Tony, JimPersonett, Domsam, WilsonRusty, and others:
FWIW, I have more or less completed my research on AGO/FSA. I reviewed AGO's most recent 10K, reviewed FSA's website (which is still up), listened to the AGO’s 2Q2009 conference, and read all/most of AGO's press releases/slide presentations since Nov 2008. Below are my thoughts. I believe all of you have a longer history with the FSA bonds than I and therefore I would appreciate your critique of my thoughts and answers to my questions.
(1) PORTFOLIO RISK - Despite my efforts, I have decided that I am not capable with a reasonable yet diligent effort to thoroughly assess the risk in FSA’s and AGO’s structured finance portfolios. Further, I do not believe that reliable historical data exists to serve as an accurate predictive tool of the future loss experience on the structured finance portfolios.
(2) PUBLIC FINANCE RISK - Given the current “interesting time”, I believe the same applies to a dramatically lesser degree for the public finance portfolios. Based upon comments by management, historically public finance guarantees have had a very small loss experiences. Further, even when losses are incurred (payouts) the insurer (i.e. FSA) often recovers some of the loss incurred via a “workout”. In short, I believe that we MAY experience the equivalent of a “100-year flood” event in public finance defaults. And therefore, the public finance portfolio will likely see loss experience far above what historical data would predict.
(3) BOND DEFAULT - When a default does occur, the insurer (i.e. FSA) is only responsible for the interest payment until the bonds mature. This is advantageous because this allows the insurer more time to cover the loss experience with future business cash flows. Further, the public entity may regain health over time and become able to service its debt. Finally, AGO mentioned that at least some portion of the time when there is an insured bond default, they are able to purchase the outstanding bonds in the open market and reduce/mitigate their losses. Combine all this with “workouts” and it seems that bond insurance losses may not always be a catastrophic events as I had previously believed.
Well their 745 million figure is what I have been looking for- some kind of idea of the additional losses they are going to have to take on real estate. Since this is more than offset by other items, this seems very manageable. I will hold off adding until we hear from Moodys which seems to have the biggest stinger out of all the rating agencies but I still see no threat to survivability in the near to intermediate term.RRW
Thank you for the various very helpful updates.
I do not question there is some risk here and that that risk is hard to quantify.I have kept my FSA bonds to within 5% of overall portfolio to limit any damage these bonds might do. I did buy and resell some bonds after the panic selloff on the NYSE which yielded a nice but not stupendous short term gain but was not prepared to hold these permanently.
The reason I am going to hang on to these are many but the main ones which occur to me now are: faith in the investment prowess of Ross;a 10 billion dollar investment portfolio which should grow as the premium book grows even if no new public finance business is written which seems unlikely; the fact that the toxic stuff is gradually amortizing on AGOs books;the monoline structure which allows losses to be paid gradually and gives time to mitigate the damage; the improving economy although I realize the real estate market is still going down, at least the upturn may be within a matter of months- this gives hope where there was little for so long; a near monopoly in public finance.
Although I am very skeptical of the Rating Agencies I will read the coming Moodys downgrade with great interest to see if they can help quantify the risk here in terms of likely losses in the near term so long as these are based on realistic assumptions. I assume management will respond which should also help.
Right now I would view any sell off after the downgrade as a chance to add a little.I do not as yet have enough confidence to back up the truck. I might add I am a little concerned that Buffet has decided public finance insurance is too risky for the premiums which are charged and has more or less quit writing it. RRW
The latest statement from Fitch has helped improve the prices on FSA and given me the opportunity to unload 1000 FSAD today at 15.50. I still have a long way to go to get to 5% allocation on the combined issues which I need to do. An allocation of 5% is very appropriate for a retiree.
By the way, my investment in KNO which you mentioned has been a real star. Thanks for telling me about it.
Best of luck to you,
(7) FSA AND ASSURED GUARANTY CORP WILL UTILIZE THE SAME PUBLIC FINANCE PLATFORM - During the 2Q2009 Conference Call, AGO stated that FSA and Assured Guaranty Corp will offer the same pricing and operate subject to the same underwriting standards (in public finance). Further, all common functions will be integrated such as origination, underwriting, surveillance, and loss mitigation for cost savings purposes. I know the guys at AGO are smarter than me, but it would seem to me that this business plan will not work perfectly. Starting with the assumption that the structure finance portion of Assured Guaranty Corp’s business will be more risky than public finance portion, I think it is logical to believe that over time FSA’s credit rating may be higher than Assured Guarantee Corp’s credit rating. If this comes to pass, the value of a public finance bond guarantee by FSA will be worth more than a similar bond guarantee by Assured Guaranty Corp which would tend to cause a disparity in market pricing. What am I missing here?
(8) FSA SUBSIDIARY OPERATING METRICS WILL CONTINUE TO BE DETAILED SEPARATELY FOR THE BENEFIT OF FSA INVESTORS. FSA will no longer issue its own 10K’s and 10Q’s but FSA’s operating data will be available on the website and in 8K filings. This is a nice gesture by management and significantly makes up for delisting our beloved FSA bonds.
(9) RECOVERY OF RMBS LOSSES – During the conference call, there was a somewhat lengthy discussion surrounding the fact that AGO (FSA was not mentioned) has slowly been recovering funds from prior losses on its RMBS portfolio. In short, through extremely labor-intensive research, AGO has been able to prove that “Representations and Warranties” were violated in the RMBS that AGO insured and took loses on. Thus far, the recoveries have primarily been in HELOC’s (home equity lines of credit), originated by Countrywide (now BofA). So far, AGO has examined 90% of the Countrywide HELOC’s. AGO has filed a claim against 85% of the loans reviewed, and so far AGO’s recovery rate is at 70% of claims filed but most claims are still pending Countrywide’s review ($31 million recovered to date). AGO started their research with the Countrywide HELOC’s because this is where they had a high rate of claims losses. AGO plans to begin reviewing “Closed in Seconds” next. AGO expects to recover a lot of paid out losses but it will take a lot of time because of the extensive, time-consuming research required. This is potentially significant. We all know about travesty in underwriting in the 2005-2007 period. Again, the FSA portfolio was not discussed with regard to this topic but I suspect the FSA portfolio has many of the same issues. Don’t count on anything, but maybe we will get some upside here.
(10) COMPETITION - According to FSA during the conference call, Berkshire Hathaway has NOT written a bond guarantee policy for quite some time (I don’t think AGO actually gave a specific time frame). Further, there is supposedly a company (name not given) that has been planning to enter the bond guarantee market for some time but so far has not written any insurance. The bottom line is that FSA and Assured Guarantee Corp are the only players currently in the bond insurance industry. This would lead me to believe that FSA and Assured currently have substantial pricing power and don’t need to “climb the risk ladder” to secure good profit margins and large volumes of business.
(11) DEBT LOAD VERSUS ASSETS – Combined AGO and FSA have less than $1.2 billion of debt with approx $730 million belonging to FSA and approx $400 million belonging to AGO (the holding company). The AGO debt numbers should include all of the subsidiary’s debt (other than FSA). FSA’s interest payments during 2008 were only $80 million which is very manageable given the $6.1 billion of invested assets that came with the that came along with the FSA acquisition. Together the FSA/AGO investment portfolio has approximately 10 billion in assets with an average yield of 4.3%. The low average yield leads me to believe that the combined portfolio is very conservatively invested as it should be. Given FSA’s asset versus debt balances, the future obviously depends upon the performance of the insurance contracts rather that the existing debt load.
(12) MY BOTTOM LINE – The bottom line fallout of my analysis is that I am bullish but cautious on the FSA bonds. Everything looks and sounds good…Wilbur Ross is onboard as a large investor, there is no competition and therefore presumably a favorable pricing environment coupled with abundant market opportunity. These positives are offset by my inability to assess the real risk in FSA’s portfolio – both the public and structured finance portions (I believe I have lots of company here). This concern is exacerbated by the current “100-year flood” I believe we are currently experiencing in the capital, credit, and real estate markets which of course all affect the debt service capacity of our favorite public finance sector. And finally, AGO (as well as I) continue to have concern over any potentially adverse actions that may be taken by the ratings agencies. Let’s hope for the ratings agency reforms that are currently being discussed. We all know that FSA sells its high credit rating and if FSA were to loose the high credit rating, FSA would not be able to initiate any new business. However, even given this scenario, FSA should be able to service the bonds a decade or more into the future so long as the claims experience remains reasonable.
(14) No number “thirteen” (I’m superstitious). My personal view on the economy is that we may have already seen the most precipitous events of the current economic downturn but I also believe there is more pain to come. In my view, the future will likely bring a slow oscillation upward and downward where the net movement of the economy is slightly downward over the next several years before we sustain real economic growth. Strong companies with wise management teams can still succeed in this type of relatively benign environment (while many lesser companies and management teams will fail). This further supports the reason why I am currently only investing in bonds and cumulative preferreds stocks of those companies with the most fortress-like of balance sheets. On the balance sheet front, FSA/AGO qualify. Lets hope the FSA/AGO management team executes well and that loss experience on the insurance portfolio behaves.
(4) BOND GUARANTEES - I believe there may be a lot of confusion amongst investors regarding the guarantors of the FSA bonds. AGO (Assured Guarantee Limited) is a holding company with several operating company subsidiaries. Namely, Assured Guaranty Re (A reinsurance subsidiary), Assured Guaranty Finance Overseas (presumably the non-US financial guarantee company), Assured Guarantee Corporation (The US subsidiary whose legacy business is most similar to the purchased legacy FSA business), and of course now FSA. Each of these subsidiaries are FIRST responsible for reserving funds to cover potential insurance claims, SECOND responsible for servicing its own bonds/debts, and THIRD paying a portion of is operating cash flow (if available) to the parent holding company (AGO). AGO may CHOOSE to also “guarantee” the bonds of its subsidiaries when there is a shortfall, but I am almost certain that AGO is NOT OBLIGATED to cover any bond defaults of its subsidiaries. I believe this conclusion is somewhat supported by the fact that AGO and each of its subsidiaries do NOT carry the same ratings agency credit ratings. This allows a holding company to put “firewalls” between the various portions of its enterprise and thereby insulate one portion of the enterprise from a bankruptcy or lawsuit in another portion of its enterprise. I believe this to be the typical holding company “design”. Finally, the holding company (AGO) may also issue and guarantee its own bonds/debt and guarantee that debt. The holding company’s only resources for servicing its debt is via dividends collected from its operating companies.
(5) FSA ONLY A PUBLIC FINANCE INSURER GOING FORWARD - During the 2Q2009 earnings conference call, AGO confirmed/reaffirmed that Assured Guarantee Corporation (an AGO subsidiary) will continue as a public AND structured finance guarantee provider going forward while FSA will continue as a public finance ONLY guarantee provider going forward. Further, per the conference call, FSA’s portfolio will rapidly transition from a “mixed provider” to a public only provider because nearly 50% of the FSA structured finance portfolio will runoff by year end 2011. New FSA public finance business will only further serve to dilute the remaining structured finance portion of the portfolio. Given this data, the FSA bonds should continue to be a safer and safer investment as time goes by. This thought is supported by AGO’s comment during the conference call that the majority of AGO’s losses since 2007 have been due to RMBS exposure. RMBS only makes up 5% of the combined FSA and Assured portfolios. However, we may seem some CMBS portfolio losses in 2011 and 2012. All that said, I would definitely prefer to own FSA bonds over AGO bonds (or the bonds of any of AGO’s other subsidiaries).
(6) FSA’s VERSUS ASSURED GUARANTEE CORP’s PORTFOLIO - As of AGO's June 2009 Investor Presentation (slides), FSA's legacy portfolio is 76% larger than AGO's ($417.3 billion versus $237.2 billion). FSA's legacy portfolio contains 18% structure finance guaranty ($75.1 billion) versus 30% for AGO's legacy portfolios via subsidiaries ($71.2 billion). Even from today’s starting point, I would again prefer to own FSA bonds over other AGO subsidiary bonds.