A general obligation bond is a form of debt that is issued by municipal governments.
If a government body has tax power, whether it is a city, state, or American territory, then it may be able to issue these type of bonds.
General obligation bonds have long been considered ‘safe’ investments.
However, in 2016, Puerto Rico defaulted on bond payments, calling into question the reliability of these products.
The Difference Between a General Obligation Bond and a Revenue Bond
A general obligation bond is backed up by the full faith and credit of the issuing government.
This is critically important as it gives the issuing municipality the ability to draw from its general fund or to use its tax power to repay bondholders. The issuing government could use property taxes, sales taxes, or even special one-time taxes or fees to generate enough cash to repay its investors.
This distinguishes general obligation bonds from the other most common type of municipal bonds: revenue bonds.
A revenue bond is a form of debt that is backed by a specific funding source.
For example, a revenue bond might be used to raise money for the initial construction costs of a toll bridge.
From there, investors who purchased that revenue bond would be paid back for money generated by the operation of the bridge. If the bridge, for whatever reason, failed to produce sufficient funds to repay investors, then the attached revenue bond would default.
Clearly, general obligation bonds are safer than are revenue bonds. Yet, despite what some investors have been told by their brokers, these products are not entirely without risks. Investors must remember that no investment is ever truly risk free.
Understanding the Puerto Rico General Obligation Bond Default
The Puerto Rican government defaulted on an $800 million general obligation bond payment that was due on July 1st, 2016.
This marked the first time in seven decades that an American state or territory defaulted in this manner. This default came after years of serious economic problems on the island.
In late 2012, Puerto Rico’s financial woes began to hit the front pages of American newspapers after Moody’s downgraded the island’s credit rating. Similar downgrades from other rating agencies soon followed.
When the government missed a payment in July of 2016, it broke its pledge to pay back general obligation bondholders before paying any other party, including police and teachers.
The Puerto Debt Crisis is Far From Over
Puerto Rico is still battling a serious debt problem. On March 14th, 2017, general obligation bond prices took another major hit after a federal oversight board approved the island’s financial recovery plan. As currently constructed, this plan leaves far less in the way of payments for bondholders.
Bloomberg Markets reported that the approval of the financial plan led to an immediate five percent overnight drop in bond prices.
While Puerto Rico owes approximately $3 billion per year in debt payments, this new plan leaves only around $800 million in the island’s budget for debt service. Puerto Rico’s government is now set to try to push down its obligations through negotiations with bondholders. This situation remains in flux, and bond investors may sustain further losses.
Investors in Puerto Rico General Obligation Bonds Have Legal Options
Many investors have been hit particularly hard by the Puerto Rico general obligation bond crisis. Investors were sold false promises of virtually guaranteed safety.
In far too many cases, large brokerage companies encouraged investors, many of whom were simply looking for safe growth, to put all of their eggs in the Puerto Rico bond basket.
Lack of proper diversification has resulted in many investors, often retirees, suffering tremendous losses. Further, some large brokerage companies even encouraged investors to take on leverage when buying bonds. This means that investors dramatically increased their level of risk.
Many investors now have valid legal claims against their brokers and brokerage firms. Indeed, FINRA officials have reported that nearly 2,000 claims related to the Puerto Rico default have already been filed.
Many more claims are still expected. Some large brokerage firms such as UBS were heavily involved in this market. If you lost money investing in UBS Puerto Rico bonds, or with any other firm on the island, please take immediate action.
Talk to a Securities Fraud Attorney Today
At the Sonn Law Group, our attorneys have extensive experience representing investors wronged in the Puerto Rico bond default crisis. To learn more about what we can do for you, please call our team today at 844-689-5754 to request your free initial case evaluation. We represent investors in Florida, Puerto Rico and throughout the United States.