Puerto Rican municipal bonds have become one among the most widely traded in the world in recent months, and while most investors were unloading them in September, retail investors were still net buyers and crossover investors took advantage of the newly attractive prices. Selling subsided toward the end of the month, but the decision of state securities regulators to investigate the sale of Puerto Rican debt to Massachusetts residents could trigger further sell-offs, according to Citi analysts Mikhail Foux and Vikram Rai.

Heavy trades of Puerto Rican municipal credit

“Over the last two months Puerto Rico has become one of the most actively traded municipal credits with secondary volumes increasing more than fivefold,” write Foux and Rai. Trading volumes, generally between $3 and $5 billion in the past increased to $20 billion in September, 8.5 percent of the secondary muni bond market. Now that the Puerto Rican bonds have seen several weeks of net sales, crossover investors have started buying and the market seems to have stabilized. Retail investors, those who buy in blocks of less than $1 million, have continued to buy though in lower volumes.

Puerto Rican muni trade volume

Puerto Rican  investors net sellers september  Puerto Rican  retail still buying

Crossover investors role in stabilizing prices

“Crossover investors played an extremely important role in stabilizing Puerto Rico’s prices in September,” write Foux and Rai. “Initially they were very active in low-dollar COFINA zero coupon bonds. When prices of tax-exempt bonds adjusted, lower crossover buyers moved into the tax-exempt sector, gravitating towards bonds with low prices, and revenue credits.” Crossover buyers have moved back to taxable bonds, which Foux and Rai think is a better fit for them, partially explaining why the tax-free market has weakened recently.

Puerto Rican muni bonds are trading with higher yields than corporate CCCs and are rated higher, which Citi thinks provides investors with a good opportunity to move from corporates to municipal bonds and gain as much as 150 basis points in effective bond yields. The main question is what will happen as the Massachusetts probe develops.

“It is encouraging to see that there was some genuine buying of PR paper late last month,” they write. “However, it remains to be seen if today’s developments in Massachusetts cause another round of selling.”