Maureen Farell (CNN Money) writes about Puerto Rico’s debt crisis, saying that it has been called the next Detroit and the next Greece and that it is “buried in debt and possibly teetering on the edge of bankruptcy.” Not great news.
But that isn’t scaring away hedge funds. So-called vulture investors that buy the bonds of troubled companies (and municipalities) have been scrambling to purchase as much of Puerto Rico’s roughly $70 billion in outstanding debt as possible over the past several months. Their interest comes following a huge plunge in Puerto Rico’s bond prices over the summer.
There’s so much Puerto Rican debt out there. When the prices became really low, the situation suddenly became interesting,” said a manager at a distressed hedge fund who declined to be named. The price of Puerto Rico’s debt plummeted nearly 40% in just a few months. That pushed interest rates on Puerto Rico bonds up to nearly 10% from 5%. (Bond prices and rates move in opposite directions.)
Analysts at Citigroup said Puerto Rico’s debt was one of the most actively traded types of municipal debt in August and September, and hedge funds were thought to be the biggest buyers. Why did Puerto Rico’s bonds fall so dramatically? Concerns that the Federal Reserve would soon cut back on its massive bond buying program caused a broad-based slump in the bond market earlier this summer.
Even though the Fed has yet to taper its asset purchases, Detroit’s bankruptcy filing in July spooked investors further. Puerto Rico, which already was struggling with a stagnant economy, was widely viewed by municipal bond investors as another problem about to explode. Once prices dropped to a certain level, the sell-off intensified because many U.S. mutual funds that invest in tax-free municipal debt had a high concentration of Puerto Rico’s debt and were forced to sell to avoid massive losses.
Roughly 80% of Puerto Rico’s $70 billion in debt is held in these muni bond funds, and Morningstar estimates that 180 mutual funds have 5% or more of their portfolio concentrated in Puerto Rico’s debt. Among the major holders: nine tax-free funds operated by Franklin; six of Oppenheimer’s funds and funds operated by Nuveen, Putnam, and Dreyfus. Vultures smelled opportunity: But several hedge fund managers thought that Puerto Rico wouldn’t default on its debt in the short-term, and the bonds were oversold. Many hedge fund managers, including the one quoted in this story, tried unsuccessfully to buy up Detroit’s debt earlier this summer.
Because the stock market has been doing so well and most municipalities are not in dire fiscal straits, distressed debt hedge funds have struggled to find good investment opportunities. Puerto Rico suddenly looked like a place with big profit potential. The price of Puerto Rico bonds have since rebounded a bit and yields have drifted back to 8.5%.
What’s next for Puerto Rico: Hedge funds and longer-term investors have sharply divergent opinions on what will happen to the price of Puerto Rico’s bonds. Most analysts believe Puerto Rico has enough financing to make it through mid-2014 without tapping the public markets again. Hedge funds are betting that Puerto Rico can survive longer than that, but how long is the question.
For full article, see http://money.cnn.com/2013/10/31/investing/puerto-rico-hedge-funds/