AGO is a monoline insurance company that trades at 6x 2008 earnings and 3.5x my estimate for 2009 earnings. The company has been dragged down along with the other monolines as the market has proverbially "thrown the baby out with the bathwater". While most of the other monolines have insured a significant amount of subprime RMBS CDOs and CDO-squared, AGO has limited subprime RMBS and no CDO exposure post 2004. As a result, while the other monolines are struggling to find capital to maintain their AAA rating AGO has been reaffirmed AAA by Moody's, S&P and Fitch. Yesterday, S&P released an updated report on loss estimates for the monolines under a stress scenario. While many monolines saw their loss estimates increase dramatically, AGO's loss estimate was increased by $500K.
December 17 - Stress Test
ABK - losses of 1,849 on capital cushion of 1575 - underfunded by 275
MBI - losses of 3,181 on capital cushion of 1775 - underfunded by 1,400
AGO - 31.1mm of losses on capital of 275mm - overfunded by 245mm
January 17th - Stress Test
ABK - losses of 2,249 on capital cushion of 1575 - underfunded by 675
MBI - losses of 3,520 on capital cushion of 1775 - underfunded by 1,750
AGO - 31.6mm of losses on capital of 275mm - overfunded by 245mm
My thesis is that AGO emerges out of this subprime catastrophe as one of the dominant players in the monoline industry. They are benefiting from massive improvements in pricing as most other monolines are capital constrained and can not offer new coverage. Earnings will accelerate in the core business as they are writing new business at ROEs in excess of 20% vs. historic sub 10%s. This will lead to EPS growing from 2.65 in 2007 to $5.00+ in 2009. The company recently completed an equity raise which it re-invested in a deal to reinsure municipal bonds underwritten by ABK. According to management, the ROE on that book of business is 20%+ (including the equity dilution, the deal is 30-35 cents accretive). I think that AGO is in a prime position to do additional reinsurance deals at these robust ROE levels in the near term as MBI, ABK, SCA, and FGIC are all in the market for more capital.
AGO's provides significant detail on its portfolio and its exposures appear to be manageable. I have reservations on only a couple of HELOC deals - one completed in 2007 and a second completed in 2005. The deals are Prime helocs, but I expect that as they mature, AGO will have to take a 50mm charge ( I expect the company to take a 13mm after tax charge for the helocs in the next quarter). The remainder of the business is in very good shape. Details on the portfolio can be found on the company's website at www.assuredguaranty.com
I believe that the monoline industry looks similar to the property casualty business after hurricanes Rita and Katrina. Those that had no (or limited) losses, generated business at significant ROEs, while those with massive losses were forced to raise capital at dilutive rates / and or liquidate. I think this market plays out the same way - Warren Buffet's entrance into the business is a testament to the future profit potential in the industry.
Some investors are worried about a material contraction in the monoline industry. Although this would have significant ramifications for large participants such as ABK and MBI, AGO only has a 1% market share of the muni market. Assuming the market contracted by 50% and AGO only secured a 20% future market share, AGO would grow production by 10-fold. With ROE's expanding to 20% over the next few years and with an estimated year end BV of $30 (ex- the mark to market) and $5 of earnings, the stock should trade to 1.7-2x BV, or $50 - $60 a share (180% - 240% upside).
- Q4/Q1 bookings and the recognition that this company is going to grow earnings and book value at an accelerated pace
- Additional large reinurance announcements (probably within the next 60 days)