Wednesday, November 25, 2009

Bookkeeping: Creating Starter Stake in Assured Guaranty (AGO)

Today we will begin a starter stake in bond insurer Assured Guaranty (AGO) - for those not familiar with the space think of the 2 disaster of companies called MBIA (MBI) and Ambak (ABK) which we talked about at length in first quarter 2008.   This is not my typical fare but a speculative, "special situation" ... a company whose competitors who have been so beaten into the ground it is currently running a near monopoly on debt issuance for muncipalities.

Technically, the company exploded higher last week on a very surprising earnings report, and has now filled that gap perfectly.  I am beggining the stake just over $23, with hopes it falls to $20-$21 where I would like to make the position larger.  For now I just did a 0.7% position to get started. 

Any break of the $20 level (or so) and we'll be cutting back or exiting fully.  This is not a "fast money" trade...

Fundamentally, the main issue here is there is still a lot of bad debt, especially of the mortgage backed security type, on the books - but far less than Assured peers... both of which have been staring down bankruptcy.  Frankly, I am unclear how both MBIA and Ambak are not bankrupt but then again many companies who should of went bankrupt have been saved somehow.   So much like buying a TARP bank you can expect more dilution (some of which was also announced last week) but again... at this point, a near monopoly in their business until new competitors begin to emerge next year (I assume).

As to their core business, we've been speaking about the problems that will be coming to the states and cities of America as "kick the can" budget policy dominates all politicians ways of thinking, since 2007.  I expect 2010 to be a horror show for many states and cities.  But as the "stimulus" plan of 2009 was a bailout of the states I expect the same thing in 2010.  In fact, I am now reading city and state politicial leadership saying the federal government should borrow FOR them, because they can do it cheaper... that's how insane America has become.  The nanny state is going to get more intense as we get forward; either way you can bet after bailing out the financial oligarchy there is no political way the federal government can do that and then tell the states you are on your own.  Expect a lot of debt issuance and all the world knows, as with Fannie and Freddie, when worst comes to worst - everything is backstopped by the US taxpayer.

Some recent items

1) Last week's earnings report:
  • Assured Guaranty Ltd. shares jumped 20% Tuesday after quarterly results suggested the company is emerging from the financial crisis as one of the few viable bond insurers. Earlier in the day, the stock hit $28.14, the highest level since the second half of 2007, when the mortgage meltdown was beginning to decimate the bond insurance business.
  • Assured reported a third-quarter net loss of $35 million, or 22 cents a share, late Monday. That compared to a net loss of $63.3 million, or 69 cents a share, in the year-earlier period.  Operating earnings, which exclude net realized investment gains and losses and other items, came in at $70.1 million, or 44 cents a share, up from third-quarter 2008 operating income of $26 million, or 28 a share, the bond insurer said.
  • The latest quarter is the first to include results from Financial Security Assurance Holdings, which Assured Guaranty acquired on July 1. Assured Guaranty recorded after-tax expenses of $34.1 million, or 22 cents per share, related to the acquisition.
  • Assured Guaranty said its U.S. public finance business generated $154.9 million in new business in the latest quarter, up 44 percent from the year-ago period.
  • Bond insurers sell guarantees that help municipalities and other issuers lower borrowing costs. Having a top credit rating is crucial, but most companies in the industry, including Ambac Financial (ABK) and MBIA (MBI) , lost their AAA ratings after the housing crisis forced them to pay big claims on mortgage-related guarantees that turned toxic.
  • Assured is also paying out on such exposures, but the company wasn't as heavily exposed as rivals and has managed to keep an Aa rating from Moody's Investors Service. That's a high-enough rating to sell new guarantees.
  • Indeed, Assured said late Monday that it insured almost 10% of all new U.S. municipal debt issued during the third quarter. In contrast, Ambac and MBIA have written almost no new business so far this year.
  • "They are the sole writer of new muni bond insurance right now from what I can see," Jim Ryan, an equity analyst at Morningstar, said in an interview on Tuesday. "You have a solid company that's made it through the worst and their performance relative to peers is outstanding."
  • "We don't see a viable competitor," he added. "Those types of returns will attract competition over the long term, but right now they're king of the hill."
  • "With the prospects of a recovery of some of the other bond insurers looking worse and worse every day, what do you think the outlook is for an industry where there is really only one player and is it possible to have an industry with just one player longer term?" UBS insurance analyst Brian Meredith asked during a conference call with Assured on Tuesday.

I got a kick out of this comment by the CEO, because he is absolutely correct... the minute a competitor shows up, the analysts will begin shrieking and assuming fetal positions.
  • Assured Chief Executive Dominic Frederico said the company expects new competitors to emerge sometime in 2010.  "There are not many industries of one, so we would not at all be opposed to seeing competition," he added during the call. "Of course, all you folks will begin to panic as soon as we get our first competitor."
It is not all roses and butterflies:
  • Despite avoiding the carnage suffered by Ambac and MBIA, Assured Guaranty still has mortgage-related exposures from the housing boom that are triggering claimsThird-quarter loss and related expenses were $133.3 million, up 62% from a year earlier, Assured reported. Most of the losses came from residential mortgage-backed securities the company guaranteed earlier this decade.
  • However, Assured is trying to reduce such losses by reviewing mortgage-backed securities it guaranteed to see if any of the underlying loans were originated improperly. When the company finds problems, it can ask originators to repurchase the loans, which limits losses.

2)  So having a top notch credit rating is the end all, and be all in this industry... after all how can you guarantee other's debt when you yourself are a basket case.  Just before the earnings report, Assured announced a plan to raise $300M in capital but helps maintain their rating.
  • The company on Monday also reiterated capital-raising plans it announced last week after Moody's Investor Service cut its insurance financial strength rating for Assured Guaranty, citing mortgage-backed securities exposure.
  • In response, Assured Guaranty President and CEO Dominic Frederico said Friday the company would implement a capital plan to maintain its investment-grade double-A ratings. The initiatives, which entail external reinsurance, intercompany capital support and about $300 million of additional capital, are to solely support rating agency capital requirements, Frederico said. 
Long Assured Guaranty in fund; no personal position

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