In the past three weeks, Assured Guaranty (AGO) has gone from $19.50 to $14.50. The newest and biggest and fear is that S&P might downgrade AGO due to changes in its rating system, meaning that AGO could be forced to raise additional capital.
Some background on AGO…
Although AGO had to raise capital and accept a $1 billion investment from Wilbur Ross, AGO still did a much better job of underwriting and managing the credit crisis than their rivals like MBIA and Ambac. AGO even managed to acquire FSA, a large muni bond insurer, expanding their market dominance. AGO is basically a monopoly right now—it was the only company writing new insurance on municipal bonds during 2010.
AGO also had a AAA until S&P downgraded them to AA+ in October 2010. AGO claims the October downgrade was unwarranted and was due to changes in criteria as opposed to changes in AGO’s capital position and risk portfolio. Furthermore, S&P did not provide clarity on their capital evaluation and the stress loss scenario S&P imposed seemed to be unduly harsh—1,600 bank failures and 25% unemployment.
Another thing I like about AGO is that value investor Bruce Berkowitz is high on MBIA. If he could purchase more of the stock he would, but New York State law prevents an investor from going above the 9.9% threshold. If Berkowitz is high on MBIA, a less well-run company compared to AGO, this gives me greater confidence in AGO.
Other Fears
Some other fears affecting investors is the impending muni crisis. Thanks to doomsayers like Meredith Whitney, investors now have a totally irrational fear that there will be hundreds of muni bankruptcies and even states going bankrupt. I see a host of reasons why things will not be as bad as they seem right now. Tax revenues for 2010 are going to be higher than they were in 2007. In the past several weeks, we’ve seen elected officials making tough decisions about their budget problems or getting prepared to make those tough decisions. Then there are simple facts like the costs of bankruptcy can easily outweigh any benefit. It’s also damn hard for a municipality to successfully file for Chapter 9, as it must: (1) be specifically authorized by state law to be a debtor (and there are only 27 states that authorize this); (2) demonstrate insolvency; (3) must be voluntary; and (4) must show proof of an attempt to avoid filing.
There’s also the fact that Chapter 9 has been pretty rare since the creation of the law in 1934. And the majority of debt defaults have occurred with unrated issues. AGO has only underwritten “BBB” or better rated bonds—78% of AGO’s net par outstanding is “A” or better.
Pundits also make bankruptcy sound like an easy choice. It’s not. Warren Buffett has also declared his fears and also stopped underwriting new business after 18 months. And as for Buffett, I would watch very closely to see if his words match up with his actions. I wouldn’t put it past him to play up the possibility of bad things happening in the muni debt markets so that he has a better opportunity to come swoop in on all of the deals when they arrive due to irrational selling.
I also like the fact that the buy-side dominated the questioning in the most recent quarterly conference call I listened to. I think there were a total of 5 different hedge funds represented versus 3 sell-side firms. And guess which group was asking the better questions? I have literally never experienced this before with a conference call. The fact that the buy-side is so well represented on a conference call is a positive sign for me.
Then there is the large discount to book value and huge discount to adjusted book value. And then there is the ongoing success of bond insurers and Fannie and Freddie of achieving rescissions and put-backs. Bond insurers could recover more than $4 billion from banks for breaches of representations and warranties on RMBS they guaranteed…
You get the point. I think there’s a whole lot of good news on the horizon and not much else can go wrong that hasn’t already gone wrong in the past three years.
Today AGO is holding a conference call to speak about S&P’s changes. I’ll be listening. Whatever AGO decides it needs to do, it will be positive for the stock price at current levels. If AGO needs more capital, then great—it gets more capital which it probably won’t need and the stock responds positively from these levels. If AGO doesn’t need more capital, then great—the stock responds positively from these levels.
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