Ambac Financial Group Inc (AMBC) 2006 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Ambac Financial Group, Inc. third-quarter earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Sean Leonard, Chief Financial Officer of Ambac Financial Group, Inc. Thank you, Mr. Leonard; you may begin.

Thank you. Good morning, everyone. Welcome to Ambac's third-quarter conference call. I'm Sean Leonard, Chief Financial Officer of Ambac. With me today are Robert Eisman, Controller, and Pete Poillon, Investor Relations. This call is also being broadcast on the Web. Our earnings press release, quarterly operating supplement, and a short slide presentation that summarizes the quarter's results, are also on our Website. Fourth quarter 2006 earnings will be released on January 31, 2007 at 6 AM, with a conference call at 11 AM.

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.

Now for some overall results for the third quarter. Net income was 213.5 million, or $1.98 per diluted share. That's up 23% on a per-diluted-share basis from the third quarter of 2005. While Ambac reports net income in accordance with Generally Accepted Accounting Principles, or GAAP, research analysts make certain adjustments to net income to calculate their reported estimates. Therefore, to enhance investors' understanding of our financial results, we continue to provide information on the items that analysts adjust out of GAAP net income to arrive at their current estimates.

Those items are net after-tax gains and losses from sales of investment securities, and mark-to-market gains and losses on credit, total return and non-trading derivative contracts. In the third quarter of 2006, net after-tax gains amounted to 6.6 million, or $0.06 per diluted share. This compares to net gains of 8.8 million, or $0.08 per diluted share impact in the third quarter of 2005.

Some analysts also back out the after-tax effect of accelerated premiums earned on obligations that have been refunded, and other accelerated premiums. Total after-tax accelerated premiums amounted to 14.5 million, or $0.13 per diluted share in the third quarter of 2006, which compares to 28.5 million, or $0.26 per diluted share in the third quarter of 2005.

Turning to credit enhancement production, or CEP. CEP, which represents gross up-front premiums, plus the present value of estimated installment premiums on insurance policies and structured credit derivatives issued or assumed in the period, came in at 216.2 million, down 16% from 256.6 million in the comparable prior period.

Now let me take you through some details of our production by segment.

Public finance. Public finance CEP was 89.8 million, down 24% from the third quarter of 2005. Overall market issuance was down about 14% relative to the comparable prior quarter. Market data shows that while refunding issuance was down significantly during the quarter, new money issuance was about flat, demonstrating that the desire to finance infrastructure needs through the debt markets remains strong. Also impacting our results for the quarter was the mix of the business coming through markets, as fewer highly-structured deals came to market. Ambac was successful, however, in closing two stadium transactions during the quarter.

Ambac's market share in the quarter based on prior written was approximately 22%, about flat to our 21% share in the third quarter of 2005. Generally, we find the municipal market to be the segment of our business that has seen the most price competition from other monolines in 2006.

Structured finance CEP was 78.6 million, down 33% from the third quarter of 2005. Over 40 million of our production in last year's third quarter came from the commercial asset-backed sector, making it a relatively difficult comparison, and we did not close any such deals this quarter. Both auto securitization and CDOs showed strong growth during the current quarter.

International CEP in the third quarter came in at 47.8 million, up 124% from a relatively-weak third quarter 2005. Our third-quarter international production was dominated by two sectors -- stadium finance and asset-backed securitizations. But the CDO segment is also quite healthy. We remain very optimistic about our long-term opportunities in the international markets.

Turning to premiums earned, net premiums and other credit enhancement fees earned, excluding refundings, increased to 190 million, up 4% from the third quarter of 2005.

Public finance earned premium, excluding accelerations, grew 3%. Public finance earnings have been impacted by lower issuance in 2006, high level of refundings in the book over the past two years, and by the mix of business written over the past several quarters.

Structured finance grew 12%. Excellent recent production in asset classes such as commercial ABS, auto securitizations and CDOs has offset the negative growth trends caused by lower MBS writings and high prepayment activity in this segment.

International earned premiums declined by 6%, as recent runoff and early terminations in the international book has more than offset the strong production thus far this year. Since January 1, 2005, we have written about 22 billion of net par in international, but the total international book actually declined by more than 15 billion over that period.

I would like to point out that approximately 11.7 million of the 24.5 million reported accelerated premiums during the third quarter of 2006 were related to one international transaction. Similarly, in the third quarter of 2005, one very large public finance refunding made up almost half of that quarter's accelerated premium at 48.9 million.

Our deferred earnings, representing future earnings on premiums already collected and the future value of installments, stands at more than 5.9 billion. These deferred earnings will be recognized as earned premium and other credit enhancement fees in the future, (indiscernible) related exposures.

Investment income, excluding VIE income, was 107.2 million, up 9%, primarily due to growth in the portfolio driven by strong operating cash flow, and the 200 million capital contribution from the parent in the fourth quarter of 2005. Offsetting the growth was a 5.3 million positive catch-up adjustment book in the 2005 third quarter for discount amortization on certain pre-refunded municipal bonds.

Losses in the LAE. Loss provisioning amounted to a $2.5 million benefit in the quarter, compared to expense of 89.1 million in the third quarter of 2005. Our third quarter '05 loss provision included 92 million for credits impacted by Hurricane Katrina. This quarter's provision includes a partial release of the Katrina reserves based on recent positive developments in the region.

Now let me provide you some details on the loss reserve activity. Total net loss reserves at September 30, 2006 amounted to 274.3 million, down from 285.7 million at June 30, 2006. Total loss reserves include case basis reserves of 126.7 million and active credit reserves, or ACR, of 147.6 million. Case reserve activity included a reduction related to a specific Katrina credit, as well as payments during the quarter amounting to 8.9 million.

ACR increased by 0.6 million, driven by a 35 million net reduction in Katrina-related ACR, that were more than offset by additional reserves set up for transactions demonstrating further diminished credit quality, primarily, a public finance infrastructure transaction, a healthcare transaction, and some asset-backed transactions. Note that none of these transactions have been discussed prior to this quarter, but these transactions are not new to our classified credit list.

Our Hurricane Katrina reserve estimate currently stands at 51 million, down from 90 million at June 30. Recently provided support from state and federal governments, particularly in the Greater New Orleans region, was the primary reason for the decline. In July 2006, the State of Louisiana issued 400 million of (indiscernible) bonds backed by the full faith and credit of the State. Proceeds from this issuance have been escrowed and will be used specifically to pay portions of that service of certain issuers within Orleans Parish over the next few years. This liquidity injection was a very positive development.

Additionally, we have recently observed other positive factors that have influenced our more positive view on certain credits within the classified portfolio, including, but not limited to, indirect federal programs recently initiated in Louisiana and Mississippi, and recovering tax [basis] in certain locations, including Greater New Orleans.

With regard to the Financial Accounting Standards Board review of financial guarantee accounting, at their September 13, 2006 meeting, they decided to begin the process of drafting a document for public comment. Until the FASB releases a final standard, expected in 2007, it would be premature to estimate the impact on Ambac's financial position and results of operations. Our financial filings with the SEC discuss the FASB's project and the potential for future changes to loss reserving, premium revenue recognition, and its bank accounting.

Some words on the financial services segment. Our financial services segment is comprised of the investment agreement business and derivative products business. Financial services net revenues, excluding realized and unrealized gains and losses, were 13.3 million, compared to 17.1 million in the comparable prior period, primarily due to lower net mark-to-market gains in the third quarter of 2006 than had been reported in the comparable prior quarter in our derivatives business. Our return on equity was 14.7% for the quarter. On an operating basis, return on equity was 14.5%.

Ambac increased the number of shares available under our share repurchase program by 6 million shares. So, including this additional authorization, Ambac has approximately 9.7 million shares remaining under its share repurchase program. During the third quarter Ambac did not buy back shares.

I'd like to make a brief comment on our recent debt redemption. As we had announced in our press release dated September 25th, on October 23rd, Ambac redeemed all of our outstanding 200 million 7% debentures at par plus accrued interest, using proceeds set aside from our 400 million issuance of 5.95 debentures in December 2005.

In conjunction with the redemption, Ambac wrote off deferred fees and expenses related to the original issuance, amounting to approximately 6 million, or 3.9 million after-tax. We will exclude the write-off from our calculation of fourth-quarter operating earnings.

In summary, Ambac had a solid quarter with acceptable business production considering the current environment and what tends to be a seasonally-slow quarter. That concludes my prepared remarks. I would now like to open it up for questions.

(OPERATOR INSTRUCTIONS). Geoff Dunn, KBW.

I was hoping you could talk a little bit about capital management. I think in the last year, you haven't been a big buyer of your stock, but you've been changing some of your reinsurance allocations, holding on to more of the business. Now you come out with a recently upped authorization for buyback, and I'm not sure there's much more reinsurance tools. Are you signaling to us that we could possibly see an acceleration of buyback activity, especially with the stock back down below adjusted book value?

Yes. Geoff, I think what we're doing is, the Board recently upped the authorization to buy 6 million shares. I think from time to time, we look at the available shares under the existing program, and this had gotten down to about 3.7 million shares remaining under the authorization. And simply to provide us more flexibility as we go into the fourth quarter next year. So, [I] would not read it as a strong signal there.

Have you run the math? If the current conditions persist, and your business opportunities remain unchanged from what kind of the run rate is now, do you have an idea of how much excess capital will be generated over the next 12 months versus the position you're in today?

We do look at that. We don't specifically comment on numbers. Obviously, there's a lot of variables that go into those types of calculations -- business opportunities, and opportunities for utilizing that capital, as well as particular credit events that would happen. I think it's -- you can look at past history and relatively -- what has been a relatively benign environment. And we have generated excess capital during that period, and have reacted accordingly.

So, I'm not sure what the future would hold, but if it's similar to the past, we might do something that's similar to that. But that's just hard to predict as we sit now. But right now, as our capital stands from the standpoint of Moody's and S&P, we feel pretty comfortable with where we stand. So, obviously, the future will dictate our actions.

Ken Zerbe, Morgan Stanley.

Could you just talk about the losses that you're taking in the MBS portfolio a little bit? How exactly are you getting these? I guess I understood that you generally have attachment points, or you insure the more AAA or very super senior tranches, and credit doesn't seem that terrible in the mortgage market right now. Why are you experiencing losses there?

What these are, Ken, the super senior attachment point is more in the CDO marketplace. And we do do -- the pool debt obligations of how we disclose that in our supplement, but we do do CDOs with mortgage-backed securities. That business, you're right, has been done at the AAA or super AAA level.

What's happening in this particular quarter is no increases to the below investment-grade, no increases to our classified list, but these are existing credits that started out as sub-prime credits, but not in those high ratings sectors, and have deteriorated towards getting closer to the end of the pool. These particular transactions are characterized by low average balance loans in (indiscernible) type states. So, this is not a systemic issue, as I would call it; it's not something new to our list. But as we get a better view as the transactions progress through their lifecycle, we're making adjustments to the reserves.

So broadly speaking, these are sub-prime deals that you guaranteed at a lower than AAA rating.

That's correct.

How far down do you go on those deals?

We'll go down to BBB.

Rob Ryan, Merrill Lynch.

You commented on the competition being most intense within U.S. municipal. Could you go into a little more detail by sector or type of bonds?

Sure. I can do that. Pretty much across the board, in the various bond types -- general obligation, leases, taxes, and whatnot in healthcare -- we've seen declines quarter on quarter in our production. What we're seeing is somewhat of a shrinking supply and an aggressive competitive environment that's serving to cause those declines.

We did have some success in closing some stadium transactions in the quarter, particularly two of them, which helped (1) our market share numbers, and obviously helped our CEP numbers in the quarter. So, we're seeing pretty much across the board in the specific niche areas that we like to participate, we did have some success. But we also see competition developing in those areas as well. It's pretty much there -- pretty much across the board.

Could you give us some examples of the type of structured transactions within municipal that you're partial toward?

Sure. Stadiums, which we've been leading that marketplace, and we feel like we have the expertise to really analyze those credits. We think there's some value added there. We've done very well there. The other area would be the military housing area, which is another area that Ambac has led in, that we specifically look to generate value amongst our various client base. So, I would say those are the two areas.

Ambac also has a strong presence in the healthcare sector, which has been very helpful over time. We think it's performed well and we have a good team there. So, that's another sector that Ambac particularly targets.

Just back to the loss issue, the healthcare transaction referenced this quarter, I believe, is completely different from the previously troubled transaction that, I believe, is close to being fully reserved for. Is that correct?

That's correct. We're hopeful that that transaction -- we're actively remediating that, and hopefully that will come to some type of closure in the near future.

So, you increased active credit reserves for healthcare credit this time. That's a different healthcare credit.

That's correct.

Darin Arita, Deutsche Bank.

Just going back to the question on the capital position, I think I recall maybe a year ago Ambac wanting to just be a little more conservative on capital, one of the reasons being the uncertainty over Hurricane Katrina exposures. And I guess given the developments that we've had, and the takedown -- partial takedown in reserves, do we feel more comfortable about this capital position than a year ago? And is that suggesting that there's more room for potential share repurchases?

I would say, clearly, with the reserve bring-down, we do feel more comfortable with, generally, the Hurricane Katrina credits. We still have a fairly sizable number for credits, specifically those that did not get as much of the Gulf zone allocation money. So, I would say that. But on the other hand, we did obviously provide for other transactions this quarter a public finance infrastructure transaction. So, that kind of counterbalanced the quarter. We'll, obviously, consider all the events and various other assumptions in looking at our capital position. But we had kind of an offset as shown by our financial results.

Just thinking about the opportunities that are available in terms of your pipeline, has that changed over the past 12 months? Is it a little bigger, or is it smaller than before?

The second quarter this year we closed out a number of large transactions; obviously, resulted in a very strong quarter, historical quarter from the size of CEP. So, we did close out some of the transactions. We did have three large transactions this quarter close. I mentioned one of the stadium transactions, which was helpful. But generally, on a qualitative basis we see the pipeline; we see a solid level of increase. So, we're still hopeful. We are optimistic on the international side. We're seeing a number of inquiries there. So, on a qualitative basis, we feel pretty good about the pipeline.

Heather Hunt, Citigroup.

Just a quick question on the lower mortgage-backed security new business. Would you say that this was a response to your rising reserves in that [classless] quarter? In other words, were you a little bit more cautious in writing new business there? And if so, should we expect some more moderation going forward?

Heather, I would say we're -- as I explained, the reserves came from a certain specific classification of the mortgage-backed credit, if you will. We don't see tremendous opportunities relating to those specific types of credits. And I would say, as a general matter, we're very selective in that sector, one, for the obvious risk that's out in the marketplace, and two, the ability to get properly compensated for that.

I would also say, as a matter, that our CDO portfolio, when we look at structured credit with MBS, we're also very cautious about mezzanine-type securities that come out of mortgage-backed securitizations. So, we are taking a cautious position for underwriting reasons, but also the availability of profitable transactions is not as great as it has been in the past.

And then on this other topic entirely, just in terms of new accounting rules, there's FAS 155, which will be affecting asset-backed securities, and then Basel II in Europe. Do you see any impact from the adoption of those?

I know the FAS 155 is currently being discussed with the regulators. I know one of the industry groups, not the financial guarantor industry group, but the American Securitization Forum, has been working with them to deal with certain concerns that have arisen regarding (indiscernible) mortgage-backed securities. So, I'm not sure how that will come out. So, I can't answer that question correctly. We'll have to see. I think there might even have been -- might be a meeting today on that, as a matter of fact. So, we'll see how that works out.

Basel II, that shouldn't have a major impact from a capital-level standpoint on us. From a business opportunity standpoint, we're obviously looking at opportunities there to help other financial institutions with potential capital concerns that they may have regarding, obviously, risk-based type charges for credits that fall in [the] investment-grade space.

Gary Ransom, Fox-Pitt Kelton.

I had a couple of questions, big-picture questions. One, just on the credit portfolio. We had some increases in reserves, and I'm leaving Katrina out of it for the minute -- for the moment. What is your view of the overall credit direction in your entire book of business? Is it where you thought before, or have there been any changes there?

Sure. On a big-picture basis, overall we haven't had -- during the quarter we haven't had many new transactions come on to the list. We have had some Katrina transactions come off the list. But overall, you'll see that the below investment-grade classifications are down slightly. You'll also see the classified lists are down slightly. So, from an overall [picture] view, you're not seeing a lot of credit deterioration. What we had this quarter was existing transactions due to the various specific attributes of those transactions deteriorate, and we recognized that in the current quarter. So, you had a little bit of a movement down of the existing list, excluding Katrina, obviously.

Just another question on the competition. Is there -- we've had some tough competition for several quarters now, and I think most people are still viewing it as a cyclical issue. But as you look across the kinds of competition you're seeing, and the kinds of transactions where it's happening, is there any part of this that you think might be secular rather than cyclical?

I don't think so, Gary. I think, in the public finance market, I think, there has been -- that's been a market -- the actual credits we're seeing for the vast majority have been consistent across the years. Obviously there's been [more] highly structured municipal public finance transactions coming to market. But I think, largely driven by available spreads, competition will affect pricing there. But I think that's -- we've seen there that that can run in cycles, most recently as 2003 vintage, which the spreads came out. So, it enabled the -- it was very favorable to us. So, I believe that's still cyclical. I don't think there's [secular changes], and I think it's too soon to make a statement like that with, say, the mortgage-backed market for something of that sort. So, I would characterize it as still cyclical, but obviously something we are keeping an eye on.

That's helpful. Thank you very much.

Howard Shapiro, KBW Asset Management.

I'm just wondering if you can kind of give us your assessment of core credit quality as we look into 2007, and if there are any sectors you are more concerned about today than you were yesterday, or kind of what your general assessment is.

I would say it would typically run towards -- I think the highest concern that we have is certainly items that are in our case reserves. Obviously, those have been defaulted items, the most immediate. But those that are on our classified list, and particularly classified lower on the list, are things that we're watching very closely and surveil at least on a monthly basis, if not more actively. What we've seen is some movement on the overall classified list and below investment-grade list to specific transportation transactions. So, we're obviously looking at those public finance infrastructure transactions very closely. But largely, I would say, obviously, the highest-risk elements, which have been healthcare and those public finance transactions that I mentioned.

Ken Zuckerberg, Fontana Capital.

Sean, I wanted to respectfully ask you to go back to Geoff Dunn's question on capital management and share buyback, and maybe better understand, you know, timing; how you think about this versus other uses of capital; whether or not the dividend or increasing the common dividend is a consideration here. Thanks very much.

Sure. Obviously, the consideration of the dividend is part of our discussions, and part of our discussions with our Board. We have increased the dividend at pretty healthy rates over the last couple of years. I think the general view, though, is that to provide in an industry that is capital-intensive, and that, obviously, relies on AAA rating from third parties, we need to have some flexibility to manage capital in that regime. So, largely we would feel that to provide that flexibility, that would be more on the share repurchase side than it would be on a large ratcheting up of the underlying dividend.

Great. And on the timing of that, of course, I know it's subject to market conditions, but I think it is pretty interesting, with the shares below adjusted book value -- at least the way we view the internal rate of return of buyback -- looks pretty attractive. Can you speak to that? And also, was there any way to provide visibility over time on, you know, being somewhat defensive in a competitive market with respect to returning capital to shareholders?

Yes. That's -- certainly we are willing to pull back on markets and be selective with the business that we write. So, that is something that we look at on individual deals and look at the potential for returns on individual deals in the construct of strategic initiatives and whatnot. But we certainly, obviously, look at that. And if those opportunities are not there, there could be the generation of excess capital, assuming relatively benign credit environment. And that would allow us to repurchase shares. Then we would, obviously, look at the underlying price. And the price of shares below adjusted book value certainly does look attractive.

One final question. Just with respect to where the capital resides, could you -- or even as allocated, could you split for us, maybe even just percentage-wise, the amount of capital committed to U.S. versus international business?

Roughly -- don't have those numbers right in front of me, but we do calculate those numbers. We could certainly give you a sense for that. But, I'm just trying to think -- our net par outstanding for international transactions is, I'm going to say, roughly, about 20%. That would generally be the case. International transactions (indiscernible) at least on the infrastructure side might have a little bit lower ratings than the transaction, so they might attract a little bit more capital, because it's sensitive to ratings and tenor.

Fair enough. I can follow up with Pete. Thank you.

Ladies and gentlemen, there are no further questions at this time. I will now turn the conference back over to Mr. Leonard to conclude.

Thank you very much for attending our conference call. Both Pete and myself are available to answer questions that come along. So, please give us a call. Thank you very much.

Thank you. This concludes today's conference. Thank you all for your participation. All parties may disconnect now.