MBIA: A Contrarian Investment Opportunity Caused by Puerto Rico's Debt Uncertainty?

MBIA is currently being thrown under the bus because of its exposure to Puerto Rico's debt, but investors' panic over exposure might be an interesting buying opportunity.

Jul 14, 2014 at 3:13PM
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Source: Company

MBIA Inc. (NYSE:MBI) is one of the financial services companies that was almost brought to its knees during the financial crisis. Though the company bounced back nicely, renewed fears about a potential financial catastrophe have now emerged.

With MBIA's exposure to Puerto Rico's debt and investor doubts about the commonwealth's willingness to honor its debt obligations, MBIA shares got hammered recently, losing about a quarter of their value over the last month alone and now trade at a serious discount to book value.

Debt woes and the rapid decline in MBIA's market capitalization could, however, signal a contrarian investment opportunity for investors who believe the market is way too pessimistic with respect to MBIA's ultimate exposure to Puerto Rico's debt.

Background
Though MBIA has restructured its business and moved forward with a new organizational and capital structure post-crisis, which has been generally perceived as good news, the bond insurance company recently made new headlines due to investor concerns about MBIA's guarantees on Puerto Rico's debt.

MBIA's shares have consolidated sharply despite the assurances of Puerto Rico's government officials, that it is not going to default on its $70 billion of debt.

Adding to the uncertainty was a new law, that would allow public corporations such as the Puerto Rico Electric Power Authority (PREPA) to restructure its debt, which could lead to losses for bondholders and for MBIA's National Public Finance Guarantee unit through which the bond insurer provides its guarantees on Puerto Rico's debt.

Investors in panic mode
According to Bloomberg and Moody's Investor Service, "the exposure of MBIA's National Public Finance Guarantee unit to the troubled Puerto Rico Electric Power Authority, the island's main provider of electricity, equaled 46 percent of its qualified statutory capital as of March 31, 2014".

Not surprisingly, projected bond losses or even bond defaults could impact MBIA substantially. And investors clearly started to adopt a much more negative outlook on MBIA as a result of the recent turmoil in Puerto Rico.

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MBIA's shares have lost almost 26% over the course of last month and investor pessimism is currently high. Unfortunately, investors often overreact to news events, both to the up- and the downside.

For the time being, no default has occurred. Investors merely assume, that Puerto Rico will default on its debt which clearly is the worst case scenario. Though many investors give in to the negativity and pessimism surrounding an investment in MBIA lately, Puerto Rico has a good record in honoring its debt obligations.

For instance, David Chafey, chairman of the Government Development Bank, and Treasury Secretary Melba Acosta Febo tried to reassure investors of Puerto Rico's creditworthiness by saying in a joint statement, that:


Puerto Rico has repeatedly delivered on its credit promises, and the willingness and ability of the Commonwealth to honor its obligations should be unquestioned in light of its actions over the last 18 months.


In addition, should Puerto Rico really be in trouble it could possibly even receive financial assistance from the United States government, which probably wouldn't like to see one of its territories descend into default.

As a result of these developments, rating agency Standard & Poor's last week cut PREPA's revenue bond rating four notches from 'BB' to 'B-' indicating high risk of default.

Debt investors such as Franklin Templeton and Oppenheimer, are now challenging Puerto Rico's law allowing for a debt restructuring outside bankruptcy.

Investor panic reflected in MBIA's market valuation
The decline in MBIA's market capitalization was brutal. Just last month, MBIA was trading around $13 and ultimately marked a 52-week low at $9.20. Shares are now trading in the $9.30-9.40 range with high degrees of uncertainty likely to persist in the short-term.

From a valuation perspective, investors certainly have driven MBIA into bargain territory and the bond insurer now is a true 50-cent dollar. Trading at just half of its book value, investors are extremely negative about a possible debt restructuring/default in Puerto Rico.

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The Foolish Bottom Line
Though the probability of a debt default has increased, I don't think default really is on the table. Puerto Rico's officials have publicly reassured investors, that the island will honor its debt obligations. Moreover, bondholders are now challenging the law legitimizing debt restructurings outside bankruptcy in court.

It is always a good time to buy when investors panic and paint the devil on the wall. At a 50% discount to book value, investors are extremely pessimistic, and probably, dead wrong about their assumptions about an all-out debt default in Puerto Rico.

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Kingkarn Amjaroen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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