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Friday, 03/11/2016 10:03:33 PM

Friday, March 11, 2016 10:03:33 PM

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Puerto Rico Bonds Snapped Up by Insurers as Crisis Nears Climax (3/10/16)

National and Ambac boost their holdings of island securities

Insurers use investment portfolios to buy distressed debt

By Michelle Kaske

The companies with the most at stake in Puerto Rico’s debt crisis have become buyers of the island’s bonds.

MBIA Inc.’s National Public Finance Guarantee Corp. and Ambac Financial Group, which together insure about $19 billion of the U.S. territory’s principal and interest against default, have used millions from their investment portfolios to buy Puerto Rico securities they guarantee. Some of the bonds trade for as little as pennies on the dollar because no payments come due until decades from now, when the commonwealth’s current bout of fiscal turmoil will be a distant memory.

“As the bonds are insured by National, we are very familiar with the credit profile of the bonds and the purchase price made it an attractive investment, especially for insured debt,” Chris Young, National’s chief financial officer, said in an e-mail.

The investments reduce the payouts the insurers could face if the island defaults and signal a bet that at least some bondholders will fare better-than-expected when Puerto Rico restructures its $70 billion of debt. Governor Alejandro Garcia Padilla wants owners of tax-backed securities to accept almost $23 billion less than they’re owed, with the prospect of recovering their losses if the island’s economy breaks out of its years-long recession.

It’s not the first time the insurers have bet that prices of bonds they stand behind have fallen too far. During last decade’s housing crisis, MBIA bought residential mortgage-backed securities that it was left covering after a default. The strategy reduced the outflow of claims payments and allowed the company to sell at a profit when prices recovered.

“It’s the normal course of business for them,” said Edwin Groshans, an analyst who tracks the insurers at Height Securities, a Washington-based broker dealer. “They’ve been insuring bonds for decades, so they have a very long track record of what a loss content is in certain scenarios.”

National boosted the amount of Puerto Rico securities it holds in its $4 billion bond portfolio to $585.6 million at the end of 2015 from $1.8 million the year before, according to its annual statement to state regulators on Feb. 29. Ambac, which has $2.6 billion of fixed-income investments, increased its commonwealth holdings to $87.4 million from $1 million a year earlier, the company’s disclosures show. The amounts reflect par value of the bonds once they mature rather than what the companies actually paid.

The jumps largely resulted from purchases of debt repaid with a dedicated share of Puerto Rico’s sales taxes. National spent about $100 million in August scooping up discounted senior sales-tax bonds worth $585 million that don’t begin paying interest or principal until 2040. Ambac in October and December paid about $10 million for $86 million of variable-rate highway bonds maturing in 2027 and 2028 and senior sales-tax debt that defers all payments until 2054.

“As part of our disciplined asset liability management program, we invest strategically and opportunistically in select Ambac insured bonds,” Abbe Goldstein, a spokeswoman for Ambac, said in an e-mail.

Who Loses?

Since the purchases, Puerto Rico has proposed foisting deep losses on owners of the sale-tax-backed securities, known by the Spanish acronym Cofina. Under the restructuring plan released on Feb. 1, those bondholders would recover about 49 percent of what they’re owed, compared with 72 percent on general obligations, which have the first claim on the government’s funds. Officials are working on a revised proposal after bondholders weighed in on the initial offer.

The specter of widespread defaults by the island has taken a toll on the insurers’ shares, causing MBIA to tumble 46 percent in the two years through December, while Ambac lost 43 percent. They’ve since recovered some as Puerto Rico moves closer toward completing a deal with creditors to cut its power company’s debt: MBIA has risen 41 percent this year to $9.14, and Ambac climbing 16 percent to $16.29, as of 10:02 a.m. in New York. Ambac and MBIA’s National insured about $10 billion and $9 billion of Puerto Rico principal and interest payments, respectively, at the end of 2015.

The insurance company’s recent investments have yielded mixed results. Ambac’s senior sales-tax bonds maturing in 2054, which it bought in October for 6.4 cents on the dollar, last traded Monday for 7.8 cents. National’s largest commonwealth bond purchase, acquired for 19.8 cents in August, last traded Feb. 18 at 19.6 cents.

The decisions may still pay off. Along with reducing how much they’d have to cover if Puerto Rico defaults, the companies may receive more than they paid for the securities under a restructuring, according to Groshans, the Height Securities analyst.

“The first benefit is not having to make the insurance payment on that bond,” Groshans said. “The second benefit is if they’re right, then the amount that they’ll recapture via the restructuring proceeding should generate cash for them to make other payments.”

Young, National’s chief financial officer, declined to comment on whether the increase in Puerto Rico holdings was part of a strategy to reduce claims payments.

“It was an attractive investment for our investment portfolio,” he said.

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