Cumberland Advisors | Oct 27, 2015 05:09AM ET
As close followers of the municipal credit asset class, we have identified three helpful indicators since fiscal year 2009–2010, the year the financial crisis harshly impacted state and local government finances. They are:
In meetings in front of strategists, economists, insurance companies, and bankers around the country, we have made the bullish case for insured Puerto Rico debt. We summarized our views on our website in a piece published October 5th, titled “Puerto Rico: A Story You Probably Haven’t Heard.”
The latest and greatest out of Puerto Rico is a draft bill put forth by the Obama Administration that will give Puerto Rico and other territories access to a new series of Chapter 9 Bankruptcy provisions. This is a new step forward in the Federal government’s involvement in the Puerto Rico saga. Prior to now, involvement has been done via executive order without new budgetary authorization from congress. For example, the revamping of P.R. Act 154 allowing U.S. companies to write-off a tax credit equal to the amount of taxes they pay to the Puerto Rican government against their U.S. federal returns (we write about this in our piece “More on Puerto Rico Debt ,” published last year); and various other acts allowing Puerto Rico-domiciled investment firms to avoid taxation on passive income. Nonetheless, this creates interesting conversation about the U.S. federal government’s role in Puerto Rico, and we have definitely felt a negative market reaction. We summarize our thoughts on this below.
The initial intent of this piece was to discuss the Puerto Rican economy’s growth path.
Puerto Rico’s economy has been improving. And now, yet another statistic indicates that. On October 21st, the United States Bureau of Labor Statistics reported that total employment on the island pierced the one million mark, up 2.27% from the level a year ago. The unemployment rate has declined; labor force participation is stable; and total nonfarm employment continues to increase. By most measures, our first forward-looking indicator (mentioned in the first sentence of this piece) is accurately predicting Puerto Rico’s return to fiscal stability.
Another tidbit: it is difficult not to find a news headline with the words Puerto Rico and restructuring in the same sentence. But who says Puerto Rico hasn’t restructured its expenses? General government expenses are down 35% from levels two years ago, and the government has been able to increase its working capital by deferring its average payment period on accounts payables from 47 days to 80 days. Puerto Rico is flexible. There are other signs of Puerto Rico’s restoration to a positive fiscal balance. We discuss these themes in our top-selling book, Adventures in Muniland: A Guide to Municipal Bond Investing in the Post-Crisis Era.
We do not recommend purchase of uninsured Puerto Rico debt. Our meetings with senior-level management at National Public Finance Guarantee and Assured Guaranty last week have reinforced our favorable outlook on these two bond insurers and their claims-paying ability. Since its first insurance policy was written 30 years ago, National Public Finance Guarantee (formerly the Municipal Bond Insurance Association, or MBIA) has paid out roughly $700 million in claims. It currently has $4.9 billion in claims-paying resources and loss experience in the low single-digit basis points in its insured portfolio over the last 30 years. Assured Guaranty is in a similar positive position. We believe it is important to couple the insurance wrapper with the underlying Puerto Rico bond structure when determining which bond to buy and which one to avoid.
Finding insured AA paper at yields approximating 5.75–6% tax-free is not an easy task. Cumberland is a buy-side, fee-for-service-only manager, able to manage complex portfolios and source bonds from its large network of dealers at low transaction cost for its clients.
There are opportunities elsewhere in munis, too. Stay tuned.
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