In April, Puerto Rico announced a debt moratorium. The emergency measure prioritizes essential service activities that promote the health, safety and welfare of the commonwealth over debt payments. One impact of the moratorium was Puerto Rico’s Government Development Bank (GDB) missing a $400 million debt payment last week. The missed payment was widely expected by the market, and SNWAM sees little spillover to the rest of the investment grade municipal space. We cannot report any forced selling from mutual funds or large outflows from the investment grade municipal sector. In fact, market observations are just the opposite. For example, supply/demand technical factors are positive when measured by the strong cash flows into the investment grade municipal sector over the past few months.
Looking forward, July 1st will be another test for Puerto Rico, when a $2.0 billion debt payment comes due. It will be interesting to see how the market reacts, because $800 million of the debt payment is for general obligation (G.O.) bonds. If Puerto Rico does default on the G.O. debt, it will be the first time since 1933 that a state level borrower missed a payment. It is expected that Puerto Rico will default on its constitutionally protected G.O. debt, and SNWAM anticipates that like what we’ve seen thus far, the risk will be idiosyncratic, as opposed to systematic municipal market risk.
Residents of Puerto Rico are U.S. citizens, and their hardships and sacrifices should not be downplayed. SNWAM has also found and continues to find opportunities in bonds that receive Puerto Rico’s triple tax exemption advantage, offer very attractive yields and are highly rated in the A category. The bonds we like and own in client portfolios are funded through U.S. congressional appropriations, and support affordable housing units on the commonwealth. Since the GBD missed its debt payment, pricing for the housing bonds has remained stable and the rating agencies have not changed their ratings or outlooks. In our opinion, the debt moratorium is a credit positive for the affordable housing bonds because congressional appropriation in excess of debt service cannot be diverted to support other debt obligations like G.O. or GDB debt. In sum, we feel good about our holdings of the housing finance agency bonds and aren’t concerned with broad market turmoil because of what’s happening with most other series of PR debt.
Source: SNWAM Research