Ambac Facing Serious Problem With Its GIC Business; Postpones Connie Lee Idea
It seemed like Ambac solved its short-term problems a few months ago but that was not to be. It seemed unlikely a few months ago but the suggestion by Moody's this week of a rating downgrade will cause serious problems for Ambac. The situation is very similar to what brought down the insurance giant AIG (however, AIG's problem was with its actual insurance issued in CDS form, whereas Ambac's problem is its side investment management busines). Namely, it looks like Ambac will be short if it had to post collateral, as required under its GIC contracts.
Ambac will be short by $1 billion to $2.1 billion (based on present market values), depending on the company rating. Now that it has shelved its Connie Lee idea--I was never a big fan of this--it should have around $850 million. I think its easy to get $1 billion but $2.1 billion could be tough and would require approval from the insurance regulator.
What is happening is that the market value of the assets are down (not surprsing given the market conditions) but since the company rating is being cut, it is requiring a greater amount of collateral. These assets were set up to be held to maturity and the assets seem to be ok quality (my guess is that if they were held to maturity, they would not result in losses), so it's not really an asset problem per se. Rather the whole investment management business was set up assuming that the company would have high ratings. This shows the perils of building a business without considering a seriously negative scenario (in this case a ratings downgrade.) It would be quite ironic and sad if Ambac's survives the subprime mortage insurance problems but somehow goes down because of its investment business.
Ambac will be short by $1 billion to $2.1 billion (based on present market values), depending on the company rating. Now that it has shelved its Connie Lee idea--I was never a big fan of this--it should have around $850 million. I think its easy to get $1 billion but $2.1 billion could be tough and would require approval from the insurance regulator.
What is happening is that the market value of the assets are down (not surprsing given the market conditions) but since the company rating is being cut, it is requiring a greater amount of collateral. These assets were set up to be held to maturity and the assets seem to be ok quality (my guess is that if they were held to maturity, they would not result in losses), so it's not really an asset problem per se. Rather the whole investment management business was set up assuming that the company would have high ratings. This shows the perils of building a business without considering a seriously negative scenario (in this case a ratings downgrade.) It would be quite ironic and sad if Ambac's survives the subprime mortage insurance problems but somehow goes down because of its investment business.
I am not too worried about the collateral requirements. If Moody's does downgrade, and it is entirely unclear what spurious argument is supposed to justify it thus time round, I see one of two things, or a mix, happenng.
ReplyDelete1. Counterparties waive collateral, ACA could do this for over six months and they were much weaker. Counterparties are probably not interested in blowing up Ambac and getting pennies on the dollar for their claim as Ambac liabilities are unwound at market prices.
2. Ambac is permitted to access capital from elsewhere in the business. They do have a lot of assets, and the regulator has no interest in seeing Ambac blow up. This was already permitted to Ambac in the wake of Lehman and AIG got a similar deal before the Fed intervened.
If Ambac falls below $1.50/share I intend to add.
One more thing:
ReplyDeleteJohn Hempton of Brontecapital says he ran Ackman's model with the latest available data, including Moody's fresh RMBS report, and says he concluded that Ambac is adequately reserved.
I think $1 bilion or thereabouts is not a problem but $2 billion could be tough. Even if the regulator approves, it is skating on thin ice. The risk is that the regulator will start to become concerned at some point. They won't let the company go bankrupt but they may somehow force a massive capital injection from the government (like AIG) that dilutes shareholders to almost nothing. That's the real risk.
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