Ambac Financial Group Inc (AMBC) 2013 Q3 法說會逐字稿

Greetings, and welcome to the Ambac Financial Group third quarter 2013 earnings release and 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 conference is being recorded. It is now my pleasure to introduce your host, Michael Fitzgerald, Managing Director and Head of Investor Relations. Thank you, Mr. Fitzgerald. you may begin.

Thank you, Operator. Good morning and thank you for joining today's conference call to discuss Ambac Financial Group's third quarter 2013 financial results. Before we get started, I would like to remind you that today's presentation may contain forward-looking statements which are based on management's current expectations and are subject to uncertainty and changes in circumstances. Any forward-looking statements are not guarantees of future performance or events. Actual performance and events may differ, possibly materially, from such forward-looking statements. Factors that could cause this include the factors described in our second quarter and first quarter 2013 Form 10-Qs and our 2012 Form 10-K, under Management's Discussion and Analysis and under Risk Factors. Ambac is not under any obligation and expressly disclaims any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Today's presentation may contain non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings press release, which is available on our website, www.Ambac.com.

Our speakers today are Diana Adams, Ambac's President and Chief Executive Officer, and David Trick, Ambac's Senior Managing Director, Chief Financial Officer and Treasurer. At the conclusion of their prepared remarks, we will open the call to your questions. As the webcast is not enabled for Q&A, please dial in to the call if you would like to ask a question. I'll now turn it over to Diana.

Thank you, Mike, and good morning, everyone. Thank you for joining today's call. We very much appreciate your interest in Ambac and your participating in today's call. In a few minutes, I will describe our current strategy and share with you some of the value creation initiatives that we have been working on. I will also provide perspective on the Company's future direction.

But first, let me say that one of our key objectives is to be transparent, so that you have access to business and financial information about Ambac that is comprehensive, timely, and accurate. We provide the market with a great deal of information through our SEC filings, our operating supplement and our website disclosures. Recently, in response to your inquiries, we posted information about our Puerto Rico exposure, so that you can better understand the nature of this exposure.

Today we are hosting our first quarterly earnings call since Ambac emerged from Chapter 11 in May. We are doing this so that we can have the opportunity to speak directly with you and answer your questions. We have also scheduled our 2013 annual meeting of stockholders for December 18 of this year. During the annual meeting, our stockholders will have the opportunity to vote on a number of subjects, including a proposal related to executive compensation, which was described in the Company's proxy statement filed last Friday. Our compensation approach rewards performance and aligns the interests of management and stockholders.

Finally, we would like to announce our intention to hold an institutional investor day in the spring of this year. At that time, you will have the opportunity to meet directly with Ambac's management team. We will provide more information about that in the coming weeks. In a moment, I will discuss our current strategy and key initiatives; but first, our CFO, David Trick, will provide an overview of the quarterly results. David?

Thank you, Diana. Before I begin, it is important to note that due to the adoption of fresh start accounting upon our emergence from bankruptcy, third quarter 2013 results are not entirely comparable to results reported in the third quarter of 2012.

For the current quarter, Ambac generated net income of $231 million, or $4.98 per diluted share, versus third quarter 2012 net income of $158 million. Key drivers of third quarter 2013 results included premiums earned of $71 million, which were down $42 million from the third quarter 2012. The decline in earned premiums can be attributed to a decline in accelerated premiums of $15 million, almost entirely related to public finance transactions, the write-off of uncollected premiums on student loan transactions of approximately $13 million, and the run-off of the insured portfolio, net investment income of $52 million, which was down $32 million from the third quarter of 2012, primarily due to pressure start adjustments that increased the overall amortized cost basis and decreased the effective yield of the investment portfolio.

With respect to our investment portfolio, our objective is to maximize risk adjusted investment returns, in part by continuing diverse identify our asset mix into asset classes where we see better relative value. Nevertheless, as others do, we find a low interest rate environment challenging for investing. The fair value of the financial guarantee investment portfolio as of September 30, 2013 was $6.3 billion. The largest asset classes in the portfolio were mortgage and asset-backed securities, including Ambac insured securities of $2.3 billion, taxable and tax-exempt municipal bonds of $1.4 billion, and corporate obligations of $1.3 million. On a fair value basis, Ambac-wrapped RMBS represent approximately 20% of the financial guarantee investment portfolio at September 30.

VIE income $55 million, up $49 million from the third quarter of 2012, and was primarily related to the impact of the increase in the Ambac CVA on the fair value of certain VIE liabilities that include a significant amount of projected financial guarantee claims. Loss and loss expenses were a net benefit of $154 million, an improvement of $136 million from the third quarter 2012. The net benefit was primarily driven by a net reversal on previously established loss reserves in the student loan and mortgage portfolios, partially offset by additions to reserves for a limited number of public finance and structured finance credits.

Gross loss reserves, which are gross of reinsurance and net of estimated subrogation recoveries, declined to $5.4 billion at September 30 from $5.5 billion at June 30, 2013. Estimated subrogation recoveries were $2.4 billion as of September 30, down $33 million from June 30, 2013. The decline in estimated subrogation recoveries is the result of lower expected losses in the insured RMBS portfolio. Including loss adjustment expenses, RMBS reserves fell by $95 million to $3.4 billion, student loan reserves fell by $120 million to $945 billion, while domestic public finance reserves increased by $43 million to $285 million, AUK reserves increased by $15 million to $619 million, and reserves for all other credits increased $16 million to $95 million. Third quarter gross loss reserves include $3.9 billion of unpaid segregated account policy claims.

Gross operating expenses were $24million, down $2 million from the third quarter 2012, primarily due to lower compensation and consulting expenses. The decline in operating expenses is the result of our disciplined approach to managing our costs and identifying ways to operate more efficiently.

Interest expense was $32 million, up $9 million from the third quarter of 2012. Due to fresh start adjustments, the unamortized discount on surplus notes decreased, as the carrying value was reset to fair value. This increased the dollar amount of discount accretion recognized in interest expense in the third quarter of 2013.

We reported operating earnings of $193 million for the third quarter of 2013, an increase of $80 million from the third quarter of 2012. The improvement was primarily due to a greater benefit in loss and loss expenses and higher derivative product revenues, partially offset by lower total net investment income, lower net premiums earned, and higher other than temporary impairment losses. Operating earnings is a non-GAAP measure that eliminates the impact of certain US GAAP accounting requirements and includes certain items that the Company has realized or expects to realize in the future, but that are not reported under US GAAP.

At Ambac Assurance, we reported third quarter statutory net income of $128 million and statutory surplus of $502 million at September 30, 2013. Taking a look at the financial guarantee insurance portfolio, the net par amount of the portfolio declined by $7.2 billion, to $189.2 billion at September 30, from $196.4 billion at June 30, 2013. Much of this is attributable to the run-off of $6.4 billion of public finance net par as a result of scheduled maturities, refinancings and refundings of underlying insured transactions. The net par of the segregated account financial guarantee portfolio fell by $1 billion, to $23.7 billion at September 30, from $24.7 billion at June 30, 2013, primarily due to the net par run-off in the mortgage and student loan portfolios. The net par amount of adversely classified credits increased by $2.6 billion, to $34.7 billion at September 30, from $32 1 billion at June 30, 2013. The increase in adversely classified credits was primarily due to the addition of our Puerto Rico exposure to the adversely classified credit list.

In recent months, we have spent a considerable amount of time focusing on our exposure to Detroit and Puerto Rico. Regarding Detroit, Ambac has approximately $170 million of gross par exposure, consisting of $92 million of limited tax GO exposure and $78 million of unlimited tax GO exposure. The GOs are a very small portion of the city's liabilities. We are actively engaged, as appropriate, in what is now a very complex situation. Through various means, including litigation and mediation, we are seeking to maximize our economic outcome in Detroit. In fact, just last Friday, we filed a lawsuit against the City of Detroit relating to the city's failure to segregate certain pledged property taxes to be used for making debt service payments on Ambac insured bonds.

Regarding Puerto Rico, we have approximately $2.5 billion of gross par exposure, consisting of approximately 90% revenue-backed debt and 10% GO exposure. As Diana mentioned, we recently posted slides on our website that provide additional insight into the profile of our exposure. We are actively monitoring the situation in Puerto Rico, and are continuously analyzing our position, along with developments in the market and within the Commonwealth. We believe the Commonwealth has taken serious steps to reform its fiscal situation towards a more sustainable path and has substantially increased its disclosures and transparency. Still, more progress is needed. I'll now turn it back to Diana.

Thank you, David. Since emerging from bankruptcy, we have continued to focus on maximizing the value of Ambac's principle asset, Ambac Assurance, as we had been doing throughout the bankruptcy process, and before. This effort involves active asset liability management that has improved the Company's financial position. I will talk about some of these specific efforts in a moment. But let me say here that we are driven by a belief that the actions we take to reduce or eliminate losses and to improve returns have had, and will continue to have, a positive long-term impact on the value of Ambac Assurance. In addition, since emergence, we have considered opportunities to diversify and grow our business focus in order to broaden Ambac's revenue base.

As I just mentioned, Ambac Assurance's ability to deliver long-term value is driven primarily through active asset liability management, specifically, by mitigating losses on poorly performing transactions, pursuing recoveries for rep and warranty breaches, executing policy commutations, repurchasing liabilities at a discount, restructuring transactions, engaging in servicer oversight and intervention, and by optimizing other recoveries. With respect to our investment portfolio, as David discussed earlier, we look to prudently maximize risk-adjusted investment returns, subject to maintaining the quality and diversification of the book and ensuring that we have sufficient liquidity to honor our payment obligations as they arise. We are continuing to shift the asset mix away from tax-exempt municipal bonds and into other investments, including Ambac insured bonds.

Next, I'd like to spend a few minutes discussing some of the value creation initiatives that we are pursuing at Ambac Assurance. I will highlight four. First, our pursuit of recoveries from counter parties that breached their representations and warranties; second, our efforts to commute insurance policies and remove risk from the balance sheet; third, our buyback program, whereby we purchase Ambac-wrapped securities at prices that result in attractive investment opportunities, as well as valuable risk mitigation; fourth, our RMBS servicing effort. It's important to note that these initiatives all involve sensitive issues, as our ability to execute involves negotiating with counter parties in the market. As such, we will provide you as much information as is appropriate regarding our strategy, assumptions or metrics, without compromising our ability to successfully negotiate and execute on these initiatives.

First, regarding our rep and warranty cases. We continue to spare no effort to enforce the contractual obligations of our RMBS counter parties and to hold them accountable for their actions. We have six ongoing lawsuits with major counter parties, and are in direct negotiation with others. In all of our cases, we seek to recover the entirety of the claim payments we have made or expect to make on the transactions involved, as well as interest and our expenses in pursuing these recoveries. To date, we have reached confidential agreements with several counter parties, covering a number of deals. And as a result, we have agreed to accept nearly $300 million in cash and other consideration. The recoveries consist of both direct payments and repurchases of loans. And in certain instances, the settlements include protection against future claims. As an example, we pursued our rights in the bankruptcy of ResCap; and subject to approval of the bankruptcy plan, we expect to receive over $60 million in that process. The bankruptcy court is scheduled to begin confirmation hearings on November 19.

We have very strong rep and warranty cases. The overall trend of decisions in litigation against our counter parties has been positive for our cases and reaffirms the logic of pursuing our cases aggressively. We will not settle these cases simply to put them behind us; however, we will make prudent, risk-adjusted decisions to settle cases, should such opportunities arise.

Turning now to policy commutations. Commutations are a key loss mitigation tool and an important element of our value creation initiatives. Commutations present an excellent way for us to manage our liabilities and remove risk from the portfolio. However, we have stringent economic hurdles and are extremely disciplined with respect to our approach. We look for situations that have a positive, risk-adjusted, long-term economic impact, while considering other factors, such as liquidity and execution risk. Student loan ABS commutations have worked well, due to their long tenures, relatively closely held positions, and their esoteric structures. Since the beginning of 2009, we have commuted approximately $6.2 billion of student loan gross par, with PV of future expected gross claims of more than $1 billion. Over the same period, we helped facilitate or consented to the refinancing of another $2.6 billion of student loan gross par. Executing commutations tends to be lumpy, in that it takes time to negotiate and execute an agreement. And they typically involve a sizable amount of par exposure. We will continue to pursue commutations of policies on student loan bonds on RMBS and other distressed policies, where it makes sense for us to do so from a return, risk management and liquidity standpoint.

A third value creation initiative that we have been pursuing involves the purchase of distressed Ambac-wrapped securities at discounts to par. We have been successful in buying Ambac-wrapped RMBS, and in doing so, we acquire an investment that generates attractive returns, while simultaneously diffusing future claims. We currently own $1.2 billion in fair value of Ambac-wrapped mortgage backed securities. And year-to-date, we have paid $288 million to purchase Ambac-wrapped RMBS, including $66 million in the third quarter. To the extent the economics of these transactions continue to be favorable and meet our disciplined return targets, it will remain a key part of our asset liability management strategy.

The last specific value creation initiative that I will discuss today relates to our RMBS servicer intervention efforts. Through our contractual rights, Ambac has transferred, or is in the process of transferring, servicing responsibilities on nearly 50 RMBS deals to special servicers, those that specialize in improving portfolio performance, mitigating losses, and increasing recoveries. These special servicers are hand-on. They employ individualized attention with direct lines of communication with the borrower. They use customized strategies. And we have found that they are more successful than other servicers in working with borrowers to get them current again. They also provide enhanced performance reporting, which in turn helps customize approaches that yield better results. Special servicing has achieved a significant improvement in delinquency status and reduction of loss severity across our specialty service portfolios. We currently use special servicers on the mortgage collateral backing over $4 billion in insured par. Our special servicers have executed over 6,500 mortgage modifications and 1,500 short sales in our portfolios. We estimate that, through their loss mitigation efforts, we have avoided over $250 million of collateral losses.

Now I would like to provide you with an update on the status of the segregated account rehabilitation plan. As a reminder, the Wisconsin Insurance Commissioner is the rehabilitator of Ambac Assurance's segregated account, and as such, has significant involvement in the asset liability management activities at the Company, as well as complete authority over the form of the rehabilitation. This structure has been in place since 2010. We maintain a constructive relationship with the rehabilitator. Under the rehabilitation plan, we are currently paying 25% of permitted segregated account policy claims; and with respect to certain policies, we are making supplemental payments in order to maximize recoveries to the segregated account. The rehabilitator is currently seeking a private letter ruling from the IRS in connection with a number of tax issues associated with potential amendments to the rehabilitation plan, including the establishment of a deferred amount rather than the issuance of surplus notes for the unpaid portion of permitted claims. Under such amendments, the segregated account would not issue surplus notes with respect to the unpaid balance of permitted policy claims, but would instead record such balance as an ongoing policy obligation, which would accrue at a rate of 5.1%, compounded annually. If the rehabilitator receives positive rulings from the IRS, he will likely consider amendments to the plan, which may require rehabilitation court approval. No final decisions on these points have been made by the rehabilitator, nor has any decision been made about the time frame for proceeding with any potential amendments to the present terms of the confirmed plan.

With respect to new business initiatives, Ambac wants to diverse and grow our business focus and broaden our revenue base. The Company is exploring opportunities to build or acquire lines of business in the financial services sector that complement our current platform. Ideally, we would like to leverage the core competencies at Ambac Assurance and create synergies, where possible. We have been and continue to refine our new business strategy and evaluate opportunities as they are developed or presented. We are advancing some discussions, but have not yet progressed any one to the point of execution. Specifically, we have considered initiatives that relate to core competencies in credit, financial guarantee, mortgage risk, public finance and asset management.

We want to be deliberate and thoughtful as we pursue new business initiatives. The primary challenge is identifying the opportunities having the best fit in terms of being a strategic match and also meeting our investment objectives. We will focus on executing what we view to be the most accretive and value added of these opportunities. We are prepared to move quickly for the right opportunity, but no announcements are imminent at this time.

This concludes our prepared remarks. Now we will open up the call to Q&A.

Thank you. We will now be conducting a question-and-answer session. In the interest of time, and in order to allow as many as possible to ask a question, we ask that you please limit yourself to one question and one follow-up.

(Operator Instructions)

Our first question is from the line of Andrew Gatlin of Odeon Capital. Please proceed with your question.

Thank you. Good morning.

Good morning.

My first question was about the increase in your purchases of your own wrapped paper this quarter was a pretty significant amount. Could you talk about how you are able to buy that much paper, at $65 million, relative to, call it, face?

For the third quarter, we purchased approximately $65 million, as you mentioned. That's the fair value of paper that we purchased during the quarter. The markets are still very active in Ambac-insured wrapped RMBS. And we have been very disciplined in how we pursue that market, and I still believe we have opportunities there. Those opportunities ebb and flow, and you can see that through the year, our purchases have gone up and down, based on market conditions. I think for the full year we spent about $288 million on wrapped RMBS in the open market, and a good chunk of that actually occurred during the second quarter.

You gave some color on how much of your outstanding obligations from student loans have been effectively commuted. But how much of your loss reserves on the RMBS side have been effectively commuted through these actions?

One of the metrics that we look at when considering that is the amount of deferred claims that we've acquired. Future losses are a little more difficult to predict. We do, obviously, have reserves up for the RMBS, and those do fluctuate over time. But the main metric that we look at is the amount of deferred claims that we've acquired. And we estimate today that our deferred claims that we've acquired through our repurchase program is about 13% of the outstanding deferred obligations.

So 13% times the, I think it's $3.8 billion?

$3.9 billion, that's correct.

$3.9 billion. Okay. Thank you very much.

You're welcome.

(Operator Instructions)

The next question is coming from the line of Jonathan Feldman with Nomura. Please proceed with your question.

Good morning. Just was wondering if you could amplify your comments on the RMBS rep and warranty settlements that you referred to in your prepared remarks, in terms to the extent that these settlements are a matter of public record, just more color on that topic and when those were achieved?

The settlements that we've entered into are not a matter of public record. We have a lot of confidentiality agreements that we need to abide by, and so we don't provide a lot of detailed information on that. As I mentioned, we do value those settlements at about $300 million, and that's a combination of cash and buybacks and protection against future claims. I can say that we currently have six deals that we're litigating, and we are also in discussions with other counter parties, and that we do have very strong claims in these cases. We have booked a remediation credit for those deals of just under $2.4 billion. And I'm sure that people are wondering, could that ultimately be a higher recovery? And of course, the answer is yes. But the current estimates reflect, by definition, our best estimates. But they are just that. They're estimates. Our goal is always to exceed expectations, but currently we try to share with the market what we believe is factual, based on today's information.

Got you. Thank you. Second question was, you talked about the deferred account, or the issuance of -- I forget the exact term -- but I think it was deferred account securities as opposed to new surplus notes. In terms of the interest accrual on those securities, would they begin when claims were presented or when the rehabilitator prospectively approves the issuance of those securities?

The rehabilitator has announced his intention to start accruing claims as of the date that the first claims were paid on these deferred amounts, and that was September of last year.

Okay. And just lastly, were you guys repurchasers of any of the Puerto Rico insured policies that you had written in the quarter?

We don't comment on that.

Thank you very much.

Thank you.

Our next question is from the line of Scott McCabe with Latigo Partners. Please proceed with your question.

Hello. It's David Sabath. I just had a question for you on your relationship with the regulator. I'm curious if you go for, whether it's commutations or reps and warranties litigation, or just Ambac paper, do you have to go through the regulator to do that or is that something you have the ability to do freely?

Well, the regulator is in charge of the segregated account. And many of the items that we've talked about today reside in the segregated account, including our RMBS and student loan exposures. The regulator has contracted with Ambac to manage this process. There is no segregated account employees. So it's Ambac employees who are driving the process and working closely with the regulator to achieve results. So it is a coordinated effort. But the day-to-day management and idea generation does largely reside with the Company.

And they've been generally supportive of your decisions?

Yes. I think you can see from what we've achieved over the last few years, in terms of commutations and buybacks and the aggressiveness of our rep and warranty litigation, that we've been very successful, yes, working together.

All right. Thank you.

Thank you.

Our next question comes from the line of Sean Lobo with Nomura. Please proceed with your question.

It's supposed to be higher.

Excuse me, Mr. Lobo. Your line is live for a question.

Oh, sorry. Hello. How are you? Thank you very much for taking my phone call. In the quarter, you guys did an impressive amount of commutations we were trying to figure out here. Can you clarify, in the quarter, is it right, you spent $65 million for $365 million in commutations?

No. The $65 million number I think you're referring to is the amount we spent on repurchases of RMBS securities.

Understood. But then is it right to say, if I look at what you guys did up until 6-30, and I compare that to 9-30, $65 million was spent to purchase $365 million worth of RMBS securities?

No. No. We spent -- consistent with the earlier comment -- about $288 million year-to-date was spent on RMBS purchases. I think what you're maybe referring to also includes transactions that were otherwise refinanced during the quarter. So while we got off risk, we didn't necessarily spend dollars to reduce the exposure. We're also looking to work with counter parties to help facilitate our exit from exposures. And there's various means by which we do that and incentivize counter parties to take us off risk without us actually having to write a check.

Thank you very much. And on the same line -- this is my one follow-up question -- when you think about your surplus notes trading also at a pretty steep discount, how do you think about those in terms of risk mitigation and your strategy, and ultimately how that plays out?

We obviously watch the surplus notes very closely. It does play into how we ultimately value transactions that we look at, when it comes to commutation transactions and other repurchases. So it's a part of the mix of information that we consider. But we also recognize that the valuation of surplus notes can be difficult. And we have to take a view ourselves at what we view the intrinsic value and purposes of our risk mitigation activity is. And what I mean by that is, ultimately, the surplus notes, they have the certain terms to them, but they have the ultimate optionality, in that interest can be deferred and principal payments on those can be deferred without there being any penalty. And the payments on those ultimately will get for the rehabilitator. So when you think about commutations and how to value risk adjusted returns on investment that we're making in our own risk, we have to take into consideration possibly when we think the payments on those notes will be made. So it's a little more complicated than just looking at where the market is trading in those positions, but it is a part of the equation.

Understood. Thank you for the explanation. Great job.

Thanks.

Our next question is from the line of Charles Post of Sterling Grace. Please proceed with your question.

Good morning, everybody. I have some R&W questions for you. Can you tell me if the $300 million that you have under agreement is part of six lawsuits?

No, it's not. These are settlements that we've already entered into.

Okay. So the six are separate.

Correct.

And in the 10-Q, you always have a chart that shows a portion of the RMBS, where you have losses, and you have R&W estimates. And then there's a portion of RMBS where you have losses, but no R&W estimate. Can you give me a little more color as to why there's no estimate for R&W recovery on that portion of your RMBS portfolio?

We don't estimate recoveries on all of our RMBS portfolio, for a number of reasons. In some cases, the counter parties don't exist any more. They've gone bankrupt. In some cases, we've assessed what our rights are under the documentation and we don't feel as strongly about them. So we do a bottoms up analysis of each one of our exposures in determining what to do in terms of assigning a remediation credit to that. And it's very fact and circumstance specific.

So are you saying to me that those are zeros for R&W? Or are you just being more conservative on that approach?

Well, for the purposes of the remediation credit, they are zeros, by definition. But that doesn't mean that all of the cases where we've assigned a zero probability are cases where we're not in conversations. We are having some negotiations in some of those cases. And in fact, I can say that on some of the $300 million, prior to reaching the settlement with them, we had zero. And so the zero doesn't necessarily mean that we're not trying or that we won't succeed in achieving the remediation credit.

And I'll just add, in some of those cases, it doesn't mean that eventually it may not lead to litigation. So there are circumstances where we're trying to negotiate settlements. In some cases, we've signed tolling agreements with those counter parties that preserve our rights to litigate in the future, and we hope that we can come to settlement outside of going to court. But ultimately, if those agreements can't be reached, then we'll take every action we need to take and we'll wind up filing suits.

And is there any way to start thinking about timing on some of these -- the six lawsuits coming to close?

Well, our process for determining the remediation credit does incorporate timing, so that we assign different probabilities of different outcomes over a spectrum of different times. But we don't provide more information than that, publicly.

All right. Thank you very much.

Thank you.

Our next question comes from the line of Thomas Howard with UBS. Please proceed with your question.

Some of my questions were answered already. This is kind of a follow-up to the prior question on liability management, what you were thinking about with the surplus notes. You gave us some good overview of what new business opportunities you were looking at. Can you give us a sense for where you think those investments in new business opportunities might be made? Would they be made through the holding company, AMBC? What resources are at AMBC to make those investments? And then what steps do you think you need to execute successfully to be able to move capital up out of your Ambac Assurance investment, for example, to the holding company to make those new business investments?

Okay. So to start with your first question, yes, the new business initiatives are most likely to be made out of the holding company, and not out of the insurance company. In terms of the resources at the holding company, while the resources at AFG are pretty straightforward, we have the ownership of AAC, we have a little bit of cash, we have some tax assets, and we have an almost billion dollars market cap that provides us to some access to capital. And so we are likely to use either access to capital, seller financing, perhaps debt, in any acquisition that we make. But that's going to be very specific to the opportunity.

Okay. And I know this is probably a long-term question, but what milestones or hurdles do you think you need to get over to start to realize value flowing up from Ambac Assurance to the holding company?

Well, there's a few things there. I don't think there's necessarily any particular milestone or metric that the regulator is looking at, in terms of allowing a dividend, for example. And I would say that any prospect for dividends is far off. You see most of the value going up to the holding company would be through, basically, three means. One is the arrangements that we have in place already with the insurance company, in terms of cost sharing and expense reimbursements, which is more of a short-term liquidity management effect for the holding company. But ultimately, it's the tolling payments and junior surplus notes that the holding company has, as well as the long-term return on the equity that the holding company has out of Ambac Assurance. And all of that is going to be dependent on, as we talk about a bit, our liability management and asset management efforts at the insurance company. So as those items progress and with the maturity of the book, greater clarity will come in terms of the timing and amount, ultimately, of what we will recover from tolling payments on our tax arrangements, junior surplus notes and the equity of the insurance company.

And I appreciate you commented on your thoughts about the surplus notes and how you look at those. Do you see opportunities with the deferred payment obligations? I'm going to prove my ignorance on the terms of those. Are those obligations that you can go to those counter parties and try to reduce commute, over time?

I think that opportunity does exist. The deferred obligations, unlike a surplus note, are not a certificated obligation. But in cases where certain securities, like RMBS that are run down and there's no underlying resources to the RMBS any longer, the outstanding amounts, which we generally refer to as claim bonds, do trade. So we couldn't trade those bonds in the open market. And there are other means by which we could commute or unwrap those securities, as we've done in the student loan market with the synthetic type commutations. So I do think there are opportunities to, either through direct purchases of RMBS, or through structured means, to acquire those DPOs, at a -- we refer to them as DPOs, deferred payment obligations -- at a discount.

And finally, the auction market preferreds? I mean, they trade at big discounts. Obviously, that's cheap capital for you, but --

Very cheap. Those are very subordinated in the AAC capital structure. They are perpetual, and they have absolutely no cost of carry. So it's very unlikely that there would be any resources for a very long time, counting on Ambac Assurance to repurchase or refinance those positions. If we were to do something -- we are open to perhaps doing something with those securities. It would have to involve other means, and would have to be structured in a way that creates value for our shareholders. I think that's achievable, so long as we have willing and reasonable counter parties to deal with.

All right. I appreciate it. Thanks.

(Operator Instructions)

The next question is from the line of Andrew Gatlin of Odeon Capital. Please proceed with your question.

Hello. Thanks for taking my follow-up. On the $2.4 billion of litigation recovery reserve, does that include the $300 million?

No, it doesn't. The $300 million is what we've already settled.

And when did you settle that? Was that after the quarter?

Oh no, no. This is sort of a roll up of what we've done to date.

Got it. Now there's a schedule that you provide in your Q and K after every period where you show -- last quarter, it was 182 problem RMBS policies, of which 50, you had done either adverse selection or random sample selection approach to try to determine if there's an R&W recovery, and132 where there had been none. And you mentioned that some of the $300 million is part of that 132 policies, I don't know what it is this quarter, where there is no reps and warranty type reserve. Is it mostly in that group? Is it partially, or very little of it?

We don't get into that level of granularity. I think what I said earlier on the call was that part of the $300 million in settlements we have achieved to date were on deals whereby we did not have a remediation credit before we conduct settlement part.

So it's been layered in over the past several years?

Correct.

Okay. Thank you very much.

Thanks.

Our next question comes from the line of Christopher Cesari with Morgan Stanley. Please proceed with your question.

Good morning. Thank you again for holding this call today. Separate from the acquisition strategy, are there any plans to apply for ratings and write new municipal business within the Company, whether it's the actual Ambac Assurance name or maybe the [Connie Lee] subsidiary? Just trying to see if there's any possibilities organically?

If we were to write new financial guarantee insurance, it probably would be through what you refer to as the [Connie Lee] subsidiary that's currently names Everspan. We have considered that in the past. Obviously, that would be a bit of a natural move for us. But it's really going to be determined by the demand for municipal bond insurance and by the returns that are available. So we would look at that as we do any other opportunity. Is it where we want to put fresh capital? And do we think that we will get the best return on that? As everybody on this call probably knows, there's been challenges in the municipal market recently, due to the compressed credit spreads and the low interest rate environment. On the other hand, municipal stress might make a financial guarantor's product more attractive. We are weighing all of that when we consider what we might do next.

Okay. Great. Thanks.

Thanks.

Our next question comes from the line of Jason Kim with Deutsche Bank. Please proceed with your question.

Good morning. Can you hear me?

Yes.

Okay. Great. Thanks for taking the call. Just a quick question on Puerto Rico. Maybe I've missed it. How much have you already reserved for the $2.5 billion Puerto Rico exposure?

We do not announce what our reserves are on a deal by deal basis. I think David had mentioned that we did classify the credit this quarter. It's classified as a 1-A credit. And we define 1-A credits as fully current with no claims anticipated. Many of our 1-A's are still investment grade, but they are vulnerable to a downgrade. So Puerto Rico fits very nicely within that. As a result of our analysis, we did take some small reserves on Puerto Rico. But our expectations continue to be that we will have no losses on those exposures.

Great. Thank you.

Thanks.

Our next question is from the line of Sean Lobo with Nomura. Please proceed with your question.

Hello. Thanks for allowing me a follow-up question. Just a follow-up on the rep and warranty conversations. In terms of where you are, you used to break our disclosure on when you expected certain settlements to come in. Can you give us a better understanding if it's still roughly half in '14, half in '15 and how we should think about the timing of that?

Well, we're not going to disclose anything on this call in excess of what we've already disclosed in our documentation. So I can't provide you the additional information.

Understood. And is it fair to assume that those conversations are ongoing today, and it's really just a matter of two sides coming together upon what you think is the right price or acceptable to you?

Not necessarily. Every deal has its own dynamics. And in some of the transactions, we feel like we're better off continuing to litigate aggressively. That's how we're going to get better results. As I mentioned earlier, we are not in any rush to settle, currently. We don't have any liquidity concerns, and we don't have any rating agency pressures. We have nothing that's going to drive us to accept a settlement that is less than what we think we can achieve if we continue to litigate. And it's really a case by case analysis of that that drives our decisions.

Understood. And then in terms of that -- is that gating issue, in terms of turning the interest coupon on for the surplus notes getting that money, in terms of the regulator's opinion?

Your guess is as good as mine.

Sure. Understood. Thank you.

Great. Thanks.

(Operator Instructions)

There are no further questions at this time. I would now like to turn the conference back to management for closing comments.

Thank you very much and thank you, everyone, for joining today. Please give Mike Fitzgerald a phone call, at 212-208-3222, if there's any further questions, and we are happy to address them then. Thank you again.

Thank you.

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