Monday, December 31, 2007

Would you trust your retirement to MBIA?

By Reggie Middleton for Seeking Alpha

Okay folks, it's official! According to Moody's, you can now put your retirement portfolio in Ambac (ABK) bonds in addition to those boring Treasuries, because it is just as safe - AAA safe! Moody's has spoken...


Moody's gave a tentative pass to the biggest bond insurer, MBIA Inc., by affirming its rating late Friday but changing the outlook to "negative," in a move sure to cause howls from bearish investors and sighs of relief from Wall Street. Moody's also affirmed the triple-A rating of Ambac Financial Group Inc., another major bond insurer.

Moody's update of its view of the bond insurers had been awaited because of concern about the impact of troubles in the mortgage market on securities that bond insurers cover. Bond insurers guarantee the principal and interest payments on more than $2 trillion in debt, including securities that are backed up by mortgages.

Both MBIA and Ambac are top-rated insurers, and both have announced moves this month to boost their capital, which could help protect those ratings. This month, a private equity firm agreed to provide up to $1 billion to MBIA, which said at the time that it was also considering additional capital options. And Ambac struck a deal under which it bought reinsurance for a $29 billion portfolio."


MBIA (MBI) takes nearly a billion dollars in value losses on its portfolio in one month, gets a 500 million dollar equity investment below current market price, and an offer for another $500 million through a discounted right's offering, which brings it back to where it was before it lost the $1 billion last month (which was in trouble) and it gets its AAA rating confirmed??? Ambac buys reinsurance from Assured Guarantee (AGO), a company in the same business as Ambac taking very similar losses, and it gets to retain its AAA rating??? Doesn't anyone see concentration risk and an uncomfortable amount of correlation here, or is it just me?

Assured Guaranty reported a net loss of $115.0 million, or $1.70 per diluted share, for the quarter ended September 30, 2007 compared to net income of $37.9 million, or $0.51 per diluted share, for the third quarter of 2006. The decline in net income was primarily due to an after-tax unrealized mark-to-market loss on derivatives (hey, isn't that what Ambac and MBIA said as well?) that was announced by the Company on October 22, 2007 of $162.9 million, or $2.40 per diluted share, on financial guaranties written in credit default swap ("CDS") contract form. As of November 30th (38 days later), it reported that it has after tax mark to market losses of $220 million. They are averaging one and a half million dollars per day in value loss, with this rate bound to accelerate in the very near future (they only had $1.6 million in 9/06 - that's a 200x increase). The macro conditions that brought upon the CDS (paper) loss are getting much worse, not better as the trend clearly indicates. About 70% of the unrealized CDS loss stems from RMBS and CMBS swaps. Well, you know how I feel about the residential market. Here is how I feel about the commercial market. Things are about to get much worse. Despite all of this, AGO now accepts $29 billion of additional ceded risk from one of the most dangerous monoline portfolios in the business. I am appalled!

I hear a lot of people crooning about this being only paper losses, and not actual claims until payment is defaulted or missed or principal is actually and materially impaired before maturity. Well, it is happening now, and in droves. AGO's management laments on how they have minimal exposure and losses to direct subprime liabilities, which appears to be true with a casual glance at their reporting, but the devil is again, in the details. Aside from 75% of AGO's mortgage portfolio being in the most toxic vintages of 2006 and 2007 (which most likely will lead to problems down the line), they have a strong correlation in product mix with Ambac, the company they just reinsured $29 billion of exposure. Ambac's loss exposure is stemming primarily from their structure product and consumer finance guarantees, not their residential mortgages, per se. Structured finance in particular is what got them in trouble. There is no real loss history on this stuff, because it is brand new and the losses that are being witnessed now are tremendous. Well, hazard a guess as to where the majority of Assured's earned premium comes from? That's right, structured finance. As of 9/30/07, it was 58%. Now, with the acquisition of Ambac's risk, and of course depending on exactly what it was that was actually reinsured (we don't really know yet, do we?) it will/can definitely shoot upwards, significantly upwards. No matter which way you look at it, there is a VERY high concentration of risk, especially in an area with no real discernible loss history and the only real discernible losses being significant. Compare and contrast to the actuarial loss histories used in life, vanilla P&C, and health lines - we're talking multiples of decades (like 50 - 60 years+), not just a few years as in CDOs. That is REAL insurance. This new fangled, financially (not so)engineered, structured product guarantee business is gambling with shareholders capital, pure and simple - slot machines - Vegas style!

I'm not trying to make it seem like AGO foolishly reinsured ABK's book. On the contrary, AGO probably just took the best stuff from Ambac (they apparently refused to insure CDOs), which really leaves the ABK shareholders worse off. They also only insured $29 billion out of a much, much larger portfolio of exposure. I am trying to point out the reduced value of reinsurance when there is a high correlation of risk between the two parties. If I am sick and you have the same disease, it may not be prudent for me to give you a blood transfusion! Some risk will be retained through counterparty credit risk, or put in simpler terms - two sick people sharing the same blood and calling it a cure. Thus, in my opinion, the number $29 billion is misleading as to the actual amount of risk transferred. Another example of this correlation is MBIA, who actually owns 17% of their main reinsurer. Now, how is that truly transferring risk? They are only transferring 83 cents on the dollar, and that 83% is further reduced by the amount of correlation in the insured portfolios and losses - and there definitely is correlation, for their reinsurer took losses for derivative mark downs the same quarter that MBIA did, and passed them on to its parent companies, of which MBIA is one, along with General Re. This monoline business model stinks, pure and simple.

AGO used capital to buy back shares in lieu of reserving for future losses through '06 and announced a new buy back program going forward last month in November to buy back more shares. Hey, why provision for losses when we can buy back shares. That's what MBIA & Ambac did and look where it got them (this is how I feel about buybacks). If you get a chance, look at these two cos. charts at about the time they borrowed money to buy back stock. Look out below!!! But wait!!! Just a few weeks ago, Assured then announces its intention to sell $300 million in shares to shore up its capital in its reinsurance division to go huntin' for new business. Like Moody's, these guys are a fickle bunch. So, my astute readers should ask, why didn't they just take the money that they used to buy back the stock and simply reinvest it in their business to begin with??? Hmmm! Good question. Could it be that management did not have the foresight to see this opportunity coming just last month. If so, what else did they "not see"? I would suggest you look into the risk profile of their newest addition to their portfolio.

Thanks to Moody's, the AAA rating moniker is now close to worthless. Either US treasuries (the AAA moniker benchmark) just got a whole lot riskier, or Moody's is full of it in assigning this rating so capriciously. Tell me, Boom Bust Blog readers, which one is it? If I was a foreign investor or an investor that did not have the wherewithal to perform my own credit analysis, I would absolutely ignore the credit ratings agencies. If I have the time, I will actually calculate the redundant risks and high concentration/correlation that did not seem to deter Moody's from viewing Ambac as safe as US Treasury. Okay, folks, now its official. According to Moody's, you can now put your retirement portfolio in Ambac debt AS well as Treasuries, because it is just as safe - AAA safe!

P.S, the CDS market considers Ambac debt near junk to junk, but what the hell would the collective knowledge of the market know.

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