By Terry Flanagan

Municipal Bonds Seen on Upswing

The municipal bond market is poised for a rebound, even as bad news continues to emanate from Puerto Rico.

“Last year, by just about any measure, was a very bad year for municipal bonds,” said Greg Gurevich, managing partner at Maritime Capital Partners. “But outside of the big headlining events – Detroit, now lately Puerto Rico – for the most part the fiscal situation in the United States, while not great, has been getting better in a lot of areas like California.”

The upshot is that the market is beginning to transition “from issuers with problems to issuers who have had problems but are getting their fiscal situation in order,” said Gurevich. “So we like we like where the market is going. We think additional yield is good for the municipal bond market, as it gives investors incentive to come back into this market. . That being said we still see problems on the horizon with specific credits, interest rate risk, as well as liquidity risk.”

Maritime trades investment grade municipal bonds, holding about 2,300 positions and doing 250 trades a day, which differ from traditional municipal bonds, which are buy and hold. Maritime uses interest-rate swaps and some credit-default swaps to hedge our portfolio of long-only investment grade muni bonds.

“When we started trading municipal bonds we found a lack of technology compared to other markets, so we had to build our own trading systems and other supporting technology,” said Gurevich. “As opposed to many municipal investors having to go through layers of brokers, what we try to do is use inefficiencies that still remain in the Municipal Bond market to our client’s advantage.”

Oppenheimer Rochester, a division of Oppenheimer Funds, last week updated the prospectuses for all 20 of its municipal bond funds to reflect that certain securities issued by Puerto Rico and its agencies are currently considered below investment grade and the funds may be subject to additional risks.
“While the full impact of the downgrade to below-investment-grade cannot be determined at this time, it is our expectation that affected Puerto Rico bonds could exhibit price volatility, at least in the short term,” Oppenheimer Rochester said in a statement

Prior to the downgrades, Puerto Rico bonds were already trading at levels that indicated a perception of distress. “While we reiterate that prices on Puerto Rico bonds have been stable since the downgrades so far, investors are well-advised to consider that this action could lower prices on Puerto Rico municipal bonds further,” said Oppenheimer Rochester.

With the downgrade of the debt, investor sentiment is likely to shift. “Municipal bond fund investors should, and I expect will, want to take a closer look at their state muni bond fund to understand their Puerto Rico exposure,” said Matt Tucker, head of fixed income strategy at iShares, in a blog posting. “I don’t know what will ultimately happen with Puerto Rico debt. Given the current trajectory of their economy and deficit it seems likely that some sort of restructure of their debt may be necessary.”

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