Wednesday, January 23, 2008 17 comments ++[ CLICK TO COMMENT ]++

Ambac Posts First Loss Since Going Public

Hate to say it but I didn't listen to the 4Q earnings conference call in full. I don't have time right now but I'll go through the transcript on my subway ride home tonight. One of the best features from SeekingAlpha.com is their free transcripts. Check out Ambac's transcript here.

You can read news articles all over the web to get the scoop on what happened in the conference call. Ambac basically posted their first loss since they went public more than 10 years ago. It is also a weird situation, which I'm sure threw people like Cramer off, in that the loss is higher than the share price (this happened without causing bankruptcy because the book value is much higher and the loss isn't a cash loss). As crazy as this may sound, Ambac actually posted negative revenue for 2008 (minus $4.18 billion). Fortune had a somewhat humourous take on this, pointing out that this makes Ambac the smallest big company on the Fortune 1000 list. The Fortune 1000 is sorted by revenue so that puts Ambac dead last even though there are a whole hoard of small caps that are much smaller than Ambac. Not exactly a laughing matter for shareholders but I have a good sense of humour and I'm still confident that Ambac is worth way more than what it is trading at.

I'm not going to post my thoughts on management's strategy until I go through the full conference call. For what it's worth, I think the media has covered all the main points. I'm not sure what I can add.

What we can be certain is that Ambac is trying to stay AAA. The question is how big of a dilution this will entail. Contrary to some people's opinion, the company is solvent but it needs capital and the share price is low. Management also said it is not pursuing run-off so that's off the table for now. I personally view a run-off as the last scenario and don't like it that much (the reason is because you can be stuck in this state for at least 2 or 3 years).

There is still the risk of government intervention--not necessarily in favour of Ambac shareholders, but in favour of insurance buyers, the industry, banks, and the government itself. I see any hostile action against the shareholders as having a low probability. This is the great thing about investing in a country (USA) where property rights are strong. It will be hard for anyone to seize assets or mandate things when Ambac hasn't defaulted on any of its payments or is out of cash. Note that liquidity is not the issue (there is enough cash to pay claims for several years); rather, the issue is the capital required to stay above statutory and rating agency requirements.

One new thing was the revelation that Ambac needs to post collateral if its rating was cut deeper on some of its investment transactions (read the last few paragraphs of this article or check the conference call transcript). This has nothing to do with bond insurance and shouldn't be an issue. My understanding is that Ambac invests some of the money from municipalities and other involved parties on their behalf into low-risk short-term bonds. The simply need to liquidate the assets (very liquid and high-quality) and post that as the collateral (or unwind the investment operation if it's legally possible).


I mentioned a while ago that one risk with this stock is that stock analysts were still positive. Well, the opinions are coming down, with the latest being Goldman Sachs cutting Ambac's price target to $10 and 2008 earnings to $2.15. That still puts Ambac at a current P/E of around 5; for people who bought this stock at $30, that's still a P/E of 15 (not cheap but not outrageously expensive either).

The stock price has been crazy lately and I wouldn't draw anything from that (just like how the initial drop was wild speculation as well). The real risk to shareholders is the possibility of being bought out for cheap or diluted like crazy. As I said, Ambac hasn't missed any payments so it's not quite an extreme distress situation where they are at the mercy of creditors (in these situations the shareholders end up beaten up pretty badly).


(Not related to this but Warren Buffett's investment in Swiss Re is a good thing. Not exactly related to bond insurance but it shows that some people are willing to put capital into insurance. I don't know how costly it will be but Ambac can still unload a chunk of its muni bond portfolio to one of the reinsurers.)

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17 Response to Ambac Posts First Loss Since Going Public

cak
January 23, 2008 at 12:48 PM

Again, the company is chatting about exploring "strategic alternatives" with "very credible parties". I guess that could mean any number of things. I read articles mentioning the NY Dep of Insurance looking to "bail out" the FG's, although who knows what bail out means and, as you say, any action by a regulator could do more harm than good. Plus I don't view the NYDOI as a credible party.

It's got to be part reinsurance, maybe part heavy hitter investor, maybe some credit line they can tap into. Unless they are truly blind, why else would they show such confidence trying to maintain or reacquire the AAA? It's very bizarre.

Callen seems competent but I was still confused by the Genader conflict and the internal argument of debt vs equity.

As part of the 1.1 bill charge, an analyst asked about 'McKinley paper'. Ambac's man said it was an internally rated BBB- product that imploded to the tune of 1/2 billion.

How would you rate that as a reflection of Ambac's risk management?

cak
January 23, 2008 at 1:33 PM

It will be very interesting to find out what Wilbur Ross' is up to. He mentioned in the CNBC interview that he was working on a project and would reveal it soon. Ambac is exploring strategic alternatives. If bought at this point in time it could be a fire sale and would sting pretty bad. I think of Countrywide at 6$.

Outside of an outright sale, given the stock action, an interim CEO and an empty board seat only a major player looking at Ambac as a long term investment would fit. Maybe it will be Ross.

January 23, 2008 at 2:04 PM

Maintaining the AAA was a mild surprise to me. It would take a lot of money to keep that rating (I would say at least $1.5 billion--depending on what Moody's says). There is also the risk of rating agencies requiring even more capital a few months from now (although I think that's a low probability) which would mess things up (look at MBIA shareholders who diluted themselves by $2 billion and are still unsure if they will retain their AAA).

I don't think Callen would put his name and reputation on the line if he didn't think something reasonable can be done. I don't think he will accept any plan which values the company at, say, $7/share (given that the stock is up to $10 that wouldn't have happened anyway). The real risk is if they go for a plan where they value things at around $15 per share, it's a tough decision. Long term shareholders will take a loss but they may not resist too much.

I haven't heard the call fully but if something is internally rated BBB then there is a real risk of it turning out badly. I mean, that's what that rating implies. It's hard for me to say how badly this reflects on Ambac's risk valuation. For instance, I am not sure if these charges take recoveries into account, or whether they are worst case loss estimates (eg. assumption of 100% loss). If I'm not mistaken, Ambac booked something like $1 billion for Katrina (need to double-check) but they hardly paid out any of that. Just to keep in mind, nearly all of Ambac's auto loans have underlying internal ratings of BBB (this is a potential risk over the next year or two).

As for Wilbur Ross, I'm a bit familar with him. I own Montpelier Re (MRH), which is a Bermuda-based small-cap reinsurer that nearly went bankrupt after Katrina. Wilbur Ross was one of the parties that recapitalized Montpelier Re (I think he actually capitalized a sidecar of Montpelier Re called Blue Ocean Re if I'm not mistaken) when it needed capital after the massive Katrina-related losses.

I don't want to get my hopes up about Wilbur Ross. There are so many distressed situations, not mention at least 5 monolines, that he could be involved in anything. Wilbur Ross seems to be a good guy but, like all distress investors, he will ask for high compensation. I don't know his history well but he seems to be a long term investor (his savvy investments in the steel industry in the 90's shows that) so his interests will align well with existing shareholders. The question is price.

cak
January 23, 2008 at 3:13 PM

A couple of comments off topic -

In one of my recent rants on your blog I mentioned on old FDR/New Deal program of 1933 called the Home Owner's Loan Act. The HOL Corporation floated Fed bonds and used the proceeds to help finance delinquent homeowners facing foreclosure. Well, it looks like we may see a replay. Chris Dodd, Chair of Senate Banking has proposed selling bonds and actually buying mtg loans, paying interest, etc. It's still sketchy but is eerily similar to the HOLC.

Also, a guy in my office is trying to re-fi a a mtg thru Wells Fargo. He was put on hold for 45 minutes before being told by a rep that they would have to call him back, they were totally swamped.

January 23, 2008 at 4:07 PM

It seems to me that the real scrutiny should be on the credit rating agencies.

The insurance group is getting burned by insuring AAA rated debt that turned out to not be AAA from the start. And racking up losses as a result. And now the same rating agencies which initially rated the CDO debt as AAA are going to punish the insurers for believing their ratings?

The downgrades may be justified, but it seems like there should be a confidence factor associated with the rating agencies. How right are they? Not very when it came to CDO's.

January 23, 2008 at 4:33 PM

Yeah, I agree with your John White. The rating agencies are in the thick of things. However, I think we can pin some blame on everyone: investors, rating agencies, bond insurers, investment banks, and even the homeowner buying a house they clearly can't afford.

cak
January 23, 2008 at 7:54 PM

A letter from Bill Ackman to Moody's.

Ackman

January 23, 2008 at 10:03 PM

Ackman is very determined. He also bets heavily (definitely a concentrated investor). Not only does he buy shares but he also seems to buy/sell CDS (he is doing that with Borders (BGP) and also Target (TGT) (not entirely sure if he sold CDS for target)).

All I know is that if the big shorts, like Ackman, cover, it's clear sailing after that in terms of stock price fluctuations. AFter that it'll come down to fundamentals such as actual home default rates and auto loan defaults...

cak
January 24, 2008 at 12:15 AM

What do you think?

bailout

cak
January 24, 2008 at 9:50 AM

Interesting Goldman valuations

Values

January 24, 2008 at 10:55 AM

Contrary to the popular view, a bailout of any sort is bad for monoline shareholders in my opinion. But then again, I'm bullish whereas most people think these companies are worth zero.

What we need are private market solutions, facilitated by the regulators. Getting the government or anyone else forced to do something is a disaster for everyone. For instance, if the banks were forced to inject capital, which is precious and they themselves don't have enough of it, and it turns out losses are higher, then what? The banks will lose their original investment, as well as any value on the insured stuff. How are they goign to justify that to their own shareholders?

Also, if you bail out the monolines now, then what happens to the industry? Can they still keep going and insure stuff in the future? How about in 5 years from now? I think there should be voluntary capital funding and then see what happens. The industry needs to survive on its own and show that it can withstand the losses.


As for the Goldman Sachs estimates, I'm more bullish than them. I see the run-off value as being near the book value. If losses are greater, then the value will be lower; if mark-to-market marks reverse then it'll be higher. I don't remember Goldman Sachs analyst opinions in the past but most analysts were completely wrong on the monolines. Most had price targets of $80+ as recently as 5 months ago; and now have a target very close to $10. I don't think they have much credibility. They are just drawing signals from the market price.

I also find it bizarre that they have a reasonably high value for the going concern SCA than the run-off SCA. SCA is going to have an awful time writing new business and I'm not sure how they will end up generating wealth. If SCA raises capital required for their projected losses, their shareholders will be diluted close to zero and the share price will be in the pennies (nowhere near $1; but it depends on the method used).

Anyway, the big problem now is that a lot of people--rating agencies included--are drawing conclusions from teh stock price movement. Given that it is so volatile (I can see Ambac dropping 50% easily) it's not good for the company. The fact that everyone is blaming the monolines for the market sell off (I don't think it has anything to do with the monolines) doesn't help matters either...

cak
January 24, 2008 at 11:41 AM

Fitch cut SCA to single A just after the market open today.

Whatever Ambac has got in the works has probably not been helped by all this stock volatility and rumors with NY regs,.

January 24, 2008 at 11:47 AM

oops... I got SCA mixed up with ACA. Ignore my comment about SCA in the prior comment...

My problem with this whole "bail out" scenario is that the market is putting all its faith in the monolines. Everyone out there is blaming the monolines for the sell off and expecting things to happen. Too many rumours and speculation...

cak
January 24, 2008 at 12:05 PM

Have you had a chance to go thru the transcript?

There was a gallows humor moment during question and answer where an analyst wondered whether Ambac was going to move into "risk model #5". What was your overall impression of the risk managers shock over the events that unfolded the past 7 months or so?

January 24, 2008 at 2:14 PM

I haven't had a chance to go through the transcript fully (I was tempted to finish reading a bunch of other articles, including the Whitman and Eveillard interview that I posted about)...

CEO looks confident. CFO seems to think things are ok too... Not sure about the risk management side of things. It's really hard to say one way or another how much Ambac messed up with their risk analysis. My worry is really the auto loans. I know that sounds crazy given that everyone is worried about mortgage assets and maintaing the ratings. But the worry for me is that nearly all the auto loans are rated BBB.

cak
January 24, 2008 at 5:25 PM

Well Siv -

Rumors percolating about a Wilbur Ross take ... what? over, under.

I had that feeling yesterday -

The pieces were all in place - empty board seat (he can step in right away, or appoint someone during the takeover process), exiting ceo - interim ceo (part of the conditions), a thorough mark down for tax purposes, the major pre-announcement with no corresponding capital plan, the massive reduction of book value...

No idea what the offer px will be but it makes sense for Ross. He's got the cash to take the co. private and get a AAA rating. With Ross in the driver's seat Buffet will be more comfortable partnering up.

As for px, Wilbur is a value player. He will definitely buy at a discount to book.

Well, this could be it.

January 24, 2008 at 7:39 PM

All the other bond insurers are in trouble too so which one will he invest in?

I'm not entirely sure Wilbur Ross will take over the whole company. Unless he partners with other parties (private equity, strategic investors, etc). The reason I'm not sure is because the downside risk is very large. He could afford it but not sure if he will want to buy the whole thing.

I don't know. I think a capital injection (without a full takeover) looks more likely. But who knows? MAybe I'm just too optimistic.

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