AGO - Assured Guaranty

[muscleman]

I see a lot of interests in MBI, so maybe it will be interesting to compare these two companies side-by-side.

Both are trading around 1/3 of adjusted book value right now. Though MBI is a bit cheaper, and if the litigation settles has potential to settle at more than the current $3.1 Billion booked on the balance sheet.

 

Bruce Birkwiz said MBI is his best idea.

Wilbur Ross said AGO is probably the best risk/reward position in his investments.

 

MBI has done a good job in preventing cross-default, so the margin of safety is pretty high.

AGO has 3 subs, and the parent gurantees debt for all subs, so structurally AGO is weaker than MBI, but since 2008 AGO has been profitable and has a dividend.

 

 

MBI has much higher legal uncertainties, while AGO has already settled the major cases of R&W.

 

MBI couldn't write new business yet, so AGO is the only muni insurer that can still write new business.

 

[muscleman]

No body is interested in AGO? ::)

[HJ]

I am interested, but find it very hard to figure out how the muni bond insurance business will look like in the period ahead. 

 

Buffett exited the muni bond insurance business that he started in the middle of the crisis, and he made comments to the effect that once upon a time, it's the financial institutions or the well to do's within a local community who owns the risks of the muni bond issued by that locality, so when politicians have to decide what to do when faced with the decision of default or not, they are reluctant to chose default, because it will just end up hurting their local community.  However, that decision looks a lot different if it's some insurer unrelated to the local economy who ultimately bears the risk. 

 

I understand that backward looking number will show that there has only been a handful of defaults when it came to GO's and essential service bonds.  Even Orange County bonds ultimately got close to 80% recovery.  But looking at Jefferson County Sewage System default, I don't know whether the future will look like the past.

 

On the flip side, historically, the muni bond insurers has actually acted somewhat like a rating agency.  Because significant amount of munies are bought by retail investors, and a lot of the issuance have been small, $20MM - $50MM for projects here and there.  Very few investors actually have the capcity to do all the credit work to understand individual credit issuances.  So the muni insurer served a purpose in structuring these bonds, and providing sort of a "rating agency like stamp of approval" to these issuances, which the retail investors are then comfortable buying.  To a certain degree, that continues to be true.  But with rating agencies keep on downgrading them, you also have to wonder if investors will continue to find value in their guarantee in the future.  Or maybe overtime, the investor base evolve to much more institutions who chose to just do their own muni credit and structuring work, and bypass AGO.  For now, as long as they continue to write new business, it at least shows that some investors continue to find value in their service.  The question is will that investor base broaden in the future, and will they be able to handle the next round of stress surrounding muni credits along the concerns raised by Buffett.  What kind of ROE are you really supposed to price in for taking that risk?

 

There is great possibilities, if the market goes back to the way it was, but also great risks.

[muscleman]

I am interested, but find it very hard to figure out how the muni bond insurance business will look like in the period ahead. 

 

Buffett exited the muni bond insurance business that he started in the middle of the crisis, and he made comments to the effect that once upon a time, it's the financial institutions or the well to do's within a local community who owns the risks of the muni bond issued by that locality, so when politicians have to decide what to do when faced with the decision of default or not, they are reluctant to chose default, because it will just end up hurting their local community.  However, that decision looks a lot different if it's some insurer unrelated to the local economy who ultimately bears the risk. 

 

I understand that backward looking number will show that there has only been a handful of defaults when it came to GO's and essential service bonds.  Even Orange County bonds ultimately got close to 80% recovery.  But looking at Jefferson County Sewage System default, I don't know whether the future will look like the past.

 

On the flip side, historically, the muni bond insurers has actually acted somewhat like a rating agency.  Because significant amount of munies are bought by retail investors, and a lot of the issuance have been small, $20MM - $50MM for projects here and there.  Very few investors actually have the capcity to do all the credit work to understand individual credit issuances.  So the muni insurer served a purpose in structuring these bonds, and providing sort of a "rating agency like stamp of approval" to these issuances, which the retail investors are then comfortable buying.  To a certain degree, that continues to be true.  But with rating agencies keep on downgrading them, you also have to wonder if investors will continue to find value in their guarantee in the future.  Or maybe overtime, the investor base evolve to much more institutions who chose to just do their own muni credit and structuring work, and bypass AGO.  For now, as long as they continue to write new business, it at least shows that some investors continue to find value in their service.  The question is will that investor base broaden in the future, and will they be able to handle the next round of stress surrounding muni credits along the concerns raised by Buffett.  What kind of ROE are you really supposed to price in for taking that risk?

 

There is great possibilities, if the market goes back to the way it was, but also great risks.

 

Thank you for your comments. I agree that AGO's new business written is less and less from Q1 to Q3 this year, but I think that is mostly caused by Moody's comment that it is reviewing AGO's rating for a possible downgrade. It is strange that after over 270 days it is still reviewing. But I think it should be done soon. If the rating is affirmed, then it should be fine.

Also the quesion is, do you think buying at 1/3 of the adjusted book value is sufficient to absorb those potential risks?

[muscleman]

AGO does not agree with Moody's downgrade, and intended to launch a new sub for pure municipal bonds.

http://www.thestreet.com/story/11819040/1/assured-guaranty-fights-back-after-moodys-downgrade.html?puc=yahoo&cm_ven=YAHOO

[HJ]

A year ago, people would have said that downgrading below AA is a death sentence to them.  But the stock rallies on the news.  It does say something, either about the current state of credit market or the runoff value of its book of business.  You have to wonder about the business prospect of a 100 x leveraged unrated insurer. 

 

At some point, I wonder if they shouldn't just change themselves into a municipal credit fund manager who is willing to put a cash funded, but limited amount of capital at risk, non recourse, for each of their bonds in the portfolio.  With the right marketing, they ought to gain significant market share at the expense of other muni bond fund managers.  The guarantee, even limited and non-recourse, ought to be a very big selling point.  You get to charge 25-50 bps of AUM, may even be higher than what they charge right now for insurance premium, and the corporate parent would definitely get a higher rating than now.

 

 

[muscleman]

A year ago, people would have said that downgrading below AA is a death sentence to them.  But the stock rallies on the news.  It does say something, either about the current state of credit market or the runoff value of its book of business.  You have to wonder about the business prospect of a 100 x leveraged unrated insurer. 

 

At some point, I wonder if they shouldn't just change themselves into a municipal credit fund manager who is willing to put a cash funded, but limited amount of capital at risk, non recourse, for each of their bonds in the portfolio.  With the right marketing, they ought to gain significant market share at the expense of other muni bond fund managers.  The guarantee, even limited and non-recourse, ought to be a very big selling point.  You get to charge 25-50 bps of AUM, may even be higher than what they charge right now for insurance premium, and the corporate parent would definitely get a higher rating than now.

 

 

 

Muni bashers always say that Muni insurers have a extreme leverage and thus more risky, which I disagree. If even in the great depression of 1929-1932, the eventual default rate is merely 0.6%, then 100x leverage looks reasonable to me.

This drama has taught me a big lesson. Always seek out for margin of safety, and always be patient and hold on. When they are well capitalized, they always have some way to dig a hole out of the cave.

I am a newbie value investor, and I lost a lot of money selling on panic in 2011. I must learn to hold on to my positions. :)

 

If they change to a bond manager and non recourse, then the savings that they can provide to the clients will be much smaller. I think they are on the right track. Just put up good capital and form a new sub for muni bond insurance, and then they can do well.

 

What I really don't understand is why there are so many people interested in MBI but no one interested in AGO. AGO is like an MBI that has just settled with BAC but stock price hasn't jumped up yet.

I put 10% of my capital into AGO and another 10% into MBI, but I started to wonder if I should just put in 20% for AGO since last November. Why buy MBI, which has similar upside, but higher uncertainty?

[muscleman]

It is confusing to me why so many people are so much interested in MBI but barely anyone interested in AGO.

The stock price of AGO has done much better than MBI in the past 2 months.

[muscleman]

Today is the end of January but I still haven't heard of any news regarding AGO vs FlagStar. Anyone?  ::)

[valuecfa]

Today is the end of January but I still haven't heard of any news regarding AGO vs FlagStar. Anyone?  ::)

 

Rakoff is taking the weekends.

[muscleman]

Today is the end of January but I still haven't heard of any news regarding AGO vs FlagStar. Anyone?  ::)

 

Rakoff is taking the weekends.

 

Sounds great! I hope we could hear from him soon. This will be good for both MBI and AGO.

[nnayyar]

I too am interested in AGO after PR scare but unfortunately having a hard time getting around the new laws. In my basic understanding it sounds like a binary event, they can or cannot decide to restructure. If they are sued then you are stuck in court limbo again for who knows how long. So it would seem more prudent to wait for a decision even though might miss a big 1 day payday?

 

FWIW, PREPA bonds are trading ~.40 to the dollar? Jefferson County and Orange County received about ~.80 recovery? This is from quick google search so if anyone was closer to the situation can confirm?

[bbarberayr]

Anyone still interested in AGO?  It is one of my top 5 holdings and will write it up if anyone wants to read.

[RhubarbXIV]

Anyone still interested in AGO?  It is one of my top 5 holdings and will write it up if anyone wants to read.

 

I'm always interested in financials on the fringe. I'd love to hear your thoughts if it's not too much trouble.

 

I'm very keen to see if they end up insuring more PR debt via this $2b offering:

 

http://www.reuters.com/article/2015/01/28/usa-puertorico-idUSL1N0V72UA20150128

[bbarberayr]

The way I look at AGO is:

 

1. You have an undervalued insurer on many metrics (see their latest quarterly).  As a financial, you want to espeically want to look at book value.  IN AGO's case operating shareholder value is the best measure and it is at 67% of this.  They also document what they call their adjusted book value, which is what they expect to earn over time and, while many things can change, it is at less than half of that.

2. They are well run and have been consistently profitable with profits every year in the last 10 except 2007.  They consistently look at ways to increase profits and book value and were able to work their way through the financial crisis.  Book value has increased by 50% over the last 10 years and they've paid an increasing dividend.

3. They are primarily in public (state, municipal) insurance.  These governments have gone through a tough few years and their financing is improving.  The governments which got into trouble (Detroit, Stockton, Alabama, Puerto Rico) are well known and AGO has done a good job of working through these situations

4. Competition has mostly gone bankrupt, strengthening AGO's position in the marketplace.  Their only competition is new insurer Build America corp, who was funded by White Mountains insurance.  White Mountains is also a well run company and show that they also believe this is now a good market.  But AGO is by far the dominant player still.

 

The risks are:

 

1. More customer financial troubles

2. Puerto Rico is worse than expected, but AGO already has reserved for this situation

3. Not much new business is being issued as municipalities are getting such low rates without insurance, the need for insurance is gone.  AGO is used to typically lower the rate a municipality pays on a bond.  Let's say the city is BBB and AGO is AA.  If AGO insurers the bond, it only has to pay the AA interest rate instead of BBB.  Because of the low rates in the market, this spread has decreased.

 

But to summarize, it is a cheap insurer, well run, all of the bad news is highly likely out there and they are dealing with it.  There seems to be very little downside risk due to the book value discount and they have built-in upside in the existing business and, if rates increase, they are well position to gain new business.

[constructive]

3. Not much new business is being issued as municipalities are getting such low rates without insurance, the need for insurance is gone.  AGO is used to typically lower the rate a municipality pays on a bond.  Let's say the city is BBB and AGO is AA.  If AGO insurers the bond, it only has to pay the AA interest rate instead of BBB.  Because of the low rates in the market, this spread has decreased.

 

Something like 40% of municipal debt used to be insured. Now it is down to around 5%. I have read people predicting that it will return to 30-40% over the next few years as interest rates rise and investors see the need for insurance from watching the latest wave of municipal bankruptcies (Birmingham, Stockton, Detroit, maybe Atlantic City, etc). That's a pretty big potential growth market, with less competition than in the past.

[prevalou]

interesting perspective

 

http://kristiculpepper.tumblr.com/post/107806563217/have-bond-insurance-underwriting-standards

[bbarberayr]

That was an interesting article prevalou.

 

AGO obviously see this too and has been working to grow the business.  They recently bought a block of business from Radian which should generate a reasonable return. 

 

They also continue to buy back shares to help rightsize the business.  And because municipal insurance is paid for at issue, but amortized over the life of the contract, they can basically see that they book value of the company will grow to more than double over time, just based on existing business on its books.  So even though not much new business is currently being written, profits will continue to flow.

[benhacker]

Regarding Muni insurance penetration, here are a few thoughts (I haven't stayed really tight on this area, so feel free to correct):

 

1) I think the peak of insurance penetration for Muni-land was high 50's. 

 

2) I think this 50% rate is not coming back for several reasons:

--> The global rating scale for the rating agencies has moved / standardize I believe.  There is no longer an arbitrage for adding a less secure mono-line "AA" guarantee onto a more secure muni "A" and getting paid.

--> Thus the market for muni insurance basically boils down to the size of the market that will get rated less than it's creditworthiness should suggest... and can indeed benefit from AGO or someone else doing some on the ground due diligence to basically put a 3rd party guarantee on the issue to make it known that it's safer.  I think the market for real muni insurance is probably >15% of the market, and *most* of this is in stuff that probably is more labor intensive than some of the deals down pre-2007 (thus, more costly). (Ironically, structured finance likely has more natural benefit for an insurance company willing to paint outside to the rating agency lines intelligently with a guarantee... but that business is basically considered 100% toxic by investors still.)

 

3) I do think any low rate effect to muni insurance will likely end but I think that is not the dominant reason for the drop from 50 to 5%.

 

4) Finally, I'm not sure how long term this is, but the 5% rate overstates the market that the monolines insure, as many municipalities have gone to direct-to-bank funding for some capital needs (I've heard 10-20% of the market, but data apparently is in the ether).

 

--

 

All in all, I think at a clear discount to book, the monolines could still be reasonable buys for debt or equity investors, but I think any thesis that hinges on any kind of return of the muni insurance market is unlikely to play out.

 

Just my 2 cents, no position.

[bbarberayr]

Regarding Muni insurance penetration, here are a few thoughts (I haven't stayed really tight on this area, so feel free to correct):

 

1) I think the peak of insurance penetration for Muni-land was high 50's. 

 

2) I think this 50% rate is not coming back for several reasons:

--> The global rating scale for the rating agencies has moved / standardize I believe.  There is no longer an arbitrage for adding a less secure mono-line "AA" guarantee onto a more secure muni "A" and getting paid.

--> Thus the market for muni insurance basically boils down to the size of the market that will get rated less than it's creditworthiness should suggest... and can indeed benefit from AGO or someone else doing some on the ground due diligence to basically put a 3rd party guarantee on the issue to make it known that it's safer.  I think the market for real muni insurance is probably >15% of the market, and *most* of this is in stuff that probably is more labor intensive than some of the deals down pre-2007 (thus, more costly). (Ironically, structured finance likely has more natural benefit for an insurance company willing to paint outside to the rating agency lines intelligently with a guarantee... but that business is basically considered 100% toxic by investors still.)

 

3) I do think any low rate effect to muni insurance will likely end but I think that is not the dominant reason for the drop from 50 to 5%.

 

4) Finally, I'm not sure how long term this is, but the 5% rate overstates the market that the monolines insure, as many municipalities have gone to direct-to-bank funding for some capital needs (I've heard 10-20% of the market, but data apparently is in the ether).

 

--

 

All in all, I think at a clear discount to book, the monolines could still be reasonable buys for debt or equity investors, but I think any thesis that hinges on any kind of return of the muni insurance market is unlikely to play out.

 

Just my 2 cents, no position.

 

I would agree that it is very unlikely we get back to any sort of similar market to what we saw in the past.  But at this valuation and the lack of competition and with smart management looking for ways to grow, I think it should turn out to be a good investment.

 

Another specialty insurer in a similar situation is Allianz (AIZ).  There large business of providing insurance for houses where people didn't pay their mortgage is shrinking and also not coming back.  But they are doing a lot of similar things to AGO like reducing the market cap to fit the business, growing BV per share and trying to expand other areas like their extended warranty business.

 

If you have the right niche in insurance, you can generate a good return as the competition generally stays away and you can price the products accordingly.  Being in the more commodity type insurance like personal home and auto where you are competing against teh State Farm's and Geico's of the world is a mcuh tougher way to make money.

[zippy1]

https://finance.yahoo.com/news/assured-guaranty-files-adversary-complaint-103000314.html

HAMILTON, Bermuda--(BUSINESS WIRE)--

 

Assured Guaranty Ltd. (AGO) released the following comments regarding the adversary complaint filed yesterday challenging the legality of the Commonwealth’s Fiscal Plan as certified by The Financial Oversight and Management Board for Puerto Rico (Oversight Board):

 

Assured Guaranty Municipal Corp. and Assured Guaranty Corp., two bond insurance subsidiaries of Assured Guaranty Ltd. (together with their parent, Assured Guaranty or the Company), filed an adversary complaint in Federal District Court in Puerto Rico yesterday seeking (i) a judgment declaring that the Fiscal Plan violates various sections of PROMESA and the Contracts, Takings and Due Process Clauses of the U.S. Constitution; (ii) an injunction enjoining the Commonwealth and Oversight Board from presenting or proceeding with confirmation of any plan of adjustment based on the Fiscal Plan, or taking any other action pursuant to the Fiscal Plan; and (iii) a stay of the confirmation of any plan of adjustment based on the Fiscal Plan pending development of a fiscal plan that complies with PROMESA and the U.S. Constitution.

 

With this action, Assured Guaranty challenges the legality of the Fiscal Plan and its gross violation of the clear statutory mandates of PROMESA, including its failure to respect liens and priorities, its misappropriation of pledged special revenues and its failure to provide for fiscal responsibility or access to capital markets. The complaint contends that these gross violations of PROMESA turn on their head generations of federal constitutional law governing the priority and protection of secured debt by giving all general governmental expenses payment priority over the payment of bond debt granted constitutional first priority or secured by liens. Moreover, the complaint alleges that the Fiscal Plan, by impairing creditors’ contractual rights and stealing their property, ensures that Puerto Rico will not regain access to the capital markets for the foreseeable future. Finally, the complaint asserts that the Fiscal Plan, unless totally recast, cannot possibly be permitted to serve as the basis for any lawful plan of adjustment that complies with the constitutions and laws of the United States and Puerto Rico.

 

In light of the Commonwealth’s and Oversight Board’s blatant disregard of PROMESA’s mandatory requirement to respect lawful liens and priorities, their brazen and unlawful misappropriation of secured bondholder collateral, and their rejection of Assured Guaranty’s offer of forbearance, the Company is determined to take reasonable and necessary actions to protect its rights as insurer of bonds of the Commonwealth and certain of its instrumentalities.

 

As always, investors owning Puerto Rico-related bonds insured by Assured Guaranty will continue to receive uninterrupted full and timely payment of scheduled debt service in accordance with the terms of Assured Guaranty’s insurance policies.

 

With $12 billion in claims-paying resources across its group of companies and approximately $400 million generated each year from its $11 billion investment portfolio alone, Assured Guaranty’s liquidity and capital position are very strong.