Ambac Financial Group Inc (AMBC) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Ambac Financial Group third-quarter 2015 results conference call.

(Operator Instructions)

As a reminder, this conference call may be recorded.

I would now like to turn the conference over to Abbe Goldstein, Head of Investor Relations and Corporate Communications. You may begin.

Thank you, Nicole. Good morning, and thank you for joining today's conference call to discuss Ambac Financial Group's third-quarter 2015 financial results.

We'd like to remind you that today's presentation may contain forward-looking statements, which are based on the 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 reports 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 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.

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 the prepared remarks, we will open the call for your questions.

I'll now turn the call over to Mr. Tavakoli.

Good morning. Thank you, Abbe, and thank you all for joining us for today's call.

We're pleased to report that we had another excellent quarter at Ambac. As David will detail in a few moments, during the quarter we reported operating earnings of $170.5 million or $3.77 per fully diluted share. Despite writing off our goodwill that was created when we emerged from bankruptcy, we now have GAAP book value of $30.10 per share, and adjusted book value has now increased to $17.81. Since emergence from bankruptcy in mid-2013, we have generated an aggregate of over $2 billion or $44 per diluted share of operating earnings.

Just this year, we've generated $684 million of operating income and increased adjusted book value by over $10 per share. Operating earnings are a result of improved conditions in the housing and credit markets, but also, in large measure, from our active asset-liability management efforts, including success in investments, including investments in our own insured bonds, commutations, litigation efforts, and other risk and loss mitigation and portfolio optimization activities. And we've achieved this despite increasing reserves related to certain of our public finance exposures, and continuing to carry significant hedges against our interest-rates exposure.

While we are pleased with our financial performance, we're equally pleased with the continued execution of our strategic initiatives and operating improvements throughout the Company. For example, during the quarter we restructured our portfolio risk teams from 3 to 2, and in the process, streamlined reporting and functionality. As a result of this and other initiatives we've undertaken year to date, we have now reduced headcount by 8%. We've also undertaken a comprehensive review of all of our expenses and vendor relationships, and are taking steps to cut costs wherever possible. We believe strongly that it's incumbent upon us to control those things we can, which makes managing our expenses a top priority.

As it relates to risk, we're undertaking several important initiatives. First, we've created a special situations group to oversee our more troubled exposures from a workout rather than surveillance perspective. While surveillance continues to play an important part at Ambac, given the size of our overall book, our research and analysis efforts need to recognize that we have pockets of distress that increasingly require more detailed engagement. We're working with all of our analysts to be more vigilant and proactive to identify credit stress early, and implement mitigation efforts, as appropriate, as quickly and aggressively as possible. We've also undertaken a Firm-wide risk management effort to make sure that we identify, understand, quantify and appropriately address all areas of risk that Ambac faces. These are important undertakings, as we face the Company's important objectives today and in the future.

An important part of our risk and loss mitigation effort is the reduction of our risk exposure wherever economically sensible. During the third quarter, we reduced the size of our insured book by another $11 billion, including a 4% reduction in our adversely classified credits. Since the beginning of this year, we've now reduced our insured book by $26 billion, including a $4 billion reduction of our adversely classified credits. As a result, when looking at our historical statutory claims-paying ratio, which is defined as net P&I in force divided by statutory claims-paying resources, we've generated improvement from 28 to 1 at the end of 2013 to 21 to 1 at the end of the third quarter of 2015.

As many of you know, an important part of our loss mitigation efforts are our prosecution of lawsuits related to our guarantees of RMBS securitizations. These cases generally seek recovery of damages we suffered as a result of the defendant's breaches of representations and warranties and/or fraudulent conduct. We currently have seven cases pending in New York State Supreme Court, and an appeal of dismissal of one case pending in Wisconsin. We were pleased that, on October 27, we received a favorable summary judgment ruling from Justice Bransten in our Countrywide/Bank of America cases, in which she held that all of our theories of primary liability against Countrywide, and successor liability against Bank of America, may proceed to trial.

In our JPMorgan/EMC second lien cases, the judge has not yet ruled on the defendant's motion for partial summary judgment, but the case continues to progress as the parties continue expert discovery. Summary judgment motions are scheduled, in that case, for early in the new year. In our JPMorgan/EMC first lien case, fact discovery is ongoing. Although we cannot predict, with certainty, the timing or outcome of our cases, we're confident in our positions in all of our cases, and will continue our intense commitment to pursuing our rights against each of the counterparties.

We had another good quarter in our investment portfolio. As David will discuss later, we've implemented various strategies in our investment portfolio this quarter by entering into a re-securitization transaction, strategic allocation to short-term and highly liquid assets, cash, and the purchase of a residual interest in a repackaged portfolio of Ambac-insured military housing bonds.

We also initiated a new program we recently introduced, which highlights leverage of our existing resources. This October, we introduced a pilot program to invest in residential real estate owned properties within Ambac-insured transactions. A main component of the value creation of this project will be the result of making repairs to the REO properties in order to bring them up to neighborhood standards. Upon completion of necessary repairs, the properties will either be immediately resold, or resold at a future date after being rented for a period of time. We are working with third-party vendors and partners for necessary expertise and infrastructure related to this initiative. This program will be rolled out gradually, in order to validate our internal investment thesis.

Another area of increased focus for us is Ambac UK, AAC's UK subsidiary, where we believe we can maximize and optimize value to AAC through increased oversight and more active asset liability management. As we mentioned on our last call, David Trick has joined the Board, and I'm spending an increased amount of time focused on Ambac UK. Ambac UK has a $19 billion insured portfolio that is of generally good quality and long tailed. Ambac UK is aggressively pursuing loss mitigation strategies against their largest significant stress credit, Ballantyne, including litigation against JPMorgan Investment Management, which was the original investment manager on the transaction. Ambac UK commenced this action against JPMorgan, asserting claims for breach of contract, breach of fiduciary duty, and gross negligence relating to defendant's mismanagement of assets supporting bonds issued by Ballantyne PLC and insured by Ambac UK that funded excess reserves for term life insurance required by regulation.

Notwithstanding our hard work and achievement, our guarantees of various obligations of entities affiliated with Puerto Rico continue to be an overhang. As Puerto Rico continues to be an important area of focus for us and all of our stakeholders, I would like to review our exposures and what we're doing to protect our interests. As of quarter end, our exposure to Puerto Rico was net par of $2.4 billion. We guarantee senior COFINA bonds, Puerto Rico Highways and Transportation Authority, or HTA, bonds, PRIFA or Rum Tax bonds, GO and GO Guaranteed bonds, and Hotel Tax bonds. We do not have exposure to PREPA, PRASA or the GDB. Details of our exposures to Puerto Rico are posted on our website. Although each transaction structure has its own legal rights and protections, we want to stress again that there is no possibility that any of our policies can be accelerated under any default scenario, except at our sole option.

As announced in our earnings press release yesterday, we are pleased to highlight that, working with the HTA, we expect that $228.5 million net par, equating to approximately $493 million of aggregate lifetime net principal and interest, of our insured HTA bonds are expected to be canceled at no cost to Ambac. We are paying no premium or fees for this cancellation. This expected cancellation consequently had a positive impact on our domestic public finance reserves in the third quarter.

The Commonwealth recently reported a revenue shortfall, and stated that certain revenues may need to be clawed back to meet general obligation debt service payments. No one really knows how the claw-back feature can be implemented, but certain things seem clear on the face of the applicable laws. Among other things, to claw back certain revenues, the Commonwealth must show that it has a revenue shortfall and cannot pay for all appropriations, and there are no other resources available to make the general obligation debt payment. A clawback of revenue is permitted only if all available resources are utilized, and only for the purpose of making payments on public debt. The government's obligation to prioritize these clawbacks in future years adds additional confusion to the applicable laws. The government has failed to make available comprehensive and current audited interim financial statements and operating reports, which would make it impossible for the government to demonstrate that a claw-back right may be available. As discussed later, Ambac believes the government can reduce expenditures, in any event, and improve tax collections in order to increase available resources by over $1.8 billion annually.

As it relates to our COFINA exposure, which has received some attention of late, we have $805 million of net par exposure, which are all capital appreciation bonds that don't mature until 2047 to 2054. Importantly, we only guarantee seniors in the COFINA structure. The COFINA structure has $6.3 billion of senior bonds and $8.9 billion of subordinated bonds. More importantly, as we have said before, we fully expect the Act 91 provisions, which have established COFINA's legal structure, to withstand any challenges to their effectiveness. Act 91 includes the establishment of a dedicated sales tax fund owned by COFINA, where first receipts of the sales tax are deposited for the benefit of bondholders. Those receipts are owned by COFINA, and are pledged to secure its bonds. The funds in the dedicated sales tax fund are exempt from clawbacks. They are not considered available resources of the Commonwealth, a position which was confirmed at the time of the COFINA bond issuances, and legal opinions from three separate Puerto Rico Secretaries of Justice. We believe strongly that COFINA bondholders have clear property rights to the segregated sales tax revenues, and any attempt to impair those rights would violate the contract and taking clauses of the US Constitution.

As it relates to solutions, Puerto Rico's decision to threaten default, and push for bankruptcy legislation, has received a lot of attention. A bankruptcy for Puerto Rico is unnecessary and destructive. Most of the Commonwealth debt doesn't qualify for Chapter 9. The administration's recent proposal for some sort of super Chapter 9 is unattainable and would cost significant harm to the municipal bond market and state financing requirements. Moreover, the very talk of default in Chapter 9 is already causing significant uncertainty on the island, and negatively affecting the economy. Nor is it clear to us that Puerto Rico is either overleveraged or overtaxed. Including federal and local debt, Puerto Rico's debt to GDP is 68%, compared to 111% overall for the states of the United States. Puerto Rico's tax collection to GDP is only 11%, compared to 23% overall for the states in the US.

The Commonwealth has failed to implement meaningful fiscal and structural reforms in order to improve the efficiency of its government and competitiveness of its economy. During the past decade, total government expenditures have increased by 47% and remain near all-time highs. Many of these expenditures relate to government workers, which account for 25% of Puerto Rico's total non-farm payroll, compared to 16% in the States. During the past decade, government revenues have failed to meet budgeted expectations, in part, due to low tax collection rates. According to a report prepared for the Commonwealth in 2014, KPMG estimates Puerto Rico's sales tax compliance is only 56%. Puerto Rico's real estate taxes are still being assessed on 1958 property valuations.

We believe the people of Puerto Rico would be much better served by its government if it abandons its gambit for bankruptcy, and focused on fixing its liquidity, and implementing fiscal and structural reforms to obtain growth. For example, we estimate that by implementing reforms such as rationalizing and consolidating government entities, centralizing procurement, and implementing other cost-saving measures, the government could reduce expenditures by $1.1 billion to $2.5 billion annually. By improving tax collection rates, the government could increase annual revenues by $700 million to $1.1 billion annually. By privatizing its public companies and utilizing public-private partnerships, the government could remove a quarter of the debt and pension liabilities from its balance sheet. Such a privatization program, combined with permitting and labor reforms, would make the economy more competitive, attract private investment, generate jobs and restart economic growth. It would also improve services and reduce costs for customers.

We're devoting substantial resources to protecting our interests as it relates to Puerto Rico, and will be zealous in enforcing our contractual and legal rights. We are pleased that our messages are starting to be heard, including at the two recent Senate Committee hearings, on the Hill and in San Juan. We've assembled a world-class team of professionals in Washington, New York and Puerto Rico to focus on solutions that produce economic growth and prosperity for the people of Puerto Rico. In summary, we are aware that Puerto Rico has a liquidity issue, and may need to restructure some of its debt. But we also believe there are far better solutions for Puerto Rico than the unilateral path of default and bankruptcy that the government is threatening in pursuing. We want to help Puerto Rico and its people, but we need a willing counterparty with whom to engage in a consensual manner.

We continue to explore options regarding a recapitalization or ways to otherwise conclude the rehabilitation process of the segregated account. Our objective has, and continues to be, to achieve an economic solution that is fair and in the best interest of shareholders and policyholders. We've been discussing potential transactions with many constituents, but the most important player in the process is the rehabilitator, with whom we continue to have active conversations. Our relationship with the regulator remains a top priority for us in all aspects of our Business. As we previously indicated, we hope to have greater clarity with respect to timing and a plan for successful rehabilitation by the end of this year.

Finally, we continue to focus on future growth and diversification opportunities. As our strategic imperative remains maximizing the value of AAC, we remain busy in the near term focusing on Puerto Rico, existing rehabilitation, aggressively pursuing loss mitigation and remediation strategies, including the RMBS litigation and other matters, but at the same time, evaluating various opportunities to explore leveraging our core strengths. Along those lines, we're currently developing strategy, as well as the framework, processes, structures and methodologies for positioning ourselves for success, as we look to business extension, strategic partnerships and acquisitions to both grow and enhance the value of Ambac. Our primary focus is on credit-related businesses, whether in asset management, insurance or other variations that complement our existing platform. We will also continue to evaluate other opportunities to strategically deploy capital and optimize our tax assets.

In conclusion, we're making progress, and I want to reiterate that, notwithstanding the uncertainties around Puerto Rico, I remain very optimistic about Ambac's future. We have an extraordinary group of professionals. Together, we're going to achieve great things for Ambac shareholders.

I'd now like to turn the call over to David for a financial review, before returning to answer your questions.

Thank you, Nader.

We experienced a net loss of $391 million or $8.66 per diluted share in the third quarter of 2015, compared to net income of $282.7 million or $6.05 per diluted share in the second quarter of 2015. However non-GAAP operating earnings were $170.5 million or $3.77 per diluted share in the third quarter of 2015, compared to $266 million or $5.70 per diluted share in the second quarter of 2015. The third-quarter net loss was driven by a $514.5 million goodwill impairment charge. Excluding the impact of this one-time impairment charge, our results for the third quarter were impacted by a lower benefit within loss and loss expenses, and derivative product losses, caused by a decline in interest rates, which was somewhat offset by higher accelerated premiums earned and higher net income from the change in fair value of credit derivatives. Net income was also adversely impacted by net VIE losses, compared to net VIE income in the second quarter of 2015.

As a result of the application of fresh start accounting, in connection with Ambac's emergence from bankruptcy in 2013, goodwill of $514.5 million was recorded, representing the excess reorganization value, which could not be attributed to the fair value of specific identified tangible and intangible assets. As of September 30, 2015, Ambac concluded that goodwill was fully impaired. The goodwill impairment charge results from a substantial decrease in the financial guarantee reporting unit's fair value, which is derived from the market value of Ambac's equity securities, simultaneously with an increase in the estimated fair value of its individual and net assets, such that the fair value of individual and net assets now exceed the financial guarantee unit's fair value.

The fair value of the reporting unit decreased due to the material decrease in Ambac's market capitalization components, including the trading value of its stock. The fair value of net assets increased primarily as a result of a decrease in the estimated fair value of financial guarantee liabilities, which was driven by wider Ambac credit spreads and continued favorable loss development. The full impairment of our goodwill assets had no impact on operating earnings, adjusted book value, statutory net income and surplus, or taxes. Driven by operating earnings, adjusted book value increased by $59.7 million or $1.33 per share to $801.6 million or $17.81 per share at September 30, 2015, and besides the $741.9 million or $16.49 per share at June 30, 2015.

For the third quarter, net premiums earned were $71.5 million, as compared to $60.9 million in the second quarter, including accelerated premiums of $28.4 million and $13.7 million, respectively. Normal premiums earned continue to be adversely impacted by the runoff of the insured portfolio. In the third quarter, public finance accelerations were impacted by calls of approximately $3.9 billion of net par versus $2.6 billion of net par in the second quarter, relating to bonds issued mostly in 2005 and 2004.

Net investment income for the third quarter of 2015 was $64.2 million, as compared to $64.8 million for the second quarter of 2015. Financial guarantee net investment income for the third quarter was $61.3 million, $1.2 million lower than the second quarter, as a result of mark-to-market losses in the trading portfolio, offset by increased income from the fixed income available for sale portfolio. Included in financial guarantee net investment income, for mark-to-market losses on invested assets, classified as trading, of $2.5 million in the third quarter, compared to gains of $1.4 million in the second quarter, resulting primarily from a widening of high-yield spreads, and continued volatility in emerging market investments held by Ambac UK.

During the third quarter, AAC strategically increased its asset allocation to cash, short-term investments and highly liquid asset-backed securities to about 12% of the portfolio from approximately 4%. This is due to growing concerns regarding volatility in the capital markets and the desire to build liquidity in connection with the recapitalization of AAC. The increase in highly liquid investments was funded mainly by an RMBS re-securitization transaction and the sale of leveraged loans. The asset allocation shift, however, did not prevent us from making value-enhancing strategic investments, such as the subordinated interest in a repackaged portfolio of AAC military housing bonds with an expected 12% IRR.

During the quarter, we also closed on a commutation of a significant portion of the stub interest associated with the surplus notes we called in 2012. We are also expecting to close on a commutation of a substantial student loan position in the fourth quarter. Net other than temporary investments and invested assets recognized in earnings was $9.2 million in the third quarter compared to $1 million in the second quarter. Impairments in both periods were impacted by changes in expected claims cash flows on certain Ambac-insured RMBS securities held in the investment portfolio. Whereas Ambac estimates the timing of such claim payment receipts, the actual timing of such cash flows are at the sole discretion of the rehabilitator, leading to impairments from time to time.

The fair value of the consolidated non-VIE investment portfolio increased approximately $222 million from June 30, 2015, to $5.7 billion at September 30, 2015, primarily due to proceeds from the RMBS re-securitization, the unsettled purchase of the military housing position, and a positive total return. As previously announced, Ambac executed a re-securitization of Ambac-insured RMBS in July 2015, through which we raised gross cash proceeds of $146 million at LIBOR plus 2.8%. $139 million of the re-securitization debt remained outstanding at September 30. Through the re-securitization, we have monetized a portion of the intrinsic value of certain insured RMBS, while retaining the rights to the residual intrinsic value and any associated financial guarantee payments.

Loss and our loss expenses for the third quarter of 2015 were a benefit of $133.2 million, as compared to a benefit of $147.5 million for the second quarter of 2015. Third-quarter benefits primarily related to lower estimated losses in RMBS, student loans and domestic public finance, which were partially offset by increased losses related to Ambac UK and short obligations, and $40.7 million of interest expense on deferred amounts. The third-quarter RMBS loss benefit of $179 million, which excludes the impact of the $40.7 million of interest expense in deferred amounts, was driven by a decrease in interest rates and improved credit profiles of our first and second lien exposures.

The student loan benefit of $34.9 million was primarily driven by a decline in interest rates in the quarter and, to a lesser degree, higher expectations with regards to the commutation of one of our remaining stress transactions. The domestic public finance loss benefit of $29.4 million was driven by net improvements across the book, including the positive impact related to the expected cancellation of certain Puerto Rico HTA bonds. The Ambac UK loss of $46.7 million resulted from the impact of foreign exchange and interest rates on policies denominated in currencies under than GBP.

During the third-quarter, net claim and loss expenses recovered, net of reinsurance from all policies, were $26.6 million, which included $57.5 million of loss and loss expenses paid, and $84.1 million of subrogation received. During the second quarter, net claims and loss expenses recovered, net of reinsurance from all policies, were $15.8 million, which included $64.6 million of losses, loss and loss expenses paid, and $80.4 million of subrogation received. Gross loss and loss expense reserves were $3.3 billion at September 30, and $3.4 billion as of June 30, 2015. The decline in loss and loss expense reserves resulted primarily from RMBS student loans and domestic public finance. Included in reserves were approximately $3.4 billion deferred amounts, including accrued interest payable. Gross loss and loss expense reserves as of September 30, 2015, and June 30, 2015, were also net of approximately $2.6 billion of estimated rep and warranty subrogation recoveries.

Net losses reported in derivative products revenue for the third quarter of 2015 were $65.1 million versus $51 million gain in the second quarter. Derivative product losses in the third quarter were driven by mark-to-market losses in the portfolio caused by declines in interest rates, net of the impact of Ambac CVA and counterparty credit adjustments. Additionally, $5.4 million of additional counterparty credit valuation adjustments on certain intermediated interest rate swap assets increased the overall mark-to-market loss. Derivatives products revenue for the second quarter of 2015 reflected gains caused by rising interest rates and an increase in the Ambac CVA, partially offset by a $12.3 million charge related to the downgrade of a counterparty to uncollateralized swap assets.

Underwriting and operating expenses for the third quarter were $25 million, compared to $25.9 million for the second quarter. Expenses over the last two quarters were impacted by the recent reductions to staff, both in terms of post-employment accrual and lower bonuses, bonus accrual and salaries. Given the timing of events, the majority of the run rate benefit associated with these efficiency initiatives will not be experienced until the fourth quarter. Operating expenses also included the direct and indirect cost of the administration of the segregated account, which accounts for approximately 6% of our consolidated operating costs year to date. An exit from rehabilitation, as is being pursued, will allow us to eliminate these costs, in addition to other costs associated with process improvements.

The provision for income taxes was $2.8 million for the third quarter of 2015, compared to $3.9 million for the second quarter of 2015. Income tax expense included US federal alternative minimum taxes of $2.7 million and $3.9 million, respectively. Taxable income of AAC is subject to annual payments to Ambac by NOL usage tier after certain credits and any additional post-determination date NOLs under its NOL tolling agreement with Ambac. AAC has fully utilized its post-determination date NOLs and its tier A credit, and has accrued approximately $17.8 million of tolling payments, including $6.4 million in the third quarter. Tolling payments, if any, accrue quarterly, and are paid to Ambac in the second quarter following the year in which they are generated. Although AAC has utilized all of its post-determination date NOLs, additional post-determination date NOLs may be generated in the future. At September 30, the Company had $4.6 billion of US federal NOLs, including $1.4 billion at AFG and $3.2 billion at AAC.

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

(Operator Instructions)

Andrew Gadlin, Odeon Capital Group.

Thank you and good morning.

Good morning Andrew.

On the HTA, cancellation of the policy, could you talk about that a little bit more? It's not clear. It sounds like Puerto Rico had bought the bonds and that enables the company to demand cancellation of either the policy or the bond, am I getting that right?

You are exactly right, Andrew.

So, when were these bonds repurchased -- was there a part of a strategy for them or did they do this in conjunction with the company? I'm trying to understand how this came to be and obviously, could it be done again? And either for this company or others?

Some of that would require me to speculate about things that I do not know. In terms of their strategy and so on. But the bonds were repurchased by the HTA some time ago, and we discovered that, and we worked with them to persuade them that the legal obligation here was to do what they have done.

Got it. Do you have any idea, the press release says that it would be expected to close shortly, any idea on timing?

Yes. As we said in the press release, we expect this to be completed very shortly. And, yes.

Okay. And on the new initiative involving REO, and I guess also, on the strategic portfolio of military housing bonds, can you talk about those two initiatives and particularly, in regards to the REO properties, how big can that be? What kind of investment hurdles does the company have in mind? And maybe just talk about that strategy a little bit.

The REO is still a relatively small, pilot program. But we've discovered in doing some analysis of our homes that go into foreclosure in the REO process that there's significant value destruction, even with respect to homes shortly after they go through that process. It is clear that the process destroys value. I don't think that's a shocker to people from an anecdotal or other perspective.

And given a significant amount of property that we have that goes through these processes, we want to see if we can recapture some of that value. And it's really as simple as that. We're going to start it, we're going to do it with partners and vendors and walk before we run in terms of our entry into this.

In terms of return profiles, we're not being overly ambitious in terms of what we expect to get in hoping that we'll be surprised to the upside. Our most important priority is to mitigate the risks of downside, as it relates to this, and, again, we are starting this out very modestly, and we will evaluate it as we go, but are confident that we can capture some value for Ambac that is destroyed in these processes. I will let David handle the military housing.

Andrew, on the military housing, it's actually a good demonstration of our efforts in the asset-liability management front, because the opportunity really arose through our risk management teams working with a counterparty and being in communication with a counterparty who is a large owner of military housing bonds. So, they expressed a desire to structure a transaction which would help them with some capital relief for their balance sheet.

So, the risk and asset teams, here, engaged to structure a transaction with the counterparty that essentially created a subordinated tranche of a portfolio of Ambac-wrapped RMBS, which gave the counterparty some capital relief for their balance sheet and provided us a nice return on a portfolio that we're intimately familiar with and already on the hook for in terms of insurance claims. So, overall it is a great transaction, and if we can create similar transactions with other portfolios of Ambac wrapped positions, we'd be happy to do it.

You essentially bought the risk piece at an attractive price and effectively commuted what you expect to be any real risk that you may have. Is that right?

I wouldn't say it was a commutation. Just strictly a repackaging of cash bonds that the counterparty had, so it shifted their risk profile in terms of the package of securities that they own, and we were happy to take back that risk, because, as I had mentioned, we already fully guarantee those bond positions and know that package of securities very intimately. So, we, in effect, did not take on any new risk by doing the transaction, but at the same time, restructured in a way that would give us a pretty attractive return on our investment.

Okay. Great. And finally, on the goodwill, and this is probably a David question, as well. Just to make sure that I understand it. The market decline alongside the asset markup is what basically says there's not much value being attributed for goodwill. Is that right?

First, let me emphasize two things.

One, that we had always expected to write-off the goodwill. 100% of the goodwill is associated with the financial guarantee insurance close block. So, therefore, at some point in time, we would have to write-off that goodwill.

And secondly, the goodwill impairment, as I mentioned in my prepared remarks, had no impact on our adjusted book value, operating earnings, our statutory net income, our statutory surplus or tax. So, with that said, there's really just two factors that mathematically contributed to the impairment of the goodwill, and effectively those two factors were the fair value of the financial guarantee business, which is mostly driven by stock market value and the estimated fair value of our net assets.

Unfortunately, through the year, we experienced a rather significant decline in the fair value of the reporting unit due, mostly, to a drop in the stock price. So, throughout the year, the fair value of the financial guarantee unit dropped by about $750 million. While at the same time, the fair value of our financial guarantee net assets improved by about $1.7 billion. So, the result of that is that the fair value the financial guarantee net assets are now greater than the fair value of the reporting units. So, in a sense the valuations have flipped from the time when the value of the unit, as mostly reflected by the stock market valuation, was greater than that of the net assets. So that flip resulted in the impairment of the goodwill, and besides the drop in the stock price, the other factors that contributed to the flip, if you will, is the change in liabilities at the insurance company which have declined in value, mostly due to improvements in the incurred losses, as well as some wider credit spreads on our Ambac insured positions.

Okay. Got it. Thanks. That's it from me.

Thanks Andrew.

Dennis Chow, Longview Investments.

Hi. I'm trying to reconcile the successes you've had in managing the assets and liabilities at AAC, versus your failure to manage capital at the AFG level. Given your pristine balance sheet, I find it hard to understand why you haven't engaged in greater repurchases of your warrants, as per the program implemented at the end of June, and why you haven't found more creative ways to work around the 5% shareholder limits required to push over the NOLs. I was wondering if I can get you to go over these issues, and what it would take for you to sort of step on that side of the gas pedal more.

Sure. Let me say, with regards to the warrant repurchases, as we previously announced, we did have a program that was a $10 million program.

We spent about half of that amount on warrant purchases, and then later in the third quarter, as we also announced, we had some parameters around the terms under which we could acquire those warrants. One of those parameters was related to the underlying volatility metric, with regard to the warrants, and during a good portion of the quarter, the volatility of those warrants was outside the parameters of the program.

And with regards to buybacks in the NOL and the 5% limitation, we have researched that issue rather extensively, and, as we have talked about in the past, have an enormous appreciation and value placed in that NOL, and there is nothing that we're going to do to risk the NOL. And it is an important part of our growth component and growth strategy, going forward. So, if there was a way around the 5% limitation, with regards to stock buybacks, without damaging or risking the NOL, we certainly would, at this point, have found it.

We've engaged, not only internal professionals, but external professionals, in terms of exploring the options there, and unfortunately we have not found a way for us to avoid tripping NOL or 5% holder limitations via a stock repurchase program. So, in the spirit of preserving that very valuable asset, we have not engaged in a stock buyback program.

Just a quick follow-up, have you explored the possibility of doing a tender offer that includes and specifically targets shareholders that would go over the 5% limit under a normal share buyback provision? In other words, specifically work with those large shareholders that would take you over the 5% limit in the context of a structured repurchase offer.

Sure. That is certainly one option we considered. But, at the same time, for that to work effectively is each one of those shareholders has to agree to proportionally participate in that program, and that's not something that we have seen as likely to occur.

Got it. Thank you.

John Knapp, CCM Opportunistic.

Thank you. Nader, David, I hope you all are doing well. Your numbers are certainly impressive.

Good morning, how are you, John?

Fine, thank you.

Thank you, very much, for the nice words.

I want to address, what I view as the elephant in the room, which I guess is somewhat dangerous to do. There was an 8-K filed which extended, Nader, your position as interim CEO through October 31. Is that correct?

That's right.

So, being from Texas, we tend to believe in the jockey, as much as the horse, and we're rather impressed with the job that you have done, Nader, what with the energy, intelligence, presence and importantly, character. Would you like to continue in your capacity as CEO on a permanent basis? That is the first question. And the second question is, what impedes that from happening?

John, I haven't made a public announcement about my desire, or lack of desire, to do this on a permanent basis, so unfortunately, I appreciate your comments and your support, but this is not the right time to do that. The board has been actively engaged in a search and evaluation process.

We have a very diligent board that is working extremely hard and being a very good support to the management team. And, John, I will just say that, as you can see on this call, the interim labels that I wear and David wears to some extent at AAC, have not abridged our ability to move this company along and execute on important initiatives and such strategies. So, this current situation has been working and has not impeded our ability to succeed, and for now, it's the construct that we have in place, as the board continues to deliberate what to do.

Thank you, Nader. Please know that we are happy shareholders with you in the saddle. That is it.

I appreciate it. Thank you.

Alex Klipper, Bank of America.

Hey, guys. Thanks for taking my call.

Just one very quick question, and then a couple more nuance questions. What percent of the Ambac insured RMBS and claims do you guys actually own now? I know that is something that you have given us in prior quarters, but I don't think that I heard it.

It is about 28%. It hasn't moved since last quarter.

Okay. Great. And then, can you discuss the decision-making to sell down your portfolio and raise cash? Was that in anticipation of a liquidity event or related to either exiting rehabilitation, or was it truly strategic, and what would get you excited to go back into the market?

So, it?s yes to most of those things. I think we had talked about this on the last call, because we had executed it before the last earnings call. But, this is a transaction that we had executed, actually, in the past. As you know, we have some limitations on our ability to repurchase our own insured securities through our investment portfolio, and the transaction that, the re-securitization transaction, not only raises liquidity at what we think is attractive rates, but also it frees up capacity in the investment portfolio to make additional acquisitions of our own securities.

So, in addition, the limitations that we have within the investment portfolio, with regards to buying our own distress wraps, also impacts our ability to make investments in other, what I'll call, high yield investment classes. At the same time we had, and have been working, as you know, on the recapitalization of AAC, which would also require some additional liquidity. So there are a whole host of strategic reasons and tactical reasons why we did that transaction.

We're also very disciplined with regards to how we invest money, so we felt like by the time the deal actually closed that the more strategic and smart thing to do, given the circumstances and the capital markets were to hold back on any real aggressive investment into the capital markets, other than those few selective items I mentioned on the call, which were both timely, and time sensitive.

And are you guys still holding that cash or did you reinvest some of it back?

Still long cash.

Got it. And then, just a more nuance question. Did you find that some of the weakness in your equity and perceived credit in the quarter, did that create any new commutation opportunities? Did you find reverse inquiry? Were people coming back to you and saying, you know what, we'd like to cut a deal?

Yes, what was somewhat surprising during the quarter is that our wraps didn't really widen out all that much. And we did not see particularly appealing opportunities during the quarter. And as David just laid out, we made a strategic decision for the time being for the various reasons you outlined to be long cash. So we're in the market all the time, looking at opportunistically for ways to commute our obligations.

Got it. And then, the final question is just on the student loan commutation, can you give a little more color on kind of what that is? Is it more troubled student loans, or is it decent stuff?

No, we generally try to avoid commuting the decent stuff, and focus on the troubled stuff. And we've done a pretty good job, and the team here has done a real stellar job, in terms of focusing on that book, because as you probably know there's really a couple remaining distressed positions. And this one is one of the few remaining on the books. It's about $250 million of net par outstanding, and we hope to have that closed within the next couple of weeks.

All right. Thanks, guys.

Sure.

Nancy Stuebe, Gabelli.

Hi, good morning, everyone.

Good morning, Nancy.

I just wanted to ask a question, something that you had in the press release, where you we said that there were larger derivative products losses, caused by steeper declines in interest rates. And I'm wondering if that has changed somewhat, now the interest rates look like they're going to go the other way. And if you have any thoughts about how it's going to look, going forward?

Sure. So you will also notice Nancy, we, in our comments about the insured portfolio in the performance of particularly the RMBS and student loan books, that many of our comments focused on the benefit that we experienced there during the quarter from the lower interest rates. So that is why we've maintained a -- sort of a position in the derivative book, because our insured portfolios are sensitive to interest rates.

And we try not to be betting too much on interest rates. And with the passage of time to a large degree, our RMBS book, in particular is almost more, become more sensitive to rates than it is to HPA. So with the quarter, and as you know interest rates have moved up in the third quarter, so all things -- in the fourth quarter, sorry. So all things being expected, being equal, we would expect to have gains in that derivative portfolio, offset by some losses in the RMBS, and the student loan portfolios that are purely interest-rate driven.

Okay. And just as a conclusion, I want to reiterate that we've been very happy with you and Nader. And I know you say it doesn't impede your ability to manage the Company, but just looking at the impact on the fair value, I think having something settled might improve that market cap of yours. Thank you.

I appreciate you that. Thank you.

Thanks, Nancy.

Jatin Dewanwala, Metacapital.

Hi, good morning. I had a couple of questions, somewhat related to the previous caller's question. The first one is that on RMBS, you took in the benefit of $179 million, and you mentioned that it was largely driven by a decline in interest rates. Is that because you project the excess interest recoveries to be higher, or was it because of some other factors?

No, the main driver there is the express -- excess spread recoveries, yes.

Okay.

Charles Post, Sterling.

Good morning, everybody. A couple of questions for you. On the Highway and Transportation Authority transaction that hasn't occurred, is that -- it looks like it's just 1Q set that was done. I am looking at your insurance exposure, and there is 1Q that sort of matches that amount. Is that correct?

Yes, it's one series of bonds.

Okay.

You are right.

Okay. Thank you. And then in the Stats Finders, a mention of two new entities being created, Osprey and Ambac Asset management. Can you tell me what those two entities are, and what they're being used for?

Yes, sure. Both of those entities are -- were established in connection with Nader's comments with regards to us investing in REO. And so, both of those entities were established to help facilitate that program.

Okay. Is there a capital commitment amount for those two entities?

There is no real capital commitment amount. We obviously, need -- in order to effect the program, we need to allocate some money to the program, to obviously acquire houses, and do the -- acquire the real estate, excuse me, and do work on the properties that we need in order to make the returns on that investment. So we will be allocating a portion of our investment portfolio to that program, but there is no required commitment per se.

Okay. And then on student loan commutation that is in the Q, was that reason for the drop in reserves on the loan portfolio, or is --?

There's a little bit in there related to that. But the majority of the student loan benefit for the quarter is related to interest rates. And presuming, as I know we will, get the commutation executed, the bulk of the benefit of that will be experienced in the fourth quarter.

Okay. And then you made that payment of $21.4 million, the partial payment. That's on the -- was that on the city unpaid interest amount?

Yes. In my prepared remarks, I'd mentioned that it was actually commuted a large portion of the -- what I call, the stub, the interest stub, the city stub, and that was associated with that.

And that leaves about $17 million out there? Is that correct or?

A little bit (multiple speakers) yes, a little bit less than that. I hesitate to get into too many details, because we're subject to a little bit of confidentiality around the pricing of that, and the counterparty.

Okay. Then the last question is, you had about $5.5 billion in investments last quarter. Now it's about $5.7 billion. How much of that is, either selling down stuff, or -- how much of that is cash from operations for the quarter? (Multiple speakers) up the portfolio? That's a nice increase.

Yes, there's about $139 million of that is the proceeds -- what remains in terms of proceeds from the re-REMIC securitization, the way that transaction works is, while we sort of raised the liquidity, the assets don't come off the books. So there's about $136 million of that increase relates to their re-securitization.

So it's also about $70 million-odd associated with the military housing purchase that didn't settle during the quarter. They will settle in the fourth quarter. So if you notice on the balance sheet, there's also a large securities payable, a portion of which relates to military housing transaction which closed -- which traded on 9/30. And the rest relates to total return performance and the cash flows from the business.

Okay. And then, just on -- in that same vein, between investment income of the portfolio and cash installment premiums, is that running about $250 million to $350 million a year? Is that a ballpark number?

Yes, that is ballpark.

That sounds about right.

So let's just say $275 million, and you have about $100 million of cash operating expenses?

Total operating expense is about $100 million. Not all of that is cash. Obviously, I've got some depreciation in there. We have some non-cash comp, in terms of our performance units and RSUs, but that is probably maybe about $5 million a year. So about $95 million of cash operating expenses.

All right. So $175 million before losses, which as the majority of your losses, you have way out there so, and most of that cash ought to be protected. So, we should be building nice cash balances, assuming no commutations, and other things that happen. Is that correct?

That is our expectation, yes.

Okay. That's a great number. Thanks, guys.

Thanks, Charles.

Michael Cohen, Opportunistic Research.

Hey guys can you -- hi, thanks for taking my question. Can you provide an update on the EMC case where Judge Ramos ordered mediation or arbitration?

Yes, Michael. Thanks for the question. Unfortunately, I can't talk about the details of our mediation proceedings. These things are done, as you know under confidentiality, and about all we can confirm is that Judge Ramos ordered it.

Can you confirm as to whether or not they were scheduled and actually took place, not necessarily the outcome of such? Or if they are scheduled to take place, and haven't taken place yet?

No, I can confirm that they took place pursuant to the judge's order.

Great. And then, if I'm not mistaken, did you guys file another lawsuit against Bank of America and Countrywide sometime in July?

Give me one second on that, Michael. Not that I am aware of. We filed, as you know, we filed a Harborview case. The case is related to the Harborview matter at the end of the year. We filed one of those cases in Wisconsin, and we just filed a parallel sort of case in the New York, in order to be protective. The case that we filed in Wisconsin was dismissed without prejudice at trial. We are appealing that dismissal. But in order to be protective, for various reasons I can't get into, we filed a parallel case in New York.

Okay, great. Thank you.

Thank you. At this time, I'm showing no further questions. I like to hand our call back over Nader Tavakoli for any closing remarks.

Thank you, operator, and thank you all. We recognize there's been some volatility in our stock price, and we appreciate the support and the patience of our shareholders. Some of what's going on is, obviously, not in our control fully, but you can be assured that with respect to those things that are, we are working tirelessly and creatively to pursue the Company's interests. We appreciate your support, and look forward to talking to you on the next call.

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Have a great day, everyone.