The yield spike on bonds from Puerto Rico's $3.5 billion junk bond sale in March has caused some market participants to question the paper's continued value.
Yields on the 8s in 2035 rose 21 basis points on Wednesday to 9.7%, according to data provided by Bloomberg.
“Some people inside the municipal market won’t touch [Puerto Rico bonds] for a while,” a trader in New York said. “It will mostly be handled by crossover buyers.”
Yields on the bonds are rising, according to market participants, because Moody's Investors Service downgraded the commonwealth's outstanding $14.4 billion GO debt to B2 from Ba2 on Tuesday, citing a newly enacted law that allows the island's public corporations to restructure debts.
"There's probably been a 70 to 100 basis points yield increase in last couple days, most after the Moody's downgrade yesterday," the trader said. "There was some activity after the [Puerto Rico Public Corporation Debt Enforcement and Recovery Act] was mentioned. It's all a function of dollar price right now, everyone is trying to get bonds to trade at what they're worth after the restructuring bill."
According to the Moody's statement, "Puerto Rico's new law marks the end of the commonwealth's long history of taking actions needed to support its debt. It signals a depleted capacity for revenue increases and austerity measures, and a new preference for shifting fiscal pressures to creditors, which, in our view, has implications for all of Puerto Rico's debt" including the GOs.
"I just want someone to take the [Puerto Rico] debt off my hands," a trader in Chicago said.
Richard Larkin, senior vice president and director of credit analysis, at HJ Sims wrote in a report that it is "foolish and naïve for someone to think that Puerto Rico bonds will lose all their value."
"There is still fundamental value for Puerto Rico bonds because of the government's ability to tax and its authorities' legal monopoly over its service areas for water, sewer and electric facilities," Larkin wrote.
Moody's also downgraded a slew of Puerto Rico agencies and public corporations, dropping the commonwealth's Sales-Tax Financing Corp.'s senior and subordinate lien bonds to Ba3 and B1, respectively.
Yields on the COFINA 5s in 40 rose by 84 basis points to 7.09% on Wednesday.
The Puerto Rico Electric Power Authority was downgraded to Caa2 from Ba3, and many other Puerto Rico agencies were also lowered.
Yields on the PREPA 5.25s in 40 jumped by 51 basis points on Wednesday to 13.46%.
"Even if this law reduces bond payment obligations through negotiation or legal mandate, it is very possible that a bondholder would do better under a 'bankruptcy' type settlement than to sell bonds at today's fire-sale prices," Larkin wrote in the report.
There has been some positive news coming out of the commonwealth, too, recently. On Tuesday Puerto Rico adopted a $9.56 billion budget, which Puerto Rico Gov. Alejandro García Padilla signed hours before the Moody's downgrades. Also, PREPA was able to make a $418 million coupon payment to bondholders, which was in doubt.
Natalie Cohen, senior analyst at Wells Fargo Securities, wrote in a report released on Tuesday that the commonwealth's pattern of paying back loans and debt with more short-term debt is reminiscent of what occurred in New York City in the mid-1970s. She advises market participants to look at a 2006 report by the Center of a New Economy that looks at New York City's fiscal crisis in the context of Puerto Rico.
"The report also discusses the fiscal crises of Washington, D.C. and Philadelphia," Cohen wrote. "We note that each of these crises was resolved over a period of 5-7 years without bankruptcy — but importantly with a 'superstructure' that included a Control Board that was given significant oversight powers and financial controls. Part of the superstructure could include bond issuance authority with 'ring-fenced' security (such as the Municipal Assistance Corporation for New York City). If things worsen in Puerto Rico, we could envision use of the GDB receivership to create such a superstructure and potential pathway to fiscal health."
Municipal bond yields rose across the curve on Wednesday, according to Municipal Market Data's triple-A scale.
Yields for bonds maturing in three-to six-years increased by zero to two basis points, by one to three basis points for seven to eight year maturities, by two to four basis points for nine to 25 year maturities, and by three to five basis points for 26 to 30 year maturities.
Yields on the most actively traded security in secondary trading rose moderately, following the market. JEA Water and Sewer System revenue bonds with 4s in 2040 yielded 4.12% to 3.76% in 197 trades compared to 4.1% to 3.7% in 211 trades on Tuesday.
An investor in the northwest said the selloff was prompted by the ADP employment report released on Wednesday morning. The report showed a 281,000 increase in private payrolls for June, up from 179,000 the previous month. Analysts had predicted a 213,000 rise.
"The ADP number this morning made people a little nervous," he said.
The trader in New York said that he thinks the yield increase is just the market snapping back after a strong rally.
"Munis have been trading really, really well," he said. "The market is running out of steam, getting a bit full, and starting to trade off."
