Puerto Rico debt roils U.S. municipal bond mutual funds

{Las noticias económicas son cada día peores porque AGP esta haciendo todo lo contrario a lo que es lógico y razonable para reactivar la economía de Puerto Rico. AGP debía empezar por darle la cara a las Casas Acreditadoras.}

Puerto Rico debt roils U.S. municipal bond mutual funds

Tue, Sep 3 2013

By Tim McLaughlin

BOSTON, Sept 3 (Reuters) – Nothing says Massachusetts like the John Hancock Massachusetts Tax-Free Income Fund.

But bonds issued by Puerto Rico account for 13 percent of the $101 million municipal bond fund’s assets. And like many other municipal bond mutual funds that loaded up on the Caribbean island’s debt, the John Hancock fund has generated a dismal return for investors so far in 2013.

Some U.S. money managers have been enticed by the tax-exempt status of Puerto Rico bonds and juicy yields that have topped 8 percent in recent trading.

But danger was lurking. The S&P Municipal Bond Puerto Rico index declined 8.88 percent in August, compared to a 1.68 percent loss in the S&P National AMT-Free Municipal Bond Index, as dealers already spooked by Detroit’s bankruptcy fretted about the island’s fiscal stability.

In a further sign of the growing perceived risks, Puerto Rico’s spread ballooned to 320 points last week, the widest for 10-year bonds over Municipal Market Data’s triple-A scale and nearly double Illinois’ 165-point spread.

Funds that bet heavily on Puerto Rico are now some of the worst performers among municipal bond funds in 2013, according to an analysis of data from Lipper Inc, a Thomson Reuters service.

Of the 20 municipal bond funds with the highest percentage of Puerto Rican debt, 16 are getting beat by at least 60 percent of their peers.

Puerto Rico bonds are attractive to U.S. municipal bond managers because they are exempt from federal, state and local income taxes in any U.S. state. Investment in Puerto Rico is within bounds for a single-state municipal bond fund as long as at least 80 percent of its income is state tax-exempt, according to the Securities and Exchange Commission’s fund naming rules.

Puerto Rico is one of the top issuers of bonds in the United States with $52 billion in outstanding tax-supported bonds compared to $96 billion in California. Investors, however, are often not aware of Puerto Rico’s weighting on their state municipal fund.

«When buying a Connecticut municipal bond fund, for example, one would expect Puerto Rico to have as much bearing on the portfolio as Alaska,» Morningstar analyst Steven Pikelny warned in December. «This would be a big mistake.»

RISKY BET

With chronic double-digit unemployment rates and a dwindling population, the U.S. commonwealth of Puerto Rico has long run substantial budget gaps. The island has yet to produce balanced budgets sought by institutional investors and bond analysts alike.

Investors have pulled money out of municipal funds for 14 straight weeks, owing largely to Detroit’s largest municipal bankruptcy in U.S. history, problems in other cash-strapped American cities and concerns about Puerto Rico, according to analysts. The concerns have whipsawed the $3.7 trillion municipal bond market, which is now taking a closer look at Puerto Rico’s large, unfunded retiree obligations and persistent deficits.

«While Puerto Rico yields are high, the risks are high too,» said Michelle Knight, who runs $600 million in muni bonds at Boston’s Silver Bridge Advisors. «This is a structurally flawed economy with unsustainable debt levels that has too many black marks to make it enticing, at least to me.»

Managers of Franklin Templeton’s $581 million Double Tax-Free Income Fund did not think so. With about 63 percent of its assets in Puerto Rican debt, the fund had the highest allocation among municipal bond funds, according to Lipper. The fund also is down 13 percent this year.

A spokesman for Franklin Templeton said money managers were not available to comment for this story.

John Hancock’s Massachusetts fund is down 8.77 percent during the first eight months of 2013, lagging 87 percent of the funds in its category. John Hancock funds are part of Canada’s Manulife Financial Corp.

In contrast, Fidelity’s $2 billion Massachusetts Municipal Income Fund, with only about 2 percent of its assets in Puerto Rico debt, is down 5.93 percent, or better than 80 percent of its peers, according to Morningstar.

On March 13, S&P cut its general obligation credit rating for Puerto Rico to BBB-minus, or one notch above junk status, warning Puerto Rico’s fiscal problems were proving difficult to fix.

But even after that dire warning from a top U.S. credit ratings agency, the John Hancock fund still liked Puerto Rico debt.

«Despite the volatility, we are maintaining the fund’s position in Puerto Rico bonds,» said Dianne Sales, the fund’s portfolio manager, in a semiannual report for the period ended May 31.

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http://in.reuters.com/article/2013/09/03/municipals-puertorico-idINL2N0GU27P20130903

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• Updated September 4, 2013, 8:29 p.m. ET

In Muni-Bond Market, Some Investors Fly First Class

Municipalities Are Allowed to Treat Large Investors Differently

By    MIKE CHERNEY  and   KELLY NOLAN

On a Friday in late March, representatives of about two dozen investment firms gathered at the New York offices of Barclays BARC.LN +1.56%PLC to hear Puerto Rico government officials explain why the island’s bonds—recently downgraded to near «junk»—were still a good investment.

The officials told the firms, major holders of Puerto Rico debt, that a controversial pension-overhaul proposal favored by investors would pass the island’s legislature. Some investors also got private meetings with island officials that day, and at least one firm at the event sold Puerto Rico bonds. Slides from the meeting were posted online by the following Monday.

Tim Foley

Puerto Rico didn’t break any laws or regulations in holding the meeting, attorneys say. The event highlighted differences in the rules governing how companies and municipal-securities issuers interact with investors.

Securities laws generally require firms to disclose what they say to investors if the information is both material and nonpublic. These regulations don’t apply to municipalities, in part because of concerns about the federal government interfering in state and local affairs.

This exception can give large money managers with access to public officials an edge in the $3.7 trillion municipal-bond market, according to industry executives and investors.

Puerto Rico’s bonds are down 16.42% this year as the island’s economic outlook has deteriorated. The bonds are on track for their worst year since 2008 when they fell 12.5%, according to the S&P Municipal Bond Puerto Rico Index.

Investors and others have informed regulators including the Securities and Exchange Commission and the Municipal Securities Rulemaking Board about the Puerto Rico meeting, but regulators haven’t said what they have done in response.

Lynnette Kelly, executive director of the MSRB, said the board is concerned about debt issuers disclosing material information to investors selectively.

«The municipal market should…ensure that all investors have equal access to information and that the market operates fairly,» she said.

Unpublicized meetings involving powerful institutions create a «two-tiered market,» said Malcolm Northam, a consultant in the financial-services business who is a former official at the Financial Industry Regulatory Authority, the Wall Street-funded self-regulator.

«That’s not how markets are supposed to work,» Mr. Northam said.

Since the financial crisis, the SEC has ramped up its enforcement of fraud in the municipal-bond market amid concerns about issuers’ disclosure practices. The SEC launched a new unit in 2010 to focus on the market and public pensions.

Since then, the agency has filed fraud charges against Harrisburg, Pa., accusing the state capital of making misleading statements about its finances, and against Miami and its former budget director, alleging the city misled investors about its financial health. Harrisburg agreed to settle the charges and didn’t pay a financial penalty. Miami has said it would fight the allegations.

The SEC also last year pushed for Congress to give it more authority to oversee municipal bonds. The MSRB, which oversees securities firms, banks and municipal advisers, encourages issuers to post information on its disclosure website.

Investors who attended the Puerto Rico meeting said officials didn’t disclose any new information.

Even so, the gathering offered attendees some advantages, including a chance to talk with people in charge of the island’s finances and an opportunity to ask follow-up questions. In May, Puerto Rico held another private gathering for some investors on the sidelines of a more-public conference in San Juan.

Other municipalities have hosted investor gatherings in more transparent fashion. Massachusetts says it allows individual investors to attend its annual investor conference.

Puerto Rico’s exclusive meeting drew ire from professional fund managers who didn’t make the list.

«Why should any one investor have more access to an issuer than another?» said Adam Mackey, managing director of municipal fixed income at PNC Capital Advisors. He wasn’t invited.

The meeting came at a crucial time for Puerto Rico, which had struggled through a prolonged recession. Many investors hadn’t met officials from the administration of Gov. Alejandro Garcia Padilla, who was elected the previous November. Puerto Rico bonds are widely held, in part because the interest—unlike on most other municipal bonds—is exempt from federal, state and local income taxes, regardless of where the investor lives.

Officials from the Government Development Bank, Puerto Rico’s financial adviser, declined to comment about the exclusive nature of the March meeting.

Ron Pearson, a financial planner in Virginia Beach, Va., who has a client with $1.2 million of Puerto Rico bonds, said he didn’t know

about the meeting but noticed that his client’s Puerto Rico bonds lost 6% of their value in March.

His client continues to hold the Puerto Rico bonds.

«My client is not happy to see his portfolio drop,» said Mr. Pearson, a former Navy pilot.

One firm that sold Puerto Rico bonds the day of the March meeting was Nuveen Asset Management. John Miller, co-head of fixed income, said his firm didn’t sell the bonds because of what Nuveen heard in the meeting.

He said Nuveen already was looking to trim its exposure to longer-term Puerto Rico debt in a handful of its funds, adding that those funds sold a similar amount of Puerto Rico bonds in the prior week. He also said Nuveen bought shorter-dated Puerto Rico bonds during the same time frame.

«What happened for a long time is that the SEC didn’t pay attention to the municipal market because there were so few bankruptcies and so few problems, and there were so many on the corporate side,» said Andrea Bacon, a public-finance lawyer at Chapman and Cutler LLP.

Many observers said they believe the agency should be looking at the issue of private meetings.

«It certainly would be an issue I would be concerned about if I were still at the SEC,» said Martha Haines, former chief of the SEC’s office of municipal securities.

Write to Mike Cherney at mike.cherney@wsj.com and Kelly Nolan at kelly.nolan@wsj.com