Investors Appear to Shrug Off Puerto Rico’s Debt Downgrade

Investors’ faith in Puerto Rico’s debt appeared undaunted on Wednesday after Standard & Poor’s cut the island’s credit rating to junk a day earlier.

Analysts and traders said prices of some Puerto Rico bonds traded lower on Wednesday, but there was no mass selling that might indicate a panic. The spread between Puerto Rico’s 30-year general obligation bonds and a benchmark of highly rated municipal bonds was unchanged from Tuesday, when S.&P. issued its downgrade, according to Thomson Reuters Municipal Market Data.

Many investors shrugged off the downgrade, saying they had anticipated it months ago, while others said the possibility of a default remained remote.

“I think the market for Puerto Rico bonds has been oversold,” said James Colby, senior strategist for Van Eck’s municipal exchange-traded funds, which have exposure to Puerto Rico bonds. “Is there a possibility for further downgrades? Yes. Does it mean they are not going to pay? No.”

Such confidence in the beleaguered island’s ability to pay back its debts is based on a longstanding bargain: Investors have been willing to lend Puerto Rico billions of dollars to deal with its grave economic problems. In exchange, its bonds have historically generated some of the highest returns in the municipal debt market.

But that bargain has become increasingly precarious. In downgrading Puerto Rico on Tuesday, S.&P. warned that the island faced a worsening cash squeeze in the face of a challenged economy. Its downgrade could further strain the commonwealth’s liquidity because it could accelerate $940 million of debt payments and require additional interest rate swap collateral postings, according to S.&P.

Gov. Alejandro García Padilla said on Wednesday that the government would renegotiate those debt deals to prevent such accelerations while also working on “financing alternatives that will bring additional liquidity.” He added that he would seek to further reduce government budgets and achieve other costs savings.

The governor’s statement was also significant in what it did not say. It did not mention whether Puerto Rico had plans to borrow money from the municipal bond market, which ratings agencies consider a crucial test of the government’s liquidity.

Bankers and investors have said that Puerto Rico has been exploring a municipal bond sale of up to $2 billion. Many had expected a deal to happen last month or by the end of this month.

The lack of mention of a bond deal by the governor “indicates an increasing sense of dread among the leadership that the market is not open to them in any capacity,” said Robert Donahue, managing director at Municipal Market Advisors.

For now, some large investors say they have faith that the government can deliver on its promises to manage its cash.

“Our assumption is that they have sufficient liquidity to cover any immediate acceleration of notes or the posting of additional collateral,” said Joseph Rosenblum, director of municipal credit research at AllianceBernstein, who described his firm’s position in Puerto Rico debt as modest.

At this point, some long-term Puerto Rico investors may have little choice but to hold on to their bonds in hopes that the island can turn a corner and the prices can rise.

Prices on some bonds have dropped to about 65 cents on the dollar. “For the buy side, there has been some discussion of ‘50 cents’ as a reasonable price,” Mr. Donahue said in a note on Wednesday.

This steep drop in prices is creating opportunity for investors, like hedge funds and private equity firms.

“It’s currently trading at 8 percent, 9 percent and 10 percent tax-exempt yields,” said Laurence L. Gottlieb, chairman of Fundamental Advisors, a firm that manages private equity and hedge fund strategies with investments in Puerto Rico and other special situations in the municipal market.

But many hedge fund managers say the bond prices haven’t dropped far enough to justify a buying spree.

Some investors say there could be better buying opportunities ahead because they expect Puerto Rico’s situation to worsen in the coming months. Other credit rating firms could downgrade the commonwealth to junk, and the island could fail to renegotiate some of its accelerating debt deals.

One hedge fund manager said he was waiting for bond prices to fall further before buying. Then he is banking on the federal government coming up with a financial rescue for Puerto Rico, something it has so far been reluctant to consider.

Peter Hayes, who heads BlackRock’s giant municipal bonds group, said his firm has reduced all of its Puerto Rico exposure.

But Mr. Hayes said he would consider buying some of the island’s debt, especially if it looked as if the island were headed for a restructuring. “At some point,” he said, “it may be an opportunity.”

Mary Williams Walsh contributed reporting.