The likely consummation of AORe's (formerly, RAM Re) commutation with FGIC will leave the Bermuda-based reinsurer with almost no exposure ceded from companies other than Assured Guaranty.
The only other client listed in AORe's annual report is Syncora Guaranty, but the evidence suggests that this is a very small amount. AORe documents show the company with total insured par outstanding ex-FGIC of $11.1B. Meanwhile figures derived from Assured Guaranty documents suggest approximately $11.5B ceded to AORe. While rounding and loss reserves likely cover this discrepancy, those adjustments leave little room for much business ceded from Syncora.
Just because Syncora's piece of the pie is small doesn't mean it's insignificant. If a cherry pie has one sliver of crap in it, most people won't eat any of it. When AORe and Syncora parted ways on most of their business over three years ago, they may have kept an uncertain credit or two on the books. Jefferson County Sewer comes to mind.
Assured itself likely has ceded JeffCo Swr exposure to AORe. That, along with ceded RMBS, should not stop Assured from reassuming business from AORe - either through acquisition or commutation - because Assured receives no rating agency capital relief from the unrated reinsurer.
As the only survivor of the financial crisis to continue writing new business, Assured must see the rating agency models as key to its current prospects. With a rating of Aa3 with a negative outlook from Moody's, a downgrade would put the company into the credit rating range of its target market. Due to the current focus on ratings, Assured must look to reduce single risk limits, especially of poor credits, which are especially detrimental in this post-apocalypse ratings world. But if the rating agency's don't recognize the a portion of the risk as ceded, there is no rating agency reason for Assured to reassume the business. Indeed, reassuming the ceded risk would essentially amount to an increase in capital to the tune of the net unearned premium and loss reserves taken as payment for a commutation.
If (read: when) Assured decides to retake this business, AORe would exist as an investment portfolio of $225M with approximately $105M in liquidation value of preferred stock. That would net out to about $45 per share, or the true Operating Book Value when preferred stock is properly accounted for.
Assured is currently trading at a discount to book value, which means the AORe opportunity presents access to the cheapest possible capital. While it is not a very large source of capital, it is accretive to shareholders and all or almost all benefits to rating agency models.
Showing posts with label Assured Guaranty. Show all posts
Showing posts with label Assured Guaranty. Show all posts
Sunday, September 30, 2012
Tuesday, November 15, 2011
Radian: The Capital Question
Radian's 10-Q filed this week revealed that a long-watched and troubled CDO defaulted, triggering a statutory loss reserve at Radian Asset (FG) in Q4. This would have brought Radian Guaranty's (MI's) risk-to-capital ratio very close to the important 25-1 ratio before taking into consideration a $50M contribution to the mortgage insurance unit.
While the default has been anticipated for years, the occurrence highlights Radian's shrinking financial flexibility. Radian may be able to finance approximately $300M more in mortgage insurance net operating losses through holding company contributions and $50M per year from financial guaranty earnings after contingency reserve builds. With just these sources and existing MI capital, it appears that $400M-$500M in near-term MI statutory net losses (not loss provisions) would put the unit over the 25-1 ratio, increasing it's dependence on regulatory waivers.
While there is good reason to believe that dependence on such waivers would be brief due to profitability starting in 2013 or 2014, avoiding such a reliance on Leviathan may be the better route. Radian has discussed unlocking embedded value in FG to the benefit of MI capital since it stacked the corporate structure. The attractiveness of such a transaction increases as Radian approaches the time when capital will be most valuable.
Such a transaction could look very similar to the FGIC-MBIA muni-only cut-through insurance transaction of 2008. Indeed, MBIA's (NPFG's) analysts may have already looked under the hood at Radian and that company is certainly a viable counterparty. But the easiest piece of business to commute would be the $20B reinsurance book which is about 95% municipal and 95% ceded from Assured Guaranty Ltd. subsidiaries.
Assured is not only familiar with all the credits involved, but they are a motivated actor. While Radian Asset's insured portfolio may have been one of the best or the best performer of the financial guaranty sector in the blowup, the units ratings have been pulled down by its runoff status, capital extraction, and corporate family. For Assured, this means the rating agency benefits of reinsurance are vastly reduced; recapturing the book would quickly provide rating agency capital if done for approximately the unearned premium minus loss reserves (nominal) and the deferred acquisition costs (likely ~20%) which largely represents the ceding commission that Assured already collects on this business.
There is good reason why Radian hasn't pursued more extensive commutations so far. Over the last two years, Radian Asset has generated significant economic and statutory income. As statutory income is earned, contingency reserves are built, increasing the potential treasure trove of capital for Radian Guaranty. There are several alternatives which Radian can enact in a timely manner. Those include direct municipal and/or reinsured municipal exposure commutations with Assured Guaranty, MBIA, or even itself a'la MIAC. Also, a future transaction could materialize with a potential insurer backed by the National League of Cities.
This all may be unnecessary. In addition to holding company funds, MI capital, and FG statutory net income, the FG contingency reserve should release capital by the end of 2013 by which time 50% of the structure finance portfolio will have matured; 65% matures by year end 2014. Additionally, the preliminary estimate of its pro-forma risk-to-capital ratio does not appear to include the corresponding contingency reserve release. That release would include $40M of the reserves built in the first three quarters and whatever reserves would otherwise be established in Q4.
Turning to MI, Radian Guaranty will earn well over $200M in premiums from post-2008 business in 2012; this portion of the MI book was underwritten to higher standards and at lower real estate values. Credit burnout has taken hold: Q3 new defaults were 57% of the Q3 2009 level. About 2/3 of "New Defaults" in Q3 2011 were actually redefaults versus a much lower proportion in 2009 (the term "New Default" refers to the default making the loan "new" to the default inventory compared to only the immediately prior quarter). These factors support a view for lower operating losses going forward and while uncertainty surrounding the default inventory remains extreme, it is much less than it was two or even one year ago.
All in, it seems that Radian can finance about $600M of net operating losses in the near term after considering the potential for FG capital initiatives. Radian could breach that level by recording an additional $1.6B of loss provisions through 2012, 5 quarters - the company currently predicts it will lose that much over the entire life of the book. At the same time, the stress losses of recent years have become less likely.
Even if Radian does manage to breach that level, the capital position can reverse quickly - as evidenced in FHA's press release today. Regulatory restrictions on writing new business have - and likely will continue - to boil down to projections of financial health of the specific insurance company. Such an approach increases the cushion for adverse loss developments. Whether or not to rely on such regulatory forebearance will likely be Radian's decision on how to manage its capital.
While the default has been anticipated for years, the occurrence highlights Radian's shrinking financial flexibility. Radian may be able to finance approximately $300M more in mortgage insurance net operating losses through holding company contributions and $50M per year from financial guaranty earnings after contingency reserve builds. With just these sources and existing MI capital, it appears that $400M-$500M in near-term MI statutory net losses (not loss provisions) would put the unit over the 25-1 ratio, increasing it's dependence on regulatory waivers.
While there is good reason to believe that dependence on such waivers would be brief due to profitability starting in 2013 or 2014, avoiding such a reliance on Leviathan may be the better route. Radian has discussed unlocking embedded value in FG to the benefit of MI capital since it stacked the corporate structure. The attractiveness of such a transaction increases as Radian approaches the time when capital will be most valuable.
Such a transaction could look very similar to the FGIC-MBIA muni-only cut-through insurance transaction of 2008. Indeed, MBIA's (NPFG's) analysts may have already looked under the hood at Radian and that company is certainly a viable counterparty. But the easiest piece of business to commute would be the $20B reinsurance book which is about 95% municipal and 95% ceded from Assured Guaranty Ltd. subsidiaries.
Assured is not only familiar with all the credits involved, but they are a motivated actor. While Radian Asset's insured portfolio may have been one of the best or the best performer of the financial guaranty sector in the blowup, the units ratings have been pulled down by its runoff status, capital extraction, and corporate family. For Assured, this means the rating agency benefits of reinsurance are vastly reduced; recapturing the book would quickly provide rating agency capital if done for approximately the unearned premium minus loss reserves (nominal) and the deferred acquisition costs (likely ~20%) which largely represents the ceding commission that Assured already collects on this business.
There is good reason why Radian hasn't pursued more extensive commutations so far. Over the last two years, Radian Asset has generated significant economic and statutory income. As statutory income is earned, contingency reserves are built, increasing the potential treasure trove of capital for Radian Guaranty. There are several alternatives which Radian can enact in a timely manner. Those include direct municipal and/or reinsured municipal exposure commutations with Assured Guaranty, MBIA, or even itself a'la MIAC. Also, a future transaction could materialize with a potential insurer backed by the National League of Cities.
This all may be unnecessary. In addition to holding company funds, MI capital, and FG statutory net income, the FG contingency reserve should release capital by the end of 2013 by which time 50% of the structure finance portfolio will have matured; 65% matures by year end 2014. Additionally, the preliminary estimate of its pro-forma risk-to-capital ratio does not appear to include the corresponding contingency reserve release. That release would include $40M of the reserves built in the first three quarters and whatever reserves would otherwise be established in Q4.
Turning to MI, Radian Guaranty will earn well over $200M in premiums from post-2008 business in 2012; this portion of the MI book was underwritten to higher standards and at lower real estate values. Credit burnout has taken hold: Q3 new defaults were 57% of the Q3 2009 level. About 2/3 of "New Defaults" in Q3 2011 were actually redefaults versus a much lower proportion in 2009 (the term "New Default" refers to the default making the loan "new" to the default inventory compared to only the immediately prior quarter). These factors support a view for lower operating losses going forward and while uncertainty surrounding the default inventory remains extreme, it is much less than it was two or even one year ago.
All in, it seems that Radian can finance about $600M of net operating losses in the near term after considering the potential for FG capital initiatives. Radian could breach that level by recording an additional $1.6B of loss provisions through 2012, 5 quarters - the company currently predicts it will lose that much over the entire life of the book. At the same time, the stress losses of recent years have become less likely.
Even if Radian does manage to breach that level, the capital position can reverse quickly - as evidenced in FHA's press release today. Regulatory restrictions on writing new business have - and likely will continue - to boil down to projections of financial health of the specific insurance company. Such an approach increases the cushion for adverse loss developments. Whether or not to rely on such regulatory forebearance will likely be Radian's decision on how to manage its capital.
Saturday, August 27, 2011
S&P's New Criteria
S&P revised their proposed criteria, most notably by applying strict leverage limits to only the AAA rating category. The limit imposes a 75:1 maximum ration to all credits, while original proposition included a dichotomy between structured finance at 20:1 and municipal credits at the now-adopted 75:1. While this uniformity concedes that a hard cap should consider the most-credit worthy insured portfolio (as The Dragon advised), the level of the limit is debatable.
The nature of the risk premium shows that the leverage ratio for bond insurers should be substantially higher than banks of equivalent creditworthiness as pointed out here and exemplified here. The exact level is admittedly part art, making an outright condemnation of S&P's limit difficult. However within the realm of what S&P had been considering, the rating agency certainly took the right path.
The wording of some of the modifiers and tests such as the capital adequacy model suggests S&P opened the criteria to more discretion of its analysts, another point for which we argued. The overall construction of the model still resembles a Rube Goldberg project, but less rickety. This is worse news for the future accuracy of S&P's model than for the guarantors. Having a rigid model allows the guarantors to game the system. For starts, lower credits and and stop-loss structures just became more attractive, especially for guarantor's seeking a AAA rating and on large and structured finance credits where expected recoveries are lower.
For all intensive purposes, this is really only immediately applicable to Assured Guaranty.
That explains why Assured made some convincing points regarding the recovery strength unique to guarantors which S&P applied. Given recent events in put-back litigation, its shocking that similar adjustments aren't made on the structured finance side. To S&P's credit, neither The Dragon nor Assured called for such adjustments. Then again, there were greater concerns.
There are other disappointments. For example:
-Investing in self-insured obligations considered a negative after low hurdle is met despite no additional credit risk taken on.
-Applying higher that expected stress losses to largest obligors test that contemplates "benign" environment.
-Largest obligors test measured across ratings categories and not sub-sector.
Nonetheless, this model is a drastic improvement and we applaud S&P for addressing areas of concern. Assured made a non-committal press release after the model was announced (and their stock shot up over 10%). While we are not going to rebuild the capital adequacy model, Assured's business risk profile is likely to be the top score given the industry score (of 2, second best) and the guarantor's being the best positioned in the industry. The business risk profile is determined by a matrix of industry score and competitive position.
Furthermore, the company's operating performance, management, financial flexibility, and liquidity scores should be the best in the industry. Even if Assured scored the worst possible - a 6 - on capital adequacy, it could reach the top half of scores with modifications from those other modifying scores. Given a top business risk profile, Assured would have to score in the bottom half of the financial risk profile score to fall out of the AA category. That should not be the case and - without actually applying many of the metrics - we'll bet it will not be the case.
The nature of the risk premium shows that the leverage ratio for bond insurers should be substantially higher than banks of equivalent creditworthiness as pointed out here and exemplified here. The exact level is admittedly part art, making an outright condemnation of S&P's limit difficult. However within the realm of what S&P had been considering, the rating agency certainly took the right path.
The wording of some of the modifiers and tests such as the capital adequacy model suggests S&P opened the criteria to more discretion of its analysts, another point for which we argued. The overall construction of the model still resembles a Rube Goldberg project, but less rickety. This is worse news for the future accuracy of S&P's model than for the guarantors. Having a rigid model allows the guarantors to game the system. For starts, lower credits and and stop-loss structures just became more attractive, especially for guarantor's seeking a AAA rating and on large and structured finance credits where expected recoveries are lower.
For all intensive purposes, this is really only immediately applicable to Assured Guaranty.
That explains why Assured made some convincing points regarding the recovery strength unique to guarantors which S&P applied. Given recent events in put-back litigation, its shocking that similar adjustments aren't made on the structured finance side. To S&P's credit, neither The Dragon nor Assured called for such adjustments. Then again, there were greater concerns.
There are other disappointments. For example:
-Investing in self-insured obligations considered a negative after low hurdle is met despite no additional credit risk taken on.
-Applying higher that expected stress losses to largest obligors test that contemplates "benign" environment.
-Largest obligors test measured across ratings categories and not sub-sector.
Nonetheless, this model is a drastic improvement and we applaud S&P for addressing areas of concern. Assured made a non-committal press release after the model was announced (and their stock shot up over 10%). While we are not going to rebuild the capital adequacy model, Assured's business risk profile is likely to be the top score given the industry score (of 2, second best) and the guarantor's being the best positioned in the industry. The business risk profile is determined by a matrix of industry score and competitive position.
Furthermore, the company's operating performance, management, financial flexibility, and liquidity scores should be the best in the industry. Even if Assured scored the worst possible - a 6 - on capital adequacy, it could reach the top half of scores with modifications from those other modifying scores. Given a top business risk profile, Assured would have to score in the bottom half of the financial risk profile score to fall out of the AA category. That should not be the case and - without actually applying many of the metrics - we'll bet it will not be the case.
Monday, March 7, 2011
Sean McCarthy
What's this? The president of AFGI resigns from his post with the same title at Assured Guaranty. Given Sean's recent testimony and trip to Japan, this seems hardly a planned sacking.
It could not be anything scandalous on Sean's part; he is a family man, a gentle giant, and he would not be given three weeks if there was disturbing personal news. Elliot Spitzer did not take quite that long in his exit.
Why were all the stocks up anyways? No we do not have attention deficit disorder, but just like to draw connections. Perhaps new financial and human capital was committed today.
BondFactor is eight short blocks from Assured Guaranty. That's not bad if you're trying to stick to your roots. Sean moved to Ireland for part of his childhood when his father secured a position there.
Sean would also be a huge asset to that BondFactor, considering that none of the biographies on that company's "Senior Executives" page shows any monoline experience. The website also advertises for senior executives on the career page.
Mergers are never painless, so maybe we are totally off base here. But this reeks of poachers. Sean is too valuable for Assured to just toss him out.
It could not be anything scandalous on Sean's part; he is a family man, a gentle giant, and he would not be given three weeks if there was disturbing personal news. Elliot Spitzer did not take quite that long in his exit.
Why were all the stocks up anyways? No we do not have attention deficit disorder, but just like to draw connections. Perhaps new financial and human capital was committed today.
BondFactor is eight short blocks from Assured Guaranty. That's not bad if you're trying to stick to your roots. Sean moved to Ireland for part of his childhood when his father secured a position there.
Sean would also be a huge asset to that BondFactor, considering that none of the biographies on that company's "Senior Executives" page shows any monoline experience. The website also advertises for senior executives on the career page.
Mergers are never painless, so maybe we are totally off base here. But this reeks of poachers. Sean is too valuable for Assured to just toss him out.
Tuesday, March 1, 2011
Assured's 2010 and a Preliminary Indication of Reinsurance Talks
Several things were made clear by Assured's recent financial report.
First, the NPV of future business can go to zero and the company's stock remains very attractive.
Second, repurchase demands are making headway.
Third, Assured has much less incentive and desire to pursue the commutations that MBIA has been inking. Assured spreads never blew out like MBIA Corp, the business they underwrote performed better, and their ratings stayed higher. The only thing that could change this are strict and "dumb" ratio limits by S&P.
Fourth, some demand for financial guarantee insurance is quite inelastic. The due diligence, surveillance and recovery skills of the insurers have value with or without ratings uncertainty.
Fifth, Sean McCarthy was in Japan. That probably means one or both of these two things:
1) he LOVES sushi and/or plum blossoms; or
2) he was visiting some friends, specifically his old friends at Tokio Marine, the largest legacy-FSA reinsurer, or Mitsui Sumitomo both of whom legacy-AGC had no relationship. They are also both rated AA which no other financial guarantor in the USA can match other than Assured. Did I mention McCarthy came from FSA? Dominic was not lying when he said reinsurance was the top choice for capital relief. It should not be shocking they are taking the first steps on a possible deal.
First, the NPV of future business can go to zero and the company's stock remains very attractive.
Second, repurchase demands are making headway.
Third, Assured has much less incentive and desire to pursue the commutations that MBIA has been inking. Assured spreads never blew out like MBIA Corp, the business they underwrote performed better, and their ratings stayed higher. The only thing that could change this are strict and "dumb" ratio limits by S&P.
Fourth, some demand for financial guarantee insurance is quite inelastic. The due diligence, surveillance and recovery skills of the insurers have value with or without ratings uncertainty.
Fifth, Sean McCarthy was in Japan. That probably means one or both of these two things:
1) he LOVES sushi and/or plum blossoms; or
2) he was visiting some friends, specifically his old friends at Tokio Marine, the largest legacy-FSA reinsurer, or Mitsui Sumitomo both of whom legacy-AGC had no relationship. They are also both rated AA which no other financial guarantor in the USA can match other than Assured. Did I mention McCarthy came from FSA? Dominic was not lying when he said reinsurance was the top choice for capital relief. It should not be shocking they are taking the first steps on a possible deal.
Friday, February 4, 2011
Positioning for the Future
In a news heavy week for bond and mortgage insurance, the public release of information surrounding a tiny acquisition by Radian Group and an even tinier commutation by RAM Holdings may be the most important.
In its fourth quarter earnings release on Thursday, Radian announced the acquisition of Municipal and Infrastructure Assurance Corp (MIAC), Macquarie Group's scuttled venture into bond insurance. (See a good summary here.) The importance of this acquisition lies in the implications for two plausible scenarios of another bond insurer (re)entering the market.
Scenario 1.
Radian monetizes all or part of its public finance book by moving it into MIAC and selling the entire or partial interest in that company. This scenario would fit with management's comments and is explicitly cited in Radian's press release. The mention of early stage discussions to potentially reinsure the entire public finance book suggests that a new source of capital is considering an entrance into the business. The Blue Dragon considers it unlikely that MBIA or Assured is on the other side of the table, but we have been wrong before.
Scenario 2.
Radian is unable to attract an investor at a reasonable price, but over the next 12 to 24 months developments convince Radian to split its structured and municipal businesses and reenter the public finance market. Radian insists that the company continues to focus on mortgage insurance. Nonetheless, Radian's holding company projects year end liquidity of $640M while less than $250MM in capital would be needed to both 1) pass the leverage portion of S&P's proposed criteria beneath the AAA ceiling and 2) insure all of the $15.8B NPO of direct public finance business remaining in Radian Asset. While this is only one portion of one rating agency's proposed criteria, it is also important to remember that a significant constraint on Radian Asset's ratings at both Moody's and S&P is managements intent to runoff the business and extract capital to support Radian Guaranty, the MI sub.
Given the financial stress across Radian, a AAA level is highly unlikely for any unit until circumstances improve. But solid capitalization and an experienced team with an excellent track record at Radian Asset and Radian Group suggest high investment grade ratings may be within reach in this scenario.
S.A. Ibrahim and his team have made three great moves relating to the mortgage crisis. First, before the crisis began they made the conscious decision to avoid residential mortgage exposure in Radian Asset in order to avoid risk concentration across the bond and mortgage insurance businesses. Second, they incurred significantly less permanent capital impairments compared to MGIC and PMI arising from business sales and capital raising at all three companies. Third, they brilliantly expanded Radian Guaranty's sales efforts as competition fled. In the opinion of The Blue Dragon, an implementation of Scenario 2 would be a fourth great but unlikely addition to this list.
Then there is RAM. Since we have given a plug for S.A. and his team, we have to give a plug to David Steel and his Chamber of Secrets. In all seriousness, though Steel and Co. have not been stalwarts of financial transparency, the slow reporting has been part of a successful campaign to reduce operating costs. The prescient commutations of the last couple years by this team, kept RAM alive with a solid though blemished track record.
This brings us to RAM's Thursday Q3 earnings release in which the company announced a $10.3M payment to commutate $123M NPO of exposure "primarily relating to residential mortgage backed securities." The exposure amounts to approximately 1/5 of RAM's combined RMBS and Home Equity exposure as of Q3 2009. Unfortunately for RAM shareholders, it does not appear likely from The Blue Dragon's point of view that this housecleaning was part of a discussion with the same source of capital that has preliminarily connected with Radian. More likely, the only potential acquirer involved was Assured (and maybe Calliope peripherally). Assured probably also is not seriously considering the acquisition, despite our arguments (accessible here.)
The rating agencies may also have been involved - in spirit only of course. RAM has placed assets in trusts for the benefit of its ceding companies. Since RAM was downgraded to junk and had its ratings withdrawn, the amount of assets in those trusts act as a cap on the benefit that Moody's and S&P will recognize in assessing the ceding companies. To appease the rating agencies, Assured would have the highest incentive to reassume ceded exposure with high capital charges and loss reserves like RMBS.
As a side effect of this deal, RAM's risk profile is modestly more stable. This leads us to consider what RAM will look like in 18 to 24 months. Assuming they can resolve their FGIC exposure without exploding, the company's loss reserves can outperform those of its ceding companies due to 30% larger reserves compared to ceded losses (RAM's share of the ceding company's booked loss on the exposure.)
Now consider that as of Q3 2009 RAM's AAA leverage ceiling in S&P's proposed criteria would be approximately 56:1. This implies that RAM would need a $359M capital base to achieve that limit. If unearned premiums were included as capital in S&P's calculation, RAM would probably be within $40M of that number today. Between Q3 2009 and YE 2012, 18.9% of RAM's insured debt service will have run off. While exposure shrinks, the mix of business benefits from shifting more toward longer-tail public finance business. Also, interest, installment premiums, and premium reserves are earned. All this happens in the ordinary course of business, but The Blue Dragon considers it under-appreciated by market participants - including bond insurer employees - traumatized by recent catastrophe.
In short, we think RAM could have a mid-investment grade IFS rating in 2013 without any more commutations or recapitalization. Further, as such a proposition becomes more widely accepted by market participants, the likelihood of commutations or acquisition increase. We see this increase as driven by RAM's desire to reenter the market in the first place or someone else's desire to enter the market in the second. Neither will happen this year unless recovery talks are farther advanced than we expect (which is significantly farther advanced than market expects.)
So there you have it: two tiny deals hidden amidst regulatory developments, rating agency responses, massive losses, and court rulings. Mix in an obsessive compulsive analyst and everybody is investment grade again.
In its fourth quarter earnings release on Thursday, Radian announced the acquisition of Municipal and Infrastructure Assurance Corp (MIAC), Macquarie Group's scuttled venture into bond insurance. (See a good summary here.) The importance of this acquisition lies in the implications for two plausible scenarios of another bond insurer (re)entering the market.
Scenario 1.
Radian monetizes all or part of its public finance book by moving it into MIAC and selling the entire or partial interest in that company. This scenario would fit with management's comments and is explicitly cited in Radian's press release. The mention of early stage discussions to potentially reinsure the entire public finance book suggests that a new source of capital is considering an entrance into the business. The Blue Dragon considers it unlikely that MBIA or Assured is on the other side of the table, but we have been wrong before.
Scenario 2.
Radian is unable to attract an investor at a reasonable price, but over the next 12 to 24 months developments convince Radian to split its structured and municipal businesses and reenter the public finance market. Radian insists that the company continues to focus on mortgage insurance. Nonetheless, Radian's holding company projects year end liquidity of $640M while less than $250MM in capital would be needed to both 1) pass the leverage portion of S&P's proposed criteria beneath the AAA ceiling and 2) insure all of the $15.8B NPO of direct public finance business remaining in Radian Asset. While this is only one portion of one rating agency's proposed criteria, it is also important to remember that a significant constraint on Radian Asset's ratings at both Moody's and S&P is managements intent to runoff the business and extract capital to support Radian Guaranty, the MI sub.
Given the financial stress across Radian, a AAA level is highly unlikely for any unit until circumstances improve. But solid capitalization and an experienced team with an excellent track record at Radian Asset and Radian Group suggest high investment grade ratings may be within reach in this scenario.
S.A. Ibrahim and his team have made three great moves relating to the mortgage crisis. First, before the crisis began they made the conscious decision to avoid residential mortgage exposure in Radian Asset in order to avoid risk concentration across the bond and mortgage insurance businesses. Second, they incurred significantly less permanent capital impairments compared to MGIC and PMI arising from business sales and capital raising at all three companies. Third, they brilliantly expanded Radian Guaranty's sales efforts as competition fled. In the opinion of The Blue Dragon, an implementation of Scenario 2 would be a fourth great but unlikely addition to this list.
Then there is RAM. Since we have given a plug for S.A. and his team, we have to give a plug to David Steel and his Chamber of Secrets. In all seriousness, though Steel and Co. have not been stalwarts of financial transparency, the slow reporting has been part of a successful campaign to reduce operating costs. The prescient commutations of the last couple years by this team, kept RAM alive with a solid though blemished track record.
This brings us to RAM's Thursday Q3 earnings release in which the company announced a $10.3M payment to commutate $123M NPO of exposure "primarily relating to residential mortgage backed securities." The exposure amounts to approximately 1/5 of RAM's combined RMBS and Home Equity exposure as of Q3 2009. Unfortunately for RAM shareholders, it does not appear likely from The Blue Dragon's point of view that this housecleaning was part of a discussion with the same source of capital that has preliminarily connected with Radian. More likely, the only potential acquirer involved was Assured (and maybe Calliope peripherally). Assured probably also is not seriously considering the acquisition, despite our arguments (accessible here.)
The rating agencies may also have been involved - in spirit only of course. RAM has placed assets in trusts for the benefit of its ceding companies. Since RAM was downgraded to junk and had its ratings withdrawn, the amount of assets in those trusts act as a cap on the benefit that Moody's and S&P will recognize in assessing the ceding companies. To appease the rating agencies, Assured would have the highest incentive to reassume ceded exposure with high capital charges and loss reserves like RMBS.
As a side effect of this deal, RAM's risk profile is modestly more stable. This leads us to consider what RAM will look like in 18 to 24 months. Assuming they can resolve their FGIC exposure without exploding, the company's loss reserves can outperform those of its ceding companies due to 30% larger reserves compared to ceded losses (RAM's share of the ceding company's booked loss on the exposure.)
Now consider that as of Q3 2009 RAM's AAA leverage ceiling in S&P's proposed criteria would be approximately 56:1. This implies that RAM would need a $359M capital base to achieve that limit. If unearned premiums were included as capital in S&P's calculation, RAM would probably be within $40M of that number today. Between Q3 2009 and YE 2012, 18.9% of RAM's insured debt service will have run off. While exposure shrinks, the mix of business benefits from shifting more toward longer-tail public finance business. Also, interest, installment premiums, and premium reserves are earned. All this happens in the ordinary course of business, but The Blue Dragon considers it under-appreciated by market participants - including bond insurer employees - traumatized by recent catastrophe.
In short, we think RAM could have a mid-investment grade IFS rating in 2013 without any more commutations or recapitalization. Further, as such a proposition becomes more widely accepted by market participants, the likelihood of commutations or acquisition increase. We see this increase as driven by RAM's desire to reenter the market in the first place or someone else's desire to enter the market in the second. Neither will happen this year unless recovery talks are farther advanced than we expect (which is significantly farther advanced than market expects.)
So there you have it: two tiny deals hidden amidst regulatory developments, rating agency responses, massive losses, and court rulings. Mix in an obsessive compulsive analyst and everybody is investment grade again.
Sunday, January 2, 2011
Rambling Speculation on RAM Takeover
If I may bring the quality of posts down here for a moment...
I can see the 9.9% voting rights limit throwing a wrench in any outright takeover offers. Especially if it's known that Calliope (38% owner) will vote against at whatever price level. When I spoke with McCarthy he mentioned that its most desirable to do portfolio acquisitions at the commutation/recapture level in order to avoid holding company volatility. If you acquire a piece of the common but can't get the rest then it would create incremental volatility in OCI on the balance sheet. I can understand them wanting to avoid volatility as confidence in their financial position determines their pricing power. But it would be so small compared to their balance sheet! I still think they should be accumulating on the open market.
If they tender or offer for say 1/2 or even 2/3 of Operating (not adjusted) book value or $2.5-$3.5, I could see it failing. Then if it failed the common and preferreds would have rocketed higher and the opportunity to accumulate on the open market is not as attractive. But still why not acquire on the open market or tender, you won't hit your target if you don't take the shot. Unless...
MBIA or Macquarie owns most of the preferreds. This doesn't look to be the case, but if it were then things might make a little more sense. A takeover would then serve to enrich a weakened competitor or possible new entrant. It could give Macquarie that push it needs to enter the market.
But now we have strayed deep into speculation and far from anything likely. What I think is happening is the preferreds are rotting away in some massive multi billion dollar portfolios where they are hardly noticed or somebody just likes them or somebody doesn't want to recognize the loss on them or a bit of all three. Meanwhile, Assured is just focused on operations and so they are missing out on highly accretive capital markets opportunities. Just ask Chris at Trafalet.
I can see the 9.9% voting rights limit throwing a wrench in any outright takeover offers. Especially if it's known that Calliope (38% owner) will vote against at whatever price level. When I spoke with McCarthy he mentioned that its most desirable to do portfolio acquisitions at the commutation/recapture level in order to avoid holding company volatility. If you acquire a piece of the common but can't get the rest then it would create incremental volatility in OCI on the balance sheet. I can understand them wanting to avoid volatility as confidence in their financial position determines their pricing power. But it would be so small compared to their balance sheet! I still think they should be accumulating on the open market.
If they tender or offer for say 1/2 or even 2/3 of Operating (not adjusted) book value or $2.5-$3.5, I could see it failing. Then if it failed the common and preferreds would have rocketed higher and the opportunity to accumulate on the open market is not as attractive. But still why not acquire on the open market or tender, you won't hit your target if you don't take the shot. Unless...
MBIA or Macquarie owns most of the preferreds. This doesn't look to be the case, but if it were then things might make a little more sense. A takeover would then serve to enrich a weakened competitor or possible new entrant. It could give Macquarie that push it needs to enter the market.
But now we have strayed deep into speculation and far from anything likely. What I think is happening is the preferreds are rotting away in some massive multi billion dollar portfolios where they are hardly noticed or somebody just likes them or somebody doesn't want to recognize the loss on them or a bit of all three. Meanwhile, Assured is just focused on operations and so they are missing out on highly accretive capital markets opportunities. Just ask Chris at Trafalet.
Wednesday, December 15, 2010
Yo Dom, check it.
Dear Mr. Dominic Frederico and Assured Guaranty,
Please consider the benefits of acquiring RAM Holdings Ltd. With such an acquisition you would assume a $20B NPO insured portfolio- $15B of which is public finance risk. For assuming that exposure, Assured Guaranty would receive $125M in statutory capital and $360M in claims paying resources. Looking at GAAP numbers, Assured would receive approximately $125M in operating shareholder’s equity and $234M in adjusted book value. The market value of the investment portfolio to be acquired is over $320M.
Assured is in a unique position as it cedes approximately $15B of this exposure (and I believe an even greater percentage of the $5B structured finance risk). This transaction may likely be effected for $50-75M dollars given that the RAM Holdings market value has not exceed $25M for over two years. Such a bargain price is also likely to be achieved due to:
1) the state of the industry;
2) low investor interest in the industry;
3) the high cost structure of Ram Holdings due to lack of scale; and
4) 8 month lag in financial reporting (though a good idea can be surmised for the interim based on ceding portfolios, of which Assured is the largest;)
5) Unique position of Assured already assuming the tail risk for lion’s share of insured portfolio.
The economics of the transaction are clearly attractive. When considering the risk involved, Assured can essentially view the acquisition as 1) the assumption of a $5B portfolio, paired with 2) the cancellation of a reinsurance policy with a maximum benefit of $300M. Said another way, Assured is already exposed to a stop-loss on $15B of exposure after the first $300M of claims. Additionally, Ram Holdings could continue on as separate subsidiary, limiting Assured’s exposure to adverse developments of the portfolios ceded by FGIC and Syncora Guarantee.
The accounting of the transaction are clearly attractive. On the companies various balance sheets, the transaction would be accretive to the statutory capital positions, operating shareholder’s equity, and adjust book value of the company.
The acquisition would not be meaningless. If you subtract the assumed acquisition cost from the adjusted book value, the difference would be larger than the PVP of new business written in first six months of 2010.
Please consider the benefits of acquiring RAM Holdings Ltd. With such an acquisition you would assume a $20B NPO insured portfolio- $15B of which is public finance risk. For assuming that exposure, Assured Guaranty would receive $125M in statutory capital and $360M in claims paying resources. Looking at GAAP numbers, Assured would receive approximately $125M in operating shareholder’s equity and $234M in adjusted book value. The market value of the investment portfolio to be acquired is over $320M.
Assured is in a unique position as it cedes approximately $15B of this exposure (and I believe an even greater percentage of the $5B structured finance risk). This transaction may likely be effected for $50-75M dollars given that the RAM Holdings market value has not exceed $25M for over two years. Such a bargain price is also likely to be achieved due to:
1) the state of the industry;
2) low investor interest in the industry;
3) the high cost structure of Ram Holdings due to lack of scale; and
4) 8 month lag in financial reporting (though a good idea can be surmised for the interim based on ceding portfolios, of which Assured is the largest;)
5) Unique position of Assured already assuming the tail risk for lion’s share of insured portfolio.
The economics of the transaction are clearly attractive. When considering the risk involved, Assured can essentially view the acquisition as 1) the assumption of a $5B portfolio, paired with 2) the cancellation of a reinsurance policy with a maximum benefit of $300M. Said another way, Assured is already exposed to a stop-loss on $15B of exposure after the first $300M of claims. Additionally, Ram Holdings could continue on as separate subsidiary, limiting Assured’s exposure to adverse developments of the portfolios ceded by FGIC and Syncora Guarantee.
The accounting of the transaction are clearly attractive. On the companies various balance sheets, the transaction would be accretive to the statutory capital positions, operating shareholder’s equity, and adjust book value of the company.
The acquisition would not be meaningless. If you subtract the assumed acquisition cost from the adjusted book value, the difference would be larger than the PVP of new business written in first six months of 2010.
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