U.S. Bond Funds Concerned About Puerto Rico Bankruptcy

U.S. mutual funds holding $1.7 billion in Puerto Rican debt have sued the commonwealth in an attempt to reverse a bill modeled after the protections offered under Chapter 11 of the bankruptcy law, according to Reuters. Puerto Rico is one of the largest issuers of debt in the U.S. municipal bond market, in part because its constitution forbids the enactment of bankruptcy law for the adjustment of debts. The complaint alleges that the commonwealth recently passed an act that explicitly mirrors these protections.

This act sent ripples through the $3.7 trillion municipal bond market, driving down the value of revenue bonds issued by PREPA, or the Puerto Rico Electric Power Authority, the news source reported. U.S. municipal bonds funds are the largest holders of the commonwealth’s debt because it is tax-exempt across the country. Fitch Ratings downgraded PREPA to CC from BB last week following the passage of the act.

Puerto Rico is known historically for paying its debts, but recent economic troubles have bond holders wondering whether PREPA will attempt to restructure, according to Money News. The island’s economy has been struggling with growth for the past eight years, and it currently has a 13.8 percent unemployment rate. The tax-free bonds offered by the commonwealth offered a competitive advantage that allowed it to sell debt in order to fill budget deficits and cover expenses. This same combination caused New York City to come dangerously close to bankruptcy in the 1970s.

If PREPA were to fail to act, investors who were recently hit by bankruptcies in Detroit and Jefferson County would have to absorb another financial blow, the news source reported.

“Puerto Rico has crossed the Rubicon; it’s crossed the line,” Richard Larkin, director of credit at Fairfield, Connecticut, investment firm Herbert J. Sims & Co., told Money News. “This is absolutely a big deal and bigger than Detroit and bigger than Jefferson County because there’s more money involved.”

I have previously written about Puerto Rico’s bankruptcy option in 2013, check out the full story at Puerto Rico Lacks Bankruptcy Option.

If you have any questions about this post or would like to discuss your company’s creditors’ rights and bankruptcy matters , please contact me, Joel R. Glucksman at ScarinciHollenbeck.com.