Ambac, MBIA: Collateral Damage

NEW YORK (TheStreet) -- Ambac(ABK Quote) and MBIA(MBI Quote) have received scant attention amid the recent rally in so-called zombie stocks like Citigroup(C Quote), Fannie Mae(FNM Quote), Freddie Mac(FRE Quote) and AIG(AIG Quote), but the troubled monoline insurers might be the scariest zombies of all.

MBIA and Ambac used to be sleepy insurance companies that guaranteed the debt of municipalities and other relatively low-risk borrowers. However, they got caught up in the securitization boom, insuring supposedly super-safe pools of subprime mortgages. In fact, in many instances it was the insurance they provided that allowed many of the issues to get triple-A ratings from ratings agencies like Fitch, Moody's Investors Service and Standard & Poor's.

Now the monolines have massive claims to pay out and there are serious questions about whether they have enough capital and earnings potential to make even those payments. Even if they can accomplish that feat, they have further obligations to their lenders and bondholders before there's anything left for shareholders. Nevertheless, MBIA shares rallied more than 53% to $6.72 in the month of August, while Ambac shares added $1.01 to $1.76.

Lest anyone forget, you generally invest in a company because you think it's going to make money. But the business models of these companies are fundamentally broken, noted Creditsights analyst Rob Haines in a recent presentation to investors.

"Over the past 30 years, the monolines have been hyping the no-loss underwriting model," Haines said, according to a transcript of his presentation. "Come on! Is anyone still falling for this carny gimmick anymore? Billions upon billions of premiums have been paid to these companies, and for what?"

While Ambac and MBIA will be able to make some payments, it may take them years to do so. In the meantime, banks and other investors have had to set aside new capital over the past year on the assumption that the monolines will not be able to pay out on the losses they supposedly insured.

Haines goes on to say that a guarantee from MBIA, Ambac, or other lesser known insurers like FGIC and Syncora is essentially "a very expensive keepsake."

Both companies have tried to split off their municipal bond insuring businesses into new units, but Ambac has struggled to raise money and MBIA is facing a lawsuit from a group of banks trying to block the move.

JPMorgan Chase analysts argue in a published report that Ambac will run out of cash in 2011 if it cannot write new business. MBIA has a better chance of making it through 2011, the report says.

Still, the fact that one analyst sees a chance for a company with a broken business model to survive for two more years is not a good reason to dive into a stock.

-- Written by Dan Freed in New York.