Market Close: Inverted PR Curve Brings 6-Month Yield Lows

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Long-term Puerto Rico bonds touched the lowest yields in as much as six months Wednesday as the island's debt curve remains inverted ahead of a $3.5 billion bond issue.

The average yield on the most actively-traded Puerto Rico commonwealth general obligation bonds fell to the lowest level since August, while some COFINA bonds traded at the most expensive levels since November.

GOs with a 5% coupon maturing in 2041, as well as those with a 5.5% coupon in 2039, fell to the lowest since August on Wednesday, to 7.53% and 7.73%, respectively. Yields on COFINAs with a 5.25% coupon maturing in 2043, the most active non-zero coupon COFINA, fell to 7.23%.

One trader said municipal bond buyers unimpressed by low-yielding new issue bonds are continuing to find Puerto Rico bonds attractive in a market with little new supply.

"Even though Puerto Rico bonds are trading at those yields there's always that supply and demand factor," one trader in New York said in an interview. "People feel better about Puerto Rico bonds than they did a week ago."

Issuance in February was the lowest the month has had since 2000, according to data from Thomson Reuters. Total-year-to date issuance is the second-lowest in the past decade, according to Bloomberg data.

"There's not much supply at the moment so people are going to buy whatever they can get their hands on," the trader said. "The new issue may see Puerto Rico bonds rally. There's a lot speculation that they may not raise money and will have to resort to private placements."

The island's government is set to issue as much as $3.5 billion in bonds next week in a move to show creditors and investors that it still has the ability to raise money. Market participants expect the deal to attract cross-over buyers from taxable markets, as well as hedge funds and speculative buyers scavenging for yield.

"There is tight supply of all muni paper as well which may be helping," one trader on the west coast said. "I expect prices to firm a lot more following the completion of the deal." Puerto Rico bonds are cheapest on the short end of the curve, creating an "inverted" yield pattern, the telltale sign of a distressed credit, according to Citi's municipal research team. Long-term bonds have rallied this year, even after the commonwealth was hit with junk downgrades from all three rating agencies.

While yields this year have fallen across most of Puerto Rico's yield curve, short-term bonds remain more than 90 basis points cheaper than comparable CCC-rated corporate bonds, according to Citi. The discrepancy in price could be an opportunity for buyers.

"Thus, if the Commonwealth is able to access sufficient long term borrowing in a timely manner, we believe that the GO curve will flatten or even revert to a slightly upward sloping one," Citi's Vikram Rai, Mikhail Foux and George Friedlander wrote.

Puerto Rico bonds were the fourth-most actively traded region in the municipal marketplace Wednesday. Trading activity on the bonds was 8% above normal by closing time, while muni activity overall was down 10%, according to data from Bloomberg.

Yields on municipal bonds rose as much as five basis points Wednesday, according to Municipal Market Advisors. The increase was as much as seven basis points at the long end of the curve, according to MMD.

New bond issues were the focus of market participants Wednesday morning as municipal bonds followed Treasuries in weakening.

With municipal issuance this week projected to reach $5.28 billion, buyers saw the opportunity to take on new paper, even while the market weakened from Tuesday, when they hit the most expensive levels since 2011.

"The market got a little ahead of itself the last couple weeks and reached a point where I guess people thought we were due for a pullback," a New Jersey-based trader said in an interview. "What we saw in yesterday's Treasuries was reflected on today's yields."

Municipal bonds weakened Wednesday morning after credit spreads at market closing on Tuesday showed 10-year bonds were the most expensive in almost three years. Yields on 10-year Triple A GOs were 31 basis points lower than those on Treasuries maturing in the same year, according to Thomson Reuters data Tuesday afternoon, the most negative spread since July 25, 2011.

The second-biggest deal of the week, $650 million of Citi-led New York City general obligation bonds, held institutional pricing Wednesday. The deal went through two days of retail pricing, with yields lowered as much as five basis points.

"The Citi deal looks fairly fully priced right now," the trader said. "We're weaker by six basis points today so I'm not sure if they're going to change it to reflect that."

Citi priced 5%-coupon bonds maturing in 2036 with a 3.97% yield for institutions and 20-year maturity bonds with a 4% coupon at 4.15%. Yields on the shortest and longest-term bonds were unchanged from retail pricing, at 0.56% with a 3% coupon in 2017 and 4.25% with a 4% coupon in 2039, respectively.

Also in the negotiated market, Goldman Sachs sold $171.39 million of Kentucky Asset Liability Commission project notes for the state's highway trust fund. The issuance contains both funding and refunding notes.

Yields on the notes range from 2.81% with a 3% coupon in 2023 to 3.35% with a 5% coupon in 2026. The refunding note yields start at 0.27% with a 1% coupon for 2015 maturities, and go as high as 0.66% on 5%-coupon notes in 2017.

The state of Maryland issued a three-tier general obligation deal to the competitive marketplace Wednesday totaling $737.4 million. New money bonds won by Bank of America Merrill Lynch comprise $450 million of the deal. The state also issued $237.4 million of tax-exempt refunding bonds won by JP Morgan Securities.

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