Financial, Real Estate, Stock Markets Trends and Current Affairs

all stemming from a lack of respect for the price compression
resulting from the real estate/credit busting. They really took a
beating on the homebuilders. I am increasingly negative on CTX now, for
they have large mortgage operations that have to be getting hit hard.

Legg Mason's SIV Troubles:
Legg Mason said it obtained a letter of credit from an unnamed bank to
support its money market fund's holdings of Cheyne Finance, a
structured-investment vehicle. The company said in a release that it
will take a charge of $142 million,
or 41 cents per share after adjustment for incentive compensation and
taxes, "principally representing unrealized losses in the SIV
securities underlying the support."

The following is an interesting commentary forwarded by one of the boombustblog readers. I am enthused at the level of knowldege and common sense prevalent in this community. It really makes me happy that I started the blog.

Letter from Buffet's camp.

As you know, many constituencies in the financial markets have been increasingly focused on the emerging issues in the financial guaranty industry for several weeks now. In fact, we ourselves have had several meetings with the New York Insurance Department to explore whether there is something we can do under the current circumstances that would be helpful in addressing the growing concerns in the financial marketplace. Unfortunately, the structured finance "side" of the business, with its many moving pieces and interdependent variables, has proven to be beyond our ability to adequately analyze. Nonetheless, we are ready and willing to lend our reinsurance support to the municipal side of the house, and in fact had set out in a letter to the New York Superintendent of Insurance a concept that we believe would address the needs and concerns of main street America's municipalities. The Superintendent has no objection to our approaching you with this proposal. We would like to meet with you and your client, MBIA, to discuss whether MBIA would have any interest in the proposal .

The key elements of the proposal we described to the Superintendent were: (1) we would raise the capital level in our monoline insurer, Berkshire Hathaway Assurance Corporation (BHAC), to $5 billion; (2) we would assume by reinsurance the muni bond portfolio of several of the monoline companies for a premium of 150% of the existing unearned premium reserves of the companies (with respect to two of the leading companies this would result in a combined unearned premium reserve of $6 billion, plus $3 billion for a total premium of $9 billion which, with the increased capital contribution to BHAC would result in approximately $14 billion of assets available to meet the combined $600 billion or so of total principal value of municipal bonds insured by these two companies); (3) we would undertake not to reduce BHAC's assets by dividends, fees, etc., for a minimum period of ten years; and (4) we had furthermore proposed that, if the companies found a preferable solution during the first 30 days of our cover, they could have a no-questions-asked walk-away option in consideration of a break-up fee that would be paid to us.

It looks like my bearish position on AGO needs to be doubled up. From the WSJ.com:

Ambac Financial Group Inc. is in discussions to effectively split itself up in a move aimed at ensuring that municipal bonds backed by Ambac retain high credit ratings, according to a person familiar with the situation.

A halving of Ambac would create one unit that insures municipal debt and one that would cover rapidly diminishing securities tied to the mortgages in a structure that effectively creates a so-called "good bank" and "bad bank." Bond insurers generate revenue by promising to cover bond payments on debt issued by a range of entities, including local governments. Bond insurers now are under pressure, though, because they also agreed to guarantee payments on mortgage debt or securities to banks, brokers and investors.

Ratings companies now are poised to further cut credit ratings on bond insurers because of those guarantees. Ratings downgrades can have chain reactions and lead to increased borrowing costs for municipalities and write-downs for banks that own debt backed by the insurance providers. To avert financial chaos, regulators in New York, including state insurance superintendent Eric Dinallo and Gov. Eliot Spitzer have pressured the companies to find solutions or else face regulatory action.

Ambac is one of two bond insurers considering an effective break-up. FGIC Corp. on Friday notified Mr. Dinallo's office, the New York State Insurance Department, that it is pursuing an effective break-up. But according to people familiar with the situation, FGIC's plan came as a surprise to a consortium of banks that had been in early discussions to shore up FGIC's capital. Talks between the two sides be prolonged and litigation may be one outcome. Ambac's plan is much further along and an announcement could be made this week.

But the plan to split Ambac is complex and has required tens of hours in recent days. While a "good bank-bad bank" model has existed for decades, there isn't a playbook for halving a bond insurer. A number of issues remain to be resolved, said a person familiar with the situation.

So, what does this mean for the companies and industries covered in my blog? Well, in my opinion, this is the beginning of the endgame. Let's walk through the game board...

This is the part where you should expect me to say all hell breaks loose. For those who don't follow me regularly, this is my take on the monolines and Ambac. Now, let's check the headlines... From Bloomberg.com:

Ambac's Insurance Unit Cut to AA From AAA by Fitch Ratings

Ambac Financial Group Inc., the second-largest bond insurer, was stripped of its AAA credit rating by Fitch Ratings after the company abandoned plans to raise new equity...Ambac Assurance Corp. was lowered two levels to AA and may be reduced further, New York-based Fitch said yesterday in a statement. The downgrade ``reflects the significant uncertainty with respect to the company's franchise, business model and strategic direction,'' Fitch said... Without its AAA rating, New York-based Ambac may be unable to write the top-ranked bond insurance that makes up 74 percent of its revenue. Ambac may quit the business or sell itself, said Robert Haines, an analyst at CreditSights Inc., a bond research firm in New York. The downgrade throws doubt on the ratings of $556 billion in municipal and structured finance debt guaranteed by Ambac.

``This makes Ambac insurance toxic,'' said Matt Fabian, senior analyst and managing director at Municipal Market Advisors in Westport, Connecticut. And therein lies the fundamental problem. The insurance was toxic from the get-go. The Fitch change in moniker status did nothing to change this, but give us bloggers and some reporters something to type about.``The market has no tolerance for a ratings-deprived insurer.''

Moody's Investors Service and Standard & Poor's, the two largest ratings companies, are reviewing Ambac's ratings for a possible reduction. Moody's said this week that it may also cut the ratings of MBIA Inc., the largest bond insurer. This all a big fat joke. They cut ratings after a 80% drop in price and announcement of a $33 per share loss? Don't do us any more favors. Like I have disclaimed earlier, I am far from a fixed income expert, but I could have sworn that the ratings agencies advisory was aimed at being predictive, and not reactive. All they are doing is telling people how much money they lost!!!

``The likelihood is quite high the others will follow,'' said John Tierney, credit market strategist at Deutsche Bank AG in New York. ``Barring some significant development on new capital, it's just a matter of time before S&P and Moody's act on MBIA and Ambac.''... The seven AAA rated bond insurers place their stamp on $2.4 trillion of debt. Losing those rankings may cost borrowers and investors as much as $200 billion, according to data compiled by Bloomberg. The industry guaranteed $100 billion of collateralized debt obligations linked to subprime mortgages, $22 billion of non-prime auto loans and $1.2 trillion of municipal debt. Buffet's stock may see a lot of demand out of this...

New York-based Merrill Lynch & Co., the world's largest brokerage, this week took $3.1 billion of writedowns on the value of default protection from bond insurers... Fitch, following its downgrade of Ambac Assurance, adjusted ratings accordingly for 137,990 municipal bonds and 114 non- municipal issues insured by the company. Bonds with underlying ratings higher than Ambac's will remain above the bond insurer's level, Fitch said yesterday in a statement...Fitch last month demanded the company raise $1 billion by the end of January. Ambac on Jan. 16 slashed its dividend 67 percent and said it would sell stock or convertible notes to bolster its capital. The plan provoked a boardroom dispute and led to the departure of Chief Executive Officer Robert Genader.

Ambac's interim CEO, Michael Callen, 67, said this week that the company planned to raise capital in ``an accelerated time frame.'' And exactly how are they going to accomplish that.

Moody's said this week that it may cut Ambac's ratings after the company forecast writedowns of $3.5 billion on subprime-mortgage securities. S&P said yesterday that it may cut Ambac's rating because its capital-raising options are ``impaired.'' I hate to say I told you so, but... The issue is now your credibility is severely damaged by making so many wrong calls to begin with, then taking so long to do something about them.

The sudden increase in scrutiny by Moody's, a month after the company affirmed the ratings, sparked tension with Ambac and MBIA. Ambac this week described Moody's decision to place its ratings on review as ``surprising.'' MBIA issued a statement yesterday, saying it had started a capital raising plan ``in good faith reliance'' on Moody's stated requirements. You guys know you weren't a AAA risk. Let's stop the shenanigans, please...

MBIA's surplus notes plunged as low as 70 cents on the dollar yesterday, indicating a yield of about 25 percent, traders said. MBIA fell 67 cents, or 7.3 percent, to $8.55 on the New York Stock Exchange, taking its decline to 48 percent this week. Now, here I am going to say "I told you so"! Actually, my words were, "wait until they start trading!". I don't know what investors were thinking went they bought these notes! Do they not have professional advisors ? If not, I will offer free access to my blog for those that need it. A quick lesson for free - stop trying to reach for above market yields, for you may be handed above market losses in return.

Ratings companies, which affirmed their assessments a month ago, are scrutinizing bond insurers to ensure they have enough capital to protect against losses. S&P this week said industry losses on subprime securities will be 20 percent more than it initially forecast. Ambac has a capital shortfall of about $400 million under the new assumptions, S&P said. Well, one of us needs to recharge the batteries in our calculators, recalibrate Excel, or something. I see billions of dollars in shortfalls... (see Monolines swoon, CDO's go boom & I really wonder why the ratings agencies are given any credibility!)

Ambac's 6.15 percent bonds due in 2037 have plunged by 25 cents on the dollar this week to 35.4 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The yield has soared to 17.6 percent from 10.5 percent and the extra yield investors demand over government securities with similar maturities has widened 7.2 percentage points to 13.4 percentage points. And Moody's considers this a AA risk!!! Can you imagine what they would mean by the term JUNK!

Prices for credit-default swaps that pay investors if MBIA can't meet its debt obligations imply a 71 percent chance it will default in the next five years, according to a JPMorgan Chase & Co. valuation model. Contacts on Ambac imply 72 percent odds. Hey, isn't that what I said in the links above???

Contracts tied to MBIA's bonds have risen 10 percentage points the past two days to 26 percent upfront and 5 percent a year, according to CMA Datavision in New York. That means it would cost $2.6 million initially and $500,000 a year to protect $10 million in MBIA bonds from default for five years.... Credit-default swaps on Ambac, the second-biggest insurer, rose 11.5 percentage points to 26.5 percent upfront and 5 percent a year yesterday, prices from CMA Datavision show.

Ambac agreed to guarantee almost $200 million of bonds sold so far this year, or 6 percent of the market for new insured issues, according to data compiled by Bloomberg. Ambac's market share was 22.5 percent as of Sept. 30, 2007, according to a Dec. 13 report from Bear Stearns Cos. In a few days I will illustrate the relationship between Bear Stearns, Ambac, and Mr. & Mrs. CounteryParty Risk.

So, after all of this, what comes next??? Is this the part where you expect me to say, "All hell breaks loose!". Well, not all hell, but I think some companies may find just a taste of it...

I was going to post an update on the Bear Stearns and GGP work, but since there was such adverse price action in Ambac stock I decided to follow up on that - again. So, here we go. If you are new to the blog be sure to click, follow and download all the links. They are worthwhile. If you are a regular to my monoline musings, at least download the following pdf link. It is new, and worth a quick reading. Feel free to email it and pass it around as well. I annotated a FAQ directly off of their site.

From the Ambac.com FAQ about 2 1/2 months ago

See first line of page 2 here: ABK FAQ 12/26/07 - Reggie Annotated.

From this blog author on 11/28/07: Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion of Equity! -

Alternatively, we have calculated the provisioning for losses that Ambac will need to make every year on the basis of the anticipated losses that the company will have to pay in coming years. In doing so we have assumed that the 85% of the premium written from 2007 onwards (excluding 15% as underwrting expesnse) will be transferred to the loss expense reserve every year. The loss reserve uptill 2007 is taken from comapny's balance sheet. The losses have been calculated on the basis of various default probabilities assummed in Strucutred Finance, Direct Subprime RMBS and Consumer Finance portfolios. We have assumed a duration of 5 years to spread the losses on various vintages over the coming years. We anticipate the company will have to create a provisoin of $ 6.8 billion under the base case scenario. That;'s about $67 per share, they are halfway there already with $33 per share announced to be expected today. Mayhap someone from this blog should invite the Ambac management team to register...

We actually had a modern day run on the bank in the UK and the equity markets shrugged it off.

It is a mistake, plain and simple. I normally don't like to tell people who specialize in a business how to run it, since they probably know more about their business than I do - but sometimes the mistakes are just so glaring. I don't care how many analysts are poring over how many books at Countrywide. BAC's error is not misjudging the value of Countrywide now, but misjudging the macro environment in which Countrywide operates.

My experience has been primarily understanding and evaluating companies from the equity perspective, but that definitely doesn't mean that I ignore the fxed income side. I am just not better at it than the other guys. What I have been noticing of late is that credit markets have been screaming murder for some time now, and the equity markets have been humming along new bullish highs and trading runs as if nothing is truly wrong. This is a strong indicator that momentum trading has again taken control of the markets. It is an environment where price trumps value. The last time this came to a head was the dot com bust. It took many institutional and individual investors 5 to 6 years to break even. Some never recouped their losses. Well, my gut has been telling me for about a year and change now that we are back there again. 2008 thus far has done nothing but confirm that we have come to a head. The pic above was an actual shot (one of very many at various locations) of the run on Northern Rock Bank in the U.K. This was real, and it was indicative of a real problem.

Well, we had a very recent run on the bank here in the states as well. There were pictures all over the web when it occurred, and now mysteriously, they are all gone. All I was able to retrieve was this screen capture of a thumbnail from Blownmortgage.com. Just as the pictorial remnants of the run have somehow disappeared, so has the equity markets prudence in the face of such a run. You can guess which bank got ran on.

Bear fightThis is an introduction and precursor to the work being done over at Reggie's laboratory concerning Bear Stearns, who has seen its share price halved since the credit market melee kicked off. A melee that many say the Bear is responsible for igniting. I don't know how fair a comment that is, but I do know one thing, though. In terms of equity devaluation for the bear, you probably ain't seen nothin' yet. Bear Stearns will soon be, if not already, in a fight for its life. It is beset with the possibility of a criminal indictment (no Wall Street firm has ever survived a criminal indictment), additional civil litigation, and client defection and aliention. Despite all of these, the biggest issues don't seem all that prevalent in the media though. Bear Stearns is in a real financial bind due to the assets that it specialized in, and it is not in it by itself, either. It's excessive reliance on highly "modeled" and real asset/mortgage backed products in its portfolio may potentially be its undoing. See Banks, Brokers and Bullsh1+ part one for a run down on model risk and part two for my take on counterparty credit risk as a backgrounder before reading this piece.

I thought of sharing with you some of the key observations that we've made while doing the valuation model for Bear Stearns, which admittedely is quite late. I first took interest in Bear Stearns in June, but only recently got around to addressing the investment banking sector in a matter suitable for the blog over the last month. During that month, BSC has seen aggressive adverse price action. My research tells me that this price action is not only justified, but will have to continue in order for BSC to be adequately priced. There will be details that support this assessment in the final report.

Bear Stearns first caught my interest at around $130. When we started with the original shortlist of the investment banks for formal analysis on December 13, 2007, Bear Stearns stock price stood at $98.39. The stock price has fallen by more than 27% since then and now trades at $71.17.

External fundamentals behind my call for additional adverse price reaction

The company's exposure to the asset and mortgage backed securities is as follows:

Mortgage and Asset backed inventories of $43.6 billion

Two simple, but unflappable tenets that I follow when investing are:

1.) Economic profit must be evident in order for the investment to be worthwhile. Economic profit exists when the reward achieved exceeds the risk assumed in getting such reward; and

2.) Simpler is better (KISS - Keep it Simple). A lack of transpasrency in the money trail of an investment diminshes its value.

Tenet number two is often misconstrued on Wall Street. Complex 'high finance' investments are not necessarily better than simpler ones. As a matter of fact, seen in light of tenet number one, increased complexity increases risk, thus reducing value.

Often vendor orientated profit is the reason for excessive complexity. If customers cannot understand the pricing (due to lack of transparency) the vendor can charge more. Vendors can then play on the customer's insecurities in that customers feel more sophisticated, knowledgeable and "cool" if they have the latest product that only the special and intelligent can understand - ala Marketing 101.

After talking with friends that specialize in structured products, risk management, and auditing industries, I came up with the idea for this piece. Why not try to offer a simplified method of looking at the risk of the monolines for the layman? Now, of course many professionals will say that the business is too complex for the layman to grasp the risks and rewards involved. Hey, that may be true, but that also brings us back to tenets one and two. If it so complex that risks cannot be seen, or so complicated that rewards are not easily applicable to the business then how valuable is the business and how risky is it really? Does such complexity really warrant a AAA rating, especially in the face of so much adversity? Complexity sure as hell appears to have stumped the management of the monolines, since they have both insured and invested in structured products for which they aren't sure of the payouts in the event of default(see below). There are simpler ways of looking at risks. When in doubt, one can always default to the market - Ambac's credit default swap spreads are reportedly trading at, or near, junk levels indicating a 20%+- probability of default (so they say on the trading desks).

I performed a decent amount of research on the two biggest monolines, which, besides being a little jovial, brought up some damn good points, not the least of which was the potential for insolvency! Nouriel Roubini queries (and rightfully so since I have queried the same and I am NEVER wrong:-), the delay in rating agency downgrading the monolines - "a business model that cannot survive without a AAA rating is a business model that cannot fundamentally deserve a AAA rating ".

This is a second set of email between me and my friend, the big willy of corporate finance. The first set is here. Here we really get into it as the classical corporate guy versus blue collar working stiff class conflict scenario. Okay, I may be exaggerating a bit, but we do challenge each other's knowledge and grasp on the topic at hand. Just to let you know, this is a really smart and accomplished guy whos is highly positioned. I remember when he was just getting started. I lent him his first set of books on structured products. Oh no! It looks like I helped to create a FrankenFinance Monster :-) All jokes aside, he is a very good friend, and I am using these email exchanges as content because I believe they illustrate a very interesting point in my view of the market vs. many of those who may be opposed to my way of viewing things. Sometimes, when you are too close to something for too long, you can't see the forest because those damn trees keep getting in your way!

He is the penultimate insider, I am about as outside as an outsider can get. We are polar opposites, yet friends for 22 years and counting. Now, on to the story... I had to modify some portions since I cannot represent any form of investment record publicly.

______________________

Wall Street Big Willie

You lost me in the first paragraph with ........"since much of the structured prodcut insurance should technically be booked at a loss at inception of the contract" .....(ridiculous since the earned "spreads" would obviously offset any losses AND actuarial analysis would clearly disagree) .

Dec. 28 (Bloomberg) -- Billionaire investor Warren Buffett is
starting a bond insurer to take U.S. local-government business away
from companies including MBIA Inc. and Ambac Financial Group Inc., the
Wall Street Journal reported.

Berkshire Hathaway Assurance
Corp. opens for business today in New York State, Buffett, chairman of
Omaha, Nebraska-based Berkshire Hathaway Inc., said in an interview
with the newspaper...

Buffett, who said in October he
was looking for investments to absorb $45 billion of cash, is
challenging the bond insurers as they struggle to retain the AAA credit
ratings that allow them to guarantee debt. The top rankings of MBIA,
Ambac and other so-called monolines are under scrutiny amid concern
they don't have enough capital for the $2.4 trillion of debt they
guarantee.

``The monolines are hurting so now is a good time for Buffett to be getting into the market,'' said Matthew Maxwell, a London-based credit analyst at Calyon, the investment banking unit of Credit Agricole SA. ``Investors might feel more comfortable investing in bonds insured by Buffett than those backed by an insurer with the legacy of the credit crisis hanging over them.''

Buffett, 77, told the Journal he will also seek permission to operate in California, Puerto Rico, Texas, Illinois and Florida.

Berkshire Hathaway has AAA ratings from Fitch Ratings, Moody's Investors Service and Standard & Poor's and its guarantee would enable municipal bond issuers to cut the cost of financing everything from hospitals to schools to sports stadiums.

Buffett, who said he would charge more than existing financial guarantors, would present competition for Armonk, New York-based MBIA, as well as Ambac and FGIC Corp. of New York, as they try to convince Moody's, Fitch and S&P that they deserve to keep their top ratings. Suuuurrrree they do! Look here Ambac Valuationmodel 03december2007 Ver1.0%281%29 (878.65 kB 2007-12-24 15:41:20)

Fitch has given MBIA and Ambac less than six weeks to raise $1 billion each or face losing their AAA ratings. Moody's and S&P earlier month placed MBIA's ranking on negative outlook. MBIA on Dec. 10 said it will get $1 billion from private-equity firm Warburg Pincus LLC to bolster its capital and Ambac took out reinsurance on $29 billion of securities it guarantees. These companies with a mere $2 or $3 billion of capital are struggling to overpay for $1 billion in financing just to keep a rating they don't deserve. How in the world can compete against a $45 billion capitalized, conservative insurer with a sterling track record and reputation? These companies are done, don't even bother to stick a fork in. I told you they were done before, they are extra crispy now for the only new business for them to write is business that they shouldn't write. That Warburg Pincus investment in MBIA is money flushed down the toilet.

`Mass Destruction'

Bonds sold by state governments make up about 33 percent of the insurance premiums collected by MBIA, the biggest of the monolines, and 50 percent of revenue for No. 2 competitor Ambac.

The companies stumbled as they expanded beyond municipal securities into structured finance securities such as collateralized debt obligations, which package pools of bonds and loans and slice them into separate pieces.

Buffett, who has described derivatives as ``financial weapons of mass destruction,'' told the Journal he will focus on insuring municipal debt rather than CDOs.

New York-based monoline ACA Capital Holdings Inc. is struggling to stave off delinquency proceedings after the value of the CDOs it guaranteed plunged. S&P cut ACA's rating by 12 levels to CCC after the company posted a $1.04 billion third- quarter loss.

ACA Financial Guaranty Corp., a unit of ACA Capital, said this week it will seek approval from the Maryland Insurance Administration before pledging or assigning assets or paying dividends.

Smelling Opportunity

Buffett has profited in the past from turmoil in the insurance business. Berkshire's after-tax profit from insurance underwriting soared to $2.5 billion last year from $27 million in 2005 after providing insurance cover for coastal properties vulnerable to storms as some premiums quadrupled because of record U.S. hurricane losses.

``If Buffett smells an opportunity, his track record suggests there is one,'' said Georg Grodzki, head of credit research at London-based Legal & General Group Plc. ``Buffett seems to believe the market is viable and the bond insurer has a future.'' Yeah, I agree. It's the monoline derivative insurer that is DOA.

Separately, Berkshire Hathaway agreed to buy the reinsurance unit of ING Groep NV for about 300 million euros ($440 million), the biggest Dutch financial-services company said in a statement today.

Berkshire's Class A stock reached a record $151,650 a share on Dec. 11, having surged 25 percent this year. The stock had only three losing years since 1988.