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This is an update of the work I am doing on AGO. Since I don't feel like putting out my usual eloquent proseCool, I'll just get right to the point. We have built-in subordination where tranche-wise information is available. For RMBS, we have this information only at an overall level (year wise) and not tranche-wise. We have subordination rate of 38% for 2007 for Prime Closed End Seconds. Had this information been available into AAA, AA, etc tranches, we would have applied this to compute net loss. However, we have tried to be realistic (to the extent there is visibility under the current credit market conditions) while applying default percentages.  

Later on, I will post AGO’s pro-forma statements incorporating loss and mark-to-market write-downs. 

At an overall level, AGO’s future performance and losses hinge upon the credit market which is being squeezed by serious credit crunch. My previous post gave anecdotal evidence of the the underlying RMBS and CMBS facing fire sales, thus putting serious downward pressure on the CDS that AGO writes. The current turmoil is likely to get much, much worse in view of aggravating recessionary conditions and worsening macro-economic factors.

We have estimated default loss under three scenarios: 

Loss on default ($ mn)

Best Case

Base Case

  Worst case

 U.S Public Finance

438

461

506

 U.S Structured Finance

1404

1545

1888

 International

307

349

406

Total Loss

2,149

2,354

2,800

 

 

 

 

 

 

While the above loss figures have been based on detailed assumptions on default percentages for each category of AGO’s exposure, it can also be substantiated by AGO’s exposure to some of the high-risk securities

·         CDO exposure:   AGO has huge outstanding amounts of exposure in leveraged structured products, and even more so when viewed in light of their equity capital. The total notional amount of insured CDS exposure to CDOs outstanding as of December 31, 2007 and 2006, and included in the Company's financial guaranty exposure was $71.6 billion and $49.4 billion, respectively against its equity base of $1.6 bn.

·         Mark to market loss:  As a result of continued widening of spreads, AGO is expected to report mark-to-market loss of $600 mn and $474 mn in 2008 and 2009, respectively. Continued market-to-market loss on the company’s CDO’s exposure will impact AGO’s financial performance.

·         HELOCs:  As of December 31, 2007, AGO had nearly $2.4 bn of exposure in HELCO ($1.6 bn in direct and $0.7 bn in reinsurance). Within direct writing, AGO has nearly $1.5 bn exposure in below grade investments (nearly its entire equity) while in reinsurance AGO has nearly $0.3 bn of exposure below investment grade.

Of $2.4 billion related to HELOC securitizations, $2.1 billion are transactions with Countrywide which were recently downgraded by Moody's and Fitch and placed on watch negative by Standard & Poor’s. Countrywide Financial Corp was forced to take a $704 million charge against its $32.4 billion prime HELOC portfolio in 4Q2007. Look here for a glimpse of info on why anything originated out of Countrywide is totally bad news. 

In view of the recent problems relating to Countrywide further fuelled by the fact that AGO has just under 1% subordination in HELOCs, we believe that AGO could see some additional mounting losses under HELCO exposure. Under our base case scenario, we expect total losses from RMBS exposure to be approximately $1,045 mn out of which $895 is relating to HELOCs.

 

Stay tuned for a more explicit analysis and my strategy regarding where I think the bubble burst momentum is going next. As usual, this is my collection of insurance and monoline analysis in the  Insurers and Insurance section of my blog.