For Puerto Rico Bondholders, The Chickens Have Come Home To Roost

After seven years of recession, a ballooning budget deficit and billions in unfunded pension liabilities, Puerto Rico’s bonds last week were downgraded by two agencies, Standard & Poor’s and Moody’s, to “junk” status.

The third rating agency, Fitch, is likely to follow the other two agencies and downgrade Puerto Rico debt to junk in the near future.

Standard & Poor’s is “worried that the territory’s fiscal plight would restrict access to debt markets and make it more difficult to repay its $70 billion debt load,” according to CNBC finance editor Jeff Cox.

Meanwhile, the Island Commonwealth is facing an imminent crisis of raising $940 million in payments triggered by Standard & Poor’s downgrade, according to Bloomberg’s Michelle Kaske. Puerto Rico officials are working on refinancing debt and renegotiating contracts to ease the almost billion dollars of accelerated payments on debt and calls for increased collateral on swaps that were triggered by the S&P downgrade. Almost half may need to be arranged within 30 days, said David Hitchcock, an S&P analyst.

The downgrades likely will cramp Puerto Rico’s ability to raise any further funds in the future through the debt markets.

As readers of this blog know, Puerto Rico has about $70 billion in municipal debt outstanding, third behind only California and New York. Those economies, however, are huge, while Puerto Rico’s economy is anemic at best.

With the downgrades, the Puerto Rico bond peril is officially front page news, with the New York Times on Sunday devoting its lead story to the island’s economic and fiscal decline.

“Puerto Rico’s slow-motion economic crisis skidded to a new low last week when both Standard & Poor’s and Moody’s downgraded its debt to junk status, brushing aside a series of austerity measures taken by the new governor, including increasing taxes and rebalancing pensions,” wrote Lizette Alverez. “But that is only the latest in a sharp decline leading to widespread fears about Puerto Rico’s future.”

She continued: “In the past eight years, Puerto Rico’s ticker tape of woes has stretched unabated: $70 billion in debt, a 15.4 percent unemployment rate, a soaring cost of living, pervasive crime, crumbling schools and a worrisome exodus of professionals and middle-class Puerto Ricans who have moved to places like Florida and Texas.”

This downgrade, while widely expected, is likely to further decimate the portfolios of UBS Puerto Rico clients. Those investors hold over-concentrated positions of the Puerto Rico bonds in their portfolios; they also own UBS’s proprietary “closed-end” funds which were comprised largely of UBS underwritten Puerto Rico bonds.

Those investors will remain stuck. The only “purchasers” of these bonds are likely to be hedge funds and other distressed debt fund investors who seek to pick up the bonds at a bargain price and profit from the spreads that occur when the bonds fluctuate in price.

Puerto Rico bondholders are left with bonds that have declined dramatically in value, and whose high interest coupons of 8% to 10% reflect the tremendous risk of default.

Furthermore, U.S. mutual funds with heavy exposure to Puerto Rico bonds have sold off some of the cash-strapped island’s debt to meet investor redemption demands, taking heavy losses after a year-long slide in prices.

The sellers included some of Puerto Rico’s most bullish U.S. mutual fund investors including OppenheimerFunds, a vocal supporter of the territory’s recent financial improvements, according to a Reuters report.

It is painfully obvious that these “junk bond” chickens have come home to roost. In the end, Puerto Rico’s Mom and Pop investors holding these bonds will wind up with nothing more than chicken feed.

Zamansky LLC are securities and investment fraud attorneys representing investors in federal and state litigation against financial institutions, including UBS. For more information about Zamansky LLC, please visit https://www.ubspuertoricofunds.com/.