Ambac Financial Group Inc (AMBC) 2015 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Ambac Financial's First Quarter 2015 Conference Call.

(Operator Instructions)

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

Thank you, Amanda. Good morning, and thank you all for joining today's conference call to discuss Ambac Financial Group's First-Quarter 2015 Financial Results.

We'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 most recent SEC-filed quarterly or annual report under Management's Discussion and Analysis of Financial Condition and Results of Operation and under Risk Factors. Ambac is not under any obligation, and expressly disclaims any obligation, to update any forward-looking statement, whether as a result of new information, future events, or otherwise.

Today's presentation contains non-GAAP financial measures. The reconciliations of such measures to the most comfortable GAAP figures are included in our earnings press release, which is available on our website at Ambac.com. Please note we have posted slides on our website to accompany this call. Our speakers today are Nader Tavakoli, Interim President and CEO; and David Trick, our CFO. At the conclusion of their prepared remarks we will open the call to your questions. I would now like to turn the call over to Mr. Tavakoli.

Good morning. Thanks Abbe, and thank you all for joining us for today's call. As we said in our press release last night, the first quarter was a very successful one for Ambac. We achieved quarterly operating earnings of nearly $250 million, or more than $5 per diluted share.

Since emerging from Chapter 11, Ambac has now achieved aggregate operating earnings of $1.6 billion. David Trick will elaborate on the quarterly performance in detail after my comments.

In addition to our positive financial performance, we made significant progress in the first quarter towards positioning the Company to better address several important mandates, if we're to successfully maximize the value of AAC, complete the rehabilitation of the segregated account, and create an environment for significant and sustainable shareholder value. We are doing this by making sure we have the best processes and people internally and externally to accomplish our near-term goals, with the appropriate sense of urgency, dedication, and commitment.

Our near-term mandates include aggressive and vigilant pursuit of our RMBS cases, early and active engagement in risk and loss management, optimizing our corporate structure and organization given our changing needs, building on our constructive relationship with our regulator, expense management and efficiency, strategic capital allocation and management, and transparent shareholder communication. I will speak briefly about some of these important initiatives.

With regard to our rep and warranty litigation, we are re-doubling our focus on proceeding with these cases as quickly as possible toward trial. Our litigation teams have been instructed accordingly. As we have said previously, we are confident in the strength of our cases, are represented by the leading law firms in this area, and will not sell our shareholders short in zealously prosecuting these important claims.

We're also confident in our right to ultimately receive interest on our losses. The delays in the proceedings are at the defendants' risk and expense.

Early this month we filed a motion for partial summary judgment in our first Countrywide case, and we have what we hope is a firm day of July 15 for the argument on that motion before Judge Branston. We anticipate filing for summary judgment on our JPMorgan EMC cases by early 2016.

As it relates to our insured book generally, our exposures continue to run off, and we are actively looking for ways to further de-risk the book. During the quarter, the overall book declined by another 5% to $137 billion.

Importantly, our troubled credits continue to shrink, and we commuted a large amount of our student loan exposure at a very attractive price. As a result of this and other factors that David will detail, we were able to reduce our gross loss reserves materially from $3.8 billion to $3.5 billion.

In risk and loss management, we're stressing the importance of early recognition of and intervention in problem exposures. As we identify potential problems, we aggressively pursue plans to manage and mitigate any potential losses. We're evaluating every area of our insured book to ensure we have not overlooked potential problems, and to optimize and de-risk our portfolio where possible.

As it relates to our significant exposure to Puerto Rico, we've previously disclosed our exposures in detail, and have updated the disclosures today. In the aggregate, we have $2.4 billion net par exposure. In our disclosures, contrary to some recent reports, we provide a schedule of principal and interest by bond type and by year for each of our exposures to Puerto Rico.

Importantly, as most of you are aware, we have absolutely no exposure of PREPA, the troubled electric utility that's the subject of most of the current restructuring discussions in Puerto Rico. We also continue to believe that notwithstanding the recent failure of the VAT tax proposal, the commonwealth and its citizens are far better served meeting their obligations than considering any default or restructuring possibilities.

Having said that, I'd like to highlight a couple of our key exposures, namely HTA and COFINA. With respect to HTA, the Highway and Transportation Authority, we have $712 million in net par exposure.

With the recent passage of the petroleum excise tax, we have improved our outlook on HTA. Pursuant to this recent legislation, a statutory lien will arise for the benefit of the HTA bondholders as soon as $1.2 billion is raised via periphery funding bonds. The statutory lien becomes valid and enforceable against any third party automatically, without the need for recording or taking possession of the funds, subject only to the constitutional geo priority.

Until the refunding periphery bonds are repaid, the Puerto Rico Treasury will be required to deposit the proceeds of the tax directly with the trustee or representative above the bondholders, up to the amount required to meet obligations under the bond documents. To the extent the GDB or another instrumentality of the commonwealth obtains the tax proceeds prior to the refunding periphery bonds being paid off, the tax proceeds must be transferred to the trustee or representative of the bondholders, and pending such transfer, are deemed to be held in trust and without any rights to set off by the GDB or other Puerto Rico instrumentality.

With respect to COFINA, we have $805 million of net par exposure. We expect the Act 91 structure, which protects COFINA's legal structure, to withstand any challenges. Act 91 includes the establishment of a dedicated sales fund, where first receipts of the sales tax are deposited for the benefit of bondholders, the granting of the deposited funds a lien, and importantly, the funds in the dedicated fund for the benefit of COFINA are exempt from claw-backs.

We believe strongly that the COFINA bondholders have clear property rights to the segregated sales tax revenues, and any attempt to impair those rights would violate the contracts and taking clauses of the US Constitution. Indeed, we're highly confident that in the event of a permanent impairment of the commonwealth's dept, the COFINA takings clause position is stronger than that of the geo bondholders.

I would also remind you that our COFINA exposure is as to PNI. There is no possibility of acceleration, and the first possible payments would not be due until 2047.

Although we are confident that our Puerto Rico positions are relatively solid, want to be prepared for and involved in any outcome. Towards that end, we've assembled a world-class team of professionals in Washington, New York, and Puerto Rico to actively monitor the situation in Puerto Rico, and as a result we have a strong voice in the various discussions taking place toward a possible resolution of the common loss difficulties.

Our access to decision makers and involvement in possible outcomes is second to none. For example, we were constructively and actively involved with legislators to favorably amend the petroleum tax, and we want to be sure that we're aware of all the possible actions that could affect our exposures on the revenue streams attached to our bonds.

We have made it very clear that we will not tolerate any actions that might impair our interests. As many of you know, I've spent a good deal of my career in the restructuring and workout arena, and while our ability to ultimately control absolute outcomes in Puerto Rico may be limited, we will make every effort to ensure that from a relative perspective, will not be short-changed.

On the asset management front, we had a very successful quarter overall. We continue to focus on leveraging our resources to maximize AAC's value towards the goal of a successful rehabilitation of the segregated account. During the quarter, we purchased another $204 million of our Ambac-insured RMBS. As we go forward, effective allocation of our assets to match the needs of the Company as it relates to the nature and duration of our potential losses will be paramount.

In expense management, we're also re-doubling our efforts towards efficiency. We have centralized our vendor management processes, and are using third parties as necessary to review and negotiate vendor relationships and invoices. Over the last few weeks we've reviewed material expenses (technical difficulty) our corporate structure to ensure that we appropriately adjust to our changing needs, and that we're as effective and efficient as we can be.

Overall, as I've said before, we're very focused on maximizing the value of AAC, and bringing the rehabilitation of the segregated account to a successful conclusion. We feel a strong responsibility to satisfy AAC's overdue obligations to its policyholders, so long as that can be done prudently and to the satisfaction of our regulator.

Towards that end, we continue to build on the constructive relationship we've developed with our regulator. Ending the rehabilitation would allow the Company to take greater control over its liabilities and assets towards enhanced returns. Given the very long duration of much of our exposures, incremental positive changes on the investment side of the book will have a profound impact on the Company's ability to meet claims and generate excess value over the long term.

As part of our asset liability management strategy, AAC continues to consider the possibility of entering into transactions, whereby we would monetize certain assets and/or restructure or exchange outstanding surplus notes and deferred obligations, with the objective of ending the rehabilitation proceeding. To that end, we're conducting discussions with the rehabilitator as well as certain surplus note and policyholders, and other potential participants.

Successful completion of the rehabilitation will convey renewed confidence by the Company to its employees and the external community about its future prospects. Achieving this goal will be challenging, but we are hopeful we can get there this year.

While we pursue the goals of AAC, we're also very focused on the future of AFG. We continue to explore opportunities to deploy AFG's resources strategically, both within the AAC capital structure and otherwise. We believe there's tremendous value in leveraging our core competencies and in-house expertise, which include among other things, credit analysis, underwriting, risk and asset management, municipal finance, and real estate. We're actively exploring ways in which we can combine our existing resources and expertise with business development possibilities. One said possibility may be around our real estate owned assets.

In closing, I am pleased with our progress in the quarter. I would like to thank our Board of Directors, who has continued to lead the Company with foresight and vision under challenging circumstances. I would also like to thank the many dedicated employees of Ambac, whose commitment and resilience has helped the Company get through some very dark days. I am confident that with our continued hard work and our Board's continued leadership, Ambac is well positioned to satisfy its policyholder claims and prosper in the years to come.

I will now turn the call over to David for a financial review before returning to answer your questions.

Thank you, Nader. Before I review our financial results, I want to point out that we have -- we are now reporting our quarterly results on a sequential basis rather than on a year-over-year basis. We believe this presentation is more relevant for now with respect to analyzing results and trends.

Net income for the first quarter of 2015 was $214.7 million, or $4.57 a diluted share, compared to $453.6 million, or $9.73 a diluted share for the fourth quarter of 2014. Operating earnings for the first quarter of 2015 were $247.6 million, or $5.27 per diluted share, compared with $476.6 million, or $10.22 per diluted share for the fourth quarter of 2014.

A lower benefit for loss and loss expenses had a meaningful impact on net income and operating earnings. The first quarter 2015 benefit for loss and loss expenses of $151 million was mostly driven by the impact of a student loan computation, lower future expected losses on student loans and RMBS, and modestly higher estimated representation and warranty recoveries.

The higher benefit in the fourth quarter of 2014 included $389 million gross of reinsurance related to an increase in the estimated rep and warranty recoveries, and favorable loss development across the majority of sectors. First quarter 2015 results were also positively impacted relative to fourth quarter of 2014 by higher premiums earned, net investment gains, and derivative product revenue, while the fourth quarter of 2014 included a loss on the partial redemption of surplus notes.

Adjusted book value was $479 million, or $10.64 per share as of March 31, 2015, as compared to $337.4 million, or $7.50 per share at year end 2014. The $141.6-million adjusted book value increase was driven by operating earnings.

For the first quarter of 2015, net premiums earned were $65.7 million, as compared to $34 million in the fourth quarter of 2014, including accelerations of $22.9 million and a negative $12.3 million, respectively. Normal premiums earned were impacted by the natural and accelerated run-off of the insured portfolio. The first quarter of 2015, accelerated premiums earned primarily related to public finance activity, which included calls related to one large exposure, and insured bonds underwritten primarily in 2005 and earlier.

Accelerated premiums earned in the fourth quarter of 2014 were adversely impacted by the October 2014 Punch Taverns refinancing, which resulted in $34.7 million of negative accelerated earnings.

Net investment income for the first quarter of 2015 was $73 million, as compared to $66.5 million for the fourth quarter of 2014. Net investment income for the first quarter of 2015 benefited from stronger performance in the trading portfolio.

Included in financial guarantee net investment income were marked-to-market gains on invested assets classified as trading of $7.8 million, compared to $1.2 million in the fourth quarter of 2014. The majority of these trading assets reside in Ambac UK, and include equities, leveraged loans, property, and hedge funds.

Excluding trading securities, net investment income from the financial guarantee investment portfolio was flat, as higher yields on, and a greater allocation to, AAC insured securities offset the impact of fourth-quarter liquidations to fund the partial redemption of surplus notes in November 2014, and the equalizing payment of deferred amounts in December 2014. The derivative products portfolio is positioned to generate gains in a rising interest rate environment, in order to provide an economic hedge against the impact of rising rates within the financial guarantee insurance and investment portfolio. Net losses reported in derivative products revenue for the first quarter of 2015 were $37.8 million, versus $63.6 million in the fourth quarter of 2014.

Results in derivative products revenue reflect net marked-to-market losses in the portfolio caused by changing interest rates, net of the impact of incorporating the Ambac CVA. Conclusion of the Ambac CVA and the valuation of financial services derivatives resulted in gains within derivative product revenue of $12.6 million the first quarter of 2015, compared with gains of $16.1 million for the fourth quarter of 2014.

The first quarter of 2015 benefit for loss and loss expenses of $151 million was driven by the impact of a student loan [computation], lower future expected student loan and RMBS losses, and modestly higher estimated representation of warranty recoveries, partially offset by $39.9 million of interest expense on deferred amounts, and higher loss and loss expenses and domestic public finance. The RMBS benefit of $101.3 million in the first quarter of 2015, excluding $39.7 million of interest expense in deferred amounts, was driven by a decrease in forward interest rate projections, contributing to additional future excess spread, and an increase of $44 million to Ambac's estimated rep and warranty subrogation recoveries.

The student loan loss and loss expense benefit of $109.4 million in the first quarter of 2015 was primarily driven by the commutation of $254.3 million of student loan insured exposure, the impact of lower interest rate projections, and an updated forecast of future losses. Loss and loss expenses of $27.1 million related to domestic public finance in the first quarter of 2015 were primarily due to increases in reserves for Puerto Rico and Las Vegas monorail. During the quarter, reserves shifted amongst Puerto Rico exposures, resulting in a small net aggregate increase.

The increase in Las Vegas monorail reserves was due to adjustments made with regard to the outlook for incremental commutations of this exposure. It is partially a function of the nature of the remaining owners of these bonds. AMBAC UK loss and loss expense benefit of $9.1 million primarily resulted from positive interest rate driven loss development, and a structured insurance transaction, partially offset by foreign-exchange charges, given that this policy is denominated in a currency other than AUK's functional currency.

During the first quarter of 2015, net claims and loss expense payments net of reinsurance from all policies were $104.2 million, which included $175.6 million of losses paid, and $82.4 million of subrogation received. Losses paid in the first quarter of 2015 included payments related to a partial commutation of a student loan exposure, a special payment related to an RMBS transaction, as well as recurring RMBS claims.

For the second quarter in a row, RMBS subrogation received exceeded RMBS claims recorded. During the fourth quarter of 2014, net claim and loss expense payments net of reinsurance from all policies were $1.1 billion, which includes a $1.1 billion of equalizing cash payments of deferred amounts.

Gross unpaid claims increased modestly by $28 million to $3.3 billion as of the end of the first quarter. In the first quarter of 2015, deferred interest accruals were somewhat offset by special payments and deal recoveries, resulting in only a modest increase in deferred amounts. Gross loss and loss expense reserves, gross of reinsurance and net of subrogation recoveries, were $3.5 billion at March 31, 2014, and $3.8 billion at December 31, 2014.

The decline in loss and loss expense reserves resulted from the payment of claims, the student loan commutation, higher estimated rep and warranty and subrogation recoveries, and lower projected losses from RMBS, student loan, and Ambac UK, partially offset by modestly higher ( technical difficulty) March 31, 2015, and December 31, 2014, were net of $2.568 billion and $2.523 billion, respectively, estimated rep and warranty subrogation recoveries. The increase in estimated rep and warranty subrogation recoveries is a result of our ongoing assessment of the value of these claims.

Underwriting and operating expenses for the first quarter of 2015 were $24.5 million, compared to $26.1 million for the fourth quarter of 2014. Expenses decreased primarily due to lower compensation expenses related to severance costs.

Interest expense was $27.9 million for the first quarter of 2015, compared to $31.4 million in the fourth quarter of 2014. Interest expense includes accrued interest on investment agreements, and surplus notes issued by AAC and the segregated account.

Additionally, interest expense included discount accretion on surplus notes, as their carrying value is at a discount to par. The decrease in interest expense in the first quarter of 2015 was largely the result of the lower surplus note balance outstanding following the November 2014 redemption.

At March 31, 2015, the Company had $4.9 billion of US federal NOLs, including $1.4 billion at AFG and $3.5 billion at AAC. Any future taxable income of AAC will be subject to annual payments by NOL usage tier, after certain credits and any additional post-determination date NOLs, under its NOL tolling agreement with Ambac. A credit is available to offset the first $5 million of payments due under each of the NOL usage tiers A, B, and C.

By March 31, 2015, AAC fully utilized its Tier A credit, and accrued approximately $1.3 million of towing payments. Towing payments, if any, accrue quarterly, and are paid in the second quarter following the year in which they are generated. Although AAC has utilized all of its current post-determination-date NOLs, additional post-determination-date NOLs may be generated in the future.

The fair value of the consolidated investment portfolio as of March 31, 2015, was $5.5 billion, virtually unchanged compared to the value at December 31, 2014. During the first quarter of 2015, Ambac purchased $204 million of insured RMBS. The fair value of AMBAC-insured RMBS in our consolidated portfolio was approximately $1.8 billion, or 32%.

Notably, the majority of the purchases in the first quarter of 2015 went through privately negotiated transactions versus dealer activity, a trend we have mentioned before. As the market for our insured RMBS has shrunk, direct purchases of securities have allowed us to achieve the scale needed to fulfill our portfolio objectives.

Of the $3.3 billion of segregated account deferred amounts at the end of the first quarter, we now own a total of approximately $766 million, or 23.4%, including accrued interest. The $118-million increase from $648 million, including accrued interest at December 31, 2014, was due to purchases in the quarter, offset by net pay-downs from the receipt of December equalizing payments in January, and shifting of deferred amounts between tranches of transactions we own, stemming from improved collateral performance.

The financial guarantee insurance portfolio net par amount outstanding, declined 5% to $136.8 billion at March 31, 2015, from $144.7 billion at December 31, 2014. Much of this is due to the run-off of $5.4 billion of public finance net par, especially related to insured bonds underwritten in 2005 through 2007.

This run-off is consistent with market activity, whereby attractive municipal bond market conditions are driving heavy refundings and collectivity. Adversely classified credits of $25.5 billion decreased by $1 billion, or 4%, compared to December 31, 2014.

As of March 31, 2015, and December 31, 2014, AAC's surplus as regards to policyholders is at the minimum surplus amount of $100 million. As a result, $26.2 million and $149.5 million of desegregated accounts liabilities were not assumed by AAC under the reinsurance agreement between AAC and the segregated account.

AAC's policyholder surplus was adversely impacted by the partial redemption and reclassification of surplus notes. Other than junior surplus notes, both AAC and the segregated account from policyholder surplus to a liability in the fourth quarter of 2014. This change was because of the treatment of surplus notes in the amended plan of rehabilitation, which requires the notes to be redeemed proportionately when the segregated account makes payments on deferred amounts.

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

Thank you.

(Operator Instructions)

Andrew Gadlin, Odeon Capital Group.

Good morning. Thank you for taking my question.

Good morning, Andrew.

On the RMBS reserve reduction, David you mentioned that it was driven by reduced lower interest rates. I assume that's expected to drive excess spread recoveries for the upcoming period?

I'm just trying to compare that to the operating supplement, where the gross RMBS claims presented is almost nothing for the remainder of 2015. Is that really excess interest coming into those deals that offsets the losses?

That's what's happening for the remainder of the year. That's correct, Andrew.

What's the outlook looking out to 2016 and 2017?

I think what we'll begin to see is a dip off of excess spread with the passage of time. A lot of the excess spread is front-end loaded over the next two to three years through 2018. Subsequent to 2018, generally speaking, we'll then see a real general decline in RMBS payments on a gross and net basis.

That's just an assumption of what the yield curve looks like today, correct?

With regard specifically to the excess spread, yes, it is a function of what forward rates look like; but in terms of gross claim payments, that's been a long-standing and consistent projection of ours that subsequent to 2008 we'll see a significant drop-off and lull in claim payments to be made up many years out in the 2035 zone by some ultimate pay bonds that mature.

Got it. You mentioned also that subrogation recoveries in recent quarters have been higher than actual claims payments on the RMBS side?

Right. That's correct.

I'm trying to think with this new forecast the remainder of the year, should we expect even more gross or net recoveries?

Well, that's what's laid out on Page 9 of the supplement. On a net basis, we still expect that there will be net RMBS claims paid, or we should say recorded. That's our current forecast.

Got it. Okay, thank you very much.

Ben Clifford, Nomura Securities.

Good morning, guys.

Good morning.

To touch on the $479 million in adjusted book value, would it be appropriate to make an adjustment of -- to add back $266 million of the DPOs you own to that number?

Sorry. The DPOs that we own are included in the adjusted book value number. The DPOs we own are on the asset side of the balance sheet, so they are included in adjusted book value.

So it's offsetting a liability?

Yes. The balance sheet -- we don't take down loss reserves or deferred obligations as a result of any insured RMBS that we acquire.

Understood. I know it was touched on earlier in the call, but again on the RMBS loss estimates, it looks like you took 2015 down substantially from the fourth quarter, but also 2016 loss estimates are down from about $250 million to about $100 million. Is that solely driven by excess spread, or are you seeing better loss experience on RMBS?

There's a few things going on, but the majority of the movement in our expectations around RMBS claim payments for -- as of the end of this quarter resulted from movements in excess spread and projections of excess spread. There is a bunch of other factors that run through our modeling, including changes in HPA and other credit factors. A lot of those things were offsetting for the quarter.

The other thing that's affecting at least the timing of payments is liquidation timelines. You can see in the table on Page 9 of the supplement that the aggregate total amount of RMBS future payments hasn't drifted that much from the end of the year, but the timing has moved around a bit.

Right, that makes sense. Is there any way to quantify the total amount of rep and warranty you're going after in your litigation, and what the interest would be on top of that? Just to know what the total pool of recoveries you're going after?

We obviously have a very good estimate and understanding of the damages we are seeking, but have not disclosed that, nor have we disclosed the interest on those amounts at this time.

Is there a (inaudible) due in terms of interest? What type of rate would you typically use?

This is Nader. It's hard to really give you specific guidance on that, but basically in these kinds of situations one of two options are available, either statutory or contract. Statutory in New York state is 9% currently, not compounded. Contract would really depend on the rates provided in each of the contracts. Those are the options.

Thank you. That's very helpful.

Alex Klipper, Bank of America.

Hi, just two quick questions. One relates to the purchase of the RMBS, Ambac-insured RMBS. I was taking a look at the statutory filings, and it looks like the write-ins for investments in Ambac-insured bonds actually went down by $62 million. I'm trying to reconcile that with the fact that you guys bought $204 million of wrapped paper in the quarter?

Sure, Alex. There's a couple things going on. One is that there were pay-downs of course of the RMBS that we own -- our RMBS. We actually sold one very tiny position, as well; but the broader impact was the fact that the student loan bonds position that we commuted was something we owned on the balance sheet. While we bought $204 million, we also sold those student loan bonds from our portfolio; as well, a portion of the RMBS we brought back in the quarter, actually bought at the holding company.

Got it. Can you give a sense of how much of the $204 million you bought at the holding company?

About $40 million.

Got it. Is that something you guys are thinking about doing going forward in terms of using your excess liquidity at the holding company?

One of the things we said when we generated the liquidity through the [Corillo] trust with regard to the junior surplus notes that AFG had was that we were going to strategically deploy that capital, both as it related to the AAC ALM program, as well as other things. We're just going to continue to opportunistically look at those options, both of those options as we go. Hard to predict the future right now, but both of those possibilities are open to us as we go forward.

Got it. Then if you can elaborate a little bit more, Nader. I think you were talking about working closely with claim holders, mitigating deferred payment amounts. I don't want to put words in your mouth, but it sounded like you said you hoped to exit rehabilitation by the end of the year?

Yes. We are hopeful and working towards making this a 2015 event. There's a lot of work to be done. It's obviously a multi-angulated negotiation and discussion with our regulator and stakeholders, and with lots of discussions and negotiations to come. But we are trying to make this a 2015 event.

Got it. Should we expect -- should we expect that you guys are thinking about another pay-down first, or just the goal is to get out of rehabilitation, and then worry about satisfying surplus notes, et cetera?

We don't control that. Those decisions with respect to those pay-downs are generally in collaboration or direction from the OCI. That is not unilaterally our decision, but I think it's fair to assume from our perspective but if what we're trying to do is a wholistic fix, that's what we're going to work towards.

Got it. Okay, great. Thanks.

[Jatin Juanawala], Meta Capital.

The first question I had was can you walk us through your thinking behind not including fraud lawsuits in your loss estimates and subrogation recoverable?

Really just a function of accounting mandates, and our understanding of them. It's as simple as that.

But the 2012 JP case, where the rep and warranty angle of the lawsuit was dismissed, that one is still included in your $4.109 billion number, if I'm correct about that?

There is some element of that in there, but we are taking -- we believe that decision was wrong. We're appealing it. As long as we're alive and kicking, we will have some element of that in there.

Okay. In terms of you mentioned earlier on the call, and also I think it's in your disclosure that the losses behind the different lawsuits where you're pursuing rep and warranty claims is $4.109 billion?

That's right.

Right, and you're reserving for $2.568 billion. Would that -- is that what your base case assumption is, or do you think that's a bit on the conservative side?

We don't try to be conservative or aggressive in our accounting. That's what the combination of legal and accounting provisions lead us to. I don't want to characterize that one way or the other.

It's important to point out that the means by which we calculated that number is on a probability-weighted approach. We look at a range of scenarios and assign probabilities to those, and generate an expected value based on the outcome of those probability-weighted scenarios.

Got it. On Puerto Rico's exposure, can you tell us what you basic assumption is? It sounds like, listening to you speak about HT and COFINA that your basic assumption is those don't take any loss, or very slight at the margin on the HT and none on the COFINA. Would that be accurate?

Look, I can't -- it's very hard at this point to predict what's going to happen in Puerto Rico. There's -- in addition to the financial complexity of the situation, there's a lot of political complexity. I think everyone on this call is fairly up to speed in terms of all of that.

We believe that the better thinking in Puerto Rico still wants to resolve the situation an amicable way. We think that both the governor and the president of the senate are committed to that.

We think best-case scenario they are going to try and have a balanced budget here for 2015, with or without a VAT. I don't know that we were ever big fans of a 14% VAT, to be honest with you. I don't think we were particularly surprised, given our access and information down there, that it failed. But we do think that the government is committed to bringing the budget into balance for this year, and they're going to work hard towards it.

That doesn't mean that they would still not like to do something with PREPA, but we're not in PREPA. We do believe that as to the rest of the commonwealth's obligations, what is important in these situations is the policymakers' will, and we think that the policymakers' will is not to default or restructure the balance of their debt.

Got it. Do you have any plans of breaking out the loss exposure to -- your losses in Puerto Rico in the future?

No, we historically and right now don't have any expectations to break out loss reserves on a policy-by-policy or exposure-by-exposure basis, but I will re-emphasize the fact that we do think we are very well reserved for our exposure to Puerto Rico.

Got it. On the --

You can understand -- let me just elaborate on that, because we're not just being difficult. We are trying to be more transparent here, and we've made a commitment to that. But you can very well understand that in a dynamic, if we were to get into negotiations on any of these situations, it handicaps you materially to go into a negotiation with the other side knowing what your reserves are. It's negotiating 101, risk management 101, that you don't want to be overly transparent when there's another party at the table who is going to press against that number.

Yes, that's very reasonable. Coming back to rep and warranty, the Capital One lawsuit was dismissed with prejudice last year in June. Has that -- I would imagine there was a settlement on the other side. Can you speak a little bit about that?

Yes, again I apologize. That is an area that I cannot speak about. We have very strict requirements not to speak about that.

Okay. All right, thank you so much.

[Josh Federman], Pyro Capital.

Thank you. I wanted to touch on highway and PREPA, given the recent change on the VAT. I understand your base-case assumption is still there's a balanced budget in 2015, but I was wondering if you had changed any assumptions or reserves related to your highway exposure, given how important the PREPA deal is, and any potential change in probability that gets done?

We don't disclose -- again, as we said before -- position by position reserving. We were very early here to recognize the problems in Puerto Rico.

We took the entire credit down to below investment grade well before the rating agencies and others, and established reserves accordingly. We have made some adjustments to our reserving among our various exposures as recently as this last quarter, but I really can't say much beyond that.

Okay. As a matter of policy or procedure, are your reserves are accurate with data up to March 31, or do you account for any subsequent events prior to filing in your reserves?

We do account for subsequent events up to the filing date.

Okay. Thank you.

Thank you.

(Operator Instructions)

Charles Post, Sterling Grace.

Good morning, everybody.

Hi Charlie.

Have you guys discussed with the rehabilitator whether you could exit rehab without receiving R&W payments? Can you exit in 2015, possibly, without receiving R&W payments?

Charles, I don't want to get into the specifics of the conversations that we've had, but I think you can assume that given the importance of those assets to the Company, and the re-payment of our obligations, you can I think fairly assume, make certain assumptions, about what may or may not have been discussed. I would rather not speak specifically, though, to the discussions.

Okay. I'm trying to get a sense towards interest. You're talking about a little quicker time frame than I expect, but I'm happy to hear it. Some of the lawsuits and filings are going to happen in 2016, so unless you get to a settlement -- I'm trying to get some color on the extent that you can provide it?

Yes. Look the answer is that in the natural order of things the cases aren't going to be decided in 2015. We're going to have a -- as we said in the prepared remarks, we're going to have a -- in all likelihood we are going to have a summary judgment hearing in the VMA matter in July and JPMorgan hopefully some point early in 2016; but obviously that does not end the case.

We are not predicting or saying in any sense that we expect those things to be resolved this year. Now obviously there are multiple different ways to end litigation or to monetize litigation.

We are looking at all possibilities, and we're open to discussions. But I would not assume that we are predicting in our base case that we're going to have either of those cases, significant cases, resolved this year.

Then is there anywhere -- I've read through the documents -- is there anywhere that discusses what the commutation payment was in the student loan commutation.

No, we haven't explicitly said what that payment was. As you can imagine, there's some confidentiality between ourselves and our counter-party with regards to that, and would not be ultimately in our strategic best interest, given our objective of trying to commute additional policies going forward, to have too many specifics with regards to the price actually paid for the commutation.

That being said, one of the drivers of the results for the quarter running through the income statement on the incurred benefit line of $151 million was the impact of that commutation. Said another way, the price was below what we had reserved for on the balance sheet.

Right. I can look at the Q and see that reserves on for-private and private student loans went down by about $200 million-plus, but the -- over in through the income statement was $100 million-some-odd, so I think there's a way to back into it there. Just wanted to see if there was somewhere it was actually disclosed. Thank you.

Your welcome.

That's all my questions.

Thanks, Charles.

Jatin Juanawala, Meta Capital.

Thank you. Sorry, just wanted to ask about the restructuring of the surplus notes. That plan has only got to do with the surplus notes, and there is no plans for the DPOs, right? There's nowhere to really change there, so what you're going to be essentially doing is right now they're [patty pursue] with each other, at the top of the hierarchy. Surplus notes would fall below DPOs. Is that what the plan is?

No, that's not what I said. I think that what we're talking about is resolving all of our deferred obligations and surplus notes -- basically all of our policy-level deferred claims.

Okay. There would be -- are you talking about making a payment, to just pay out surplus in DPOs, or some other mechanism? Can you shed more light on what's being talked about?

We haven't really laid out a plan, because we don't really have a fully baked plan yet. As I said before, we're still in the midst of discussions and negotiations on all of this.

I don't want to imply that this is any further along than it is. But I think we plan to satisfy to the satisfaction of the Company and the policyholders and the OCI our overdue claims and surplus notes.

Would you have to reach out to all investors of surplus notes to get approval, or is there a threshold that you have to cross before you can make the change?

Yes, those determinations have not been made.

Okay. All right, thank you.

Thank you. At this time I'm showing no further questions. I would like to turn the call back to Nader Tavakoli for any closing remarks.

I'd like to thank you all for joining us today. I look forward to updating you on the Company's progress as we go forward. Thanks again.

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