The Puerto Rican government has focused upon the hedge fund investors who have purchased bonds in the secondary market, but those investors only represent about one-third of the bondholders.1 Much of the rest of the island’s roughly $70 billion in muni bonds are held by mutual funds owned by retail investors, and by brokerage accounts for investors both on the island and around the country. Members of public pension plans definitely will be affected by any future settlement of the commonwealth’s debt difficulties, but so will many other individuals, including retirees who were advised to invest in Puerto Rico bonds as a fixed-income alternative.

7) Bond Market Action
Prices for Puerto Rico bonds have not fluctuated too much recently because there is not much new information. The news of the GDB default did not create much market activity because it already had been widely expected. Yet, while Puerto Rico bonds have not been at the top of the performance list this year, most have provided positive returns.

Meanwhile, the recent headlines on Puerto Rico do not appear to have had an effect on the broader municipal market. The Barclays Municipal Bond Index was slightly positive in the two trading sessions following the announcement on May 1, and as of May 3, had returned 5.6% over the prior 12 months despite the ongoing headlines about Puerto Rico’s troubles.2 This suggests that investors have been able to isolate the commonwealth’s difficulties from the broader muni bond market.

8) The Current Situation
So where does that leave us? The Puerto Rican government is clearly stressed, and the island’s economy is in decline. This is not new information, as the downward cycle has been ongoing for more than a decade. The commonwealth’s challenges are daunting, but because the government hasn’t released audited financial information for a while, and because it is exerting every effort toward pushing Congress for a legislative solution, it is tough to quantify Puerto Rico’s exact situation. The island is losing population due to its weak economy, and its unemployment rate is much higher than that of the rest of the United States. The government clearly needs help in turning the economy in the right direction, but it also needs to improve tax collections and focus on initiatives other than having Congress rewrite bankruptcy laws.

With Congress moving slowly, a resolution to the situation will also will move slowly. The Puerto Rican government is unlikely to seriously engage with creditors until it finds out if it can improve its negotiating position, with help from Congress. In the meantime, officials will continue to use public statements to try to influence the situation, perpetuating the uncertainty. Eventually, the Puerto Rican government will need to negotiate with all bondholders.

9) What’s Next?
The next big date for Puerto Rico is July 1, 2016, when payments are due on general obligation bonds. These bonds have the highest position in the security structure, based upon the Puerto Rican constitution, so they are supposed to be paid before any other expenses. If the government chooses not to make the required payments, it likely will trigger legal action by creditors and lead to entangling the U.S. Supreme Court with regard to the outcome. This surely will happen unless the Puerto Rican government chooses to negotiate with creditors in advance. Going forward, the headlines could be challenging, but we see the possibility of a resolution occurring within the next few months.

Daniel S. Solender, CFA, is a Lord Abbett partner and director of municipal bond management.

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