Puerto Rico has been making headlines for months. Yesterday, the clincher finally appeared: S&P downgraded the island’s debt to “junk” status. What does it mean for the municipal bond market? After all, given the triple-tax-exempt status of Puerto Rico bonds, they are widely held by muni investors across the nation.

The answer may surprise you: We don’t expect it will be very meaningful to the broader market at all.

The downgrade was not at all unexpected. As I alluded to in my November blog post, there has been a large disconnect between the rating agencies’ assessment of Puerto Rico’s debt and the market’s view. In fact, Puerto Rico bonds have been trading as non-investment grade since last summer, so the new BB+ rating is actually a better reflection of the island’s credit profile and pricing.

Whereas the broader municipal market was down 2.55% last year, Puerto Rico was down 20.47%. Clearly, investors had taken notice. Many actually sold down their positions over the course of the summer and fall, giving those that hung on ample time to position for the downgrade.

In addition, S&P Dow Jones last month made the decision to remove all U.S. territories (including Puerto Rico) from its investment-grade indexes, indicating they no longer meet the objectives established for those indexes. This required investment-grade index products to sell their Puerto Rico exposure, which effectively alleviates forced selling in the aftermath of the downgrade.

What Next?

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