The many market views of Puerto Rico

December 17, 2013

“That is what makes markets” is a financial industry aphorism that means there can be a broad spectrum of views about an asset or a specific security. This is most true for the municipal bonds of Puerto Rico.

With the darkest view of Puerto Rico bonds, BlackRock’s Managing Director and Head of Municipal Bonds Group Peter Hayes told Fox Business News that the Commonwealth may have to restructure its debt “somewhere between now and the middle of 2014 when their fiscal year begins.”

In this Reuters Insider MuniLand video, Emily Raimes, Senior Credit Officer at Moody’s, outlines the fiscal and economic factors that her ratings team will be evaluating after placing Puerto Rico on negative credit watch last week.

Risk management firm Kamakura plotted all trades of the benchmark Puerto Rico general obligation bond 2041 and the Puerto Rico Sales Tax Financing Corporation Senior Series 2011C Current Interest Bonds due 2040 (Cofina) against matched maturity U.S. Treasury yields. The increasing yields spell trouble:

S&P Indices plotted its Municipal Bond Index against the National AMT-Free Municipal Bond Index with this comment:

The S&P Municipal Bond Puerto Rico Index has seen a negative total return of 19.45 percent year to date and the weighted average price of bonds in the index has fallen by over 24 percent this year. The weighted average yield (YTW) of bonds in the index ended at 7.26 percent, or 419 bps higher than investment grade bonds.

Moody’s published a tough note on two insurers of Puerto Rico debt: Assured Guaranty and National Public Finance, saying:

National does not disclose net par exposures, but reports approximately $5 billion in total gross par exposure to Puerto Rico issuers (approximately $2.7 billion rated Baa3 review down or below), while Assured Guaranty subsidiaries, including lead company Assured Guaranty Municipal Corp. (insurance financial strength A2/stable), have approximately $5.5 billion of total combined net par exposure to Puerto Rico issuers (approximately $4.1 billion rated Baa3 review down or below).

These exposures constitute a significant portion of the qualified statutory capital and other claims paying resources of both National and the Assured Guaranty group (see Exhibit 1) and, if downgraded, would increase overall below investment grade exposures relative to capital, reversing some of the improvement seen over the past few years.

The team at Deutsche Asset and Wealth Management has a mixed to positive view of Puerto Rico in a December publication:

We believe there is the potential for very strong returns in Puerto Rico bonds, especially if a broadened base of investors gain confidence that the credit has stabilized. Much of the selling that took place in Puerto Rico bonds came from investors who were forced to sell for various reasons. In recent months non-traditional municipal-bond investors have started to purchase the bonds, which has stabilized prices.

But, potential returns will not come without price volatility, and will be dependent upon continued improvement of fiscal and economic conditions. Each negative headline that addresses the Commonwealth’s fiscal challenges creates a real potential for another round of price volatility. We continue to keep manageable exposure in order to minimize that volatility for our clients.

H.J. Sims’ Richard Larkin is muniland’s most positive analyst on Puerto Rico. His 2014 preview includes his view that:

Puerto Rico’s finances will stabilize, regardless of whether the rating agencies pull the trigger and vote to take the Commonwealth’s debt below investment grade.

Puerto Rico is the starkest example of a diverse market view of a distressed credit.

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I have positions both in P.R. and VENEZUELA REP. Which one is riskier?

Security Description: VENEZUELA REP NOTES 8.500% 10/08/2014 ISIN #US922646BM57 SEDOL #B032273
Event Description: DOWNGRADED TO Caa1 ON 12/16/13
CUSIP: 922646BM5

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