Bonds issued by the Commonwealth of Puerto Rico and related entities have experienced dramatic price swings since mid-August, amid shifting expectations about future supply and a growing media spotlight on the island's budget fundamentals.
After a sharp selloff in August and early September culminated with a number of the securities trading at 10% yield handles, Puerto Rico bonds recently staged a partial rebound. The accompanying chart illustrates Interactive Data evaluated price trends for seven long-maturity bonds from five of Puerto Rico's 17 tax-exempt bond issuing municipalities, instrumentalities and public corporations.
Major issuers of Puerto Rico tax-exempt debt include:
- Commonwealth of Puerto Rico (GO) — responsible for many services typically provided by mainland cities (e.g., police and fire protection, education)
- Puerto Rico Aqueduct and Sewer Authority (PRASA) — owns and operates the island-wide public water and wastewater systems.
- Puerto Rico Electric Power Authority (PREPA) — generating and distribution facilities supply 99% of the power consumed on the island.
- Puerto Rico Public Buildings Authority (PBA) — issues revenue bonds to finance office buildings leased by Commonwealth government agencies, as well as public schools and hospital facilities.
- Puerto Rico Sales Tax Financing Corporation (COFINA) — created in 2006 to finance and repay $6.8 billion of outstanding Commonwealth of Puerto Rico debt. COFINA issued revenue bonds secured by a new sales tax.
- Government Development Bank for Puerto Rico (GDB) — fiscal agent and financial advisor to the Commonwealth.
- Puerto Rico Highways & Transportation Authority (PRHTA) — issues revenue bonds backed by Commonwealth of Puerto Rico taxes on gasoline and other fuel, highway tolls and license fees.
Like the broader municipal bond market, Puerto Rico bond prices held fairly steady through the first four months of 2013, turned downward in May and continued to decline throughout the summer. The deterioration occurred against a backdrop of rising U.S. Treasury yields, the City of Detroit's July 18 bankruptcy filing, and outflows from municipal bond funds that induced bid-list selling. Weakness in Puerto Rico bonds was exacerbated by fear of rating downgrades to "junk" status and a string of headlines spotlighting concern about budget fundamentals.
Despite those concerns, on August 8 strong demand for Puerto Rico's first public debt offering of the year enabled PREPA (the issuer) to increase its sale to $673 million from $600 million. However, bids and trade prices for Puerto Rico bonds suffered after an August 24 Barron's cover story suggested the island's finances could turn into "an even bigger problem" for investors than Detroit. On September 9, certain Commonwealth of Puerto Rico GO bonds and Public Building Authority bonds traded at yields above 10%. The following day, the Puerto Rico Government Development Bank (GDB) announced it was scaling back bond issuance for the remainder of the year. Since the municipal market turned upward on September 12, many Puerto Rico bonds have likewise traded higher.
The chart shows that the timing and scope of evaluated price declines differed among issuers, and even among different bonds of the same issuer. For instance, Interactive Data's evaluated prices for a COFINA zero coupon bond maturing August 1, 2054 (CUSIP 74529JAP) bottomed in mid-August and climbed slightly thereafter. In sharp contrast, our evaluated price for the Commonwealth of Puerto Rico 6.5% GO bond maturing July 1, 2040 (CUSIP 74514LWX) plummeted more than 10 points on August 28 and again on September 9. Meanwhile, an insured Commonwealth GO bond — a 5.75% coupon maturing July 1, 2037, insured by Assured Guaranty — declined gradually from mid-July through the end of August, but dropped more than 8 points on September 6. A PRASA 6.15% coupon issue maturing July 1, 2038 — part of a lesser-known subset of bonds that are taxable to mainland U.S. investors — dropped less than 2 points over the course of August, but declined precipitously in mid-September while prices of federal tax-exempt Puerto Rico bonds were rebounding. 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.
Another way to examine recent market activity for Puerto Rico bonds is to look at the number of retail-size and institutional-size trades. Information compiled from MSRB trade records and analyzed by Interactive Data is shown in the accompanying table. The growth in institutional volume from the first week of August through mid-September is quite dramatic, and may reflect selling by municipal bond mutual funds to meet redemptions spurred in part by retail investor fears following publication of the Barron's article.
Jon Barasch is director, municipal evaluations and
Jon Jacobs is senior fixed-income analyst for Interactive Data.