Ambac Financial Group, Inc. Q4 2008 Earnings Call Transcript

| About: Ambac Financial (AMBC)

Ambac Financial Group, Inc. (ABK) Q4 2008 Earnings Call February 25, 2009 8:30 AM ET


Sean Leonard – Senior Vice President and Chief Financial Officer

David Wallis – Chief Executive Officer

Cathy Matanle – Managing Director, Portfolio Risk Management

Douglas C. Renfield-Miller - Chief Executive Officer, Everspan Financial Guarantee Corp.


Andrew Wessel - J.P. Morgan

Arun Kumar - J.P. Morgan

Darin Arita - Deutsche Bank Securities

Bryan Monteleone - Barclays Capital

[Paul Steinborn – Plainfield]

Eleanor Chan - Aurelius Capital


Greetings and welcome to the Ambac Financial Group, Inc. fourth quarter earnings conference call. (Operator Instructions)

It is now my pleasure to introduce your host Sean Leonard, Senior Vice President and Chief Financial Officer for Ambac Financial Group, Inc. Thank you, Mr. Leonard. You may begin.

Sean Leonard

Thank you. Good morning, everyone, and welcome Ambac's fourth quarter 2008 conference call. I'm Sean Leonard, Chief Financial Officer at Ambac. With me today are David Wallis, Chief Executive Officer, Cathy Matanle, Managing Director, Portfolio Risk Management, and Doug Renfield-Miller, Chief Executive Officer of Everspan Financial Guarantee Corp.

Our earnings press release, quarterly operating supplement, and a slide presentation that follows along with this discussion are available on our website. I recommend that you view the slide presentation as we speak today. Also note that this call is being broadcast on the Internet at

During this conference call we may make statements that would be regarded as forward-looking statements. These statements may relate to, among other things, management's current expectations of future performance, future results and cash flows, and market outlook. You are cautioned not to place undue reliance on these forward-looking statements which reflect our current analysis of existing trends and information as of the date of this information, and there is inherent risk that actual results, performance or achievements could differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

These differences could arise from a number of factors. Information concerning factors that could actually cause results to differ materially from the information we will give you is available in our press release and in our most recent Form 10-K and subsequently filed Form 8Ks. You should review these materials for a complete discussion of these factors and other risks. Copies of these documents may be obtained from the SEC website.

I will now turn it over to David Wallis, who will comment on Ambac's strategic priorities. David?

David Wallis

Thanks, Sean, and good morning, everyone.

Since we last reported to you on November 5, 2008 events in the financial markets have continued to evolve in a mostly downward direction with astonishing rapidity. Sparing you a blowbyblow account of these extraordinary developments, I'll summarize by saying that the fourth quarter of 2008 and indeed all of 2008 obviously represents the most challenging period of our recent financial history.

The good news, despite these headwinds the strength of our business model, together with the common sense of our regulator, have allowed Ambac to successfully navigate a very difficult period.

A major achievement for Ambac during the quarter was the successful handling of the collateralization requirements that arose from ratings triggers in our Financial Services business. In retrospect, this business was an outlier to the take no liquidity risk business model that has been a core strength of Ambac and is intrinsic to Financial Guarantee in general. In this environment or any other, it is now abundantly clear that the business model of principal and interest payments over time juxtaposed against premiums collected upfront is the lifeblood of this industry. We have learnt from this and will not stray again.

Another major activity in the quarter was furtherance of our goal of launching a pure play municipal subsidiary. We continue to work closely with our regulator and the rating agencies and hope for proceeding with this initiative soon.

Everspan, the reincarnation of an existing subsidiary, will have a simple and permanent focus on municipal finance. Doug Renfield-Miller will give more detail on this later in the call.

Before the detailed presentations of my colleagues, let me briefly look forward and outline our priorities for 2009 and thereafter. We have three key areas of focus, namely, one, aggressive portfolio management; two, the launch of Everspan; and three, leveraging existing skill sets and core strengths. Let me provide some color on these areas of focus.

Firstly, managing the risks in our portfolio continues to be a vital and dominant strategy. We continue to make good progress in this area under very adverse economic conditions. Reflecting the importance of this function and the high level of activity within it, we now have 74 dedicated staff engaged in managing and de-risking our portfolio. This large staff is producing value added results and whilst the CDO commutations have been the most visible, this is by no means the only area where success has been achieved.

Secondly, Everspan is a vital focus. Subject to regulatory approval and marketable ratings, our intent is to capitalize Everspan as a wholly owned subsidiary of Ambac Assurance. In addition to providing much-needed capacity to the municipal finance market, we believe Everspan will provide better returns to existing Ambac policyholders than the fixed income securities that Ambac would otherwise be invested in.

A third strategic goal is to define and execute upon a set of domestic and international strategies which take advantage of our existing skills in the current fractured marketplace for credit-related financial service products. To be sure, this is a crowded marketplace and we must be realistic about our ability to remuneratively compete within it; however, given our existing capabilities, customer and geographic reach, perhaps augmented by selected further enhancement to our skill base, we can create value for our shareholders.

Internationally different market environments and regulatory regimes may present varying options and we will work hard to evaluate and lay the groundwork to maximize these opportunities.

While Cathy Matanle will discuss our portfolio in detail, I want to take a few minutes to comment on the recent actions of the federal government. We believe that the homeowner affordability and stability plans will ultimately contribute to a stabilization of the housing market. The three core policy measures incorporating increased affordability, foreclosure prevention via modification and strengthening of the GSEs are likely sufficient to have a positive impact.

It is difficult, however, to quantify the benefits of these programs, especially in nonagency products. We are developing our thinking in this area.

Let me comment on TARP. There has been a great deal of speculation about the participation of members of our industry in TARP. We have been fortunate in having the benefit of several private meetings and discussions with different representatives of both the previous and the new administration. We have been encouraged and impressed by the level of understanding and questions asked, together with the honest efforts to understand the dynamics of our business and the role that we play in the financial markets.

At the present, however, there is little or no assurance that TARP funds will be forthcoming and equally it is unclear to us as to the overall benefits of such funds if they were to be available. We do not need public funds to support our obligations to policyholders. The successful development of a strong platform in Everspan will provide a new benchmark in transparency and will provide a permanent adherence to the chosen and invariant core business. This investment will be both supportive to policyholders and accretive to shareholders.

Concluding, there is little doubt that 2009 will see a continuation of the severe challenges that we have been grappling with, but we have made some significant progress. We are looking forward with confidence and merely dealing with the present. We are conscious that our market capitalization may be perceived as effective option value against a poor environment and an overly concentrated portfolio. We will continue work very hard to repay holders of this option.

With that, I'll turn it back to Sean.

Sean Leonard

Thank you, David.

Please turn to Slide 4. Slide 4 provides a brief overview of the financial results, focusing primarily on factors driving our results, and then I will also briefly comment on statutory surplus levels and liquidity.

Net loss for the fourth quarter of 2008 was $2.3408 billion or $8.14 per share. That compares to a net loss of approximately $3.2739 billion or $32.03 per share in the fourth quarter of 2007. The fourth quarter of 2008 loss was driven by changes in the fair value of our CDO portfolio, increased net provision for loss and loss adjustment expenses primarily related to RMBS transactions, and an increase in the valuation allowance on our deferred tax asset, partially offset by increased accelerated earned premiums resulting from refundings. The fourth quarter of 2007 loss was driven by $5.2 billion of changes in fair value related to our credit derivative portfolio.

Total net premiums earned amounted to $228.1 million, up 9% from the fourth quarter of 2007. Normal earned premium, a component of total earned premiums, amounted to $146.9 million in the quarter, down 18% from the comparable prior quarter primarily due to runoff and accelerations of the portfolio due to refundings and a large reinsurance transaction which took place in December of 2007.

Accelerated premiums of $81.2 million increased significantly once again, up about $51 million over fourth quarter of 2007.

Refunding activity remains heavy in auction rate and variable rate debt notes as issuers refund existing bonds due to increasing interest rates experienced in those securities since early 2008. This heavy refunding activity enhances our capital position as we free up capital as the exposure comes off our books. Our net par outstanding at December 31, 2008 amounted to $434.3 billion, down 17% from the beginning of the year.

Our structured finance portfolio is down $30 billion or 18% from 2007's year end.

Investment income decreased about $9.8 million or 8% to $109.5 million, primarily driven by cash payments made during the quarter for commutations and other losses. In the fourth quarter we paid $1 billion in early November to commute four CDO of ABS transactions. We have also repositioned a portion of our investment portfolio to short-term securities to provide enhanced flexibility. Those negative factors were partially offset by cash flows from premiums collected and net interest income from the investment portfolio and the net proceeds from the March 2008 capital raise.

Loss and loss expenses amounted to $916.4 million, up over $700 million from fourth quarter 2007. Cathy will provide greater detail about our credit portfolio and various loss assumptions that led to our loss provision for the quarter.

During the quarter the deferred tax valuation allowance increased to approximately $2 billion, an increase of about $1.5 billion from September 30, 2008. Over the past several quarters Ambac has recorded significant marked-to-market losses on its CDS portfolio and has incurred losses in its insured RMBS portfolio. For purposes of estimating future taxable income available to utilize our net operating loss carryforward and other deferred tax assets, management revised its estimate of potential future increases in loss reserves to conservatively reflect the potential impact that further deterioration in Ambac's insured portfolio would have on future taxable income. The revised estimate resulted in an increase in the valuation allowance.

During the fourth quarter Ambac recorded net marked-to-market losses related to its credit derivative portfolio amounting to approximately $594 million. Marked-to-market losses were primarily impacted by deteriorating price performance in the CDO of ABS portfolio and internal downgrades in that portfolio. We have also seen price declines in other asset classes in the credit derivative portfolio. Partially offsetting these items was the larger discount effect of wider Ambac credit spreads in the calculation of fair value and the commutations that I previously mentioned.

To assist users of our financial statements in the analysis of our reported earnings, we also report our earnings on an operating and core basis. Slide 5 summarizes these earnings measures. Both of these earnings measures are considered non-GAAP. Operating earnings excludes the net income loss impact of net gains and losses from sales of investment securities and marked-to-market gains and losses on credit, total return and non-trading derivative contracts that are not impaired. Core earnings further excludes the net income impact of accelerated earned premiums from refundings.

Operating losses per share in the fourth quarter of 2008 amounted to $6.79 per share. In calculating the operating loss we exclude the impact of unrealized gains and losses from our credit derivatives portfolio but do not exclude the impact of estimated credit impairment within that portfolio. However, in the fourth quarter Ambac did not record additional credit impairment on our credit derivative portfolio.

Credit derivative impairment was favorably impacted by the commutation of four poorly performing CDOs in November offset by increasing [inaudible] loss assumptions in RMBS securities that comprise those CDO transactions. Core losses, which is operating losses less the net income per share impact refundings, amounted to $6.97 per share.

Now turning to Slide 6, we summarize Financial Guarantee revenues. While business writings were down substantially in 2008, total Financial Guarantee core revenues, which includes normal earned premiums, fees on credit derivative contracts, investment income and other income remains fairly steady, with the full year 2008 having only declined about 5% compared to the full year 2007. This is impressive considering that we wrote little business in 2008 and clearly demonstrates one of the advantages of our business model.

Our deferred earnings, which represent future earnings on premiums already collected and the future value of installment premiums amount to $5.1 billion at year end. That balance is made up of $2 billion of premiums already collected and invested in our investment portfolio and $3.1 billion of premium we estimate will be paid to us in installment premiums over the lives of the transactions.

Turning to Slide 7, I would like to discuss our loss provisioning on our direct RMBS insurance portfolio. During the quarter we paid $288 million in RMBS claims. Total RMBS losses for the quarter were $769 million, primarily related to deterioration in our second lien RMBS portfolio. However, we also saw deterioration in our Alt-A and subprime first lien portfolios and reserved accordingly.

Our second lien portfolio continues to be the subject of very detailed reviews by our remediation team and outside consultants, and we've continued the process of reviewing poor performing transactions for breaches of representation and warranties. Our efforts to date have uncovered significant breaches and in the fourth quarter Ambac recorded additional expected recoveries of approximately $348 million. Cathy will provide more information on those efforts.

In addition, during the quarter Ambac increased non-RMBS reserved by $149 million, primarily related to other classes of asset-backed securities. On this side we have summarized active credit reserves or ACR, CASE reserves and impairments that we've reported over the last four quarters. Note that the $1 billion reduction of credit derivative impairment primarily relates to our fourth quarter commutations.

Now I'd like to discuss the company's liquidity both at our operating and holding company levels. Let me start with AAC liquidity and on Slide 8 a snapshot of our Financial Guarantee investment portfolio.

Ambac Assurance's claims and resources at December 31 amount to $13.5 billion. Those resources are supported by our fixed income investment portfolio. The portfolio had a market value of $7.7 billion at year end and an amortized cost of $9.4 billion and, as you will notice, the balance mortgage and asset-backed securities has increased significantly from an amortized cost of $863 million at September 30 to $3.1 billion at December 31.

The increase is due to asset purchases of mortgage-backed securities from the investment agreement business in support of that business's liquidity needs and as approved by our Wisconsin regulators and disclosed in our press release on November 6. Those securities are primarily Alt-A RMBS that were originally rated AAA but have been downgraded, some to below investment grade. Ambac Assurance purchased the investment grade rated securities that we considered unimpaired at values greater than the distressed market values determined at the time of the sales. For below investment grade rated securities, AAC purchased those securities at the current distressed market value.

The remainder of the investment portfolio is made up primarily of high-quality municipal bonds, U.S. government obligations, and U.S. agency obligations. We expect to receive principal and interest related to this high-quality portfolio amounting to $555 million in the next 12 months. In addition, we expect to receive approximately $400 million of installment premiums during 2009. Also note Ambac expects to receive $280 million in tax refunds related to taxes paid in 2007 and 2006 during the second quarter of 2009.

On Slide 9 let me briefly discuss the components of liquidity at the holding company. Total holding company cash and intercompany receivables amounts to approximately $233 million at December 31. That amount represents approximately two times the holding company's annual debt service needs or approximately 1.8 times total cash needs.

On Slide 10 we have laid out the statutory capital position as of the end of the quarter. Based on AAC's financial results year to date, Ambac Assurance will not be able to declare and pay dividends to the holding company in 2009 without first receiving approval from the Office of the Commissioner of Insurance of the State of Wisconsin or OCI. AAC has received approval from OCI to pay preferred stock dividends through the end of February 2009, and we are currently seeking approval to pay further dividends on that preferred stock.

AAC's statutory surplus amounted to $1.6 billion at December 31, 2008. An additional $100 million of preferred stock will be reflected in the first quarter of 2009 financials as a transaction settled in early January. In addition, AAC's contingency reserve amounts to $1.9 billion at the end of the year. A portion of risk relates to expired public finance policies.

In the first quarter of 2009 Moody's has been systemically downgrading Alt-A mortgage-backed securities. Those downgrades will likely result in impairment charges to reflect in AAC's first quarter statutory results.

I would like to conclude my statements with a few brief comments on the investment agreement business and this is on Slide 11.

First, with the support of Ambac Assurance in the form of asset purchases at statutory value from Financial Services investment portfolio and intercompany unsecured loans, the investment agreement business liquidity concerns that we discussed in previous quarter have been alleviated. The investment agreement business has met all of its collateral and termination requirements.

Second, the investment agreement portfolio continues to decline, having come down another $2.5 billion during the quarter, and now the balance of that portfolio is approximately $2.6 billion, down from $7.7 billion a year ago. We have negotiated terminations in that portfolio resulting in significant realized gains during the fourth quarter.

That concludes my prepared remarks on the financial results. Cathy Matanle will now talk through some detailed elements of the portfolio. Cathy?

Cathy Matanle

Thanks, Sean.

Let's move on to the portfolio, starting on Page 13. Page 13 shows the high level breakdown in ratings of our $434 billion insured book. What started in the early part of 2008 as a U.S. residential mortgage crisis has deteriorated into a global economic crisis. This has caused us to heighten our surveillance efforts throughout 2008, to aggressively identify vulnerable credits and asset types across the insured portfolio. The reserve and impairment activity to date is still substantially driven by our mortgage-related assets, and these continue to be our major concern from a materiality perspective.

However, as you know, the Financial Guarantee business model is well developed around active remediation and exerting our control party rights, and as a result we aggressively work transactions in all areas to achieve the best possible outcomes. We do not divert surveillance staff to the more troubled classes, preferring instead to both increase staff with the requisite expertise and apply proper analytics so as to maintain appropriate oversight across the entire book.

Because the vast majority of ratings deterioration has been in the structured finance sector, I will focus all of my prepared remarks on this part of our portfolio, starting with MBS on Page 15.

The direct MBS portfolio comprises 350 unique exposures totaling $40 billion of net par at year end 2008. In this presentation and the appendix we have updated many of the charts and graphs we've discussed in past quarters. I will focus my remarks this morning on our own views and tactics in light of this continued and well-reported performance deterioration.

Almost one-third of this portfolio is now rated below investment grade by Ambac and approximately half of the portfolio is now adversely classified due to poor performance against expectations. Our U.S. residential mortgage pools are assessed monthly for performance-driven ratings and classification changes and for higher touch surveillance. We paid claims on our second lien book throughout 2008 and we expect to continue to pay MBS claims on second lien product and first lien product over the next two to three years. Remediation and loss mitigation efforts are ongoing.

On Page 16 we show a high level breakout of our direct MBS book by type and rating. The 36% of below investment grade rated deals are 58% second lien and 42% first lien, predominantly Alt-A in the latter case. Sean has already reported the reserving impact of this deterioration.

Turning to Page 17 and second liens, for second lien product, HELOCs and closed-end seconds, the worsening economy is now impacting earlier vintage deals, although to a far lesser extent than 2006 and 2007 vintages. We continue to use a roll rate methodology to model performance and size reserves. Roll rates, especially the important initial roll from current to 30 to 60 days delinquent remain elevated, with no clear signs of abating. Clearly, economically stressed homeowners' options to avoid default are severely constrained as a result of the largely shut down nonconforming home loan market, combined with continued home price depreciation now destroying equity on even earlier vintage home loans.

Similarly, severities on seconds are also very stressed. They are now frequently in excess of 100% given the high cost to carry loans in a disrupted marketplace. Second lien product will not benefit from modifications except in the future and then very indirectly to the extent that such programs stabilize the housing market and LTVs improve.

I would now like to turn the first lien product of our direct MBS book. I'm on Page 18, but there are accompanying charts in the appendix as well. We are exposed to first lien product that is predominantly Alt-A and to a lesser extent subprime and prime. Our subprime is earlier vintage, with very low pool factors. These deals are generally performing within our expectations, including our paying of modest claims in these deal's tails.

Our Alt-A includes a wide range of nonconforming MBS pools ranging from mid-prime to the affordability mortgage product. We'll discuss the latter in a moment.

The Alt-A product received significant attention in the quarter due to a widely reported underperformance across the board and associated rating agency actions in the sector. Voluntary prepaids remain at historical lows as a result of highly problematic refinancing options arising from the interrelated issues around the nonconforming market disruption, borrower eligibility, and house price declines, especially in the hardest hit areas.

Liquidation rates and loss severities are both increasing, attesting to both the poor refinancing market just discussed as well as the minimal impact of loan modification in the nonconforming sector to date. We believe loan mods will benefit this space, although the timing and magnitude remain unclear. Even in this early stage, however, a key part of our servicer oversight in this area is to work with servicers toward ultimately maximizing the potential benefit of appropriate loan modifications designed to keep eligible borrowers in their homes. It is likely we will start paying claims monthly on our Alt-A portfolio by the middle to latter part of this year.

On Page 19, as I mentioned, I want to discuss the affordability product briefly. Affordability product comprises the home loans with low initial monthly costs that rise over time, either as interest only periods phase out or principal is allowed to accrete in the early periods. The protracted mortgage market disruption raises the probability these transactions will show default and severity spikes when resets occur in the coming months.

Option ARMs comprise $5.5 began of our $5.9 billion affordability product MBS portfolio. Approximately 25% of the option ARM deals are now rated below investment grade and half are adversely classified. All were originally AAA rated.

I will finish up MBS with a summary of our progress and continued attention to loss mitigation via remediation and risk management surveillance. Page 20 highlights remediation recoveries as of December 2008. Remediation recoveries embedded in our reserves increased by $343 million in the quarter to now total $855 million.

Our remediation has been oriented towards second lien product because of the early and very dramatic underperformance of transactions with counterparties of substance. Our approach is to focus our remediation on the re-underwriting of underlying home loans to identify loans that were not compliant with the representations made to us. We will apply such an approach to first lien product where appropriate, although breaches are less apparent and deals are more often orphaned.

Where our efforts to put back loans or otherwise work with transaction sponsors proves to be ineffective, we have no alternative but to enforce our rights and remedies through legal action. We have commenced litigation with one counterparty on four transactions and have approximately 40 formal buyback requests outstanding. We are re-underwriting additional loans in all of these cases as well as other transactions, which are in earlier stages.

Our progress is a function of getting sufficient access to information from parties. This is a frequently protracted process that in itself can lead to violations of our rights to receive information. You will recall we assume our recoveries will not occur for several years from the inception of our buyback requests.

Turning to Page 21, servicing is a vitally important mitigant in MBS pools. We use our control rights and experience working with servicers to work towards best possible overall servicing for the various asset types. Our work in this area has resulted in the approval of four servicing transfers, with one additional transfer pending. We are asserting our rights against at least one servicer for not performing under the terms of their servicing agreement. I already mentioned the potential and important benefit of servicer modifications for first lien product and our role assuring such modifications are appropriate and well executed.

We continue to closely monitor the actions of the government, the agencies and the various banks that have participated in TARP. The debate around loan modifications, foreclosure prevention and cramdowns is likely to continue well into 2009. Given the evolving and uncertain regulatory environment and the operational challenges of implementing these programs, we cannot predict the impact of all the measures on our portfolio, but we remain focused on assuring our transactions benefit to the extent possible.

Turning now to ABS CDOs on Page 23, the CDO of ABS portfolio now stands at $23 billion. The CDO squared portfolio has effectively been reduced to zero via commutation; 85% of the net par in this sector is now rated below investment grade. All transactions are monitored monthly, remodeled quarterly, and reviewed for rating and classification changes also quarterly. Our overall claims paying profile is very long dated in the remaining CDOs of ABS. Nevertheless, we remain focused on reducing tail risk through commutations and other measures.

On Page 24, while our net impairment was flat for the fourth quarter there were differences among underlying deals' modeled performance and therefore their individual impairments depending upon collateral composition and performance. We again increased the cumulative losses and severities we assigned to various underlying RMBS collateral types and vintages. In addition, losses from CDO collateral varied among the deals that had been our CDO collateral depending upon the extent losses were already reflected in earlier periods versus the current period. On that note, we expect liquidation of inner CDOs, already frequent, to continue on throughout 2009.

The liabilities our CDS cover are generally floating rate. As a result, modeled performance benefits as interest rates are reduced, and both our modeled claims for interest shortfalls and the need to divert principal to pay interest benefit us in the latter case by reducing our ultimate insured principal shortfall. We expect to pay some claims in this portfolio in 2009 largely to cover interest shortfalls on our most stressed deals.

Turning to loss mitigation on Page 25, as with all underperforming credits in the portfolio, we've taken an aggressive approach to loss mitigation with CDOs of ABS. We've commuted five transactions totaling $5 billion of par, 3 CDS squareds and 2 high grade deals. We are fully exercising our control rights as they relate to the structure, the manager and the collateral in all of the remaining deals. We're accelerated five transactions to divert cash flows from junior classes to pay down our tranche and we are also focused on less-direct ways to cut off cash flow leakage to the junior tranches.

A final point on CDOs of ABS on Page 26. Many of you have been asking about future commutations. We are in serious and ongoing discussions with targeted counterparties with significant exposure to Ambac. We continue to believe that this is the most cost effective way to reduce risk in the near term; however, since payouts are significant, we will not agree a commutation price unless it achieves targeted objectives regarding the deal's economic and capital implications and the commutation itself delivers meaningful protection from the deal's projected trajectory of losses in our stressed cases.

Another variable in commutations in the various government programs globally which affect timing and success of commutation discussions. Programs potentially impact the deals, the collateral, Ambac and our counterparty, therefore we and our counterparties will delay resolution when such programs, often in early stages, disrupt the otherwise existent [inaudible] landscape.

David started the call by commenting on the general economic environment. On the next two pages I will highlight other areas in the structured finance portfolio that we are closely monitoring.

On Page 27, in the quarter we significantly increased reserves on a structured insurance transaction that has been on our classified list for a couple of years. This is a transaction where the investment assets supporting a closed block insurance portfolio were invested in mortgage-backed securities that have become increasingly impaired. We are working with all parties associated with this transaction to mitigate loss on this transaction.

In the student loan market, this market was negatively impacted by the disruption in the short-term funding markets known as the VRDN markets. The interest rates on the VRDN funded liabilities that we wrap increased significantly when markets closed and VRDNs were put back to investment dealers at onerous backstop rates. In some instances the backstop rates exceed the rate earned on the underlying pool's assets. The underlying assets are generally performing within expectations.

We are closely tracking government efforts designed to stabilize the student loan market, especially the Department of Education conduit that is being made available for federally guaranteed or FELF loans as a loss mitigant for applicable parts of this asset class. For assets that do not qualify for this program we are exploring other restructuring alternatives, including direct pay letters of credit and working to restructure transactions when market conditions improve. There is additional detail on our student loan and auto related exposure in the appendix.

Finally, turning to Page 28, the CLO asset class is encountering increased stress, but at this time all of our transactions remain investment grade. Deal exposures here are smaller than in our CDO of ABS portfolio and unlike the CDO of ABS transactions, CDOs of underlying corporate collateral such as CLOs are structured with some experience gained in earlier stress periods.

Nevertheless, we are actively monitoring performance of deal triggers, defaults of underlying obligors, manager and trustee compliance with waterfalls and reinvestment, and rating agency action on both the underlying collateral as well as the junior tranches in our own deals. We tend to take Ambac rating action out ahead of the rating agencies in this asset class. And once again, we've included additional information about CLOs in the appendix.

And with that I will turn it over to Doug.

Douglas C. Renfield-Miller

Thank you, Cathy.

I'd like to provide a quick update on our recent Everspan efforts but first, for those who are new to the story, let me provide a brief background and our key objectives for this new Financial Guarantee subsidiary.

Everspan Financial Guarantee is the new name for Ambac's wholly owned but dormant subsidiary formerly known as Connie Lee Insurance Company. Ambac acquired Connie Lee in 1997. It is licensed to write Financial Guarantee insurance in 47 states and we are working on the remaining U.S. jurisdictions.

Connie Lee did not write any new business after Ambac acquired it in 1997 and thus the company's book of business has steadily amortized down to approximately $640 million today. The company currently has about $150 million of capital.

Our key objectives in bringing Everspan to market are forthright, as follows: We hope to redefine the Financial Guarantee business with a back to basics purely municipal public purpose business platform. Everspan will offer unprecedented transparency via its website, allowing investors and others the ability to evaluate Everspan for themselves in real time. Everspan will operate to a no surprises, what you see is what you get standard. Everspan policyholders will be insulated from Ambac Assurance. Everspan will have segregated capital, an independent Board, independent risk management, and will be separately regulated by the Wisconsin Commissioner of Insurance.

Everspan will also have strong governance. A majority of Everspan's directors will be independent and unaffiliated with Ambac Assurance and significant changes to Everspan's narrow business scope, payment of dividends, etc., will have to be approved by a majority of Everspan's independent and unaffiliated directors. Note that Everspan's bylaws prohibit it from paying dividends to its parent for the first three years of its operations.

There are no current plans for Everspan to assume any of Ambac's legacy public finance or other exposures. We believe that Everspan's capacity is best utilized for new business and that the market will value a clean entity. With regard to existing Ambac Assurance policyholders, it is important to note that Everspan will remain a subsidiary of Ambac Assurance. Value creation in Everspan will indirectly accrue to the benefit of all Ambac's current policyholders.

Now to bring you up to date. We have completed our formal submission to Moody's and S&P and expect to hear back from them in the next few weeks. Everspan's Board has been identified and should hold its first meeting in the coming weeks to adopt Everspan's new bylaws, approve service agreements with Ambac, formally adopt our risk-centric policies and procedures, and take other corporation action.

Aside from ratings, we only need to finalize Ambac's additional capital contribution to Everspan. We expect to launch Everspan with at least $500 million of capital subject to Wisconsin regulatory approval. If all goes as expected, Everspan should be in the market during the second quarter.

Let me close by commenting on the Financial Guarantee sector, which took its fair share of blows in 2008. This led some to question the value of the product that we provide; however, it is clear that there is both a demand and need for Financial Guarantees in the public finance sector. We are confident that there will be good demand for Everspan's back to basics approach and for the cost-effective credit enhancement Everspan will provide.

Current low insured penetration rates reflect lack of supply, not a lack of demand for credit enhancement. The municipal market is unique in its structure, its investor base, its financial reporting and perceptions of its creditworthiness. The roll that financial guarantors play in this market is much broader than the insurance we offer. I'm confident that with Everspan we can provide renewed value to our core municipal issuers and their investors.

With that, I'll turn it back over to Sean.

Sean Leonard

Thanks, Doug. Now we would like to open the call up for questions. Operator?

Question-and-Answer Session


Thank you. (Operator Instructions) Your first question comes from Andrew Wessel - J.P. Morgan.

Andrew Wessel - J.P. Morgan

I just had a couple of questions about the intercompany transfers of assets. But first, so the hold co has $2.3 billion in lines about, available from Ambac Assurance. How much of that has been drawn as of 12/31 and to date?

Sean Leonard

Andrew, we have a good slide in the deck, Slide 38. But what Slide 38 shows is the various approvals we have for the different companies and different products, Financial Services products. But it shows the approved limit and it shows the amount used.

So as it related to the investment agreement book, it's pretty clear there. We purchased in about $2.6 billion of securities. Those securities had a par value of $3.1 billion. They had a book value of $2.6 billion. The difference between par and book was impairments that were already taken in the business in prior quarters, and the market value of those securities were about $1.2 billion.

Andrew Wessel - J.P. Morgan

So the market value was $1.2 billion?

Sean Leonard

Yes. And they're primarily Alt-A RMBS securities.

Andrew Wessel - J.P. Morgan

So from a cash transfer basis, it's market value of $1.2 billion and you borrowed $2.6 billion against that?

Sean Leonard

Well, the insurance company paid $2.5 billion and it got assets which we believe have a statutory value of that but have a lower market value due to the stress pricing on that portfolio.

Andrew Wessel - J.P. Morgan

And then there's the $1 billion of unsecured lending up and I guess my question is, if you go back to Slide 9, it mentions the $233 million of cash and intercompany loans. It seems like total on the hook to the op co is going to be, I mean, you're looking at like almost $3 billion, right, or over $3 billion that you would owe back to the op co over time?

Sean Leonard

Well, the Ambac Assurance - the op co in your language - received the securities. So it purchased the securities for the first line, so it has those securities. The deal is that those will sit in the back end of the portfolio from a liquidity perspective; we won't have to sell those. So the current market price is kind of a very distressed price, so we think that the value's going to  there's going to be more cash flow coming back than the market value. So the securities are already in the business, so there's nothing else to be done there.

The unsecured lending, the $1 billion, was cash provided as well as the cash that arrived into the IA business due to the intercompany purchases, asset purchases. That was used to pay off the investment agreement liabilities and to collateralize some liabilities that are already there. So there is value, we believe, in that business in the same way in that the market value of the securities that remain in the IA business versus the amortized costs or par value, there's a wide difference there, and we think there's ultimately value between those two numbers due to the extremely low market value.

Andrew Wessel - J.P. Morgan

So for the Alt-A - so just, I mean, I guess I'll break it up into two parts - the Alt-A securities were sold. It's not like that's out on a repo agreement or anything like that. It's just there was a sale for $2.5 billion and that's it. There's no follow up transaction or obligation?

Sean Leonard

That's correct.

Andrew Wessel - J.P. Morgan

And so that was $2.5 billion of cash on $1.2 billion of market securities, market value. And then the loans that you had, I guess, going back to Slide 38, $1 billion of unsecured lending and $760 million of lending on the swap book and another $150 million of, I guess, a security purchase. So, I mean, you can call it $1.7 - $1.8 billion, something like that, of just loans that are unsecured - I understand that - but when you look at the parent company liquidity or holding company liquidity, we're looking at $233 million cash balance and intercompany loans. I mean, you're on the hook to pay back on an unsecured basis almost $2 billion, or am I looking at that incorrectly?

Sean Leonard

No, I think you're looking at it incorrectly. There's a couple of points I'll make there. The swap book, when you look at the amount used for the swap book, that's to help that business post collateral. In that portfolio we have contracts with municipalities and then we've hedged those. There's interest rate risks with folks on Wall Street. The loan here is for collateral posting. The business itself has net GAAP book value on a marked-to-market - and when you mark all the swaps it has value. So that's viewed to be a temporary lending, collateral lending, and that will come back as we continue to aggressively remediate and bring down those exposures.

The TRS business is cash for securities, so it's similar to the first line on this chart. Ambac Assurance has the obligation for the investment agreement liabilities. It's issued a policy, so the operating company has that obligation already. This is performance of the obligation providing, you know, to push the liabilities out, give us a chance to negotiate terminations, which we've done, and to keep the claim payments away from Ambac Assurance and then let the asset values recover. And since you're not forced to liquidate those securities at incredibly low prices, you're allowing those securities to cash flow. So it's not an obligation of the parent company, in your language.

On Page 9 that's just the parent company, you know, that cash is obviously available to pay its interest and any expenses that it has, so I wouldn't combine the two.

Andrew Wessel - J.P. Morgan

And so then the last question on this topic, the unsecured loan, the $1 billion unsecured loan, that is just counted as collateral somewhere in the parent company and it isn't part of that $233 million of cash [inaudible].

Sean Leonard

Yes, these loans obviously were not made to the parent company, you realize that. These were made to the businesses, the investment agreement business and the various different businesses reside in separate legal entities.

Andrew Wessel - J.P. Morgan

And then other question is on mortgage remediation. So if there haven't been any cash returned yet and it sounds like a very onerous process to go through - obviously if you've bought assets underwritten fraudulently, it makes sense to try to get some remediation - but the way you're recording future revenue or expected future revenue from those remediations on those bonds, first I guess there's a cost benefit and I wonder if you could address that just from a kind of strategic perspective? And then also how does that revenue that you're recording or the expected gain or recovery, how does that flow through statutory income?

Sean Leonard

Sure, I can take that. I mean, clearly the cost benefit's there because the numbers are huge, the performance is abysmal, the underwriting is atrocious. So there's clearly a lot of benefit compared to the cost of utilizing vendors and law firms to go through individual loan files. I don't think there's any question about that.

So that's clearly why we're pursuing folks with deep pockets. We're not pursuing all sponsors in this case because some of them don't have deep pockets, so we're weighing that from a cost-benefit perspective. But for those major financial institutions that we're pursuing, we believe obviously the benefit far, far outweighs the cost.

From the standpoint of your comments on revenue, we're not booking revenue. What we're doing is from a loss reserve perspective we're trying to estimate what the present value of our future claim payments are. Claim payments are actually made to an RMBS trust and obviously out to the bondholders, and clearly we haven't missed any of those claim payments so that's obviously what's going on here. So we're trying to assess what types of remedies the trust has to recover based upon the legal agreements that were struck at the beginning of the transaction. So I would look at it as we're calculating a net liability that represents the present value over time of the money that will leave Ambac. So it's not revenue; it's a reduction of a liability.

Andrew Wessel - J.P. Morgan

So from a statutory income basis, it's not reversing out future loss reserve or loss provision expense?

Sean Leonard

Well, it's a net number. For statutory we record loss reserves for defaulted items, so we call them CASE reserves. What we do is we look at an individual transaction and project out its performance, including any potential remedies - recoveries, if you will; no different than recovering on a sale of a piece of collateral that exists underneath the loan - we look at that as kind of a recovery, and we set up the net liability present valued at 4.5%.

Andrew Wessel - J.P. Morgan

I was just trying to get to the fact of whether or not that was going to be included in total statutory.

Sean Leonard



Your next question comes from Arun Kumar - J.P. Morgan.

Arun Kumar - J.P. Morgan

A couple of questions for you, one regarding Everspan and one as a follow up to Andrew's question earlier on the intercompany. Starting with Everspan, you said, Doug, you mentioned that you wanted to capitalize the company at $500 million. Could you tell us how much capital you actually have there now? I believe it was $150 million or so last year.

And what is the status of your discussions with the Wisconsin regulator in terms of approving the capital transfer? In your slide presentation you stated that you've already presented your plan to the rating agency and you expect to hear back in a couple of weeks. Presumably you've already gotten the approval from the regulator, but could you spend 30 seconds on that?

Douglas C. Renfield-Miller

Certainly. You're correct, we currently have, I think it's $153 million of capital within Everspan. And then if you recall back last year we had gotten approval from Wisconsin to put an additional $850 million down; that was prior to our downgrade. So we've had very good ongoing discussions in terms of what is the correct number to put down. But we're quite confident that, again, subject to Wisconsin approval, we'll have at least $500 million in total capitalization, so an additional $350 million down and possible more.

Just one point to stress, though. The capital that goes down does not actually leave Ambac per se. All it does is convert was is essentially an investment in the investment portfolio in, say, municipal bonds at the moment into an equity investment with Everspan, of which there should be very good value going forward. So it's not capital lost forever; however, it's clearly segregated from a legal perspective once it is down there.

Arun Kumar - J.P. Morgan

The other think you mentioned in your slides is the existing municipal business is going to stay with the Ambac Assurance and only new business is going to be written out of Everspan. Now, have you considered any kind of a cut-through reinsurance like some of your peers have now publicly announced or are you going to end up with two classes of wrapped municipal bonds, one at Ambac Assurance and one at Everspan with totally different credit qualities?

Douglas C. Renfield-Miller

We'd obviously love to make everybody happy, but the fact is that Everspan will have a limited capital base and we think the capital base is best utilized supporting new municipal finance out in the market. Also, as noted, the value creation within Everspan does accrue to the benefit of Ambac Assurance before flowing back to shareholders. And Wisconsin's taken a very strong view, which is perfectly understandable, that they owe a duty to all policyholders; they cannot discriminate among policyholders. And so that is effectively what this structure achieves.

So if we could make everybody happy by providing cut-through, obviously we would. But given the capital base of Everspan, we think it's best utilized to help jump start the municipal finance business and just get out with the market.

Arun Kumar - J.P. Morgan

The follow up question I had was a numbers question related to AAC and the support to the Financial Services business, which is on, I think, Slide 38, and I think Andrew Wessel asked a couple of questions on that. The question I have is that unsecured lending from AAC, the $1 billion, now based on the discussion you had a couple of minutes ago is it right to assume that that unsecured loan from AAC, that's the admitted asset on the statutory balance sheet of AAC?

Sean Leonard

That's a partially admitted asset on the balance sheet of AAC, so the numbers that we had provided, the $1.6 billion of statutory capital, it has approximately $700 million of that billion as an admitted asset, so a reserve of $300 million against it.

Arun Kumar - J.P. Morgan

And the second follow up question on the same topic is why would you give an unsecured loan from AAC when you had a secured facility of $1.2 billion? Wouldn't it be safer to give a secured facility? Could you comment on that?

Sean Leonard

Yes, we needed to, I mean, the whole idea here was to meet some collateral posting and termination requirements. It is possible with - the other reason is due to the market value of the securities, so you would have to - the market value doesn't exist in the business to support a secured loan in the sense that the business needed more money to meet its financial obligations on a market value basis. So that's why we did it that way.

There is a possibility with further downgrades of securities, so the business still has asset-backed securities, it's got a mix of asset-backed. A lot of the Alt-A RMBS have been purchased out based on what we've been talking about. But there is additional downgrades that have come in that portfolio so we might have to switch the unsecured and secured a little bit. But the major reason is that the market value did not support a secured lending facility.

Arun Kumar - J.P. Morgan

And what's the terms of that unsecured - is it a five-year loan or is it more than that or is it a twoyear loan?

Sean Leonard

Well, it'll be outstanding as long as the business - any excess cash flows that come off the business will be used to ultimately repay that loan. So you can see kind of what the profile of our liabilities looks like. I'm looking for the chart to refer it to you; 33 kind of provides a good example of it. So that's kind of a view of the liability runoff. The assets themselves, you know, are probably pretty similar to that type of timeframe so an average life of five years. But if the market value recovers on the RMBS and the ADS securities, obviously then, if those assets are sold, we can pay off that loan.


Your next question comes from Darin Arita - Deutsche Bank Securities.

Darin Arita - Deutsche Bank Securities

I had a question on the qualified statutory capital and was wondering how far can that decline before you start bumping up against single risk limits?

Sean Leonard

Well, we've already run into single risk limits, Darin, at these levels, so we're in the process of remediating those through some plans that we have to discuss with the New York Insurance Department. So the single risk limits, which are basically, you know, it's just a limit, it's not a surplus or a solvency type limit; it's kind of a discuss with your regulator your plans for remediating that. Part of that is clearly some of the things we've been talking about here today about remediation. We also have available to us the use of potential intercompany transactions. So we'll be talking that through.

We do not trigger any other types of tests like what's called an aggregate risk type calculation, which is a statutory calculation, or any other calculations, so it's just the single risk is something we need to address with New York.

Darin Arita - Deutsche Bank Securities

And can you talk about how the transfer of contingency reserves to surplus works and to what extent that can continue?

Sean Leonard

Sure. What's left is about $1.9 billion. We released during the quarter about $1.5 billion. What the contingency reserve is it's a formulaic kind of establishment of reserves. The idea is that you can release that when the policies in which you're actually setting it up for have been canceled or refunded, whatever the case may be, but you're no longer on those exposures in which you're setting us this formulaic reserve, or you have large losses in pieces of your portfolio and there's some tests relating to loss ratios and the like.

We've clearly exceeded the test as it relates to our structured finance business based on the losses we've taken in the portfolio, so the view was that we were able to release it based upon those rules with discussion with Wisconsin.

And the overall notion is that it's redundant reserves because you're setting up CASE reserves and credit derivative impairments and you still have a contingency reserve, so you're double counting the reserve on the exposure. So that's kind of the idea. And when policies are you're no longer on the risk, it's considered to be redundant as well. In both cases, though, you need to get permission from your domiciliary regulator, which in our case is Wisconsin.

Darin Arita - Deutsche Bank Securities

And then just a question on your Alt-A exposures. I was wondering how the credit quality compares on the Alt-A securities that Ambac insured versus those that it purchased from the investment agreement business?

Sean Leonard

The general comments there and I'll turn it over to my colleagues. The investment agreement business, all of the exposures, all the investments that were originally AAA rated investments. They're kind of split between the various tranches of AAA being that there's first pay, second pay, third pay, so they were split among those, but they were all originally AAA rated securities.

So I think our overall impairment views in that portfolio - which is probably less than $100 million on a fundamental basis, not a marked-to-market basis - so I think that probably compares favorably that the standpoint of the original credit enhancement in the investment securities was all at the AAA level.

David Wallis

I think the most important feature here is vintage. And obviously the various charts are on our website, but one of the more pleasing aspects of our Alt-A portfolio on the insured side is that of the roughly $5.7 billion in relation to mid prime, as I think we call it on that website, we have, I think it's about $2.7 billion in 2007, but then quite a chunk in 2005 and prior to that, which generally speaking, as we all know, is less stressed.


Your next question comes from Bryan Monteleone - Barclays Capital.

Bryan Monteleone - Barclays Capital

I had a question on Slide 10, where it talks about statutory loss of $1.46 billion. Based on the $225 million of premiums and the $916 million of impairments, then apply the $500 or $600 million statutory loss, and it sounds like you add another $300 million out of reserve against the unsecured investment agreement loan gets you up to $800 or $900 million. I was just trying to understand the delta between that and the $1.46 on Slide 10. Is that related to a change in the discount accretion rate on reserves or is there something else there?

Sean Leonard

No, there's a couple of things going on there. One is the numbers that we report in our press release are U.S. GAAP. That differs from statutory in premium recognition, if you will. The statutory premium recognition is different, so there's some differences there. Statutory accounting only requires the booking of reserves for defaulted items, so it would just be the CASE reserve changes so there's no changes in discount rates or anything like that. So statutory income statement would pick up changes in CASE reserve amounts, and we disclose those in our operating supplement on Page 19.

The other difference, the other big difference is deferred taxes, how deferred taxes are treated from a statutory and a GAAP basis.

Bryan Monteleone - Barclays Capital

Right, but there were no deferred tax assets on the statutory balance sheet at September 30th, right? There was nothing to write-off?

Sean Leonard

Well, it's very large non-admitted amounts. The non-admitted deferred tax asset in the statutory counts at the end of the year. I don't have September in front of me, but at the end of the year it was about $2 billion.

Bryan Monteleone - Barclays Capital

Right, but that was non-admitted, right?

Sean Leonard

Yes, so there's a non-admitted concept there. That's different than, obviously, what we're doing for GAAP.

The last item is we did book an additional impairment for an exposure that we viewed to be imminent, if you will, of default, imminent being in the next 12 months, so that was booked in the fourth quarter as well from a statutory perspective.

So when you add the mix of all those things, that's what creates the difference.

Bryan Monteleone - Barclays Capital

What was that last [inaudible] related to?

Sean Leonard

It's relating to a credit derivative transaction that's somewhat unique that we have on the books.


Your next question comes from [Paul Steinborn – Plainfield].

Paul SteinbornPlainfield

I realize you don’t have a lot of cash at the hold co, but given where your bonds are currently trading and [inaudible] language in the stimulus bill, any thoughts on buying back some of your debt?

Sean Leonard

Sure. We believe there's a lot of value creation opportunities available to us. One of them relates to the potential to purchase back our preferred stock that exists at the Ambac Assurance level. We're able to and we've successfully executed a number of transactions to buyback some of our RMBS - Ambac wrapped RMBS securities that we're paying claims on, so we've been successful in purchasing securities at a very heavy discount. We think there's a lot of value there. There's value in preferred stock. And I think down the road I think there is value in potentially buying back our debt securities as well.

So I would say all those are value creation opportunities, coupled with commutations and other things that all compete for the liquidity we have around the company, but within the Ambac Assurance and the parent company level.

David Wallis

I'd just add to that that Sean's right to highlight the fact that there are different and competing uses of cash and cash is an important and vital resource for us, so we have to weigh all these things up in taking those sorts of decisions.


Your next question comes from Eleanor Chan - Aurelius Capital.

Eleanor Chan - Aurelius Capital

My question also relates to the holding company liquidity. It was mentioned that the [AFG] cash and intercompany loans at 12/31 was $233 million. I noticed that this was a change to like how you guys previously disclosed it. You previously only disclosed the cash amount not including the intercompany loan. So I'm just wondering if you can provide us a breakdown of how much of that $233 million is cash and how much of that is intercompany and also which entity is it a receivable from?

Sean Leonard

Sure. The breakdown of the cash balance, of the $233 million, the cash balance is $111 million; loans that were made to mainly the interest rate swap business were $122 million. That's the breakdown of those balances.


Ladies and gentlemen, there are no further questions at this time. I will turn the conference back over to management for closing comments.

Sean Leonard

Sure. Thank you very much. We appreciate the questions we received today. We will be available clearly to discuss any additional questions that folks may have, so please give us a call. And thanks again for attending our conference call.


Ladies and gentlemen, this concludes today's conference. All parties may disconnect now.

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