Ambac Financial Group, Inc.

Greetings and welcome to the ENDAC Financial Group Inc. Second Quarter 2023 Earnings Call. 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 Sabaki, Head of Investment Relations. Please go ahead.

Thank you. Good morning, and welcome to AMBAC's second quarter 2023 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 environments, and after prepared remarks, We'll take your questions. For those of you following along on the webcast, during prepared remarks, we will be highlighting some slides from the investor presentation, which can be located on our website. Our call today includes forward-looking statements. The company cautions investors that any forward-looking statements involve 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 as the forward-looking statements in our earnings press release and our most recent 10Q and 10K, all 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 section on our website amvac.com i would now like to turn the call over to mr claude leblanc thank you chuck and welcome to everyone joining today's call during the second quarter we continue to make material progress in advancing the strategic review of our legacy financial guarantee business in addition to significantly progressing the development and growth of our core specialty pnc business With respect to our legacy business, working with our Wisconsin regulator, we believe we have made significant progress towards the finalization of a new capital and operating framework for AEC. The ultimate timing and determinations for the framework remain in the hands of our regulator, the OCI. However, based on the significant progress made to date, we have already commenced the evaluation of certain strategic options. During the quarter, we initiated discussions with a number of key stakeholders in order to begin preliminary evaluations. We also progressed other key strategic initiatives focused on the de-risking of our platform and further improving our economic and regulatory capital. I will provide more details on these initiatives in a moment. As previously mentioned, our strategic options are not mutually exclusive. and we are evaluating all options on both a time and risk-adjusted basis. With the significant progress made to date, we believe we will be in a position to consider initiating certain strategic options focused on value creation and crystallization as early as the fourth quarter. As we previously noted, certain strategic initiatives will be subject to regulatory approvals and, in all cases, consideration of prevailing market conditions. With respect to our core specialty P&C business, we continue to record significant top and bottom line growth for both Everspan, our hybrid fronting platform, and Serata, our insurance distribution business. Our differentiated market positioning, combined with favorable market trends, position us well for continued robust growth in the coming quarters. Our consolidated financial results for the second quarter showed a modest gap net loss and positive adjusted net income, reflecting the momentum of our new businesses and the increasing stability of our legacy financial guarantee business. During the quarter, we also completed repurchases for just over 200,000 common shares. David will discuss our financial results in more detail shortly. But first, I would like to provide some additional information on our achievements for the quarter. As noted, we continue to focus on the de-risking of the legacy financial guarantee portfolio via select risk-sculpting transactions, which will benefit us significantly in facilitating strategic options for the business. One very notable de-risking transaction for the quarter involved a substantial reinsurance transaction, which reduced our largest risk concentration in addition to certain adversely classified and very long-dated policies. This transaction will also be maturely beneficial from both an economic and regulatory capital perspective. This reinsurance transaction, along with other key de-risking initiatives, reduced our watch list and adversely classified credits by nearly $1.5 billion, down approximately 20% from the prior quarter. Turning now to our P&C businesses. Our specialty P&C platform continues to scale and deliver strong results, with over $94 million of premium production this quarter, a 45% increase over the prior years. Everspan Group continued its upward trajectory, generating gross premium written of $53 million, which was up 30% over last year. The company continues to expand and diversify its MGA program partners, which currently stand at 16, up from 11 a year ago. Everspan's book continues to become more balanced across risk classes, which should have the long-term benefit of more stable and predictable underwriting results. From an overall industry perspective, market conditions remain supportive of our continued business growth at Everspan, particularly in the E&S markets. Demand for E&S capacity remains robust, with many programs transitioning out of the more rigid admitted markets and moving forward on a non-admitted basis. This dynamic is reflected in some of the recent data coming out of excess and surplus line stamping offices for California, Florida, and Texas, which has shown trailing three-month year-over-year premium change growing from over 13% in May to 19% in July. For Everspan, ENS premium represented 78% of its gross premium written this quarter, up from 67% in the first quarter. Against this backdrop, we were on target for Everspan to generate approximately $250 million of gross premiums this year, subject, of course, to market conditions. We also expect Everspan to reach profitability in the back half of the year and begin to contribute to the overall EBITDA growth of our P&C businesses. Serata, our insurance distribution business, also had a strong quarter, generating $41 million of premium, up 72% over the prior year. We continue to see significant opportunities for Serata, whether in the form of additional de novo platforms, product expansion across our current businesses, or through additional M&A. Yesterday, we announced the acquisition of a controlling stake in the Riverton Insurance Agency, which is a New Jersey-based professional line specialist that will add over $40 million of annual premium to our platform and expand our product capabilities. Toronto remains on target to meet or exceed its 2023 target premium of $200 million, while maintaining attractive margins. I will now turn the call over to David to discuss our financial results for the quarter. David.

Thank you, Claude, and good morning, everyone. For the second quarter of 2023, AMBAC reported a net loss of $13 million, or $0.29 per diluted share. compared to net income of $5 million or $0.11 per diluted share in the second quarter of 2022. Adjusted net income was $3 million or $0.07 per diluted share compared to an adjusted net loss of $38 million or $0.84 per diluted share in the second quarter of 2022. The $18 million decrease in net income for the second quarter of 2023 compared to the second quarter of 2022 was driven by several items related to the legacy financial guarantee business. First, results for the second quarter of 2022 benefited from $57 million of realized gains from the extinguishment of debt. Second, net gains on derivative contracts declined $29 million compared to the second quarter of 2022. During the quarter, we terminated our macro hedge interest rate derivative position, which had a modest impact on results. And third, there was a $16 million increase in incurred loss and lost expenses, mostly due to the relative impact of higher discount rates in the second quarter of 2022. These differences were mostly offset by a $57 million improvement in investment income and a $29 million reduction to interest expense. The $41 million increase in adjusted net income for the second quarter of 2023 compared to the second quarter of 2022 was driven by new business growth, the improved investment results, and lower interest expense. Compared to GAAP net income, adjusted net income excludes gains on extinguishment of debt, relies on investment gains and losses, intangible amortization, and litigation costs. Everspan generated 53 million of gross written premiums in the quarter, up 30% over the prior year period, experiencing growth from both existing programs as well as new programs from its expanding roster of MGA partners. Debt premiums written in the quarter of 9 million were up 13% over the prior year period. This represented a retention rate of approximately 17% of gross premium compared to 20% last year. The lower retention rate stemmed from the relative growth of fully funded programs. Earned premiums and program fees were $8 million and $2 million, up 173% and 250% respectively from the second quarter of 2022. The loss ratio was 73.7% in the second quarter of 2023, compared to 66.5% last year. We thought it prudent to increase the overall loss pick to 69%, including Ulay, from 66%. This change resulted in a true-up adjustment included in this quarter's loss ratio. The impact on Everspan's bottom line was minimal as the increase in losses was almost fully offset an adjustment to sliding scale commissions recognized as a benefit through acquisition costs. Everspan continued on its path to profitability with near break-even results for the second quarter. Its modest pre-tax loss of $118,000 compared to a loss in excess of $1 million for the second quarter of 2022. The RADA premiums placed of $41 million in the quarter were up 72% compared to the second quarter of 2022, benefiting from the acquisitions of Ultrans and Capacity Marine last year, as well as organic growth. The insurance distribution segment produced $1.6 million of EBITDA for the second quarter, up from $1 million produced in the second quarter of 2022, on an EBITDA margin of 16.3%, versus 15.5% last year. It's worth highlighting that Serata's current earnings pattern is highly seasonal, with the first quarter being the largest. We expect the seasonality to become more muted over time as we diversify the platform. For the first six months of 2023, Serata generated $6.2 million of EBITDA versus $3.8 million in the first six months of 2022 on EBITDA margins of 25.2% and 25.1% respectfully. Consolidated investment income for the second quarter was $35 million compared to a $21 million loss in the second quarter of 2022. Despite reducing our allocation to alternative investments by $116 million since the beginning of 2022, alternative investment income rose $32 million compared to last year and trading asset gains of $4 million increased $16 million over the prior period. During the second quarter of 2023, the average yield on available for sale securities was approximately 4.6%, up from 3% last year. Total loss and loss adjustment expenses were $7 million in the second quarter of 2023, compared to a $12 million benefit in the second quarter of 2022. EverSpan losses accounted for approximately 6 million of losses in the quarter with the balance from the legacy financial guarantee segment. This compared to last year where the legacy financial guarantee segment generated a benefit of 14 million as a result of higher discount rates, more than offsetting the 2 million of incurred losses at EverSpan. General and administrative expenses were 36 million for the second quarter. up from $30 million in the second quarter of 2022. The increase in operating expenses was due to a $5 million increase in litigation costs at AAC, higher headcount in our growth segments, including from the consolidation of All Trans and Capacity Marine, and other associated costs with the continued growth of the PNC businesses. These expenses were more than offset by lower headcount and associated expenses at the legacy financial guarantee business. Interest expense was approximately $16 million, down from $45 million in the second quarter of 2022, given the retirement of all of AAC's senior secured debt and a reduction in outstanding surplus notes over the last year. AAC's remaining surplus note debt as of June 30, 2023, was $969 million, inclusive of accrued and unpaid interest. Turning to the balance sheet, Shareholders' equity of $1.25 billion, with $27.59 per share at June 30, 2023, was down slightly from the $27.66 per share at March 31, 2023. The change was driven by the $13 million net loss and a $13 million increase to unrealized losses on available for sale investments, being mostly offset by foreign exchange translation gains related to AUK of $21 million in the quarter. Adjusted book value of $1.22 billion, or $26.97 per share, at June 30, 2023 was down from $27.89 per share on March 31, 2023. This $0.92 per share decrease in adjusted book value was due mostly to the legacy financial guarantee, the risking reinsurance transaction Claude previously mentioned. Consideration for the reinsurance transaction included a $6 million upfront payment and $42 million of future installment premiums. During the quarter, we repurchased 205,000 shares of common stock at an average price of $14.42 per share. which more than offset shares issued as part of employee and board member compensation. At June 30th, 2023, AFG, on a standalone basis, including investments and subsidiaries, made cash investments and net receivables of approximately $223 million, or $4.91 per share. I will now turn the call back to Claude for some brief closing remarks.

Thank you, David. Going into the second half of the year, we are well positioned to generate and crystallize significant value from both our legacy financial guarantee and core specialty P&C businesses. We expect to have greater near-term visibility on the strategic options available for our legacy business, which will enable us to progress towards an execution mode. I am also very pleased with the continued strong growth of our core specialty P&C businesses. We are seeing the pipeline for both organic and strategic growth opportunities continue to rapidly expand as we become increasingly recognized for our differentiated market strategy. I look forward to updating you on our progress in the coming quarter. Operator, please open the call for questions.

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 Start 2 if you would like to remove yourself from the question queue. For participants using speaker equipment, it may be necessary to pick up your headset before pressing the Start button. One moment, please, while we pull for questions. And our first question comes from Juliano Bologna with Calcutt Points. Please go ahead.

Good morning. I'd like to touch on the potential timeline that you mentioned. When you were saying, you know, to look at some strategic alternatives in 4Q, I'm curious to be thinking about kind of launching a process for them, or do you think there's the potential to execute some of those, you know, potential transactions in 4Q?

thanks Juliano so and good morning you know currently we're evaluating all of our options and progressing all of them in parallel as we've indicated they're not mutually exclusive so some of them could be executed or commenced in parallel with others and in terms of the the timeline you know we believe we will be in a position to having evaluated our options to initiate or commence a initiating some of our options as early as the fourth quarter, again, subject to regulatory approvals as required and market conditions.

That's very helpful. Then thinking about it from a broader capital allocation perspective, you obviously have a fair amount of capital at the holding company level. There isn't necessarily much capital needed at Everson at the moment. And if you release more capital from from AAC or AAC over time. I'd be curious how you think about capital allocation at that point and the best use of your capital because you already have some capital to deploy at the holding company levels today.

Thanks, Julian.

You know, capital allocation is something we, you know, debate and discuss, you know, frequently as we talked about before. And certainly, I think we've talked about before, Everspan does not significant need for capital going forward. Our current, you know, plans generally involve more capital allocation as we demonstrated with the recent acquisition of Riverton that Claude mentioned in the Serrata insurance distribution businesses. But, nevertheless, all of our capital allocation decisions, you know, always revolve around the opportunities in the marketplace to deploy capital new businesses versus what the benefit is and return possibilities are for returning capital to shareholders.

That's great. And then just thinking on the litigation expense side, I'd be curious just thinking about the cadence of potential litigation expenses over the next few quarters. Should we expect that to continue at the same level or start to trend down over the next few quarters?

Yeah, the expense certainly has been running hot, as we've talked about, every quarter. We do expect that expense to moderate in coming quarters, but at least in the short term, there's going to be continued spend to resolve the outstanding litigation.

Thank you for taking my questions, and I will turn back in the queue.

Our next question comes from Jeffrey Dunn with Doney and Partners. Please go ahead.

Thanks. Good morning. I wanted to ask more about the reinsurance transaction. It looks like it was more watch lists than adversely, adverse credits. And just based on the numbers, it looks like it's more housing, revenue bonds maybe. Was it military housing? Was it something else about that that stood out? Can you talk a little bit more about how you identified that particular transaction?

Thanks, Jeff. I think it's fair to say the majority or the bulk of it was military housing. And as we've indicated in the past, this is a concentration risk in our portfolio. There are also many long dated exposures and some very large exposures. So I think it's an area that we have been keen at looking to to sculpt in our portfolio. It also included some adversely classified credits, as we mentioned, and other credits that we viewed as also very long dated and, you know, potential stress credits that we wanted to exit. So I think overall, it was a sort of a package of credits that we wanted to exit and had been working on this transaction for In fact, a number of years. So we were very fortunate to be able to complete it this past quarter. But I think your summation as to being primarily military housing, I think, is a good one.

Okay. And just from an economic standpoint, I mean, $6 million up front and then the installment, what was actually the company's cost for this? Because if it's $6 million up front, that doesn't seem overly burdensome for getting rid of this type of exposure. Was the remaining 40-odd million installment specific to the deal, or what is the actual payment by AMBAC above and beyond the premium flow associated with the transaction?

There wasn't payment above and beyond the premium flow from the transaction, so we're simply giving up the premium associated with the deal that were ceded.

Gotcha. Okay, thank you.

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 and have a good day.