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Estimating the Probability of Default & Risk to Investors in UBS Puerto Rico Funds

Posted: Nov 12, 2013 | Posted in:

UBS Puerto Rico funds currently hold an estimated $10 billion in Puerto Rican debt.  Puerto Rico has issued an estimated $70 billion in bonds in recent years, and $2.8 billion dollars will be due within the next year.  This is bad news for bond investors, and for the bond market as a whole, as it is unclear where Puerto Rico will be getting the money to pay its outstanding debts.

Amidst a market where investors have pulled $6.5 billion from municipal bond funds in September, there is great concern that Puerto Rico’s credit rating will be downgraded and that further losses will occur.  Many financial experts are taking a close look at the risk to investors and the financial market as a whole.  As a result, experts have estimated the probability that Puerto Rico will default on its debt.

Probability of Default on UBS Puerto Rico Funds

The Standard & Poor Puerto Rico bond funds index has declined 21 percent this year, and it is likely to fall further in light of recent estimates indicating the likelihood of default on Puerto Rican debt.

The MuniNet Guide, CMA (a unit of Standard & Poor) estimated Puerto Rico’s probability of default at greater than 77 percent.  S&P has also expressed little faith that Puerto Rico will be able to generate the cash to pay for its outstanding liabilities.  S&P recently affirmed that Puerto Rico has a BBB-minus rating or “low investment grade” status.

S&P and its units are not the only organizations projecting default for Puerto Rico.  Capital Markets Research, an analytical unit of Moody’s, also indicated that there is a high probability that Puerto Rico would default.  According to Capital Markets Research (CMA), the five-year cumulative CDS-implied expected default frequency credit measure rose to 15.65.  The one-year expected default frequency is 3.05.

Based on the projected expected default frequency, Puerto Rico was rated Caa2 on the Moody’s Investors Service rating scale based on its five-year projected default, and rated Caa3 based on its one-year expected default frequency.   Bonds rated Caa3 are of poor standing and carry a very high credit risk.  Bonds rated Caa2 are also high risk, but slightly less risky than those rated Caa3.

With Puerto Rico bonds garnering low ratings from both major ratings agencies and with such a high probability of default, investors in UBS Puerto Rico funds have great reason for concern.  When credit agencies rate Puerto Rico bonds at below-investment grade, this rating can become a self-fulfilling prophecy because commercial banks will be less able to provide short-term liquidity to Puerto Rico and because there will be higher collateral requirements for Puerto Rico’s interest rate swaps.

Unfortunately for many investors, if Puerto Rico does default, they will lose significant amounts of money that they had invested in funds they thought were safe.  Investors in UBS Puerto Rico funds may wish to take legal action against their investment advisors to try to recover their investment capital if they were misled about the risk level of the funds.