Assured Guaranty (NYSE:AGO) continues to be an intrinsic value per share compounder via a combination of operating profits and accretive stock buybacks. While the stock has performed well in a very challenging market, the reality is that Mr. Market is not close to appreciating that the Puerto Rico nightmare is mostly in the past, and this higher interest rate environment is likely to lead to robust earnings and adjusted book value growth. 2022 is teaching us that once again, valuations matter. Assured Guaranty is a value investor’s delight with the strongest prospects and the sturdiest balance sheet in its history as a public company.
On May 5th, AGO reported strong first quarter earnings, with operating income coming in at $90MM, or $1.34 per share. The company increased adjusted operating shareholders’ equity per share and adjusted book value per share to record highs of $90.09 and $133.21, respectively. New business production was decent in a very challenging capital markets environment, with PVP coming in at $69MM. AGO insured $3.6B of U.S. public finance new-issue par in the first quarter, which was the second highest amount of par in a decade, behind only last year’s record amount. Public finance PVP was $49MM, which was the 3rd highest first quarter since 2009. Insurance was utilized on 8.5% of all par issued, up from 7.8% in last year’s first quarter, and 8.2% for full-year 2021. Insurance was utilized on 17.8% of all transactions, which was the 2nd highest penetration rate in a decade.
Assured is the dominant company in the industry, insuring 58% of par on all insured deals. The company insured $4.8B of insured par in the quarter when including international infrastructure and structured finance. These divisions broaden the market at which the company can write business to and diversifies risk exposures. With credit spreads widening and rates rising, I expect new business to ramp up as issuers tap into insurance to keep credit costs more manageable. It won’t happen all at once, but over time as issuers start to need liquidity once again after the aggressive capital markets activity, we have seen the last few years, AGO should really thrive.
Most importantly, the company consummated the settlement of its Puerto Rico GO, PBA, CCDA and PRIFA exposures. This reduced the company’s exposure to BIG credits by roughly $1.3B. The percentage of BIG credits in the insured portfolio is now less than 3% for the first time since the 3rd quarter of 2008. The company received cash and new G.O. bonds totaling approximately $1.2B, as well as contingent value instruments. As a testament to AGO’s improving financial strength, Moody’s upgraded AGM and AGUK to A1 from A2, with a stable outlook. Management continues to intelligently deploy surplus capital, buying back 2.7MM common shares for $155MM. Pursuant to the quarter ending, the company has bought another 1MM shares for $61MM. As has been the case with all stock buybacks since the inception of the program, all were importantly done at material discounts to any conservative estimate of intrinsic value.
The news gets better. This past Monday, the Oversight Board filed the proposed plan of adjustment to restructure claims against the Highway and Transportation Authority, which should gain federal court approval by the second half of this year. These were the most worrisome credits due to the size of the exposure ($1.256B) and the complications with them, such as the arguably illegal “clawback” etc. The FOMB terminated the third previously agreed to RSA on PREPA, but that is now in mediation, and I don’t expect terms to change much whatsoever. PREPA is an excellent credit as the monopoly utility in Puerto Rico, but sadly the company is plagued by corruption and grift, that frankly the FOMB neglected for far too long. Puerto Rico would be loath to see the utility go to receivership, so they are incentivized to make a fair deal. In summary, if anything, I’d expect reserve releases on these remaining exposures, not sizable additions.
Another long awaited and encouraging development was that the asset management division improved its adjusted operating income to breakeven for the first quarter. Results were bolstered by performance fees and costs are getting more balanced with the legacy Wind Down funds becoming a smaller part of the business. AGO has benefited from the acquisition of what is now AssuredIM from higher investment returns, via the portion of assets invested in the internal funds, which target 10% plus returns. The operating performance has been disappointing thus far, generating losses, but this is the first breakeven quarter, and if we start seeing profits, that will greatly bolster the ROE over time.
At a recent price of $58.11, AGO trades at 64.5% and 43.6% of operating and adjusted shareholders’ equity per share, respectively. The company has been buying back approximately $500MM of stock per annum since 2014, after initiating buybacks in 2012. The share count has dropped from 194MM in 2012 to 65MM as of the end of Q1 2022. AGO maintains $11 billion of claims-paying resources after returning $4.4B to shareholders. They have successfully managed the Financial Crisis when none of their peers were able to do the same and continue to write business, along with the largest municipal bankruptcy in U.S. history, Puerto Rico.
If we conservatively assume about $100MM per quarter of income this year for AGO, in addition to $500MM of buybacks, plus about $65MM of dividends, we will get a net decline in equity of roughly $165MM, keeping all else equal. If the company can buy back $500MM of stock at $60 per share over the next 4 quarters, that would lead to the retirement of 8.33MM shares, leaving the company with 56.67MM shares outstanding. This would increase book value per share, operating shareholders’ book value per share, ABV per share to $99.47, $100.49, and $150, respectively. The company has tremendous excess capital, especially after Puerto Rico is resolved, because the insured portfolio was mostly amortizing over the last decade, as new business production stalled. You can see how impactful the compounding math is, buoyed by such a cheap valuation.
I believe that we are at an inflection point where new business production will begin exceeding the runoff, which will bolster unearned premium reserves, ultimately leading to higher revenues. In addition, we have higher rates, which will help the investment portfolio, less of a drag from the asset management business, and the continued rightsizing of the capital base. These factors should lead to a higher ROE and a more favorable valuation. Currently there is a $75.10 gap between adjusted book value per share and the current stock price. Based on the 65MM shares, that is $4.881B. Using a 20% tax rate, AGO could incur $6.1B of pretax losses for the ABV to equal the current market capitalization of the company. Where are those losses going to come from when you look at the quality of the insurance book? Meanwhile, the company is going to be past the overhang of having to reserve for Puerto Rico, and it has the best opportunity in a decade to write new business in a higher rate environment. Since insurance premiums are tied to net debt service, higher rates mean higher premiums. Suffice it to say, I’m bullish on AGO and I think the market has yet to catch on to the underlying fundamentals of the business. I think the stock should trade at $80 per share and could compound at a double-digit rate from those levels if we see new business production ramp up materially.