Will TARP Cover Both Ambac and MBIA? 30 comments
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What are the potential effects of TARP on Ambac (ABK) and MBIA (MBI)? By way of preface, I have a strong set of opinions on the legislation: but, rather than add my voice to the clamor of comment by numerous better placed and more capable pundits, I feel it will be more constructive to focus my effort on two companies where I have large long positions and a good deal of background knowledge. I intend to write about the stocks, adding explanations of the legislation and my views on its implementation where relevant. MBIA and Ambac, while frequently discussed together, are not the Bobbsey Twins and I will differentiate where appropriate.
Effect of Market Actions – such as reverse auctions on specific classes of assets. In common with all holders of such assets, MBIA and especially Ambac would benefit from any increase in market prices for MBS. Ambac has a large exposure to undervalued MBS in its asset management business – the danger of downgrade-induced collateral postings and redemptions makes them a liquidity accident waiting to happen. An improvement in asset prices would materially reduce this exposure.
As insurers of MBS, and particularly where the insurance is provided in CDS form, an improvement in asset values would reduce the mark to market insurance losses the mono-lines, report, increasing GAAP book value and reported earnings. This would tend to increase share prices, in turn improving access to capital markets – the rating agencies' "financial flexibility," with favorable effects on possible ratings downgrades or upgrades.
A market action covering MBS insured by the mono-lines, if done at prices reflecting the protection afforded by the A or double A rated insurance, would increase value across a wide swath of transactions they have insured, restoring their credibility and the value of their credit enhancements. This is important to the municipal bond market, which is coming under stress. I saw Arnold Schwarzenegger on TV, declaiming about California's fiscal crisis. These Californians are the same guys that didn't need to insure the bonds they issued six months ago.
MBIA in my opinion has positioned itself to take advantage of mis-pricing in the markets. To the extent prices become more rational, MBIA's opportunities to profit from the situation will be reduced.
As of its 2nd quarter conference call, 7/25/08, MBIA had repositioned its Investment Management Service portfolio by reducing its exposure to corporates, munis, CMBS and ABS in favor of governments and cash, a decision that looks good in retrospect. MBIA made the flight to safety before it became too expensive. When earnings come in, it will be important to see what further repositioning the company may have done on this portfolio. A somewhat more aggressive allocation might be profitable.
Direct Buys – I regard Ambac as a candidate for such transactions. The realization of anything like intrinsic or hold-to-maturity values on the MBS in its asset management business would greatly reduce liquidity risk. I don't think MBIA would have to go this route.
Warrants - the legislation requires Treasury to acquire warrants for stock of the seller when buying assets, but leaves the terms of the warrants to the discretion of the Secretary. I shudder when I consider the "nominal" price on the warrants that were to have been part of the AIG bridge loan. On the other hand, Paulson stressed in his presentations the need to have many participants, to include the stronger players, in the market stabilization process. That consideration would imply that the warrants would be on non-confiscatory, perhaps even mutually beneficial terms.
With Ambac trading at around 3, and its adjusted book value at 17.75, the strike on the warrants is critical, as is the amount of warrants required. I would like to see the strike on the warrants set to where the exercise would add meaningful capital without a prohibitive amount of dilution for existing shareholders. It could be a win-win. I can dream, anyway. On the other hand, if we get an ideological bias like we had on AIG, I would prefer Ambac stayed away from the process.
The warrants required on market transactions would presumably be on better terms than those on direct transactions.
Mark to market – the legislation reaffirms the SEC's authority to amend or suspend mark to market accounting. The SEC Office of the Chief Accountant recently released guidance in conjunction with FASB, somewhat mitigating mark to market as currently applied. Where I saw relief was the observation that distressed market sales, or quotes that are indications, as opposed to actual offers to buy, do not create required market prices for accounting purposes. You don't have to use Merrill Lynch's 22 cents on the dollar. When the market is not functioning, it is permissible to use hold to maturity or intrinsic values, but market perception of risk needs to be included, as well as the length of time the asset's market value has been impaired.
Over and over, judgment is mentioned as a requirement. I suggest that MBIA and Ambac use judgment to present management's best estimates of value, where it is at all possible in the context of the new guidance. I will continue to look to nonGAAP adjusted book value as a starting point for my estimate of the future share prices of my holdings.
Insurance – as legislated, the insurance provision is self-limiting. The amount of insurance provided by Treasury, less any premiums held in reserve, reduces the total program authorization one for one. Without the benefit of leverage, why bother?
I didn't see reinsurance mentioned either by inclusion or exclusion. Possibly Ambac, which has some transactions that seem to attract a lot of rating agency capital, at least under stress case scenarios, could get some relief on that issue by re-insuring a few transactions. The point of any such transaction would be relief from rating agency stress case capital requirements. If a stress case scenario creates a total loss and a triple A rating requires capital of 1.3 times stress case losses, you are in a surreal logical environment. Any form of relief is welcome.
Ambac CEO Mike Callen did an interview on Bloomberg where he mentioned he had been down to Washington looking for help, talking to Eric Cantor, who introduced the insurance idea, among others. Not cause and effect – Callen downplayed immediate benefits from the insurance idea, because it came up too late to get fully thought out and subjected to adequate debate.
Perhaps this is more of a foot-in-the-door proposition: it's on the table, maybe over the coming year some more refined ideas can be put in place.
Considerations - the act mentions "the need to ensure stability for United States public instrumentalities, such as counties and cities, that may have suffered significant increased costs or losses in the current market turmoil." Ambac and MBIA have the power to reduce borrowing costs for states, counties and cities. As such, actions to enhance their credibility and ability to provide credit enhancement support the considerations mandated by law.
Summary and Conclusion - This is potentially a very good piece of legislation; however, it necessarily leaves the Secretary of Treasury with a great deal of discretion in creating the implementation. It creates the authority to do a lot of harm or a lot of good. My reservations would stem from Paulson's past actions, my hopes would arise from the thought that adequate supervision would insure the purposes of the legislation are served by Paulson or by his successor after the election.
Two issues of implementation: "moral hazard" ideology seems to crystallize in an attitude inimical to the rights of shareholders. Specifically, if a company requires any help or intervention, there seems to be an urge to wipe out the shareholders. The warrant requirement plays into this danger.
Also, there is a regulatory/administrative bias in favor of bigger is better solutions. By favoring large companies, and feeding them off the smaller companies, the taxpayer can be protected from any risk at the expense of shareholders. I am uncertain whether this could affect Ambac or MBIA, which are relatively small businesses in this scheme of things.
I am long both companies. I regard the legislation as favorable to my interests overall because it will improve capital and credit markets. The potential effect on MBIA is not as great because the company asserts that it is a business that is not dependent on capital markets for funding, and is insulated as much as possible from actual economic loss due to rating agency downgrade risk. For Ambac, the implementation of the legislation could either create or destroy value, but would most likely reduce the chance of a go to zero outcome at the cost of reducing the chance of a home run. The security of a direct transaction will carry a price in dilution by warrants. I will continue to hold and monitor the implementation of the legislation and actions of company management for specific effects on my holdings.
Disclosure: Long ABK and MBI.
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This article has 30 comments:
On Oct 06 12:11 PM Old Coach wrote:
> Tom, excellent piece. We would all take 30 and throw a parade at
> this point. But realistically, would 15 be a reasonable target for
> ABK after the dust settles?
Additionally, given that MBI has alledged fraud on the part of BAC (as currently owner of Countrywide Financial), it would stand to reason that any punitive financial costs should be born by the banks, not the insurers.
>>There are conflicting interests for different holders, about whether to liquidate a CDO, whether some holders get paid before others even if there is no liquidation, and numerous variations on those themes.
This "tranche warfare" is set to get ever messier, because not only are holders of CDOs involved, holders of insurance contracts on payments of the CDOs also have rights to determine what happens to the CDOs.
The billions of dollars worth of hedges that banks bought on the CDOs they held on their books from bond insurers like Ambac and MBIA often involved handing over the voting rights on the CDO.
With hindsight, this was an extremely unwise move. An estimated $100bn of such CDSs on CDOs were written by bond insurers. The underlying CDOs are essentially worthless without these rights. The rights which allow holders to decide whether or not a structure is liquidated is what will determine whether it has any value at all.<<
us.ft.com/ftgateway/su...
What am I missing here?
The Banks have to obtain the voting rights to sell them off.
So the logic should follow that they need to either settle with the Monolines, or find a way to buy their CDS's out and have total control over the process.
I hope Tom can address this, either in a future article, or as an additional comment here.
If you're that bullish, i.e. ABK to $15, why wouldn't you rather buy their 100-year debentures- AKF and AKT? That are now selling at $5-ish, yielding in the 30% range, have a call value of $25, and would be senior to the common in a (brrr..) bankruptcy! They have the same 5-bagger potential, more safety, and pay 30% while you're waiting!
On Oct 07 09:36 AM Fulldeck wrote:
> Tom-
> If you're that bullish, i.e. ABK to $15, why wouldn't you rather
> buy their 100-year debentures- AKF and AKT? That are now selling
> at $5-ish, yielding in the 30% range, have a call value of $25, and
> would be senior to the common in a (brrr..) bankruptcy! They have
> the same 5-bagger potential, more safety, and pay 30% while you're
> waiting!
I did check up their debentures before. They are very very illiquid and very hard to get at. The float is small to - I believe its not even US$300MM in total isze. In fact, I was looking for bonds of bond insurers to buy earlier this year as I was concerned about dilution risk. And this led me to realise that the bond insurers are not funded by borrowings but rather by equity - quite a difference from all the bond and preferred offerings we have seen issued by the other financials.
On Oct 07 09:36 AM Fulldeck wrote:
> Tom-
> If you're that bullish, i.e. ABK to $15, why wouldn't you rather
> buy their 100-year debentures- AKF and AKT? That are now selling
> at $5-ish, yielding in the 30% range, have a call value of $25, and
> would be senior to the common in a (brrr..) bankruptcy! They have
> the same 5-bagger potential, more safety, and pay 30% while you're
> waiting!
Don't know if it will continue but the trade actually saved me a few dollars today.
Can you briefly explain what is the major difference between AKF & AKT? I know very little about debentures; why are they trading at different price?
"I did check up their debentures before. They are very very illiquid and very hard to get at. The float is small to - I believe its not even US$300MM in total isze. In fact, I was looking for bonds of bond insurers to buy earlier this year as I was concerned about dilution risk. And this led me to realise that the bond insurers are not funded by borrowings but rather by equity - quite a difference from all the bond and preferred offerings we have seen issued by the other financials."
You are correct that AKT/AKF are thinly traded- somewhere around 45K shares/day over the last ten days. So it's probably not appropriate for the day or short-term swing trader.
For the longer term investor, however, the lower volume can lead to a low bid being filled more readily, presumably by a "forced-sell" investor or some such distress situation. I've caught a few myself. Also notable, the coupon payments are interest, not dividends, and as such are subject to higher taxes. On the other hand, the company cannot reduce the payments (as they have with dividends), currently in the 30% annual yield range.
Further, in a bankruptcy situation, AKT/AKF are classed as "general creditors", to the best of my understanding reading online SEC documents, specifically-
"The form of the indenture has been filed as an exhibit to the registration statement and you should read the indenture for provisions that may be important to you. General The debt securities will be our direct unsecured general obligations. The debt securities will rank equally with all of our other debt. Because we are a holding company, our rights and the rights of our creditors, including the holders of debt securities, to participate in the assets of any subsidiary upon its liquidation or recapitalization will be subject to the prior claims of the subsidiary’s creditors, except to the extent that we may ourself be a creditor with recognized claims against the subsidiary. A prospectus supplement relating to any series of debt securities being offered will include specific terms relating to the offering. "
Link-
www.secinfo.com/$/SEC/Filings.asp?AN=...
I have requested the full prospectus to confirm this, but have not yet received it. I STRONGLY urge anyone interested in AKT/AKF to DO THEIR OWN DUE DILIGENCE!
Press release links from Ambac-
AKF- www.ambac.com/Press/Pr...
AKT- www.ambac.com/Press/Pr...
As for "user 275784"s question, the difference in prices seems to be more a result of the thinly traded market than the minimal difference in yield.
This is just my cursory analysis of these securities. I welcome any further clarification.
www.secinfo.com/$/SEC/Filings.asp?AN=...
thanks
www.ambac.com/pdfs/ABK...
The author of the article you linked says that some mortgage backed securites are trading at 30 to 50% less than their intrinsic value due to the premium for risk or illiquidity imposed by market prices, based on "option adjusted spread" (OAS) analysis.
He proposes that Treasury implement TARP by buying MBS at prices very close to intrinsic or hold to maturity value, as computed by OAS. Paulson's original presentations to Congress show that he intended the program to buy at close to hold to maturity values in order to create an orderly market and increase the value of assets on the books of financial institutions. His intention was not to "take the toxic waste" off their books at market price.
The author sees Treasury buying at hold to maturity values as a win-win: I agree and believe that was Paulson's original intention. If TARP is successfully implemented along those lines, it will go a long way toward stabilizing financial markets, and making ABK/MBI profitable.
On Oct 08 07:52 PM User 276151 wrote:
> your comments please,
>
> thanks
>
>
> www.ambac.com/pdfs/ABK...
www.ambac.com/pdfs/ABK...
I find it naive at best; totally self-serving, deceptive, and transparent at worst.
Paulson's plan was meant to QUICKLY instill confidence in the credit market, without anyone looking into the details. Maybe if he were to have been allowed to do that QUICKLY, it would have helped. But it would have been a psychological cure, not a true financial one.
Unfortunately (or fortunately, if the specter of one man wielding all that unfettered power bothers you), he was not allowed to act quickly. Congress had to get its financially ignorant smell all over it, thereby losing the psychological impact of quick action, and adding loopholes and time-consuming, albeit perhaps necessary regulation.
Now, if the Treasury spends the full $750 billion buying securities at "marked to maturity" value, it would only have enough money to inject significant capital into a few institutions. Yet, if it buys them at fire-sale prices, it would inject INSUFFICIENT capital into a broad range of institutions.
John Markman had an interesting article, (link below)-
>>>Loopholes in a 'joke' bailout
Emilio knows all about the intersection of fear, lies and action. He worked as an energy trader for Enron back in the day, and lived to tell the tale. He now trades gasoline futures for a major refiner, and he chuckled at the spectacle of legislators appearing to believe they were stanching the credit crisis with their vote. "If you really read the bill, and understand how it will be interpreted, it's the scariest thing you ever saw," said the trader, who asked me not to use his real name. "These guys have no idea what they're unleashing."
Emilio knows, because he learned from the master manipulators at Enron. For an example, he said, check out Section 113 of the bailout bill, titled "Minimization of long-term costs and maximization of benefits for taxpayers." This is the section that Congress haggled into the bill to ensure a payoff, via warrants, for citizens if mortgages purchased from banks are later sold for a profit. Yet Emilio says bank lobbyists snookered the government by sneaking in an exception under subsection 3a, "Conditions on purchase authority for warrants and debt instruments." The clause, titled "Exceptions -- De Minimis," states that any debt instruments worth less than $100 million won't trigger the payback provision.
Emilio says that banks will simply issue their debt in tranches of $99 million or less, and avoid allowing the government -- and thus taxpayers -- to get a piece of the banks' profits. "It's a joke," he scoffed.
Other traders who scanned the bill came to the same conclusion, through their own prisms, agreeing that the bill would provide only an illusion of action while failing to address the key problems facing the financial system: Too many houses will remain on the market; they were bought with too much leverage that is vaporizing in spurts; and those losses have left banks with too little capital from which they can lend.
Even worse, the traders pointed out, the government can make money on the loans only if it pays so little for them that they can be sold at a much higher price. And yet if the government doesn't pay enough, then the banks won't receive enough to make a difference in their balance sheets. So here's how the taxpayers will be cheated, they said: Banks will take advantage of the suspension of mark-to-market accounting by stating that loans originally held at "par," or the equivalent of the purchase price, and now valued by the market at 20 cents on the dollar, will really be worth 85 cents if held until the loan matures. The banks will then sell the loans to the government at a fake discount of 75 cents on the dollar.
"The lobbyists made sure this bill was rammed through so that these rip-offs couldn't be fixed in committee," said another trader. "Everyone on the Street knows it solves nothing."<<<
articles.moneycentral....
While I'd love to believe Ambac's "Perspective", I think they will have to look elsewhere for their White Knight. And the author, Robert Selvaggio, should (does?) know better. The article is a disservice to the community of Ambac investors that want honest talk, not "feel-good" analyses.
Perhaps it should have been titled "Deceptives".
FD
I read with great interest the comments regarding Ambac's debentures. I'm posting below the links to theAKF and AKT prospectuses that are at the SEC's website. I'd appreciate any thoughts you or any else may have regarding the debentures
AKF
www.sec.gov/Archives/e...
AKT
www.sec.gov/Archives/e...
I have enjoyed reading your very sensible analysis about MBI and ABK.
Here's an article by the New York State Insurance Regulator on the Prospects of the Financial Guarantors:
Oct. 8 (Bloomberg) -- Eric Dinallo, superintendent of the New York State Insurance Department, comments on the outlook for the bond insurance industry. He spoke in an interview on Bloomberg Television.
On whether there's a future for bond insurers:
``I think the news about the housing sales going up is really huge, because that implies that we've begun to hit bottom on the defaults and the market is beginning repricing. Then that means the defaults will begin to end as you can get some kind of a mortgage or some sort of transaction that clears prices.
``If that happens, then the defaults will level off, as we've said time and again, then you begin to see the bond insurers not have such a black hole that they have to pay off on. ``I think they do have a life and a future. I think the muni-market is being hammered in part because everyone's frozen, they don't know what rating they're going to go to market on.
``Once they figure out the future ratings, what they want to come to market as, I've said before that tens of thousands of small municipalities still have to commoditize. They've got to be tradable at a price, and that means at a rating. Because all of these traders are not going to do diligence for all of the municipalities out there, and that's what I think bond insurance's biggest opportunity is, is to commoditize them.
On why bond insurers aren't on the federal government's bailout list: ``If the other side of their obligations is on the list, in other words if you see those CDOs getting sold into the $700 billion marketplace, then presumably the CDSs that the bond insurers have written get extinguished. ``That will be a huge up-tick for the position of bond insurers. If they get through this, then we will begin to see credit unfreeze, municipalities come to market.''
online.wsj.com/article...
So much for the Troubled Asset Relief Program. And so much for the Perspectives article on the Ambac site.
I doubt the author, Selvaggio. even read the bill. With today's morph of the program, $250B is injected directly into 9 major banks (not to buy their troubled assets), and another $125B will go to a slew of other banks- essentially, a first step toward bank nationalization. So HALF of the already insufficient money that was to be available to buy "troubled assets" is already gone. And the rest is earmarked for various congressional goodies, e.g., expanded deposit insurance, mortgage bailouts, interbank loan guarantees and on and on.
An argument can be made that this is a helpful solution, Time will tell. But its direct benefit to the monolines is now even more opaque. The line of "ifs" that need to happen before bond insurers are aided is even longer.
I own Ambac via the debentures. I can't see any good reason to own the common in this environment (see my reasons above),
I'ts deceptive and self-defeating, however, to pump articles like Ambac's Perspectives or Dinallo's supposed guesses, reality be damned. The TOTALLY NEW TARP (it needs a new acronym) may eventually help Ambac or it may not. But the road to that point is now decidedly foggier.
And the TARP is no longer a TARP... maybe some sort of a fishing net- with holes in it, but definitely not a TARP.
www.ambac.com/pdfs/ABK...
'nuff said.
On Oct 14 08:23 AM Fulldeck wrote:
> From the WSJ-
> online.wsj.com/article...
>
> So much for the Troubled Asset Relief Program. And so much for the
> Perspectives article on the Ambac site.
>
> I doubt the author, Selvaggio. even read the bill. With today's morph
> of the program, $250B is injected directly into 9 major banks (not
> to buy their troubled assets), and another $125B will go to a slew
> of other banks- essentially, a first step toward bank nationalization.
> So HALF of the already insufficient money that was to be available
> to buy "troubled assets" is already gone. And the rest is earmarked
> for various congressional goodies, e.g., expanded deposit insurance,
> mortgage bailouts, interbank loan guarantees and on and on.
>
> An argument can be made that this is a helpful solution, Time will
> tell. But its direct benefit to the monolines is now even more opaque.
> The line of "ifs" that need to happen before bond insurers are aided
> is even longer.
>
> I own Ambac via the debentures. I can't see any good reason to own
> the common in this environment (see my reasons above),
>
> I'ts deceptive and self-defeating, however, to pump articles like
> Ambac's Perspectives or Dinallo's supposed guesses, reality be damned.
> The TOTALLY NEW TARP (it needs a new acronym) may eventually help
> Ambac or it may not. But the road to that point is now decidedly
> foggier.
>
> And the TARP is no longer a TARP... maybe some sort of a fishing
> net- with holes in it, but definitely not a TARP.
If you liked AKF and AKT, and it's hard not to to, at today's 25% plus increase (at the moment), plus our ongoing ~30% annual interest rate, you might want to look at similar debentures issued by Financial Security Assurance, a subsidiary of Dexia. FSA has been eating Ambac's lunch in the new muni bond issuance arena-
From a (linked below) Reuters article-
>>>"Although pricing has been strong, a shrinking municipal market, combined with the possible entry of new competitors, will likely pressure pricing in our view," S&P said.
Financial Security Assurance and Assured Guaranty Corp garnered the lion's share of the new issue market for municipal bond insurance, S&P said. FSA and AGC also insured a significant amount of secondary transactions, along with Berkshire Hathaway, the agency said.
For the first six months of the year, FSA wrote about $71.6 billion of public finance insurance, while Assured Guaranty wrote about $37.4 billion, according to S&P.
Berkshire Hathaway wrote about $16.5 billion, MBIA Insurance Corp about $7.2 billion and Ambac Assurance about $2.4 billion, S&P said.<<<
Reuters link-
www.reuters.com/articl...
FSA has three debenture issues-
FSB pays $1.72/year, currently selling in the low $5's
FSE pays $1.56/year, currently selling in the high $4's, and
FSC pays $1.40/year, currently selling in the mid $4's.
And here's the Prospectus supplement for FSE (I'd welcome seeing the others from someone who can find them)-
www.fsa.com/system/sec...
Of course, a return like this doesn't come without risk;,specifically, Fitch, who Ambac and MBIA fired recently "...(placed the) AA Rating of Financial Security Assurance Holdings Ltd. and AAA Rating of
Financial Security Assurance Inc. on Rating Watch Negative" on October 9. Here's FSA's response-
www.fsa.com/system/pre...
And parent company Dexia's comment-
www.dexia.com/e/news/p...
Even if Fitch goes through with the downgrade, it would likely leave FSA in a stronger position (IMHO) than Ambac.
I'm sure YOU would do your own due diligence, Tom, but I STRONGLY urge anyone else interested in these issues to do so also. With reward comes risk!