Monday, January 7, 2008 9 comments ++[ CLICK TO COMMENT ]++

Purchase: Ambac (ABK)

I initiated a new position in Ambac (ABK) today. It is a high risk position that I plan to hold for the long term (unless something makes me change my mind). I have posted my positive evaluation of Ambac in the past and am sticking with those views for the most part.

I decided to purchase now since any news of Ambac raising capital may push the price up. Failure to raise capital will cause the price to collapse so that's a risk I'm taking.

This is a high risk position--further compounded by the fact that I'm putting 25% of my portfolio into it--with a small possibility of bankruptcy. What can hurt Ambac is if the economy deteriorates significantly. The key number to watch, at least on the subprime front, is a subprime default rate of 19%. That's the number that some rating agencies used for their stress test to determine capital requirements... Longer term, the items to watch are auto loan performance, and potential market share loss due to competitors and uncertainty over brand.

The big short term risk is that Ambac will be unable to raise the $1 billion or so in capital that is needed. Failure to do so can cause a big plunge in the stock price. I'm willing to take this risk (rather than waiting to see if management is successful in raising capital) because I believe they will pull together some deal. Since their business model rests on a AAA rating, they will do almost anything necessary to retain it. The real question, to me, is what penalty they pay to raise that money. As Martin Whitman has remarked, share issuance or rights offering is perhaps the most effective at this point in time.

This is the highest financial risk I have taken in my life :) I have invested in super-high-risk stuff (like DFC last year) but that was a negligible amount of money so it's really not "too risky". Ambac is for real and will determine my portfolio performance, not to mention the financial status of my life (given my sucky job :( ), over the next 3 years!

I will likely not follow Ambac as closely as I have, and will only post thoughts about key events in the future.

Purchase Price: $23.30
Time Frame: Long-term

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9 Response to Purchase: Ambac (ABK)

Neanderthal
January 7, 2008 at 9:19 PM

Siv,

Just curious, why did you finally decided to just go with ABK and not MBI

January 8, 2008 at 10:31 AM

Good question... I had been wrestling with that question in my mind all weekend long.

The things going for MBI are... Martin Whitman has a huge stake... it is trading at a lower price-to-book-value than Ambac (this wasn't the case 3 months ago)... and it has mostly RMBS problems, rather than derivatives like CDOs...

The reasons I picked Ambac over MBIA are:

* I understand it better since I spent more time following it (this doesn't mean its necessarily better)
* its management is clean and has long experience
* used to be the best run monoline (ROE of 12%, with peak of something like 14%) so if it doesn't go bankrupt and can recover, it may outperform
* more comfortable with its insurance exposure (except for CDO-squareds)
* rating agencies only require $1 billion more in capital (for the time being); in contrast, MBI already raised $1 billion and needs another billion
* I have a hypothesis on CDO performance. It may end up being the case that CDOs perform better than direct RMBS in the grand scheme of things. No proof of this yet and the market obviously thinks that CDOs are riskier (since they are a derivative of RMBS). But I wonder if the original intention of pooling RMBS to diversify and lower the overall risk may end up playing out as envisioned. I came around to this thinking after noticing that MBI was taking bigger losses than ABK in the rating agency stress tests. Underwriting expertise plays a role but I wonder if there is something more to it. Could the structure of a CDO be inherently less risky? It is sort of like saying a CDO is to RMBS as a mutual fund is to an individual stock. Mutual funds, which are basically pooled shares, tend to be less risky than someone randomly picking a few stocks (let's assume that we don't know if the stock picker is skilled). I'm really curious to see how the CDOs do this year... Remains to be seen. I'll try to write up a post on my thinking later when I get some time...

cak
January 8, 2008 at 11:34 AM

The stock is getting hit pretty hard today. Don't know why, really. Mysak did have a column today.

Mysak

January 8, 2008 at 11:56 AM

I picked a nice time to invest huh? ;)

Thanks for the Mysak article link... don't think it's his article impacting the price. MBIA is also down around 8% right now...

It's more likely this story: MS cuts bond insurer ratings.

cak
January 8, 2008 at 12:13 PM

Thanks.

I recall Ambac had a full page response back in early Nov to a Morgan Stanley report.

MBI will report earnings on Jan 31. ABK has not formally announced but should be in the Jan 24 - 31 frame. Obviously, with the Fitch note, it will be important that Ambac announce any capital raise during that time or before.

January 8, 2008 at 1:56 PM

One of the risks for bond insurer investors--something I pointed out a long time ago--is that most analysts are still, believe it or not, bullish on the insurers. So there is a possibility of weakness if analyst opinion is cut.

Anyway, the whole market is very weak right now. Countrywide is down big time and it is dragging down everything else...

Neanderthal
January 8, 2008 at 5:50 PM

Siv,

Thanks for your reply. It has been a brutal day for the financials, especially CFC. Good thing I sold it for some loss harvesting a while back.

I originally bought it for the bigger discount but have come around to see that they seem to have better management compared to MBI. Plus it is the only company in which no senior managment made any recent sales and significant buys.
Small comfort but it seems to hold up better than mbi.

Hang in there.

John

cak
January 8, 2008 at 9:45 PM

This is what makes the climb so much more difficult:

CNBC

The problem with TV journalism is the sensationalist nature of the reporting. In this case, Dylan Ratigan went on the air and stated emphatically that 'we now have our first default in municipal bonds".
He was later corrected during a commercial break and said that the bonds "were not in default" but
at no time did he apologize or even seem overly concerned by his error.

Unfortunately, Ratigan now considers himself an expert on all things muni and muni insurance.
It is really getting crazy out there.

January 9, 2008 at 12:08 PM

Cak, yeah, the lame story on the Las Vegas monoline sort of shows how a lot of people make a big deal out of nothing.

In any case, I'm in it for the medium term (2-5 years) so I don't care about what happens in the near term. I'm more concerned with fundamental issues such as whether ABK can raise capital (today's MBIA bond issuance plan gives some idea), and whether the losses on CDOs are deteriorating or not.

If we, the bulls, relied on news, Ambac should be bankrupt now and everyone should just pack up and go home ;)

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