It is difficult, I believe, to imagine that there is an investor who has no opinion on recent events affecting the Commonwealth of Puerto Rico. The actions recently taken by the three leading bond rating agencies to move the ratings of certain Puerto Rico issues to below investment grade have created a firestorm of commentary and angst over the possibility that Puerto Rico, the ninth largest issuer of tax-exempt municipal bonds, might default on its payment obligations.
Source: Van Eck Global Research using data compiled by Bloomberg. As of February 13, 2014.
As has been thoroughly reported, a good number of municipal bond mutual funds and ETFs across the country have (or had) exposure to many of the Commonwealth’s issues of triple tax-exempt bonds (federal, state, and local levels of taxation), going into this current crisis1. Selling by wealth managers began in earnest last summer and only exacerbated the downward spiral of valuations, putting greater pressure on the island to seek to maintain a foothold in the capital markets. Significantly, S&P has mandated, as a condition of Puerto Rico’s avoiding further erosion of its BB+ credit rating, that it raise capital in the bond markets, which it plans to do in the next few weeks.
Despite all of this, I offer these observations: since Moody’s joined S&P to drop the credit of Puerto Rico to below investment grade, there has been no diminution in the trading of its bonds. Yes, there have been sellers, but there have also been buyers. Several dealers have reported daily trade activity in the hundreds, representing $20 million to $30 million in nominal value.
It has also been reported that certain very large and opportunistic money managers are building large positions in Puerto Rico bonds, which may provide the liquidity the market needs. This may be suggestive of an oversold market, and a chance, perhaps, to position accordingly, given some expectations for recovery.
Whatever the outcome, it remains important to note that below investment-grade ratings do not mean imminent default. We should consider these factors as important markers in this evolving narrative.
1Source: Bloomberg Brief Newsletter. As of February 10, 2014. “Puerto Rico Cut Means Realignment for Indexes.”
The Market Vectors High-Yield, Short High-Yield, Long, Intermediate, and Short Municipal Index ETFs invest assets in municipal bonds issued by Puerto Rico. (Click the preceding hyperlinks to view current geographic weightings.) This means the Funds are susceptible to additional risks, including economic, political, regulatory or other factors adversely affecting issuers in Puerto Rico. Recent downgrades affecting these bonds may exacerbate Puerto Rico’s current financial difficulties and the liquidity and risk profile of its outstanding bonds, which may affect these Funds.