All bets are off when it comes to the likelihood of distressed debt-focused hedge funds and municipal bond fund managers making money or at least coming out whole on their investments in the debt of the Commonwealth of Puerto Rico.
Gov. Alejandro Garcia Padilla said in late June that Puerto Rico can't repay the $72 billion in debt that it has incurred through issuance of general obligation bonds, sales tax-backed bonds and public corporation/agency bonds.
Most U.S. defined benefit and defined contribution plans, endowments and foundations won't be directly affected by the outcome of Puerto Rico's debt restructuring because, as tax-exempt entities, they largely don't invest in tax-exempt debt.
However, a slice of their money managers, especially high-yield debt managers and distressed debt hedge funds, have exposure to the island's financial crisis through their bond holdings.
The breakdown of debt holders is about one-third hedge funds, one-third mutual funds and one-third individual retail investors, said Matt Fabian, a partner at specialty researcher Municipal Market Analytics Inc., Westport, Conn.
“It is extremely difficult to project the returns investors might expect from the many ways that Puerto Rico may restructure its entire capital structure,” Mr. Fabian said.
“There are too many moving parts. What is clear is that the capital structure will need much deeper haircuts than have been proposed so far,” Mr. Fabian stressed.
The U.S. territory has three options for dealing with its debt, observers said.
The first and most viable option is debt restructuring. The second option is convincing the U.S. Congress to pass legislation that will extend Chapter 9 municipal bankruptcy protection to the U.S. territory.
Cesar Miranda, Puerto Rico's secretary of the Department of Justice, already has acted on the third option by announcing that the commonwealth will appeal to the U.S. Supreme Court to overturn decisions by two lower courts.
The 1st U.S. Circuit Court of Appeals in Boston on July 6 affirmed the February decision of the U.S. District Court in San Juan, Puerto Rico, to strike down the 2014 Puerto Rico Public Corporation Debt Enforcement and Recovery Act. That law gave municipalities, including public utilities and other government agencies, on the island bankruptcy protection to enable them to restructure. U.S. Chapter 9 bankruptcy law specifically excludes Puerto Rico.
Mr. Padilla signaled his government's willingness to “make difficult decisions to meet the challenges we ... know are ahead,” in a June 29 statement.