|Shares Out. (in M):||45||P/E||0||0|
|Market Cap (in $M):||650||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
Buy Ambac Financial Group common stock, ticker AMBC.
The range of outcomes for the value appears to have favorable skew, with only 20% downside and 150% upside. This is a counter intuitive situation, because Ambac's main operating subsidiary is characterized by the reverse (that is the nature of bond insurance) and is the source of the opportunity in the common. Judging all the probabilities is a challenge, but I consider the adverse scenario unlikely.
Investors and accountants alike are uncertain about the value of AMBC. During the prior 52 weeks, the stock has been as low as $13, and as high as $27. During the past three years, adjusted book value per share has fluctuated between a low of $1 deficit and a high of $32. Given the uncertainty, it makes sense to review the assets, beginning with the most certain, and proceeding to the less certain and contingent ones.
I will skip a history of Ambac and a description of the business. Those can be found readily, including in some highly rated posts to this community.
AFG.1) $8.47 per share of cash and investments
Ambac Financial Group (AFG) is a holding company, and most assets and liabilities are accounts of the main operating subsidiary, Ambac Assurance Corporation (AAC). AAC has large existing liabilities and massive contingent liabilities. So the net worth of AAC is highly uncertain. But AFG holds $381 million of investments ad $4.2 billion of net operating loss carryforwards with no debt. A description of AFG's assets in on page 63 of the Form 10-Q filed November 8, 2017 and on page 24 of the "Third Quarter 2017 Investor Presentation."
The trend in AFG's "cash and investments" has been stable, outside of $120 million increase since the end of 2015, mostly due to $100 million of tax tolling payments. This is because AFG's operating expenses, around $10 million per year, are roughly covered by up to $5 million per year from AAC (after March 2017 this reimbursement is at the sole discretion of the rehabilitator with a $4 million cap) and investment income.
AFG.2) $3.50 per share of future tolling payments for use of net operating loss carryforwards (NOLs)
Ambac accumulated a tax net operating loss (NOL) exceeding $6 billion, primarily from over $10 billion (billion with a B) in pretax losses in 2007 and 2008. In 2013, the company emerged from Chapter 11 bankruptcy protection with a Reorganization Plan that stipulated how the NOLs would be shared intercompany between AFG and AAC. A substantial portion of the NOLs were allocated to AAC ($2.8 billion remain), and as AAC utilizes the NOLs it makes tolling payments to AFG pursuant to a formula. A description of how the tolling payents are calculated is on page 53 of Form 10-Q filed November 8, 2017 and on page 26 of the "Third Quarter 2017 Investor Presentation."
So far, AFG has received $100 million in cash tolling payments from AAC. In May 2016, AFG received $71 million, and in May 2017, AFG received $29 million AFG can collect $136 million in additional cash tolling payments, or $3.50 per share. This is sort of an off balance sheet receivable because the DTA is fully offset by a valuation allowance and DTL.
Tolling payments will pause, however, because AAC generated new NOLs (after September 30, 2011) of $254 million in 2017 that must be utilized exclusively by AAC before tolling payments related to the old NOLs (before September 30, 2011) are resumed. By my calculation, AAC generated $209 million of taxable income in 2016, $834 million in 2015, and over $40 million in 2014.
AFG.3) Up to $6 per share of deferred tax assets, undiscounted
Ambac has $4.2 billion of net operating loss carryforwards (NOLs). AAC was allocated a majority, which now equal $2.8 billion, and the usage of these NOLs drives the tolling payments to AFG described previously. AFG was allocated a minority, which now equal $1.4 billion. The NOLs begin to expire in 2029. Because the holding company does not have a source of taxable income, the AFG NOLs have not been utilized and there is no DTA net of the valuation allowance and DTL.
Ambac is pursuing business transactions that could utilize the NOLs. While the likelihood of succeeding is remote, similar economic incentives have attracted capital and savvy investors before. Recall that KKR led a nearly $600 million capital raise for WMI Holdings for the purpose of acquiring a business to utilize Washington Mutual's $6 billion of NOLs. Based on my research and discussion with bankers, the probability that AFG can realize much of the $6.50 per share in potential future value is remote. But it is a contingent asset that represents upside, and therefore worth mentioning. Obviously, just because I cannot figure out how Ambac might realize value does not mean they will not.
Downside looks like $11.50, or 20% from recent prices around $14.50. This could be lower if the $1.65 per share of interests in the Corolla Trust are further impaired (they are carried at 56% of par already). This could be higher if the $6+ per share of deferred tax assets can be realized.
While the financial reporting is complicated, the business is not. The upside is limited to the net asset value, plus any contingent assets. Initially, the upside scenario from AAC does not look compelling.
But the accounting is misleading, and material adjustments should be considered in construction of an upside scenario. This yields upside from AAC of $24 per share.
AAC.1) $135 per share of investments – no adjustments
In most cases, Ambac collects cash from the borrower at the outset of the financial guaranty contract. These proceeds are invested in a portfolio of securities to cover AAC’s operating expenses and to meet claim liabilities. Today, AAC’s investment portfolio has a carrying value of $6.1 billion and yields 6.1%. The investments are carried at fair value, and most are Level 2 assets. Details of every security can be found in AAC’s statutory filings, and the company supplies the information in a Microsoft Excel file on its website under Investor Relations.
AAC.2) $41 per share of legal recoveries – with $15 per share of upside
Ambac estimates that it will recover $1.8 billion from underwriters, primarily Bank of America and Nomura, for claims payments that Ambac made on void policies. The estimate is based on various scenarios and different probability weightings, and is recorded on the balance sheet as a contra-liability that reduces gross loss reserves.
Technically speaking, when AAC issued financial guaranty insurance policies covering the payments on residential mortgage backed securities (RMBS) underwritten by banks (i.e. Countrywide), the policies included agreements and policies that describe various representations and warranties made by the underwriter, as well as remedies available to the insurer (i.e. AAC) in the event of a breach of those representations and warranties. Because many RMBS performed well below expectations, Ambac began to investigate the underwriting and discovered that over 60% of the loans were in breach of representations and warranties.
Bank of America settled with the other two major bond insurers already. In 2011, Bank of America settled with Assured Guaranty for over $1.1 billion, and in 2013, Bank of America settled with MBIA for $1.6 billion. A possible explanation for why Bank of America has not settled yet with Ambac is that BAC considered Ambac in a weak negotiating position given that Ambac utilized bankruptcy protection and AAC is still in rehabilitation (heightened regulatory supervision and making certain claims payments only partially in cash). AAC is on the verge of exiting rehabilitation, however.
For two reasons, this particular asset could be worth more than $1.8 billion. First, the $1.8 billion probability weighted estimate is significantly less than the amount Ambac seeks to recover. If Ambac is seeking $2.75 billion and settles for 80%, or $2.2 billion, then it will record a gain of $400 million or $8 per share. Second, the $1.8 billion does not include recoveries for fraudulent inducement. If Ambac recovers $300 million, then it will record a gain of $300 million, or $7 per share.
With 45 million shares and significant net operating loss carryforwards, every $100 million of recoveries in excess of the $1.8 billion book value is worth $2.20 per share of value, or 15% of the current share price. So there is significant upside potential for the common equity shareholders.
AAC.3) $146 per share of claims liabilities -- $5-6 per share upside
Ambac’s claim liabilities include (a) $3.0 billion of unpaid claims, (b) $0.8 billion of accrued interest on unpaid claims, and (c) $3.0 billion of estimated future claims.
The first two are referred to as deferred amounts, which total $3.8 billion. Ambac negotiated to satisfy these obligations are 93.5%, which will reduce the liability by $250 million, or $5-6 per share. Ambac has repurchased $1.6 billion of this obligation. The liability remains gross of the purchases at $3.8 billion, and the carrying value of Ambac-insured RMBS (of which deferred amounts is a component) is $2.2 billion with a yield of 10%.
The $3.0 billion of estimated future claims could also be overstated. The trend has certainly been for Ambac to revise this estimate lower. Four years ago, Ambac’s reserve ratio was 20% and today it is only 16%. Another 1% reduction would equal $60 million, or more than $1 per share.
AAC.4) $47 per share of debt and preferred shares – upside of $3 per share
Debt includes $755 million of surplus notes and $332 million of accrued interest for a total of $1.1 billion. The rehabilitation exit plan calls for these notes to receive new claims equal to 93.5%, resulting in upside of nearly $2 per share.
Debt includes $350 million of junior surplus notes and $94 million of accrued interest. Ambac owns 30% of these notes, carried at a fair value of 56% of par plus accrued. If the asset is worth the liability, that would cause upside of nearly $60 million, or more than $1 per share.
Ambac has $660 million of preferred shares that are carried as a noncontrolling interest at $264 million. Further upside could come from repurchasing these at a discount to par.
Upside to $36 per share from a combination of $12 per share for AFG and $24 per share for AAC.
The main risk to the value of AAC (and AMBC) is that Ambac has insured Puerto Rico public finance obligations equal to $9.5 billion of net principal and interest. The financial obligations are clearly detailed in the company’s investor presentation on Puerto Rico exposures. The company has $801 million of loss reserves.
The key insight is that Ambac has purchased 40% of the largest exposure, $7.3 billion of Senior Sales Tax Revenue bonds (COFINA) and at current market prices the remaining 60% could be acquired for under $600 million (10% of the investment portfolio). In addition, Ambac has purchased 24% of the second largest exposure, $1.0 billion of Infrastructure Financing Special Tax Revenue (PRIFA).
It appears to me that Ambac has a much higher reserve ratio and much smaller immediate cash obligations that MBIA, and MBIA recently completed a $250 million share repurchase.
Note also the series of insider buying recently.
Ambac continues to purchase Ambac insured COFINA debt and significantly reduces tail risk
|Entry||01/22/2018 10:33 PM|
nice time on the writeup! exiting rehab today should be huge for book value accretion, R&W settlement soon and possibly an outright sale of the company?!
|Subject||Question (potentially stupid)|
|Entry||03/27/2018 04:18 PM|
I am new to the story here, but I am confused the accounting of AMBC's purchase of AMBC-gtd debt.
If I understand correctly, there are $9.5bn of insured PR bonds. They have $800mm in reserves against these bonds.
Thus far, they have bot back about $4.5bn of total PR bonds. Let's say they bot these back at about 50 cents on the dollar to make math easy.
What happens on the balance sheet when they buy these bonds back?
I would think that the $800mm in reserves would go down by about 4.5/9.5 * $800mm and that they would then hold the purchased bonds on balance sheet at market prices. So the instant they buy back bond, they book a profit. But this is perverse as they are only able to buy back bonds so cheap because market thinks Ambac credit is bad.
So can you describe the details of the accounting here and how it comes thru balance sheet and income statement?
|Subject||Re: Question (potentially stupid)|
|Entry||03/27/2018 05:21 PM|
Let me correct my question as I now understand that the COFINA bonds are 0% coupon until 2047-2054. The Cusip 74529JAP0 trades for 12-13 cents on the dollar. The Cusip 74529JAN5 trades for about 19 cents on the dollar.
So to ask the same question with better numbers: what is the accounting for a purchase of $100mm 'JAP0 bonds for $12mm? Is the reserve lowered? And then how is the bond and its price movements treated in time?
|Subject||Re: Re: Re: Question (potentially stupid)|
|Entry||03/27/2018 08:23 PM|
thank you. I just read transcript and see that.
|Subject||Market Value of AMBAC gtd debt?|
|Entry||03/28/2018 01:38 PM|
Has anyone tried to figure out the market value of the AMBAC gtd PR debt?
I am trying to think through what the losses/gains are based on various PR scenarios. Here is my thinking.
So I have the market value of Ambac gtd PR debt (including that bot by Ambac) at about $2.2bn, of which about $1.1bn is COFINA debt.
So, if we assumed they bot all the Ambac gtd PR debt, they would essentially have non-gtd Ambac debt on their balance sheet at $2.2bn less the reserve . . . so about $1.4bn.
So now I am thinking thru various scenarios with two variables . . . what is haircut on payments and at what rate to Treasuries will PR non-gtd debt trade after the restructuring. I am assuming the bad scenario where COFINA/Rum bonds get same treatment as GO bonds.
As an example, if debt was haircut 40% and PR non-gtd debt went to T+300bps post restructuring, then they would essentially breakeven.
Anyone else run a similar analysis?
|Subject||Re: Thoughts on COFINA?|
|Entry||06/26/2018 10:19 AM|
enterprisinginvestor + lvampa,
We agree. This has turned into one of our largest positions as we keep adding on the news flow even as the stock has risen. What do you see as the endgame here? Does this eventually get acquired at $30 after it gets cleaned up further? Does Buffett still want to get involved in the muni gty biz?