Ambac Financial Group, Inc.

Q4 2022 Earnings Conference Call

3/1/2023

spk03: And welcome to the AMBAC Financial Group in Fourth Quarter 2022 Earnings Score. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to Charles Sebesky, Head of Investor Relations.
spk05: Thank you. Good morning, and welcome to AMBAC's fourth quarter 2022 call to discuss financial results. Speaking today will be Claude LeBlanc, President and CEO, and David Trick, Chief Financial Officer. They will discuss the financial results of our business and the current market environment. And after prepared remarks, we'll take your questions. Our call today includes forward-looking statements. The company cautions investors that any forward-looking statement involves risks and uncertainties and is not a guarantee of future performance. Actual results may differ materially from those expressed or implied in the forward-looking statements due to a variety of factors. These factors are described under the forward-looking statements in our earnings press release and our most recent 10Q and 10K filed with the SEC. We do not undertake any obligation to update forward-looking statements. Also, in our prepared remarks or responses to questions, we may mention some non-GAAP financial measures. Reconciliation to those non-GAAP measures are included in our recent earnings press release, operating supplement, and other materials available in the investor relations section of our website at AMBAC.com. I would now like to turn the call over to Mr. Claude LeBlanc.
spk00: Thank you, Chuck, and welcome to everyone joining today's call. Yesterday we posted a separate presentation to our website that I will be referencing during today's call entitled 2022 Year-End Review. I'm going to start on slide three of this presentation. 2022 was a transformational year for AMBAC. A year during which we resolved a number of our most significant challenges and At the same time, materially progressed our new business strategy. Today, I am pleased to report that AMBAC is in its strongest financial position since the 2007 financial crisis. In 2022, we successfully resolved all of our remaining legacy RMBS rep and warranty litigations, recovering nearly $2 billion through settlements, and we completed the restructuring of our largest and most distressed financial guarantee exposures, notably our PRIFA CCDA, and HTA, Puerto Rico exposures, amongst others. As a result of these successes, in addition to our active asset liability management activities, which resulted in the capture of over $150 million of discount, we reduced our outstanding debt by $1.8 billion and increased our book value by $214 million, or $5.43 per share. In our specialty P&C businesses, we expanded our platform through both organic growth and acquisitions, producing in excess of $280 million of premiums. Everspan continued to increase its market share, generating gross written premiums of $146 million for the year. In addition, we successfully recruited top industry talent to our businesses, all of which positions Anvac very well for strong future expansion and earnings growth. For the year ending December 31, 2022, AMBAC reported net income of $522 million or $11.31 per diluted share and adjusted earnings of $555 million or $12.01 per diluted share. AMBAC ended the year with a book value of $1.25 billion, an increase of 21%, and adjusted book value of $1.27 billion, an increase of 46%, over year-end 2021. David will discuss our results in more detail shortly. Turning now to the review of our legacy financial guarantee business on slide four of the presentation. Each of AAC and AUK succeeded in materially increasing their book value and adjusted book value and the quality thereof, one of our key strategic priorities. In summarizing some of our key achievements for the year, First, we have monetized all of our outstanding weapon warranty receivables when considering the receipt of the Nemours settlement in January of 2023. Secondly, we reduced our Puerto Rico exposure by 77%. Next, our debt leverage is down 74%. Loss reserves are down 51%. Adverse credit exposure is down 26%. And finally, net par outstanding is down 19%. Over the same period, book value per share increased 24% and adjusted book value per share increased by 50%. Turning to slide five of the presentation. As outlined last quarter, our recent accomplishments coupled with our significant de-risking and de-leveraging activities positions us to begin the process of reevaluating the amount of capital needed to support our legacy businesses, as well as initiate a comprehensive review of the alternative strategic paths available to maximize value. Our strategic review process will evaluate alternative options on both a time and risk adjusted basis. I would also like to point out that certain alternatives are not mutually exclusive and may be considered in connection with others. Options under active consideration include, one, the ongoing active runoff of a profitable, delivered, and de-risked legacy platform, potentially consolidated with AUK. Two, strategic portfolio de-risking transactions with the goal of freeing up capital and further increasing the value of our businesses. Three, strategic joint venture arrangements to generate increased value and financial flexibility at AEC and AFG. And lastly, a full or partial sale of the legacy business, which would consider the value for the well-preserved NOLs held by AEC. As previously mentioned, managing through the operating and capital reevaluation process with our regulator will take some time, but I wanted to offer an update on our progress thus far. Our periodic examination process with our insurance regulators is well underway, and we are working towards establishing a new capital and operating framework with our Wisconsin insurance regulator by the middle of this year. Second, we are working with advisors in both the US and the UK to assist us in the evaluation of strategic options for both AAC and AUK in order to further maximize value creation and recovery for shareholders. The outcome from this analysis, combined with the outcome from the operating and capital framework, in addition to other considerations, is expected to provide us with greater clarity on preferred options and the timing thereof. We will update you further once the review process is complete. Turning now to our specialty P&C business on slide six of the presentation. Everspan Group, our specialty P&C program business, had a great first full year of business generating gross premium written of $146 million, up over tenfold from its launch in May 2021. Everspend continues to expand and diversify its program partners, which currently stand at 14, up from 7 at the start of 2022. The team remains focused on growth with strong underwriting-focused program partners, backed by a leading panel of highly rated reinsurers. The US MGA market remains robust and expanding with an expected range of 70 to 100 billion in premiums, which supports a strong pipeline of new program partners for Everspan. While growth is important, Everspan is a disciplined underwriting platform and selective in its risk assumption. In 2022, Everspan received over 180 submissions, but only contracted with nine that met their desired risk profile. The January 1st reinsurance renewals provided evidence that the disruptive forces within the P&C supply and demand dynamic identified earlier in the year were real, especially as it relates to property cat-exposed business. However, Everspan, which has limited property exposure and program renewals spread throughout the calendar year, has so far been able to successfully mitigate these challenges with the broader industry. And to some degree, we believe that these industry dynamics may well provide Everspan with additional growth opportunities, especially in our preferred classes of business, as competitors work to address the changes in property cap capacity. We expect these factors, along with the strength of Everspan's current programs, to provide the business with the opportunity and resources to keep building on its gross premium growth. This year, we expect Everspan to generate in excess of $250 million of gross premium and reach profitability in the back half of the year, and to continue growing to upwards of $500 million of gross premium over the next several years. Turning to slide 7 in our insurance distribution business, Serata, our insurance distribution segment, had another good year, with premiums placed at $135 million, up 15% over 2021. which generated $7 million of EBITDA. Serata is just getting started, and there is a lot of runway for growth both organically and strategically. Notably, Serata's 2022 performance only includes two months of results from the fourth quarter acquisitions of Altrans and Capacity Marine. Exchange, our first MGA acquisition, has recently announced several growth initiatives that we are very excited about. First, Exchange RE. a reinsurance MGU that will underwrite accident and health reinsurance coverage on a worldwide basis, utilizing U.S. Fire as a carrier. Secondly, Distribution Re, a captive for exchanges employer stop-loss clients that will ensure accident and health risks, mainly in the form of high-deductible medical stop-loss plans, both of which will add to top and bottom-line growth in 2023. As our business continues to transform, we have continued to successfully attract top P&C talent, including the recent hire of a leading industry executive, John Tatum, who is in the process of building out our second de novo incubation, an MGA, in the construction space. These accomplishments, combined with an active M&A pipeline, position Serata favorably to hit projections exceeding $200 million, a place premium with attractive margins for 2023. Lastly, I would like to take a moment to acknowledge Jim Prier, who stepped down from our board after having served as a director for over seven years. The board and management have benefited tremendously from Jim's counsel and service over the years, leading to the significant milestone accomplishments dating back to the segregated accounts exit from rehabilitation in 2018 and through our numerous other achievements culminating to where we are today. On behalf of the board and management, I want to personally thank Jim and wish him the best on his next endeavors. We plan to use Jim's departure as an opportunity to refresh our board. The board routinely reevaluates its composition to ensure the expertise and other qualities of the board as a whole are well-suited to the company's business and strategy. In light of the accomplishments and significant growth in our specialty P&C business, The board's governance and nominating committee is well advanced in its search to add a highly skilled director that brings additional specialty PNC insurance expertise to help Stewart and back in its next phase of growth. We look forward to updating you on that initiative at the appropriate time. I will now turn the call over to David to discuss our financial results for the quarter. David.
spk04: Thank you, Claude, and good morning, everyone. For the fourth quarter of 2022, AMBAC reported net income of $175 million or $3.86 for diluted share compared to a net loss of $22 million or $0.42 per diluted share in the fourth quarter of 2021. Adjusted earnings for the fourth quarter of 2022 were $190 million or $4.18 for diluted share compared to an adjusted loss of $10 million or $0.16 per diluted share in the fourth quarter of 2021. Adjusted earnings excluded legacy financial guarantee insurance, intangible amortization expense of $12 million, and unrealized foreign exchange transaction losses of $2 million for the fourth quarter of 2022. The $197 million increase in net income for the fourth quarter 2022 compared to the fourth quarter 2021 was driven by several notable items. First, we realized the $121 million net gain from the previously announced settlements of legacy RMBS litigations. $78 million of the $121 million net gain related to the Bank of America settlement and $43 million related to the Nomura settlement. For the sake of clarity, I will walk through the various components of the gain and where they are recorded in our financials. As it relates to the net Bank of America gain, $126 million of the gain is recorded as a litigation recovery in our income statement and related specifically to our allocation of a portion of the settlement to the Harborview Ford litigation and $5 million of the gain represents realized gains recorded in realized investment gains on Sitka notes we held in the investment portfolio. Netted against these gains was $53 million of Sitka note call premium and accelerated discount amortization expense recorded through realized gains and losses on extinguishment of debt. As it relates to the mora litigation, $43 million of net gains were recognized through loss and loss adjustment expenses. Secondly, we realized a $77 million gain from the repurchase at a discount of $364 million of principal and accrued interest of surplus notes. This gain was recorded in net gains on extinguishment of debt and was partially offset by the previously mentioned $53 million Sitka note expense. On account of these debt reductions, interest expense was $14 million less this quarter compared to the fourth quarter of 2021. As they occurred throughout the fourth quarter, the full impact of these debt reductions on interest expense will not be realized until the first quarter of 2023. Premiums earned were $17 million in the fourth quarter, up from $10.5 million earned in the fourth quarter of 2021. For the quarter, Everspan earned premiums grew $5.3 million, while legacy financial guarantee net earned premium grew $1.3 million, due to the acceleration of premiums related to the de-risking of Puerto Rico. Total net premiums earned for the quarter included $13.3 million of normal earned premium. Everspan accounted for over 40% of normal earned premium in the fourth quarter of 2022, compared to just 5% in the fourth quarter of 2021. As Everspan continues to grow, and we continue to de-risk the legacy financial guarantee insured portfolio, We expect Everspan's earned premium to exceed that from the Legacy Financial Guarantee Book in 2023. In addition, we would highlight that of the $52 million of specialty PNC gross written premiums in the quarter, Everspan retained about 20% or $10 million, which will earn in over the next year. Everspan's business model allows it to retain up to 30% of gross written premiums. Everspan also collected $2.3 million and earned approximately $1.4 million of program fees in the quarter. As a reminder, program fees earn in over the course of a policy similar to how premium is earned. Therefore, as Everspan continues to add programs and grows premiums written, both earned premium and program fees will grow significantly. Serrata, a distribution segment, also continues to grow both organically and strategically. Premiums placed of $38 million in the quarter were up 46%, benefiting from both the recent acquisitions of Alltrans and Capacity Marine in November, as well as organic growth from exchange. Insurance distribution business revenues come from commissions earned as a percentage of premiums placed. Total revenues for the quarter were $9 million, up 42% from the prior year period. The insurance distribution segment produced nearly $2 million of EBITDA, net of non-controlling interest for the fourth quarter, up from the $1 million produced in the fourth quarter of 2021. Revenues and EBITDA were favorably impacted by two months of old trans and capacity marine results and organic growth at exchange. Investment income for the fourth quarter was $23 million, down from $27 million in the fourth quarter of 2021, as a result of volatility across markets and a smaller allocation to alternatives. More specifically, the decrease in investment income during the fourth quarter of 2022 related to a net gain on fund investments of about $2 million compared to a $13 million gain in the fourth quarter of 2021. Allocations to alternative fund investments have been reduced by approximately $58 million year to date in connection with the regular rebalancing of the portfolio. Income from fixed income securities was up $7 million compared to the same period last year due to higher average yields. Capital deployed in fixed income available for sale securities for the fourth quarter was at a yield of approximately 5.7%. Loss and loss adjustment expenses were a $55 million benefit in the fourth quarter of 2022. compared to a $15 million benefit in the fourth quarter of 2021. The structured finance portfolio generated a benefit of $58 million this quarter compared to an expense of $24 million in the fourth quarter of last year. The principal driver to this quarter's results was the $43 million gain from the Nomura settlement. The remainder of the benefit for the quarter related to an overall net improvement in the performance of the reserve portfolio. Net gains on derivative contracts, which remain positioned as a partial economic hedge against interest rate exposure in the financial guarantee and investment portfolios, were $5 million for the fourth quarter compared to $3 million for the fourth quarter of 2021. During the quarter and year, we reduced the sensitivity of the macro hedge, generally in line with the exposure we are hedging. As of year end 2022, the sensitivity to a one basis point change in interest rates was approximately 156,000, compared to over 530,000 at the beginning of the year. We expect to continue to reduce the DVL-1 throughout 2023. General administrative expenses were $51 million for the fourth quarter, up from $29 million in the fourth quarter of 2021. The increase in operating expenses was due to an increase in legal expenses at AAC, higher headcount for specialty PNC and other associated costs with the continued growth of the business, acquisitions of all trans and capacity marine, and the impact of timing on certain corporate expenses which impacted fourth quarter 2021, which more than offset broader expense reductions in the legacy business. Interest expense in the fourth quarter was approximately $30 million, down from $44 million in the fourth quarter of 2021 and $49 million in the third quarter of 2022. Approximately $12 million, or 40%, of this quarter's interest expense related to SITCA and Tier 2 notes, all of which are now fully redeemed. During the fourth quarter, we also repurchased surplus notes totaling $364 million of par and accrued interest, which resulted in the previously mentioned $77 million gain and a $2 million reduction of interest expense. As a result of these repurchases, AAC's remaining surplus note debt as of 12-31-22 is $945 million, inclusive of accrued and unpaid interest. Shareholders' equity increased by $244 million, or $5.42 per share, to $1.25 billion, for $27.85 per share at December 31, 2022, from the end of the third quarter. The increase was primarily due to fourth quarter earnings, unrealized gains on available cell investments of $11 million, and foreign exchange translation gains related to AUK of $51 million. Adjusted book value increased to $1.27 billion, with $28.29 per share at December 31, 2022, from $1.04 billion, or $23.13 per share, at the end of the third quarter. This $5.16 per share increase in ABV was primarily due to adjusted earnings and FX translation gains. At December 31, 2022, AFG, on a standalone basis, excluding investments and subsidiaries, at cash, investments, and net receivables of approximately $223 million, or $4.96 per share. During the quarter, AFG sold all of its AAC surplus notes back to AAC, which increased AFG liquidity by approximately $95 million. I will now turn the call back to Claude for some brief closing remarks.
spk00: 2022 was an exciting year with the achievement of meaningful value-enhancing accomplishments. As we look ahead to 2023, our key strategic priorities will focus on one, growth and diversification of Everspan Group. Two, targeted growth at Serrata both organically and through M&A. And three, as it relates to our legacy business, completing the following. One, the legacy business capital and operating framework. Two, our comprehensive review of strategic options for the legacy business. And three, initiating key strategic steps towards maximizing value for shareholders. We look forward to updating you on our progress in the coming months. Operator, please open the call for questions.
spk03: Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.
spk01: One moment please while we poll for questions.
spk03: Our first question is from the line of Paul Devin with C. Devin and Association. Please go ahead.
spk02: Good morning, folks. How are you? A couple things. First, I can't believe Claude and David will never be talking really about Puerto Rico or BMA or Nomura again. So first off, congratulations to everybody on the team for getting that behind you. But now... It's time to sort of what have you done for me lately and looking forward. And I wonder, Claude, if you can talk a little bit about more granular on the growth plans for Serrata, also Everspan. And then I had one minor question for David. With respect to the unassigned negative surplus in AAC, I know that was down to about $80 million at the end of the third quarter. When do you think that will go positive? Thanks. Thanks.
spk00: Thanks, Colin. Appreciate the questions, and we're also happy not to have to talk about Puerto Rico and Numero going forward, so good point in history. In terms of our go-forward businesses, we are seeing tremendous opportunities at Serrata, both on the de novo side as well as on the strategic or M&A side. I think the offering that we've put forward in the market where we support our MGA, MGU and wholesale businesses through a business service offering, in addition to having the possibility of Everspan as a capacity provider, I think distinguishes us in a way that has led a lot of, whether it be sellers or individuals who are looking to either launch an MGA or take an MGA to the next step, consider us as a true viable option relative to to other options in the market. So I think we've been very pleased with the types of opportunities we've been seeing and we're seeing more and more as time goes on. And I think we're very excited about the prospects for growth and scaling of the Serata platform. As far as Everspan goes, that is an organic game. So the portfolio there just continues to scale. We have distinguished ourselves coming out of the box by being a party that looks to retain risk. So we, on the scale of hybrid fronting carriers, we are on the far right where we retain up to 30% of risk. And I think that has distinguished us significantly in the market. And I think the team that we have built with leading underwriters, actuaries, claims people, really distinguishes us in the market as being really a primary group. platform for the program business relative to peers. So again, we feel very confident that that business will continue to scale. We are attracting high-quality partners and seeing a very, very deep pipeline of opportunities approaching us in the future. So with that, I'll turn it over to David on the unsigned surplus.
spk04: Sure, thanks. Thanks for the question. So unsigned surplus is about $75 million negative at the end of the year. It actually would have been positive had it not been for the repurchase of the surplus notes, which are carried on a statutory basis at their par amount, not their par plus accrued amount. So while we don't provide financial projections of earnings and retained earnings in the future, certainly our objective is to continue to deleverage and de-risk the balance sheet of AEC. as part of our broader strategic initiatives and as certainly as part of that we would expect to continue to grow both the size and quality of the surplus and you know the factors that will go into the timing of that unassigned surplus becoming positive will include of course the earnings power of the business but also but also our capital management activities including any future debt transactions and de-risking transactions. So there's a bit of timing to the magic of when that number may become positive in the future.
spk02: David, fair enough. Thank you for that. And Claude, just to follow up with Sarada, obviously you've done all trans, you did Capacity Marine, and you're looking at a lot of things. I appreciate it's hard to say what opportunities you're seeing, but perhaps are there certain areas where Serata is just not interested? What don't you want to get into as much as what might be attractive?
spk00: I think we have a relatively broad appetite at Serata, and we certainly are focused on MGU, MGA, as well as wholesale. We're not focused, obviously, on the retail brokerage side, but I think fundamentally what's core to platforms in Serata is really their underwriting performance and distribution performance. We are really looking at each of our MGA partners at Serata and that goes as well as program partners for Everspan for platforms that are very strong in the underwriting area that we believe and we can assess their viability both in the hard markets that we're in today but also longer term in the soft markets. So We have fundamental criteria we look at that are, you know, we follow very carefully in evaluating opportunities. And we also look at, you know, areas where we see strong synergies as between our MGA partners and distribution partners and also potential synergies with Everspan. So those are other categories and areas that we would focus on in terms of identifying good opportunities at Serata.
spk02: Thank you very much.
spk00: Thanks, Colin.
spk03: Thank you. Ladies and gentlemen, to ask a question, please press star 1 on your telephone keypad. You may press star 1 to ask a question. There are no further questions at this time. This concludes today's teleconference. We thank you for participating. You may disconnect your lines at this time. Thank you for your participation.
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