Puerto Rico Pushes for Debt Relief, Outlook Remains Mixed | American Funds

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Investment Insights

May 2017

Puerto Rico Pushes for Debt Relief, Outlook Remains Mixed

“Our commitment to deep research allows us to be selective, look for relative value and invest around trouble spots.“

Karl J. Zeile Fixed Income Portfolio Manager Los Angeles office 26 years of experience (as of 12/31/16)

“The Title III process was specifically written for Puerto Rico … it should not be viewed as a precedent for state bankruptcy”

Lee Chu Fixed Income Investment Analyst Los Angeles office 8 years of experience (as of 12/31/16)
  • Puerto Rico’s move toward restructuring debt was expected.
  • We have very limited exposure to bonds issued by Puerto Rico government entities.
  • We continue to largely avoid Puerto Rico’s government bonds and anticipate that debt recoveries following a restructuring are likely to be lower than some investors may anticipate.

What Just Happened?

On May 3, Puerto Rico’s federal oversight board formally began the legal process that should enable it to restructure tens of billions of dollars of bonds. So far, just over $40 billion of Puerto Rico’s outstanding bonds could be eligible for restructuring. This development marks the first step toward what would be the largest ever municipal restructuring.

Given the Commonwealth’s failure to reach an agreement on debt relief with bondholders, the move was not a surprise. Puerto Rico is unable to file for bankruptcy under Chapter 9. Instead, it sought relief under a new federal law (“PROMESA”) specifically written to provide a path for Puerto Rico to restructure its governmental debt.

What Could Happen Next?

It’s important to note that Puerto Rico’s efforts to restructure its debt are not precedent-setting for states in the U.S. “The Title III process was specifically written for Puerto Rico. While it could potentially extend to other territories, it should not be viewed as a precedent for state bankruptcy,” explains Lee Chu, a municipal bond investment analyst at Capital Group.

Puerto Rico’s efforts to use the courts to cut its debt burden should, therefore, have minimal consequence for other municipalities that encounter severe financial challenges.

Given the scale of the proposed restructuring, it’s difficult to say how long the legal process could take, or the precise recovery level that bondholders may have to accept (that is, the proportion of their initial investment that they will get back). The framework specific to Puerto Rico leaves much to the discretion of the federal oversight board and the judge.

Investment Outlook

Puerto Rico’s financial health has been a cause for concern for quite a while, and overall exposure in the American Funds family of mutual funds has been limited.

The combination of debt principal haircuts, reduced coupons and future shifts in the perceived riskiness of Puerto Rico’s outstanding debt could lead to recovery values for bonds being much lower than current market pricing suggests. That said, our investment professionals have been able to look beyond the negative headlines to find opportunities.

“Our commitment to deep research allows us to be selective, look for relative value and invest around trouble spots. Just as in some states and municipalities that have been in fiscal distress, there are opportunities to invest in projects and non-profit organizations in territories like Puerto Rico without taking governmental repayment risk,” says Karl Zeile, a municipal bond portfolio manager at Capital Group.

“In Puerto Rico, for example, we have invested in bonds issued by private universities and hospitals on the island. These entities could actually fare relatively well in spite of a governmental debt restructuring, as their long-term prospects are tied to a more stable island economy,” Karl adds.

Puerto Rico-Related Debt Exposures

puerto-rico-table-716x274

Data as of March 31, 2017.
The table above shows the American Funds mutual funds that have exposure to Puerto Rico-related debt and the level of that exposure as a percentage of total net assets. A significant proportion of this exposure is accounted for by bonds with an insurance wrap (an insurance company guarantees scheduled payments of interest and principal on a bond or other security in the event of an issuer default). The Bond Fund of America’s percentage of total net assets invested in Puerto Rico-related debt was 0.02% as of 3/31/17.
Note: The funds’ portfolios are managed, so holdings will change over time.


Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

This material is intended for use by financial professionals or in conjunction with the advice of a financial professional.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing. 

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and not to be comprehensive or to provide advice.