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Do You Invest in Puerto Rico?

The answer may surprise you.

For many of us, Puerto Rico probably conjures images of sun and fun, and perhaps a visit on a cruise ship. The U.S. territory doesn't look quite the same, though, when viewed through the lens of municipal-bond holders. Although its yield-rich bonds have been popular among investors, the Commonwealth has become notorious in recent years for its poor fiscal health. Its problems are many, and, as noted by Morningstar municipal credit analyst Candice Lee, they include an overburdened pension system whose funding levels are by far the lowest in any U.S. state or territory, and whose largest plan is currently projected to run out of funds by 2018.

The territory's overall budget situation doesn't look any better. In addition to its pension weakness, the Commonwealth continues to run budget deficits and suffers from very high annual debt service requirements. It's not as though the local government has stood idly by. There have been some improvements in recent years, including pension and tax-reform efforts. Lee notes that they haven't pushed the needle very far, though, given that the territory's economy has deteriorated, while its debt service--and borrowing to meet budget gaps--has grown. According to data collected by NewOak Capital Advisors, Puerto Rico ranks ahead of every U.S. state in terms of debt/GDP and debt/revenue ratios. That firm has also taken a stab at evaluating the pricing of the Commonwealth's debt and figures that its 30-year bond yields would need to exceed at least 6.5%--well ahead of their recent 5.4% mark--in order to be attractive.

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