Abitibi and Bowater Combine; Financials getting hit; Monline Insurers Getting Clobbered

Some random comments on things...

Abitibi and Bowater Merger

Abitibi and Bowater merged on October 29th and is trading with the symbol ABH (TSX and NYSE). Now it's up to management to deliver their $250 million savings that they promised. I have been tracking this company for almost an year now and I still don't know what to make of it. Is it a declining business with high capex (a Berkshire Hathaway)--something Buffett recommends against? Or will it be a survivor in the forestry business? Pope & Talbot declared bankruptcy several days ago and is this the start of further restructuring in this sector? Will ABH start taking away market share? The Canadian dollar has kept strengthening over the last few months so things are not looking good for Canadian forestry companies.

As I have remarked before, ABH is a highly leveraged play on any recovery in the (primarily) newsprint business. One of the reasons to consider it as a contrarian opportunity is if you believe this will be a 'last survivor' in a declining industry.

Financials Getting Clobbered

I think contrarians and value investors finally have something that should make their life exciting. I was personally bored over the last year and it actually led to some dumb moves due to being impatient (impatience, along with greed & fear are one-half of the investing equation). Things have changed significantly in the last few months. The whole financial sector, not to mention anything related to housing, is getting hit. I'm sure a lot of value investors are pouring over big-name financial companies like MER, C, BAC, CFC, MBI, ABK, BSC, WM, MCO, and so forth. I am devoting most of my time, apart from reading books and investing articles, to Ambac (ABK). Is this a steal of a life-time or is it a disaster-in-waiting? It looks like the former and I'm setting up myself to take a position in December (or early next year).

Ugly Week for Monoline Insurers

You know it's pretty bad when a multi-billion dollar company loses half its market capitalization within a couple of weeks. Ambac, as well as other monoline insurers (like MBIA), seem to be the market's public enemy #1 these days (not that Citigroup is a good place to be either). Ambac was down another 20% today, with equity rating cuts from Morgan Stanley and Goldman Sachs. As I have remarked before, it is probably best to stay on the sidelines until the analysts cut their ratings.

There is some question whether there will be a failure in one of these monolines. I am not sure about the smaller ones but I highly doubt that Ambac or MBIA will fail or lose their AAA rating. If Ambac or MBIA loses its AAA rating there will be massive chaos in the bond market. In particular, more than $500 billion of municipal bonds may sell off because their bond rating will end up being lower than what they were thought to be (because Ambac and others insured it). I'll quote some notes from a Bloomberg article below--I think this article provides the bear case that one needs to consider.

The bond insurance industry has guaranteed more than $1 trillion of bonds issued by U.S. cities and states as well as bonds backed by mortgages, credit cards and other assets, and the guarantee allows borrowers to use the insurers' AAA rating. A loss of confidence by investors in the insurers' credit quality threatens the survival of the industry and the price of the thousands of bonds it guarantees.

There are also some estimates of CDO losses that are mentioned:

He [Ken Zerbe of Morgan Stanley] increased his expectation for losses on collateralized debt obligations or CDOs, predicting that Ambac could take losses of $2.1 billion and MBIA could take losses of $415 million. When other types of securities were included, particularly those backed by home equity lines of credit, Zerbe said he expected Ambac to lose $3.5 billion and for MBIA to lose $2 billion.

I don't know what's in the report but I'm assuming this is the worst case, where the full value of CDOs is written off. If you don't don't think CDOs and other debt will go to zero then losses will be smaller (since monolines generally only insure the interest and principal payments).