Evaluating Ambac: Intrinsic Value Withstanding Market Volatility 13 comments
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Ambac (ABK), the beleaguered financial guarantor, looks to be close to liquidation on the surface. Its share price has fallen a stupdendous amount, from around ninety dollars before the subprime implosion, to two and change today.
This drastic decrease in market capitalization appears warranted on the surface -- Ambac, along with many of its peers, strayed from the lucrative business of plain-vanilla municipal bond credit enhancement. The company's foray into exotic and ill-conceived structured finance deals has placed unprecedented levels of stress on Ambac's financial position, leading to exaggerated pronouncements of doom from the media and various investment professionals. The company itself, perhaps understandably, has continually claimed it has ample resources to fulfill all contractual obligations.
In determining the veracity of the claims of both parties, it is essential to understand the nature of the insurance Ambac has written.
Ambac's irrevocable guarantee of either i) timely interest and ultimate principal or ii) ultimate principal on insured deals limits the possibility massive one-time payouts, and ensures that the company will have many years -- in some cases, multiple decades -- to pay for impaired exposures.
In the vase majority of cases, Ambac's exposure to problematic asset classes is hedged by a variety of failsafe risk mitigation techniques. Ambac's insurance written on Collateralized Debt Obligations [CDOs] targeted the most senior tranches of the transactions in question, which are only affected by credit deterioration when tranches subordinate to them are fully eroded -- in many cases, north of 20% of the transaction must be eroded before any Ambac-insured tranches are affected.
Also, many are not aware of the profound effects accounting techinicalities have on reported monoline earnings -- which are horrendous to behold. Because most SF transactions are insured via Credit Default Swap [CDS], the monoline industry must establish a "fair-value" figure for insured exposure -- forcing industry participants to "mark-to-market" a product for which there is no market. This has caused a grotesquely distorted picture of actual expected claims, relying on market panic over industry-standard computer models and not accounting for mitigating factors as explained above. Credit impairment, not unrealized MTM price fluctuations, is the metric by which losses should be gauged.
Ambac's claims-paying-resources totaled 13 billion dollars, invested in specificially timed treasuries and other high-quality paper. Due to market concern over the company's creditworthiness, amortization of insured credits and steady income from installment premiums and investment income, Ambac expects to be cash flow positive this year -- and is aggressively engaging in remediation, which, when one considers the highly concentrated nature of the impairment, could materially improve the company's prognosis.
Ambac's recent attempt to transfer $1 billion from its insurance subsidiary to a dormant affiliate, Connie Lee, looks questionable in light of the recent rating agency actions against Assured Guaranty and FSA. Notwithstanding, the recent deal to insure $264 million in military housing shows AA rated guarantors can still find profitable business -- while an eventual return to AAA would be optimal.
Beyond the current turmoil Ambac is undergoing, one must look to the FG industry's promising future. While such a statement might seem outlandish -- Moody's (MCO) recently changed the method by which it rated municipalities, resulting in mass upgrades; uncertainty over the financial positions of guarantors has lead to a dropoff in insured paper issuance -- broader, international trends lend merit to its veracity. Many states run budget deficits of 8% or more annually, and overall issuance is almost certain to rise in years to come. Guarantors serve an invaluable service by enhancing the creditworthiness of bonds, and broader macroeconomic trends speak to the importance of this business model. The global infrastructure boom will also increase demand for sound, reliable credit enhancement -- one a more careful and measured FG industry will exploit.
Ambac is a long-term play on intrinsic value withstanding market volatility, and one I would advise any investor to look into carefully.
Disclosure: Author holds a long position in ABK
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This article has 13 comments:
On the muni side, if the business model ever worked, it is now over. The rating agencies can no longer lie - a so-called triple-B muni is in fact a triple-A on the corporate scale. Once rating agencies are forced to end the false distinction between "corporate" and "muni" scales, that eliminates the artificial need for insurance.
On the corporate side, the business model never worked. A small part of the corporate credit spread is for liquidity and traders' capital. Not nearly enough to justify insurance premiums at less than 40% of market spread.
Finally, the author seems to dismiss mark to market. But investors have a right to know. If you can't sell it, it ain't worth much.
I think in a run off mode (i.e. no or minimal business) the intrinsic value of the company is in the high single digits. If the "connie lee" idea works it could be worth a bit more.
jegan ;-)
The mark to market that is of concern here is not about assets, its about liablities. They show the premium which an insurance company would charge today to write coverage on the difficult risks they insured by CDS. The difference between what they charged when they wrote the business and what insurance companies would charge today is booked as a mark to market loss. It has no real relationship to the expected claims payments, which is the issue.
So there is no liquidity issue, they pay principal and interest when due, and the mark to market is relevent only as it affects public perceptions.
Cash flow positive means nothing here. Rating agency will downgrade the ABK to junk, that will lead to more collateral posting on the CDS portfolio, ABK will have trouble posting and regulator will step in, the counterparties(major banks) will end up owning ABK jointly in a massive restructuring. End result: ABK equity holder wipe out. Counterparties write down all of the CDS(if they haven't done so already)
SCA -- Huge Injection of Capital
NEW YORK (Associated Press) - XL Capital Ltd. Monday said it is bailing out its former subsidiary Security Capital Assurance Ltd., saving the bond insurer from insolvency.
The Bermuda-based insurer also said its profit tumbled 56 percent in the second quarter as softening market conditions continue. It announced management changes and a dividend cut and said it was conducting a strategic review of its life reinsurance operations.
XL will pay SCA about $1.78 billion in cash, issue 8 million shares to SCA and transfer its 46 percent stake in SCA to a trust. The agreement substantially eliminates XL Capital's total net exposure under reinsurance agreements and guarantees with SCA subsidiaries.
Simultaneous with the creation of the trust, SCA will terminate eight credit default swap agreements with Merrill Lynch & Co. and the related financial guarantee insurance policies with an insured gross par outstanding of $3.74 billion at June 30. SCA will pay Merrill $500 million in exchange.
Regulators including the New York State Insurance Department have signed off on the deal, which remains subject to other conditions including a successful $2.5 billion capital raise by XL Capital.
After paying preferred dividends, the Hamilton, Bermuda-based insurer earned $237.9 million, or $1.34 per share, compared with a profit of $544.5 million, or $3 per share, a year ago.
Operating profit, which insurers emphasize because it excludes investment losses and other costs insurers do not consider reflective of their business, totaled $1.50 per share.
Analysts expected that result to be $1.94 per share, according to Thomson Financial.
Profit in the insurance division dropped nearly 28 percent to $73.8 million. XL spent 94 cents of each premium dollar administering claims, compared with 90.6 cents on the dollar last year.
In the reinsurance division, which writes contracts promising to cover losses on insurers' insurance policies, profit more than halved to $54.5 million from $129.8 million. The company spent 89 cents of each premium dollar, more than 10 cents above the 2007 quarter.
Looking ahead, XL Capital expects to post a charge of $50 million to $60 million in the rest of the year, related to its decision to cut up to $120 million from its run rate operating expenses from 2009 onwards.
XL halved its quarterly dividend to 19 cents per share, payable Sept. 30 to shareholders of record Sept. 12. The prior payout was 38 cents.
Also, Chief Operating Officer Henry Keeling is retiring Aug. 1, and XL Capital said it was eliminating the COO post.
In other management news, Michael Lobdell, executive vice president and chief executive of global business services, is leaving Aug. 31, while Fiona Luck, chief of staff, was named special adviser to the CEO.
XL Capital shares fell more than 10 percent to $16.52 in after-hours trading Monday. The stock closed at $18.37. Security Capital shares soared 88 percent to 98 cents in after-hours trading.
Full Story: money.cnn.com/news/new...
ih.fotothing.com/43092...
Mkt close: $.52, AH Close: $.95
To vc4u2c I would say that until ultimate losses are more quantifiable, a hard-and-fast target is elusive. In the near term, catalysts would include Q2 earnings (which may be bad, considering large MTM losses on CDO of ABS remarked upon by Citi, Merrill and SCA) capitalization of Connie Lee (which looks more likely than when I wrote, with Moody's having said it would be more likely to give AAA to a muni-only insurer, according to DJ newswires) and the outcome of commutation talks which I'm fairly certain are ongoing.
The SCA situation was extremely encouraging -- however, the fact that the company would have become insolvent were it not for XL infusion, it may actually have had MORE leverage with counterparties, as it could simply have been taken over and had its CDS paid out as stipulated in contracts. Ambac/MBIA better capital position could be adverse in this limited sense, ironically.
ih.fotothing.com/43985...
Cheers,
www.investorvillage.co...
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