Without a net: Oppenheimer has $4 bln in uninsured Puerto Rico debt

BOSTON, July 16 Wed Jul 16, 2014 3:54pm EDT

BOSTON, July 16 (Reuters) - OppenheimerFunds' municipal bond portfolios hold $4 billion in uninsured Puerto Rico debt, leaving them open to bigger potential losses than rivals as the Caribbean island's fiscal problems escalate.

Rival U.S. municipal fund managers began selling uninsured Puerto Rico debt several months ago, at prices not far below insurance-backed bonds. But OppenheimerFunds' management team has kept in place one of the mutual fund industry's biggest bets, on the cash-strapped island's turnaround, fund portfolios show.

Much of that bet is not backed by insurance, unlike at other mutual fund companies, according to Oppenheimer's latest disclosure about its Puerto Rico holdings. Unrealized capital losses at OppenheimerFunds could surge if the value of Puerto Rico bonds do not recover.

The Standard & Poor's Municipal Bond Puerto Rico Index is down 3.85 percent so far in July, lagging the 0.33 decline on the broader S&P Municipal Bond Index.

OppenheimerFunds' Rochester brand of municipal funds ended June with about $28.4 billion in assets. And nearly 17 percent, or $4.7 billion, in fund assets had direct exposure to Puerto Rico. Some $4 billion of that direct exposure was not insured, according to Oppenheimer.

Uninsured bonds issued by Puerto Rico's electric authority, for example, are trading around 40 cents on the dollar, down from more than 70 cents in mid-June, according to trade activity quoted on Electronic Municipal Market Access.

OppenheimerFunds, a unit of insurer MassMutual Financial Group, declined to comment.

Until recently, OppenheimerFunds management team has insisted that Puerto Rico is able and willing to make good on about $70 billion in outstanding municipal debt. But that resolve may be weakening after Puerto Rico last month passed a law that would allow the U.S. territory to reduce or defer payments on its debt, leaving bondholders vulnerable to losses.

"Clearly, it is not a big leap to view the legislation as an indication that Puerto Rico's willingness to pay may be weakening," OppenheimerFunds told investors in a July 3rd letter. "But all of this is speculation, and in our opinion, likely premature."

Nevertheless, municipal funds run by OppenheimerFunds and Franklin Templeton sued the commonwealth last month, asking a federal judge in U.S. District Court in Puerto Rico to strike down the law. Fund managers at Templeton, part of Franklin Resources Inc, declined to comment.

Small funds run by Oppenheimer appear most vulnerable because they have the highest percentage of direct exposure to Puerto Rico while holding the largest proportion of bonds issued by the island's beleaguered electric authority, fund disclosures show.

Nearly 35 percent of the $65 million in net assets at the Oppenheimer Rochester Maryland Municipal Fund are directly exposed to Puerto Rico debt. None of the Puerto Rico bonds in the fund are insured, according to Oppenheimer's latest disclosure.

ELECTRIC SLIDE

Making matters more risky, the fund's exposure includes a 4.4 percent holding in Puerto Rico Electric Power Authority (PREPA) bonds. That is considered Puerto Rico's most toxic debt after PREPA recently disclosed it used about $42 million from its reserves to make a July 1 bond payment of $472 million. PREPA's debt also could be restructured under Puerto Rico's newly passed law.

In total, Oppenheimer's Rochester funds hold about $821.4 million of PREPA bonds, according to its complaint in the U.S. District Court.

Rivals have been less willing to hold uninsured Puerto Rican debt. At Eaton Vance Corp in Boston, municipal funds sold uninsured PREPA debt last year at relatively attractive prices, said Tom Metzold, a senior portfolio manager at the company.

In October, for example, Eaton Vance sold uninsured PREPA debt for about 72 cents on the dollar and substituted it for insured debt for about 78 cents on the dollar, Metzold said. That turned out to be a good trade because the uninsured PREPA bonds are now trading around 40 cents on the dollar, compared to insured ones trading near par.

"The market is saying that the insurance is worth something," Metzold said.

Bond insurance guarantees payment of the principal and interest on municipal bonds.

While several portfolio managers said they are confident that municipal bond insurers can make good on their Puerto Rico guarantees, credit-rating agency Moody's Investors Service is showing some concern.

Assured Guaranty Ltd, MBIA Inc and Radian Group Inc all have significant exposure to Puerto Rico, Moody's said. MBIA's National Public Finance Guarantee reported $1.5 billion in gross exposure to Puerto Rico debt at the end of March. (Reporting by Tim McLaughlin; Editing by Richard Valdmanis and Richard Chang)