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Last week, Ambac raised additional capital by offering common stock and equity units. Dilution was severe, and in recomputing adusted book value/share that number went from 55.20 to about 20 after the offering. The stock traded at 8.xx most of the day Friday. I was disappointed as I thought that the recapitalization could be done by less dilutieve means, such as a soft capital arrangement initially funded by the bank counterparties. Guess again. S&P and Moody's reaffirmed ABK at triple A with negative outlooks, and Fitch announced that their review was continuing but that they did not believe either ABK or its competitors could enjoy stable ratings until they capped their CDO exposures.
Fitch is continuing its role as the aggressive enforcer of capital requirements for triple A rating.
MBI asked Fitch to withdraw its ratings, which were under review. The reasons initially stated publicly were bland. However, MBI wrote privately to Fitch and explained quite clearly that Fitch's rating methods did not produce stable ratings and that FItch's capital requirements for SF were roughly twice those of S&P or Moody's. In addition, MBI questioned the benefit of Fitch's rating because Fitch is not a major presence in the Structured Finance rating business. Fitch responded by publishing MBI's letter and writing back in a tone that can only be described as catty, for instance, implying that MBI didn't have the funds to pay FItch's fees and questioning MBI's good faith. The exchange is available on Fitch's website, and is getting some press attention.
My take on it is that Fitch's model responds excessively to certain unspecified inputs, and that the inputs, and specifically the worst case scenario, just keep getting bigger, so that it is not possible to make a capital plan based on FItch's requirements, because they keep escalating. Fitch's views make implementation of a split between structured finance and public finance difficult, because they are so very different from what S&P and Moody's requrie. In the split, according to Fitch, much more capital needs to be allocated to the structured finance. Fitch is in the process of making themselves irrelevent. I support MBI's action.
What to do with my holdings? I continue to believe that the stock of both companies is undervalued. However, the prices at this point are totally news driven, and have been up and down 20 to 30% over very short periods of time. Coming months will see a continuation of this process as the FOMC meeting, earnings, mortgage default news, and various rating and regulatory pronouncements will contribute to volatility. Full recovery of share prices may be painfully slow. Under the circumstances, I will start reducing my positions if and when good news causes them to rally. The funds can either be invested in other opportunities or reinvested in ABK and MBI the next time they tank.
Those few of you who read my blog know of my concerns about the moral hazard created by credit default swaps that are not supported by an insurable interest. I wrote a letter to the editor of Barron's, along the lines of what I have put in my blog, and it was published March 3. I was pleased that I was able to get my views in front of a larger audience. I have been on a letter writing campaign, presenting my opinion to industry participants, legislators, financial publications, and regulators. I wrote to Governor Spitzer a couple of weeks ago, words of wisdom on moral hazard, of course judging from today's news it wasn't somthing he wanted to hear about...
Tom
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Comments (1)
Wow, I have to check out Barrons for your letter! Congrats. I know you understand this topic better than anyone I know. I now support your view that it seems Ambac, based on an interview of the CEO, could pay a worst case scenario * 1.3 which is what it took to get Moodys happy.
Since they are no longer writing structured finance insurance and the muni market is getting crowded (along with certain places deciding not to get insurance anymore, (was it California?), are they headed toward falling revenues? I guess the question is, how is their business going forward?
There are some great rips and dips in these stocks and I bet with a little good timing you could make a large chunk of it back. I was wondering if you were selling at 8 1/4 the day after the secondary.
Good luck,
Uncle John
Reply:
John,
I had actually done the work to look at ABK's revenue/earnings going forward but was feeling low at the point I did my blog and didn't address it.
Ambac's business has premiums coming in for years into the future. Bonds often run for 30 years, with premium earned every year. So, Ambac will continue to earn premium for years, even if they don't write any new business. The information is quantifiable and is available on Ambac's website in the Quarterly Operating Supplement.
Based on that information, the new share counts after dilution, and a little guesswork I see 1.90 normalized earnings per share for 2008. That would ignore Mark to Market (which should reverse at some point) and additional developments on the sub-prime losses (predictable, I can't guess what they would be.) So this computation and the adjusted book value at 20 both point in the same area. Basically Ambac has about 2 years where they could live off their fat, then if they aren't writing business it could get to be a problem.
Actually I made a few small profits just shuffling in & out of ABK both on SLO and in my personal portfolio. In SLO I sold some at 10.12 to make room to participate in a rights offering, if one would occur. Then as the stock went down I bought it back at 9.xx and 8.xx, which reduced my average cost. A pity I didn't wait until the offering, I could have got it back cheaper. I think I got distracted by the "news," maybe I should have just watched the price. I have been thinking, my proper strategy here could be day or swing trading, not something I usually do.
Tom
Posted by Uncle John | March 11, 2008 1:53 AM