Will Detroit Crush Assured Guaranty Earnings?

Assured Guaranty (NYSE: AGO  ) will release its quarterly report on Thursday, and a big boom in home prices after a long slump has done the trick to boost the company's stock price substantially so far this year. But despite calls for modest growth in Assured Guaranty earnings, the future direction of the company is far from certain right now, given the challenges facing the industry and the overall economy.

For years, Assured Guaranty reaped the benefits of standing behind various types of financial instruments, insuring investors against risk of loss from mortgage-backed securities, public-finance obligations, and other investments. Yet during the financial crisis, the risk part of the risk-reward equation finally asserted itself, sending Assured Guaranty and its peers close to their breaking point. Those companies that survived the crisis have recovered sharply lately, but how long can that recovery continue? Let's take an early look at what's been happening with Assured Guaranty over the past quarter and what we're likely to see in its quarterly report.

Stats on Assured Guaranty

Analyst EPS Estimate

$0.63

Change From Year-Ago EPS

3.3%

Revenue Estimate

$202.2 million

Change From Year-Ago Revenue

(7.8%)

Earnings Beats in Past 4 Quarters

4

Source: Yahoo! Finance.

Will Assured Guaranty earnings keep rising?
Analysts have had mixed views on the prospects for Assured Guaranty earnings lately, with a nickel-per-share reduction in June-quarter estimates more than offset by a massive $0.70 per share jump in predictions for the full 2013 year. The stock's performance falls somewhere in between, having risen a modest 5% since early May.

Assured Guaranty and its peers have benefited greatly from the improvement in the housing market. Hard-hit insurers Radian Group (NYSE: RDN  ) and MGIC Investment (NYSE: MTG  ) have seen even more impressive share-price gains than Assured Guaranty, arguably because they got closer to the brink than the relatively healthier Assured Guaranty did. With home prices on the rise, mortgage insurers benefit two ways: from the increasing credit quality of remaining legacy mortgage-backed securities that they insure, and from new business underwritten under higher standards with less risk of loss.

Assured Guaranty also won some nice settlements during the quarter. In its case against UBS (NYSE: UBS  ) , the investment bank agreed to shoulder some of the responsibility for mortgage-backed securities that went bad, and for which Assured Guaranty had to pay claims, with an initial payment of $358 million and the potential for further payments in the future. Flagstar Bancorp also ended up on the paying end of a settlement with the insurer, as Assured Guaranty received $105 million to settle mortgage-backed security claims.

New concerns have arisen in light of the bankruptcy filing of the city of Detroit, as Assured Guaranty could have to cover substantial claims on unsecured city debt. But even in the wake of the Detroit bankruptcy, Assured Guaranty is doubling down on the municipal-bond insurance market. By launching its Municipal Assurance subsidiary, Assured Guaranty is aiming to focus on general obligation bonds, water and sewer bonds, education bonds, and other well-known and well-understood categories of public-finance debt. Complementing its other public-finance subsidiaries, the new vehicle should add to Assured Guaranty's overall coverage of the space even as rival MBIA (NYSE: MBI  ) and other companies look more closely at the industry.

In the Assured Guaranty earnings report, look for discussion and comment about the impact of the Detroit bankruptcy not just on immediate earnings, but also on the industry as a whole. Adverse results could raise moral hazard risks throughout the muni-bond market, as municipalities find it easier to stick insurance companies with losses rather than forcing taxpayers and city residents to shoulder the financial pain themselves. 

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