rico, the Puerto Rico Electric Power Authority, and the Puerto Rico Sales Tax Financing Corporation, among other related organizations.
Yields on general obligation bonds from the commonwealth's massive $3.5 billion March general obligation sale have surged, with 8s in 2035 rising to 9.68% on Tuesday from 9.18% on June 30, the Monday after the law was passed, according to data provided by Bloomberg.
"There's been a fair amount of trading going on in Puerto Rico," a trader in Virginia said. "That general theme is keeping muni from performing a little better versus treasuries."
In a report published on Monday, Kevin Horan, Director of Fixed Income Indices at S&P Dow Jones Indices, wrote the S&P Municipal Bond Puerto Rico Index's year-to-date return dropped from a high of 10.65% at the end of June to negative 0.16%. The index showed a total return of 154.12 and one year annual returns of negative 18.05% on Tuesday.
PREPA bonds trading spiked on Tuesday after the authority was given an extension on bank credit payments it had due in early July.
Trading on all PREPA bonds is currently 472.9% above its 100-day average, according to data provided by Bloomberg.
This has boosted trading on all Puerto Rico bonds, which are currently 195.7% above their 100-day average, making it the most actively traded U.S. state or territory.
"[The spike in Puerto Rico trading] really revolved around PREPA. The GOs have been fairly stable, probably coming off a couple points from where they've been trading a couple weeks ago," the trader in Virginia said. "PREPA decided to sell-off after the commonwealth announced a new law allowing state authorities to restructure debt in a different manner. There was the announcement yesterday that PREPA had extended the time frame for repayment of some of its credit lines. It was mainly to do with their bank credit lines, to extend the time frame for repayment of some of those lines."
PREPA was supposed to pay Citibank $10 million on its $146 million line of credit on July 3, and was supposed to finish paying Citi back by mid-August.
A spokeswoman for PREPA announced on Monday that it had negotiated with its lenders, and can delay certain payments until July 31.
"On one hand this buys PREPA a little bit more time, but it goes to show how fragile their liquidity is, and how much the heightened possibility that some type of restructuring will have to take place," the trader said, " There is still a great deal of uncertainty surrounding Puerto Rico's future."
The trader in Virginia said he saw a $100 million Puerto Rico bid list Tuesday morning.
Secondary data from Markit showed a block trade of PREPA 5.75s of 2036 with a bid price of 41.5 and a bid yield of 14.8%.
A block trade of the authority's 5.5s of 2038 went at a bid price of 41.5 and a yield of 14.05%.
The trader in Virginia said that he does not see Puerto Rico sellers having a problem with finding bids.
"I feel like I'm seeing a lot of quoted two-sided markets from the street, I think there are buyers," he said. "It's just a matter of how comfortable a seller can get with their execution levels — can you get comfortable selling them after they've sold off that much? If you were holding PREPAs in the 60s and now they're at 40, it's not finding a bid, it's getting comfortable with that potential loss. I think liquidity is holding up in Puerto Rico markets for now. It's just that some of the bid levels have come way down."
The trader in New York said that market participants are just waiting to see where this week's fund flow numbers come in to see the Puerto Rico sell-off's true impact on the muni market.
"While [the sell-off] started last week those fund flows mostly had to do with the holiday week," he said.
The trader in Virginia said the fund flow will be a good indication how retail has reacted to the negative credit news coming out of Puerto Rico.
"There's been a little bit of shift in sentiment in muni market," he said. "It will be interesting to see what fund flows look like given what is going on with Puerto Rico and how sensitive retail is to what's going on in muni market; it might put on additional selling pressure on retail."
