Puerto Rico, like many other government organizations, used municipal bonds to raise funds. Municipal bonds, like other bonds, appeal to investors because they are often secure and reliable investments. Municipal bonds also have the benefit of being tax-free. This incentive was especially appealing for Puerto Rico bonds because it was available to investors from all over the world. Investors found the Puerto Rico bonds to be very appealing, and the island issued over $70 billion in municipal bonds, which became a burden for Puerto Rico, which it is now fighting to repay.
Individual investors bought the bonds, but companies like UBS bought them and bundled them into proprietary closed-end bond funds. Firms like UBS advised their clients to invest in unsuitably high concentrations of Puerto Rico municipal bonds, exposing them to undue risk. The use of leverage (borrowed money) to purchase even more bonds ratcheted up the danger.
The value of Puerto Rico municipal bonds plummeted in 2013, owing to the commonwealth’s financial woes, which have subsequently been compounded by other financial strains, notably Hurricane Maria’s devastation. Investors who bought bonds through bond funds, such as those marketed by UBS, have experienced even greater losses as a result of the funds’ use of leverage to buy the assets.
Standard and Poor’s downgraded Puerto Rico’s general obligation bonds to “junk” status in February 2014, indicating that an investment in the bond was considered very risky and below investment grade. This clearly reduced the incentive to invest in the bonds in the future. Puerto Rico has defaulted on a $58 million bond payment by 2015, and had defaulted on another $174 million bond payment by January 2016.
As a result, the value of Puerto Rico’s municipal bonds (and any associated closed-end bond funds) has plummeted, resulting in significant losses for investors. To make matters worse, many of those investors were unduly reliant on their brokers’ assurances that the bonds were steady and secure investments.
UBS was accused of selling Puerto Rico bond funds, according to regulators. FINRA, for example, found that UBS did not have an effective supervisory structure in place to prevent unsuitable bond fund transactions. UBS also failed to monitor the over-concentration of funds in customer accounts and failed to examine the appropriateness implications of growing leverage risk.
Customers of UBS, as well as customers of Wells Fargo, Morgan Stanley, Merrill Lynch, and RBC Securities, who purchased Puerto Rico bond funds, may have a claim against their broker and/or brokerage firm for negligence, violations of securities regulatory rules, failure to supervise, and breaches of fiduciary duty.
What is the status of Puerto Rico bonds?
MIAMI, Florida — On Tuesday, a federal judge approved Puerto Rico’s exit from bankruptcy under the largest public-sector debt restructuring plan in US history, nearly five years after the financially beleaguered territory claimed it couldn’t pay its creditors.
Hurricanes Irma and Maria, a series of earthquakes, and the coronavirus epidemic have only exacerbated Puerto Rico’s economic woes since it declared bankruptcy.
The restructuring proposal will cut the government of Puerto Rico’s debt, which totals $33 billion, by nearly 80%, to $7.4 billion. In addition, the agreement will save the government approximately $50 billion in debt payments.
Puerto Rico will also begin repaying creditors, albeit at a reduced rate, something it has not done in years. In 2015, the government announced that it would be unable to repay its debts.
Is it still safe to invest in municipal bonds?
- Municipal bond interest is tax-free in the United States, however there may be state or local taxes, or both.
- Be aware that if you receive Social Security, your bond interest will be recognized as income when determining your Social Security taxable amount. This could result in you owing more money.
- Municipal bond interest rates are often lower than corporate bond interest rates. You must decide which deal offers the best genuine return.
- On the bright side, compared to practically any other investment, highly-rated municipal bonds are often relatively safe. The default rate is quite low.
- Interest rate risk exists with any bond. You’ll be stuck with a bad performer if your money is locked up for 10 or 20 years and interest rates climb.
Are municipal bonds risky?
- Municipal bonds are a wonderful option for consumers who want to keep their money while earning tax-free income.
- General obligation bonds are used to quickly raise funds to meet expenses, whereas revenue bonds are used to fund infrastructure projects.
- Both general obligation and revenue bonds are tax-free and low-risk investments, with issuers who are quite likely to repay their loans.
- Municipal bonds are low-risk investments, but they are not risk-free because the issuer may fail to make agreed-upon interest payments or be unable to repay the principal at maturity.
Is it true that Puerto Rico bonds pay interest?
Spain occupied Puerto Rico beginning in 1493, when Christopher Columbus arrived on the island. Puerto Rico was ceded to the United States after the end of the Spanish–American War in 1898. The US then refused to pay the colony’s creditors, claiming they were owed a dreadful amount.
Before 1898, the people of Puerto Rico had Spanish citizenship; after 1898, the people of Puerto Rico did not have either independent nor colonial citizenship. President William McKinley signed the Foraker Act in April 1900, allowing only the House of Representatives of Puerto Rico to be elected by popular vote. Puerto Rico was characterized as an unincorporated “territory appurtenant and belonging to the United States, but not a part of the United States under the revenue clauses of the Constitution” in the Insular Cases, a series of Supreme Court decisions from the early 1900s.
Although legally defined as a commonwealth or protectorate, Juan R. Torruella considered Puerto Rico’s relationship with the United States to be colonial because the US Federal Government has ultimate economic and political decision-making authority and Puerto Rican citizens do not have full constitutional rights. Puerto Rico is subject to US legislation due to its political position. One of these laws is the Jones-Shafroth Act, which exempts interest payments from bonds issued by the government of Puerto Rico and its subdivisions from federal, state, and municipal income taxes (the so-called “triple tax exemption”), regardless of the bondholder’s location. Puerto Rican bonds were appealing to municipal bond investors because of this right. Because of this, Puerto Rico was able to issue bonds that were always attractive to municipal investors, regardless of the state of the island’s finances. As a result, Puerto Rico began issuing debt to cover its expenses, a practice that it has continued since 1973. The island also started issuing debt to pay off earlier debt, as well as refinancing older debt with low interest rates with debt with higher interest rates.
Puerto Rico was officially prohibited from declaring bankruptcy under Chapter 9 of Title 11 of the United States Code by Congress in 1984. Congress withdrew the tax credits between 1996 and 2006, resulting in the loss of 80,000 employment on the island and caused its population to drop and economy to contract in all but one year since the Great Recession began. Because Puerto Rico’s constitution stipulates that “all available resources” must first be used to pay the Commonwealth’s general obligation bonds, the Commonwealth began issuing Puerto Rico Sales Tax Revenue Bonds in 2006 to circumvent the constitution’s restrictions by being paid directly into a separate urgent interest fund. The sales tax has been raised to 11%. In 1958, the last property tax assessment was completed. Between February 4 and 11, 2014, three bond credit rating agencies downgraded Puerto Rico’s bonds to non-investment grade (commonly known as “junk status” or speculative-grade) when the island’s outstanding debt reached $71 billion, roughly equal to 68 percent of GDP. Bond acceleration clauses were activated as a result of the downgrading, requiring Puerto Rico to repay some debt instruments in months rather than years. Investors were fearful that Puerto Rico might default on its debt at some point. Puerto Rico’s ability to issue bonds in the future would be harmed if it defaulted. Puerto Rico now claims that it will be unable to maintain current operations unless dramatic actions are taken, which could result in public upheaval. Protests against the austerity measures have already taken place. Puerto Rico’s present debt problem is the result of these events, as well as a succession of governmental financial deficits and a recession.
How much debt does Puerto Rico have?
SAN JUAN, PRINCIPALITY OF PUERTO RICO — Puerto Rico’s nearly five-year bankruptcy struggle has come to an end as a federal judge signed a deal on Tuesday that reduces the US territory’s public debt load as part of a restructuring and allows the government to begin repaying creditors.
The deal, which is the largest municipal debt restructuring in US history, was authorized after arduous bargaining, contentious hearings, and numerous delays while the island recovers from fatal hurricanes, earthquakes, and a pandemic that exacerbated its economic plight.
“There has never been a public restructuring like this anyplace in America or the world,” David Skeel, chairman of a federal control board formed to monitor Puerto Rico’s finances, said of the plan.
He pointed out that there are no bankruptcy provisions for countries or US states like the one handed to Puerto Rico.
“This was an astoundingly difficult, huge, and important bankruptcy,” Skeel said, noting that the island’s debt was three times that of Detroit.
The government of Puerto Rico claimed in 2015 that it could not afford to pay its $70 billion public debt, which had accrued over decades of mismanagement, corruption, and excessive borrowing. In addition, it owed more than $50 billion in public pension obligations. A year after the United States Congress established the financial monitoring and management board for Puerto Rico, it filed for the largest municipal bankruptcy in US history in 2017.
Is it a good time to go to Puerto Rico right now?
The optimum time to visit Puerto Rico is between mid-April and mid-June, just after the hectic winter season and before the rainy summer season. The weather in the spring is likewise very comfortable, with temperatures scarcely escaping the mid-80s on most days. Winter brings the island’s greatest weather, which is partially why it’s the busiest and most expensive season to visit, but with proper planning, you may get a good deal during those months as well. You may also plan a fun and inexpensive trip during the fall, when hotels can be found for as little as $80 per night. Keep in mind that visiting in the fall exposes you to the affects of Atlantic hurricane season.
Is it possible to lose money investing in municipal bonds?
These funds have a low risk of losing value, and the interest they pay is consistent. They also pay a very low interest rate as a result of their safety. Risk and reward are inextricably linked: a lesser risk equals a lower payoff.
Opportunity cost
Municipal bonds’ tax advantages aren’t as valuable if you’re in a lower tax band as they are if you’re in a higher tax bracket.
If that’s the case, you could be better off putting your money into alternative investments for a larger return.
They may not be liquid
If you need money quickly, you should be aware that municipal bonds may have liquidity problems.
You might not be able to find an active market for your bonds, which means you won’t be able to sell them when you want at the price you want.
Is it wise to invest in municipal bonds in 2022?
The key drivers of the municipal market are all positive, therefore 2022 is expected to see ongoing robust demand for municipal bonds. Taxes are first and foremost. Investors are still concerned about increasing taxes and will do everything possible to avoid them, keeping demand high.
Are municipal bonds inherently more secure than corporate debts?
When deciding whether to purchase corporate or municipal bonds, there are a number of considerations to consider. The quality of the corporation issuing the bond, the tax consequences, yield, liquidity, and how the money earned through the issuance of the bond will be used are some of the most important of these variables.
Quality of Issuer
The issuer’s quality is one of the first things you should look into before buying a bond or any other financial instrument. Bond issuers will have varying credit ratings, which means that investing in the securities they’ve made accessible exposes you to credit risk.
Bond issuer credit ratings are provided by two agencies: Moody’s and Standard & Poor’s. The rating scale used by Moody’s spans from C to AAA, with AAA being the highest attainable grade. Standard & Poor’s uses a rating system that ranges from D to AAA, with AAA being the highest possible rating.
Higher ratings indicate that the bond’s issuer is less likely to default. After all, individuals who invest in the security stand to lose if the corporation that issued it fails to meet its obligations.
Corporate Bonds Come With Higher Default Rates
Corporations issue corporate bonds, and each corporation is distinct. Some people make more money than others, some have superior management teams, and some will continuously fulfill their duties while others will fail.
Instruments issued by corporations have a higher default risk than municipal bonds, therefore it’s very crucial to pay attention to how rating agencies grade the bond before you invest.
The good news is that even businesses rarely go bankrupt. Only approximately 0.13 percent of companies that issue bonds default, according to the Corporate Finance Institute.
Tax Implications
You must pay taxes on all income you earn, whether it is from a side hustle, your day job, or investment returns. However, not all forms of income are taxed in the same way. When determining whether to invest in corporate or municipal bonds, consider the following tax effects.
How Corporate Bonds Are Taxed
Corporation-issued bonds are sometimes referred to as taxable bonds since the revenues earned from these investments are subject to both federal and state income taxes at the general income tax rate. Your tax bracket determines the exact rate you’ll pay on your returns.
How Municipal Bonds Are Taxed
Gains from municipal bond investments are always tax-free on the federal level and are frequently tax-free on the state level as well. The tax exemption is effectively a “thank you” from both the federal and local governments for investing in projects that benefit your community with your money.
While munis are immune from state and local taxes in the vast majority of circumstances, this is not always the case. If you buy a municipal bond from a municipality other than the one where you live, for example, your local authorities may choose to tax the bond’s returns at the usual local income tax rate.
For example, if you live in New York City and invest in a municipal bond issued by a government body in Florida, New York City may charge you its standard local tax rate on the investment’s profits.
Yields
Bond yields fluctuate dramatically based on the credit of the issuing institution, the maturity period of the bond, and other considerations.
In general, the following is how corporate and municipal bond yields compare:
Corporate Bonds Generally Have Higher Yields
Local governments are well-respected institutions with a track record of good financial management. Corporations, on the other hand, will have a wide range of financial strength and creditworthiness.
Corporate bonds have higher interest rates than government bonds because companies are typically less creditworthy than governments. After all, if corporate bond yields were the same as government bond yields, no one would lend to riskier businesses. Who wants to buy a corporate bond when you may get the same returns by investing in lower-risk municipal bonds?
Munis Provide Small Gains
Bonds issued by the government have a lower risk of default, making them a safer option for investors. When it comes to investing, however, safer options tend to yield lesser returns, and municipal bonds are no exception.
These bonds’ pricing takes into account the extremely minimal default risk, resulting in lower interest rates, smaller interest payments, and poorer overall returns.
That is, until taxes are included in. A high-income earner, for example, may discover that municipal bonds are a better fit because they are tax-free on both the state and federal level. For an investor in the highest tax bracket, however, much of the profit on corporate bonds would be wiped out by taxes.
Liquidity
Whether investing in bonds or any other asset, investors should constantly consider liquidity. The ease or difficulty of changing an investment back into cash, if desired, is referred to as liquidity.
Bonds with low liquidity will be difficult to convert into cash before their maturity dates, whereas bonds with high liquidity will be easy to dump and change into spendable money on demand.
Corporate Bonds Are Often Less Liquid
While any type of bond can be sold on the secondary market, there must be a buyer for the bond to be sold. Investments in high-risk bonds and other corporate bonds may become illiquid in some situations if no other investors are interested in buying them.
Furthermore, when the economy and markets are doing well, bond liquidity decreases. During bull markets, investors prefer not to have their money invested in fixed-income assets, preferring instead to focus on the higher return potential of equities.
Municipal Bonds Are Highly Liquid
The municipal bond market is quite active, and municipal bonds are often easier to sell than corporate bonds. Because muni bonds are issued by entities that are almost certain to meet their commitments while also delivering tax benefits, they are appealing investments for high-income individuals.
How Funds Are Used
Investors are becoming increasingly worried about how their money is being used. In fact, there’s a whole industry devoted to social impact investing, which is investing in assets that use your money to help causes you care about.
So, when you invest in these two different sorts of bonds, how is your money spent?
How Corporations Use Money Raised Through Bond Sales
Corporations may need to raise capital for a variety of reasons. The following are a few of the most common:
- Working Capital is a term used to describe the amount of money Making money takes money, and maintaining a business can be a costly task. Corporations may need working capital for general purposes if their money is locked up in inventory, new equipment, and other assets required to keep them moving in the correct direction. Companies can issue bonds to raise cash for immediate operational requirements while pledging to repay investors later.
- Acquisitions. Companies frequently merge with one another, resulting in deals in which the total worth of all pieces exceeds the value of the original assets. Acquisitions, on the other hand, are a costly business, and companies frequently require additional capital to complete merger and acquisition deals.
- Research. Almost every publicly traded firm on the market today spends a significant amount of money on research and development. Corporations may issue bonds to fund this research in some instances.
How Municipalities Use Money Raised Through Bond Sales
The vast majority of government-issued bonds are used to fund public-sector initiatives.
When a major thoroughfare is riddled with potholes or your county’s library needs to be repaired, for example, governments frequently issue bonds to cover the costs of these projects. Governments can repay investors either through project revenue or tax revenue generated by the projects they fund.