A downgrade of Puerto Rican debt could eat into the capital cushions of the two biggest bond insurers, as they work to rebuild their finances after the credit crisis, a rating agency has warned.
MBIA and Assured Guaranty will need to set aside more than $100m apiece if the credit rating of the US territory is cut by two categories, Standard & Poor’s estimated after “stress testing” the companies’ exposure to Puerto Rican municipal bonds.
The pair have written insurance on almost $11bn of Puerto Rican bonds, whose value has tumbled as investors have begun to doubt that the island will be able to pay its debts.
Bond insurance company shares have also fallen sharply as investors have examined their potential exposure to a downgrade or even a default of Puerto Rico. The island’s politicians have been struggling to balance the budget amid 13.9 per cent unemployment and a disappointing recovery from recession.
The S&P analysis provided a fillip to the shares on Monday, since it concluded that MBIA and Assured had already built capital reserves above the required minimum, giving headroom if they needed to reserve more to cover potential losses on Puerto Rican debt.
Insurers must increase reserves if the credit rating of the bonds is lowered. MBIA, through its subsidiary National Public Finance Guarantee Corp, has insured $5.3bn of Puerto Rican municipal debt; Assured backstops $5.5bn.
The companies would need to take capital charges of $65m apiece if Puerto Rico is downgraded from BBB to BB, and $115m if it drops one category lower.
Assured and MBIA have been trying to improve their own credit ratings so that they can restore their businesses underwriting new municipal bonds, which were put on hiatus during the credit crisis thanks to losses from insuring mortgage-backed securities. As part of that effort, Assured has built a capital adequacy cushion of at least $400m, and National of $350m.
Mark Palmer, an analyst at BTIG, said that the S&P report amounted to “a resounding passing grade for the capital levels” of the two companies, and provided confidence that Assured will soon be able to start returning capital to shareholders. There had been “a significant market overreaction recently in their shares in the midst of the Puerto Rico fear frenzy”.
Chris Ryon, a municipal debt portfolio manager at Thornburg Asset Management, cautioned that the insurers may also hold significant exposure to Detroit, which filed for bankruptcy earlier this year.
“It is true that insurance companies don’t have to make a one-time payment in the case of a default. There’s a lot of factors at play, such as exposure in terms of maturity and what’s their earnings potential, which could help offset some of the impact,” Mr Ryon said. “But the real problem here is the order of magnitude of the situation in Puerto Rico: several times bigger than what we’ve seen in Detroit.”
Assured said last week that it had cut its exposure to Puerto Rico by 17 per cent annually since 2010 and that it believes the territory was making strides to improve its finances.
Puerto Rico’s Treasury secretary said on Monday that first-quarter revenue for the fiscal year starting in July beat previous government estimates and rose 5.4 per cent to $1.7bn. The island had initially estimated its first-quarter revenue would rise 4.4 per cent, missing its budget target.
By Stephen Foley and Vivianne Rodrigues in New York