Puerto Rico Debt Restructuring Law Highlights Guarantor Exposure

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Financial guarantors that insure $15 billion of Puerto Rico bonds have taken a drubbing in the stock market as the island's debt restructuring law triggered a series of credit downgrades.

MBIA Inc., the parent of National Public Finance Guarantee, plunged 18% from June 26 through the close of trading Tuesday, while Assured Guarantee Ltd. dropped 9.3% and Ambac Financial Group Inc. slid 12%. However, in Wednesday's trading session, while MBIA stock prices declined further — 0.9% — Assured and Ambac shares climbed 1.3% and 0.2% respectively.

The law allows public corporations such as the Puerto Rico Aqueduct and Sewer Authority, the Puerto Rico Electric Power Authority and the Puerto Rico Highway and Transportation Authority to negotiate debt terms with bondholders or to restructure the debt with the approval of the local court.

Moody's Investors Service this month downgraded PREPA bonds to Caa2 from Ba3. Commonwealth of Puerto Rico general obligation bonds were pushed down four notches to B2 from Ba2, the commonwealth's COFINA sales tax senior bond rating was cut to Ba3 from Baa1, and the Puerto Rico Aqueduct and Sewer Authority was knocked to Caa1 from Ba3. Standard & Poor's on Wednesday cut PREPA to B-minus, from BB.

"The issue of the willingness to pay has now been raised," said analyst Mark Palmer, managing director of BTIG. "While we would point out that GOs and COFINA debt is constitutionally protected, the downgrades still could have an impact on the bond insurers. They need to set aside capital in amounts relative to the ratings of bonds they insure while that is typically based on the insurers' internal ratings, the external ratings come into play on those determinations."

Triet Nguyen, managing partner at Axios Advisors LLC said the COFINA downgrade "shocked a lot of people. Should the other rating agencies follow suit, they may be forced to raise capital or their reserves against it."

Both Assured and MBIA's National Public Finance Guarantee have recently hired restructuring advisors, Reuters reported. MBIA has hired a professional from the Blackstone Group, while Assured is working with Houlihan Lokey, an investment bank.

"All of the insurers have to bring their own advisor to the court to present their own theory of how to restructure the debt so that they are hurt the least," said Jonathon Carmel, portfolio manager at Carmel Asset Management.

Palmer said that unlike MBIA and Ambac, Assured has the ability to buy back its stock, which would be a buffer against any impact from the recovery act.

"The stocks may come under some mild amount of pressure when these things get sorted out, but they are not a threat to the companies in any shape or form," Carmel said. “MBIA is worse off than [Assured], but in either case it isn’t life-threatening.”

Officials at the insurance companies said they are optimistic that the U.S. territory will devise a solution to counteract the potential default. The companies had wrapped $15 billion of total net par of Puerto Rico debt as of March 31, including $7.5 billion in public corporation debt subject to the new law.

"We believe that the commonwealth of Puerto Rico and its public corporations recognize the importance of finding solutions that improve their financial stability, balance their budgets and honor their obligations to creditors, and we are willing to work cooperatively with the commonwealth and its public corporations to support that effort," said Robert Tucker, managing director at Assured.

Assured insures the most Puerto Rico debt with $5.34 billion in net par outstanding. Of this amount, $2.6 billion is subject to the terms of the act, including $852 million of PREPA bonds and $384 million of PRASA bonds. With approximately 10,000 direct U.S. public finance obligors, Assured insures 10 different Puerto Rico issuers.

"Puerto Rico's net par exposure of $5.3 billion represents about 1% of total $449.6 billion in net par insured," Tucker said. "Our total par under the act is spread across four different issuers, each of which has their own revenue streams. Further, our obligation is limited to paying scheduled debt service as it comes due, and we have maturities that extend out as far as 2047."

Assured is confident that it has a strong capital position and can handle Puerto Rico's debt distress if a default should occur. The insurer has $12 billion in claims-paying resources and generates $400 million each year from its investment portfolio alone. Earlier this month, Standard & Poor's stated that Assured's capital adequacy cushion — the amount of capital remaining at the end of their depression test — was $1.45-1.55 billion at the end of 2013, up from $450-$550 million in 2012.

"Investors in commonwealth-related bonds insured by Assured Guaranty are protected by our unconditional guaranty that ensures payment of their principal and interest on time and in full in accordance with the terms of Assured Guaranty's insurance policies," Tucker said. "Further, investors are clearly seeing the additional benefits of our insurance through the greater price stability of our insured Puerto Rico bonds relative to uninsured bonds."

MBIA has a total of $4.83 billion of Puerto Rico debt, the second biggest exposure among the bond insurers. About $2.5 billion of this exposure is subject to the terms of the act. The amount includes $1.53 billion of PREPA bonds.

"In the event that Puerto Rico or any of its public corporations pursue a debt restructuring, National will ensure that its policyholders receive all of their principal and interest payments on time and in full," Kevin Brown, managing director of MBIA said.

"Assured has $1.5 billion of capital cushion at the current rating level," said Marc Cohen, an analyst at Standard & Poor's, which earlier this year upgraded Assured to AA from AA-minus and boosted NPFG to AA-minus from A. "National has between $400 to $500 million of capital cushion. They can sustain significant losses and continue to maintain the current rating."

Ambac Assurance Corp. also has $2.5 billion of net par value of outstanding exposure to Puerto Rico debt, according to data from company filings. About $897 million is affected by the new act. Ambac does not insure PREPA bonds.

Financial Guarantee Insurance Corp. holds $1.48 billion of net par exposure to Puerto Rico debt with only $569.6 million subject to the new act, while Syncora Guarantee has the least at stake with a total of $521 million of net par exposure and $219 million of PREPA bonds.

Ambac, FGIC and Syncora declined to comment regarding the individual credit and exposure, citing company policies.

The new legislation has some market participants questioning whether the recovery act is constitutional or simply a bankruptcy law.

"Puerto Rico will try to put PREPA and other public corporations into bankruptcy," Palmer said. "If that occurs the situation will come down to the leverage that the bond insurers have in this situation including the prospects of the public corporations losing access to capital market going forward if they decided to be too punitive in the restructuring proposal. Any approval of restructuring would require 50% of bondholders to vote and 75% approval."

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