Puerto Rico has opted to have its municipal bond debt restructured. We looked at the Wall Street Journal article and saw four firms are major holders: Franklin, Lord Abbett, Oppenheimer and Goldman Sachs. What is interesting to note is these four large municipal bond funds were not badly hurt with the drop in bond prices.
This territory of the U.S. has $70 billion in municipal bond debt that must be restructured. Puerto Rico has opted to go into a court-appointed oversight board to restructure the debt. I do not believe states and territories can go into bankruptcy, so that term is not quite appropriate. But that is what it is.
The Franklin Federal Tax Free Income Fund (FKTIX) has over $12 billion in assets. According to its website, the fund has 0.99% invested in Puerto Rico. Also according to the company, the fund’s three-year performance was 3.62% versus the Bloomberg Barclays Muni Bond Index of 3.55%. It does not appear Franklin was hurt too badly.
The next fund is the Lord Abbett Municipal High Yield Bond Fund (HYMAX). According to its website, the fund’s year-to-date return is 3.51% versus the Bloomberg/Barclays High Yield Muni Index of 4.76%. The fund has over $2 billion in assets and 4.6% invested in Puerto Rico. Again, it does not look like the fund has done that poorly in relation to its index.
The Rochester High Yield Municipal Bond Fund (ORNAX) from Oppenheimer has the largest exposure at 12.4% to Puerto Rico. Its year-to-date return is a whopping 7.63%. If it lost any money in Puerto Rico, it made it up elsewhere. That is a great return for sleepy municipal bonds. Assets under management are $5.8 billion.
The last fund is theGoldman Sachs High Yield Municipal Bond Fund (GHYIX). Looking at its holdings, I see a few hundred million invested in Puerto Rico. Again, this fund was hardly affected. Its year-to-date return was 4.89%. The fund has $9.4 billion assets under management.
As I look at the inventory on Charles Schwab (SCHW, Financial), I see many Puerto Rican bonds trade at par or at a premium. Standard & Poor's still rates many of these bonds as AA-. These are the stronger entities.
A look on FINRA shows the stuff that has gotten beat up. These are bonds trading at pennies on the dollar. If you had the time and knowledge, you could go through these and make a killing. I have neither the time nor knowledge to do so.
I did want to give a shout out to Meredith Whitney. Several years ago, she predicted a souring of municipal debt. While this has not quite happened, the Puerto Rican default vindicates some of Whitney’s predictions. Here is a link to an article from five years ago chastising Whitney for being wrong on municipals. While municipals have been strong with low interest rates, perhaps Puerto Rico could be the canary in the coal mine. Who knows?
It is hard to say if there will be more defaults. Many states have unfunded pension liabilities. The pensions actuarial return on their investments are often north of 7%. The odds of pensions earning future returns of over 7% on billions of dollars in assets are slim to none.
Disclosure: We own none of the investments listed.
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