Octave Specialty Group, Inc. (OSG) Q1 2019 Earnings Report, Transcript and Summary

Greetings, and welcome to the Ambac Financial Group, Inc's First Quarter 2019 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 first quarter 2019 financial results. We would 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 supports 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. During the first quarter, we continued to make tremendous progress on the active de-risking of our insured portfolio reducing our insured net par by over $2.5 billion. Of which, more than half was driven by our active de-risking strategy of the adversely classified and watch list credits. This represents a further 5.2% decline in our overall insured portfolio in the quarter following the significant 25 reductions achieved in 2018. The reduction in net par outstanding for the first quarter of 2019 includes the impact of one of our most successful de-risking efforts, the execution and implementation of the COFINA Plan of Adjustment which became effective on February 12, 2019. During the first quarter, the COFINA Plan of Adjustment along with the associated commutations and subsequent distributions from the related trust reduced our net par exposure to COFINA by 77% or $620 million. As a result, our COFINA net par decreased from $805 million as of December 31st 2018 to $185 million as of March 31st 2019. And our overall Puerto Rico net par exposure decreased from $1.9 billion to $1.3 billion over the same period. In a few minutes, David will provide us more details on the overall impact of the COFINA restructuring and the effects on our financial results this quarter. In addition to the COFINA restructuring, there are many other significant de-risking transactions executed including, one, the execution of commutation of an adversely classified public finance transaction which reduced net par exposure by $350 million. Two, negotiations that led to the refunding of bonds associated with two watch list asset-backed leased securitizations which reduced net pars by $95 million. And three, the final pay down of a watch list aircraft securitization transaction which reduced net par by $77 million as a result of a previously negotiated remediation agreement. In addition, following the end of the quarter, we successfully negotiated a lock-up agreement with bond holders and subsequently launched an Irish law scheme of arrangement in connection with a proposed restructuring and commutation of one of Ambac U.K.'s largest exposures, a $900 million insurance securitization. While no assurance can be given as to the outcome of the court process, if successfully completed we anticipate that this transaction could close some time during the second or third quarter of this year. Collectively, these results illustrate our steadfast focus on reducing long-tail risk in our insured portfolio by utilizing various strategies to address risk factors that have or may result in material future losses to the company. We are very pleased with the momentum created by our ongoing de-risking achievements. And we are optimistic about our ability to continue progressing and executing this key component of our overall strategy. Turning now to our review of our remaining Puerto Rico exposure, overall we continue to be encouraged by the continued signs of macroeconomic improvements for the commonwealth. The unemployment rate in March was 8.8%, one of the lowest unemployment rates in Puerto Rico going back at least 55 years. Private sector employment during March 2019 reached its highest level since 2015 growing year-over-year by 4%. We are hopeful that this sustained economic momentum will eventually lead to a substantial revision to the financial projections in the commonwealth fiscal plan. Unfortunately, the Oversight Board approved a certified fiscal plan for the commonwealth yesterday. The revised projections for certain inputs such as slower federal disaster aid rollout and included updates to fiscal priorities, but remained unadjusted to correct for many other deficiencies long recognized and identified by stakeholders. As we have expressed in the past, we believe that fiscal plan is deeply flawed and the projected annual budget surplus deficits especially in the long term do not accurately reflect the real potential future fiscal position and debt capacity of the commonwealth government. A credible commonwealth fiscal plan is critical to developing consensual debt restructurings that properly respect the rights and expectations of investors and other creditors as well as the current and future needs of Puerto Rico. Another area of increasing concern relates to the possible corruption in Puerto Rico and the long-term impact that this may have on the commonwealth's ability to regain access to capital markets. Over the last few weeks, federal and local authorities have been investigating possible corruption within different areas of the Puerto Rico government. There have also been high levels of midterm turnover a Puerto Rico agency has in Governor Rosselló's cabinet secretaries, now at least 40 people and counting. President Trump and the U.S. Senate need to act quickly to nominate and confirm the current members of the Oversight Board not only to maintain the momentum around consensual debt restructurings but also to ensure proper oversight of the commonwealth and its fiscal framework. Federal action is critical to ensuring to a high level of local government transparency, accountability, and stability over the long-term. As the situation in the Puerto Rico involves, there remains many challenges that need to be addressed given uncertainties relating to incomplete restructuring, processes, and various unsolved political and legal issues. Switching now to our loss recovery efforts, all arguments were heard by the appellate court on May 2nd in our main RMBS litigations against Bank of America and Countrywide. We are awaiting the court's decision so that this case can progress towards the confirmation of a trial date. While there are many unknowns at this moment such as the timing and outcome of the issues heard on appeal and the trail court schedule, we are hopeful that this trial and this case will occur late this year or early next year. Turning now to our continued efforts to improve the effectiveness and efficiency of our operating platform, during the quarter, we continued to evaluate and implement changes in operational areas that will provide greater efficiencies and over time our overall operating expense run rate. One example of this was a signing of a new lease for office space for our U.S. headquarters at One World Trade. Our move is planned for later this summer and will provide Ambac with several benefits including the consolidation or New York Office space, material economic rent savings, and increased operational flexibility. With regards to new business initiatives, we continue to actively progress our evaluation of opportunities. We are pursuing strategies that we believe will optimize our business model, diversify our platform, and drive long-term value to our shareholders. As we have previously stated, all capital allocation assessments will continue to be measured against the return of capital towards shareholders. In closing, we are off to a very strong start in 2019 and remain optimistic about our ability to continue progressing our strategy to deliver long-term value for our shareholders. I would now like to turn the call over to David Trick to discuss our financial results in a more detail. David?

Thank you, Claude, and good morning to everyone. During the first quarter of 2019, Ambac incurred a net loss of $43 million or $0.94 per diluted share compared to a net loss of $20 million or $0.45 per diluted share in the fourth quarter of 2018. First quarter adjusted loss was $9 million or $0.20 per diluted share compared to adjusted earnings of $11 million or $0.24 per diluted share in the fourth quarter. Relative to the fourth quarter, our first quarter results reflect the strengthening of public finance loss reserves and lower realized investment gains partially offset by higher investment income, lower derivative losses, and higher VIE income. More specifically, premiums earned were $28 million during the first quarter versus $29 million during the fourth quarter. Normal earned premiums decreased by about $1 million to $16 million or 5% due to the continued reduction of the insured portfolio including the seed of $1.5 billion of net par exposure in the 4Q 2018. Accelerated premiums of $12 million in the first quarter of 2019 were driven by active de-risking primarily related to the COFINA Plan of Adjustment. Investment income for the first quarter was $55 million, $17 million increase from $37 million for the fourth quarter of 2018. During the first quarter, the investment portfolio benefited from the rebound in the equity and credit markets generating a $19 million favorable swing from the fourth quarter. Net realized investment gains of $17 million for the first quarter were primarily driven by the conversion of our investment in AAC insured COFINA bonds into cash and new uninsured COFINA bonds in connection with the closing of the COFINA Plan of Adjustment and opportunistic COFINA bond sales. Related to the COFINA Plan of Adjustment, Ambac insured senior COFINA bondholders who elected not to commute their bonds under the associated Ambac policy received units issued by a trust into which were deposited there Ambac insured COFINA bonds along with a ratable distribution of cash paid by COFINA and new COFINA bonds which will offset a portion of Ambac's remaining COFINA insurance liability over time. This trust was determined to be a variable interest entity and was consolidated in Ambac's GAAP financial statements during the first quarter. In connection with the consolidation, a gain of $14.9 million was recognized as income from Reais. The gain represents the difference between the net carrying value of liabilities under insurance accounting and the fair value of the net liabilities of the trust. $274.2 million of assets and $335.3 million of liabilities were consolidated related to the COFINA Trust. Loss and loss expense reserves incurred were $12 million in the first quarter compared to a benefit of $42 million in the fourth quarter. The change was mostly due to the strengthening of public finance reserves partially offset by favorable development in the RMBS, student loan, Ambac U.K. and other credit portfolios. Loss and loss expenses in the public finance portfolio in the first quarter was $69 million which were primarily due to the strengthening of reserves for a non-COFINA Puerto Rico exposures. The first quarter benefit in the RMBS portfolio of $39 million was the result of credit improvements and the impact of lower interest rates on excess spread partially offset by higher loss expenses. Favorable development in Ambac U.K. student loans and other exposures collectively produced a benefit of $18 million in the first quarter as a result of positive credit developments, lower interest rates and foreign exchange gains. Net losses on derivative contracts were $16 million for the first quarter and $45 million for the fourth quarter both due to declines in forward interest rates. The fourth quarter also included a $4 million counterparty credit adjustment, interest rate derivative losses in the first quarter were more than offset by approximately $54 million of gains recognized in the insured and investment portfolios driven by forward interest rate movements. As it relates to expenses, first quarter operating expenses were $25 million, an increase of $4 million from the fourth quarter. This increase was mostly due to higher cyclical costs related to incentive compensation including equity grants and payroll taxes. Every first quarter, we experienced an increase in compensation expense as equity grants made mostly in connection with our short-term incentive program or expense upon grant as compared to cash bonuses which are accrued for throughout the year. Non-compensation expenses were $10.3 million for the first quarter up slightly from $9.7 million in the fourth quarter due mostly to incremental spend on advisors partially offset by reduced core operating expenses. As a reminder, I noted last quarter that we will experience higher rent expense in 2019 despite materially lower economic or actual rent payments associated with our upcoming headquarters move and consolidation. While we remain focused on reducing our core operating expenses, but as noted previously and experienced this quarter, we do expect that there will be volatility quarter-to-quarter related to the nature of our operations and the pursuit of our strategic priorities. Turning briefly to the balance sheet, shareholders equity increased $0.51 to $35.63 per share at March 31, 2019 due mostly to unrealized investment portfolio gains of $56 million and translation gains of nearly $15 million primarily related to Ambac U.K. and partially offset by the net loss for the quarter. On an absolute basis, adjusted book value increased modestly to $1.253 billion at March 31, 2019 from $1.251 billion at year-end 2018. The increase was related to changes in foreign exchange rates and the impact of lower interest rates on the value of expected installment premiums partially offset by the first quarter adjusted loss. Adjusted book value on a per share basis declined $0.06 to $27.52 per share at March 31, 2019. Despite the modest decline in adjusted book value per share, we believe the quality of adjusted book value increased materially during the quarter as though net $1.1 billion decline adversely classified in a watch list credits translated to eliminating approximately $24 per share of higher risk exposure. On a standalone basis as of March 31, 2019 AFG held cash, investments and receivables of approximately $469 million or $10.35 per share. That concludes my formal remarks. I will now turn the call back to Claude for some brief closing remarks.

Thank you, David. The results of this quarter reflect our ongoing commitment to execute on strategies that we believe will deliver long-term value to our shareholders. We would like to thank our long-term value driven shareholders for your continued support. Operator, please open the call 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 with Odeon Capital Group. Please proceed with your question.

Hey, good morning. Claude, you mentioned in your prepared remarks, you discussed that Ballantyne restructuring transaction which is in process, and could you give us any more information on sort of the magnitude of the benefit that could be realized from successful completion of that deal?

Sure, let me pass that one to David.

Andrew, sure, the -- I can't give you too many specifics in part, because the transaction is still a live transaction and is subject to several matters before it actually becomes official and could close. The biggest one of course being as we disclosed in the Q approval by the court in Ireland that has jurisdiction over the transaction, but we do highlight and provide some details in the Q, I believe it's on page 48 for everyone who like to take a look at some of the details that we do disclose. We do make reference there to the fact that the transaction if it does close will have a significant impact on our AUK reserves, and we do disclose the fact that our gross AUK reserves are about $258 million. So, if the transaction does close, of course, AUK will have to make some payments in order to affect the -- what is effectively a commutation. So that will reduce those reserves. And in addition to that, it will have a positive economic effect. So, another portion or a significant portion of reserves will be reduced by -- hopefully, we'll be at effectively a gain on the transaction, and it will have effects throughout the other parts of the income statement. So, to the extent of the gain, our U.K. subsidiary is a taxpayer. So there will be some tax effects as well. There'll be some effects on our intangible amortization of the effects on accelerated premiums, and there'll be some effects on expenses with regards to success fees that we have related to advisors, who are assisting on the transaction. So there's been a number of effects, but the way we describe it in the Q, I think is a fair description, which will be that it will be significant in a positive way.

Got it? Thanks very much. Last quarter, we were discussing this Citi Group SEC settlement, and you are hopeful that we would know more by this time that certainly fits with the disclosures and the statements that have been made to the court, but there's been nothing filed recently. Do you have any idea what's holding that up and when we might know more?

Unfortunately, we have not heard too much more from the SEC. We as reported last quarter there has been a delay. We understand relating to the federal shutdown that took place at the beginning of the year, which may still be causing challenges in processing through some of these decisions, but we remain optimistic that it is progressing, and hope to hear back from the SEC in the coming months.

Okay. Thank you. And then final question regarding the tolling payments from AAC to Holdco, including the one that I think was about 37 or so million last year that was retained by AAC, do you have any update on, or any thoughts on when we might get more information on the release of those tolling payment?

It's something that we continue to be in active discussions with the regulator. As you know, we had a change in commissioner and also a re-integration of Ambac with the general staff at the OCI in the last year. So, I believe we're making significant progress, and I believe the significant risk reductions that we've implemented, they're still analyzing that in number of other transactions that completed, but we remain optimistic that will be released at some point in the not-too-distant-future.

Okay. Thank you very much.

Thank you. Our next question comes from the line of Derek Pilecki with Gator Capital. Please proceed with your question.

Thank you. I was wondering if you could give some more clarity about your thoughts of the Countrywide trial date being set, and when do you expect a ruling from the appellate court, when do you expect the trial judge to set the trial date?

Thanks, Derek. So I think we have the oral arguments last week. We believe they went very well for Ambac. I think the feedback we've been receiving in trying to analyze timing surrounds the nature, number, and complexity of some of the arguments that could take some time for review by the first apartment. So I think at this point, it's difficult to assess the exact timing, but I think the guidance suggest it could be a number of months, hard to put bookends around that, but we believe hopefully sometime by the late summer, we should -- or early fall, we should get to a point where there should be a decision issued, if not sooner, and it could be much sooner. But that is the timing on the arguments and decisions that we're currently assuming or estimating. And with that, given the approach and demeanor of Judge Sherwood, who clearly wanted to progress the case quickly, we remain optimistic, obviously depending on his schedule, but he'll be looking to schedule a trial date as soon as decisions are reached by the appellate court. So, our timing still remains on a base case that we're optimistic that possibly sometime later this year or early next year we could have a trial date set.

Moving on to Puerto Rico reserves, I was surprised that there was an addition to reserves this quarter, especially given the improvement in the economy in Puerto Rico and the settlement of the COFINA deal, could you give more clarity what the thinking is there?

Sure, at a high level I think the economy, you're right, is improving, and we know that, and that's clearly a positive. I think on the negative what we're seeing, which is a myriad of things, but the significant litigation that has been launched by parties in the last number of months, in addition to the status of the oversight Board and the decision surrounding the appointments clause, also the corruption that seems to be continuing in prevalence in Puerto Rico. A number of these factors are leading us to re-examine some of the assumptions in our models based on the timing of expected resolutions of Puerto Rico matters. So, those were some of the factors that drove consideration around losses, and again, a lot of this is timing. There's also interest rate movements, which affected the loss reserves amongst others. I should also point out though that part of the reserve increase on the municipal side went beyond simply Puerto Rico. There's also lots of servers [ph] that were increased or established relating to instrumentalities tied to the events of the California wildfires of late last year that were also part of the adverse development. Now David, if you want to add anything to that.

I think that covers it.

In the release, you said you sold your COFINA bonds, could you just talk strategically what the thought process [indiscernible] all the value there, or would they have been a good long-term holding, have you redeployed the money into other assets?

Sure. So we didn't sell all of the COFINA bonds that were part of the -- as we call them, COFINA 2.0 collateral that came in based on the AAC insured bonds we owned. So, we still are long about 220 million or so fair value of COFINA bonds and the rest were sold. The thinking behind that was that we were getting a -- we were involved in a de-risking transaction from COFINA, and therefore, we wanted to de-risk, and so, on a net basis of course while we still long some of the new bonds, we have materially reduced our exposure to COFINA. We saw good value for the bonds, or we thought it was good value for the bonds, and we continue to see that the bonds we hold continue to show good value and good liquidity other than the taxable bonds, which will probably be sitting on longer than the residual taxes [ph] that we own as we await some rulings from the IRS with regards to their tax status. So, some of the cash has been redeployed, we are evaluating and discussing that now in terms of how to redeploy the remainder of the cash.

Okay. And last question, David, could you just update us on total claims paid in Puerto Rico, and if you have any assumed recovery of this money in the balance sheet?

We do have assumed recoveries in the balance sheet. We paid something in the magnitude of $25 million or $30 million in the first quarter. With regards to Puerto Rico claims, we have another additional payment coming up in the latter part in July, which is about $80 million or so. So, we do continue to re-evaluate those balances on the balance sheet. And Claude had alluded to in his comments part of the shift in value of the loss reserves of the quarter relate to timing. Part of that, of course, is the timing of recoveries that we have booked on the balance sheet as well, but we have not gone as far as to disclose the specific gross payments and gross recoveries that we have on the balance sheet. They'll be a little more detail and we usually go into enclosed probably a lot of a lot of confusion, but nonetheless, our aggregate claims paid to date in Puerto Rico is about $424 million.

Great, thank you.

Thank you. Our next question comes from the line of Charles Post with Sterling Grace. Please proceed with your question.

I as wondering if you could update us on the percentage of run bonds you own now, a few dollars amounts there for two categories that is used to provide the percentage?

Sure. That's unchanged. We didn't buy any additional bonds in the first quarter -- about 38% of the -- are in short bonds that we own.

Thank you. And then on the Junior Surplus Notes, do you guys still own those?

The Junior -- I mean they're are holding company, I'll update you, you know, we monetize those few quarters back.

Okay. So that -- like $75 million phase that's totally gone now?

That's correct. Those are gone.

Okay, great. Thank you.

Sure.

Thank you. There are no further questions at this time. This concludes today's teleconference. Thank you for your participation. You may disconnect your lies at this time and have a wonderful day.