What Does Puerto Rico's Debt Crisis Mean for the U.S.?

 

 

What does Puerto Rico’s debt crisis mean for investors?

 

While the world’s eyes were on Greece, Puerto Rico Governor Alejandro García Padilla announced last Sunday that the commonwealth could not pay its $72 billion in public debt. After decades of very slow growth and recession, the island’s central government is at the breaking point and wants the debt either deferred or renegotiated; analysts think it might run out of cash later this month.1

 

The municipal bond market is being noticeably impacted by this development. Mutual fund investors have long been attracted to Puerto Rico’s bonds, which offer sizable yields while being exempt from federal, state and local taxes. In 2014, the initial yield on Puerto Rico’s general-obligation bonds was 8.7%. According to Morningstar, 298 of 565 U.S. muni bond funds currently have some percentage of their assets in Puerto Rican debt.1,2

 

Puerto Rico’s Public Finance Corporation owes $94 million it must pay by July 15 and its central bank must pay $140 million in bond principal by August 1. Governor Padilla and his administration are quickly exploring their options – including the possibility of filing for Chapter 9 bankruptcy, a choice available only to cities under current U.S. laws.1,3

 

If the federal government does not permit a Chapter 9 bankruptcy for Puerto Rico, small investors and cities, counties and states that want to fund infrastructure projects will have to deal with some troubling question marks. Its bondholders may not be able to recoup some of their losses (not the case when Detroit and certain California cities filed for bankruptcy). The percentage of insured Puerto Rican bonds is unknown.1,3

 

This week, Padilla announced that the commonwealth would attempt to meet with bondholders and negotiate a years-long moratorium on debt payments. As Puerto Rico’s debt is worth about eight times as much as Detroit’s, state and local governments could soon be staring at higher borrowing costs if Puerto Rico pushes for debt relief.3,4

 

On a positive note, Puerto Rico’s government did pay off $1.9 billion in debt due July 1. So far, analysts have not noticed the kind of dramatic outflows from muni funds that would roil the municipal bond market. A sustained outflow would probably begin with these funds selling off some of their more liquid holdings, impacting high-grade bond prices to start.4,5

 

Jeffrey Lipton, head of municipal bond research and strategy at Oppenheimer and Co., told CNBC this week that there could be a “short-term municipal market dislocation” should a default or major restructuring of Puerto Rican debt occur. Barring those events, he said he did not foresee "a longer-term systemic threat to the municipal market.”4

 

On July 29, the Obama administration said there would be no bailout for Puerto Rico. It could be that Congress makes an exception for Puerto Rico and allows it to file for Chapter 9 bankruptcy. If not, then its government could try to convince bondholders to give it a reprieve by exchanging the bonds they now hold for long-term bonds at lower interest rates. There is no easy solution, and that means more anxiety for the world’s debt markets.6

 

Sincerely,

 

 

Earl Schultz

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1 - fortune.com/2015/06/29/puerto-rico-economy-crisis/ [6/29/15]

2 - blogs.wsj.com/moneybeat/2015/06/30/puerto-ricos-crisis-deals-a-blow-to-municipal-bond-funds/ [6/30/15]

3 - csmonitor.com/Business/2015/0629/Puerto-Rico-can-t-pay-its-debt-governor-says.-How-will-it-impact-investors-video [6/29/15]

4 - tinyurl.com/pjhugou [6/30/15]

5 - fortune.com/2015/07/01/puerto-rico-avoids-default/ [7/1/15]

6 - newyorker.com/business/currency/why-congress-should-let-puerto-rico-declare-bankruptcy [7/1/15]


Earl Schultz and Shannon LaRosse are investment adviser representatives of, and securities and advisory services are offered through, USA Financial Securities Corp., Member FINRA/SIPC. www.finra.org A Registered Investment Adviser located at 6020 E. Fulton St., Ada, MI 49301. Strategic Wealth Advisory is not affiliated with USA Financial Securities.

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