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November 29, 2007



Remember what happenned to Jack Nicholas in the movie. Blurting dialogues just does not cut it.

I agree with your analysis and that AMBAC is fraught with danger. You made any analysis of what is going to probably happen - a worst case scenario for the longs.

On the other hand, have you done any scenario study - a worst case scenario for the shorts, if it turns out that the rating agencies come out with favorable ratings, and in addition, Ambac comes out with more news that they have found XXX that is ready to infuse more than the needed cash? (As we see more and more capital infusion is coming into the market when it is needed - CITI got it, Etrade got it etc.)Even though the euphoria may be short lived while nobody will know for a couple of months at least how much truth is behind the rosy picture presented by the agencies and AMBAC, given that the shorts are huge in number/volume, the Fed cutting interest rates is more than 50%, and market events may help Ambac in the short run, how badly will the shorts get burned ??? Will this go beyond $35, towards $40, with all the help from the shorts of course. A couple of Hedge funds may go down under, given that they have betted against MBI too.

Life can be a bitch, even when you are right. I have a feeling, a suspicion that the shorts will get burned on this one.

Andy Gaudet

Your summary is a lot of mental masturbation with no factual analysis or credible results. You could have at least provided historical claims payout data by Ambac e.g. losses to date. Don't include any of your gloom and doom forecasts on mark to market which have no meaning anyway in yerms of Ambacs portfolio strngth and earnings capability. And yes, you are cut out of the same mold as Ackman.

Thomas Davis

I found it interesting that you mentioned a drop in Public Finance revenues due to a drop in housing prices in various municipalities. I thought these revenues were based on a home's assessed value, which is stable, and not the home's market value. It seems there would be no lossed in the area of Public Finance, just a leveling off.

Also, I thought that Ambac would be required to make interest payments over the life of the bonds that it insures, not over the 5 year periods that you mentioned.

Your analysis seems to indicate that Ambac would be responsible immediately for the value of the bond plus any interest payments. But the homes have underlying value and homes are still be sold, albeit at a slower rate that a year ago.

There will be some pain while the real estate market sobers up, but I think that Ambac will be around for a few more years.

BTW, I am long on the stock with a few put options to cover my downside over the next few months.


This seems to be a controversial topic. Let's address the questions:

@ Thomas Davis
The assessed values are tied to how the municipality in question wishes to assess values. I live in NYC, where the assessed value was hiked three consecutive times until it reached the level of the market value in my tax statement. Many of these levels (marked to market, basically) either no longer stand as accurate or soon will not. There is also the matter of corporate tax and personal income in the wake of a recession. Taking NYC for example, the real estate and finance industies are just not going to add to the coffers like they use to. As a result, Mayor Bloomberg, a finance guy, made sharp cuts across the board. The same has happened in California and many other municipalities. Whether the cuts are sufficient remains to be seen.

Financial guarantee insurance is a short tail insurance policy with a relatively short payout, as opposed to mediacal malpractice liability which is a long tail casualty line. Ambac does have relatively short payout periods, although it is most likely dependant on exactly what is being insured. The 5 year duration is plausible as a generalization. I addition, it is not the bonds that will cause Ambac it's biggest headache. It is the structured products, which are taking significantly losses - some of which have manifested in the latest quarter.

As for the home having value, depending on the complexity of instrument (ex. structured products) there is a significant disconnect between what was the underying asset and the derivative vehicle. Even if there wasn't, the values that some of these homes where borrowed against are easily more then 100% of the debt outstanding, particularly in the west and southeast as time moves forward and the real asset market reverts to the mean.


I actually like that Nicholson quote :-)

I don't do analyses based on what benefits longs and shorts. I just analyse prospects and let the facts speak for themselves. I would just as easily be long ABK if I thought it was worth it. Alas, I don't believe that to be the case.

I did run three different scenarios though, and they are in the blog post - Optimistic, Base Case, and Pessimistic. Whether the rating agencies give ABK their blessings or not does little to alleviate their solvency issue in the present. They still have a book of business that has signiicant potential losses lined up. My scenarios indicate that ABK will need between $2billion and $16 billion dollars of capital to continue business. They currently have a market cap of $2.6 billion. Using the optimistic scenario, what do you think happens to the share price with the 50% dilution effect of an injection of 100% of the value of the shares outstanding. From a straightline calculation, roughly halving the share price - and that is the best case scenario. This if from a fundamental persective. I am sure they will get a trading pop with a big investment. Hey Countrywide got a one day pop from their investment via BofA.


@ Andy Gaudet

Hmm! Doom and Gloom forecasts and mental masturbation. I think you have been the 1st rude poster on my blog, ever. Oh well, so be it. ABK posts is first significant loss ever, we are in the midst of the worst housing recession in recent history, financial institions are taking record losses on their real asset related financial holdings, credit and liquity is freezing up globally as solvency is in question in both the household and corporate balance sheets, home building companies are reporting billions of dollars (each) of value loss in their inventories while operating with deep negative margins as we have near record low interest rates that are not slowing our decent into recession. Now, exactly where in there is my gloom and doom forecast???

I think the blog post is quit detailed - a least for a blog post (including a loss tail analysis), but I'll tell you what - I will post additional data on the proposed defaults of Ambac's portfolio via pdf (it won't fit in this narrow blog in html). I am not doing it because of your "mental masturbation" comments, but because I want the more credible patrons of the site to have a much info as possible to come to their own conclusions. So, does the Bloom blog populace desire more info???

Thomas Davis

Thanks for the time you took to reply.

I'll hold my position, but watch it carefully.

What do you think about the puts to protect the downside? Wise choice?


Time for shorts to eat crow.... Early next week will be fun to watch. To 40 by end of the week. Thanks to the shorts who will cover like crazy. We will see what analysis you can provide thereafter.

George Spritzer

Your analysis is interesting but seems static and weighted toward the negative and does not put enough weight on potential (totally unexpected) bullish events that could happen.

Have you noticed the recent upturn in the ABX numbers? ABX-HE-AAA 07-2 is now 73.56, up more than 10% from the recent low of 66.41. Suppose it hits 90 by year end?


@ Thomas
I don't give invesment advice via this blog, and you would be best served not to accept it either. It has always been my experience that those who don't hedge always regret it more than those that do (but you didn't hear that from me:-)

@ George
If things turn up significatly, then the optimistic scenario would take precedence. That is why I gave three scenarios: good, likely, and bad. I truly don't think the analysis is weighted toward the negative, only the findings.

BTW, and index that shoots up by year end does not make things fine and dandy. We are in a hell of a bind here in the real asset and credit markets, and a sharp uptick in the ABX will not fix it. Read my FrankenFinance post. The problem was never subprime, it was lax underwriting standards. ABK's subprime exposure is no where near their worst problem. It was the structured products which were poorly underwritten and imprudently purchased.


I did not see where you factored into your analysis the collateral subordination in the RMBS pools that ABK insures. ABK typically insures AAA tranches that have approximately 20% subordination. That would mean that there will be no payout on policies until the default rate exceeds 20%. At that time ABK would make timely payments, not the whole obligation, while seeking recovery on the underlying assets. Given the subordination I would think that recovery would be very high. What am I missing?

David Hug

You may be correct regarding your ananlysis of ambac, Reggie, but the chart shows the early stage of a rally. I'd cover the shorts until the rally fizzles.


@ Arnie, good to see you're paying attention, I think. Starting at page 4 of the pdf, subordination is addressed for about 30 different ABS CDOs, each having an individual subordination, of coursse. But all hovering somewher around 20%. I see you have done your homework. This Ambac, analysis represent an awful lot of work ad research, I hope you get something worthwhile out of it.

Due to the amount of work that went into it, it is impractical to post every single calculation, assumption, and justificiation, but pdf has a lot of it.


Mr. Davies comment needs a bit of clarification on Public Finance revenues (property taxes). Revenues are impacted in 2 ways. First, strapped borrowers stop paying their property taxes as many states cannot force sale for 5 years post initial delinquency. Second, as happened in the early 90's borrowers appealed their property tax assessed values and had them reduced.


Before taking a short position on Ambac (which I have not yet done but plan to), I decided to begin to look at things optimistically over the week-end. I reasoned that Ambac's exposure to subprime mortgages in 06 and 07 was not that high, and the prime and midprime stuff for these years will probably perform worse than other years, but may do OK. In addition, despite the market price drops on Ambac's ABS CDOs, who really knows what will happen to these?

That was until I decided to look at one randomly selected auto securitization for 2006 -- Triad. Here is what I gleaned from the prospectus.

Total collateral $1.174B
Ambac insured layers: $1.092B (i.e., 7% subordination)

New car collateral: $277M, average FICO 565
Used car collateral: $898M, average FICO 567

The weighted average APR for the total pool is 17.31%. Losses for 2002 and 2003 pools are around 13%. 2004 and 2005 look a little better.

It is somewhat surprising that losses have not begun to chew away at the securities that Ambac insures on the 2006 deals, but I am willing to bet that this will start very soon.

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