RBS analyst Tom Jenkins described Ambac as being “on life support” in a note on Tuesday; FT Alphaville tends to agree.
The bond insurer (remember those?) said on Monday that it expected to report that its statutory losses on credit derivatives (read: CDS on CDOs backed by residential mortgages) had increased by $1.6bn in the second quarter – to $4.9bn.
The company said it expected those losses – as well as $800m in additional claims on securities backed by home equity loans – would reduce its statutory surplus. Ambac has to maintain a minimum statutory surplus of $2m or risk being taken over by its regulators in Wisconsin; at the end of the first quarter of this year, the insurer’s surplus stood at $372.8m.
From the statement, emphasis ours:
The increase in impairment losses, which relate to [Ambac's] insured portfolio of collateralized debt obligations of asset-backed securities transactions (CDOs of ABS), was driven by rising forward LIBOR rates, which increase estimated future cash outflows, and further deterioration of the underlying collateral within the CDO of ABS transactions. The statutory loss and loss expenses relate primarily to deterioration in [Ambac's] second-lien and Alt-A mortgage-backed securities financial guarantee portfolios.
Ambac has also persuaded counterparties to two transactions, which had an approximate net notional value of $2.8bn as at Mar 31, to tear-up the contracts; in return, Ambac will pay out $750m.
On Tuesday, five-year CDS contracts on Ambac hit a record, climbing 12.75 percentage points to 65.5 per cent upfront, according to CMA data. In other words, the market is pricing is a near 90 per cent probability of default for the company within the next five years.
Here’s comment from RBS’s Jenkins:
Ambac will report a statutory loss of USD800m for the quarter on USD1.6bn of hits, and the company announced another USD750m to come in July (i.e. post reporting date). The most important aspect of this loss is that it will now need to get regulatory approval to reclassify contingency reserve to surplus to avoid breaching minimum statutory limits – it has only USD1.95bn in contingency reserves and will need to release at the very least half of that to get back on an even keel.
Wisconsin has approved this before, but there has to be a limit somewhere and it may allow it one more drink at the trough, but it would be little more than a shot of diamorphine in the arm of the terminal ill patient. Furthermore in a cash preservation mode, Ambac will also stop paying dividends on Ambac Assurance prefs and interest on Ambac Financial subs. The prognosis is now very poor.
Importantly, as Jenkins notes, this means investors should be paying very close attention to the exposures of the major investment banks to bond insurers like Ambac.
Deutsche Bank, according to RBS, has a notional exposure of €33.5bn to bond insurers, and it’s not the only one. Per Jenkins:
SocGen, Barc, BNP, UBS, Commerz are the better documented high exposures to MBIA and Ambac (back in the day, the ‘healthier’ monolines) but we should not forget ANZ which had AUD3.3bn FV of credit intermediation trades (read: largely monoline exposure); and Swiss Re.
UPDATE:
S&P on Tuesday sharply downgraded Ambac, cutting its counterparty credit, financial strength, and financial enhancement ratings by multiple notches to ‘CC’ from ‘BBB’. It is important to remember that not so very long ago, this was a triple-A rated entity, assumed to be bullet (if not subprime) proof.
Related links:
Solvency concerns swirl around bond insurers – FT
Bond insurers vs investment banks, redux – FT Alphaville
The death throes of the bond insurers – FT Alphaville