President Donald Trump’s offhand comment to a TV interviewer that Wall Street can ‘wave goodbye’ to Puerto Rican debt in the wake of Hurricane Maria may have sent those bonds tumbling, but managers holding the island’s municipal debt reacted more pragmatically.
‘We had skepticism that he had the power to do that,’ said Craig Brandon, co-director of municipal investments at Eaton Vance. ‘Any debt restructuring is being handled through Promesa [the Puerto Rico Oversight, Management and Economic Stability Act] and the federal oversight board whose job it is to manage the process. Federal judge Swain [US District Court judge Laura Taylor Swain] is the person who has the power to decide where the debt comes out. We viewed it as an off-the-cuff comment by the president, not so much as a policy directive.’
However, after Trump’s comments on Fox News on October 3, investors did not want to wait for the answer to the question of whether the president had the power to forgive the island’s $74 billion of debt. The price of Puerto Rico’s benchmark general obligation bond plunged to a record low the next day, sinking to 32 cents on the dollar, down 12 cents.
‘The muni market is very much retail-driven, very headline-sensitive,’ said Bill Delahunty, Eaton Vance’s director of municipal research. He likened the response of investors to the headlines on Puerto Rico’s debt to the recent decline in the general obligation bonds of Hartford, Connecticut. In September, the mayor threatened that the town would file for bankruptcy under Chapter 9 if it did not get a bailout from the state.
While Trump may not have the power to dismiss Puerto Rico’s debt quite as easily as he signs executive orders, investors should not entirely discount the power of his office, said Terri Spath, chief investment officer at Sierra Investment Management in Santa Monica, California.
‘There’s the massive influence of the US president standing at a microphone saying we’re going to write off the debt of this island that is already facing the weather and a financial crisis. He can influence how much creditors can get. It’s lower now than before.’
So how low is low? Brandon said it was impossible to know given the hurricane damage, the economic crisis gripping the island and the prospect of a mass exodus after the storm.
‘Who can say what Puerto Rico will look like five or 10 years down the road? One argument says there’ll be a massive rebuilding effort, but others argue that many were on the fence about leaving and the hurricane was the last straw,’ he said.
Spath said her firm has no exposure to Puerto Rico as of around September 30, when she sold Sierra’s holding in the Oppenheimer Rochester High Yield Municipal fund, which had more than 9% exposure to Puerto Rican debt. That was before Trump’s statement.
‘Oppenheimer backed up the truck and took a bet on Puerto Rico with 9.2% exposure. Even without the hurricane, the outcome for that is years away. It moved through our sell levels and we sold,’ she said.
Oppenheimer is the firm with the most exposure to the island’s debt – almost $3 billion, according to Morningstar Direct. It is followed by Franklin Templeton on $1.1 billion. A spokeswoman for Franklin said the firm has been reducing its exposure, with Puerto Rican bonds making up less than 1% of its tax-free income group’s assets under management as of September 30, with no individual fund holding more than 3%.
Brandon said Eaton Vance was ‘generally on the sidelines, although we do own some insured Puerto Rico bonds. We’ve mostly been out of uninsured Puerto Rico bonds for a few years. We started getting out in 2013 or 2014.’
Eaton Vance’s exposure to Puerto Rican debt is $191 million, according to Morningstar Direct. Brandon explained that 98% of the Puerto Rican bonds that the firm owns are insured.
He pointed out that municipal defaults usually do not catch people by surprise, but it was hard to predict when to buy back in.
‘We’ve been watching this since the late ‘90s or the early 2000s,’ he said. ‘Things accelerated in 2006. The end game on Puerto Rico is very much unknown. It’s hard to quantify how much the bonds should be worth right now.’