Ambac Financial Group Inc

NYSE:AMBC

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Greetings, and welcome to the Ambac Financial Group, Inc. Second Quarter 2024 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to Charles Sebaski, Head of Investor Relations. Please go ahead, sir.

[Charles Sebaski, executive]

Thank you. Good morning, and welcome to Ambac's Second Quarter 2024 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. For those of you following along on the webcast, during prepared remarks, we'll 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. Those factors are described under forward-looking statements in our earnings press release, our most recent 10-Q and 10-K 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 of those non-GAAP measures are included in our recent earnings press release, operating supplement and other materials available on the Investors section of our website, ambac.com. I would now like to turn the call over to Mr. Claude LeBlanc.

[Claude LeBlanc, executive]

Thank you, Chuck, and welcome to everyone joining today's call. Our reported results for the second quarter were favorable compared to the prior year. We generated a net loss of just under $1 million, adjusted net income of $8 million and consolidated EBITDA of $27 million. David will discuss our financial results in detail shortly. Today, I would like to provide an update on the 2 strategic announcements we made earlier in the quarter.

In June, we announced an agreement to sell our legacy financial guarantee business to Oaktree Capital Management for $420 million. This was the culmination of several years of targeted efforts to optimize the portfolio, maximize recoveries and progress the business towards a steady state runoff in preparation for a strategic review. The Oaktree bid was the best value to shareholders, measured on a notional, time and risk-adjusted basis. The sales price achieved was consistent with or above a range of estimated values that we evaluate.

The sale of AAC is expected to close during the fourth quarter of 2024, although the ultimate timing will be subject to approvals outside of our control. Upon the close of the sale, we will implement a share repurchase program of up to $50 million to be initiated in the first 3 months of closing depending on market conditions. In making this decision, management and the Board took into consideration our anticipated year-end liquidity and capital position and our go-forward capital needs and obligations amongst other considerations.

Following the execution of the share repurchase program, we will evaluate authorizing additional capital return activities measured against other capital deployment opportunities and based on market conditions. Last week, we also announced the closing of the Beat Capital acquisition. I would like to take this opportunity to officially welcome John Cavanagh and his partners and the entire Beat team to the Ambac family. In Beat, we have found an organization with a similar culture and values. Both Cirrata and Beat employ a partnership model to align interest. The combination offers significant potential for revenue, capital and expense synergies, which we believe will allow us to achieve superior returns and create long-term value for our shareholders.

The Cirrata, Beat combination establishes us as a leading insurance distribution platform with exceptional global growth opportunities through both organic and inorganic means. We believe the combined breadth and depth of our capacity relationships, distribution channels and a highly desirable operational environment makes us a premier destination for top MGA talent. Our distribution businesses are primarily focused on specialty and E&S lines where specialization and flexibility of rate and form have led this segment to outperform the growth of the broader P&C markets.

On a combined basis, Ambac's Specialty P&C businesses are now expected to generate approximately $1.4 billion of premium on a pro forma basis for 2024 essentially doubling the size of our P&C platform. The combined Cirrata, Beat insurance distribution platform now comprises 16 MGAs, up from 5 as of the end of the second quarter. As we seek to accelerate our premium and margin growth, our combined platform is uniquely positioned to continue to attract what we believe to be best-in-class talent as well as top MGAs. Together, we are better positioned to leverage our key differentiated offerings for the benefit of our MGA partners, which include: first, aligned risk capital, unlike the majority of our insurance distribution peers, we can accelerate the launch and support the continued development and growth of our distribution businesses.

Our Lloyd's syndicates and capital-light carriers enable us to align interest with our capacity providers and gives us the ability to incubate and launch distribution ventures more rapidly. This distinct market advantage positions us for strong future growth. Second, as a public company, we offer key risk and oversight controls that benefit our businesses as well as our key stakeholders. And lastly, business agility, supported by our extensive technology-focused shared service offering.

Turning now to our second quarter results, excluding our Beat business. Our consolidated specialty P&C insurance platform continued to generate strong production with over $165 million in premium, a 75% increase over last year. Our insurance distribution business placed over $53 million of premium, up 31% over the prior year. This was supported by the ongoing benefit of organic growth initiatives and the addition of Riverton to the platform last August. We also announced the launch of Tara Hill in the second quarter an MGA focused on management and professional lines.

Going forward, we believe Cirrata's business profile and mix will be meaningfully and positively impacted by the Beat acquisition. We look forward to providing investors with more details on the combined business in the coming months. Everspan had strong growth in the quarter, generating gross written premium of $111 million, which was up from 109% over last year and produced a combined ratio of 109.4%, improving from the 112.7% last year as the portfolio continues to scale and diversify.

This quarter, the underwriting results were impacted by increased loss frequency in commercial auto. As we indicated in prior quarters, we continue to take a cautious approach to reserving and expect some near-term volatility as Everspan's portfolio scales and diversifies across programs and lines of business. Consistent with our focus on disciplined underwriting, we discontinued the subject commercial auto program this quarter. We believe rates are keeping up or exceeding loss cost trends for all of our other programs.

At the same time, Everspan maintains a strong pipeline of program opportunities which we believe will further our goals to diversify the portfolio, support growth, reduce our combined ratios and deliver strong future ROEs. I will now turn the call over to David to discuss our financial results for the quarter. David?

[David Trick, executive]

Thank you, Claude, and good morning, everyone. For the second quarter of 2024, Ambac generated a net loss of just under $1 million or $0.02 per diluted share improving from a net loss of $13 million or $0.29 per diluted share in the second quarter of 2023. Adjusted net income increased to $8 million or $0.18 per diluted share for the quarter compared to adjusted net income of $3 million or $0.07 per diluted share in the second quarter of 2023.

Our results for the second quarter 2024 were impacted by several items including $5 million of net gains from minority strategic investments in Insurtech-related businesses, $12 million of net gains from the termination of a retiree benefit plan and approximately $16 million of legal and advisory expenses related to the acquisition of Beat and the sale of AAC. In addition, during the second quarter, we continued to experience significant growth in our specialty P&C businesses. Cirrata premiums placed grew 31% to over $53 million from $41 million in the second quarter of 2023, driven by the acquisition of Riverton and 11% organic growth.

Gross commissions were $13 million up 32% compared to the second quarter of 2023. Revenue benefited both from the acquisition of Riverton and 12% organic growth. EBITDA was $2.4 million $2 million after minority noncontrolling interest for the second quarter of 2023, up 47% and 54% from the $1.6 million, $1.3 million after minority noncontrolling interest, respectively, reduced in the second quarter of 2023. The resulting gross EBITDA margin was 18.1% this quarter compared to 16.3% in the second quarter of 2023.

This margin expansion was largely driven by organic growth including an A&H policy renewal, which shifted to the second quarter of 2024 would have been the third quarter. We expect Cirrata's earnings and margin profile to be positively impacted in the third quarter by the inclusion of 2 months of Beat's results with the closing of the acquisition effective July 31. Everspan's net premiums written in the quarter of $32 million were up 254% over the prior year period based on a retention rate of approximately 29% of gross written premium of $111 million. This compares to a 17% retention rate of gross premium written of $53 million last year.

As was the case last quarter, both the growth in net premiums and higher retention levels stem mostly from workers' compensation and nonstandard auto programs written in the back half of 2023 as assumed reinsurance. Earned premiums and program fees were $27 million and $3 million, up 248% and 60%, respectively, from the second quarter of 2023. The loss ratio of 85.1% in the second quarter of 2024 was up from 73.7% in the second quarter of 2023. Year-to-date, the loss ratio was 80.5% compared to 70.4% last year.

The second quarter loss ratio included 6.9 percentage points of prior accident year development mainly driven by increased frequency in commercial auto. This elevated commercial auto frequency also led to 4.2 percentage points of the catch-up from the first quarter of this year. The 2024 accident year loss ratio, excluding both the prior period development and inter-period catch-up was 73.9% compared to 69.5% in the second quarter of 2023. One of the ways Everspan manages exposure is through sliding-scale commissions, which is recorded against acquisition costs and linked to loss performance.

For the second quarter of 2024, sliding scale commissions produced a benefit of 5.6% compared to a 4.2% benefit last year. The expense ratio was 24.3% in the second quarter of 2024, down from 39% in the prior year quarter, benefiting from the overall growth at Everspan. In addition, the expense ratio benefited this quarter from the increase in sliding scale commissions of 140 basis points noted earlier. The resulting combined ratio for the second quarter was 109.4%, an improvement of 330 basis points from the respective prior year period.

The year-to-date combined ratio of 104% is down meaningfully from 117.1% last year to date. Everspan's combined ratios overall are continuing to trend downward as the business grows in third quarter suffice. And as noted by Claude, we have taken decisive action to contain the losses in commercial auto. Excluding commercial auto, Everspan produced a loss ratio for the quarter of 68.7%. For the quarter, Everspan experienced just over a $1 million tax loss compared to a roughly breakeven result for the second quarter of 2023. For the second quarter, the legacy financial guarantee segment generated net income of $11 million versus a net loss of $9 million in the prior year period.

The year-over-year improvement was primarily driven by higher discount rates and a onetime gain related to the termination of a benefit plan. Consolidated investment income for the second quarter was $36 million compared to $35 million in the second quarter of 2023. The improvement stemmed from higher average yields on fixed income securities, which increased 60 basis points over the same period. Consolidated loss and loss adjustment expenses were $18 million in the second quarter of 2024, compared to $7 million in the second quarter of 2023.

ARIS ban losses grew by $17 million compared to the prior year to $23 million. Legacy financial guarantee produced a net benefit of $5 million favorably impacted by higher discount rates versus lower discount rates in the prior year and favorable credit development. Shareholders' equity of $1.37 billion or $30.25 per share at June 30, 2024 compared to $30.19 at March 31, 2024. The net loss in the quarter was more than offset by a $4 million unrealized gain on available-for-sale investments.

Adjusted book value of $1.32 billion or $29.23 per share at June 30, 2024, was up 1% from $29.03 per share at March 31, 2024. At June 30, 2024, AFG on a standalone basis, excluding invents and subsidiaries, at cash, investments and net receivables of approximately $202 million or $4.47 per share. I will now turn the call back to Claude for some closing remarks.

[Claude LeBlanc, executive]

Thank you, David. This quarter represents an inflection point for Ambac as we made significant progress on all key strategic priorities: first, completing the transformation of Ambac to a pure-play specialty P&C company by entering into an agreement to sell our legacy financial guarantee business to Oaktree Capital; second, establishing a leading insurance distribution business through the combination of Beat and Cirrata. The execution of these strategic priorities is not an endpoint, but the beginning of our future. We have strong conviction that Ambac's go-forward business strategy provides a tremendous opportunity to create additional value for our shareholders through continued growth of our insurance distribution business, which has been materially advanced by the recent acquisition of Beat Capital Partners and positions us as a leading pure-play specialty P&C business.

Our focus remains on maximizing long-term shareholder value, which we are committed to doing by growing our specialty P&C businesses as well as through prudent capital allocation. I look forward to updating you on our progress in the coming quarters. Operator, please open the call for questions.

[Operator]

[Operator Instructions] Our first question comes from Giuliano Bologna with Compass Point.

[Giuliano Anderes-Bologna, analyst]

Maybe to kick off one of the notes in the presentation highlights that there's some potential obligations to fund minority interests at the MGAs, particularly range from $250 million to $370 million. I'm curious about the potential timing of that? And if you could maybe accelerate some of those or internalize some of the minority interest before some of those obligations are along the way.

[David Trick, executive]

Giuliano, thanks for the question. Yes. So those obligations relate primarily to the puts and the calls that we have with the MGAs that are currently part of the Cirrata family as well as now with the acquisition of Beat. So typically, when we partner up with these MGAs, we acquire about 80% on average -- 60% to 80% on average of MGAs and the remaining minority interest of 20% to 40%, we enter into put call arrangements. So we're coming to a point where on some of our earlier acquisitions, we're in the put call period for our first acquisition and others will be coming at a regular cadence at this point, including with Beat, which our first put call would be in 2026.

So we can't really accelerate them, but we are in a point in time in our evolution at Cirrata that these puts and calls are becoming in the case of the call, exercisable and the put, which should be more of the obligation could be put to us. So we do anticipate over the next couple of years, that we'll be exercising some of those calls and/or responding to some of those puts, which ultimately would be funded by cash on the balance sheet as well as potentially some external financing.

[Giuliano Anderes-Bologna, analyst]

That's very helpful. Then a slightly different topic. There's a discussion about $6 million share repurchase authorization, I'm curious about 2 different aspects around that. The first one is if there's any ability to accelerate any of that before potential sale of AAC closes, and the second one is $50 million is not necessarily immaterial to your market cap and you still have a 5% ownership limitation in place. I'm curious if there's any way to lift the 5% cap or if there's any interest in between the 5% cap or how you could work around that $50 million share repurchase program executed.

[Claude LeBlanc, executive]

Giuliano, the $50 million is a plan that we have indicated we will initiate immediately post close of the AAC transaction. We do have some additional capital available between now and close, but we have earmarked that for other business purposes and just prudent capital management. We're going to wait until we close the AAC transaction to officially along to that. You're right, it is a -- on the larger side, if you will, in terms of buybacks relative to our market cap, although as we've indicated, we believe that our share trading values are below our view of the value of the company, and we believe that, that gap, we hope will reduce between now and the closing of the transaction, potentially and actually with the close of the transaction.

But we do have strong conviction to deploy the full $50 million if market conditions are appropriate depending on where stock price is and as it relates to the 5% limitation, while that is something that we'll keep a close eye on as we progress. We have developed a plan to mitigate the risk of that. But we won't be using that as a hard line in the event that there was potentially some shift. That's something that we'll be prepared to deal with, although we're not looking to create ship that would, in any way, jeopardize the NOLs.

[Giuliano Anderes-Bologna, analyst]

That's helpful. And then just thinking about -- obviously, there are 2 moving parts between now and the closing of the transaction in terms of holdco liquidity moving around. But I'm curious, when you think about further out, I'm curious how you think about holdco leverage and how much leverage you might be willing to use the holding company level to fund additional growth opportunities Yes. Or just different investments for the platform.

[David Trick, executive]

Sure, Giuliano. So we are not afraid to leverage, certainly, we could use leverage if it makes economic sense. We want to -- we're going to leverage the company, whether it's because of puts and calls or other acquisition opportunities, it's going to be measured against what the profile of those investments and acquisitions are to make sure that we have the right leverage for the balance sheet that protects the balance sheet at the end of the today. That's our primary goal is to grow the business in a responsible way and protect the balance sheet and optimize the financial flexibility.

But as a normal course company and growing company now, leverage makes a lot of sense, and it's one of the ways that we can optimize our cost of capital and the efficiency of our balance sheet so I think over a longer term, as a normalized level of leverage could be in the range of 2 to 3 -- 2 to 4x EBITDA that may peak up at certain point in time depending on short-term transactions. But as a normal cost that seems to be the level of leverage that would make sense for us over the long term.

[Giuliano Anderes-Bologna, analyst]

That's very helpful. Appreciate the time.

[Operator]

Our next question comes from Deepak Sarpangal, with Repertoire Partners.

[Deepak Sarpangal, analyst]

Thank you. Good morning, Claude, David and Chuck. One quick follow-up first, just given the first question from Giuliano on the put call potential obligations or opportunity. So on Slide 15, you had listed this $250 million to $370 million over the next 5 years. How much of that relates to Beat and how much -- versus how much of it relates to the previous ends?

[David Trick, executive]

Certainly, it will -- the relative value, if you will, will shift depending on the performance of each of the businesses. And these are typically structured in a way that's a result of a multiple of future EBITDA. So giving that range gives an effect to a few things. So ultimately, the larger portion of that is related to Beat, that's the smaller portion of it at current expectations of performance is related to the existing MGAs.

[Deepak Sarpangal, analyst]

And maybe this touches on the comment David just made about the company being in a stronger position and ultimately, the most efficient balance sheet, including a certain amount of leverage. But in the range that you gave for $250 million to $370 million, you previously said that those multiples should be similar to what you paid for Beat so let's call it, roughly 16x EBITDA. So if I take $250 and $370 million divided by 16, we're talking about probably an incremental $15 million to $23 million of EBITDA that you can acquire.

But tell me if my math is incorrect, but what that looks like to me is that effectively -- because I know some of these are contingent on performance that in those scenarios, you're talking about roughly doubling your EBITDA, at least as it relates to something like Beat, correct?

[David Trick, executive]

So there's 2 components of that. First of all, the existing MGAs we have set schedules in terms of what the multiples are. And there's certainly a range there of multiples we could pay for the minority interest but I don't believe any of those touch 16. I think the range on those -- I know from 10 to 14, let's say, and then, of course, as it relates to Beat, we have acquired 60%, so the opportunity to acquire additional 40%, nearly comes close to doubling of course, the available EBITDA there.

But also in the Beat structure, you may recall, Beat owns a number of MGAs in which they own a majority stake 60% to 70%. And we also have negotiated for the ability to acquire those minority interest or a portion of those minority interest in the actual MGAs at a discount to that multiple that you mentioned.

[Deepak Sarpangal, analyst]

Okay. Yes. So I mean, I think the point being that given that effectively, there's likely some EBITDA growth involved in that? And with David's comment that you do have both access to and a willingness to borrow prudently when it makes sense that some portion of that incremental EBITDA would effectively increase your cash available for -- from debt financing. So some of that would kind of further reduce kind of the amount of reserve that you might need. And I think there's a lot of interesting information on the Slide 15. I guess one clarification I wanted to make is that in your current plan, which I understand is conservative and prudent -- you've got the initial $50 million share repurchase plan.

And as Claude referenced, you'll be able to consider and evaluate additional capital returns beyond that measured against other opportunities. It looks here that you also have a $50 million cash reserve and that you are assuming the repayment of the bridge and co-investment. So -- but even after all of that at the bottom of this slide, there's almost $200 million of excess cash available to both grow the business as well as for additional capital returns. Is that correct?

[David Trick, executive]

That's correct.

[Deepak Sarpangal, analyst]

Got it. right. And so -- and even in the event that you were able to utilize some debt financing once you repay the bridge that could be well over $200 million and still leaving you with a $50 million cash reserve. So really liking the position that we should be in as we approach the close of this deal. And then I thought it might be helpful to get a better sense of verification because it was a really interesting comment that Claude made about -- first of all, I appreciate like a lot of work that would have gone into the merger proxy and there's a lot of information there.

You've got the initial share repurchase program and it is depending on market conditions. But -- so obviously, there's all kinds of things that could happen, especially by that point. But you have the flexibility both to adjust that in either direction, including, as you referenced, if the stock price is in a position where it remains substantially dislocated from fair value, you have the ability to do a significant amount more than that $50 million, correct?

[Claude LeBlanc, executive]

That is correct.

[Deepak Sarpangal, analyst]

And I guess, just for the voice of doubt because we certainly have a view that there's been a lot of very favorable progress and development with the company, and we appreciate your stewardship of that without predicting the future based on how things currently stand today at anything -- if hypothetically, we were at today's stock price around the course of the deal. Would you agree or disagree that the overwhelmingly attractive use of capital would be to take advantage of that and to create accretion and benefit from this wide disconnect in your share price from fair value.

[Claude LeBlanc, executive]

Yes. Certainly, at these levels, and I think we're closer to certainly the numbers that we were pre announcement, where we are today. There's tremendous return value. So we have strong conviction into that range, and we will always continue to balance it against other opportunities that we're looking at. But I think we're now looking at this from a much longer-term perspective on growth and value creation than simply the events of the sale of the purchase. We have very strong conviction around our growth prospects for this combined throughout a Beat platform going forward. And we are also going to be very active in working with the investor community to ensure that our message is getting out there on our growth opportunities going forward.

So we will keep those considerations in balance. But given where the stock price is today, there's no question that we are -- we have strong conviction in purchasing our stock at these levels and we'll do that for so long as there's opportunities to do that.

[Deepak Sarpangal, analyst]

That's great. Look, we think that the growth opportunities are really exciting. And again, we think that the market hasn't really come around to fully appreciating that. And so hopefully, we can't take advantage of both of those situations, the inorganic growth opportunity, the organic growth investments and buying ourselves at a very large discount. And effectively buying down the price of our already attractive acquisitions. One quick clarification as well -- second call, which is on the transaction costs I think there was a footnote on Slide 22, if I'm not mistaken, that the Q2 noncompensation expense included the costs related to the transactions totaling $15.6 million, can you -- how much of the transaction expenses have already been expensed versus remain to be expensed. And then how much of the transaction expenses have already been paid versus still need to be paid?

[David Trick, executive]

Sorry, I didn't hear the latter part of that, but...

[Deepak Sarpangal, analyst]

I was curious how much of it was already expensed because I know in the merger proxy, there was like I think it's like $22 million total, including the past 2 years and then -- but there was like $6 million contingent on the close of the AAC sale and some of it may have already been expensed in the P&L. So kind of like what's both the amount that's been accrued or expense? And then what's the amount that like has actually been dispersed, if you will remaining. Yes.

[David Trick, executive]

So the amounts in the first quarter were primarily accrued expenses. What's to come is really bankings related to investment bankers on each of the transactions. So additional expenses to come and there's, of course, variability in some of the legal expenses say a significant portion of the expenses have been accrued, but there is some additional expenses that will be incurred in the third quarter as it relates to Beat and then assuming it close in the fourth quarter of the AAC transaction fourth quarter for the AAC transaction.

[Deepak Sarpangal, analyst]

Okay. That sounds great. But congratulations on closing the Beat deal and look forward to closing the AAC transaction as well. And continuing to advance our various strategic priorities.

[Claude LeBlanc, executive]

Thanks Deepak.

[Operator]

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.