NEW YORK (TheStreet) -- Some investors were quick to ditch Puerto Rican bonds when the island said it couldn't meet its credit obligations, but many others don't even realize some of the commonwealth's $72 billion in debt is lurking in their portfolios.
"Puerto Rico paper is in roughly half of the mutual funds out there," said Philip Villaluz, a municipal bond strategist with Schroders. It's heavily concentrated in funds run by Oppenheimer (OPY), which holds nearly $5 billion, and Franklin Templeton (BEN), which holds more than $2 billion, Villaluz said.
Prices on the commonwealth's debt, even the general obligation bonds that are the most secure form of government debt, dropped sharply after Gov. Alejandro Garcia Padilla's weekend statement about the commonwealth's financial problems. Citing a report by Anne Krueger, the inaugural managing director of the International Monetary Fund, the governor called on both residents and bondholders to make concessions that would rejuvenate Puerto Rico's economy.
The commonwealth's debt is so high that raising taxes and cutting spending wouldn't fix anything, he said: If Puerto Rico continues to borrow, its debt will double to $140 billion in just 10 years, or more than $40,000 for each man, woman and child.
What the governor proposes instead is restructuring its debt to postpone payments "for a number of years" so the money can be invested in Puerto Rico. "It is time that those who lent to us also come to the table of sacrifices, at which we are already seated, so that later we can all together share the fruits of that sacrifice," Padilla said.
It's a plan greeted that investors have greeted with anger and dismay. Among the debt now at risk is a popular $3.5 billion series of general obligation bonds issued last year that would pay an annual 8% coupon rate, with a maturity in 2035.
That bond's tax-free yields, coupled with a high interest rate, prompted large purchases by hedge funds and firms specializing in distressed debt, who snapped up about 70% of bonds. Retail investors and funds including Oppenheimer and Franklin Templeton also took large pieces, Villaluz said.
Prices on the bond dropped 11% this week to 69 cents on the dollar, but the selloff might have been even worse if investors were aware of the stake held in regular mutual funds. Already the bond has fallen 21% this year.
Franklin Templeton officials are analyzing the policy recommendations of a Krueger's report, titled Puerto Rico - A Way Forward and "waiting to hear more from the governor on next steps," said Stacey Coleman, a spokeswoman.
By James Passeri
Why a Puerto Rican Default is More Dangerous Than You Think
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