Octave Specialty Group, Inc. (OSG) Q3 2017 Earnings Report, Transcript and Summary

Good morning. My name is Chris, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Ambac Financial Group, Incorporated Third Quarter 2017 Earnings Teleconference. Our hosts for today's call are Lisa Kampf, Head of Investor Relations; Claude LeBlanc, Chief Executive Officer; and David Trick, Chief Financial Officer. Today's call is being recorded and will be available for replay beginning at 11:30 AM Eastern Standard Time. The dial-in number is 800-585-8367 domestic, or 416-621-4642 internationally, using ID number 99386743. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Ms. Lisa Kampf.

Thank you. Good morning, and thank you all for joining today's conference call to discuss Ambac Financial Group's third quarter financial results. We'd like to remind you that today's presentation may contain forward-looking statements, which are based on management's current expectations and are subject to uncertainty and changes in circumstances. Any forward-looking statements are not guarantees of future performance of events. Actual performance and events may differ, possibly materially from such forward-looking statements. Factors that could cause this include factors described in our most recent SEC-filed quarterly or Annual Reports under Management's Discussion and Analysis of Financial Condition and Results of Operation and under Risk Factors. Ambac is not under any obligation, and expressly disclaims any obligation to update any forward-looking statement whether as a result of new information, future events, or otherwise. Today's presentation contains non-GAAP financial measures. The reconciliations of such measures to the most comparable GAAP figures are included in our earnings press release, which is available on our Web site at ambac.com. Please note we have posted slides on our Web site to accompany this call. I would now like to turn the call over to Mr. Claude LeBlanc.

Thank you, Lisa, and welcome to everyone joining today's call. I'm pleased to report during the third quarter, we continued to make significant progress towards improving Ambac's risk profile and financial stability by executing against our strategic priorities. Yesterday, after market close, we reported a net loss for the third quarter of approximately $191 million or a loss of $4.20 per diluted share, and an adjusted loss of approximately $150 million, or $3.30 per diluted share. In addition, book value decreased $3.67 to $33.33 per share, and adjusted book value decreased $3.79 to $24.56 per share. While we were disappointed with the results of the quarter, which were impacted by increased uncertainty as a result of the situation in Puerto Rico, we continue to make strong progress with regards to our strategic priorities. David with elaborate on the details of our financial results shortly. With respect to our strategic priorities, this quarter we took significant steps to reduce our cost structure and make organizational changes with the goal of improving our future operational effectiveness and efficiency. Following a comprehensive analysis of our operational needs, we reduced our overall headcount by approximately 19% from the beginning of the year, resulting in expected future annual compensation cost savings of approximately 20% or $8.5 million annually. Second, we remain focused on active management of our assets and liabilities. As of today, AAC now owns approximately 40% and 24% of its insured COFINA and PRIFA bonds respectively, following the additional purchase of insured bonds since quarter end. We also actively progress our loss mitigation strategy during the quarter, resulting in a number of key successful remediations in both known and potential future adversely classified credits as we continue to actively de-risk our portfolio. While our adversely classified credits increased by 0.5% as a result of the downgrade of a large international exposure, the full impact of this reclassification was largely offset by portfolio runoff in our ongoing risk remediation efforts. As a result of these efforts and the normal runoff of our book, net par exposure outstanding decreased 6.3% from June 30. More specifically, our activities this quarter included one, the de-risking of the remaining portion of the key exposure related to a distressed domestic asset-backed VIE. Two, we facilitated transaction that led to the commutation of 45 million of adversely classified bonds. Three, Ambac U.K. executed a structured finance de-risking transaction that resulted in a par reduction of approximately £190 million. Lastly, during the quarter, as a result of a settlement reached between a mortgage insurer and the trustee among other parties, which we helped facilities, we expect to receive approximately $50 million with respect to two of our RMBS transactions as reimbursement for claims previously paid. As you will hear later, our corporate strategy will maintain as a priority the proactive and aggressive execution of de-risking in issuance. Our goal in pursuing this strategy is to continue to lower our risk exposure and improve our long-term adjusted book value, and more importantly improve the quality of adjusted book value. Turning now to Puerto Rico, as everyone is aware, Hurricane Maria has had a devastating impact on the island of Puerto Rico. Near-term rebuilding and recovery should be the highest priority for everyone concerned, not only for the affected people of Puerto Rico, but also their local officials, federal public officials, investors, and creditors alike. Ambac has supported Puerto Rico's capital markets for decades, and continues to support the people of Puerto Rico as a long-term investor with a paramount interest in the long-term recovery of the island. We have done this directly through charitable hurricane relief contributions, as we did in prior crises periods, and also indirectly by calling for all concerned to pause litigation and to refrain from weaponizing Hurricane Maria. It hurts the people of Puerto Rico and hurts long-term recovery for the island when public figures or private parties try to turn a natural disaster into a opportunities or tools for advancement of their own interest. Over the next few months, Puerto Rico will require a great deal of emergency response coordination, financial support and aid, supervision to advance recovery efforts, and rebuild the island. To its credit, the federal government has taken steps to provide much needed financial aid and other resources to restore essential services and infrastructure throughout the island. Making sure there is enough money provided to the people of Puerto Rico to recover and that the money provided is spent wisely and efficiently is where near-term focus should be. Unfortunately, it appears that the hurricane is being viewed as an opportunity by certain public officials on island and by the oversight board. During Tuesday's Natural Resource Committee hearing, the oversight board's executive director doubled down on a plan to review and certify revised fiscal plans over a rush two to four-month timeline, essentially by the beginning of next year. This makes no sense. No responsible body should recommend the development of a fiscal plan prior to seeing and considering the results of recovery and stabilization efforts. And it is unjustifiable to mandate that fiscal plan projections fall from the prior 10-year plan to a five-year plan period. There was unsupported conservatism, and lack of consideration for key assumptions relating to the fiscal planned projections prior to the hurricane. But now the recommended five-year fiscal plan term seems deliberately designed to show large expenses [ph] for recovery, but not the actual recovery and rebuilding of the island in the later years. The oversight board appears to be repeating the same process mistakes that drew congressional review earlier this year, when it certified the prior fiscal plan despite numerous errors, questionable assumptions, and a lack of information and non-compliance with the PROMESA law. Instead of taking a reasonable pause, court filings show that FAFT [ph] and the oversight board have actively opposed even a temporary stand down. Ambac calls on the oversight board and the Commonwealth to pause litigation and debt restructuring efforts for a reasonable period of time to gather information and focus all stakeholders on supporting long-term rebuilding, implementation efforts, and economic growth. Ambac also supports independent oversight and accountability over the billions of taxpayer dollars that will be flowing into Puerto Rico so that the money is used in ways that help the people of Puerto Rico, and which will support the long-term economic growth plan of the island. There is precedent for this. Donald E. Powell was appointed as the federal coordinator of Hurricane Katrina aid and recovery efforts, and reported to the president directly. This role was tasked with helping government leaders to reach consensual rebuilding plans, bridge regional and person divides, and to persuade Washington to provide appropriate federal funding. In the same vein Ambac encourages congress to consider the appointment of an independent person or board to supervise the deployment of federal funds and reconstruction efforts. The current oversight board is set up to be a vehicle for imposing fiscal control on island and for restructuring debts and negotiating with creditors. It is also hard to see how the current oversight board, which is in litigation with both the Rosario administration and creditors, can balance its already challenging financial restructuring oversight role with a role as fiscal spending gatekeeper, auditor, and economic growth coordinator to rebuild Puerto Rico. Despite all these considerable concerns, Ambac stands ready to be a constructive partner in a process that has the best long-term interest of Puerto Rico and its residents in mind. The direction of the narrative must shift away from short-sighted fixes at the expense of the people of Puerto Rico and creditors alike, and focus more on the respect for the role of law and commitment to repay debt that was provided willingly over so many years. I'll now address other key business updates. On September 25, the Wisconsin Insurance Commissioner filed the rehabilitation plan amendment documents to officially begin the process for concluding the rehabilitation of AEC's segregated account. This included an affidavit of support as part of the court filings from the original signatories to the rehabilitation exit support agreement to reflect their continued support for the transaction. The plan confirmation hearing has been set for January 4 and 5 of 2018. If approved by the rehabilitation court, the segregated account exit from rehabilitation will be the culmination of one of the Ambac's major strategic initiatives, which will allow us to rationalize our capital and liability structure and simplify our corporate governance structure. As noted, we have seen increased support for the transactions since announcing it in July as additional parties have signed on to the rehabilitation support agreement. The DPO, beneficial interest owners, and general account surplus note holders will now fully support the transaction totaled approximately 34% and 54% respectively of the total outstanding balances held by third parties were 61% and 60% when combined with Ambac's holdings. We are pleased that the transaction is moving forward and continue to believe that transaction will provide material additional value for our stakeholders and shareholders alike. While we are encouraged with this progress, there are still many steps to be completed to close this transaction. And we will continue to work diligently alongside our external professionals and the OCI to that end. We still expect to exit from rehabilitation to occur in early 2018 assuming court approval and satisfaction of all conditions. Additionally, our RMBS litigation continues to progress as we remain focused on aggressively pursuing remedies to recover losses. As we discussed last quarter, our request to appeal certain rulings of the intermediate appellate court to the New York Court of Appeals, the state appellate court of New York, in our main RMBS suit against Countrywide was granted. Briefing for the appellate case will be completed later this month and we expect all arguments to occur in the first half of 2018, but no date has been set yet. We will look forward to commencing the trial shortly after the decision is rendered by the appellate courts, but the trial date has not been scheduled. We continue to believe in the strength of our claims against Countrywide. And we remain committed to taking this case through trial, hopefully by mid next year. We will continue to aggressively prosecute our remaining cases and progress them to a conclusion. I'll now turn the call over to David Trick to walk you through our third quarter financial results. David?

Thank you, Claude, and good morning. For the third quarter of 2017, Ambac reported a net loss of 90.9 million or $4.20 per diluted share compared to net income of 7.1 million or $0.16 per diluted share for the second quarter of 2017. Adjusted loss in the third quarter was 149.8 million or $3.30 per diluted share compared to adjusted earnings of 70.4 million or $1.54 per diluted share in the second quarter. Our third quarter results primarily reflect adverse development in Puerto Rico which masked further progress achieved across the entirety of our business towards reducing risk and improving our operating platform. Turning to some more specifics of the financial results, premiums earned were 53 million during the third quarter versus 43.2 million during the second quarter. Normal earned premium decreased during the quarter to 26.8 million from 30 million or 11% primarily due to the continued run-off of the insured portfolio including previously pre-refunded policies. Accelerated premium increased by 13 million to 26.2 million, primarily related to the impact of proactive de-risking in the international sector. Premium receipts were 32 million during the third quarter. An increase of 16 million versus the second quarter, primarily due to the accelerated premium receipts related to a terminated international transaction. Net investment income for the third quarter and the second quarter of 2017 was 87.2 million and 85.2 million respectively. Net investment income for the third quarter increased as a result of improved performance from ASC's investment insured RMBS securities and higher allocation to insured non-RMBS bonds, primarily Puerto Rico bonds. Partially offset by reduction in duration and size of the investment portfolio. The reduction in duration resulted from a buildup in liquidity in anticipation of executing our holistic restructuring in the first quarter of 2018 in connection with the segregated accounts exit from rehabilitation. Mark-to-market gains on invested assets classified as trading was $4.9 million in the third quarter of 2017 compared to 3 million in the second quarter of 2017. Gains on AFG's investments in [indiscernible] notes and higher equity and hedge fund returns in the Ambac U.K.'s investment portfolio accounted for the quarter-over-quarter increase in trading income. Losses and loss expenses incurred were 209.8 million for the third quarter of 2017, up from 66.1 million for the second quarter. The third quarter incurred loss was primarily driven by the adverse development in the public finance portfolio offset by improved credit performance in RMBS including the impact of a pool mortgage insurance policy recovery resulting from a settlement between the trustee and mortgage insurer. Directionally, third quarter incurred losses were similar to the second quarter during which we experienced adverse development in the public finance portfolio mostly due to Puerto Rico and improved credit performance in the RMBS and Ambac U.K. portfolios. More specifically, public finance produced incurred losses of 212.5 million, primarily due to adverse development in Puerto Rico. The increase in our Puerto Rico reserves reflects our perception of the short-term economic implications of and political overhang related to Hurricane Maria more so than the long-term economic implications. RMBS produced an incurred benefit of 34.4 million in the third quarter driven by a near 50 million gain from the pool mortgage insurance policy settlements and improvements in general credit performance. The RMBS incurred benefit included reduction of just over 40 million in our estimate of rapid warranty [Ph] recoveries as a result of our improved experience during the quarter. Our estimated representation of warranty recovery amounts as of September 30, 2017, is now 1.8 billion net of reinsurance. Ambac U.K. produced an incurred benefit of 12.7 million in the third quarter, primarily due to 8.9 million of foreign exchange gains as the pound Ambac U.K.'s functional currency strengthened relative to the dollar and euro. Net gains reported in interest derivatives for the third quarter were 4 million compared to 34.1 million of gains in the second quarter. The net gain for the third quarter was solely due to the micro-hedge reflecting a modest rise in short-term interest rates compared to a slight decline in the second quarter. The gain in the second quarter was driven by the commutation of an insured structured interest rate swap connection with the termination of the underlying insured transaction which closed in the third quarter. Third quarter operating expenses increased by 2.7 million from the second quarter to 33.8 million; the increase compared to the second quarter of 2017 was mainly due to a $3.6 million increase in severance cost related to the firm wide corporate reorganization and approximately $1.6 million increase in long-term performance based incentive compensation, partially offset by lower cost associated with the holistic restructuring transaction. As we noted previously, we remain focused on reducing our core operating expenses but also anticipate that we will experience volatility quarter to quarter associated with normal course operations and various other initiatives including those related to the segregated accounts, exit from rehabilitation, and severance expenses. That's said, restructuring and OCI fees accounted for a total of just over 9.2 million in the quarter compared to approximately 11.4 million in the second quarter. These amounts equate to approximately 53% and 60% of non-compensation expenses during the third and second quarters of 2017, respectively. Upon completion of the holistic restructuring transaction, we expect to be able to eliminate all such restructuring cost and the majority of our OCI related cost. Third quarter total comprehensive loss of 167.1 million led to a decrease in stockholder's equity at September 30, 2017, to 1.5 billion or $33.33 per share. The total comprehensive loss was due to the net loss from the quarter, partially offset by approximately 25 million in foreign exchange translation gain. Adjusted book value decreased by 171.1 million to 1.1 billion or $24.56 for diluted share at September 30, 2017, compared to nearly 1.3 billion or $28.35 per share at June 30, 2017. The main contributor to the decrease in adjusted book value was the adjusted loss for the third quarter. That concludes my formal remarks. I will now turn the call back to Claude who is going to provide an update on our strategic review process.

Thank you, David. As noted in our prior earnings calls, Ambac as been progressing a comprehensive corporate strategy review which we completed during the third quarter. The goal of the exercise was to review our key corporate strategy and priorities as well as explore options for future new business initiatives. Based on our review, our key strategic objectives are: (1) To continue active runoff of our insured portfolio with a focus on known and potential future adversely classified credits as we seek to improve the risk profile of the insurance company, and to maximize the risk-adjusted returns on invested assets. (2) Pursuing a successful exit from rehabilitation of the segregated account by working closely with the regulator to ensure that the exit from rehabilitation progresses on schedule. This will facilitate the rationalization of our capital and liability structure, and enable us to simplify our corporate governance framework going forward. (3) Ongoing loss recovery efforts through active litigation management and the exercise of contractual and legal rights. (4) The ongoing review of our organizational effectiveness and efficiency, with a focus on expense management. And lastly, regarding our assessment of available options to generate long-term value for shareholders, I am pleased to report we have identified certain business sectors adjacent to Ambac's core business in which we will evaluate future opportunities subject to acceptable criteria. Our focus will be on pursuing opportunities that we believe will generate long-term shareholder value with attractive risk-adjusted returns. This will be done through a measured and disciplined process to identify opportunities that are one, synergistic to our core business. Two, will match or leverage Ambac's core competencies, three, are rapidly scalable or available through mergers and acquisitions. And fourth, that may also allow us the utilization of Ambac's net operating loss carry-forwards. As we evaluate our options and timing for new business we will remain focused and will consider the resource needs and business priorities of our overall corporate strategy. I look forward to updating you as we progress this important initiative. The Board, Executive Management, and all employees at Ambac remain steadfast in our commitment in seeking to generate long-term sustainable value for shareholders. We are pleased with our achievements thus far, but there is still much left to be done, and we look forward to updating you on our progress later in the year. Operator, we will now open the call up for questions.

[Operator Instructions] Your first question comes from the line of Andrew Gadlin of Odeon Capital Group. Your line is open.

Good morning. David, could you review again your comments on the RMBS settlement and the movement in the RNW [ph] recovery reserve?

Sure. Based on the settlement, we expect to have a recovery which we haven't received yet, but anticipate likely in the latter part of the fourth quarter, about $50 million from the pool mortgage insurance policy settlement. In connection with that and other improvements in credit performance in the RMBS book during the quarter, we reduced the rep and warranty estimate about $40 million. So the net impact on the results within RMBS for incurred losses for the quarter, about the $10 million net benefit between the pickup in the settlement and reduction in rep and warranty credit, which again was associated with, in part, with the settlement as well as the improvement in credit performance during the quarter.

So, basically it's a $50 million improvement in credit performance, and about a $40 million decrease in recovery?

The $50 million is just solely for the pool policy settlement. Generally speaking, there is credit improvement performance throughout the book so that total net incurred benefit for RMBS in the quarter is 34.4 when you wash everything through.

Got it. And then Claude, you mentioned in the strategic review you've identified, not just future business opportunities, but individual types of businesses. Can you talk a little bit more about that what those might be?

Sure. Good morning, Andrew. I think at this point we obviously have outlined the -- indicated that these are sectors that are adjacent to Ambac's core business. We've not outlined specifically what those sectors are for obviously reasons. But I think when you look at our business, which is clearly focused on insurance and credit, I think we're focusing on sectors that you would imagine and expect fall within the categories of our core discipline and our core business today. And again, at this point, that's as much as we want to share with the market, but we will update the market as we progress our initiatives so as not to give up any bargaining leverage as we progress our initiatives going forward.

Understood. Thank you.

[Operator Instructions] Your next question comes from Andrew Hain of Stifel. Your line is open.

Yes, hi. Good morning. I just had a quick question about -- I wanted to gain a better understanding of how you guys are looking at the dollars that the U.S. has sent down to Puerto Rico in the form of disaster relief. My understanding is there hasn't been a determination made as to how those funds will be, I guess, lined for repayment or maybe potentially forgiven. And I think there's even potentially a hearing on that down the road. Could you just maybe fill us in on how you guys are looking at that at this point? Maybe what are the next key events in making that determination?

Sure. I think the amount that has been provided for under the October 26 bill, of $36.5 billion is $4.9 billion that is to be lent to Puerto Rico through the FEMA Disaster Loan Program. It is possible that the federal government could have structures of priority debt obligation. However, based on historical precedent we believe that over 90% of such loans have been forgiven in the past. And there is also a lot of momentum in congress to clarify the terms of the forgiveness. This past week, 30 Senate democrats sent a letter to the ONB [ph] asking that the liquidity loans be cancelled, forgiven, or converted. So our expectation currently is that it will be forgiven, but that's a decision that has to be reached hopefully in the not-too-distant future. We do support the tracking of the loans as well, so we think it is important that the loans that are utilized are tracked. And we expect that they will be used in the areas of greatest need, and clearly right now electricity and water and things like that are obviously top-of-line for the Commonwealth and the government. So it is our expectation that that's where the moneys will be directed or the bulk of the moneys will be directed near-term.

And so just to clarify, the reserves, the reserves on your books then assume that the treatment is, as you described it, it would be forgiven?

Again, we don't really -- we're not expecting to be a direct beneficiary of any federal loan dollars. So again, it's not our expectation that these dollars come into the hands of any of the creditors. We're also not a guarantor on any of the PREPA [ph] debt in areas where you would expect a lot of the dollars would be spent near-term. So I think from our perspective, we're looking at the federal aid as being something that is being provided as has been provided to other communities suffering from these natural disasters. And that's something that would attribute or narrow [ph] directly back to creditors.

And sorry to harp on, just lastly, so do you think this is an issue that gets cleared up by the end of 2018, one way or the other?

We hope so. Again, I think there's lots of momentum to move things forward expeditiously. And we're very supportive of clarifying this matter and getting as much aid to Puerto Rico as soon as possible. And in terms of the grant versus loan issue, again, I think the expectation, if it's not later this year, we expect it'll be sometime in 2018.

Great. Thanks for your time.

Thank you.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating. You may now disconnect.