Determining Assured Guaranty's True Value

A quick overview from the finished AGO valuation model. I will offer more details over the next day or two and post a full downloadable report in the investor user groups. I've been fairly busy of late, thus could not respond to comments. I would also note that although AGO is an interesting academic study, I find that XL Capital is a more profitable bearish play to date, which was made even more so when its share price shot up after it was downgraded.

Mark-to-market losses: We have estimated mark-to-mark loss of $600 mn in 2008 based on expected widening of credit spreads. We expect credit spreads to increase by 70 bps in 2008. This is over and above the increase in spread witnessed in last couple of months. AGO is expected to report 70% of its 2008 mark-to-mark loss in the first two quarters of 2008 since we expect credit spreads to widen faster in the first half. We also expect spreads to continue to widen in 2009 albeit at lower levels as we expect the credit market turmoil to persist in the medium term.

Losses on public finance: Under our base case scenario for public finance we expect losses of $461 mn against AGO's total exposure of $81 bn in public finance. This implies an overall loss rate of 0.56% which is consistent with the historical default rate of municipal bonds. Of this, $200 mn relates to losses relating to healthcare (implying a default rate of 1.92%) followed by investor-owned utilities with $90 mn of expected loss (implying default rate of 3.87 %).

We have computed our default rate based on the historical default rate for each of these sectors derived from the historical cumulative 5-15 year default rate. Further, we have adjusted these historical default rates based on the current market scenario and their underlying ratings. Since AGO's exposure towards investor owned utilities have BBB ratings, we have assumed a slightly higher default rate.

Losses on structured finance: In the structured finance division, we expect total loss of $1,545 mn of which $1,045 mn is related to Prime RMBS (with $895 mn from HELOC) and rest towards subprime RMBS, CMBS, consumer receivables and other structured finance.

HELOC: Within Prime RMBS, we expect $895 mn of loss towards HELOC. Since bulk of AGO's HELOC exposure is in below-investment grade securities (91.5% of Direct Prime HELOC) and in Countrywide Financial (87.5% of Prime HELOC), we have applied higher than historical default rate (15%-30%) to better reflect the company specific exposure. Under the base case scenario, we have applied a loss rate of 3.5% on AAA HELOC and 52% on BBB HELOC.

Prime Closed End Second: For Prime CES we have estimated loss of $132 mn which is in line (or perhaps more conservative) with the popularly expected loss of $175-$225 mn.

Subordination and default rate: As stated earlier, we have not considered subordination explicitly wherein we don't have subordination information tranche wise. Like for CES RMBS, we have subordination at the group level and not trance wise. Since 38% subordination would most likely be skewed towards AAA securities than BBB securities, we have not assumed 38% subordination for both AAA and BBB trances. Instead we have adjusted default rate for different tranches. Based on historical default rates for each tranche adjusted for current market conditions and company specific factors, we have assumed loss rate (net of subordination) of 18% for AAA CES and 36% for BBB CES (2007 vintage) and loss rate of 0.05% for AAA CES and 7.55% for BBB CES (2004 vintage).

Table below summarizes subordination level (group level), our loss rate trance wise and group level and the implied default rate assumed by my team.

click to enlarge

We believe the above implied default rates are more realistic in nature given the high delinquency and default rates witnessed under the current credit market scenario and do not breach the 75% mark.

Wilbur Ross investment: Wilbur Ross investment looks more likely to come through under the current scenario. However, a lot will depend upon the credit market conditions and AGO's ability to maintain an overall AAA rating among other conditions.

Of note is the perfomance of AGO's investment portfolio. As should come as no surprise to some, extended duraton fixed income securities have taken some capital losses. This should be noticed since strong investment performance is how insurers make money!

Comments

[beachtango:]

Mr. Middleton,
My ocomment is that you should not comment on bond insurers anymore...Of all the bond insurers AGO seems quite well positioned and less exposed to explosions in the sub-prime mess.
Also, I and many others on these message boards take great exception regarding your efforts to shoot down companies (MBI, ABK) that are earnestly attempting to recover, prevail and benefit the American public. I think you should focus on solutions. Everyone knows these companies made mistakes, the list of financial institutions is quite lengthy that are in deep water due to decisions that at the time seemed acceptable risks. All of the aforementioned has been discussed endlessly. Now we repair the already identified issues. Rehashing over and over serves no one..not even your short positions. I would say you are out of your league at this point young chap. You have had your fun and made your monies. You should change your cynic tone, because it's quite transparent. as well as boring...have a nice day.

2008 Mar 14 02:51 PM

[pavlov:]

Beachtango, you made your own bed...now lie in it!
Feel a little uncomfortable from your own urine and feces?
Too bad!
Suck it up!
Take the pain!

2008 Mar 16 04:20 PM