During October, Puerto Rico bond prices recouped a portion of their late-summer plunge that pushed yields above 10% for certain bonds. The rebound followed efforts by Commonwealth officials to address the island's wide-ranging fiscal challenges, plus speculation that the federal government might step in to assist Puerto Rico. It also coincided with a general upturn in risk appetite across asset markets after the U.S. Congress passed legislation on October 16 that ended the partial shutdown of the federal government and temporarily suspended the debt ceiling through February 7, 2014.
Opportunistic purchases by hedge funds also helped lift Puerto Rico bond prices from their recent lows, according to widely published reports. For example, throughout early and mid-October, hedge funds frequently bid up prices of COFINA (Puerto Rico Sales Tax Financing Corp.) bonds.
COFINA, which is expected to soon mount a new offering of third lien sales tax bonds, is the highest-rated Puerto Rico municipal issuer. Its outstanding first subordinate lien bonds are rated A3 by Moody's and A+ by both S&P and Fitch.
Even after rallying last month, Interactive Data's evaluated prices for Puerto Rico municipal issues remain well below levels that prevailed shortly before investors were spooked by an August 24 Barron's cover story that likened the island's finances to those of Detroit (see Evaluated Puerto Rico Prices chart). The S&P Municipal Bond Puerto Rico index gained 1.7% during October, but is down 18.8% over the 12 months ended November 18. The steepest portion of the 2013 decline came during the two weeks after that Barron's article was published.
In the wake of the selloff, the Commonwealth government scaled back issuance for the remainder of 2013, moved toward reforming its under-funded pension system, and hosted a number of meetings and calls with investor groups. Officials also indicated that Washington is preparing to help - possibly with economic-development aid targeting the Puerto Rico economy, rather than a bailout for the island's government.
The other chart, tracing the Interactive Data evaluated pricing for 5-year default protection on the Commonwealth of Puerto Rico, shows little sign that lenders have become sanguine about repayment prospects. Unlike the back-and-forth price movements in the cash bond market, Puerto Rico's 5-year CDS spread has ascended monotonically in a stair-step pattern since the beginning of August. While the CDS spread has stabilized since peaking on October 11, it has barely narrowed since then.
As of November 15, five-year protection against a Puerto Rico debt default cost 833 basis points according to Interactive Data's CDS evaluations. That is more than four times the cost of protection against a default by Illinois, the lowest-rated U.S. state, and more than eight times the cost of default protection for California state debt.
On November 14, Fitch Ratings placed Commonwealth of Puerto Rico general obligation bonds on Rating Watch Negative, along with commonwealth-guaranteed bonds of Puerto Rico Building Authority and PRASA, and pension funding bonds of the Puerto Rico Employees Retirement System. In announcing a formal review of those entities' current BBB- ratings, Fitch emphasized the recent "unexpected deterioration in (Puerto Rico's) capital market access" as a primary reason for lowering the ratings.
In the cash bond market, certain bonds issued by the Commonwealth and related entities have held steady in November after moving substantially higher in price and lower in yield during the second half of October. However, the price recovery has not been uniform. Some issues - including the PRASA (Puerto Rico Aqueduct and Sewer Authority) 5.125% coupon maturing July 1, 2037, and the Commonwealth 5.75% coupon GO maturing July 1, 2037 insured by Assured Guaranty - recovered to levels at or near where they stood on August 23. Others did not. The evaluated price of the Public Building Authority 6.125% coupon maturing July 1, 2023 barely budged during October and stands 18% below its August 23 level.
Interactive Data's bid-side evaluations are market-based measurements that represent our good faith opinion as to what the holder would receive in an orderly transaction (typically in an institutional round lot position) under current market conditions.
A listing and description of seven major issuers of Puerto Rico tax-exempt debt can be found in the October 1 Bond Buyer article "Dissecting Puerto Rico Bonds' Summer Swoon." A complete listing is available on the Government Development Bank for Puerto Rico website.
Jon Barasch is Director, Municipal Evaluations, and
Jon Jacobs is Senior Fixed-Income Analyst for Interactive Data.