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Deteriorating Conditions in Puerto Rico Will Pressure High-Yield Muni ETFs

ETFtrends.com

Mounting concern over Puerto Rico’s ability to repay debt obligations could continue to add to volatility in high-yield municipal bond exchange traded funds.

High-yield munis dropped off in late June on Puerto Rico default fears but has traded higher since, along with the broader markets. Over the past week, the Market Vectors High Yield Municipal Index ETF (HYD) gained 0.6%, SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB) was up 0.6% and the shorter duration Market Vectors Short High-Yield Municipal Index ETF (SHYD) was relatively flat.

The more speculative-grade muni ETFs hold a position in the island commonwealth. Puerto Rico is 2.9% of HYD, 8.8% of HYMB and 5.1% of HYD.

However, in another sign that the island could be on shakier grounds, Public Finance Corp has failed to transfer funds to make a $58 million bond payment due August 1, reports Nicole Bullock for the Financial Times.

PFC funds make payments from appropriations in Puerto Rico’s budget each year, but lawmakers did not provide money for the bonds this year.

“In accordance with the terms of these bonds, the transfer was not made due to the non-appropriation of funds,” Melba Acosta Febo, president of Puerto Rico’s Government Development Bank, told the FT.

Meanwhile, the Caribbean island is still working on a restructuring its $72 billion debt obligation. At the end of June, Puerto Rico governor Alejandro García Padilla was concerned about the government’s ability put together enough cash, stating that the island’s debt was “not payable.”

With default concerns at the forefront, Pacific Investment Management Co. also said it doesn’t own any Puerto Rico debt, reports Michelle Kaske for Bloomberg.

“Adjusting to a sustainable servicing capacity over the longer term would necessitate larger haircuts through reduction of principal,” Sean McCarthy, head of Pimco’s municipal credit research in New York, said. “If not, then Puerto Rico, like Greece, faces future rounds of restructuring.”

McCarthy argued that the island may be forced to pay less than the full value of securities when they mature, pointing to Puerto Rico’s economic weakness. The economy has shrunk every year but one since 2006 and is expected to contract 1.2% in 2016. Moreover, the more are abandoning the island, with a projected 245,000 residents expected to leave by 2025.

“Puerto Rico’s debt is not sustainable without real economic growth and a consolidated surplus,” McCarthy added. “These will remain elusive over the next several years by any reasonable estimate.”

For more information on the munis market, visit our municipal bonds category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.