The Federal Reserve’s decision to maintain its current pace of quantitative easing and the subsequent market rally could not stop municipal bond funds from recording their 17th consecutive week of outflows. The outflows and rising rates are hitting the long end of the yield curve with the Bank of America Merrill Lynch 1-22yr municipal index recording a loss of 2.4% year to date while the short end of municipal curve is holding up well with a positive 0.6% year to date return. Looking forward to the fall we could foresee some technical support to the municipal market as visible supply of new debt is limited, though at the same time interest and maturity reinvestment slows.
Last week we wrote that our municipal credit holdings were experiencing improved fiscal health and positive trends in certain credit metrics. This week we again remind our readers why it is so important to have an active manager review credit performance after Puerto Rico released dismal financial results. For Puerto Rico’s entire governmental funds group, the numbers reveal a loss of $172 million in FY 2012 versus a loss of $1 billion in FY 2011. Hmmm, improving you say? These numbers look better than they really are because they include substantial issuance of debt to provide cash to cover expenses. The entire governmental funds group borrowed $5.4 billion in 2012 against $2.5 billion in 2011. Stripping out the effects of borrowing we see the governmental funds group actually ran a deficit of $5.5 billion in FY 2012 versus $3.4 billion in FY 2011. Borrowing to pay expenses has been going on for a long time and the Commonwealth’s accountants matter-of-factly note on p. 122 of the CAFR that “[t]he Commonwealth’s recurring expenditures have exceeded its recurring revenues during the past thirteen years...” One might reasonably ask how long the financial markets in general, and certain municipal bond funds in particular, will continue to enable this kind of mismanagement, not to mention what the unwind might look like. Taken as whole, total liabilities for bonded debt, pension, and OPEBs expanded in FY 2012 by $8.9 billion (9.1%) to $106.4 billion, which equates to $29,015 per capita and 153% of the Commonwealth’s GDP. As a public service we would encourage anyone that holds Puerto Rico or its component unit debt to take a hard and deep look at their credits and ask themselves: “Do the risks outweigh the rewards?” If you are unable to analyze your credits please ask SNWAM for assistance.