Since last Thursday, fresh rumors about the Federal Reserve Bank’s eventual winding down of its Quantitative Easing efforts (often referred to as “Fed tapering”) have kept the fixed-income markets on the defensive, particularly in light of the previous week’s stronger-than-expected April employment report. Since the beginning of the month, the yields on the 10-year and 30-year Treasuries have backed up significantly by 26 basis points and 30 basis points, respectively.
As these Fed tapering stories don’t usually come out of nowhere, one can only assume the Fed has already started to put the market on notice about the eventual end of QE. The idea, of course, is to give market participants enough time to digest the implications of such a move and hope they will react in an orderly manner.
Municipals were also caught up in the selloff but, as usual, outperformed their taxable counterparts: tax-exempt yields on the long end of the curve went up by a more subdued 13 basis points. This week, a fairly light new issue calendar (only about $5.5 billion) should provide some measure of support. The only notable issues on the negotiated side are a $366.5 MM for the Dallas/Ft Worth Airport and a $350 MM Los Angeles Wastewater Refunding.
Puerto Rico: Heading Back to the Danger Zone?
With all due apologies to Kenny Loggins, Puerto Rico paper is once again back in the headlines, and not in a flattering way.
It all started with a report from local newspaper El Nuevo Dia, which quoted Puerto Rico Transportation Secretary Miguel Torres Diaz as being concerned about a potential default by the PR Highway & Transportation Authority (“The Authority”) as early as this week. After this little news item was picked up by the national press, PR government officials quickly refuted the report. According to the Bond Buyer, a Government Development Bank (“GDB”) spokesman confirmed that the Authority will not default “in the week of May 13″(!)
…we would tend to believe that the Commonwealth will go out of its way to avert a default in the short-term, as the timing could not be worse: PR needs to preserve what little market access it still has for its upcoming bond deals…
The specificity of that statement gave investors little reason for comfort: do they mean to say it could it still happen after this week? For our part, we would tend to believe that the Commonwealth will go out of its way to avert a default in the short-term, as the timing could not be worse: PR needs to preserve what little market access it still has for its upcoming bond deals, rumored to be as much as $2 billion in size.
While the Highway & Transportation Authority is certainly the weakest among all agencies that have become dependent on Commonwealth support, we would be more concerned about the potential impact on the GDB itself. As Axios senior analyst Carol Karsten put it, “all roads lead to the GDB, and PRASA and Highways, even PREPA, are dependent on GDB’s ability to make loans that then must be repaid timely so that another interagency loan can be made. If just one agency does not pay back on time, then all the wheels can fall off that fragile cart.” (Note: we are working on an in-depth review of PR GDB. Please contact us at email@example.com if you’re interested in ordering a copy of that report.)
At the end of the day, everything hinges on the future course of PR’s economy. The economic challenges facing the new Padilla Administration were highlighted last week at a luncheon hosted by the Municipal Analysts Group of New York (MAGNY). The guest speaker, Fed Economist James Orr, quite succinctly summarized PR’s economic problems as follows.
First, PR’s Index of Coincident Economic Indicators (CEI) has been steadily declining since November 2005, well ahead of the 2008 crisis. There was a slight uptick from mid-2011 to late 2012, but the decline has since resumed. In contrast, New York City’s CEI took a dive from April 2008 through October 2009 but has gone straight up since.
Secondly, after rising steadily since the late 1980s, PR’s Real GNP Per Capita has been on a downtrend since 2006. The jobless rate still hovers around 15% currently, almost twice as high as the U.S. rate. The labor force participation rate stood at only 47.5%, trailing the U.S. level by 17.9%. Youth unemployment is particularly acute in the 16-24 age cohort. The chemical sector, including pharmaceuticals, traditionally the mainstay of the PR economy, has been shrinking with the expiration of tax incentives.
We suspect this convergence of trading levels is only a temporary phenomenon and, upon resolution of the current crisis, if and when that happens, sharp credit distinctions will once again emerge among the various PR entities.
Finally, the island has found itself increasingly uncompetitive from an energy and cost of doing business standpoint. Unlike most mainland states, the Commonwealth does not even have a utility regulatory commission and its primarily oil-based electric generation capacity is extremely expensive.
From a trading standpoint, we find it interesting that credit spreads on all PR agencies and instrumentalities, with the exception of COFINA, are converging toward the +230/+250 basis points (versus AAA) level. For example, long PR G.O.s are trading around +230, PREPA around +240 and PRASA around +247. In other words, the market has come to the conclusion that, in the end, all these different entities are really one and the same credit. While there used to be a distinct hierarchy among PR issuers, that hierarchy has been erased by the Commonwealth’s current fiscal crisis.
We suspect this convergence of trading levels is only a temporary phenomenon and, upon resolution of the current crisis, if and when that happens, sharp credit distinctions will once again emerge among the various PR entities. Until that happens, investors will be well-served by making sure they hold only the best relative values among the PR names.
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