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Written by Reggie Middleton
Sunday, 24 February 2008
I have recently switched servers and upgraded back end software which caused me to lose a about 2 to 24 hours of data, depending from what part of the world you are posting from. The new site missed a few interesting comments which I will post in here so all can see: Despite all the fear and gloom and doom there is value in many of these derivative assets. As long as the assets are performing they are worth the present value of their future cash flows. The markets are not efficient. An owner of an asset is who is not forced to liquidate into an inefficient market is wise to wait. I disagree with your contention that these assets should all be valued at the inefficient market value. Take a look at Primus. Their credit default swaps are underwater if they were liquidated today, but if held to term they are fine. Unless you want to make the assumption that the world is coming to an end and all the businesses are going to default on all their loans. ________________ Comment: This post responds mainly to the detailed posts related to AGO in the Banks, Brokers, Bull thread, but are being provided here. Thank you very much for sharing your thoughts and analysis. 1. As you allude, the foundation for the business model is a fantasy world created by the rating agencies, a fantasy world that should be dismantled or severely overhauled. A link is provided below to an article that makes this case very convincingly. This may be the best reason to avoid an investment in any bond insurers. 2. Even so, many, many businesses are built on fallacies. Perhaps a more important question is whether customers are buying .. and for Assure it looks like they are. Assured's recent revenue growth on muni business has been excellent, and I suspect that the rates/spreads are higher and underwriting better on going forward muni business than it has been in the past. So if the fallacy is perpetuated, most competitors drop out, and Assured is able to continue writing, the future might not be that bad. Admittedly, these are a lot of ifs, but none of them seems extremely unlikely. 3. The stuff about losses and combined ratios could mean that things are getting worse, but it could also mean that Assured is simply reporting what we already know. If you compare Assured's most recent reported losses with S&P's most recent stress test, the reported losses (including MTM) are larger than the stress test losses by a factor of at least 10. By comparison, MBIA's stress test losses are greater than the reported losses (MTM reserve charges). Some of this probably results from flaws in the stress test (I could cite a number, but would take longer than it would be worth), but I also believe part of it is that Assured's accounting is not as aggressive as MBIA's. 4. We may have a philosophical difference on MTM losses -- I am not yet sure -- but in this case I definitely agree with you. The comment about MTM netting to zero is at the same time a tautology (no losses unless there is a default -- thanks for telling me), and also quite scary. Comments like this (and the CEO saying everything will ultimately turn out hunky dory for Ambac and MBIA) are a key reason that I decided to liquidate my long position. (The calls did pretty well based on a run-up after various sell-side analysts recommended the shares for the same reasons that I bought the calls in the first place. Someone really smart would have been way ahead of the analysts and probably never bought, but fortunately I was just dumb enough to be only a half-step ahead of the crowd.) http://money.cnn.com/2008/02/20/magazines/fortune/birger_muniratings.fortune/index.htm?source=yahoo_quote ______________ Comment: Given the 11.7 billion in assets the assuming nominal case will all of the Level II and Level II, I would guess that BSC will run out of equity. Look forward to heavy dilution of share holder value. Ontop of that the markets should continue to sink as the economy shrinks. I have been holding 09 put for three months. __________ omment: Hey Reggie thanks for the great info you continue to crank out. I like checking in a few times a day and seeing new data -- this is THE site for folks who want to know the real story on the stocks you are covering. As I did with AGO I want to "place my order" for the next shoe to drop that I am hoping you will cover. CALIFORNIA CLOSED END MUNI BOND FUNDS. These funds are often highly leveraged and the of course they are getting somewhat hammered currently thanks to the ARS nightmares. My thesis goes further though. I expect the ARS crisis to be alleviated in the near term with the monos breaking up or getting bailed out or whatever they do to "save" munis. But, as we have discussed before, I see munis running into MAJOR problems in the intermediate term due to the actual municipalities hurting thanks to dramatically reduced tax revenue. Plus there is no question in my mind that muni investors will be demanding higher rates for any rating to cover the new "perceived" risk that has now been exposed (but of course has always been there). I can't think of a state where this is more likely to happen than in California that is hurting in so many other ways. Not sure on the time frame of this implosion, could take 12-24 months, but it could happen NOW if the ARS solution goes worse than is expected. I have heard the closed end muni funds described as "nothing but vapor" due to their insane leveraging to get higher yield -- so I am throwing this idea to you to see if you can help us find the right funds to sell short or perhaps to BUY if a really good one gets oversold. I know you are busy--but you mentioned in a recent post you wanted to get ahead of the game on areas that are not crowded -- I am hoping you will do your thing on closed end munis and help us learn about this market that is sure to be very very volatile in the very near future. thanks again for all that you do. _________ Reggie, presuming no one is silly enough to buy BSC, what would be the implications of a bailout for ABK & MBIA for BSC? Would it be cheaper for the banks with the counterparty risk to ABK & MBIA to bail them out than let them fail? Seems like the consequences of the monolines failing are just to awful for the institutions (banks and government) to allow it to happen. _____________ Add this page to your favorite Social Bookmarking websites Set as favorite Bookmark Email This Hits: 793 Trackback(0) TrackBack URI for this entry Comments (3) Subscribe to this comment's feed Structured product valuation and voodoo written by Reggie Middleton, February 24, 2008 Despite all the fear and gloom and doom there is value in many of these derivative assets. As long as the assets are performing they are worth the present value of their future cash flows. The markets are not efficient. An owner of an asset is who is not forced to liquidate into an inefficient market is wise to wait. I disagree with your contention that these assets should all be valued at the inefficient market value. Take a look at Primus. Their credit default swaps are underwater if they were liquidated today, but if held to term they are fine. Unless you want to make the assumption that the world is coming to an end and all the businesses are going to default on all their loans. The theoretical value of those products are present value of their future cash flows. The actual value is their market value here and now. The reason why I called your definition "theoretical" is because it is just that. Since the cash flows are in the future, how do you know what they are? This is why I use DCF sparingly in my models, it is highly theoretical and relies on significant guesswork. It is quite valid of all of your assumptions pan out, but that is a big "if". In addition, if the derivative players (ex. Ambac, MBIA and the banks) really thought that the market got the valuation wrong on these assets, they would be snapping all of these "undervalued gems" faster than a vulture at a carrion convention. Alas, they really don't seem to be buying any more, do they? I, for one, believe that a few of these real asset and financial institutions stuck with the underlying, credit and derivative securities written on top of said underlying are highly overvalued and I am more than 103% leveraged against them. Why? Because I believe there is profit to be had on the downside and I am actively pursuing such. That is my business. Hopefully, you would not take me very seriously if I screamed overvaluation and short, yet I would not be acting on such myself. That is how I perceive those who say the market is undervaluing derivatives written on underlying assets bought at the very tippy top of the biggest housing and credit bubble this country has ever known. +0 Asset performance should dictate credit worthiness? written by Jon Pearlstone, February 24, 2008 Despite all the fear and gloom and doom there is value in many of these derivative assets. As long as the assets are performing they are worth the present value of their future cash flows. The markets are not efficient. An owner of an asset is who is not forced to liquidate into an inefficient market is wise to wait. I disagree with your contention that these assets should all be valued at the inefficient market value. Take a look at Primus. Their credit default swaps are underwater if they were liquidated today, but if held to term they are fine. Unless you want to make the assumption that the world is coming to an end and all the businesses are going to default on all their loans. This would imply that ALL investments are AAA rated as long as the CURRENT payment shows up? I am a very open minded student of the financial markets but that assertion is perhaps the worst defense of the "mark to model" (mark to MYTH) world we are now living in that I have ever heard. All financial accounting standards are very clear. Assets are to be marked to market value so users of financial statements can get a clear view of the precise position of the company being evaluated at that very point in time. I can only assume that posts like the one I quoted above show up because people have so incredibly much to lose once the truth finally must be realized. +0 ... written by alex, February 25, 2008 These varied perceptions are what makes a market. For the time being the bearish view is winning across the board. I for on am picking my spots to be long as the baby has been thrown out with the bathwater, IMHO. If you look at Buffet's port CDS' have increase from 12billion to 35 billion in the last year. Fairfax Financial is another example. +0 Write comment Name Email Website Title Comment smaller \| bigger Subscribe via email (Registered users only) I have read and agree to the Terms of Usage. Write the displayed characters
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