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Muni Bonds: Puerto Rico Readies $3 Billion in Junk Debt

After three credit ratings agencies downgraded the commonwealth territory, Puerto Rico municipal bonds have rallied and is now offering $3 billion in bonds. Investors interested in gaining exposure to Puerto Rican debt can take a look at a couple high-yield municipal bond exchange traded funds.

Puerto Rico is offering $3 billion in general-obligation municipal bonds maturing in 2035 with yields between 8.625% to 8.872%, Bloomberg reports.

The S&P Municipal Bond Puerto Rico General Obligation Index has rallied 13.7% year-to-to-date as yields on Puerto Rican debt declined from a record 10.59% on Jan. 2. Bonds have an inverse relationship to yields, so a falling yield corresponds with rising prices.

David Chafey, chairman of the Government Development Bank, stated that the proceeds will help balance budgets, repay debt and give the island enough time to pay its bills through June 2015.

The commonwealth previously had a low investment-grade rating but was downgraded by Fitch, Moody’s and S&P ratings agencies to speculative-grade, junk status in February due to concerns about its ability to access capital markets. [BlackRock: What Puerto Rico’s Downgrade Means for Investors]

According to Morningstar data, Puerto Rico makes up 70% of U.S. muni mutual funds. Many investors like include Puerto Rico debt because it is exempt from Federal taxes and local taxes in every state, whereas muni investors are only exempt from state taxes if they are filing in the same state as the municipal bond issuer. [BlackRock: Do you own Puerto Rico in your Muni Fund?]

Investors interested in exposure to Puerto Rico’s debt can take a look at a couple high-yield municipal bond ETFs. Puerto Rico is the third largest component in the popular Market Vectors High Yield Municipal Index ETF (HYD) . HYD has an effective duration of 10.7 years and a 5.76% 30-day SEC yield, or a 9.54% taxable equivalent 30-day SEC yield for those in the highest income bracket.

Additionally, the SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB) includes a 3.3% exposure to Puerto Rico, HYMB has a 9.5 year duration and a 5.08% 30-day SEC yield, or a 8.98% taxable equivalent 30-day SEC yield for those in the highest income bracket.

Alternatively, the recently launched Market Vectors Short High-Yield Municipal Index ETF (SHYD) tries to limit interest rate risk with a lower effective duration of 5.12 years but comes with a smaller 4.62% 30-day SEC yield, or a taxable equivalent of 7.65% for those in the highest income bracket. SHYD also has the largest weight to Puerto Rico at 21.3%. [Market Vectors Rolls Out Short-Term High-Yield Muni ETF]

There are currently no Puerto Rico municipal bond-specific ETF, but Van Eck’s Market Vectors is working on one and registered the Market Vectors Puerto Rico Municipal Index ETF last year.

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