Detroit, Puerto Rico, Chicago - Oh My!


Jul 27, 2015, 09:00 ET from Western Asset Management

NEW YORK, July 27, 2015 /PRNewswire/ -- Municipal credits experiencing tough financial conditions – such as Detroit, Puerto Rico and Chicago – have been the focus of financial news headlines. Yet despite these localized problems, the broader municipal bond market is performing well.

This is the outlook espoused by portfolio manager Rob Amodeo of Western Asset Management, a subsidiary of Legg Mason. Mr. Amodeo leads Western Asset's municipal fixed income team.

"Stressed issuers in Illinois, New Jersey, Puerto Rico and other regions will remain in the news," Mr. Amodeo said. "There's no getting around those problems, which are substantial, but muni bonds are cheap relative to taxable bonds. Their tax advantages represent tremendous value."

"People ask, when is a good time to invest in municipal bonds? If you pay taxes – they are always a consideration."

Western Asset has positioned its portfolios to reflect these themes and trends, consistent with its investment philosophy of active management with emphasis on diversification and value.

"We like investment grade credit and favor revenue bonds over general obligation debt," Mr. Amodeo reported. "We continue to have significant overweights to revenue and essential services bonds where credit spreads have room to tighten further: transportation, specific utilities, the right health care issuers and some corporate backed obligations, known as IDRs. In particular we believe high-yield municipal bonds are poised to underperform, in the near term."

"During the past 18 months municipal bond values have appreciated, but they still look attractive compared to taxable fixed income. Investors may not realize that yields on high quality – in many cases AAA – municipal bonds are higher than U.S. Treasuries with similar maturities."

Still, investors remain concerned about fiscal stress in the public finance markets.

"During the past several months, open-end mutual funds have experienced large redemptions," Mr. Amodeo said. "Two weeks ago outflows from open-end municipal mutual funds spiked. More than a billion dollars left the market, with the greatest impact on the high-yield sector. This is the strongest negative pace since January 2014."

These moves stem largely from the widely-publicized commotion created by a few high-risk municipal issuers. They have similar problems, yet each situation is unique and deserves careful analysis. As Mr. Amodeo reinforced, this can create opportunity.

"The result of all this turmoil is a favorable entry point for careful investors," Mr. Amodeo said. "The municipal market is fragmented, has high information barriers, and is, at times, inefficient and illiquid. Fundamental factors add to complexity. Investors must have a good understanding of public policy, economic diversity, demographic trends and other credit metrics."

Western Asset is keeping a close watch on Chicago, where pension liabilities continue to pressure already strained city finances: police, fire, municipal and labor pensions remain significantly underfunded. In May, Moody's downgraded Chicago's debt from Baa2 to Ba1 – junk bond status – although S&P and Fitch maintain their weak investment-grade issuer ratings.

"Chicago is a stressed situation but that city has the ability to overcome their challenges," Mr. Amodeo observed. "We do not believe it is the next Detroit."

"Pension reform is needed, and there are four key negotiating points: increasing employee contributions, adjusting the retirement eligibility age, reducing cost of living adjustments, and offering a choice between defined contribution plans and traditional pensions. Other budgetary challenges exist too, but Chicago is a highly diversified economy. They have revenue raising abilities. For example, Chicago will probably increase their property tax levy."

"We're cautious but not completely avoiding the Chicago region," Mr. Amodeo said. "Chicago recently came to market with a loan offering long-dated bonds with yields near 6 percent. Chicago's debt cheapened to the point where you could sell emerging market debt, buy Chicago debt, and pick up yield. We sidestepped a lot of weakness there and felt it was a good entry point, so we added 25 to 50 basis points of exposure. Our total exposure to the Chicago region ranges near 2 percent, with positions across a variety of revenue sectors such as healthcare, water and sewer, and transportation bonds."

Risky municipal issuers also include Puerto Rico and its affiliated institutions. Western Asset considers the financial conditions for most of these institutions to be dire.

"The backdrop to Puerto Rico is an economy mired in a lengthy recession and saddled with more than $70 billion in debt, across government and public corporation issuers," Mr. Amodeo said. "A resolution to Puerto Rico's economic problems will not occur in the short term, and any bond workout will vary by issuer. We do not believe recent developments there will act as a catalyst for widespread investment-grade muni market contagion because ownership of Puerto Rico's debt has dispersed, and now includes a variety of hedge funds and opportunistic holders."

"Higher yielding sectors, however, may face increased volatility. Many Puerto Rico investors own other high-yield credit sectors. Some of our portfolios hold very small allocations to debt backed by Puerto Rico's sales tax revenue."

Despite the blaring headlines and the complexity of today's municipal market, investors should not be intimidated by the outsized risks of a few issuers. Western Asset believes the broader municipal bond market presents good value to those who can benefit from tax-exempt income.

"Even the riskier credits can be avoided or scaled appropriately to match individual investment objectives," Mr. Amodeo concluded. "This is a good time to consider municipal bonds."

About Robert E. Amodeo CFA

A portfolio manager with 26 years of experience in fixed-income markets, Robert Amodeo is now the Head of Municipals and has been with Western Asset Management since 2005. Previously he worked for Salomon Bros. Asset Management from 1992 to 2005, rising from analyst to managing director; Salomon Brothers Inc., from 1988 to 1992, as an analyst after starting as an accountant; and as an accountant from 1987 to 1988 at The Bank of New York. A Chartered Financial Analyst, Mr. Amodeo earned a Master of Public Administration in advanced management and finance from Columbia University, and a B.S. from Long Island University.

About Western Asset Management

Western Asset Management is one of the world's leading fixed-income managers with $453 billion in assets under management as of June 30, 2015. The firm is a wholly owned, independently operated subsidiary of Legg Mason, Inc. From offices in Pasadena, Hong Kong, London, Melbourne, New York, Sao Paulo, Singapore, Tokyo and Dubai, the company provides investment services for a wide variety of global clients, across an equally wide variety of mandates. To learn more, please visit

About Legg Mason

Legg Mason is a global asset management firm with $699 billion in assets under management as of June 30, 2015. The company provides active asset management in many major investment centers throughout the world. Legg Mason is headquartered in Baltimore, Maryland, and its common stock is listed on the New York Stock Exchange (NYSE: LM).

Basis point
A basis point is one one-hundredth of one percent (1/100% or 0.01%).

General Obligation Bond
General obligation bonds are issued by a municipality and are backed by the general ability of the municipality to raise revenue. No specific tax or project revenues are identified as the source of future payments and no assets are used as collateral.

Revenue Bond
A municipal bond financed by the revenue from a specific project, such as a toll bridge, highway or sports arena.

Investment-Grade Bonds
Are those rated Aaa, Aa, A and Baa by Moody's Investors Service and AAA, AA, A and BBB by Standard & Poor's Ratings Service, or that have an equivalent rating by a nationally recognized statistical rating organization or are determined by the manager to be of equivalent quality.

All investments involve risk, including loss of principal. Past performance is no guarantee of future results. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks and possible loss of principal. As interest rates rise, the value of fixed-income securities falls. High-yield bonds possess greater price volatility, illiquidity and possibility of default. An investor may be subject to the federal Alternative Minimum Tax, and state and local taxes may apply. Capital gains, if any, are fully taxable.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity.


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