Thursday, January 17, 2008 1 comments ++[ CLICK TO COMMENT ]++

Well... It Looks Like All the Monolines are Going Down

Worst investing day--and week--of my life!!! I have taken massive losses before but not quite so quickly and so much in dollar terms. Nothing like losing something like 70% within one week after you invest, with a real possibility of bankruptcy. If it weren't for the TSX short ETF, this could easily be the worst week of my investing life--including the future 30 years ;) I don't think the final chapter of Ambac's Life is written yet, although it feels like death is near.

The whole bond insurance sector is getting killed today. Even if you had picked, say, MBIA instead of Ambac, you would have been clobbered, with MBIA down 30% on no MBIA-specific news (but there are a lot of rating agency news saying that losses are going to be higher). Even one of the safest in the sector, Assured Guaranty, is down 15%+. The market really thinks that most of these bond insurers are going down.

(source: finance.yahoo.com)

The tickers in the image above are S&P 500, S&P/TSX Composite (Canada), and the bond insurers (the last two tickers are the Ambac exchange-traded debentures). For what it's worth, the whole market is getting hit with the bond insurers likely the worst performing industry. Ambac is trading at its all-time historical low (most of the other bond insurers are also likely near their all-time lows).

Banks and others will likely have to book some losses if monolines are downgraded. Depending on what actually happens, damage may be contained. Even if Ambac loses its rating, it will likely be cut to AA so those relying on insurance will only have to write off a one notch downgrade. However, it will likely cause huge paper losses for so-called "municipal" bondholders and other related bondholders who are sensitive to an AAA rating.


Ambac Thoughts

This isn't going to be any consolation to any monoline shareholder but I wish all of you the best. A word out to Neanderthal who invested a bundle in Ambac and exited the position with a massive loss.

As for me, I'll hold on to my shares for the time being. Maybe I'm just dumb but I still don't see the problem, other than the difficulty in raising capital. Unlike the bears, I still think bond insurance is a viable business--even for structured products. I actually think structured products are the future and bond insurance will play a big part in that. I also think that public-private partnerships (basically utilizing so-called "municipal bonds") in developing countries will take off. So the business model still looks OK in my eyes. It's just that the monolines didn't price things properly (as Buffett remarked) and the maximum loss for companies like Ambac is uncertain. This situation reminds me of mega-catastrophic insurance. A company I am a shareholder in, Montpelier Re (MRH), nearly went bankrupt after Katrina but it doesn't mean that mega-cat insurance is unviable. For what it's worth I invested in MRH after it collapsed in price, but not so sure where Ambac is right now.

I also feel that Ambac will generate enough cash flow to pay off most of its present claims and to cover operating costs. The problem is that you need a big capital cushion to retain the AAA rating and generate new business. Simply paying existing claims doesn't do the shareholders any good.

Ambac's exchange-traded debentures finally broke down. They were holding up for the most part, through the crisis, but fell off a cliff today. Previously I remarked that AKF and AKT were preferred shares but they are actually exchange-traded bonds (Ambac doesn't have any preferred shares AFAIK; their total bond liabilities are around $1 billion, in case anyone is thinking there is some liquidation value). After the sell-off today, the yields on those are around 11% (callable at par after 2008). You can get more info from Quantum Online, the best free bond info site IMO, by searching for AKF and AKT. (On a side note, one of those was issued to buyback shares earlier last year. Generally that is not a bad idea if you are not leveraged but if the business falls apart, as has been the case here, you can see what you are stuck with).

The problem with the monolines is that everything is uncertain, including their critical ratings. The fact that the rating agencies keep changing their models (eg. starting to incorporate market price info instead of hard data), and their vague opinions, and change in assumptions doesn't help anyone.

S&P just said that their December loss estimates may need to be 20% higher. I don't think that's a big deal, as I mentioned in a comment response yesterday. The original S&P loss estimate for Ambac (around $1+ billion) needs to increase by 100% for it to reach Fitch's capital demands.

Moody's seems to indicate that the situation would be worse and is almost implying that it will come down harder than Fitch. A higher number isn't a bad thing if the rating agencies came up with a number and kept it. Instead, with their constant change in methodology and figures, the insurers have a hard time raising capital. I suspect this latest round of revisions is probably the last big one that the rating agencies will undertake. The industry may not even exist by the time the next change occurs.

For what it's worth some of Ambac's shareholders are saying that Ambac shouldn't issue shares now. I remember having this discussion with Neanderthal and I agree that we have probably hit the price level where share dilution is too big for it to matter. Ambac will have to make a decision on whether to raise capital or to lose its rating and try to function with AA (this basically takes it out of the municipal bond market).

Two people make a market... so who's buying all these beaten-down stocks? Speculators?

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1 Response to Well... It Looks Like All the Monolines are Going Down

synchro
January 17, 2008 at 10:30 PM

At this point, only the shorts are buying the shares to cover. My Marty Whitman is still at it.

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