By Rick Pitcairn, CFA®, Chief Investment Officer
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August 4, 2015 – On August 3, 2015, the Puerto Rico Public Finance Corporation defaulted on most of its $58 million debt payment. Not surprisingly, this has made headlines across the financial and mainstream media. However, headlines don’t always equate to real significance and we do not believe this situation will have any meaningful effect on Pitcairn clients or the broader capital markets.

We have been in contact with our fixed income and hedge managers to assess any portfolio sensitivity to Puerto Rico’s worsening debt situation. Pitcairn portfolios do have some exposure to Puerto Rican debt, but that exposure is negligible. Furthermore, we see very little risk that Puerto Rico’s debt problems will spread to other high-yield or municipal debt markets as long as the current situation doesn’t materially change for the worse. Nevertheless, we think it’s important to share with you what we know and confirm that we are abreast of the situation.

Understanding the Default

The Puerto Rico Finance Corporation borrowed money to help balance Puerto Rico’s budget. The debt is not considered an obligation of the Puerto Rican commonwealth and the legislature must appropriate money to make payments to bondholders. To date, the legislature has not appropriated any funds for these debt payments.

In all, Puerto Rico has $78 billion in debt outstanding. The current situation has its roots in 2006 when Congress allowed tax breaks to businesses operating in Puerto Rico to expire. As a result, businesses pulled out and the population declined, leading to lower tax revenues and reduced public services. The end result is a government with high debt levels, less tax revenue, and 12% unemployment. Rather than borrow their way out of this problem, the governor has committed to finding revenue sources, restructuring debt, and implementing necessary service cuts.

There’s no question this will be a very difficult situation for the people of Puerto Rico, but probably not for global financial markets. We will remain vigilant and, of course, we hope the plan of Puerto Rico’s government leaders is successful. Whether it is or not, we do not think the debt issues will require any adjustments to individual client portfolios or Pitcairn’s global allocation strategy. If you have any other questions about this evolving situation, please contact your relationship manager.

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