Since at least 2012, when the three major rating agencies began downgrading Puerto Rico bonds, it’s been clear that Puerto Rico’s economy and bondholders were in serious trouble.
If you are an investor in Puerto Rico bonds or closed-end bond funds, buckle up. It appears that the finish is very near, with the island commonwealth perhaps months or even mere weeks away from its economy coming to a screeching halt.
A report last week from Reuters spelled out that Puerto Rico is heading towards its economic finale. “Puerto Rico’s top finance officials said the government of the U.S. Territory will most likely shut down in three months because of a looming liquidity crisis, and they warned of a devastating impact on the island’s economy,” according to Reuters.
The report warned that the government has an “absence of liquidity to operate” and that additional financing to support government operations is “currently remote.”
In other words, Puerto Rico is running out of cash.
Unlike virtually any other municipality, Puerto Rico is largely reliant on hedge funds for its financing needs, according to Reuters. The hedge funds, like other loan sharks, are looking for additional vigorish or vig from the government in the form of tax reforms. This could be in the form of tax hikes on residents or mass lay-offs of government workers as a condition for providing extra financing.
Meanwhile, Standard & Poor’s downgraded a swath of Puerto Rico bonds late Friday and reiterated that ratings cut again on Monday morning, according to a report on CNBC.com. This is a serious indicator of Puerto Rico’s potential for default.
S&P said that, absent improvements in the economic and business conditions in Puerto Rico, its analysts believe that “debt and other financial commitments will be unsustainable,” according to the CNBC.com report. The downgrade to a rating of CCC+ means that S&P believes Puerto Rico has the same abilities to pay its loans as Greece.
As this blog has previously noted, at least 1,000 cases have been filed by investment fraud lawyers on behalf of customers who bought Puerto Rico bonds and closed-end funds through UBS and other banks. The cases focus largely on the over concentration (having all of your eggs in one basket) and the lack of liquidity of Puerto Rico bond funds.
In fact, The New York Times recently underscored a Federal Reserve report that “suggests that individual investors may have gotten the misleading impression” that bond mutual funds “trade more readily than the bond market themselves.”
These bond funds now “hold a much higher fraction of the available stock of relatively less liquid assets – such as high yield corporate debt, bank loans and international debt – than they did before the financial crisis,” according to the Fed report, which was cited by columnist Diana B. Henriques.
And as such bond funds expand, they may pose a looming threat: “Their growth heightens the potential for a forced sale in the underlying markets if some event were to trigger large volumes of redemptions.”
Translated, that means the value of investors’ bond fund holdings could crumble if an unexpected event caused a large group of investors to sell all of their bond fund holdings at once.
While the collapse of the Puerto Rico economy would be devastating for the island, much of that pain will be borne by the retail bond and bond fund holders. Many of those Puerto Rico bonds are held in closed-end funds issued and marketed by UBS and sold by their financial advisors. Mom and Pop investors in those funds have been watching the approach of Puerto Rico’s fiscal day of reckoning for the last three years. Buckle up.
Zamansky LLC are securities and investment fraud attorneys representing investors in federal and state litigation against financial institutions. For more information about Zamansky LLC, please visit http://www.ubspuertoricofunds.com/.