Smart Money Betting on Bond Insurer Payoff: Street Whispers

NEW YORK ( TheStreet) -- Bond insurers MBIA ( MBI) and Assured Guaranty ( AGO)have been some of the hottest investments in the financial sector over the past five days, and while most Wall Street analysts long ago dropped coverage of these companies, big name investors are increasingly betting they can continue their rebound.

In the second quarter, hedge fund Perry Capital upped its stake in MBIA and Assured Guaranty to three million shares from 30,500. Perry, a protégé of former Treasury Secretary Robert Rubin when both men were at Goldman Sachs, joins Morningstar fund manager of the decade Bruce Berkowitz in betting MBIA can hang on long enough to win a multi-billion dollar settlement from Bank of America ( BAC) and get back into the municipal bond insurance business.

Investors were reassured on that count after MBIA reported second quarter earnings after the market closed Aug. 8. Since that time, shares are up 18.72% through Wednesday, when they closed at $13.41.

Assured Guaranty shares started running ahead of the company's Aug. 10 earnings report, possibly on investor optimism following MBIA's results. From the Aug. 8 close through Wednesday, Assured's shares have jumped 16.61%. Top shareholder WL Ross & Co., which bought 10.65 million Assured Guaranty shares in April 2008 at an average price of $23.47, now looks to have made the right decision as the investor steadily accumulated just under 9 million shares in the ensuing years, never paying more than $12.

While both MBIA and Assured Guarantee got way over their heads insuring mortgage backed securities in the 1990s and early 2000s, they have so far managed to remain solvent, while competitors were driven out of business. They now want to get back to their traditional role insuring municipal debt.

Some have their doubts about muni bond insurance, including Warren Buffett, who after taking a stab at the industry in 2008 concluded a year later it was a "dangerous business," because, as he wrote in his annual shareholder letter, "what mayor or city council is going to choose pain to local citizens in the form of major tax increases over pain to a far away bond insurer?"

But BTIG's Mark Palmer, one of the only sellside analysts to cover MBIA and Assured Guarantee, believes the reduced competition in muni bond insurance means there is room to make a profit notwithstanding the concerns raised by Buffett.

One obstacle to writing new business, however, is the low interest rate environment, which means many municipalities don't need insurance to lower the cost of issuing debt. Doing so is already dirt cheap. Assured Guarantee is also under the threat of a ratings downgrade from Moody's Investors Service that could hurt its ability to write new insurance. MBIA, meanwhile, needs to settle a long-running lawsuit with Bank of America that challenges the validity of a 2009 reorganization that split off MBIA's municipal bond insurance business from its exposure to frothy real estate loans.

Still, even if Assured Guarantee and MBIA can't get back into the muni bond underwriting game, that doesn't mean their shares can't rise substantially from here. Palmer argues Assured shares are worth at least $16 even if the company stops writing new insurance and merely allows its existing portfolio to run off. MBIA, meanwhile, will get a big pop if it wins a $2 billion settlement from Bank of America as Palmer and other analysts believe it will.

-- Written by Dan Freed in New York.

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