Pick up this strange gem?
Now, its another 1.5 hour before your wedding begins. Both of you were in disarray, however something needs to be done quickly and decisively. You rushed down to a diamond ring shop just 5 miles from the church hoping to get a proper ring at least. But in disbelieve the diamond shop had closed.
You can't believe your crazy bad luck. As you knee down in despair , praying to God for a miracle , you spot a small tiny diamond that lies out the diamond shop on the ground You picked it up and examined it. You ponder hard, as to whether this tiny diamond was actually real or it actually came from a small stupid girl's barbie doll necklace. Remember, time was running out, you have less then one hour before the wedding starts, you caution yourself that your "wife to be" is a professional gem analyst and that any fake gem or diamond would be immediately caught by her trained eyes, this would then really upset her and that's what you do not want. You also do not want to be late for the wedding, because its generally not nice to leave your wife standing there alone in front of the congregation waiting for you. So the question is, you will pick up this small diamond and fixed it onto that ring or choose go down another 10 miles to buy a proper diamond ring and risk being late?
This story somewhat depicts my dilemma as to whether i should or shouldn't buy this stock trading on the US stock market. Just like the groom, im afraid that i might pick up a fake gem and upset my wife which is my portfolio. And if i don't pick up this gem (stock), im might miss out or be late for a huge rally that may come.
This strange gem called ABK (Ambac Financial Gorp)
Their primary business is to provide financial guarantees and financial services to clients in both the public and private sectors around the world.
As such, Bond insurers like them have lost billions of dollars by moving beyond their traditional business of backing muni bonds and insuring risky sub prime debt. The losses could result in the insurers losing their coveted triple A debt rating, which is crucial for their business and of course that has come to pass. Recently they have received a Baa1 rating from Moody's Investors Service, Inc. with a developing outlook and a AA rating from Standard & Poor's Ratings Services with a negative outlook.
----The problems---------
1)Rating Risks
Since June, when Ambac was stripped of its "AAA" ratings,the insurer's ability to write new business has come to a virtual standstill. Continuing deterioration in housing and the economy, meanwhile, makes it more likely the company will face more claims on mortgage debt it has insured.
2)Broken Business Model/Negative NAV value
The company's business model is essentially broken, it's not going to be able to underwrite any significant volume of new business at any point in the foreseeable future, which probably suggests runoff as being at least the near-term and intermediate status quo for them," said David Havens, desk analyst at UBS in Stamford, Connecticut. Under Ambac's balance sheet, the company when to factor in Deferred tax benefit of $2.8billion, in which in order for this asset to be realised, it has to have an earnings that justify such a benefit. As such, with losses in its income statement, JP Morgan have to assume that this so called tax benefit has to be written down by 50% in doing so resulting in a negative net asset value of $3.24
To summarise Ø Ambac is a company with a broken business model saddled with substantial liabilities and negative tangible equity
3)Effects of the downgrade (http://www.istockanalyst.com/)
The downgrade likely means Ambac will not underwrite any more business, said John Flahive, director of fixed income for BNY. Market prices of existing bonds insured by Ambac and MBIA Inc. were trading lower before the downgrade, and Flahive suggested any further downgrade could accelerate the decline.
Prior to Ambac's downgrade, T.J. Marta, a fixed-income analyst at RBC Capital Markets, said a downgrade of the company would lead to downgrades of all the municipal bonds it insured. Subsequently, it will become more difficult for cities, counties and other local entities to issue debt for building projects
The more profound fissure opening is the potential for the loss of the triple-A guarantee rating for market leaders MBIA and Ambac, which would virtually put them out of business. Their business model depends on their ability to put the imprimatur of a triple-A rating, effectively performing the modern-day alchemy of turning leaden credits into gold.
4)Not too big to fall.
Ambac sold insurance worth about $60 billion of corporate,sovereign, asset-backed and other debt, mainly using credit default swaps. As concerns about the company's health increase, investors and banks that bought protection from Ambac may unwind their deals to offset the risk of Ambac's failure. With no news on any bailout or any government intervention, this insurance company is deemed not "too big" to fall. Suffice to say with many on going problems in the US financial world, companies like AIG/Fannie/Freddie all wanting a piece of the $700billion bailout, and with regards to the fall in Lehman brothers, this company is more or less on its own.
5) Long term negative effects
One rating agency published that “…the bulk of ultimate losses will be recognized over a longer period of time, as evidenced by cumulative loss levels which are currently averaging 1.5% to 4.2% across the vintages reviewed.” They further confirmed that, “Current losses are still low because loans remain relatively unseasoned in more recent vintages and partly because modifications may also be slowing down loss recognition. In other words, if one were to invest his or her money in this stock, one has to hold for a very long LONG time.
With a mountain of problems facing the company, there is always that small ray of hope that the company might overcome their problems and likewise become a gem for me to hold.
Therefore, Four glaring factors that invoke me to take note. They are
++Eye of Buffet++
1) Warren Buffet set his eyes on the company, he wanted to offered a second level of insurance on their municipal bonds of up to $800billion early as Feb 13, 2008 for three insurance company including Ambac. So the question here is, why would Buffet want to establish such a move? Did he see value in these companies such as Ambac? Or did he just want the high premiums by backing muncipal bonds because he is confident that the company will be able to pay the premium first regardless of what happens to their other assets and subsequently to their ratings?
++Reversal of Upgrade++
2)The fact that Moody downgraded the company to baa1 junk status, without doing an analysis of their portfolio goes to show that there is a possibility that Moody might just regrade Ambac again in the future.Ratings reversal upside potential, if Ambac were to achieve a AAA IFS rating from both Moody’s and S&P at some point going forward, I believe the stock may be able to outperform analyst's estimates.
++Doing all they can++
3)Yes they are! What do you do if your company is saddled with a huge amount of toxin assets, but have a good business model that has tested the passage of time for about 80 over years?
You first have to settle to concern of solvency. Because your assets are negative after factoring out those toxin sub-prime related instruments. Your liabilities do not decrease, so that gives raise to this liquidity gap. Which in turn downgrades your rating as a insurance company. Therefore, i listed down what they are doing or have been doing so far for the company.
- Ambac has received approval from the Wisconsin Office of the Commissioner of Insurance (OCI) to utilize the resources of AAC to resolve this liquidity gap. They will continue to work collaboratively with the OCI as we seek to reduce balance sheet risk in an orderly fashion. Wisconsin Insurance Commissioner,is Ambac's main bond insurance subsidiary to make up this shortfall.
- Ambac continues to pursue a number of loss remediation strategies in its direct RMBS portfolio. Those strategies allowed Ambac to reduce its expected ultimate loss by approximately $260 million in the second quarter of 2008, and they are working diligently to expand on those efforts
- In addition, they are in active discussions with CDO of ABS counter parties. The successful resolution of these discussions would result in decreased uncertainty related to these exposures and likely would result in an improvement in their capital position. Collateralized debt obligations (CDOs) are an unregulated type of asset-backed security and structured credit product.
- Aggressively managing their mortgage-related exposures and have made demonstrable progress in reducing the risk in their insured portfolio. Ambac’s financial strength will continue to improve as we de-lever and commute and re mediate their exposure.
4)I already missed out once! ABK traded at $1.30 as at 1st July 2008. I hesitated to buy , with obvious reasons. Then lo and behold, the stock traded at $8.06 in Sept and as of now at Nov 11 2008 it has fallen back to $1.46+ per share. Time to buy? Maybe ..maybe not. Because of the fact that ABK can raise to $8.06 , already breaks my heart and cause me to feel great regret for not buying. I don't want this to happen again.
+++Other positive points to take note of++++
One potentially bright point for Ambac's liquidity would be
if it makes agreements with counter parties to tear up contracts
on risky residential mortgages. Ambac said in a response to Moody's downgrade on Wednesday
that the rating agency failed to account for the early termination of some of its contract exposures, and for federal efforts to improve the liquidity of financial institutions. "Something that could change the game and prevent them from becoming even more unhealthy, would be to commute a substantial number of the chunky ABS CDO exposures and risks they have,"
said UBS' Havens. "That could very substantially improve their prospects." http://www.reuters.com/article/marketsNews/idINN0757391420081107?rpc=44
Strategies
- Strategy 1: ABK trades at $1.48 per share at Nov 12th 2008. One has to wonder why hasn't the share price goes go all the way to zero? Just like in the case of Indy Mac. Could there be a slight possibility that they might surivive this crisis? Who knows? I believe the price at $1.48 per share has factored in lot of these negative news, like poor prospects,more losses, negative NAV, insolvency. To play safe i would like to go in at a price of $1.30-$1.10, would cut loss at $0.80. Take profit at $3.40
- Strategy 2: Since ABK's rating have already been dropped to bbba1, i could wait on the sidelines and see whether the company is able to survive the effects of such a downgrade. Because my main concern is solvency, are they able to survive and not go bankrupt on me.
- Strategy 3: Study the technical analysis throughly , enter when MA 10 and MA 40 cuts, stocastics indicates an upside cross over and RSI states upside potential. Or just wait for another huge bear market and then scoop up the shares from there.
- Strategy 4: Wait for any government intervention to be factored in. Beacuse, like i said, the thing that bothers me the most is the company's solvency. If there is, government intervention in the future, i would be satisfied paying a price of $1-$2 per share, no more then that of course.
I know, im not following any of Buffet's value principals and the chances of me picking up a fake gem is quite high. Im i speculating ? Probably..but i already estimated the probability of the upside and the downside. And its looking good at $1.46 per share.
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