GuruFocus Premium Membership

Serving Intelligent Investors since 2004. Only 96 cents a day.

Free Trial

Free 7-day Trial
All Articles and Columns »

Marty Whitman’s Conviction in Ambac is Working out; Still waiting for MBIA and Radian Group?

August 29, 2008 | About:

Legendary investor Marty Whitman’s purchases of bond and mortgage insurers Radian (RDN), Ambac (ABK) and MBIA (MBI) have been very controversial, and widely discussed. Watching an investment plunging 95% and continuing to buy more, what kind of conviction does that need?

Will these investment work out? We are still waiting to see. But the investing in Ambac is working out. With this article we will to review his moves in these bond insurers.

Marty Whitman started to buy these bon insurers in 2007, by Oct. 31, he owns about 10 million shares of Radian (RDN) at about $30 a share, MBIA at about $60 a share, and 2 million shares of Ambac at $20 a share. He wrote in the shareholder for the quarter ended Oct. 31, 2007:

“For example, MBIA Common has been selling at about a 57% discount from Adjusted Book Value, and Radian Common has been selling around a 77% discount from a book value written down to reflect $400 million of calendar third quarter 2007 unrealized losses based on mark to market accounting. Both MBIA and Radian appear to be very well financed.”

Apparently to him, financial guaranty insurance qualifies as a good business:

“Historically, financial guaranty insurance has been a highly profitable business for the monoline insurers, even though the insureds received a very attractive deal by being able to obtain AAA ratings at low cost. Insurance company profitability is measured by a combination of underwriting profits and net investment income. Underwriting profit is measured by the “combined ratio”, i.e., the ratio of the sum of losses and expenses to net premium income and net premiums written. Net investment income, usually all interest income, tends to be larger as long as loss liabilities are “long tail”, i.e., the losses do not have to be paid out until long after the insurance premiums have been collected and then invested in bonds. Typically, MBIA’s insurance subsidiaries have enjoyed a combined ratio each year under 40%. Net investment income for the MBIA insurance subsidiaries has grown over the years to almost $600,000,000 per annum. The prospects appear quite good to Fund management that, once past the current housing difficulties, MBIA will return to its historic patterns of very attractive combined ratios and relatively steady growth in net investment income.”

By Jan. 31, 2008, the prices of all three stocks have lost more than 60%. Marty Whitman added significantly to his positions and he wrote:

“On February 11th, TAVF acquired from MBIA, 10,610,425 shares of MBIA Common at $12.15 per share. This brought the Fund’s holding to 23,148,845 shares of MBIA Common, or about 10% of the issue outstanding. Previously, Third Avenue also had acquired $197,000,000 of 14% Surplus Notes issued by an MBIA insurance subsidiary. Since December 2007, MBIA has raised about $2.6 billion of new capital, of which TAVF has supplied almost $326,000,000.”

“MBIA is now strongly capitalized. It ought to qualify easily for an AAA rating with a $17 billion claims paying ability. If so qualified, MBIA would be in a position to underwrite a large amount of profitable new business. However, there seem to be three impediments tangential to capitalization that might prevent MBIA from receiving a credit rating of AAA-Stable.”

“Obviously, I feel good about TAVF’s investment in MBIA. The Fund ought to do well under almost any scenario. By any objective standard, the MBIA investments are attractive ones with the insurance subsidiaries deserving of an AAA-Stable rating. Yet, there exists a sense of discomfort due to the dangers of Rating Agency subjective considerations and capricious regulators.”

By April 30, 2008, these three stocks lost another 60% in prices, and Marty Whitman doubled his position in MBIA, added significantly to Ambac, and kept Radian almost unchanged. He wrote in this quarter’s letter:

“Net-net, the bear raids seem beneficial for the Fund. The raids are beneficial if all they do is depress the prices of common stocks by propagandizing faulty analysis, e.g., Ambac and MBIA. TAVF can acquire securities at true bargain prices. However, insofar as bear raiders can actually reduce corporate values, e.g., Bear Stearns, where important customers and creditor constituencies were convinced that Bear Stearns was not credit-worthy, bear raiders can be a real problem. Since TAVF is not going to become a bear raider, Fund management’s job is to avoid those situations where bear raiders actually harm companies; and to acquire common stocks of well-capitalized companies where all the bear raiders succeed in doing is to depress common stock prices without diminishing the underlying values of the businesses which are the targets of the bear raiders.”



“Bear raids will continue unabated unless those people leading shortselling forays can be shown some downside, whether economic, legal or both. For example, there appears to be a four-pronged approach toward trying to destabilize MBIA as a going concern. First, there are efforts to strip the holding company of assets so that the holding company might become insolvent. Second, there is pressure brought on the ratings agencies to remove the AAA ratings from MBIA’s insurance subsidiaries. Third, there are pleas to regulators suggesting that they restrict the insurance subsidiaries’ ability to write policies. Finally, and as part of the other three, the bear raiders are trying to discourage clients from doing business with MBIA. None of these actions seem to have any merit at all. But from the bear raiders point of view, why not press these approaches? After all, there is no downside.”


In the quarter ended July 31, 2008, Marty Whitman tripled again his position in Ambac as its prices lost another 60%. He did not add significantly to the other two positions. He wrote:

“Both Ambac and MBIA are distressed securities because there clearly seems to have been a permanent impairment of their businesses as monoline insurers providing AAA wraps to municipalities and financial structured instruments. Both Ambac and MBIA have lost their AAA credit ratings. Yet, in effective run-off, it seems likely that the companies will generate large amounts of cash and large amounts of favorable tax attributes, even assuming a reasonable worst case basis where claims prove to be two or three times larger than what the companies are presently reserving for. One of the most favorable characteristics of insurance companies (such as Ambac and MBIA) is the relative ease of exit from present activities, combined with the ability to employ resources elsewhere. Both Ambac and MBIA have claimed that they intend to reenter the monoline insurance businesses as AAA providers of wraps for municipal bond issuers. Whether such businesses can be rebuilt remains an open question.”

“In a most meaningful way, Ambac and MBIA remind me a lot of one of Third Avenue’s most successful investments – Mission Insurance Group. Mission’s name has now been changed to Covanta Holding Corporation, which was acquired out of Chapter 11 in 2004. Insurance is a minor Covanta activity. Its main area of operations is the creation of energy from waste. Since March 2004, Covanta’s stock price has risen over 540%, 24% of which has been over the past 12 months. The prices for the acquisitions of Ambac Common and MBIA Common during the quarter were less than 30% of Fund management’s estimate of reasonable worst case NAVs, assuming they remain going concerns.”

Marty Whitman has lowered his cost to Ambac to about $5.5 a share, MBIA to $23 a share, and Radian group to $28 a share. These stocks are more than tripled from their July bottoms. Marty Whitman had made money on Ambac, and still waiting for MBIA and Radian to recover.

Will these investment proved to be successful? With his cost, Ambac may pay him off nicely, the positions in MBIA and Radian have higher cost, and it will take longer to recover.

What can GuruFocus users do with these investments? Do we have the same conviction? Or these investments are just “too hard”?

Bill Ackman, another key player of bond insurers, in the opposite direction, has been short on these stocks. He still holds short positions in MBIA on June 30. He seems to be right so far. Will both of them be right? One in short term and the other in long term?

This is what Marty Whitman wrote about Bill Ackman:



“Ackman recently laid out his views in two publications, “How to Save the Bond Insurers”, dated November 28, 2007, and “Bond Insurers Transparency: Open Source Research”, dated January 30, 2008. He also published “Is MBIA Triple A?”, in 2002.”


“While he is an articulate advocate, Ackman’s arguments are off base.”

“William Ackman appears to be disingenuous when he writes and talks about saving MBIA’s policyholders. Why does he care about policyholders? Ackman’s objective is to drive down the market price of MBIA securities.”


Rating: 3.8/5 (50 votes)

Comments

Sivaram
Sivaram - 5 years ago
The story is still nowhere near the end. The monolines are very volatile and can collapse as easily as they rose...

This is a good example of how it is difficult for concentrated small investors to follow in the footsteps of the superinvestors. I took a position in Ambac at too high of a price but never really had enough money to keep adding on the way down. Part of it is certainly, as you point out, conviction. However, the lack of capital certainly makes it very difficult. I suppose someone with a more diversified portfolio would be in a position to add to a losing portfolio; but then again I wonder if they would take positions in distressed investments like these. Getting in early is very painful for concentrated small investors...

One other big difference is the inability of small investors to participate in certain capital infusions. The average investor would have never come near this but someone bullish like me would have loved to have been able to buy the MBIA surplus notes. If you don't think the monolines are insolvent, this would have been close to a steal of the decade.


As for Radian, it'll be interesting what happens there. My guess is that its fate will depend heavily on what happens to Fannie and Freddie. Radian is going nowhere until we get clarity with the GSEs...
smartdada
Smartdada - 5 years ago
Bought 1000USD of Radian when it was selling at 2.08$ !! My only deception, not to have bought more shares when it was so dirt' cheap!!!


Sivaram
Sivaram - 5 years ago
Why do you say Radian is dirt cheap? Seriously... are you sure that they will get out of the housing mess alive?
pravchaw
Pravchaw premium member - 5 years ago
Good for you Smartdada. Like you I got in nearly the bottom. I bought Ambac (@ 1), MBI (@ 5) , RDN (@ $1) and MGIC (@ 4). My investment has to date quardrupled and will likely quadruple again in the next 3 months.

These are dirt cheap stocks left for dead by panicked investors.

Sivram: Your call on ABK is correct - my advice for whatever its worth is to sit tight for at least 6 months. I don't think the fate of the mortgage insurers is tied to the GSE's (as their debt is now guaranteed by the fed). The mortgage insurers are indeed tied to mortgage defaults.

Also I predict the GSE's are going to quadruple in short order - but that is another story.

smartdada
Smartdada - 5 years ago
Sivaram,

Have a look to the book value; Radian has a book value of 30$!

Marty Withman holds 18% of the company and bought his first shares between 41 and 62$ From the beginning he considered Radian a cheap.

Pravchaw, well done ! When Radian was selling at 70 cents my convictions were not strong enough to buy.. but we still have plenty of time with the GSE's...

The good news : even if 1 company survive you will make enough money to compensate with your losses!
sabonis
Sabonis premium member - 5 years ago
I am not formally calling BS here, but over the last 12 months I had written posts about Radian on here trying to get a discussion and NOBODY was commenting except to say how I should stay away from it, it was garbage, etc.

Now that the stock is taking off, all of a sudden people on here are claiming they got in at $1 and how they knew all along that it was going up.

Like I said, i am not saying anyone is making things up, but as they say "success has many fathers but failure is an orphan"...
pravchaw
Pravchaw premium member - 5 years ago
Sabonis - You are entitled to your opinion and I agree I got lucky.

Buying early is a common problem for value investors. All success is relative as many of positions are deep underwater (i.e., I bought AIG at $55 and kept buying all the way to $18). I think AIG is a quadruple in 5 years.

Once housing prices level off, I plan to sell the bond/mortgage as their long term liabilities are difficult to guess. However for the short to medium term there is a lot of upside still remaining.
TimTravis88
TimTravis88 - 5 years ago
"NOBODY was commenting except to say how I should stay away from it, it was garbage, etc."

The GSE issue in regards to MTG and RDN is important like Sivaram mentioned, because they are basically keeping these companies a float in terms of new business after the ratings downgrades, because the GSE's have lowered their ratings requirements for insurers to continue to write new business for them. They need the mortgage insurers to survive and eventually thrive so that their existing insurance with the GSE's remains good, and for the GSE's to continue to do business without raising even more capital the biggest insurers need to stay in business, and there are not very many new entrants clamoring to get into that business right now for various reasons.

The risk is greater for RDN and the lower tiered insurers then it is for MTG which is the market leader in a stronger financial position, but of course the upside in RDN may warrant the additional risk. I'm focusing on MTG right now and I think both ABK and MBI have a long ways to go still.

Date: July 7, 2008 12:58PM

Sabonis,

I agree with you on Radian in terms of potential and I think it is quite likely the market has drastically overshot on the downside with that name. The main concern is what effect any capital raising activities would have on that company. RDN interests me but I've elected to put my resources to work on the most well financed and financially strong insurers that are selling at fractions of their book values.

Three names that give me a greater sense of security are MBIA, ABK, and to a slightly lesser extent MTG. One development that occurred last Thursday that I haven't heard much about in the news is that ABK announced a $50 million dollar share buyback. It might not seem like a lot but at these prices it would significantly decrease the float assuming they follow through with it. MBIA actually has a much better liquidity position at this point due to its more aggressive capital raising and I would expect them to announce a significant buyback in the near future.

The main issues I see that are causing massive dislocations of stock prices and my own intrinsic values on names such as AIG, FRE, FNM, C, MBI, ABK, are misunderstandings in regards to the MTM losses that have been taken, and concerns about the dilutive effects of more capital raising. While these fears are understandable and legitimate I think the opportunity to reap huge returns is there for the enterprising investor with a strong stomach and an ability to endure large shifts in the short term value of their portfolio. One thing that I do a lot of is sell puts on names that are at risk for additional dilution. This subjects you to MTM accounting on your portfolio but it creates a larger margin of safety for the long term investor. It also takes advantage of the existing volatility in these companies stock prices so if you have done the research, and aren't looking for Mr. Market to be your mentor in stock analysis, then this is a tremendous time for value investors.
Sivaram
Sivaram - 5 years ago
Smartdada: "Have a look to the book value; Radian has a book value of 30$! "

If you don't mind me playing Devil's Advocate... how much of that book value is going to be destroyed by losses? That's really the question to answer... because the book value may be overstated...


"Marty Withman holds 18% of the company and bought his first shares between 41 and 62$ From the beginning he considered Radian a cheap. "

Yeah but one subtle point to note is that Whitman didn't add to Radian in the last quarter (if I recall.) In contrast, he added to Ambac and MBIA.


The problem with the mortgage insurers is that it's an all-or-none game. Whoever that survives is going to make a killiing; while others can easily go to zero.
smartdada
Smartdada - 5 years ago
Sivaram,

Thanks for your comments, I really appreciate this discussion. You are perfectly right, mabye book value is not worth 30$ but even if it's worth 10$ we can afford paying 4$ the share ! Also I do have a portfolio which includes MBI, ABK & RDN. My guess : If one of the 3 survives (hopefully it will) the subprime mess, it will more than make up for any loss!

pravchaw
Pravchaw premium member - 5 years ago
Sivaram, I agree that the monolines mortgage insurers RDN and MTG are in a binary do or die situation, though MTG has the edge on survival because of its capital raise (but because of dilution less upside). The surviving mortgage insurers will indeed clean up in the years to come. Money flows from weak hands to strong.

However multi-line insurers should also be considered ORI, GNW come to mind. Does any one have an opinion on these?

Frankly I am less sanguine about ABK and MBI as I am not sure they have a good on going business model as the whole question of a wrapping insurance on high quality muni's in being called into question. Wrappers for CDO's is probably frozen for a long time.
abecfilms
Abecfilms - 3 years ago
Always fun to revisit articles like this...
superguru
Superguru - 3 years ago
Yes, fun reading these. Reveals investor psychology.

Whitman's timing on these could have not been more unfortunate. Bought at top and sold at bottom.

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK
Email Hide