Bond insurers argue against legality of Puerto Rico debt


Two legacy bond insurers have filed motions in support of the Puerto Rico Oversight Board’s effort to declare illegal $6 billion of the commonwealth’s bonds issued in 2012 and 2014.

Ambac Insurance Corp. and Financial Guaranty Insurance Co. — firms that ceased writing new policies after the 2008 financial crisis but would continue to pay claims — filed motions in Puerto Rico’s bankruptcy court last week to declare the bonds illegal.

Ambac went further, saying the fiscal 2012 and 2014 “GO bonds should be declared null and void, and claims thereon disallowed.” This would mean that Puerto Rico shouldn’t be required to pay the bonds. The language also raises the question whether Ambac believes bond insurers would have to pay the claims. Ambac didn’t respond to a request for comment for this story.

Ambac insures Puerto Rico GOs, though not the contested fiscal 2012 and 2014 bonds. However, Ambac also insures $162 million of contested Puerto Rico Public Building Authority bonds.

The Oversight Board is contending that this debt should be considered as belonging to the Puerto Rico government. If the building authority bonds are included in the total, Puerto Rico’s government went beyond its constitutional debt limit in fiscal year 2012, the Oversight Board contends.

On April 2 the board filed a statement in the court that it may challenge the validity of PBA bonds and GO bonds sold from July 1, 2009 onwards.

Ambac doesn’t make clear in its filing or in its Puerto Rico Exposure document for the fourth quarter of 2018 whether it insures any PBA bonds issued since the start of fiscal 2009 or the start of fiscal 2012.

On Thursday, FGIC filed a notice of participation in the bankruptcy saying that it intends to argue that the GO bonds issued since fiscal year 2012 were invalid.

Further, it indicated that it believes that the appropriate relief is for Puerto Rico to stop paying these bonds. Neither FGIC nor one of its lawyers responded to a request for comment for this story. While FGIC insures both general obligation and otherwise Puerto Rico guaranteed debt, none of this debt was issued after 2007.

“Bond insurance policies should be enforceable even if the underlying bond is declared invalid,” said Matt Fabian, partner of Municipal Market Analytics.

Puerto Rico attorney John Mudd said Ambac may be acting to reduce its exposure.

“Ambac wants the [PBA] bonds paid,” said Mudd, who represents a municipality in Puerto Rico’s bankruptcy and writes a blog on the crisis. It “therefore claims they are valid bonds and also claims they should be considered in the constitutional debt limit, in order for those GO’s to be disallowed and there be more money to pay said bonds and hence, less haircut.”

In its filing Ambac wrote: “the invalidation of the challenged GO bonds [from fiscal 2012 and 2014] would have great significance for Ambac both as a holder and/or insurer of $56 million in GO bonds issued before 2012, as well as a holder and/or insurer of gross accreted bonds totaling $1.08 billion issued by the Puerto Rico Highways and Transportation Authority, Puerto Rico Infrastructure Financing Authority, and Puerto Rico Convention Center District Authority.”

If Ambac held PBA bonds that were invalidated and then tried to use the court’s invalidation as a reason not to pay, this would probably breach its insurance contract, Mudd said.

According to Janney’s Muni Monthly, about 22% of debt issued by Puerto Rico public sector entities was backed by bond insurance.

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