Wednesday, November 5, 2008 5 comments ++[ CLICK TO COMMENT ]++

Situation Turns Dire For Ambac... Book Value Finally Negative

Given the collapse of the credit markets, it isn't really surprising but it looks like Ambac's situation has deteriorated significantly (MBIA also reported but since I don't own it, I don't follow it closely.) Here is a news update from MarketWatch:

The company blamed the bigger loss on hits from credit derivatives, increased loss provisioning primarily related to second-lien residential mortgage-backed securities (RMBS) insurance transactions and market losses on RMBS within the financial services investment portfolio.

Its operating loss was $7.81 a share, against the 74 cents a share loss that analysts forecast by FactSet estimated.

I don't think analysts really follow Ambac closely anymore or know what is going on but talk about missing estimates by a magnitude of 10x. A risk for investors is the fact that analysts are still overly bullish with their estimates--and I'm not talking about Ambac. I haven't looked up the numbers but I suspect that there will be some wild misses in the commodities complex now than prices have plunged significantly.

I just quickly looked through the 3Q08 presentation and it looks like real impairment of at least $2.5 billion was booked. Talk about a terrible investment decision. I was investing in Ambac early in the year with the view total losses might amount to several billion, yet we have Ambac booking more than $2 billion in just one quarter.

The biggest risk right now is breaching statutory requirements. Ambac is still above regulator requirements from what I can gather but it is awfully close.

A sign that this is quickly heading towards zero, not that this hasn't been obvious, is book value. It has finally hit a negative value of -$2.97 per share, from +$6.76 per share last quarter. Adjusted book value is still positive, at +$7.18 per share. For reference, the share is trading around $2.51 right now. It should be noted that the market is pricing in a dire scenario. The stock, although off 25% today, is still way above the lows set in July. There is still the possibility of mark-to-market losses reversing and improving the potential return but the company needs to survive on its own.

A bet on Ambac was a bullish bet on housing and, unfortunately, that completely backfired. My feeling was that if housing declines 20%, the monolines would recover. Right now it looks like housing might drop further, possibly by 30% (I think they dropped around 40% during the Great Depression but that seems unlikely.) In fact, so many negative events have transpired that this decision looks mild. I mean, I never would have expected in my wildest nightmares that AIG's share price would be below Ambac's. Just about the only right thing was picking a monoline which cannot face a run on the bank.


5 Response to Situation Turns Dire For Ambac... Book Value Finally Negative

November 5, 2008 at 3:27 PM

The terrible GAAP earnings and associated negative book value is of course not a problem if you do not set much store by mark to market accounting. The big additional reserves booked for CDO's are a different matter, that represents expected real losses. Ambac is now rapidly headed for the upper bound of my own expectations for losses, so I will have to start reconsidering this investment.

Meanwhile, MBIA, which I do follow closely as I bought it alongside Ambac, is reporting numbers that are not nearly as bad. That is interesting as it implies one of the following happening:

1. Ambac is too pessimistic;
2. MBIA is too optimistic;
3. There are big differences between their insured book that are not at all apparent but make a massive difference in practice;
4. A bit of all or some of the above;

Let's see if I can figure out something more from the newly released data.

November 5, 2008 at 3:41 PM

GAAP numbers don't mean much but Ambac actuall took massive reserves. Not good at all.

A poster by the name of slc2sf2 on the MBIABK Yahoo msg board also points that out and he says the following:

SLC2SF2:"I was wrong on point 3. MBIA credit spreads increased during the
quarter, which surprised me, because Ambac's spreads improved.

The dichotomy between ratings and credit spreads (both of which
imply that MBIA is in worse shape) and share prices (which suggest
that Ambac is in worse shape) is strange.

In addition, estimated credit impairments on wrapped CDOs is amazing
(as in I don't believe it as opposed to I am surprised that things
have not gone as bad as I expected). The CDOs and the collateral
performance has not been that much different than for Ambac, yet
Ambac has realized credit impairments that are multiples of what
MBIA has recognized. I think MBIA is making a mistake by
underreporting credit impairment losses on CDOs. Short term, it may
seem like a good idea, but longer term, it will continue to damage
MBIA's credibility."

He is bearish and I believe short these stocks but his observation may be pretty valid. MBIA had much better underwriting or they are not as liberal in applying losses as Ambac.

In any case, did you get a chance to listen to the conference call? Does the new CEO seem up to it? He is the risk manager who oversaw the disastrous foray into these mortgage bonds but he likely understands these better than almost anyone else out there...

November 5, 2008 at 5:42 PM

I was at work during the conference call and didn't have time to listen. It's available on their website so I will listen to it later. New CEO seems ok, not much he can do anyway, the dice were rolled back in 2006/2007.

Well,SLC2SF2 *thinks* he has the answer, but I am just not sure and neither should he be.

I will consider all 4 possibilities I listed. What I am wondering about is that if MBIA is simply not reserving nearly enough how they are getting it past their regulator. Statutory capital requirements are based on regognized loss reserves, so regulators *should* care about the accuracy as should the accountants. It is not as if it is a small difference, within a reasonable margin of error. Ambac has reserved over 2x as much as MBIA on a somewhat smaller book.

It is *quite* possible that it really is option 4. MBIA has been more of a "bad boy", keeping much of the newly raised capital at holdco, telling the rating agencies to stuff their opinions where the sun don't shine, buying back stock and also buying back their own debt far below par. Ambac has been much more cautious and Ambac now overreserving a bit while MBIA is underreserving a bit, but not enough to worry the regulator or accountants, would fit that pattern perfectly.

And of course, I can't yet rule out that there *are* important differences between their insured books that are not readily apparent but are now translating in much lower expected losses for MBIA. I will have to check again for vintage/geograpical or other differences that I may have missed or disregarderd as unimportant before.

Meanwhile, "not good at all" is a severe understatement on these numbers. Even "utterly disastrous" is an understatement if you ask me. Ambac does have about $20/share in adjusted economic book value left, but with quarters like these that margin of safety is shrinking quiker then I like.

November 5, 2008 at 5:57 PM

In other news, Moodys just downgraded Ambac to Baa1 so we will soon know if they will be allowed to cure to cash shortfall in Financial Guaranty from Assurance or will be left to implode...

November 5, 2008 at 8:57 PM

Yep... this is close to the endgame. Sorry about your losses... oh well...

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