• Underfunded Pension Plans. The plans are approximately 6 percent funded, which is unacceptable. Recent changes are welcome, such as shifting most employees to a defined contribution plan similar to a 401(k), but it’s too late to right this ship.
Ratings
For years the rating agencies have preserved remarkably high ratings on the bonds — ratings that we viewed as too high by a long shot. More than 10 years ago, we viewed all Puerto Rico bonds except the COFINAs as speculative grade, with a significant potential for payment default. This illustrates a simple component of our approach to credit risk. We look at credit ratings and read the reports, which contain some good analysis, but we form our own opinion of the risk. Often we are roughly in agreement with the rating agencies, but just as frequestly, we believe ratings are too high or too low. That ability to develop our own independent credit opinion, compare it to published ratings, and then act on our convictions is a value-creating approach to credit.
“Opportunities” Offered By The Sell Side
Broker-dealers often beat the drum of “opportunity” in Puerto Rico debt, publishing optimistic reports, listing bid/offer quotes, and disseminating trade posts that make it appear that it’s as easy to sell bonds as it is to buy bonds. In October of this year, one sell-side analyst strongly advised clients to buy the bonds, claiming “retail investors concerned with income and not prices have a sound investment in commonwealth issued debt.”
These sell-side recommendations are focused on exploiting near-term volatility rapidly paced buying and selling. At Thornburg, we’re bond investors, not bond flippers, and if you’re a long-term investor, you want to own quality bonds with healthy long-term prospects.
What If They’re Insured?
Some advisors hold insured bonds, thinking that will protect them from default, since all bond insurers except Financial Guaranty Insurance Company (FGIC) and XL Capital Assurance (XLCA) are still paying on claims. We believe that the other insurers in run-off mode — ACA Financial Guaranty Corp, Radian Group and CIFG Group — will eventually run out of claims-paying resources. And for those bond insurers that are still writing new business, such as Assured Guaranty and National Re, we are certain that this doesn’t protect the market value of the bonds prior to maturity, and we believe those insurers may incur huge claims on their portfolios that could result in down grades and run-off status. So we are sticking to our rule that we want the underlying credits in our portfolios to be healthy, even if the bonds are insured. In addition, if you approve a bond because it carries insurance from XYZ insurer, and then load up the portfolio with XYZ bonds, you end up with heavy exposure to XYZ, and diversification is the name of the game in bond investing.
Is There A Price At Which We Would Buy?
Yes. There is a price at which we would buy, and no, we will not say what that price is, except that it’s much lower than current prices. Currently most uninsured Puerto Rico GO bonds with a 5 to 6 percent coupon in 10 years are trading in the range of $75. Of course, we are paying close attention and watching every day as the action unfolds. We do expect to see further weakening and we’re content to let the market move in our direction.
Josh Gonze is a portfolio manager of the Thornburg municipal bond portfolios and a managing director of the firm. He is responsible for credit analysis for new municipal bond transactions, monitoring credit quality within the portfolios, and evaluation of sector-wide credit trends.