Puerto Rico, sandwiched between the Dominican Republic and the U.S. Virgin Islands, is small, but its municipal-bond market impact could be huge as it faces a potential default.
Puerto Rico is $70 billion in debt; has $37 billion of unfunded pension liabilities, an unemployment rate of nearly 14 percent, and a population of just 3.6 million, which has been on the decline as people and corporations leave the cash-strapped island.
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So what's it to U.S. investors? Even if you do not own the debt outright, you could still be passively invested in it. In fact, Puerto Rico shows up in about 75 percent of all muni-bond mutual funds, according to research firm Morningstar. The problem: It's not obvious to muni-bond fund investors. Morningstar tracks about 180 funds in total with weightings of 5 percent or more in the territory's bonds.
What makes the debt so attractive? For one, some bonds have hefty payouts, yielding more than 11 percent. That is sizable interest in the current low-yield environment. Also appealing is the island's triple tax-exempt status; as an investor, you do not pay federal, state, or local taxes on any interest earned.
"Puerto Rico has an extremely strong willingness to pay, very strong legal protections on both general obligation [GO] debt and revenue [COFINA] debt, and it has made progress toward fixing some of the fiscal problems," said Daniel Loughran, senior portfolio manager at OppenheimerFunds. His firm has 20 mutual funds with varying levels of exposure to Puerto Rico.
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