I Agree with Evercore Asset Management: Ambac Should Forget About the AAA Rating

Given the massive drop in the share price of Ambac, I don't think issuing shares is viable anymore. One of Ambac's shareholders, Evercore Asset Management, is urging management to avoid purusing the AAA rating at all costs (here is their full press release (thanks to Housing Wire for the mention)). Evercore has supposedly been urging Ambac to give up its capital infusion strategies for several months. So this is not a last-minute opinion. For me, it is a last minute opinion. I only came to this conclusion after seeing the share price drop today. I think raising $1 billion to $2 billion is acceptable to me when the market cap is around $2 billion. Given that Ambac is only worth $633 million right now, you will basically give away the company in order to maintain the rating. This is clearly not maximizing shareholder interests.

I'll quote some of the points that I find useful from Evercore's press release:

We are long-term oriented, contrarian investors, with a typical holding period measured in years. We advise on more than 700,000 shares of Ambac on behalf of our clients. We wrote to you last month to express our opinion, as a co-owner of the company, on the undesirability of raising costly capital to preserve Ambac's triple-A rating.

The notion of issuing equity with the stock now at a small fraction of that late December price is simply absurd. It is impossible for the value of future business to even come close to offsetting the dilution that will occur. Municipalities are wrapping their bonds at the lowest rates in years, and Berkshire Hathaway is entering the business. Even if these things were not happening, it would still be impossible for new business to be sufficiently profitable to justify raising new capital...The sale of $1 billion or more of new equity amounts not so much to raising capital as it does to a sale of the company at an extremely depressed price.

I totally agree. The thing to remember is that most of the AAA benefit is for enhancing municipal bonds (just to make it clear to those not familiar, these aren't just bonds issued by municipalities. They can also be public-private partnerships, for-profit quasi-government entities, and so forth). Although muncipal bonds are Ambac's core business--the business it founded--it is simply not in a position to maintain it.

It is time for Ambac to recognize that, in entering the structured finance business, the company gambled its triple-A rating and has now lost that bet. Attempting to buy back the triple-A rating by giving away most of the company makes no sense. The business of triple-A guarantees must now be left to those whose previous actions have not saddled them with both a need to raise capital and a perception of potential losses of the magnitude that now causes Ambac to be priced at a small fraction of its book value. All that can be done now is to maximize the value of the existing book of business for the benefit of Ambac's shareholders.

If Ambac follows this strategy, it will almost completely exit from the municipal bond business. The only business it will be able to write are if the underlying bonds are below AA.

Unless Ambac is still massively under-reserved for eventual claims, there is substantial economic value to be captured even in a runoff scenario. Adding back the mark-to- market losses that the company still claims do not predict future losses, adjusted book value (which fully recognizes net unearned premiums and the present value of future installment premiums) stands at roughly $86 per share. Against that alternative, a proposal to sell a significant amount of stock at the current price is unconscionable.

Even if claims ultimately amount to a multiple of Ambac's current reserves, the value realized in runoff will far exceed the current stock price.

If you support this strategy (of not maintaining the AAA rating), you need to realize that this is the end of the muni bond business--at least for many years. You are essentially betting that the quality of Ambac's underwriting in the past is good enough to avoid losses and result in a higher value than the current stock price. This is something that I have believed for a while and is why I don't think Bill Ackman is right. His view basically gives zero credence to the underwriting skills of the monolines. The super-senior AAA tranches in CDOs; the highly paid, highly competent, insurance specialists working for Ambac; the 30 years of business culture and experience; etc; should all mean something. Shouldn't it? They should take lower losses than what the market perceives based on investment bank write-offs (investment banks don't have the same expertise in trying to pick good risk over bad--Goldman Sachs excepted ;) ).

From the standpoint of Ambac's current shareholders, the owners of the company, there is absolutely nothing to be gained from continuing to attempt to maintain a triple-A rating. It would be far preferable to go either into a period of "hibernation" during which time the company would not actively pursue any new business where a triple-A rating from all three agencies is required or into outright runoff. Under either scenario, current shareholders could expect to receive considerably more value for their shares than they would if they are massively diluted by an attempt to maintain triple-A status.

Completely agree!!! I urge all shareholders to support this strategy. Issuing $1 billion (or who knows how much) when the market cap is $633 million is giving away the business and fleece the current shareholders.


Having said all that, if the stock price rises to a much higher level soon (a highly unlikely proposition) then I would consider the share issuance as being back on the table.