J.P. Morgan is out with another major call on Assured Guaranty (NYSE:
AGO) raising their price target to $42 from $28 following earnings announcement out last night.
AGO reported op EPS in line with the pre-announced $0.45 per share. Included in its Q was a premium amortization schedule that was well above what JPM had previously modeled. In short, they were not properly accounting for the way FSA's premium revenue is recognized going forward as AGO purchased the company at a large discount to book. As such they are raising their estimates substantially and pushing their price target up to $42, using the same 7x multiple to their new 2011 estimate. With shares trading at half firm's target, they would be aggressive buyers.
Premium discount amortization significantly higher than modeled.
When AGO acquired FSA it booked ~ $1.6B of premium discount. A majority of the discount was applied to RMBS exposures that have a shorter duration than the overall portfolio. As a result, the discount amortization built into future premium earnings will run at a significantly higher rate than we had expected. AGO disclosed in its Q that deferred premium revenue earned will be ~ $1.1B over the next four quarters and gradually decrease ~15-20% annually over the next 3 years. This increased revenue does not change the economics of AGO's business but will bolster regulatory capital dramatically.
RMBS loss mitigation efforts pay off.
AGO has been negotiating with mortgage originators to recover losses from improperly underwritten mortgages based on existing warranty covenants. In its 3Q earnings release AGO announced that they have reached an agreement to have $146M of mortgage loans repurchased by the originator and expect to put back an additional $804M of RMBS loans for a $527M total net benefit.
Additional capital to be raised by year-end.
As previously announced, AGO has initiated a capital plan in order to have its Aa3 rating affirmed by Moody's. The plan includes external reinsurance, inter-company capital support, and $300M of new capital. The external reinsurance has already been negotiated, and the $300M of capital is expected to be raised by year-end. This capital may be a mix of common and preferred or convert/hybrid equity.
Significant earnings power increase.
JPM is raising their 2010 and 2011 earnings estimate to $5.00 and $6.00 per share from $3.00 and $4.00, respectively, to reflect significantly higher earned premiums and loss mitigation efforts.
Trading at just 3.5x JPM's normalized earnings estimate of $6, compared to the doubledigit multiple on normal earnings we had seen in the past, the stock is cheap in firm's opinion.
