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#: ‘In a muni bankruptcy, the same entity emerges, and the same issues’: Puerto Rico exits bankruptcy with questions remaining

#: ‘In a muni bankruptcy, the same entity emerges, and the same issues’: Puerto Rico exits bankruptcy with questions remaining

Is statehood the answer?

Puerto Rico on Tuesday received court approval to exit its municipal bankruptcy, restructuring over $30 billion of debt, but leaving plenty of questions about the sustainability of its finances.

The island entered bankruptcy in 2017 after years of excessive borrowing, abetted by Wall Street. Its municipal bonds were exempt from federal, state and local taxes in any U.S. jurisdiction, making them attractive to fund managers in a market long starved for supply. Puerto Rico’s financial position was worsened by a weak economy, out-migration to the mainland, and its location in the Caribbean, making it vulnerable to costly storms like Hurricane Maria.

Critics of the approved plan of adjustment say it leaves in place conditions that aren’t sustainable, such as generous retirement benefits, even as it slashes the island’s overall debt load. But for the municipal bond market
HYD,
+0.08%,
especially those hunting yield, the big question is whether Puerto Rico will return to the position it held for years before Gov. Alejandro García Padilla declared it could not pay its debts.

“This is a significant step forward,” said John Mousseau, president and CEO of Cumberland Advisors, which has $4.1 billion in assets. Cumberland holds only insured Puerto Rico bonds. “This bankruptcy has been a dark cloud for a long time. It hasn’t been beneficial to anyone. If you end up with a plan where no one is happy you probably have the right plan.”

‘People said no one would ever buy Detroit’s paper again, but they are. I think people will be buying [Puerto Rico debt] again.’


— John Mousseau

Mousseau believes one of the big lessons from the restructuring is the need for transparency and accountability. Investors who had loaded up muni-bond funds with the island’s debt took big losses as its financial woes became clearer, as shown in the 2013 analysis from Morningstar, below.


Source: Morningstar analysis

Still, Mousseau said in an interview, “people have short memories. People said no one would ever buy Detroit’s paper again, but they are. I think people will be buying (Puerto Rico debt) again. It will be more secure but not without risk.”

“One of the real differences between a corporate bankruptcy and a municipal bankruptcy is that in the corporate world it’s a new company that emerges,” said Matt Fabian, a partner with Municipal Market Analytics, a firm that watched — and warned — about Puerto Rico’s finances for years. “In muni bankruptcy, the same entity emerges, and the same issues that got them into bankruptcy in the first place may still exist.”

In fact, Fabian thinks investors might have a reason to be more skittish about questionable issuers thanks to the Puerto Rico experience. When the commonwealth began to teeter, nearly all of its debt was sucked into the restructuring, no matter how clearly delineated and different the sources of repayment were.

“They’re different credits if there’s no problem,” Fabian told MarketWatch. “Once there’s a problem, they’re the same credit.”

Now, Puerto Rico must present four years’ worth of balanced budgets in order to be free of the oversight board that steered it through the restructuring.

‘The U.S. owes Puerto Rico an effort to grow organically, to give it a sense of sustainability, to allow the profits to stay there.’


— Matt Fabian

While the government is now sitting on “a ton of cash,” in Fabian’s words, after skipping debt service payments for the past few years and benefitting from some pandemic federal aid, the bigger questions about its economy remain.

“Our development strategies for Puerto Rico have always been some kind of tax preference that encourages [mainlanders] to put their money there,” he said. “That was always problematic because it’s taking profits off the island. The U.S. owes Puerto Rico an effort to grow organically, to give it a sense of sustainability, to allow the profits to stay there.”

Mousseau thinks Puerto Rico should be granted statehood.

Some 52% of islanders voted for statehood in the latest referendum, held in 2020. In December last year, a coalition of 51 organizations argued that a bill calling for a yes or no vote on Puerto Rico statehood should move forward, but a crowded agenda in a closely divided Congress has reduced such action to lower priority.

“As a commonwealth they reported into Congress, which should have been watching this [financial downfall],” Mousseau said. “You talk about lack of oversight, you don’t get that lack of oversight when you’re a state. It’d probably really improve the island over time.”

Read next: An assumed ‘Treasury put’ may have doomed Puerto Rico bond investors

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