Octave Specialty Group, Inc. (OSG) Q3 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to the Ambac Financial Group, Incorporated Third Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your hosts, Ms. Lisa Kampf, Head of Investor Relations; Claude LeBlanc, Chief Executive Officer; and David Trick, Chief Financial Officer. I will now turn the call over to Lisa.

Thank you. Good morning, and thank you all for joining today's conference call to discuss Ambac Financial Group's third quarter of 2018 financial results. We'd like to remind you that today's presentation may contain forward-looking statements, which are based on management's current expectations and are subject to uncertainty and changes in circumstances. Any forward-looking statements are not guarantees of future performance of events. Actual performance and events may differ, possibly materially from such forward-looking statements. Factors that could cause this include the factors described in our most recent SEC-filed quarterly or annual report under Management's Discussion & Analysis of Financial Condition and Results of Operations 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 that presentations have been posted to the Events & Presentations section of our IR Web site, which support our comments today. I would now like to turn the call over to Mr. Claude LeBlanc.

Thank you, Lisa, and welcome to everyone joining today's call. This was another active quarter for Ambac during which we executed several key transactions in line with our strategic priorities. First, Ambac together with other creditors, the Oversight Board, COFINA, and the Puerto Rico Puerto Rico Fiscal Agency and Financial Advisory Authority executed a Plan Support Agreement and Term Sheet for the restructuring of COFINA bonds. And on October 19, the Oversight Board filed the COFINA Plan of Adjustment and Disclosure Statement reflecting the terms of the Plan Support Agreement. This is a significant development for one of Ambac's largest adversely classified credits, and if confirmed by the court overseeing COFINA Title III proceeding would favorably resolve 78% of Ambac's Puerto Rico insured debt service. I will provide more details on Puerto Rico in a moment. Second, in August, we completed the exchange offer for our Auction Market Preferred Shares or AMPS, which we discussed in detail during our last earnings call and the effects of which are reflected in our results this quarter. To remind everyone, this transaction provided us with several material benefits. First, we captured a discount of approximately 250 million or 45% on 527 million of outstanding AMPS, which we believe provides us with increased financial and strategic flexibility. Second, through this transaction, we further deleveraged Ambac's capital structure and reduced certain financial and other risks. And third, we believe this transaction further improves the quality and strengthens the book value and adjusted book value of Ambac Financial Group. During the quarter, we also continued to actively de-risk Ambac's insurer portfolio, with a particular focus on watchlist and or adversely classified credits. As part of these actions, following the close of the quarter, we executed a reinsurance transaction with a third-party to reinsure the full amount of certain public finance insurance policies, totaling 1.5 billion of performing par exposure with total principal and interest of approximately 3.4 billion, primarily comprising of non-callable capital appreciation bonds, and including approximately 240 million of classified and watchlist credits. With our continued efforts to actively de-risk watchlist and adversely classified credits, we are accelerating our efforts to reduce and scope [ph] our insured risk exposures, improve the quality of our book dvalue, and increase the optionality of our platform. Now briefly on our results announced yesterday; after market closes, we reported a net less of 22.2 million or a loss of $0.48 per diluted share for the third quarter of 2018. Including the impact of the AMPS transaction I mentioned earlier, we reported a net loss attributable to common stockholders of 103.8 million or $2.27 per diluted share, and an adjusted loss of approximately 76 million or $1.66 per diluted share. Book value, also reflecting the financial impact of the AMPS exchange transaction decreased by $0.93 to $38.77 per share, and adjusted book value decreased by $2.34 to $28.50 per share. David will discuss our financial results in more detail in a moment. Now, turning to our operational highlights, during the quarter we kept our focus on improving our risk profile, maximizing risk-adjusted returns on invested assets and strengthening our balance sheet, both through the AMPS transaction as well as additional principal pay-downs on the secured notes issued as part of the holistic restructuring transaction that closed earlier this year. With regards to our de-risking activities, in addition to the reinsurance transaction discussed earlier, other notable risk-mitigating transactions completed during the third quarter included, one, the negotiated termination of a $720 million Watch List credit, reducing consolidated VIE assets and liabilities by approximately $6 billion; two, an agreement to sell airplanes in an aircraft securitization which will significantly reduce Ambac's exposure to this asset class, and will ultimately decrease our adversely classified credits by approximately $224 million; third, a student loan commutation transaction that reduced our aversely classified credits by $127 million; and four, a structured finance reinsurance transaction which reduced our exposure by $139 million, reducing our Watch List credits by $83 million. Our active de-risking activities to date have helped reduce our total insured par exposure by $10.5 billion, to approximately $52.2 billion. Turning now to Puerto Rico, as we discussed previously, Puerto Rico's economy continues to revitalize, and recent debt restructuring progress is laying the foundation for a return to the capital markets. As of September 2018, the Puerto Rico Economic Activity Index increased by 5.2%, the first year-over-year increase after almost six years of negative growth. September's unemployment rate, of 8.4%, was the lowest unemployment rate in Puerto Rico since 1942, when Puerto Rico first began collecting unemployment figures. Additionally, Puerto Rico's government bank account balances have swelled to almost $11 billion as of September 28, an $876 million increase from August 31st. However, it's unclear to what extent the positive economic momentum is reflected in the commonwealth's fiscal plan over the long-term or how all this will impact bondholder recoveries. Looking beyond the stimulative effects of recovery activity, commonwealth stakeholders came together during the third quarter to consensually restructure and resolve contentious litigation around Puerto Rico's most important debt issuance, the COFINA sales and use tax securitization. The oversight board filed the COFINA plan of adjustment and disclosure statement as part of the COFINA Title III case on October 19th. The oversight board also filed a motion in the commonwealth Title III case to approve the settlement of the commonwealth COFINA dispute under bankruptcy rule 9019. As described in publicly available documents, the commonwealth COFINA settlement would entitle COFINA to a portion of the pledged sales tax base amount on a first dollar basis. The COFINA restructuring further provides for the COFINA portion of the sales tax revenues to be held in segregated accounts, includes a non-impairment covenant as well as other strong protections. The COFINA debt restructuring, as filed by the oversight board, will provider holders of Ambac-insured senior COFINA bonds the ability to choose between one of two debt election options. Pursuant to the plan under the first option, Ambac reps [ph] senior COFINA bondholders can commute their Ambac insurance policy and receive a consideration package with a nominal value equal to approximately 93% of the prepetition claim amounts. This consideration package consists of new COFINA bonds and cash paid by COFINA under the COFINA plan. In addition, commuting policyholders will also receive a cash payment from Ambac equivalent to 5.25% of prepetition claim amounts in exchange for their Ambac insured bonds. Under the second option, Ambac-insured bondholders can elect to exchange their existing bonds for trust certificates which will be supported by consideration deposited into a trust comprised of the same plan consideration package paid by COFINA as well as rights subject to offsets under the existing Ambac financial guarantee policy. Ambac will not be insuring the new COFINA bonds or the trust certificates. If confirmed by the Title III courts, the proposed COFINA restructuring represents a consensual solution to approximately 24% of the total commonwealth central government and instrumentality bond debt, and will yield more than $17 billion in debt service savings to the commonwealth. Final terms of the COFINA plan of adjustment and related documentation remains subject to change and court approval and local legislative action. A confirmation hearing is scheduled to be heard during the first quarter next year. In the meantime, we will continue to work actively to progress all aspects of our strategy and litigation with respect to mitigating losses in Puerto Rico. Now, turning to our active litigation matters, in September, and this passed Monday, the judge in our main RMBS case versus Bank of America Countrywide heard six motions brought by the defendants. We expect the court to rule on the motions before the end of the year but cannot predict the timing of the rulings. It is very likely that one or more decisions will be appealed, and it could take several months or longer for the appellate court to decide on any issues on appeal. Depending on the issue, the trial judge or the appellate court may postpone the trial, currently scheduled for February 25, 2019, until such issues on appeal are decided. Our legal team is actively preparing for trial and we remain committed to vigorously pursuing our rights. Finally, as it relates to new business, we continue to actively evaluate various options for long-term growth, particularly given the milestones achieved in 2018. We remain committed to exploring various types of transactions and strategic opportunities of different magnitudes. We've been evaluating opportunities in credit, insurance, asset management, and other financial service businesses as potential sectors for select business transactions that are synergistic to Ambac in which we can leverage our core competencies. As we have stated previously, we will be measured and disciplined in our approach as we pursue opportunities to deploy our capital with the goal of creating sustainable long-term shareholder value. We would like to thank you for your continued support as we advance our strategic priorities. I will now turn the call over to David to discuss the financial results for the quarter. David?

Thank you, Claude, and good morning. Ambac incurred a net loss of $22.2 million or $0.48 per diluted share, excluding the impact of the AMPS exchange transaction of $81.7 million, during the third quarter of 2018. Including the impact of the AMPS exchange transaction, Ambac reported a net loss attributable to common stockholders of $104 million or $2.27 per diluted share. These results compare to net income of $4 million or $0.09 per diluted share for the second quarter of 2018. Ambac also incurred an adjusted loss in the third quarter of $76 million or $1.66 per diluted share, compared to adjusted earnings of $36 million or $0.78 per diluted share in the second quarter. The loss attributable to common stockholders and the adjusted loss led to a $0.93 decline in shareholders equity to $38.77 per share, and a $2.34 per share decline in adjusted book value to $28.50 per share respectively at September 30, 2018. The AMPS transaction progressed our objective of simplifying our capital structure and economically deleveraging our balance sheet. The transaction resulted in the capture of $253 million of discount compared to the liquidation preference of the AMPS repurchased and the reduction of the outstanding consolidated liquidation preference of AMPS from over $616 million [ph] to only $103 million. This was accomplished through the issuance on a fair value basis of approximately 286 million of surplus notes including a crude interest, the payment of $11 million of cash, and the issuance of approximately $8 million of warrants. The AMPS were carried on the balance sheet at approximately 40% of their liquidation preference, equating to their fair value at the time Ambac emerged from bankruptcy. The fair value of the consideration package paid was approximately 55% of the liquidation preference, resulting in the realization of an $82 million reduction to net income attributable to common stockholders. Coupled with the warrant issuance of $8 million, stockholders' equity and adjusted book value decreased by $74 million as a result of the transaction. In addition to the AMPS transaction, our third quarter results reflect relative to the second quarter lower investment income and lower realized investment gains and to a lesser degree higher interest and operating expenses partially offset by higher interest rate derivative gains from our macro hedge. Investment income for the third quarter of 2018 was $58 million. An $8 million or 13% decline from $67 million for the second quarter of 2018. This decline reflected a reduction of the size of the investment portfolio and a lower allocation to higher yielding Ambac insured RMBS partially offset by gains on invested assets classified as trading. Net realized gains for the quarter totaled $30 million as compared to $47 million in the second quarter. The principal sources of these gains were the sale of Ambac insured RMBS securities. These sales were executed in connection with our efforts to rebalance the investment portfolio subsequent to the impact of the segregated accounts exit from rehabilitation and a connection with the reduction of $72 million of the Ambac Note. Ever to-date redemptions of the Ambac Note of $186 million, repayment of the secured borrowing during the second quarter and the payment of loss and loss expenses of $229 million during the third quarter contributed to the decline in investment income when coupled with the reallocation of assets to more liquid positions. Losses and loss expenses incurred were $34 million for the third quarter of 2018 compared to $33 million for the second quarter. Losses incurred in the third quarter were primarily driven by loss expenses incurred in connection with our remediation efforts partly offset by net positive credit developments. The negative impact of rising interest rates on the both insured and investment portfolios continued to be partially mitigated by the macro hedge which produced gains of $17 million during the third quarter compared to gains of $9 million in the second quarter. Third quarter operating expenses were $28 million, an increase of $2 million or 9% from the second quarter. This slight increase was due mostly to higher professional fees related to the AMPS exchange transaction of $3.3 million partially offset by lower expenses relating to regulatory oversight cost and net lower compensation cost inclusive of higher severance cost in connection with further right sizing. Total operating expenses related to the AMPS transaction in the third quarter of 2018 amounted to $5.9 million. We remain focused on reducing our core operating expenses but similar to the second and third quarters of 2018 which contain cost associated with various strategic initiatives consistent with our stated objectives, we expect to experience volatility quarter to quarter associated with normal cost operations in various other events. Interest expense for the third quarter of 2018 increased $3 million to $66 million from $63 million in the second quarter of 2018. The increase reflected the issuance of surplus notes from the AMPS exchange transaction partially offset by lower interest expense resulting from the principal pay downs of the Ambac Note and the full redemption of RMBS secured borrowing in the second quarter of 2018. Interest on debt backed by representation of warranty litigation accounted for $45.4 million or 69% for the third quarter interest expense. That concludes my formal remarks. And I will now turn the call back to Claude for some brief closing remarks.

Thanks, David. We have had a very active and successful 2018 thus far and remain committed to progressing our strategic priorities to create long-term sustainable value for our shareholders. We remain keenly focused on taking measured steps big and small to optimize our business model in a way that provides optionality to create value and drive growth. Thank you for joining us today. I will now turn the call back to the operator to open for questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Andrew Gadlin of Odeon Capital Group.

Hey, Good morning. I was wondering if you could discuss the two subsequent events disclosed via that small Goldman Sachs settlement in November as well as the reinsurance deal, are the financial impact from those events included in the Q3 numbers?

Hey, Andrew, thanks for calling in. The Goldman Sachs settlement was part of a class action suit that we filed a claim in. As a result of that, we -- it was launched by, I think, two pension funds who made a claim back in 2016, never really expecting anything material to come of it, and in November we received about $27 million as a result of the settlement and that will be booked in the fourth quarter. And I had a little hard time hearing the second part of your question, was that related to reinsurance transaction?

Correct. Yes.

The reinsurance transaction from a financial statement impact was not booked in the third quarter that too closed in the fourth quarter, and the result of that will begin to be reflected starting fourth quarter '18, sorry.

And will the impact be meaningful from the reinsurance deal?

The reinsurance will have a meaningful impact on fourth quarter, you'll probably see the biggest impact would be from how we calculated adjusted book value and that will have an impact on the amount of UPR that is included in adjusted book value.

And can you give us an order of magnitude what the impact will be?

Less than $0.50 a share.

Got it. Okay. And then, Claude, thank you for your comments and your explanation of the COFINA settlement and certificate process. I was wondering if you could talk about a couple of elements there, in terms of that commutation effort that you guys will be launching, would that be expected to go alongside the completion of the COFINA or is that something that could happen, months after hopefully COFINA is approved?

So I think we are -- obviously, it's a very complex transaction, and we're still working through a lot of the detail with the OB on their plan of adjustment. Again, the detail of what is public is in that plan, I guess, I would say that anything we might do or consider vis-à-vis commutation would likely be done following the confirmation date. At this point we've not made any decisions relating to actions relating to our securities.

And then you also have this unique litigation angle against Bank of New York, would that be kind of pursued alongside that or does that have to wait for plan confirmation, how should we think about that.

So, you're referring to the Bank of New York litigation relating to the plant, is that…

Yes, related to COFINA on their non-acceleration. Is that -- when can we start to see movement there. I know that that's been staid?

So I think at this stage we have not made any determinations vis-à-vis litigation. I think it's still something we're evaluating and again something that we'll allow -- we'll evaluate through to the -- like with the confirmation date before we make any decisions.

Got it, thank you. All right. That's it from me, thanks.

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