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

Includes: AMBC, MBI
by: Whitney Tilson
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