A few updates on thoughts on Syncora on areas that I've been emailed on.
Banks including JPM persistently acted like they were (or are) in the land of smiles on their exposure to monoline put backs, right up to settling in the realm of 100% of liabilities in the case of JPM/Syncora. In fact as far as I can tell, JPM has now settled for over 100% of Syncora's gross economic (net of remediation) losses in the relevant deals (JPMF 2007HE1, SACO I Trust 2007-1, and BSSP 2007-r5). Syncora likely had extra leverage given that losses attributable to uninsured CF notes are likely only going to have a shot of recovery through Syncora litigation. All in, as they say in the land of smiles, kapun kraup Mr. Diamond.
I'm not privy to how the 2010 remediation and subsequent deals contracted recovery claims. Without that knowledge I can't say it is impossible that uninsured CF holders won't make a valid claim on part of this settlement. I'm not expecting that though.
Elephants aren't only disappearing in Thailand. I am expecting Syncora will ultimately get another bump in surplus of 250M-400M above current (very low, maybe 25-50M) recovery estimates on their Lehman Greenpoint claim (JPMF 2006 HE1 ax). But that is the only big boy source of upside to Syncora's insured book, which I think has the more problem credits relative to capital than Assured, MBIA, Ambac, Radian Asset, or American Overseas.
In the past, I have described ABV without new biz as analogous to maturity value of a zero coupon, if installment premiums are not included and roughly offset op ex. So that ABV is basically net assets - net ultimate losses which you can get too via adjusting a securities-only BS or working off the statutory statements. This is just one way to think about it and it is not a conservative one because (among other things) the yield on liabilities exceeds the yield on assets. Such an ABV number per share for Syncora is very likely closer to (including under) ten than 20 with a higher risk of being 0 than say Ambac's risk of being worth less than 16.67 in 2023. But there is definitely a wider distribution of possible outcomes both ways for Syncora. Combine that with low liquidity and you've got one spicy dish for sure.
To say the same thing in a new way Syncora could end happier, but Ambac is the better bet for a happy ending.
Showing posts with label Ambac. Show all posts
Showing posts with label Ambac. Show all posts
Friday, March 7, 2014
Wednesday, February 26, 2014
G'day Bond Insurers
There's nothing surprising in Syncora's announcement of a settlement with JP Morgan. The only "new new" to us is the timing, and while that was highly uncertain it can't be called a surprise. As predicted, the stocks are better indicators of news than headlines. Ambac's stock is telling us that JPM's most recent dose of reality in it's litigation reserves may filter through to the their settlement discussions as well.
Syncora is an easier settlement for the banks than some other FGs because of its size, other trouble spots in its portfolio, and the 2009 MTA restructuring which resulted in about half SYCRF common and all of newly created preference shares being issued to structured finance counterparties. In many cases these were the same banks that were across the table in R&W litigation talks. These all provide opportunities to disguise the actual value of the R&W settlement.
Being a smaller insurer also made it easier to compile the deal level loss data on Syncora. I think I've published this before but regardless you can check it out here. Syncora ought to have targeted full recovery of actual and expected paid claims and we would be surprised if they took anything less than 85%. Not counting losses neutralized by previous restructuring, these loses were definitely over 210M and very likely over 225M. (Note this excludes the BSSP 2007 R5 deal because it's been a while since we've reviewed the indenture in this more exotic securitization trust.) Given the size of Syncora's current R&W recovery benefit and it's claims against Greenpoint, Syncora's economic benefit from settlement is very very likely more than 75M above accounting benefit marks and probably closer to double that.
Whether or not this will be clear in Syncora's financial statements will be determined by the structure of the settlement. For example the full cash value that JPM paid could have been reduced by, trading Syncora corporate securities or insured securities that JPM likely carried far below market value and farther below par. JPM could also have indemnified Syncora on other exposures.
Ambac continues to be a harder pill to swallow for its R&W counterparties, mostly because of the dolars involved. However, the results and methods we used in this spreadsheet (originally published in this Sept 2012 post) have been confirmed by Bank of America's new disclosure of "over $2.5B" in R&W of Ambac loss compensation claims. Any overestimation of claims in the spreadsheet are most likely compensated for in there being no accounting for other lawsuits and non-litigious recoveries. Furthermore given Ambac's stated intent and position of strength in its breach of contract cases and preliminary success in its fraud cases, the company will likely experience greater than 100% recoveries if only due to interest and legal cost recoveries and not punitive damages for fraud.
The legacy securities of the DISCs that we recommended buying (and bought) at a rounding error from zero are now at the equivalent of a DISC at 40. And while it's a fair time for a victory lap, Ambac common and especially the warrants still seems like a compelling long-term investment. The warrants offer similar upside to an economic book value as Syncora common, with a higher quality portfolio, better disclosures, and management seemingly more intent on full recoveries of R&W (and maybe even fraud) claims. Both are compelling.
As an aside it's worth noting that while the surplus notes are now trading near par, the perpetual preferred are now trading at 33 by way of Alliance Semiconductor common stock (ALSC, thank you Stephen Pendergast). The Surplus notes are a senior claim and will eventually have cumulative fixed interest (versus non-cumulative non-fixed). I can't figure out if this is a screaming bargain or a trap. Consider for instance that American Overseas (formerly RamRe) is playing hardball with preferred security holders, placing $3 million in a trust to redeem par value of many times that of preferred securities at maturity in 2066. When in doubt, stay without.
That's all for now.
Syncora is an easier settlement for the banks than some other FGs because of its size, other trouble spots in its portfolio, and the 2009 MTA restructuring which resulted in about half SYCRF common and all of newly created preference shares being issued to structured finance counterparties. In many cases these were the same banks that were across the table in R&W litigation talks. These all provide opportunities to disguise the actual value of the R&W settlement.
Being a smaller insurer also made it easier to compile the deal level loss data on Syncora. I think I've published this before but regardless you can check it out here. Syncora ought to have targeted full recovery of actual and expected paid claims and we would be surprised if they took anything less than 85%. Not counting losses neutralized by previous restructuring, these loses were definitely over 210M and very likely over 225M. (Note this excludes the BSSP 2007 R5 deal because it's been a while since we've reviewed the indenture in this more exotic securitization trust.) Given the size of Syncora's current R&W recovery benefit and it's claims against Greenpoint, Syncora's economic benefit from settlement is very very likely more than 75M above accounting benefit marks and probably closer to double that.
Whether or not this will be clear in Syncora's financial statements will be determined by the structure of the settlement. For example the full cash value that JPM paid could have been reduced by, trading Syncora corporate securities or insured securities that JPM likely carried far below market value and farther below par. JPM could also have indemnified Syncora on other exposures.
Ambac continues to be a harder pill to swallow for its R&W counterparties, mostly because of the dolars involved. However, the results and methods we used in this spreadsheet (originally published in this Sept 2012 post) have been confirmed by Bank of America's new disclosure of "over $2.5B" in R&W of Ambac loss compensation claims. Any overestimation of claims in the spreadsheet are most likely compensated for in there being no accounting for other lawsuits and non-litigious recoveries. Furthermore given Ambac's stated intent and position of strength in its breach of contract cases and preliminary success in its fraud cases, the company will likely experience greater than 100% recoveries if only due to interest and legal cost recoveries and not punitive damages for fraud.
The legacy securities of the DISCs that we recommended buying (and bought) at a rounding error from zero are now at the equivalent of a DISC at 40. And while it's a fair time for a victory lap, Ambac common and especially the warrants still seems like a compelling long-term investment. The warrants offer similar upside to an economic book value as Syncora common, with a higher quality portfolio, better disclosures, and management seemingly more intent on full recoveries of R&W (and maybe even fraud) claims. Both are compelling.
As an aside it's worth noting that while the surplus notes are now trading near par, the perpetual preferred are now trading at 33 by way of Alliance Semiconductor common stock (ALSC, thank you Stephen Pendergast). The Surplus notes are a senior claim and will eventually have cumulative fixed interest (versus non-cumulative non-fixed). I can't figure out if this is a screaming bargain or a trap. Consider for instance that American Overseas (formerly RamRe) is playing hardball with preferred security holders, placing $3 million in a trust to redeem par value of many times that of preferred securities at maturity in 2066. When in doubt, stay without.
That's all for now.
Monday, October 14, 2013
Quick Thoughts on Syncora and Ambac
As expected, Syncora reported its worst quarter since the 2009 MTA last quarter (as measured by change in the Dragon's ABV metric.) If you lightened up in the mid 60s as we suggested, getting back in today at the .52 offer will lock in a good trade. While that trade has been working out, Puerto Rico isn't about to default and JP Morgan is confronting RMBS litigation reality (among other issues) in its litigation reserves. If you made the same trade on Ambac, banking profits there might be wise too. The patient investor will buy and snooze. No need to check headlines, the stocks will tell you when a deal is wrapped up.
Saturday, August 10, 2013
Thoughts from the Back Row
1. Radian's delinquent inventory is now less than half it's peak level. And there are clandestine cures in the current number. Recently we've been thinking a lot about the rescission and denials that never were: the claims that were never reported because the loan files were never found, never delivered to the servicer, and never compiled at all. Eventually, the banks realized robosigning wasn't going to work for them.
At the same time, Radian is writing business at a pace that will likely add close to half a billion in value over the life of the business. In a year, today's headlines about the effect of future capital requirements on Radian will prove to be a fart in the wind. However, a correction would be healthy and could be imminent.
2. Syncora should be reporting it's worst quarter since reorganization. There seems to be a hard bid in the 0.6s. It may be wise to lighten up before an ugly quarter, but we wonder if the bid is JP Morgan or Greenpoint and if it cares how much money the company loses. Meanwhile, Syncora wrapped Detroit COPs trade near 48 for a current yield (variable) of 1% or less. If the paper were 20, 60% of the loss is gone on any repurchased paper. It seems pretty clear where that bid is coming from.
3. If you wiggle the numbers around (student loan losses were higher but surplus note repurchases more than offset that), the most recent report on the rehabilitation of Ambac's segregated account looks better than Scenario One. Scenario One was a projection of Ambac's performance under a base case scenario which was made at the commencement of rehabilitation. Surplus was projected to exceed outstanding notes by $4B in 2020, with another $1.2B in qualified statutory capital. That now looks more likely to happen has soon as the company wraps up its R&W claims, especially considering that reserves on repurchased wrapped paper are not released, and there is a lot of it.
4. Obama's support for the principles of the Corker-Warner bill makes a fall or winter vote a real possibility. It won't rally the house republicans around those principles, but it will pin them into being the only opposition to a bill that rids the nation of the ugly legacy of Fannie and Freddie. That's a brand that neither Hensarling nor Boehner is shooting for.
At the same time, Radian is writing business at a pace that will likely add close to half a billion in value over the life of the business. In a year, today's headlines about the effect of future capital requirements on Radian will prove to be a fart in the wind. However, a correction would be healthy and could be imminent.
2. Syncora should be reporting it's worst quarter since reorganization. There seems to be a hard bid in the 0.6s. It may be wise to lighten up before an ugly quarter, but we wonder if the bid is JP Morgan or Greenpoint and if it cares how much money the company loses. Meanwhile, Syncora wrapped Detroit COPs trade near 48 for a current yield (variable) of 1% or less. If the paper were 20, 60% of the loss is gone on any repurchased paper. It seems pretty clear where that bid is coming from.
3. If you wiggle the numbers around (student loan losses were higher but surplus note repurchases more than offset that), the most recent report on the rehabilitation of Ambac's segregated account looks better than Scenario One. Scenario One was a projection of Ambac's performance under a base case scenario which was made at the commencement of rehabilitation. Surplus was projected to exceed outstanding notes by $4B in 2020, with another $1.2B in qualified statutory capital. That now looks more likely to happen has soon as the company wraps up its R&W claims, especially considering that reserves on repurchased wrapped paper are not released, and there is a lot of it.
4. Obama's support for the principles of the Corker-Warner bill makes a fall or winter vote a real possibility. It won't rally the house republicans around those principles, but it will pin them into being the only opposition to a bill that rids the nation of the ugly legacy of Fannie and Freddie. That's a brand that neither Hensarling nor Boehner is shooting for.
Thursday, October 18, 2012
Ambac Vacation Notice
I'm not going anywhere. Nor is Ambac. Nor is the IRS. Or are they? The answer to that question will determine whether Ambac's Plan of Reorganization goes on vacation in turn.
Max Webber told you that a federal bureaucracy would take this long. The innards of this federal behemoth have churned for months without acting on Ambac's settlement offer. Our lawyer friend recently pointed out the interesting consequences of this inaction.
Under U.S. law, a confirmed plan of reorganization under Chapter 11 can only be reversed in the case of fraud and even then only within a few months of confirmation. The court confirmed Ambac's plan 7 months ago. Ambac had so many moving parts, it required an intricate plan with several contingencies, not least of which was a time limit for consummation of the plan. If the plan was not consummated within six months of confirmation, the debtor would - and does now - have the right to vacate the plan. If the plan is not consummated within a year, then it shall automatically be vacated.
This consummation thing is more than standard language for a marital prenup. Consummation of the plan entails Ambac actually exiting bankruptcy, something that cannot occur if an IRS settlement does not close.
Let's say this one last way. Ambac has the right to vacate the confirmed plan of reorganization at this moment, and it will automatically vacate the plan if a massive federal bureaucracy doesn't agree to a settlement by March 14, 2013.
It's time for a discount double check.
We hope you already bought DISCS when we published this. We did, and after learning about this predicament we sold our Sr. Unsecured (38-40) and put about half the proceeds into more DISCS (4-5.5). It turns out that this is a compelling trade whether the POR is implemented (still our base case) or not.
Let's look at valuation under the POR first. With 1.5% of the common and 10% undiluted of the company at a strike price of $750M, the DISC to Sr. Debt price relationship is severely disjointed given the extreme set of possible outcomes. Sr. Debt with a price of 40 currently values the holding company at $500M. This translates into a value of about 1.875 for the common equity portion of the DISCS. To justify the implied value of the warrants with their decade-long life, a black-scholes model produces an implied volatility of 23%, less than twice today's VIX. The smartest investors know that physics equations are too heavily relied upon in finance and economics today. With that in mind, scenario analyses can provide greater insight.
A peak at our adjusted statutory book value translates into a residual value of AFGI (the Hold Co) of $1.5B. That would translate into a value for the DISC's warrant rights of 18.75 and common equity rights of 3.75 for a total value of 22.5 per bond (4.5x current price). Meanwhile the Sr. Unsecured would be valued at about 110 per bond (2.5x current).
The above analysis takes loss reserves at face value. We have discussed the strength of the financial guarantor position in their legal battles over mortgage repurchases. We stand with Jay Brown in his view that the repurchase remedy can, should, and will (if the guarantors see it through) cover 100% of losses as long as the deal sponsor is still solvent. If we assume an 80% recovery rate on Ambac's lawsuits against solvent banks, residual value of AFGI moves to $3.5B; DISCS to 80 (16 x current); Sr Debt to 244 (6x current).
Given that our bear case scenarios (which we view as unlikely) of failure in R&W litigation or liquidation of the hold co would leave both Sr. Debt and DISCs close to or actually worthless, we view the leveraged return potential of the DISCs as highly attractive.
That is all good and well if the IRS hive mind approves the settlement offer by spring. This could all be settled tomorrow, but that is anything but a safe bet to an outsider. So what happens to Ambac and the DISCS if the POR goes up in smoke?
Our debtor would not be liquidated. Rather, another plan would need to be crafted. This presents the threat of a new POR that gives Sr. Debt more or all interests in the reorganized debtor and less or none for the DISCS. This is most likely if the underlying enterprise value of Ambac is less than at the confirmation of the current POR. An equal and opposite force exists: if the enterprise value is higher, then a new POR would more likely give DISCS greater recovery.
Given current market prices of Ambac debt and the ripening of repurchase litigation for harvest, the risk seems to the upside. For DISCS holders, vacation is still a nice treat.
Max Webber told you that a federal bureaucracy would take this long. The innards of this federal behemoth have churned for months without acting on Ambac's settlement offer. Our lawyer friend recently pointed out the interesting consequences of this inaction.
Under U.S. law, a confirmed plan of reorganization under Chapter 11 can only be reversed in the case of fraud and even then only within a few months of confirmation. The court confirmed Ambac's plan 7 months ago. Ambac had so many moving parts, it required an intricate plan with several contingencies, not least of which was a time limit for consummation of the plan. If the plan was not consummated within six months of confirmation, the debtor would - and does now - have the right to vacate the plan. If the plan is not consummated within a year, then it shall automatically be vacated.
This consummation thing is more than standard language for a marital prenup. Consummation of the plan entails Ambac actually exiting bankruptcy, something that cannot occur if an IRS settlement does not close.
Let's say this one last way. Ambac has the right to vacate the confirmed plan of reorganization at this moment, and it will automatically vacate the plan if a massive federal bureaucracy doesn't agree to a settlement by March 14, 2013.
It's time for a discount double check.
We hope you already bought DISCS when we published this. We did, and after learning about this predicament we sold our Sr. Unsecured (38-40) and put about half the proceeds into more DISCS (4-5.5). It turns out that this is a compelling trade whether the POR is implemented (still our base case) or not.
Let's look at valuation under the POR first. With 1.5% of the common and 10% undiluted of the company at a strike price of $750M, the DISC to Sr. Debt price relationship is severely disjointed given the extreme set of possible outcomes. Sr. Debt with a price of 40 currently values the holding company at $500M. This translates into a value of about 1.875 for the common equity portion of the DISCS. To justify the implied value of the warrants with their decade-long life, a black-scholes model produces an implied volatility of 23%, less than twice today's VIX. The smartest investors know that physics equations are too heavily relied upon in finance and economics today. With that in mind, scenario analyses can provide greater insight.
A peak at our adjusted statutory book value translates into a residual value of AFGI (the Hold Co) of $1.5B. That would translate into a value for the DISC's warrant rights of 18.75 and common equity rights of 3.75 for a total value of 22.5 per bond (4.5x current price). Meanwhile the Sr. Unsecured would be valued at about 110 per bond (2.5x current).
The above analysis takes loss reserves at face value. We have discussed the strength of the financial guarantor position in their legal battles over mortgage repurchases. We stand with Jay Brown in his view that the repurchase remedy can, should, and will (if the guarantors see it through) cover 100% of losses as long as the deal sponsor is still solvent. If we assume an 80% recovery rate on Ambac's lawsuits against solvent banks, residual value of AFGI moves to $3.5B; DISCS to 80 (16 x current); Sr Debt to 244 (6x current).
Given that our bear case scenarios (which we view as unlikely) of failure in R&W litigation or liquidation of the hold co would leave both Sr. Debt and DISCs close to or actually worthless, we view the leveraged return potential of the DISCs as highly attractive.
That is all good and well if the IRS hive mind approves the settlement offer by spring. This could all be settled tomorrow, but that is anything but a safe bet to an outsider. So what happens to Ambac and the DISCS if the POR goes up in smoke?
Our debtor would not be liquidated. Rather, another plan would need to be crafted. This presents the threat of a new POR that gives Sr. Debt more or all interests in the reorganized debtor and less or none for the DISCS. This is most likely if the underlying enterprise value of Ambac is less than at the confirmation of the current POR. An equal and opposite force exists: if the enterprise value is higher, then a new POR would more likely give DISCS greater recovery.
Given current market prices of Ambac debt and the ripening of repurchase litigation for harvest, the risk seems to the upside. For DISCS holders, vacation is still a nice treat.
Wednesday, September 5, 2012
Ambac Analysis: Looking Through a Glass of Milk
FASB 163 and FASB 46 has created a lot of opportunity for accountants to charge higher fees. These pronouncements are what one ought to expect of putting accountants in charge of what investors see. For bond insurers in particular these two accounting rules have made financial statements less relevant by distancing them from economic value. This is not to mention making accounting more costly for reporting companies.
Throw in a healthy portion of financial distress and a bankruptcy, and statutory statements look more intuitive then GAAP.
With that in mind, we have created this spreadsheet examining Ambac by adjusting the operating subsidiary's (AAC) financials in a similar way to how we have looked at Syncora. In Ambac's case, we have the added adjustment for the de facto AAC liabilities in the segregated account.
Ambac's financial statements are the murkiest of any large public company we have ever seen. By looking at the statutory statements we simplify the valuation process. We first adjust present value numbers presented on the balance sheet by 1) senior claims on the residual value of AAC, namely surplus notes, claims in the segregated account, and AAC auction market preferred shares (ARPS); and 2) the present value of future installment premiums.
Dividing this sum by the par of senior hold co debt gives us an adjusted book value per bond (ABV) which expressed as a percent of par equals 104. This tells us that if future investment income covers future costs, the value of a sr. debt will acrete from 104 by the aggregate discount factor (different values are discounted by different rates, we have not calculated the aggregate but at most it would equal the yield on Ambac's investment portfolio or 6.02%).
We can then adjust for our view on future loss and recovery developments. Syncora's recent settlement with Countrywide include a cash payment that was over twice Syncora's reserve. Assured Guaranty's settlement with Countrywide covered about 80% of losses. Both of these settlements suggest a 50% increase in Ambac's repurchase benefit could prove conservative (it would make total recoveries $3.5B below Q2 2012 expected future claims payments not including the RMBS portion of the $3,653M of claims presented and unpaid at quarter end). It also leaves plenty of room for things to go wrong in other areas (like with the IRS). Round it down to $1,500M, add it to our ABV calculation and your looking at 211. The bonds currently trade at 30.
This of course ignores the effect of DISCs on diluting value to sr. debt, but there is little in the way of guidance on how warrants recovered by these creditors might be structured. The DISCS will also receive a slice of common. These very well may prove the most rewarding investment in Ambac. This assumes deconsolidation is avoided. We think this is a very good bet, though the risk is apparent.
Throw in a healthy portion of financial distress and a bankruptcy, and statutory statements look more intuitive then GAAP.
With that in mind, we have created this spreadsheet examining Ambac by adjusting the operating subsidiary's (AAC) financials in a similar way to how we have looked at Syncora. In Ambac's case, we have the added adjustment for the de facto AAC liabilities in the segregated account.
Ambac's financial statements are the murkiest of any large public company we have ever seen. By looking at the statutory statements we simplify the valuation process. We first adjust present value numbers presented on the balance sheet by 1) senior claims on the residual value of AAC, namely surplus notes, claims in the segregated account, and AAC auction market preferred shares (ARPS); and 2) the present value of future installment premiums.
Dividing this sum by the par of senior hold co debt gives us an adjusted book value per bond (ABV) which expressed as a percent of par equals 104. This tells us that if future investment income covers future costs, the value of a sr. debt will acrete from 104 by the aggregate discount factor (different values are discounted by different rates, we have not calculated the aggregate but at most it would equal the yield on Ambac's investment portfolio or 6.02%).
We can then adjust for our view on future loss and recovery developments. Syncora's recent settlement with Countrywide include a cash payment that was over twice Syncora's reserve. Assured Guaranty's settlement with Countrywide covered about 80% of losses. Both of these settlements suggest a 50% increase in Ambac's repurchase benefit could prove conservative (it would make total recoveries $3.5B below Q2 2012 expected future claims payments not including the RMBS portion of the $3,653M of claims presented and unpaid at quarter end). It also leaves plenty of room for things to go wrong in other areas (like with the IRS). Round it down to $1,500M, add it to our ABV calculation and your looking at 211. The bonds currently trade at 30.
This of course ignores the effect of DISCs on diluting value to sr. debt, but there is little in the way of guidance on how warrants recovered by these creditors might be structured. The DISCS will also receive a slice of common. These very well may prove the most rewarding investment in Ambac. This assumes deconsolidation is avoided. We think this is a very good bet, though the risk is apparent.
Monday, July 11, 2011
Plan of Unorganization
The lack of acceptance by the Wisconsin OCI may make Ambac's plan of reorganization filed last week a non-starter - but not necessarily.
The disagreement with OCI, which is rehabilitating the Ambac's Segregated Account, stems from the allocation of the tax sharing agreement between AFGI and AAC. Accoriding to OCI:
"The Rehabilitator engaged in discussions for several months with AFGI and its bankruptcy Creditors Committee to see if mutually agreeable terms could be arrived at for equitably allocating net-operating-loss tax attributes and certain other resources between AFGI, Ambac Assurance Corp. and the Segregated Account."
The POR contains three potential Tax Sharing Agreements which could be effected with OCI. If none of those TSA's are implemented, the POR contemplates a deconsolidation by way of gifting or selling 20% of AAC. AFGI would then sue OCI and AAC for the tax refunds of approximately $700M. If AFGI were to then run out of cash, it would liquidate.
To all of this, OCI says "The Rehabilitator of the Segregated Account of Ambac Assurance Corporation does not believe that the reorganization plan proposed by Ambac Financial Group, Inc. (“AFGI”) is in the best interests of policyholders of the Segregated Account, or for that matter, those of the AFGI creditors."
We can only presume that OCI infers their rejection of the TSA's as they are unlikely to offer a sweeter TSA to AFGI. While the Edgeworth box - the total amount to be gained by all parties by reaching an agreement - is large, the unusually adversarial relationship between holding company and subsidiary/regulator is making middle ground hard to come by.
It appears that OCI is sticking to a reductionist view of minimizing cash outflows to the holding company. Meanwhile AFGI sees more cash as essential to maximizing its value and protecting itself from unintended deconsolidation, a threat arising from pending surplus note issuance. Deconsolidation would throw a wrench in all cost sharing and inter-company payments by making them subject to income tax.
Not being privy to negotiations, its hard to discount which side is acting the greater fool. It shouldn't shock anyone that we think creditors ought to pursue whatever route minimizes the likelihood of a chapter 7 liquidation, whether it be by way of intended or unintended deconsolidation. Meanwhile, much of AAC's subrogation asset is moving closer to realization which could tremendously effect the value of AAC equity in a chapter 7 liquidation or otherwise.
For these reasons, we are predisposed to reject the plan and see what the creditor committee can put together. Even if that plan turns out substantially the same, it would buy more time for uncertainties with the IRS and putbacks to lift. That could make OCI more amenable to discussions and ease threats from chapter 7. Furthermore, the plan is unlikely to be enacted by the judge if she has serious doubts of the reorganized debtor to continue as a going concern. For better or worse, Shirley has called chapter 7 a "Sword of Damocles" in this case.
Accepting the plan would however create an interesting leverage for AFGI at the negotiating table with OCI and AAC. The rules of the game would change such that AFGI would be guaranteed a greater share of benefits of any settlement. OCI would have the ability to select any of the three TSA's or none at all, determined by which it feels is in policyholders best interest. OCI would undoubtedly place any AFGI claims on AAC into the segregated account and have any attempts of outside litigation remanded back to the Wisconsin courts.
While OCI powers in rehabilitation proceedings are broad, they are not omnipotent. This is a real threat to OCI which from a pure "dollars and sense" point of view predispose them to accepting one of the TSA's. But OCI might not have so much sense. Now we think economic theory is great and value maximizing agents are really neat. But the same people that sat on the Casey Anthony jury are market participants. There is nothing strong about the efficient market hypothesis form that applies to OCI. In other words, we think OCI is a threat to itself, primarily due to a reductionist view of sending cash to the holding company. (Or does it just want us to think so in its pursuit of maximum value...)
So there are definitely merits to this strategy, it would probably work, but there is no reason to take the risk of OCI blowing itself and everyone else in the room to Kingdom Come. The onus is on management to change are mind. They might do that by showing "the consensual direction" of settlement terms that OCI contemplates or protecting the only asset that we really care about, AAC equity.
We might start to feel lonely in our focus on this asset. Perhaps were trying too hard to find friends, but after staring at it for hours OCI's statement gave a 'magic eye' effect to the appearance of 'just hang on, it looks like we'll get this bad boy out of rehab.' Some old port and another hour and it adds 'just like Tapley told ya.'
(Sr. Unsecureds ended the week trading around and pricing in the high 13s with several $1mm+ blocks trading. DISCS are pricing at 1. As such we estimate enterprise value in the $175M area.)
The disagreement with OCI, which is rehabilitating the Ambac's Segregated Account, stems from the allocation of the tax sharing agreement between AFGI and AAC. Accoriding to OCI:
"The Rehabilitator engaged in discussions for several months with AFGI and its bankruptcy Creditors Committee to see if mutually agreeable terms could be arrived at for equitably allocating net-operating-loss tax attributes and certain other resources between AFGI, Ambac Assurance Corp. and the Segregated Account."
The POR contains three potential Tax Sharing Agreements which could be effected with OCI. If none of those TSA's are implemented, the POR contemplates a deconsolidation by way of gifting or selling 20% of AAC. AFGI would then sue OCI and AAC for the tax refunds of approximately $700M. If AFGI were to then run out of cash, it would liquidate.
To all of this, OCI says "The Rehabilitator of the Segregated Account of Ambac Assurance Corporation does not believe that the reorganization plan proposed by Ambac Financial Group, Inc. (“AFGI”) is in the best interests of policyholders of the Segregated Account, or for that matter, those of the AFGI creditors."
We can only presume that OCI infers their rejection of the TSA's as they are unlikely to offer a sweeter TSA to AFGI. While the Edgeworth box - the total amount to be gained by all parties by reaching an agreement - is large, the unusually adversarial relationship between holding company and subsidiary/regulator is making middle ground hard to come by.
It appears that OCI is sticking to a reductionist view of minimizing cash outflows to the holding company. Meanwhile AFGI sees more cash as essential to maximizing its value and protecting itself from unintended deconsolidation, a threat arising from pending surplus note issuance. Deconsolidation would throw a wrench in all cost sharing and inter-company payments by making them subject to income tax.
Not being privy to negotiations, its hard to discount which side is acting the greater fool. It shouldn't shock anyone that we think creditors ought to pursue whatever route minimizes the likelihood of a chapter 7 liquidation, whether it be by way of intended or unintended deconsolidation. Meanwhile, much of AAC's subrogation asset is moving closer to realization which could tremendously effect the value of AAC equity in a chapter 7 liquidation or otherwise.
For these reasons, we are predisposed to reject the plan and see what the creditor committee can put together. Even if that plan turns out substantially the same, it would buy more time for uncertainties with the IRS and putbacks to lift. That could make OCI more amenable to discussions and ease threats from chapter 7. Furthermore, the plan is unlikely to be enacted by the judge if she has serious doubts of the reorganized debtor to continue as a going concern. For better or worse, Shirley has called chapter 7 a "Sword of Damocles" in this case.
Accepting the plan would however create an interesting leverage for AFGI at the negotiating table with OCI and AAC. The rules of the game would change such that AFGI would be guaranteed a greater share of benefits of any settlement. OCI would have the ability to select any of the three TSA's or none at all, determined by which it feels is in policyholders best interest. OCI would undoubtedly place any AFGI claims on AAC into the segregated account and have any attempts of outside litigation remanded back to the Wisconsin courts.
While OCI powers in rehabilitation proceedings are broad, they are not omnipotent. This is a real threat to OCI which from a pure "dollars and sense" point of view predispose them to accepting one of the TSA's. But OCI might not have so much sense. Now we think economic theory is great and value maximizing agents are really neat. But the same people that sat on the Casey Anthony jury are market participants. There is nothing strong about the efficient market hypothesis form that applies to OCI. In other words, we think OCI is a threat to itself, primarily due to a reductionist view of sending cash to the holding company. (Or does it just want us to think so in its pursuit of maximum value...)
So there are definitely merits to this strategy, it would probably work, but there is no reason to take the risk of OCI blowing itself and everyone else in the room to Kingdom Come. The onus is on management to change are mind. They might do that by showing "the consensual direction" of settlement terms that OCI contemplates or protecting the only asset that we really care about, AAC equity.
We might start to feel lonely in our focus on this asset. Perhaps were trying too hard to find friends, but after staring at it for hours OCI's statement gave a 'magic eye' effect to the appearance of 'just hang on, it looks like we'll get this bad boy out of rehab.' Some old port and another hour and it adds 'just like Tapley told ya.'
(Sr. Unsecureds ended the week trading around and pricing in the high 13s with several $1mm+ blocks trading. DISCS are pricing at 1. As such we estimate enterprise value in the $175M area.)
Wednesday, June 29, 2011
Considerations of WI OCI
Assured Guaranty had a clear incentive to take a haircut on potential put-back recoveries. This because of a threat of downgrade. And so they reached a capital accretive settlement with Bank of America.
The Wisconsin Office of the Commissioner of Insurance has proclaimed that it would not take any account of the non-policyholder Ambac stakeholders. Given that the level of recoveries necessary to make AAC stable may be less than it takes to put AAC common equity in-the-money, this is not good for any security holders. By the same logic, it seems to create an opportunity for liable securitization sponsors to settle for less than if company management was at the helm.
Furthermore, taken at face value the Wisconsin OCI statement implies that the agency would issue 1 Gazillion surplus notes to Bank of America for an extra penny in recoveries. At this point, it might seem that things are not looking so hot for the AFGI Sr. Unsecured position that The Dragon has liked. We still like that position and have several consoling thoughts regarding this threat of impairment.
First, nobody wants to see excessive surplus notes instigate a change of control that would erase the value of the deferred tax asset. So there is a hurdle the size of the DTA.
Second, the OCI is not an adversary to Ambac. The OCI wishes to see policyholders paid above all else. But the OCI has little incentive to move up the date of recovery by a year if it means severely injuring what was once one of the largest companies under its jurisdiction. Such actions would show bad faith to other current and prospective WI-domiciled companies. Along that line on should note that the insurance regulation is competitive among states. It is sometimes criticized for the beggar-thy-neighbor policies that attract business to more accommodating domiciles.
Third, the OCI does not want to impede justice, especially to the detriment of its constituent companies. The OCI also does not have the resources to man the litigation process and make fully informed decisions outside of the guidance of management.
Lastly, even if settling all repurchase litigation at say 60% of potential value would mean full payment to policyholders, the risk of having to settle with each sponsor uniquely dilutes the incentive to take the haircut. If one case is settled and no other counterparties will sit down, the risk is that the one case was the strongest and could have covered for deficiencies in others.
So this sort of impairment does not keep us up at night, though it is in the realm of possibilities. Its important to consider these risk, but the life of our call option still seems long.
The Wisconsin Office of the Commissioner of Insurance has proclaimed that it would not take any account of the non-policyholder Ambac stakeholders. Given that the level of recoveries necessary to make AAC stable may be less than it takes to put AAC common equity in-the-money, this is not good for any security holders. By the same logic, it seems to create an opportunity for liable securitization sponsors to settle for less than if company management was at the helm.
Furthermore, taken at face value the Wisconsin OCI statement implies that the agency would issue 1 Gazillion surplus notes to Bank of America for an extra penny in recoveries. At this point, it might seem that things are not looking so hot for the AFGI Sr. Unsecured position that The Dragon has liked. We still like that position and have several consoling thoughts regarding this threat of impairment.
First, nobody wants to see excessive surplus notes instigate a change of control that would erase the value of the deferred tax asset. So there is a hurdle the size of the DTA.
Second, the OCI is not an adversary to Ambac. The OCI wishes to see policyholders paid above all else. But the OCI has little incentive to move up the date of recovery by a year if it means severely injuring what was once one of the largest companies under its jurisdiction. Such actions would show bad faith to other current and prospective WI-domiciled companies. Along that line on should note that the insurance regulation is competitive among states. It is sometimes criticized for the beggar-thy-neighbor policies that attract business to more accommodating domiciles.
Third, the OCI does not want to impede justice, especially to the detriment of its constituent companies. The OCI also does not have the resources to man the litigation process and make fully informed decisions outside of the guidance of management.
Lastly, even if settling all repurchase litigation at say 60% of potential value would mean full payment to policyholders, the risk of having to settle with each sponsor uniquely dilutes the incentive to take the haircut. If one case is settled and no other counterparties will sit down, the risk is that the one case was the strongest and could have covered for deficiencies in others.
So this sort of impairment does not keep us up at night, though it is in the realm of possibilities. Its important to consider these risk, but the life of our call option still seems long.
Saturday, June 18, 2011
A Brief Diatribe and Long Babble on Ambac
If you shouldn't ask a barber whether you need a haircut, then you probably shouldn't ask an accountant if you need absurd, labor-intensive, uneconomical accounting measures. Unfortunately someone asked.
No, no, nobody asked for my opinion; rather, I am referring to the Financial Accounting Standards Board and their lovely pronouncements of the last several years. In short, they have shown the world which tools not to use in the valuation process while making it more painstaking to extract crucial figures.
The crucial figures are those that indicate how much cash security holders will get and when. Yes, the discounted cash flow, "when do I get the skrilla?", model is the mother of all valuation. Actually building precise models is mostly an exercise in futility when the subject is something as volatile as a bankrupt financial guaranty holding company with a subsidiary in rehabilitation. A multitude of ultra-sensitive and constantly changing assumptions overwhelms conventional precision. Even a single variable can confound a model. For example, assigning a single discounted value to the possibility of permanent impairment by actions of Ambac's rehabilitator is impractical.
A more intuitive approach would be assigning probabilities to a few outcomes representing the real diaspora of possible future events. Said again for the statistician, take a sample representing the population. That is easier said than done when the outcome turns on the decisions of a few individuals.
Continuing with an example for Ambac Hold Co's Sr. Unsecured bondholders, one would then need to apply the same process for other major unstable variables - in this case repurchase litigation, bankruptcy, and loss developments. Better to dump the whole thing into black-scholes and go for a coffee. The inherent difficulty of discounting such components tends to elicit a desire to pack our bags, buy Microsoft, and extrapolate the Office Suite sales off into the sunset. But THAT desire to walk away is precisely what ought to draw at least an initial interest.
Catastrophic past losses and the possibility for total loss should also incite interest along with natural and prudent alarm. Having established interest still leaves us a long way from an investment decision. Lets take a step back before we move forward. Lets take capital structure out of the equation.
Without the firm's own securities, the main components of an economic balance sheet are investments and actuarial accounts. Specifically that is investment portfolio, net expected recovery assets, reinsurance, and premiums receivable on the left and net expected case loss reserves on the right. All of the numbers we will use will continue to be Ambac's and for these they are:
6,983,082+796,622+141,131+2,290,920-6,296,761=$3,773,863k
Investments+Subrogation Recoverable+Reinsurance Recoverable-Loss Reserves=Net Major Assets
With this number we will keep in the back of our minds that we must: 1) adjust our valuation for risks in the insured portfolio; 2) adjust our valuation down for the present value of costs; and 3) adjust our present value up to account for the present value of installment premiums. Due to the economy of time I spend on the couch doing this, we do not bother with the latter two numbers as they are overshadowed by the forces of loss and recovery developments. As for the first item, we note that as a Sr. Unsecured bond holder downside is limited to zero and our view is that recovery potential skews insured portfolio risk to the upside.
Now lets approach capital structure. Here, we all conservatism to reign and so value all liabilities at par though market value may be as little as 15% of that. The predicament of Ram Holdings has proved this method relevant by certain large preferred shareholders being unwilling to tender at deep discounts. Back to the perspective of a Sr. Unsecured Ambac creditor, liabilities valued in this way make for a negative $2,850M ($2.05B AAC surplus notes + $800M AAC Pref. Shares) adjustment bringing our earlier $3,773.9M number to $923.9M. That is approximately 3/4 of Sr. Unsecured bonds.
This process has taken us past three of the unstable variables we identified. We bypassed repurchase litigation and other loss reserve developments by taking the balance sheet estimates at face value. We dealt with bankruptcy by taking a value of the assets below the reorganizing entity. We have given conservative valuations of subsidiary liabilities. This process has not had any effect on the actual uncertainty of the underlying value. What we have done is found a number to start working with.
Another way - which we will not go through here - to arrive at a preliminary number would be to start with the rehabilitator's base case projections and adjust them for developments since 6/30/10. Using either method, one starts by relying on the assumptions of potentially biased constituents.
Whichever method is chosen, one garners a starting point from which she can apply adjustments. For instance, an increase in repurchase recoveries of $1.5B after bankruptcy would make Sr. Unsecureds 200% of par equivalent. If repurchase litigation hits the skids, any AFGC security is worthless. What are the chance of the rehabilitator permanently impairing AAC equity value?
The issues of repurchases and rehabilitator impairment are the two biggest factors we wrestle with. And while we have developed views on these points, it's sunny outside so we will leave that for another time. So lets get to an ending thought before the cane hooks us off the stage.
As we mentioned earlier Ambac is a far cry from the blue chips. In approaching such a complex situation, one cannot simply model out revenues and expenses into the horizon. Rather, three basic steps should be taken: 1) identify the major risks, 2) get a starting number (or several) that deals with those risks, and 3) apply your views of those risks to the valuation and see what happens. Total loss is a viable outcome but not much more - if at all - likely than a parabolic upswing in price.
We invest in such a way that makes a zero OK. The culture and/or mandate of many professional investment shops precludes taking such risks. Most individuals simply won't approach or don't know how to approach such risks. We postulate that is why distressed investing can be so rewarding.
No, no, nobody asked for my opinion; rather, I am referring to the Financial Accounting Standards Board and their lovely pronouncements of the last several years. In short, they have shown the world which tools not to use in the valuation process while making it more painstaking to extract crucial figures.
The crucial figures are those that indicate how much cash security holders will get and when. Yes, the discounted cash flow, "when do I get the skrilla?", model is the mother of all valuation. Actually building precise models is mostly an exercise in futility when the subject is something as volatile as a bankrupt financial guaranty holding company with a subsidiary in rehabilitation. A multitude of ultra-sensitive and constantly changing assumptions overwhelms conventional precision. Even a single variable can confound a model. For example, assigning a single discounted value to the possibility of permanent impairment by actions of Ambac's rehabilitator is impractical.
A more intuitive approach would be assigning probabilities to a few outcomes representing the real diaspora of possible future events. Said again for the statistician, take a sample representing the population. That is easier said than done when the outcome turns on the decisions of a few individuals.
Continuing with an example for Ambac Hold Co's Sr. Unsecured bondholders, one would then need to apply the same process for other major unstable variables - in this case repurchase litigation, bankruptcy, and loss developments. Better to dump the whole thing into black-scholes and go for a coffee. The inherent difficulty of discounting such components tends to elicit a desire to pack our bags, buy Microsoft, and extrapolate the Office Suite sales off into the sunset. But THAT desire to walk away is precisely what ought to draw at least an initial interest.
Catastrophic past losses and the possibility for total loss should also incite interest along with natural and prudent alarm. Having established interest still leaves us a long way from an investment decision. Lets take a step back before we move forward. Lets take capital structure out of the equation.
Without the firm's own securities, the main components of an economic balance sheet are investments and actuarial accounts. Specifically that is investment portfolio, net expected recovery assets, reinsurance, and premiums receivable on the left and net expected case loss reserves on the right. All of the numbers we will use will continue to be Ambac's and for these they are:
6,983,082+796,622+141,131+2,290,920-6,296,761=$3,773,863k
Investments+Subrogation Recoverable+Reinsurance Recoverable-Loss Reserves=Net Major Assets
With this number we will keep in the back of our minds that we must: 1) adjust our valuation for risks in the insured portfolio; 2) adjust our valuation down for the present value of costs; and 3) adjust our present value up to account for the present value of installment premiums. Due to the economy of time I spend on the couch doing this, we do not bother with the latter two numbers as they are overshadowed by the forces of loss and recovery developments. As for the first item, we note that as a Sr. Unsecured bond holder downside is limited to zero and our view is that recovery potential skews insured portfolio risk to the upside.
Now lets approach capital structure. Here, we all conservatism to reign and so value all liabilities at par though market value may be as little as 15% of that. The predicament of Ram Holdings has proved this method relevant by certain large preferred shareholders being unwilling to tender at deep discounts. Back to the perspective of a Sr. Unsecured Ambac creditor, liabilities valued in this way make for a negative $2,850M ($2.05B AAC surplus notes + $800M AAC Pref. Shares) adjustment bringing our earlier $3,773.9M number to $923.9M. That is approximately 3/4 of Sr. Unsecured bonds.
This process has taken us past three of the unstable variables we identified. We bypassed repurchase litigation and other loss reserve developments by taking the balance sheet estimates at face value. We dealt with bankruptcy by taking a value of the assets below the reorganizing entity. We have given conservative valuations of subsidiary liabilities. This process has not had any effect on the actual uncertainty of the underlying value. What we have done is found a number to start working with.
Another way - which we will not go through here - to arrive at a preliminary number would be to start with the rehabilitator's base case projections and adjust them for developments since 6/30/10. Using either method, one starts by relying on the assumptions of potentially biased constituents.
Whichever method is chosen, one garners a starting point from which she can apply adjustments. For instance, an increase in repurchase recoveries of $1.5B after bankruptcy would make Sr. Unsecureds 200% of par equivalent. If repurchase litigation hits the skids, any AFGC security is worthless. What are the chance of the rehabilitator permanently impairing AAC equity value?
The issues of repurchases and rehabilitator impairment are the two biggest factors we wrestle with. And while we have developed views on these points, it's sunny outside so we will leave that for another time. So lets get to an ending thought before the cane hooks us off the stage.
As we mentioned earlier Ambac is a far cry from the blue chips. In approaching such a complex situation, one cannot simply model out revenues and expenses into the horizon. Rather, three basic steps should be taken: 1) identify the major risks, 2) get a starting number (or several) that deals with those risks, and 3) apply your views of those risks to the valuation and see what happens. Total loss is a viable outcome but not much more - if at all - likely than a parabolic upswing in price.
We invest in such a way that makes a zero OK. The culture and/or mandate of many professional investment shops precludes taking such risks. Most individuals simply won't approach or don't know how to approach such risks. We postulate that is why distressed investing can be so rewarding.
Thursday, February 10, 2011
Ambac Quick Take Update - How about DISCS?
The fundamentals for our earlier released ideas on Ambac Sr. Debt are improving. Meanwhile, prices have not changed much.
Recent publications have been positive. First, there was JP Morgan denying putback demands from securitizations while seeking to putback the same mortgages to originators. Now, more light on Bear Stearns’ collecting money and benefits from non-qualifying collateral and not passing it on to the affected securitization trusts.
Less importantly for Sr. Debt, the suit brought by the IRS against Ambac will likely make this bankruptcy an even longer one. Notably, Ambac has filed a request for extension on the deadline to submit a key plan on how it will treat creditors. These delays give more time for recovery lawsuits to develop. This essentially extends the duration of the call on assets provided by the subordinated DISCS, which have been trading between 0-3% of par recently. While we still expect these to be wiped out, it may be worth throwing some on top of a sr. unsecured position, just in case.
I mean, seriously, who wants to be stuck with a 500% return when 3000% is possible?
UPDATE II - The previous update regarding Ambac Assurance preferred securities should be ignored as your lazy no good analyst failed to confirm the information until after posting the update. While these 144a securities do exist and make sense at the proposed price, no pricing or availability can be sourced by The Blue Dragon at this time.
UPDATE II - The previous update regarding Ambac Assurance preferred securities should be ignored as your lazy no good analyst failed to confirm the information until after posting the update. While these 144a securities do exist and make sense at the proposed price, no pricing or availability can be sourced by The Blue Dragon at this time.
Unimaginable
To what does this title refer? Perhaps it is the devastation that has occurred in the financial guaranty market. Or it could be the conduct of bankers in the world's largest banks. It could be the developments in the guarantors’ struggles for restitution. It could be extreme credit developments that happen far too often.
Art and crappy blogs necessitate interpretation, so we'll have to let you decide. But at this point in the resurrection of bond insurance, it is worthwhile to take a look at where we stand as it relates to less certain recoveries.
Jaw-dropping developments are following jaw-dropping developments. Though only of anecdotal value, having non-business-centric news stories aghast at the transgressions of your alleged wrong-doer is encouraging. Such is the case today with Louise Story of the New York Times reporting on Bear Stearns' ill-mannered handling of ineligible mortgages.
For almost a year or more, it has been publicly revealed that these underwriters generally used reviews by Clayton Holdings to negotiate and not pass on pricing on mortgages. The individual crystallizations of these trespasses make for powerful legal ammunition, not to mention reading.
Art and crappy blogs necessitate interpretation, so we'll have to let you decide. But at this point in the resurrection of bond insurance, it is worthwhile to take a look at where we stand as it relates to less certain recoveries.
Jaw-dropping developments are following jaw-dropping developments. Though only of anecdotal value, having non-business-centric news stories aghast at the transgressions of your alleged wrong-doer is encouraging. Such is the case today with Louise Story of the New York Times reporting on Bear Stearns' ill-mannered handling of ineligible mortgages.
For almost a year or more, it has been publicly revealed that these underwriters generally used reviews by Clayton Holdings to negotiate and not pass on pricing on mortgages. The individual crystallizations of these trespasses make for powerful legal ammunition, not to mention reading.
Perhaps equally powerful to involved parties were last week’s same-day announcements of two rulings on MBIA v. Merrill Lynch. One ruling dismissed the remaining Breach of Contract claim while another, lower court ruling granted MBIA access to rating agency files on the disputed deals. There are three explanations for the appearance of coordination in these rulings. 1) Coincidence. 2) At least one of the two presiding judges/panel of judges considered this case to be an important component of potential settlement talks. For that reason, coordinated announcements were sought to minimize swings in the balance of power at the negotiating table. 3) Eileen Bransten, the lower court judge, saw the dismissal ruling and – in what one might describe as an “oh shit” moment – expedited her ruling to facilitate the since announced amended complaint by MBIA. The Honorable might be inspired in such an action by a deeper familiarity with the case.
Assign weights of probability to these scenarios as you may. However you do so, the likelihood of what most consider a long-tail event continues to grow. Considering that much of what we know today was known by these parties at some earlier time, the information value provided by MBIA’s 4th quarter financial release could be the largest it has ever been, going into or coming out of the recent calamity, or any other time. Ever.
For those sitting in an Ambac office, we think you will be underwriting deals again someday, albeit after a total rebranding or acquisition of the company. Of course it will be years either way, but on March 2nd we will have a much better idea if that time will come in 2013 or 2020. For those at Nat’l PFG, don’t write off 2011 just yet, though we consider 2012 most likely.
Change begets itself. George Soros pounds this home the idea of reflexivity. Developments in the courtroom may already be spilling over into the supply of capital for financial guarantor recapitalization, as very mildly suggested by Radian’s recent comments. With that in mind, our post's title may refer to the future for this industry.
Wednesday, January 12, 2011
Another Cheap Call Option
As Ambac senior debt is for the bond insurers, TGIC is for the private mortgage insurers. Though TGIC looks to be a little bit farther out of the money, the payoffs could be huge. The recent elimination of TGIC debt makes the possibility of a common stock home run feasible. In fact, common equity is directly behind policyholder and operating liabilities of the subsidiary in seniority.
In the capital structure, this is the inverse of Ambac's situation where the bonds would likely claim all future value of the holding company. One of the greatest values of both these ideas is the long life of the securities. To be sure, we consider our Ambac strike price to be much lower with a high payout in our base case scenario. TGIC is our dark horse. And if he's an outside smoker, we'll make a ton while if he isn't we'll lose our principal which isn't much.
Below is a link to the spreadsheet with a simple model of TGIC's future. You can copy it to your own software in order to manipulate or add variables to see the effects. It is quite sensitive, which is half the idea. The other half is that the actuarial assumed losses are too pessimistic.
The technology team - or Mr. Tapley by another name - has learned a very little about sharing spreadsheets, so rather than paste it in a jumble here I've published a link:
https://spreadsheets.google.com/pub?key=0AlFMaAd3v9o0dElZV0pVcEVVWWw2VDhVR0RNdHZLMkE&hl=en&output=html
In the capital structure, this is the inverse of Ambac's situation where the bonds would likely claim all future value of the holding company. One of the greatest values of both these ideas is the long life of the securities. To be sure, we consider our Ambac strike price to be much lower with a high payout in our base case scenario. TGIC is our dark horse. And if he's an outside smoker, we'll make a ton while if he isn't we'll lose our principal which isn't much.
Below is a link to the spreadsheet with a simple model of TGIC's future. You can copy it to your own software in order to manipulate or add variables to see the effects. It is quite sensitive, which is half the idea. The other half is that the actuarial assumed losses are too pessimistic.
The technology team - or Mr. Tapley by another name - has learned a very little about sharing spreadsheets, so rather than paste it in a jumble here I've published a link:
https://spreadsheets.google.com/pub?key=0AlFMaAd3v9o0dElZV0pVcEVVWWw2VDhVR0RNdHZLMkE&hl=en&output=html
Wednesday, January 5, 2011
Ambac Sr. Unsecured and ACA/Goldman
Find a chair and sit in it. Some investors find this type of combobulating discombobulating. Anyway:
Consider yourself agnostic on future loss developments (including recoveries) for a moment. Under such a circumstance you would feel that Scenario 1 under the WI Insurance Commissioners rehabilitation plan (see www.ambacpolicyholders.com) is a balanced forecast. In that scenario, by 2020 statutory surplus net of surplus notes would be roughly 2x the par value of hold co. debt outstanding as of that corporations bankruptcy filing. That multiple goes up if you assume that the $400M of DISC's (similar to TRUP's) is wiped out in reorganization. All the active pari pasu maturities of sr. debentures and notes are quoted and recently trading under 20. With this type of math, you needn't bother unsheathing your HP 12c.
But you really aren't agnostic on loss developments or mortgage-gate, are you? You aren't all jolliness floating down the River Styx like Mark Tapley. That's OK. Here's a big piece of potential upside to lift your spirits.
No financial guarantors are booking benefits for non-putback recoveries. Any recoveries in this area would come from lawsuits under motions relating to breach of contract and negligent misrepresentation. For this class of suit all eyes are on MBIA vs. Merrill. I am still surprised that I still have not seen any commentary relating the ACA/Goldman settlement to this class of suit. IT IS THIS CLASS OF SUIT.
Sure, the SEC was sitting in the FGs seat and with much more leverage, but the circumstances of the case are largely the same. Sure, the suit was resolved by settlement without admission. And sure, one could argue Goldman's motivation was PR, political, or otherwise unrelated to their position in the case. But that does not change the fact that Goldman paid 55% of the initial par value of the deal to put the issue behind them. The FGs don't have subpoena power or public and political ire on their side. They do have a large amount of powerful and incriminating information (think Clayton Holdings. The best summary I have seen on the subject is from John Mauldin toward the end of this article: http://www.johnmauldin.com/frontlinethoughts/the-subprime-debacle-act-2-part-2-mwo102310/)
Ambac has a lot of losses in this area and hasn't booked any recoveries. If it recovers 25% of par in compensatory damages, then the residual value of sr debt is double Scenario 1 or $2B higher. That implies a 1900% return over 9 years. If recoveries look like 55% or 100% or more, then we can switch from multiples to exponents.
It is also worthwhile to note that 1)litigation is beta neutral and 2)a very low probability of Scenario 1 (no CDO recoveries) or better makes these bonds very interesting.
See the February update on developments and DISCS here.
Consider yourself agnostic on future loss developments (including recoveries) for a moment. Under such a circumstance you would feel that Scenario 1 under the WI Insurance Commissioners rehabilitation plan (see www.ambacpolicyholders.com) is a balanced forecast. In that scenario, by 2020 statutory surplus net of surplus notes would be roughly 2x the par value of hold co. debt outstanding as of that corporations bankruptcy filing. That multiple goes up if you assume that the $400M of DISC's (similar to TRUP's) is wiped out in reorganization. All the active pari pasu maturities of sr. debentures and notes are quoted and recently trading under 20. With this type of math, you needn't bother unsheathing your HP 12c.
But you really aren't agnostic on loss developments or mortgage-gate, are you? You aren't all jolliness floating down the River Styx like Mark Tapley. That's OK. Here's a big piece of potential upside to lift your spirits.
No financial guarantors are booking benefits for non-putback recoveries. Any recoveries in this area would come from lawsuits under motions relating to breach of contract and negligent misrepresentation. For this class of suit all eyes are on MBIA vs. Merrill. I am still surprised that I still have not seen any commentary relating the ACA/Goldman settlement to this class of suit. IT IS THIS CLASS OF SUIT.
Sure, the SEC was sitting in the FGs seat and with much more leverage, but the circumstances of the case are largely the same. Sure, the suit was resolved by settlement without admission. And sure, one could argue Goldman's motivation was PR, political, or otherwise unrelated to their position in the case. But that does not change the fact that Goldman paid 55% of the initial par value of the deal to put the issue behind them. The FGs don't have subpoena power or public and political ire on their side. They do have a large amount of powerful and incriminating information (think Clayton Holdings. The best summary I have seen on the subject is from John Mauldin toward the end of this article: http://www.johnmauldin.com/frontlinethoughts/the-subprime-debacle-act-2-part-2-mwo102310/)
Ambac has a lot of losses in this area and hasn't booked any recoveries. If it recovers 25% of par in compensatory damages, then the residual value of sr debt is double Scenario 1 or $2B higher. That implies a 1900% return over 9 years. If recoveries look like 55% or 100% or more, then we can switch from multiples to exponents.
It is also worthwhile to note that 1)litigation is beta neutral and 2)a very low probability of Scenario 1 (no CDO recoveries) or better makes these bonds very interesting.
See the February update on developments and DISCS here.
Tuesday, January 4, 2011
The latest settlement... until the next one.
If you're reading this, you know about it so I'll spare you the review.
My take: it's good for B of A and has good implications for Financial Guarantors too. How can that be?
Well it shows BofA's GSE reserves were about half of what they should have been but BofA will not be wiped off the face of the earth. And this is pleasing to both sides. Look at the stocks today.
Every settlement that doesn't point to exploding investment banks is good for both sides. For the banks it's obvious. For the guarantors it's deeper than just ability to pay. The more the GSE's and uninsured private labels take care of themselves or are otherwise distinguished from the guarantors, the less danger of a rush to the courthouse.
This is the case because the the court system enforces the law with economic incentives in mind. This applies to both judicial and the real economics. Most literature on the subject is focused on long-term incentives. With that in mind, if a ruling would cause one of the biggest investment banks to explode and confidence in all others to evaporate, judge Bransten might still be given pause. Talcott Franklin's innovation was actually a negative to the bond insurers. If Bransten looks out West she can see Bill Gross and his gang perched on the grapevine or the Fed down the street staring right back at her.
Now for the uninsured private labels, securities law provides some distinction from the suits brought by the guarantors. Every 10B-5 dismissal is a win not only for the investment bank/securities underwriters but also the guarantors. If the FG industry can pull in 30B without creating a rush to the courthouse from their winnings, the result is intuitively pleasing in the limited sense of having punished the banks significantly while leaving them standing and restoring the FG industry. If there is little chance of more suits following, exemplary damages could come into play. However, compensatory damages could easily be made large enough to create sufficient deterrence. Start with claims paid and go to legal fees to unearned profits to the cost of financial distress. What will restore a bankrupt Ambac to what it would have been? (Those dollars would flow to the sr. unsecureds if your curious. Quote 13/15 on the 11's. A post on Ambac and implications of ACA Holdings is currently past due. In short, a bet on Ambac Sr. Unsecured is a bet that the ACA/Goldman ruling was (or could be with a probability of about 0.5%) a reliable precedent for CDO fraud.) But as is my way, I have meandered into unbridled speculation.
The point I started to make is that there is room for the costs to grow to investment banks without hurting their prospects. Now, this was acute in especial with BofA. They were under-reserved by roughly half with regard to the GSE's and only (as far as I can make out) have about $500M reserved for insured and uninsured private label (the lion's share of which is probably for Assured.) The $100B discount to book value says the market doesn't buy it, but that is plenty of ground for guarantors to win huge and BofA to prove out. It is also ground in which any greater traffic to the courthouse is manageable for banks and Bransten alike.
My take: it's good for B of A and has good implications for Financial Guarantors too. How can that be?
Well it shows BofA's GSE reserves were about half of what they should have been but BofA will not be wiped off the face of the earth. And this is pleasing to both sides. Look at the stocks today.
Every settlement that doesn't point to exploding investment banks is good for both sides. For the banks it's obvious. For the guarantors it's deeper than just ability to pay. The more the GSE's and uninsured private labels take care of themselves or are otherwise distinguished from the guarantors, the less danger of a rush to the courthouse.
This is the case because the the court system enforces the law with economic incentives in mind. This applies to both judicial and the real economics. Most literature on the subject is focused on long-term incentives. With that in mind, if a ruling would cause one of the biggest investment banks to explode and confidence in all others to evaporate, judge Bransten might still be given pause. Talcott Franklin's innovation was actually a negative to the bond insurers. If Bransten looks out West she can see Bill Gross and his gang perched on the grapevine or the Fed down the street staring right back at her.
Now for the uninsured private labels, securities law provides some distinction from the suits brought by the guarantors. Every 10B-5 dismissal is a win not only for the investment bank/securities underwriters but also the guarantors. If the FG industry can pull in 30B without creating a rush to the courthouse from their winnings, the result is intuitively pleasing in the limited sense of having punished the banks significantly while leaving them standing and restoring the FG industry. If there is little chance of more suits following, exemplary damages could come into play. However, compensatory damages could easily be made large enough to create sufficient deterrence. Start with claims paid and go to legal fees to unearned profits to the cost of financial distress. What will restore a bankrupt Ambac to what it would have been? (Those dollars would flow to the sr. unsecureds if your curious. Quote 13/15 on the 11's. A post on Ambac and implications of ACA Holdings is currently past due. In short, a bet on Ambac Sr. Unsecured is a bet that the ACA/Goldman ruling was (or could be with a probability of about 0.5%) a reliable precedent for CDO fraud.) But as is my way, I have meandered into unbridled speculation.
The point I started to make is that there is room for the costs to grow to investment banks without hurting their prospects. Now, this was acute in especial with BofA. They were under-reserved by roughly half with regard to the GSE's and only (as far as I can make out) have about $500M reserved for insured and uninsured private label (the lion's share of which is probably for Assured.) The $100B discount to book value says the market doesn't buy it, but that is plenty of ground for guarantors to win huge and BofA to prove out. It is also ground in which any greater traffic to the courthouse is manageable for banks and Bransten alike.
Subscribe to:
Posts (Atom)