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  • Muni Nation

    Devastation in Puerto Rico Complicates Muni Market

    Jim Colby, Portfolio Manager
    October 03, 2017

    Beyond the feeling of acute sadness for the Commonwealth and its populace, the devastation will only serve both to prolong and complicate the negotiations and underlying issues surrounding the default of Puerto Rico's outstanding obligations.

    Pretty much every aspect of everyday life on the island has been affected. It is very clear that a near-complete rebuild of the power supply system, under the aegis of the Puerto Rico Electric Power Authority ("PREPA"), will be required. The highway system, under the Puerto Rico Highways and Transportation Authority ("PRHTA") is barely holding itself together. The Puerto Rico Aqueducts and Sewers Authority ("PRASA") may need to rebuild totally the water and sewer system. And schools have suffered such damage that it is as yet unclear just how many can be salvaged. This is on top of the fact that many schools had already been closed due to the budget constraints across the island.

    The Federal Emergency Management Agency ("FEMA"), already stretched across the states of Texas, Florida, and the Florida Keys, is being forced to allocate, rather than dedicate, all its resources to Puerto Rico and the U.S. Virgin Islands. This only complicates further the prospects of near-term recovery.

    The one possible silver lining, which has not yet been publically discussed (as far as I know), is a recovery bill in Congress to hasten the rebuild and recovery of the islands' economy. Given the extent of the human suffering of these U.S. citizens, the possibility of swiftly privatizing essential services with U.S. government support is more possible now than it was prior to the hurricane.

    In the meantime, however, there appears little hope, near term, for any holders of Puerto Rico bonds who may choose to rely upon the contractually stated obligations under which the bonds were originally issued, to anticipate that repayment can or will proceed in the near future.

    For muni investors who have chosen to utilize the ETF structure as their way to obtain tax-free income, it should be clear that their choice of a highly diversified vehicle, built both to represent the broad landscape of the muni high-yield marketplace and with the intent of limiting risk associated with singular events such as this destructive hurricane, has been effective.

    In addition, since Puerto Rico has been a significant and large issuer in the high-yield universe, index rules that employ a "capping" mechanism have offered further investor protection by reducing overall exposure. Such a mechanism has helped mitigate the impact of a valuation reduction.

    As horrible as the outcome of the hurricane and subsequent recovery may be, the lesson for investors around their choice of deploying their assets through the auspices of the ETF structure has been a starkly real one.


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