The situation in Puerto Rico continues to deteriorate. 

Earlier this year, ratings agencies Moody’s Investors Service and Standard & Poor’s downgraded Puerto Rico’s general obligation (GO) bonds, already in “junk” territory, even farther (to Caa1 and B, respectively), citing concerns about the deteriorating economic and financial situation.

Ratings on many other Puerto Rico bonds were also downgraded—including its sales tax-backed bonds (to B3 and B, respectively), which were widely viewed as one of the more stable credits for the commonwealth. Making matters worse for the territory, a February legal ruling limited Puerto Rico’s ability to restructure its municipal bond debt.

According to Moody’s, it’s highly probable that the territory’s general obligation bonds, sales tax-backed bonds (issued by the Puerto Rico Sales Tax Financing Corporation, or COFINA), or other central government debt will default in the next two years.

So how did the situation in Puerto Rico get so bad?

The Commonwealth of Puerto Rico has been struggling with a government debt crisis for several years. Although the islands are a territory of the United States, it and its public corporations aren’t covered by U.S. Bankruptcy Code. To address this situation, Puerto Rico last summer passed legislation that would have allowed the commonwealth’s public corporations to negotiate with creditors and legally reorganize their debt if those negotiations failed.

The move spooked investors, who saw it as a sign of the territory’s unwillingness to repay debt. The legislation only applied to Puerto Rico’s three largest public corporations and specifically excluded the territory’s GO and sales tax-backed bonds. The commonwealth’s three largest public corporations are:

Puerto Rico Electric Power Authority (PREPA)

Puerto Rico Highway and Transportation Authority (PRHTA)

Puerto Rico Aqueduct and Sewer Authority (PRASA)

A February ruling from a U.S. District Court Judge said last year’s legislation was invalid because it was pre-empted by the U.S. Bankruptcy Code. Therefore, if the territory’s public corporations were to default, they would be unable to reorganize their debt under the formal protection of the bankruptcy system. While they could still restructure, those efforts would be outside the supervision of a court.

Puerto Rico’s primary problems stem though from its high debt burden and poor economic condition.  For example, the current unemployment rate for the commonwealth is 13.7%, more than twice the national rate.  Quite simply, the economy in Puerto Rico has slowed to the point that tax revenues are not enough to satisfy debt obligations.

According to reports, Puerto Rico’s debt burden is equal to almost 95% of its economic output. In comparison, the median debt burden for the 50 U.S. states is closer to 3%.  It is for this reason that Puerto Rico’s debt burden appears to be unsustainable.

To further compound problems, Puerto Rico’s problems have begun to spill over to U.S. based municipal bond funds.  Many municipal bond funds—including state-specific funds—hold Puerto Rican debt to boost their yields while also taking advantage of the commonwealth’s triple tax exemption. Interest payments on the commonwealth’s debt are exempt from federal, state and local income taxes in all 50 states. Approximately 30% of muni mutual funds have holdings in Puerto Rico.

According to Morningstar, the municipal bond funds that appear to have the most exposure include:

Franklin Double Tax-Free Income A (FPRTX) which has $110,282,812 invested. This is reportedly 47.2% of the total$233,553,864 investment.

Oppenheimer Rochester MD Municipal A (ORMDX) which has $23,093,065 invested. This is reportedly 36.9% if the total $62,603,594 in the fund.

Oppenheimer Rochester VA Municipal A (ORVAX) which has $40,736,112 invested. This is reportedly 33.8% of the total $120,667,805 in the fund.

Oppenheimer Rochester Fund Municipals A (RMUNX) which has $1,376,856,503 invested. This is reportedly 22.3% of the total $6,185,980,085 in the fund.

Oppenheimer Rochester LtdTerm NY MunisA (LTNYX) which has $726,558,930 invested. This is reportedly 20.6% of the total $3,515,612,163 in the fund.

Oppenheimer Rochester Michigan Muni A (ORMIX) which has $10,105,790 invested. This is reportedly 19.5% of the total $51,801,240 in the fund.

Oppenheimer Rochester Ltd Term Muni A (OPITX) which has $608,173,909 invested. This is reportedly 19.2% of the total $3,160,840,263 in the fund.

Oppenheimer Rochester AZ Municipal A (ORAZX) which has $12,059,832 invested. This is reportedly 18.8% of the total $64,312,517 in the fund.

Oppenheimer Rochester NC Municipal A (OPNCX) which has $15,577,530 invested. This is reportedly 17.3% of the total $89,810,812 in the fund.

Oppenheimer Rochester NJ Municipal A (ONJAX) which has $82,876,129 invested. This is reportedly 17.3% of the total $479,016,636 in the fund.

Oppenheimer Rochester AMT-Free NY MuniA (OPNYX) which has $190,431,569 invested. This is reportedly 16.3% of the total $1,166,986,059 in the fund.

Oppenheimer Rochester MA Municipal A (ORMAX) which has $9,850,542 invested. This is reportedly 16.1% of the total $61,339,160 in the fund.

Wells Fargo Advantage WI Tax-Free Inv (SWFRX) which has $24,420,696 invested. This is reportedly 15.3% of the total $160,092,126 in the fund.

Oppenheimer Rochester Ohio Municipal A (OROHX) which has $10,310,176 invested. This is reportedly 14.6% of the total $70,479,154 in the fund.

Oppenheimer Rochester PA Municipal A (OPATX) which has $123,108,661 invested. This is reportedly 13.9% of the total $883,561,556 in the fund.

Alpine High Yield Managed Dur Muni A (AAHMX) which has $5,835,739 invested. This is reportedly 13.8% of the total $42,105,336 in the fund.

Oppenheimer Rochester High Yld Muni A (ORNAX) which has $715,302,841 invested. This is reportedly 13.2% of the total $5,406,587,424 in the fund.

Oppenheimer Rochester Ltd Term CA MuniA (OLCAX) which has $89,003,199 invested. This is reportedly 12.9% of the total $687,146,588 in the fund.

MainStay High Yield Municipal Bond A (MMHAX) which has $215,681,931 invested. This is reportedly 12.9% of the total $1,727,077,784 in the fund.

Oppenheimer Rochester CA Municipal A (OPCAX) which has $150,523,359 invested. This is reportedly 11.4% of the total $1,328,984,067 in the fund.

What can investors do?

The White Law Group continues to investigate the liability that brokerage firms may have for recommending high-risk, speculative bets in Puerto Rican debt.

Brokerage firms are required to perform adequate due diligence on any investment they recommend and to ensure that all investments recommended are suitable in light of the client’s age, investment experience, net worth, income, and investment objectives.  If a brokerage firm fails to perform adequate due diligence or recommends and investment that is unsuitable, the firm can be held responsible for losses in a FINRA arbitration claim.

The White Law Group is not only looking in to claims involving U.S. based municipal bond funds with Puerto Rico exposure, but also direct bets in Puerto Rico bonds.

If you suffered losses investing in a U.S. based municipal bond fund or a direct investment in a Puerto Rico municipal bond and would like to know your litigation options, please call The White Law Group’s Chicago office at 312/238-9650 for a free consultation.

The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Franklin, Tennessee.  For more information on The White Law Group, visit http://whitesecuritieslaw.com.