Ambac Financial Group Inc (AMBC) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Ambac first-quarter 2014 conference call.

(Operator Instructions)

As a reminder, today's call is being recorded. I would now like to turn the conference over to Abbe Goldstein, Head of Investor Relations. Ma'am, you may begin.

Thank you, Shannon. Good morning, and thank you all for joining today's conference call to discuss Ambac Financial Group's first-quarter 2014 financial results.

Before we get started, I'd 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 2013 Form 10-K and in our quarterly report on Form 10-Q for the three months ended March 31, 2014, under Risk Factors, and in our quarterly report on Form 10-Q for the three months ended March 31, 2014, under Management's Discussion and Analysis of financial condition and result of operations. 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 contains 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 at ambac.com.

Our speakers today are Diana Adams, Ambac's President and CEO; and David Trick, Ambac's Senior Managing Director, CFO and Treasurer. At the conclusion of their prepared remarks, we will open the call to your questions. Please note that we have posted slides on our website to accompany this call. I would now like to turn the call over to Diana.

Thank you, Abbe. Good morning, everyone, and thank you for joining today's call. We are pleased to report another quarter of solid financial results. During the quarter, our efforts remained focused on mitigating losses and maximizing value at our Assurance subsidiary, Ambac Assurance. We also continued to pursue growth and diversification opportunities at the Holding Company.

We have four key value-creation initiatives at Ambac Assurance that we have highlighted in the past and that I will update you on today. First, we are actively pursuing recoveries from counter parties that breached their representations and warranties in residential mortgage-backed securities insured by Ambac. 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 negotiations with others. We have very strong rep and warranty cases. We monitor other RMBS-related litigation and, in our view, the trend of decisions against our counter parties and other RMBS sponsors continues to be positive for our cases.

We will not settle these cases simply to put them behind us. However, we will consider settlements when we believe we can achieve a better risk-adjusted resolution than through continued litigation. In all of our cases, we are seeking to recover actual and expected claim payments on the transactions involved, as well as interest and our expenses in pursuing these recoveries.

During the first quarter, we had no new settlements. We continue to advance our litigation with most of our cases in active discovery at this time. Our estimated rep and warranty breach remediation recoveries reflect a probability-weighted scenario analysis of multiple possible outcomes. In the first quarter, this estimate was little changed at $2.2 billion.

Turning now to policy commutations. Over the past few years, we have successfully eliminated billions of dollars in future liabilities by commuting our obligations at a discount. These transactions not only reduce Ambac's future liabilities, but they also reduce volatility, as they eliminate uncertainty over the magnitude of future claims. We have stringent economic hurdles and are disciplined with respect to our approach to commutations. Our focus is on transactions that have a positive, risk-adjusted, long-term economic impact, while considering other factors such as liquidity and alternative uses for our limited capital.

In the first quarter, we acquired $280 million in par of student loan securities in anticipation of commuting the associated expected future losses. This contributed to a reduction in Ambac's student loan reserves.

A third value-creation initiative that we have been pursuing involves the purchase of distressed Ambac-wrapped securities. We purchased $75 million of RMBS in the first quarter, and in doing so made an investment that generates attractive risk-adjusted returns while capping losses.

The last value-creation initiative that we have discussed on prior calls relates to our servicer-intervention efforts. Because the performance of RMBS transactions is highly influenced by the quality of servicing of the mortgages embedded in those deals, we have spent years working to improve servicing. We work with existing legacy servicers and we also transfer servicing to our so-called special servicers. We have a direct contractual arrangement with our special servicers and they work closely with us, employing a high-touch approach to improve portfolio performance, mitigate losses, and increase recoveries.

Special servicing has achieved a significant improvement in delinquency status and reduction in loss severity across our RMBS specially serviced portfolios. As we reported at the end of last year, we use special servicers on the mortgage collateral backing $4.5 billion of insured par, which represents approximately 29% of our insured RMBS portfolio. We are currently in active negotiations with a couple of legacy servicers to transfer additional exposures to our special servicers.

Now, I would like to provide you with an update on the status of the segregated account rehabilitation plan. The Wisconsin Insurance Commissioner, who is the rehabilitator of Ambac Assurance's segregated account, is seeking court approval to amend the rehabilitation plan. The hearing is scheduled for June 11. The proposed amendments continue to defer the payment a portion of segregated account policy claims. Instead of issuing surplus notes to satisfy unpaid claims, the amended plan will create deferred amounts that continue to be due to the policyholder and that will accrue interest, generally at an annual rate of 5.1%.

In addition, if the motion is approved, the rehabilitator has stated that he intends to increase the cash payout ratio on segregated account policy claims from the current level of 25% to 45%. This is expected to take effect on or after the July 20, 2014, payment date. He also intends to make a catch-up payment to policyholders who have been paid 25% of their claims. The catch-up payment will be equal to 26.67% of deferred amounts that are outstanding at the time of the increase in the payout ratio and the interest thereon. The rehabilitator expects any catch-up payments to be made on or after the November 20, 2014, payment date.

Assuming an annual 5.1% interest rate, accrued interest on the unpaid portions of claims would be approximately $277 million through the end of the first quarter. This accrued interest amount is not currently reflected in the Company's financial results and will be recorded only upon approval of these amendments by the rehabilitation court.

Although the commissioner disapproved the June 7 payment of interest on the surplus notes, if he receives the approvals he is seeking and makes a catch-up payment, Ambac and the segregated account will also be required to redeem a portion of the senior surplus notes. This redemption would occur on the date catch-up payments are made on deferred amounts.

The aggregate amounts to be applied against such redemption will be equal to 26.67% of the senior surplus notes, and accrued and unpaid interest, outstanding as of the date that the payout ratio increases from 25% to 45%, which as I mentioned earlier is expected to be on or after July 20. The rehabilitator's proposed amendments to the plan and supporting documents were prepared by the rehabilitator in his sole and absolute discretion. Ambac management was not involved in decisions regarding the timing of the proposed amendments or the potential changes to the payout ratio.

Finally, with respect to new business initiatives at Ambac Financial Group, we continue to explore ways to diversify and grow our business and broaden our revenue base. As I've said in the past, we are considering opportunities to acquire or build businesses that leverage core competencies in credit risk and long-term assets liability management. These new businesses may include financial services businesses, such as asset management, asset servicing, and insurance. We will focus on executing what we view to be the most accretive and value added of these opportunities. I'd now like to turn the call over to David for a financial review.

Thank you, Diana. Before I begin, it is important to note that, due to our emergence from bankruptcy, Fresh Start reporting has been adopted in relation to the Company's financial results for periods from May 1, 2013. As a result, financial results for the first quarter of 2014 are not fully comparable to first-quarter 2013 results.

Net income in the first quarter of 2014 was $155.9 million, or $3.31 per diluted share, compared with $282.3 million, or $0.93 per diluted share, in the first quarter of 2013. During the same periods, operating earnings were at $176.6 million, or $3.75 per diluted share, compared with $297.4 million, or $0.98 per diluted share. Earnings in the first quarter of 2014 were positively impacted by a greater benefit from loss and loss expenses, which were more than offset by lower net realized investment gains, net investment income, and net premiums earned, and higher, other-than-temporary impairment losses and product losses.

For the first quarter of 2014, net premiums earned were $82.5 million, as compared to $100.3 million in the first quarter of 2013. The decrease in net premiums earned was primarily driven by decreases in public finance and structured finance normal earned premiums, resulting from the run-off of the associated insured portfolios. In addition, accelerated premiums earned decreased as a result of lower public finance and structured finance refunding, partially offset by an increase in international refundings.

Net investment income for the first quarter of 2014 was $70.8 million, as compared to $84.5 million for the first quarter of 2013. The decrease in net investment income was primarily driven by Fresh Start adjustments that increased the overall amortized cost basis and decreased the effective yield of the portfolio. The impact of Fresh Start was muted by our continued efforts to strategically reallocate the portfolio.

The gain attributable to the change in fair value of credit derivatives for the three months ended March 31, 2014, was $7.4 million, as compared to $12.8 million for the three months ended March 31, 2013. The change in fair value of credit derivatives for both periods includes improvement in reference obligation prices, gains associated with the run-off of the portfolio, and credit derivative fees earned, net of the impact of the Ambac Assurance CVA.

The reduction in the Ambac CVA resulted in losses within the overall change in fair value of credit derivative liabilities of $9.8 million for the three months ended March 31, 2014, and $69.5 million for the three months ended March 31, 2013. CDS notional outstanding decreased from $2.8 billion at year end to $2.5 billion at the end of the first quarter of 2014.

Derivative products had a loss of $53.8 million for the three months ended March 31, 2014, as compared to a loss of $0.6 million for the three months ended March 31, 2013. Derivative products revenue during both periods reflect mark-to-market gains and losses in the portfolio caused by changing interest rates, offset by the Ambac -- the impact of the Ambac CVA. The first quarter of 2014 loss was driven by falling interest rates, partially offset by gains of $5.4 million from the impact of the Ambac CVA.

In the first quarter of 2013, interest rate-driven gains were more than offset by losses of $30.1 million from the impact of the Ambac CVA. The derivative products portfolio has been positioned to generate gains in a rising interest-rate environment in order to provide an economic hedge against the impact of rising rates on certain exposures within the financial guarantee insurance portfolio.

VIE losses for the three months ended March 31, 2014, were $5.5 million as compared to a gain of $38.3 million for the three months ended March 31, 2013. Losses on VIE for the first quarter of 2014 resulted from the increased value of outstanding VIE debt related to improvement in values as Ambac insured obligations.

Interest expense was $32.3 million in the first quarter of 2014 as compared to $23.2 million for the same period last year. The increase in interest expense was due to the impact of Fresh Start reporting. If the rehabilitation plan is amended, as Diana described, surplus notes would be redeemed at a redemption price that would include an amount equal to accrued interest on such redeemed surplus notes.

Settlement of these liabilities would result in a change -- charge representing the accelerated recognition of the unamortized discount on the redeemed surplus notes. Ambac will record this charge only upon redemption of such notes. As of March 31, 2014, the unamortized discount on the portion of the segregated account and general account surplus notes expected to be redeemed was approximately $82.4 million.

Loss and loss expenses for the first quarter of 2014 were a net benefit of $140 million, as compared to a net benefit of $51.1 million for the three months ended March 31, 2013. The first quarter of 2014 loss benefit was driven by lower estimated losses in RMBS and student loans, partially offset by higher estimated losses as a result of declines in discount rates during the period. Reductions in RMBS estimated losses of $103 million were primarily due to improvements in HPA, as well as some improvement in underlying transaction performance.

Lower estimated losses in our student loan portfolio of $83 million were primarily driven by changes in commutation expectations. In the first quarter of 2014, Ambac acquired approximately $280 million par of student loan securities and is anticipating commuting the associated expected future losses. Our view of the likelihood of commutations for these and other securities increase, resulting in lower probability-weighted loss reserves.

Positive RMBS and student loan loss development was partially offset by incurred losses in the AUK portfolio, which were entirely driven by lower discount rates applied during the quarter. The first quarter of 2013 was impacted by lower estimated losses in RMBS and public finance, partially offset by higher estimated losses in student loan securities.

Loss and loss expense reserves, gross of reinsurance and net of estimated subrogation recoveries, decreased to $5.3 billion at March 31, 2014, compared with $5.5 billion at December 31, 2013. Excluding loss expense reserves, RMBS reserves fell by $101 million, to $3.2 billion; student loan reserves decreased by $91 million, to $891 million; domestic public finance reserves increased by $5 million, to $343 million; and AUK reserves increased by $41 million, to $674 million. First-quarter loss reserves include $4 billion of unpaid segregated account policy claims.

Estimated RMBS rep and warranty discounted subrogation recoveries were $2.2 billion as of March 31, 2014, relatively unchanged from year end. The provision for income taxes of $3.2 million for the first quarter of 2014 compared to $0.6 million for the same period last year. First quarter of 2014 income taxes consisted primarily of alternative minimum taxes. Both periods also included income tax expense as a result of pretax profits in Ambac UK's Italian branch, which cannot be offset by losses in other jurisdictions.

At March 31, 2014, the Company had $5.2 billion of US federal NOLs, including $1.4 billion at Ambac Financial Group and $3.8 billion at Ambac Assurance. The financial guarantee insurance portfolio, net par amount outstanding, declined 3.1% to $173.5 billion at March 31, 2014, from $179.1 billion at December 31, 2013. Much of this is attributable to the run-off of $3.7 billion of public finance net par.

The breakdown of the insured portfolio by sector was unchanged for the first quarter of 2014 relative to year end 2013. Public finance was 65% for the total net par outstanding, structured finance was 17%, and international was 18%. The breakdown by portfolio type also remained constant, with the general account representing 73% of the total net par outstanding, and segregated account 13%, and Ambac UK the remaining 14%.

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. We have agreed to terms of the settlement on the unlimited GOs, which represented 74% of Ambac's allowed claim. On the limited GOs, we filed an objection to the emergency manager's plan last evening. We expect to continue litigation and court-ordered mediation. We will continue to pay claims to bond holders for scheduled principal and interest.

With respect to our investment portfolio, our goal remains maximizing 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. The fair value of the consolidated investment portfolio, as of March 31, 2014, was $6.7 billion. The largest asset classes in the portfolio were mortgage and asset-backed securities, including Ambac-insured securities of $3.1 billion, corporate obligations of $1.6 billion, and municipal bonds of $1.2 billion, of which $739 million were tax exempt.

In the first quarter of 2014, we purchased $75 million of Ambac-wrapped RMBS, helping bring the fair value of Ambac-insured RMBS in our portfolio to approximately $1.4 billion, or 21% of the consolidated investment portfolio. Of the $4 billion of segregated account deferred obligations at the end of the first quarter, we own approximately $593 million, or 15%. To the extent the economics of these transactions continue to meet our return targets, they will remain a key part of our asset and liability management strategy.

In light of the previously announced proposed amendments to the plan of rehabilitation that Diana addressed, total net cash outflows associated with the payment of deferred amounts and the redemption of surplus notes are expected to exceed $1.5 billion in 2014. We have begun developing a plan to fund this payout. So far, we have concluded that this can be done without the need to impair any positions. However, this is subject to change. That concludes our prepared remarks. Now we will open up the call to Q&A.

(Operator Instructions)

Andrew Gadlin, Odeon Capital Group.

Wanted to ask about the S3 that was filed last night, anything imminent that we should be looking for?

Andrew, no, I think the S3 filing is just part of our natural evolution as a public Company and as we look forward. And in terms of increasing our financial flexibility we thought it was something that we should have in place.

Okay. In the operating supplement, switching gears, there's a new breakout of the Ambac insured paper you own as part of your loss mitigation strategy which is about $1.6 billion, $1.5 billion on a book value basis. Looking at the numbers and comparing overall RMBS versus last quarter, it looks like you're marking that bucket of paper to about a 7.5%-ish yield to maturity versus 5.9% last quarter. I was wondering if you could talk about why you increased the expected yield on that book?

Well, I think there's a couple things going on there, Andrew. We did make more acquisition of RMBS during the quarter and there was also some acquisitions of non-mortgage related transactions that had relatively attractive all-in yield.

So it's simply the issue that you've been directing the book towards higher yielding paper, a lot of it your own?

That's correct.

Okay, all right. And then on the NOL, I think you said in your prepared remarks that the NOL at AAC is down to $3.8 billion?

Right.

At what level would you be triggering some of the tolling payments up to the holding Company?

Well the differential between that $3.8 billion and the $3.65 billion, which is about $150 million, is the amount of current taxable income we'd have to generate before we trigger into tolling payments. But one word of caution is as Diana mentioned, some of the impacts of the rehabilitation plan has not been yet factored into our financial results. For example, the $277 million of interest on the deferred amounts, that for example will result in taxable losses that if not offset with income will add to the NOL.

So a portion of the $277 million would be recognized at year end and add to the NOL?

That's right. Before year end most likely.

So it'd be roughly a quarter, right, roughly 26% of it?

No, the $277 million is the amount that has been accrued through March 31, 2014 if the plan was in place. So if the plan was in place right now, we would have incurred $277 million of interest expense on those deferred amounts.

Right. What I'm saying is that what's the percentage of that $277 million that would be recognized towards year end when the incremental payment is made and it's probably roughly a quarter.

No, it's 100% of that.

Oh, 100% will be recognized of that $277 million?

Correct.

Okay. All right, thank you very much.

(Operator Instructions)

Ben Clifford, Nomura Securities.

On your RMBS losses there at $1.4 billion, if you were to take into account your owned RMBS policies and net out that effect, a rough estimate of what you think the decrease in your losses there would be?

Sure. We haven't really disclosed that amount. What we have disclosed, continue to disclose is the amount of deferred obligations that we own and I discussed during my prepared remarks. So that amount counts for 15% of our deferred amounts. The amount of future losses, they're often referred to as our gross claim liability that we own, we have not previously disclosed.

Take into account that $593 million of deferred payment obligations that you own, that loss reserve would be more like $800 million?

Sorry, we're having a hard time hearing, if you could speak into the phone a little more closely.

Sorry. Just looking at the $593 million of deferred policy obligations that you own, would that RMBS loss reserve be decreased by $600 million, so roughly $800 million?

Well, when looking at the impact, if your question ultimately is what's the impact on our net equity position of owning that $593 million, you can't just simply subtract out that $593 million from the deferred amount. Because they're in our asset side or the balance sheet, but they're owned as investments. So you'd have to subtract out the value at which they're marked on the balance sheet as against the loss reserve to get a net bottom line impact.

Fair enough. And then on the rep and warranty side, talk a little bit about the developments in your damages claimed in the different cases since your initial complaints.

Could you repeat that question?

Sorry. Look at the rep and warranty side, can you talk a little bit about how the damages claimed in those six cases have changed since your initial complaints in each of those cases?

We don't really talk in any detail about our cases because we don't comment on active litigation. But as I said in my prepared remarks, we do look to see what similar cases, how they develop and what we've seen is we think that there's been good legal developments in other cases that reflect well, albeit indirectly, on our litigation.

Great. And then one last question, do you expect any future cash recoveries from your res cap settlement if any more money flows into that trust?

It's hard to determine. We recovered amounts at the end of the year as everyone knows. We did receive units as part of the overall recovery of res cap and I believe there's been some -- some of the underlying mortgage trusts have received some units, so ultimately if -- and that includes some mortgage trusts that we own. So to the extent there is some level of recoveries on those units directly into our MBS Trust that we insure, then we'll see some incremental benefit from that. In the first quarter, I think we received about -- through our trust, about $13 million from that.

Thank you.

Alex Klipper, Bank of America.

Just a quick question on your gross other subrogation line item. I think it's something we've talked about in the past, but basically that number only went down by about $10 million, but you received about $70 million in the quarter. And it's about the sixth quarter in a row I think you would say you've revised that number up. So can you give us a little color around what's going on there, what would be -- what would continue this trend, what would make it stop? How comfortable do you feel about that number? How conservative do you feel the number is, et cetera?

Sure. First of all, we don't necessarily view the number as being conservative. The number is calculated as part of a very complex model that we run in order to estimate our RMBS losses. And one of the outputs of that is ultimately the amount of payments that we're going to make out the door related to RMBS as well as the amount of payments that come back in which is the other subrogation to help offset those losses.

And during the quarter, this quarter as I noted, we had positive development, reserve development from RMBS positions and that was a result of both a reduction in the ultimate payments that we expect to make as well as an increase in the expected subrogation and netting down to positive results for the RMBS. So the trend that you're observing in terms of subrogation recoveries coming down, less than by that which we recovered during the quarter, is just a function of the ins and outs of the MBS portfolio which entails some very complex positions and netting with -- against the expected ultimate payments resulting in positive reserve development for the quarter.

And if your sub -- rep and warranty recovery were to increase from your current balance sheet number, would that have any effect on the other subrogation number? Would you expect that to go up at all or is it completely separate?

Completely separate.

Okay. Thanks.

Thank you. I'm showing no further questions at this time. I would like to turn the conference back over to Diana Adams for closing remarks.

Thank you, Operator, and thank you everyone for participating in our call. We look forward to speaking to you in the future on these calls.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.