Optimistic Insurers on Hook for $16 Billion in Puerto Rico

Bond insurers including Assured Guaranty and MBIA Inc. are on the hook for almost $16 billion of Puerto Rico debt as a new administration there aims to curb speculation that the U.S. territory could go the way of Detroit.

Total net par outstanding exposure to Puerto Rico bonds by Assured, MBIA's National Public Finance Guarantee, Ambac Assurance Corp., Syncora Guarantee and Financial Guarantee Insurance Corp was $15.7 billion by June 30, according to an analysis by the Bond Buyer. The financial guarantors have wrapped a wide spectrum of Puerto Rico debt, from commonwealth general obligations to below investment-grade aqueduct and sewer bonds.

"Puerto Rico is one of the major systemic risks they're facing," said Triet Nguyen, managing partner of Axios Advisors LLC. "If it does come down to substantial default, then bond insurance will get hit the same way they're going to get hit on Detroit. The key is going to be the Puerto Rico economy, at the end of the day, it drives everything else."

Puerto Rico Governor Alejandro Garcia Padilla, charged with the task of reigning in the territory's persistent deficit and reviving a flailing economy to avoid additional credit downgrades, has assuaged some concerns by passing pension reform and an improved 2014 budget since taking office in January. Continued economic faltering could strain entrenched financial guarantors, analysts said.

"The impact on bond insurers with any further downgrades on these exposures is that it causes more consumption of capital in our analysis," James Eck, senior credit officer at Moody Investors Service, said in an interview. "Insurers need to hold more capital to cover the increased probability of default of speculative grade credits."

Moody's Investors Service cut its rating on Puerto Rico's GO bonds to Baa3 from Baa1 in December 2012. Standard & Poor's Ratings Services and Fitch Ratings Group cut their credit ratings on the debt to BBB-minus from BBB, and to BBB-minus from BBB-plus, respectively. The ratings are one notch above speculative, or junk, grade.

Assured Guaranty has the most at stake in Puerto Rico's recovery, with $5.70 billion in net par outstanding. With $2.17 billion of commonwealth GOs, Puerto Rico represents the eighth biggest U.S. exposure in the bond insurer's portfolio. Among the company's fifty largest U.S. public finance exposures, most of which carry at least single-A ratings, Puerto Rico's BBB-minus GOs are the worst-rated credit.

"The adoption of a substantive pension reform plan demonstrates that officials of the commonwealth are focused on making the necessary choices in helping Puerto Rico maintain its critical access to the capital market," Robert Tucker, managing director of corporate communications at Assured, said in an email.

Assured will only take on Puerto Rico exposure in order to facilitate a refunding of existing debt, to reduce overall exposure over time, Assured said. The company had $12.1 billion in claims-paying resources as of a June 30 quarterly report.

The top insurer's $384 million of BB-plus rated aqueduct and sewer authority bonds make up the company's third-largest below investment grade U.S. public finance exposure. The authority's poor performance has been driven by uncollected income from a majority of processed water, according to an April report by Janney Capital Markets. In July, the authority broke from a historical reluctance to raise charges by increasing water and sewer rates by 60%.

"Low-hanging fruit like leakage in utilities and tax collections are really a large part of Puerto Rico's problem," Nguyen said. "If they close some of those loops, that will help."

MBIA's National Public Finance Guarantee has wrapped $5.19 billion of Puerto Rico debt, the second-biggest exposure among bond insurers. The amount includes $1.15 billion of commonwealth GOs, as well as $1.56 billion of BBB-plus rated Electric Power Authority bonds, which represent the company's seventh-biggest U.S. credit.

National is the only insurer holding Puerto Rico Government Development Bank debt, with $234 million of the BBB-minus rated bonds. The GDB acts as the commonwealth's fiscal operator and advisor, approving bond issues and developing the island's financial strategies.

"All of our exposure is performing satisfactorily," Kevin Brown, spokesman for National, said in an email. "We have been closely monitoring Puerto Rico's financial condition and have observed a number of positive developments under Governor Padilla, including landmark pension reform in April, a budget with new revenue producing reforms and reduced reliance on deficit financing."

Ambac has a total of $2.53 billion of net par value of outstanding exposure to Puerto Rico debt, according to data from company filings. The biggest part of that, $805 million, is in Puerto Rico Sales Tax Financing Corporation. COFINA sales tax-backed bonds are some of the territory's highest-rated debt, with AA-minus scores from Fitch and S&P.

"Separating out the commonwealth's GO bonds from its bonds that are backed by discrete revenue sources is important," Mark Palmer, an analyst at BTIG Research, said in an interview. "We've seen with Detroit and elsewhere that that is a distinction to make. When discrete revenue goes into a trouble, the downside isn't as big."

Syncora and FGIC together are exposed to a total of $2.29 billion of Puerto Rico debt, mostly comprised of commonwealth GOs. FGIC is also exposed to $483 million of highway revenue bonds and $360 million of infrastructure bonds.

"A lot of these exposures were built up over the years, and it's always been a big part of the business model to have very high operational leverage," Eck at Moody's said. "The view has been that the probability of default is low, and when the credits do default, the recovery is fairly high. Some of the more recent high-profile defaults may punch a hole in that view."

Eck said that while improvements had been made since the onset of Gov. Padilla's administration, uncertainty about the economy and the size of the exposures relative to capital means Moody's is keeping close tabs on the situation. Eck and BTIG's Palmer said that distant maturity dates could also provide cushion to insurers in the event of a crisis, enabling claims to be paid over a long period of time so as to retain liquidity.

"Given the sheer amount of Puerto Rico debt that the bond insurers have wrapped, it makes sense for it to be near the top of their risk management focus list," BTIG's Palmer said. "Speculators who may be shorting the shares based on a negative outcome may be barking the up wrong tree, though."




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