Thursday, 05 June 2008 05:00

For the ignorance arbitrage business model, the End Game nears

Yep, I said it. The monoline business model that MBIA and Ambac used relied on the ignorance of the clients and market participants to survive. These companies attempted to undercut the market pricing of risk - charging clients consistantly less than what Mr. Market would, and pocketing the difference, all the while doing so with 100x plus leverage against products with sparse or unkowon loss histories. It was bound to hit the wall. In a few hours, I'm probably going to release some research that shows how regional banks have backed themselves up against the failure wall using 7x to 20x leverage, so just imagine 100x plus leverage...

We are now about to close a chapter in this book, but fear not fellow blogophytes, there is a new chapter whose 1st page is about to be turned...

From Bloomberg : MBIA, Ambac Signal They May Give Up Aaa Battle After Moody's Threatens Cut

MBIA Inc. and Ambac Financial Group
may give up attempts to retain Aaa credit ratings of their
bond insurance units after Moody's Investors Service put them
under review for a second time this year.

The world's largest bond insurers said they won't raise
capital after New York-based Moody's said yesterday that the
most likely result of its examination would be a downgrade of
the companies' insurance financial strength rankings.

1 day after Cuomo says, "The Truth or Else", guess what happens... Expect downgrades on more structured products as well

June 4 (Bloomberg) -- New York Attorney General Andrew Cuomo
is nearing an agreement with Moody's Investors Service, Standard
& Poor's and Fitch Ratings that would let the credit-rating firms
avoid sanctions over their role in the subprime-mortgage crisis,
people with knowledge of the accord said.

The companies won't admit wrongdoing and will have six
months to implement policies such as a new fee structure and
increased disclosure about the deals they rate, said the people,
who declined to be identified before a public announcement that
might come as early as this week.

Cuomo would end his nine-month probe of the ratings
companies, started as part of a broader investigation into the
mortgage industry. Cuomo said in February he was focused on ``the
role played by the ratings agencies in the mortgage meltdown''
that caused more than $386 billion in credit losses and asset
writedowns at banks. Investors had anticipated Cuomo would force
bigger changes, and Moody's Corp. and McGraw-Hill Cos., parent of
S&P, rose in New York trading.

I'm not going to say I told you so...

I instituted a short campaign in September of last year, and started
releasing research and opinion about that date as well. In November, I
put out some strongly opinionated stuff and got a lot of feedback.

This is part one
of a two part response to comments and questions on the recent events
concerning the Ambac and MBIA. The second part will be a forensic
marking to market of Ambac's portfolio based upon the recent E*Trade
sale. Required reading for this article includes:

  1. A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton.
  2. Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion Market Cap
  3. Follow up to the Ambac Analysis
  4. Monolines swoon, CDOs go boom & I really wonder why the ratings agencies are given any credibility
  5. Bill Ackman of Pershing Square - How to save the Monolines

For those interested in the history, see Insurers and Insurance in m blog. There are literally 100's of pages of opinion and analysis over the last 9 months.

The dominoes should start to fall...

If any body believes I have an inkling of knowing my way around these
investment markets, I strongly suggest you re-read my Asset Securitization Crisis series, in particular, "Counterparty risk analyses - counter-party failure will open up another Pandora's box"
(must read for anyone who is not a CDS specialist). We wil be entering
into the next phase of the crisis, for I believe that the CDS market
will start showing fissures that will illuminate rampant counterparty
credit risks through the global capital markets. These insurers used
CDS almost exclusively for their structured product wraps and insurance.

Moody's originally put Ambac and MBIA under review in
January, only to affirm the ratings of MBIA a month later and
Ambac in March. The credit rating company cited ``meaningful
uncertainty'' about Ambac's ability to regain market share since
the first reviews, and ``diminished new business prospects'' for
MBIA in yesterday's announcement. This uncertainty is well grounded.

``You can't go to somebody to raise capital if you don't
know what the rules for capital raising would be,'' Armonk, New
York-based MBIA Chief Executive Officer Jay Brown told reporters
yesterday. ``Goal posts move, targets change.'' On the surface, he has a valid point here, but the truth of the matter is he know full well that the company didn't deserve a AAA rating. They played along with the phony, funny money rules of the credit wizard, and when it was time for them to be "funny monied", they cry foul????

Moody's decision is ``liberating'' for New York-based Ambac,
and may enable it to consider options other than selling stock
or debt, Doug Renfield-Miller, an executive vice president at
the company, said at an investor conference. I've always alleged that it was a waste of resources and a destruction of shareholder value to chase an ephemeral AAA rating that you both never deserved and couldn't retain. IMHO, these companies are pretty much finished as the guarantors they once were.

Wider Losses

MBIA and Ambac raised a combined $4.1 billion in the past
six months to convince Moody's, Standard & Poor's and Fitch
Ratings they had enough capital to justify their top rankings.
Fitch cut Ambac to AA in January and MBIA to AA in April. Notice how Fitch is not part of this "settlement". They worked hard to save face and regain their credibility. I actually covered my shorts on these two insurers after booking fat profits, but reinstated them (See "Short Seller Dreamin') after hearing that the returning MBIA CEO who spearheaded the drive into structured products requested that Fitch no longer review the company. That was a bone headed move for a company whose stability is in question and whose ratings agencies credibility is already called into serious question. Such management blunders screamed out, "SHORT ME SOME MORE, PLEASE!!!"

MBIA Insurance Corp.'s financial strength rating likely
will fall to the Aa range, though a drop to the A category is
possible, Moody's said yesterday in a statement. Ambac Assurance
Corp.'s ranking will probably be cut to Aa, Moody's also said.

``I don't think they're going to respond in any way to keep
the rating,'' said Jim Ryan, an analyst with Morningstar Inc. in
Chicago. ``I don't think there's anything they can do.''

MBIA may start a new insurance business with $900 million
it raised in February, Brown said. Actually, I think the Insurance Commisioner of NY will want you to keep that money to pay policy claims and back your liabilities... Ambac shareholders suggested
the company stop writing new business and enter a state of ``run
off,'' where it winds down as policies mature, Renfield-Miller
said. Best idea yet.

While raising capital isn't likely, ``we're not giving up
with Moody's or the other rating agencies. We're going to
continue our dialogue, and try to convince them they've erred,''
Renfield-Miller said. Keep hope alive. Their own asses are on the line now (see side bar). Know more credit wizard cartoonery. See the cartoons, credit wizard one and two .

Market Disconnect

Ambac reported a $1.66 billion net loss in the first
quarter after $3.1 billion in charges related to subprime-
mortgage securities it insured. MBIA lost $2.4 billion as the
value of derivatives it sells to guarantee debt tumbled $3.58

MBIA, which had plunged 90 percent in the past year,
dropped $1.06, or 15.8 percent, to $5.63 in New York Stock
Exchange composite trading yesterday, the lowest since June 1988.
Ambac, down 97 percent in the past year, fell 51 cents, or 17
percent, to $2.49, a new low.

``The disconnect between the market's perception and the
rating agencies' assigned ratings has finally become an elephant
in the room too big to ignore,'' Kathleen Shanley, an analyst at
Chicago-based bond research firm Gimme Credit, wrote in a report
yesterday. Actually, the NYS regulators and DA got tired of the lying bullsh1t!

The prospect of downgrades earlier this year roiled markets
because of concern that guarantees for more than $1 trillion of
debt may be worthless. The problem is no less signfiicant now then it was then. Let's see if the media proffers a muted reaction.

AAA Focus

Until yesterday, MBIA and Ambac executives said they were
focused on keeping Aaa ratings.

``Our goal is to rebuild confidence and to insulate our
ratings from future volatility,'' Ambac CEO Michael Callen said
at the company's annual meeting on June 3.

Brown told shareholders at MBIA's annual meeting in May
that ``we are very comfortable that we have raised adequate

Credit-default swaps tied to MBIA's insurance unit rose to
a record. Sellers of five-year contracts demanded 23.5 percent
upfront and 5 percent a year yesterday, according to London-
based data provider CMA Datavision. That's up from 18.5 percent
initially and 5 percent a year two days ago. Wow, I generally don't buy CDS, but it does seem to have been a very profitable trade. You know, the devil is in the details though. In order to monetize those paper profits, you have to unwind the traded - you know... Brokers, Bankers, and Bullsh1t. It will be interesting to see who gets stiffed for those profits they thought they had, and what happens to those funds NAV calculations. Side pockets, here we come!!!

The upfront cost to protect Ambac debt jumped to 25.5
percent from 21.5 percent, CMA prices show. The contracts pay
the buyer face value in exchange for the underlying securities
should the company fail to adhere to its debt agreements or if
it can't make good on its guarantees.

``It's next to impossible'' for the companies to raise
capital, Andrew Wessel, an analyst with JPMorgan Securities in
New York, told Bloomberg Television.

The Partial Cost of Monoline ABS Failure
Par Equity Exposure Ratio
Bear Stearns* $15,673,088,703 $11,793,000,000 132.90% icon BSC ABS inventory
Morgan Stanley** $22,956,101,796 $31,269,000,000 73.41% icon MS ABS Inventory
Lehman Brothers*** $3,151,328,632 $22,490,000,000 14.01% icon LEH ABS Inventory
Citigroup $8,100,028,623 $127,113,000,000 6.37% icon C ABS Inventory
Countrywide**** $12,639,385,566 $15,252,230,000 82.87% icon CFC ABS Inventory
Wells Fargo**** $4,700,835,231 $47,738,000,000 9.85% icon Wells Fargo ABS Inventory
Goldman Sachs $18,673,869,328 $42,800,000,000 43.63% icon GS ABS Inventory
WaMu**** $7,658,982,498 $23,941,000,000 31.99% icon WaMu ABS Inventory
Merrill Lynch $10,224,387,634 $38,626,000,000 26.47% icon ML ABS Inventory
Centex***** $511,740,636 $3,197,130,000 16.01% icon CTX ABS Inventory
Wachovia**** $5,328,228,928 $76,872,000,000 6.93% icon Wachovia ABS Inventory
Totals $118,950,151,688 $477,918,010,000 24.89%

* collapsed two months after I warned on the blog: Is this the Breaking of the Bear?

** the most exposed bank to counterparty credit risk on the street: The Riskiest Bank on the Street and Reggie Middleton on the Street's Riskiest Bank - Update

*** at risk due to the largest proportionate MBS inventory on the street, effectively un hedgeable at this amount and in these markets

**** card carrying members of the Doo-Doo bank 32 list. See:As I see it, these 32 banks and thrifts are in deep doo-doo! and Doo-Doo bank drill down, part 1 - Wells Fargo.

***** Centex and Lennar have (had) some of the largest subprime mortgage operations in the country. They don't publicize it much, but I am sure they are getting stuck wth a lot of paper, as well as real estate on their books. I have an update to Lennar which I will hopefully get to post in a few days. Till then, see the older analyses: Lennar Insolvent: Enron redux??? and Voodoo, Zombies, Lennar�s Off Balance Sheet Accounting and Other Things of Mystery & Myth.

For those who haven't read them, see :Banks, Brokers, & Bullsh1+ part 1 and Banks, Brokers, & Bullsh1+ part 2

Fall out from the municipal sector, most of whom have already been granted monoline immunity from regulators (they knew this was coming and actually expect ratings to fall to junk status ): Municipal bond market and the securitization crisis - part I and Municipal bond market and the securitization crisis - part 2 (should be read by whoever is not a muni expert - this newsbyte may be worth reading as well)

Fallout before the US trading day starts:

Asia-Pacific Bond Risk Rises to Six-Week High on MBIA, Ambac: The cost of protecting Asia-Pacific
bonds from default increased to a six-week high, led by banks
and consumer lenders, after Moody's Investors Service threatened
to cut the ratings of
MBIA Inc. and Ambac Financial Corp.

The potential loss of the two bond insurers' top Aaa credit
rankings renewed concern that guarantees for more than $1 trillion
of debt may be worthless, leading to more losses in global credit
markets. The first downgrade reviews in January boosted Asian
credit-default-swap benchmark indexes to what was then a record.

``It just shows, you can never price in enough bad news,''
said Tim Condon, head of Asia research at ING Groep NV in
Singapore. ``There's a bout of credit angst.''

The Markit iTraxx Japan index rose 1 basis point to 91 as of
2:23 p.m. in Tokyo, according to Morgan Stanley. Australia's
benchmark default-swap index advanced 2.5 to 110.5, Credit Suisse
Group AG prices show. Rising prices suggest deteriorating investor
perceptions of credit quality.

Contracts on Macquarie Group Ltd., Australia's biggest
investment bank, posted the largest increase among the world's
financial companies, according to data compiled by Bloomberg.
Credit-default swaps on Macquarie's senior and subordinated bonds
both gained 5 basis points to 145 and 230 respectively, according
to Citigroup Inc. prices.

Japanese Notes Advance as Stock Losses Boost Demand for Debt June ...: June 5 (Bloomberg) -- Japanese five-year notes rose on
speculation a decline in the Nikkei 225 Stock Average boosted
demand for the relative safety of government debt.

Yields approached a two-week low on concern credit-market
losses may spread as U.S. and European financial firms release
earnings. Moody's Investors Service said yesterday it may
downgrade the world's biggest bond insurers and Lehman Brothers
Holdings Inc. lowered its rating on the Japanese banking sector.

``While inflation is still the biggest focus of the market,
some attention is paid to credit market concerns before earnings
results of financial institutions, leading to debt buying,''
said Atsushi Ito, a strategist at Morgan Stanley Japan
Securities Co. in Tokyo. ``Declines in stocks added support.''

Last modified on Thursday, 05 June 2008 05:00