|Shares Out. (in M):||45||P/E||0.0x||0.0x|
|Market Cap (in $M):||1,139||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||0||EBIT||0||0|
AMBC, Ambac Financial Group, a monoline insurer in its past life, emerged from bankruptcy last month, after three years of being in rehabilitation thanks to the subprime RMBSs it insured before the financial crisis. As it stands, the company operates as a runoff. Per most recent 10Q it is …actively managing its assets and liabilities with a focus on maximizing investment portfolio returns and mitigating or remediating losses on poorly performing transactions, including through executing policy commutations, repurchasing liabilities at a discount, pursuing recoveries of losses through litigation and the exercise of contractual and legal rights, and restructuring transactions.
With very limited research coverage from the Street due to the firm’s recent reemergence with no clear business direction to talk of, significant value is being overlooked by the market and is likely to be in mid $30 handle, meaningfully north the currently observed ~$25. The value comes from two main sources:
The policy commutations (mentioned in the 10Q excerpt above) may end up being a significant source of value too. However, let’s ignore them now, since company reporting in this matter has been very scarce, and it’s unclear what opportunities there are in this arena. Suffice it to say, these commutations will only be undertaken if they add value and thus constitute an option for the company.
The R&W recoveries alone, with reasonable recovery rate assumptions, can more than justify current market cap and provide near- to-medium-term catalysts for the share price.
The largest recoveries sought are from Countrywide/BAC. Of the $2.5bn of overall Breached R&W losses indicated by the co, $1bn are attributed to Countrywide in the recently updated complaint. Countrywide/BAC litigation is also the most likely to be resolved sooner rather than later, as BofA is trying to put most of the Countrywide related legacy issues behind it.
The crux of AMBC’s litigation is quite similar to the recently resolved MBIA’s case against Countrywide and can be crudely summarized as follows:
a) Countrywide misrepresented everything there was to misrepresent about the quality of the mortgages that it securitized
b) AMBC insured the securitized mortgages relying on Countrywide’s false representations
c) Ambac sustained crippling losses as the mortgages massively defaulted during the housing crisis
d) BofA is responsible for the losses having bought Countrywide
Likelihood and timing of successful resolution
Looking at Ambac’s R&W recovery pursuits (especially against BofA), through the prism of the recent success by MBI against the same counterparty, it’s hard not to be optimistic. Before BofA finally decided to settle with MBIA a month ago, the judge in the case made critical plaintiff-friendly rulings on several issues, e.g. Successor Liability (i.e. what is BofA’s responsibility for Countrywide’s liabilities), Loss Causation ( i.e. whether there is a need to tie specific claims payments to particular misrepresentations), Statistical Sampling (i.e. whether conclusions can be extrapolated to the entire set of loans by proving fraud in only a small sample), etc. All of these provide powerful weapons for AMBC in its upcoming battle and are likely to induce BofA to initiate settlement talks, accelerating the catalyst for AMBC stock.
Another accelerating factor is the fact that the presiding judge (Judge Eileen Bransten) is the same judge that issued those rulings in the MBI litigation above. She is obviously very familiar with the issues and has displayed leanings favorable to the plaintiffs, further motivating BofA towards timely settlement.
Besides just improving Ambac’s chances, these precedents also make many of the time-consuming pre-trial steps unnecessary, thus shortening the timeline of this litigation, that is, if settlement talks don’t resolve everything sooner.
Finally, in a less likely (but not unrealistic) scenario, the ongoing widely-covered litigation challenging the 2011 $8.5bln settlement between BofA and mortgage securities investors can accelerate the AMBC case timeline as well. If the disputed $8.5bn settlement is seriously jeopardized, BofA may be motivated to quickly settle the AMBC litigation. Dragging its feet with MBI already created precedents used by AMBC and other parties against it. If the $8.5 bln is blown up, unleashing many new plaintiffs and lawsuits, the last thing BofA would want is to arm them with new, more powerful successor liability and other precedents coming from the prolonged AMBC litigation.
The magnitude of the recoveries
Looking at recent precedents and AMBC’s financial statements, we can expect a range of recoveries that alone could outstrip the current market cap of $1.17bn. The co. indicates $2.5b of losses it aims to recover in the Breached R&W litigations. $1b of it was stated in the Countrywide complaint. The obvious fair question is “How much of this can be recovered?” But given that the $1bn figure refers to the losses sustained prior to the 2011, another critical question is “what were the Countrywide-related losses sustained between the filing time and now?” Clearly, the losses did not stop at the point of the filing, and may have even accelerated for some time. We don’t know what they amounted to, but they are likely to be meaningful.
Looking at the Ambac’s litigation against Credit Swiss as guidance, according to the Feb 2010 complaint, by that date Ambac made over $44m in claim payments on the CS-issued securities with breached reps and warranties. On March 1st 2013 AMBC and CS settled. How much did CS pay? In the most recent AMBC’s 10Q, the RMBS subrogation table indicates a $54m reduction from the “impact of sponsor actions,” where sponsor actions include “loan repurchases, direct payments to Ambac, and other contributions from sponsors.” This also corresponded to a reduction of 2 RMBS transactions from the 22 for the prior quarter. This must be coming from the CS settlement, as there have been no other settlements in Q1 to talk about.
Where is the difference between $44m lost in 2010 and $54m recovered in 2013 coming from? The difference is attributable to the losses from incremental claim payments made by AMBC to CS in the 3 years after the filing of the complaint. Those incremental losses were likely incurred at an accelerating rate, since more and more loans defaulted as the crisis worsened.
We can only guess what the total CS loss amount was and what the agreed upon recovery rate was in settlement, but the bottom line is, they recovered MORE than the $44m originally mentioned in the complaint. 25% more (almost certainly implying the total loss nearly double the original amount and a likely recovery rate somewhere north of 60% on the total loss).
Applying similar logic to the Countrywide case, given similar timeframes of the two complaints, it’s not unreasonable to expect recoveries not far from the $1bn amount, if not more, given that the losses must have continued to pile up significantly above the original $1bn figure in the housing collapse aftermath for 2 years after the complaint’s filing.
Beyond the Countrywide case, with the currently targeted $2.5bn total recovery amount potentially evolving this way into a much larger number, there’s a significant upside likely to become visible as AMBC’s wins or settles its upcoming cases against BofA and other counterparties (JPM, First Franklin, CapitalOne and Nomura)
Finally, there’s an additional source of upside in the R&W recoveries side of the story. AMBC has been quite late in the game initiating their lawsuits against their counterparties. From their recent 10Q, losses from only 46% of their policies have been addressed in the suits seeking the $2.5bln we keep discussing. The other 54% of the policies have their corresponding portion of the AMBC’s $6bln loss reserve, ($2bln+ of losses, in fact), but no lawsuits were filed for those yet, and no expected recoveries have been priced in. Any new lawsuit addressing those losses, assuming even the most conservative recovery rates, will create further positive catalysts increasing potential recoveries.
That brings us to the NOL’s. While part of the $5bln can be unlocked against the taxes on any of the above-mentioned recoveries, most of the NOL’s value can only be materialized through a new cash-flow positive business the company plans to enter eventually. Listed as one of the two shareholder value maximizing strategies in their 10Q is
…pursuing new financial services businesses, apart from Ambac Assurance and Everspan Financial Guarantee Corp. These new businesses may include advisory, asset servicing, asset management and/or insurance.
In their recent communications with the Street AMBC went out of their way to indicate that in their search for a new business they are moving away from insurance model and are actively considering other financial services directions. This may indicate the company is not sitting on its hands with an abstract goal of establishing a new business with an open-ended timeline, but rather may now be exploring something more concrete and is undertaking steps in a new direction.
Looking medium term, the company benefits from the ongoing housing recovery, as lower realized default rates reduce future losses stemming from claims. Recent financial statements point to a loss expense reserve of $6bn+. This figure is priced in by the market and any reduction due to improving economic conditions should be favorably reflected in future valuation.
Lastly, looking at the immediate technical catalyst, AMBC is eligible for inclusion into Russell 2000 index in the end of the month. Close to 4m shares would need to be bought by the indexers during the reconstitution, providing a meaningful boost to the share price.
Management of the company has been difficult to reach, and it is unclear how executives are incentivized and what the composition of their compensation packages is. One would assume, given low cash generation in the company, it would be meaningfully weighed towards stock awards. Hopefully this information will be released in the next 10Q, but until then we cannot discount a risk of management pursuing some dilutive transaction if their interests are not properly aligned with those of the shareholders.
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.
This investment may change at any time.
|Subject||Insurance Holding company?|
|Entry||06/12/2013 01:17 PM|
Why would any R&W recoveries flow to the holding company here? Isn't the insurance subsidiary in the hadns of the regulator (rehabilitation) and aren't the R&W claims assets of the insurance subsidiary? Similarly, aren't the NOLs also an asset of the insurance subsidiary and any value will come from the NOL preservation agreement struck in bankruptcy?
|Subject||RE: Insurance Holding company?|
|Entry||06/12/2013 02:51 PM|
The benefit to the holding company from the R&W recoveries comes in two ways. First, most of the Countrywide losses (the $1bn from the complaint) were incurred before the rehabilitation was initiated. Those were actually paid out claims and any recoveries of those would not go to the segregated account established after that. Even the subsequent cash losses that that took place after the segregated account was established will have partial tax benefits.
The other, less immediate benefit is that with the recoveries that do stay in the segregated account (mostly non-cash reductions in liabilities) AMBC will be accelerating the runoff and getting them closer towards getting out of the rehabilitation, enabling its entities to eventually return capital.
According to the tolling agreement the $3.4bln of NOLs remaining after they relinquished ~$1bln can be used across corporate structure and is not tied to the segregated account. Plus the Holding company itself has its own NOLs, though not as massive.
|Subject||RE: RE: RE: RE: RE: RE: Insurance Holding company?|
|Entry||06/13/2013 01:12 PM|
Sure (there was another comment in that regard earlier). The holding company still benefits from the R&W recoveries in direct an in indirect ways. First, most of the Countrywide losses (the $1bn from the complaint) were incurred before the rehabilitation was initiated - that's how they got into trouble to begin with. Those were cash losses actually paid out claims and any recoveries of those would NOT go to the segregated account established after that.
The other, less immediate benefit is that with the recoveries that do stay in the segregated account (mostly non-cash reductions in liabilities) they will be accelerating the runoff and getting them closer towards getting out of the rehabilitation, enabling its entities to eventually return capital. This obviously doesn't expedite things as much as Id want to, but it is bringing them closer to the goal.
Also, according to the IRS agreement the $3.4bln of NOLs remaining after they relinquished ~$1bln can be used across corporate structure and is not tied to the segregated account. Plus the Holding company itself has its own NOLs, though not as massive.
|Subject||RE: Ambac catalysts|
|Entry||09/03/2013 10:07 PM|
Any new thoughts on the catalysts here?
Specifically, any thoughts on the timing of news on rep&warranty recoveries, the timing/form that incentive comp plan details are likely to be released (or whether they'll be filed at all), or other news you expect to be released that will serve as a catalyst?
Also, you didn't discuss the surplus notes or preferred? Did you evaluate either as investments and if so where did you come out vis a vis how attractive you deemed each to be at the current price?
|Subject||RE: RE: Ambac catalysts|
|Entry||09/04/2013 12:27 PM|
Mgmt has indicated that in the Fall they’ll communicate the incentive comp plan as well as their strategic plan.
They are obviously getting a lot of pressure from shareholders in this regard.
You are right to focus on that as the next catalyst, as it would make sense for them not to rush with any reps/warranties settlements or other catalysts prior to that,
I have not focused on surplus notes or preferred.
|Entry||09/11/2013 02:19 PM|
Any thoughts on the recent sell off in the name? Presumably it is focused on the exposure to Puerto Rico (and muni fears in general)
In reviewing the net par exposures at AMBC, looks like $2.5bn exposure, of which only $60mm or so is general obligations, the rest is various revenue bonds - sales tax (aka COFINAs), highway and other infrastructure, which should be 'better' exposures if precedents are to be believed.
How do you think about this risk and what types of haircuts they may have to take on this?
Just reading the news it sound like Puerto Rico's situation hasn't changed drastically in recent weaks, it is panic selling leading to muni bond redemptions to more selling etc.
Do you agree? Why or why not?
|Subject||RE: Puerto Rico|
|Entry||09/12/2013 03:38 PM|
I agree that it is a panic selling. While we are not expects in the Puerto Rico debt situation, it seems to be neither a new nor an imminent issue. It did not become relevant because of any new Puerto Rico specific developments, but rather came up as a result of the recent Detroit events and the search for the next shoe to drop.
There’s a lot of analysis out there contrasting the two jurisdictions and highlighting inherent differences between the situations (in particular addressing your point of AMBC’s higher quality exposure). However, unlike AGO and MBI, which sustained relatively moderate hits, AMBC became the go-to vehicle for bearish sentiment, thanks to its brief life as a public company with less than exhaustive disclosure, still unknown business plan and non-communicative mgmt which didn’t even hold an earnings call last month.
Mgmt’s lack of incentive to support the stock here in advance of the anticipated release of compensation structure (the point I made in my previous posting) may be another piece of the puzzle. It is expected (though we have not seen any firm commitment from the company) that the company will establish and make public its compensation this Fall. From mgmt’s perspective the selloff may seem like a great opportunity to have their options struck at lower levels. An opportunity they wouldn’t want to jeopardize by doing something shareholder-friendly, like addressing the Puerto Rico concerns.
|Subject||I am lightening up|
|Entry||10/02/2013 09:06 AM|
This idea has clearly not worked. I have nothing incremental to add, but as a matter of risk management, I am going to cut down my position over the next few days (absent a rally), and thought I should apprise the board of the fact.
Peer companies AGO and MBI have also gotten crushed, although not to the extent that AMBC has, and it occurs to me that AMBC, given the lack of communication with the street, is a more dangerous stock to own from a PM point of view (tougher to justify owning to the boss vs. AGO, for example), and I suspect that explains some of the underperformance. That said, given the change in recent psychology I am having a tough time recommending owning AMBC over AGO or MBI at these levels.
AMBC will be having a conference call in November. Hopefully they will disclose more information then that will resolve some investor concerns in owning the name.
|Subject||RE: RE: I am lightening up|
|Entry||10/02/2013 12:32 PM|
i think still too early to call on this one. the way i've played it is through Jan 15 leaps...cap my risk and if it works out make a bundle. The value creation for this is by far and away the putbacks to Countrywide and others; which ought to get resolved in 2014. If they win those cases, the stock can't help but go higher (even if there is risk/issues with Puerto Rico).
|Subject||RE: Author Exit Recommendation|
|Entry||02/04/2014 04:11 PM|
Tyler- I'd love to hear your thoughts on AMBC and why you sold. Seems like the thesis remains solid. The lawsuits have yet to play out. PR and Detroit are obviously scary, but the exposure seems priced in here. Thanks for the write up.
|Subject||RE: RE: Author Exit Recommendation|
|Entry||02/04/2014 08:28 PM|
I have nothing really incremental to add. I think the newer write up is pretty good, I got shaken out of some of my position due to market constraints (so some of it is just an emotional "time to move on" moment), Puerto Rico is back in the news today and I want to try to find something where I feel I have more of an edge.