US Equity markets were ending last week on a down note, when rumors of an Ambac (ABK) rescue plan started circulating (via Charlie Gasparino of CNBC).
A few issues seem to be getting overlooked in the kneejerk reaction to this. Let's see if we can identify some more interesting elements:
1) This is the fifth such rumor in 2008, and I'm not sure why that is. Is it wishful thinking, or have the other deals fallen apart -- for good reason, too?
We had the initial rumor over a month ago (Next on the Worry List: Shaky Insurers of Bonds);
that was a $15 billion dollar bailout. Then came the Wilbur Ross Ambac
rescue plan. Another bank consortium plan came and went. Lastly, the
Buffett offer, which was widely misrepresented as Berkshire (NYSE:BRK.A)
injecting money, when Buffett merely offered to sell reinsurance to the
2) The current rescue operation is for but $3B. This small sum is intriguing -- not just relative to the prior rumors. First, the duolines have potential exposure anywhere from $30 to $75 billion dollars. On top of that, the bank's counterparty and hedging exposure has been estimated at $150B to $200B. Can $3B really solve this problem?
3) From the FT Friday: Banks to aid Ambac with up to $3bn
The banks looking at supporting Ambac include Citigroup (NYSE:C), Wachovia (NASDAQ:WB), Barclays, Royal Bank of Scotland, Société Générale (OTCPK:SCGLY), BNP Paribas, UBS (NYSE:UBS) and Dresdner. They have the most exposure to guarantees supplied by Ambac on structured bonds and derivatives, the value of which could fall sharply, resulting in billions of dollars of writedowns if the insurer's credit ratings drop far below the triple-A level. (emphasis added)
Hence, the banks who are Part of the rumored consortium are (of course!) the ones who have the most to lose if any of the Duolines fail. This is not so much a bailout as a possible attempt to kick the can down the road. They have the most exposure to guarantees supplied by Ambac on structured bonds and derivatives, the value of which could fall sharply, resulting in billions of dollars of writedowns if the insurer’s credit ratings drop far below the triple-A level.
What's truly bizarre is that a dozen banks spending three large may actually be a relatively good deal for them, if it avoids a quarter trillion in writedowns.
4) Coincidence or good timing? Look who's expected to report writedowns this week: Fannie Mae (FNM), Freddie Mac (FRE), Lehman (LEH), Morgan (NYSE:MS) and Goldman Sachs (NYSE:GS), and Royal Bank of Scotland.
The bottom line: Until this deal gets done and the details are better known, it's simply another in a long string of rumors. Worse yet is what it means: Banks have so much derivative exposure they are willing to throw away $3 billion to prevent the counter-parties from getting a ratings agency downgrade.
Banks to aid Ambac with up to $3bn
Aline van Duyn and Ben White in New York
Fri Feb 22 19:25:37 EST 200