The President Just Made These 3 Stocks A Steal

Comments by President Trump rocked the municipal bond market last Wednesday after the President said that Puerto Rico’s $74 billion in bonds would have to be “wiped out.”

The comments sent the island’s general obligation bonds plunging to a record low of $0.30 on the dollar, a 35% drop from trading at $0.46 a day earlier. That’s in a market where muni bonds are thought to be some of the safest investments available and rarely trade more than a few cents higher or lower in a session.

The comments hit one industry particularly hard, an industry that has already had to face weakening investor sentiment for more than a year. But it could also mark a low for the industry, a buying opportunity in a normally very safe portion of the market.

Shares of these financial companies are trading as low as half their book value and could be ready for a long-awaited rebound.

#-ad_banner-#​Municipal Insurers Weather The Storm
Companies insuring municipal bonds against default fell immediately after the President’s comments, with shares falling the most since Hurricane Irma threatened Puerto Rico in early September.

The President told Sean Hannity that, “[Puerto Rico] owes a lot of money to your friends on Wall Street. We’re going to have to wipe that out. That’s going to have to be, you know, you can say goodbye to that.”

Muni bond insurers have struggled since Puerto Rico defaulted on some of its general obligation funds in 2016. In total, the island owes more than $74 billion. The idea that the federal government could absolve this debt sent investors scrambling for cover.

Hans Humes, Greylock Capital CEO, tried to reassure the market in a Bloomberg interview, noting that “It’s not the President’s call. It’s incredibly unlikely and would be incredibly disruptive if those bonds were to go to zero.”

The President’s own budget director Mick Mulvaney worked quickly to walk back Trump’s comments, saying that the President shouldn’t be taken literally on the matter. 

The White House Budget Director told Bloomberg, “I think what you heard the President say is that Puerto Rico is going to have to figure out a way to solve its debt problem,” and that there would be no bailout of the bonds. The price of Puerto Rico’s 2035 G.O. bonds rebounded to $0.38 after Mulvaney’s statement.

Even Puerto Rico’s Governor, Ricardo Rosello, attempted to soothe investors, saying the island would resolve its debt through the formal bankruptcy process and would not be unilaterally wiped out.

Despite investor jitters, the municipal bond market is still considered one of the safest investments next to U.S. Treasuries. There were just 99 defaults over the 45 years through 2015, a default rate of less than 0.1%. Insurers of the debt carry loss reserves to cover the defaulted debt, hold high levels of cash, and invest in liquid assets.

Three Insurers Trading At Discounts And Ready To Recover
Beyond a return to rational pricing after the President’s remarks, bond insurers should benefit from a solid outlook over the next year. Moderate economic growth and persistently low interest rates should support public bond issuers, helping them to refinance debt and avoid defaults. 

While more Puerto Rico bonds may default, insurers have largely covered their exposures with loss reserves. The bankruptcy process is likely to take a while but the consensus among credit analysts is for recovery rates as high as $0.30 on the dollar for the bonds.

Investor sentiment has driven insurers to bargain-basement levels. The three companies in the space trade for a discount of 50% or more to the average 1.4 times book value multiple in the broader insurance industry.

Ambac (Nasdaq: AMBC) shares slipped 5.5% on Wednesday, bringing total losses for the year to 25.9%. The stock trades for just 0.5 times its book value and the company carries $4 billion in loss reserves. The company carries no debt and has balance sheet cash and investments of $379 million.

MBIA (NYSE: MBI) shares plunged 8.4% on Wednesday, and are down 27% for the year. Shares trade for 0.5 times book value and the company has a high exposure to Puerto Rico at $4 billion in gross insured outstanding. Even on the higher exposure, the company has a solid balance sheet, with $9.8 billion in assets against $7.8 billion in total liabilities.

Assured Guaranty (NYSE: AGO) shares slipped 2.9% on Wednesday for a total loss of 3.5% on the year. Shares trade slightly higher at 0.7 times book value on stronger fundamentals but still well below the industry average for insurance companies. The company is very well covered on its Puerto Rico exposure. Annual investment income of $400 million is higher than the average annual net debt service for the next decade on all its Puerto Rico insured bonds.

Risks To Consider: Long-term risks remain in the $3.8 trillion municipal bond market, with public promises in deficit even though shorter-term value exists.

Action To Take: Position for a rebound in value for bond insurers as moderate economic growth and low rates support the muni bond market.

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