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Assured Guaranty (AGO)
Assured Guaranty is the New Darling of Wall Street- But for How Long?
Wilbur Ross, the famous billionaire investor known for swooping into distressed assets and restructuring companies in industries as diverse as coal and textiles, finally made his much anticipated move into the troubled financial guaranty business last evening, and did a major favor to CNBC by disclosing it first on their network this morning. And the other major beneficiary of Ross' largesse: Assured Guaranty Ltd, the fifth biggest player in the $2.9 trillion bond insurance business. Assured is going to receive an immediate capital infusion of $250 million from Ross' investment vehicle, WL Ross & Co., in the form of common stock purchases, with an option to demand another $750 million from Ross within the next 12 months. So why does a man known for making risky big bets eschew industry leaders MBIA and Ambac and go with a smaller, safer player such as Assured Guaranty?
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Safe is the keyword here. MBIA (MBI: Charts, News, Offers) and Ambac (ABK: Charts, News, Offers) have been hit hard in the last few months (e.g. Ambac's stock is down roughly 60% over the last 6 months) because they went away from their core business of guarantying something that almost never defaults (i.e. staid municipal bond issues) to writing policies on complex financial instruments such as collateralized debt obligations (CDOs) and mortgage backed securities, which are likely to default at a much higher rate given the current state of the mortgage market. And the most pressing problem for companies such as Ambac and MBIA is that they now have the bond rating agencies on their back (e.g. S&P, Fitch etc.) who are threatening to take away their prized Triple-A rating (as they have already done from the smaller Financial Guaranty Insurance Company). The rating agencies are as culpable for the mortgage mess as anybody else for not doing a better job of reviewing bonds before assigning them a rating (after all, everybody doesn't deserve a Triple-A), but that's a story for another day. To preserve their pristine ratings, Ambac and MBIA are now forced to raise massive amounts of capital which, among other things, is extremely dilutive to current shareholders.
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Wilbur Ross was expected to join the stream of capital flowing into Ambac and MBIA, but he has mixed it up a little instead by taking a big stake in Assured Guaranty. This Bermuda based insurer doesn't have most of the problems that its bigger peers are currently dealing with because it mostly chose to stay away from writing business on complex mortgage instruments which are now almost toxic. Assured Guaranty's Triple-A rating is under no threat whatsoever and therefore, it is in the enviable position of writing new business at a much higher clip that its competitors (e.g. MBIA today announced that it has been writing very little new policies recently) because its capital base is much more secure. So not only is Assured in the position to steal away business, it now probably has enough cash to do some buying, of the M&A variety. Assured could snag a sizeable stake (at a huge discount) in Ambac, MBIA or some other player in the industry. The street is acknowledging the solid position that Assured is in, by pushing the stock up over 10% in mid-day trading today on a day when Ambac and MBIA are both down close to 5%.
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So while there is certainly a bullish case to be made for Assured, there are a few things that could throw it off-course. One is the risk that the discipline which has kept it away from mortgage related instruments could slowly evaporate due to a greater sense of self-confidence and lead the company to make riskier bets. Assured has already started making more moves in the reinsurance business. In December, it agreed to reinsure $29 billion of contracts from Ambac. Assured at the same time said the contracts it is taking over from Ambac met its underwriting standards (i.e. it's not junk) but who really knows if that was the case. If it was, it will take a while before we know. The other big problem for Assured is that there is more than one billionaire besides Wilbur Ross hoping to make a killing in the bond insurance business by attacking weak prey and that is Warren Buffett. Buffett started his bond insurance venture from the ground up just a couple of months and he has to go from state-to-state to get a license while Assured is already a longstanding player in the field. Having said that, Warren Buffet, in the words of Wilbur Ross himself, is a "natural Triple-A" aka if both Buffett and Assured mess up in the future, the latter is more likely to lose its rating first.
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