The Emperor (Mr. Ackman) Has No Clothes

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Includes: AGO, AMBC, MBI
by: Steve Lukather

It seems that the market has uncovered some rather large holes in Mr. Ackman's recent pronouncement that the financial guarantors and their policyholders are screwed.

It amazes me how simple some of these concepts were and makes me wonder how such and astute money manager could miss these concepts in his analysis.

  1. Insurance vs. Investment Bank. Guarantors write insurance and as such there are significant protections written into their contracts (holding the unwind rights on CDOs they insure is pretty valuable). Also, they are not responsible for the entire insurance obligation listed in their financials due to subordination and other contratual protections written into insurance contracts. Look through Assured Guaranty's (NYSE:AGO) supplemental disclosures to get more comfortable with the value of this aspect of their businesses.
  2. Present Value.  A $1 billion CDO liability that is not due until 30 to 40 years from now is only $181mm in PV terms at a 5% discount rate.
  3. Buying CDS on Insurance Opcos. Mr. Ackman's vision for the industry was that they would all be put into receivership. Mr. Ackman bought FSA CDS to reflect this view. The Maryland Insurance Commission has just worked out a settlement to keep ACA out of recievership and bankruptcy. For ACA to be restructured without recievership essentially makes the CDS contracts (at the insurance opco level) worthless. It is my understanding that the provisions in insurance related CDS contracts do not include a restructuring clause. Thus there is no payment to buyers of ACA CDS on this settlement. This also points to the fact that the regulators will not (unlike the ratings agencies - their recent move on AGO is a joke) bow to market pressure and remain strongly supportive of the industry.

Both Ambac (ABK) and MBIA (NYSE:MBI) disclosed adjusted book values in their Q2 results; if I adjust these disclosures, I get the following: Ambac's $3.6 billion MtM losses (which I expect to reverse) gets added back for a book value per share of $30.04. MBIA's expected addtional $2.5 billion of reserve build gets subtracted out for a book value per share of $29.13. In my opinion, Ambac has been far more conservative in its reserves. They reserve to their more conservative internal ratings, where MBIA reserves to the lower of S&P and Moody's. Most of the firms in this sector offer amazing buying opportunities for the long-term investor.

More important is that these adjusted book values will not change all that much going forward. Why? Because most of the downside to adjusted book value per share has been modelled in at current reserve levels. Because correlations for senior tranche structured debt instruments remain and unsustainable levels. Lastly, becase the recent mortgage bill will have a huge affect on senior tranche RMBS related products due to higher recovery rates for RMBS assets.

I have not seen many 700% return opportunties paired together with minimal liquidity risk. The really crazy thing is the fact that this does not even include the fact that their business could pick up in the future.

Even if wrapping muni securities goes away (which it won't because the economics still work), some of these firms could get involved with writing mortgage insurance.

Remember some of the simple things that Mr. Ackman left out of the analysis next time you see him on CNBC.

Disclosure: Author holds a long position in ABK