Ambac Financial Group Inc (AMBC) 2009 Q2 法說會逐字稿

Greetings and welcome to the Ambac Financial Group Inc. second-quarter 2009 earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Sean Leonard, Senior Vice President and Chief Financial Officer for Ambac Financial Group Inc.. Thank you, Mr. Leonard. You may now begin.

Thank you, and good morning, everyone, and welcome to Ambac's second-quarter conference call.

I'm Sean Leonard, Chief Financial Officer of Ambac. Presenting with me today is David Wallis, Chief Executive Officer. Cathy Matanle, Ambac's Deputy Chief Risk Officer, is also with me today and will be available to answer questions later on when I open the call up to question and answer.

Our earnings press release and a quarterly operating supplement are available on our website. Please note that we have not prepared a slide presentation, but we have prepared and put some of the key information that was in prior slide presentations in our operating operating supplement.

Also note that this conference 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 relate 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 in our press release and our most recent Form 10-K for the fiscal year ended December 31, 2008, and also disclosed from time to time by Ambac in its subsequent reports on Form 10-Q and Form 8-K.

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 Ambac's strategic priorities. David?

Thanks, Sean, and good morning, everyone. As Sean will summarize, the quarter's results are very disappointing, as continued poor performance of the RMBS-related portfolio and rising forward interest rates have escalated projections of future claims.

In the face of this continued degradation, we have refined the focus of our activities in order to heighten our concentration on risk management and holding company liquidity issues. Let me briefly comment.

On June 19, we announced the postponement of our efforts to launch Everspan, our intended public-finance-only financial guarantor. This decision was taken after an extensive, but ultimately unsuccessful, effort to raise external capital in order to satisfy rating agency requirements.

Given the Everspan decision, together with the recent rating agency downgrades clearly resultant from the pre-release of this quarter's results, we have no ability to write insurance business. It is therefore abundantly clear that our focus has to be management of our balance sheet with an intensifying emphasis upon risk management activities.

Given the holding company's liquidity position, we are seeking any and all possible alternatives to resolve the situation. Among these lines, per the announcement of last week, we have elected to discontinue payments of interest on Ambac Financial Group's subordinated debt securities.

We have also discontinued payment of monthly dividends on Ambac Assurance's auction market preferred shares.

In relation to our risk -- key risk management objectives, we have recently expanded our capabilities in two related areas, these being mortgage servicing and risk analytics.

Mortgage servicing. Given the acute pressure that mortgage services are under, never having been properly equipped to handle current stresses, we have grown a specialist group to focus upon our own interests in this important area. This group will seek to enforce rights, monitor the fulfillment of agreed servicing protocols, and seek to enhance the efficiency and overall economics of the servicing function with respect to RMBS transactions.

Analytics. Given the difficulties experienced in predicting and analyzing the performance of many insured transactions throughout the freefalling housing market, we have acquired a new group, MSM Capital Management, to assist us in this process. Once fully assimilated, this group will be an important fulcrum around which we will be able to better predict, manage, and mitigate the risks that we face.

These mortgage servicing and analytics related groups, together with existing expertise and resource, will progressively constitute a center of excellence in an overall platform of risk management activity.

Finally, a brief note on CDO of ABS commutation activity, where we have reduced our exposure by approximately $2.8 billion at a cost of circa $750 million. From a purely internal perspective, commutations and settlements represent a difficult balance between large cash outlay and risk reduction.

Although we are satisfied that the balance of these elements has been satisfactory thus far, it will likely become increasingly difficult to make further progress as we weigh the present value of these two elements as against any available alternatives and our general liquidity requirements.

With that, let me turn it back to Sean.

Thank you, David. In my prepared remarks, I will provide an overview of the quarter's GAAP financial results and the primary factors driving them. I will also provide a brief overview of our statutory results and surplus levels, and finally, a brief overview of the Company's liquidity position.

One reminder, though, before we get to the quarter results. As of January 1, 2009, Ambac implemented the new accounting standard for financial guaranty insurance contracts, called FAS 163. The most significant changes related to the implementation of FAS 163 are the recognition of premium revenues, recognition on the balance sheet of future installment premiums, and reporting of losses.

Due to the changes in accounting for these items, 2008 and 2009 results are not comparable.

Now I will discuss the financial results for the quarter. Net loss for the second quarter of 2009 was $2.3966 billion, or a loss of $8.33 per share. That compares to net income of $823.1 million, or net income of $2.80 per diluted share in the second quarter of 2008.

This second-quarter 2009 loss was primarily driven by three factors. First, our net provision for loss and loss adjustment expenses, amounting to $1.2308 billion. Second, other-than-temporary impairment losses on securities in our financial guaranty and financial services investment portfolios, amounting to $862.1 million on a combined basis, and third, additional valuation reserves on our deferred tax asset.

I will discuss each of those items during my prepared remarks, but it should be clear that, once again, our financial results were highly impacted by our exposure to deteriorating mortgage-related exposures and securities.

Total net premiums earned in the second quarter 2009 amounted to $177.7 million, a decrease of 45% from the second quarter last year. The majority of the decrease is due to lower accelerated premiums, which are a component of total net premiums.

Accelerated premiums for the second quarter of 2009 amounted to $33.8 million during the quarter, down significantly from $159.2 million in the comparable prior quarter.

In 2008, a lack of liquidity in the auction-rate and variable-rate bond markets had resulted in significant refinancing activity in the municipal sector, especially in the healthcare segment.

Investment income amounted to $120.4 million, down 5% from second quarter 2008. The decrease was primarily driven by cash payments made for commutations and other losses since the second quarter of 2008.

Those negative factors were partially offset by the $800 million of Ambac Assurance preferred stock issuance in the fourth quarter of 2008 and the first quarter of 2009, as well as cash flows, premiums collected, and net interest income from the investment portfolio.

During the second quarter, Ambac Assurance and the [vestment] agreement business reported other-than-temporary net security losses of $675 million and $187 million, respectively.

During the quarter, we decided to designate certain securities for sale with an objective of repositioning the investment portfolio. We are seeking to achieve two main objectives with the repositioning. First is to move a greater percentage of our portfolio into taxable securities and second is to seek better relative value opportunities within our Alternative-A investment portfolio.

During the second quarter, Ambac recorded net mark-to-market gains related to its credit derivative portfolio amounting to approximately $1 million.

A number of offsetting market factors were observed during the quarter. Positively impacting the mark was improved pricing within the CLO portfolio and -- CEO of ABS portfolio amortization during the period. Negatively impacting the mark was internal downgrades within the CDO of ABS portfolio and overall movements in Ambac Assurance credit spreads during the quarter.

Total RMBS incurred losses for the quarter were $1.1235 billion, primarily related to deterioration in second lien and Alt-A securities. During the quarter, Ambac paid $340 million in RMBS claims, most of which related to second-lien transactions.

Second-lien RMBS incurred losses of approximately $453 million were largely driven by a combination of stubbornly high default rates and loss severities. Incurred losses in our first-lien exposures were approximately $670 million, largely driven by services more aggressively liquidating backlogs of non-performing loans.

Loss severities continue to be elevated. In the second-lien asset class, severities were often significantly higher than 100%, while those in the first-lien asset class have often breached 70%. The vast majority of incurred losses resulted from transactions which were previously reserved.

During the quarter, Ambac also incurred losses amounting to approximately $107 million related to non-RMBS transactions, and were concentrated in two transactions. One was a previously reserve structured insurance transaction, which experienced increased stress and higher modeled losses, and second was a transportation transaction that was also previously reserved.

Ambac increased its estimate of remediation recoveries on RMBS transactions, due to breaches of [refs] and warranties, by about $280 million during the second quarter. Our total RMBS reserves are net of approximately $1.2 billion of estimated remediation recoveries at June 30.

The increase in the estimate of remediation recoveries is a result of additional breaches discovered during the quarter. We applied methodologies consistent with those applied in previous quarters.

While we are actively investigating other exposures with similarly suspicious profiles, the increase this quarter is solely a result of additional breaches discovered in exposures where we have taken recoveries in previous quarters.

As of the end of the quarter, we had over 4,000 additional loans reunderwritten, compared to year-end 2008, for a total of just under 13,000 reunderwritten loans.

Our hit rate of loans with apparent breaches continues to exceed 90%.

During this quarter, and that's with -- the past few quarters, Ambac has not taken any tax benefit related to the pretax operating loss because any deferred tax asset that is generated as a result of the loss has attracted a valuation allowance.

Additionally during the second quarter, as a result of continued deterioration in the Company's insured RMBS transactions, and our resultant inability to reliably project future taxable income, Ambac recorded a $573.9 million valuation allowance against the unreserved deferred tax asset from the prior quarter.

Ambac currently has only about $100 million of deferred tax asset related to unrealized investment security losses remaining on our balance sheet.

Now I'd like to provide a brief overview of our statutory accounting results. As most of you know, the statutory basis of accounting for certain financial statement line items can be quite different from the generally accepted accounting principles, or GAAP basis. For the purposes of this call, I will limit the discussion to loss and loss expense reserves and impairment losses on credit derivatives.

Statutory loss and loss expenses incurred amounted to $751 million during the second quarter. Obviously, that amount differs from GAAP losses that I discussed earlier.

The reason for the difference is that stat accounting permits recording of loss reserves only for transactions that have defaulted, while GAAP accounting requires that we estimate loss reserves for troubled transactions that have defaulted and those that have not yet defaulted.

Statutory impairment losses on credit derivatives amounted to $1.5687 billion in the second quarter. This represents the amount we expect to pay out over time for our CDO of ABS transactions, including the expected payments of both interest and ultimate principal.

The increased impairment during the quarter was driven by rising forward LIBOR rates, which increases estimated future cash outflows for interest payments, and further deterioration with the underlying collateral of the CDOs of ABS transactions.

Statutory accounting allows us to discount our estimates of future payments of losses and impairments using the investment portfolio yield at the end of the prior fiscal year end. Ambac uses a discount rate of 4.5% for statutory accounting purposes.

At June 30, 2009, Ambac Assurance's statutory capital and surplus amounted to $305.6 million and statutory contingency reserves amounted to $173.6 million.

Ambac Assurance had petitioned the Wisconsin Office of the Commissioner of Insurance, or the OCI, to release a significant portion of the contingency reserves as of June 30, 2009. Ambac received permission to release approximately $1.8 billion, and the aforementioned balances reflect such release.

As a result, Ambac Assurance's statutory capital and surplus at June 30, 2009, has not breached the minimum surplus requirements of any state in which we are licensed to write business.

Now I would like to discuss the Company's liquidity, both at our holding company and operating company, starting with the holding company. Total cash and short-term securities amounted to approximately $164 million at June 30. That amounts to approximately 1.8 times the holding company's annual debt service needs of approximately $89 million.

Due to statutory operating losses recorded by Ambac Assurance in 2008, Ambac Assurance will not be able to declare and pay dividends to the holding company in 2009 without first receiving approval from OCI. Dividends from the operating company and holding company in 2010 will depend on Ambac Assurance's ability to generate statutory income in 2009.

Based on our six-month results to date, it is unlikely we will generate statutory net income in 2009, thereby negating any 2010 ordinary dividend capacity.

As David mentioned earlier, we recently announced that, in order to preserve cash at the holding company, we have elected to discontinue paying the semiannual interest on Ambac's directly-issued subordinated capital securities, or DISCS, beginning August 1, 2009. Deferment of interest payments on these subordinated securities is permitted for a period of 10 years.

With regard to operating company liquidity, Ambac Assurance's claims and resources at June 30 amounted to $11.9 billion, or approximately $11.2 billion adjusted for the CDO settlement and commutation that occurred in July. Those resources are primarily supported by Ambac Assurance's fixed-income investment portfolio.

Total financial guarantee investments, not including VIEs, had a fair value of approximately $7.5 billion at quarter end and an amortized cost basis of approximately $7.8 billion.

Ambac Assurance's cash flow has been significantly impacted by the level and timing of loss payments in the quarter, and we expect approximately $1.3 billion of loss payments on our RMBS and CDO exposures over the remainder of the year.

And as previously mentioned, cash payments totaling $750 million related to the two CDO of ABS transactions that settled or commuted in July will have a further negative impact.

Offsetting those outflows for the balance of 2009, we expect to receive principal and interest related to the high-quality investment portfolio, amounting to approximately $339 million. Additionally, we expect to receive about $200 million of installment premiums over the remainder of 2009 and approximately $275 million in tax refunds expected to be collected in the third quarter, related to taxes paid in 2007 and 2006.

In order to preserve cash and surplus at Ambac Assurance, we recently announced that we will discontinue paying the monthly dividend on Ambac Assurance's outstanding auction market preferred shares, beginning August 1, 2009.

That concludes my prepared remarks on the financial results. Now I would like to turn it over to the Operator to start the question-and-answer session.

(Operator Instructions). Arun Kumar, JPMorgan.

A couple of quick questions. One is, the theme among several of your peers in the industry have been in recoveries, commutations, and so on. But you have been able to commute a fair amount of the CDOs that you've wrapped.

I wondered if you could give us any progress on the amount of recovery efforts going forward? I know that has been an area of emphasis over the past several quarters, if you will. If you could just tell us where you stand in terms of recoveries, dialogue with the institutions that put those structures together, and also, if you could give a little bit of color on expectations for future commutations.

I know you said it's going to be fairly difficult. But given the financial condition of the firm, I would think that it's probably not going to be all that difficult in getting commutations down the road. At probably even better terms than what you've achieved so far.

Sure. I'll take a first stab at that. As I think is public, obviously we intend, across all aspects of our business, to actively pursue, in our eyes, wrongdoing. So, we have obviously launched litigation in respect of certain of our exposures, and if we think that bad things have been done, we'll continue to do that.

I don't want to go into those sorts of comments any further than that, save that we continue to enforce our rights.

In respect of commutation discussions, I think, as I briefly indicated at the end of my script, it's a balance. Yes, it's risk reduction, but also, obviously, it's large cash out the door. And whilst we still have considerable claims-paying resource, you have to balance the risk reduction as against the cash out the door and the alternative uses for that cash.

What we've done is -- we are happy with, we analyzed it carefully. I absolutely take your point in terms of being cognizant of others' views of ourselves as perhaps encapsulated in our [CDS] spread, but we're certainly not in a position and are not willing to just commute.

I think it's obvious to all that we can't commute our way out of this, so to speak, so we need to be very selective and very disciplined in any conversations that we have. And I think, candidly, we'll find commutations increasingly difficult as we have alternative uses for that cash.

Right. The question, the follow-up would be, given the amount of statutory capital that you have, based on the regulatory approval that was granted to you, if you continue to have losses in your CDO portfolio, RMBS or elsewhere, the amount of capital that you have would be depleted even further.

Wouldn't that strengthen your hand in commutations and get substantially better than the $0.26 that you commuted the transactions in the past month or so?

Perhaps you would like to offer your role as a consultant today. That's possible. And if it does, that's great. But we'll see.

Darin Arita, Deutsche Bank.

With respect to the $1.6 [billion] of impairments and credit derivatives in the quarter, can you give a breakdown of the contribution from the LIBOR rate movements versus the deterioration of the underlying collateral?

Sure, Darin, it's Sean. The contributions would be about 55% coming from the forward LIBOR curve shifts, and the balance coming from portfolio deterioration.

That's helpful. And with respect to your loss reserves, you'd changed the discount rate that you're using to the risk-free rate. Can you give some sensitivity on how the losses would change with maybe, say, a 50 or 100 basis-point change in the risk-free rate?

Yes, I assume you're talking about the GAAP. Clearly on our statutory numbers, we are still using, as I mentioned, the portfolio. The 4.5% rate.

I don't have -- an answer for the sensitivities. Is that something we have in our 10-Q? Darin, I'd have to get back to you on that. I don't have that information at my fingertips.

That's fine. And then, just lastly, in terms of the holding company liquidity without a dividend. Without being able to declare an ordinary dividend in 2010, what are the other plans that you have to improve the holding company liquidity?

Obviously, as we mentioned, Darin, we've cut coupon and preference share payments, and we'll explore any alternative that may or may not be available.

As you point out, the traditional, if you will, means of servicing debt at the insurance or holding company has been dividends from the operating company, which will depend upon improved performance in terms of RMBS-related matters.

(Operator Instructions). Donna Halverstadt, Goldman Sachs.

I think the answer to my question is going to be no, but given that, unless you live 24/7 with stat accounting, I don't think you really know all the ins and outs, I'm going to ask it anyways.

Now that you've released the contingency reserve, or the bulk of it, are there any other statutory maneuvers you can use in the future to materially bolster surplus?

Donna, it's Sean. It would be very unhealthy to live with statutory accounting 24/7. So -- that's a general comment.

What we can do is -- there are some sensitivities to surplus levels. The obvious ones are loss development, which is -- we brought the levels down quite a bit.

But there are some -- we are talking to our reinsurers. We can commute contracts, but we would only do so not with a view towards statutory accounting results but a view towards proper economics.

You know, with the paydown of the intercompany loans, we'll -- since the unsecured piece of the loans, we have a 30% reserve on, there's some sensitivities there as those loans get paid down.

There will be some -- some benefit to increased values on the Alt-A securities and just general accretion, because we've written those securities down to a level where the -- to a market yield-type of level, so investment income will be boosted from that.

And then, there is the whole realm of permitted practices, which is something that could be discussed. But that's -- that would be, I think, the last thing in the line of things we would do. And then, just any commutations, if we have any of those that are successful, that would reduce our levels of impairment.

The other thing I wanted to ask -- I know in the past, you all have said that, even if you hit or breached the $2 million with [consome] minimum, that the regulator has discretion as to what he does. Can you give us some color on the limits of his discretion or what sort of kind of pathway we should expect in that event?

Yes, I don't think they have pretty broad discretion. So the limits, I don't believe, would be significant.

I think that it's at their discretion, based upon the facts and circumstances as they see it, and how they want to treat the situation, considering what else may be out there relating to contractual provisions and other things that would be perhaps detrimental to the policyholders.

They have a view, obviously, of protecting the policyholders, so I think they would [canvass] how a potential action would affect that over, not the short-term perhaps, a longer-term horizon.

Thank you. There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Great. Thank you very much. Thank you for attending our second-quarter conference call. We are available to answer questions, myself and Pete Poillon, so please call us here if there are any additional questions that investors have. Thank you once again.

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