Monday, November 26, 2007 0 comments ++[ CLICK TO COMMENT ]++

S&P Initiates Review of Bond Insurers

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 reaffirmed.

Further, she said stocks in the sector have fallen so far they already reflect a weaker credit rating. For example, she said the more than 70 percent decline in Ambac's stock this year seems to imply the market expects $7 billion in insured losses, which she said is unlikely.

Hunt cut her price target from $95 to $50, factoring in roughly $2.1 billion in losses.


Heather Hunt, the Citi analyst, expects $2.1 billion in losses. I can't remember but I think Morningstar was expecting $1 billion to $2 billion. And Accured Interest was expecting $2 billion to $3 billion.

The real question for Ambac shareholders--and those considering going long--is whether the market is already pricing that loss. The analyst seems to think that the market is pricing $7 billion in losses. Analysts, like all of us, are just guessing and I'm not sure how true that $7 billion is. One possible flaw with some bullish analyst estimates is that they may be valuing the business at historical norms (say, a normal price-to-book of 1.3 (the 10 yr average for Ambac is actually around 1.7)). If the market re-prices the whole sector, say from a p/bv of 1.3 down to 1, then the stock is never going to go bank to the original levels (at least for many years). I think analysts sort of realize this, as one can tell by them cutting target stock price from $100ish down to $50ish.

Unless you were a super-long-term investor, I think a realistic target for Ambac is something like $50. If I were to take a position, I would invest with the expectation of around $50 (which is a 100% return from current price in the $25's). (note that from a longer term point of view, assuming the company doesn't go bankrupt, require massive capital injection, or take more losses from credit cards and other possible future debt problems, the stock price should be higher. From what I recall, Ambac earns around $750 million per year on existing policies so you are looking at a normalized P/E of around 3 at current price).

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