Octave Specialty Group, Inc. (OSG) Q2 2020 Earnings Report, Transcript and Summary

Greetings, and welcome to the Ambac Financial Group, Inc. Second Quarter 2020 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 host, Ms. Lisa Kampf, Head of Investor Relations; Claude LeBlanc, Chief Executive Officer; and David Trick, Chief Financial Officer. I will now turn the call over to Lisa.

Thank you. Good morning and thank you all for joining today's conference call to discuss Ambac Financial Group's second quarter 2020 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 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 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. Management is participating in this call from remote locations. If technical difficulties occur and we have to terminate the call, you will be able to read the transcript of our prepared remarks, which we posted to the Investor Relations section of our Web site. In addition, management will be available to address any questions that remain unanswered. Please feel free to contact me, via the contact information in our press release to schedule a call. I would now like to turn the call over to Mr. Claude LeBlanc.

Thank you, Lisa. For those of you joining us on today’s call, we hope that you and your families are keeping safe and healthy as the COVID-19 pandemic continues to ravage many states across the country, and we all grapple with its ongoing effects. With the health and safety of our employees and staff remaining a top priority and that continues to work primarily remote with no interruptions to our business operations. Following the New York Tristate area entering reopening phases 3 and 4 in July, a limited group of employees have returned to our offices on a voluntary basis. We continue to monitor the evolving pandemic conditions and we’ll make adjustments as needed to our working environment based on current facts and circumstances. Turning to our second quarter results. Last night, Ambac reported a net loss of 35 million or $0.77 per diluted share for the second quarter and an increase in book value per share of $1.46 per share to $23.34 from March 31, 2020. The adjusted loss was 24 million or $0.52 per diluted share for the second quarter, resulting in a decrease in adjusted book value per share of $1.05 to $21.06 at June 30, 2020. Our results for the second quarter reflect the continued strain on credit markets, primarily driven by the COVID pandemic, partially offset by the rebound of the capital markets since the end of the first quarter. Our insured portfolio fared relatively well during the quarter, in part due to the significant loss litigation and derisking actions accomplished in recent years. To date, we have not yet paid any COVID-19 related claims. However, significant uncertainty remains regarding the ultimate impact of COVID-19, in particular on municipal exposures which could see increased strain in coming quarters if the effects of the pandemic are prolonged and depending on the response from state and federal governments. We will continue to actively monitor and assess exposures in our portfolio most susceptible to pandemic-related risks and changes in the economic outlook and seek to implement and execute strategies to address evolving areas of risk. David will provide additional details on our quarterly results in a few minutes. Turning now to our insured portfolio. Net par exposure was 35.3 billion at June 30, 2020, down 3% from March 31, 2020 and 7% year-to-date. Watch list and adversely classified credits were 14 billion at June 30, 2020, up 1% from the first quarter and down 2% year-to-date. Our risk and surveillance teams have continued to perform in-depth reviews and maintain active dialogue with issuers on credits most exposed to the COVID disruption. As a result of our continued analysis, during the past two quarters, we migrated several credits to the adversely classified category and, where appropriate, established our increased economic reserves. The majority of the reserve increases were attributed to the public finance sector and primarily related to our Puerto Rico exposures. During the quarter, we also continued to focus on mitigating areas of risk, utilizing various tools at our disposal. This included shoring up one of our largest remaining single risk exposures related to the whole company securitization in the UK where we worked with the issuer to secure additional liquidity while at the same time increasing future optionality for Ambac with regards to this transaction. We also facilitated the reinsurance transaction related to our remaining exposure to the New Jersey Turnpike ability and commuted a significant portion of our remaining exposure to PG&E. As a core strategic priority, we remain focused on derisking our watch list and adversely classified credits and we’ll work to leverage all options at our disposal to continue to scalp and derisk our insured portfolio and reduce potential tail risk. Turning now to Puerto Rico. Local and federal governments continue to provide relief and assistance in response to COVID-19. The rate of aid expenditure and efficacy of spending as well as developments on the health front will all influence the timeline for Puerto Rico’s economic recovery. Puerto Rico has been in bankruptcy since 2017 and the timing of its exit remains uncertain. Regrettably, legal and other advisors working for the Oversight Board and commonwealth government have cost the Puerto Rico taxpayers nearly three-quarters of a billion dollars in fees and expenses as of July 22, 2020 with no end in sight. This is money that could have been spent on disaster relief or on other public policy goals. Puerto Rico deserves better oversight and strategic direction to help it navigate the opportunities and challenges in the months ahead. To that end, Ambac welcomed the news of potential changes in the membership of the Oversight Board. The Oversight Board has pursued a mice scattered path of legally challenging market expectations and statutory regimes that were established for the purpose of encouraging investment in Puerto Rico, like with the revenue bonds. Unfortunately in early July, Judge Swain issued orders denying a large part motions to the lift stay that would have allowed Ambac and others to enforce their rights related to HTA, CCDA and PRIFA in an alternative form. Ambac intends to appeal the orders denying the motions to lift the stay and we’ll continue to vigorously litigate our rights and protect the interest of the revenue and other bonds that we insure. As we stated previously, Ambac remains committed to working with government representatives to achieve holistic, consensual and durable resolutions for Puerto Rico. Negotiating in good faith with a broad set of commonwealth creditors is the only way to help Puerto Rico successfully navigate economic uncertainty and restore access to capital markets. Turning now to our loss recovery efforts. We are pleased with the encouraging developments this quarter in our rep and warranty case against Countrywide and Bank of America. On June 11, the intermediate appellate court denied Countrywide’s motion for leave to appeal certain pre-trial decisions to the highest court in New York State. And in late June, Justice Sherwood affirmatively scheduled a five-week trial to begin on February 22, 2021. While there remains some risk of further delay in this case based on additional motion practice, we are hopeful that our trial schedule will remain in place. We believe the biggest potential obstacle is the COVID pandemic. However, courts in New York are carefully reopening and we hope conditions will improve to allow us to proceed to trial next February as scheduled. We strongly believe in the merits and strength of our case and look forward to its resolution at the earliest possible opportunity. Now turning to new business. As it relates to the implementation of our specialty insurance new business strategy, we are pleased to report that the Wisconsin office of the Commissioner of Insurance recently approved the sale of Everspan Insurance Company from AAC to our holding company AFG. We intend to use Everspan as a platform for specialty program insurance business pillar, a key component of our broader new business strategy. In connection with this development, we are pleased to welcome two highly respected executives to the Everspan team, Wyatt Blackburn and Steve Dresner. Wyatt has been hired as President and Steve as Chief Underwriting Officer and Chief Reinsurance Officer of Everspan. Wyatt is a well recognized and respected industry veteran with over 37 years experience, most recently with State National. Steve Dresner joined us from Crum & Forster and has over 36 years of experience in both the insurance and reinsurance industry and brings with him proven underwriting expertise in a specialty program business. We look forward to updating you as we progress our strategy in upcoming quarters. I will now turn the call over to David Trick to discuss our financial results in more detail.

Thank you, Claude, and good morning, everyone. During the second quarter of 2020, Ambac reported a net loss of 35 million or $0.77 per diluted share compared to a net loss of 280 million or $6.07 per diluted share in the first quarter of 2020. Second quarter results reflected lower loss and loss expenses and the impact of the partial reversal of the financial markets disruption, which occurred during the first quarter. Interest and operating expenses also declined. During the first quarter, the economic and financial markets disruption, particularly lower interest rate and higher market risk premiums caused by the pandemic, contributed significantly to our financial results causing material non-economic losses. During the second quarter, these contributors subsided with an immaterial net impact. Adjusted loss for the second quarter was 24 million or $0.52 per diluted share compared to an adjusted loss of 265 million or $5.75 per diluted share in the first quarter. The variance between adjusted and net loss for the second quarter was largely due to 14 million of insurance intangible amortization. Briefly touching on some highlights, premiums earned were 11 million in the second quarter versus just over 10 million during the first quarter. The slight increase was driven by the net impact of negative accelerations during the first quarter, continued runoff of the insured portfolio and an increase in the premium allowance during the second quarter. Investment income, excluding realized gains, was 52 million for the second quarter compared to a net loss of 21 million in the first quarter. Second quarter investment income was comprised of mark-to-market gains on pooled investments of 26 million and income from available for sale securities of 26 million. The solid performance of our pooled investments was led by hedge and public equity fund returns which produced returns north of 10% for the quarter, partially reversing the fair value losses recognized in the first quarter of 53 million. Income from available for sale securities was 26 million in the second quarter compared to 31 million for the first quarter. The decline was a result of lower interest rates on short-term and floating rate investments, redemptions of owned LSNI notes and the sale of certain securities. Securities were sold early in the quarter to reduce risk and build liquidity in the face of uncertainty regarding COVID-19. Some of this liquidity was redeployed during the quarter and therefore is expected to be further reflected in third quarter results. Securities sales generated 9 million of net realized gain during the second quarter. Loss and loss expenses incurred were 16 million in the second quarter compared to 117 million in the first quarter. Second quarter incurred losses were driven by public finance sector losses, which were partially offset by a benefit from RMBS. Public finance losses incurred were 42 million in the second quarter driven by increased Puerto Rico reserves related to assumption changes and higher loss expenses. Public finance losses incurred in the first quarter of 170 million were driven by the sharp decline in discount rates as well as additions to Puerto Rico reserves and credits impacted by COVID-19. The RMBS benefit of 35 million in the second quarter compared to a benefit of 83 million in the first quarter was due to a further increase in expected excess spread recoveries resulting from lower interest rates and improvements in credit, partially offset by higher loss expenses. Operating expenses for the second quarter of 20.5 million decreased 13% from 23.5 million in the first quarter. The decrease was a result of lower compensation costs related to both the timing and level of incentive compensation accruals as well as lower headcount. Interest expense decreased 5 million in the second quarter to 58 million, following the redemption of 77 million of secured notes, lower interest rates and lower discount accretion on surplus notes. The second quarter net loss was more than offset by an increase in unrealized gains on securities of 104 million resulting in an increase to shareholders’ equity of $1.46 per share to $23.34 per share or 1.1 billion at June 30, 2020. Adjusted book value decreased to 965 million or $21.06 per share at June 30, 2020 from 1.01 billion or $22.11 per share at March 31, 2020. This adjusted book value decrease was mostly driven by the adjusted loss for the second quarter. Unlike book value, adjusted book value is not impacted by changes in unrealized gains and losses. As for AFG on a stand-alone basis, as of June 30, 2020, AFG had cash investments and net receivables of approximately 481 million including nearly 340 million of liquid assets or $10.51 per share. I will now turn the call back to Claude for some brief closing remarks.

Thank you, David. While the full extent of future economic disruptions stemming from the pandemic remains uncertain, we believe Ambac’s runoff financial guarantee business continues to be well positioned to manage through the potential challenges due in large part to our disciplined and prioritized risk and exposure management strategy. At the same time, the current environment has also serviced a number of attractive market opportunities which we believe could lead to future material value creation for our shareholders. We remain active in exploring new opportunities and look forward to updating you on our progress in future quarters. Operator, please open the call to questions. Thank you.

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

Yes. Thank you. Good morning. Thanks for taking my question. First of all, thanks very much for the commentary on some of the proactive steps the company is taking to address the stress in the municipal market. Looking broadly, we’re looking at an environment where interest rates are at historic lows. We know that what that means to some other insurance companies, but in the case of Ambac I think there are quite a few puts and takes. If you could talk a bit about what those puts and takes are, the positives and negatives arising from lower interest rates and pertaining to the company?

Thanks and good morning, Mark. Maybe I’ll start off with just at a high level from a risk management perspective and I’ll pass it over to David who will touch on some of the capital management aspects of it. But generally speaking, with a lower rate environment, we do see opportunities to do incremental refinancing transactions at better pricing for municipalities and we have engaged with a number of munis, particularly the ones that we have seen in more stressed situations related to COVID and we are working with a few of them to find ways to help them refinance and access capital at better pricing. So I think from that perspective, there are better opportunities for some of these muni credits to refinance. The other area that’s benefitted us is on our structured finance portfolio, in particular RMBS, where rates go down we were able to collect additional excess spread. So as we mentioned last quarter where we took reserves at – increased economic reserves relating to expected stresses in the RMBS portfolio, the reserves on a net basis decreased because of the increased expected recovery from excess spread, which is also an economic benefit to the company. So those I think are probably two of the key, what I’ll say, benefits that we see coming out of this. Obviously, lower investment returns on a fixed income portfolio, but there we have made some changes and reallocations to look for areas of better relative value returns to offset some of that decline. But with that, I’ll turn it over to David Trick who will give a little bit more color on that.

Mark, I think Claude touched on a lot of it. But thinking about the right-side of the balance sheet first, the benefit really relates to excess spread in the RMBS as well as other structured finance transactions that either have excess spread or carry costs associated with them, including, for example, student loans where there’s lower negative carry within the student loan portfolio. So from a structured finance standpoint, from an excess spread deal recovery and cash flow standpoint for our structured exposures where we have real embedded losses, low interest rates is a very, very strong positive for us. It also keeps, of course, our cost of our floating rate debt low, so that’s been helpful as well from an interest cost standpoint. And from the asset side of the balance sheet, of course, it becomes a little more challenging to invest in fixed income securities. We’ve been finding our pockets and including our own insured securities as well as some other alternative investments, I guess I’ll call it, to try to optimize the risk adjusted returns on the investment portfolio. And I would just close in saying really that the other consideration really is the risk that comes with low interest rates from that environment not continuing to exist. So the risk that rates go up, which no one really anticipates in the short term, is certainly still a real risk and something that we think about regularly and we’ve had hedges on the books for a long time related to that, and we’ve modified those hedges over time to the lowest point they’ve ever been, but it’s something we continue to monitor and want to make sure we protect the assets, particularly the excess spread that exist on our book today from an unexpected or a long-term drift up in interest rates.

Very good. Thank you very much.

Sure.

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

Good morning. I think on the last earnings call you had implied that you had bought back some Ambac liabilities in early April in the credit market dislocation. Was that – did you repurchase actual Ambac issued liabilities or were there Ambac insured bonds?

Hi, Derek. How are you? It’s David Trick. Thanks for the question. We did buy some Ambac-wrapped securities. We spent about $150 million in the quarter of Ambac-wrapped bonds.

Okay. And my other question was, when you give the cash and investments at AFG of $481 million, are there any liabilities at AFG that would have to net against that amount?

The only liabilities at AFG are some payables and that’s netted against the receivables. So the $481 million is a net number, but there’s no debt or financial obligations at the holding company. It’s just simply working capital payables.

Great. Thanks.

Sure.

Thank you. Ladies and gentlemen, there are no further questions at this time. This concludes today’s conference. We thank you for participating. You may now disconnect your lines. Thank you, again.