Assured Guaranty: Poised To Grow In 2023 And Beyond

Summary

• Since 2013, AGO has repurchased 73% of its shares outstanding, all at massively accretive prices.
• The stock trades at less than 42% of adjusted operating book value.
• BIG exposure is the lowest since the Great Recession, having declined by $2.2B on recent Puerto Rico resolutions.

Seiya Tabuchi/iStock via Getty Images

Assured Guaranty (NYSE:AGO) has been one of the great capital allocation stories of the last decade under the leadership of CEO Dominic Federico and CFO Robert Bailenson. As the insured portfolio shrank after the Financial Crisis dramatically changed the industry, management used its growing excess capital position to accretively buy back stock at massive discounts to intrinsic value. This enabled robust growth in most per-share metrics and intrinsic value, despite pressures from issues such as Puerto Rico's default, low interest rates, and reduced business demand for much of the last decade. As we move into 2023, most of the headwinds have dissipated and the future is looking very bright for both AGO and its shareholders.

Assured Guaranty insures scheduled payment of principal and interest when due. In 2010, Assured Guaranty followed its former industry peers, in losing its coveted AAA rating. It was a function of the ratings agencies changing their models, as opposed to problems in AGO's financial structure, which was in excellent condition. This cemented the change in the business model, as the insurers were no longer able to provide credit protection on AAA credits. The spectacular declines of the behemoths of that era MBIA (MBI) and Ambac (AMBC) weakened investor faith in the industry. As the target market shifted to A and BBB type credits, insured volumes took many years to rebuild. For several decades, AGO continued to honor its obligations, post reasonable profits, despite major bankruptcies in Puerto Rico, Detroit, Stockton, and the lingering mortgage issues stemming for the Financial Crisis.

Over time, investor trust was regained and demand for Assured's insurance has grown. AGO's insured par outstanding dropped from $646.6B in September 2009, to $233.3B at the end of December 2022. Despite that, claims paying resources have declined by far less from $12.8B, to $10.8B. This diminished insured leverage allowed the company to free up capital that it ultimately used mostly for massively beneficial stock buybacks. Since 2013, AGO has repurchased a staggering 141MM shares, or 73% of shares outstanding at the beginning of the repurchase program, for roughly $4.7B. Management did indicate that buyback capacity would be a bit more constrained in the first half of 2023, as it pursues scale in asset management via acquisition, but I fully expect robust buybacks in the 2nd half and into the next few years.

The Federal Reserve's historically low interest rate policies reduced demand for bond insurance, as the spreads were so low, the savings from bond insurance weren't as substantial as in a higher interest rate environment. In addition, low rates reduced net investment income from the investment portfolio. Finally in 2022, due to the rampant inflation brought on by Fiscal Stimulus, the Fed's aggressive rate hikes have created very attractive yields, benefiting future earnings prospects for AGO and other insurers. Higher rates resulted in rapidly declining bond prices, which reduced AOCI quite dramatically for AGO and other insurance companies and banks. The decline wasn't nearly as bad for AGO in comparison to other financial stocks though, as the benefit of the buybacks is so accretive that it offset a good portion of the damage. While higher rates reduce demand for refinancings, it does create a bigger savings benefit from bond insurance, which is improving demand and bond insurance penetration. Investors see the value AGO provides and have even accelerated their buying in the secondary market.

The default of nearly every Puerto Rico bond was a disaster of epic proportions. Puerto Rico's government has been the epitome of corruption for decades, sadly squandering the Commonwealth's immense potential from its strategic location and tourist appeal. In June 2016, PROMESA legislation was passed to resolve the debt, and a Federal Oversight Board was appointed soon after. Instead of pushing for consensual resolutions to these debts, the FOMB has enabled Puerto Rico to overspend, not pay any debt even when it was easily affordable and has used litigation to attempt to completely destroy the legal rights of creditors in institutional asset classes such as revenue bonds. For 7 years now the FOMB has ruined Puerto Rico's access to capital, and halted the modernization of vital assets such as PREPA, simply due to its desire to punish creditors. Despite their efforts, some legal rights have been protected, and this has allowed most Puerto Rico credits to be resolved, including the GO, HTA, PBA, etc. The last debt that still isn't paying is the easiest to restructure PREPA, due to its monopoly hold on electricity on the island, and the strong net revenue lien that creditors have, but that the FOMB is trying to say doesn't exist. This has led to multiple consensual RSA or restructuring support agreements, but time and again the FOMB has intervened to destroy the deals to pursue their sick agenda. Ultimately, we will see PREPA resolved in 2023 and I believe the losses have already been taken, so while still in the headlines once in a while, Puerto Rico is no longer a big issue for AGO. The vast majority of its once over $5B of net par exposure, has been whittled down to $1.38B, with just over $700MM that isn't paying or subject to a finalized restructuring agreement.

In 2022, AGO earned $267MM, or $4.14 per share of operating income. The company generated $375MM of net business production PVP), which marks the fifth consecutive year that full-year PVP has exceed $350MM. AGO insured roughly $22B of new business par, surpassing $20B for the fifth year in a row. The company repurchased 9MM shares of stock for a total cost of $503MM ($55.88 per share), which was 13% of year-end 2021 shares outstanding. AGO's operating shareholders' value per share hit a new record of $93.92, while adjusted book value per share also finished at a record of $141.98.

At a recent price of $59.30, AGO trades at just 63% of operating book, and 41.7% of adjusted operating book value per share. These are on the lower end of the company's historic trading range, despite a fantastic outlook for business. The vast majority, if not all of Puerto Rico's losses are in the past and Below Investment Grade exposure in the insured portfolio has been reduced by $2.2B. BIG par exposure has fallen to just 2.5% from a high of 5.1% at year-end 2011. The percentage of BIG credits has dipped below 3% for the first time since the Great Recession. $1.4B of BIG exposure relates to Puerto Rico, with 47% already covered by negotiated support agreements or are currently paying. This dramatically reduced risk profile, combined with steadily improving new business production, as AGO poised to start growing once again. As new premiums are collected, the investment portfolio will benefit from higher rates and investment income.

While investors including myself are disappointed that AGO is slowing down its pace of buybacks in the first half of this year, I fully expect management to continue building shareholder value through a combination of buybacks and acquisitions. The entry into asset management has been disappointing but not disastrous. While it has improved the returns of the investment portfolio, operating profits have not followed. Management indicated in the conference call that they are likely to inorganically create scale, likely through an acquisition. CEO Dominic Federico was very adamant that if they did so, they would expect to see profits accrue very quickly, as opposed to some long-term Quixotic enterprise. Management's success has earned trust, but the idea of doubling down on asset management, which was likely the most glaring mistake made in the last decade, deserves some modest scrutiny. If it pays off and the company can start producing higher returns and profits from the investment management division, it really would be icing on the cake.

I believe AGO is worth between $70-80 per share conservatively. Intrinsic value should continue to grow due to retained earnings and buybacks. Higher rates for longer should be good for AGO's business prospects. While there will be more defaults and troubled credits in the future, getting Puerto Rico's massive default off the books will be an enormous relief and could lead towards realizing a higher valuation. Management is extremely focused on increasing returns on equity, so continued growth of the insured portfolio, cost discipline, higher investment income, and continued capital management will be the key pillars of that strategy. As a long-term investor in AGO, I feel great about the business and stock prospects. Short-term market participants might waver as the buyback tailwind won't be quite as strong this year, but long-term investors should be richly rewarded.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of AGO either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Haketia]

Hey Tim, AGO’s insured par down 30% in 1Q23 from $4.9B to $3.4B. Will they be selling this business line too as with the Asset Management? It would really remarkable if you could spin this one into good news…

www.bondbuyer.com/...

[Tim Travis]

@Haketia Might have something to do with debt issuance being down due to the massive increase in interest rates over the last year. Market share has been going up.

[Haketia]

@Tim Travis Penetration is still very low and a 30% drop is massive

[Tim Travis]

@Haketia It's not low given their target market of mostly A, BBB, and sprinkled in a bit of AA. A 30% drop is less than what many banks saw in terms of their capital markets bond issuance businesses. Nobody should be shocked issuance is down when rates rise as rapidly as they did last year. If rates stabilize a bit or go down, you'll see issuances go up. The rate of change greatly hurt capital markets activities last year, more so than the actual nominal rates.

[Tim Travis]

Excellent news with AGO merging its investment management business into a larger enterprise. Take the risk of a dilutive acquisition off the table and instead removes the earnings overhang and arguable distraction. Hope focus is on buying back stock, reinsuring or acquiring legacy insurance books, and writing profitable business. The alternative asset acquisition had potential, but something was never right with the cost structure, with scale seeming to be the primary problem. This is a vastly superior alternative than doubling down would have been imho.: seekingalpha.com/...

[IL Cricket]

@Tim Travis Completely Agree. This is a good outcome; nibbled a bit more when it down at 45-46 during the bank turmoil.

[Haketia]

@Tim Travis Yep, time to count the losses and to sell the 30% (assuming that anyone is willing to pay anything) to recoup some of the price paid to Feldstein.

This bit from the statement is plain nuts. Doubling down by adding $1 billion alternative credit risk. What a deal…

“In addition, U.S. insurers Assured Guaranty Municipal Corp. and Assured Guaranty Corp. will engage Sound Point as their sole alternative credit manager to invest $1 billion over time in alternative credit strategies, including nearly $400 million currently managed by AssuredIM as of December 31, 2022.”

The Blue Mountain acquisition was a clear disaster from day one. Surely the rating agencies, regulators, etc. have “requested” Frederico to exit a market that he never understood.

[sumark4221]

@Haketia Haketia
You never miss an opportunity to interpret things darkly.
Is it concerning that AGO committed to investing $1 BN in alt credit strategies?
Yes, yes it is. But you are already penciling in losses from such a strategy.
You are a smart guy. Can you not acknowledge that a30% stake in a $47 BN AUM manager could generate $60ishMM/yr if Sound Point successfully scales up?

You predicted doom and gloom for PR. AGO navigated it well
Now we have AIM being rationalized.

Share price is 52% of BV. Not a whole lot of room for material downside except for outside financial distress.

AGO has clearly been unable to catch a break in jts PVP business.
Primary issuance is way down despite expanding u/w spreads.

Perhaps nobody wants to view the glass as half full.

But, if AGO can get to 10% penetration rate of $400 BN market. That is $40 BN.
Assume u/w spread of 175-200 BP
That is $700-800MM in PVP

Am I saying that is a sure thing? Of course, not.

But, that is not impossible in 2024. AGO could have earnings of $700+mm
That would be $11ish per share.

At $52 today, stock offers intriguing upside with limited downside.
And if AGO resumes share buyback, everything keeps getting better.

[Haketia]

26% down since the “car crash” earnings call…

[sumark4221]

@Haketia Over the same time period
AIG PRU PFG. All down approximately 20%
LNC down almost 30%
TRV outperforming at down only 10%

Be sure to list all the car crashes on the financial highway.

AGO getting tarred and feathered with them all.

You like to harp on AGO’s issues. Yes, AIm sucks wind. But, it no longer is hemorrhaging.

AGO investment portfolio is predominantly IG corporate debt. No silly MBS coupons with 2-3% handles . And no investments in CRE as some other insurance companies do. Sure, their $600MM invested in AIM is also likely down.

On other hand, as USD has crashed from its peak in 2022, AGO should soon see a positive adjustment on their overseas assets.

Will AGO continue lower? Probably.
But, they don’t face any existential crisis as do many regional banks have faced down here recently.

Nobody wants to own financials right now. Simple as that. But AGO is not having to run to the discount window for desperate financing.

They don’t have to try to sell distressed CRE or CMBS.

They have fumbled AIM. And they ought to be soliciting secondary business at PVP margins of 300 BP as investors paid that for $3.6 BN in secondary wraps last year.

But, I am the first to agree that the overall stormy seas will rock all financials, deserved or not.

Please tell us all the horrific things wrong at AIG PRU LNC

[Haketia]

@sumark4221 AGO’s fall started on the day of the “car crash” earnings call. 9% down after one hour of trading… :-)

[sumark4221]

CDS for several of these insurers have blown out today on concerns of their balance sheet assets, such as CRE and MBS holdings.

AGO doesn't own much of those investments, and certainly does not own CRE.

AGO not nearly as screwed as these regional banks which is causing all this mayhem

[sumark4221]

First Republic Bank

Now trading at 30% of its BV
Apparently, the overall level for the average S&P bank is 150% of BV

AGO is not a bank.
At $48, stock is now almost 50% of BV which is $93.

Its assets consists almost entirely of $9 BN in bond holdings, mostly INV Grade with duration of 3.5 years.

No dicey MBS or C&I loans.
Heck, AIM might even be worth $200-300MM.

After the fallout in banks this week, the costs to banks will rise due to higher cost of capital and additional regulatory burdens.

Yet, will the avg bank now trade from 150% down to just 1X BV?

Lower, yes. But down by 1/3?
If you lined up AGO's income statements, balance sheet, and sources of "deposits" and redacted its name from the numbers, would an investor look favorably on this "bank"?

If that same investor were asked what percentage of BV it would expect to pay for this bank, would it say it deserved to trade at
1. BV
2. Industry average (let's now call that 125%)
3. 1.50-2X BV as if it were JPM
4. Or 50% of BV, similar to a suddenly struggling First Republic, whose credit ratings is now junk (whereas our "bank" has AA rating at the "bank"/opco level and A-rated at holdco

For all of the legitimate challenges ahead for AGO, I don't think there are too many CEOs of mid-sized regional banks who wouldn't trade/swap balance sheets and business outlook with AGO.

Will AGO be lower next week?

Well, if CS collapses or FRC can't be saved, then surely AGO will be lower. But will regulators be swarming AGO offices to monitor how swiftly its deposits are fleeing and how troubled is its mortgage holdings and possibly all its CRE loans and consumer loans?

Wouldn't a bank CEO love that his biggest problem is figuring out how to upgrade/enhance his underperforming non-core money management arm, whereas his core business is fine, though on hold for greater revenue as extreme market VOL retards customer flow

[sumark4221]

@sumark4221 I forgot to add this
Our mystery "bank" does not need to raise equity at this time to shore up its balance sheet.
Instead, it is still able to buy back stock, even though the pace is much lower at this time. Yet, there is cautious guidance that normal buyback will resume in 2Hb 2023

Again, this "bank" is apologizing for having to slow it's buyback.

First Republic is rumored to be possibly issuing additional equity at just 30% of BV

AGO has wood to chop, for sure. But, come on, at 50% of BV, I would say there is value there. Heck, it could even drop to 40% of BV. Why not? This could possibly become Lehman 2.0 if the authorities let CS go down

[Haketia]

Wow :-) 20% down since the “Car Crash Earnings Call”. Frederico’s performance was dismal.

Food for thought. Why should the regulator agree to any special dividend amidst this turmoil?

[sumark4221]

@Haketia I think you are being way too bearish

The latest two day plunge is almost entirely due to the banking crisis headlines

While AGO has its own issues to deal with, its business model is far superior to a bank's.

Investors are selling all financials. Heck, even MBIA and AMBC are down and they are both in wind down mode.

I am not suggesting AGO should be up. Any donkey knows that.

But their regulations are not worried about a bank run or mismarked gargantuan mortgages. PR is more of their concern. As you we'll know, PRrEPA is actually moving along nicely behind the scenes.

And for all of AGO's activities, its PVP business is "steady as she goes" with signs pointing to cautious opportunities for growth

If anything, AGO is, again, supremely cheap. Regulators don't opine about the value of the equity.

Underwriting standards, credit developments, and earnings are their concern.

Yes, AGO has stumbled with AIM.
But, it isn't anything fatal like SVB just experienced.

But, yes, AGO shares likely still under pressure. No argument. But don't confuse this selloff with existential problems at AGO, even if AIM strategy is still unclear

[Haketia]

@sumark4221 AGO was already more than 10% down when all this started. It had fallen 9% within minutes of the earnings call, then fell again. We see any news such as earnings, etc. as a potential catalyst for sharp falls.

The regulators will now be generally more cautious and this does affect the special dividend.

[sumark4221]

@Haketia You say the "regulators will now be generally more cautious..."

That's an opinion, not a fact.
You imply that regulators have been less caughtous up until now.

How will the regulator react if PREPA finally gets resolved?
How will regulator react if AGO reinsures MBIA legacy book for $500MM in PVP, representing 250 BP of u/w spread?

For all its struggles, AIM is not hemorrhaging money.
What should bother the regulators?

There is no deposit run or mismarked mortgage bonds.

Yes, AGO share price will continue to drop. But unless I missed something, AGO didn't suddenly become a regional bank

[Haketia]

Hey Tim, hope all well.

Another eventful week. It was a brilliant call, wasn't it? Frederico's performance was really underwhelming though, as you know we have a very high opinion of his accounting/spinning skills but he surprisingly looked out of his depth.

You state that "Management did indicate that buyback capacity would be a bit more constrained in the first half of 2023, as it pursues scale in asset management via acquisition, but I fully expect robust buybacks in the 2nd half and into the next few years."

Could you please elaborate on the last bit? How do you envisage that these "robust buybacks" will take place in 2H and the next years? How will they be approved and what sizes do you expect?

At the moment you have a (using Frederico's terminology) $200M "allowance", the rest of the funds are beyond reach. The size of the "allowance" depends, among other factors, on the Investment Income and AGO currently does not even cover operating expenses.

[Tim Travis]

@Haketia As of right dividends and special requested dividends, which shouldn't be a problem whatsoever as PR is almost 100% resolved and they have the lowest BIG exposure in their history. If you want to go on record doubting they will buy back stock, I'd suggest you are making a mistake.

[OKE2020]

@Haketia Like the continuing investment rumble match between you and Tim. I see your first printed sell/short recommendation on AGO was on 3-15-2020 when AGO was $31. Three years later, AGO is up 103% and the S&P is up 61%. Your follow up reports and comments have not come to past in the demise of AGO. Sometimes it's best to pack up and move on to the next idea. Would really appreciate a fresh reboot on a new idea reflecting the market upheaval we've gone thru the past 3 years. Respectfully........

[Haketia]

@OKE2020 Yes, well observed. We have been following the company for a number of years (even before 2020) and went public in February 2020 (Seeking Alpha published the article in March) until approx. August 2020 at a time in which the stock went down significantly . We did so because we thought that it was obvious that the stock would drop as it did and we hope that you followed our recommendation. Our last article was in July 2020 and the stock bottomed in September. We identified Tim's articles as a weak spot for the company that would be easy to exploit, hence the reason why we decided to publish at Seeking Alpha.

Why would anyone continue to short the stock in perpetuity after it has already tanked 50% as it did from Feb to Sep 2020? Do you think that we wait there stubbornly? Why should anybody do that? We of course took our chips and waited for the next opportunity.

We do not have a dogmatic position and our view on the stock price changed when it became clear that there would be change of government in Nov 2020 as that would mean a significant amount of money being pumped into the market. We adapt to the general circumstances and we recommend that you do the same. That is the reason why we did not publish any further article although we continue to monitor the company very closely as it provides and will provide further investment opportunities.

Our general view on the company remains the same as it was in 2019 but we do not have anything personal against the company or Frederico (he is a superb accountant as we have mentioned may times in the past). It would be great if the stock would go up to $120 tomorrow as it would create a huge opportunity to short it. It is about being pragmatic.

We may publish further articles in the future if we think that they can support our activities. At the moment we focus on event-driven opportunities such as earnings announcements (see for example last week) as the company does not sit on solid foundations and this leads to excellent short-term opportunities. Last week was very fruitful for us and we will continue to monitor the company very closely as further opportunities will arise. Why shouldn't we use those opportunities?

[sumark4221]

Tim
Nice recap. But, no new reason to buy

AIM strategy is not inspiring.
If they are going to make an acquisition, it means either

A. Paying top $$ for a high quality platform or

B Paying cheaply for another mediocre platform in the hopes of building scale

Either way, they should liquidate the $500-600MM invested in AIM funds, rather than commit precious additional capital.

Personally, I think they should redeem their investment in AIM as risk/reward is far different now that INV Grade bonds yield north of 5%, along with US T Bills.

Core PVP business seems not to be on track for any near term breakout. Just steady as she goes.

Left unsaid was that MBIA/National settled PREPA at roughly 80 cts

[gemclip]

Hi Tim. Another good article. I continue to be patient. Wanted to acquire more shares after the drop after the earnings report. But I wasn’t fast enough and the shares recovered most of their losses.

Blue Mountain seems to have been a mistake- but a modest one. I believe the acquisition price was $160MM. I’m not in favor of them doing another acquisition in the asset management area as this hasn’t done that well. The Blue Mountain CEO was going to stay and didn’t. I would be curious to know what happened there.

I wondered, based on the language of the earnings call, if they aren’t getting close to completing a deal for MBIA.

Another mistake they made was not communicating their plans to significantly reduce buybacks in the first half of 2023. Hard to believe that they didn’t know that 3 months ago.

That being said, they know they have too much capital and have done a great job buying back shares.

Puerto Rico’s FOMB has been terrible. I can’t believe how long this has dragged on. Obviously, they think it is in their benefit to do so. Fortunately, we should be getting near the end of the saga.

Regards.

[sumark4221]

@gemclip
While purchase price was "only" $160MM, they have sustained approximately $100MM in operating losses since then. So, closer to $260+MM spent with no return yet.

With over $500MM of AGO capital invested in AIM funds, why not withdraw that to pay for any further acquisition? Suddenly, they are capital constrained and they still want to tie up precious $500MM in a passive fixed income alta

[sumark4221]

@sumark4221
In a passive fixed income alternative fund?

[Tim Travis]

@sumark4221 The return on the AIM funds have been quite good. They mentioned 9.4% per annum in the call. I'd rather not see an asset management acquisition too unless there is something exceptionally special, which would have to be the hurdle rate. The funds invested in AIM funds are just an alternative to traditional fixed income, with more volatility but should produce higher long-term returns.