Big Firms in the U.S. Move to Shield Investors From Island’s Bonds as Worries Build Over Finances

Brokers Bypass Puerto Rico’s Debt

Big Firms in the U.S. Move to Shield Investors From Island’s Bonds as Worries Build Over Finances

By    KELLY NOLAN   CORRIE DRIEBUSCH    and    MIKE CHERNEY

Large brokerages are limiting small investors’ access to Puerto Rico’s debt amid deepening unease about the island commonwealth’s financial health.

UBS AG UBSN.VX -0.82%and other firms have separately warned more than 40,000 U.S. financial advisers and brokers to steer clear of about $70 billion of Puerto Rican debt currently on the market, according to people familiar with the matter.

Reuters

Wells Fargo analysts warned its advisers about Puerto Rico’s debt.

The warnings are the latest blow to the $3.7 trillion municipal-bond market. Puerto Rico’s debt has been popular with U.S. investors for its high yields and special tax benefits. Some 77% of U.S. municipal-bond mutual funds hold bonds sold by Puerto Rico, according to Morningstar.

Some of Puerto Rico’s bonds have slipped to trade between 60 and 70 cents on the dollar and are rated just above «junk» levels. Economic growth and tax collections in Puerto Rico have been weak, and the island recently dialed back its plans to borrow in the debt markets, citing high borrowing costs and «ripples» from Detroit’s record municipal bankruptcy in July.

UBS said it told clients this week who want to buy Puerto Rico debt that they must sign a document acknowledging the risks. Earlier this month,Wells Fargo WFC -0.26%& Co. analysts sent a note to the firm’s more than 15,000 advisers warning of the hazards of Puerto Rico’s debt.

Raymond James Financial Inc. RJF -1.23%has been restricting access to Puerto Rico’s bonds due to the «uncertain nature» of the commonwealth’s finances, said Kevin Giddis, the securities firm’s head of fixed-income sales, trading and research. The firm began limiting investors’ access about a year ago, said a person familiar with the situation.

«Investing in Puerto Rico is not for the faint of heart,» said Alan Schankel, a strategist at Janney Montgomery Scott. «We think Puerto Rico will avoid default, but this outcome isn’t assured.» Mr. Schankel is advising clients to limit Puerto Rico holdings to no more than 5% of a muni-bond portfolio.

Puerto Rico officials declined to comment on the investment firms’ warnings and restrictions.

The retreat from Puerto Rico’s debt comes as island officials have sought to reassure investors and analysts. The island expects to raise more than $1 billion from new and increased taxes, officials have said. Puerto Rico also made changes this year to its main pension system that the government says will help pay off future obligations.

Financial firms typically take steps to restrict access to investments only in extreme cases, when they are concerned about the safety of a particular security or product, financial advisers said. Placing curbs on brokers is particularly unusual in the municipal-bond market, which until recently has been considered a safe harbor for retail investors and retirees to park their savings and collect yields.

Big mutual funds have been selling Puerto Rico’s bonds all year as fears about the island’s health spread. Earlier this month, Putnam Investments LLC surprised market participants by putting up for sale nearly $50 million of the island’s debt in a single trading session; investors said that was an unusually large amount. Putnam declined to comment.

Franklin Templeton, Eaton Vance Corp. EV -0.59%and Nuveen Investments have been cutting their exposure to Puerto Rico bonds over the last year, according to Morningstar data. Franklin Templeton has reduced its holdings of Puerto Rico bonds by more than $1 billion in the past year, according to the data. It now owns about $4.8 billion of the island’s debt, Morningstar said.

Nuveen declined to comment, while Franklin Templeton and Eaton Vance couldn’t immediately provide comment.

There are also some investors who see the recent increase in the island’s borrowing costs as a buying opportunity, including OppenheimerFunds’ Rochester municipal group, which owns about $4.3 billion of Puerto Rico’s debt. The mutual-fund firm is a major holder of the island’s debt and believes its finances are on the mend, it has said.

«There are some who think Puerto Rico is going to implode and others who think they have time,» said Joe Rosenblum, director of municipal research at AllianceBernstein AB -4.56%. «We think they have time.»

AllianceBernstein has kept its exposure to Puerto Rico fairly steady, Mr. Rosenblum said.

Similar to U.S. states, Puerto Rico is restricted from filing for municipal bankruptcy. A financial audit for fiscal 2012—released Monday after a roughly four-month delay—showed a budget deficit of $1.337 billion. The commonwealth’s three pensions funds were, combined, more than 91% unfunded.

Fixing the problems won’t be easy. New taxes in Puerto Rico have «traditionally dealt with difficulties in implementation as well as evasion,» said Moody’s Investors Service analysts.

And selling debt is getting harder. Last week, some Puerto Rico bonds reached yields of 10% in the secondary market. Officials said the commonwealth would scale back issuance for the rest of the year, to just $500 million to $1.2 billion, depending on market conditions, from an earlier plan of about $2.6 billion.

Puerto Rico has taken about $1.4 billion in short-term financing through various deals with banks, including Barclays BCS -2.40%PLC and RBC Capital Markets.

—Matt Wirz contributed to this article.

Write to Kelly Nolan at kelly.nolan@wsj.com, Corrie Driebusch at corrie.driebusch@wsj.com and Mike Cherney at mike.cherney@wsj.com

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