Storm of Puerto Rican Bonds Hits U.S Mainland

Over the past few weeks this blog has addressed the storm to hit individual investors who own municipal securities issued by The Commonwealth of Puerto Rico.

First it was major securities houses in August and September ordering tens of thousands of brokers to stop selling these Muni Bonds to clients.

Next, it was revealed that one of those same securities houses, UBS, has reportedly packaged and sold more than $10 billion of highly leveraged Puerto Rican municipal bond funds to individual investors over the past ten years. Furthermore, UBS brokers on Puerto Rico allegedly encouraged clients time and time again to borrow money from UBS in margin accounts and credit lines to buy the bond funds. Remember, large amounts of leverage only magnify losses, particularly when a market whipsaws, which is the case right now with Puerto Rican Muni Bonds.

Suffering under the weight of a struggling economy and staggering pension fund obligations, Puerto Rican bonds have tremendously underperformed the broad municipal market. The S&P Municipal Bond Puerto Rico Index was down 21% year-to-date through October 10. That’s 19 percentage points worse than the S&P Municipal Bond Index, according to Jason Kephart in InvestmentNews.

Now we learn that the storm of Puerto Rican debt has indeed hit the U.S. mainland. And a mutual fund giant, OppenheimerFunds, is at its center, according to Kephart.

And this isn’t the first time in recent memory that OppenheimerFunds has stared into the face of such losses from investments in bonds, which are supposed to preserve investors’ capital, not destroy it.

“OppenheimerFunds’ municipal bond funds have been rocked by big bets on Puerto Rican debt, stirring up memories of its Core Bond Fund’s disastrous 2008,” Kephart wrote last Friday. “The $125 million Oppenheimer Rochester Virginia Municipal Bond Fund (ORVAX) is down more than 15% this year, ranking it dead last among single-state municipal bond funds and second-worst among all municipal bond funds. The average single-state municipal bond fund is down 5.58%.”

Observers were quick to tell Kephart that the losses facing OppenheimerFunds clients would come as a shock to Virginia-based investors in the fund, given that the state isn’t facing any particular head winds.

“’When you start getting bond fund losses in the 10% range, you’d better have a looming catastrophe,’” said one investment adviser. “’Short of a North Korean invasion of Virginia, losing 15% in a Virginia-specific bond fund is probably going to make people very upset.’”

According to Kephart, the main culprit behind the fund’s underperformance has been its big bet on Puerto Rican bonds, which have tremendously underperformed the broad municipal bond market.

And OppenheimerFunds has Puerto Rican Muni Bonds across its fund platform, according to Kephart.

“The Oppenheimer Rochester North Carolina, Arizona, Massachusetts and Maryland funds are the only other single-state municipal bond funds that hold more than 25% of assets in Puerto Rican bonds, according to Morningstar,” he reports. “The median single-state municipal bond fund holds just 2.38% of assets in Puerto Rican bonds. Each of the (OppenheimerFunds) is down more than 11% year-to-date through Oct. 10.”

And this isn’t the first time OppenhiemerFunds’ bond funds have loaded up on risk. In 2008, the Oppenheimer Core Bond Fund (OPIGX) blew up because of its mortgage-related debt and credit default swaps and fell 35% that year. The S&P 500’s decline was 37%. Why didn’t OppenheimerFunds adhere to new risk controls for its bond funds after that disaster?

The Puerto Rican Muni Bond storm has hit the U.S. mainland. It will likely take investors in these OppenheimerFunds years to dig out from the wreckage.

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