Puerto Rico Default Risk Could Impact Average Americans

Puerto Rico’s expected default on August 1 on a small tranche of the government’s almost $73 billion dollar debt could have huge implications for millions of American retirees who are unaware they are invested in that debt.

The Puerto Rican Federal and municipal governments owe bond holders a combined $450 million dollars on Saturday August 1. Most of that is expected to be paid, but there are questions about the ability of Puerto Rico to make payments on debt issued by its Public Finance Corporation (PFC) of roughly $58 million dollars, and Government Development Bank’s (GDB) $169 million dollars, which are owed to investors.

Reuters reports Puerto Rico is expected to make the GDB payment, but no word on the PFC debt.

According to Morningstar Analyst Beth Foos, “…half of U.S. open-ended municipal-bond funds hold some exposure to debt of the commonwealth…funds collectively own more than $11.4 billion of the islands debt or just over 15% of its outstanding issuance.”   

Millions of American retirees are invested in those muni-bond funds like the Oppenheimer Rochester Fund Municipals (RMUNX) or Goldman Sachs High Yield Muni (GHYAX) to name a few. Foos writes in a recent Morningstar note that Oppenheimer fund and Franklin Templeton Investments are two of the largest holders of Puerto Rico's debt. The price of Puerto Rican debt has been falling since late June when Governor Alejandro Padilla declared the commonwealth would be unable to pay its debts.

Height Securities Analyst Daniel Hanson writes, the “Looming August 1st bond defaults…could drive bonds much lower…” Bonds issued by Puerto Rico’s PFC are currently trading at roughly 14 cents on the dollar. Oppenheimer funds issued a statement to the Wall Street Journal on July 19 regarding negotiations between debt holders and Puerto Rico to avoid default. That statement said, “We have been managing investments in Puerto Rico for more than 20 years, and remain steadfast in serving the long-term interests of our shareholders.”

While a default on any of Puerto Rico’s debt would most likely wind up in protracted legal battles, Moody’s Investors Service issued an analysis on July 22 discussing the expected recovery rate investors might get should Puerto Rico default. The PFC and GDB bonds which Moody’s rates highly speculative have an expected recovery rate between 35 and 65 cents on the dollar. But pressure is growing in Washington D.C. for Congress to pass legislation which would grant Puerto Rico chapter 9 bankruptcy protection. Without it, Treasury Secretary Jack Lew says a Puerto Rico default, “…has the potential to further harm retiree investment portfolios across the country."

Legislation has been introduced in Congress to create bankruptcy protection for Puerto Rico to restructure its debt. But noted bond experts like Cate Long ask where would it end since no U.S.state or territory has the legal authority to declare bankruptcy even though some face crippling debt. Long says, “Puerto Rico represents a philosophical battle ground to the idea that states can spend more than they take in.”

Adam Shapiro joined FOX Business Network (FBN) in September 2007 as a New York based reporter.

By Adam Shapiro

Puerto Rico Default Risk Could Impact Average Americans