The amendments to AMBAC Inc.'s stock registration filings with the Securities and Exchange Commission provide stark testament to the difficulty of selling the still-obscure concept of municipal bond insurance to the public.
And especially now, when Bridgeport, Conn., is seeking bankruptcy protection and Philadelphia's financial solvency is a recurring question, enticing an investor to buy shares of a company that stakes its guarantee on municipalities' fiscal responsibility is an uphill battle.
A week ago, AMBAC had to postpone indefinitely its sale of 17.6 million shares, or 50.3% of the company, literally moments before it was set to hit the New York Stock Exchange.
Merry Anderson, senior vice president at AMBAC's operating subsidiary, AMBAC Indemnity Corp., said, "I think there's a lot of misunderstanding as to how it works. On the other hand, it has taken problems to get the industry noticed. When everything was running smoothly, nobody wanted to know about bond insurance."
The obscurity of municipal bond insurance weighed heavily on the SEC's consideration of the deal, as evidenced by the lengthy amendments. Also, the fact that Municipal Bond Investors Assurance Inc. already has stock outstanding was of little help, since the principal examiner did not work on the MBIA sales, one underwriter said.
For example, the deal ran into a snag over the actual risk of default assumed by municipal bond insurers. A June 14 article in The Washington Post linking the Bridgeport, Conn., bankruptcy petition to the financial strength of bond insurers led SEC examiners to request the following disclaimer about default rates:
"While safeguards [developed since the Depression] address many of the causes of earlier defaults, they may be inadequate to prevent an increased level of defaults in the future caused by unforeseen economic factors," the last amendment says, "or from the increasing levels of fiscal stress that several states and municipalities are experiencing currently."
The Washington Post article also cited Bond Investors Association's municipal default calculations, so the SEC specifically included reference to the group's data, even though many in the industry believe the numbers are misleading.
John E. Petersen, senior director of the Government Finance Officers Association, in a letter to The Bond Buyer disagreed with the investor association's practice of lumping technical and actual monetary defaults together as if they were the same thing. "Aggregate numbers should focus on the commonly understood definition of an indisputable default: namely, failure to make payments as promised to bondholders," Mr. Petersen wrote.
Andy Nybo, research analyst at the Public Securities Association, said the investor association's method of arriving at default rates is "comparing apples to oranges." The par amount defaulting in any one year should not be compared with the new issuance of that same year, he pointed out, but rather should be traced back to the year of issuance and attributed to the volume sold then.
If calculated that way, Mr. Nybo pointed out, the highly unusual situation of $1.85 billion of Executive Life-backed taxable bonds sold in 1986 would be considered as defaults of that year, not of 1991 when the bonds missed coupon payments. Given that $150.99 billion of bonds were sold in 1986, the Executive Life-backed issues -- a municipal debacle rivaling the Washington Public Power Supply System's $2.25 billion default in 1983, the industry's largest -- would account for only 1.2%.
But to the uninitiated, even an SEC examiner, a 2% number together with the uncertainty of Bridgeport's bankruptcy bid casts the financial guarantee industry in a dubious light, particularly when insurers are said to engage in so-called zero-loss pricing, i.e., charging fees on expectations of no defaults.
Consequently, the SEC also required that AMBAC spell out the anemic premium rates that have affected the industry since 1986. Investors may have considered this data very closely when wrangling for an acceptable common stock price for the company.
One amendment states: "During 1987 and 1988, AMBAC's average premium rates declined due to, among other things, increased availability of capital within the industry, lower interest rate spreads between insured and uninsured spreads, and the improvement in credit quality of insured bonds. Since 1989, AMBAC's average premium rates have remained relatively stable."
The amendments also shed light on different methods of accounting. The second amendment filed June 17, for example, significantly lowered the book value of the company, to $613.6 million from $652.9 million, as of March 31.
Citibank Financial Guaranty Holdings -- the sole owner of AMBAC Inc. -- made the downward adjustment in net tangible book value calculations, at the behest of the SEC, to account for "deferred acquisition costs."
The almost $40 million discrepancy arises out of two treatments of time. In the more liberal generally accepted accounting principles, AMBAC's underwriting expenses were gradually farmed out to the future. In the second, the statutory accounting method, the expenses were taken "up front," or as the municipal bonds were insured, according to Dave Penchoff, vice president at Standard & Poor's Corp.
The change brought the proposed per-share book value down to $17.53 per share from $18.65 per share, according to the amendments. AMBAC officials declined to comment on any issues related directly to the stock sale, citing SEC guidelines.
Market participants speculated that the deal's postponement was because institutional buyers -- slated to take up to 80% of the issue -- wanted the stock more cheaply than Citibank would accept. As it was, senior underwriter Salomon Brothers Inc. tentatively priced it rather low -- $22.50 to $26.50 per share -- or at price/earnings ratios of about seven to nine.
The general market's P/E, represented by Standard & Poor's 500 stock index, was 17.6 last week. The P/E for the weakest of the large Dow Industrial sectors, the financial stocks, was 13.1, still well above the proposed AMBAC price.
Finally, both the Federal Reserve and the Office of the Comptroller of the Currency -- the federal regulatory arm with direct oversight of the banking industry -- are on record as saying that Citibank must either "deconsolidate" AMBAC from the balance sheet or raise capital to offset the insurers' portfolio of business. Citibank and AMBAC still plan to go ahead with the sale.
If the sale is eventually consummated, AMBAC would have to act as a banking subsidiary and engage only in comptroller-approved lines of business, but the insurer would not have to meet the banking industry's capital requirements, according to a spokeswoman in the comptroller's office.
