Municipal Bond Forum
On Don’t Lose Sleep Over Bond Insurers Woes cont’d:
Q
You say, “Bond Insurers are only compelled to pay principal and interest if the underlying borrower cannot do so.” Does this mean that the insurer is obligated to pay to the bondholder the future interest stream on the defaulted bond as well as the principal at term in the same manner as the original borrower? Or does this mean that the insurer is only obligated to pay to the bondholder the principal at the time of default? In other words, the bondholder is guaranteed only the return of his principal and will forego the future interest stream of the original bond.
A
James A. Klotz responds:
Actually, the insurer has the option to pay off the entire debt at the time of default or to maintain the terms of the original bond indenture (interest and principal). The latter is almost invariably the preferred approach.
The reasons for this are obvious. Often, the issuers’ problems are short-term in nature and remedies can be implemented to correct the shortfalls. In this scenario, the issuer, at some point, resumes its payments of principal and interest. The issuer is further obligated to reimburse the insurance company for payments made during the period the issuer was unable to do so.
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