Ambac Financial Group Inc (AMBC) 2009 Q3 法說會逐字稿

Greetings and welcome to the Ambac Financial Group, Inc., third quarter 2009 earnings call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Sean Leonard, Senior Vice President and Chief Financial Officer for Ambac Financial Group, Inc. Thank you, Mr. Leonard. You may begin.

Thank you. Good morning, everyone, and welcome to Ambac's third quarter conference call. I'm Sean Leonard, Chief Financial Officer of Ambac. With me today are David Wallis, Chief Executive Officer; and Greg Raab, Ambac's Chief Risk Officer, both of whom will be available to answer questions later on, when I open up the call for questions and answers.

Our earnings press release and selected risk exposures for the third quarter are available on our website. 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 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 risks 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 can 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 on 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.

In my prepared remarks I will provide an overview of the third quarter's GAAP financial results and the primary factors driving them, as well as a brief overview of the Company's liquidity position. Please note that, as we have stated in prior quarters, we continue to work to reduce exposures through commutations, which completed prior to our filing of the statutory financial statements, will have a collective impact on the statutory financial results as of September 30.

Therefore, Ambac's statutory filings are not yet finalized, and I'm not able to answer any questions about our statutory financial results on this call. Statutory statements are scheduled to be filed no later than November 16. When the statutory financial statements are complete, we will finalize our quarterly operating supplement and post it on our website.

Before I get to the quarter's results I would like to remind you that, as of January 1, 2009, Ambac implemented a new accounting standard for financial guaranty insurance contracts, now known as Accounting Standards Codification, or ASC Topic 944. ASC Topic 944 was previously known as FAS 163. The most significant changes related to the implementation of ASC Topic 944 were to 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 results and 2009 results are not comparable.

Now I'll discuss the financial results for the quarter. Net income for the third quarter 2009 was $2,188,300,000, or $7.58 per diluted share. That compares to a net loss of $2,431,200,000 or a loss of $8.45 per share in the third quarter of 2008. The third quarter 2009 net income was driven by significant unrealized mark-to-market gains in our credit derivatives portfolio.

Additionally during the quarter, Ambac recorded income from cancellations of certain reinsurance agreements. These two income items were partially offset by insurance loss provisioning and losses in our interest rate swap portfolio. I will discuss each of these items in more detail later in my prepared remarks.

Total net premiums earned in the third quarter of 2009 amounted $238.4 million, a decrease of 16% from the third quarter last year. The majority of the decrease is due to lower accelerated premiums, which are a component of total net premiums earned. Accelerated premiums for the third quarter of 2009 amounted to $90.3 million during the quarter, down 29% from $127.3 million in the third quarter 2008. Whereas the overwhelming majority of the accelerated premiums were recorded in 2008 resulted from refunding municipal finance transactions, over half of the recent quarter's accelerated earnings resulted from the termination of one international transaction.

Investment income amounted to $132.3 million. That's up 7% from the third quarter of 2008. The increase was driven by increasing yields on the portfolio after our recent initiative of shifting a greater percentage of the portfolio from tax-exempt securities to taxable securities and seeking better relative value opportunities has begun to take effect.

In addition, previous quarters' impairment charges have reset the book yield to a much higher market yield on certain mortgage-backed securities. That positive result was partially offset by the declining investment portfolio, as cash payments for commutations and other losses since the third quarter of 2008 has outpaced cash flows in flows from operations, such as premiums collected and interest income and the $800 million of AAC preferred stock issuance in the fourth quarter of 2008 and the first quarter of 2009.

During the third quarter, Ambac recorded net mark to market gains related to its credit derivative portfolio amounting to $2,132,900,000. That amount has two components. First, realized gains and losses, which amounted to $732.9 million realized loss; and, second, unrealized gains which amounted to $2,865,800,000. The net realized loss of $732.9 million was driven by settlement and commutation payments of $746 million made in July, as discussed in our last quarterly conference call, partially offset by CDO of ABS fees received. The unrealized gain of $2,865,800,000 was primarily driven by Ambac Assurance credit spread widening significantly during the quarter as well as improved pricing of (inaudible) obligations other than CDOs of ABS. Negatively impacting the mark was internal downgrades within CDO of ABS portfolio.

During the third quarter Ambac was able to negotiate the cancellation of reinsurance arrangements with three of our reinsurance counterparties -- Radian, Swiss Re and MBIA, the net impact of the three cancellations with Ambac recapturing a net amount of approximately $15.3 billion par exposure. The result on our net income was approximately $303 million as settlement amounts exceeded the recaptured upfront unearned premium reserves and loss reserves recorded for such transactions. The gains were recorded in other income and as a reduction in underwriting and operating expenses.

Total incurred losses for the quarter were $459.2 million, primarily related to a handful of asset-backed securitization credits and a public finance transportation transaction. All the transactions had been previously reserved but have deteriorated over the past few months.

The RMBS incurred losses were negative $259 million during the quarter, favorably impacted by increased estimates for remediation recoveries in the second lien portfolio, partially offset by additional deterioration noted in certain segments of the portfolio. While initial delinquency [rolls] are steadying somewhat, large later-stage buckets are driving continued poor performance, especially in losses severities across both first- and second-lien transactions.

Ambac increased its estimate of remediation recoveries on RMBS transactions due to breaches of representations and warranties by approximately $738 million during the third quarter. As of September 30, our RMBS reserves are net of approximately $1.9 billion of estimated remediation recoveries. The increase in the estimate of remediation recoveries is a result of additional breaches discovered during the quarter, the addition of two more transactions to the scope of our review and an enhancement to our estimation process on certain transactions to include an extrapolation of breaches across the population that is based on a statistically significant sampling of loan files.

Given the scale of losses in the RMBS portfolio, the evidence of pervasive breaches noted to date and recent performance addressing these contractual breaches, Ambac believes limiting remediation credit to the loan amounts where actual breaches have been discovered understates the amount Ambac is expected to recover from institutional sponsors. As a result, the number of transactions where random samples were extrapolated to estimate the amount of subrogation recovery increased from one as of June 30, 2009, to seven as of September 2009. Correspondingly, the number of transactions where an adverse sample was used decreased from 10 to six. We are actively working these transactions to resolve these breaches through litigation or otherwise and continue to believe our assumed recovery time of three years is appropriate.

During the quarter, Ambac paid gross claims amounting to $406.6 million, almost all related to RMBS transactions. After the impact of the reinsurance buybacks, Ambac paid net $315.1 million during the quarter. During the quarter, the mix of RMBS claim payments shifted from predominantly second-lien transactions to approximately 60% second lien, with the balance coming from first-lien transactions. We expect this trend to continue as the claims we have been projecting on first-lien deals are realized.

Within the Financial Services segment, the derivatives products business results declined by $205.3 million quarter on quarter due to valuation adjustments on the swap portfolio, losses resulting from interest rate movements during the quarter and losses realized on transactions that derivative counterparties terminated as a result of the downgrades of AAC as guarantor of the swaps.

Now I'd like to discuss the Company's liquidity, both at our holding and operating companies. Starting with our holding company, total cash, short-term securities and bonds amounted to approximately $165 million at September 30. That amounts to approximately 1.9 times the holding company's annual debt service needs of approximately $89 million. Due to statutory operating losses recorded by Ambac Assurance in 2008, AAC is not able to declare NP dividends to the holding company in 2009 without first receiving approval from OCI. Dividends from the operating company to the holding company in 2010 will depend on Ambac Assurance's ability to generate statutory income in 2009, which appears unlikely at this point.

In terms of liquidity of the operating company, excluding variable interest entity investments, Ambac Assurance has an investment portfolio with a fair value and amortized cost of approximately $7.7 billion, which includes over $1.2 billion of short-term investments. This portfolio is available to provide support for operating cash flow deficiencies and further risk reduction opportunities.

Total claims paying resources amounted to approximately $11.4 billion as of September 30, down from approximately $11.9 billion at June 30, primarily due to the CDO of ABS commutation and settlement payments in July and claim payments on insured RMBS transactions. Those reductions in claims paying resources were partially offset by the reinsurance recaptures.

Looking forward, we expect to pay approximately $2.5 billion of insured policy loss payments between the fourth quarter of 2009 and the end of 2010. Offsetting these outflows for that period, we expect to receive principal and interest related to the investment portfolio amounting to approximately $921 million and $475 million of installment premiums. These amounts and our best estimates of cash flows for periods beyond 2010 will be provided in our quarterly operating supplement.

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) Andrew Wessel, JP Morgan.

Just on the remediation efforts with the mortgage-backed security deals, so you've said it's $1.9 billion of cumulative expected claims you expect to get back from the seller servicers. Can you update what you've actually gotten back, cash into the firm, on those claims?

Yes. Up until this point in time, we've collected approximately $60 million on loan put-backs, actual loan put-backs. We've obviously put back quite a bit to the various pools and sponsors of the pools, over 12,000 loans across a dozen or so transactions. But we've actually -- we've collected $60 million, and we are also in active discussions relating to more of a global settlement relating to one of the transactions.

Global settlement, okay. And then, that's going into the opco, right; not holdco?

No, Andrew. What happens there is, it's really the monies going into the trust itself, so the securitization trust is the one collecting the funds. So what's effectively happening indirectly is our claim payments will go down. So money goes into the trust, say the $60 million that we collected, and the transactions that it relates to. There's more cash in the trust to make its financial obligations to its note holders of the trust, and therefore what's been happening in those transactions is our claims have been going down. Just indirectly, it comes to us. But I just wanted to run you through those details.

Right, no, that's helpful. And then in terms of -- has there been any -- you haven't filed any lawsuits or anything against any other seller services? Because we've seen one competitor in the industry who's pretty healthy who is getting cash back and then one of your competitors in the industry who isn't that healthy who has just taken a legal route. Have you made any suits, or is it you're trying to work this out, out of court?

Well, we're taking a variety of strategies. And in certain cases, we have filed lawsuits. In the other case where we got the money back we've been having face-to-face meetings and trying to resolve the issues. It doesn't preclude, obviously, some type of form of legal remedies, further legal remedies, other than through the actual put-back process. But it's kind of a combination of approaches where we think, based upon our view of what's in our best interest, we'll continue to consider various alternatives and we'll act accordingly.

My other question has to do with the last statement you made about you're expecting to pay at least $2.5 billion -- I was trying to write down quickly -- but will pay at least $2.5 billion of claims in the next five quarters and will have investment income of a little over $900 million and premium payments of about $475 million to offset that. Are those the right numbers?

Yes, yes.

So that's a $1.5 billion shortfall. So is that all coming out of -- will that all kind of bleed out of the investment portfolio over the next five quarters?

Yes, largely, that's right. And then also, too, Andrew, the $921 million includes principal and interest. So a piece of that is the roll-down of the investment. It's not all investment income, so just to clarify that. When we issue our operating supplement, we'll have splits for that, the principal and interest splits, so you get a sense for what that looks like over the next five quarters.

But yes, yes; that's right. There's other potential things that could happen there, is the $2.5 billion of payments doesn't consider any impact for put-backs at all. So there's a potential for some of that to -- while our estimate includes a three-year bullet from the time that the process has gotten started for each individual transaction, when I disclose that $2.5 billion, it doesn't include any of that put-back.

The other potential item which would be favorable is if there is a law change relating to net operating loss carry-backs which is being discussed, and that could be helpful to us.

And on that topic, since deferred tax asset isn't included in statutory -- if I understand it, it's not included in your statutory capital for statutory purposes. Is there any kind of impact from a ruling on that to your statutory capital levels? Or is that just purely more of a GAAP issue?

Just on a potential NOL carry-back extension?

Yes.

That would have, obviously, positive cash impact. But it would affect both statutory capital levels and GAAP income levels, which we've largely reserved. You're taking a valuation allowance against the piece of deferred tax asset related to the net operating loss.

Amanda Lyman, Goldman Sachs.

It's actually Donna Halverstadt. Our question had actually been on the NOL. So, to the extent that the carry-back provision is extended, would you quantify for us what size of a refund you might expect to receive in 2010?

Yes. We think, if it goes through as drafted, or at least the draft we saw late last week of the bill, yes, we think the numbers will be approximately $400 million.

Arun Kumar, JP Morgan.

A couple of questions, one a little more general than the other one is a little more number specific. The first one is your statutory filing that you plan to do on November 16 and the reason you didn't give the numbers today. Are there actions underway, whether that's going to be commutations or otherwise, that could favorably improve your capital position? Because as of the end of the last quarter you had come relatively close to the line in terms of the minimum capital required. But commutations and other transactions could change that number somewhat. Could you give us any commentary on the status of those discussions you're having with counterparties at this point that may impact statutory capital?

I'd prefer not to get into details of discussions, just for commercial reasons. The reason why we didn't provide stat numbers is they're just simply not done yet. Just as we've had a history in the past of doing is, there seems to be increased interest towards end of quarters, particularly in the month succeeding the end of the quarter. And that's something that we have reflected in the numbers to make the best estimate of what we think potential claims would be. Nothing is better than an actual settlement or some type of agreement; you know, that influences the estimate. So we are not done yet. So I'd really prefer not to comment on where that stands. We're not talking in a long time; we're probably talking a week and a half before those numbers will be made available.

Sure. Just to follow up on the numbers question, also one of Donna's questions, in terms of the NOL, the $400 million that you alluded to, would that be a statutory gain or would that impact your statutory capital? Presumably, it would.

Yes, it would. It would be a positive. We would get cash, and that would be a pickup in our statutory capital.

And the timing for that? Do you have any idea as to when that's likely to work its way through the system?

If things worked out well, we think that from enactment, perhaps six to eight weeks.

The other question and the numbers question, and I'll just run a couple of numbers through you where you can comment one way or the other. In terms of the remediation recoveries, the $750 million that had increased from $1.1 billion to $1.9 billion, based on the past practices, it appears that that amount would be a positive to statutory capital.

Yes. Those that relate to transactions that have defaulted would be considered in the overall view and estimate of what we think the ultimate potential claims are on those defaulted items. That's right.

And other one, the $732 million of realized losses due to settlements from creditors with the contracts -- is that just a prior-period item, or that could impact statutory capital as well?

No, no. What that is, is that's the actual payment relating to the CDO of ABS commutations that were done in July, minus the fees we collected. So I provided those numbers in my prepared remarks. But those -- so effectively, what it was is we trued up our accrual for those payments as of June 30. So that's just a payment of a liability that already existed at June 30.

And in terms of the $459 million for RMBS securities, the loss in loss expenses, that presumably could be a combination of GAAP and stat; correct?

That's correct.

But the split is obviously -- you have not commented on that, but I'll leave that to you if you want to comment on that.

And, lastly, the $300 million commutations from your reinsurance cancellations, that would be a statutory gain; correct?

That's correct. The statutory numbers are just modestly higher than that, due to different bases for the unearned premium reserve accounts and the loss reserve accounts. But, you know, they are modestly higher than that $303 million that I provided.

And just on the losses, I'd prefer to hold off on that as well, but just highlight the fact that statutory just reflects defaulted items, and there's kind of a mix of both in there.

Could you comment a little bit on your relationships with the Wisconsin regulator in terms of how they are looking at you? Obviously, up to this point in time they've been fairly accommodating in terms of various transactions, be it the loan to the asset management company or other issues. Could you comment on tenor -- I mean, the tone of your conversations with them in terms of your statutory capital levels? And what do you think they could do in the future?

Sure, it's David Wallis here; I'll take that one. Our relationships with Wisconsin continue to be absolutely appropriate. We are in very frequent discussions and communication with them. I think that we have a very transparent relationship. They know exactly what's happening here and clearly consider all that's happening here in the context of our position in making any decisions that they might want to make. Obviously, I'm not going to speak for them in any way. But they are thoroughly apprised of our position, and we are in constant communication and the relationship continues to be excellent.

So it appears -- based on your commentary, that it appears very unlikely that on November 16, when you file your statutory statement, that the Wisconsin commission is going to step in and say that they're going to push you under some kind of supervision?

Well, obviously, I can't speak for Wisconsin and I'm not going to. But all I can say is that they and we communicate frequently and transparently, and the relationship remains very [amicable].

Scott Frost, HSBC.

Could you go over a couple things? Just on the seller servicers, with respect to your remediation recoveries, could you tell us who they are, if you can? But are there any concentrations there, and what is their credit quality and things like that? Do you have any details on that?

It covers four issuers.

Four issuers? Well, what are there -- have you disclosed who they are?

No, we haven't.

Can you tell us their ratings?

Well, you can -- what we do disclose, which I think what might be helpful, is we do disclose our exposures for all of our transactions, and one can -- all the RMBS transactions for the vintages that you would expect to be a subject of these types of reviews. And you can sort by the variety of the seller servicers that are involved with these transactions. So we'd prefer not to go into that detail, but one can look at that information and get a pretty good sense for what transactions are likely to be the targets here.

Can you tell us -- you referenced part of the gain you experienced from derivatives, I guess, was your own spread widening. Could you tell us how much that was? Is that in the disclosure somewhere that I missed?

Yes. I'm not sure I mentioned that, but the total change due to just the credit spread widening, so the discount rate change, if you will, is a little bit short of $2.7 billion.

Okay, but that's your spreads widening; right?

That's correct.

[Stephen Lesko], Credit Suisse.

I have a question about the $746 million cash payment from the July 2009 commutations. In your second-quarter earnings you mentioned that that was from two transactions, one reduced significantly and one that was fully commuted. Can you comment on which two and how much the one was reduced?

No; we'd prefer not to get into the details of the transactions, just for commercial and other reasons. But suffice it to say that they were both significant reductions of risk that were on the balance sheet at that particular point in time.

Okay, but when you said in the second quarter there was $2.8 billion net notional, was it a $2.8 billion notional reduction, or those two originally had $2.8 billion insured and one (multiple speakers)?

No; that was the actual reduction in the par amounts that we were responsible for. One transaction was fully settled, and the other one was, I would consider, modified, but substantially modified.

(Operator instructions) [Patrick Dennis], DK Partners.

A quick follow-up question on NOL carry-back being extended. You mentioned the $400 million number. What entity would that balance actually flow through? Would that be at AAC, or would that go through a holdco?

The process would be, we file a consolidated return, the money would come into the holding company. Due to the tax sharing agreements that we have, it would be sent down to Ambac Assurance, the insurance company.

Seeing as we have no further questions, this does conclude today's teleconference. You may disconnect your lines at this time, and we thank you for your participation.

Well, thank you, everyone, for participating in the call. We are available to answer any additional questions, and we would be happy to do so. Please call us at your convenience. Thank you.