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Wall Street Getting Skittish Over Puerto Rican Debt

SanJuan

Puerto Rico’s troubles continue to mount as two of the biggest underwriters of its debt, Citigroup and UBS, felt compelled to disclose the extent of their exposure to the island territory last week. According to the Financial Timesthey did their best to put a positive spin on things:

Citigroup, which has a 95-year history in Puerto Rico, told the Financial Times its exposure to the island’s municipal debt market was “relatively manageable for the size of our operations” and protected by bond insurance.

The comments followed UBS’s disclosure last week that it had lent $1.7bn against Puerto Rican debt and closed-end fund collateral, through its US wealth management arm. The value of that collateral, which is tied to the fluctuating value of the bonds, was worth $3.2bn at the end of September, it said.

As yields have soared on the debt, it becomes more challenging for the bank to sell its collateral if necessary.

“The worst thing that could happen is that all Puerto Rican debt became worthless – that would be $1.7bn of uncollateralised lending,” said John Dalby, chief financial officer of the UBS unit. But that outcome was “extremely unlikely”, he added.

Those are soothing words indeed, but that they had to be said at all appears to have sent a chill through Wall Street, with analysts demanding that other banks state their position as well.

As we noted last month, Puerto Rican bonds have long been attractive for investors due to their exemption from three levels of taxation (local, state, and federal). This, combined with the high yields seen in the aftermath of Detroit’s bankruptcy, sent money rushing into the territory’s bond market despite its high debt and declining creditworthiness.

Now some of these same investors appear to be getting butterflies as they begin to internalize what kinds of knock-on effects their exposure to Puerto Rico might have on their own portfolios, and on the muni bond market as a whole. This remains a story to watch closely.

[San Juan photo courtesy of Shutterstock]

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