Wednesday, January 15, 2014

Puerto Rico seen as likely to default on its debt ! With the Treasury Department on record as saying there would not be a US bailout for Puerto Rico , bond insurers MBIA , Assured , Ambac , Syncora and Financial Guarantee Insurance Co appear exposed at this time due to the amount of debt they've wrapped ( 15.7 out of the 70 billion in Puerto Rico debt .. )

Puerto Rico Default "Likely", FT Reports

Tyler Durden's picture

The market just hit a fresh all time high today which means another major default must be just around the horizon. Sure enough, the FT reported moments ago that a Puerto Rico default "appears increasingly likely" and is why creditors are meeting with lawyers and bankruptcy specialists (supposedly Jone Day, which means where Corinne Ball is Ken Buckfire, fresh from its recent league table success with the Detroit bankruptcy, can't be far behind) on Thursday in New York.  The FT cited a restructuring advisor, supposedly desperate to sign the engagement letter with creditors and to force the bankruptcy, who said that "the numbers are untenable" and "to issue new debt the yield would have to rise and where they can’t raise new money they will have to stop paying."
The untenability of PR's cash flows results from a "debt service burden that requires paying between $3.4bn and $3.8bn each year for the next four years. As doubts grow about the ability of the commonwealth to service that debt, the cost of doing so will inevitably rise."
For Puerto Rico bonds, such an outcome would not be exactly a surprise, most recently trading at 61:
The rest of the story is largely known:
If Puerto Rico is forced to take that step, the effects will ripple through the entire $4tn municipal bond market. Because the debt is generally triple tax free, in a world of zero interest rates demand is high and it is distributed widely, including in funds that imply they have no exposure to Puerto Rico.

But yields have gone up nevertheless – and prices down – suggesting the markets are increasingly nervous about prospects for repayment. Estimates on how much of that debt is insured range from 25 per cent to 50 per cent of total issuance.

“Everyone thinks they can get out in time,” the restructuring adviser said.

Puerto Rico cannot really raise taxes much more, since the debt per capita is more than $14,000, while income per capita is almost $17,000, a ratio – at 83 per cent – that makes California, Illinois or New York – each at 6 per cent – models of prudence. Meanwhile, at 14 per cent, the unemployment rate is twice the national average.
What would make a Puerto Rico default more interesting is that as in the case of GM, political infighting would promptly take precedence over superpriority and waterfall payments. According to the FT, "any radical step, which the local government denies considering, would involve significant legal wrangling. Congress could step in and create an insolvency regime, lawyers say, since it has comprehensive jurisdiction, but that too would give rise to partisan fighting. The Democrats would say that pension claims have priority while the Republicans would uphold the priority of payments to bondholders, citing the constitutional sanctity of contracts."
Of course, since in the US a bond contract now is only worth the number of offsetting votes it would cost, nobody really knows what will happen. And so, we sit back and watch, as yet another muni quake appears set to hit the US, in the process obviously sending the S&P to higher, record highs.
In the meantime, keep an eye on bond insurers AGO and MBI which have taken on water in today's session precisely due to concerns over what a Puerto Rico default would do to their equity.

Truth or Lies ? From October of 2013 ....

Treasury: No Bailout Plans for Puerto Rico

The U.S. Treasury Department isn’t planning to provide assistance to Puerto Rico and continues to monitor the situation after the commonwealth’s bond yields rose to records, according to a Treasury spokeswoman who spoke on condition of anonymity.

Governor Alejandro Garcia Padilla, 42, is struggling to revive a shrinking economy and keep Puerto Rico’s debt above junk. The U.S. territory, whose bonds are tax-exempt nationwide, must borrow by Dec. 31 to balance its budget. Officials plan to use debt backed by sales-tax revenue, as the securities are rated three to four levels above the island’s general obligations.
Even the sales-tax securities, which Moody’s Investors Service cut on Oct. 3, trade with historically high yields.

“Forced selling in local island bond markets has added stress to overall trading,” Alan Schankel, managing director at Janney Montgomery Scott LLC in Philadelphia, said in a research note Oct. 4. “Volatility and price pressures remain ongoing for Puerto Rico bonds.”

Puerto Rican bonds have fallen 18 percent in 2013, including price change and interest payments, on pace for their worst year since at least 2000, according to Standard & Poor’s data. Commonwealth general-obligation bonds maturing in July 2041 traded today with a yield as high as 9.2 percent after reaching 10.06 percent on Oct. 4, the most since Sept. 9, according to data compiled by Bloomberg.

Senate President Eduardo Bhatia told municipal-bond analysts in New York yesterday that the White House and Treasury are “wondering how they can help Puerto Rico send a very strong signal of stability right now,” according to the New York Times.
The senator’s office in San Juan didn’t respond to telephoned and e-mailed requests for comment today.

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."