Thursday, January 17, 2008 12 comments ++[ CLICK TO COMMENT ]++

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.

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

cak
January 17, 2008 at 9:36 PM

SIV -

Thanks for the great posts and new info.


Could you explain how runoff would work in this situation? Does that imply the liquidation or paring off of existing triple A policies? What is it exactly?

How would that benefit Ambac if the housing/credit card/heloc situation continues to deteriorate?

I'm just trying to figure out how this staves off bankruptcy. Or do you think that this is the most effective way to avoid what looks right now as dead reckoning?

I, like you, think there is opportunity in insuring structured products. It's whether or not there is any time on clock left and if management has the courage, smarts, and gambling spirit to initiate such an undertaking. I'm not sure.

I have to tell you that I faxed an in-your-face letter to Genader the day I read Accrued's AMBAC report of NOV 22. I even faxed them AI's report straight off the web. I told them they needed to get their act together, that they were way behind the curve and told them to raise the 2 billion AI was thinking they needed. The stock was in the upper 20's I think. All they did was jabber about waiting for the ratings reports to come in. They wasted valuable time, and here we are 2 months later with nothing. That's why I don't think Genader leaving is all that big a deal. In fact, I think other managers should own up and get out.


Poor MBI. They raise 2 bill and still get hit by Moody's. There has been a lot of media attacks on the ratings agencies, and it looks like they are succumbing. Marty Whitman stated in his report that public pressure would get the agencies going after everything, including the "soft" stuff.

cak
January 17, 2008 at 9:53 PM

Another peeve -

Why would the company pre-announce and make mention of capital raising plan without stating what it was? Did they think that just by mentioning "capital raise" that it would save the stock? Even today, the co. issues a press release saying that they were "shocked" with the Moody's threat. See? These people are on a different planet. It reminds me of Sallie Mae where the wacky CEO got all indignant when JC Flowers dropped the buyout bid from 60 to 50. No way, said Al Lord, only to watch the stock drop to 17.

Ranting.

synchro
January 17, 2008 at 10:26 PM

The capital raising exercise is moot anyway. Just look at MBIA's surplus note performance. It is being quoted 80 cents on the dollar, after _3 days_ of issuance. What institution in its right mind would want to be the next sucker? Altneratively, it would be insane to issue a surplus note w/ a 18% yield -- the NY DOI would not allow such a coupon to be paid.

January 17, 2008 at 11:09 PM

Ranting is good... it gets things off your chest... and generates some ideas...

As synchro said above, raising capital is almost impossible now. I mean what are their choices:

(i) stock issuance: too dilutive
(ii) equity-like notes (eg. MBIA): no chance in hell the market will accept anything below 20% yield
(iii) convertible bonds: hard to get off
(iv) preferred shares: possible but highly dilutive

I hope Ambac doesnt do something stupid and sell itself to Berkshire at current price or unload its muni bonds and leave the shareholders (us) with the structured product liabilities.

I think Ambac had a plan for a $1 billion capital infusion. That's likely why they moved up the conference call. That's also why they were surprised and had to question their original $1 billion capital plan. In the worst case, if I'm not mistaken, Ambac has an $800 million preferred share (they have some sort of put option that lets them use this) that they can tap at any time (not sure what coupon they have to pay). I think the Moody's assessment threw all this away.

I totally agree with you that they should have raised the capital when they had the chance. I mean, I was investing just this week with the impression that the capital infusion was almost certain. Too late to harp on that point now...

I'll have to look into the run-off situation and see how it will work. Martin Whitman was sort of touching on this in his commentary. He said something like the run-off value may be higher htan the stock price he was buying at.
Ièll do some research and post more on that, now that run-off or going dormant are the choices.

One big risk with run-off is that the holding company wonèt have any funds to pay its operating expenses. This will happen if the state regulator blocks any payments from the insurance subsidiary to the holding company until they are certain that insurance claims donèt materialize (this can take years).

(Windows Vista is messed up. Apostrophes donèt show up properly. Let me exit Internet Explorer) :(

January 17, 2008 at 11:30 PM

Before we look at run-off, Ambac actually has another choice: lose its AAA rating and operate without it. That may be something that should be considered before run-off is considered. I would love to hear what other prominent shareholders, like Martin Whitman, Warburg Pincus, and others (there are a few other value funds invested) think.

I think the "hibernation" (operating with AA) may be the best for now. If you think we will know for sure how bad hte mortgage losses will be by the end of this year, then staying low-key for an year or two may be worth it. I'm not entirely sure hte "hibernation" strategy is necessarily different from the run-off...


With the run-off, you are ASSUMING that losses will NOT increase in the future. You basically can't write any new business so you won't have the revenue generation capability to offset increasing losses if you go into this mode.

Your tactic (hope?) with the run-off is with the view that:

(i) future losses will not increase (or else you won't have enough capital to pay claims. you will also get cut further down from AA, not that this matters since you are not writing new business)
(ii) booked mark-to-market losses will not be realized (this is the key thing--I'll talk about it below)
(iii) recoveries (from foreclosure of homes and other means) will be higher than what is perceived right now

The main point with this strategy is to see if the mark-to-market turns out to be higher than the reality. This is what monolines have been claiming when they say that the mark-to-market are not indicative of losses. You booked the mark-to-market value, and now you will wait to see what the true loss is. If the true loss turns out to be lower than the mark on the books, the marks will reverse and you will actually "make money" (i.e. the book value will go up).

For instance, with that huge loss that was declared recently, the book value dropped by $30-something (don't recall the exact loss) to around $20 (adjusted book value is higher but let's ignore that for now). But if true losses are only $20, your book value will now increase by $10 to $30. In the end, ignoring costs of shutting down operations, severance packages, etc, the company is worth $30 (in this example). Your original mark-to-market pegged the company at $20/share but it actually turned out to be $30. The loss that was marked reversed since the true loss was not that.

Ambac's adjusted book value, which includes things like premiums collected but not earned/etc, is still somewhere in the $50's (after that huge loss). This is what gives hope that the run-off may yield a better result. In some sense, Ambac can take another huge loss similar to what it recently disclosed and the stock price will still be below the book value but I will lose money (our cost basis is higher) (I am not expecting that of course; when I invested, my feeling WAs that the big loss is 4Q07 and then a gradual decline in losses).

I think we can see how run-off will work by looking at SCA. They will likely go into run-off (if Ambac can't raise capital, they definitely can't) and they are probably 6 months in front of Ambac.

iÈLL TRY TO POST SOMETHING COHERENT LATER.. INTERNET EXPLORER AND VISTA ARE MESSED UP RIGHT NOW :(

cak
January 18, 2008 at 9:24 AM

At least the co. has shown a little common sense. Maybe they need to bring in Evergreen tupes right away to discuss ways on how to best operate the company from this point on.

Unfortunately, the stock is trading up this morning on speculation a white knight may step in and save the day. Those hopes may be dashed on Tues.

A major problem is the ratings agencies are in a complete state of panic, showing little patience and threatening ratings downgrades to companies that have already raised expensive capital (MBI).


NEW YORK, January 18, 2008-- Ambac Financial Group, Inc. (NYSE: ABK) (Ambac) stated today that it has determined that as a result of market conditions and other factors, including the recent actions of certain ratings agencies, raising equity capital is not an attractive option at this time. The Company is continuing to evaluate its alternatives.

cak
January 18, 2008 at 9:42 AM

Another "short" hedge fund manager goes after the ratings agencies, continuing the sideways tactic of punching the shares from the outside.

Greenlight

January 18, 2008 at 10:11 AM

MBIA has really been screwed by the rating agencies. Ambac and MBIA were similar size companies (market cap, earnings, sales, etc), with MBIA being slightly bigger. But MBIA raised almost $2 billion whereas Ambac ceded $25 billion in muni bonds for reinsurance. MBIA now has $2 billion in claims (the note, Warburg Pincus, etc) above the existing shareholders. At least, Ambac didn't dilute anyone yet (I hope they don't do something stupid and dilute shareholders on Monday but I think they are backing off that).

cak
January 18, 2008 at 2:05 PM

Deutsche Bank analyst agrees with Evercore AA idea, except he's talking about MBI. I can only imagine the deep frustration within the ranks at MBI. To me, some kind of third party needs to intervene, sit everybody down and hash this thing out in a comphrensive and intelligent manner. The whole thing looks out of control.



January 18, 2008 10:20 AM EST

Deutsche Bank downgrades MBIA Inc. (NYSE: MBI) from Buy to Hold and lowers its price target from $32 to $15.

The firm attributed the Hold rating to the recent rapidly changing perspectives "of the capital needs by the rating agencies." Deutsche said that MBIA has made progress in its capital plan, but noted that the volatile views of the top three rating agencies -- S&P, Moody's and Fitch -- related to the capital requirements for insurance companies may cause MBIA to be forever "chasing the end of a rainbow to maintain" its triple-A ratings.

MBIA has just completed reviews on its capital base less than a month ago, but is already looking to "raise the bar again", as Deutsche puts it, in an attempt to maintain a triple-A rating. As additional capital causes dilution of shareholder value, the firm feels major insurers such as MBIA should not continue raising capital and instead just accept a rating downgrade and begin updating its business model. If this were the case, MBIA would most likely be able to continue distributing a regular dividend and halt any further capital dilution.

cak
January 18, 2008 at 2:22 PM

Citigroup analyst comments after downgrade of MBI (I apologize if you've read these)


Citigroup analyst Heather Hunt said Moody’s “review for downgrade" of Ambac and MBIA may mean a move to “AA” from “AAA” rating status, making a run-off likely.

A run-off is a situation where a company books no new business and only earns money on already-completed insurance deals

“This is not bankruptcy,” Hunt said. “Record losses would be paid over time and can be absorbed by current capital and income on existing business that is contractually obligated to them.”

She said that the stocks' valuations suggest financial distress but that their financials do not.

However, "in the face of worsening credit market conditions and volatility, it is difficult to maintain buy ratings, despite extraordinarily low valuations," Hunt told clients.



Hunt assigned a price target of $7 to Ambac's shares.

Anonymous
January 18, 2008 at 5:38 PM

I don't own ABK, but am heavily entrenched in MBI...*heavy sigh*. I don't understand the current erosion in share price. Here are my thoughts on MBI (applicable to ABK as well); perhaps overly simplistic, but...

MBI traded at $70+/share in May '07 (I believe ABK was at $90+). Was that a realistic price? No; I think it was overvalued. However, assuming half of that value was a by-product of CDO/subprime originations, it implies a “net” non-CDO value of $35/share. And furthermore, assuming there was a 15% premium imputed in last year's value due to the unrealistic run-up in share price, that'd knock another $10 off, thus implying a net net value of $25/share. I think this is realistic. Heck, just to be conservative, let’s knock another 20% off that…down to $20/share. Is this in the realm of realism? I think so. After all, their primary book of business is NOT the CDO/subprime garbage, but rather the municipal and corporate business built year after year, long before 2001/02 when the subprime frenzy started.
MBIA is going to take some real cash losses on its CDO/subprime book of business; that’s a given, but it still holds a huge chunk of business in municipal/corp issues. Is that worth $20/share? Probably. So, again, I ask “Is $8/share a fair representation of it's value?” Frankly, I'm having trouble connecting the dots, so I have to say "No, it's undervalued and oversold!"
The market is acting on emotion; borderline hysteria, rather than underlying fundamentals. Because the credit market turmoil is breaking new grounds, defying conventional wisdom and traditional models, folks are panicked, they don't know what to expect, so they sell!

I'm not worried about MBIA, but I do find highly disconcerting the seemingly uncontrolled reactionary mentality of investors frustrating.

I believe the investment risk for MBI (and ABK) isn’t reflected in the possibility of bankruptcy; I think that’s unlikely, but rather the likelihood of a foreign entity, taking advantage of a weak dollar, making a cash tender offer to acquire the company…which would leave investors who bought at higher valuations on the proverbial short end of the stick.

January 18, 2008 at 11:06 PM

Anon,

I have always felt that the market has been irrational. But the stock price sell-off is starting to have real impact on the firms. Ambac just lost its rating, and MBIA may not (but it's hard to say).

I have always felt that the market wasn't distinguishing the monolines' RMBS and CDO exposure from the investment banks/hedge funds/etc who lost money on them.

A lot of people also don't seem to realize--including Jim Cramer--that the stress tests by the rating agencies are some extreme probabilities. Not only have those losses not materialized, the probability is that they may not.

In any case, no point going over the market sentiment when your are being clobbered.

If MBIA can keep its rating, it needs to salvage its operations and try to survive. I think MBIA has a slight advantage in that they still haven't lost the rating (depends on what Moody's does; Fitch affirmed). I really feel bad for MBIA shareholders because if they lose the rating (not just now but even in one or two months), the money they raised at steep cost to shareholders was moot.

Ambac, on the other hand, lost its rating and will lose up to 75% of its revenue (muni bonds). Ambac's strategy now should be to minimize costs and try to develop a model where they don't rely on AAA.

You may want to tune into Ambac's conference call on Tuesday to see if they provide some insight for your MBIA investment...

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