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Bankers Rack up Fees From Puerto Rico Bonds Even as Investors Face Losses

Posted: Nov 12, 2013 | Posted in:

Investors in Puerto Rico Bonds have faced huge losses this year, with the S&P Puerto Rico index down around 21 percent as of October 10, 2013.  Bond funds are usually relatively stable, so these huge declines in value have come as a surprise to many investors.  Amid concerns that the Puerto Rico bond market will turn into another massive disaster (like the credit default swaps and subprime mortgage bonds situation in 2008), it is important for every investor to be aware that there are some winners in the massive investment in Puerto Rico bond funds: the big banks.

The Wall Street Journal reports that Wall Street securities firms, lawyers and other financial professionals were paid around $1.4 billion in fees and commissions since 2006.  The financial professionals collecting these massive sums of money often bought Puerto Rico bonds for mutual funds without fully disclosing the risk to average investors who were counting on these funds to provide income for retirement or to help grow their savings.

Investors Face Losses and Bankers Collect Fees

Puerto Rico has made 87 different deals since 2006, selling $61 billion in bonds even as unemployment on this island territory significantly exceeded unemployment in the United States.  It has become increasingly clear that Puerto Rico is going to have a very hard time repaying the massive debts that have been incurred.

With Puerto Rico issuing so much debt, despite a lack of evidence to indicate that it could meet its payment obligations, serious questions can be raised about how and why fund managers chose to continue to buy Puerto Rico bonds.  The large fees could help to explain why financial professionals made these purchases.  Securities firms were able to charge underwriting fees higher than the fees traditionally assessed on other U.S. cities and states that are facing financial trouble, like Detroit.  Regulations also allowed fund managers to invest in these Puerto Rican bonds for state-specific funds, since state-named funds can invest not only in their own debt but also in other municipal debt.

For financial firms, Puerto Rico funds provided a tax-free way to diversify that is considered a permitted purchase, even for state funds, and could provide a higher yield.  These attractive features, coupled with higher fees, likely led to some state-named funds gaining weightings greater than 10 percent of Puerto Rico bonds and led many other major mutual funds to having weightings greater than five percent of Puerto Rican debt.

Investors are now paying the price for purchases made by fund managers chasing bigger returns and higher fees.  OppenheimerFunds, for example, has been hit hard.  One fund, the Oppenheimer Rochester Virginia Municipal Bond Fund, lost 15 percent of its value in 2013.  This $125 million dollar fund was one of the most heavily invested in Puerto Rico bonds, but many other funds have also been hit hard by the Puerto Rico debt crisis.

The fund managers, of course, have retained their billions in fees and commissions as investors have borne the brunt of the losses.  Investors do not have to sit by and allow this to happen, however, as those who were not warned of the risk may have a case against the financial professionals who misled them.