2023-05-10 17:39:58 ET
Summary
- AGO trades at just 55.6% of operating shareholders' equity and 37% of adjusted book value.
- AGO's pending sale of its asset management business to Sound Point converts a money-losing operation into a profitable one, removing a distraction.
- New business production continues to improve, despite a tough issuance market due to higher interest rates.
- AGO's last remaining Puerto Rico exposure PREPA has been reserved for over the last decade and should not lead to substantial losses from current levels, removing a huge overhang.
Assured Guaranty ( AGO ) has made tremendous progress in growing intrinsic value, resolving nearly all its Puerto Rico exposure, and positioning itself to write attractive new business in several areas. While PREPA remains to be resolved, AGO finds itself with its cleanest insured portfolio in at least 15 years and a very strong capital position that is poised to benefit from higher rates. The divestiture of the unprofitable asset management business is a big positive, removing the negative operating loss overhang from the previously under-scaled enterprise. AGO's future is based on attractive new business production, accretive capital management via buybacks of its deeply undervalued stock, and a significant reduction in claims paid upon the final resolution of the last remaining nonperforming Puerto Rico exposure.
On May 9, AGO reported a very solid Q1, earnings of $68MM, or $1.12 per share of operating income. Operating shareholders' equity per share and adjusted book value per share reached record highs of $94.58 and $143.04, respectively. Book value per share grew to $88.70, up from $85.80 in Q4, helped by gains in the investment portfolio due to lower rates. As AGO's below investment grade exposure dwindles down, which largely includes Puerto Rico and legacy RMBS exposure from the Great Financial Crisis, earnings should be less volatile as losses experienced should be a lot lower moving forward. Municipal finances are in pretty solid shape generally after the massive stimulus from the Covid/Lockdown era. With an average duration of 3.5 years in the investment portfolio, maturing bonds and new premiums written can be reinvested at much higher rates than what has been available over the last 15 years, which should provide a nice tailwind for the company's earnings and return on equity.
New business production was strong with $112MM of PVP, which was the largest amount of Q1 PVP in a decade, and only the second time during that period when Q1 PVP exceeded $100MM. The company insured over $5B of new business par, which was the second-largest first quarter amount in a decade. Due to higher interest rates, Public Finance new issuance was down roughly 23%, and AGO's Public Finance production was down 25% in line with the market. It's quite remarkable that AGO posted such a solid quarter for new business when its biggest market was pressured so severely. Industry par penetration continues to see positive momentum, registering at 7.7% in Q1, which is only the third time in a decade that Q1 par penetration exceeded 7%. Industry transaction penetration of 18.9% in Q1 is only the second time in a decade that Q1 transaction penetration exceeded 18%. AGO continued to boast a leading market share, insuring more than 60% of par of all insured deals in the quarter. The positive outliers in new business production in the quarter were in Non-U.S. Public Finance where they generated $30MM of PVP, and Structured Finance where they had the biggest Q1 in a decade, generating $60MM of PVP. The Structured transactions were primarily an insurance securitization transaction, as well as an excess-of-loss guaranty of a minimum amount of billed rent on a diversified portfolio of real estate properties. These bespoke transactions are focused on bilateral agreements to improve policy beneficiaries' capital management efficiency.
In April 2023, AGO announced an agreement to combine the majority of its asset management business with Sound Point Capital Management, LP, forming the world's fifth-largest CLO asset management company by AUM. AGO will own approximately 30% of the combined company. I view this as a very good outcome in that it should remove the operating loss overhang that asset management has consistently brought, while also removing a management distraction. AGO stock sold off quite hard after Q4 earnings when investors believed management was indicating an interest in expanding further into the space, but this divestiture seems very favorable, as the more scaled business should be able to generate profits. AGO expects the transaction to be immediately accretive to EPS, ROE, and book value per share, which is all fantastic news. Management mentioned that the fair value equity stake should meet or exceed the goodwill intangibles related to the Blue Mountain deal, which is very good news, as it protects or grows existing book value metrics.
AGO boasts an $8.7B investment portfolio with an average A+ rating, in addition to $396MM in AssuredIM funds with a fair value of $296MM. The overall duration of the fixed maturity securities is only 3.5 years, so the company is in solid shape there. AGO's adjusted operating portfolio leverage sat at 42 at the end of Q1, near its lows historically, and down from 157 at the fourth quarter of 2009. Since starting the capital management strategy in 2013, AGO has repurchased 141MM, or 73% of shares outstanding from the beginning of the program, for roughly $4.7B. For the first time in many years, AGO's buyback activity was very weak in Q1 due to its operating company dividend capacity being more limited in the first part of this year. The company still paid an $18MM ($.28 per share quarterly) dividend and stored up some additional money to pay expenses related to the Sound Point transaction. Management indicated that buybacks should resume this quarter on a smaller-than-normal level, but at current prices, these buybacks are obviously enormously accretive. Management made some very timely debt refinancings the past few years, but there is still $330MM of 5% notes maturing in 2014 that ultimately will either need to be retired or refinanced. It seems like they might retire a decent portion of them based on the commentary in that this was one of the reasons they were storing extra cash at the holding company level.
AGO continues to wind down its Puerto Rico exposure, with all delinquent bonds settled except for PREPA. As a result of these settlements and normal amortization, AGO eliminated $2.2B of BIG insured par. According to the terms of these resolutions, AGO received cash of approximately $0.8B and recovery bonds with a face value of approximately $1.4B and CVIs with an original notional value of $0.9B. A large percentage of these have now been sold, and the company still has remaining recovery bonds and CVIs with a fair value of $436MM as of March 31, 2023. Additionally, trust accounts related to GO, PBA, and HTA exposure that have not been extinguished hold additional securities with a market value of $216MM. PREPA continues to be a challenge, and the judge extended mediation to July 28 and has directed the parties to engage in good faith. In March, the court issued some pretty negative rulings related to the liens that bondholders had but also held that PREPA bondholders have recourse under the trust agreement in the form of an unsecured net revenue claim. Of course, this irregular term "unsecured net revenue claim" seems like an obfuscation of what creditors actually have, which is a pledge on the net revenues of PREPA. This judge has made some very questionable rulings, and I think she and the Federal Oversight Board probably know that a settlement would be far more preferable than going all-in to see if the ruling stands up in an appeals court. AGO has been reserving for PREPA for nearly a decade now, and management has a long history of erring on the conservative side in its estimates. They didn't feel the need to increase reserves this quarter despite the negative ruling, although they did increase reserves in March, so I think they feel like they might be done there based on their best estimates. I expect the parties to either settle this or parts of the rulings to be reversed in appeals court, as they go against the very foundation of the revenue municipal bond market and the rules that have existed for decades.
At a recent price of $52.68, AGO trades at just 55.6% of operating shareholders' equity, and 37% adjusted book value, despite having its cleanest balance sheet in at least 15 years. The stock was sold off after Q4 earnings, as I believe the market was concerned that instead of divesting the asset management business, they are going to acquire another one. This seems like a much more favorable solution that will simplify the business and allow management to concentrate exclusively on its core bond insurance operations. The enhanced operating profits from the joint venture will provide additional capital and earnings, which can ultimately be used for stock buybacks. Even if a bear wants to obsess about PREPA, keep in mind that any additional losses would be tax-deductible, and management can create a $2/1 value by buying back its own stock. An additional, although unlikely, $100MM of reserves is about $80MM after tax, and a $100MM buyback at current prices would offset any hit to book, and this is a company that had been buying back $400 to $500MM of stock per annum. I believe the stock is conservatively worth $70-$80 per share and offers a fantastic risk/reward at current prices.
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Assured Guaranty Is A Dollar Trading At 50 Cents