Ambac Financial Group Inc (AMBC) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Ambac third-quarter 2014 conference call.

(Operator Instructions)

As a reminder this conference is being recorded. I will now turn the call over to your host, Abbe Goldstein, Head of Investor Relations and Corporate Communication. Please go ahead.

Thank you, Stephanie. Good morning and thank you for joining today's conference call to discuss Ambac Financial Group's third-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' 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 nine months ended September 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 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, and thank you for joining today's call. Results in the third quarter were driven by the ongoing disciplined execution of our strategy. Active management of or insured exposures led to a smaller insured portfolio, a decrease in adversely classified credits, and a release of reserves in the third quarter. Investment income increased driven by our proactive shift in investment portfolio allocations.

We continue to actively pursue RMBS representation and warranty recoveries. At the end of the third quarter we had five ongoing lawsuits with major counterparties and were in direct negotiations with others. Our strategy remains consistent. We will aggressively litigate these lawsuits and will settle only when we believe we can achieve a better risk-adjusted resolution than through continued litigation.

This quarter, in an effort to increase transparency, we are updating the status summary of our rep and warranty litigations. We are also introducing information on claims paid to date on all transactions that contribute to our rep and warranty subrogation credit.

With respect to buybacks and commutations, we continue to pursue transactions that derisk Ambac Assurance's portfolio. In the third quarter we purchased approximately $52 million of Ambac's insured RMBS.

On the commutation side, as we've said in the past, opportunities are lumpy, and in the third quarter we did not close any commutations. The higher pricing environment and concentrated holdings of large blocks of Ambac liabilities caused us to lower the probability of commutations in near term. Nevertheless, we continue to seek opportunities and are well positioned to execute transactions that maximize the value of Ambac Assurance.

On the servicing side, we currently have RMBS collateral underlying $4.5 billion of insured net par serviced by special servicers, which represents 31% of the RMBS book. We expect to complete additional servicing transfers in the fourth quarter. Additionally, we are also working with our student loan servicers to implement special servicing strategies along the lines of what's been successful in the RMBS sector to reduce student loan delinquencies and increase recoveries.

In addition to these value-creation initiatives, which we've discussed on all our prior calls, we are also considering the possibility of entering into transactions that monetize assets and transactions that restructure or exchange outstanding debt and insurance obligations. As market conditions and our own portfolio evolve, we continuously assess opportunities, both traditional and new, to maximize the value of Ambac Assurance.

I'll now turn to Puerto Rico where we are engaged in constructive discussions with the Commonwealth, particularly as it relates to the Puerto Rico Highway and Transportation Authority, or HTA. Legislation was recently introduced with the purpose of providing funding to operate Puerto Rico's highways and to put the HTA on a path toward long-term fiscal stability. Ambac supported the Commonwealth's efforts to address HTA's financial, operating and capital needs, and we believe the proposed legislation advances these goals.

Nevertheless, the situation in Puerto Rico remains dynamic with ongoing financial pressures and uncertainties. We believe our reserves are reasonably sized given the current situation, the overall size of our exposure to Puerto Rico, the interrelated nature of the credits, and the sluggishness of the economy. We incorporate these considerations as well as a variety of positive outcomes in developing our reserves.

Detroit's bankruptcy exit plan was approved last Friday and Ambac settlement of both our unlimited and limited tax GO exposures was finalized. The unlimited tax GO settlement represents 74% of Ambac's allowed claims.

The limited tax GO settlement represents 44% of Ambac's allowed claims and has two components. 34% is in the form of restructured limited tax GOs and 10% is a share in the city's long-dated limited tax GO B notes issued as part of its exit plan. Ambac continues to pay claims in full of scheduled principal and interest on the bonds we insure.

This quarter we have made a correction to our calculation of adjusted book value, a non-GAAP measure. This correction increased our ABB at yearend 2013 by $231 million. As a result, year-end adjusted book value was negative $50 million and the third quarter 2014 ABV is negative $65 million.

The correction relates to a single exposure at our subsidiary, Ambac UK. The Punch transaction was restructured in October but its restructuring had been expected for some time. The reserve that we booked for this deal in anticipation of the restructuring includes a large amount of foregone future premiums. These foregone premiums reduced GAAP stockholders equity.

Our ABV calculation starts with GAAP stockholders' equity and makes certain adjustments. One adjustment we make is to reduce stockholders' equity for premiums that are included in our GAAP numbers but that we don't actually expect to realize. We backed out premiums on this AUK deal even though a large portion of these premiums had already been eliminated from the starting number through the reserving process. So, we effectively reduced ABV twice for these foregone future premiums.

Importantly, our GAAP stockholders equity was correct for all periods. Through our reconciliation process we identified this flaw into ABV adjustment and we have now corrected it. The positive revision relates only to this one settlement. No other exposures were impacted. Revisions to ABV from prior periods are included in our operating supplement for the quarter, which is posted on our website.

As previously announced, effective on June 12, 2014, the rehabilitator increased the payout ratio of permitted claims of the segregated account from 25% to 45% starting on July 21. 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 ratio, we will make a catch up payment of 26.67% of the deferred amounts that were 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.

In October, we requested and received approval from the Wisconsin Insurance Commissioner to redeem a portion of the surplus notes a month earlier than initially expected. The earlier redemption will save us about $1.8 million in interest that would have otherwise been paid to third parties. The catch up payments and redemptions are expected to exceed $1.5 billion in aggregate.

On August 28, we closed a private placement which monetized about 80% of the segregated account junior surplus notes held by Ambac, for net proceeds of $224 million. We also retained a 20% interest through subordinated owner trust certificates. The monetization of our junior surplus notes provides the Company with the financial flexibility to support our initiatives and enhance shareholder value. Potential uses of proceeds include growth and diversification through acquisitions that leverage our key competencies, and liability management at Ambac Assurance.

Before I turn the call over to David for our financial review, I would like to address the question we have received from many of you about a share repurchase program. After careful consideration by the Board and the management team we have decided not to implement a share repurchase program at this time. We continuously analyze the uses of our liquidity in context of our funding needs and relative value opportunities to enhance shareholder value.

Separately, a share repurchase program could move us closer towards triggering a change of control of Ambac for tax purposes. If triggered, we would lose most of our NOLs. Therefore, we would need to proceed carefully if we do decide to repurchase shares in the future.

I'd now like to turn the call over to David for a financial review.

Thank you, Diana. Net income for the third quarter 2014 was $82.5 million or $1.77 per diluted share compared to $231 million or $4.98 per diluted share in the same period last year. Operating earnings in the third quarter 2014 were $142.7 million or $3.06 per diluted share compared to $193.4 million or $4.17 per diluted share in the same period last year.

Net income and operating earnings declined in the third quarter 2014 compared with the third quarter 2013, primarily because of a lower benefit for loss and loss expenses and lower derivative product revenues, partially offset by higher net investment income and lower other than temporary impairment losses. Net income was also impacted by lower income from VIEs.

For the third quarter 2014, net premiums earned was $64.8 million as compared to $70.9 million in the third quarter 2013. Normal net premiums earned in the third quarter 2013 were negatively impacted by approximately $13 million of premiums deemed uncollectible, primarily in the structured finance sector.

Accelerated premiums for the third quarter 2014 were $9.2 million as compared to $19.7 million in the third quarter 2013, including negative accelerations of $1.7 million and $0.2 million, respectively. Although the impact of accelerations is down versus prior periods, the deal volumes called in the public finance market has slowed minimally.

Net investment income for the third quarter 2014 was $83.6 million as compared to $52.1 million for the same period last year. Net investment income for the third quarter primarily reflected the growing allocation of the financial guarantee investment portfolio towards distressed Ambac-insured securities, a higher allocation to corporate obligations and positive cash flow from operations. These favorable dynamics were partially offset by sales of securities beginning in August and September to fund the $1.5 billion of rehabilitation payments to be made in November and December. Investment income will be negatively impacted in the fourth quarter from these liquidations.

The gain related to the change in fair value of credit derivatives for the third quarter of 2014 was $7.4 million compared with a gain of $31.2 million for the same period last year. The change in fair value of credit derivatives for the third quarter 2014 reflected more modest improvement in reference obligation prices and slower run-off of the portfolio than the third-quarter 2013.

Credit derivatives fees earned continued to decline with the size of the portfolio, which was $2 billion as of September 30, 2014 compared to $5.2 billion as of September 30, 2013. The impact of incorporating the Ambac CVA resulted in losses within the overall change in the fair value of credit derivative liabilities to $0.2 million for the three months ended September 30, 2014 compared to $3.4 million for the three months ended September 30, 2013.

Net losses reported in derivative product revenue for the third quarter were $15.7 million versus a net gain of $12.4 million in the same period last year. Results in derivative products' revenue reflected mark-to-market gains or losses in the portfolio caused by changes in 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 gains within derivative product revenues of $4.6 million for the third quarter of 2014 compared with losses of $1.1 million for the same period last year.

Income on VIEs for the third quarter 2014 was $9.1 million compared to $55.1 million in the third quarter 2013. Income on VIEs for the third quarter 2014 was primarily related to increases in fair value of VIE assets, along with a decrease in fair value of certain VIE note liabilities caused by the slight CVA increase. Income on VIEs for the third quarter 2013 was primarily related to the impact of an increase in the Ambac CVA on the fair value of certain VIE note liabilities that included significant projected financial guarantee claims.

Loss and loss expenses for the third quarter 2014 were a benefit of $28.7 million as compared to a benefit of $154.3 million for the third quarter 2013. The third quarter 2014 benefit was driven by positive credit development and active portfolio management, resulting in lower estimated losses in international, domestic public finance, student loans and other structured, which were somewhat offset by slightly higher estimated losses in residential mortgage-backed securities, as well as $51.7 million of interest expense on deferred amounts.

Excluding interest on deferred amounts, incurred losses were a benefit of approximately $80.4 million. Interest on deferred amounts was not a component of last year's numbers as the amended rehabilitation plan had not yet been implemented.

Reduced international losses were the result of the previously mentioned negotiated refinancing of Punch, a distressed transaction insured by Ambac UK. Domestic public finance improved slightly with no significant changes in Ambac's credit views.

Puerto Rico reserves were down slightly due to amortization in the quarter, as were reserves for Detroit following greater clarity on the negotiated settlement terms. Other structured exposures improved due to favorable developments on a private structured insurance transaction.

In addition, student loan exposures benefited from lower interest rates, improved performance of underlying student loans, and improved restructuring prospects for one transaction. RMBS estimated losses in the third quarter 2014 were driven by lower projected losses in second lien RMBS, which were more than offset by a combination of higher estimated losses in first lien RMBS and a decrease in estimated rep and warranty subrogation recoveries, the latter of which stemmed from the improvement in second lien RMBS projected losses.

Gross loss and loss expense reserves were $5.5 billion at September 30, 2014 and $5.6 billion at June 30, 2014. Reserves as of September 30 and June 30 are net of $2.2 billion and $2.3 billion, respectively, of estimated rep and warranty subrogation recoveries.

For policies which is have estimated rep and warranty subrogation recoveries as of September 30, 2014, Ambac had estimated ultimate losses of $4.5 billion, which include paid claims net of recoveries received of $1.8 billion and a discounted value of future expected claim payments of $2.7 billion. Future expected claim payments include deferred amounts and accrued interest on deferred amounts of $1.9 billion and $166 million, respectively.

Ambac Assurance is actively pursuing remedies in enforcing its rights through lawsuits and other methods to seek reimbursement for breaches of rep and warranty for fraud related to the RMBS transactions. As of September 30, 2014 approximately $4.4 billion of total deferred amounts, inclusive of accrued interest payable of $360 million, remain unpaid. The aggregate amount of equalizing payments scheduled for December 22, 2014 for deferred amounts is estimated to be approximately $1.1 billion.

Underwriting and operating expenses for the third quarter 2014 were $25.5 million compared to $25 million for the third quarter 2013. Expenses increased year over year, in part due to approximately a $1 million variance in premium taxes related mostly to one Ambac UK policy and the write-off of uncollectible premiums in the third quarter of 2013. Additionally, lower compensation costs in the third quarter 2014 were driven by several factors including changes to headcount and retiree benefits.

Interest expense was $31.8 million for the third quarter 2014, unchanged compared to the third quarter 2013. Interest expense includes accrued interest on investment agreements and surplus notes. Additionally, interest expense includes discount accretion on surplus notes as their carrying value is at a discount to par.

Subsequent to the monetization of the junior surplus notes they are now reflected as debt on our balance sheet along with other surplus notes. The increase in interest expense from the junior surplus notes monetized in August 2014 was offset by lower discount accretion on a portion of the previously outstanding surplus note liabilities and run-off of the investment agreement portfolio.

As contemplated by the amended segregated account rehabilitation plan, the rehabilitator will redeem certain segregated account surplus notes on November 20, 2014, approximately one month earlier than initially anticipated. As Diana mentioned the early redemptions avoid $1.8 million of interest cost. The redemption amount payable to third parties is $413.6 million.

The redemption of surplus notes will result in a charge representing the accelerated recognition of the unamortized discount on the redeemed surplus notes. As of September 30, 2014, the unamortized discount on a portion of the segregated account and Ambac Assurance surplus notes expected to be redeemed is $75.5 million.

Provision for income taxes was $2.3 million for the third quarter 2014 compared to $0.6 million for the third quarter 2013. Third-quarter 2014 income taxes consist primarily of 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 September 30, 2014 the Company had $5.3 billion of US federal NOLs including $1.2 billion at Ambac and $3.9 billion at Ambac Assurance.

Net cash provided by operating activities was $86.1 million for the third quarter of 2014. The principal sources of Ambac's operating cash flows are installment premiums on Assurance contracts, fees on credit default swaps, investment coupon receipts, claim and reinsurance recoveries, and subrogation recoveries.

The principal uses of Ambac's liquidity are the payment of operating expenses, claim and commutation payments, loss for mediation expenses, seated reinsurance premiums, and tax payments. As discussed, the amended rehabilitation plan will have an adverse consequence to Ambac's future cash flows as the payout ratio has increased, and as a consequence of the November redemptions and December payments.

During the third quarter of 2014, Ambac and the segregated account made net cash payments in respect of policy claims of $5.6 million. Loss and loss expense payments for the quarter were $81.3 million, including $27.8 million of supplemental payments, almost all of which were related to policies allocated to the segregated accounts. Subrogation recoveries in the quarter were $75.7 million.

With respect to our investment portfolio our goals remain maximizing risk-adjusted investment returns subject to maintaining the quality and diversification of the book, and insuring that we have sufficient liquidity to honor our payment obligations as they arrive. The fair value of the consolidated investment portfolio as of September 30, 2014 was $7.1 billion. The largest asset classes in the portfolio were mortgage- and asset-backed securities, including Ambac insured securities of $3 billion, corporate obligations of $1.8 billion and municipal bonds of $0.9 billion, of which $495.8 million were tax exempt.

In the third quarter 2014, we purchased $52 million of Ambac wrapped RMBS, helping bring the fair value of Ambac-insured RMBS in our portfolios to approximately $1.6 billion, or 23% of the consolidated investment portfolio. Of the $4.4 billion of segregated account deferred amounts at the end of the third quarter we own approximately $685 million or 17%.

Financial guarantee insurance portfolio, net par amount outstanding, declined 6% to $157.4 billion at September 30, 2014 from $167.7 billion at June 30, 2014. Much of this is due to the run-off of $6.8 billion of public finance net par. Adversely classified credits of $28.8 billion decreased by $2.3 billion with 7% compared to June 30, 2014. The breakdown of the insured portfolio by sector was virtually unchanged for the third quarter 2014 relative to June 30, 2014.

Public finance was 65% of the total net par outstanding, structured finance was 17%, international was 18%. The general account represented 73% of total net par outstanding, unchanged from June 30, 2014. The segregated account remained 12% and Ambac UK unchanged at 15%.

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

(Operator Instructions)

Our first question comes from Andrew Gadlin with Odeon Capital Group.

Good morning. I wanted to ask a question about a line in the 10-Q for the first time -- as part of the asset liability management strategy, Ambac would consider entering into transactions where it would monetize assets and restructure, exchange, et cetera. Can you talk a little bit about what you're contemplating there?

Sure, we can talk a little bit about it. We wanted to make this disclosure but we are still in the early stages of the consideration process, so we're not prepared to share too much information. But we're looking at the potential to monetize assets, as we said, or possibly exchange or restructure past due claims or claims-like liabilities for other non-claims liabilities.

The goal, of course, would be to further derisk Ambac Assurance, which is, of course, the goal for all of our asset liability management initiatives. It would simplify the capital structure. And ultimately we're seeking to rehabilitate the segregated account.

Any idea on timeline for that?

Like I said, it's early stage and these things can be complicated so it could take some time. But it's a little early to be more precise than that.

Got it. And anything would involve the regulatory approval, correct?

Yes, it would, and our regulators are aware of these efforts. We've been working in coordination with them.

Got it, thank you. One more question on the disclosure about reps and warranty and ultimate losses. It looks like there's embedded in there an assumption of future losses of approximately $650 million?

That's approximately right, Andrew.

Okay. So, if I compare that to the numbers on page 10 of the operating supplement where you present estimated future gross RMBS claims, it looks like some of the policies here where you're pursuing full recovery represent one-third of your total expected future RMBS claims.

That's about right.

Okay, so hopefully if you're successful you could wipe out about as much as one-third of the future gross claims.

That's certainly one way of looking at it. The other way of looking at it is, at this point, our rep and warranty subrogation receivable exceeds all of our future expected claim payments out of the RMBS book.

Got it. Okay thank you very much.

(Operator Instructions)

Our next question comes from Ben Clifford with Nomura Securities.

Yes, first question. In the rehabilitator's 2013 annual report released in May, the yield to maturity of the RMBS securities in the AAC investment portfolio was 30%. I don't know if you can quantify or explain the assumptions behind the 30% yield number, whether it includes DPO payments in the future, et cetera?

Sure. It's very hard for us to respond to disclosures that the rehabilitator has made because not all those disclosures are necessarily calculated or consistent with our own disclosures, and the assumptions underlying those disclosures may be different than ours. But at the point in time in which that disclosure was made, the general approach to calculating yields on underlying RMBS securities had incorporated the concept of receiving surplus notes in the future.

And since the amended rehabilitation plan went into place, the method for calculating yields and cash flows on RMBS that are insured by Ambac has, of course, changed to contemplate the payment of DPOs and accrued interest on those DPOs as opposed to the receipt of surplus notes in the future. So, there has been some calculation differences that I presume that the rehabilitator would also reflect in his reserves or his calculations going forward.

Right. And if you were to ballpark maybe a yield number for your owned RMBS policies in your book, is there any way to quantify that?

In our disclosures in the operating supplement on a GAAP basis, we have a line item there that is Ambac-insured loss mitigation strategy bonds where we have a current pretax yield maturity of 10.6% on a GAAP basis. And to be clear, that includes both RMBS and the large block of student loans that we acquired back in the first quarter of 2014.

And does that include DPO payment, owned DPO payments, as well?

Yes, it does.

Okay. And, second question, you mentioned in this call and past calls that other than the five major rep and warranty cases, your direct negotiations with other parties. I don't know if you can talk about what kind of cases or what kind of recoveries you're pursuing there?

No, we can't. We don't comment on those items.

All right. And the last question, on your website, under the supplemental payments tab, you've been making substantial payment to the Chevy Chase Trust over the past four or five months. I don't know if that's something that you can explain what the rationale is behind making those payments?

The rationale behind all of our supplemental payments is really just an economic one. As you know, each RMBS security, or many RMBS securities, have very unique and different waterfall and other features and structural features. There are certain obligations that the Company has whereby we can maximize our ultimate subrogation recoveries, such as excess spread, by making incremental payments on those securities.

So, with the Chevy Chase and others that are listed on our website, by actually making supplemental payments we're actually maximizing the recoveries that we get from those securities. So, our decision whether to pay supplemental payments, which is done in conjunction with the rehabilitator, is purely an economic one, and one that maximizes and preserves the subrogation assets that we have on our balance sheet.

Okay, thank you.

Our next question comes from Sean Lobo with Vulcan.

Hi, good morning guys. Thank you for the incremental disclosures in the earnings presentation. As it pertains to excess spread, can you give us the magnitude of what [scope] may be? Is it hundreds of millions of dollars or something smaller?

Sorry, you broke up a little bit. I didn't quite get the full question.

Yes, can you help us quantify the total amount of excess spread you're modeling?

Sure. In our 10-Q, we have a table that outlines that. As of the end of the third quarter -- this is on page 25 of the Q -- the subrogation, which is mostly excess spread but there are other forms of subrogation that's included here, on a PV basis is about $667 million, $668 million.

And then we continue to see the excess subrogation going lower and reserves are getting released. Can you help us understand the modeling discrepancies there?

The subrogation here has gone lower as we collect on subrogation recoveries, so that we're monetizing on that asset effectively. And as you do that, since the subrogation is an offset to loss reserves, it's a contra liability, as you turn that contra liability into cash, your reserves would increase as a result at the same time you have the cash on your balance sheet. So, the net impact would be zero.

Got it. You previously disclosed I believe, off the top of my head, the number is $2.4 billion for rep and warranty litigation, but in your presentation you have $2.2 billion. Can you explain the delta?

This quarter, the change in rep and warranty recoveries primarily related to the lower expected losses in the second lien RMBS portfolio. So, as our future view of losses changes, our rep and warranty subrogation recovery had to change in line with that. So, we had a rather significant decline in second lien losses in the quarter, and because we expect to pay less losses, we also expect to receive less in subrogation.

That's very helpful. As an investor, then, how do I think about the fact that two of your lawsuits are no longer on the website and your rep and warranty litigation has gone lower?

Sorry, what was the first part of that question?

Two of your lawsuits are no longer on the website. Can you comment on those?

I think you're referring to Capital One and --?

Credit Suisse last year.

Credit Suisse. And I think we've commented in the past that Capital One case was dismissed, as was the Credit Suisse case. And that's all we can say about those cases at this time.

Got it. Thank you very much for your time.

I'm showing no further questions. I will now turn the call back over to Diana Adams for closing remarks.

Okay, I just want to thank everyone for joining us today. Have a good day.

Thank you.

Thank you, ladies and gentlemen. That does conclude today's conference. You may all disconnect. And everyone have a great day.