Ambac Financial Group, Inc. (NYSE:AMBC) Q1 2022 Earnings Conference Call May 11, 2022 8:30 AM ET

Company Participants

Charles Sebaski - Head of Investor Relation
Claude LeBlanc - President & Chief Executive Officer
David Trick - Executive Vice President, Chief Financial Officer & Treasurer

Conference Call Participants

David Belport - Wells Fargo Advisors

Operator

Greetings and welcome to Ambac Financial Group, Inc. First Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Charles Sebaski, Head of Investor Relations; Claude LeBlanc, Chief Executive Officer; and David Trick, Chief Financial Officer.

I will now turn the conference over to Charles. Please go ahead, sir.

Charles Sebaski

Thank you. Good morning and thank you, all for joining today's conference call to discuss Ambac Financial Group's first quarter 2022 financial results.

We'd like to remind you that today's presentation may contain forward-looking statements about our business, including, but not limited to, new business, credit outlooks, market conditions, credit spreads, financial ratings, loss reserves, loss mitigation, loss recoveries, investment returns or other items that may affect our future results. These statements 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 report under Management's Discussion and Analysis of Financial Conditions 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 reconciliation 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 and Presentations section of our IR website which support our comments today.

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

Claude LeBlanc

Thank you, Chuck, and welcome to everyone joining today's call. For the quarter ending March 31, 2022, Ambac reported net profit of $2 million or $0.04 per diluted share, and adjusted earnings of $14 million or $0.30 per diluted share. In addition, this quarter, we announced a share buyback program which began in April, and to-date, we have repurchased over 1.5 million shares for just over $13 million or an average price of $8.78 per share. Yesterday, we announced the addition of $15 million to our share repurchase program, bringing the total unused authorized amount to $21.8 million.

David will discuss our results in more detail shortly. As previously shared with investors, 2021 was a transition year for Ambac as we launched our Specialty P&C Insurance business and progressed our strategy to become a growth-oriented company. Our results for the first quarter of 2022 for Specialty P&C Insurance platform are a clear reflection of our early successes, which are very encouraging. We experienced growth across both our Specialty P&C participatory fronting and insurance distribution businesses with total specialty P&C insurance production of nearly $70 million representing a 71% increase from the first quarter of last year. This growth is being driven by the scaling and expansion of our new businesses further supported by the favorable market conditions and the progressing secular shifts in the insurance market.

As it relates to market conditions, we have continued to see rate increases at moderating pace in most lines of business, a dynamic, which supports the continued growth of the rapidly evolving program and fronting markets in the US. The MGA market is estimated to be generating between USD60 billion and USD65 billion of premium annually having doubled over the last decade. Fueling the growth of the fronting market, which grew by nearly 53% year-over-year in 2021. This is the trend we anticipate will continue in the coming years, subject to market conditions. For the first time this quarter, in addition to our traditional consolidated reporting, we are now providing segment reporting on our two growing operating businesses. Everspan Group, which we will report in our Specialty P&C Insurance segment and Serotta Group [ph], which we will report in our insurance distribution segment.

Our Specialty P&C Insurance business, Everspan Group was launched in the second quarter of 2021 and our strategy from the beginning was to differentiate our business model from other fronting businesses. A key component of this differentiation is our ability and willingness to retain up to 30% of underwriting risk, which creates significant alignment of interest with Everspan's reinsurance partners. This distinction further expands our ability to differentiate Everspan as a leading solutions and service market for our valued program administrators.

In the first quarter of 2022, this strategy has been successful and generating $24 million in gross premium written across the 10 programs launched over the last year, including three this quarter, representing a run rate of approximately $100 million, which we expect to grow in consecutive quarters with a strong pipeline of prospective programs going into the second quarter. Our leadership team at Everspan is represented by industry executives with proven track records in all key aspects of our business model, underwriting, actuarial and claims.

Turning to our distribution business, our insurance distribution segment led by Xchange, our first MGU partner is profitable and growing, having placed over $45 million of premium for the first quarter of 2022, an increase of nearly 13% over the prior year, which represents a record quarter for the company. Going forward, we expect the company will continue to successfully expand its business and distribution network, both organically as well as through select strategic transactions. Recently, we announced that Xchange entered into a renewal rights transaction for a $13 million portfolio of employer stop loss or ESL business. The transaction was self-funded is expected to be immediately accretive to earnings and is anticipated to expand Xchange's ESL premiums by over 15%. As importantly, we believe this transaction will open up new distribution relationships nationally and Xchange's core ESL business.

Overall, we are very pleased with the progress, each of our P&C insurance businesses has shown this quarter and we believe, we are well positioned for continued growth both organically and through strategic transactions in 2022.

Turning now to a legacy financial guaranty business. During the quarter, we had two significant developments at AAC. As previously announced, the plan of adjustment in Puerto Rico, which related to our GO and PBA exposures was finalized on March 15. This facilitated a reduction to our Puerto Rico-insured principal and interest exposure by $450 million. And since the end of the quarter, we have further reduced our Puerto Rico exposure by $716 million, eliminating all of our remaining PRIFA and CCDA exposures.

As a result, as of today, our only remaining insured Puerto Rico exposure is to HTA and our residual exposure to COFINA. These transactions collectively represent a 49% reduction in our remaining Puerto Rico exposure, which led to Ambac's recognized gain of $198 million in the quarter. As it relates to our remaining HTA exposure in Puerto Rico, the HTA Plan of Adjustment was filed on May 2, and we expect that it will be confirmed and become effective before the end of the year. However, until the Title III process is concluded for HTA, some uncertainty still exists around the final outcome.

Looking at the balance of our portfolios, we continue to reduce risk in the insured portfolio through active derisking and natural portfolio runoff. Net par exposure was $27 billion at March 31, down nearly $1 billion or 4% from December 31, 2021. Ambac's Watch List and Adversely Classified Credits were reduced to $9.6 billion at March 31, down approximately $0.6 billion or 6% from the prior year end. Overall, Ambac has removed a material amount of uncertainty from its legacy insured portfolios over the last couple of quarters. Absent new material developments in the insured portfolios, we would anticipate this to result in lower future loss volatility.

The other significant development at AAC during the quarter related to a New York Court of Appeals ruling in an unrelated RMBS litigation known as heat. While this decision did not involve any of our RMBS cases, the decision in the court of appeals limits damage recoveries for one of our various paths to recovery in certain of our RMBS cases. As a result of this change in law, AAC reduced its rep and warranty subrogation recoverable by $186 million. Changes in discount rates and underlying insured RMBS transaction performance contributed an additional $38 million to the overall reduction of the recoverable.

As it relates to our RMBS loss recovery efforts, we are actively pursuing all claims in our rep and warranty litigations. And in our main case against, Bank of America Countrywide, we are preparing for trial and look forward to resolving our claims as favorably and as expeditiously as possible. As more fully described in letters filed with the court on March 24 and March 28 by our outside counsel, Ambac has multiple paths in that case to recover our claim payments in addition to significant prejudgment interest, which began accruing more than 10 years ago.

Furthermore, we believe that heat does not impact our two primary paths to recovery, one, discovery; and two, reimbursement, neither of which was addressed by heat. At trial, Ambac intends to prove the following. First, in light of the recent heat decision through multiple paths, we intend to prove that Countrywide discovered the breaches without the need for notice. We have been preparing the discovery case against Countrywide for years and have always planned to prove discovery along with our notice breach approach at trial.

Ambac's discovery case is also unique in the RMBS space, given that Countrywide originated approximately 85% of the loans in the transactions at issue in the case, meaning that Countrywide employees reviewed every application for every loan that Countrywide originated. Countrywide's role as originator with most of the loans at issue in the litigation, makes our case markedly different from other outstanding RMBS litigations. Countrywide also discovered breaches through its role as sponsor of each securitization transaction and a servicer of the loans. As such, Countrywide discovered breaches of reps and warranties without the need for any notice.

Second, Ambac has a separate reimbursement claim under its insurance and indemnity agreements with Countrywide. As an insurer, Ambac has an extra form of protection through contractual rights and revenues provided in these agreements. An appellate court has already held at the sole remedy repurchase protocol, which is what -- was that issue in heat does not apply in our reimbursement claim. Other RMBS plaintiffs, like trustees do not have this kind of alternative path to recovery.

Third, we intend to prove that Countrywide prevented Ambac from providing additional notices by failing to timely provide Ambac with loan files and other materials in its possession. We also intend to prove the futility of providing further notices. Countrywide refused to repurchase all but a small number of effective loans that Ambac noticed, even though that its own internal fraud and quality control divisions acknowledged to be defective. With respect to other cases, we are making progress on our fraud-only case against Countrywide and our cases against First Franklin and Nomura, which we hope to progress the trial as early as next year.

To dimensionalize our damages, as we look across all cases against RMBS sponsors, in Countrywide, we're seeking damages of well over $2 billion. And in our other cases, First Franklin, our fraud-only case against Countrywide and Nomura, we're seeking aggregate damages of more than $1 billion. We have confidence in our claims and intend to vigorously pursue them to fear a final resolution. As a reminder, the recoverable on our balance sheet for our breach of contract cases does not include prejudgment interest or any recovery from our fraud-only claims, both of which could be material.

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

David Trick

Thank you, Claude and good morning, everyone. Before I discuss our first quarter results, I'd like to emphasize two changes, we made to the presentation of our financial results this quarter. First, our results are being presented on a year-over-year basis rather than on a sequential basis, our formal presentation method. Secondly, we have begun disclosing our results through three segments: Legacy Financial Guarantee Insurance, Specialty Property & Casualty Insurance, and Insurance Distribution. Both of these changes are a result of the continued growth and expansion of our new businesses relative to the continued runoff of the legacy financial guaranty business.

For the first quarter of 2022, Ambac reported net income of $2 million or $0.04 per diluted share compared to net income of $17 million or $0.08 per diluted share in the first quarter of 2021. Adjusted earnings for the first quarter were $14 million or $0.30 per diluted share compared to adjusted earnings of $41 million or $0.59 per diluted share in the first quarter of 2021. Difference between adjusted earnings and GAAP net income for the first quarter of 2022 related mostly to the exclusion of $14 million of insurance intangible amortization from adjusted income.

The reduction in net income for the first quarter of 2022 as compared to the first quarter 2021 was primarily caused by the $33 million gain on the extinguishment of debt in the first quarter of 2021 related to the junior surplus note exchange transactions. Other notable variances relative to the prior period include higher loss and loss expenses and lower investment income offset by higher gains from interest rate derivatives and higher VIE gains. As part of our new segment disclosure and as Claude referenced, we are now reporting several new metrics, including P&C insurance production. P&C insurance production is a combination of both gross premiums written at Everspan and premiums placed through our insurance distribution segment.

P&C production is a proxy for the basis upon which program fees, earned premium and gross commission income will be generated. Gross premium written at Everspan was $24 million in the first quarter compared to a de minimis amount in the first quarter of 2021 and up over 3x from the $7 million written in the fourth [ph] quarter of 2021. Premiums placed in the distribution business totaled $45 million in the first quarter compared to $40 million in the first quarter of 2021, an increase of 12%.

Taken together, P&C insurance production was $69 million in the first quarter, up 71% over the first quarter of 2021 and over 2x the production of last quarter. First quarter is seasonally the largest quarter of the year for the insurance distribution business. Premiums earned were $15 million in the first quarter compared to $14 million in the first quarter of 2021. Financial guarantee earned premiums continued to trend downward as a result of our active derisking efforts and organic runoff of the insured portfolio. Everspan's contribution to net earned premium, although modest was just over $1 million for the quarter as compared to nil for the prior period and over double the prior quarter.

In addition, we would highlight that of the $24 million of gross written premiums in the quarter, Everspan retained $5 million of net written premium, which will earn in over the next year. Everspan also collected $1 million of program fees, approximately 1/4 of which were earned in the first quarter and the remainder of which will also earn in over the remainder of the year. As Everspan continues to add programs and as each program grows gross written premium, we'd expect to see both earned premium and programming fees grow exponentially.

Our Distribution segment also continues to grow. As previously noted, $45 million of premiums were placed in the quarter, a 12% increase from the $40 million placed last year. Insurance distribution business revenue comes from commissions earned based of the amount of premium at places. And for the first quarter, gross commissions were $9 million, up 19% from $7 million in the prior year period. The insurance distribution segment produced $2.7 million of EBITDA for the first quarter, up almost 13% over the first quarter 2021. Investment income for the first quarter was $5 million, down from $49 million from the first quarter of 2021.

The decrease in investment income during the first quarter was related to three items: first, pooled fund investments generated a net gain of about $1 million in the quarter compared to $28 million in the first quarter of 2021. Given market conditions, we believe our pooled funds performed well in the quarter. This compares to extraordinary pooled fund performance in the first quarter of 2021 at approximately 4.6% or a 20% annualized rate.

Secondly, we incurred a $9 million loss on Puerto Rico plan consideration classified as trading, which represented a small component of our large overall gain from the Puerto Rico restructuring in the quarter. Thirdly, we lost $7 million of income as a result of the refinancing of Ambac [indiscernible], a large portion of which we owned in the investment portfolio. However, interest expense was also down by a similar and offsetting amount year-over-year. During the first quarter, we also recorded realized gains of $9 million from a class action litigation recovery related to RMBS bonds we formally owned in the legacy financial guaranty segment investment portfolios.

Loss and loss expenses were $24 million in the first quarter compared to $8 million in the first quarter of 2021. Public Finance experienced $190 million of positive development in the first quarter compared to a $9 million loss in the prior year, all of which was driven by Puerto Rico. Future development of our Puerto Rico loss reserves, which now solely relate to our HTA exposure will be influenced by many factors, including the confirmation and confirmation of the HTA plan, our ability to execute risk mitigation opportunities, timing, the value and liquidity of new bonds and CVI subrogation related to HTA as well as a number of other factors. While future development in our Puerto Rico reserves may occur, we do not currently anticipate such development to be significantly material.

The structured finance portfolio generated a loss and loss expense of $213 million this quarter compared to a benefit of $8 million in the first quarter of last year. This change resulted primarily from a $224 million reduction to our rep and warranty credit, $186 million of which was the direct result of the previously mentioned New York Court of Appeals decision. In addition, there was a $27 million reduction related to an increase in discount rates and $11 million related to a reduction in underlying transaction losses. Net gains on derivative contracts, which are positioned as a partial economic hedge against interest rate exposure in the financial guarantee and investment portfolios were $57 million for the first quarter compared to gains of $25 million for the first quarter 2021. The interest rate derivative portfolio is designed to benefit from rising rates as a partial economic hedge against rate exposure in Ambac's financial guarantee insured and investment portfolios.

Operating expenses were $34 million, up from $33 million in the first quarter. The slight increase in operating expenses for the first quarter was due to higher defensive legal expenses in the legacy financial guarantee segment, higher headcount and other expenses associated with building and growing our new businesses and growth-related sub-producer commissions in the insurance distribution segment, partially offset by lower corporate consulting and advisory fees.

Turning to the balance sheet, shareholders' equity decreased $2.77 per share to $19.65 per share or $0.9 billion at March 31, 2022 from year end 2021. The decrease was due to net unrealized losses on investments of USD105 million and USD23 million of foreign currency translation losses. Adjusted book value decreased to $841 million or $18.07 per share at March 31, 2022, from $874 million or $18.88 per share at December 31, 2021. This $0.81 per share decrease was primarily due to foreign currency translation losses and the impact of higher risk fee rates used to discount economic future installment premiums. At March 31, 2022, ASG on a stand-alone basis, excluding investments in subsidiaries and cash, investments and net receivables of approximately $243 million or $5.22 per share, including approximately $118 million liquid assets.

I will now turn the call back to Claude for some brief closing remarks.

Claude LeBlanc

In conclusion, we are excited by the material progress and growth we have seen in our Specialty P&C Insurance platform as the fronting and MGA markets continue to show strong growth and profitability. We continue to see attractive opportunities to deploy capital in our insurance distribution business in order to grow organically and through strategic transactions. We also see meaningful opportunities to capture growth and expense synergies across our growing businesses through our dedicated business services unit, supporting the existing and future technology, distribution and infrastructure needs of our distribution partners.

We will also continue our focused derisking and loss recovery efforts in key areas of our legacy financial guarantee companies. And at the appropriate time, we'll explore strategic options for this business with the goal of maximizing value for our shareholders. As we continue the transition and expansion of our P&C platform, we believe the company's value will be increasingly driven by the individual segments, and therefore, align with our strategic focus on the specialty P&C insurance and distribution businesses. These new businesses are characterized by capital-light models, EBITDA managed and growth-focused. Accordingly, we believe the framework we're evaluating our new businesses and for Ambac as a whole, will need to include such new metrics, separate and distinct from our legacy financial guaranty business, which today is capital intensive and event-driven.

We further believe the assessment of value for each underlying segment in addition to our holding company capital better reflects the value of our enterprise. We look forward to continuing to update you on our progress in the coming quarters.

Operator, please open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We have a first question from the line of David Belport with Wells Fargo Advisors.

David Belport

Yes, I have a question regarding the warrants that expire April 30, 2023. Has there been any talk or discussion as far as extending the warrant time with regard to the potential for a delay in the trial. Obviously, these are 10-year warrants and just wondering whether there is any possibility of extending those warrants, and I believe there should be.

David Trick

No, honestly, we have not had that discussion, but thank you for the feedback. We'll certainly take it under consideration and provide you with any appropriate feedback once we've had an opportunity to review your suggestion.

Operator

[Operator Instructions] We have next question from the line of [indiscernible] with Rosen Equities.

Unidentified Analyst

I was encouraged by some of the language in the press release about trying to see some of these litigation claims pursued to ultimate adjudication given the long timeline here, I actually followed back in 2007, 2008 when some of this stuff was kind of incepted. And I saw some of the conduct that went on with some of the originators and securitizers. So I'm very interested to see you guys being able to put some of the some of that into trial. So I appreciate that. And I'm interested to know, do you think that there's the potential for -- the potential for the trial to be delayed if that we need some time to kind of work out how to figure whether we have to figure out a new mechanism to kind of judge how to gauge how many of these loans need to be -- how we basically re-underwrite these loans like based on the ruling and the DOJ case.

Claude LeBlanc

As we described in our letter to Justice Reed on March 28 that we referenced, that is available on the court side and we were going to have it available on our investor section of our website as well. We believe that in the heat US Bank decision, that should not have any impact on the timing of our trial or the scope of our trial. And we believe that we should be able to proceed to trial as scheduled in September. It's a pause [ph] to sell off other issues or other cases developed in other directions. But as we've explained extensively in my prior remarks and in the letter, our case is very uniquely positioned and differentiated in the market, which is also why we believe there's a clear path to trial in September.

Unidentified Analyst

Makes a lot of sense to me. And I actually read that letter, and it was good to kind of see articulated some of the ways that you're kind of in a different situation relative to the trustee and has some kind of differentiating factors in terms of your rights and contractual aspects of the case. I was also encouraged that you guys kind of came back into the market buying stock. I think that's also very important that you've illustrated that some of the parts valuation of the company here, barely ascribes any value to the event-driven potential proceeds or value that could be ascribed to AFG from AAC in the medium to long term. And I also like that you kind of re-upped the buyback a bit in the last few days.

And I'm wondering, would you guys kind of -- we're not -- I'm not trying to put you on but make a granular kind of commitment. But let's say, over the course of the year, if you continue to get distributions from the Specialty P&C businesses, do you think that there's scope to even add more to that buyback if the prices remain compelling later on in the year?

David Trick

Sure. It's something we will take into consideration. The stock buyback is something that we evaluate on a regular basis and try to weigh liquidity versus opportunities in the market to buy the stock, where we can be opportunistic versus capital deployment and new business opportunities. So it's a recurring and evolving evaluation of capital deployment. And certainly, it's one we'll continue to evaluate as the weeks and months go up by here and see where we come out on the current authorization and where our opportunities to deploy capital are throughout the course of the year. So it's something we continue to and we'll regularly continue to evaluate.

Unidentified Analyst

Well, I'll just endorse the thinking to this point strongly.

Operator

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