Update on Bond Insurance Companies

In today’s extremely expensive stock market, we’ve been discussing a few incredibly attractive opportunities with 50%-75% upside potential, and large margins of safety. To find these opportunities, you have to look at areas that are highly out of favor based on short-term concerns, but that have strong long-term outlooks. There are lots of companies that have good short-term outlooks, but unfortunately, the prices more than reflect those fundamentals. If you get a year with no major selloffs, like last year, buying these stocks might work out. Unfortunately, more than 90% of years have a great deal more volatility than last year did and when valuations are as high as they are currently, the odds are even greater that overall stock market returns will be minimal to negative over the next 5 years or so.

At T&T Capital Management, we have investments in three different bond insurance companies, Assured Guaranty (AGO), Ambac (AMBC), and MBIA (MBI). Ambac and MBI are basically in a runoff situation and are no longer writing new business. The value will be realized as the companies sell off assets and reduce liabilities, to produce cash that will ultimately go to shareholders. Ambac exited bankruptcy several years ago and is in the midst of a restructuring that will greatly reduce costs and add to its intrinsic value. They should find out if they get court approval for this restructuring towards the end of this month, which would be a major catalyst for the stock. Later this year, Ambac should either get a settlement or a legal victory against Bank of America on its rep and warranty litigation against the bank. There isn’t much doubt that they will win this case as there have been many legal precedents, but Bank of America has just been stringing things out as long as they could. AGO and MBI have already settled with Bank of America on the exact same issue. With a current price at $15.86 a share, we believe the long-term intrinsic value of Ambac is greater than $25 per share.

MBI is in a similar position as Ambac in that it is basically in runoff. With a recent stock prices of around $7.62, MBI’s adjusted book value should be over $30 per share, after its aggressive stock buybacks in the 4th quarter of 2017. The company will likely be sold at some point to Assured Guaranty once we get more clarity on Puerto Rico. This would be a major catalyst and any deal would likely be over $12 per share. Prior to a full merger, I’d expect to see a reinsurance arrangement where AGO assumes the risk on most of MBI’s current book of business excluding Puerto Rico and maybe Chicago. This would be very attractive for both AGO and MBI as it would increase AGO’s adjusted book value per share, and would likely accelerate the process of getting cash to MBI’s holding company, which is one of its major priorities. As we get more clarity on final Puerto Rico losses, the full merger could be consummated.

AGO is by far the strongest company of the three and is writing a great deal of attractive new business. Recently, at a price of $33.36, the stock market is implying that AGO will realize another $3 billion in losses on its Puerto Rico exposures, without allowing for any other loss mitigation tactics. That gives us an incredible margin of safety on this investment as I believe those loss estimates are highly unlikely. What is amazing is that AGO could easily handle that amount of loss and still be in a strong financial position.

Above is a great graphic highlighting AGO’s demonstrated financial strength. The company has paid $9 billion to insured investors over the last 10 years. After reimbursements from rep and warranties or other remediation, the net claims have been $4.4 billion. Almost all of these losses were due to mortgage exposure that it had during the Financial Crisis. AGO has a history of being a very conservative underwriter as it avoided the synthetic CDO exposures that destroyed just about all of its competitors during the Financial Crisis. Even with all of these claims, the company has still grown its claims-paying resources by $1 billion. They have also more than doubled their book value per share of course. I am very confident that they can continue to grow both their book and intrinsic values per share through these next few years in spite of Puerto Rico, and if we are right we should make a great deal of money. AGO has never been in a stronger position than they are right now and Puerto Rico claims go out 20-30 years in many cases, so it is far easier to manage in terms of liquidity, than claims were on structured finance transactions.

“I am very confident that they can continue to grow both their book and intrinsic values per share through these next few years in spite of Puerto Rico, and if we are right we should make a great deal of money.”

The next few weeks could have a lot of noise regarding Puerto Rico that isn’t going to be highly relevant long-term, as the commonwealth is submitting its new 5-year fiscal plan, which will be very negative towards creditors. Whatever they submit, keep in mind that it is likely to be completely illegal based on the Promesa law, which is what is relevant to this restructuring. Basically, these are one-sited negotiating tactics to try to make the financial situation look as dire as possible so they can pay as little debt as possible. The reality is that the financial data coming out of Puerto Rico has been better than expected, and it should get far better as insurance and Federal money filters its way through the island. Creditors should start to see some significant legal victories as this year progresses, and as we get further into the court cases.

We will take advantage of any short-term volatility to add to these highly attractive opportunities. Lastly, I’ve attached a recent report by Mark Palmer of BTIG, which goes into more detail about what we should expect to see coming out of Puerto Rico for those that are interested in learning more about what is undeniably a very complicated situation. Thank you very much and if you have any questions, please don’t hesitate to give me a call directly at 805-886-8140

If Puerto Rico’s Fiscal Plan Offers Zero Debt Service to Bondholders, Buy AGO, MBI, AMBC on Any Weakness



Tim Travis