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By Cara Esser | 06-20-2014 02:00 PM

Why Munis Need Closer Scrutiny

Western Asset's Rob Amodeo explains how it's no longer a "set it and forget it" muni market, and he also details why he likes some Puerto Rican bonds.

Cara Esser: I'm Cara Esser, fund analyst at Morningstar here from the Morningstar Investment Conference. Today with me, I have Rob Amodeo from Western Asset. He is head of municipal-bond management.

Thanks for joining me, Rob.

Rob Amodeo: My pleasure.

Esser: Rob, give us your take on the changing muni landscape and what it means for investors today?

Amodeo: There are so many differences in today's marketplace versus just a few years ago. And then just look back to six months ago, the marketplace was in oversold conditions. But more broadly, it is a credit market. It's a marketplace where you have to understand the credit profile, the specific issuer, the cash flows that are going to come back and repay you your principal. And that I think is a little bit different than when investors looked at municipal bonds in the years prior. It was a set-it, forget-it, do-it-yourself type marketplace. That's no longer the case. You need to have good credit analysts looking at your credits.

Esser: You've sold out all of your tobacco bonds recently. Can you tell us why?

Amodeo: We are tobacco-free. When you look at the demand for cigarettes, the combustible cigarettes, it's decreasing. It's decreasing at a rate that would put the principal at jeopardy. Many of these tobacco bonds are likely to extend, if not ever repay their principal. So we're avoiding that sector.

Esser: And what about Puerto Rico?

Amodeo: Puerto Rico is a fascinating story. If you take the accomplishments of Alejandro García Padilla administration and you drop them into struggling states, most of those states would welcome those accomplishments. Investors, however, have been confronting a very, very rocky road, and small changes in demand lead to marked changes in prices.

There are a couple of credits down there that we like. The sales and use tax, they are called COFINA bonds. When you look at the fundamentals of the COFINA bonds, they're actually improving. When you look at the tax proceeds that came from sales and use taxes last year, it's almost $1.2 billion. The debt service is less than $700 million last year. This year they're looking to collect $1.3 billion. Again, debt service is about $700 million.

Debt service, first, is covered by those sales and use tax collections, then the money goes to the General Fund. The General Fund doesn't collect the money first and then pay off the debt. So we like that fundamental. Even with the very weak economy down there, you're starting to see fundamentals in the sales and use tax, the COFINA bonds, stable. It's rated A by Standard & Poor's and Fitch on the junior loans and a AA by S&P and Fitch on the senior loans. Try to find another credit like that in Puerto Rico.

Esser: Rob, thanks for joining me.

Amodeo: It's my pleasure. Thank you.

Esser: I'm Cara Esser at the Morningstar Investment Conference.

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