Ambac Financial Group Inc (AMBC) 2014 Q2 法說會逐字稿

Welcome to the second-quarter 2014 conference call.

(Operator Instructions)

As a reminder, today's meeting is being recorded. I would now like to introduce your host, Ms Abbe Goldstein, Head of Investor Relations and Corporate Communications. Ms Goldstein, please go ahead.

Thanks, Janine. Good morning. Thank you for joining today's conference call to discuss Ambac Financial Group's second-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- and six-months ended June 30, 2014 under Management's discussion and analysis of financial condition and results of operations 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 contains non-GAAP financial measures. Reconciliations of such measures to the most comparable GAAP figures are 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, we have posted slides on our website to accompany this call.

I'd now like to turn the call over to Diana.

Thank you, Abbe. Good morning, everyone. Thank you for joining today's call.

Ambac's net loss in the second quarter was $208 million. Our results include a $308 million charge for accrued interest on past due claims of Ambac's Segregated Account, of which $50 million accrued in the second quarter. Although this has been anticipated for some time, the amended plan of rehabilitation of the Segregated Account was approved in June, making this the first quarter that the accrued interest is reflected in our financials. But for the accrued interest, our earnings would've been positive.

During the quarter, loss development reflected RMBS improvements, higher estimated representation and warranty remediation recoveries and net improvements in other structured credits. These positive developments were partially offset by increased Puerto Rico reserves as well as higher student loan reserves driven by lower probabilities of commutations resulting from the current higher price for commuting Ambac Assurance risk. At Ambac Assurance, or AAC, we remain focused on our four value creation initiatives, which are rep and warranty recoveries, commutations and restructurings, insured buybacks and servicer intervention. We'd like to provide you with an update on each of these initiatives.

First, we continue to actively pursue RMBS rep and warranty recoveries. At the end of the second quarter, we had five ongoing lawsuits with major counter-parties and were in direct negotiations with others. Our strategy remains consistent. We will not settle cases simply to put them behind us. However, we will settle 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.

Our top priority in these cases is to maximize our recoveries for the benefit of Ambac and our constituents. On June 16, the case against Capital One was dismissed. Because we cannot comment further on this, we have received feedback from some of you about Ambac's lack of communication regarding our RMBS litigation. While we understand the frustration, matters involving litigation are sensitive and confidential. Discussing Ambac's strategy with respect to any particular case or counter-party could jeopardize or impede Ambac in our efforts to optimize outcomes.

Turning now to policy commutations. We continue to focus on transactions which we expect to incur losses, where commutation would have a positive risk-adjusted long-term economic impact. We also consider other factors such as liquidity and alternative uses for our limited capital. In the second quarter, we saw pricing for AAC risk increase. This higher pricing environment caused us to lower the probability of commutations in the near-term. We will remain patient and disciplined with respect to timing and pricing of commuting our risk.

Buying back Ambac's own structured securities is another priority in our value creation initiatives at AAC. In the second quarter, we continued to pursue this as part of our strategy and purchased approximately $136 million of Ambac insured RMBS through both open market and privately negotiated transactions. Going forward, the higher price of our insured bonds will impact our appetite for buybacks as it does for commutations.

Our fourth value creation driver relates to our servicer intervention efforts. We have learned from experience that the quality of servicing of mortgages embedded in our RMBS deals can significantly improve delinquencies and reduce loss severity. We have, for example, seen improvements in delinquency levels in the deals transferred late last year as part of the ResCap bankruptcy. With the transfer of three deals to special servicers during the second quarter, we now use special servicers on the mortgage collateral backing $4.7 billion of net insured par or 31% of our insured RMBS portfolio, up from $4.5 billion or 29% in the first quarter. In addition to our servicing transfer efforts, we also work with existing or legacy servicers to introduce techniques that have worked well in other deals.

Now for an update on the rehabilitation plan for the Segregated Account. On June 11, the Wisconsin Insurance Commissioner acting in his capacity as the Rehabilitator of AAC Segregated Account received court approval of amendments to the rehabilitation plan, which became effective on June 12. The amended rehab plan requires Ambac to pay interest on unpaid claims, generally at 5.1%. Accordingly, we recognized this accrued interest amount in the Company's financial results for the first time, which was $308 million through June 30, 2014. Furthermore, the Rehabilitator increased the payout ratio of permitted claims of the Segregated Account from 25% to 45% starting on July 21, 2014.

Deferred amounts that continue to be due to policyholders will accrue interest, generally at an annual rate of 5.1%. In connection with the increased payout, we will make a catch-up payment of 26.67% of the deferred amounts that are outstanding as of July 20, 2014 and the interest thereon. Ambac and the Segregated Account are also required to redeem a portion of the senior surplus notes. The catch-up payments and redemptions will be made on December 22, 2014 and are expected to exceed $1.5 billion in aggregate.

Going forward, we remain committed to our parallel strategic priorities. While we continue to focus on value creation initiatives at Ambac Assurance as I just described, we are also exploring ways to diversify and grow our business and broaden our revenue base at Ambac Financial Group. We are pursuing opportunities to acquire or build businesses that leverage our core competencies in credit, risk and asset liability management. To help fund our strategic priorities, we are considering a monetization of a substantial portion of the $350 million of junior surplus notes issued to us by the Segregated Account upon our emergence from bankruptcy. The proceeds of which could be used for acquisitions, liability management and general corporate purposes.

Before turning the call over to David, I would like to talk about a couple of our high profile public finance exposures, Detroit and Puerto Rico. With respect to Detroit, we have reached settlements for both our unlimited and limited GO exposures with the City of Detroit, where we had gross par outstanding of $78 million and $92 million respectively at the time the City filed for bankruptcy. As we have talked about before, the unlimited tax GO settlement represents 74% of Ambac's allowed claim with respect to those bonds. The limited GO, or LTGO, settlement is comprised of new LTGO notes equivalent to 34% of the LTGO allowed claim and a 20% share of any notes remaining in a litigation reserve related to the City's pension bond litigation. The latter may increase our recovery by up to an additional 19% of our allowed LTGO claim. Our settlements are subject to the execution of the City's plan of adjustment to emerge from bankruptcy. We will continue to pay claims in full of scheduled principal and interest on the Detroit bonds insured by AAC.

Puerto Rico continues to face serious financial pressures and uncertainties. We recently enhanced our disclosure providing debt service schedules for each of our Puerto Rico exposure types. In total, at the end of the second quarter, we had $2.5 billion net par exposure to Puerto Rico. Net par includes Capital Appreciation Bonds or CABs, which are reported at the par amount at the time of issuance of the insurance policy. At the end of June, the Commonwealth passed the Puerto Rico Public Corporation's Debt Enforcement and Recovery Act, which allows certain of Puerto Rico's public corporations in financial distress to seek restructuring.

Our $733 million in net par exposure to the Highways and Transportation Authority revenue bonds and our $137 million net par Hotel and Occupancy tax bonds are both potentially subject to the new law. The situation in Puerto Rico remains dynamic. There continues to be an enormous amount of speculation about what may happen. As is the case with all of our stressed credits, we are proactively involved in managing our exposures. We have put in place a team of external advisor to complement our internal resources. We believe we are adequately reserved for the range of outcomes we have currently identified.

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 second quarter of 2014 are not fully comparable to second-quarter 2013 results. The net loss in the second quarter 2014 was $207.9 million or $4.61 per diluted share. Operating losses were $113.3 million or $2.51 per diluted share. Included in the second-quarter 2014 net loss in operating losses was $308.1 million pretax or $303.6 million net of tax interest accrued related to unpaid Segregated Account claims. Such interest generally began accruing from the first distribution date after the date on which the interim payment in respect of such permitted policy claim was made, which began in September 2012.

These pretax and net of tax accrued interest amounts include interest accrued in the second quarter 2014 of $49.8 million and $48.8 million respectively. For the second quarter of 2014, net premiums earned were $65 million, compared -- comprised of $57 million of normal net premiums and $8 million of accelerated premiums and lower in total than the same period last year by $22.7 million. Results in the quarter were driven by decreases in public finance and structured finance normal earned premiums resulting from the runoff of the associated insured portfolios and accelerated premiums earned resulting from lower public finance, the structured finance refundings and terminations, partially offset by premium income from international finance policy, which paid a make-whole termination premium.

Net investment income for the second quarter of 2014 was $80.1 million, an increase of $21.7 million compared to the same period last year. The improvement was fueled by the ongoing reallocation of the investment portfolios, particularly the growing allocation to Financial Guarantee investment portfolio towards distressed Ambac insured securities. The loss attributable to the change in fair value of credit derivatives for the second quarter was $1.2 million, an improvement of $20.7 million compared to a loss for the three-months ended June 30, 2013.

The change in fair value of credit derivatives for the second quarter 2014 included improvements in reference obligation prices, gains associated with runoff of the portfolio and credit derivative fees earned, net of the impact of incorporating the Ambac Credit Valuation Adjustment or CVA. The reduction in the Ambac CVA resulted in losses within the overall change in the fair value of credit derivative liabilities of $13 million, an improvement of $92.9 million, compared with a loss for the three-months ended June 30, 2013. Credit derivative notional outstanding continued to run off from $2.5 billion at the end of the first quarter to $2.2 billion at the end of the second quarter 2014. 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.

Net losses reported in the derivative products revenue for the three-months ended June 30, 2014 were $48 million, a decline of $98.5 million from the three-months ended June 30, 2013. Results in derivative products revenue reflect mark-to-market gains or losses in the portfolio caused by changing interest rates, net of the impact of incorporating the Ambac CVA. Inclusion of the Ambac CVA in the valuation of Financial Services derivatives resulted in losses within derivative products revenue of $9.9 million, an improvement of [$17.2] million, compared with a loss for the three-months ended June 30, 2013.

VIE losses for the second quarter of 2014 were $38.1 million, reflecting the decreased fair value of net assets related primarily to the lower Ambac CVA applied to certain VIE note liabilities that include significant projected Financial Guarantee claims. In aggregate, the improved market perception of Ambac credit risk led to CVA-related mark-to-market losses of $62 million in the second quarter. Loss and loss expenses in the second quarter 2014 were driven by accrued interest on deferred amounts of $308.1 million and higher estimated losses of $93 million in domestic public finance and $29 million in student loans, partially offset by lower estimated RMBS losses of $235 million. Increases in domestic public finance losses were driven by recent events in Puerto Rico, which more than offset reserve releases resulting from settlements reached with the City of Detroit.

Increases in student loan losses were associated with lower probabilities of near-term commutations based on the current higher-price for commuting AAC risk. Reductions in RMBS estimated losses were primarily due to improved RMBS cash flow projections and higher estimated rep and warranty subrogation recoveries, which I'll describe in a few moments. Loss and loss expense reserves, gross of reinsurance and net of estimated subrogation recoveries, increased to $5.6 billion as of June 30, 2014, compared with $5.3 billion at March 31, 2014. As of June 30, 2014, approximately $4.3 billion of deferred amounts including accrued interest payable of $308.1 million remain unpaid. Using the balance of deferred amounts at June 30, 2014, the aggregate amount of equalizing payments to be made on December 22, 2014, on deferred amounts is estimated to be approximately $1.1 billion.

Excluding loss expense reserves, RMBS reserves increased by $197 million to $3.4 billion. This amount includes $307 million for accrued interest. Student loan reserves increased by $29 million to $920 million. Domestic public finance reserves increased by $66 million to $409 million and include $1 million of accrued interest. AUK reserves decreased by $2 million to $672 million. Estimated RMBS rep and warranty discounted subrogation recoveries were $2.3 billion as of June 30, 2014, compared with $2.2 billion as of March 31, 2014 and include a favorable impact from a change in our estimation method.

Our estimated rep and warranty remediation recoveries reflect a probability weighted scenario analysis of multiple possible outcomes. Historically, our estimate was based on random sample and adverse sample methods. The need to use a combination of these two methods was a function of the population of loan files the sponsors made available for our review. As of the second quarter 2014, with improved data availability, we no longer need to rely on the adverse sample approach. This change contributed approximately $123 million to the increase in our rep and warranty estimate. Underwriting and operating expenses for the three-months ended June 30, 2014 were $24 million, down $2.9 million from the three-months ended June 30, 2013. Expenses in the second quarter 2014 were lower primarily due to lower compensation related expenses.

Interest expense was $32 million in the second quarter of 2014, as contemplated by the amended Segregated Account rehabilitation plan the Rehabilitator will redeem certain Segregated Account surplus notes on December 22, 2014. The cash amount available for redemption of the Segregated Account surplus notes will be equal to 26.67% of the sum of par and accrued interest on such Segregated Account surplus notes, in each case outstanding as of July 20, 2014.

Such redemption will also trigger a similar proportion redemption payments on AAC's surplus notes. The redemption amount is estimated to be approximately $413.6 million, respective those surplus notes owned by third-parties. The redemption of surplus notes will result in a charge in the fourth quarter of 2014 representing the accelerated recognition of unamortized discount on the redeemed surplus notes. As of June 30, 2014, the unamortized discount on the portion of Segregated Account and AAC surplus notes expected to be redeemed is $79.3 million.

The provision for income taxes was a benefit of $2.2 million for the second quarter 2014. Second quarter 2014 income taxes consist primarily of a federal tax benefit of $2.6 million for a reversal of first quarter alternative minimum taxes, partially offset by a $500,000 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 June 30, 2014, the Company had $5.4 billion of US federal NOLs including $1.4 billion at Ambac and $4 billion at Ambac Assurance.

Net cash provided by operating activities was $133.8 million. The principal sources of Ambac's operating cash flows of gross installment premiums on insurance contracts and fees and credit default swap contracts, investment and coupon receipts, claim and reinsurance recoveries and RMBS subrogation recoveries. The principal uses of Ambac's liquidity are the payment of operating expenses, claim and commutation payments on both insurance and credit derivative contracts, seeded reinsurance premiums and tax payments. As discussed, the amended rehabilitation plan will to have adverse consequences to Ambac's future cash flows, as the payout ratio has increased as a consequence of the December payments.

During the second quarter of 2014, Ambac and the Segregated Account had net cash inflows in respect of policy claims of $82.7 million. This is primarily due to RMBS and other subrogation recoveries in the quarter of $169.6 million. Loss and loss expense payments for the quarter were $86.9 million, of which $51.3 million related to policies allocated to the Segregated Account as required by the Rehabilitator of the Segregated Account and $31.1 million related to Detroit claims. Segregated Account claim payments included 25% of permitted policy claims and supplemental payments as required by the rehabilitation plan.

To date, we have recognized $360 million in value from our rep and warranty subrogation efforts, including negotiated cash payments to Ambac and loan repurchases from RMBS trust. This amount which has been previously disclosed includes $95 million received in the second quarter, of which $90 million was previously reflected on our rep and warranty recovery estimate and $5 million of which was included in other subrogation. We remain committed to aggressively pursuing optimal risk-adjusted outcomes in our recovery efforts.

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 June 30, 2014 was $6.8 billion the largest asset classes in the portfolio were mortgage and asset backed securities including Ambac insured securities of $3 billion, corporate obligations of $1.9 billion and municipal bonds of $1 billion of which $530 million were tax exempt. In the second quarter 2014, we purchased $136 million of Ambac-wrapped RMBS, helping bring the fair value of Ambac insured RMBS and our portfolio to approximately $1.6 billion or 24% of the consolidated investment portfolio.

Of the $4.3 billion of Segregated Account deferred obligations at the end of the first quarter we owned approximately $674 million or 17%. The Financial Guarantee insurance portfolio net par amount outstanding declined 6.4% to $167.7 billion at June 30, 2014, from $179.1 billion at December 31, 2013. Much of this is attributable to the runoff of $7.6 billion of public finance net par. The breakdown of the insured portfolio by sector was virtually unchanged for the second quarter of 2014 relative to year-end 2013. Public finance was 65% of the total net par outstanding, structured finance was 17% and International was 18%. The general account represented 73% of the total net par outstanding unchanged from year-end. The Segregated Account decreased to 12% from 13%. Ambac UK increased to 15% from 14%.

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

(Operator Instructions)

Andrew Gadlin, Odeon Capital Group.

Question on the junior surplus note disclosure. Is anything there imminent? Or is that just a long-term opportunity?

We're actively considering the monetization of a portion of the junior surplus notes, so I would say it's active.

Is there an intention to fund a near-term acquisition? Is this a signal that there's something more imminent on that front?

Well, it's both a preparation and a reaction. Investors have shown interest in Ambac at various levels of the capital structure. We think that there are ways which involve the monetizing a portion of the junior surplus notes to both meet this interest and also increase AFG's financial flexibility.

Okay. In terms of the adjusted book value calculation which you provide, there's a larger charge of accumulated other comprehensive income. Can you talk about what went into that number this quarter?

Sure. The change in other comprehensive income is related to changes in the fair value of the Financial Guarantee -- mostly the Financial Guarantee investment portfolio. So it's not really a charge. It's just reversing out from the reported equity number, the mark-to-market on the investment portfolio. So as we've disclosed in the past, we historically have not included mark-to-mark unrealized gains and losses on the investment portfolio in the adjusted book value calculation.

What were the big pieces driving that mark-to-mark gain? Is that largely due to some of your own wrap policies where now you're accruing interest?

That's a large portion, is the Ambac wrapped securities. But we've seen general appreciation in all of our investment positions through the quarter. I wouldn't say that the accrual of interest on our own wrapped securities really contributed a significant change in the mark-to-market. As Diana mentioned and I mentioned in my comments, we've just overall seen an increase in the value of Ambac claims in the marketplace. That's reflected in the securities -- Ambac wrapped securities that we own.

Got it. Okay. Then could you just provide a little more detail on the difference between using the random versus the adverse sample approach in your litigation? Why you recognize that as a benefit?

Sure. Well, during the quarter, we obtained access to additional information in some of our cases that we're litigating. As a result of getting access to that information, we were able to apply the random sample approach.

Previously with regards to those specific cases, we didn't have access to a broad range of the loan files. Instead, we only had access to what we call adversely selected loan files, which is basically just loan files related to underlying defaulted loans.

So now that we have access to a broader set of loans, we can apply the random sample method, which we believe is statistically relevant and valid in terms of assessing what the breach rate is across the broader pool and gives us greater transparency into the ultimately to what we believe is the breach rate in the pool as opposed to a very limited adverse sample method.

Okay. Got it. All right. Thank you very much.

Sean Lobo, Vulcan Capital.

Just on the junior surplus monetization. First question that I'm interested in. If other investors are interested in this, do we just reach out to you directly, is that the process?

Well, as Diana said, this is something that we're actively discussing, but we really have nothing to say about in terms of process. That's something that if develops in the future, investors will hear about it at that time.

Got you. Then two, in the construct of a liability management transaction given you have no debt at the holdco, would this be for share buybacks? Can you help me get a better understanding what liability management --

Sorry. From a liability management standpoint, having additional liquidity at the holding company just gives us some additional flexibility to conduct liability management operations outside the regulatory framework of the insurance company.

Got you.

So, it would relate to liabilities at the insurance company.

Then, just last question, you used to previously provide sort of just high-level guidance on the rep and warranty? So the timing in aggregate in 2015 and 2016, will you bring that back at any sort of point in time? Or has that changed?

No, our general view of the rep and warranty timeframe is still relatively short. So I would think of it in context of over the next couple years.

Great. Thanks. Great result, guys. Thanks so much for your time.

(Operator Instructions)

Ben Clifford, Nomura.

I know you can't give specifics on the Capital One legal case, but I was just wondering, is there anything general you could go through in terms of mechanics of the deal, whether it's cash paid for losses you paid in the past? Or whether they're buying loans at the trust level or anything like that?

The only thing we can say is that the case was dismissed. We cannot provide additional color.

Okay. So the $90 million that you received in the quarter, in terms of rep and warranty, would that relate to that case? Or is that not something you can disclose?

That's not something we can disclose.

Okay. So the RMBS loss expense in the quarter was a positive development of $235 million. That includes a loss of $3 million to $7 million for the accrued interest on the DPOs, right?

No. That excludes the interest on DPOs.

Okay. Got you. All right. Final question, Ambac UK, is there anything -- any progress there in terms of maybe moving some capital resources out of that entity? Or maybe bringing some policies back over here? Or any commentary you can give?

Yes. As a shareholder, AAC is the sole shareholder of AUK. It is a very long-term prospect because AUK's obligations are very long tailed. There's really not sufficient capital to pull any out in the near or even medium-term.

All right. Thank you.

[Hondo San, Cadiz.]

Just wanted to follow-up on the RMBS loss expense category that was referenced earlier. The $234 million is a bit of a step-up from first quarter and certainly year-over-year. Was that purely due to the improving underlying RMBS pool? Or was there something else driving that? Or could you two break down a little bit more as to what drove that larger increase relative to the prior quarter year-over-year?

Okay. So that -- the $235 million is a benefit to us. So net basis, we have lower incurred losses on RMBS. There's really two main components of it. One is we talked about the improvement in rep and warranty recoveries. That is embedded in that number. That's -- figure that's about $150 million of that number. The rest is related to improved projections of cash flows on RMBS.

Got it. Okay. That's helpful. I appreciate it.

Sure.

I am showing no further questions in the queue and would like to turn the conference back to leadership for any further remarks.

Okay. Thank you. As there are no further questions, I'd like to thank everyone for joining us today. Have a good day.

Ladies and gentlemen, thank you for participating in today's program. This does conclude the meeting. You may all disconnect. Everyone, have a wonderful day.