July 23, 2015 / 11:36 PM / 2 years ago

Exclusive: UBS backs away from its Puerto Rico funds after downgrades

(Reuters) - UBS AG is backing away from its own Puerto Rico bond funds, warning clients that they can no longer use them as collateral for certain loans after the island’s financial troubles resulted in downgrades by major credit rating agencies.

The waning moon is seen behind a logo of Swiss bank UBS in Zurich February 10, 2015. REUTERS/Arnd Wiegmann

In a July 13 letter to clients, reviewed by Reuters, UBS’ Puerto Rico arm said it would contact investors to discuss alternatives.

“The firm will also reduce to zero the collateral value assigned to all Puerto Rico closed-end funds shares,” UBS wrote to investors.

Puerto Rico’s Governor Alejandro Garcia Padilla dropped a bombshell on holders of its $72 billion debt in June saying that he wants to restructure debt and postpone bond payments. The fiscal problems have investors and credit rating agencies fearful the island will default on payments and not reach an agreement with creditors by an Aug. 30 deadline.

The UBS funds, many of which were stuffed with UBS underwritten Puerto Rico debt, have been a source of ongoing legal headaches for the firm.

Reuters reported last June that the FBI was investigating allegations about UBS’ sales practices that touted the funds’ high yields and tax advantages.

A UBS spokesman declined to comment on the letter or the funds. Some funds with AAA-rated debt are exempt from the policy, UBS said in the letter.

The funds are not traded on exchanges and UBS sets their value.

It is unclear why UBS declared the value of the funds’ shares at zero for collateral purposes, but still lists share prices on its website. For example, one of the riskiest funds was worth $3.46 per share as of Thursday, according to UBS.

UBS’ unwillingness to accept the funds as collateral reveals how risky the firm believes they are, said Craig McCann, an economist in Fairfax, Virginia, who is testifying on behalf of investors in arbitrations against UBS.

UBS clients now face potential liquidation of their assets with UBS and even legal actions against them if they fail to produce more collateral to replace the funds, said Jeffrey Sonn, a lawyer in Fort Lauderdale, Florida, who represents some of the investors.

    That would exacerbate problems for investors who have already taken heavy losses on the Puerto Rico funds, Sonn said.

UBS has offered programs for buying back fund shares, but investors’ lawyers say another program is now unlikely. 

But while this latest move by UBS is likely to cause problems for many investors in the short term, it could substantially boost the hundreds of investor arbitration claims against UBS over the funds, said Lisa Bragança, a lawyer for Stoltmann Law Offices in Chicago representing some of the investors.

“This is a real pickle for UBS to say the collateral value assigned to the closed-end fund shares is zero,” Bragança said.

By doing so, UBS is effectively admitting that it sold a bad product and that the funds are too risky for the firm itself, let alone average investors, lawyers said.

Many UBS brokers had misgivings about the funds even as UBS’ Puerto Rico chairman was pushing them to sell the bonds, according to a voice recording, reported by Reuters in February.

Many of those investors bought even more fund shares with money they borrowed through credit lines from another UBS unit, after several UBS brokers may have improperly advised them to do so, according to a $5.2 million settlement between UBS and Puerto Rico’s financial regulator in 2014.

Reporting by Suzanne Barlyn; Additional reporting by Megan Davies; Editing by Charles Levinson and Lisa Shumaker

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