Muni market beware: Puerto Rico running out of time

Muni market beware: Puerto Rico running out of time
If the commonwealth defaults, it will cause a shock to the system.
APR 04, 2014
As if fears over rising interest rates and months of mass selling weren't enough of a head wind for municipal bond investors, Puerto Rico now appears to be running out of time to get its fiscal house in order. The commonwealth was put on review by another major ratings agency, paving the way to what could be a shock to the municipal bond market. Moody's Investor Services Inc. became the second of the three major ratings agencies to put Puerto Rico general obligation municipal bonds and related securities officially on watch for a downgrade to below-investment grade Wednesday. The review follows a similar action by Fitch Ratings Inc. in mid-November. “Downward pressure on the rating arises from the commonwealth's weakening liquidity, increasing reliance on external short-term debt and constrained market access, within the context of a weakened and now sluggish economy,” Moody's said in a rating action note announcing the review. To Peter Hayes, head of the municipal bonds group at BlackRock Inc., it's only a matter of time until Puerto Rico is officially downgraded. “If you look at the price of the bonds and the credit rating, there's a very big disconnect,” he said. “Somebody has it wrong. The bonds are trading like distressed debt but rated investment grade.” (UBS offers to repurchase Puerto Rico muni bond funds) The S&P Municipal Bond Puerto Rico Index has fallen 18.49% year-to-date through Dec. 11, almost nine times the loss of the S&P Municipal Bond Index, which measures the performance of the entire universe of investment-grade municipal bonds. The falling prices, and consequently higher yields, are making it harder for Puerto Rico to borrow money to fund its debt. Fitch Ratings analyst Karen Krop warned in November about Puerto Rico's lack of access to the municipal market as a primary concern in a statement regarding Fitch's review of the commonwealth's general obligation debt. “Continued lack of reasonable external market access would be considered a material reduction in financial flexibility and cause for a downgrade,” she wrote at the time. The systematic risk to the municipal bond market isn't from the downgrade, though. It's what comes next, Mr. Hayes said. “Puerto Rico's access to the municipal market is closing, if it isn't closed already,” he said. “Once that happens, they are going to have to talk about some kind of restructuring, bailout or default.” (Puerto Rico muni bonds: A contrarian view) With approximately $70 billion in outstanding debt, a Puerto Rico restructuring, actual default or bailout by the federal government would be by far the largest of its kind. Detroit, for example, has $18 billion of municipal bond debt outstanding. The timing for the muni market couldn't be worse. Municipal bond funds have suffered 29 straight weeks of outflows, according to Lipper Inc., as concerns that interest rates will rise and bond prices will fall have created a market with far more sellers than buyers. Interest rate fears are also behind the Morgan Stanley Research prediction of an 80% chance that municipal bonds could lose money for the second year in a row in 2014. The average intermediate-term municipal bond fund is down 2.22% year-to-date, according to Morningstar. “This year's been all about shedding interest rate risk,” Mr. Hayes said. “If you throw some bigger event on top of that, then it becomes a bigger ripple effect.” The worst performing municipal bond funds this year, like the Oppenheimer Rochester single state municipal bond funds, are those that have loaded up on Puerto Rico debt. More than three-quarters of municipal bond funds, however, have at least some exposure to Puerto Rico bonds, according to Morningstar.

Latest News

‘No detractor’ to using direct indexing as an investment strategy
‘No detractor’ to using direct indexing as an investment strategy

Thirty four percent of advisors surveyed by InvestmentNews say they use direct indexing strategies but 39 percent don’t.

After watching advisors bolt, B. Riley now losing investment bankers
After watching advisors bolt, B. Riley now losing investment bankers

“This is on the B. Riley Securities side of the business, the dealmaking side,” one senior industry executive said.

Does sell and stay really work?
Does sell and stay really work?

There are three essential elements you must bring to the table to increase the chances of a successful post-sale career.

Retirement savings rise with two account types posting record highs
Retirement savings rise with two account types posting record highs

Across generations, how are savers doing with their 401(k) contributions?

What's making America's billionaires richer, faster?
What's making America's billionaires richer, faster?

New report shines some light on today's billionaires' investments.

SPONSORED How MRP’s Synthetic Equity is balancing growth and protection for advisors

"Synth Equity has been such a tailwind for these advisors who really understand the story," Measured Risk Portfolios’ head of distribution said.

SPONSORED The future of prospecting: Say goodbye to cold calls and hello to smart connections

Streamline your outreach with Aidentified's AI-driven solutions