Financial, Real Estate, Stock Markets Trends and Current Affairs

If you remember how I said I invest - form an investment thesis,
research the hell out of it, gain a cheap position, sit back and see if
your were right or wrong. Well, you all know how negative I am on the
global macro scene - and I have shared that I think Bernanke, et. al.
will blow the "Mother of All Bubbles". Morgan Stanley's global
strategist have chimed in on this as well.

This is the result of my research on Assured Guaranty (AGO). Since it is rather extensive, I will only post the industry and company highlights in HTML. The full version has valuation, mark to market losses, peer group comparisons, pro formas, etc. Technically this is still a draft/release candidate, but I will release it to the public domain (registered blog members) anyway. Beware, it is (as is everything else) a work in progress and subject to change. You can download it here:

Assured Guaranty_Consolidated (796.13 kB 2008-03-21 12:12:42) or continue on for the industry overview.

I. INDUSTRY & OVERVIEW INVESTMENT HIGHLIGHTS

AGO remains vulnerable to continued bond market troubles

Assured Guaranty (AGO) has until now fared better than its peers in credit and capital markets owing to a significant cushion that it has in the form of a relatively higher share of superior grade investments in its insured portfolio. While stocks of other bond insurers, specifically Ambac, MBIA and Security Capital Assurance, have fallen sharply over the last few months, AGO has sailed successfully through the rough waters with its stock performance hardly bearing the brunt of the current turmoil in the bond insurance market. This has been primarily on the back of the favorable ratings AGO has till now enjoyed from various credit agencies. However, despite AGO's strong fundamentals the debacle in the credit market could seriously impact its financial position, causing rise in default losses and mark-to-market write-downs of its portfolio. The rating agencies, which have so far maintained triple-A ratings on AGO and have been under constant pressure to review all bond insurers' ratings, are likely to start considering a rating downgrade in view of projected losses from defaults. Any downgrade of AGO rating will seriously impact its advantageous position over other bond insurers and make it more competitive for the Company to insure new offerings.

I.1. Investment concerns

o Destabilizing US bond insurance industry. Having been hit hard by the unfolding debacle in subprime mortgage debt, the bond insurance industry is witnessing large-scale losses and rating downgrades. Large insurers like MBIA and Ambac which are striving to maintain their triple-A ratings are trading at 6.5% and 15.1%, respectively, to their last 12 month high. FSA and AGO are the only insurers which have managed to retain top ratings right through the debacle. While a large number of market participants are contemplating a further downgrade of ratings (including for AGO and FSA) in view of current gridlock in the credit markets, many of them are also projecting a rise in the global speculative-grade default rate which was at the lowest level at 0.7% in February 2008 in the last 12 years.

o Credit ratings likely to be a case for question. Credit agencies including S&P, Moody's and Fitch have maintained triple-A rating on AGO all this while, injecting a lot of confidence in the investors, but questions are being increasingly raised on the authenticity and justification of credit agencies' ratings in view of the subprime and credit market meltdowns. Ambac and MBIA commanded triple-A ratings until huge losses on their portfolio surfaced and their stocks lost over 80% of their value. Recently, while S&P reaffirmed an AAA rating for these two stocks, Fitch downgraded Ambac to AA and is considering downgrading MBIA. In addition, the fact that AGO also assigns internal rating to its portfolio raises a lot of doubts over possible revision amid a likely increase in default rates off worsening credit conditions.

o Increasingly challenging environment to retain triple-A ratings. Bond insurers including AGO are under constant pressure to maintain triple-A ratings to ensure that their ability to guaranty new issues does not deteriorate. With an estimated $250 billion of subprime mortgage write-downs still projected to be in the pipeline and bond insurers like Ambac and MBIA having already eroded a substantial portion of their capital, it is going to be extremely hard for them to retain the top ratings. Rating agencies are also under constant pressure to review their ratings amid rising concerns that the cushion the bond insurers have against possible (and rising) defaults is inconsistent with triple-A ratings. AGO, which has a relatively higher exposure to investment-grade securities, is likely to bear the brunt of losses and face a possible revision in its top-rating. While this may impact AGO's ability to insure new bond issues, it may also endanger the additional $750 mn financing arrangement from Wilbur Ross, which is contingent upon maintenance of triple-A rating by the Company.

o Stress on municipal bonds. Mounting fears of US recession led by weakening macro-economic fundamentals have raised concerns over a rise in defaults on municipal bonds. With conditions in the US residential and commercial sector continuing to worsen, municipal authorities face a difficult task of achieving their tax receipt targets which could in turn lead to increased budget deficits. California's deficit, for instance, had already ballooned to $16 bn in February 2008 from $14.5 bn in January 2008 off reduced tax collections caused by falling housing prices. Lowering employment levels (as evidenced by the biggest layoffs in five years of about 63,000 jobs in February 2008), fast declining capital expenditure and decelerating industrial output are adding to the woes.{mospagebreak}

o Escalating mark-to-market losses on CDO/CDS. Widening credit spreads in the fast deteriorating credit markets have resulted in large scale write-down in value of RMBS and other underlying securities. The US housing and mortgage sectors have hardly shown any positive response to Fed's aggressive rate cuts in the recent months to ease panic liquidity conditions stemming from uncertainty over the future of the US economy. The falling values of the underlying RMBS and CMBS are putting serious downward pressure on CDO/CDS that AGO underwrites impacting the Company's bottom-line. AGO reported mark-to-market losses of $221 mn and $411 mn in 3Q07 and 4Q07, respectively, resulting in negative earnings of $115 mn and $260 mn in these periods. AGO's mark-to-market write-downs are likely to be equally significant in 2008 and 2009 since the macro economic indicators have not demonstrated any recovery amid a growing probability of recession, which could result in further widening of credit spreads. As a result, we expect AGO to report $598 mn and $469 mn mark-to-market losses on CDS exposure in 2008 and 2009, respectively.

Not only did they add that much liqudity, they expanded the eligible collateral to include CMBS. It appears that the I banking system was in more trouble than we were led to believe. Now, those companies with high levels of ineligible collateral will still have many of the same problems as last week. In addition, the Fed can swap for treasuries all it wants, no one will want to buy these structured and MBS securities. Too many people know what's behind them and what level in the boom-bust cycle they were written on.

From Bloomberg :

The Federal Reserve, in its first extension of credit to non-banks since the Great Depression, lent $28.8 billion as of yesterday to the biggest securities firms to try to stabilize capital markets.

In a separate announcement, the Fed expanded collateral eligible for its first auction of Treasuries March 27 to include bundled mortgage debt and securities linked to commercial real- estate loans. The value of the sale was set at $75 billion, part of a $200 billion facility unveiled last week... The recipients of the Fed's credit are getting cash and Treasury notes in exchange for securities tied to mortgages and other distressed debt...

The central bank's Primary Dealer Credit Facility, announced March 16, allows Wall Street banks to borrow money overnight at a 2.5 percent interest rate, the same charged to commercial banks. The Fed bypassed its own emergency-lending policies and used broader authority in the Federal Reserve Act to give both kinds of companies the same borrowing costs.

Six Months

The central bank said the loans will be available for at least six months. The Fed's decision to be lender of last resort to the 20 primary dealers of government debt came two days after the Fed provided emergency financing to Bear Stearns through JPMorgan.

The Fed's weekly balance sheet released today showed other credit extensions, including loans to facilitate JPMorgan's purchase of Bear Stearns, averaged $5.5 billion a day for the week ended yesterday. The balance ended at zero, according to the Fed's weekly balance sheet.

The zero balance on the Bear Stearns loans signals that the Fed has yet to extend the $30 billion in financing to JPMorgan in exchange for collateral that includes ``less liquid'' Bear assets. The $5.5 billion daily average of the JPMorgan-Bear Stearns loan indicates that a March 14 bridge loan, assuming it was paid off three days later, totaled about $13 billion.

`Show Some Leadership'

Morgan Stanley and Goldman Sachs Group Inc. said yesterday that they borrowed to ``test'' the new lending facility. Lehman Brothers Holdings Inc. Chief Financial Officer Erin Callan said in a Bloomberg Television interview that the firm was using the lending window to ``show some leadership.'' The Fed report today showed that the lending averaged $13.4 billion in the week ended yesterday...

In the Term Securities Lending Facility, the New York Fed bank today altered its plans so it will accept the expanded collateral list, which includes residential mortgage-backed securities, in the first weekly auction instead of the second.

The new eligible collateral for the TSLF includes agency collateralized-mortgage obligations and AAA/Aaa-rated commercial mortgage-backed securities, in addition to similarly rated private-label residential mortgage-backed securities and any collateral normally eligible for Fed open-market operations...

The Fed scheduled the second auction for April 3 and said the central bank's Open Markets Desk will announce the size and the eligible collateral the prior day.

From RGE Monitor:

• McCormick: March 20: Surging demand for U.S. Treasuries is causing failures to deliver or receive government debt in the $6.3 trillion a day market for borrowing and lending to climb to the highest level in almost four years.
• SF Fed: a large share of securities firms' assets are reverse repurchase transactions with other market participants. The primary liquidity risk facing securities firms is the risk that sources of funding will become unavailable, thereby forcing a firm to wind down its operations and liquidate asset portfolio. To mitigate this risk, securities firms hold liquid securities and attempt to diversify their funding sources.
• March 20: Fed expands collateral for $200bn 'Treasury Swap' facility (TSLF) to include bundled mortgage debt (i.e. AAA RMBS) and securities linked to commercial real- estate loans i.e. AAA CMBS (originally only federal agency debt, federal agency MBS, and non-agency AAA/Aaa-rated private-label residential MBS). First $75bn auction to be held on March 27.
• Failures, an indication of scarcity, surged to $1.795 trillion in the week ended March 5, the highest since May 2004, and up from $374 billion the prior week. They have averaged $493.4 billion a week this year, compared with $359.6 billion over the last five years and $168.8 billion back through July 1990.
• Alea: We have seen negative repo rates before on (possibly squeezed) notes and treasuries but I don’t recall ever seeing that on T-bills. Quote 3 month T-bill repo: -0.20% also 4 year notes around -0.25%
• NY Fed: Surges in fails sometimes result from operational disruptions, but often reflect market participants' insufficient incentive to avoid failing.
• Krugman: The flight to safety has driven the yield on three-month Treasuries down to 0.55%. Meanwhile, three-month LIBOR — the rate at which banks lend to each other — is up slightly, so that the difference, the TED spread is back close to its earlier peaks--> companies/households not benefitting from rate cuts as their debt is priced off LIBOR