In a down market, only the fittest survive. With financial guarantors facing downgrades and insolvency, Assured Guaranty is pooling its resources with the only other triple-A rated monoline, Financial Security Assurance (FSA).
This is an acquisition that Assured hopes will bring strength in size. "In this environment, bigger is better," said Sabra Purtill, managing director of global communications and investor relations for Assured. "Our core business is providing certainty to investors; we provide them with a guarantee. And it is clear in our minds, that to be a reliable provider of insurance in this market and going forward, you need to have big, stable, unquestionable balance sheet strength."
Last week, Assured Guaranty struck a deal with Dexia SA, the parent company of FSA, to buy FSA for $722 million -$361 million in cash and approximately 44.6 million of Assured shares.
The purchase is a steal for Assured. FSA's non-GAAP adjusted book value, which is the economic value of the company excluding franchise value, was $4.5 billion at end of September.
The acquisition will position Assured as the only pillar of strength, other than Berkshire Hathaway, in the crumbling bond insurance market.
Indeed, just last week, Syncora Holdings, which includes bond insurer Syncora Guarantee, formerly XL Capital Assurance, took a $1.6 billion hit for 3Q08. This came primarily as a result of $981 million in losses on ABS CDOs and $213 million in losses related to HELOC, closed-end second, and Alt-A RMBS securities, according to a Barclays Capital report released after the company announced its earnings on Nov. 17.
Syncora's management expressed serious doubt about the ability of the company "to continue as a going concern."
By contrast, Assured looks well positioned to weather the storm. Although the bond insurer will take on $730 million in outstanding FSA debt, the company will be fully protected against exposure to FSA's financial products segment. The acquisition includes FSA's guaranteed investment contract business, whose losses will be guaranteed by FSA's parent company Dexia, as well as the French and Belgium governments.
The combined company will have $651 billion in net par outstanding, comprised of 66% public finance and 34% structured finance, according to a recent report from CreditSights. Pro forma claims resources would be $13.2 billion, including $5 billion in qualified statutory capital, and the pro forma GAAP equity base would be $3.6 billion.
A Bigger Book
Indeed, the acquisition will provide Assured with a significant book of business which will bring more investors and better trading liquidity in Assured's insured paper, Purtill said. Furthermore, it will bring greater diversity to Assured's portfolio. "FSA has been writing public and structured finance business for a lot longer than we have so we will gain a lot of balance in our risk profile as a result of coming together as one organization," Purtill said.
While both companies have RMBS portfolios that are under stress, neither one of the portfolios have high enough losses to warrant solvency concerns, she added.
Interestingly, both Assured Guaranty and FSA started as structured finance only bond insurers, and with that expertise avoided ABS CDOs, Purtill said.
With the increased stability, Assured is hoping to restore confidence in structured finance products. "We need to help, hand in hand with the structured finance industry, in rebuilding investor's confidence in the structured finance product. We need to convince regulators, legislators, and municipal bond investors and municipalities, that structured finance is not inherently dangerous and risky," Purtill said.
Since Assured has not yet cleared anti-trust regulations, it was not able to discuss potential business plans for the structured finance side of the company. Before the announcement of the acquisition, FSA said that it would no longer be underwriting structured finance business. One of the possibilities in the deal is that FSA could become the municipal-only business of the newly combined company, and Assured Guaranty could become the structured finance company.
However, the ultimate business model will depend on the rating agencies' review, since both FSA and Assured Guaranty are still on review for a downgrade by Moody's Investors Service. While both Standard & Poor's and Fitch Ratings said that the deal should pose limited ratings risk for Assured or FSA, Moody's said its ratings reviews of both companies will depend on capital adequacy given the elevated risks in the insured portfolio, and the negative environment affecting the financial guarantor industry in general.
There are also some "best practices" regulations in N.Y. for article 69 companies, which would place limits on the ability to write structured finance. Assured will have to work with regulators to assess the potential impact.
The amount of structured finance business that Assured will be able to write will be directly correlated to the size of the company. FSA and Assured Guaranty together will have a much larger capital base, which translates into more capacity. Although another question would be, when will the new deals return to the structured finance market?
A Leg Up on the Competition
The company is also tapping FSA before another competitor, such as Bershire Hathaway, or a firm looking to start up a bond insurance business, for example, scoops up the company. Indeed, FSA announced net losses last week of $333.5 million for the 3Q08 and $1,085.6 million for the first nine months of 2008.
Dexia has pumped a lot of money into FSA since the credit crunch began. In addition to the $5 billion unsecured liquidity facility provided to the financial products (FP) business, Dexia also provided a $500 million capital commitment agreement to cover economic losses in the FP portfolio occurring after June 30, 2008. As per this agreement, a $208 million contribution will be made to the company by Nov. 30, which made it increasingly likely that Dexia would begin looking for suitors for the business, according to one market source.
The transaction will be financed with a public equity offering by Assured, who has also received a back-up commitment from funds affiliated with WL Ross & Co. to fund the cash portion of the transaction.
The deal is expected to close in 1Q09, subject to shareholder approval for the issuance of additional shares and regulatory approval from New York and Maryland.
Banc of America Securities served as financial advisor on the transaction and Mayer Brown is the legal counsel.
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