Why I'm Starting a Stake in Assured Guaranty

Wednesday, we began 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 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 begining 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's 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 that should have 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 political 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 go 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 claims. Third-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 others' debts when you yourself are a basketcase. 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

Comments

[BobGeorge]

"We don't see a viable competitor," Jim Ryan, an equity analyst at Morningstar, said in an interview on Tuesday. It is my understanding that Warren Buffett via Berkshire Hathaway has entered this market. If that is not "a viable competitor" than what is ? I for one would not want to compete Mr. Buffett's Berkshire Hathaway, its cost of funds is almost zero percent.

2009 Nov 26 09:28 AM

[TraderMark]

when the Ambak and MBIA hubbub was happening everyone said Buffet would be here and I too had thought he had started. But the CEO who claims new competition would start in 2010, and the analysts who follow the sector all claim there is not much there. Not sure why the disconnect myself.

The larger point is no industry has zero competition for long. So anyone investing should not assume 10 years of no competition... but in a very small competitor space, it seems the incumbents have been mortally wounded. So now we wait for the next entrants, unless Phoenix like miracles happen with MBIA and Ambak.


On Nov 26 09:28 AM BobGeorge wrote:

> "We don't see a viable competitor," Jim Ryan, an equity analyst at
> Morningstar, said in an interview on Tuesday. It is my understanding
> that Warren Buffett via Berkshire Hathaway has entered this market.
> If that is not "a viable competitor" than what is ? I for one would
> not want to compete Mr. Buffett's Berkshire Hathaway, its cost of
> funds is almost zero percent.

2009 Nov 26 10:23 AM

[tommiegun]

Goldman and JP Morgan have entered this bond insurer industry under the name "Essent Guaranty".

They are buying assets of failing bond insurers. In addition JP morgan is the defendant in several lawsuits from bond insurers one of which is MBIA.

MBIA has sued JPM for obtaining insurance on fraudulant CDOs. JPM has retaliated by suing MBI for starting bond insurer "National" a subsidiary of MBI.

JPM retaliated against MBI by downgrading their stock. UBS subsequently ungraded MBI and downgraded AGO.

AGO has recently been downgraded by Moody's.

2009 Nov 26 01:03 PM

[tommiegun]

Don't buy AGO, this is a pump and dump stock read this:

Nov 17 (Reuters) - Assured Guaranty Ltd: * JP Morgan raises Assured Guaranty Ltd price target to $42 from $28; rating overweight * JP Morgan says would be aggressive buyers of Assured Guaranty with shares trading at half the brokerage's target price ((Bangalore Equities Newsroom; [phone]; within U.S. [phone])) (For more news, please click here) COPYRIGHT Copyright Thomson Reuters 2009. All rights reserved.

This nonsence was published on an indian website. They regularly promote stocks with no inherent analysis or reasoning in India.

2009 Nov 26 01:08 PM

[Gtarras]

Mark
I'd be very careful and tried to learn as much as you can about AGO's TruPs exposure. this asset class might cause major damage to their book. while AGO's subordination is very high in these transactions, the underlying quality is deteriorating rapidly (regional banks). deferrals are a credit event, and many banks are taking that path. my personal opinion they will take bigger hits there than the market estimates now (subordination is eroding rapidly, and we've had 130 bank defaults so far with 4x as many expected to follow).. HELOCs are also an issue. i'm also looking into AGO, but decided to stay away for now.

2009 Nov 26 02:53 PM

[Alan Young]

This sounds suicidal to me, too. Munis are very risky due to collapsing tax bases. If a muni is strong, it will look at two insurers going bankrupt already and decide that insurance is useless; if not, it could weigh on its insurer's book like cement shoes. This only looks good if you really believe that the economy is recovering.

2009 Nov 26 05:00 PM

[TraderMark]

Fair enough

Much like all banks the question is can they "out earn" their losses. Hard for anyone to tell...


On Nov 26 02:53 PM Gtarras wrote:

> Mark
> I'd be very careful and tried to learn as much as you can about AGO's
> TruPs exposure. this asset class might cause major damage to their
> book. while AGO's subordination is very high in these transactions,
> the underlying quality is deteriorating rapidly (regional banks).
> deferrals are a credit event, and many banks are taking that path.
> my personal opinion they will take bigger hits there than the market
> estimates now (subordination is eroding rapidly, and we've had 130
> bank defaults so far with 4x as many expected to follow).. HELOCs
> are also an issue. i'm also looking into AGO, but decided to stay
> away for now.

2009 Nov 27 12:02 AM

[TraderMark]

I used to think Munis were a suicide mission. Then I realized the US government will backstop everything in its power.

Do you really believe they will let CA for example to default? They will just print money and keep handing it out.


On Nov 26 05:00 PM Alan Young wrote:

> This sounds suicidal to me, too. Munis are very risky due to collapsing
> tax bases. If a muni is strong, it will look at two insurers going
> bankrupt already and decide that insurance is useless; if not, it
> could weigh on its insurer's book like cement shoes. This only looks
> good if you really believe that the economy is recovering.

2009 Nov 27 12:03 AM

[Gtarras]

i agree that munies are fairly safe and that the govt will be bailing them out. with all sorts sources of funding drying up, the last thing the US needs is ruined reputation of muni credit. plus, in case of default, they recover on average 97%.


On Nov 27 12:03 AM TraderMark wrote:

> I used to think Munis were a suicide mission. Then I realized the
> US government will backstop everything in its power.
>
> Do you really believe they will let CA for example to default? They
> will just print money and keep handing it out.

2009 Nov 27 02:52 PM

[johnny inca]

>>Frankly, I am unclear how both MBIA and Ambak are not bankrupt, but then again, many companies that should have went bankrupt have been saved somehow

It is exactly this kind of thinking that has MBIA at the $4 a share level. People don't know what they have, and are waiting for a sure thing / clarity. If / when it arrives MBI will already be at $15, and those who waited will have missed the main boat ride.

Instead of buying assured and hoping it falls (?) the best risk reward play is to just buy MBIA and roll the dice.

2009 Dec 03 06:56 AM

[Novice Trader]

MBIA is down, but it's most certainly NOT out.

2009 Dec 06 12:52 PM

[dell_stk]

I agree with Johnny it is better to buy MBIA now than buying AGO. There are pretty good chances for MBIA to get over 10$ levels. I also think that currently MBIA is in the accumulation mode.
I am not sure of ABK, but MBIA seems to be a winner.


On Dec 03 06:56 AM johnny inca wrote:

> >>Frankly, I am unclear how both MBIA and Ambak are not bankrupt,
> but then again, many companies that should have went bankrupt have
> been saved somehow
>
> It is exactly this kind of thinking that has MBIA at the $4 a share
> level. People don't know what they have, and are waiting for a sure
> thing / clarity. If / when it arrives MBI will already be at $15,
> and those who waited will have missed the main boat ride.
>
> Instead of buying assured and hoping it falls (?) the best risk reward
> play is to just buy MBIA and roll the dice.

2009 Dec 29 01:57 PM