We first analyzed the bond market view of the Commonwealth of Puerto Rico on December 12, 2013. Since then, the drama surrounding the Commonwealth of Puerto Rico and its ability to obtain financing has intensified considerably. See "Puerto Rico Investors Bracing for Default" for background. 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, with a particular focus on trades since December 12. We note that the credit default swaps of Puerto Rico have never traded according to the data provided by the Depository Trust & Clearing Corporation, so the bond market is the dominant source of information on the market's view.
We find that spreads on both classes of Puerto Rico bonds have narrowed somewhat since the end of 2013, a conclusion based firmly on traded bond prices recorded on the EMMA website of the Municipal Securities Rulemaking Board.
Analysis of Puerto Rico Bond Issues
We re-analyze all of the trades from June 1, 2013 through January 28, 2014 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 early redemption provisions on the bonds are described in this paragraph:
Although some of the bonds issued by the Commonwealth on the same date (July 12, 2011) were insured, the 5.75% bonds due July 1, 2041 are not covered by that insurance.
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.
The seniority of the bonds is described as follows:
The 5.25% bonds due August 1, 2040 are subject to early redemption as described in this paragraph:
We now turn to the market's view of both bonds.
Puerto Rico Municipal Bond Issue Yields and Credit Spreads
The MSRB website EMMA 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, 2013 through January 28, 2014, there were 735 trades for a total principal value of $341.1 million of the 5.75% Commonwealth bonds due 2041. This is more than 110% of the total principal amount of these bonds. The average trading volume per day during this period was 4.7 trades per day for an average of $2.2 million, with a high of $81.8 million per day and a low of $0. We remind the reader that there were zero transactions in the credit default swaps of Puerto Rico during the same period.
For the 5.25% bonds due 2040 issued by the Puerto Rico Sales Tax Financing Corporation, there were 899 trades for a total principal value of $615.9 million. This is more than double the principal amount of the bonds outstanding. The average trading volume was $4.0 million per day in 5.8 trades, with a high of $97.3 million and a low of $0. Between the two bond issues, trading averaged $6.2 million per day and the total trading volume over all days was $957 million.
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. Because of the current trading levels on the bonds, we ignore the impact of early redemption in what follows. 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 at first, fallen briefly in late October and early November, and then resumed climbing through the end of December. In January, however, yields and spreads have generally declined. The credit spreads themselves are shown in the next graph:
The largest trade on January 28 was done at a price of 71.75-72.00 for a principal amount of $1.97 million and a credit spread of 4.75%-4.78%. This compares with the highest trades recorded from June 1 to December 12, which were done at credit spreads close to 700 basis points. Small trades done on January 28 had credit spreads closer to 5.61%.
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:
The only trade on January 28, 2014 was for more than $1 million at a price of 80.562. The credit spread at this price level was 3.26%, compared with credit spreads that occasionally exceeded 4.00% before year-end.
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 January 28 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 January 28, the credit spreads on the Commonwealth general obligation bonds were 1.50% 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, but the last few weeks have resulted in a narrowing of spreads compared to credit spreads in the fourth quarter of last year. Many argue that such trading is now limited almost exclusively to hedge funds, but EMMA data continues to show a reasonable number of trades of $100,000 and under. 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.