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Puerto Rico Bonds Could Face Further Downgrade Next Year

Posted: Nov 12, 2013 | Posted in:

Puerto Rico bonds have turned out to be a very bad deal for investors.  The S&P Puerto Rico bond fund index has suffered losses of 21 percent year-to-date as of October 2013.  Puerto Rico bonds have declined in value because the bonds were downgraded amid concerns that the U.S. territory could not pay and would be forced to default on its debt.

While this news has been terrible for investors, many of whom were exposed to Puerto Rico bonds in mutual funds they thought were safe, a recent article in the Wall Street Journal indicates that the bond fund crisis is likely to continue for a long time and that things are only going to get worse for investors heavily exposed to Puerto Rican debt.

Puerto Rico Could Face Credit Downgrade

The troubles with Puerto Rico’s debt are apparent, and the bonds are already viewed as near-junk status.  Puerto Rico, however, has reportedly bought itself some time before facing a further downgrade.  The Wall Street Journal reports that Puerto Rico passed pension reform and took out short-term financing from banks in an attempt to deal with the immediate crisis it is facing.  The crisis centers on the fact that the territory has nearly $70 billion in debt and only 41 percent of its population is employed in the labor force.  One employed person out of every five works for the government.

Puerto Rico will likely have significant difficulty obtaining sufficient funds to pay for its outstanding debts, although the territory’s current budget anticipates profiting more than $2.5 billion in revenue from fees and instituting new taxes.  This amount represents more than 25 percent of the island’s general fund budget.

Puerto Rico’s plan is to boost the economy and, over the next five years, institute a plan that will create more than 130,000 jobs by the start of 2018.  Puerto Rico also reportedly intends to cut the current budget deficit of $820 million by 50 percent for the next fiscal year.

Investors, however, are less certain as to whether Puerto Rico is going to succeed in these endeavors.  Generating sufficient funds through revenue from the small percentage of people who are actually employed will put a major strain on workers, and any growth in jobs or the economy that will come from Puerto Rico’s five-year plan is theoretical.

If Puerto Rico is not successful, the Wall Street Journal indicates that a downgrade of its general credit rating is expected by the middle of next year.  This, of course, could be a disaster for bondholders who are already concerned about the negative total return on the S&P Municipal Bond Puerto Rico index.

Investors who have a large stake in Puerto Rico’s future will need to watch carefully to see how the bond market reacts in upcoming months and to see if Puerto Rico’s plan for growth and increased revenue materializes.  Otherwise, investors in Puerto Rico bonds will be left with little option but to absorb further losses or take action against fund managers and financial advisors who failed to disclose the risks of investing in the bonds.