Ambac's Earnings: You Can't Make This Stuff Up

When I read Ambac's (ABK) earnings release, I thought nothing could be worse. Then I listened to the conference call and I really thought nothing could be worse. But then I read the slide presentation (all 78 pages are posted here (.pdf), which really took the cake. Attached below are some of the highlights from the presentation (the first slide is from the Pershing Sq. presentation last Nov., explaining HELOCs and Closed End Second mortgages).

Reviewing these slides, there are two big messages:

A) The default trend slides (5, 6, 8, 9, 12, etc.) show an unfolding train wreck; and B) Reserves are still way too low.

Just look at slide 2: Ambac is reserving $636 million on $5 billion of exposure to CES, $432 million on $11.4 billion of HELOCs, $200 million on $6.5 billion of mid-prime RMBSs and $16 million on $8.1 billion of subprime RMBSs. I think the HELOC number is the most absurd: 3.8% losses?!

Keep in mind that these are exposures to RMBSs themselves, not CDOs and CDO-squareds comprised of tranches of RMBSs. In our analysis (which was similar to the Open Source Model Pershing Sq. released -- see the last page of our presentation on the mortgage crisis), we had assumed minimal losses on the RMBSs -- and then Ambac confesssed last week to $1.3 billion of expected losses (note that they're not claiming these are mark-to-market losses that will be reversed).

To see how wrong Ambac's models were, check out pages 19 and 20, in which Ambac insured a second-lien RMBS deal with Bear Stearns in 4/07 and projected 10-12% losses, and now they're projecting collateral loss of 81.8%!!!

Pages 23-28 of the attached cover Ambac's $32 billion of exposure to CDOs. On page 28, they've finally admitted that they're going to get clobbered on the CDO-squareds (they've written them down 70% -- in reality, it will likely be 100%), but they've taken only 1.2% impairment on $26.5 billion of exposure on regular CDOs. This is a complete joke -- according to Ambac's internal ratings, $7 billion is already rated below investment grade (page 24)!

The Goldman analyst is starting to get in the right ballpark, estimating $11.8 billion in losses. How this leads to a need to only raise an additional $3.4 billion to maintain Ambac's (increasingly ludicrous) AAA rating is beyond me, but even this amount ain't gonna happen for a company with a $1.1 billion market cap today. He also continues to value MBIA and Ambac as ongoing entities, saying "We do not believe that a run-off valuation scenario is appropriate for either Ambac or MBIA, as both companies have recently raised capital to avert a ratings downgrade from triple-A (from Moody’s and S&P), and both companies continue to write new business (albeit at depressed levels relative to history). Still, we present our “run-off” valuation model below for reference (see Exhibit 5)."

But the clincher is this line: "We lower our estimates for Ambac to -$18.05 in 2008 (from +$0.95) and -$6.40 in 2009 (from +$0.90), but increase our 2010 estimate to +$2.10 (from $1.00). We lower our estimates for MBIA to -$21.75 in 2008 (from -$1.81) and -$8.50 in 2009 (from -$1.33), but increase our 2010 estimate to +$3.25 (from -$1.14)."

Wow, it's trading at 1x 2010 earnings -- what a buy! Ya just can't make this stuff up!

Disclosure: Author's fund is short ABK and MBIA

Read this doc on Scribd: ABK slides

Comments

[Strobe]

Good insight on the commentary, calling them on their own numbers. I've been negative on these companies for a while and some of the recent numbers are shocking even to me.

Scribd needs to add a rotate feature to their viewer. That was totally annoying to read.

[RichShinnick]

Shouldn't this crash the market...oh wait, we moved to other stories. Remember when this was the "most important" market story, well now it is on the 13th page just behind the war in Iraq. Meaningless old news, who cares, or so it seems. Sometimes it appears that the MSM picks a story and the world revolves around it until the MSM picks another story for the world to revolve around... what will it be this week? The market went up\down this week because....fill in the blank.

[SpartanBrother]

How is it by simply disclosing that the author is short ABK allows him to post such one-sided myopic dribble? The analysis is intentionally incomplete and serve the agenda of the short. Get a real job.

[adam axler]

If you're not interested in this story, then why bother commenting? Whitney, your appearance on Fast Money a few months ago was an excellent one, where you remained convinced these stocks would bottom at 0 despite Ratigan's rant of "but these stocks are up 30% in one day!" Good call.

[flatman]

So what do you bet XLF is up again today?

[Eric Fox]

Don't forget these comments from the Conference call:

"Holding company cash approximately $158 million, this covers approximately 1.2 years of debt service, dividend payments and operating expenses for the holding company. And plans to dividend approximately $54 million per quarter from Ambac Assurance to the holding company, which would grow this cash position to approximately $238 million by year end. That is approximately 1.8 times the holding company’s annual cash needs. We feel very comfortable with our liquidity position at the holding company."

"Projected claim payments for the full year 2008 amounts to approximately $151 million and we expect to pay out only about 24 million related to CDO losses in 2008." (from the insurance sub, not the holding company)

(Disclosure - I have no position on either side)

[oldlures1]

Personally, on the matter of bond insurers, I take anything from Pershing with a grain of salt. At the very least, a reader should consider Pershing's opinion in light of probable bias, as Ackman has historically maintained a large short position on the insurers.
There are always two sides to any story, and I believe this is no different. The informed reader is well-served to consider the alternate perspective, such as...
-- Mar. 3 '08 article "Whitman takes on Ackman over Bond Insurers"
-- Dec. 25 '07 article "Marty Whitman back bond insurers - says Ackman is wrong"
I'm not saying Pershing is entirely incorrect, but rather, in this matter, contemplation of alternate opinion is a worthwhile exercise.

[VacantHomes]

Paul Jackson at Housing Wire has some more analysis of this situation:

www.housingwire.com/20.../

Basically, lots of fraud. Ambac got ripped off by Bear Stears and some other investment banks, as well as the credit rating agencies.

[Eric Fox]

Vacant homes has an interesting point....Can Ambac and MBIA walk away from claims if they allege fraud?

[VacantHomes]

Yeah, that is a good question. I was mostly interested in the Housing Wire article because I'm hopeful that Ambac may finally shed light on the gritty details of the mortgage debacle caused by the investment banks/credit rating agencies. I have no position in Ambac, although I tend to agree with Pershing's analysis that Ambac has little chance of survival if they are really on the hook for all of the bonds which will go bad.

But, if Ambac actually manages to save itself by proving fraud on the part of Bear Stearns/Moody's/etc (which seems highly possible), that would be an interesting outcome!

[VacantHomes]

(By "bonds" above, I mean RMBS/CDOs, of course...)

[gabeborenstein]

This would have been an appropriate article in the mid of 2007,when the share of the financial companies including the bond insurers were trading at the high.One more time ,as early as as June of 2005 ,I have discussed cyclical/market risks with Mark Gilbert (Bloomberg -London). I have specifically addressed the severity of contraction ahead and its impact on the markets-the warning was ignored I have specifically addressed the CDO and the" structured products"risks on September 18 ,2007 with Brian Sullivan(Bloomberg TV).That warning was ignored -but six weeks later the market upheaval had started.To discuss at this point the risk exposure that the bond insurers face is meaningless.The FED has implicitly minimized the "subprime "risks when it had "term swapped" the peceived lower quality paper for the treasuries. Clearly by "devaluing" partial risk exposure by up to 70% ,Ambac and other bond insurers have opened a possibility for a mega revaluation in the period ahead.As the economy rebounds in the second half of 2008 ,driven by the fiscal and monetary policies ,the value of the subprime derivatives will be restated .We already know from the FED actions that no financial entity will be allowed to default because of the sequential global risks. In my opinion (correct untill now),the financial sector has made a bottom and is poised for a record rally ,bearish articles not withstanding-I certainly was bearish on Ambac in 2007 at 95 dollars.At four dollars per share let the others sell and face a thirty dollar risk.

[Eric Fox]

Hey, I wonder if Whitney Tilson actually wrote this article. The reason I ask is that he hasn't responded to any of the comments here. Maybe someone on his staff wrote it. Or perhaps he is too busy organizing the Value Investing Congress.