AMBC - Ambac Assurance Corp

[JRH]

Muni Insurer, fresh out of bankruptcy. 

 

Very good summary:

 

http://reminiscencesofastockblogger.com/2013/05/18/the-hidden-values-of-ambac-ambc/

 

Links to Herzeca's blog post on the potential for Ambac to follow MBIA's litigation template on putbacks:

 

http://mbibaclitigtion.blogspot.ca/2013/05/summing-up-and-what-next.html

 

BTIG report:

 

http://www.scribd.com/doc/141956633/BTIG-Ambac-Financial-Group-Initiation-5-16-13

 

Lots of chatter on Twitter ($ambc) on some useful details as well (i.e. warrants).

[JRH]

Some talk in the MBIA thread starting here:

 

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/mbi-mbia-inc/msg117791/#msg117791

[BargainValueHunter]

What are the terms of the warrants?

 

Is there an advantage in holding the warrants vs. the common?

 

 

 

[PlanMaestro]

I was wondering why no one had started a thread. The warrants are non-Tarp: no dividend adjustments and in general the dilution protections look weak. Seem expensive to me with an intrinsic vol in the 40s.

 

However, considering that the warrants expire in 2023 a lot depends on how cheap is the underlying. I've not seen a good valuation and worst case, most probably because no one really understands it yet.

 

[no_free_lunch]

A few things, just my simple attempt to answer some comments earlier in the thread.

 

The EPS for the last quarter were based on the old share count, there are now only 45M shares after the re-org.  Based on that share count the EPS last quarter would have been $6 and change.  I wouldn't expect that type of earnings on a long-term basis as there were negative loan losses and gain on assets.  The blog link posted at the start of the thread has a better interpretation of more normal earnings, $2 / quarter in a low loan loss environment seems reasonable to me.  That amount will trail off over the next decade if they don't write new business.

 

Regarding the warrants, see propsectus here.  It is a bit weak compared to the tarp warrants but it sounds like it would cover spinoffs at least.

 

http://www.sec.gov/Archives/edgar/data/874501/000114420413025536/v343212_8a12b.htm

 

(i) In case the Registrant shall (A) declare a dividend on its Shares payable in Shares or securities convertible, exercisable or exchangeable into Shares, (B) subdivide the outstanding Shares, whether by way of stock dividend, stock split or otherwise, © combine the outstanding Shares into a smaller number of shares, whether by way of stock combination, reverse stock split or otherwise, or (D) issue any shares of its capital stock in a reclassification of, or similar transaction relating to, the Shares (including any such reclassification in connection with a consolidation or merger in which the Registrant is the continuing corporation), the number of Shares acquirable upon exercise of the Warrants on such date shall be proportionately adjusted so that the holder of any Warrant exercised after such action shall be entitled to receive the aggregate number of Shares which, if such Warrant had been exercised immediately prior to such action (or, in the case of a dividend, immediately prior to the record date therefor) and at a time when the common stock transfer books of the Registrant were open, such holder would have owned upon such exercise and been entitled to receive by virtue of such action. In any such event enumerated in clauses (A) to (D) above, the exercise price of the Warrants shall be adjusted to equal (A) the exercise price immediately prior to such adjustment multiplied by the number of Shares for which a Warrant is exercisable immediately prior to such adjustment divided by (B) the number of Shares for which a Warrant is exercisable immediately after such adjustment.

 

Regarding the valuation, maybe this is a simple way to view it:

 

After fresh start, the company has $0.4B equity.  $2.3B is a true-up to match to fair value so we should just ignore that for now as it's mostly assuming recovery of loan losses.  With that removed you have -$1.9B book.

 

Loan loss reserves of $6.5B at 60% recovery rate would give you $3.9B increase to book.  I have no idea if this is a reasonable recovery estimate but I believe it was suggested on the blog and by a previous board poster.  That would set the book at $2B.

 

There is $5.2 B Net Operating Losses oustanding by my count.  If the business can clean up it's finances , remain profitable and engage in new business wouldn't those be added back to book?  At 35% tax rate that's an additional $1.8B.  Admittedly it would take years for these losses to be added back to book.  In this rosy scenario that pushes your book back to $3.8B.

 

You also have the $2.6B in premiums receivable.  At the very least, this should keep the lights on until the finances are shored up.  In a low loan-loss environment they could actually add considerable dollars to the book.

 

Finally, there is the possibility of new business at some point.

 

Downside is pretty simple, $0 per share and $0 per warrant.  This above all else is why I am going with the warrants, given the risk I am taking I need that higher leverage rate if the stock goes up.  True, I will eat the financing on the warrants if the share price surges but that seems like a good problem to have.

[BargainValueHunter]

A few things, just my simple attempt to answer some comments earlier in the thread.

 

The EPS for the last quarter were based on the old share count, there are now only 45M shares after the re-org.  Based on that share count the EPS last quarter would have been $6 and change.  I wouldn't expect that type of earnings on a long-term basis as there were negative loan losses and gain on assets.  The blog link posted at the start of the thread has a better interpretation of more normal earnings, $2 / quarter in a low loan loss environment seems reasonable to me.  That amount will trail off over the next decade if they don't write new business.

 

Regarding the warrants, see propsectus here.  It is a bit weak compared to the tarp warrants but it sounds like it would cover spinoffs at least.

 

http://www.sec.gov/Archives/edgar/data/874501/000114420413025536/v343212_8a12b.htm

 

(i) In case the Registrant shall (A) declare a dividend on its Shares payable in Shares or securities convertible, exercisable or exchangeable into Shares, (B) subdivide the outstanding Shares, whether by way of stock dividend, stock split or otherwise, © combine the outstanding Shares into a smaller number of shares, whether by way of stock combination, reverse stock split or otherwise, or (D) issue any shares of its capital stock in a reclassification of, or similar transaction relating to, the Shares (including any such reclassification in connection with a consolidation or merger in which the Registrant is the continuing corporation), the number of Shares acquirable upon exercise of the Warrants on such date shall be proportionately adjusted so that the holder of any Warrant exercised after such action shall be entitled to receive the aggregate number of Shares which, if such Warrant had been exercised immediately prior to such action (or, in the case of a dividend, immediately prior to the record date therefor) and at a time when the common stock transfer books of the Registrant were open, such holder would have owned upon such exercise and been entitled to receive by virtue of such action. In any such event enumerated in clauses (A) to (D) above, the exercise price of the Warrants shall be adjusted to equal (A) the exercise price immediately prior to such adjustment multiplied by the number of Shares for which a Warrant is exercisable immediately prior to such adjustment divided by (B) the number of Shares for which a Warrant is exercisable immediately after such adjustment.

 

Regarding the valuation, maybe this is a simple way to view it:

 

After fresh start, the company has $0.4B equity.  $2.3B is a true-up to match to fair value so we should just ignore that for now as it's mostly assuming recovery of loan losses.  With that removed you have -$1.9B book.

 

Loan loss reserves of $6.5B at 60% recovery rate would give you $3.9B increase to book.  I have no idea if this is a reasonable recovery estimate but I believe it was suggested on the blog and by a previous board poster.  That would set the book at $2B.

 

There is $5.2 B Net Operating Losses oustanding by my count.  If the business can clean up it's finances , remain profitable and engage in new business wouldn't those be added back to book?  At 35% tax rate that's an additional $1.8B.  Admittedly it would take years for these losses to be added back to book.  In this rosy scenario that pushes your book back to $3.8B.

 

You also have the $2.6B in premiums receivable.  At the very least, this should keep the lights on until the finances are shored up.  In a low loan-loss environment they could actually add considerable dollars to the book.

 

Finally, there is the possibility of new business at some point.

 

Downside is pretty simple, $0 per share and $0 per warrant.  This above all else is why I am going with the warrants, given the risk I am taking I need that higher leverage rate if the stock goes up.  True, I will eat the financing on the warrants if the share price surges but that seems like a good problem to have.

 

 

Informative post. :)

 

Would it be a bad idea to write covered calls on a half position in the common as a way of justifying holding the other half in warrants (for the leverage) in case of a "best case scenario situation?

 

 

[yitech]

The options are very short-term, latest strike is November of this year.  I have no idea how long this thing will take to play out but Novemer just seems too soon.  The options are also very expensive.

 

Question for anyone here. I saw an item called Insurance intangible, which is around $2.345B. On p.59 of the 10Q, "Insurance intangible: Represents the fair value adjustment for financial guarantee insurance and reinsurance contracts."

 

It seems like some sort of fair-value adjustment. Do you think it ought to be assigned zero value? Does anyone know what the heck it really is?

[no_free_lunch]

For my analysis I removed it.  I couldn't figure out exactly what it is either. However, if you go to page 25 of the 10-Q there is a section where they adjust their balance sheet to fair value.  There are a number of adjustments made but they result in the book being adjusted up (via adjusting liabilities down) by about $2.5B.  To do this, the main item is they adjust the losses down significantly.  I think they are applying the same process but post fresh-start to bring things in line with what they are calling fair value.

 

Basically, I think if you use the $.4B book from fresh-start then you are already including assumptions of $2-2.5 B to loan loss recovery.  It just seems simpler to take it out.

[jay21]

If anyone works with RMBS or knows someone that does,  I'd love to hear if they think going long wrapped RMBS is a better play and/or what their recovery assumptions are for the surplus note.

[Guest hellsten]

Muni Insurer, fresh out of bankruptcy. 

 

Very good summary:

 

http://reminiscencesofastockblogger.com/2013/05/18/the-hidden-values-of-ambac-ambc/

 

Links to Herzeca's blog post on the potential for Ambac to follow MBIA's litigation template on putbacks:

 

http://mbibaclitigtion.blogspot.ca/2013/05/summing-up-and-what-next.html

 

BTIG report:

 

http://www.scribd.com/doc/141956633/BTIG-Ambac-Financial-Group-Initiation-5-16-13

 

Lots of chatter on Twitter ($ambc) on some useful details as well (i.e. warrants).

 

Thank you for posting. Ambac is definitely an interesting idea. Who in the world of "professional" money management would have the balls to buy a company that just emerged from bankruptcy and which is not covered by Morningstar or ValueLine :)

 

From BTIG presentation:

We estimate AMBC’s paid claims to R&W counterparties such as JPMorgan, Bank of America/Countrywide, Credit Suisse, Nomura, and FirstFranklin at $2.5bn. If the company was able to recover 50% of this amount, that $1.258 bn would exceed AMBC’s current market capitalization of $1.065bn.

 

So they might be able to recover $14.3-24.3 per share.

 

The risks seem low according to BTIG:

The primary risks to achieving our price target include the possibility that reserves against losses associated with RMBS and other insured instruments may proveinadequate, that fiscal stress of state and local governments could translate into increased losses, and that declines in value of investment portfolio could impede Ambac’s ability to pay its liabilities.

 

Legal details are speculation, but provide much of the potential upside:

In this recent example, Justice Bransten was right on the law, and Justice Ramos was wrong on the law.  I will cover this example in a future blog post, but this example has particular significance to speculators in Ambac stock, as two of Ambac's largest R&W cases are in front of, you guessed it, Justices Bransten and Ramos.

 

In future posts in this blog, I will focus on Ambac's cases in particular, as I have a dog in that fight. Ambac is the monoline that has the largest potential fraud and breach of contract damage recoveries remaining among the monolines, and it appears that it may just be catching the wave.

…

But as more decisions are handed down, and the legal position of the monolines becomes increasingly secure, it appears that the mbs litigation wave is rolling to shore with increasing amplitude, and Ambac is now in the best position to catch this wave.

Source: http://mbibaclitigtion.blogspot.ca/2013/05/lessons-learned-and-new-blog-title.html

 

Another interesting document from 2010 has this to say about Ambac vs. MBIA:

many investors we have spoken with over the years had considered Ambac the more sophisticated of the two companies. We believe the premature failure of Ambac relative to MBIA can be largely attributable to its inability to execute a split of its book of business and failure to raise sufficient additional capital before the markets shut down.

Source: http://www.scribd.com/doc/101757923/Why-MBIA-is-Different-Than-Ambac

[JRH]

Thank you for posting. Ambac is definitely an interesting idea. Who in the world of "professional" money management would have the balls to buy a company that just emerged from bankruptcy and which is not covered by Morningstar or ValueLine :)

 

It is almost certainly underfollowed at the moment, but I couldn't personally convince myself it is undervalued.  My key observations:

 

- The pro-forma post-bankruptcy balance sheet appears to be more comparable to MBI/AGO "adjusted book value" where future premiums are discounted back to the present (thus highly discount rate-sensitive) and recorded as an asset (I might be answering Yitech's earlier question here).

- The putback receivable on the balance sheet implicitly expects a certain recovery on losses but I couldn't find enough information to understand whether it was conservative, reasonable, or aggressive.  I followed Christian Herzeca's commentary through the MBIA/BAC litigation and think I generally understand his rationale for further litigation wins but unfortunately I don't know how to quantify that back to intrinsic value.

 

That's really all it took for me to pass.  I'd love for those things to clear up and take a swing, but couldn't do it based on what I know today.

[no_free_lunch]

BTIG has another post on Ambac, this time discussing the new "intangibles" section of the balance sheet.

 

It’s actually the net amount of Fresh Start Accounting-related impact on several different line items. These include premium receivables, reinsurance recoverable on paid and unpaid losses, and subrogation recoverable on the asset side of the balance sheet, and unearned premiums, loss and loss expense reserve, and ceded premiums payable on the liability side.

 

http://www.btigresearch.com/2013/05/28/ambac-financial-what-exactly-is-that-2-35bn-insurance-intangible-on-the-pro-forma-fresh-start-balance-sheet/

 

 

[yitech]

On P.25, it does fair-value adjustments. VIE Debts are mostly Level 2 while VIE Loans are mostly Level 3(more opaque). Is the VIE Long-term debt non-recourse to the equity holder? I mean if it is recourse only to the VIE Loans, the balance sheet doesn't seem so dangerously levered.

[constructive]

The 10K doesn't offer much on the noncontrolling interest:

 

"Non-controlling interests: The fair value adjustment [from $660M down to $223M] is based on current quotes from market sources."

 

It seems like the noncontrolling interest is related to VIE ownership/financing [page 11]. In an upside scenario, do you think this liability would be written back up? Maybe older filings have more info.

[constructive]

On P.25, it does fair-value adjustments. VIE Debts are mostly Level 2 while VIE Loans are mostly Level 3(more opaque). Is the VIE Long-term debt non-recourse to the equity holder? I mean if it is recourse only to the VIE Loans, the balance sheet doesn't seem so dangerously levered.

 

Ambac’s subsidiaries provided financial guarantees in respect of assets held or debt obligations of special purpose entities, including VIEs. Ambac’s primary variable interest exists through this financial guarantee insurance or credit derivative contract. The transaction structure provides certain financial protection to Ambac. This financial protection can take several forms; however, the most common are over-collateralization, first loss and excess spread.

...

 

We determined that Ambac’s subsidiaries generally have the obligation to absorb the VIE’s expected losses given that they have issued financial guarantees supporting the liabilities (and in certain cases assets) of a VIE. [Page 10]

 

[yitech]

On P.25, it does fair-value adjustments. VIE Debts are mostly Level 2 while VIE Loans are mostly Level 3(more opaque). Is the VIE Long-term debt non-recourse to the equity holder? I mean if it is recourse only to the VIE Loans, the balance sheet doesn't seem so dangerously levered.

 

Ambac’s subsidiaries provided financial guarantees in respect of assets held or debt obligations of special purpose entities, including VIEs. Ambac’s primary variable interest exists through this financial guarantee insurance or credit derivative contract. The transaction structure provides certain financial protection to Ambac. This financial protection can take several forms; however, the most common are over-collateralization, first loss and excess spread.

...

 

We determined that Ambac’s subsidiaries generally have the obligation to absorb the VIE’s expected losses given that they have issued financial guarantees supporting the liabilities (and in certain cases assets) of a VIE. [Page 10]

 

Thanks, constructive!

[yitech]

The 10K doesn't offer much on the noncontrolling interest:

 

"Non-controlling interests: The fair value adjustment [from $660M down to $223M] is based on current quotes from market sources."

 

It seems like the noncontrolling interest is related to VIE ownership/financing [page 11]. In an upside scenario, do you think this liability would be written back up? Maybe older filings have more info.

 

"The adoption of SFAS 160 will require Ambac to reclassify $700,000 for non-controlling interests in subsidiaries from liabilities into equity. This is primarily related to the issuance of Ambac Assurance’s perpetual preferred shares in December 2008 under the contingent capital facility described in Note 14." [page 142 '09 10K]

 

"Due to the dislocation in the auction rate markets and Ambac Assurance’s downgrade below triple-A by Moody’s and S&P, the dividend rate on the auction market preferred has continuously been reset at the maximum rate of one-month LIBOR plus 200 basis points. At December 31, 2008, the $700,000 is recognized as minority interest on the Consolidated Balance Sheets." [page 173 '09 10K]

 

I think it's more likely that it would be written up in an upside scenario. Otherwise the Fresh-start accounting might include an entry such as Noncontrolling interest subject to compromise.

[constructive]

Good find yitech. If the ARPs are really perpetual, I wouldn't necessarily mark them back up because the fair value is pretty low. On the other hand they might not really be perpetual if they're associated with subs that will run off, or if they're legally vulnerable.

 

I had a thought on NOLs and writing any future business. My approach wouldn't be to assign a dollar value to the NOLs, it would be to place a P/B multiple on the terminal book value estimate. So if you assume they can write new business at 12% ROE including the NOLs, you might assign a 1.2x multiple. Of course any future value should also be discounted back to the present.

[constructive]

Is anyone familiar with the preferred? I wonder if they are a more attractive investment than the common.

 

http://www.otcmarkets.com/stock/ALSC/news?id=61645

 

ALSC claims that Ambac wrongfully forced conversion of Auction Rate securities to AMBAC preferred, now trading at .21 to .375 of face value.

 

"Alliance plans to continue its participation in the lawsuit against AMBAC Assurance Corporation alleging that AMBAC Assurance wrongfully converted the original securities purchased by ALSC into AMBAC preferred shares."

[BargainValueHunter]

http://finance.yahoo.com/news/analysis-detroit-crisis-may-lift-121029630.html

 

Before the crisis, about half of all new municipal bonds had insurance from nine insurers, with nearly 60 percent covered in 2005. Last year, just 3.6 percent were insured, and this year the number is just over 3 percent, Thomson Reuters data shows.

 

Bond insurers collapsed during the financial crisis after they ventured into mortgage-backed securities in the years before 2007. Ratings agencies slashed their AAA ratings to junk or withdrew them altogether. That meant bond issuers no longer benefited from their coverage.

 

With insurers failing to make promised payments, their stock tanked and so did their businesses.

 

Insurers are among the biggest players in Detroit's case, as about 86 percent of the city's $8 billion debt is insured by six companies. But the bulk of losses is expected on only about $530 million of unsecured general obligation bonds, which are payable over the next 22 years.

 

That makes the hit insurers would take from Detroit manageable, analysts say. At the same time, coming after other municipals bankruptcies such as Jefferson County in Alabama or Stockton and San Bernardino in California, Detroit would help investors see the benefit of bond insurance.

[muscleman]

Is anyone familiar with the preferred? I wonder if they are a more attractive investment than the common.

 

http://www.otcmarkets.com/stock/ALSC/news?id=61645

 

ALSC claims that Ambac wrongfully forced conversion of Auction Rate securities to AMBAC preferred, now trading at .21 to .375 of face value.

 

"Alliance plans to continue its participation in the lawsuit against AMBAC Assurance Corporation alleging that AMBAC Assurance wrongfully converted the original securities purchased by ALSC into AMBAC preferred shares."

 

I can't find the symbol for it. From the form 25, it looks like the old common stock and two kinds of debts are canceled, and a new common stock is issued, but I didn't find any info about preferred.

It seems like the new AMBAC has common and warrants though.

http://ir.ambac.com/releasedetail.cfm?ReleaseID=761498

[BargainValueHunter]

The 2023 warrants were crushed today.

 

Is Puerto Rico going to be the death of Ambac or a "2011 BAC" style opportunity?

[BargainValueHunter]

To add...

 

http://www.bondbuyer.com/issues/122_168/optimistic-insurers-on-hook-for-16-billion-dollars-in-puerto-rico-1055101-1.html

 

Ambac has a total of $2.53 billion of net par value of outstanding exposure to Puerto Rico debt, according to data from company filings. The biggest part of that, $805 million, is in Puerto Rico Sales Tax Financing Corporation. COFINA sales tax-backed bonds are some of the territory's highest-rated debt, with AA-minus scores from Fitch and S&P.

 

http://www.marketwatch.com/story/ambac-reports-profit-out-of-bankruptcy-protection-2013-08-14-948545

 

For the two-month period from May 1 to June 30, the newly emerged company reported a profit of $205.7 million, or $4.42 a share, on total revenue of $242.8 million. The predecessor company posted a loss of $811.1 million, or $2.68 a share, with total revenue being negative $6 million during the second quarter a year ago.

 

The latest two-month period had only $36.6 million in total expenses before reorganization items and no debt-extinguishment related losses, while the predecessor company's results were weighed down by losses in derivate products and net realized losses on extinguishment of debt, as well as $806.8 million in total expenses before reorganization items.

[BargainValueHunter]

http://online.wsj.com/article/BT-CO-20131010-711139.html

 

Of the company's exposure to Puerto Rico debt, about 90% is revenue debt--including revenue pledges from toll receipts, and sales, gas, rum, and hotel-occupancy taxes.

 

Ambac's largest exposure is to sales-tax revenue bonds totaling $808 million and issued by the Puerto Rico Sales Tax Financing Corp. Those bonds are safer than other debt issued by Puerto Rico, as the government isn't allowed to tap the agency's sales taxes to pay other obligations.

 

Other exposure listed by Ambac, including the rum and hotel-occupancy tax revenue bonds, are subject to claw back under Puerto Rico's constitution.

 

Ambac also said about 10% of the total Puerto Rico debt it insures is commonwealth general obligation-backed debt.

[muscleman]

To add...

 

http://www.bondbuyer.com/issues/122_168/optimistic-insurers-on-hook-for-16-billion-dollars-in-puerto-rico-1055101-1.html

 

Ambac has a total of $2.53 billion of net par value of outstanding exposure to Puerto Rico debt, according to data from company filings. The biggest part of that, $805 million, is in Puerto Rico Sales Tax Financing Corporation. COFINA sales tax-backed bonds are some of the territory's highest-rated debt, with AA-minus scores from Fitch and S&P.

 

http://www.marketwatch.com/story/ambac-reports-profit-out-of-bankruptcy-protection-2013-08-14-948545

 

For the two-month period from May 1 to June 30, the newly emerged company reported a profit of $205.7 million, or $4.42 a share, on total revenue of $242.8 million. The predecessor company posted a loss of $811.1 million, or $2.68 a share, with total revenue being negative $6 million during the second quarter a year ago.

 

The latest two-month period had only $36.6 million in total expenses before reorganization items and no debt-extinguishment related losses, while the predecessor company's results were weighed down by losses in derivate products and net realized losses on extinguishment of debt, as well as $806.8 million in total expenses before reorganization items.

 

But what is the adjusted book value for AMBC? Isn't it only 400 Million? If this is trading at 2x adjusted book value, that is not cheap.