Restoring Credibility to Ambac and MBIA 27 comments
-
Font Size:
-
Print
- TweetThis
Readers are familiar with my opinion on the proper valuation of Ambac (ABK) and MBIA (MBI). GAAP metrics are not useful: the non-GAAP adjusted book value is the proper measure of their worth, and share prices should recover to that level over the next several years. The primary considerations that are keeping a lid on prices revolve around credibility – specifically, an intertwined set of issues between the bond insurers, their most severe critics (led by Ackman), and the rating agencies, S&P and Moody's. The purpose of this article is to present my analysis, which demonstrates that the reputation and credibility of ABK and MBI have been needlessly impugned, and to lead the investment community to a better understanding and appreciation of the quality and value inherent in these businesses.
To summarize how the present impasse arose: Ackman attacked the bond insurers, claiming they were insolvent, and was able to impair their reputations to the point where the share prices plunged and CDS spreads widened to the level of junk. The rating agencies, already suffering from self-inflicted damage to their own credibility, eventually downgraded both companies, citing not inadequate capital, but rather lack of financial flexibility as a primary concern. That was a euphemism and referred to the share price: with prices beaten down to artificially low levels the companies cannot raise capital on economic terms.
In essence, the rating agencies validated Ackman's attack, not because it was correct in fact, but because it achieved its goals. The agencies did not have sufficient credibility to give the triple A rating any meaning or to dispel misinformation and distortion fomented by Ackman. As time passes, it is becoming clearer, day by day, that both companies are more than adequately capitalized, responsible corporate citizens going about their business, providing protection and paying claims. It is time to recognize these facts.
The status of the rating agencies is all too clear. Those who bought bonds backed by sub-prime mortgages, on the grounds they had investment grade ratings, experienced shocking losses. Investigations by the Attorney General of the State of New York revealed that rating agencies had neglected to require adequate information before applying their ratings. They were being paid by the investment banks, and in the interest of getting the fees they became very easy to do business with.
Of course, when the trouble started, they ran amok trying to cover their footsteps, and vigorously downgraded most of the bonds they previously saw as investment grade, many to the level of junk. When rating the bond insurers, they assiduously kept moving the goal posts - more capital, more reviews, more revisions to the model and the forecast, more impossible stress case scenarios. Triple A ratings did nothing to help the bond insurers attain access to capital markets, as the rating agencies' credibility had been hopelessly compromised. So much for the agencies – those who trusted them lost a lot of money.
Moody's, when dishing out the totally gratuitous 5 notch downgrade to MBI, cited "aggressive capital management," such as but not limited to share buybacks. Now, with a stock worth 40 dollars beaten down to under 5, management would normally find it a no brainer to buy back stock in copious quantities, publicize the operation as a fait accompli, and restore share prices (and financial flexibility) to proper levels.
Similarly, confronted with unremitting attacks from all angles, MBI management very prudently elected to maintain capital at the holding company level, so as to be able to deploy it effectively in self-defense. Moody's took umbrage, interpreted the funds out of existence, and launched a punitive downgrade, which precipitated a needless but well-contained loss in the Asset Management business. MBI, to its credit, has taken action to insulate itself from further harm from this source. In a nutshell, Moody's has gotten way off base, attempting to apply a straitjacket to prevent any possible vestige of financial flexibility from manifesting itself.
In my opinion, Moody's, having done a miserable job of managing its own affairs, used its capital adequacy models and rating powers in an effort to dictate to the management of MBIA.
How about that most vocal and persistent of industry critics, William Ackman? He made money, there is no question about that. But his credibility will not stand the test of time. The dire scenarios he predicted have not come to pass. There is the dawning realization that ABK and MBI will not go to zero. There will be no bagels, no double donuts. He misled market participants, fanning the fires of fear, for his own financial benefit. Donating the proceeds to charity will not give him clean hands, The whole thing was a sort of negative Ponzi scheme, you made money if you got out early enough.
Now we come to the bond insurance companies. Here the record is mixed – Security Capital (SCA) settled at a discount, with Dinallo in the wings. Aca Capital (ACA) is on the ropes, trading on the pink sheets. But, barring a financial cataclysm of unimaginable scope and severity, policyholders of MBI and ABK will be paid in full. They believed their investments were safe because of the bond insurer's guarantee. As the smoke clears, they are receiving principal and interest when due. Those who take lump sum settlements will do so as their own free choice, because they need immediate cash or prefer to eliminate uncertainty or indeed desire to profit by exiting their hedges simultaneously.
In effect, MBI and ABK provided the only credible credit analysis – they said their guarantees made bonds they insured safe, and they have every expectation and intention of delivering on that promise, to the tune of billions. Their credit determinations have credibility, in the best and most pragmatic sense: the bond insurers put their money where their mouth is, as compared to the rating agencies, who deny any responsibility for their mistakes.
An insurance policy from MBIA provides more security than an Aaa from Moody's, as an example. Think about it: if the Aaa security defaults, as many did, Moody's has no responsibility, it washes its hands of the whole matter. If a security wrapped by MBIA defaults, in contrast, policyholders receive principal and interest when due, exactly what they bargained for. When Moody's downgraded MBIA , I sensed ulterior motives, as if it could restore its own credibility by impugning that of others.
Of course, mistakes were made, and the management and employees of ABK and MBI were making decisions and providing information when that occurred. If you went back and listened again to the 3rd quarter 2007 conference calls and presentations, you would be puzzled and wonder how could anyone be so dumb?
The answer is, they had inadequate models that were ratings driven and not driven by the prospective performance of the collateral. There was an assumption that the ratings were predicative of future collateral performance – seriously in error. That points back to the rating agencies and the lack of due diligence – the ratings didn't provide a clue as to future collateral performance. Garbage into a flawed model, bad underwriting decisions out. In the final analysis, the best underwriting is innovative and entrepreneurial: it is about accepting risk and making money; and if underwriters don't make any mistakes they are dodging a lot of opportunities in the process.
If you would like to argue in the other direction, that MBI and ABK underwrote to a zero loss standard, or should be doing so, it doesn't create any logical problems. If they are successful in achieving the zero-loss goal, an insurance policy from them bestows an iron-clad triple A rating. Policyholders know there won't be any losses, but if there are, they will be paid. The best insurance policy is the one you never need to use. MBI and ABK provide a combination of loss control and risk management in the credit field, backed by a guarantee of results - timely principal and interest.
Credibility in a financial institution is largely a function of the balance sheet, business model, and corporate culture. It can be hard to accurately assess until the stress case arrives. ABK and MBIA were both subjected to a perfect storm, an unprecedented melt-down in the the housing industry, fueled by unparalleled dishonesty, greed and recklessness in the mortgage industry and among home buyers, together with an unbelievably vicious attack by a determined band of distort and short bear raiders.
I am talking about the financial world's equivalent of arson for profit. Ackman took out insurance, in the form of CDS, on MBI and ABK. Then he did his damnedest to create a loss so he could collect on the insurance – literally, he torched their reputations in an effort to take them down to zero. When I wrote "as the smoke clears," it fits pretty well: there was ample smoke, created by Ackman's efforts to incinerate his targets and obfuscate his own nefarious motives. Amazingly, this conduct has proceeded without undue regulatory hindrance, at least to date.
To extend the metaphor a bit further, arson does not work very well on fire resistant buildings. Here in Connecticut years ago, we had a case of arson: the perpetrator wanted to burn down the former Sponge Rubber plant in Shelton, which was fire resistant. Undeterred, he used ample quantities of dynamite, high explosives and incendiary devices, creating a sonic boom that was heard within a 50 mile radius, and leveling the building. He did time, and has not repeated the offense.
ABK and MBI are still standing, after an attack far more severe and prolonged than the scientifically placed detonations that took down Bear Stearns in a matter of days. Somewhat beyond fire resistant, they are fortress-like. The only permanent harm occasioned by Ackman's attack is the unnecessary dilution to shareholders, arising from his concerted efforts to drive down share prices while they were in the process of raising capital.
Although temporary, the harm done to the reputations of the two companies is severe and will take time to recover. But it will, because their performance defines their credibility. They have withstood the financial crisis and the highly unethical attack, and no realistic person doubts their ability and their determination to pay their claims. The entire credit system is in a state of flux, and it is not possible to predict the future landscape of the industry with any certainty. However, MBIA and Ambac will be there, bastions of strength, because they have stood the test. And, they will find ample demand for their products and services, because they can provide that most elusive of all commodities - financial security.
Implications for investors: Valuations for ABK and MBI vary substantially depending on whether one envisions a run-off scenario, a protracted hibernation, or a relatively prompt resumption of profitable new business activity, whether in providing triple-A protection for municipal bonds, or in other areas of credit enhancement. When the reputations of these companies are rightfully restored, the best case scenario will become reality.
Disclosure: Long ABK and MBI.
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
David Fry
-
2
TraderMark
-
3
Don Dion
-
4
Cliff Wachtel
-
5
Mike Havrilla
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 27 comments:
were not breave to buy . we sold and sold !!
its about time to buy. we might do it now !!
The banks and IB's are all lying about not being able to value their Level3 assets, but Merrills sale has provided some illumination (.22 or .05) depending on how you spin it.
ABK, MBI, FMN, FRE all short to zero's as they incorrectly priced risk IMO. Good luck and good trading!
Please.
Where's the math? You know, how much of the book is CDOs, what their guarantees will require in payment, how much new business is written and how much of that results in RECURRING revenue?
For the unitiated (or too dull to research) municipal issues make a one-time payment at issue for the wrap. There is no recurring revenue. If the municipal issue revenue dries up, a major part of the income necessary to pay claims disappears.
The issue is in the non-municipal book, at least for now. Later (a year or two from now) it will be in the municipal book too. Anyone take a look at California's budget? Florida's? Oh heck, Birmingham AL?
Lots of these wraps will boom and require payments. Were the premiums charged appropriate? If not......
Again - show me the math. I'm not interested in a puff piece, which is what this is - it is utterly devoid of mathematical FACTS.
Yet it is the math that will determine the outcome here, not puffery and bluster.
Why is it missing?
Either the author is incapable of analyzing it, hasn't bothered to analyze it (in which case being long the stock is nothing more than gambling at the blackjack table), or HAS analyzed it, is trapped in a long position and is, in desperation, trying to pump the price so he can get out cleanly.
Which is it?
Please....
The market fundamentals are based and theorized on these
but...
are driven on emotion and greed and fear.
so..
No formulas ...No math..
just the human element
& that involves no calculations, just emotions , wrong , right, good, bad or indifferent.
NO math No formulas needed
Enjoy the exponential gains of ABK and MBI.
I know I already have...
P.s The decimal is now moving to the right side not left.
I would fix the point about Ackman.
He definitely has no obligation "to lead investors", so here is nothing to be blamed for.
Mass media claim having the obligation, they created "Ackman phenomenon" and their role, though being critical, is not cleared here.
Even more, Ackman actually DID what he told, as opposed to investment banks practices, providing analysis with the purpose to benefit from doing opposite, as it was most probably done recently by JPM to ABK.
By the way, is here any proof that Ackman did it on purpose vs. he believed in what he was talking about?
Investors should avoid scapegoating on lousy sentiment for the sake of fair analysis.
Just thoughts, opinions welcomed.
Disclosure: Only long on ABK and MBI since Jan,08.
I see nothing in your article to support your thesis that ABK and MBIA are viable entities. Their problems are just started to play out. Instead I see a pathetic attack on Ackman. It is ironic that both yourself and that joke Tom Brown write for seeking alpha since there are many similarities between the two of you. Both are making calls with no factual support (Brown on financials) that will ultimately be proven wrong and both of you attack short sellers (Brown attacks Whitney) and come away looking desperate.
By considering the present value of unearned premiums and future installments, and making a realistic exitmate of the extent to which mark to market losses will reverse over time, a factual estimate of the value of the companies can be derived.
For ten years prior to the troubles, both companies traded in a range, with the midpoint roughly equal to adjusted book value, which increased about 10% per year. When they resume writing new business, I expect them to return to this pattern.
If you're long on MBI & ABK then you have a complete loss coming to you eventually.
Mark-to-market losses will REVERSE?!
Based on what?
Tom, the marks taken by financials are not factual. They have ALL been inflated.
Have you seen "true sales"? Nope. Those recent IB sales? They're not true sales - they're self-financed, so what LOOKS like a 25 cent mark is really a nickel, as the financing is non-recourse and internal.
This sort of nonsense, along with just flat-out false marks in "Level 3" are fantasy material. They are not going to reverse - they will continue to deteriorate instead.
These firms all bet the farm in the early part of the decade on entering the CDO wrap business. It was a bad bet then and it still is.
Wrapping municipals is a good business 99% of the time as the premiums are inflated relative to actual default expectations but right now even municipals on balance are not safe. Yes, there are SOME safe munis, particularly general-obligation bonds in places that are not exposed to housing price declines, but for the rest, I wouldn't touch them with a 10' pole.
Disclosure: NO POSITION in these firms; I just know how to read a balance sheet.
PS: GAAP is even too generous in many cases. Non-GAAP is a farce. In the end it is about cash flow; if you can't cash flow the business you're dead, irrespective of what else you think you can do. This is coming from someone who saw the same game run in the 00-03 Tech Wreck and avoided all of it while many of my friends had their investment accounts destroyed.
The rating agencies were incompetent and their opinions were valueless, so what.
ABK and MBIA were foolish to insure or wrap the risks they did based upon opinions of the rating agencies. Thats not doing underwriting. A true underwriter always discounts the opinion of a party with no skin in the game.
Now, to your point that they are not zeroes. You acknowledge that GAAP suggests zeroes. To support your position there is positive value, you present value future potential sales, profits and thus cash flow. From there you fail to explain how large the existing hole in equity is that must be filled before positive value can be etimated.
Finally, the future sales are not guaranteed. Smart investor/competitors in a free market will see that ABK and MBIA will have to charge significant premiums on future business to pay for the past mistakes(the hole). They will enter the business and have pricing power. Customers(municipaliti... have public fiduciary obligation to buy the lest costly insurance, versus the MBIA/ABK brand (if any).Thus, a considerable amount of your projected future sales and profits will not come to fruition. Have you heard of a guy named BUFFETT.
Also, beware of future municipal bond losses. Watch where geographically Buffett excludes future business.
To conclude, I think you are being guided by emotions, not principled investment analysis. What am I missing?
From a pure game theory perspective, the conclusion is very clear. Of course, this is pure game theory. But if we do our numbers, the probability tells me that it is more likely to go upwards than down. The shorts will be fighting against all the positive energy that is being put into restoring the stability and credibility of this industry.
I would not bother engaging the shorts on their points - their agenda is never 'investing' but 'destroying'. Value is created by building businesses, not destroying them. Its amazing how many shorts (incl hedge fund managers) are able to get away with murder in the last few years.
I'm long ABK and happily so. Will stick to these position and wait out. At the worst, its a perpetual option. At the best, I hope it will be at least a 5 bagger in the next few years.
seekingalpha.com/artic...
Time for folks to review the CC Transcript via your website
Scrutinizer
The MI's are the victims here. They were deluded into believing the credit ratings that Moody's and S&P placed on those CDOs and Mortgage Backed Securities, and the banks are culpable for their liar loans and loose lending practices.
The first step in ANY mortgage industry recovery is to resolve the status of Mortgage Insurers. And given the potential litigation the insurers could resort to over the lending practices by the banks, both sides have every incentive to work out a deal.
Btw.. astonished this article didn't mention RDN, with a Book value of $30/share and $1 Billion in cash. This company strikes me as one of the most conservative of the MIs and they are acknowledged as having some of the least exposure to sub-prime and Alt-A risks.
Scrutinizer
You could have bought the August 2.50 optoin for about 15 cents. The pop to 6 last week put the option about $4. So buy a risk - no. Witth a story - yes.
S&P and Moody's weren't doing their jobs.
I am long and have leaps. Didn't do the Aug. 2.50 trade.
Good for them to come back swinging!
In regards to AMBAC and MBIA I would probably forget about the share buy back program and save all the cash possible to max out the capital/liability ratio aiming at regaining a triple A rating status again, why not? both companies are doing a good job at delevering from toxic liabilities already. AMBAC and MBIA are cracking open CDO-ABS-MBS-SIVs containing fraudulent loans. AMBAC is cracking open 84,000 of them, many rated triple A but the examination is revealing that those 'triple A' ones contain JUNK (a gift from Moody's, thank you Moody's!) so it will take some time to remediate their books. The other suggested strategy is to sell their CDS and policy contracts on these triple A rated-JUNK to bottom feeders for an 'attractive price' (similar to PMI) with this they will achieve a good capital/liabilities ratio to regain their triple A status and write new public high quality business again.
I wonder if there are more trades along the same lines in other beaten down financials?
On Aug 17 10:31 PM Da Bear wrote:
> When ABK was downgraded and the stock went to 1. A great time for
> a rebound bounce or a tank. Look at the story. Ditto MBIA.
>
> You could have bought the August 2.50 optoin for about 15 cents.
> The pop to 6 last week put the option about $4. So buy a risk - no.
> Witth a story - yes.
>
> S&P and Moody's weren't doing their jobs.
>
> I am long and have leaps. Didn't do the Aug. 2.50 trade.
>
> Good for them to come back swinging!