Hedge fund billionaire David Einhorn, the CEO of Greenlight Capital, is short bond-insurer Assured Guaranty (AGO).
“It is a melting ice cube that is paying out the drops while it still can,” Einhorn said. “When regulators, auditors, or ratings agencies figure them out, I doubt there will be many more drops left for shareholders.”
Einhorn presented his short thesis at the Sohn Conference in New York wearing the same brightly-colored tie he donned in 2002 when he revealed his Allied Capital short, a trade that minted him as a formidable short-seller that’s chronicled in his best-selling book “Fooling Some of the People All of the Time.”
“Today I’m going to present another short of a mid-sized financial institution most of you haven’t heard of that has serious problems, including losses it hasn’t accounted for, created its own proprietary grading system which helps hide the losses. It has fooled its sleeping auditors and regulators, and lures investors by aggressively returning capital it hasn’t earned,” Einhorn said. “This time I hope I won’t have to write a book about it.”
Shares of Assured Guaranty fell more than 6% in after-hours trading.
Bond insurers guarantee the interest and principal payments when bonds default.
Major bond insurers like MBIA and Ambac crashed during the 2008 financial crisis once they suffered ratings downgrades. According to Einhorn, the reason Assured Guaranty was relatively unscathed at the time was because it had its triple-a rating downgraded by Moody’s back in 1999.
“This probably saved the company because without a triple-a rating, from both S&P and Moody’s during the peak of the structured credit mania, it couldn’t compete and it wrote less bad business, guaranteeing the toxic CDOs that brought down most bond insurers.”
Following the financial crisis, Assured Guaranty “wobbled, but it didn’t fall down.”
“One big problem”
Today, the company faces “one big problem” and “several significant problems on the horizon,” Einhorn said. The “big problem” is Puerto Rico, which Einhorn calls the “wild card” in the AGO story. Puerto Rico had already been a “financial disaster” saddled by billions in debt before Hurricane Maria devastated the island last fall.
Hurricane Maria caused an estimated $95 billion in damage and accelerated the exodus of citizens from the territory. Meanwhile, federal aid has helped alleviate some of the problems, but not for the bondholders.
“AGO has a lot of exposure to Puerto Rico. It comes in a lot of different flavors,” Einhorn said, referring to the different types of bonds.
Puerto Rico may be “just the tip of the iceberg,” Einhorn said, pointing that there are other below investment-grade bonds the company is exposed to elsewhere including $17 billion in exposure to Illinois.
Einhorn has bought Puerto Rican bonds has a hedge, while selling Assured Guaranty shares short.
In a statement released overnight, Assured Guaranty refuted Einhorn’s claims.
“Mr. Einhorn’s analysis of Assured Guaranty fails to acknowledge the positive implications of our significant financial strength and strong operating performance, and demonstrates a fundamental lack of understanding of our business model and the municipal debt markets. In the event of a municipal default, Assured Guaranty is obligated to cover shortfalls in scheduled principal and interest payments only when those payments are due. Our insurance policies do not permit acceleration of payments without our consent. Mr. Einhorn’s focus on total debt service ignores this lack of acceleration, as well as the strength of our balance sheet, and the highly liquid nature of our investment portfolio, which generates significant investment income over time.
“Furthermore, Assured Guaranty is well reserved for its municipal exposures and, due to the non-acceleration feature, does not face liquidity risks. We have $11.5 billion of cash and investments1 with $2.8 billion of estimated excess capital over S&P’s AAA level.2 In addition, we have strong legal rights, including for Puerto Rico under PROMESA, which requires that fiscal plans must respect contractual liens and constitutional priorities established under Commonwealth law.
“Throughout its history, Assured Guaranty has successfully mitigated potential losses and defended its legal rights in numerous distressed municipal situations, including Jefferson County, AL; Stockton, CA; Hartford, CT; Detroit, MI; and Harrisburg, PA.
“For all these reasons and others, we strongly disagree with Mr. Einhorn’s assertions. We remain focused on continuing to generate long-term value for our shareholders.”
Julia La Roche is a finance reporter at Yahoo Finance. Follow her on Twitter.