Friday, March 14, 2008 0 comments ++[ CLICK TO COMMENT ]++

Ambac Chairperson's Letter

Ambac released a letter from the CEO talking about their situation. It is a typical public relations letter with very little substance. The only noteworthy point in the letter (at least to me) is their strategy of staying in the structured finance business.

Ambac’s business has been and will continue to encompass more than U.S public finance. Diversity of our business strengthens Ambac, as acknowledged by the rating agencies. In the U.S. we will continue to insure student loans, utility issues and certain other structured finance issues that meet our enhanced risk parameters. Outside the U.S., Ambac will continue to insure securities funding hospitals, roads, schools, public transportation and so forth.

In contrast, unless I am misunderstanding MBIA, it looks like MBIA wants to wind down its structured finance business and concentrate on municipal bond business. MBIA is also trying to split over the next 5 years, whereas no word of any split from Ambac. My guess is that Ambac gave up on the split idea after looking into it deeply over the last month.

Although it's fashionable to cast a negative light on structured finance products, I personally believe the future growth is in that area. I really don't think structured products are going to dissapear.

The structured product area will also provide a significant competitive advantage since Berkshire Hathaway Assurance Corporation is not entering that field. Smaller monolines also likely don't have the expertise to challenge the (formerly) dominant players like Ambac or MBIA. You can also survive with a AA rating in structured product insurance so if Ambac ever gives it up and loses its AAA rating, then it will be doomed.

Having said this, structured product insurance will face greater losses in the future due to the weakening US economy. My expectation is for higher losses in student loans, auto loans, credit card loans, and so forth. Hopefully Ambac didn't misprice insurance for these areas. I have greater confidence with Ambac's underwriting in, say, auto loans because they generally had a low original rating (originally BBB) and are priced as if the asset is depreciating (cars depreciate). In contrast, houses were priced as if they appreciate in general and their underlying ratings were often AAA. Student loans also look safer than mortgages but it depends on specifics (my impression is that student loans depend a lot on government regulations).

In insurance, higher insured losses are part of the business and not necessarily a bad thing. When losses are higher, premiums generally increase so your future business will earn more; when losses are low, premiums are low and competition is also higher. The key thing is to price the riks properly and have enough excess capital such that your ability to pay claims isn't questioned.


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