Thomas Metzold, Senior Portfolio Manager and Advisor at Eaton Vance, talks with The Bond Buyer’s Chip Barnett about the situation in Puerto Rico and what’s next for the commonwealth. He also discusses the effect of island’s economic woes on high-yield municipal bond funds and looks at what Congress could to do help. He also takes a look back at all changes in the municipal bond market over the course of his career and says “the key is to be adaptable.”

BARNETT: Hi I'm Chip Barnett and I'm here today with Tom Mesal. Hi Tom.

MESAL: Good morning.

BARNETT: I wanted to talk to you today about Puerto Rico and what you think about the long-term prospects of its survival and it's viability of paying debt?

MESAL: I think there are real problems but I think it's manageable. The key will be trying to coordinate the various motivations and objectives of the hedge funds versus the bondholders versus the insurance companies. There's a workable solution, this is not something that's going to devolve into anarchy. There will be a solution.

BARNETT: Where do you see going from here, what is the next move in Puerto Rico?

MESAL: There is obviously a lot of stuff that's being discussed right now. Every day there is something new that hits the headlines. I think because it's in the headlines so much it tends to have a more negative feel to it than the reality of people moving forward towards a solution. We talk about Chapter Nine bankruptcy for the public corporations. Would that be beneficial? I think so on the margin, there's other things Congress can do. They can possibly get rid of the Jones Act. They can no longer have Puerto Rico subject to the minimal wage lot. What they need to do is grow the economy.
It's not about necessarily cutting debt so much as it is growing the economy and working out a schedule whereby they can make for repayment of debt. Which is one of the things they've said they want to do. Again if all the parties can try to get on the same page I think we can find a solution that works for everybody.

BARNETT: Do you think that will happen soon or do you see this happening over a long period of time?

MESAL: I think it's going to take a minimum of 12 months, maybe even longer. Again you've got three major constituencies that all have their consultants. They all have their lawyers, obviously that's one of the benefits of having Chapter Nine bankruptcy is that you've got guardrails around the situation. Something that's fair and equitable and at least a judge can pound the gavel and say, "Yes I know all three of you may not be happy but this is what we're going to do," and it works. Detroit was not a situation where everybody was happy, but it was a solution that ended up working in the end.

BARNETT: Do you see a spillover from Puerto Rico like say the fund flows, the high yield funds which you've seen so much outflows recently?

MESAL: I do think that that's something we have to be concerned about because Mom and Pop retail who are the largest holder of mutual funds, and of course the largest holder of municipal bonds in general either in the form of individual bonds or ETFs or closed-end funds, open-end funds. If they get spooked by the situation because it gets covered in such a way that it makes people redeem their funds, you have that run on the market. What we saw in 2008, what we saw with Meredith Whitney. We have to be cognizant of that. I would like to think that this has been dragging on for so long, it's not as high profile as it once was and I think it's containable. I think that we can get through this without having that run on the market situation, but we have to be aware of it, it's possible.

BARNETT: Muni performance so far this year has been mediocre.

MESAL: It's been blurred, we've been moving in lockstep with the Treasury Market and I wouldn't be surprised if we move similarly in lockstep. Although it's possible that with some good news be it Muni's are not involved in any tax reform discussions. Be it that the Puerto Rico situation takes a turn for the positive. We have to remember there's more bonds being called, redeemed and mature than there are new bonds coming into the market. That supply/demand dynamic is still positive. We do have to realize that the Fed is possibly going to raise rates, I don't think it's going to be until 2016. Nonetheless, how Muni's react to that will be very interesting.
That said in the last Fed tightening period June of 04 through June of 06, the Fed raised rates 17 times for 425 basis points and Muni's actually rallied, long term Muni's rallied. Remember the reason the Fed's raising rates is because the economy's getting better. If the economy's getting better that's better for Municipality Credit quality.

BARNETT: Taking a look backward over the last 30 years what do you see that has been remarkable to you? What has changed in

MESAL: Sure. Well first of all I think since 2008 we've seen this permanent structural change in the Municipal Bond market with respect to the consolidation of broker dealers. The demise of the auction preferred share market. The loss of AAA ratings by the Municipal Bond Insurers, but more importantly we've seen the impacts of technology.
When I first got in this business we had fiscal delivery bonds where you clipped the coupon. We now book order entry in DTC, we now have Bloomberg machines that give us all this information. We used to have all Moody's red books that you had to flip through thousands and thousands of pages to get the sinking fund schedule. The impact of technology has been great, it's brought the advent of mutual funds, its brought ETFs. Its brought us products that we've never had before. At the same time, that so-called efficiency creates sometimes greater volatility. The ease and effortlessness with which money can move in and out of funds and ETFs and what not gives us a reason to be careful and be considerate of what's going to happen as we move forward into other products that provide greater potential volatility. I look at that and I look of course at what happened with the financial crisis and the way people buy in some Muni's has changed and I think it's going to continue to evolve and we're going to see even more changes. The key is to be adaptable.