In the wake of the bankruptcy of Detroit, the intensity of investor focus on municipal bond risk has dramatically increased. In many municipal entities, the problems of both strategy and execution of public pension fund management are a major problem. Perhaps no municipal bonds are under more scrutiny than the various bonds issued by entities affiliated with the Commonwealth of Puerto Rico. In this note we analyze the current market view of two key Puerto Rico bond issuing entities and show how that view has evolved since June 1, 2013.
In this note, we analyze all of the trades from June 1 through December 12 on two Puerto Rico-affiliated bonds. The first bond, issued by the Commonwealth of Puerto Rico, was issued on these terms:
The original issue documentation and current financial information is available from the EMMA website of the Municipal Securities Rulemaking Board ("MSRB").
The second bond was issued by the Puerto Rico Sales Tax Financing Corporation on these terms:
The documentation for this bond issue is also available at the EMMA website of the MSRB. We now turn to the market's view of both bonds.
Puerto Rico Municipal Bond Issue Yields and Credit Spreads
The MSRB website EMMA also includes recent trading activity on a vast array of municipal bond issues in the United States. We use that data to derive the credit spreads of the 5.75% bonds due 2041 issued by the Commonwealth of Puerto Rico and the 5.25% bonds due 2040 issued by the Puerto Rico Sales Tax Financing Corporation. From June 1 through December 12, there were 665 trades for a total principal value of $334.8 million of the 5.75% Commonwealth bonds due 2041. This is 110% of the total principal amount of these bonds. The average trading volume per day during this period was $2.5 million, with a high of $81.8 million per day and a low of $0.
On the 5.25% bonds due 2040 issued by the Puerto Rico Sales Tax Financing Corporation, there were 803 trades for a total principal value of $762.0 million. This is more than double the principal amount of the bonds outstanding. The average trading volume was $4.6 million per day, with a high of $97.3 million and a low of $0. Between the two bond issues, trading averaged $7.1 million per day and the total trading volume over all days of $1.1 billion.
On each day for which a trade was reported, the yields to maturity for each trade were collected from the MSRB website. The remaining maturity of the bonds was calculated and the matched maturity U.S. Treasury yield was calculated using Treasury rate information from Kamakura Risk Information Services and the U.S. Department of the Treasury. The credit spread was calculated simply as the bond yields minus the matched maturity U.S. Treasury yields. We turn now to those results.
Commonwealth of Puerto Rico Public Improvement Bonds of 2011
The evolution of yields to maturity and matched maturity Treasury yields on the 5.75% general obligation bonds due 2041 are shown in this graph:
All trades during this period are reflected on this graph with no omissions or smoothing. For the readers' convenience, we have added a smooth line to the reported yields on the 5.75% bonds due 2041. Obviously, the spreads versus matched maturity Treasuries have climbed steadily, fell briefly in late October and early November, and then resumed climbing. The credit spreads themselves are shown in the next graph:
Recent credit spreads on an annualized basis have exceeded 500 basis points. The highest trades recorded from June 1 to December 12 were close to 700 basis points. Spreads on December 12 ranged between 5.24% and 5.28% over matched-maturity U.S. Treasuries.
Puerto Rico Sales Tax Financing Corporation Sales Tax Revenue Bonds
Senior Series 2011C Current Interest Bonds (PR)
The yield to maturity on the 5.25% bonds due 2040 is shown versus U.S. Treasuries in this graph:
Credit spreads on the same bonds are plotted here:
Recent credit spreads have exceeded 300 basis points. Spreads on December 12 ranged from 3.23% to 3.25% over matched maturity U.S. Treasuries.
Comparing Credit Spreads for the Commonwealth of Puerto Rico General Obligation Bonds and the Puerto Rico Sales Tax Financing Corporation Senior Series 2011C Bonds
If we plot the credit spreads on the two bonds jointly, the results show a dramatic difference in the perceived credit risk of the two entities:
Over the full June 1 to December 12 period, the Commonwealth general obligation bonds have traded at a widening premium to the credit spreads on the Puerto Rico Sales Tax Financing Corporation. On December 12, the credit spreads on the Commonwealth general obligation bonds were 2.02% higher than the spreads on the Puerto Rico Sales Tax Financing Corporation bonds.
Trading in municipal bonds issued by Puerto Rico entities is not for the faint of heart. Indeed, many argue that such trading is now limited almost exclusively to hedge funds. Potential investors in the municipal bonds of Puerto Rico need to do extensive analysis before executing such trades, and the website of the MSRB is an excellent place to begin such analysis.
Regular readers of these notes are aware that we generally do not list the major news headlines relevant to the organization in question. We believe that other authors on Seeking Alpha, Yahoo, at The New York Times, The Financial Times, and the Wall Street Journal do a fine job of this. Our omission of those headlines is intentional. Similarly, to argue that a specific news event is more important than all other news events in the outlook for the organization is something we again believe is inappropriate for this author. Our focus is on current bond prices, credit spreads, and default probabilities, key statistics that we feel are critical for both fixed income and equity investors.