persistentone3 Posted June 30, 2015 Share Posted June 30, 2015 I want to start a discussion around whether any of the muni bond insurers might become a good investment after Puerto Rico defaults. The two largest exposures are to MBI and AGO. My first look at MBI suggests there is no margin of safety. There is a high probability that its regulator will forbid payments to cover interest on the PR bonds, and there is a real Chapter 11 risk. I want to review AGO superficially and I can turn that into a post in Investment Ideas once I get better facts. AGO looks more interesting than MBI. The following table shows AGO's par value coverage of PR debt: http://static.cdn-seekingalpha.com/uploads/2015/6/1096303_14346538539628_8_thumb.jpg Some questions to address: 1) How much of par value will the bonds lose? Even if we assume that there will be a 70% wipeout of par value on all of these bonds, that still isn't enough to wipe out AGO's equity. Note that I didn't make reference here to any special negotiated terms that AGO may have on specific bonds that would limit their losses. For example, is AGO only covering losses after the first X% are taken directly by investors? Or does AGO have reinsurance on some of the bonds that would establish a maximum cap on losses? If I had to guess, I would say that the actual workout will be better than a 70% of par loss on the government bonds, particularly since Puerto Rico has authority to raise taxes and recently passed a higher sales tax. It's worth noting however that I track at least one PR government bond that is trading at 40% of par, and this is before the default. So apparently there is a risk for a large wipeout. The PREPA utility bonds are much more problematic. The utility for Puerto Rico needs billions to improve its infrastructure, and the worst part is their main customer - the Puerto Rican government - never pays them. I think a huge wipeout on these bonds should be factored in as more likely than not. 2) How much is the present value of the interest payments on the bonds that AGO needs to insure? I don't have this calculation, but I assume this number is manageable since it is probably two years or less of the full interest payment, followed by many years of payments that only bridge the difference between the workout amount on the bonds. AGO appears to have enough liquidity to make the interest rate payments that they will need to cover on these bonds. Does AGO have a published number for this present value interest rate payments value? A clue regarding AGO's solvency: * Watch the three AGO preferreds B, E, and F and look for a break below $20 (part $25). I won't be surprised to see these trade to $10 to $14 during peak of a selloff. * Monitor the two AGO bonds CUSIPs 04621WAA8 and 04621WAC4. So far both trade above par. * Monitor the difference between insured and uninsured bonds with the same maturity at PREPA (which I view as the place they will take the biggest hit). A PREPA insured bond is CUSIP 74526QNT5 and trades near par. An uninsured bond is 74526QKV3 and trades around 50% of par. If the market perceived a risk of non payment by AGO, that should show up in the price for the insured bonds. How I think this all plays out: 1) PREPA will miss its huge July 1 payment. PR government defaults will follow. 2) MBI will announce that its regulator is blocking its payment to cover the missed PR payments, and things from that point become a liquidity crisis for MBI. They may be forbidden from writing new business. They may elect to go Chapter 11. 3) If MBI fails to make its payments, further panic will ensue on PR bonds, sending those even lower. 4) AGO is likely to sell way down based on the above events, and I think there is a strong risk of institutional panic selling. I want to have a pretty good calculation of the worst case adjusted book value for AGO, and if during the panic they sell for maybe 50% of that adjusted book, it's a go for an investment. Can anyone add good facts to the above discussion, or maybe point to writeups that attempt some of these calculations? I have seen some articles on Seeking Alpha that claim the haircuts will only be 30% of par, but I think this is a view through rose colored glasses. If you look at enough bonds and their actual trading history, it is clear that the market expects a 50% haircut or worse. Then the question becomes how many of these bonds have reinsurance or other features that can limit AGO's losses. Link to comment Share on other sites More sharing options...
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