At the Sohn conference 2018 David Einhorn (Trades, Portfolio) of Greenlight Capital presented another short idea. His target is a medium-sized bond insurance company called Assured Guaranty (AGO, Financial). Just after Einhorn's thesis leaked and the company issued a defensive press release I wrote about it here on GuruFocus. Now, Einhorn's presentation, which I didn't have at the time of the original article, contains juicy additional information! For good measure, the timeline was like this:
- Einhorn presented his case to the Sohn audience.
- Einhorn's general idea leaked to the press.
- Assured Guaranty stock dropped around 6%.
- Assured Guaranty issued a press release defending itself.
- Einhorn's presentation was leaked but updated to reflect on the Assured Guaranty press release.
Einhorn's thesis can essentially be distilled into a single point: Assured Guaranty is underreserving for losses.
Assured apparently doesn't have to mark-to-mark its liabilities and according to Einhorn's work is only estimating a loss of 20% on its Puerto Rico exposure.
Assured Guaranty has quite a bit of Puerto Rico bond exposure. Puerto RIco is in sort of dire straits financially. The market values Puerto Rico bonds at 40 cents on the dollar.
They would have to double in value to match the value that is apparently assigned to them. Einhorn suspects the difference in perception is mainly caused by the post-hurricane Maria price collapse:
"It doesn’t appear that AGO has taken the hurricane into account. While the bond market fell about 30 points after the hurricane through year”end, implying about $1.5 billion in incremental losses, AGO boosted its reserves by a measly $111 million.
While prices have recovered since, they are still well below where they traded pre” hurricane. We’ll see where AGO establishes its reserves for the March quarter shortly."
Assured has much exposure to other troubled areas as well. Seemingly most of its reserves are needed to cover Puerto Rico losses. This leaves very little margin of safety for losses in other areas:
The slide above shows areas where the book could potentially take a hit. Greenlight highlighted the company's internal rating system, contending that the company on average rates its exposures higher compared to credit agencies.
Einhorn expects Assured Guaranty will need to halt buybacks of its stock. If Greenlight's calculations come true, it will even have to:
- Let go of its AA rating, which should mean it can't replace its existing business by writing new insurance.
- Raise equity to protect its rating, which will dilute shareholders and negatively impact the shareprice.
If Puerto Rico bonds hold up really well, for example doubling from here, Assured Guaranty could come through fine. To hedge against that scenario, the hedge fund purchased Puerto Rico debt. If the bonds do well they can double or more, but Assured may not do that well, as bond losses weren't baked in to begin with.
It's an interesting short thesis, and it will be interesting to see if this one turns things around for guru David Einhorn (Trades, Portfolio). The full presentation and comments can be found on Greenlight's site.
Disclosure: No position except in GLRE stock.
