Puerto Rico's muni-bond risk bears watching, BlackRock managers say

If you are looking for signs of cracks in the municipal-bond market, keep your eyes on Puerto Rico, not California. If the market were to begin anticipating a default of the U.S. territory's muni-bond funds, it could start a Meredith Whitney-like run on the tax-free bonds, top managers in BlackRock Inc.'s muni bond group said at a press conference in New York Thursday, referring to the founder of Meredith Whitney Advisory Group LLC. “Puerto Rico is the fattest tail risk in the muni market,” said BlackRock muni strategist Sean Carney. Even though the territory is relatively small and responsible for just $60 billion of the $3.7 trillion muni debt market, a default would have a big ripple effect because its bonds are widely owned by mutual funds and individual investors. “That would be a big deal,” said Peter Hayes, head of BlackRock's Municipal Bond Group. “There would be a rush to the exits and broad selling to get defensive.” But BlackRock isn't predicting a default for Puerto Rico, at least not now. “It would take a series of unexpected events to get to that point,” said Joe Pangallozzi, co-head of tax-backed muni credit research. Puerto Rico's troubles are nothing new. It entered a recession in 2006, while the U.S. economy was still happily humming along. It has yet to start growing again. For the 2013 fiscal year, Puerto Rico has a deficit of $2.5 billion, up from $1.6 billion for fiscal 2012, according to Moody's Investors Services. In December, Moody's downgraded Puerto Rico's general-obligation debt to Baa3, the lowest level above junk. Standard & Poor's followed suit last month. Puerto Rico's lawmakers are expected to vote this week on a pension reform bill that could lift some of the weight off its muni bonds.