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15-04-2017 Hits:77699 BoomBustBlog Reggie Middleton

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10-04-2017 Hits:77269 BoomBustBlog Reggie Middleton

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28-03-2017 Hits:47782 BoomBustBlog Reggie Middleton

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28-03-2017 Hits:79605 BoomBustBlog Reggie Middleton

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27-03-2017 Hits:79135 BoomBustBlog Reggie Middleton

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A quick overview from the finished AGO valuation model. I will offer more details over the next day or two and post a full downloadable report in the investor user groups.  I've been fairly busy of late, thus could not respond to comments. I would also note that although AGO is an interesting academic study, I find that XL Capital is a more profitable bearish play to date, which was made even more so when its share price shot up after it was downgraded.

Mark-to-market losses: We have estimated mark-to-mark loss of $600 mn in 2008 based on expected widening of credit spreads. We expect credit spreads to increase by 70 bps in 2008. This is over and above the increase in spread witnessed in last couple of months. AGO is expected to report 70% of its 2008 mark-to-mark loss in the first two quarters of 2008 since we expect credit spreads to widen faster in the first half. We also expect spreads to continue to widen in 2009 albeit at lower levels as we expect the credit market turmoil to persist in the medium term.

Losses on public finance: Under our base case scenario for public finance we expect losses of $461 mn against AGO's total exposure of $81 bn in public finance. This implies an overall loss rate of 0.56% which is consistent with the historical default rate of municipal bonds. Of this, $200 mn relates to losses relating to healthcare (implying a default rate of 1.92%) followed by investor-owned utilities with $90 mn of expected loss (implying default rate of 3.87 %).

We have computed our default rate based on the historical default rate for each of these sectors derived from the historical cumulative 5-15 year default rate. Further, we have adjusted these historical default rates based on the current market scenario and their underlying ratings. Since AGO's exposure towards investor owned utilities have BBB ratings, we have assumed a slightly higher default rate.

Losses on structured finance: In the structured finance division, we expect total loss of $1,545 mn of which $1,045 mn is related to Prime RMBS (with $895 mn from  HELOC) and rest towards subprime RMBS, CMBS, consumer receivables and other structured finance.

HELOC: Within Prime RMBS, we expect $895 mn of loss towards HELOC. Since bulk of AGO's HELOC exposure is in below-investment grade securities (91.5% of Direct Prime HELOC) and in Countrywide Financial (87.5% of Prime HELOC), we have applied higher than historical default rate (15%-30%) to better reflect the company specific exposure. Under the base case scenario, we have applied a loss rate of 3.5% on AAA HELOC and 52% on BBB HELOC.

Prime Closed End Second: For Prime CES we have estimated loss of $132 mn which is in line (or perhaps more conservative) with the popularly expected loss of $175-$225 mn.

Subordination and default rate: As stated earlier, we have not considered subordination explicitly wherein we don't have subordination information tranche wise. Like for CES RMBS, we have subordination at the group level and not trance wise. Since 38% subordination would most likely be skewed towards AAA securities than BBB securities, we have not assumed 38% subordination for both AAA and BBB trances. Instead we have adjusted default rate for different tranches. Based on historical default rates for each tranche adjusted for current market conditions and company specific factors, we have assumed loss rate (net of subordination) of 18% for AAA CES and 36% for BBB CES (2007 vintage) and loss rate of 0.05% for AAA CES and 7.55% for BBB CES (2004 vintage).

Table below summarizes subordination level (group level), our loss rate trance wise and group level and the implied default rate assumed by my team.

 
 RMBS

Subordination (a) 

Loss rate - AAA (2007) 

Loss rate - BBB (2007) 

Loss (b) 

Exposure (c) 

Cumulative Loss rate (b/c ~ d)

Implied default rate (a+d) 

Prime 1st Lien RMBS 6% 0.10% 0.87% 10  $       2,891 0.35% 6.35%
Prime CES RMBS 38% 18.60% 36.86% 132  $           456 28.95% 66.95%
Prime HELOC RMBS 1% 1.80% 40.35% 895  $       2,357 37.97% 38.97%
Alt-A RMBS 23% 0.50% 14.40% 51  $       5,533 0.92% 23.92%
Subprime RMBS 39% 5.10% 10.16% 153  $       7,010 2.18% 41.18%

We believe the above implied default rates are more realistic in nature given the high delinquency and default rates witnessed under the current credit market scenario and do not breach the 75% mark.

 

Wilbur Ross investment: Wilbur Ross investment looks more likely to come through under the current scenario. However, a lot will depend upon the credit market conditions and AGO's ability to maintain an overall AAA rating

among other conditions.

Of note is the perfomance of AGO's investment portfolio. As should come as no surprise to some, extended duraton fixed income securities have taken some capital losses. This should be noticed since strong investment performance is how insurers make money!  

Investment profile        
         

 

Amortized  Cost

Gross  Unrealized gain

Gross  Unrealized loss

Estimated  Fair Value

 

Fixed maturity securities

 

 

 

 

U.S. government and agencies 297 14 (0) 311
Obligations of state and political subdivisions 1,043 39 (3) 1,079
Corporate securities 179 5 (1) 183
Mortgage-backed securities 860 10 (5) 865
Asset-backed securities 68 0 (0) 68
Foreign government securities 71 2 (0) 73
Preferred stock 8 0 0 8
Total fixed maturity securities 2,527 69 (9) 2,587
Short-term investments 553 0 0 553
Total investments 3,080 69 (9) 3,140
         

 

Spread Analysis

 

Credit Spreads scenario analysis % change Estimated Pre-Tax Change in  Gain / (Loss)              
Widening of spreads 100% (867.5) (864.9) (862.3) (861.3) (860.3) (857.7) (856.7) (855.6)
Widening of spreads 50% (431.4) (430.1) (428.8) (428.3) (427.8) (426.5) (426.0) (425.5)
Widening of spreads 25% (213.0) (212.4) (211.7) (211.5) (211.2) (210.6) (210.3) (210.1)
Widening of spreads 10% (86.9) (86.6) (86.4) (86.3) (86.2) (85.9) (85.8) (85.7)
Base Scenario 0% 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Narrowing of spreads -10% 82.0 81.8 81.5 81.4 81.3 81.1 81.0 80.9
Narrowing of spreads -25% 209.8 209.2 208.6 208.3 208.0 207.4 207.2 206.9
Narrowing of spreads -50% 422.5 421.2 420.0 419.5 419.0 417.7 417.2 416.7
                   
CDS exposure ($ mn)       71,387       71,175       71,088       71,002       70,791       70,705       70,619       70,533
                   
Mark-to-market (gain /loss) 1Q-08 2Q-08 3Q-08 4Q-08 1Q-09 2Q-09 3Q-09 4Q-09
P&L a/c                  
Unrealized (losses) gains on derivative financial instruments       (213.0)       (212.4)          (86.4)          (86.3)       (211.2)          (85.9)          (85.8)          (85.7)
    Change in credit spread 25% 25% 10% 10% 25% 10% 10% 10%

 

 

Relative Valuation  

   

Price

Shares outstanding

BVPS

    2008 2009 2010
Assured Guaranty AGO 24.6 80.1 19.4 16.2 18.6
XL Capital XL 33.8 177.9 60.0 66.2 75.8
Ambac ABK 7.7 101.6 17.4 19.3 13.6
MBIA MBI 12.1 236.1 22.7 18.2 13.1
Security Capital Assurance SCA 18.6 33.3 17.1 18.5 20.5
The PMI PMI 0.8 65.3 40.0 40.9 N/A
Radian Group RDN 6.3 81.1 36.1 37.2 45.0
Source: Bloomberg Concensus Estimates          
             

Company

Market Cap
(US$ mn)

Net Debt              (US$ mn)

Current EV
(US$ mn)

P/B

        2008E 2009E 2010E
Assured Guaranty            1,969                 339                2,308            1.3            1.5            1.3
XL Capital            6,006            (1,011)                4,995          0.56          0.51          0.45
Ambac               786            10,352              11,138          0.45          0.40          0.57
MBIA            2,867            32,120              34,986          0.53          0.67          0.93
Security Capital Assurance               620               (203)                   417          1.09          1.01          0.91
The PMI                 50                   39                     90          0.02          0.02  N/A 
Radian Group               507                 948                1,455          0.17          0.17          0.14
Industry Average       0.47 0.46 0.60
Relative P/B Valuation  
AGO 2008
Book value per share 19.43
Industry P/B 0.47
Target Stock Price (US$) 9.14

This valuation does not use adjusted book value, which we feel is required to reflect the superior book quality of AGO in comparison to its peers. The final report next week will have the fully adjusted book valution, which I estimate will be between $17 to $19 per share.