Thursday, July 10, 2014

Were the bag-holders of this fund able to get out in time?

Larry Levin's Daily Market Commentary
Puerto Rico
"I wonder if the bag-holders of this fund were able to get out in time? I doubt it. "
Larry Levin, July 2014
Earlier in the year, when the Puerto Rican (PR) bond malady was close to spreading, I wrote about its dangers. Would there be a bail out? Would there be some special law drafted that allowed it to avoid bankruptcy? Or would the problem simply be ignored?

It looks like the latter two are the answer. Future problems, like all risk in this centrally planned world, were ignored. A new law, however, was also passed and that allows certain public corporations to restructure its debt, which is essentially allowing them to bypass the fact of the PR insolvency.

From the FT earlier this year we read...
If Puerto Rico is forced to take that step, the effects will ripple through the entire $4tn municipal bond market. Because the debt is generally triple tax free, in a world of zero interest rates demand is high and it is distributed widely, including in funds that imply they have no exposure to Puerto Rico.
But yields have gone up nevertheless – and prices down – suggesting the markets are increasingly nervous about prospects for repayment. Estimates on how much of that debt is insured range from 25 per cent to 50 per cent of total issuance.
“Everyone thinks they can get out in time,” the restructuring adviser said. Wednesday we read that the new law is creating havoc. I guess the market is a little miffed that only some “special” corporations get to restructure debt, but others holding the debt are actually holding the bag.
A Franklin Templeton Investments municipal-bond fund with the industry’s biggest allocation to Puerto Rico has sunk to the lowest in its 29-year history as prices on the struggling commonwealth’s debt set record lows.
The price per share of the $300.4 million Franklin Double Tax-Free Income Fund fell to $9.28 yesterday, the lowest since its inception in April 1985. The drop follows Moody’s three-step downgrade of Puerto Rico’s GOs last week to B2, five levels below investment grade.
Franklin’s fund directed about 69 percent of assets to Puerto Rico debt as of May 31, according to Franklin Templeton’s website.
Puerto Rico securities have traded at distressed levels for almost a year. Prices on some of the self-governing U.S. territory’s bonds sank even more after lawmakers last month approved a bill allowing some public corporations to restructure debt. The island’s securities have dropped for nine straight days, the longest slide since December, S&P Dow Jones Indices show.

Franklin Funds and Oppenheimer Rochester Funds are challenging the new law in a Puerto Rico court. I wonder if the bag-holders of this fund were able to get out in time? I doubt it.