Can Turtles Fly?

UPDATE: According to this news article , Berkshire Hathaway Assurance will be capitalized with $105 million, with more depending on business performance. If we go with a typical 100-to-1 par insurance value (Berkshire Hathaway Assurance may use a slightly lower value while charging a higher price), then it will be insuring around $10 billion. That's very small (Ambac's public finance total par value exposure is $300 billion, with Ambac writing around $20 billion of new insurance per year). So the Berkshire entrance won't be a giant gorrilla entering the industry; it will be more of a nimble start-up, likely working its way to bigger things. UPDATE 2 : A couple of interviews with Buffett by Fox News regarding his bond insurance move (Thanks to Reflections on Value Investing for the original mention). Well, I have commented on the possibility before and it finally happened: Warren Buffett's Berkshire Hathaway is setting a bond insurance unit , Berkshire Hathaway Assuran...

One of the smaler monolines, ACA Capital Holdings, is likely on its way to winding down whatever it can. Its stock was delisted last week(?) (didn't meet NYSE requirements) and today Maryland's insurance regulators started taking control of its operations. This move gives ACA Holdings some time to raise capital. Unfortunately, I don't think anyone is going to inject capital into ACA. Banks like CIBC, a big Canadian bank, have been thinking about providing some capital since ACA insured some of their bonds, but I suspect very little will be done in the end. You can see the gravity of the situation by looking at ACA's potential losses under S&P's stress test here (read my original posting on the stress test here ). As you can see, ACA has a capital base of around $600 million whereas S&P's stress test results in a loss of $2.1 billion. Given that ACA is a lesser known monoline, that is a huge loss (all of it in CDOs as well). In contrast, the bigger ones...

Thanks to some poster on a forum post on gurufocus.com, I ran across this old article by Martin Whitman on distress investing: An Introduction to Distress Investing by Martin Whitman, 2002 (jump to the page numbered 3; or page 6 of the PDF). Since I'm trying to hone my contrarian skills (the verdict is still out on that :) ), distress investing is attractive to me. However, it is hard for small investors since equity generally gets wiped out and you have little say or resources at your disposal to challenge anything the company does. Nevertheless, it is a part of the investment world that is often ignored due to its complexity and danger. Bond Insurance Article On another note, Joe Mysak of Bloomberg thinks that bond insurers may be the big buys next year for the "brave" :) . I think it's nothing new for anyone that is bullish on the bond insuers and have been following them; but others may get a good quick bullish overview of the situation. The Tribune deal closed ...

Martin Whitman recently commented on the bond insurers and how he had increased his stake in Radian, MGIC, MBIA, and Ambac. He supposedly owns 10%+ of both Radian and MBIA (versus less than 3% in each early in the year). He isn't concerned with Bill Ackman's stance and thinks Bill Ackman understands neither the insurance business nor restructurings. There is an important point that one needs to think about when considering Martin Whitman's views. As Martin mentioned in the video, he is looking at this as a restructuring play. I'm not really sure how a bond insurer fits into the "restructuring strategy". Typically the restructuring plays are conventional corporations with reasonably estimable losses and liabilities. The big problem with the bond insurers is the uncertainty of future losses. Martin Whitman emphasizes that this is a long term play, where he wants to be part of any restructuring. I don't really understand his point about restructuring. Is he ...

Fitch, the last remaining rating agency without an opinion, released their updated rating review . It doesn't look like they are releasing any free excerpts so I'm not sure about the details. All I can go by is what the news sites say: The AAA rating of Ambac's bond insurance unit was put of Rating Watch Negative by Fitch, which means the agency will downgrade to AA+ in four to six weeks unless the company can boost is excess capital levels before then. A review by Fitch of Ambac's exposure to CDOs and residential mortgage-backed securities found that the insurer is roughly $1 billion short of the extra capital it needs to keep its AAA rating, the agency explained. Can't say much without looking at the actual report but it seems like Ambac needs to raise $1 billion . We just need to wait and how Ambac actually raises money. One piece of new information (at least to me) was the following: The review included an assessment of a $3 billion commitment by Ambac to fund...

Delta Financial filed for bankruptcy protection a while ago ( read my post here ). A total loss for me. I should have sold it off a few weeks ago to save a few hundread dollars (clearly a newbie mistake since I had no intention of holding on to it). DFC was small portion of my portfolio so it didn't hurt me as much as it could have (a loss is a loss though). Speaking in hindsight is generally useless given that anything that works out looks good even if it is a bad investment, and anything that doesn't work out always seems bad. In my case, this was probably a bad decision from the beginning. It was somewhat of a rash decision (impatience strikes again) given that I never really understood the mortgage lending business very well. I started looking into it after reading that Mohnish Pabri viewed it favourably but this is one of his mistakes I guess. I thought Delta's low exposure to risky housing markets like California, as well as Delta's higher fixed-interest loans (ty...

The Tribune takeover closed successfully today. Tribune shareholders will receive $34 (not sure how soon) and I'm satisfied with how my strategy was executed. This deal basically saved me this year (I would be posting greater losses for this year otherwise). Unfortunately--but this goes for almost 2/3 of my investments--the Canadian dollar appreciated quite a bit and shaved around 8% off returns. This is somewhat dissapointing but I'm not too worried because I think the US$ will start to strengthen some time over the next few years (there is a potential for capital flight if there is a crisis somewhere--often there is when the US economy slows). This was my first "good" risk arbitrage position and I'm glad to have learnt lessons about currency fluctuations and the takeover process. One thing I learned is that it is likely not worth considering risk arbitrage in foreign currencies unless the potential return is 15%+ (assuming you are not hedging to your currency (...

When took a cursory look at MBIA a few months ago, it looked safer than Ambac. But, man, was I wrong. The fortunes of the two have diverged lately, and with the latest disclosure of seemingly higher CDO-squared exposure than market expectation , it looks like MBIA may indeed be a riskier pick. I think the analyst being quoted in the article pretty much nails the present situation: "This new disclosure completely changes our view of MBIA being a 'more conservative underwriter' relative to Ambac," said the Morgan Stanley report, which was co-written by analysts Ken Zerbe and Yoana Koleva. S&P losses for MBIA are also higher and here is the breakdown of their analysis (table 7 in the press release): (source: S&P Detailed Results Of Subprime Stress Test Of Financial Guarantors, Dec 19 2007 (table 7) ) Based on the 9 bond insurers that S&P was reviewing, they are projecting an industry-wide loss of $10.8 billion. The verdict is still out on whether the bond in...

I thought S&P would not release their stress test results so soon but they just did. It is mostly along the lines of Moody's report from last week. Two relevant press releases for the results are here and here . Here is the relevant info for Ambac: We affirmed the 'AAA' financial strength and financial enhancement ratings of Ambac Assurance and the 'AA' debt ratings of Ambac Financial Group, Inc. but the outlooks have been changed to negative. The rating affirmations reflect the fact that Ambac's adjusted capital cushion of between $1,750 and $1,800 million is in line with its modeled stress losses. The announced reinsurance transaction with Assured Guaranty Re Ltd. was an important addition for Ambac, adding approximately $250 million on a risk adjusted basis to its capital cushion . The negative outlooks reflect the potential for further mortgage market deterioration relative to the company's marginally adequate capital cushion. Ambac's outlook wa...

This post will capture the final piece of analysis I'll do before purchasing Ambac (still depends on how events unfold over the next few weeks). I initially evaluated Ambac a few months ago so read that to get details on Ambac's historical profitability and what it is capable of. The initial analysis, which occurred after the 1st sell-off in the stock but before the massive 2nd sell-off, didn't really go into valuation or risk. It quickly became obvious that valuation isn't the problem with Ambac (it's undervalued by almost any measure); instead, the real issue is risk. Margin of Safety Before I say anything, I should note that Ambac has a chance of going to zero ! As Mark Sellers (don't know who he is but just saw the interview at The Motley Fool), says in this interview , a company like MBIA can go bankrupt so he doesn't invest in it. So if you can't afford a total loss, none of the bond insurers are for you. If you want a beaten down financial that w...

The next few days will probably impact the monolines more than anything in the next 2 years. It's like when you were in school and were writing a test that you had to do well in order to go to the university of your liking. The world doesn't end if you fail the test but it makes life more difficult and alters your path in life--forever. I don't think I'm overstating the situation faced by the monolines. If you don't know what all my blabbering is about, it is the rating agency decisions that will be delivered over the next few days. I can't understate the signficance of these ratings. Of all the industries in this world, the monolines depend on it more than anyone else. The whole business model depends on getting good ratings and for companies like Ambac (ABK) and MBIA (MBI), in having nothing less than AAA. S&P initiated their review a bit late so they may not have anything by next week but Fitch and Moody's will provide an opinion. Test #1: Moody's...

Ambac announced today that it is going to use reinsurance from Assured Guaranty . Some details: The portfolio totals approximately $29 billion of net par outstanding and will be ceded under an existing master facultative reinsurance agreement with AG Re. Pursuant to the commitment, AG Re has agreed to provide reinsurance under the terms of Ambac’s current surplus share treaty program that expires March 31, 2008. Ambac has also agreed to offer AG Re the opportunity to provide reinsurance under the terms of Ambac’s surplus share treaty programs that commence April 1, 2008, 2009 and 2010. There isn't much information in that press release but I would guess that the $29 billion reinsured is from their high quality municipal bond portfolio. I don't know how the rating agencies calculate these reinsurance contracts when determining capital requirements. The way I look at it, Ambac will end up holding all the high risk CDOs (it's hard to insure them at good prices and it's not...

TheStreet.com has a good summary of Sam Zell's comments during a luncheon in Chicago. I hate quoting almost the whole article but all the points in the article are worth considering. Sam Zell thinks the situation won't be as bad as the general consensus seems to think. He told those in attendance that "we're not in a liquidity crunch," but instead that the economy is going through "a significant repricing of risk." Zell has said this before and I find it interesting that he sticks with that view (i.e. market repricing risk, and not a liquidity risk) when the consensus is the opposite. As for me, I'm not sure what to make of all this. I definitely believe the market is re-pricing risk but am not sure if that is all there is to it. And he had harsh words for the way some asset holders are treating their mortgage assets, saying "accounting is taking over for reality." Pointing out that the mark-to-market process has produced huge writeoffs, n...

Fitch indicated today that Security Capital (SCA) doesn't have enough capital for its AAA rating. It is short by $2 billion, which is very large for its present market cap of around $400 million. The company's capital is at least $2 billion below what it needs to retain the AAA following downgrades of collateralized debt obligations the insurer backs, Fitch said. SCA has four to six weeks to come up with ``firm capital commitments'' to meet the guidelines, or the rating will fall two levels to AA, Fitch said. I suspect it is going to be awefully difficult for SCA to raise $2 billion. Bill Ackman thinks this will be the first bond insurer to go bankrupt. The rating agencies will provide their guidance for Ambac and others soon. Although SCA is one of the weaker AAA insurers, the potential rating downgrade shows how severe the deterioration in the ABS and CDO market has been in just a few months. If you look at my prior post where I showed the chart of capital under var...

A commonly used valuation measure for stocks is the P/E ratio. Well, the comparable ratio for housing is the home-price/rent ratio. It's not exactly comparable and the drivers of stocks and housing are somewhat different but, nevertheless, it's a good ratio to use for newbies like me. Since I'm trying to pick a bottom in housing--or at least avoid a falling knife--I think looking at the home price to rent ratio is worthwhile as a crude measure. The Wall Street Journal has the following chart of the home price to rent ratio (thanks to Paul Krugman's blog for the initial mention of Barry Ritholtz's blog , who references the WSJ chart :) ): (source: The Wall Street Journal ) This is a scary looking chart. It could take a while for that ratio to go back to historical norm. Similar to Paul Krugman, charts like these is what made me believe that housing was in a bubble. People simply won't be able to afford houses when the ratio expands. This ratio was put into pract...

MBIA has raised $1 billion in capital from Warburg Pincus , a private equity firm. The market likes the move (most bond insurers are up 8%+) but the real question now is whether it is enough. Here is what Warburg Pincus is doing: Buying 16.1 million shares for $31 ($500 million) 7yr warrants to purchase 8.7 million shares @ $40 and 7yr "B" warrants to purchase 7.4 million shares @ $40 (total $500 million) 2 seats on the BOD (out of 13) Heavily dilutive but it isn't a bad deal in my eyes. About $500 million for warrants that only have value if price goes above $40. Given that the current price is around $33, Warburg Pincus clearly thinks that the stock go up 30% from here within the next 7 years. Pretty bullish statement from Warburg Pincus. Shareholders face the full brunt of the dilution but that is to be expected. The real question is whether this is enough and whether this will be the end of capital funding activities. If MBIA, and other bond insurers, have to raise e...

UBS Quantifies Subprime Losses UBS, the Swiss bank, just quantified the losses from subprime to an additional US$ 10 billion (in addition to the $3.4 billion taken a few months ago). This is a huge loss no doubt but I think this is a sign of the the beginning of the end of the subprime mess . In addition to taking the loss, the company announced that it will raise capital by: Selling a 9% stake (11 Billion Francs) via mandatory convertible notes to Singapore government's investment arm Selling roughly a 1.6% stake (2 billion Francs) via mandatory convertible notes to a Middle Eastern entity (speculated to be the government of Oman's investment arm) Plan to convert the cash dividend to a stock dividend (yikes!) Re-sell 26.4 million shares held in treasury that were to be cancelled Sizeable dilution for shareholders but shoring up capital is a primary need for the financial companies. The stock is actually up around 2% today (on NYSE in US$ terms) after all that massive dilution...

Well, it isn't much of a surprise shareholders or anyone following the company but Delta Financial (DFC) said that it will seek bankruptcy protection . Quick notes from MarketWatch: Delta Financial Corp. said on Thursday that it plans to file for bankruptcy protection, becoming the latest mortgage lender to succumb to the subprime crisis that's swept the industry this year. DFC announced last month that it was getting help from hedge fund firm Angelo Gordon & Co., but that agreement depended on the company selling roughly $500 million of loans on to other investors in a securitization, or arranging other financing for the loans. On Thursday, Delta said it couldn't complete the securitization. Warehouse lenders, which provided short-term financing for Delta's loans before they're securitized, have now told the company it has defaulted. The fate of Delta Financial is no differen than the countless other mortgage lenders that have gone bankrupt this year. I decide ...

With Tribune lowering the amount of debt financing for the LBO, it is one step closer to closing its deal. Tribune said it has told the lead arrangers of its second-step financing that it intends to use up to $500 million of its cash to cut its bridge loan commitment to $1.6 billion from the original amount of $2.1 billion. The stock was up 7.8% but is still around 6% below the takeover price of $34. The market still thinks there is a decent chance of everything falling apart.

Neanderthal wondered about Ambac's reinsurance situation in one of the comments to a prior post of mine. His point, which is raised in the Pershing Square presentation, is whether reinsurers will be able to pay if there are massive losses. I did a quick search (the world is so much more productive with electronic PDF documents that you can search :) ) and here is what I found. I looked at the 2006 annual report so the info is not exactly up to date. However, we are just trying to get a rough idea and although the reinsurance agreements may have changed materially in the last few months, it's probably the best info out there (unless the info is contained in some of Ambac's presentation slides or something). You can find information about reinsurance starting on page 17 in the 2006 annual report. Ambac's Reinsurance As of Dec 31, 2006 , the largest reinsurer accounted for 1.8% of gross par outstanding. Given that the total outstanding insured amount is roughly $519 billi...

Well, I think today's surprise interest rate cut by the Bank of Canada pretty much puts a nail in the coffin of the Canada decoupling from the US theory--a theory I never really believed. I put a lot of emphasis on this move because Canada isn't showing as much stress as the US (export-oriented industries and manufacturing are getting hit badly but it's not that bad yet; real estate really didn't develop into a huge bubble here; etc). So a cut really means that the Bank of Canada, which is highly respected and generally considered to be more transparent than many other central banks, really feels that there is a big crisis that's unfolding. The next dominoes to fall in the decoupling argument will be Europe, followed by Latin America (particularly Brazil) and then China. Once all this is done, everyone throughtout the world will know the word "subprime"... The interesting thing is that, due to the huge run-up in cyclicals and comodities, equity investors r...

Thanks to Rational Angle for providing the link to Bill Ackman's presentation on bond insurers at the Value Investing Congress. I have been looking for this and didn't realize it was posted at the official site of the forum. The presentation pretty much covers nearly all the bearish items to be made regarding the bond insurance industry. The presentation raises some interesting points that I didn't pay attention to (such as whether the reinsurance companies themselves will be able to pay out losses if there is a blowup). I didn't read it fully yet and may post my views if I want to rebut anything. I find some elements of the presentation to be superficial. For instance, the title is pretty much doublespeak . The presentation is titled "How to Save the Bond Insurers" when in fact Pershing Square is short the bond insurers and pretty much offers suggestions to bankrupt the bond insurance holding companies. This is no different than people who are short homebui...

Late Friday, FCC gave approval for the Tribune (TRB) takeover . Media companies are not allowed to own newspapers and television stations in the same market, and Tribune had a waiver that allowed it to do so. Upon change of ownership, the waiver needs to be re-approved and that is what everyone was waiting for the FCC to do. Now it is up to the bankers to raise the debt to finance the takeover by Sam Zell. The stock price trading way below the takeover price of $34 pretty much says that the market thinks there could be some issues with the debt financing. I took a position in TRB with the belief that the deal will go through--and I don't think anything has changed (even with the credit market problems). Given the interest by Sam Zell (he talks as if he already owns Tribune) and the steps taken by Tribune to facilitate the deal (including increased leverage to buyback shares earlier this year as part of the deal), I think there is a high chance of the deal going through. If there ar...

Joe Nocera of the New York Times has an article describing Bill Ackman's pursuit of MBIA. For those not familiar, Bill Ackman is an investor that has been bearish on bond insurers for many years. He recently gave a presentation at the Value Investing Congress implying that companies like MBIA and Ambac are insolvent if they can't raise capital. Let me quote some key comments in the article: Mr. Ackman is an emerging star in the “shareholder activist” division of the hedge fund big leagues. In the last few years, he has taken aim at McDonald’s, Wendy’s and, most recently, Target, usually emerging from these tugs of war with profits for his hedge fund. His firm, Pershing Square Capital, which he founded in 2004, now bulges with over $6 billion in assets. “If I think I’m right, I can be the most persistent and most relentless person in America,” he says. But for sheer, obsessive doggedness, nothing he has ever done can compare with his pursuit of a company called MBIA Inc. In fac...

One of the risk arbitrage plays that I have mentioned before is BCE of Canada (BCE; TSX: BCE). BCE is the largest telecom in Canada and it is being taken over by a consortium. The payment is in cash and is supposed to close early next year. Fabrice Taylor of The Globe and Mail has written a good column summarizing the details and the risks. Note that everything mentioned is in Canadian dollars. BCE also trades on NYSE. f all goes well, BCE shareholders will get their money some time in the first quarter of 2008. Let's assume the last day of the quarter, March 31, to be conservative. The offer is $42.75 a share while the stock is quoted today at $39.20. The four-month return, then, is a little more than 9 per cent - and even more if investors get a dividend before the deal closes. As the author suggests, you are looking at around 9% in 3 or 4 months. This is a low-risk arbitrage situation so that's a good return. If you are an American and are bearish on the US$ (I am not) then...

Well, anyone considering investing in Ambac (or others) should definitely look at the bear case. Reggie Middleton provides a super-bearish case saying that "Ambac is effectively insolvent". Take a look and form your own opinion. I haven't read it yet so I don't have anything to say. For what it's worth, he is short Ambac and MBIA. Some people might think somone's report is nothing more than propaganda in light of that but I generally think the opposite. If anyone is putting their own money on their calls, I respect that... The problem with Ambac for both shorts and longs is that this story may not end for at least 1 year. Some people think that the market will take a stand one way or another after the rating agencies release their rating evaluations but I suspect not. Every bad news is going to push the stock down and the occasional good news, along with short-covering, will push the price up. The stock has been moving almost 5% on a daily basis over the last...

The FCC, which is moving at a snail-like pace, indicated today that they will try to have a vote on the Tribune (TRB) acquisition by the end of Friday. The stock is still nowhere near the acquisition price of $34. If the FCC waiver is granted by Friday, the last remaining step is for the bankers to raise money for the deal. On another note, I have noticed that the spreads on takeovers have widened again. Almost sure-bets like BCE (BCE; TSX: BCE) have dropped recently. Other bids worth monitoring are Clear Channel (CCU) and Credit First Boston (CBH). I haven't evaluated any of them deeply (except when I mentioned BCE in some posts several months ago) so none of these are concrete ideas. If I recall, all these deals close next year so if you like the prospects then you need to be willing to tie up your capital until next year. Given that December sometimes involves heavy tax-loss selling, it may be more attractive to buy beaten-down stocks instead of going for merger arbitrage deals...

Bill Ackman supposedly thinks that MBIA and Ambac will be bankrupt by mid 2008 if they can't raise capital: Bond insurer MBIA Inc could be insolvent as soon as the second quarter of 2008 if it were unable to access additional capital, according to a slide at a presentation by Pershing Square's William Ackman. Ackman estimates MBIA will incur $2.2 billion of losses in the fourth quarter, and rival bond insurer Ambac Financial Group Inc will incur $4.2 billion of losses . Nothing new from Bill Ackman, who has been bearish on the bond insurers since 2003 (based on some article I read back then (I think in Forbes). Since I'm bullish (although not bullish enough to take a position right now), this makes me uneasy. If he were not a so-called value investor, I would sort of brush it off but since he is a value investor (meaning he is likely basing his views on bottom-up approach*), it is something one should consider. I really want to get my head around where he is wrong. He has ...

AccruedInterest posted a breakdown of the loss estimates that was used for Ambac in the prior blog entry. The author goes on describe the situation facing Ambac and others when it comes to raising capital. As I remarked in my prior post, reinsurance is the least dilutive but it will hit future earnings and I would guess that it will shave 2% to 3% off future ROE. But if a lot of capital needs to be raised then multiple methods may be needed, including issuing shares (the most expensive of all). The tricky thing for those sitting on the sidelines is that we don't know how much dilution the market is pricing in (the knowledgeable experts may but newbies like me don't). My strategy, assuming my risk arbitrage position on TRB is closed successfully, is to wait until late December and see what the rating agencies say. You can try to outguess them by buying before their decision but that is very risky.

Birinyi Associate's TickerSense posted the chart below showing stock market returns throughout the world (thanks to SeekingAlpha for the original reference): (source: TickerSense, Birinyi Associates) If you visit their site, you'll get a table showing the returns for individual countries. The top 5, in order, are China (135.18%), Ukraine (121.20%), Bangladesh (90.83%; who says poor countries suffering a crisis don't do well? ;) ), Romania (76.15%), and Slovenia (74.59%). The bottom 5 are Ireland (-29.89%), Venezuela (-28.04%), Estonia (-14.41%), Japan (-12.14%), and Ecuador (-9.79%). You can tell from the map that developed countries (USA, most of Europe, Japan) are posting negative returns, while the dark green areas with hig returns are high growth emerging markets. The middle green varies but you can easily tell that commodity countries are dominant. What this map says--to me--is that the developed countries are slowing (none have entered a recession or posted less than...

Ambac says that they will consider using more reinsurance in the future: Ambac CFO Sean Leonard said the company will continue to defend its triple A rating, and added that there's a lot of opportunity for the company to reinsure its transactions. He said about 85 percent of the company's portfolio is non-mortgage related. Go to Ambac's homepage to check out the presentation at the Bank of America conference. A PDF presentation can be found here . Well, the presentation is biased in favour of the bull case (what else is to be expected from management?) The strategies that Ambac will use to meet capital requirements are supposedly: In order of preference: Reinsure block of current book Increase reinsurance on future business Alter mix of business to less capital-intensive transactions Debt or soft capital issuance – approximately $600 million of capacity Equity issuance (source: Banc of America Bond Insurance Mini Conference Presentation , November 27 2007) It looks like t...

I was wondering what S&P was doing all this time but they finally initiated a review of the bond insurers . Recall that Fitch and Moody's have already initiated their review and are supposed to release their thoughts within the next month (timing is just an estimate). According to what Fitch was saying a few weeks ago when they started their review, Amabac has a moderate probability of their AAA rating being under threat, while MBIA had a low probability. There is a huge gap in the equity analysts covering the bond insurers, not to mention the bloggers and other small investors like us. I only have access to the free analyst reports from my discount brokers so my analyst knowledge is limited. Morningstar thinks that the market is overreacting on Ambac (as well as other insurers). Based on the article referenced above, Citigroup analyst thinks the same: Citi Investment Research analyst Heather L. Hunt expects the AAA ratings on Ambac, MBIA and Assured Guarantly Ltd. to be reaffi...