Ambac Financial Group Inc (AMBC) 2008 Q3 法說會逐字稿

Greetings and welcome to the Ambac Financial Group third quarter fiscal year 2008 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS). As a reminder, this call is being recorded.

It is now my pleasure to introduce your host, Mr. Sean Leonard for Ambac Financial Group Incorporated.

Thank you. Good morning, everyone. Welcome to Ambac's third quarter conference call.

I'm Sean Leonard, Chief Financial Officer of Ambac. Presenting with me today are David Wallis, Chief Executive Officer; and Kathy Matanle, Managing Director of Portfolio Risk Management, who will discuss our credit portfolio. Our earnings press release, quarterly operating supplement and a slide presentation that follows along with this discussion are available on our website. I recommend that you view the slide presentation as we speak today. Also note that this call is being broadcast on the internet at www.ambac.com.

During this conference call, we may make statements that would be regarded as forward-looking statements. These statements may related to among other things management's current expectations of future performance, future results, and cash flows and market outlook. You are cautioned not to place undue reliance on these forward-looking statements, which reflect our current analysis of existing trends and information as of the date of this presentation. There is an inherent risk that actual results, performance, or achievements could differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. These differences could arise from a number of factors.

Information concerning factors that could actually cause results to differ materially from the information we will give you is available on our press release, and in our most recent Form 10-K and subsequently filed Form 8-Ks. You should review these materials for a complete discussion of these factors and other risks. Copies of these documents may be obtained from the SEC website. I will now turn it over to David Wallis, who will comment on the current market environments, our discussions with the Treasury and Ambac's strategic priorities. David.

Thanks, Sean, and good morning, everyone. Since we last reported on August 6, few if any would be predicted the tumultuous events of the last few months. These events have been somewhere between significant and transformational in nature, and have touched most areas of the globe. Summarily, financial markets have been exceptionally volatile and have generally declined significantly.

Many institutional participants in these markets have been transformed, or in a few exceptional cases, no longer exist. In the US specifically, and far from alone in this, house prices have declined significantly, consumer confidence has hit record lows, and credit markets have suffered more or less complete seizure. Unsurprisingly, official and consensus views on the economic outlook have deteriorated. That is the story of the last three months, and this quarter's results are reflective of this [distressive] contents.

More strategically, it is reasonable to characterize our opposition as being balance sheet dilutive by our exceptional historic standards, bur on a forward-looking basis is possessing valuable skills and connections in an environment crying out for just those assets. The real question is how to get from where we are presently to an appropriate and [remunative] usage of those skills and connections in the future.

Let me review the present position. The current spotlight on our ratings, more specifically Ambac's Moody's rating, post their release concerning Ambac of September 18. Crystallization of the reference downgrade would precipitate the significant liquidity issue within our financial services business. Let me take these rating and liquidity items in turn.

Firstly, ratings. Clearly, we can neither speak for nor predict what rating agency opinions might or could be. Let me be clear that there are many elements of the ratings analysis with which we would wholly agree, and it is no doubt it is a difficult task. However, let me also say, there are significant elements and assumptions within some of the analytics that leave us confused and somewhat incredulous. Sean will discuss some of these issues a bit later. Suffice to say under our current business model where our ratings have always been an essential cornerstone, this quarters production numbers amply demonstrate that even current ratings are seemingly irrelevant in new business underwritings. The sum, this unfortunate state of affairs is a matter of confidence in general with confidence in ratings in particular.

Secondly, liquidity. While one can debate the precise causes of this rating liquidity issue which largely emanates from mortgage markets woes within the guaranteed investment contracts business, the essential point is that we believe the issue is to be a liquidity issue and not a solvency issue. Naturally, we are in constant touch with our regulators with whom we continue to have a completely open and constructive relationship.

I'll now comment upon the major drivers of this quarter's results. Cutting to the chase, there are really two major elements; a meaningful deterioration of the performance of our second lien mortgage book and amendments of some of the assumptions underlying our high-grade ABS and CDO portfolio. Regarding second liens, last quarter we observed an apparent topping out of certain key credit metrics. This quarter we have seen an apparent reversal of these metrics. Therefore, using the same type of methodologies as previously, we have been compelled to reflect these changes in increased projected losses.

On ABS CDOs, which account for a significantly larger element of this quarters reserves and impairments, we have revised and refined our assumptions and are going to briefly walk through these. Within our high-grade ABS CDOs, we commence with an analysis of the underlying RMBS uses, looking at booked cumulative losses and individual delinquency buckets. We've given delinquency buckets in certain prescribed rolls that default from these, together with assumed prepayment fees, then for varied severity assumptions, it is possible to infer what proportion of loans that are current would need to default at these prescribed severities in order to generate certain future ultimate cumulative losses.

Focusing on the change from the last quarter, we have chosen to raise our severity assumptions, now 55% for subprime and 45% for Alt-A which have lead us to project the 2006 subprime a couple elative loss for the Q6 will be 19% on average, where that's Alt-A equivalent, which given the raw analysis have led us to project that 2006 subprime cumulative loss for the Q6 underlying are high-grade transactions will be 19% on average whereas the Alt-A equivalent, depending on product, is projected at 8% to 13%. For reference, the 19% subprime assumption compares to around 8% for the exceptionally poor 2000 vintage, and a present booked cumulative loss within the vintage of around 5%. [Extracting] from mortgages, these assumptions infer that around 4% of 2006 borrowers will default, a staggeringly high number.

Obviously there is inevitable crystal ball uncertainty in any and all of these very forward-looking projections. Aside from the economy but [patently] is correlated to it, are the [parently] of current public and private sector measures, designed to stem the tide of delinquency and foreclosure activity in order to reduce ultimate loss. Just as it is hard to comprehend the current state of distress, it is at least as hard to comprehend the scale of the collective public and private sector response. Our judgment is that these activities or their successors will have a materially beneficial impact upon the targeted metrics. Just as many [suits sayers] proclaim this time is different as optimism abounds, many utter the same words now as pessimism mounts; very seldom is either extreme borne out.

I'll close by reviewing present priorities and a view of the future. The monoline industry is an essential lubricant in some critical credit markets, both municipal and asset backed. These markets are presently [more of them, the chagrin] and expense of all.

The industry is systemic to the efficient operation and existence of these markets. The industry gives issuers access to them, and by virtue of the enormous issued volume outstanding, is impactful on the balance sheets of insured debt holders and other counter parties. Just as issues of confidence have frozen the back market and consequent flow of credit, an [analogous] position is occurring within the monoline dominated markets. For the major monoline participants, the issues are confidence and/or liquidity, but not solvency.

In this systemic and solvent context, it should not surprise anyone that some participants within the industry have commented upon the top proposals and have a great interest in them. Here at Ambac, we consider ourselves as eminently eligible and aligned to assist in the restoration of liquidity and stability to the financial system, further [rubic] of the act. This is therefore, a primary current focus for us and some of the remaining participants in the industry. Page 4 lists some of these programs.

A second major activity is to ensure an unchanged focus on managing and de-risking our portfolio. Whilst the collective term is monolines, this nomenclature belies the range of value-adding activities going on underneath the traditional herd of the financial guarantee. We remain confident that these important activities will continue to produce value for our stakeholders.

The third major activity continues to be Connie Lee, our intended limited focus subsidiary. We have put in an extraordinary effort across the multiple facets of business plan production and validation, and eagerly await the considered response of the rating agencies. It is clear that there have been different levels of understanding of our proposal, which we believe will give rise to a stable and attractive proposition, and we are presently working hard to assist any and all in analysis of it.

Finally, I started off by commenting upon the fact that within Ambac we possess valuable skills and connections in an environment crying out for just those assets. I absolutely believe this to be the case. We are fortunate in having the business model to see us through the present extreme environment, whilst being able to plan and act for the future.

These activities are vital as an extended status quo is simply not an option for us or any business. We have to use our qualities, and appropriately flex and potentially shift our business model so as to create value by serving our core issuer and investor stakeholders. We have a terrific alignment with those stakeholders, and especially in this environment, conserve them whilst providing satisfactory returns to our shareholders. Rest assured, we are working very hard to get back these happier state of affairs. Now I'll turn it back to Sean.

Thank you, David. I will now provide a brief overview of the financial results, focusing primarily on factors driving our results, and then we'll also briefly comment on rating agency reviews and liquidity. If you would please turn to page 8 in the slide presentation for a summary of our financial results.

Net loss for the third quarter of 2008 was $2.4 billion or $8.45 per share. That is down from a net loss of $360.6 million, or $3.53 per share in the comparable prior year quarter. Driving most of the decline is net non-cash mark-to-market losses in our our CDO of ADS portfolio. Also contributing to the quarterly loss, are an increase in net provision from loss and loss adjustment expenses, primarily related to second lien RMBS transactions and realized losses in our financial services investment portfolio.

Partially offsetting these losses are increased accelerated earnings premiums, resulting from refundments. To assist users of our financial statements in the analysis of our reported earnings, we also report our earning ops an operating and quarter basis. Page 9 summarizes these earnings measures. Both of these earnings measures are considered non-GAAP. Operating earnings excludes the net income loss impact of net gains and losses from sales of investment securities and mark-to-market gains and losses on credit, total return and non-trading derivative contracts that are not impaired. Core earnings further excludes the net income impact from of accelerated earned premiums from refundings.

Operating earnings per share in the third quarter 2008 were $7.81 per share; that's a loss. Remember that in calculating operating earnings, we exclude the impact of unrealized gain losses from our CDO portfolio, but do not exclude the impact of estimated credit impairments within that portfolio. In the third quarter, Ambac recorded a credit impairment of $2.51 billion pre-tax or $5.67 on a per share basis.

This amount is reflected as a reduction in our operating and core earnings results. In calculating CDO impairments for the quarter, we decided to increase our assumptions, as David stated, of cumulative loss related to the RMBS as it's within these transactions. Cathy will provide greater detail about our credit portfolio and various loss assumptions that led to our impairment estimate, but I would like to address a point about the TARP and other governmental programs and actions. Ambac believes these initiatives are expected to have a positive impact on liquidity and credit throughout the markets. Therefore, we have considered them when selecting management's global assumptions of cumulative losses in the underlying collateral of the [CU obate transactions].

Turning to core earnings, which is operating earnings less net income per share impact of refundings, amounted to $8.11 loss per share. Normal earned premium amounted to $155 million in the quarter, down 13% from the comparable prior-year quarter, primarily due to the reduced premiums written, runoff and accelerations of the portfolio due to refundings and the insured guarantee transaction that took place late last year. Accelerated premiums of $127.3 million, increased significantly once again, up about $111 million over the third quarter of 2007.

Refunding activity remains heavy in auction-rate and variable-rate debt notes, due to the extreme ill liquidity experienced in those markets since early this year. This heavy refunding activity enhances our capital position as we free up capital as the exposure comes off of our books. Our net par outstanding at September 30, 2008, amounted to $461.5 billion, that's down 12% from the beginning of the year. Investment income increased $9.8 million or 8% to $126.8 million, while increased volume driven by net positive cash flows from operations and the net proceeds from the March capital raise, but partially offset by cash flows related to the $850 million commutation payment made in August and claim payments on second lien RMBS transactions.

Now turning to page 10, we summarize financial guarantee revenues. While business writings are down drastically, total financial guarantee core revenues, which includes normal earned premiums, frees on credit derivatives and investment income, remains fairly steady, having only declined about 6% quarter-on-quarter. Year-to-date, core revenues are down less than 1%. This demonstrates the advantage of our long-term book of business, and our business model that allows us to collect a large portion of our premiums up front, invest those funds in a conservative fixed income investment portfolio, and to earn the premiums over the long lines of the bonds.

Our deferred earnings, which represent future earnings on premiums already collected and the future value of installment premiums, amount to $5.6 billion at September 30. That balance is made up of $2.2 billion of the premiums already collected and invested in our conservative investment portfolio, and $3.4 billion of premiums we estimate will be made to us in installments over the lives of the transaction.

Turning to page 11, I will discuss mark-to-market and impairment activity. During the third quarter, Ambac recorded net mark-to-market losses related to its credit derivative portfolio, amounting to approximately $2.7 billion. Mark-to-market losses were once again impacted by deteriorating price performance in the underlying RMBS collateral of the CDO of ADS transactions, and significant internal downgrades in the portfolio. As a brief reminder, FAS 157 requires Ambac to adjust the estimated fair value of its derivative liabilities to incorporate the risk of the Company's own non-performance. Planned Ambac's credit spreads as required had a $1.38 billion positive impact on the mark-to-market loss for the quarter.

I would like to now discuss our loss provisioning on our direct RMBS insurance portfolio. During the quarter, we paid $187 million in RMBS claims. Total RMBS losses for the quarter were $540 million. The increase incurred is primarily the result of deteriorating results in our second lien RMBS portfolio. It is notable that four second lien transactions represent about 50% of our total RMBS reserves.

Those transactions and several others are the subject of very detailed reviews by our remediation team and outside consultants. As discussed last quarter, Ambac is in the process of reviewing performing transactions for breeches of reps and warranties. Our efforts to date have uncovered significant such breeches. And in the third quarter, Ambac recorded estimated expected recoveries of approximately $250 million. Kathy will provide more information on those efforts. In addition, during the quarter, Ambac increased non-RMBS reserves by $73 million, primarily related to other classes of asset-backed securities.

Very quickly, on page 12, we have summarized the losses and impairments that we have taken over the last four quarters. On page 13, I would like to spend a few minutes discussing rating agency reviews. As most of you know, Moody's put us on review for downgrade in mid September, and as a result of the changes in ultimate losses estimates primarily in subprime R&D asset securities. That review is ongoing.

Ultimate future loss estimation is not an exact science. We don't profess to have a crystal ball, but we do believe that certain factors about their ratings model, our business model and even the global environment, need be considered before reaching conclusion on Ambac's capital position and financial strength. We have met several times with Moody to discuss these factors.

On this slide, we show certain cumulative losses assumptions published by the ratings agencies compared to our own. We will be able to update our capital position once both Moody's and S&P have completed their reviews. Later I will discuss our regulatory capital position.

Now I would like to discuss the Company's liquidity from a few perspectives; Ambac assurance, the insurance company liquidity, holding company liquidity, and liquidity impacted by rating changes. Let me start with Ambac assurance liquidity on page 14 with a snapshot of our financial guarantee investment portfolio. Ambac assurance claims resources at September 30, amount to $15.4 billion.

The backbone to those resources are conservative fixed-income investment portfolio. That portfolio totals $9.9 million and is made up primarily of high-quality municipal bonds, US government obligations, and US agency obligations. In the fourth quarter alone, we expect to receive principals and interests related to this high-quality portfolio amounting to $143 million. In addition, we expect to see about $91 million of installment premiums during the quarter. Those amounts total to $234 million, and compared to expected claim payments for the quarter of $258 million. Also of note, in late October, Ambac received $546 million in tax refunds related to taxes paid in 2007 and prior.

On page 15, let me briefly discuss the components of liquidity at the holding company. Total holding company cash amounts to approximately $187 million at September 30. Ambac assurance paid a quarterly dividend amounting to approximately $54 million at the hold-co in October and plan to end the year with approximately $200 million in cash at that entity. That is approximately 1.9 times the holding company's annual debt service needs.

On page 16, we have laid out the statutory capital as of the end of the quarter. Based on Ambac assurance financial results year-to-date, it is not likely that Ambac assurance will be able to declare and pay dividends to the holding company in 2009 without first receiving approval from the office of the Commissioner of Insurance at the State of Wisconsin. We would expect they will make those decisions at the time we make the quarterly requests.

As a reminder, Ambac announced back on September 19, that we suspended the previously announced authorization to repurchase up to 50 million in common shares. We did no in order to support the Company's goal of maintaining sufficient parent company liquidity. In early October, the Board of Directors of Ambac declared a quarterly dividend of $0.01 per share of common stock. That dividend is payable on December 3 of this year. As a result of the net loss recorded in the third quarter, Ambac's GAAP stockholders equity is now negative. Delaware corporate laws prevent us from paying any further dividends until our stockholders equity is positive.

Lastly, I would like to discuss our liquidity requirements which will be triggered by ratings changes. This is outlined on page 17. The severe dislocation in the structured credit markets continues to negatively impact our investment portfolio. The negative mark-to-market on the highly rated securities that comprise the GIC investment portfolio has created a gap between the realizable values of the GIC liabilities and the GIC assets. That gap may lead to a current liquidity obligation, because of boundary triggered structure in most of the GIC contracts which require us to [calatarize] or terminate (inaudible) upon certain rating levels.

Similarly, a downgrade of Ambac assurance and resulting collateral posting obligation and potential cash termination payments on our currency and interest rate swaps in our derivatives business. Our presentation provides the updated collateral posting needed on our various downgrade scenarios for all of our financial services businesses. Upon a downgrade to single-A flat, you see our collateral posting requirement increases to $2.8 billion. On a downgrade to BBB-flat, the collateral posting requirement increases by an incremental $400 million to $3.2 billion. We continue to work closely are our regulators to receive permission to use the resources of Ambac assurance to support this liquidity issue.

That concludes my prepared remarks on the financial results. Cathy Matanle will now talk through some detailed elements of the credit portfolio. Cathy.

Thank you, Sean. Let me move on to the portfolio. Although the mortgage prices and now weak economy have heightened our surveillance efforts of vulnerable credits and assets across the insured portfolio, mortgage-related assets continue to by our major concern. Therefore in my prepared remarks, we'll address this portfolio. I'll start with a high level overview then move to address the direct MBS book, then the CDO of ADS book. In both cases, covering reserves, performance, and remediation. Please note, we have provided in the appendices an update on the CLO portfolio, as well as an updated MBS claims projection chart.

Turning to page 19, let me start by summarizing the key sub sectors of both the direct MBS and CDO books of business. Exposures are down slightly due to extremely low voluntary prepayment rates, underlying the mortgages in both of these portfolios. The direct MBS book now stands at $42 billion, versus $45 billion at the end of the second quarter. The second lien portfolio, which comprises closed-end seconds and HELOCs stands at about $15 billion or essentially flat to the second quarter.

The CDO of ABS portfolio is $30 billion. We have high grade CDO of ABS exposure of about $25.5 billion. The CDO portfolio has been reduced dramatically from $2.5 billion to $1 billion after the commutation of the AAB spoke transaction back in August.

On page 20, we provide a current snapshot of Ambac's current reserves and impairments. As of the end of the third quarter, Ambac has approximately $6 billion in total mortgage-related reserves and impairments. 78%, $4.8 billion relates to the CDO of ABS book while the remainder relates to the direct MBS book.

Of the direct MBS portfolio on the left, the majority of Ambac's reserves relate to the second lien product shown in the top two boxes. The majority of the category labeled other, comprises affordability products and lot loans. In in the quarter, we increased reserves by $15 million for the former and took a new reserve of $61 million for the latter.

Our total exposure to lot loans is the four deals that are now reserved. They have a total par of $344 million. There are impairments against each of the 18 CDO of ABS transactions that we now rate below investment grade. $1 million of the impairment relates to the two remaining CDO squared which are unchanged in the quarter.

Next I'll make some brief comments on MBS followed by CDO and ABS. Moving to page 22, I'm planning to move through the next two pages quickly. They are just snapshots to provide context. The pie chart on the left shows the composition of the direct MBS portfolio. The chart on the right shows the vintage distribution of the current exposures. On page 23, the two pie charts show Ambac's rating distribution of the book as of June 30 on the left, and September 30 on the right. Ratings deterioration in the MBS book is driven by the second lien product which accounts for 70% of the ratings now below investment grade.

Let 's now discuss the MBS collateral performance trends in the quarter. As David explained, we use the same models in the quarter that we used to model performance in the past, revising assumptions to reflect deal performance in this quarter. During the quarter, it was the increase in initial roll rates, meaning those homeowners who moved from current to 30-days delinquent, that predominantly drove the higher model losses. Additional factors include continued severe roll rates into the later stage delinquency from foreclosure, more front-loaded claims payments, and slower prepayments.

As mentioned earlier, our Alt-A and subprime portfolios continue to perform within the parameters that we have established for them. Our lot loans moved to below investment grade in the quarter. Falling home prices and ample inventory of existing homes contribute to underperformance of these transactions. We model these deals consistently with our other MBS assets, but take into account the repayment terms that are unique to these deals and the potentially higher severities that exist over our other first lien product.

Given the significance of the second lien portfolio on the quarter's result, the next few pages address this part of the direct MBS portfolio. Page 25, seven of our 46 HELOC transactions are now rated BIG, below investment grade. This represents 36% of our HELOC net par. Eight of our 31 closed in second transactions are now rated BIG, in this case representing 66% of the net par.

Turning to page 26. In prior quarters, we have shown you deal performance on select underperforming MBS transactions. On the next two pages we have done this again, graphing the two most important drivers to those selected deals underperformance. This first page, page 26, shows the rising trend in this 30 to 60-day delinquency bucket.

On page 27, we show the declining voluntary prepayment rates for these same deals. These rates are approaching zero, as homeowners overleveraged against declining home values cannot refinance out of the pools.

On page 28, turning to the HELOC. Although we have been distinguishing HELOC deals from closed in seconds in our reporting, we find that the lines really blur between the two asset types once the deals are underperforming. Nevertheless, the distinction does help us to explain the apparent root causes of the underperformance, as shown in the next two pages. For example, on page 28, the divergent performance of bank and non-bank originated HELOC product that we reported to you in the past continues to hold. You should note that HELOC claims in the quarter were $79 million, 42% of the Company's total paid claims in the third quarter.

On page 29, and also as reported in prior periods, the majority of the reserves in the closed-in second product continue to be related to the piggyback second lien product, usually a high LTV purchase loan. Closed-end seconds paid claims in the quarter totaling $106 million which is 56% of the Company's total paid claims. The majority of our remediation efforts relate to the closed-end second product.

Turning to page 30, let's move on to progress and remediation. This page summarizes our work in the quarter investigating breeches in our pools, and separately addressing [servicer] matters, ranging from servicer replacements to loan modifications. For the quarter, as Sean mentioned, we increased our estimated remediation recoveries by $249 million to an aggregate of $521 million.

This is based upon additional reunderwriting of mortgage loans on a total of nine transactions. An average of 78% of all the loans we have reunderwritten evidenced breeches of REPS and warranties, in most cases exhibiting multiple breeches. We're making significant headway with sponsors, sending 17 breech notices or claims in the quarter.

Where our efforts to put back loans or otherwise work with sponsors of the transaction proves to be ineffective and we fail to receive cooperation, we have no alternative but to enforce our rights and remedies through legal action. We are presently filing a complaint in connection with four transactions involving EMC, a mortgage subsidiary of Bear Stearns which is now owned by JP Morgan. This action is the culmination of over a year-long effort to come to a cooperative resolution in these transactions.

Turning now to CDOs on page 32. As I indicated, the majority of our exposure is now rated below investment grade, having started at super AAA by Ambac and the rating agencies. We have seen considerable ratings deterioration quarter-over-quarter. For example, at the end of the first quarter, we had three high grade deals rated below investments grade. By the end of the second quarter, 11, and now 15.

Until this quarter, the driver was rapid deterioration of the inner CDO buckets within the high-grade transactions. This quarter, however, we saw a dramatic deterioration in the RMBS underlying the high-grade deals. Despite initial ratings in the single and AA-rated categories, many of these underlying RMBSs are not able to withstand the increasing cumulative losses that we are assuming.

Turning to page 33. As with all underperforming credits in our portfolio, we take an aggressive approach to loss mitigation with these CDO credits, as you can see from this list of select activities. We are fully exercising our control rights as they relate to structure, the manager and the collateral. We have accelerated four transactions to divert crash flows from the junior classes to take down our tranch, and we are also restructuring transactions to achieve the same end.

Finally, page 34 on the subject of commutation. There has been a modest slowdown in our CDO commutation momentum due to the uncertainty of the various government programs designed to stabilize the financial system and the individual homeowner. Nevertheless, we continue to believe that this is the most cost effective way of reducing risk in the near term, and we are confident that our discussions will continue to advance fruitfully. Our commutation strategy is focused on transactions where our counter parties have significant exposure to us and the views of projected performance start to converge, in other words our bid and ask get closer.

The price we are willing to pay will depend on Ambac's view of the ultimate loss, the timing of claims payments, and the capital implications. Let me end by saying, we have had meaningful discussions with all of our key counter parties, and we will continue to advance these discussions to settlement. And with that, I will turn it back to Sean.

Thank you, Cathy. That's the end of our prepared remarks. We would now like to open it up for question.

Thank you. (OPERATOR INSTRUCTIONS). One moment, as we poll for questions. Our first question is coming from the line of [Arun Lamar] of JP Morgan.

Good morning, gentlemen. Couple of question. The comments you made earlier in the call regarding liquidity based on a potential rating action. We don't know if that's going to happen, but the question is if Moody's does take you down a couple of notches, how do you expect to remediate this situation. Have you had any recent dialogues with the Wisconsin Insurance commissioner, in terms of allocating assets, especially in light of the fact your capital has dropped quite a bit in the third quarter? And the second question is, if you look beyond this year and getting in to next year with the fact that you don't have any dividend capacity what kind of liquidity position do you expect to have, given that you don't have any bank line currently?

Sure. I can take that question. This is Sean.

In talking about discussions with the Wisconsin Insurance Department, we have had quite active discussions as David pointed out in his remarks. This goes back quite sometime, so this is not, obviously an issue that's crept upon us. It's been out there, and it's an issue that Wisconsin Insurance Department is well briefed on.

Regarding our plans -- our plans to solve those liquidity issues are to utilize the resources of the insurance company to meet collateral posting requirements and termination requirements in both the GIC and the interest-rate swap business. That will be a combination of purchases of assets out of the business. It will be a bit of secured lending to the business, which we have already done some of already. It will be some unsecured lending to the business to accomplish the result of either terminating or collateralizing.

Obviously we'll take -- if we were to be downgraded, we'll take an economic view of whether or not to terminate or to collateralize contracts based on the terms of the liabilities, rates and the like, and what type of posting requirements are required under those contracts. For example, long-term fixed rate collateralizing with treasuries would not be in our best interest. Those are the plans to handle that, and we have had active discussions with Wisconsin and are up to date.

Relating to the holding company liquidity, we have provided a good overview in the materials -- on page 15 of the materials, which gives you a sense for where we expect to be at the end of the year, relating to our cash balances. We will need to discuss with Wisconsin the plans to take dividends next year, but in the case that we are not able to take those, we do have approximately 1.9 coverage over the debt service requirements for 2009.

Just as a quick follow-up. In terms of your book equity is largely being wiped out and your stat capital down substantially, one projects ahead and any further deterioration in your portfolio of RMBS and other exposures you have -- the Wisconsin Commissioner arguably could be very concerned that your stat capital may also go the way of your GAAP capital. And in that case, what is the likelihood that they let you do do anything in terms of the GIC portfolio, rather than staying focused on your whole business and otherwise as opposed to (inaudible) the GIC holders whole?

Sure. It's David. I'll take that question. Those are issues that obviously are on the table, and clearly, the regulator in Wisconsin is primarily concerned with policyholders. I would say, as Sean commented, we have a very open and transparent relationship with Wisconsin.

This is not news. They have spent a lot of time with us, and their advisors also, and are fully cognizant of what our position is. Obviously we can't speak for them; we work with them continually, more or less on a daily basis. I think they are very aware of all of the issues that you raised, as are we. And as Sean implied, this isn't news.

Thank you.

Just a couple of other comments. You made some comments about statutory capital. We provided a reconciliation of where we stand as of the end of the third quarter, and what is not on this page is a substantial contingency reserve that we have established that we have not taken down.

The statutory rules would allow a petition to the Insurance Commissioner when -- in situations where the loss rates are onerous and there are certain requirements that surround that, and where policies were to be expired, refundings and the like. That would be a discussion we would have with them at that appropriate time.

Thank you.

You're welcome.

Thank you. Our next question is from the line of [Cy] Lund of Morgan Stanley. Please go ahead with your question.

Good morning. I have a question on the ABS CDO exposure. I'm looking at slide 32, and I'm trying to get some more detail on the notes still outstanding on the CDO ABS because it is just a bar chart. Can you give us the numbers on what the CDO ABS net par exposure is and what the extent of the impairment is on that as well?

Sure.

Sure. There's a slide that describes -- and if I ask you to turn back to Slide 19. Slide 19 provides the detail where there's heavy mortgage-related securities in the CDO.

That number is approximately $30 billion, so that obviously corresponds to the bar chart and you see the breakout that we have there. $25.5 million high grade. $0.5 million in mezzanine, $1.1 million of CDO squared, and then we have a commitment to provide a guarantee of $2.9 million. When you add that up, that gets you your number.

Now if you were to flip -- just flip the page, if you would like, on page 20. Page 20 shows you the estimated impairment for the CDO of ABS portfolio of $4.8 million.

Okay. Thank you. And then just a higher level question as well. David, congratulations on the new role of CEO. Can you talk us through any strategic changes or transition issues that have some up with Michael Callen stepping down over the last several weeks?

Sure. No transition issues what over. We have had arguments about the corner office, but that's it. Nothing serious at all.

In terms of strategic issues, our priorities are as we laid out. Clearly, there is a lot of activity rate up. That's in a sense, somewhat sprung up over the last few weeks. It's obviously a current focus for us.

We don't see that as are silver bullet, and as the be all and end all, we think we're eligible. We hope we're eligible. It depends on the terms of eligibility should we in fact be eligible. We think there's a business beyond TARP if TARP doesn't occur in relation to ourselves. That brings us to a more internal focus in relation to the portfolio as I described, and the Connie Lee initiative as I described.

It's clear -- you look at the municipal markets right now, year-on-year volume is down 57%. You look at the cost of funds to municipalities, it is way above taxable rates. These are extraordinary times, and the markets are under distress. We act as a lubricator if you will, between investors and issuers and man, does the world need a bit of oil right now. There are real opportunities for us.

I think we need to take advantage in a helpful way, in terms of the systemic position that I think we are in, to meet the needs of issuers and investors and get the thing going. We think we can and we're looking forward to it.

One quick follow-up. Thank you. If I assume a further increase in cumulative losses on CDO of ABS from say 23 to 25, is there a linear progression from the 16 to 18 you had up to the 19 to 21? Should we assume a linear progression as potential losses are increased on the CDO portfolio?

No, you have probably shouldn't. It's not really linear, it's -- the deterioration, should those projections occur, is exponential is the wrong word, but it's faster than linear. Clearly, one's views there depend on one's view of the world. As we outlined, we do think that the terrific efforts, both by the private and the public sector, will have an impact there. We believe that pretty firmly. We think that there is some evidence to suggest that there will be an impact. But no, in answer to your basic question, the impact isn't linear.

If you turn back the clock, though, just to make a point I think we made on a prior call, that one of the meaningful things that has occurred in relation to the CDO of ABS has been the very fast, unexpectedly fast, write-off of CDO buckets. That obviously, is a one-hit wonder. We disclosed pretty fully on our website the extent to which that component of these deals is written off.

That is largely over with, that leaves the performance of mortgages as the real variable here. We have chosen, for the reasons we outlined, to up our assumptions. These are very forward-looking estimates.

We're not expecting claims in some cases for 10, 20, even 30 years. 5% is roughly where the [cohort] loss is right now. We're forecasting 19. We'll see. But in answer to your basic question, no, the basic math of this stuff is such that the losses or the future impairments are not linear in their nature.

Okay. Thanks very much.

Thank you. Our next question is coming from the line of Darin Arita with Deutsche Bank. Please go ahead with your question.

Thank you. Can you give a little more color on your discussions with Treasury, post your posting of comments to them last week?

Sure. Obviously, we believe absolutely that we are systemic. By the way, I'm talking about the industry, this isn't an Ambac banging ball; this is an industry move. I think clearly, why are we systemic? We all know our place in the municiple industry.

There are also other effects. There are effects upon the holders of insured debt and counter parties. Banks clearly have written down their exposure to us. That's capital depleted. That isn't helpful in the context of the need to get bank credit going.

I think there are also other issuers and other factors aside from municiple factors that obviously would welcome a return to a healthy monoline industry. I think that some of the healthcare issuers, the student loan issuers, and also one or two other asset-backed issuers would welcome our return. The first point is a systemic point. The facts, I hope -- I believe, speak for themselves.

The second point, really, is the solvency points. Clearly, it is not in the interest of taxpayers, and we are absolutely at one on this -- to prop up the failing institution. That isn't, we believe, where we sit.

We think our issues on liquidity are along the lines that we've discussed, not solvency. Clearly, treasuries and others want to be persuaded of that fact, because in a sense, they don't want to throw good money off the bat. I hope and believe that that argument, is a very tenable one, and that we'll win it.

The next point, comes down to the precise nature of any measures that could be undertaken here. And here, there's a debate. We have posted some suggestions, as did others, in relation to the request to comment from the TARP. I think are many alternatives here. All of those details have yet to be played out.

In summary, the main points are systemic, that's what it is about. That's the state of the world right now. Solvent, yes, no. We think yes clearly in our case, and then getting down to the detail both in relation to the size of any perspective measures, and also the precise structure. It's those last two elements where clearly more work needs to be done.

Has Treasury responded at all since October 29?

There has been dialogue, as you would expect, but obviously no formal response.

Okay. With respect to your current ops reserves, how much worse do you expect things to get with respect to home prices and delinquency trends?

It's crystal ball, and we're making very forward-looking estimates of very complicated matters. What we have tried to do is obviously take a decent run at this in relation to the assumptions and the rational of the assumptions that we have outlined. One way of looking at this if you imagine it in your mind's eye; the normal normal distribution, Clearly, hence the TARP, hence all of the concerns in the markets at present, we're way out there in the tail of that distribution now. The TARP and other private-sector measures are, and we believe, will pull in that tail. What we're seeing is -- what we will see is a compression from where we are now, which is clearly in a very, very stressed environment, but we expect that some of the more extraordinary stress losses that have been promulgated, we think they'll prove to be not well-founded, and that the tail, if you will, the kind of extreme end of what might happen will be surmounted effectively by the TARP.

Now what is the joker in the pack? Well it's the broader economy. I think what you have to do is to balance out the incentives for homeowners now, the fact that we are in a terrifically stressed environment, the fact that the TARP, I think, will have a tremendously beneficial impact.

It's beginning to have an impact clearly in the banking markets now. The other side of the argument is, well, what is the economy. Clearly there is a huge amount of connectivity between all of these issues. In our view, we have taken a very good run at this, and we -- it's tough to project the future. We have been consistently wrong. But we're feeling comfortable or comfortably uncomfortable in relation to the estimates we have made.

What is your estimate then for a peek to trough home price decline, underlying these loss reserves.

Sure. What we have done, it's a different way of asking -- of replying to the same question. We have upped our severities quite considerably. We're standing at 55% in relation to subprime, 45% in relation to Alt-A,. Obviously that reflects [dilution] in house prices along the liquidation timeframe which incur carrying costs in between times. All of that adds up to a cumulative loss estimate of around 19% for '06 subprime. In other vintages, we have moved in a [commensurately] if you will -- and 8 or 13 I believe were the numbers in relation to mid prime.

All right. Thank you.

Thank you. Our next question is coming from the line of Gary Ransom with Fox-Pitt. Please go ahead with your question.

Yes, good morning. I noticed you also took a write-off of some of the deferred tax assets. Could you talk a little bit about what strategies you might have in either in the investment portfolio, because I believe you still have a lot of tax excerpt bonds there, where there might be ways to speed the realization of some of those.

Sure. When you're looking at the realizability of a preferred tax asset, one needs to consider what type of taxable income one would have in the future to allow you to use those future tax deductions. Clearly in our case, the deferred tax asset is being driven largely by the extensive nature of mark-to-market unrealized losses that we have taken to date. What we're looking at is the scheduling out of our revenues, utilizing certain assumptions for expenses and scheduling out those losses and loss payments -- or losses for insurance policies and losses on credit derivatives that are on our balance sheet.

There are tax-claiming strategies that could be considered. Clearly, the most obvious one is what you mentioned. We do have a portfolio of tax exempt securities. We have brought that in a bit. We'll obviously be looking to bring that in further to balance --optimize is the better word to use -- optimize the portfolio from the standpoint of tax planning and utilization of net operating losses in to the future. We brought this -- since June 30, you might notice that we brought the tax-exempt portfolio down by about $2 billion on the investment side.

Okay. Thank you. Another question on the CLOs, corporate spreads have moved a lot. I couldn't tell if there was any mark-to-market of any significance on the CLOs. Is that in fact the case?

Yes.I would characterize that as the case, compared to what is going on in the CDO of ABS portfolio. We do have mark-to-market in the CLO portfolio. That is primarily lower due to the high-grade nature of that portfolio, and the lack of significant internal downgrades that have been apparent in the CDO of ABS portfolio. But we do have mark-to-market.

The portfolio for CLOs and -- is a little bit shy of $20 billion. It's a smaller balance. It is a more highly rated balance. We have a slide that goes through that -- of the ratings and the quality of those transactions that produces --

That's in this appendix in the back?

Yes, it is. I can point you to it, if you just give me a second. If you look on page 50.

Okay.

You have a combination of CLOs and other transactions for par -- at least on the derivative side. Not all of these are derivatives, but close to -- a little bit over $30 billion.

All right. Thank you. One last question on the loss mitigation and some of the -- you filed claims in some cases. I am just trying to understand what the process has been. You've tried to work with them to come to some settlement, and you just can't reach a settlement, so then you have to file a claim. Is that basically the process that has happened?

Yes. You basically kickoff looking at loans -- reunderwriting loans. These are individual loans. And pointing out where those loans are deficient in relation to the representation of warranties that were made, pursuant to the description of what loans should have gone in to that particular shelf or that particular issue.

You say, well, this loan is deficient, here is why. Please take the loan out and put in a loan that fits the criteria that we agreed upon or inject cash. What happens is, generally speaking -- this is a generalization -- that the issuer has 90 days to consider this matter. Or in fact, usually should replace the loan or inject cash on the earlier of 90 days of being aware of the deficiency in the first place. Then what you get in to -- very slowly, candidly, because of the 90-day point, is a debate about, is that representation and warranty breeched or not? We happen to have a very strong view on some of these reps and warranties.

At the end of that 90-day period, assuming that not sufficient loans have been taken out and cash put in, then you're into filing a claim. Honestly, getting in to court and so on and so forth, and that's what is beginning to happen. We're not surprised by that. We have prior experience in these issues in the estimates that we have made -- we have allowed a period -- in fact in all cases -- of about three years to come to a satisfactory solution on these things.

I think this is an extended dance. It will take a time to come through, but we do believe it will come through.

Are your estimates for the recovery -- is that a conservative estimate in the sense that you could conceivably recover much more than that ultimately?

We believe it is conservative. Obviously we cannot recover more than claims will pay, so you can't in a sense make a profit on this. The upper bound is set, as it were. As Kathy pointed out, when you have got transactions -- and we have got transactions where we believe serious breeches in warranties, so this is not just the small stuff. Serious warranty breeches of 70% to 80%. If you have a tranche deal -- some of these deals are tranched. We obviously take the top tranche, it therefore implies some terrific coverage to any projected gross plan that we might incur. But no, we can't take a profit, as it were above that which we project to lose on a gross basis.

All right. Thank you very much.

Okay.

Thank you. Our next question is coming from the line of Steve Stelmach with FBR Capital. Please go ahead with your question. Mr. Stelmach, your line is in queue for question.

Hi, good morning. This is a follow-up on the TARP question. Is your expectation that TARP participation in the guaranteed program would somehow reverse out previous credit impairments? And if not, David, you mentioned a [bit is small] beyond TARP. Could you describe how you expect to execute that business model, given what is now a negative equity position.

Sure. It's of two points, really. TARP -- I described TARP and all of the details, particularly the insurance within TARP are worked out. You could broadly classify potential impacts of being direct or indirect. There are programs beginning to be put in place that will effect the mortgage markets directly. The FDIC for example is making all sorts of noise in relation to -- obviously trying to keep people in homes and so on and so forth.

What that would do, and other similar measures -- if in the private sector -- JP Morgan has announced a pretty major series of steps, I think it was last week. What that would do is obviously tend to reduce the upward March of delinquencies, foreclosures and cumulative losses. To the extent to which worst forecasts of losses do not accrete to those levels, clearly that would be very a helpful factor.

Secondly, in relation more particularly to our ourselves, I would probably say the industry, not ourselves not being Ambac centric -- as with the banks, there are all sorts of possibilities. One thing that obviously is well-known is the capital purchase program in relation to injection of preferred shares. I'm not saying that that will happen. But clearly there is a precedent of that in the banking sector. There are other ideas under the insurance rubric of the acts, and some of those we talked a bit about in the submission we made in response to questions.

Does it make sense to have some kind of excess of loss policy? Could there be some other form of reinsurance or other structure? All of these things are possible. I think there are mortgage direct -- and industry direct steps that can and I think could well happen.

I would just mention one last piece of the program within the asset purchase program. There could be some benefits to our residential mortgage-backed securities that we own, our Alt-A securities in our GIC portfolio. We set out some ideas that we had in the submission that David mentioned that we sent out at the end of last month. That would have an element -- it may not change the intrinsic view, particularly if we were to take the credit risk to those underlying assets. But what it would do is increase the values of those assets which would obviously help book value and potential help some of the impairment values. That would be obviously dependent upon the price and the participation -- what level of participation there was in the program.

Just in relation to your second part of the question, as it were, and I think you referenced our negative equity position. The question, essentially, I think was, how can you carry out business planning in that state. Sean, I think described on the call as is evident from our figures, that that negative equity position is fairly a large function of mark-to-market as I tried to describe. If you look at the world today and think about the skills that we have in our core markets, municipal-related markets, does the man from mars think that there is more or less need for those skills today than there was six months ago or year ago? I think the answer is pretty evidence there is more need for those skills. The question is how can we position ourselves possibly for some form of restructuring activity like the Connie Lee initiative, for example, to take advantage of that. And then serve our fixed income and issue to stakeholders. Ultimately we believe we can do that, and we're working extremely hard to do that.

Okay. Thank you very much.

Thank you. Our last question is coming from the line of Douglas Makepeace of Sperry Fund Management.

Thank you. The current environment makes the adjusted book value number even less calculatable than it was before. Can you give us some updated talking about that, please?

Sure. Sure.

I'm sorry I didn't catch the last, updates about -- Oh. Sure. Just book value numbers. At the end of the quarter, or about -- slightly more than $7.50. I believe we also have a slide that shows the components that you might want to just refer to -- if you have the presentation handy. That's on page 55. It shows the progression, At the end of the third quarter -- I'm sorry, $7.18 is the end of the quarter number, and it shows you the components for that. One could also, depending on your view, could to the points that David mentioned. A significant depressing impact on these numbers is the extent of reductions that we have taken from mark-to-market on our credit-derivative portfolio, as well as the full mark-to-market that we have taken in our Alt-A GIC portfolio. Depending on one's views, you can adjust the numbers for that as well.

Okay. Thank you very much.

You're welcome.

Thank you. There are no further questions at this time. Would like to turn the floor back over to Mr. Sean Leonard for closing comments.

Sure. We appreciate everyone. There is just a couple of additional points that might be helpful. I didn't have the number handy, but if you take the adjusted book value and exclude those unrealized gains and losses that I just mentioned, the numbers come out slightly less than $20 per share. That's one point.

The other point is on Ambac assurance corporation, so the GAAP financial statements of the insurance company on a consolidated basis. The equity at that level on a GAAP basis is positive, largely due to the guaranteed investment contract business being outside of that and the equity investments made by the parent company through the debt.

We appreciate everyone participating in the call. We are available to answer questions as they arise. Thank you very much. Good-bye.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.