The Price of Risk: Market Readies for $3billion Puerto Rico Junk Bond Sale

Puerto Rico general obligation bonds tracked in the S&P Municipal Bond Puerto Rico General Obligation Index have rallied 13.67% this year ahead of the planned $3 billion bond sale by Puerto Rico this coming Tuesday.  Yields of bonds in the index have dropped 122bps to end March 7th 2014 at 7.12%.  The success of the pending bond sale and the yields investors are willing to accept in return for the taking on the risk of lending their money to Puerto Rico will be very telling. This is Puerto Rico’s first new bond issue since it was down graded by all three ratings agencies to below investment grade last month.

On the eve of such a large sale of bonds a few things are going in Puerto Rico’s favor.  The municipal bond market has absorbed large bond issues in the past.  The triple tax-exemption on the interest earned on most bonds issued by Puerto Rico has, in the past, added to their value proposition. This deal is designed for institutional investors and those investors have been demonstrating they are willing to take on risky assets paying higher yields. Yield remains a powerful driver for investors. Average yields of these bonds have peaked at over 8% during the last two months which has attracted the attention of these yield hungry investors.

The last several weeks have illustrated the extent of that demand as yields for Puerto Rico G.O.’s have finally come back below the yields of CCC and below corporate bonds.

The graph below charts yield to worst of bonds in the S&P Municipal Bond Puerto Rico General Obligation Index vs. the yield to worst of bonds in the S&P U.S. Issued CCC & Lower High Yield Corporate Bond Index.

Source:  S&P Dow Jones Indices LLC.  Data as of March 7, 2014.

Source: S&P Dow Jones Indices LLC. Data as of March 7, 2014.

The recent steep decline in yields have pushed bond prices up resulting in Puerto Rico out performing the rest of the municipal bond market and other bond market segments so far this year. This new issue will tell us a lot about the depth of the market along with what price investors are willing to pay for the risk.

The table below highlights select fixed income asset classes and their year-to-date performance.

Source: S&P Dow Jones Indices LLC.  Data as of March 7, 2014.

Source: S&P Dow Jones Indices LLC. Data as of March 7, 2014.

The posts on this blog are opinions, not advice. Please read our disclaimers.

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