AGO, as well as the other monolines, are quite time consuming to review an analyze. This makes it quite "expensive" for me, since analytical time is money, not to mention oppurtunity costs. That being said, we are only about half way done. I usually don't post spoilers to my blog, but I will make an exception since this is so newsworthy and heavily anticipated.
First, let's review this press release:
... announced today that it has signed an agreement for WL Ross & Co. LLC (“WL Ross”) to purchase $250 million of common shares of Assured and to provide a commitment to purchase up to $750 million of additional common shares of Assured at the option of the Company. The closing of the initial $250 million investment is subject to regulatory approvals and other customary conditions. The closing of any subsequent investments will require shareholder approval, which the Company will request at its 2008 annual general meeting. First and very important observation, they signed a conditional commitment, they did not recieve any monies and may not.
“We are extremely pleased that Wilbur Ross has chosen Assured as his preferred investment vehicle in the financial guaranty industry,” commented Dominic Frederico, President and Chief Executive Officer of Assured Guaranty Ltd. “This flexible capital source will allow us to continue to capitalize on the significant growth opportunities we see and will support our further expansion in both the direct and reinsurance markets.” From what I have gathered, much of the strucutred product guaranty business is dead. For one, the buyers market for the stuff is near nill, and the willingess to insure it at anything near practical terms has faded. I think this is smoke and mirrors. AGO is a very well managed company from what I have gathered (one of the best in the industry), but they have written poison too, and it has hurt them to the point where the pain is evident.
Wilbur Ross, Chairman and Chief Executive Officer of WL Ross & Co. LLC stated, “We believe that Assured has an excellent opportunity during this time of uncertainty in the financial markets to provide investors with credit enhancement products in both the public and structured finance markets. We look forward to a long and profitable association with Assured.” Again, re: structured products - smoke and mirrors, but we will see.
The purchase price per common share for the initial investment will be the higher of (i) 97% of the average of $22.43 (the Company’s NYSE closing price on Friday, February 22, 2008) and the average NYSE closing price for Friday, February 29, 2008 and Monday, March 3, 2008, or (ii) $21.76 (97% of $22.43). A condition to closing the initial investment is that Wilbur Ross, Chairman and Chief Executive Officer of WL Ross, will be appointed to the Company’s Board of Directors.
The additional $750 million commitment by WL Ross is available at the option of the Company for one year from the date of the closing of the $250 million investment. The price for subsequent investments will be 97% of the volume weighted average price of the Company’s common shares for the 15 trading days prior to notice of any subsequent investment. Is subsequent investment defined as Ross's investment only or any other third party? This is a key point! The ability of Assured to make a mandatory draw on the $750 million commitment is subject to (i) the subsequent investment price of Assured’s common shares being no more than 17.5% above or below the price per common share of the initial investment, As Moody's Zero noted, this is a significant caveat. It effectively removes the ability of AGO to draw down on the capital in dire straights of or when the share price collapses. There competitors have seen > 17.5% drop in share price in less than one trading day and have never regained it (at least not to date). If this in turn trips net worth covenants in their debt, this effectively nullifies the investment. In addition, it puts an applied cap on the updside of the stock. If there largest investor won't pay the price that was prevalent last year, even the most name brand stricken amongst us may not! (ii) the maintenance of triple-A (stable) ratings for Assured Guaranty Corp. and double-A (stable) ratings for Assured Guaranty Re Ltd. from Standard & Poor’s, Moody’s and Fitch The may also be a problem. Moody's and S&P are just rolling over as usual, acting like they are immune to litiigation, but Fitch really does look like they are aggressively trying to gain respect. There are definitely some losses coming down the pike for AGO. See the graphs below and the absence of material adverse changes in the credit quality of the Company’s financial guaranty portfolio Well we have to define "material adverse changes, becuase we have already experienced that and investment portfolio The investment portfolio has already seem some significant mark to market drawdown, see the chart below from the most recently publicly disclosed information at the time of a drawdown.
This is a sensitivity grid tat show changes in CDS positions a result of credit spread delta.
Change in fair values on the net balance of Assured Guaranty's net structured credit default swap derivative positions assuming immediate parallel shifts in credit spreads at September 30, 2007 | |||||||
Credit Spreads | Estimated Net Fair Value (Pre- Tax) | Estimated Pre-Tax Change in Gain / (Loss) | |||||
September 30, 2007: | |||||||
100% widening in spreads | (443.8) | (241.8) | |||||
50% widening in spreads | (320.9) | (118.9) | |||||
25% widening in spreads | (261.4) | (59.4) | |||||
10% widening in spreads | (225.8) | (23.8) | |||||
Base Scenario | (202.0) | 0.0 | |||||
10% narrowing in spreads | (159.3) | 42.7 | |||||
25% narrowing in spreads | (97.3) | 104.7 | |||||
50% narrowing in spreads | 15.4 | 217.4 | |||||
The unrealized loss on derivatives results largely from the decline in fixed income security market prices resulting from higher credit spreads due to the recent lack of liquidity in the High Yield CDO and CLO market as well as continuing market concerns over the most recent vintages of subprime residential mortgage-backed securities, rather than from credit rating downgrades, delinquencies or defaults on securities guaranteed by the Company. Now, let's take a look at these spreads...
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The H igh Yield CDX
As for the credit quality of the portfolio, let's not assume AGO floats on water. Remember when rates were dropped heavily by the Greenspan? Well that caused a flush of global liquidity which allowed structured product default rates to fall between 50% to 66%. This was directly after a significant spike marked by the recession, 9/11 and the dot com bubble burst. Well, this bubble burst is much worse than the dot com one. Where do you things these default rates are headed now?
Now, let's take a look at AGO's par exposure...
Housing, investor owned utilites and healthcare are at risk... Tax backed project may be at risk in this environment for smaller utitilies.
My guess would have been would have been that leveraged loans and junk bonds would have sunk AGO. These area do indeed have awful macro conditions and spread are flying through the roof, but management was prescient enough to stay in the super senior AAA area with significant subordination. They are getting hit hard with directly written subprime HELOCs guarantees though (1% subordiation). Their prime and ALt-A will hit them very hard as well. Look at these numbers.
Direct Subprime | |||||||
Ratings : | Super Senior | AAA | AA | A | BBB | BIG | Total |
2003 and prior | 0 | 0 | 0 | 0 | 0 | 0 | 0 |
2004 | 248 | 173 | 0 | 0 | 0 | 47 | 473 |
2005 | 1,986 | 1,384 | 0 | 0 | 0 | 0 | 3,788 |
2006 | 996 | 694 | 0 | 0 | 196 | 0 | 1,900 |
2007 year to date | 303 | 211 | 500 | 0 | 0 | 0 | 577 |
Total | 3,533 | 2,462 | 500 | 0 | 196 | 47 | 6,738 |
Year | Net Par O/S | Pool Factor | Subordination | Cumm loss | 60+ Delinq | ||
2005 | 3788 | 44% | 52% | 1% | 30% | ||
2006 | 1900 | 69% | 32% | 1% | 26% | ||
2007 | 577 | 64% | 40% | 2% | 24% | ||
6,265 | 59% | 39% | 1% | 27% |
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These numbers are as bad as Countrywide, oh yeah! That's why.
Consumer receivables
Mortgage-related
problems seem to have seeped into consumer lending. Citigroup increased
its provision for credit losses by $3.3 billion, because it expects
higher delinquencies on credit cards, auto loans, unsecured personal
loans, and mortgages.
Corporate bonds
The
default rate of corporate bonds may also be affected by the strength of
the economy. 0.675% - default rate on corporate bonds rated triple-A by
Moody's.
Structured finance and corporate bonds
Over
the 1991–2005 period, the average annual default rate for Fitch-rated
global structured finance bonds was 0.70%, compared with 0.65% for
corporate bonds.
Fitch’s global structured finance average annual
default rate at the investment-grade level was 0.13%, compared with
0.11% across Fitch’s global corporate universe. Further, default rates
were similar at the non-investment-grade level with 3.40% for Fitch’s
global structured bonds versus 3.27% for Fitch’s global corporate
ratings.
CMBS
There
could be higher delinquencies from 2005 through 2007 vintage as CMBS
issuance reached record levels. CMBS issuance stood at $206 bn and $215
bn in 2006 and 2007, respectively, versus $170 bn in 2005.
Fitch
expects commercial loan defaults to increase in 2008, it said that the
loan default rates implied by the pricing of the CMBX market indices
are “extremely high.”
Differences exist among the four CMBX indices, including differences in
credit characteristics. However, the loan default rates implied by
current CMBX pricing on the most recently issued CMBX index are
extreme. If one looks at CMBX.NA.BBB-.3, which closed at a spread of
938 basis points (bps) on Dec. 31, 2007, some market participants
indicate that the implied default rate is almost three times historic
default rates. Actual historic CMBS 10-year cumulative loan default
rates are 8%, which means the implied default rates on CMBX are as high
as 24% on average, given the recent pricing of CMBX. “Fitch expects
loan defaults to rise given the current capital market environment, but
not three-fold,” said Susan Merrick, Managing Director and head of
Fitch’s CMBS group.
There's a lot of pain to be felt from the UK RMBS, UK Public Finance and US muni market. I've highlighted in red what I am wary of .
Geographic exposure | ||
U.S.: | Net Par Outstanding | % of NPO |
California | 13,068 | 7% |
New York | 7,351 | 4% |
Florida | 6,403 | 3% |
Texas | 4,718 | 2% |
Illinois | 4,243 | 2% |
Massachusetts | 3,763 | 2% |
Pennsylvania | 3,509 | 2% |
New Jersey | 2,613 | 1% |
Washington | 2,540 | 1% |
Michigan | 2,300 | 1% |
Other states | 31,405 | 16% |
Mortgage and structured | 73,820 | 37% |
Total U.S. | 155,733 | 78% |
International: | ||
United Kingdom | 25,133 | 13% |
Germany | 4,386 | 2% |
Australia | 3,086 | 2% |
Italy | 899 | 0% |
Turkey | 822 | 0% |
Other | 10,220 | 5% |
Total International | 44,546 | 22% |
Total exposures | 200,279 | 100% |
The following are the hits to equity I expect AGO to take. What I haven't done yet is to calculate the payoff periods. This is rather indepth, and the longer the period the more bullish for AGO. A significicant capital infusion also takes the profit potential out of the short by adding cushion to capital. I have not factored in Wilbur Ross, and it is not a done deal so all we can do is speculate at the moment. This is all just a rough compilation of notes and snippets of the model under development. I rushed to get it up to spark discussion. So, discuss away!!!
Overview losses as % of tangible equity
Base Case | Pessimistic Scenario | |||
U.S. Public finance | U.S. Public finance | |||
General obligation | 3.09% | General obligation | 3.38% | |
Tax backed | 2.74% | Tax backed | 2.99% | |
Municipal utilities | 0.43% | Municipal utilities | 0.47% | |
Healthcare | 12.52% | Healthcare | 13.72% | |
Transportation | 0.20% | Transportation | 0.23% | |
Higher education | 0.06% | Higher education | 0.07% | |
Investor-owned utilities | 5.63% | Investor-owned utilities | 6.14% | |
Housing | 3.44% | Housing | 3.76% | |
Other public finance | 0.89% | Other public finance | 0.98% | |
Total U.S. public finance | 29.01% | Total U.S. public finance | 31.74% | |
U.S. structured finance | U.S. structured finance | |||
Pooled corporate obligations | 1.52% | Pooled corporate obligations | 6.12% | |
Prime mortgage-backed and home equity | 27.73% | Prime mortgage-backed and home equity | 35.65% | |
Subprime mortgage-backed and home equity | 10.52% | Subprime mortgage-backed and home equity | 12.31% | |
Consumer receivables | 5.32% | Consumer receivables | 6.38% | |
Commercial mortgage-backed securities | 6.04% | Commercial mortgage-backed securities | 6.47% | |
Commercial receivables | 1.15% | Commercial receivables | 5.76% | |
Structured credit | 3.26% | Structured credit | 8.70% | |
Insurance securitizations | 0.27% | Insurance securitizations | 0.72% | |
Other structured finance | 0.28% | Other structured finance | 0.73% | |
Total U.S. structured finance | 56.10% | Total U.S. structured finance | 82.85% | |
International | International | |||
Infrastructure and pooled infrastructure | 4.44% | Infrastructure and pooled infrastructure | 4.93% | |
Pooled corporate obligations | 2.82% | Pooled corporate obligations | 3.17% | |
Regulated utilities | 3.69% | Regulated utilities | 4.04% | |
Mortgage-backed and home equity | 0.54% | Mortgage-backed and home equity | 0.69% | |
Public finance | 0.28% | Public finance | 0.31% | |
Commercial receivables | 2.80% | Commercial receivables | 3.36% | |
Commercial mortgage-backed securities | 0.22% | Commercial mortgage-backed securities | 0.29% | |
Future flow | 3.66% | Future flow | 4.39% | |
Insurance securitizations | 3.45% | Insurance securitizations | 4.14% | |
Structured credit | 0.87% | Structured credit | 1.04% | |
Consumer receivables | 0.16% | Consumer receivables | 0.22% | |
Other international structured finance | 0.50% | Other international structured finance | 0.60% | |
Total international | 23.42% | Total international | 27.17% | |
Total losses | 108.53% | Total losses | 141.76% |