Puerto Rico has been making headlines for months. Yesterday,
the clincher finally appeared:
downgraded the island's debt
to "junk" status. What does it mean for the municipal bond
market? After all, given the triple-tax-exempt status of Puerto
Rico bonds, they are widely held by muni investors across the
The answer may surprise you: We don't expect it will be very
meaningful to the broader market at all.
The downgrade was not at all unexpected. As I alluded to in my
November blog post
, there has been a large disconnect between the rating agencies'
assessment of Puerto Rico's debt and the market's view. In fact,
Puerto Rico bonds have been trading as non-investment grade since
last summer, so the new BB+ rating is actually a better
reflection of the island's credit profile and pricing.
Whereas the broader municipal market was down 2.55% last year,
Puerto Rico was down 20.47%. Clearly, investors had taken notice.
Many actually sold down their positions over the course of the
summer and fall, giving those that hung on ample time to position
for the downgrade.
In addition, S&P Dow Jones last month made the decision
to remove all U.S. territories
(including Puerto Rico) from its investment-grade indexes,
indicating they no longer meet the objectives established for
those indexes. This required investment-grade index products to
sell their Puerto Rico exposure, which effectively alleviates
forced selling in the aftermath of the downgrade.
Puerto Rico remains on review for downgrade by Moody's and
Fitch, and the next month could see action from either or both
agencies. Regardless of the rating,
the grim facts around Puerto Rico's economic, fiscal and
demographic state are clear. While we applaud the
administration's efforts to free up liquidity and aid the ailing
pension system, a restructuring may be unavoidable. In fact, the
island will need to borrow relatively soon to meet its
obligations, and it may well find it difficult or impossible to
access the market for financing. That may dictate whether Puerto
Rico buys some additional time or finds itself pressed into a
Ultimately, Puerto Rico's troubles have been well telegraphed
and largely priced into the market, underscoring our call for
minimal downgrade-related ripple effects.
As always, we would point to thorough
as the lynchpin to effective decision-making in
today's municipal market
. There are big disparities across credits and issuers, even in
Puerto Rico. It's critically important to know what you own, and
to know what to avoid.
Peter Hayes, Managing Director, is head of BlackRock's
Municipal Bonds Group and a regular contributor to
You can find more of his posts
Sources: BlackRock, S&P Indices