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Puerto Rico Expected to Default on Debt Even After Restructuring Bill Is Signed

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Even after President Barack Obama signs the long-awaited bill that lets Puerto Rico restructure its debt, the ultimate outcome for holders of the island’s debt remains uncertain.

“Investors don’t know …  how much debt they can support,” says Lyle Fitterer, who leads the tax-exempt fixed income team at Wells Fargo Asset Management.

In order to answer that question, investors need an audit of the island’s financials and knowledge about how Puerto Rico will treat its pension obligations – whose unfunded liability tops $40 billion – versus its debt obligations, which total $72 billion, says Fitterer.

Knowing how much debt Puerto Rico can support will provide investors some idea of how much of a haircut, or discount, they can expect for the bonds they hold, says Fitterer, who spoke with ThinkAdvisor at a UBS global investment forum in New York. Then who gets paid first – pensioners or bondholders – is key.

Another unknown for investors: the composition of the board that will restructure Puerto Rico’s debt under the bill, known as PROMESA, for Puerto Rico Oversight, Management and Economic Stability Act.

The board will have seven members — four Republicans and three Democrats — chosen by Obama from a list compiled by House Majority Leader Paul Ryan R-Wis., and Senate Majority Leader Mitch McConnell, R-Ky.

One thing that is certain: Once the bill is signed into law, lawsuits filed by bondholders for missed municipal bond payments retroactive to December  – and there have been a few already — would be barred, providing the island breathing room to restructure debt.

Meanwhile, Puerto Rico is poised to default on more than half of a $2 billion debt payment due Friday, July 1 – all general obligation debt – even after the restructuring bill is signed into law, according to the island’s governor, Alejandro García Padilla.

“No amount of contingency planning can shield us from the fallout of the defaults in the coming days; no amount of contingency planning will replace the necessity of a debt restructuring regime,” the governor in a commentary published on Wednesday.

All this leaves Puerto Rico’s municipal debt “fairly uninvestable,” says Fitterer. He noted that Wells Fargo Asset Management owns very little Puerto Rican debt, only some short-term insured bonds.

Despite the problems with Puerto Rico, the muni market overall is doing well, says Fitterer.  Quality is high and demand is strong, buttressed by foreign buyers seeking yield while their domestic bonds have none. Overseas investors are buying taxable and tax-exempt munis, says Fitterer. Why tax-exempt when they can’t benefit from the exemption? “For diversification,” says Fitterer.

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