Ambac Financial Group, Inc. (NYSE:AMBC) Q1 2021 Earnings Conference Call May 10, 2021 8:30 AM ET

Company Participants

Lisa Kampf – Head-Investor Relations
Claude LeBlanc – Chief Executive Officer
David Trick – Chief Financial Officer

Conference Call Participants

Giuliano Bologna – Compass Point

Operator

Greetings, and welcome to the Ambac Financial Group Inc. First Quarter 2021 Earnings Call. At this time, all participants are placed 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, 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.

Lisa Kampf

Thank you. Good morning, and thank you all for joining today’s conference call to discuss Ambac Financial Group’s first quarter 2021 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 recovery, 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 reports under management’s discussion and analysis of financial condition and results of operation and under risk factors, and that 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. 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 the 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, Lisa, and welcome to everyone joining us on today’s call. This morning Ambac reported net income of $17 million or $0.08 per diluted share, and adjusted earnings of $41 million or $0.59 per diluted share for the first quarter. At March 31, our book value was $1.1 billion or $23.02 per share and adjusted book value was $908 million or $19.66 per share.

Our first quarter results were positively impacted by material progress on our strategic priorities, including gains of $37 million realized from our junior surplus note transaction and the inclusion of operating results from our new MGU platform exchange. We also regained significant de-risking momentum during the quarter and materially progressed our specialty property and casualty insurance strategy.

Starting with the review of our de-risking activities, net par exposure was $31.4 billion at March 31, down 7% from year-end and Watch List and Adversely Classified credits were $12 billion at March 31, down 8% from December 31. Active de-risking transactions accounted for 56% of the total decline in net par exposure for the quarter.

Notable transactions completed include; one, the execution of a material reinsurance transaction or certain public finance credits with net par outstanding of approximately $823 million. Par ceded included general obligation, lease and tax back revenue, higher education and transportation exposures, as well as $158 million of Watch List and Adversely Classified credits. Two, the successful exit of our Mets Queens Baseball Stadium exposure, a $540 million Adversely Classified credit by at the refinancing and quota share reinsurance transaction. And lastly, the negotiation of additional credit and liquidity improvements for AUK’s largest COVID affected exposure.

The U.S. economy is experiencing a strong recovery year-to-date, with U.S. GDP expected to have grown at an annualized rate of approximately 9% in the first quarter. Higher retail sales, increased manufacturing output and government stimulus, including the $1.9 trillion American Rescue Plan Act with $350 billion slated for state and local governments, together with other fiscal and monetary stimulus in 2020 are driving the strong economic recovery.

Additional stimulus could come from the American Jobs plan and $1.5 trillion projected in discretionary spending in the U.S. budget for 2022. Given these strong economic conditions, we remain cautiously optimistic about the outlook for our insured portfolio, which we believe will continue to improve, particularly as vaccination rates continue to increase.

Turning now to Puerto Rico. As reported on May 5, the Oversight Board has reached a plan support agreement with Assured Guaranty and MBIA amongst other creditors. This agreement impacts two of our revenue bond exposures, HGA and CCDA. However, the agreement does not include PRIFA, our largest remaining Puerto Rico exposure. Ambac is not a signatory to the plan support agreement.

However, we continue to believe that a consensual negotiated settlement leading to a global resolution of Puerto Rico’s bankruptcy is in the best interest of the Commonwealth. Borrowings such as settlement, Ambac will continue to pursue all of its legal rights and remedies to arrive at a resolution that respects the property rights and security interests of revenue bond holders.

We are firmly of the opinion the Puerto Rico has ample debt paying capacity to structure a reasonable outcome on revenue bonds. This can be achieved in a way that would not impinge on the Commonwealth’s ability to flourish economically and to serve its residents who had to suffer through this lengthy and costly bankruptcy process.

Regarding our loss recovery efforts, our fraud appeal in our main case against Bank of America Countrywide was argued in April and we expect a decision from the First Department within the next couple of months. We are preparing to go to trial with or without a fraud case. Assuming no change or developments that could impact the timing or nature of our case, we hope that Justice, Robert Reed, recently appointed to our case, will schedule a trial date for the second half of this year or early 2022.

With regards to our capital management initiatives, during the quarter, we executed a note exchange transaction resulting in the acquisition of all outstanding junior surplus notes in exchange for the issuance of surplus notes. This resulted in the extinguishment of $76 million in debt and accrued interest. David will speak to these transactions in more detail in a moment.

Turning now to our new business initiatives at AFG. The P&C industry continues to report healthy rate increases and we expect pricing will continue to outpace estimated loss cost trends, leading to improved underwriting margins. We believe that the improvements in combined ratios across the industry present a tremendous opportunity to generate strong risk-adjusted returns as we rapidly progress the ramp up of Everspan and our P&C specialty business.

Everspan Group has made significant progress following its launch in February. Our license expansion initiatives for Everspan Insurance, our specialty admitted carrier has progressed materially and Everspan now has full P&C authority in 26 jurisdictions. Everspan indemnity or surplus lines carrier is authorized for excess and surplus lines in all 50 states and is whitelisted in the majority of the states that maintain a registry.

I’m also pleased to report that Everspan’s first program was recently launched with Cardigan General Insurance Services, a subsidiary of Venbrook Group, and a nationally recognized managing general agency that focuses on specialty programs and services. We are very excited about the Everspan Cardigan partnership, which allow Cardigan to enhance our specialty transportation product offering and diversify their state footprint. Our first program was also backed by strong and highly rated reinsurance panel.

Our management team’s expertise and collaborative deal structuring approach has been positively received in the market. Everspan has a significant number of submissions under active review and we expect that continued favorable market conditions will provide a robust program pipeline for Everspan in the coming quarters. We are also exploring a number of strategic initiatives, including the potential acquisition of additional shelf carriers to support Everspan’s short and long-term objectives.

Turning now to Xchange. The acquisition of Xchange under Pillar II, which encompasses fee-based MGA and MGU businesses, was accretive to our first quarter results and we are pleased with our team’s performance during the quarter. With strong renewals on its Employer Stop Loss business and growing revenue generation in its Affinity business, Xchange is well-positioned for growth in the coming quarters.

Consistent with the strategy, the team is pursuing opportunities for product diversification and expansion of its strong panel of insurance care relationships as well as opportunities to develop additional revenue sources. We’re also actively exploring opportunities to grow the MGA, MGU program management business via additional acquisitions and/or partnerships, as well as the establishment of de novo modeling MGA in targeted specialty P&C lines of business. With regards to Pillar III, we continue to actively explore various investment opportunities in businesses which are complementary to our Pillar I and Pillar II strategies.

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. For the first quarter of 2021, Ambac reported net income of $17 million or $0.08 per diluted share. This compares to a net loss of $14 million or $0.31 per diluted share in the fourth quarter of 2020. Adjusted earnings for the first quarter were $41 million or $0.59 per diluted share, compared to adjusted earnings of $4 million or $0.08 per diluted share in the fourth quarter. The variance between adjusted earnings and GAAP and income relates mostly to the exclusion of insurance and intangible amortization, which amounted to $19 million in the first quarter.

Our first quarter results reflect the advancement of a number of our strategic initiatives, most notably, our continued efforts to simplify and deleverage our capital structure. To that end, we executed two transactions, which combined results in all junior surplus notes being extinguished and exchange for surplus notes, a GAAP gain from extinguishment of debt of $33 million and a net realized investment gain of $4 million.

In addition, our first quarter results were favorably impacted by the inclusion of exchanges results for the first time, continued strong results from our investments diversification strategy and gains on interest rate derivatives, partially offset by incremental reserves taken on Puerto Rico.

Briefly turning to some more specifics. Premiums earned were $14 million in the first quarter compared to $18 million during the fourth quarter. The decrease in the first quarter was driven by lower accelerated premium as a result of the proactive de-risking of international credit, which produced $6 million of accelerated premium in the fourth quarter of 2020, partially offset by an increase in normal earned premium as a result of a reduction in the allowance to premiums receivable in the first quarter.

Although down slightly, investment income remained strong at $49 million compared to $53 million in the fourth quarter. Performance was led by continued solid results in equities and hedge funds, partially offset by losses from the emerging markets debt and lower income from the Corolla Trust certificate. AFG sold the Corolla Trust certificates in exchange for AAC issued surplus notes as part of the junior surplus note exchange.

Included in the first quarter investment income were gains on pooled funds of $27 million and income from available for sale securities of $22 months compared to $31 million and $23 million in the fourth quarter, respectively. Investments in pooled funds at a total return of 4.6% for the first quarter compared to 5.8% in the fourth quarter. Other income of $5 million for the first quarter, included commission revenue from exchange of $7 million, partially offset by foreign exchange losses and certain expenses related to consolidated VIE.

Loss and loss expenses incurred were $8 million in the first quarter compared to $9 million in the fourth quarter. Domestic public finance losses incurred were $9 million, stemming from increased Puerto Rico reserves related to the recent developments, which Claude just discussed, partially offset by the benefit of higher discount rate. The benefit of $7 million in the fourth quarter reflected the favorable impact of higher discount rates and positive credit developments, in general, resulting from the active management of the insured book, partially offset by an increase in Puerto Rico reserves.

Operating expenses were $33 million, up from $26 million in the fourth quarter. The increase was driven by the inclusion of Xchange’s commission’s to sub producers and operating cost, costs related to the junior surplus notes exchange and seasonal compensation costs. While operating expenses increased this quarter, the increase including non-recurring cost was primarily driven by the inclusion of Xchange and the advancement of other strategic objectives, all of which will generate both near-term and long-term value. Nevertheless, we remain focused on prudently managing expenses across the entirety of the Ambac platform.

Turning to the balance sheet. As a result of the exchange transaction, which eliminated all outstanding junior surplus notes related accrued interest, AAC issued $279 million par of surplus notes with associated accrued interest of $183 million, lowering its debt and outstanding interest by $76 million. Out of this issuance, AFG surplus notes of $40 million par with $26 million of accrued interest, which are eliminated in consolidation in exchange for its equity investment in the Corolla Trust.

The exchange transactions were beneficial to both AAC and AFG in several ways. For AAC, the exchange lowered AAC’s outstanding debt and accrued interest by $76 million, no cash outlay and reduced its annual interest expense by approximately $4 million, further simplified the capital structure and reduced the duration of outstanding debt. And for AFG, the surplus notes received in the exchange improved liquidity relative to the investment in Corolla equity exceeded on a fair value basis the carrying value of the Corolla equity and have an expected duration shorter than the Corolla equity. Through its investment in AAC, AFG is also the residual beneficiary of the deleveraging of AAC.

During the first quarter, we also early redeemed another $16 million of the AAC secured notes, mostly through the sale of a portion of the securities collateral at market levels below the cost of the secured debt. Shareholders’ equity decreased $0.55 per share to $23.02 per share or approximately $1.1 billion at March 31, 2021. The decrease was due to net unrealized losses on securities of $24 million and a $13 million increase to the redemption value of exchanges non-controlling interests, partially offset by net income of $17 million and $6 million of foreign exchange translation gains.

Adjusted book value decreased to $908 million or $19.66 per share at March 31, 2021 from $919 million or $20.05 per share at December 31, 2020. The $0.39 decrease was driven by $13 million increase to the redemption value of exchanges non-controlling interest and the impact on expected future premium from the reinsurance transaction and the Mets Queens ballpark de-risking, partially offset by $41 million of adjusted earnings.

Unlike book value, adjusted book value is not impacted by changes in unrealized gains and loss. AFG on a stand-alone basis, excluding investments in subsidiaries as of March 31, 2021, the cash investments and net receivables of approximately $274 million or $5.94 per share including approximately $155 million of liquid assets. The decrease in assets of $92 million or $2.05 per share from December 31 was mostly related to the capitalization of Everspan.

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

Claude LeBlanc

Thank you, David. I’m very pleased with the accomplishments during the first quarter of 2021. We remain focused on all of our strategic priorities and expect our momentum to continue as we progress our efforts in the coming quarters.

Operator, please open the call for questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Giuliano Bologna with Compass Point. Please proceed with your question.

Giuliano Bologna

Good morning. I think you didn’t think to touch on some of the developments, obviously getting bills on the Puerto Rico side is positive. When we look at the loss reserves and losses are methodology kind of in the first quarter. Is there anything related to those, the new announced transactions included in the scenario analysis that you’re using for the first quarter or is that rolling in during the second quarter?

David Trick

Hi, Giuliano. It’s David Trick. And thanks for the question. We fully incorporated everything we learned through, I think was the announcement on May 5 into our reserving process and as you may recall, we were scheduled to release earnings on Thursday, but given the announcement that came out that we wanted to fully analyze and consider, that’s why we delayed earnings to today. So we incorporated everything into our scenario analysis that we know of as of and through the 5.

Giuliano Bologna

That sounds good. And then thinking about the REC margin litigation and the primary and largest case about there, we can center it. Are there any big milestones in terms of hearings or anything coming up in the near-term that which you potentially will be focused on there?

Claude LeBlanc

So at this point we’re just waiting to hear back from the First Department on our appeal of the fraud case, and we expect that will come through, hopefully in the next – it could be as soon as the next week or two or could take a few months. And then following that, we’re hoping that we’ll have the opportunity to meet with Justice, Reed to establish a trial date, which we hope could be as early as later this year or early 2022.

Giuliano Bologna

That sounds very good. Then one final one, just thinking about, some of the holding company’s liquidity and liquid assets, is there any plan in terms of how you want to manage that? Obviously, you’re looking for more expansion and more transactions on that side to keep adding new business lines. Or is there other usage of capital currently where you may need to capitalize some of the business lines that you’re building out. Or how do you think about the excess beyond that?

David Trick

Sure, Giuliano. A couple of things, I think you touched really on most of it. There are other transactions or call it external transactions that we’re looking at as we’ve talked about regularly. And in addition to that, looking at potential other sort of de novo transactions, particularly in the sort of Pillar II sector. But in terms of Everspan, I think Everspan is pretty well capitalized at this point. There is some sort of capitalization and I should say operating investments we may make there. But I think from a Everspan standpoint, we’re set. So it’s really – those other types of transactions, de novo, start-up opportunities, and that’s all the third-party acquisitions that we would be looking to allocate capital toward in the future.

Giuliano Bologna

That sounds good. I appreciate it. And I’ll jump back in the queue.

Claude LeBlanc

Thanks, Giuliano.

Operator

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