Muni Bond Insurers Get a Lease on Life

Since Ambac is effectively short all these CDS contracts, if the value goes down for any reason, that's a gain for Ambac! Worth mentioning is that Ambac's CDS holdings have improved significantly since June 30, (quoted at 18 points up front, down from 36). On the conference call Ambac indicated that the $976 million gain would have swung to a $1.3 billion loss had it used July 31 CDS figures.

Media reports are going to focus on the CDS loss/gain shell game, but that is all beside the point. What really matters to Ambac investors is:

• Clarity on its expected losses in structured finance.
• Efforts to terminate CDS contracts, thus lending clarity to the their expected losses.
• Progress on recapitalizing Connie Lee.

On that front, Ambac reported mostly good news. Real clarity on structured finance losses isn't coming any time soon. The housing and economic picture is just too uncertain. But Ambac is now all but fully reserved on its remaining collateral debt obligation-squared transactions with large residential mortgage-backed security, or RMBS, exposure. Therefore, any recovery in these assets will be accretive to capital.

Ambac management suggested that it remained in serious talks to commute additional CDS contracts. Ambac had announced a deal with Citigroup on Aug. 1 to terminate $1.3 billion of protection on a CDO-squared transaction in exchange for a cash payment from Ambac.

When asked why Citigroup (or anyone else) would agree to terminate if Ambac is indeed a strong counter-party, company management suggested that some of its counter-parties may have bought CDS protection on Ambac and now have a large gain on that hedge. The way it was said leads one to wonder if Ambac in fact knew this to be the case. Either way, the company was positive on the prospects of future termination deals.

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At the time of publication, Graff had no positions in stocks mentioned, although positions may change at any time.

Tom Graff is a Managing Director of Cavanaugh Capital Management, a registered investment advisor in Baltimore Maryland. The opinions expressed here are Graff's own and in no way are the statements of Cavanaugh Capital Management, and may or may not reflect the strategies being pursued for clients of Cavanaugh Capital Management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Graff appreciates your feedback; click here to send him an email.