What’s Next For Puerto Rico Debt?

October 6, 2013, 6:09 p.m. ET.

Q: How nad is the situation?

A: While no action seems imminent, many lawyers and other experts on distressed debt predict that at least some of Puerto Rico’s outstanding bonds eventually will be restructured. That could mean changes to interest rates or to the amount of time Puerto Rico has to repay.

The tipping point will likely come if Puerto Rico runs out of money to cover debt payments and can’t refinance with new bonds. Puerto Rico has cut back on its bond-issuance plans and is turning to banks for short-term loans.

Q: If things get bad enough, can’t Puerto Rico file for bankruptcy-court protection like Detroit did in July?

A: No. Chapter 9 of the U.S. Bankruptcy Code is only for municipalities. Puerto Rico is an unincorporated territory. Some experts said it might be possible to at least try restructuring some of Puerto Rico’s debt in Chapter 9 or Chapter 11, the part of bankruptcy companies use to reorganize. For example, some bond issuers in Puerto Rico are classified as «semi-autonomous authorities,» possibly giving them a loophole to seek protection from certain obligations, lawyers said.

Q: Can’t the U.S. government ride to Puerto Rico’s rescue?

A: Yes, but the U.S. government has never bailed out a shaky state. Some experts expect any help from U.S. officials to be indirect, perhaps through limited tax credits or guarantees of some obligations.

Q: Could things get even more complicated for bondholders?

A: For sure. One example: Some bankruptcy lawyers are examining the potential impact of the U.S. Constitution’s 11th Amendment. The amendment limits the power of federal courts to hear lawsuits against state governments that are filed by citizens of another state or foreign country. It’s possible that Puerto Rico could face claims only in Puerto Rico courts.

Q: How can investors make money on Puerto Rico’s financial distress?

A: The stricken bonds, down more than 18% so far this year, look appealing to «distressed debt investors,» especially given the small number of recent company restructurings. Some of the same investors are looking at Detroit.

It’s a risky bet. In Detroit, bond investors face a slog in bankruptcy court and battles with other creditors aiming to shield themselves from steep losses.

-Emily Glazer

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