Not all municipal bonds from Puerto Rico are created equal, yet investors spooked by reports about the commonwealth’s fiscal health are treating them similarly, said Robert Amodeo, head of Western Asset Management Co.’s municipal group in New York.
Amodeo, whose company oversees about $30 billion in state and local debt, said he mainly invests in Puerto Rico sales-tax bonds, known as Cofinas, some of which Moody’s Investors Service rates Aa3, the fourth-best grade.
He also discussed why there will always be a “next Detroit” for today’s Bloomberg Brief: Municipal Market newsletter.
Q: Is Detroit’s bankruptcy an outlier or a sign of things to come?
A: Detroit’s problems are common -- a mismatch between expenses and revenue that has come to the point where they’ve filed for bankruptcy. The pension benefits and other post-employment benefits are sizeable. What differentiates Detroit is the size of the problem.
Q: Western Asset Management is a division of Legg Mason Inc. (LM), which has been identified as one of the biggest holders of Detroit obligations. What repayment scenarios do you envision?
A: The G.O. debt and the pension-obligation certificates we believe are more vulnerable to haircuts. The water and sewer bonds have a revenue pledge and we stand first in line behind operating expenses.
If the respective monoline insurer has the ability to pay, you should receive full coupon and principal when due.
Q: What is your strategy for Puerto Rico debt, given the selloff?
A: Like any battered region, there are different names. We have virtually no G.O. debt. Our exposure is really to the sales-tax revenue, which is coming in stronger. It’s one of the few bright spots coming out of that island.
Right now there’s this herd mentality where everything is getting beaten down just because it has the name Detroit in it or Puerto Rico in it. But if you dive down to the fundamentals and the lien status, you can find good value in those regions if you feel comfortable with the volatility that may come with it.
Q: What do you like about the Cofina bonds?
A: They are rated well into investment-grade territory, which differentiates them from the other credits in Puerto Rico. We’re looking at the fundamentals, we’re looking at the gross lien pledge and we’re looking at valuations and our conclusion is that there’s good value.
Prior to two years ago, if you visited Puerto Rico and paid a dollar of sales tax, less than 50 cents would find its way to the territory’s tax coffers. Their collection process has improved greatly.
Q: Is it fair to compare issuers such as Puerto Rico and Chicago, which are facing fiscal stress, with Detroit?
A: There will always be a next Detroit. It comes down to good policy versus bad policy and maintaining a well-diversified economy. If you don’t have that and you’re not building upon that, you’re going to fall into financial disrepair.
People now recognize that municipal credits can be complicated and you have to be able to really look at the credit and understand where the revenue comes from and where you stand in case things go bad.
Q: Did investors fail to consider the risk that general-obligation bonds might not get top priority in the case of a default or bankruptcy like Detroit?
A: People didn’t attach the proper spread to general-obligation debt. They did overlook that there are all types of G.O. and G.O.-related debt out there: Unlimited, limited, certificates of participation, lease obligations, appropriation debt. People believed in prior years that they had the full faith and taxing authority. The issue with Detroit is: What if they don’t have flexibility to raise taxes? That’s the new wrinkle here.
I don’t want to be an alarmist because there are some very good G.O. issuers out there. The stress in the market is in the lower-quality, smaller names that may struggle.
Q: Muni bonds are experiencing the worst losses since 1999, driven by persistent withdrawals from mutual funds. Is the market behaving like it usually does -- outflows lead to sales which lead to price declines which lead to more outflows which lead to more sales -- or is this time different?
A: The negative demand cycle seems to feed on itself at times. Selling drives additional selling, and then valuations get to a point where these bonds are too cheap. And you can make the case that we’re at that point.
These large outflows can be viewed as an exit strategy of a great majority of the money that found its way seeking yield during the low interest-rate cycle in the past couple of years.
Q: What will cause the fund withdrawals to reverse?
A: An improving fundamental landscape combined with cheap valuations. These high-profile credit stresses are overshadowing this market. There’s a broad improvement in the fundamental strengths within the public-finance arena.
The selloff has been severe, and more severe in municipal bonds than some other parts of the fixed income marketplace, but it has unlocked some good value.
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