Investors scramble to avoid Puerto Rico losses

Once seen as a golden opportunity, big-money investors are now scrambling to keep their bets on Puerto Rico whole.

Hedge funds, mutual funds and other investors piled in over the last two years, thinking others had overreacted to the island's fiscal problems by dumping local bonds.

But the value of their debt holdings fell sharply early this week on a string of bad news.

The U.S. territory's governor surprised observers by saying its $72 billion in debts weren't payable. The White House explained that it was not contemplating a bailout. Ratings agencies cut their assessments of Puerto Rican bonds. And a report by a group of former International Monetary Fund officials detailed just how bad the island's fiscal problems are.

"The coming weeks will bring showdowns between ... the governor and bondholders, and out of the rubble, we expect the PR government to emerge leaner, having shed some debt and restructured some operations," Height Securities said in a report Monday.

In other words, more observers think that hedge funds and other creditors should expect to accept less than face value for the bonds they own. Some Puerto Rico bonds were trading at 68 cents on the dollar Tuesday.

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The bad news doesn't mean investors are giving up.

Two bands of mostly hedge fund bondholders continue to put pressure on local officials. They still hope to come up with a deal that gives Puerto Rico the money it needs to fund its operating budgets and, at the same time, provide a profit for investors. The negotiations are now more urgent giving looming deadlines: a total of $1.9 billion in various bond payments, including general obligation debt, are due on July 1, according to a market participant.

The largest band of investors owns different types of government-backed bonds.

A year old, the so-called Ad Hoc Group is made up of 35 members and represents $4.5 billion in Puerto Rican debt holdings such as GO bonds, seen as having the best chance of a full payment. Not all the investors in the group are disclosed, but its steering committee—those that actively negotiate with the government—are Fir Tree Partners, Centerbridge Partners, Davidson Kempner Capital Management, Stone Lion Capital Partners, Brigade Capital Management and Monarch Alternative Capital.

There was no comment Monday or Tuesday, but the group wrote in a letter on June 24 that it wanted to meet with government officials and "be part of the solution to the Commonwealth's fiscal challenges." The Government Development Bank for Puerto Rico, which represents the other side, declined to comment.

The other investor alliance is holders of bonds from the Puerto Rico Electric Power Authority, or PREPA. Also called an ad hoc group, it includes hedge funds Knighthead Capital Management, Marathon Asset Management, Goldman Sachs Asset Management, D.E. Shaw Group, BlueMountain Capital Management, Angelo, Gordon & Co. and large mutual fund investors Franklin Templeton and OppenheimerFunds.

Together the group holds about 40 percent of the utility's bonds, or around $3 billion worth. Insurers such as MBIA and Assured Guaranty also have significant exposure to PREPA bonds and their stocks were hammered this week as a result.

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The group negotiated with PREPA officials Monday, according to a person familiar with the situation, but no solution had been reached. PREPA owes about $400 million in a bond payment Wednesday, and a short-term deal could push the negotiating deadline forward in the hopes of a more comprehensive restructuring. Past extensions have been for 30 days.

A spokesman for PREPA bondholders declined to comment, and a representative for PREPA did not respond to a request.

Source: Thomson Reuters

CNBC's Kate Kelly contributed reporting.