BTIG is initiating Assured Guaranty (NYSE:AGO) with a Buy and $35 price target.
Firm views Assured Guaranty’s equity as deeply undervalued at current trading levels and anticipate that as the fears that have depressed its share price abate and the viability of its business model becomes more apparent, it will gravitate toward its intrinsic value. Consequently, they believe investors who can appreciate that Assured’s risk profile is overstated, and that its ability to generate profitable new business is understated, could realize outsized returns.
While the headwinds Assured (AGO) faces – weakness in the U.S. municipal bond market and the budgetary pressures facing insured municipalities, residual RMBS positions, and exposure to troubled Eurozone countries – are not inconsequential, we believe the market grossly underestimates the company‟s ability to manage these risks. Moreover, we believe fears about these issues have caused many investors to overlook the opportunities AGO has before it as the only bond insurer that continues to write new business while achieving consistent profitability, as well as the benefits it may derive from additional mortgage put-back representation and warranty (R&W) settlements.
We are initiating coverage of Assured Guaranty with a BUY and a $35 price target which is based on a 0.75x multiple of the company’s 2012E year-end stand-alone adjusted per share book value of $48.56. We believe some discount to adjusted book value is appropriate, for while we view the AGO’ss portfolio exposures as manageable, they nevertheless present the potential for some loss of value. AGO trades at 0.23x the company’s 3Q11 adjusted per share book value.
We believe the market reacted appropriately in providing AGO’ss stock with a boost last week after Standard & Poor‟s announced that the company would maintain its vital „AA’s rating, particularly when the company‟s ongoing efforts to boost capital appear to have given the rating staying power. However, we also believe that the stock price does not come close to reflecting what the removal of the rating overhang could mean for AGO as the only currently functioning monoline, and that last week’s price action may presage much larger gains ahead.
While the size of the insured and insurable portion of the U.S. municipal bond market is much smaller than it had been prior to the credit crunch, AGO’ss former competitors have either filed for bankruptcy, been acquired, or are in some form of run-off mode. Consequently, AGO has a virtually unimpeded opportunity to increase its penetration of the U.S. public finance (based on new issue transactions) from the 13.3% share it reported in 3Q11. We believe S&P‟s bond-insurance ratings overhaul had a significant negative impact on new business origination in 2011 and it is reasonable to believe that the market – and AGO‟s volumes – could rebound meaningfully in 2012.
AGO during its 3Q11 conference call provided additional information on its exposure to troubled European countries, and the PIIGS (Portugal, Italy, Ireland, Greece and Spain) in particular. The company’s total exposure to the five countries is $3.2bn, including $2.2bn of exposure to Italy. The only Eurozone exposure not backed by a revenue-generating project is a $291mm exposure to the government of Greece. AGO does not believe that the current proposal for Greek debt restructuring, which calls for a “voluntary” 50% haircut, would trigger a loss payment since it is characterized as voluntary and is not binding on bondholders. In the event of a Greek default, AGO would be responsible only for the interest payments and final principal payments on the $291mm in debt. Given the long-dated nature of these exposures – the maturities are 2037 and 2057 – we believe the present value of this figure would be manageable for the company. To put this in perspective, AGO’s 3Q11 operating income included the effect of lower risk-free rates used to discount losses of approximately $120mm in pre-tax loss expense.
We noted that AGO during 3Q11 repurchased 2mm shares of its stock for a total of $23mm even as concerns about S&P‟s new ratings criteria could impact its capital requirements. The company’s ongoing efforts to improve its capital levels through commutations and terminations as well as purchases of wrapped securities and pursuit of R&W settlements could generate excess capital going forward. We believe a portion of this capital could be used for additional buybacks or returned to shareholders in the form of dividends.
Notablecalls: AGO looks like to be in the sweet spot for several reasons:
1) BTIG initiation last week caused a ~30% rally in MBIA (NYSE:MBI), another bond insurer.
2) AGO looks like a leveraged play on the PIIGS debt issue, which looks like could be resolved soon. Notice the yields on last Italian bond action? That’s why the mkt has been going up.
3) This thing has been beaten down so hard it’s prone to produce a big move.
I would expect a 20% move in AGO based on this, putting $13-13.50 levels in play, possible as soon as today.