Puerto Rico’s Junk Bonds Still Attracting Interest

Puerto Rico’s Junk Bonds Still Attracting Interest
Photo by Kurious (Pixabay)

Puerto Rico municipal bonds have been downgraded to junk status, but the re-rating seems to have already been priced in, creating an opportunity for investors who aren’t limited by restrictions on their high yield exposure.

Crossover investors are active in Puerto Rico muni market

“Crossover investors continue to play a very active role (the vast majority of them are not sensitive to ratings) and might utilize the downgrade to add to their positions. We reiterate that the Moody’s Corporation (NYSE:MCO) downgrade also seems to be priced in since PR’s bonds have been already trading in distressed territory since August 2013 and price change has been very limited last week,” write Citi analysts Mikhail Foux, Vikram Rai, and George Friedlander.

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PR debt breakdown 0214

There may be some forced selling as portions of Puerto Rican debt are removed from major indices, but the Citi report expects the impact to be minimal because funds have had a long time to prepare for this downgrade. It will reduce the number of potential buyers since many funds have restrictions on their total exposure to high yield bonds.

So far, the muni bond market has been unaffected by the downgrade – munis saw another week of inflows and investors bought $19 million in Puerto Rican paper. While Puerto Rico has been bombarded with negative press over the last six months, fears that it could be the next Detroit have never really taken root.

RBC deal changes focus from ratings to growth

“We expect Puerto Rico to focus on creating an additional liquidity cushion potentially by tapping the market via a large deal, which is likely to attract strong interest from crossover investors,” Foux, Rai, and Friedlander wrote before the Royal Bank of Canada deal was announced, predicting that “focus may begin to shift from rating and liquidity concerns to the economic outlook for PR and its ability to balance its budget.”

The additional funding guarantees that Puerto Rico isn’t going to default anytime soon, giving the US territory more time to work on structural reform and to benefit from the US recovery. Ironically, part of the justification behind the downgrades was that ratings agencies weren’t convinced that Puerto Rico could access financing if the need arose – an argument the RBC deal refutes.

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