While news of Puerto Rico's downgrade hung over the municipal market Wednesday, the market outperformed Treasuries and closed mostly flat on the day.
"We have been under-performing Treasuries for a quite a while and today we are going the other way slightly," said a New York trader.
The market was in the midst of absorbing roughly $5 billion of new volume this week - dominated by the pricing Thursday of a $1 billion Illinois general obligation sale by Citi.
On Wednesday, the generic, triple-A general obligation bonds were unchanged across the board. At the close, the 30-year held steady at 3.85% where it opened, according to Municipal Market Data. The 10-year triple-A GO ended at a 2.52%.
In Treasuries, the 30-year yield ended at 3.64%, where it opened, while the 10-year closed at 2.671%, after being quoted at 2.649% earlier in the day. The two-year fell one basis point to 0.31% from the open.
"The municipal market ended Wednesday sliding mostly sideways," wrote Thomson Reuters' analyst Domenic Vonella in a daily market commentary. "Positive supply and relative value technicals in the tax-exempt sector were unable to overcome the backdrop of a weaker U.S. Treasury market, P.R. headlines, Northeast storm, and general price uncertainty," he wrote.
The largest new deal of the day was a $733.46 million subordinate tier toll revenue and refunding from the Grand Parkway Transportation Corporation priced by Goldman, Sachs & Co.
The bond anticipation note, which was rated SP1-plus by Standard & Poor's, was priced with a 3% coupon due Dec. 15, 2016 with a 0.65% yield.
Another New York trader said bellwether bonds like blocks of New York City GOs were trading around 55 basis points off the MMD scale, which is where they have been in recent sessions.
"I didn't see any major weakness or strength in any of the benchmark stuff," he said. "We underperformed all last week, and today we slightly outperformed Treasuries since Treasury rates are still lower," he said.
Traders and members of the buy side community weighed in on the downgrade of Puerto Rico -- even though it was widely anticipated and did little to move prices in the general market.
Standard & Poor's downgraded Puerto Rico's general obligation bonds to speculative or junk grade, cutting the rating to BB-plus from the investment grade of Baa1. The rating remains on watch negative S&P said in its announcement Tuesday.
"I think with the downgrade, P.R. paper is a little weaker, but not as weak as you would expect. And by no means is there panic," a New York trader said.
The inclement weather in the Northeast made it a "hard day" to judge the market reaction, but the trader said there were only a few Puerto Rico items out for the bid - none from the large, institutional holders of the island's debt.
OppenheimerFunds, Franklin Advisors, and Wells Fargo Advisors are the top three fund holders of Puerto Rico debt, according to data provided by Morningstar Inc.
Yields on Puerto Rico GOs with a 5% coupon due in 2041 were trading higher by 25 basis points throughout the day as word of the downgrade spooked some investors. A Florida trader said he saw some Puerto Rico GOs trading at 8.75% Wednesday morning.
"Pretty impressed so far," is how a Southwest trader described his impression of the market's reaction.
Despite some "mispricing" of P.R. paper Wednesday, he said there was "barely any selling, and some better prices, too, on many bonds."
"Then again, most of this stuff is already trading at B or B-minus levels," he said.
He still sees bonds that have "massive rally potential when the dust settles."
"When P.R. gets a deal done and comes up with a balanced budget or a surplus after all the moves the Governor is making, the ratings agencies are going to reverse their tune pretty quick," he said.
The market reaction on the buy side ran the gamut from calm and unfazed to disappointment and calls to action from the U.S. government.
Peter Hayes, head of the municipal bond group at BlackRock Inc. doesn't expect the downgrade will be very meaningful to the broader market.
"The downgrade was not at all unexpected," he said in a blog post Wednesday. "There has been a large disconnect between the rating agencies' assessment of Puerto Rico's debt and the market's view," he wrote. "In fact, Puerto Rico bonds have been trading as non-investment grade since last summer, so the new BB+ rating is actually a better reflection of the island's credit profile and pricing."
Others took issue with the downgrade.
"A below-investment-grade rating will make for a smaller potential pool of creditors, and certainly increase interest rate costs for the island," said Marie Autphenne, director fixed income research and strategy at Stifel in an email Wednesday.
Standard & Poor's cited liquidity concerns when it downgraded the commonwealth's GO debt, which precedes a widely speculated $2 billion debt sale as early as this month.
Last week, Gov. Alejandro Garcia Padilla announced efforts to balance the commonwealth's fiscal 2015 budget.
"The rating downgrade comes at a time when the island has begun to make some positive strides towards a more balanced budget," Autphenne said.
Traders quoted the downgraded P.R. debt higher in yield by as much as 30 basis points at midday Wednesday - about five basis points weaker than where they were trading that morning.
"We expect to see further selling in the coming weeks from retail accounts, perhaps at further distressed levels," Autphenne said.
