Ambac Financial Group, Inc. (NYSE:AMBC) Q4 2020 Earnings Conference Call March 2, 2021 8:30 AM ET
Company Participants
Lisa Kampf – Head-Investor Relations
Claude LeBlanc – President and Chief Executive Officer
David Trick – Executive Vice President, Chief Financial Officer and Treasurer
Conference Call Participants
Mark Palmer – BTIG
Derek Pilecki – Gator Capital
Giuliano Bologna – Compass Point
Matt Weber – Sage Venture Partners
Operator
Greetings and welcome to the Ambac Financial Group, Inc. Fourth Quarter 2020 Earnings Call. At this time all participant lines on 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, Miss 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.
Lisa Kampf
Thank you. Good morning. And thank you all for joining today's conference call to discuss Ambac Financial Group's fourth quarter 2020 financial results and its platform diversification strategy.
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 guarantee 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 annual report under management's discussion and analysis of financial condition and results of operations 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 website at ambac.com.
Please note that presentations have been posted to the Events and Presentations section of our IR website, which support our comments today.
I would now like to turn the call over to Mr. Claude LeBlanc.
Claude LeBlanc
Thank you, Lisa. And welcome to everyone joining today's call. 2020 was an unprecedented year marked by a global pandemic, volatile financial markets and political and social unrest, which created significant uncertainty and stress on Ambac’s operations, as well as our insured and investment portfolios. Notwithstanding these challenges, the dedication and commitment of our employees allowed us to navigate through this period and make material progress across all of our strategic priorities, which I will cover in a moment.
For the year ended December 31, 2020, Ambac reported a net loss of $437 million or $9.47 per diluted share, and an adjusted loss of $378 million, or $8.19 per diluted share. For the fourth quarter, Ambac reported a net loss of $14 million or $0.31 per diluted share and adjusted earnings of $4 million, or $0.08 per diluted share.
At December 31, 2020, our book value was $1.1 billion or $23.57 per share and adjusted book value was approximately $900 million or $20.05 per share.
David will discuss the results in more detail shortly.
During the year, we remained focused on executing our strategic priorities, namely: one, stabilizing the platform by improving our risk profile; two, loss recovery through the exercise of our contractual and legal rights; three, exploring ways to rationalize our capital and liability structure; four, improving the effectiveness and efficiency of Ambac’s operating platform; and five, advancing our new business and diversification strategies.
With regards to our de-risking activities, 2020 was very challenging, particularly during the first two quarters as a result of credit market dislocations. During the first half of the year our risk and surveillance teams performed comprehensive, in-depth reviews on credits most susceptible to COVID disruption and related economic recession. We closely monitor these exposures, moving some to the adversely classified category, and where appropriate established or increased reserves based on our risk assessments. Notwithstanding the challenging market conditions, we were able to execute a few key transactions during this period, including the refinancing of our last remaining Chicago geo exposure with net par of $171 million.
As credit markets stabilized, and de-risking opportunities began to open up in the second half of the year, we accelerated various initiatives to reduce exposures and mitigate risks, including developing credits we had identified as being mostly impacted as a result of the pandemic.
Key achievements included, one, the improvement of credit and liquidity protection for key COVID-stressed exposures, including two of our largest insured exposures. Two, the commutation of an international utility transaction, with net profit standing of $298 million. Three, the refinancing of an international stadium transaction with net par of $217 million. And four, the commutation, refinancing and cancellation of several municipal and structured credit exposures. For the year, these and other transactions combined with portfolio runoff decreased our insured portfolio by 11% from $38 billion to $34 billion as of December 31, 2020.
Adversely Classified and Watch List Credits decreased by net 8%, from $14 billion to $13 billion year-over-year, notwithstanding material offsets relating to the impact of credits added during the year due to our COVID assessments; and two, an increase of over $150 million to the impact of the pound and euro appreciating versus the dollar.
Post year end, we also closed a material quota share reinsurance transaction, not reflected on our 2020 results involving a portfolio of public finance credits, with net par outstanding of $823 million as of December 31, 2020. This transaction that closed in January, included general obligation, lease and tax back revenue, higher education and transportation credits, including $160 million of Watch List and Adversely Classified credits.
And I'm also pleased to report that to date Ambac has not paid any direct COVID-related claims.
Turning now to Puerto Rico, we remain optimistic about the island's economic recovery over the short and long term as the flow of vital federal recovery, stimulus and infrastructure funding improves under new local and federal government leadership. While Puerto Rico's economic picture continues to improve and tax collections repeatedly exceed the Oversight Board’s projections, we continue to believe the collective focus of key stakeholders should be on a near term global resolution to the bankruptcy process. The Oversight Board recently announced a Plan Support Agreement, or PSA will lead into Commonwealth obligations supported by 70% of general obligation and public buildings authority bond holders, including conditionally support from assured guarantee and MBIA.
Ambac disagrees with the PSA, as it still contains many of the flaws of the prior PSA, including being based on a fiscal plan with erroneous and misleading financial projections, and providing for the use of money belonging to the secured revenue bond holders. In order to reach a consensual, holistic and permanent solution, we believe material progress needs to be made with key revenue bond creditors, particularly the model lines, who are not likely to support a PSA that fails to respect their legal rights and financing structures.
We also believe there are creative and constructive solutions available that could resolve the revenue bonds and avoid further costly litigation and delays while creating new sources of funding and restoring access to the capital markets for Puerto Rico. We remain willing to engage with the Oversight Board and the Commonwealth on a restructuring plan that respects the property rights and security interests of revenue bondholders.
Turning now to our loss recovery efforts, in our main case against Bank of America Countrywide, we await a new trial date after the trial is scheduled for February was postponed due to COVID. In the meantime, we are appealing the dismissal of a fraud claim. The timing for the trial will depend on a number of factors, including: one, the appointment of a new judge for our case following the retirement of Justice Sherwood; two, the calendar of the new judge; and three, the impact of the pandemic on court proceedings, as well as the status of our fraud appeal. At this point, we believe the trial could take place in the next 12 months, but it could be later based on these other variables.
On a related note, we were pleased to see the trial court's decision in MBIA versus Credit Suisse late last year. We believe the decision strongly validates the strength of RMBS contract claims and the value of prejudgment interest.
Turning to our efforts to rationalize our capital and liability structure. During the year, we further delevered the balance sheet with additional early redemptions of the Secured Note by $121 million, which brings our total senior note redemptions to over $500 million. With regards to the investment portfolio, during 2012, we progressed our goal to broaden diversification and improve risk adjusted returns. And despite the first quarter market turmoil, created by the pandemic and other headwinds, we delivered a total return of approximately 4.1% for 2020, entirely driven by strong performance in the last nine months of the year. Such performance was aided by our ability to reallocate assets to take advantage of opportunities created by the first quarter turmoil.
With regards to our operating platform, operating expenses for 2020 decreased $10 million from the prior year, reflecting our focus on reducing core operating expenses and the implementation of sustainable reductions to long-term operating expenses related to our legacy business. We do however, expect some volatility in expenses and increasing expenses related to our new business operations.
In conclusion, I am very pleased with our accomplishments in 2020. We believe that our actions taken in prior years to stabilize our insurance platform, simplify our capital structure and manage our operating cost, favorably positioned us to successfully navigate these challenges. In 2021, we remain committed to all of our strategic priorities as we continue to build on our efforts to enhance long-term shareholder value.
I will now turn the call over to David Trick to discuss our financial results for the fourth quarter. After his remarks, I will return to discuss our new business strategy. David?
David Trick
Thank you, Claude. And good morning, everyone. During the fourth quarter of 2020 Ambac reported a net loss of $14 million or $0.31 per diluted share, this compares to a net loss of $108 million or $2.33 per diluted share in the third quarter. The improvement in the fourth quarter compared to the third quarter was driven by lower loss and loss expenses incurred and higher net investment income.
Adjusted earnings for the fourth quarter were $4 million or $0.08 per diluted share, compared to an adjusted loss of $93 million or $2.1 per diluted share in the third quarter. The variance between adjusted earnings and GAAP net income for the fourth quarter related mostly to the exclusion of $16 million of insurance intangible amortization.
Contributing to our results for the quarter were premiums earned of $18 million in the fourth quarter, compared to $15 million during the third quarter. The increase was driven by higher, accelerated premiums related to the active de-risking of an insured international utility transaction. Investment income of $53 million, which was up $16 million, compared to $37 million in the third quarter, was driven by solid investment portfolio performance stemming from strong, equity and credit markets and capital reallocated after the first quarter market impact of COVID. Investments in pooled funds performed the strongest with the fourth quarter total return of 5.8% compared to 3% in the third quarter. Total return across the consolidated portfolio is 1.8% in the fourth quarter versus 2.4% in the third quarter.
Included in fourth quarter investment income or gains on pooled funds and other equity investments of $31 million, and income from available-for-sale securities of $23 million, compared to $14 million and $24 million in the third quarter respectively. Loss and loss expenses incurred were $9 million in the fourth quarter, compared to $83 million in the third quarter. RMBS losses of $15 million were down from $27 million in the third quarter. Fourth quarter RMBS insured losses were due to incremental loss expenses related to representation and warranty litigation costs, partially offset by the favorable impact of higher discount rates and slightly better credit performance.
Third quarter RMBS insured losses of $27 million were due to higher expected losses resulting from the COVID-19 driven global recession and incremental loss expenses related to representation and warranty litigation costs, although finance produced an incurred benefit of $7 million in the fourth quarter, compared to a $43 million loss in the third quarter. The fourth quarter benefit reflected the favorable impact of high discount rates and positive credit development in general, resulting from the active management of the insured book, partially offset by an increase in Puerto Rico reserves resulting from assumption changes.
Third quarter incurred losses of $43 million were predominantly driven by increased Puerto Rico reserves related to higher loss expenses and assumption changes. Operating expenses were $26 million, up modestly from $23 million in the third quarter. The increase resulted from cost incurred in connection with the acquisition of Xchange, higher variable incentive compensation and head count additions at Everspan.
Shareholders equity increased $0.98 per share to $23.57 per share or $1.1 billion at December 31, 2020. The increase was due to $43 million of foreign exchange translation gains. And net unrealized gains on securities of $15 million partially offset by the net loss of the quarter.
Adjusted book value increased to $919 million or $20.05 per share at December 31, 2020, from $891 million or $19.44 per share at September 30, 2020. The $0.61 increase in adjusted book value is mostly driven by the impact of foreign exchange translation gains. Unlike book value, ABB is not impacted by changes in unrealized gains and losses.
AFG on a standalone basis, excluding investments in subsidiaries as of December 31, 2020, had cash, investments and net receivables of approximately $366 million or $7.99 per share, including approximately $244 million of liquid assets. The decrease in assets from September 30 resulted from the December 31 acquisition of Xchange along with the initial capitalization of Everspan indemnity.
Liquidity was aided in the quarter by the long-awaited receipt of $28 million of tolling payments from Ambac Assurance. Connection with such payment, we also agreed to reallocate $210 million of additional NOL to AFG from AAC and forego future tolling payments. While Xchange was included in Ambac's consolidated balance sheet as of December 31, 2020, the main impact was the reduction to cash in the establishment of goodwill and intangible assets. The impact of Xchange on our operations will begin to be recognized in the first quarter of 2021.
In the first quarter of 2021, AFG also completed the capitalization of Everspan in conjunction with this receipt of A minus, AM Best rating. AFG funded this $82 million of capital infusion with cash on hand.
I will now turn the call back to Claude to discuss Everspan in our platform diversification strategy in more detail.
Claude LeBlanc
Thank you, David. Turning now to our new business strategy. Our platform diversification strategy is focused on creating a portfolio of synergistic recurring fee-based businesses under a common ownership structure that will generate strong earnings and allow for the utilization of Ambac's NOLs. This strategy is grouped into three pillars.
Pillar one is built around Everspan Group, our specialty property and casualty program platform. Everspan Group currently includes admitted carrier Everspan Insurance Company and surplus lines Carrier Everspan Indemnity Insurance Company. These entities received an AM Best financial strength rating of A minus Excellent in February of 2021. And with capital in excess of $100 million, we'll operate as a Class eight P&C insurance platform. We expect to begin writing new specialty programs in the second quarter of this year.
Everspan may retain up to 30% of the risk it underwrites, aligning itself with its reinsurance partners, further distinguishing itself as a specialty program, participatory fronting insurance platform. We are sourcing program business from multiple channels, including managing general agents, reinsurance brokers, aggregators and other producers. Everspan will generate revenue for fronting fees, net premiums on retained risks and investment income.
We believe Everspan's success will be driven by its competitive advantages, including: One, it's AM Best, A-minus Excellent rating; two, a Class eight financial size designation; three, broadly licensed, E&S and admitted carriers; four, a leading management team with deep leadership experience, spanning the insurance, reinsurance and MGA markets; five, a risk appetite to retain up to 30% of underwritten risk creating strong alignment of interest with reinsurers. And lastly, access to a strong public holding company infrastructure with broad institutional relationships.
The team is led by Wyatt Blackburn. As President, Wyatt has 37 years experience writing successful specialty programs, 35 of which were with the longest-running specialty writer of this type, state national. And Steve Dresner, who serves as Everspan's Chief Underwriting Officer, Chief Reinsurance Officer and has a similar number of years of experience writing specialty program business, most recently at Crum & Forster.
We also believe our launch is well-timed as market and pricing conditions continue to improve and capacity providers continue to maintain and exercise discipline. Recent market data for market scout noted an increase in rates in Q4 2020 for both P&C and personal lines of 7.1%. Lines of coverage with the largest rate increases were umbrella liability, professional lines and D&O liability. Going into 2021, rate increases are expected to continue across all lines with an average forecasted rate increase of 11.6% according to a study reported on by Marsh & McLennan and sited in business insurance.
Given these favorable market conditions, we expect Everspan's disciplined approach to risk management and underwriting as well as a lack of channel conflicts, will attract significant interest from both insurance distributors and reinsurers. Further benefiting Everspan and the fronting carrier market is the evolving commoditization of capital and MGA demand for new capacity sources as traditional carriers face increasing challenges.
Turning now to Pillar two, which encompasses fee-based MGA and MGU businesses. The MGA/MGU program manager sector is attractive because it offers access to high-growth earning businesses with attractive rates of return and the ability to diversify revenue by recurring commission revenues. According to a 2020 strategic study series by Conning, [ph] U.S.-based MGAs produced $65 billion in annualized premium, representing 10% of the P&C market.
Additionally, the MGA universe has grown an average of 6% over the last five years. Ambac expects to grow its MGA/MGU program manager business using several strategies, including organic growth, additional acquisitions and new partnerships and investments in de novo platforms. The pace of that growth will depend on market conditions and for M&A transactions, our ability to find attractive target companies at a fair price. Our acquisition of Xchange marked the first step in delivering on our Pillar two strategy.
On December 31, 2020, Ambac acquired 80% of the membership interest of Xchange, a specialty accident and health MGU. Since its inception in 2010, Xchange and its industry leading management team have delivered outstanding growth and profitability supported by major insurers, reinsurers, third party administrators, brokers and producers. The Xchange team is led by Peter McGuire, a seasoned executive with over 30 years of experience in brokerage, underwriting and reinsurance, who previously worked at QBE, Starr Insurance Companies and Willis Towers Watson before co-founding Xchange with James Denison, Ned Browne and Ken Zieden-Weber, all of whom have extensive insurance and reinsurance experience.
In 2020, Xchange generated gross premiums of over $100 million for their carrier partners with strong EBITDA margins. We expect the acquisition of Xchange to be immediately accretive to Ambac. Going forward, Xchange will continue operating under its own brand with its existing leadership team. Future plans include expanding its geographic distribution and product diversification, adding new carriers and generating additional revenue sources as a reinsurance intermediary.
Turning now to our third pillar. Pillar three includes complementary service businesses that will support pillars one and two, including potential investments in insure tech platforms and third party administrators. Our timing for our pillar three strategy is longer-term and will be based on market opportunities. We are excited about our accomplishments, which we believe will provide Ambac the following key benefits. One, revenue diversification through P&C based fee and premiums; two, capital-light, fee and premium businesses valued by market participants and analysts on a multiple of EBITDA; three, the opportunity for Ambac Financial Group to utilize its NOLs, unlocking additional shareholder value; and four, ownership of a platform operating in a high-growth sector of the P&C market that generates attractive risk-adjusted returns.
In conclusion, 2021 marks a transition year for Ambac as we progress our new business strategy. We are encouraged by our progress thus far, and we are excited about the possibilities that lie ahead of us as we look to further enhance long-term shareholder value by generating meaningful return on capital. We look forward to providing you with additional updates in the quarters ahead.
Operator, please open the call for questions. Thank you.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question is from Mark Palmer with BTIG. Please proceed with your question.
Mark Palmer
Yes, thank you. Good morning. I have a couple of questions that pertain to how a couple of macro factors impact Ambac's platform. A lot of attention of late about rising interest rates. Wanted to see, based on all the changes that have occurred in the platform, what is the impact of rising interest rates? To what extent does it benefit the platform or not?
David Trick
Hi, Mark. It’s David. Thanks very much for your question. There's a number of impacts from rising rates. The most obvious and prevalent one really relates to the discount rates that we utilize for reserving purposes. And so as discount rates increase, certainly, the value of our loss reserves come down. And there's a few pluses and minuses along the way there in terms of the dynamic between subrogation and loss reserves. But nonetheless, from a financial reporting standpoint, the higher discount rates is certainly a benefit. And from our investment portfolio overall, I would say it's a slight benefit. We are relatively a short duration investment portfolio. So to the extent we can redeploy cash as rates are rising, that's a good thing for us from an investment standpoint.
The only drawback to rising rates for us really relates to the subrogation in our RMBS portfolio. More specifically the RMBS insured portfolio. And as rates rise, and that's mostly on the short end of the curve, that hurts excess spread. So we've deployed a number of hedges over the years to try and mitigate some of that risk, which has been a cost to. But nonetheless, we think we'll hedge part of that risk as we head into a period of uncertainty here with regards to movements along the curve.
Mark Palmer
Thank you. I have one quick follow-up. There's a $1.9 trillion stimulus package being considered by Congress right now, of course, a sizable portion of that would be allocated to states and municipalities, what's your take on what the impact of that stimulus could be in terms of the credit environment as it pertains to the municipalities.
Claude LeBlanc
Thanks, Mark. This is Claude. Obviously, assuming the bill goes through in its current form, we think that stimulus package will be beneficial to very beneficial for states and municipalities, I think there's still some question in terms of how it will be allocated as between within the state to various resources, whether it would be to fill budgets, or allocated to certain municipalities for certain express purposes. So I think there's still some questions around how and when it will be distributed and for what purpose. But as a general matter, we think the size of the package and the expressed intent of use all looks generally quite favorable for municipalities.
Mark Palmer
Thank you.
Operator
And our next question is from Derek Pilecki with Gator Capital. Please proceed with your question.
Derek Pilecki
Good morning. I had a question about holding company cash and investments. I assume the $82 million invested in the Everspan came out of holding company cash. Is that correct? And what is the current balance of holding company cash and investments?
David Trick
Sure, yes. That’s correct. The funding of Everspan came out of the holding company cash. So at the end of the year, we ended at $366 million in terms of total assets as a holding company, and that was the major cash outflow after the year end. So it's just a reduction of $82 million of liquid assets at the holding company.
Derek Pilecki
And then my second question is about Xchange. Could you provide with the revenues and operating margin were for Xchange during 2020?
David Trick
We haven’t disclosed that. Obviously, it has no impact on our P&L for 2020 and heading into 2021 will be reflected in our first quarter results. I can tell you that in 2020, the company produced decent amount over $100 million of gross premiums written for the year and has high double-digit EBITDA type margins.
Derek Pilecki
And did that acquisition close in 2020?
David Trick
December 31.
Derek Pilecki
Thank you.
David Trick
Sure.
Operator
And our next question is from Giuliano Bologna with Compass Point. Please proceed with your question.
Giuliano Bologna
Good morning. Kind of looking forward, I was curious thinking about the holding company, there's obviously some capital that's influenced to Everspan capitalizing Everspan, and then you also have some capital for acquisitions. It sounds curious how you think about kind of deploying all of that capital because you have under $500 million of capital, but obviously between $450 and $500 million of capital at the holding company level, and you just received a debt of $8 million total coming up in the fourth quarter. Kind of curious how you think about using all of that capital, because there will still be some capital leftover over after capitalizing Everspan and then beyond that, making the acquisition Xchange, I'm curious about the allocation strategy for the remainder going forward?
David Trick
Yes, thank you Giuliano. So there’s a number of things. One, as we've talked about in the past and Claude described with regards to the three-pillar strategy, we are very disciplined in terms of how we look at opportunities to deploy capital. And I think that's evident in some of the transactions we recently announced. We do need to maintain capital at the holding company for liquidity and operations of the business. And that which is viewed as excess of that can be deployed for strategic purposes. And Claude described the three-pillar strategy and we don't really anticipate additional capital needing to go to Everspan. But certainly, with regards to the other two pillars, that's something we're actively looking at and pursuing and evaluating opportunities.
And so that capital at this point in time is being preserved for strategic purposes.
Giuliano Bologna
That sounds good. And then on the heels of settling out the Corolla Trust, are there any other opportunities in the capital structure to go after that you might be able to accelerate or settle out some exposures or surplus net exposures earlier?
David Trick
We've cleaned up a fair amount of the capital structures as. And certainly, we will remain opportunistic, but there's nothing in the pipeline at this point.
Giuliano Bologna
That sounds good. I appreciate the time and I'll turn it back in the queue.
David Trick
Thanks.
Operator
And our next question is from Matt Weber with Sage Venture Partners. Please proceed with your question.
Matt Weber
Hi, good morning. I wanted to ask about the Bank of America Countrywide case. Could you please discuss the use of the potential proceeds from this case if Ambac is successful? Specifically has the company committed to anything within the capital structure that would consume these proceeds and what is the waterfall for these funds?
Claude LeBlanc
Good morning. And thanks for your question. There is capital certainly credit debt that's been pledged or is being used to fund our litigation. So, I think there is a waterfall and I’ll let David walked through that. Any excess funds beyond that would be general-purpose funds for the company that we will evaluate the use of after settling the litigation.
But David, if you want to walk through the debt structure where we have given us.
David Trick
Yes, there's really two obligations that we have related to rep and warranty. First is what we refer to as the LSNI note, or often referred to as a Tier 1 debt. So with the proceeds from the rep and warranty up to the first $1.4 billion, we are required to pay down that LSNI note. And then after that we are required to use proceeds above $1.6 billion to pay down what is referred to as our Tier 2 notes. So we are obligated to pay down both those obligations upon proceeds.
As I described the outstanding balance on the Tier 2 notes is about $306 million at the end of the year, which includes a principal and accrued interest. On a gross basis, the LSNI note balance is $1.6 billion, but AAC owns about $460 million of those notes. So the net balance, if you will, is about $1.2 billion of those Tier 1 notes.
Matt Weber
Thank you.
David Trick
Sure.
Operator
And there are no further questions at this time. And this also concludes today's teleconference. We thank you for participating. You may disconnect your lines at this time. Thank you for your participation.
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