Taken from the 11/28 Pershing Square presentation:
Goldman Sachs Estimate Of Bond Insurer Losses
In response to requests from investors, Ambac recently identified some of the specific CDOs to which it had exposure. Goldman Sachs conducted a “thorough analysis of the unmasked transactions” and reached a “discouraging” conclusion
($ millions)
Ambac MBIA
Low ($7,400) ($4,800)
High (10,500) (7,200)
Cushion (Deficit) to Required AAA Capital
| Low | ($6,218) | ($3,600) | |
| High | ($9,318) | ($6,000) | |
| Remaining Statutory Capital | |||
| Low | ($1,176) | $2,025 | |
| High | ($4,276) | ($375) |
Source: GS Equity Research, ABK Company Update, 11/13/07
“We see a Baa credit enhanced to a Aaa credit
by someone guaranteeing it for a 10-15 basis
point charge. Yet, the spread in the market yield
might be 100 basis points. Well, that doesn’t
strike us as smart. … I would say that at some
point, you can get into a lot of trouble at 140-to-1
insuring credits.”
Warren Buffett at
2003 Berkshire Hathaway Annual Meeting
Reported by Outstanding Investor Digest
“I took a look at the business model and said, ‘My God,
how can this business model possibly work? How can
you take less than what the spread is in the marketplace
indicates and make it work over time?’ You know,
essentially what it says, we take a portion of the spread.
We [earn] spread on the risk, or the spread on a
structured risk is 50 basis points. We take in 15, 20, 30
[basis points] over time. We say that model works. It’s
called risk selection. And our goal in life is to do it right
all the time.”
Joseph W. Brown
Former Chairman & CEO, MBIA Inc.
12/10/02
“The financial guarantee business is highly
confidence sensitive...For this reason, concerns
about the credit strength or competencies of a
particular guarantor would likely have serious
negative consequences for its ability to write new
business, lessening its franchise value…in no other
industry is an entity’s strong credit posture so
central to its business model.”
Moody’s Special Comment, December 2006
The companies mention in this blog's analyses are holding companies for the actual insurers, who themselves are subsidiaries.
Why Would Anyone Bail Out a Holding Company?
In CIFG “rescue”, the Holding Company, Natixis, essentially gave its
Insurance Subsidiary, CIFG, to certain of its large shareholders who
agreed to extend capital to fund losses
Terms were not disclosed, but we expect Natixis will take a near or total
writedown of the value of its investment in CIFG
Investors won’t invest in a Holding Company because it is structurally
subordinate to hundreds of billions of dollars of Insurance Subsidiary
exposure
Tens of thousands of individual credits make it practically impossible to
gain comfort regarding the magnitude of potential loss exposures
As sums required to bail out Bond Insurers reach into the billions of
dollars, new investors would be better off “greenfielding” a new Bond
Insurer (in a tax free jurisdiction) without having to assume billions of
unknown liabilities
Bill Ackman, Pershing Square manager
How can a company be rated "AAA" if it cannot withstand even a one notch downgrade?
Bond Insurers’ Mark-to-Model methodology reflects only a fraction of
the change in the underlying spreads:
“At transaction pricing, we may be charging a premium that is one third
of the originated cash bond spread. So that is used, the
particular percentage is used throughout the life of the contract unless
we see a reason to change that as a kind of the synthetic price for the
risk that we’re taking. So if that particular spread would move from 30
to 60, we would move up the price that we would charge—our
theoretical price that we would charge underlying the contract, say,
from 10 to 20. And effectively that additional 10 basis points that
would be theoretically charged would be discounted over the
weighted average life of the transaction to arrive at an unrealized loss
amount.”
Ambac CFO, Q3 Conference Call, 10/24/07
Analyst Question: “Just quickly again just highlight the bullet points
of why there is a model that the quotes are an input to, rather than just
being used purely.”
Answer: “If we were to use a bond quote when the transaction
originated, the underlying cash spread on the bond is going to exceed
the premium that’s being charged on a particular transaction due to
the various tailoring of the contract and the lack of funding and
liquidity type issues inherent in the contract. …”
Follow-Up: “So, you’re tracking the actual quotes, but it’s on a
relative basis and present value [inaudible]?”
Answer: “Yes. If not -- and this is in some of the new accounting
standards, but you need to calibrate the model -- if not, you would
have losses upon origination of the contract.”
Ambac CFO, Q3 Conference Call, 10/24/07
Warren Buffett on Credit Derivative Accounting
“There are dozens of insurance organizations that have written
credit guarantee contracts in derivative form in the last few
years, in fact, on a huge scale. And I will guarantee you that in
virtually every single one of those…whoever wrote it
recognized some sort of an income entry. … And you know
that many of those are going to go bad and maybe as a
category, it’s going to be a terrible category. But nobody ever
wrote a contract and recorded a loss at the time they wrote it.
… In fact, I find it extraordinary that if you have two derivative
dealers—Dealer A and Dealer B—and both write a ticket,
Dealer A records a profit and Dealer B records a profit,
particularly if it’s a 20-year contract. That is the kind of world
I’d love to live in, but I haven’t found it yet.”
Warren Buffett
2003 Berkshire Hathaway Annual Meeting
as reported by Outstanding Investor Digest
I need a translator for this post!
Posted by: Linda | December 07, 2007 at 01:36 AM
Reggie, if yesterdays rate adjustment plan was a non event how should I interpret my 22% loss being short DHI? Is this just an even greater entry point of shorting more?
Thanks
Mario
Posted by: Mario | December 07, 2007 at 06:09 PM