Jeffrey Wade
Puerto Rico's bonds have been rated below investment-grade since 2014, indicating a high level of distress or default risk. This has resulted in a shift in ownership from traditional municipal bond investors to those seeking riskier investments. UBS Puerto Rico has been at the centre of a bond fraud lawsuit, where they encouraged investors to over-concentrate in high-risk, illiquid, closed-end municipal bonds without disclosing the risks. UBS clients lost their life savings, and the funds that suffered the largest losses were concentrated in the bonds of two issuers: the Employees Retirement System of the Government of the Commonwealth of Puerto Rico and the Puerto Rico Sales Tax Financial Corp. Insured Puerto Rico bonds are held in various Vanguard funds, and investors in insured bonds have received uninterrupted payments, even in the case of default.
| Characteristics | Values |
|---|---|
| Insurers | Assured Guaranty Municipal Corp. (AGM), Assured Guaranty Inc. (AG), National Public Finance Guarantee Corp (MBIA), AMBAC, Fannie Mae, Freddie Mac, Ginnie Mae |
| Insured Bonds Worth | Slightly more than uninsured bonds |
| Uninsured Bonds | FGIC |
| Uninsured Bonds Market Value | Drops significantly |
| Insured Bonds Market Value | Virtually unchanged |
| Insured Bonds Yield | 30 basis points (0.30%) less per year |
| Uninsured Bonds Yield | 30 basis points (0.30%) more per year |
| Litigation | UBS Puerto Rico Bond Fraud |
| Risk | High |
| Bond Rating | CC, D, and Caa3 |
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What You'll Learn
Insured vs. uninsured Puerto Rico bonds
Puerto Rico's economy has been facing severe challenges, which have impacted investors holding government bonds. The territory began to default on some of its bond commitments in 2015, and bankruptcy was declared in 2017.
There is a notable difference between insured and uninsured Puerto Rico bond values. Insured bonds are worth slightly more than uninsured bonds, and investors in insured bonds have not suffered any losses. The market value of uninsured bonds has dropped significantly, while the value of insured bonds has remained stable. Insured bonds are less risky, and investors require lower yields on these bonds. The difference in yields between insured and uninsured bonds is about 30 basis points (0.30%).
The UBS Puerto Rico Closed End Funds were concentrated in the riskiest subset of Puerto Rico municipal bonds – uninsured bonds with little or no market outside of UBS funds. These funds suffered losses in direct proportion to the amount of uninsured Puerto Rico bonds held.
Municipal bond insurance provides protection for the bond purchaser against risks from the issuer. However, there have been questions about whether insurers can invalidate policies in certain circumstances, such as bankruptcy. Assured Guaranty, a bond insurance provider, has protected investors from Puerto Rico defaults, making claim payments to holders of certain Puerto Rico Electric Power Authority (PREPA) bonds.
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UBS Puerto Rico bond fraud lawsuit
UBS Puerto Rico has been accused of selling risky bonds to investors and retirees, leading to significant financial losses. UBS has faced a lawsuit alleging that they encouraged investors to purchase high-risk, illiquid, closed-end municipal bonds without disclosing the risks. UBS has settled with the SEC for $26 million in disgorgement and fines without admitting fault. However, a judge ruled that the SEC failed to prove fraud by two high-ranking UBS PR executives. UBS has also faced criminal probes by US authorities for directing clients to borrow money to buy mutual funds that later plummeted in value. UBS's actions caused investors to lose billions in UBS Puerto Rico municipal bond funds. UBS Puerto Rico bond funds under investigation include the Tax-Free Puerto Rico Fund, Puerto Rico AAA Portfolio Target Maturity Fund, and the Puerto Rico GNMA & US Government Target Maturity Fund.
In 2025, UBS faced an appeal in a Puerto Rico Bond Lawsuit dismissal, filed by Vanessa Santini Hernández and Lourdes González Gutiérrez. The plaintiffs accused UBS of violating their conservative risk preferences and engaging in a "scheme" to sell them risky bonds and securities. The complaint alleged that UBS advisors explicitly recommended the purchase of closed-end funds and bonds and that UBS sought to boost its profits by selling these risky products. UBS's actions resulted in investors losing large portions of their savings and retirement funds. The case was initially dismissed by a Puerto Rico superior court, citing the lack of detail in the complaint and the time lapse since the alleged wrongdoing. However, the plaintiffs sought to overturn the dismissal and hold UBS accountable for their losses.
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Puerto Rico's bond ratings
Puerto Rico's bonds have been insured by companies such as Assured Guaranty Municipal Corp. (AGM), Assured Guaranty Inc. (AG), National Public Finance Guarantee Corp (MBIA), AMBAC, Fannie Mae, and Freddie Mac. Insured bonds are less risky and have a lower yield than uninsured bonds. UBS Puerto Rico closed-end funds have suffered losses in direct proportion to the amount of uninsured Puerto Rico bonds held in portfolios.
In 2021, Moody's withdrew its Puerto Rico ratings, affecting various entities, including the Puerto Rico Public Buildings Authority, the Puerto Rico Aqueduct & Sewer Authority, and the Puerto Rico Electric Power Authority. At the time of the withdrawal, Puerto Rico's general obligation rating was Ca with a negative outlook.
S&P Global Ratings also discontinued its Puerto Rico ratings in 2018 after lowering them to D in 2016 following the island's first default on its general obligation bonds. Similarly, Fitch Ratings downgraded Puerto Rico's long-term issuer default rating and general obligation bond rating in 2016.
Despite the withdrawals and downgrades, investors owning Puerto Rico-related bonds insured by companies like Assured Guaranty continue to receive uninterrupted full and timely payments. Assured Guaranty has made claim payments to holders of certain Puerto Rico Electric Power Authority (PREPA) bonds and Custodial Trust Units related to AGM- and AG-insured Puerto Rico Highways and Transportation Authority (HTA) policies.
Overall, while there have been concerns about Puerto Rico's creditworthiness and the performance of its bonds, insured bonds have provided a level of protection for investors, shielding them from default risks and ensuring timely payments.
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Assured Guaranty's role
Assured Guaranty Municipal Corp. (AGM) and Assured Guaranty Inc. (AG) are two bond insurance subsidiaries of Assured Guaranty Ltd. (together with its subsidiaries, Assured Guaranty). In July 2024, these subsidiaries made claim payments to holders of certain Puerto Rico Electric Power Authority (PREPA) bonds which defaulted. AGM and AG also made claim payments on Custodial Trust Units related to AGM- and AG-insured Puerto Rico Highways and Transportation Authority (HTA) policies.
In the event of a claim, the relevant bond trustee, paying agent, or custodian files a claim with Assured Guaranty on behalf of the bondholders. Assured Guaranty then makes the claim payment directly to that party, which distributes the funds to investor accounts. Assured Guaranty's standard municipal bond insurance policy stipulates that the company will make the claim payment no later than one business day after receiving the claim, but not before the payment due date.
Assured Guaranty has had a significant presence in Puerto Rico's bond market. In March 2022, its subsidiaries settled their exposure to various Puerto Rico bonds, including the Puerto Rico General Obligation (GO) and Puerto Rico Infrastructure Financing Authority (PRIFA) bonds. The subsidiaries received plan considerations under the Commonwealth Plan of Adjustment and other agreements.
In December 2022, Assured Guaranty's subsidiaries also resolved their exposure to the HTA bonds they had insured. As part of the HTA Plan of Adjustment, the subsidiaries received cash and new bonds backed by toll revenues. These actions by Assured Guaranty have helped protect investors and reduce their exposure to potential financial losses in the Puerto Rico bond market.
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Risks and uncertainties
Investing in Puerto Rico municipal bonds carries several risks and uncertainties. Firstly, there is a possibility of significant changes in inflation, interest rates, credit markets, credit spreads, foreign exchange rates, or general economic conditions, including potential recessions. These macroeconomic factors can directly impact the performance and safety of Puerto Rico bonds.
Secondly, investors face the risk of insured losses exceeding the expectations of the insurance provider, Assured Guaranty, or the failure of Assured Guaranty to realize loss recoveries assumed in its expected loss estimates. This could be influenced by the resolution of Puerto Rico's economic situation and the recovery of securities received in connection with previous resolutions.
Additionally, there is a chance of budget or pension shortfalls, credit losses, or impairments on obligations of state, territorial, or local governments, which could further impact the safety of the bonds. The ability of creditors and the Commonwealth to implement a consensual restructuring also plays a role in mitigating these risks.
The investment landscape in Puerto Rico is further complicated by litigation and potential future legal actions. For example, there have been lawsuits against UBS Puerto Rico alleging fraud and inappropriate recommendations of high-risk investments to clients. These legal proceedings can impact the overall stability and safety of investments in Puerto Rico bonds.
Moreover, investors should be cautious about the potential for adverse developments in Puerto Rico or its instrumentalities, as well as governmental or legislative actions or inactions by Puerto Rico or the United States. These factors can introduce uncertainty and impact the value and safety of the bonds.
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Frequently asked questions
Insured bonds are held by those seeking less risky investments, while uninsured bonds are held by those seeking riskier investments. Insured bonds are worth slightly more than uninsured bonds, and investors receive about 30 basis points less per year for investing in insured bonds.
Insured Puerto Rico bonds are considered safer than uninsured bonds, but they are not risk-free. Investors in insured bonds have still suffered losses due to factors such as inflation, interest rates, and economic conditions.
There are several risks and uncertainties associated with insured Puerto Rico bonds, including changes in inflation, interest rates, economic conditions, and litigation. Additionally, there is a possibility of the bond issuer filing for bankruptcy, which can impact the insurer's ability to enforce payment.
In such a scenario, the insurance policy is expected to pay the bond purchaser. The insurance company would then likely sue the issuer to recover the money. However, there have been concerns about the potential for the insurance policy to be invalidated.
