Ambac Financial Group Inc (AMBC) 2004 Q4 法說會逐字稿

Good morning, Ladies and Gentlemen and welcome to the Ambac Financial Group Incorporated Fourth Quarter Earnings Conference Call.

(Operator Instructions)

It is now my pleasure to introduce your host, Mr. Thomas Gandolfo, Chief Financial Officer of Ambac Financial Group Incorporated. Thank you, Mr. Gandolfo, you may begin.

Thank you. Welcome to Ambac's Fourth Quarter Conference Call. My name is Tom Gandolfo, I'm the Chief Financial Officer and with me today are Rob Eisman, our Controller and Peter Poillon, head of Investor Relations. Our earnings press release and quarterly supplement are on our web site and will be mailed out to those who requested it. The call is also being broadcast on the web and will be accessible through March 31. First quarter 2005 earnings will be released on April 20, 2005 at 8:00 a.m. with a conference call at 11:00. During this conference call, we may make statements that would be regarded as forward-looking statements. These statements are based on management's current expectations. I refer you to our press release for factors that could change actual results.

Let me jump into the highlights for the fourth quarter. Net income was 188.8 million or $1.69 per diluted share. That was up 17 percent on a per-diluted share basis from the fourth quarter of '03. While Ambac reports net income in accordance with generally accepted accounting principles or GAAP, the research analysts make certain adjustments to reported net income to calculate their reported estimates. Therefore, we continue to provide information on those items that analysts adjust out of the GAAP net income to arrive at their current estimates to eliminate any confusion. Those items are: Net after tax gains and losses from sales and investment securities and marked market gains and losses on credit and total return derivative contracts and derivative hedge contracts, which, in the fourth quarter, were net gains of $10.7 million or $0.09 per diluted share. This compares to net gains of 5.5 million or $0.05 per diluted share impact in the fourth quarter of '03. I'd like to point out that the credit-related marked market adjustment from total return swaps are now included in this adjustment out of GAAP net income. This mark-to-market item relates to the portion of the change in fair value of our total return swap book, attributable to the change in credit spreads. This is consistent with the way deal -- handle our credit derivative reporting. During the fourth quarter of 2004, the total return swap mark-to-market was a gain of approximately $4.1 million. That's about $0.02 a share. Prior periods were relatively insignificant. Prior year was about a penny a share and we've restated the numbers that we present to you for consistency. Some analysts also back out the after-tax effect of accelerated premiums. Excuse me, earned on obligations that have been refunded or other accelerated premiums. Total after-tax accelerated premiums amounted to 7.2 million or $0.07 per diluted share in the fourth quarter. And that compares to 16 million or $0.15 in the fourth quarter of '03.

Moving on to credit enhancement production, we did change the name of the measure that we formerly referred to as adjusted gross premiums and the new name is "Credit Enhancement Production." We did this because this is a non-GAAP measure and we want to avoid any confusion of this measure with the comparable GAAP measure known as gross premiums written. So, that was -- that was the purpose of the name change. The definition of comp -- credit enhancement production or CEP is the same as the former measure, HEP. It represents up-front premiums plus the present value of estimated installment premiums on insurance policies and structured credit derivatives issued during the period. CEP came in at 344.2 million, that was down 20 percent from the strong production of the comparable prior year. Prior -- last year -- we reported 428.9 million of CEP in the fourth quarter of '03.

Now let me jump into the various sectors. First, Public Finance. Public Finance CEP came in at 101.5 million. That was down 49 percent from the fourth quarter of the prior year. While MUNI issuance reported by third party sources was almost flat quarter on quarter from 93 billion in the fourth quarter of '03 to 91 billion in the fourth quarter of '04, insured penetration remained strong at 53 percent. Ambac's market share in the quarter was approximately 25 percent. That's flat to the fourth quarter of '03 and slightly higher than the first three quarters of 2004. CEP was down from the prior year due primarily to reduced issuance in those highly-structured segments of the public finance market that Ambac focuses on. That would be, you know, more of a project finance, structured housing transactions like that. Additionally, competitive pressures have adversely affected pricing in -- in the public finance sector during the quarter.

Moving on to Structured Finance. Structured Finance CEP came in at 88.5 million, that's down 19 percent from the fourth quarter of '03. We continue to close transactions on a wide breadth of asset classes. During the quarter, our consumer asset-backed security writings, particularly the home equity sector, were strong, coming in at more -- just over $31 million. That compares to 18 million in the prior year quarter. Higher consumer asset-backed writings in the fourth quarter '04 were offset by fewer domestic investor-owned utilities and pool debt obligation transactions in the quarter. As those markets continue to experience very narrow credit spreads.

Moving on to International. International CEP in the fourth quarter came in at 154.2 million that was up 26 percent from the prior year quarter. The quarter results were highlighted by a large whole business securitisation and cer -- and various European infrastructure transactions. Business production is still very lumpy in this market, however, it still provides the greatest opportunity for growth as capital markets continue to expand geographically and by product.

Moving on to premiums earned, net -- net premiums and the other credit enhancement fees earned, excluding refundings, increased at 177.7 million. That was up 12 percent from the fourth quarter of 2003. Public finance, our most mature product, continues to display good growth. It came in at 14 percent. Structured finance grew 7 percent while international grew 18 percent. As previously discussed, earned premium growth in the U.S. Structured Finance and International has moderated as those respected books have grown significantly making comparisons difficult. Also, we are experiencing difficult competition from the other Financial Guarantors and from the market in the form of senior sub execution in the MBF sector. And also seeing extremely tight credit spreads in the CDO market. The reduced growth in those two -- in those two sectors of our business, is negatively impacting our earned premium growth rate in the structured and international markets. Deferred earnings, which represents future earnings that are either in-hand or contractually due us, grew to 5.2 billion. Those deferred earnings will be recognized in earned premium in the future over the life of the related exposures.

Moving on to losses. Loss provisioning amounted to 16.9 million, which is relatively flat to the fourth quarter of '03 and down a bit from 17.7 million in the third quarter of '04. Net insurance loss reserves at December 31, '04 are 238 million, that's a $10 million increase from September 30, '04. To further breakdown reserves, our case basis reserves increased $52 million to 117 million and our ACR decreased 42 million to 121 million. The increase in case reserves was due primarily to the establishment of a $40 million case reserve for an enhanced equipment trust certificate transaction or EETC transaction, and an $18 million increase in established -- already-established case reserves on a stre -- stressed healthcare credit, that has defaulted on its debt obligations. The EETC exposure represents a securitisation of aircraft leases where Ambac wrapped the senior most layer of that transaction. Prior to the fourth quarter, we had allocated approximately $17 million of our -- of our ACR reserve to this credit. So, we have a net increase here about $23 million. We did increase the reserve in the fourth quarter because it was in the fourth quarter that the airline filed for bankruptcy and defaulted on its debt obligation. And we obtained updated market information on the transaction. In addition to the insurance reserves, we do have $14 million of reserves that we established through mark-to-market accounting on our creditor of this book.

Moving on to Financial Services, Financial Services net revenues, excluding realized and unrealized gains and losses, were 14.6 million, that compares to 9.5 million in the comparable prior period. The increase was primarily driven by improved net interest margins in our investment agreement book. Our focus in the investment agreement business has been on fixed contingent draw contracts and we no longer write flexible draw transactions. This strategy has been in place now two years and we're seeing the fruits of that strategy play out here. You know, this strategy has resulted in significant improvement and significant -- much-enhanced stability in the net revenue stream in that business line.

Moving on to return on equity, return on equity came in at 15.4 percent. We're very pleased with that number, particularly in light of the historically low interest rate environment that we're in and the negative impact that that's had on our investment income. Investment income is about a third of our revenue, yet we're still see very attractive ROEs.

In summary our quarter results were solid and the top line production was strong despite the difficult competitive environment the industry currently faces. We do believe we have good momentum going into 2005. With that I would like to open it up to questions. Shawn.

Ladies and gentlemen, at this time, we will be conducting a question and answer session. [ Operator instructions ]

Geoffery Dunn, Keefe, Bruyette & Woods

Can you give a little bit more detail -- I think normally your underwriting you assume the airline goes bankrupt and you typically have liquidity facilities in place for 18 months. If they just went bankrupt now, why such a material provision?

Sure. Geoff, this is -- this is a credit that we've been monitoring for some time. And although the bankruptcy did occur in the fourth quarter, this is an item that we did reserve for back in the third quarter. We reserved 17 million. As we saw this credit begin to deteriorate, actually in the third quarter, and then certainly that deterioration accelerated in the fourth quarter when they did declare bankruptcy and defaulted on their debt. What we thought -- the reason for the increase -- we established the initial reserve at 17. The reason for the increase in the fourth quarter is we did think -- and we still continue to think -- that these planes are important to the fleet of this carrier and as you know, it's fairly common for airlines to go bankruptcy and continue operating. They don't go into liquidation. So, we do think that, there's a possibility that they will look to retain these planes, although I will say, we are negotiating on several fronts here, to either sell or release these aircraft to -- to the highest bidder and best credit. So, that's what happened in the fourth quarter, Geoff, we basically, you know two, events, you know, the default -- the bankruptcy, they rejected the leases and we want to be prudent here in that, we may have to repossess these aircraft in the fourth quarter and if we do, we have to remarket them to other airlines and there may be some downtime.

So, what is the total exposure to this transaction? And is there a liquidity facility in place that will prevent you from actually making payments for the next 18 months?

Sure. Total exposure on a gross par basis is 170 million. On a net par, we do have fairly significant reinsurance on this credit, about 27 percent reinsurance. On a net basis, our exposure is 124 million. There is a liquidity facility in place. That is actually -- will pay the principal and interest for the -- for 18 months. However, that liquidity facility does have to get paid back at the end of the 18 months. The purpose of those liquidity facilities is really to protect us from a liquidity perspective, but eventually, over time, they are senior in the structure and do get repaid. So, we have to consider -- it mitigates our liquidity risk, it doesn't eliminate any eventual loss that we have on the deal. So, we did factor that into consideration when we -- when we developed our reserves here.

Okay, and just a quick follow-up: On the International business, you closed a large transaction with the Pub deal. What does the pipeline for international look like in '05? Are we starting to see the re-emergence of large transactions enter the pipeline?

Yes, what we did. I think we talked about this a little while last quarter and the quarter before. The pipeline looks attractive. Now, when I say pipeline, I want to say not pipeline of deals we've been mandated, but pipeline of deals that are out there. We do think that we have an advantage on the competitive front there because in this market, for the very, very large deals, it's really MBIA, FSA, Ambac, to some extent FIDGIC, but you don't have all the other competitors that you deal with here in in the United States. So, we do think that bodes well for us, so, we think it looks good. Now, as we said, we did -- this was a good quarter internationally. We closed that deal and that was a very attractive deal. But, these things are going to be spotty. It's going to be lumpy. It's not going to be every quarter. But -- but the activity in the International markets looks good.

Okay, thanks.

Thanks, Geoff.

Terry Shue, JP Morgan.

Hi, Tom.

Hi, Terry.

If you can elaborate on the competition in the MUNI market, if you look at the fourth quarter -- I track these numbers, I know that depends on mix and it doesn't really mean very much to look at the absolute number, but if you divided the -- what do you call it now -- let's say the AGP versus par. It went down a lot. Is it more just the type of deals, as you said, fewer structured transactions? And can you elaborate on the competitive environment?

Sure. Yeah, absolutely, the -- you know, we had about a 49 percent reduction in CEP in MUNI and Public Finance and the majority of that is due to the mix of business this quarter. We did not see a significant volume of transactions in that more-structured municipal business that we like to participate in. Those would be, the structured housing, you know, infrastructure-type transactions. So we did not see that this quarter and that is the majority of the reduction. However, due on a comment on the competitive environment, we did see competition in public finance intensify this quarter. And it's unfortunate because credit spreads, although they tightened some, are still pretty -- relatively wide on a historical basis, but we did see certain competitors jump in and they were willing to take significantly less of the credit spread to -- just to ensure that they won the deal. So, they left a lot on the able to ensure they won the deal and that was disappointing and we hope that trend doesn't continue.

I gather that you didn't give very much on your pricing but you probably had to give a little -- in terms of meeting your return targets. Can you comment on that?

Yes, that's correct. You know our style and, you see it in investor -- investor utilities, you see it in CDOs. When we feel we can't get paid -- there's plenty of other places to get paid out there. We redirect our capital. However, we're not going to, depart from the municipal market. It's too -- too core to our business. So, we will -- we will continue to play. We will price rationally, we will lose deals as a result of that. But, we will -- we won't back out of that market. We will be there.

Can you, at all, quantify in terms of meeting return bogeys, how much it cost you in terms of just the environment pressuring rates?

Well, it's not -- to date it hasn't cost us significantly. If the current pricing environment continues, it would have an impact on the -- our targeted ROE in that particular sector. I can't really put a percentage number on it for you, Terry, because it's -- really this has been a bit of a short-term phenomenon here. We saw it -- this was not the case last year or even late last year. We did see it intensify in the first quarter.

However --

Excuse me, the fourth quarter.

Yeah. However, as you said, this -- this type of trend is spotty. If the competitor decides to sober up, it could change again, that kind of thing, right?

You know, that's an excellent point, Terry. This is nothing new. It's a good point. We've lived through this many times in the past. In fact, it's not an uncommon phenomenon that we've seen and -- and generally it corrects itself.

Right. It's not quite like a cyclical thing, when you talk about property casualty cycles because the players are so few and we all know who each player is. So, I'm hoping that it's -- .

You know who each player is and the key is, you know, you can see everybody's ROEs, we all disclose it, Ambac has the highest in the industry. And the good thing -- the good thing here, and particularly with the new entrance, everybody -- capital is not unlimited and, you have to put your capital to use at attractive returns because we disclose -- everybody discloses your ROEs every quarter and, you know, shareholders demand that. And what that does, fortunately, is it does put a floor on pricing and it does bring some discipline because people have to live with the reported ROEs.

Going back to the credit events, would you say that things have deteriorated or this is just a continuation of what we've seen and just a recognition, like in the EE -- the equipment trust certificate situation having to put up more reserves? And is there some possibility that the case reserves are conservative and you get more recovery?

Well, let me talk just credit in general. That's a good question. Really, there's a handful of deals that I've talked about and the only new deal is the EETC. For about a year now I've been talking about a CDO transaction where we paid some modest claims, under 10 million and I think I said that we thought we may pay another 10 to 15 million on that before we got out of it. Actually, good news on that transaction, that transaction matures in May. So, four months that thing is gone. And as it looks now, I don't think we're going to pay another dime on that. So, that 10 to 15 million estimate I was giving you was high and fortunately I think we're going to get out of that without paying anymore claims. We had three MBS transactions that we're paying claims on. It's the same transactions that we've been paying on now for about a year. It's been hovering between 6 and 9 million a quarter. That -- those transactions are performing exactly within our expectations of what we modeled and what we built our reserves on. I think we will be paying claims there for another 12 to 18 months, but I don't -- I -- they are going to be within our established reserves. The healthcare credit, that we did increase reserves on this quarter, that is the same credit I've been talking about for a year now. What happened there, we had some recent meetings with management. We looked at their current financial results and looked at their financial projections, they were disappointing. That caused us to increase the reserve. The new item is the EETC credit and what's happened there -- one, unfortunately, this was one of our oldest deals, it's one of the first deals we did. And the airline industry is going through a very difficult time right now. You know, nine -- they had the 9/11 event to deal with, that significantly reduced passenger demand. Fortunately passenger demand is up. However, now they're facing, high fuel costs and they're cutting each other's throats in -- on competition and on fares. So, that's weakened the industry. So you add a combination of a weak industry with one of our oldest deals, the remainder of our portfolio, particularly the newer deals, the current appraisals, still show a loan to value below one, which is a good thing. This transaction was -- it was not the case. Overall credit, other than these ones I've mentioned, we actually saw a slight improvement. Below-investment grade came down this quarter to 4 billion 528. That's .99 percent of our net par outstanding, that compares to four -- almost 4.9 billion at September 30th or 1.1 percent of our net par. So, that's kind of a high level overview of credit, Terry.

Okay, thanks.

Rob Ryan, Merrill Lynch.

Good morning.

Hi, Rob.

I wonder if you could update us on the guidance you gave in October related to the 2005 growth for operating earnings per share, excluding refundings?

Core earnings? Oh, yeah, excluding refundings, absolutely. Sure. Right now, Rob, we are -- we give guidance of 12 to 14. We're comfortable with that guidance. Depending on if we do, we're going to be repossessing these aircraft in the first quarter, we do think we will release them or sell them rather quickly. Depending on how long we hold those, because we will be funding the purchase of those aircraft, that that will have an impact, which will probably bring us in on the lower range of that guidance. So, closer to the 12 percent than the four percent. But we still think we can come in on that 12 percent range.

Okay. And what is the anticipated effect on your earnings from the scheduled February '05 recapture from Radian?

Well, the scheduled '05 recapture -- I'd rather -- we may not, the timing of that, Rob, we haven't really disclosed, we did disclose the timing, we haven't publicly disclosed the earnings impact. I'd rather not at this time. If we could.

Okay, and what's the update on the potential for yet another recapture of -- from Radian ?

They're likely, but don't hold me to this, we'll be -- no further recaptures from Radian. We have no plans, let's put it that way, for further recaptures.

Do you plan to continue to hold the recapture rights, however? Or give them up?

Undecided at this point. There may be recapture, small recaptures from other reinsurers, particularly reinsurers that have -- are no longer in the business, but more to come on that.

Great, thank you.

Thank you.

Gary Ransom, Fox-Pitt and Kelton.

Good morning. I just wanted to follow up your final comment about good momentum going into '05. Could you elaborate at all on what you see as the environment or what you think is likely to happen as we go into '05 and provide some opportunities for that momentum to -- to happen?

Sure, where we see the opportunities -- let me touch on the three markets. In Public Finance, although we don't expect total issuance to be at the record levels we saw in '03 and '04, we still think, volumes going to be pretty healthy in '05. I don't know if you saw the bomb buyer yesterday, there was a long discussion on what they projecting volumes. I think they were projecting in the 325 to 330 -- excuse me, yes 325 to 335 billion. We were more in the 300 billion range internally. If it wasn't for '03 and '04, any other year that would be a very good year of issuance. And what we also think we're going to see more of is the Structured Municipal, you know, municipalities are more and more realizing that large infrastructure projects, stadium financings, housing, those are things that you're being pushed to the capital markets, which is a good thing for our industry. So, we think we're going to see good healthy capital markets activity there in '05. In Structured, we are still seeing good mortgage activity, we're seeing good commercial asset-backed activity. Securitisations of future revenue streams. The only -- the tough area in structured is really investor-owned utilities. In International, the U.K. remains very supportive of the PFI initiative. The good news there is you're seeing other countries look at what's worked so successfully in the U.K. and adapting that strategy in their -- in their markets. Italy, Spain, France, we hope Germany down the road, as the launch banks back off a little bit. We opened an office in Milan. We're seeing good activity there. We're working on deals there. So, we think those are the positives, when I say good momentum for '05, we're seeing good capital markets activity out there.

Okay, that's helpful. I mean it sounds like those comments extend out beyond '05, as well, to some extent?

Yes, we hope so, particularly in International.

Yes.

The PFI initiative internationally is kind of what you're seeing more and more of here in the U.S., as well, which is a good thing.

All right, thank you.

Thank you.

Geoffrey Dunn, Keefe, Bruyette & Woods.

I just want to follow up on the guidance. Originally, if we hadn't had this new change, the core earnings would have been 592, that's where your previous guidance was. Can you give us the total year impact of the new exclusion of the mark-to-market just so that when people go through the math, we know what has to do with the accounting change versus what the real number change is?

The total impact of the mark-to-market on total return swaps?

Yes, the incremental exclusion we're now using.

Sure. Let me give you a quarter-end market, Jeff. For the quarter it was four -- just about four million dollars compared to the prior year quarter of about just under two million dollars. For the year, the mark-to-market gains on total return swaps was 9.4 million and for the prior year it was about three million. Let me just elaborate on what that is, too, and why we think it should come out. It is really -- these are not trading positions and although we're -- these are positions where we've taken, the credit risk through a derivative, similar to a credit derivative and as credit spreads tighten, you recognize these unrealized gains. We have every intent -- and that's generally something in in principles, that's the way you have to do it in derivative accounting. We have every intent hold these securities to maturity and recognize the spread income through interest income and not trade out of them. We think it's a little misleading to be recognizing these gains as, core earnings, if you will, when over time, as the bond approaches maturity, you will reverse the mark-to-market and recognize it through interest income. So, we don't want to double-count these gains. By the way, those are pretax numbers I just gave you, Geoff.

Thanks.

Mike Grasher, Piper Jaffray.

My questions have been answered, thank you.

There are no further questions at this time.

Okay. Well, if there are no further questions, thank you for listening in today. And Rob, Pete and myself are here all day today and we're happy to take calls -- any calls for any additional questions you may have. Thank you for attending.

This concludes our teleconference. Thank you for your participation.