Municipals end session flat; market gears up for $3 billion G.O. junk bonds from Puerto Rico

By Sheri Kasprzak

New York, March 10 - Municipals closed out the session mostly unchanged as Treasuries were little moved, market insiders said.

"I'd call it flat," a trader late said in the session.

"We're waiting for the supply to start coming in, and everyone's watching the Puerto Rico deal. It will be interesting to see how it impacts the market [following the commonwealth's downgrades to below investment grade]."

Treasuries offered little direction for municipals Monday, with the 10-year and five-year Treasury note yields falling by 1.5 basis points and the 30-year bond yield falling by half a basis point ahead of $64 billion of auctions.

Puerto Rico preps G.O. bonds

Market participants will be closely watching Puerto Rico's planned $3 billion offering of series 2014A general obligation bonds (Ba2/BB/BB), which will price Tuesday through Barclays, Morgan Stanley & Co. LLC and RBC Capital Markets LLC.

The commonwealth intends to use proceeds from the offering to repay some Government Development Bank lines of credit, repay some bond anticipation notes issued by the Puerto Rico Sales Tax Financing Corp. and refinance outstanding G.O. bonds.

"The current transaction, the vast majority of which will replace existing debt rather than adding to the commonwealth's debt load, is designed to bolster liquidity at the Government Development Bank for Puerto Rico and remove potential near-term liquidity stresses," wrote Fitch analysts Laura Porter and Karen Krop.

"Fitch's rating assumes that the commonwealth will be able to address liquidity pressures through such borrowing, and the inability to do so could result in significant credit deterioration. Puerto Rico's current management has repeatedly shown its ability and willingness to take quick action to address financial challenges and external market concerns, much of which has required legislative action. However, underlying the need for these measures is the very difficult economic, financial and market situation that management continues to support."

Puerto Rico G.O. index rallies

Puerto Rico G.O. bonds, as tracked in the S&P Municipal Bond Puerto Rico General Obligation index, have rallied 13.67% this year ahead of the offering, said J.R. Rieger, vice president of fixed-income indexes with S&P Dow Jones Indices.

Yields of bonds in the index have dropped by 122 bps to end on March 7 at 7.12%.

"The success of the pending bond sale and the yields investors are willing to accept in return for taking on the risk lending their money to Puerto Rico will be very telling," Rieger wrote Monday.

A few things are working in the commonwealth's favor, said Rieger.

"The municipal bond market has absorbed large bond issues in the past," he noted.

"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."

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