Ambac (ABK) is known for its bond insuring business. As the second largest municipal bond insurer, Ambak has cleverly diversified deriving premiums from public finance, structured finance and international segments at roughly a third each. International is down for the first six months of 2007 and public finance commands a larger percentage of the pie. Standard & Poor's analyst Cathy A. Seifert isn't troubled by the 33% drop in premium flow from the international segment. We are.
We think that in order to spruce up international premiums, margins will be pressured. There is less loyalty in the international market and there is no dearth of cash out there. All are looking for ways to invest other than buying U.S. treasuries. The way this game is played, earnings from diversified bonds together with premiums both cover the obligor and present handsome profits. With ten year treasuries where they are, investors are changing the landscape and may encroach on Ambac's lunch, however complicated this may seem.
Some analysts expect EPS growth to come from share buy-backs in 2008. This may be hampered from the necessity to maintain a larger cash reserve. At present we can not quantify the hit that the residential mortgage backed securities segment will take in 2008. We don't think that ABK can place a figure on this either at this time.
The risk to our analysis is that we are over emphasizing the RMBS ramifications. Estimated EPS for 2007 (ending 12/07) is $7.72. In addition we are assuming a modest contraction in operating margins in 2008 coupled with a modest deterioration in credit quality; hence, 2008 EPS are estimated at $7.85/$8.15.
We acknowledge that the 2007/2008 evaluation line is at the low end of ABK's trading range, reflecting the uncertainties that lay ahead. Should the stock trade substantially below the evaluation line this would signify a low risk - long term buy opportunity.
Disclosure: no conflicts