Assured Guaranty (NYSE:
is in the business of insuring bond offerings for corporations
and municipalities. Not the most exciting stuff, but the bond
insurance industry is relatively small with only a few key
players. Essentially, these insurers put their stamp of approval
on new bonds sold by companies or municipalities and agree to
back the principle for creditors in the case of default.
For undertaking this risk, the insurance company is paid a
premium (typically by the selling party), which represents a
recurring income stream until the bond actually matures. Selling
parties, such as corporations, cities or counties, are willing to
pay this premium because they can typically sell the bonds with a
lower rate of interest because investors know that they are much
more likely to receive their principal back at a bare
In addition to the spread between premiums received and claims
paid out, insurance companies typically have a second major
source of income. This income comes from returns on the massive
amounts of capital that the insurance companies are required to
hold as protection in the event that they are required to meet
Over the past several years, it has been difficult for bond
insurers to generate profit from this area because of the
historically low interest rates. Not only is it difficult for AGO
to make money on conservative investments like Treasuries and
mortgage-backed securities, the broad market reach for yield has
made it difficult to find attractive
that have decent yields without too much risk.
With interest rates poised to rise as the Federal
Reserve completes its bond-buying program
, Assured Guaranty may be in for some relief on the investment
side. The company recently sold $500 million in senior notes,
which gives it a capital boost and can be invested in more
attractive securities over the next year. The company has stated
that it will use the cash for general corporate purposes, which
may include buying back shares of its stock (which currently pays
a 1.7% dividend yield).
A stock repurchase appears to make a lot of sense given the
company's current balance sheet and market value. As you can see
below, at the end of 2013, the company claimed an adjusted book
value of $49.58 per share, while the stock is currently trading
just above $23. If the balance sheet valuation is accurate,
Assured Guarantee can create a tremendous amount of value for
shareholders simply by purchasing its own stock at a discount to
book value. (My colleague David Sterman
recently profiled the best bargains
in a different class of investments that are trading at a
discount to their intrinsic value.)
Source: Assured Guaranty
In addition to the successful bond offering and opportunity to
repurchase shares at a discount, AGO should be helped by an
improving economy. As unemployment falls, the stock market
continues to hold up well, and corporate profits expand, AGO
should face less risk of default from the bonds it underwrites.
Based on a significant discount to book value, potential for
increased investment gains and a strengthening economy, I expect
shares to trade higher.
The stock recently pulled back with the broader market, and
the added volatility and lower price point provide an excellent
opportunity for selling puts. Today, I want to sell AGO Oct 23
puts with a limit order of $1.30.
By selling these puts, we are accepting an obligation to buy
100 shares of AGO per contract at the $23 strike price if the
stock closes below this level when the puts expire on Oct. 17.
Since we are receiving $1.30 in option premium from selling the
puts, our net cost will be closer to $21.70. We will need to set
aside $21.70 per share (or $2,170 per contract) of our own
capital for use in the event that the puts are exercised.
If AGO remains above $23, the $130 in income will represent a
gain of 6% over the $2,170 in capital set aside. Since this will
be generated over the next 89 days, our per-year rate of return
comes out to 24.6%.
Assured Guaranty is expected to report earnings in the first
week in August. Analysts are currently predicting earnings per
) of $0.55, up from $0.52 in the same quarter last year. For
2014, AGO is expected to earn $2.53 per share, giving it a
forward price-to-earnings (P/E) ratio is in the single
Action to Take -->
Selling puts gives us a chance to set up an attractive income. Of
course, if the stock drops and we are assigned shares at a net
cost of $21.70, I am happy to make that investment as AGO
represents a compelling value.
This article was originally published at
The 24.6% Yield Hiding Out in the Bond
Insurance Market (It's Not Junk!)
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