Octave Specialty Group, Inc. (OSG) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Ambac Financial Group's Third Quarter 2015 Results Conference Call. At this time all participants are in a listen-only-mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [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, Nichole. 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 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 conditions and results of operations 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. 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 we have posted slides on our website to accompany this call. Our speakers today are Nader Tavakoli, Interim President & CEO and David Trick, our CFO. At the conclusion of their prepared remarks, we will open the call for your questions. I will 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 are 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 an increase to adjusted book value by over $10 per share. Operating earnings are 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 rate 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 three to two 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 create 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, quantified and appropriately addressed 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 [ph] in-force divided by statutory claims paying resources, we have generated improvement from 20 to 1 at the end of 2013 to 21 to 1 at the end of the third quarter 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 the activities of primary liability against Countrywide and successor liability against Bank of America may proceed to trial. In our JP Morgan 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 to expect discovery. Summary judgment motions are scheduled in that case for early in the New Year. In our JP Morgan EMC first lien case fact discoveries are 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 resecuritization 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. The 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. On 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're 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 longtailed. Ambac UK is aggressively pursuing loss mitigation strategies against their largest significant stress credit, Ballantyne including litigation against JP Morgan Investment Management which was the original investment manager on the transaction. Ambac UK commenced its action against JP Morgan 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 achievements, 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'd like to review our exposures and what we're doing to protect their interests. As of quarter end our exposure in Puerto Rico was net of our $2.4 billion. We guarantee senior COFINA bonds, Puerto Rico Highways and Transportation Authority or HTA bonds, PREPA Rum Tax bonds, GO and GO Guaranty bonds and Hotel Tax bonds. We do not have exposure to PREPA, [indiscernible] 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 options. As announced in our earnings press release yesterday, we're 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're 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. 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 clawback feature can be implemented, but certain things seem clear on the face of the applicable laws. Among other things, to clawback 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 [ph] these clawbacks in future years adds additional confusion to the applicable laws. The government has failed to make available comprehensive and current audited and interim financial statements and operating reports which would make it impossible for the government to demonstrate that a clawback 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 withdrawal 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've said before, we fully expect the Act 91 provisions which 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 bond holders. 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 in legal opinions from three separate Puerto Rico Secretaries of Justice. We believe strongly that COFINA bondholders have clear operative rights to the segregated sales tax revenues and any attempt to impair those rights would violate the contract and taking clauses of the U.S. Constitution. As it relates to solutions, Puerto Rico's decision to threaten the follow up and push for bankruptcy legislation has received a lot of attention. A bankruptcy for Puerto Rico is unnecessary and destructive. Most of the Commonwealth's debt doesn't qualify for Chapter 9. The administration's recent proposal for some sort of Super Chapter 9 is unattainable and would cause significant harm to the municipal bond market and state financing requirements. Moreover, the very talk of the follow up in Chapter 9 is already causing significant uncertainty on the Island and negatively affecting the economy. Nor is it clear to us if 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 U.S. 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 nonfarm 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 focus 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 are devoting substantial resources to protecting our interests as it relates to Puerto Rico and will be zealous in enforcing our contractual and our legal rights. We are pleased that our messages are starting to be heard, including at the two recent Senate Committee hearings on the Hill in St. 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 and pursuing. We want to help Puerto Rico and its people, but we need a willing counterparty with them to engage in a conventional manner. We continue to explore options regarding a recapitalization of ways to otherwise conclude the rehabilitation process of the segregated accounts. 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's existing rehabilitation and 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 strategies 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 an asset management, insurance or other variations that complemented 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 are going to achieve great things for Ambac’s shareholders. I'd now like to turn the call over to David for a financial review before we turn in 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 $514.5 million of 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 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 as 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 the individual or net assets, such that the fair value of individual and net assets now exceeded 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 $741.9 million or $16.49 per share at June 30 at 2015. For the third quarter net premiums earned were $71.5 million as compared to $60.9 million in the second quarter including accelerated premium of $28.4 million and $13.7 million respectively. No more premiums earned continued to be adversely impacted by the run offs at 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 were $64.2 million as compared to $64.8 million for the second quarter of 2015. Financial guarantee and net investment income for the third quarter was $61.3 million, $1.2 million lower than 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 and net investment income from mark-to-market losses on invested assets classify this trading of $2.5 million in the third quarter compared to gains of $1.4 million in the second quarter, resulting primarily from a whining of high-yield spreads and continuous 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 a highly liquid to asset backed security to about 12% of portfolio from approximately 4%. This was 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 resecuritization transaction in the sale of leveraged loans. The asset allocation shift however, did not prevent us from making value enhancing strategic investments such as the subordinated interests 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 interests associated with the surplus notes we called in 2012. We are also expecting to close on the 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 all in the investment portfolio, where if Ambac estimates the timing of such claimed 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 resecuritization and settle the purchase of the military housing position in a positive total return. As previously announced, Ambac executed a resecuritization 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 resecuritization debt remained outstanding at September 30. Through the resecuritization we have monetized a portion of the intrinsic value of certain insured RMBS or retaining the rights to the residual intrinsic value and any associated financial guarantee payments. Loss and the 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 will partially offset by increased losses related to Ambac UK insured 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 and deferred amounts was driven by a decrease in interest rates and improved credit profile 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 our remaining stressed transactions. 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 at 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 other than GDB. During the third quarter, net claim and loss expenses recovered net of reinsurance small 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 small policies were $15.8 million which included $64.6 million of losses, loss of 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 was $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 in 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. Derivative products revenue for the second quarter of 2015 reflected gains caused by raising interest rates and an increase in the Ambac CVA, partially offset by a $12.3 million charge related to the downgrade of the 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 accruals and lower bonus accruals and salaries. Given the timing of events, the majority of the run rate benefit associated with these efficiency initiatives will not be experienced into the fourth quarter. Operating expenses also included the direct and in-direct cost of the administration of the segregated account which accounts for approximately 6% of our consolidated operating cost year-to-date. And the exit from rehabilitation as is being pursued would 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 U.S. 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 in its tier A credits 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] Our first question comes from the line of Andrew Gadlin of Odeon Capital Group. Your line is now open.

Thank you and good morning.

Good morning, Andrew.

Good morning, Andrew.

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

Yes, you’re exactly right, Andrew.

So when would these bonds you put it as part of a strategy for them or did they do this in conjunction with the company? I’m just trying to understand how this came to be and obviously could it be done again and either for this company or others?

Yes, some of that would require me to speculate about things that I don’t 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, and do you have any idea and the press release says that it will 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 then on the new initiative involving OREO 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 OREO 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?

Yes, the OREO is still a relatively small pilot sort of program, but we’ve discovered in doing some analysis of our homes that go into foreclosure in the OREO process that there is significant value disruption 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 is a shocker to people from an anecdotal or other perspective. And given the significant amount of property that we have that go through these processes we want to see if we can recapture some of that value and it’s really as a simple as that. We’re going to start it with – 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 profile, we are not being overly ambitious in terms of what we expect to get and hoping that we will be surprised to the upside. Our most important priority is to mitigate the risks of downside as it relates to this and again we’re 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's destroyed in these processes. I will let David handle the military housing.

Andrew on military housing it is actually a good sort of demonstration of our efforts in the asset liability management front, but the opportunity really arose through our risk management teams working with counterparty and being in communication with the 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 in 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 provide us a nice return on portfolio that we’re intimately familiar with and already on the hook for in terms of insurance claims. So overall it’s a great transaction and if we can create similar transactions with other portfolios of Ambac wrapped positions we'd be happy to do it.

Okay. You essentially bought the risk piece at an attractive price and effectively commuted, would you expect to be any real risk that you might have, is that…?

Yes, no, I wouldn’t actually say is, it was a commutation. It is just strictly a repackaging of cash bonds that the counterparty had. So it shifted their risk profile in terms of the packages 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 a new risk by doing the transaction, but at the same time restructured it in a way that will give us pretty attractive return on our investment.

Okay, great and then finally on the goodwill, will try a David question as well, just to make sure I understand it, the market cap declined alongside the asset mark-up is what basically says there is not much value being attributed for goodwill, is that right or?

First let me emphasize two things, one that we had always expected to write-off the goodwill. All the - 100% of the goodwill is associated with the financial guarantee insurance closed block and 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 or statutory net income or statutory surplus or tax. So with that said, there is 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 our stock market value, excuse me, and the fair value – estimated fair value of our net assets. And unfortunately through the year, we experienced 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 guaranty net assets are now greater than the fair value of the reporting unit. So in the sense the valuations have flipped from the time line, 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 is it from me.

Thanks Andrew.

Thanks.

Thank you. Our next question comes from the line of Dennis Chow [ph] with Longview Investments. Your line is now open.

Hi, I just want 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. I mean, given your pristine balance sheet I find it is hard to understand why you haven’t engaged in greater repurchases of your warrants as per the per value implemented at the end of June and why you haven’t found more creative ways to work around the 5% shareholder limits report [indiscernible] NOLs. I was just wondering if we can get you to go over these issues and what it would take for you to sort of step on that side of gas pedal more?

Sure, first let me say with regards to the warrant repurchases we previously announced we did have a program that was $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 and one of those parameters was related to the underlying volatility metric with regard to the warrants. During a good portion of the quarter, the volatility of those warrants was outside the parameters of the program. And with regards to buybacks and the NOL and the 5% limitation, we have researched that issue rather extensively and as we have talked about in the past have enormous appreciation and value placed in that NOL. There was nothing that we're going to do to risk that NOL and it’s 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 the stock buybacks without damaging or risking that 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 the stock buyback program.

I mean, have – just a quick follow up, have you explored the possibility of doing a tender offer that includes any specific targets shareholders that would go over the 5% limit under 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?

Yes, sure I mean that's certainly one option that we considered, but at the same time for that to work effectively is each one of those shareholders has to agree to proportionally purchase a paid in that program and that’s something that we’ve seen as likely to occur.

Got it, thank you.

Thank you. Our next question comes from the line of John Knapp of CCM Opportunistic. Your line is now open.

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 done Nader, both at energy, intelligence, presence and importantly character. Would you like to continue in your capacity as CEO on a permanent basis? That’s the first question and the second question is what impedes that from happening?

John, we haven’t made a public – 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’s working extremely hard and being a very good support to the management team and John I’ll 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 bridged our ability to move this company along and execute on important initiatives and such strategy. 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 note that we're happy shareholders with you in the saddle. That’s it.

I appreciate it, thank you.

Thank you. Our next question comes from the line of Alex Klipper of Bank of America. Your line is open.

Hi, guys. Thanks for taking my call.

Hi Alex, hi.

One very quick question and then a couple more, I mean nuance questions. What percent of the Ambac insured RMBS and claims do you guys actually own now and I know that's something you’ve give us in prior quarters, but I don’t think I heard it.

It’s about 28%. It hasn’t moved since last quarter.

Okay, great and then can you kind of discuss the decision making to sell down your portfolio and raise cash, was that in anticipation of the liquidity event or related to either exiting rehabilitation or was it truly strategic and sort of what got you excited to go back into the market?

That's yes to most of those things. I think we had to talk about this on our last call. We had executed it before the last earnings call, but this is a program that we had 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, the resecuritization transaction not only raises liquidity at what we think is attractive rates, but also frees up capacity in the investment portfolio to make additional acquisitions or own securities. So, and in addition, the limitations that we have within the investment portfolio with regards to our buying our own raps, distressed raps also impacts our ability to make investments in other sort of calls, sort of 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 were a whole host of strategic reasons, 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 more strategic and smart thing to do given circumstances in the capital markets were to pull back on any real aggressive investment into the capital markets other than those few selective items I had 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 that back into…?

We would generally focus to long cash.

Got it. And then just sort of more a nuance question, but I guess 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? A - Nader Tavakoli Yes, what was so much surprising during the quarter is that our raps didn’t really widened that 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 opportunistically for ways to commute our obligations.

Got it and the final question is just on the student loan commutation, it was - can you give a little more color on kind of what that is, is it more troubled student loans or is 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 really stellar job in terms of focusing on that book as you probably know. There is 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.

Great, all right. Thanks guys.

Sure.

Thank you. Our next question comes from the line of Nancy Stuebe of Gabelli. Your line is now open.

Hi good morning everyone.

Good morning.

Good morning, Nancy.

I just want to ask a question something you had in the press release where you said that there were larger derivative product losses, caused by steep declines in interest rates, and I’m wondering if that has changed somewhat now that interest rates look like they are going to go the other way and if you have any thoughts about how that's going to look going forward?

Sure. So you also notice Nancy we in our comments about the insured portfolio and the performance of particularly the RMBS and student loan books, many of our comments focused on the benefit that we experienced there during the quarter from the lower interest rates. So that’s why we’ve maintained any sort of position in the derivative books 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 larger degree our RMBS book in particular is almost more become sensitive to rates than it is to HPA. So with the quarter as you know interest rates have moved up in the third quarter, so all things in the fourth quarter sorry. So all things being affected, being equal we would expect to have gains in that derivative portfolio offset by some losses in the RMBS and 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 fair value, I think having somethings settled might improve that, that market cap of yours? Thank you.

I appreciate that, thank you.

Thanks Nancy.

Thank you. Our next question comes from the line of Jatin Dewanwala of MetaCapital. Your line is now open.

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 a 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?

The main driver there is the excess spread recoveries, yes.

Okay.

Thank you. Our next question comes from the line of Charles Post with Sterling. Your line is now open.

Good morning everybody. Couple of questions for you, on the Highway and Transportation Authority transaction that hasn’t occurred, is that looks like [indiscernible] sort of matches that amount, is that correct?

Yes, it’s one series of bonds.

Okay.

And you are right.

Okay, thank you. And then in the stat filings there is the mention of two new entities being created [indiscernible] Asset Management, can you tell me what those two entities are, are they being useful?

Yes sure, both of those entities are – were established in connection with Nader’s comments with regards to us investing in OREO and so both of those entities are 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 acquire houses and do the acquire the real estate, excuse me and do the work on the properties you need in order to make the returns on that investment. So we will be allocating portion of our investment portfolio to that program, but there is no required commitment per se.

[Indiscernible] The reason for the drop in reserves on the student loan portfolio or is…?

There is a little bit in there related to that, but the majority is 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’d meet that $21.4 [ph] million the partial payment was that from the city unpaid interest amount?

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

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

A little bit less than that. I hesitate to get into too many details, those were subject to a little bit of confidentiality around the story, pricing of that and the and the counterparty so…

Okay, and the last question is you had about $5.5 billion in investments last quarter and now it's about $5.7 billion. How much of that is either selling down or how much of its cash from operations for the quarter? Marking the personal [ph] that's a nice increase.

Yes, there's about $139 million of that is the proceeds what remains in terms of proceeds from the [indiscernible] securitization with a transaction versus while we sort of raised liquidity the assets don't come off the books. So there is about $136 million of that increase relates to the resecuritization. So it's about $70 million odd associated with the military housing purchase that didn't settle during the quarter. They will settle in the fourth quarter and so if you notice on the balance sheet there is also large securities payable a portion of which relates to military housing transactions closed, traded on September 30 and the rest relates to total return performance and cash flows from the business.

Okay and in this on sort of in that same vein, between investment income of a portfolio in cash installment premiums, did that run in about $250 million to $300 million a year is that a ballpark number?

That’s ballpark.

Yes, that sounds about right.

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

Total operating expense is about $100 million, not all that is cash. I'd say I would get some depreciation in there. We have some non-cash comp in terms of our performance units and RSUs, but that's probably maybe about $5 million a year and so about $95 million of cash operating expense.

Alright, so you were $175 before losses which the majority of losses you have way out there. So and most of that cash flow would be protected. So we should be building nice cash balances assuming no commutations and other things to happen, is that correct?

That's our expectation, yes.

Okay. Great numbers, thanks guys.

Thanks.

Thanks Charles.

Thank you. And our next question comes from the line of Michael Cohen of Opportunistic Research. Your line is now open.

Hi guys, can you, hi thanks for taking my question. Can you provide an update on EMC case where Judge Romulus [ph] 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 Romulus [ph] 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.

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

Just give me one second on that Michael, not that I'm aware of. Yes, as you know we filed a [indiscernible] review case. The case is related to the [indiscernible] review 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 New York in order to be protective. The case that we filed in Wisconsin was dismissed without prejudice at trials. We are appealing that dismissal, but in order to be protective for various reasons I cannot 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'd like to hand the call back over to Nader Tavakoli for any closing remarks.

Thank you, operator, and thank you all. We recognize there has 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're 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.