Ambac Posts Second Quarter 2008 Earnings
Ambac released its 2008 second quarter earnings today and I honestly don't know what to think of it (that's one reason I didn't post anything on it all day long.) It's all highly confusing and to see what I mean, I don't know if Ambac beat analyst estimates or missed it. GAAP earnings came in positive, largely from mark-to-market gain, but operating income was negative. Additional credit impariments of around $1 billion were booked (this is what really matters) so this is bad news.
The mark-to-market earnings are almost meaningless (except to accountants it seems.) It just confuses everyone in my opinion. Ambac notes that they expect the marks to go negative starting in July so we may see negative earnings next quarter. For those not familiar, basically what is happening is that the mark-to-market prices are based on credit spreads (among other things) and they are fluctuating wildly given the stressed scenario we are witnessing. Clearly, the accountants that rolled out mark-to-market accounting (aka fair-value accounting) worship at the alter of efficient market theory and never understood that prices can be irrational and wildly volatile during stressful times (thankfully the FASB seems to be backing off their latest proposal to force companies to bring off-balance-sheet items onto their balance sheets. Recall that this was what caused the collapse of Fannie and Freddie shares and significantly increased uncertainty.) There is a difference, after all, between being a free market proponent and believing that the market is right at all times.
Overall, I don't consider the situation to be good. They booked at additional $1 billion in actual losses :( As usual it's coming from CDOs. That's a very bad sign. I was hoping for losses to stabilize at a lower value but that isn't the case yet.
The good news is the fact that they are making some headway in remediation, along with commutation of select deals. Rest of their portfolio seems to be in good shape as well.
It's not clear what the market was looking for but judging from the fact that the stock is up 23.68% today, I'm guessing that the market is looking at reported GAAP earnings only. Ambac is a very hard stock to evaluate for both the longs and the shorts. It wouldn't surprise me if it sells off sharply over the next few months (especially if the Connie Lee idea backfires.) The longs--at least those who came in early--have been burned very badly with this stock. The shorts who came in late have also likely suffered huge losses. The fact that the stock is up 500% in less than one month from its low at $1.04 shows how hard it is to bet either way in the short run. Theoretically, if you shorted the stock at the low early in July, you would be showing a 500% loss; but in practice most short sellers are technically oriented and have stop losses and would probably bail out with a 30% to 40% loss.
Ambac Financial Group, Inc. today announced second quarter 2008 net income of $823.1 million, or net income of $2.80 on a fully-diluted per share basis. This compares to second quarter 2007 net income of $173.0 million, or net income of $1.67 on a fully-diluted per share basis. The increase in the second quarter of 2008 is primarily due to recording net mark-to-market gains on credit derivatives, increased accelerated premiums from refundings, and loss reserve reductions on the direct residential mortgage-backed securities (RMBS) portfolio, partially offset by market losses on RMBS within the financial services investment portfolio.
The mark-to-market earnings are almost meaningless (except to accountants it seems.) It just confuses everyone in my opinion. Ambac notes that they expect the marks to go negative starting in July so we may see negative earnings next quarter. For those not familiar, basically what is happening is that the mark-to-market prices are based on credit spreads (among other things) and they are fluctuating wildly given the stressed scenario we are witnessing. Clearly, the accountants that rolled out mark-to-market accounting (aka fair-value accounting) worship at the alter of efficient market theory and never understood that prices can be irrational and wildly volatile during stressful times (thankfully the FASB seems to be backing off their latest proposal to force companies to bring off-balance-sheet items onto their balance sheets. Recall that this was what caused the collapse of Fannie and Freddie shares and significantly increased uncertainty.) There is a difference, after all, between being a free market proponent and believing that the market is right at all times.
- Financial guarantee revenues, excluding net securities gains/losses and accelerated premiums from refundings (both are defined below), were flat at $314.1 million, quarter over quarter, despite little new business generated during the quarter.
- Net loss reserve reductions of $339.3 million were recorded for the quarter primarily relating to the second-lien direct RMBS portfolio. The majority of this benefit resulted from the inclusion in our loss reserve estimates of substantiated representation and warranty breach recoveries in certain transactions.
- Net mark-to-market gains on credit derivatives amounted to $961.6 million. However, estimated impairment losses in this portfolio amounted to $1,061.9 million during the quarter primarily due to credit deterioration and internal downgrades in several transactions...
- Progress continues in our efforts to establish a triple-A rated public finance subsidiary. The appropriate approval forms have been filed with the Office of the Commissioner of Insurance of the State of Wisconsin (OCI) and the Company believes that it will receive a favorable response; rating agency review is ongoing.
Overall, I don't consider the situation to be good. They booked at additional $1 billion in actual losses :( As usual it's coming from CDOs. That's a very bad sign. I was hoping for losses to stabilize at a lower value but that isn't the case yet.
The good news is the fact that they are making some headway in remediation, along with commutation of select deals. Rest of their portfolio seems to be in good shape as well.
It's not clear what the market was looking for but judging from the fact that the stock is up 23.68% today, I'm guessing that the market is looking at reported GAAP earnings only. Ambac is a very hard stock to evaluate for both the longs and the shorts. It wouldn't surprise me if it sells off sharply over the next few months (especially if the Connie Lee idea backfires.) The longs--at least those who came in early--have been burned very badly with this stock. The shorts who came in late have also likely suffered huge losses. The fact that the stock is up 500% in less than one month from its low at $1.04 shows how hard it is to bet either way in the short run. Theoretically, if you shorted the stock at the low early in July, you would be showing a 500% loss; but in practice most short sellers are technically oriented and have stop losses and would probably bail out with a 30% to 40% loss.
It seems to me the GAAP profit is almost entirely driven by "writing down" the value of Ambac's own liabilities. At the end of june Ambac CDS spreads were at levels implying imminent default, so on that basis the "market value" of Ambac's liabilities declined substantially. That would explain why they expect this to reverse in july as CDS spreads have been coming down. Pretty meaningless indeed from a business point of view (but it might help convince people that the marks to market are meaningless in the first place and that would be a plus.)
ReplyDeleteThere is good news here in the form of the reductions in the reserves against CES/HELOC and the "burnout" of new delinquincies on these loans. They are also distinctly optimistic about Connie's chances of making it of the launch pad, that too sounds good.
The one thing I had really hoped not to see (but got a big dose of) is an increase of loss reserves. As you say, that is bad news, especially given the size of the additional reserve. They doubled their CDO loss expectations in a single quarter so that had better not continue. Still, the reserves appear to be mostly driven by collateral downgrades which might be overdone in the current environment. So as with the CES/HELOC we moght yet see a reduction of reserves.
MBIA presents q2 tomorrow, will be interesting to compare and contrast...
Some news about Your Main Man's assets being pulled:
ReplyDeletehttp://www.clusterstock.com/2008/8/ legendary-fund-manager-bill-miller-fired-by-client
Somewhat ironic that the man who built his lucky streak on averaging down (masqueraded as "value investing") is now having his assets yanked out of his hands.
But...in the spirit of being Fair and Balanced, his performance lately has been better due to some short squeezes taking place in his favorite haunts.
ContrarianDutch: "MBIA presents q2 tomorrow, will be interesting to compare and contrast..."
ReplyDeleteMBIA has exposure to commercial real estate, which hasn't done that well lately (although nowhere near as bad as residential.) It'll be interesting to see what happens to MBIA.
MBIA also didn't commute any of their contracts (yet) so it'll be interesting to see if they cut any deals (but didn't announce them)...
Synchro,
ReplyDeleteI saw that. I was thinking of whether to post that but decided against it. Maybe I'm too biased towards Bill Miller but that almost sounds like pulling out assets near the bottom. Here you have a pension fund that decided to pull the assets now, when they should have done that 4 or 5 years ago. Furthermore, they seem to swap the assets into passive index funds and fund-of-hedge-funds. Probably the worst move you can make now but what do I know?
If people thought that private equity was in a bubble, wait until the hedge funds start shutting down. This seems especially likely now that the commodity boom seems to have ended--at least for the time being. Hedge funds are supposed to have low correlation with the broad market but that hasn't been the case in the last few years. It depends on the specific fund but let's just wait and see how many of these funds actually do well in this bear market...