Bad debt in the bond mutual funds

[rayinpenn]

NY Times article today detailing Puerto Rico's 72 billion dollar debt crisis.

"It is estimated that 75 percent of the mutual funds tracked by Morningstar now hold at least some Puerto Rico debt."

Puerto Rico's governor announced they can't repay it. I have no doubt they will restructure the debt but anyone who has paid attention knows it is a house of cards. They are borrowing to service debt which is as bad a sign as can be.

Dare I say it? could it be the bond funds don't represent the safety most believe they do. When does the debt become like lead in your lifeboat?

California $617.6 billion
New York $300.1 billion
Texas $287 billion
New Jersey $282.4 billion,
Illinois, with $271.1 billion


Sent from my iPad using Early Retirement Forum.

 

[Big_Hitter]

Dare I say it? could it be the bond funds don't represent the safety most believe they do.


.

even mutual funds are subject to default risk

 

[rayinpenn]

Obviously but so many consider them a safe habor.


Sent from my iPad using Early Retirement Forum.

 

[jebmke]

some state tax exempt funds identified in the paper today had ~50% in PR bonds. Fund buyers probably didn't look at prospectus or holdings so I am not that sympathetic.

 

[JoeWras]

I examined the portfolio holdings of one of the Vanguard munis, VWIUX. Looks like they hold about 0.2% in PR bonds.

I remember this subject came up last year in one of their video streams and basically they said they are keeping their exposure low based on the risk.

Obviously, it isn't zero. They do have a small amount of riskier funds.

Now if NY or CA starts having serious issues, then this fund is going to crater. NY+CA accounts for 1/3 of the fund's holdings.

(EDIT: Found an article from 2013 discussing VWIUX, and at that time exposure was 0.8%. So they clearly have been reducing their position over the years.)

 

[pb4uski]

One article reported that ~$11.3b is owned by mutual funds and the majority of the exposure is muni-bond and high-yield bond funds. According to the Investment Company Fact Book the net assets of muni and high yield bond funds at the end of 2014 was ~$534b. I suspect that the $11.3b number is par value so the value included in the $534b is probably already discounted some for credit risk since it would be marked-to-market.

I suspect that there will be a hit, but not a cataclysmic hit other than for investors in mutual funds that decided to make a big bet on PR bonds.

 

[JoeWras]

some state tax exempt funds identified in the paper today had ~50% in PR bonds. Fund buyers probably didn't look at prospectus or holdings so I am not that sympathetic.

This is the scary part. If you look at some of the funds typically sold by brokers, they have very high PR bond exposure. These are sold as "Arizona" or "North Carolina" tax free bonds, for example. Problem is they are not all AZ or NC bonds, but like you say may have up to 50% in PR.

YIKES.

 

[Options]

Tune out the noise.

See this:

https://institutional.vanguard.com/VGApp/iip/site/institutional/researchcommentary/article/InvComUncertainMarketsBondIndexGoodChoice

Specifically:

Highlighting the uncertainty of fixed income markets, Mr. Barrickman cited forecasts of rising rates that haven't panned out in recent years. "The consensus forecast that rates couldn't stay so low for so long has proven wrong," he said. "There are numerous variables that drive interest rate changes, including unemployment rates, inflation, economic growth, and short-term technical factors such as trading dynamics. All of these factors are difficult to predict in their own right."

Emphasis Added

Everyone is the smartest person in the room until they're not.

 

[JoeWras]

Tune out the noise.

Yep. I'm still in. With indexing on a broad base.

But, it isn't "noise" if you find yourself in a fund called "Virginia Muni" when it consists of 25% PR bonds!

The lesson here is know what you are investing in.

BTW, I wondered why Vanguard doesn't offer munis for many states, while other companies do. I think it has to do with the liquidity issue. Somes states just don't have a lot of Muni debt. It isn't even practical, or possible to create a fund.

Those companies which created these state-specific tax advantaged funds in small market bond states relied on the volume of PR bonds which could be added to the mix.

 

[rayinpenn]

I lost faith in the rating agencies some time ago and lost faith the "experts" when long term capital management Nobel laureates bankrupted their firm. Seems like common sense is a lost art. Clearly all we can do is seek diversification and pray noone you care about has their pension funds invested in that junk....

Would you loan money to a "spender" friend who is in debt up to their eyeballs?
Anyone remember what a Brady bond was? how about LDC debt.


Sent from my iPad using Early Retirement Forum.

 

[ERD50]

NY Times article today detailing Puerto Rico's 72 billion dollar debt crisis.

"It is estimated that 75 percent of the mutual funds tracked by Morningstar now hold at least some Puerto Rico debt." ...

"at least some" - that isn't very helpful. Sounds like typical 'scare' headlines.

I checked FTBFX, and there were two holdings of Liberty Cablevision of Puerto Rico (not even direct PR debt). Each added up to 0.009% of total holdings.

Dare I say it? could it be the bond funds don't represent the safety most believe they do. ... .

And what do 'most' believe? Do they believe that none of their holdings can default? That isn't reasonable, unless maybe they are in the highest safety rated funds. What I believe (since I look at the prospectus), is that the big index-style bond funds are well diversified.

What do you believe?

-ERD50

 

[rayinpenn]

What I believe is I am concerned with how easily we accept the increasing debt loads of our government institutions...


Sent from my iPad using Early Retirement Forum.

 

[brewer12345]

What I believe is I am concerned with how easily we accept the increasing debt loads of our government institutions...


Sent from my iPad using Early Retirement Forum.

PR is "special." Banana republic that has been the bastard child of Congress forever. The local economy has been a trainwreck since around 2005. Most of the banks on the island have failed, some more than once (a real accomplishment). Then you have all these idiot yield chasers willing to lend on easy terms and a population that can split for the mainland US any time they like and show up as bona fide citizens with a passport and everything.

 

[Mulligan]

PR is "special." Banana republic that has been the bastard child of Congress forever. The local economy has been a trainwreck since around 2005. Most of the banks on the island have failed, some more than once (a real accomplishment). Then you have all these idiot yield chasers willing to lend on easy terms and a population that can split for the mainland US any time they like and show up as bona fide citizens with a passport and everything.

The thing I like about your posts Brewer (besides the fact I agree with almost everything you ever post) is no one should finish reading it without knowing which side of the fence you are on!


Sent from my iPad using Tapatalk

 

[brewer12345]

The thing I like about your posts Brewer (besides the fact I agree with almost everything you ever post) is no one should finish reading it without knowing which side of the fence you are on!


Sent from my iPad using Tapatalk

Heh, I actually don't have a dog in this one, I just think the outcome was predictable. I visited pr many times and appreciate the place, people and culture. I just do not want to lend them money.

 

[Options]

...

But, it isn't "noise" if you find yourself in a fund called "Virginia Muni" when it consists of 25% PR bonds!

The lesson here is know what you are investing in.

...

Absolutely. What is one doing in a Virginia Muni fund with 25% PR bonds to begin with, unless of course, one is the smartest person in the room.

 

[clifp]

I've held some PR infrastructure financing bonds (evidently Rum tax) since 1999 which mature in 2017. The 5.5% coupon has been paid faithfully every 6 months.

I have to admit I was anxious today, but I just checked my account and the interest payment was deposited :dance

Every since Brewer alerted to me of the problem many years ago I've been trying to figure out what to do with them. The Schwab quote of $97.13 I know from past experience isn't actually what I can sell them for so I've just been holding them. Last I looked I was getting approximately 15%/year to hold them.

They are insured although it is far from clear that bond insurance company has the money to pay the claims. Some of the final structurally damaged caused by the great recession.

 

[aja8888]

PR is "special." Banana republic that has been the bastard child of Congress forever. The local economy has been a trainwreck since around 2005. Most of the banks on the island have failed, some more than once (a real accomplishment). Then you have all these idiot yield chasers willing to lend on easy terms and a population that can split for the mainland US any time they like and show up as bona fide citizens with a passport and everything.

I have a lot of experience in PR working with clients (Mainland and Foreign) that were interested in buying and rehabilitating several refineries and chemical plants on the island. One facility in particular was Conoco/Phillips refinery and parazylene unit in Gueaga (SP). That plant was shut down and mothballed for years and just about rusted into the ground before it was looked at several times and eventually not sold.

Other facilities previously operated by a host of owners (private equity, big funds, etc) all eventually either rusted into the soils or could not meet capital upgrade requirements enforced by EPA Region 2 out of New England (yes, they have jurisdiction). Feedstock issues are also a killer as refinery naphtha (not crude oil) is brought in by expensive ships for processing into fuels. (No oil production on the island).

Then there is the tuna canning industry....one plant was left out of 5 (?) and it was Bumble Bee's. I doubt if that is still operating.

In summary, industry is dying and leaving and the remaining jobs are low paying.

 

[bingybear]

We can't just say that people look at bond funds as safe investments and then talk about PR bonds without a little more definition. I agree that many see high quality bond funds as a bit more safe (sans interest rate risk). But PR bonds are likely now on the riskier side of high yield or beyond what some HY will use. A bond is not a bond.. and a bond fund is not a bond fund... you have to look at the goals of the fund, quality and duration of the bonds. If one is chasing yield, it is likely to be at the expense of quality and has increased risk.

 

[Tadpole]

So moving from bonds to "frontier" markets is becoming a flight to safety.

 

[rayinpenn]

I've held some PR infrastructure financing bonds (evidently Rum tax) since 1999 which mature in 2017. The 5.5% coupon has been paid faithfully every 6 months.

I have to admit I was anxious today, but I just checked my account and the interest payment was deposited :dance

Every since Brewer alerted to me of the problem many years ago I've been trying to figure out what to do with them. The Schwab quote of $97.13 I know from past experience isn't actually what I can sell them for so I've just been holding them. Last I looked I was getting approximately 15%/year to hold them.

They are insured although it is far from clear that bond insurance company has the money to pay the claims. Some of the final structurally damaged caused by the great recession.

For what it is worth I think I'd sell.. It may be a slow death but I see nothing but bad things for PR debt.


Sent from my iPad using Early Retirement Forum.