Fitch Downgrades Ambac to AA

Well, what I thought never would happen, finally happened. Fitch downgraded Ambac to AA.

Credit rating agency Fitch Ratings downgraded bond insurer Ambac Financial Group Inc. to "AA" from "AAA" on Friday, which could force the company to stop writing new insurance...

The rating also remains on negative credit watch for a further downgrade.


Fitch also adjusted the ratings on 137,990 municipal bonds and 114 non-municipal issues as needed (higher of the underlying rating or Ambacès new AA rating).

I invested in Ambac with the expectation that it will retain its AAA rating. However, that is not what happened and I'm forced to consider the situation as it has unfolded. Losing the AAA rating is a big disappointment to me given that one of my reasons for investing in Ambac was with the thought that it would retain its rating while others were downgraded. This is going to get complicated (I hope Ambac fleshes out some strategy in the conference call on Tuesday) but it essentially means the following in my opinion:


  1. Its municipal bond business will literally go to zero. Ambac may still be able to write some credit enhancement for A or lower rated muni bonds.
  2. Customers will lose faith in Ambac. Ambac's brand has been permanently tarnished. Getting back the AAA is out of the question for years--if ever.
  3. Ambac needs to come up with a completely new strategy for its raison d'etre (i.e. reason for being). It has little expertise in writing AA insurance.
  4. It seems likely that nearly all the other monolines, except Assured Guaranty, Berkshire Hataway Assurance, and a select few, will be downgraded as well. I think MBIA will be downgraded (although there is a possibility it may not). If there is widescale downgrades, the competitive advantage of Ambac does not diminish as much. Nevertheless, AGO, BRK-B, and others, will take away business.
  5. Those holding Ambac-insured AAA bonds will see the value of their bonds fall to its underlying rating or AA (whichever is higher). You should see some sell offs in the muni bond market, which tends to be sensitive to AAA ratings (some investment funds, banks, and others, only hold AAA-rated bonds). Structured products, and others, will also see some price erosion. This will likely cause mild write-downs at investment banks, hedge funds, and others who hold AAA-rated Ambac-insured bonds with lower underlying rating.


The fact that Ambac has an interim CEO right now doesn't help matters. There is little more to be said than what CAK said when he lost respect for the former CEO due to his abrupt resignation. Anyway, the new interim CEO has been on the Ambac board for a while and has good experience in other financial institutions so we need to wait and see what transpires.

The run-off value still looks to be much higher than the share price. I have been thinking about this all day and will see if I have any concrete thoughts on this later. Ambac is going to be a long-term investment whether you like it or not.

Comments

  1. AnonymousJanuary 18, 2008 at 3:31 PM

    I put everything in this stock also. I am going to find a tall building. LMFAO!!!

    ReplyDelete
  2. Sivaram VJanuary 18, 2008 at 3:47 PM

    I only put 25% (or maybe around 30%) in so it's not a total disaster. But it's still a huge paper loss--and is the biggest dollar loss in my life. But before you jump (assuming you are still reading this ;) )...

    The situation isn't as dire as it seems IMO. It's very murky but the book value is still high. People like Jim Cramer and others don't understand (because they only look at the stock price) but the book value is around $20 (adjusted book value is around $50). This is all after taking that massive mark-to-market loss recently. Assuming there isn't political intervention to hurt Ambac (there will be pressure on the insurance regulator to find some scapegoat and the monolines are a good candidate), that book value is what the company should be worth (assuming you think losses have mostly been accounted for). Unlike manufacturing companies or retailers, homebuilders, or whatever, there is no inventory, patents, land, etc that may overstate the book value. What you see is what you get. What is unknown is the potential for future losses.

    I could be wrong but I'm starting to understand what Martin Whitman was saying. Read his commentary and see if you can value the company. The only uncertainty is future losses, which I believe will be lower than before (most of the huge losses are likely already accounted for; Ambac stopped writing insurance on risky stuff in mid-2007)...

    ReplyDelete
  3. Sivaram VJanuary 18, 2008 at 3:52 PM

    This is why I say I might be the dumbest guy on the planet but if I was slightly richer (or had a professional job), I actually wouldn't mind buying Ambac right now. I don't know. Either my thinking is severely wrong or there is a lot of unrealized value here...

    Anyway, the situation now will resemble bankrupty (although it's not)... so it's time to evaluate the book value more thoroughly, instead of looking at future growth rates, or new business generation, or whatever...

    ReplyDelete
  4. Sivaram VJanuary 18, 2008 at 3:54 PM

    Before I mislead anyone, I will say that if losses turn out to be really large in the future, then Ambac can actually go bankrupt.

    ReplyDelete

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