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NEW YORK, Jan 31 (Reuters) - Puerto Rico bonds facing possible junk ratings are no longer part of the S&P National AMT-Free Municipal Bond Index because of the debt's outsized yields and spotty liquidity, S&P Dow Jones Indices said on Friday.
The policy shift, announced Jan. 8 and effective on Friday, raises worries that demand for Puerto Rico debt from investors tracking the index will soften when the Caribbean island is readying a bond sale or other possible financing.
Meant to track general obligation and other investment-grade, tax-exempt U.S. municipal bonds, the S&P index excludes healthcare, multifamily housing and other generally riskier sectors.
"Puerto Rico municipal bonds are now trading at levels more appropriate for high yield taxable corporate bonds," S&P Dow Jones said. "Puerto Rico municipal bonds also are experiencing varying degrees of liquidity ... (and) no longer meet the objective established by this investable investment grade index."
With a shrinking economy, Puerto Rico has outstanding bond debt of about $70 billion with tax-free yields sometimes over 10 percent. All three U.S. credit-rating agencies rate it as barely investment grade and are considering rating downgrades to junk.
A downgrade could spur selling of Puerto Rico bonds by investors limited to investment-grade securities and raise the island's borrowing costs.
S&P Dow Jones said Puerto Rico bonds would stay in other indices such as the S&P Municipal Bond Index and the S&P Taxable Municipal Bond Index.
Puerto Rico debt has rallied some in recent weeks after a steep selloff that began in September, with the S&P Municipal Bond Puerto Rico Index so far this year posting returns of 2.3 percent. For all of 2013, negative returns were 20.46 percent.