Wednesday, 12 March 2008 01:00

AGO update

A quick overview from the finished AGO valuation model. I will offer more details over the next day or two and post a full downloadable report in the investor user groups. I've been fairly busy of late, thus could not respond to comments. I would also note that although AGO is an interesting academic study, I find that XL Capital is a more profitable bearish play to date, which was made even more so when its share price shot up after it was downgraded.

Mark-to-market losses: We have estimated mark-to-mark loss of $600 mn in 2008 based on expected widening of credit spreads. We expect credit spreads to increase by 70 bps in 2008. This is over and above the increase in spread witnessed in last couple of months. AGO is expected to report 70% of its 2008 mark-to-mark loss in the first two quarters of 2008 since we expect credit spreads to widen faster in the first half. We also expect spreads to continue to widen in 2009 albeit at lower levels as we expect the credit market turmoil to persist in the medium term.

Losses on public finance: Under our base case scenario for public finance we expect losses of $461 mn against AGO's total exposure of $81 bn in public finance. This implies an overall loss rate of 0.56% which is consistent with the historical default rate of municipal bonds. Of this, $200 mn relates to losses relating to healthcare (implying a default rate of 1.92%) followed by investor-owned utilities with $90 mn of expected loss (implying default rate of 3.87 %).

We have computed our default rate based on the historical default rate for each of these sectors derived from the historical cumulative 5-15 year default rate. Further, we have adjusted these historical default rates based on the current market scenario and their underlying ratings. Since AGO's exposure towards investor owned utilities have BBB ratings, we have assumed a slightly higher default rate.

Losses on structured finance: In the structured finance division, we expect total loss of $1,545 mn of which $1,045 mn is related to Prime RMBS (with $895 mn from HELOC) and rest towards subprime RMBS, CMBS, consumer receivables and other structured finance.

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Tuesday, 11 March 2008 01:00

Short Seller Dreamin'

I have very little confidence in MBIA's management. They literally calling out to the weak handed short sellers that missed their recent 56+ point share drop to just jump on the bandwagon. Management is what you actually bet for when long a stock, and ultimately who you will be betting against when shorting a stock. It appears as if MBIA's management is a safe short bet given this macro environment!

Fitch Ratings-New York-10 March 2008: Fitch Ratings President and CEO Stephen W. Joynt today sent a letter to MBIA in response to its letter of March 7, 2008 requesting that Fitch withdraw the company's IFS ratings.


Below is the full text of the letter from Fitch Ratings to MBIA:

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As I pointed out in my critique of MBIA's Letter to Owners, management has a little beef with the Fitch rating agency. Fitch is the only international rating agency that has shown some balls and credibility as of late. Yes, they passed out those AAA's like "Snickers" on Halloween in the past, but at least now they are trying to save face. That's a lot more than I can say for S&P and Moody's. The net effect is that S&P and Moody's have effectively watered down the moniker of AAA status to being just that, a moniker, without any real or tangible meaning behind it. The industry needs Fitch's harder (or should I say more realistic) stance, to actually lend any semblance of credibility to the term "AAA".

With that being said, MBIA is apparently expecting a downgrade from Fitch and has literally requested that Fitch not rate them any more. They would allow the rating of thier bonds, but not their claim's paying capacity. This is a major faux pas on behalf of management. By even trying to give Fitch the boot, they further water down the already quite diluted respectability of the other two agencies AAA ratings. Do you remember my comical skit on MBIA's valuation from Halloween last year? The cartoons truly exemplify the perception the (smarter end of the) market has on the ratings agencies. The article seems to have been right on point, if not overly conservative in terms of valuation as well, even if you didn't like my jokes (I don't know why you wouldn't like them, I'm actually rather funnySealed). I've been short these guys for a while. Now, nobody in thier right minds will trust MBIA, S&P or Moody's. Do you guys think that your investors, clients and short sellers are stupid! Hey, we're a AAA risk because we won't hire anybody who'll say otherwise - Yeah, that'll work out just fine...

It is not as if the market had much confidence in the trio to begin with, forcing them to pay 14% super junk rates in a 7% environment for a (ahem) "AAA" risk. You guys at MBIA better hope you don't have to come back to the capital markets any time soon! Then again, this should be damn good for Fitch's buy side advisory business.

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Make of this what you will. From MBIA's latest 8K...

As previously disclosed on the Company’s current report on Form 8-K, filed on December 26, 2007, to induce Warburg Pincus Private Equity X (“Warburg Pincus”) to enter into and consummate the Investment Agreement, dated as of December 10, 2007, with the Company, the members of senior management of the Company listed below committed to purchase a certain dollar amount of stock from the Company at a per share price of $31 within 60 days of the consummation of the transaction. As discussed in the Form 8-K filed on December 26, 2007, to facilitate the above described stock purchases, while assuring compliance with the applicable NYSE rules, on December 21, 2007, the Compensation Committee of the Board awarded each of the officers listed below stock options under the 2005 Omnibus Incentive Plan in respect of the number of shares of the Company’s Common Stock set forth opposite his or her name with an exercise price of $31.00 per share.

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Friday, 07 March 2008 00:00

Whoa!!! Somebody's exaggerating...

I was listening to congress grill and persecute a few CEO's for no valid reason, except for maybe the fact that they couldn't find any more baseball players, when on of them stated that he just finished a committee exploring the monoline's portfolios. He said that in one of the pools, 18% of the mortgages actually had the 1st payment missed. Now, if this is true, somebody in the monolines may not be as forthcoming as they could be.

Published in BoomBustBlog
Thursday, 06 March 2008 00:00


The following is the MBIA "LETTER TO OWNERS DATED MARCH 3, 2008" excerpt and my comments. My next post will be my comments on out ongoing monoline research, and in particular Assured Guaranty.

Dear Owners:

... Obviously the big news of the week was the affirmation of our Triple-A ratings by both Standard & Poor’s and Moody’s. This added to the growing confidence shown by our investors in MBIA’s firm financial footing and the steps we’ve taken to weather the worst credit crisis in a generation. The reaffirmation of our Triple-A ratings means that MBIA holds up under the worst-case scenarios the rating agencies use to stress test our claims-paying ability. The fact is, the losses from the U.S. mortgage market would have to be many times higher than any credible projections before MBIA’s ability to satisfy its obligations to policyholders would be compromised. The bottom line is that the rating agencies recognize the moves we have made to raise additional capital and that, over the next 12 to 18 months, they will observe how we fortify our position and make changes to our business model so as to support the highest ratings. The ratings agencies and the management of the major monolines have been so wrong, so often on the mortgage risks thuse far that thier current opinions have less than zero credibitiy. In addition, notice how they commented on their mortgage risk, but failed to opined on the risks and liabilities coming down the pike in consumer finance, leveraged loans, CMBS, high yield CDOs, and looming increase in municipal bond risk. These risks, taken in light of there significantly diminished revenues, are far from trivial.

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Wednesday, 05 March 2008 00:00

Quote of the day: Alpha, Schmalpha

From alacrablog :

There was a lot of side talk at Money:Tech about information that can generate alpha.
Basically the theme was if discover or create some proprietary data
that will generate excess risk-adjusted returns, why would you sell it?
You should trade it! Bill Janeway
of Warburg Pincus offered something like the following: "Alpha is the
money you make when you perform better than the market. Schmalpha is
the money you make when you perform better than your clients..."

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This is an update of the work I am doing on AGO. Since I don't feel like putting out my usual eloquent proseCool, I'll just get right to the point. We have built-in subordination where tranche-wise information is available. For RMBS, we have this information only at an overall level (year wise) and not tranche-wise. We have subordination rate of 38% for 2007 for Prime Closed End Seconds. Had this information been available into AAA, AA, etc tranches, we would have applied this to compute net loss. However, we have tried to be realistic (to the extent there is visibility under the current credit market conditions) while applying default percentages.

Later on, I will post AGO’s pro-forma statements incorporating loss and mark-to-market write-downs.

At an overall level, AGO’s future performance and losses hinge upon the credit market which is being squeezed by serious credit crunch. My previous post gave anecdotal evidence of the the underlying RMBS and CMBS facing fire sales, thus putting serious downward pressure on the CDS that AGO writes. The current turmoil is likely to get much, much worse in view of aggravating recessionary conditions and worsening macro-economic factors.

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The is a very interesting interview that anyone invested in the
major monolines should read. Later on, I will post what looks like an
indication of Fitch getting tough with MBIA.

From CNBC :

We also have talked an awful lot about what's been happening with the
bond insurers. You made a deal that you brought up on our air a couple
of weeks ago, where you said you would take over the municipal bond
portfolios for Ambac, for MBIA, for FGIC if they came to you. Did you
hear from any of them? Did any of them take you up on that deal?

Well, we heard from them, but we tossed our hat in the ring, and they
tossed the hat back. But fortunately--it's been fortunate for us,
because we've been writing business that they insured, and we're
getting a far better rate than we offered to take it over from them. So
here--we've written 206 transactions in the last three weeks, and we
have been paid an average of 3 1/2 percent to take on business that
they wrote at 1 percent. But we don't pay until they go broke. So in
effect, the municipality has to quit paying, and over here I've got the
bond insurers. And it's just--it's the three you named plus a few
others. And they have to go broke, and then we pay. So we're getting
paid 3 1/2 percent to be in a secondary position when we offered to do
it for 1 1/2 percent in a primary position.

QUICK: And we're still talking about municipalities.

BUFFETT: Municipals.

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This, from, portends the added risk we have been discussing in the Muni markets. As many have forecast, the muni risk is being too heavily discounted in the equity markets... I will post a another recap of insurers covering the aggregate CDO/RMBS risk and rank them either later on today or tomorrow.

Auction Supply `Tsunami' Foreshadows Deeper Municipal Losses

By Michael McDonald

March 3 (Bloomberg) -- U.S. states and local governments may extend the worst slump in municipal bonds on record as they replace as much as $166 billion of auction-rate securities.

California, Boston's biggest hospital and Duke Energy Corp. are converting their bonds to other types of tax-exempt debt after auction failures drove rates as high as 20 percent. The potential supply equals almost 40 percent of the municipal securities sold last year, overwhelming a market that tumbled 4.9 percent last month, according to indexes maintained by Merrill Lynch & Co., which began compiling market data in 1989.

Rates increased last month as investors shunned the securities on concern the insurers that guaranteed the debt may be downgraded, and as dealers refused to buy bonds that went unsold at auctions. The higher borrowing costs are squeezing states and towns just as slowing growth threatens to cut revenue. I know there are some vulture investors hoarding these higher yielding munis, but there is some added risk there.

``It's a supply tsunami,'' said Robert Fuller, principal of Capital Markets Management LLC in Hopewell, New Jersey, a financial adviser to municipalities. ``All of that is going to be redone and it's going to be redone fast,'' he said of auction-rate bonds.

Twenty-one states face budget deficits in fiscal 2009, including 16 that are short at least a combined $30 billion, according to the Washington-based Center on Budget and Policy Priorities. This is saying a lot...

Jefferson County

Standard & Poor's slashed the ratings on $3.2 billion of debt issued by Jefferson County, Alabama, to below investment grade on Feb. 29, citing costs from auction-rate and other bonds and interest-rate swaps used to finance its sewer system. Junk muni bonds! Who's the insurer???

``The county can provide no assurance that net revenues from the sewer system will be sufficient to permit the county to meet the interest rate and amortization requirements of the liquidity facilities,'' officials said in a notice last week.

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