Can Turtles Fly?

Bond insurers have somehow managed to transform a breathtakingly dull corner of the financio-sphere into an action-packed, thrill-a-minute spectacle filled with dire peril, a torrent of rating-agency press releases, and eager entreaties from big-name billionaires. BusinessWeek BusinessWeek captures what I have said previously. I hope those sitting on the sidelines are enjoying the show. A day doesn't go by without some potentially market-moving news emerging from one of the monolines. After the market closed, Ambac indicated that it is lowering the quarterly dividend to $0.01. It also indicated that it will not write structured finance insurance for 6 months. Supposedly this frees up $600 million. They are also discontinuing some areas that aren't expected to perform well.

I have never been one to accept the decoupling theory. In case you are not familiar, this is the theory that postulates that emerging markets do not depend on the US economy anymore. The thinking is that one can avoid market corrections by investing in foreign countries. The first few months of this year has put that theory to test and it hasn't held up well so far. Plotted below are the US$ year-to-date returns for some key countries (using Dow Jones indexes). As things stand at the end of February, USA had a return of -9.2% versus -7.8% for the world (including USA). Most of the countries are posting negative returns. Canada is holding up well due to strong commodity prices but my guess is that it will fall when the US economic slowdown is certain and the effects of the 'Subprime Virus' works its way throughout the world. Japan--a market closely watched by me--is holding up well due to strengthening of the Yen. Historically all the world's stock markets have been infl...

UPDATE: Ross says his investment in AGO does not preclude him from putting money into one of the other monolines through AGO. In plain English this means that AGO may entertain the thought of offering reinsurance to others (obviously at better rates than Buffet's ridiculous offer). Since Ambac is pursuing a very large capital injection I don't think they will consider reinsurance for the time being (however, given that the structure of the deal is constantly changing, anything can happen). I hate to be posting a lot of unsubstantiated speculations but Ambac is a big, critical, holding for me so I'm following it closely. The latest rumour from CNBC is that the Ambac deal being put together by a consortium of banks, private equity, and other interests, has hit a wall . The snag was hit Wednesday, when raters said they wanted to see more capital injected in the bond insurer if it is to get a triple-A rating, after the consortium of banks had agreed to come up with $2.5 billio...

I'm not trying to be arrogant but this post is going to sound like I am. Does anyone even know what a AAA rating for a company is? How many know the difference between a debt rating and a financial strength rating? Unfortunately, it seems like a lot of the monoline bears don't seem to grasp the difference between a debt rating and a financial strength rating. The latest ones to mistakingly mix the two are monolines bears like Doug Kass ( read his article here ) and Mike Shedlock ( erroneous Pfizer comparison here ) (I actually think one should read their sites for sometimes insightful off-the-wall bearish views and I think both of these guys know more about investing than me--but not on this point :) ). The holding company debt of Ambac and MBIA were never rated AAA. Even during the glory days a few years back, neither of these entities were rated AAA as far as I know. Instead, what is rated AAA is the financial strength of their insurance subsidiaries. What is the difference? ...

Well, I never thought that the monolines, who, even during their best days, are not even one-tenth the size of a decent bank, would have the power to rally the world markets as much as they did. The rallies in the last two days have been massive; but this also makes me concerned that there could be a big sell-off if positive news don't emerge. In any case, the cause of the rally today was favourable action towards MBIA and Ambac from the ratings agency S&P. S&P carried out a new stress test and took the following ratings action (you can get their detailed report from their website ): FGIC: Rating cut from AA to A; credit watch with developing implications XL: Rating cut from AAA to A-; credit watch negative CIFG: AAA affirmed (negative outlook) MBIA: AAA affirmed (negative outlook); removed from credit watch ABK: AAA affirmed; credit watch negative (Assured Guaranty, FSA, Radian, and SCA were not reviewed for various reasons) Nothing surprising in my eyes so there isn...

Sticking with the chess analogy I had been using for months, it looks like Ambac will make its final few moves soon. After the strategy being discussed below is executed, it will come down to waiting and seeing how subprime mortgage losses and recoveries. If things deteriorate much further, the company is done for (from a shareholder point of view). Sadly for me, I was investing with the view that Ambac would have raised around $1.5 billion a few months ago. Management made a huge mistake and we are now raising greater amount in worse market conditions. Anyway, we just have to play with what we have (it's a good lesson for investors I guess). The Plan Originally reported by CNBC, bankers are close to finalizing the capital injection plan for Ambac . If rating agencies approve the plan, it will supposedly be unveiled Monday or Tuesday: Under Ambac’s plan, one part of the company would guarantee relatively safe municipal bonds, while the other would insure more complex securities bac...

(all quotes from Splitting headaches, Feb 21 2008, The Economist) (source: The Economist; Illustration by Satoshi Kambayashi) "We were not designed or structured to be the most important company in the entire financial system. -- Jay Brown, MBIA CEO" So starts off the article titled Splitting Headaches from The Economist (February 21, 2008). That quote is from Jay Brown--the executive that ran MBIA during the early 2000's. He also happens to be the nemesis of Bill Ackman (Ackman's prior hedge fund likely collapsed upon investor withdrawl due to the SEC investigation initiated by MBIA--although he had other problems as well). The quote pretty much sums up the present situation in the monoline world. The monolines as I like to call them are commonly called bond insurers in the press. Companies a fraction the size of a large international bank have ended up playing a crucial role in the financial world. With rating agencies preparing to downgrade them to levels that ...

Given MBIA's recent strategy of withdrawing from the bond insurer trade association, Association of Financial Guaranty Insurers, it looks like the big three (MBIA, Ambac, and FGIC) are going to split their muni bond business from the structured product business. Here is what MBIA had to say: Jay Brown, Chairman and Chief Executive Officer of MBIA said, "It has become clear that MBIA and the other members of AFGI no longer share a common vision for the industry. For one thing, we believe that the industry must over time separate its business of insuring municipal bonds from the often riskier business of guaranteeing other types of securities, such as those linked to mortgages. Additionally, we disagree with AFGI's positions on the appropriateness of monoline financial guarantors insuring credit default swaps and the ability of U.S. financial guarantors to reinsure U.S. domestic financial guarantee insurance transactions with foreign affiliates without paying U.S. corporate...

I have been researching Japanese stocks and started looking at real estate more deeply. Japanese real estate stocks and REITs had a big run-up in 2005 (mostly on foreign investor demand) but have come tumbling down in the last year. Suruga Corporation I have Suruga Corporation (TSE: 1880) on my watchlist and have been reading up on it. It's a small company so their website only has basic information in English (as a sidenote, for a tech-savvy society, Japan is weak when it comes to the Internet). Suruga's main business is real estate construction. A company trading 20% below book, with a P/E around 5, and an ROE of around 15% should make me jump at the opportunity but it doesn't. The problem I have is that due to my inexperience I don't know how to judge cyclical companies. I'm not sure if this low P/E is an earnings peak or not. The fact that the stock has sold off and is near multi-year lows makes me think the P/E is not a cyclical peak but I don't understand...

Well, I don't really have anything insightful to say about what is happening in the monoline world. There are too many uncertainties, and too many competing plans floating around. I'll present some bearish and bullish articles I ran across... Accrued Interest has a blog entry pointing out that a split is perhaps the best for Ambac. The author pretty much sums up the present predicament for the AAA-rated mononlines. I made a lengthy pos in the comments area so check that out if you are interested in my thinking. The way I look at it, a run-off is still a possibility for shareholders if the cost of maintaining a AAA rating is too high. But I am not sure if the government, shorts, or other parties are going to like that. I would be supportive of a split if (i) the government provides cover for any lawsuits from structured products insurance buyers, (ii) capital infusion doesn't cost "too much", and (iii) present shareholders get a piece of the muni bond business (if...

UPDATE: Added to link to Tom Brown's rebuttal of the bears... MBIA Replaces CEO I never really understand the goings and comings of MBIA. The latest event is the CEO shuffle : Bond insurer MBIA Inc said Tuesday that former Chairman and CEO Joseph Brown was returning to replace current CEO Gary Dunton as the company, beset by mortgage-related losses, scrambles to maintain a top credit rating... Between 1999 and 2004, Brown ran MBIA and its main unit, MBIA Insurance Corp. He joined the firm as a director in 1986 and retired last May. Well, it's hard to say what is positive news and what is negative these days. I am guessing that this is good news given that the CEO ran the company before and was with the company as recently as early last year. I am guessing that Warburg Pincus and other key shareholders likely pushed for the change (there was little else that happened to warrant a shuffle). Ambac Trying to Raise Capital Ambac is trying to raise around $2 billion via a rights of...

Bill Miller published the 4th quarter commentary and it is always an interesting read. He is having a tough couple of years and he says it is somewhat similar to 1989 and 1990. Here are some excerpts... Are we in 1990? The past two years are a lot like 1989 and 1990, and I think there is a reasonable probability the next few years will look like what followed those years. The late 1980s saw a merger boom similar to what we have experienced the past few years and a housing boom as well. In 1989, though, the merger boom came to a halt with the failure of the buyout of United Airlines to be completed. The buyout boom had been fueled by financial innovation. Then it was so-called junk bonds..Now it is subprime loans repackaged into structured financial products... By 1990, housing was in freefall, the savings and loans were going bankrupt (as the mortgage companies did in 2007), financial stocks were collapsing, oil prices were soaring in 1990 due to a war in the Middle East, the economy ...

I don't consider myself as a pure value investor but if one was inclined towards value investing and was to blindly invest in a company, I can't think of too many better candidates than Sears Holdings (SHLD). It's amazing to see so many superstar value investors take a position in Sears (note: the list may have changed since then so we don't know the exact holdings). The list includes Martin Whitman, Jean-Marie Eveilard, Bruce Berkowitz, Mohnish Pabri, and...uh... Bill Ackman. For once, I'm on the same wavelength as Ackman ;) I don't invest blindly based on others (not only do you not have the same risk profile and investing time horizon, but you will also learn nothing (I'm trying to learn on my own :) )). But Sears is starting to look attractive on its own. If you are looking for something with a lower risk profile and don't ever want to hear the word subprime ever again :) Sears may be worth considering. Current Numbers Here is how Sears stacks up ...

The biggest news in the monoline world right now is the notion of splitting the muni bond business from the structured product business. I'm sure that everyone, especially anxious shareholders, have been contemplating this scenario. I personally think Ambac is unlikely to seperate the muni bond business from the structured product business (but I can be wrong). The government would have to force the situation or at least provide some compensation (to the structured product insurance buyers). In general, I think the splitting strategy is quite dumb and simplistic. I don't really know how one can discriminate against those that bought insurance on the structured products. One should also remember that structured products are not subprime residential real estate assets alone; they also include ABS of credit card loans, student loans, auto loans, commercial real estate, and so forth. There is going to be all sort of collateral damage to the educational institutions, auto retailers,...

I decided to take a risk arbitrage position in BCE (TSX & NYSE: BCE). I was considering PENN but I feel it is better to go with a safer bet with a 10% lower return. As I quoted in a prior post, arbitrage deals work until they don't. I don't want to be the last one holding the bag when it fails. Derek DeCloet of The Globe & Mail--one of the best business reporters in Canada--pretty much summarizes the situation in his latest article . Just to recap the risks... The risks clouding this takeover are three: The bondholders could win their lawsuit in Quebec Superior Court; the buyers, led by the Ontario Teachers' Pension Plan, could walk away; or the banks, led by battered Citigroup, could break their agreement to fund the deal. The way I see it, the bondholders are unlikely to win. I mean, how can you sue a company for taking on more debt when you never bought a bond that stipulated that they cannot do that? I don't think the buyers will walk away. They seem commit...

FGIC became the first company to split their business in two ; one handling muni bonds and another for structured products. I'm not familiar with FGIC so I don't know what happens to their international operations, if they have any. (Just to clarify, they are in the process of trying to split. This may take a while.) Dave Merkel of The Aleph Blog thinks the state can't force a split of the business: ...the state insurance commissioners lack authority to favor one class of claimants over another to the degree of setting up a “good bank/bad bank” remedy, where municipalities get preferential treatment ovr other potential claimants... The insureds that would be forced into the “bad bank” would likely not have agreed to the contract had they known that the claims-paying ability of the guarantor would be impaired. It does seem bizarre that the regulator will favour one party over another but governments aren't necessarily efficient or know the complexities of many problems....

UPDATE: Just ran across this GaveKal forum post with a good discussion of the monolines and some of the issues that have cropped. I generally respect GaveKal for their off-the-wall thinking. Well, the day started off with hearings on the state of the bond insurance industry. Most of the prepared testimony made it to the press yesterday so nothing materially significant happened. Eliot Spitzer started off by saying the monolines should split the municipal bond business and the structured finance products business. What was surprising to me was how he implied that something will happen within a week if the bond insurers can't raise capital on their own. I am not an expert on government regulations but I believe he doesn't have any power to do anything to the insurers. It all comes down to what Eric Dinallo, the New York regulator, does (in the case of Ambac, whose "home" is in Wisconsin, it depends on the Wisconsin regulator as well). The New York regulator seems to su...

US Congress is holding a hearing on the bond industry today . We have parties representing different interests including the New York insurance regulator, Federal Reserve, bond issuer, rating agency, bond insurers, and bond insurer shorts. Missing from the hearing are the big Wall Street investment and money center banks, some of whom have big exposure to the insured bonds and structured products. Bond insurance buyers, such as hedge funds, pension funds, and retail investors, are also not represented. So this is all from the "seller/issuer" point of view. The federal government probably can't (and won't) do anything right now but, nevertheless, we can get a sense of where some parties stand. The Federal Reserve likely won't do anything either since insurance is likely outside their mandate. As an Ambac shareholder, I'm still against any government intervention. We need a private-sector plan. If the government wants to do something, they should direct their ef...

UPDATE 2: Wilbur Ross says he thinks the Buffett deal makes little sense but will pressure the regulators and banks to act. He is still working on a deal and will have better economics than the Buffett deal. I'm not really sure what the rating agencies think of all this. UPDATE: Ambac just said it rejected the Buffett offer. Supposedly the company that rejected the offer before (that Buffett was referring to) was someone else (likely MBIA IMO). None of this should be a huge surprise to anyone. Buffett's asking price is steep no doubt. You know the price is too high when Bill Ackman says it's a good deal (LOL). The real question mark in my mind is what happens if the price is lowered. Then things get interesting... I still think if Ambac were to raise capital, reinsurance for some portion of the required capital makes sense. Nothing surprising but Warren Buffett publicly announced that he is willing to underwrite (through reinsurance) $800 billion worth of municipal bon...

I'm adding Thornburg Mortgage 7.5% Cumulative Convertible Redeemable Preferred Shares Series E (TMA-PRE) to the watch list. Anything to do with residential real estate is very risky so this is not for the faint of heart. Thornburg mortgage (TMA) is a mortgage loan company (a REIT without physical real estate holdings) concentrating on jumbo adjustable rate mortgages (ARM). In other words, it caters to the upper middle-class and upper class real estate buyers. It essentially makes money on the difference between in the cost of the mortgage and what it charges. I am attracted to the preferreds because they are convertible and have a decent yield (9%). I'm still trying to figure out what is a good return for me but my current thinking is that anything that yields 10% for the long-term is worth looking at. Stocks have a long-term return of around 10% so a bond that can beat that is worth considering. However bond/preferred coupons don't increase so inflation is a huge risk. To...