Puerto Rico bonds continued to trade at yields consistent with weeks prior to a series of three rating downgrades, as low new issuance kept trading activity muted. Retail investor behavior continued to deviate from that of institutions.
Yield on commonwealth general obligation bonds with a 5% coupon maturing in 2041 were up one basis point Wednesday to 8.16%, 10 basis points lower than this time last week. The bonds have fallen more than 100 basis points in yield since the beginning of the year.
"At least so far, the Puerto Rico downgrades don't seem to have carried as much weight at large," Matt Fabian, director at Municipal Market Advisors, said in an interview. "In part it's because trading is so slow overall, you have a small primary, and not much supply in the secondary either. You've also had poor weather and a lot of things to suppress trading, which has helped the market survive."
Puerto Rico bonds were downgraded Tuesday by Fitch Ratings, the third and final rating agency to cut the island's bonds to junk. The government said it plans to sell general obligation bonds in an upcoming loan managed by Barclays, RBC Capital Markets and Morgan Stanley.
"Right now we're just junk paper; we're not missing any payments," a trader in New York said in an interview. "As soon as Puerto Rico misses an interest payment, it'll start spilling over into other muni paper and people will start looking at what they're holding, asking if it's okay."
While overall yields have not weakened since the downgrade announcements, the move by the rating agencies has further divided the Puerto Rico bond market into two separate camps of retail and institutional investors.
The high-profile downgrades and resulting negative headlines have caused retail investors to back out of positions in the territory's debt, while many institutional investors, some deterred from buying the bonds, continue to stay the course.
"From our perspective, much of the discounted institutional trading occurred predominately in the third and fourth quarter and, as a result, what we are seeing this week is retail capitulation," Yaffa Rattner, head of muni analytics at Piper Jaffray, said in an interview.
The number of non-zero-coupon Puerto Rico bond trades at or below 50 cents has climbed to around 110 this week, from 20 two weeks ago, and now represents as much as 3.10% of all trades, according to data from MMA.
"When you see the number of these trades, there is this fringe of the market that has emerged and gotten larger as the commonwealth's problems have gotten worse," Fabian said. "That level of selling at these distressed levels hasn't abated since the downgrades."
The most actively traded municipal bonds Tuesday were Puerto Rico 5% GOs of 2041 and Puerto Rico Highway and Transportation Authority unrefunded revenue bonds with a 5% coupon in 2032, according to the Municipal Securities Rulemaking Board.
The Highway and Transportation Authority bond, insured by Assured Guaranty, was propelled by about 90 trades totaling $1.12 million after the market closed Tuesday. The series of trades, with yields at 7.22%, could be anything from a separately managed account liquidating holdings to one retail network hitting many customer bid-wanted at once, market observers speculated.
"It does support the idea of retail selling pressure," Fabian said. "News of the [bond issue] has maybe given some comfort to some of the institutional buyers, but there's continued divergence between retail and institutional."
Municipal bond yields climbed Wednesday, playing catch-up to Treasury losses that occurred Wednesday after testimony by Federal Reserve chair Janet Yellen.
"We're definitely weaker again here today, up a few basis points on the long end already," another trader in New York said in an interview. "We were softer yesterday afternoon, and while the longer end definitely was cheaper, they probably should be a lot cheaper."
Treasury yields jumped Tuesday as Yellen made her first speaking appearance since ascending to the chair following Ben Bernanke's exit; municipal bond yields finished the day up by just one basis point in some parts of the curve.
The chair's testimony before the House Financial Services Committee indicated she expects "continuity" in the Federal Open Market Committee's policy, surprising some on Wall Street who perceived Yellen to be more dovish than Bernanke.
"With the Treasury market selling off, we're trying to follow suit with that today," the trader said. "If all the factors impacting munis were in line we'd be selling a lot more right now, but with very limited supply there's not much to go on."
Just $2.56 billion of new deals are expected this week, including the week's biggest bond issue, $496.4 million Louisiana GO bonds, which was already sold. Some deals originally scheduled for Friday have been pushed up to come to market before a forecasted snowstorm hits the northeast.
"Deals are getting pushed up because of the storm, you'd be crazy to try and come on Friday this week," the trader said.
The biggest deal in the negotiated market set to price Wednesday was $114.7 million of Cypress-Fairbanks, Texas,
variable-rate bonds led by JP Morgan. Goldman, Sachs & Co. brought $97.73 million of revenue refunding bonds for the Metropolitan Water District of Southern California.
Yields according to Municipal Market Data's AAA scale were as much as two basis points higher on bonds maturing between 2021 and 2027. Those maturing from 2018 to 2044 gained as much as one basis point.
Treasuries yields continued climbing, with the 30-year moving four basis points higher to 3.72% and the 10-year jumping six basis points to 2.77%. The two-year yield rose one basis point to 0.35%.
