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SAN FRANCISCO, June 29 (Reuters) - Shares of banks and bond insurers exposed to Puerto Rico plummeted on Monday due to growing fears the U.S. Commonwealth would default on its debts, and options activity on many of those shares hinted at further declines to come.
Bond insurers were hit the hardest. Assured Guaranty shares fell 15.8 percent while MBIA Inc fell 21 percent. Ambac Financial Group dropped 11 percent. All three have sold insurance against potential defaults of Puerto Rican debt.
Retail banks operating in Puerto Rico also suffered. Popular Inc was down 10 percent; OFG Bancorp fell 14 percent and First Bancorp was down 13 percent.
Puerto Rico faces crunch time this week with a June 30 deadline to restructure some of its debt or bump the deadline. Over the last day, former IMF staffers issued a damning report about the U.S. Commonwealth's financial stability and Governor Alejandro Garcia Padilla told The New York Times the island's debts were not payable and that creditors would probably have to take significant concessions. Padilla had previously rejected the possibility of default.
"The uncertainty created by the reversal of (Padilla's) stance makes the bond insurer stocks unbuyable until clarity around the situation develops and the magnitude of the losses the insurers stand to realize becomes more apparent," brokerage BTIG said. It downgraded Assured Guaranty and MBIA to "neutral" from "buy".
Up to Friday's close, MBIA's shares had fallen 13 percent this year, while Assured Guaranty's shares had gained 5.5 percent and Ambac had lost 8 percent.
About 4.2 percent of Assured Guaranty's shares were sold short in mid-June, up from 3.6 percent at the end of May. Close to 4.7 percent of MBIA's shares were short sold in mid-June.
Options volume on Assured Guaranty soared to 79,000 contracts, or 22 times normal, boosted by a hefty put spread where a trader appears to be rolling a large position in January puts down five strikes from $25 to $20.
If so, the trade could be hinting at concerns about additional losses in the stock through the second half of 2015.
Options activity in bond insurers Assured Guaranty and MBIA Inc ballooned to several times normal.
Investors, who may have been long credit and used equity options on MBIA to hedge the downside, appeared to be closing some of those hedges for gains, Jim Strugger, derivatives strategist at MKM Partners, said.
For MBIA, options volume was at 36,000 contracts, or 9 times the average volume. Puts betting on the shares dipping below $7 by mid-August were the busiest, with volume of about 8,500 contracts traded, according to Trade Alert, an options analytics firm.
A Puerto Rican default would stress the balance sheets of bond insurance sellers, said Andrew Gadlin, an analyst at Odeon Capital Group who covers Ambac.
"But given that this is one big event, as opposed to multiple events coming from all sides, they will all be able to get past it," Gadlin said. (Reporting by Noel Randewich, additional reporting by Saqib Ahmed; Editing by Chizu Nomiyama)