Fitch: Investors Sell Puerto Rico Bonds; PRICA Adds Uncertainty
NEW YORK--(BUSINESS WIRE)--Pressure on US mutual funds to sell Puerto Rico (PR) bonds could contribute to deteriorating capital markets for the commonwealth's debt, Fitch says. Tuesday's credit downgrade and recent updates to the Puerto Rico Investment Company Act of 2013 (PRICA) may introduce additional selling pressures by mutual funds operating out of PR. Funds already cut their exposure to PR bonds significantly in the second half of 2013.
Fitch Tuesday downgraded PR general obligation and certain GO-linked credits to 'BB' from 'BBB-', resolving a negative rating watch from Nov 14, 2013. COFINA sales tax bonds, the island's top credit, remained at 'AA-/A+'.
US mutual funds have already sold much of their PR municipal bond holdings since May 2013. Fitch reviewed holdings of 92 Fitch rated municipal closed-end funds across 6 large asset managers. The group cut their PR exposure, on average, by more than 65% through Dec 2013, with two managers exiting their holdings entirely.
US mutual funds have historically invested in PR bonds because of its triple tax-exempt status and good liquidity compared to eligible non-PR issues. For example, a single-state fund investing in bonds exempt from Federal and New York State income tax might have 95% New York State municipal bonds and 5% PR municipal bonds.
Sales of PR municipal bonds were more pronounced for single-state funds because they historically carried higher exposure. As of Dec. 31, 2013, single-state funds had reduced exposure to 1.5% from 4.7% on average, while national funds had declined to 0.8% from 2.0%. Among US funds that retained PR exposure, COFINA bonds constituted on average 34% of PR holdings at the end of the year, down from 66% at end of May. This suggests that US funds chose to sell COFINA bonds instead of realizing losses on the more depressed GO and other GO-linked credits.
The selling pressure converged prices among the two issues in fall of 2013. This allowed fund managers operating out of PR to trade in a number of their GO holdings for the higher quality COFINA bonds, which better positioned them to weather the GO downgrades that followed.
In addition to credit deterioration, the enactment of the new PRICA, which governs the island's mutual funds industry with over $11 billion in assets as of year end, could add pressure on PR bond prices and liquidity in the future. Mutual funds operating out of PR currently invest almost exclusively in PR municipal debt. If they adopt the new PRICA, they would be allowed to diversify their portfolios outside of the commonwealth or into local corporate exposures. Selling municipal bonds could further stress prices of the island's debt, as noted in See Fitch commentary on the new PRICA published Jan 29, 2014.
PR bonds suffered strong price declines over the second half of 2013, but have stabilized recently. Prices of GO pension funding bonds, 2036 maturities, originally declined 56% since May 2013, but are up 14.1% today from lows last week. This compares to a 35% price drop in COFINA sales tax bonds, which are up 9.2% from their Dec 2013 lows, and a 10.9% drop in the broader Barclays U.S. Municipal Long Bond index, which is up 5.1% from its lows in Sept 2013.
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The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.