Ambac Financial Group Inc (AMBC) 2018 Q2 法說會逐字稿

Greetings, and welcome to the Ambac Financial Group Inc. Second Quarter 2018 Earnings Call.

(Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Lisa Kampf, Head of Investor Relations; Claude LeBlanc, Chief Executive Officer; and David Trick, Chief Financial Officer.

I will now turn the call over to Lisa.

Thank you. Good morning, and thank you all for joining today's conference call to discuss Ambac Financial Group's Second Quarter of 2018 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 of 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 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 comparable GAAP figures are included in our earnings press release, which is available on our website at ambac.com. Please note that presentations have been posted to the Events & Presentations section of our IR website, which support our comments today.

I would now like to turn the call over to Mr. Claude LeBlanc.

Thank you, Lisa, and welcome to everyone joining today's call. This has been another busy and productive quarter for Ambac. In June, we announce the execution of a support agreement with certain holders of our Auction Market Preferred Shares, or AMPS, and in July, launched a tender offer for all of the outstanding AMPS in our efforts to further deleverage and simplify Ambac's capital structure.

This exchange offer was successfully closed on August 3. The transaction was completed with holders representing 84.4% of our outstanding AMPS, who exchange their positions for a consideration package consisting of surplus notes, cash and holding company warrants. David will provide greater detail on the transaction shortly. But the transaction delivered several benefits, including: first, an increase in our financial and strategic flexibility with the discount capture of approximately $227 million; second, improvement in the quality of our book value and adjusted book value; and lastly, clarity with respect to our corporate governance structure and increased flexibility with respect to future potential capital distributions.

We are pleased with the level of participation of the AMP holders in the outcome of the exchange offer as well as the other long-term benefits of this transaction for Ambac and its shareholders.

During the quarter, the company and its advisers were also actively involved in mediation discussions to resolve Ambac's largest Puerto Rico exposure, the COFINA senior bonds. Yesterday, the FOMB released an overview summary of some of the key terms for securities forming part of a consensual COFINA plan of adjustments. Ambac has been a party to these negotiations and continues to be involved in the ongoing negotiations.

As noted in the disclosure, the announced transaction is subject to final terms as set forth in separate definitive written agreements. Because of the confidential nature of mediation, we cannot comment any further on what's been disclosed.

Now on to our financial results. Yesterday, after market closed, we reported net income for the second quarter of approximately $4.3 million or $0.09 per diluted share and adjusted earnings of approximately $36.5 million or $0.78 per diluted share. Book value decreased by $1 to $39.70 per share and adjusted book value decreased $0.72 to $30.84 per share, primarily as a result of foreign exchange movements during the quarter.

During this quarter, we also made meaningful progress in improving our risk profile, maximizing the risk-adjusted return on invested assets, strengthening our balance sheet and through the AMPS transaction and debt redemptions deleveraging and simplifying our capital structure.

I am pleased with our performance this quarter and what we have accomplished so far as it reflects the continued execution of our strategic priorities following the Segregated Account Exit from rehabilitation in the first quarter of 2018.

Turning now to our active risk remediation activities for the quarter. Our insured portfolio decreased by 5.2% or $3 billion to $56 billion as of June 30, down from $60 billion as of March 31 and our adversely classified and watch list credits were down 5.5% to $23.1 billion from $24.4 billion at March 31.

During the quarter, Ambac's derisking activities included, first, the proactive termination of 11 adversely classified RMBS transactions, reducing net par exposure by $284 million and the successful derisking of a number of municipal finance exposures, eliminating approximately $133 million of net par exposure, including $33 million of adversely classified net par exposure.

In addition, we also advanced transactions during the quarter that closed in July after quarter end. The impact of which will be reflected in our results next quarter, including: first, a student loan commutation transaction that will reduce our adversely classified credits for Q3 by $127 million; and second, the refinancing of a European transaction that takes Ambac completely off risk and will reduce our ACC and watch list credits by approximately $30 million.

Our focus on watch list and our adversely classified credits has accelerated the overall derisking of the insured portfolio, which will reduce long-term volatility and over time, improve the quality of book -- of our book value and adjusted book value.

Moving now to litigation. We sought to improve our position in an appeal in the Bank of America Countrywide litigations, and although the Court of Appeals ruled against us, we remain confident in the strength of our case and we are fully prepared to go to trial on our put-back and fraud claims. A trial date for our main case has been scheduled for February 25, 2019, and a hearing on certain pretrial motions has been scheduled for the end of September. With the most recent appeals behind us, we are now focused on aggressively progressing our case to trial in New York State Supreme Court.

Separately, following the litigation settlement with certain military housing parties, we successfully closed out the last remaining objection to the second amended plan for the exit from rehabilitation of AACs segregated account, putting an official end to the rehabilitation proceedings.

And finally, as it relates to Puerto Rico, we are pleased to see encouraging signs of economic stability and positive momentum as the Commonwealth continues to recover from the impact of Hurricane Maria. Improving consumer confidence and business sentiment along with federal aid and private insurance funds have resulted in a revival of economic activity. The city rebound is a testament to the resiliency of the people of Puerto Rico, and evidence of things on a macro level are finally moving in the right direction.

Against this backdrop, the oversight board and other parties have publicly disclosed ongoing efforts to reach restructuring agreements with various creditors. While Ambac cannot comment on confidential negotiations, we continue to believe long-term consensual solutions that stabilize Puerto Rico's financial profile, capital market access and ability to provide for its residents is in the best interest of all stakeholders.

To maintain the current positive trajectory and sustain an economic revival over the long term, it will be critical that all stakeholders, especially the Rosselló administration and the oversight board worked together to achieve the best possible outcome for the people of Puerto Rico. Intergovernmental litigation is a wasteful use of time, energy and taxpayer money that will lead to suboptimal outcomes. There needs to be a much greater degree of goodwill and cooperation between Puerto Rican-elected officials and the oversight board, not only to achieve their structural and spending reforms in the fiscal plan, but also to restore growth and opportunity to the people and businesses of Puerto Rico.

The Commonwealth's fiscal plan, budget and economic and disaster recovery plan will all be critical in this regard. However, the Commonwealth's fiscal plan and budget continues to lack transparency regarding data, assumptions and definitions, making reconciliation and due diligence difficult.

To ensure an effective process during the ongoing restructuring and recovery efforts, Ambac looks forward to continued federal involvement and oversight. As we reflect on our significant achievements for the first half of the year, including the exit from rehabilitation, significant risk remediation transactions, governance changes and the recently completed AMPS transaction, we remain focused on our long-term strategic goals of creating long-term sustainable value for our shareholders.

We continued to take a measured and disciplined approach in analyzing opportunities to deploy capital, whether it be in Ambac issued or insured securities or strategic growth opportunities. As we have previously stated, all capital allocation activities will continue to be measured against the return of capital to our shareholders.

I will now turn the call over to David to discuss the financial results for the quarter. David?

Thank you, Claude, and good morning. For the second quarter of 2018, Ambac reported net income of $4 million or $0.09 per diluted share compared to net income of $306 million or $6.70 per diluted share for the first quarter of 2018. Adjusted earnings in the second quarter were $36 million or $0.78 per diluted share compared to adjusted earnings of $330 million or $7.22 per diluted share in the first quarter.

Compared to the first quarter, our second quarter results reflect higher losses incurred, higher interest expense, lower investment income and lower derivative gains, partially offset by higher realized investment gains and lower operating expenses. Much of this variability related to the execution of the rehabilitation exit transactions during the first quarter of 2018 and the resulting changes to our financial position, which became more apparent during the second quarter.

Consequently, I will focus today's prepared remarks on the main drivers of our second quarter results. The Segregated Account Rehabilitation Exit transactions had a meaningful impact on the size and composition of the investment portfolio as well as the pace of recognition of discount accretion on AAC insured RMBS. These transactions were the principal drivers to a decline in second quarter investment income, which amounted to $67 million, a $44 million or 39% decline from $110 million for the first quarter of 2018. Included in second quarter, net investment income were gains on invested assets classified as trading of $3.6 million compared to losses of $1.6 million in the first quarter of 2018. The improved performance was driven mostly by the favorable performance of equity markets on investments at Ambac U.K.

Net realized gains for the second quarter totaled $47 million as compared to $5 million in the first quarter. The principal source of these gains was the sale of Ambac insured RMBS securities. The sales are executed in connection with our longer-term plans to rebalance the investment portfolio and to simplify our capital structure. Sales included securities held as collateral against our RMBS resecuritization, which is -- was fully repaid by quarter end. And positions held as collateral against the Ambac note, which will pay down by $113 million. These sales were executed at spreads well below the cost of funding for both pieces of debt.

In addition to reducing annual interest expense by about $2.8 million, repayment of the RMBS securitization of $61 million freed up about $186 million of cash and securities held as collateral, providing with a -- providing us with additional flexibility.

Losses and loss expenses incurred were $33 million for the second quarter of 2018 compared to a benefit of $247 million for the first quarter. Losses incurred in the second quarter were driven by military housing loss expenses and additions to Puerto Rico and AUK loss reserves, partially offset by the impact of derisking transactions and credit improvements in RMBS, and to lesser degree, other sectors including student loans. The benefit in the first quarter included $288 million of discount captured on deferred amounts as a result of the rehabilitation exit transactions.

More specifically, the RMBS benefit of $26 million was driven by a $10 million benefit from the termination of 11 RMBS transactions during the quarter as well as improved collateral performance. These improvements were partially offset by a $17 million reduction in our estimate of representation and warranty recoveries, driven mostly by positive transaction performance and additions to our LAE reserves. Loss and loss expenses in the first quarter of 2018, we're driven by negative -- the negative impact of interest rates on excess spread and loss expenses incurred.

Public finance incurred losses were $44 million compared to a benefit of $11 million for the first quarter of 2018. The second quarter losses were due to the military housing litigation settlement and modifications and assumptions in the analysis of our Puerto Rico reserves. The benefit in the first quarter was primarily due to an increase in discount rates, partially offset by additions to Puerto Rico reserves.

Ambac UK incurred losses of $24 million were primarily as a result of $17 million of foreign exchange rate movements and some adverse development related to high interest rates on one of Ambac UK's remaining adversely classified credits. Other benefits were $10 million in the second quarter related to our remediation efforts on various transactions, including with regards to student loans.

Our macro hedge produced gains of $9 million in the second quarter compared to $26 million in the first quarter. As forward interest rates increased during the quarter albeit at a lower level than in the first quarter, the macro hedge continued to serve as an effective partial hedge against the impact of rising rates in our insured portfolio.

Second quarter operating expenses were $26 million, a decrease of $10 million or 28% from the first quarter. The decrease was due to nearly $12 million of lower expenses relating to the rehabilitation exit transactions and regulatory oversight costs and $3 million related to the timing of certain compensation costs. These improvements were partially offset by approximately $2.5 million of expenses related to the AMPS exchange transaction and $2.4 million of performance-based compensation related to the rehabilitation exit transactions.

Going forward, for at least a near term, OCI advisory fees are expected to run approximately $600,000 per quarter. As noted previously, we remain focused on reducing our core operating expenses, but likely we'll experience volatility quarter-to-quarter associated with the normal cost operations and various other events such as is the case of the AMPS transaction.

Interest expense for the second quarter of 2018 increased $14 million to $62 million from $48 million in the first quarter of 2018. The increase resulted from a full quarters' worth of expense related to the new debt issued in the first quarter in connection with the rehabilitation exit transactions, specifically the Ambac note and the Tier 2 notes.

Interest on the new debt accounted for $46.5 million or 75% of second quarter interest expense with legacy surplus notes accounting for the majority of the remainder.

In addition to redeeming in full, the RMBS securitization and a portion of the Ambac note, our capital management activity for the quarter included agreeing to terms on the AMPS transaction, as Claude mentioned. These transactions, particularly the AMPS transaction, progressed our objective of simplifying our capital structure and economically deleveraging our balance sheet. The AMPS transaction, which closed on August 3, resulted in a capture of $252 million of discount on a fair value basis compared to the liquidation preference of the AMPS and a reduction of the outstanding consolidated liquidation preference from over $660 million to only $103 million. This was accomplished through the issuance of approximately $286 million fair value of surplus notes, including accrued interests, the payment of $11 million of cash and the issuance of approximately $8 million in fair value of warrants.

As the AMPS were carried on the balance sheet at fair value at the time Ambac emerged from bankruptcy, we will realize an $83 million reduction to net income attributable to common shareholders in the third quarter of 2018 and a reduction to total Ambac Financial Group, Inc. stockholders' equity and adjusted book value of approximately $75 million.

Total comprehensive income for the second quarter was a loss of $49 million, resulting in stockholders' equity at June 30, 2018, from $1.8 billion or $39.70 per share, down $45 million and $1 per share from March 31, 2018. Adjusted book value is $1.4 billion or $30.84 per share at June 30, 2018, $33 million or $0.72 per share lower than at March 31, 2018.

The decline in book value and adjusted book value was a result of the impact of unrealized foreign exchange losses related to the 6% depreciation in the British pound relative to U.S. dollar. Volatility of the pound in the near term is expected to continue as uncertainty related to Brexit continues.

That concludes my formal remarks. And now I'll turn the call back to Claude for some brief closing remarks.

Thanks, David. We have had a busy first half of the year. And as we move into the second half of 2018, we will continue to strive to execute on our strategic priorities to create additional sustainable value for our shareholders. We are optimistic about our future and remain keenly focused on taking concrete steps to create long-term value for our shareholders.

Thank you for joining us today. I'll now turn the call back to the operator.

(Operator Instructions) Our first question is coming from Andrew Gadlin of Odeon Capital Group.

I was wondering if you could talk about the last night's COFINA deal and the language there regarding monolines that new bonds could be issued in trust to secure custody receipts structure. What would that mean potentially for Ambac?

Thanks for your question. As we noted in our opening remarks, we are restricted in disclosing information surrounding the settlement as a result of the mediation confidentiality. But I think there have been a number of structures involving custodial receipts that have been done in other like municipal finance bankruptcies in the past. So I could refer you to those, and we can reference you to the information that was published by the FOMB, but really can't speak more to it than what's in that document.

Were any of those other structures -- did any of them involve monolines? Could you help us clearly understand whether this would effectively diffuse your exposure?

I-- yes, I can't really comment on those aspects, and I think -- Again, depending upon the structures, the actual economics and flow of securities and cash have been treated differently. But, yes, there are examples if you look back at Jefferson County, Detroit amongst other restructurings that you get a sense of the type of structures that have been used in the past.

Okay. And then good progress on running of some of the watch list securities. Can you talk about some of the efforts underway in terms of, it is the focus across the board. Or are you more focused right now on military housings, student loans, et cetera?

Yes, I think it's a blend of things. I think we certainly have an across-the-board focus to bring down our overall watch list and ACC exposures, but we do target certain, what I'll call, heightened exposures and we also look at things opportunistically, obviously. So I think it's a broad coverage, and obviously strategy is behind our approach in each case, so we don't discuss the details of that. But we are, as we've indicated, very heavily focused on these credits for our derisking activities. And military housing would certainly be in the mix, but again I would -- it's really the full spectrum of credits in those categories.

Okay. And then can you discuss the circumstances around the deferral of tolling payments coming from AAC to the holdco? Do you have any idea on when that could be listed and what sort of triggers OCI as looking further?

They have not indicated any triggers, I think the OCI has -- there may have been so many transactions, we just exited rehab, our ACC Segregated Account rehab. We have been involved in the AMPS transaction. So I think there -- there's a volume issue I think that they're working through, and they've indicated that they would like more time to review the tolling payment before its paid. So we're just waiting to hear back from them. They may request additional information, we don't know at this time.

Any sense on timing taken?

No specific sense of timing at this point. The payment was due in May. So it's obviously past the payment date, and they requested we withhold the payment. So again, we're -- patiently waiting, and we'll be working with them to address any questions and allow them to complete the review.

(Operator Instructions) Our next question is coming from Sean Lobo of Vulcan Capital.

From a ministry perspective, have those securities been distributed to holders of the AMPS yet? Or is that still in progress?

The new securities, including the warrants and the student loans -- the surplus notes have been distributed as of April 3.

August.

August 3.

(Operator Instructions) Our next question is a follow-up coming from Andrew Gadlin of Odeon Capital.

One follow-up. It looks like you sold some of the -- it looks like AFG sold some of their surplus notes this quarter...

That's right.

Is that right?

Just a few million dollars.

Could you talk about that decision and what drove that?

Yes, I think we've commented in the past that we're -- at the holding companies, certainly we're managing capital against a couple of different goals. One of which, of course, is the return on that -- the investment of that capital of the holding company, but also trying to balance liquidity against the various different strategic objectives we have at AFG.

And so we had an opportunity to sell the securities at what we thought is a reasonable price, and so we took the opportunity to generate some cash at the holding company.

Our next question is coming from at Ed Groshans of Height Capital.

Just first, you mentioned loss and loss adjustment expense relative to Puerto Rico. Was it more the settlement with COFINA that resulted in some of the adjustments or whether other factors that led to the loss and loss adjustment expense for your Puerto Rico exposure?

It's a multitude of factors, and I wouldn't say specific to any discussions going on with COFINA. It's a holistic approach that we take to assessing the cost of future remediation activities and certainly the time and effort spent around COFINA factors into that, but it's generally to see -- forward-looking view of -- where our future cost may be, and I wouldn't point any one specific thing as the driver to that.

Okay. But COFINA is one of -- relative to your other exposures outsized right?

Yes, that's right, but I would not say that the LAE expenses are necessarily like a loss reserve would be tied directly to this particular sizable exposure. It's more tired sometimes to the complexity of exposure, the time with which we think a remediation effort may take and other factors that are not necessarily purely the size.

Okay. All right. And on previous calls, you started talking about new business activities and a new focus for Ambac going forward, moving away from bond insurance. Can you just give us an update on those activities?

Sure. As we've indicated that, that is a component of our overall strategy. Our core strategy remains on the derisking of the portfolio, capital management, expense management. We have started working towards looking at new business activities and are active in that process, but we've also indicated that it's not something we're going to rush into, it's going to be a very disciplined approach and we will update the market as things progress. So we have nothing substantial to update this quarter, but we will continue our efforts and update the market in due course.

Okay. Does the completion of the rehabilitation -- accelerate is probably not the right word, but quicken in the process towards looking at those different opportunities?

Yes, I think there's a number of things that the AMPS transaction, the rehab resolution of COFINA if and when that is completed. I think all these things certainly help in terms of allowing us to reprioritize time on those efforts.

But I would say that everything is happening and moving in parallel, and we're focusing on all these initiatives together. But clearly, the flexibility of having some of these items behind us are a benefit.

Thank you. There are no further questions at this time. This concludes today's teleconference. We thank you for participating. You may disconnect your lines at this time. Thank you for your participation.