Traders bet on Puerto Rico bond insurance
After Puerto Rico's bonds tumbled by the most in at least 17 years, Wells Capital Management, MacKay Shields and Belle Haven Investments sifted through the wreckage and decided it was time to buy.
The US investors are not betting on being repaid as a result of an end to the fiscal crisis gripping the debt laden Caribbean island. They're betting insurers can stand by promises to cover principal and interest bills if Puerto Rico reneges on its debt.
Governor Alejandro Garcia Padilla's announcement last week that the island can't afford to repay what it owes sparked a rout that caused some insured Puerto Rico securities to trade for as little as 76 cents on the dollar. Prices rebounded as investors snapped up the debt, speculating that a widespread default won't wipe out the biggest guarantors.
"It's one of these classic muni (municipal bond) headline issues: A lot of people want to be the first out of the door and sell theirs first," said John Loffredo, who helps oversee $13bn (€11.73bn) of munis at MacKay. "We've been actively participating in AA rated insured muni bonds that are triple tax-exempt that we believe are mispriced."
The escalation of Puerto Rico's debt crisis last week rattled mutual and hedge funds that have parked money in the island's debt because it's tax-exempt nationwide and offered yields higher than other investments.
The US dependency and its agencies, such as public infrastructure companies, owe $72bn (€65bn) after years of borrowing to paper over budget shortfalls. Garcia Padilla said he wants to negotiate with investors to delay payments that are draining the government's coffers.
Prices on some debts backed by a unit of Assured Guaranty Ltd slid 7 cents on June 30 to an average of 85 cents on the dollar, pushing the yield to 6.4pc. The same day, sales-tax debt backed by the same insurance company plunged 14 cents to 80 cents in the dollar.
Uninsured debts due in 2041, by contrast, trade at about 59 cents on the dollar.
Assured Guaranty, a bond insurer, is rated AA, the third-highest investment grade, by Standard & Poor's, which affirmed the grade last week.
Comparably rated 30-year municipal bonds yield about 4pc.
Bond insurers pledge to pay interest and principal on time if a borrower defaults. That means that even if Puerto Rico officials are able to postpone debt payments, holders of insured securities won't be affected as long as the insurers have sufficient funds.
Shares of Assured Guaranty and rivals MBIA and Ambac Financial Group fell last week amid speculation about the fallout from Puerto Rico. (Bloomberg)