|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995
In this discussion, we have included statements that may constitute “forward-looking statements” within the meaning of the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and
outside our control. These statements may relate to our future plans and objectives, among other things. By identifying these statements for you in this manner, we are alerting you to the possibility that our actual results may differ, possibly
materially, from the anticipated results indicated in these forward-looking statements. Important factors that could cause our results to differ, possibly materially, from those indicated in the forward-looking statements include, among others,
those discussed under “Risk Factors” in Part I, Item 1A of the Annual Report on Form 10-K and “Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995” in Part I, Item 1 of the Annual
Report on Form 10-K.
Any or all of management’s forward-looking statements here or in other publications may turn out to be wrong and
are based on current expectations and the current economic environment. Ambac’s actual results may vary materially, and there are no guarantees about the performance of Ambac’s securities. Among factors that could cause actual results to
differ materially are: (1) changes in the economic, credit, foreign currency or interest rate environment in the United States and abroad; (2) the level of activity within the national and worldwide credit markets; (3) competitive
conditions and pricing levels; (4) legislative and regulatory developments; (5) changes in tax laws; (6) the policies and actions of the United States and other governments; (7) changes in capital requirements whether resulting
from large numbers of downgrades in our insured portfolio or changes in rating agencies’ rating criteria with respect to financial guaranty insurers; (8) changes in Ambac’s and/or Ambac Assurance’s credit or financial strength
ratings; (9) changes in accounting principles or practices that may impact Ambac’s reported financial results; (10) inadequacy of reserves established for losses and loss expenses; (11) default of one or more of Ambac
Assurance’s reinsurers; (12) market spreads and pricing on insured pooled debt obligations and other derivative products insured or issued by Ambac; (13) prepayment speeds on insured asset-backed securities; and (14) other risks
and uncertainties that have not been identified at this time. Ambac is not obligated to publicly correct or update any forward-looking statement if we later become aware that it is not likely to be achieved, except as required by law. You are
advised, however, to consult any further disclosures we make on related subjects in Ambac’s reports to the SEC.
Introduction
Ambac Financial Group, Inc., headquartered in New York City, is a holding company whose subsidiaries provide financial guarantee products and other
financial services to clients in both the public and private sectors around the world.
Ambac’s principal operating subsidiary, Ambac
Assurance Corporation, a leading guarantor of public finance and structured finance obligations, has earned triple-A financial strength ratings, the highest ratings available from Moody’s Investors Service, Inc., Standard & Poor’s
Ratings Services, and Fitch Inc. Please refer to Capital and Capital Support within the Liquidity and Capital Resources section of this Management’s Discussion and Analysis for further discussion on these triple-A ratings’ importance to
our business. Financial guarantee
21
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
insurance is a promise to pay scheduled interest and principal if the issuer fails to meet its obligations. A bond guaranteed by Ambac Assurance receives
triple-A ratings, typically resulting in lower financing costs for the issuer and generally makes the issue more marketable, both in the primary and secondary markets. As an alternative to financial guarantee insurance, credit protection relating to
a particular pool of assets, security or issuer can be provided through a credit derivative.
Ambac’s activities are divided into two
business segments: (i) Financial Guarantee and (ii) Financial Services.
Ambac reports its financial guarantee business segment
broken out by three principal markets: Public Finance, Structured Finance and International Finance. Public Finance includes all U.S. municipal issuance including general obligations, lease and tax-backed obligations, health care, public utilities,
transportation and higher education, as well as certain infrastructure privatization transactions, such as toll road and bridge financings, public transportation financings, stadium financings, military housing and student housing. Structured
Finance obligations include securitizations of a variety of asset types such as mortgage loans, home equity loans, student loans, credit card receivables, operating assets, leases, pooled debt obligations, investor-owned utilities and asset-backed
commercial paper conduits originated in the U.S. Included within the operating asset sector are securitizations including aircraft, rental car fleets, shipping containers, rail cars, film rights, franchise fees, pharmaceutical royalties, and
intellectual property. International Finance covers public purpose infrastructure projects, utilities, and various types of structured financings originated outside of the U.S, including asset-backed securities, whole business and future flow
securitizations. International structured financings also encompass pooled debt obligations that may include significant components of domestic exposures.
Management believes that the financial guarantee business thrives on economic cycles. For example, a strong economic environment with good or improving credit is beneficial to our financial guarantee portfolio.
However, such conditions, if in place for an extended period of time, will reduce credit spreads and result in lower pricing. Conversely, in a deteriorating credit environment, credit spreads widen and pricing for our product improves. However, if
the weakening environment is sudden, pronounced or prolonged, the stresses on our portfolio could result in claims payments in excess of normal or historical expectations. Ambac’s management believes that its business is well positioned to
withstand, and in fact prosper, within normal economic and business cycles. Further, Ambac’s financial guarantee business today enjoys a strong competitive position in a variety of product segments on a global scale and is positioned for
further geographic product expansion. Management believes that geographic product expansion will be driven, over the long term, by critical infrastructure needs worldwide and the expansion of global credit markets.
Ambac’s Financial Services segment provides financial and investment products including investment agreements, interest rate swaps, currency swaps,
and funding conduits, principally to clients of the financial guarantee business. Additionally, the Financial Services segment enters into total return swaps with professional counterparties. Ambac focuses on these businesses due to the
complementary nature of the products to its financial guarantee product.
22
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
Overview
Ambac’s diluted (loss) earnings per share were ($3.53) and $0.25 for the three and nine months ended September 30, 2007, a large decrease from $1.98 per diluted share in the third quarter of 2006 and a (96%) decrease from
$6.26 per diluted share in the nine months ended September 30, 2006. These negative variances were primarily driven by (i) a pre-tax unrealized mark-to-market loss on credit derivative exposures of ($743.4) million or ($5.31) per diluted
share and ($805.4) million or ($5.63) per diluted share for the three and nine months ended September 30, 2007, respectively, resulting from unfavorable market pricing of collateralized debt obligations with significant amounts of sub-prime
residential mortgage collateral, and (ii) higher loss and loss expenses in 2007. In addition, the nine months ended September 30, 2007 earnings variance was impacted by a large gain in 2006 from the sale of three aircraft related to a
previously reported defaulted enhanced equipment trust certificate (reported as “Other Income” in the accompanying Consolidated Statements of Operations). Return on average shareholders’ equity was (24.7%) and 0.6% for the three
and nine months ended September 30, 2007, respectively, compared to 14.7% and 15.8% for the three and nine months ended September 30, 2006, respectively.
During the first half of 2007, Ambac completed the buyback of $400 million of its common stock under its accelerated share buyback program. The total number of shares purchased under the agreement amounted to
4.46 million common shares.
Critical Accounting Estimates
The discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting
principles (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses and related disclosure of contingent assets and
liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.
Critical accounting estimates are defined as those that require management to make significant judgments and could potentially result in materially different results under different assumptions and conditions. Management has identified the
accounting for loss and loss expenses and the valuation of financial instruments as critical accounting estimates. This discussion should be read in conjunction with the consolidated financial statements and notes thereon included elsewhere in this
report, and in the 2006 Form 10-K filed with the SEC on March 1, 2007.
Financial Guarantee Insurance Losses and Loss
Expenses
. The loss reserve for financial guarantee insurance discussed herein relates only to Ambac’s non-derivative insurance business. Losses and loss expenses are based upon estimates of the ultimate aggregate losses inherent in the
non-derivative Financial Guarantee portfolio as of the reporting date. The evaluation process for determining the level of reserves is subject to certain estimates and judgments.
23
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
The liability for losses and loss expenses consists of active credit and case basis credit reserves.
Ambac establishes an active credit reserve to reflect probable and estimable losses due to credit deterioration on insured credits that have not yet defaulted or been reported as of the reporting date. The active credit reserve is established
through a process that estimates probable losses inherent in the adversely classified credit portfolio. These estimates are based upon: (i) Ambac’s internal system of credit ratings, which are analogous to the risk ratings of the major
rating agencies; (ii) internally developed historical default information (taking into consideration ratings and average life of an obligation); (iii) internally developed loss severity assumptions; and (iv) the net par outstanding on
the adversely classified credit. The loss severity assumptions and default information are based on rating agency information and are specific to each bond type and are established and approved by Ambac’s Portfolio Risk Management Committee.
The Portfolio Risk Management Committee is comprised of senior risk management professionals and other senior management of Ambac. Our Surveillance group is responsible for designating the classified rating of individual credits and assigning credit
ratings, which in turn affect default probabilities used in estimating active credit reserves.
For certain adversely classified credit
exposures, Ambac’s additional monitoring and loss remediation efforts may provide information relevant to the estimate of the active credit reserve. Additional remediation activities which inform our estimates of the active credit reserves can
include various actions by Ambac. The most common actions include obtaining detailed appraisal information on collateral;, more frequent meetings with the issuer’s or servicer’s management to review operations, financial condition and
financial forecasts and more frequent analysis of the issuer’s financial statements. In estimating the active credit reserve Ambac uses relevant credit-specific information obtained from its remediation efforts to supplement the statistical
approach discussed above.
Case basis credit reserves are established for losses on insured obligations that have already defaulted. We
believe our definition of case basis credit reserves differs from other financial guarantee industry participants. Our case reserves represent the present value of anticipated loss and loss expense payments expected over the estimated period of
default. Loss and loss expenses consider defaulted debt service payments, estimated expenses associated with settling the claims and estimated recoveries under collateral and subrogation rights.
The primary assumptions impacting the estimate of loss reserves are the probability of default and severity of loss given a default. The probability of
default assumption represents the percentage chance that a particular insured obligation will default over its remaining life. Probability of default assumptions are based upon rating agency studies of bond defaults given a particular asset class,
rating and remaining tenor of an underlying obligation, modified as appropriate by Ambac’s experience and judgment. Severity of loss represents the amount of loss that would be incurred on a defaulted obligation due to the difference in the
amount of net par guaranteed and the value of the related collateral and other subrogation rights. Loss severity estimates are based upon available evidence such as rating agency recovery rates with respect to debt obligations in the particular
asset class, review of financial statements, collateral performance, and/or surveillance data such as collateral appraisals. However, when credits are in default or have specific attributes that warrant an adjustment, we typically develop a best
estimate of the loss based upon transaction specific elements rather than a statistical loss as our knowledge is greater as to the ultimate outcome of these credits due to our surveillance and remediation activity.
24
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
For the active credit reserve component of our total reserves, as the probability of default for an
individual credit increases and/or the severity of loss given a default increases, our loss reserve for that insured obligation will also increase. Political, economic or other unforeseen events could have an adverse impact on default probabilities
and loss severities. Downgrades to the underlying rating of a classified credit, particularly those individual credits with a large net par balance, could have a significant impact on our reserves. Case basis credit reserves are only sensitive to
severity assumptions because the underlying financial obligation has already defaulted (that is, a 100% probability of default).
Adjustments to our loss reserves may create volatility in our financial results in any given quarter or year. Loss reserve volatility will be a direct result of the credit performance of our insured portfolio including the number, size,
asset classes and quality of credits included on our classified list. The number and severity of adversely classified credits depend to a large extent on transaction specific attributes, but will generally increase during periods of economic stress
and decline during periods of economic stability. Due to the small number of credits and size of certain individual adversely classified credits, modest changes in underlying ratings or classifications can have a large impact on any quarter’s
provision for losses and loss expenses. Furthermore, external influences on our transactions beyond our control may result in favorable or unfavorable development on our reserves. Historically Ambac has not ceded large percentages of outstanding
exposures to our reinsurers, therefore, reinsurance recoveries have not had a significant effect on loss reserve volatility. The table below indicates the number of credits and net par outstanding for case reserves and active credit reserves on
non-investment grade credits at September 30, 2007:
|
|
|
|
|
|
|
|
|
|
|
$ in millions
|
|
Number of
credits
|
|
Net par
outstanding
|
|
Net Loss
Reserves
(1)
|
|
Active credit reserves
|
|
48
|
|
$
|
1,860
|
|
$
|
166.7
|
|
Case reserves
|
|
10
|
|
|
822
|
|
|
107.1
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
58
|
|
$
|
2,682
|
|
$
|
273.8
|
|
(1)
|
Net of reinsurance recoverable on unpaid losses of $10.3 million.
|
Ambac has exposure to various bond types issued in the debt capital markets. Our experience has shown that for the majority of bond types, we have not experienced claims and therefore the estimate of loss severity has remained constant.
However, for certain bond types, Ambac has loss experience that indicates that factors or events could have a material impact on the original estimate of loss severity. We have observed that, with respect to four bond types in particular, it is
reasonably possible that a material change in actual loss severities could occur over time. These four bond types are healthcare institutions, aircraft lease securitizations known as Enhanced Equipment Trust Certificates (“EETC”),
collateralized debt obligations (“CDOs”) and mortgage-backed and home equity securitizations. These four bond kinds represent 52% of our ever-to-date claim payments. Typically, bonds insured by Ambac in the healthcare sector are secured by
revenues generated by a hospital enterprise. The value of a hospital and its ability to generate revenues are primarily impacted by the essentiality of that hospital enterprise to a particular community. For example, hospitals that do not have
significant competition in a community generally have more stable collateral values than facilities in communities with significant competition. Intense competition in the global airline industry and high energy costs could adversely impact our EETC
transactions. We currently do not have any exposure to EETC in our classified credit portfolio. Continued increases in residential mortgage defaults as a result of fraud, foreclosures, increases in
25
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
interest rates, unemployment and/or personal bankruptcies could adversely impact residential real estate values and the probability of default and severity
of loss for our transactions. As a result of our experience to date, we note that the mortgage-backed and home equity ultimate severities have usually been less than or equal to our current severity assumption. However, our past experience had been
observed during a period of rising real estate values for much of the United States and past results are no indication of future performance. When calculating modeled loss estimates for an insured CDO obligation, Ambac considers the unique
attributes of the underlying collateral and transaction. It is reasonably possible that loss estimates for CDOs may increase as a result of increased probability of default and severity of loss of the underlying collateral; however Ambac’s
exposure to CDOs in its classified credit portfolio is currently limited.
Currently, the credits that comprise our case basis credit
reserves primarily include mortgage-backed and home equities from the four bond kinds discussed above as well as transportation credits. The case basis credit reserve, net of reinsurance for mortgage-backed and home equity transactions, was
approximately $60.8 million at September 30, 2007.
Generally, severity assumptions are established within our ACR for entire asset
classes and therefore represent an average severity of loss given a default. However, it is our experience that ultimate severity outcomes often vary from averages. Therefore, we have not provided reasonably possible negative scenarios for the
severity assumption. The table below outlines the estimated impact on the September 30, 2007 consolidated loss reserve from reasonably possible increases in the probability of default estimate arising via an assumption of one full letter
downgrade for each credit (including both investment grade and non-investment grade) of the appropriate bond type that presently resides within the adversely classified credit listing.
|
|
|
|
|
|
|
|
|
(Dollars in millions)
Category
|
|
Net Par
Outstanding
|
|
Increase
in
Reserve
Estimate
|
|
Transportation
|
|
$
|
1,074
|
|
$
|
77
|
|
Mortgage-backed and home equity
|
|
$
|
1,274
|
|
$
|
74
|
|
Health care
|
|
$
|
446
|
|
$
|
39
|
Ambac’s management believes that the reserves for losses and loss expenses are adequate to
cover the ultimate net cost of claims, but the reserves are based on estimates and there can be no assurance that the ultimate liability for losses will not exceed such estimates.
Valuation of Financial Instruments
. The fair market values of financial instruments held are determined by using independent market quotes
when available and valuation models when market quotes are not available. Ambac’s financial instruments categorized as assets are mainly comprised of investments in fixed income securities and derivative contracts.
Investments in fixed income securities are accounted for in accordance with Statement of Financial Accounting Standards (“SFAS”) 115,
“Accounting for Certain Investments in Debt and Equity Securities”. SFAS 115 requires that all debt instruments and certain equity instruments be classified in Ambac’s balance sheet according to their purpose and, depending
26
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
on that classification, be carried at either cost or fair market value. The fair values of fixed income investments are based primarily on quoted market
prices received from a nationally recognized pricing service or dealer quotes. For those fixed income investments where quotes were not available, fair values are based on internal valuation models. Key inputs to the internal valuation models
include maturity date, coupon and generic yield curves for industry and credit rating characteristics that closely match those characteristics of the specific investment securities being valued. Valuation results, particularly those derived from
valuation models, could differ materially from amounts that would actually be realized in the market. Approximately 2% of the investment portfolio was valued using internal valuation models at September 30, 2007 and December 31, 2006.
Ambac’s exposure to derivative instruments is created through interest rate, currency, total return and credit default swaps. These
contracts are accounted for at fair value under SFAS 133 “Accounting for Derivative Instruments and Certain Hedging Activities,” as amended (“SFAS 133”). Fair value is determined based upon market quotes from independent sources,
when available. When independent quotes are not available, fair value is determined using valuation models. These valuation models require market-driven inputs, including contractual terms, credit spreads and ratings on underlying referenced
obligations, yield curves and tax-exempt interest ratios. Due to the size of both the portfolio and individual credits and correlation in our credit derivative portfolio, modest changes in factors that impact their fair value can have a large impact
on any quarter’s mark-to-market gains or losses. Fair value of credit derivative contracts are primarily driven by the fair value of their underlying reference obligations which are in turn driven primarily by market perceptions of credit and
liquidity risk of such reference obligation. As the credit protection provider, Ambac assumes only credit risk; we do not assume liquidity risk or other risks and costs inherent in direct ownership of the underlying reference securities. Therefore
we typically receive only a portion of the return demanded by securities holders as fees to provide credit protection on such securities. Because of this relationship and in the absence of severe credit deterioration, changes in the fair value of
our credit default swaps will generally be less than changes in the fair value of the underlying reference obligations. So far in the fourth quarter of 2007, we have observed a continued lack of liquidity and credit deterioration in the
collateralized debt obligation market and as a result may experience future mark-to-market losses. Please refer to Item 3. “Quantitative and Qualitative Disclosures About Market Risk” for fair value sensitivities for our credit
derivative portfolio as a result of changes in credit spreads.
The net fair value of all derivative contracts at September 30, 2007
and December 31, 2006 was ($451) million and $352 million, respectively. This decrease in net asset value relates primarily to the unrealized mark-to-market loss on credit derivatives during the first nine months of 2007.
Ambac uses both vendor-developed and proprietary models, based on the complexity of transactions. The selection of a model to value a derivative depends
on the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. For derivatives that are less complex and trade in liquid markets, such as interest rate and currency
swaps, we utilize vendor-developed models. For derivatives that trade in less liquid markets, such as credit derivatives on collateralized debt obligations and total return swaps, a proprietary model is used because such instruments tend to be more
complex and pricing information is not readily available in the market. These models and the related assumptions are continuously re-evaluated by management and enhanced, as
27
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
appropriate, based on improvements in modeling techniques. Key variables used in our valuation of credit derivatives on collateralized debt obligations
include the balance of unpaid notional, tenor, fair values of the underlying reference obligations and assumptions about the portion of fair value changes attributable to credit versus liquidity risk and other factors. The fair values of the
underlying reference obligations are obtained from broker quotes when available, or are derived from other market indications such as new issuance spreads for similar transactions.In accordance with the Emerging Issues Task Force (“EITF”)
Issue 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (“EITF 02-3”), recognition of a trading profit or loss at
inception of a derivative transaction is prohibited unless fair value of that derivative is obtained from a quoted market price, supported by comparison to other observable market transactions, or based upon a valuation technique incorporating
observable market data. Ambac defers trade date gains or losses on derivative transactions where the fair value is not determined based upon observable market transactions and market data. Management’s judgment is applied in recording
adjustments to fair value that take into account various factors, including but not limited to, credit risk, future administration costs, the bid offer spread and illiquidity due to lack of market depth. The FASB issued SFAS 157, “Fair Value
Measurements” in September 2006 which is effective for financial statements issued for fiscal years beginning after November 15, 2007 and will supersede the guidance in EITF 02-3. Please refer to Note 9 of the Consolidated Financial
Statements for further discussion on how SFAS 157 will impact derivative transaction gains and losses.
Results of Operations
The following paragraphs describe the consolidated results of operations of Ambac and its subsidiaries for the three and nine months ended
September 30, 2007 and 2006, and its financial condition as of September 30, 2007 and December 31, 2006.
Consolidated
Net Income
Ambac’s net (loss) income for the three months ended September 30, 2007 was ($360.6) million or ($3.53) per
diluted share, a decrease of $574.1 million or ($5.51) per diluted share, compared to $213.5 million, or $1.98 per diluted share in the three months ended September 30, 2006. Ambac’s (loss) before income taxes was ($494.9) million for the
three months ended September 30, 2007, a decrease from income before income taxes of $297.1 million in the three months ended September 30, 2006. Of the ($494.9) million of loss before income taxes in the third quarter of 2007, ($463.7)
million was from Financial Guarantee, ($7.3) million from Financial Services and $(23.9) million from Corporate, compared to $301.0 million, $15.1 million and $(19.0) million for Financial Guarantee, Financial Services and Corporate, respectively,
in the third quarter of 2006. Corporate consists primarily of Ambac’s interest expense on its long-term debentures outstanding, partially offset by interest income on investments held at the parent company.
Financial Guarantee net income for the three months ended September 30, 2007 decreased primarily as a result of unrealized mark-to-market losses on
credit derivative exposures driven primarily by the impact of market pricing of pooled debt obligations with significant amounts of sub-prime residential mortgage collateral, a higher provision for loss and
28
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
loss expenses, lower other income and higher underwriting and operating expenses, partially offset by higher net investment income. The Financial Services
segment decrease in the third quarter of 2007 is primarily attributable to net mark-to-market losses on total return swaps, lower net realized gains compared to the third quarter of 2006 (which included recoveries received from National Century
Financial Enterprises, Inc. (“NCFE”)), as well as lower revenue from the derivative product and the investment agreement businesses.
Ambac’s net income for the nine months ended September 30, 2007 was $25.8 million or $0.25 per diluted share, a decrease of ($647.4) million compared to $673.2 million, or $6.26 per diluted share in the nine months ended
September 30, 2006. Ambac’s income before income taxes was $26.4 million for the nine months ended September 30, 2007, a decrease of 97% from income before income taxes of $925.8 million in the nine months ended September 30,
2006. Of the $26.4 million of income before income taxes in the nine months ended September 30, 2007, $80.9 million was from Financial Guarantee, $14.7 million from Financial Services and $(69.2) million from Corporate, compared to $899.1
million, $85.0 million and $(58.3) million for Financial Guarantee, Financial Services and Corporate, respectively, in the nine months ended September 30, 2006.
Financial Guarantee net income for the nine months ended September 30, 2007 decreased primarily as a result of the unrealized mark-to-market losses on credit derivative exposures mentioned above, lower other
income compared to the comparable period in 2006 (which included recoveries from the sale of three aircraft from a defaulted enhanced equipment trust certificate transaction), and a higher provision for loss and loss expenses, partially offset by
higher net premiums earned and higher net investment income. The Financial Services segment decrease in the nine months of 2007 is primarily attributable to lower net realized gains as mentioned above, net mark-to-market losses on total return swaps
and lower revenues from the derivative product and investment agreement businesses.
Included in the nine months ended September 30,
2006 income before income taxes in the Financial Guarantee segment, is the impact from cancellations of the remaining reinsurance contracts with AXA Re Finance S.A. (“AXA Re”) and American Re-Insurance Company (“American Re”).
The insured par that was recaptured as a result of the cancellation totaled approximately $3.9 billion. Included in ceded premiums written in Ambac’s Consolidated Statement of Operations is $37.0 million in returned premiums from the
cancellation, of which $29.3 million was deferred. The difference, $7.7 million, included in net earned premiums, results from the difference between the negotiated amount of returned premiums and the associated unearned premium remaining on the
previously ceded portion of the underlying guarantees. The net impact of this cancellation to the Consolidated Statement of Operations amounted to approximately $3.1 million, $2.0 million after-tax.
Financial Guarantee Segment
Ambac
provides financial guarantees in respect of debt obligations through its principal operating subsidiary, Ambac Assurance Corporation, as well as credit protection in the form of credit derivatives through Ambac Credit Products LLC, a wholly owned
subsidiary of Ambac Assurance. Ambac provides these services in three principal markets: public finance, structured finance and international finance.
29
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
Ambac Assurance guaranteed $33.4 billion of gross par value bonds during the three months ended
September 30, 2007, an increase of 25% from $26.7 billion during the comparable prior year period. During the nine months ended September 30, 2007, Ambac Assurance guaranteed $103.9 billion in par value debt obligations, an 8% increase
from $96.5 billion in par value debt obligations guaranteed in the nine months ended September 30, 2006.
The following table provides
a breakdown of guaranteed net par outstanding by market sector at September 30, 2007 and December 31, 2006:
|
|
|
|
|
|
|
|
|
(Dollars in billions)
|
|
September 30,
2007
|
|
December 31,
2006
|
|
Public Finance
|
|
$
|
300.0
|
|
$
|
282.2
|
|
Structured Finance
|
|
|
176.7
|
|
|
162.6
|
|
International Finance
|
|
|
79.5
|
|
|
74.2
|
|
|
|
|
|
|
|
|
|
Total net par outstanding
|
|
$
|
556.2
|
|
$
|
519.0
|
|
|
|
|
|
|
|
|
30
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
The following tables provide a rating distribution of guaranteed net par outstanding based upon
internal Ambac Assurance credit ratings at September 30, 2007 and December 31, 2006 and a distribution by bond type of Ambac Assurance’s below investment grade exposures at September 30, 2007 and December 31, 2006. Below
investment grade is defined as those exposures with a credit rating below BBB-:
|
|
|
|
|
|
|
|
|
|
|
Percentage of Guaranteed Portfolio
(1)
|
|
|
|
|
September 30,
2007
|
|
|
December 31,
2006
|
|
|
AAA
|
|
18
|
%
|
|
16
|
%
|
|
AA
|
|
21
|
|
|
20
|
|
|
A
|
|
41
|
|
|
43
|
|
|
BBB
|
|
20
|
|
|
20
|
|
|
Below investment grade
|
|
<1
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
100
|
%
|
|
100
|
%
|
|
|
|
|
|
|
|
|
Summary of Below Investment Grade Exposure
(1)
|
|
|
|
|
|
|
|
|
Bond Type
|
|
September 30,
|
|
December 31,
|
|
(Dollars in millions)
|
|
2007
|
|
2006
|
|
Public Finance:
|
|
|
|
|
|
|
|
Transportation
|
|
$
|
1,013
|
|
$
|
1,264
|
|
Health care
|
|
|
410
|
|
|
404
|
|
General obligation
|
|
|
184
|
|
|
292
|
|
Tax-backed
|
|
|
132
|
|
|
134
|
|
University
|
|
|
30
|
|
|
69
|
|
Other
|
|
|
121
|
|
|
120
|
|
|
|
|
|
|
|
|
|
Total Public Finance
|
|
|
1,890
|
|
|
2,283
|
|
|
|
|
|
|
|
|
|
Structured Finance:
|
|
|
|
|
|
|
|
Mortgage-backed and home equity
|
|
|
1,470
|
|
|
848
|
|
Enhanced equipment trust certificates
|
|
|
621
|
|
|
950
|
|
Investor-owned utilities
|
|
|
588
|
|
|
509
|
|
Pooled debt obligations
|
|
|
68
|
|
|
90
|
|
|
|
|
|
|
|
|
|
Total Structured Finance
|
|
|
2,747
|
|
|
2,397
|
|
|
|
|
|
|
|
|
|
International Finance:
|
|
|
|
|
|
|
|
Transportation revenue
|
|
|
30
|
|
|
397
|
|
Public finance infrastructure
|
|
|
—
|
|
|
149
|
|
Other
|
|
|
38
|
|
|
40
|
|
|
|
|
|
|
|
|
|
Total International Finance
|
|
|
68
|
|
|
586
|
|
|
|
|
|
|
|
|
|
Grand Total
|
|
$
|
4,705
|
|
$
|
5,266
|
|
|
|
|
|
|
|
|
|
(1)
|
Internal Ambac credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance. In cases where Ambac has
insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used. Ambac credit ratings are subject to revision at any time and do not
constitute investment advice. Ambac Assurance, or one of its affiliates, has insured the obligations listed and may also provide other products or services to the issuers of these obligations for which Ambac may have received premiums or fees.
|
31
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
The total number of credits with Ambac Assurance ratings below investment grade were 58 and 65 at
September 30, 2007 and December 31, 2006, respectively. The decrease in Public Finance transportation is primarily due to an upgrade of a transportation credit to investment grade. The increase in Structured Finance’s mortgage-backed
and home equity category is due to the downgrade of six transactions. The decrease in International Finance’s transportation revenue category is due to the refinancing of the Eurotunnel credit.
Structured Finance includes exposure to sub-prime and mid-prime first and second lien residential mortgage-backed securities. Ambac has exposure to the
U.S. sub-prime market through direct guarantees in our MBS portfolio, guarantees of pooled debt obligations and, to a lesser extent, guarantees of bank sponsored multi-seller conduits that contain residential mortgage-backed securities
(“RMBS”) in their collateral pool. Furthermore, Ambac has issued a $3 billion commitment to provide a financial guarantee on a pool of CDO of asset-backed securities, mostly RMBS. Currently, this pool is primarily comprised of CDOs that
were originated prior to 2006 (71%) and 83% of the pool is rated AA or better (48% rated AAA). Ambac is afforded first loss protection consistent with other collateralized debt obligations noted below.
MBS Portfolio exposure:
Ambac
classifies first-lien mortgage loan borrowers into three broad credit risk classes: prime, mid-prime and sub-prime. The most common statistical metric that is used to determine the credit risk of a borrower is the FICO score (Fair Isaac Credit
Organization). FICO credit scores are calculated by using models and mathematical tables that assign points for different pieces of information, which in their view, best predict future credit performance. Score-model developers find predictive
factors in the data that have proven to indicate future credit performance. Credit scores analyze a borrower’s credit history considering numerous factors such as: late payments, the amount of time credit has been established, the amount of
credit used versus the amount of credit available, length of time at present residence and negative credit information such as bankruptcies, charge-offs, collections, etc. FICO scores range from 300 to 850. Generally, FICO scores of these three
classifications are as follows: prime (FICO score over 710), mid-prime (FICO score between 640 and 710) and sub-prime (FICO score below 640). We have classified our insured exposures among these three classifications based on the predominant
characteristics of the securitized loan collateral as noted within the offering circular of the RMBS transaction.
Additionally, Ambac will
insure RMBS transactions that contain predominately underlying second-lien mortgage loans, such as home equity loans. A second lien mortgage loan is a type of loan in which the borrower uses the equity in their home as collateral and is subordinate
to the first lien on the home. The borrower is obligated to make monthly payments on both their first and second lien loans. If the borrower defaults on their payments due on these loans and the property is subsequently liquidated, the liquidation
proceeds are first allocated to pay off the first lien loan and any remaining funds are applied to pay off the second lien.
32
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
Ambac insures tranches issued in RMBS, including transactions that contain risks to the above types
of mortgages and risk classifications. We insure the RMBS from a given loss attachment point to the top of the capital structure. Recent downgrades by the major independent rating agencies have been concentrated in transactions which are comprised
principally of first and second lien mortgage loans originated during the 2005 – 2007 period. The following tables provide details with respect to US transactions issued in specified years and underlying credit rating of Ambac’s affected
RMBS book of business:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Net Par Outstanding
At September 30, 2007
|
|
|
Year of Issue *
($ in billions)
|
|
Second
Lien
|
|
|
Sub-prime
|
|
|
Mid-prime
|
|
|
1998-2001
|
|
$
|
0.3
|
|
|
$
|
1.2
|
|
|
<$
|
0.1
|
|
|
2002
|
|
|
0.4
|
|
|
|
1.2
|
|
|
|
0.1
|
|
|
2003
|
|
|
0.1
|
|
|
|
2.4
|
|
|
|
0.3
|
|
|
2004
|
|
|
2.7
|
|
|
|
0.8
|
|
|
|
0.7
|
|
|
2005
|
|
|
2.3
|
|
|
|
1.6
|
|
|
|
2.3
|
|
|
2006
|
|
|
6.8
|
|
|
|
1.0
|
|
|
|
0.6
|
|
|
2007
|
|
|
5.5
|
|
|
|
0.6
|
|
|
|
2.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
18.1
|
|
|
$
|
8.8
|
|
|
$
|
7.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% of Total MBS Portfolio
|
|
|
32.0
|
%
|
|
|
15.5
|
%
|
|
|
12.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent of Related RMBS
Transactions’ Net Par
|
|
|
Internal Ambac Credit
Rating*
|
|
Second
Lien
|
|
|
Sub-prime
|
|
|
Mid-prime
|
|
|
AAA
|
|
|
1
|
%
|
|
|
6
|
%
|
|
|
77
|
%
|
|
AA
|
|
|
<1
|
%
|
|
|
4
|
%
|
|
|
19
|
%
|
|
A
|
|
|
28
|
%
|
|
|
37
|
%
|
|
|
1
|
%
|
|
BBB
|
|
|
66
|
%
|
|
|
48
|
%
|
|
|
3
|
%
|
|
Below investment grade
|
|
|
5
|
%
|
|
|
5
|
%
|
|
|
0
|
%
|
|
*
|
Internal Ambac credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance. Ambac’s credit
ratings are subject to revision at any time and do not constitute investment advice. The insured RMBS in the BBB portion of the table are all relatively large senior tranches that reside at the top of the capital structure. Because of their size and
position in the capital structure, these tranches generally produce lower levels of loss severity, upon collateral default, than BBB-rated mezzanine tranches with similar collateral.
|
RMBS exposure in Collateralized Debt Obligations:
Ambac’s RMBS exposure embedded in CDOs relates primarily to the asset class commonly referred to as CDO of asset backed securities or CDO of ABS. Since Ambac has established a minimum requirement for
participation in these transactions to be a triple A rating from one or more of the major rating agencies, the existing transactions were executed at subordination levels that were well in excess of an initial rating agency triple A attachment point
(i.e. the level of subordination that was initially required to achieve such rating). Ambac’s participation in CDO of ABS transactions is at the senior class in the capital structure. Our exposure to sub-prime RMBS embedded in CDO of ABS
relates primarily to CDO of high-grade ABS transactions, but also includes CDO of mezzanine ABS transactions. At September 30, 2007, Ambac’s exposures to CDO of ABS, where the RMBS collateral represents greater than 25% of the collateral,
were $29.2 billion, of which $26.2 billion related to CDO of high-grade ABS. In October 2007, the independent rating agencies downgraded a number of MBS and CDO transactions. In addition, the junior tranches of some of our CDO of ABS transactions
have been downgraded or placed on the watch-list for negative rating action.
33
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
Our CDO of ABS transactions contain exposures to some of these downgraded transactions, which may impact pricing of such securities. If prices of these
securities are reduced, such reductions would cause mark-to-market losses in the fourth quarter of 2007.
High-grade CDO of ABS
transactions are typically comprised of underlying RMBS collateral generally originally rated single A through triple A by one or more of the major rating agencies at the inception of the CDO. High-grade transactions contain a mix of sub-prime,
mid-prime and prime mortgages. High-grade deals may contain components of other high-grade and mezzanine CDO exposure. These CDO components would also generally have single A through triple A ratings. The higher investment grade ratings of the
underlying collateral give rise to the term “high-grade.” Ambac’s CDO of high-grade ABS exposures have underlying collateral that consists of 39% sub-prime, 36% other RMBS and 13% mezzanine CDO exposures. The current ratings of the
sub-prime RMBS collateral is 8% Aaa, 41% Aa, 39% A, 8% Baa and 4% below investment grade.
CDO of mezzanine ABS transactions are structured
similar to high-grade transactions. The primary difference is that the underlying collateral exposure in a mezzanine transaction is comprised primarily of triple B originally rated tranches of sub-prime and mid-prime mortgages (at the inception of
the CDO). Typically, mezzanine transactions require a more significant level of subordination to achieve triple A credit ratings because of the lower credit quality of the underlying collateral pool.
Ambac typically provides credit protection in connection with CDOs through credit default swaps that replicate the protection provided by financial
guarantees. Credit default swaps are derivative contracts that are subject to mark to market accounting under generally accepted accounting principles. Ambac has tailored its credit derivative contracts to contain certain provisions that are similar
to our standard insurance contracts in order to mitigate certain liquidity risk that is inherent in standard credit derivative contracts. While derivative contracts generally provide for mark-to-market termination payments in the event a derivative
transaction is terminated early, Ambac has typically limited these events to its own payment default or bankruptcy.
The two key liquidity risk mitigation
terms are as follows:
|
|
•
|
|
“Pay as you go” in the event of a loss - The significant majority of our credit derivatives (post 2004) are written as “pay-as-you-go”. Similar
to an insurance policy execution, pay-as-you-go provides that we pay interest shortfalls on the referenced transaction as they are incurred on each scheduled payment date, but only pay principal shortfalls upon the earlier of (i) the date on
which all of the assets designated to fund the referenced obligation have been disposed of and all proceeds of those assets have been fully distributed to note holders and (ii) the legal final maturity date of the referenced obligation. Unlike
the dealer credit derivative contract, our contracts do not give the buyer of protection the option to physically settle upon the occurrence of a credit event; i.e. the protection buyer cannot deliver the reference obligation and for a payment equal
to the par amount of the reference obligation.
|
|
|
•
|
|
No collateral posting - None of our outstanding credit derivative transactions includes ratings based collateral triggers or otherwise require Ambac to post
collateral regardless of its ratings or the size of the mark to market exposure to Ambac.
|
34
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
Public Finance:
Public Finance bond obligations par value written was $14.2 billion for the three months ended September 30, 2007, which was 53% higher than $9.3
billion of par value written in the three months ended September 30, 2006. During the nine months ended September 30, 2007 par value written was $42.7 billion, which was 35% higher than $31.7 billion of par value written in the nine months
ended September 30, 2006. The increases were primarily due to higher overall market issuance, which were up 13% and 24% for the three and nine months ended September 30, 2007, respectively, partially offset by a lower percentage of bonds
issued with financial guarantee insurance. The overall market issuance for the nine months of 2007 was driven by both the new money (up 19%) and refundings (up 30%) components of the market. Ambac’s market share was 28.0% and 24.0% for the
three and nine months ended September 30, 2007, compared to 22.5% and 23.6% for the three and nine months ended September 30, 2006.
The table below shows the percentage, by bond type, of new Public Finance business gross par guaranteed by Ambac Assurance during the nine months of 2007 and the full year 2006.
New Business Guaranteed by Bond Type
|
|
|
|
|
|
|
|
|
Bond Type
|
|
Year-to-Date
2007
|
|
|
Full Year
2006
|
|
|
Public Finance:
|
|
|
|
|
|
|
|
Lease and tax-backed revenue
|
|
27
|
%
|
|
34
|
%
|
|
General obligation
|
|
27
|
%
|
|
24
|
%
|
|
Utility revenue
|
|
14
|
%
|
|
11
|
%
|
|
Health care revenue
|
|
9
|
%
|
|
10
|
%
|
|
Higher education
|
|
8
|
%
|
|
9
|
%
|
|
Transportation revenue
|
|
8
|
%
|
|
6
|
%
|
|
Housing revenue
|
|
6
|
%
|
|
4
|
%
|
|
Other
|
|
1
|
%
|
|
2
|
%
|
|
|
|
|
|
|
|
|
|
Total Public Finance
|
|
100
|
%
|
|
100
|
%
|
|
|
|
|
|
|
|
|
Structured Finance:
Structured Finance obligations par value written was $11.0 billion for the three months ended September 30, 2007, which was 14% lower than $12.8
billion of par value written in the three months ended September 30, 2006. During the nine months ended September 30, 2007, par value written was $45.5 billion, 12% lower compared to $51.6 billion in the nine months ended
September 30, 2006. The decreases in Structured Finance obligations guaranteed for the three months ended September 30, 2007 were primarily due to lower pooled debt obligations and lower mortgage-backed and home equity loan
securitizations, partially offset by higher student loan par guaranteed. In addition to the above, the decrease for the nine months ended September 30, 2007 also include lower asset-backed and conduits par guaranteed.
35
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
The table below shows the percentage, by bond type, of new Structured Finance business gross par
guaranteed by Ambac Assurance during the nine months of 2007 and the full year 2006.
New Business Guaranteed by Bond Type
|
|
|
|
|
|
|
|
|
Bond Type
|
|
Year-to-Date
2007
|
|
|
Full Year
2006
|
|
|
Structured Finance:
|
|
|
|
|
|
|
|
Pooled debt obligations
|
|
35
|
%
|
|
33
|
%
|
|
Mortgage-backed and home equity
|
|
30
|
%
|
|
30
|
%
|
|
Asset-backed and conduits
|
|
20
|
%
|
|
25
|
%
|
|
Student loan
|
|
11
|
%
|
|
5
|
%
|
|
Investor-owned utilities
|
|
4
|
%
|
|
4
|
%
|
|
Other
|
|
<1
|
%
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
Total U.S. Structured Finance
|
|
100
|
%
|
|
100
|
%
|
|
|
|
|
|
|
|
|
International Finance:
International Finance bond obligations par value written was $8.2 billion for the three months ended September 30, 2007, which was 78% higher than
$4.6 billion of par value written for the three months ended September 30, 2006. During the nine months ended September 30, 2007, par value written was $15.7 billion, which was 19% higher than $13.2 billion of par value written for the
nine months ended September 30, 2006. The increase in International Finance obligations guaranteed during the three months ended September 30, 2007 were primarily due to higher asset-backed and conduit obligations, sovereign/sub-sovereign
obligations, transportation obligations and investor-owned and public utility obligations, partially offset by lower pooled debt obligations. The increase in the nine months ended September 30, 2007 is primarily due to higher asset-backed and
conduit obligations and transportation obligations, partially offset by lower pooled debt and sovereign/sub-sovereign obligations.
The
table below shows the percentage, by bond type, of new International Finance business gross par guaranteed by Ambac Assurance during the nine months of 2007 and the full year 2006.
New Business Guaranteed by Bond Type
|
|
|
|
|
|
|
|
|
Bond Type
|
|
Year-to-Date
2007
|
|
|
Full Year
2006
|
|
|
International Finance:
|
|
|
|
|
|
|
|
Asset-backed and conduits
|
|
37
|
%
|
|
25
|
%
|
|
Pooled debt obligations
|
|
21
|
%
|
|
36
|
%
|
|
Sovereign/sub-sovereign
|
|
13
|
%
|
|
15
|
%
|
|
Investor-owned and public utilities
|
|
11
|
%
|
|
12
|
%
|
|
Transportation
|
|
10
|
%
|
|
6
|
%
|
|
Mortgage-backed and home equity
|
|
5
|
%
|
|
3
|
%
|
|
Other
|
|
3
|
%
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
Total International Finance
|
|
100
|
%
|
|
100
|
%
|
|
|
|
|
|
|
|
|
36
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
Gross Premiums Written
.
Gross premiums written for the three and nine months ended
September 30, 2007 were $286.6 million and $797.6 million, respectively, an increase of $74.3 million or 35% from $212.3 million in the three months ended September 30, 2006 and an increase of $52.7 million or 7% from $744.9 million in the
nine months ended September 30, 2006.
Up-front premiums written during the three and nine months ended September 30, 2007 were
$149.0 million and $387.1 million, respectively, an increase of 121% from $67.5 million in the three months ended September 30, 2006 and an increase of 15% from $337.7 million in the nine months ended September 30, 2006. Up-front premiums
written in the third quarter of 2007 saw increases in both Public and International Finance sector, partially offset by a slight decrease in the Structured Finance sector. The first nine months of 2007 saw an increase in Public Finance, partially
offset by decreases in Structured and International Finance.
Installment premiums written for the three and nine months ended
September 30, 2007 were $137.6 million and $410.5 million, respectively, a decrease of 5% from $144.8 million in the three months ended September 30, 2006, and an increase of 1% from $407.2 million in the nine months ended
September 30, 2006. Installment premiums written in the third quarter of 2007 saw decreases in Public Finance and International Finance, partially offset by an increase in Structured Finance, while the first nine months of 2007 saw increases in
both Structured and International Finance, partially offset by a decrease in Public Finance installment premiums written.
The following
table sets forth the amounts of gross premiums written by type for the three and nine months ended September 30, 2007 and 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Public Finance:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Up-front
|
|
$
|
123.0
|
|
$
|
61.6
|
|
$
|
334.1
|
|
$
|
262.6
|
|
Installment
|
|
|
5.1
|
|
|
9.4
|
|
|
20.1
|
|
|
23.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Public Finance
|
|
|
128.1
|
|
|
71.0
|
|
|
354.2
|
|
|
286.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Structured Finance:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Up-front
|
|
|
5.8
|
|
|
5.9
|
|
|
22.1
|
|
|
22.7
|
|
Installment
|
|
|
75.9
|
|
|
72.9
|
|
|
230.4
|
|
|
225.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Structured Finance
|
|
|
81.7
|
|
|
78.8
|
|
|
252.5
|
|
|
247.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
International Finance:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Up-front
|
|
|
20.2
|
|
|
—
|
|
|
30.9
|
|
|
52.4
|
|
Installment
|
|
|
56.6
|
|
|
62.5
|
|
|
160.0
|
|
|
158.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total International Finance
|
|
|
76.8
|
|
|
62.5
|
|
|
190.9
|
|
|
210.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
286.6
|
|
$
|
212.3
|
|
$
|
797.6
|
|
$
|
744.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total up-front
|
|
$
|
149.0
|
|
$
|
67.5
|
|
$
|
387.1
|
|
$
|
337.7
|
|
Total installment
|
|
|
137.6
|
|
|
144.8
|
|
|
410.5
|
|
|
407.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
286.6
|
|
$
|
212.3
|
|
$
|
797.6
|
|
$
|
744.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
37
Reinsurance.
Ambac Assurance’s reinsurance program is principally comprised of a
surplus share treaty and facultative reinsurance. The surplus share treaty requires Ambac Assurance to cede covered transactions while affording Ambac Assurance the flexibility to cede par amounts of such transactions within a predefined range.
Management uses facultative reinsurance to cede risks in amounts greater than the maximums that can be ceded under the surplus share treaty and risks which are excluded from the surplus share treaty. Ceded premiums written for the three and nine
months ended September 30, 2007 were $35.1 million and $93.0 million, respectively, an increase of $8.8 million or 33% from $26.3 million in the three months ended September 30, 2006 and an increase of $17.7 million or 24% from $75.3
million in the nine months ended September 30, 2006.
Included in ceded premiums written in the nine months ended September 30,
2006 is $37.0 million in return premiums from reinsurance contracts that were cancelled. Excluding the return premiums from the nine months ended September 30, 2006, ceded premiums written were $112.3 million. For the nine months ended
September 30, 2007, ceded premiums written decreased 17% compared with the nine months ended September 30, 2006 after excluding the return premiums. Ceded premiums as a percentage of gross premiums written were 12.2% and 12.4% for the
third quarter of 2007 and 2006. Ceded premiums (exclusive of the return premiums) as a percentage of gross premiums written were 11.7% and 15.1% for the nine months ended September 30, 2007 and 2006, respectively. The decline in ceded written
premiums as a percentage of gross written premiums written for the nine months ended September 30, 2007 (exclusive of the return premiums) was attributable to the underwriting of larger public finance transactions during the nine months ended
September 30, 2006.
Net Premiums Earned and Other Credit Enhancement Fees
.
Net premiums earned and other credit
enhancement fees for the three and nine months ended September 30, 2007 were $214.8 million and $684.7 million, basically flat compared to $214.6 million for the three months ended September 30, 2006 and an increase of 6% from $648.0
million for the nine months ended September 30, 2006. The increase for the three months ended September 30, 2007 was primarily the result of higher normal premiums earned (which is defined as net premiums earned less refundings and calls
of previously insured obligations and other accelerations, such as reinsurance cancellations, (collectively referred to as “accelerated earnings”) and reconciled to total net premiums earned in the table below) and higher other credit
enhancement fees, partially offset by lower accelerated earnings. The increase for the nine months ended September 30, 2007 compared to the prior year period is a result of higher normal premiums earned, higher accelerated earnings and higher
other credit enhancement fees earned.
The following table provides a breakdown of net premiums earned by market sector and other credit
enhancement fees:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
(Dollars in Millions)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Public Finance
|
|
$
|
59.0
|
|
$
|
58.8
|
|
$
|
176.4
|
|
$
|
172.7
|
|
Structured Finance
|
|
|
73.0
|
|
|
70.9
|
|
|
218.8
|
|
|
210.9
|
|
International Finance
|
|
|
46.4
|
|
|
45.1
|
|
|
137.4
|
|
|
133.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total normal premiums earned
|
|
|
178.4
|
|
|
174.8
|
|
|
532.6
|
|
|
517.5
|
|
Accelerated earnings
|
|
|
16.4
|
|
|
23.7
|
|
|
99.2
|
|
|
86.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net premiums earned
|
|
|
194.8
|
|
|
198.5
|
|
|
631.8
|
|
|
603.6
|
|
Other credit enhancement fees
|
|
|
20.0
|
|
|
16.1
|
|
|
52.9
|
|
|
44.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net premiums earned and other credit enhancement fees
|
|
$
|
214.8
|
|
$
|
214.6
|
|
$
|
684.7
|
|
$
|
648.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
38
Premium earnings under both the upfront and installment revenue recognition methods are in proportion to
the principal amount guaranteed and result in higher premium earnings during periods where guaranteed principal is higher. However, given the same underlying attributes of an insured obligation such as tenor, gross premium amount, and amortization
schedule, the timing of revenue recognition may differ for premiums collected upfront versus premiums collected in installments. When an issue insured by Ambac Assurance has been refunded or called, any remaining unearned premium (net of refunding
credits, if any) is earned at that time. The level of refundings or calls vary, depending upon a number of conditions, primarily the relationship between current interest rates and interest rates on outstanding debt. Earnings on refundings typically
relate to transactions where the premium was paid up-front at the inception of the policy. Net premiums earned during the three and nine months ended September 30, 2007 included $16.4 million and $99.2 million, respectively, from accelerated
earnings as compared to $23.7 million and $86.1 million for the three and nine months ended September 30, 2006, respectively. The following table provides a breakdown of accelerated earnings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
(Dollars in Millions)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Public Finance
|
|
$
|
14.4
|
|
$
|
9.1
|
|
$
|
79.6
|
|
$
|
48.8
|
|
Structured Finance
|
|
|
1.7
|
|
|
1.8
|
|
|
6.8
|
|
|
13.2
|
|
International Finance
|
|
|
0.3
|
|
|
12.8
|
|
|
12.8
|
|
|
16.3
|
|
Reinsurance Cancellations
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
7.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total accelerated earnings
|
|
$
|
16.4
|
|
$
|
23.7
|
|
$
|
99.2
|
|
$
|
86.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Normal net premiums earned increased 2% from $174.8 million in the third quarter of 2006 to $178.4
million in the third quarter of 2007. Normal net premiums earned for the nine months ended September 30, 2007 was $532.6 million, an increase of 3% from $517.5 million in the nine months ended September 30, 2006. Normal net premiums earned
for the three months ended September 30, 2007 increased 0% for Public, 3% for Structured, and 3% for International Finance, respectively, from the three months ended September 30, 2006. Normal net premiums earned for the nine months ended
September 30, 2007 increased 2% for Public Finance, 4% for Structured Finance and 3% for International Finance, from the nine months ended September 30, 2006. Public Finance normal earned premium growth has been negatively impacted by the
high level of refunding activity over the past two years, competitive pricing and the mix of business underwritten in recent periods. The growth in normal earned premiums in Structured Finance was driven by strong business production in asset
classes such as pooled debt obligations and commercial asset-backed securities over the past several quarters. The increase in the level of growth in International Finance normal earned premium has resulted from improving deal flow.
Other credit enhancement fees, which is primarily comprised of fees received from the credit derivatives product were $20.0 million and $52.9 million for
the three and nine months ended September 30, 2007, respectively, an increase of 24% from $16.1 million in the three
39
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
months ended September 30, 2006 and an increase of 19% from $44.4 million in the nine months ended September 30, 2006. The increases are primarily
due to higher domestic credit derivative writings.
Net Investment Income
.
Net investment income for the three and nine
months ended September 30, 2007 was $115.8 million and $341.1 million, an increase of 8% from $107.2 million in the three months ended September 30, 2006 and an increase of 9% from $313.3 million in the nine months ended September 30,
2006. The increases were primarily attributable to the growth of the investment portfolio resulting from the positive operating cash flows of the Financial Guarantee book of business (primarily premiums written and coupon receipts on invested
assets). Investments in tax-exempt securities amounted to 78% and 77% of the total fair value of the Financial Guarantee portfolio as of September 30, 2007 and September 30, 2006, respectively. The average pre-tax yield-to-maturity on the
investment portfolio was 4.63% at September 30, 2007 compared with 4.65% at September 30, 2006.
Net Mark-to-Market
(Losses) Gains on Credit Derivative Contracts
.
Net mark-to-market (losses) on credit derivative contracts for the three and nine months ended September 30, 2007 were ($743.4) million and ($805.4) million, respectively, compared to net
mark-to-market gains of $2.6 million and $9.9 million in the three and nine months ended September 30, 2006, respectively. During the third quarter of 2007, a net mark-to-market loss was recorded across the entire credit derivative portfolio,
with the largest declines related to collateralized debt obligations of asset-backed securitizations (“CDO of ABS”) containing sub-prime mortgage-backed securities as collateral, including CDOs containing other CDO of ABS securities as
collateral (“CDO of CDO”). Unrealized losses of CDO of ABS comprised approximately 71% of the total unrealized losses for the three months ended September 30, 2007. The remainder of the mark is attributed primarily to CDOs of
corporate assets, both loans and bonds. The negative mark-to-market is driven by current market concerns over the credit quality of the most recent vintages of sub-prime residential mortgage-backed securities and the recent lack of liquidity in
collateralized debt obligations of the asset–backed security market resulting in a reduction in market-quoted prices on the underlying reference obligations of our credit derivatives. There were no realized net losses paid on credit derivatives
for the three and nine months ended September 30, 2007 and 2006. So far in the fourth quarter of 2007, we have observed rating agency downgrades of mortgage-backed securities and CDOs, a continued lack of liquidity in the collateralized debt
obligation market and continued credit deterioration and as a result Ambac may experience future mark-to-market losses.
Other (Loss)
Income
.
Other (loss) income for the three and nine months ended September 30, 2007 was ($1.3) million and $7.2 million, respectively, compared to other income of $3.0 million and $35.4 million for the three and nine months ended
September 30, 2006, respectively. Included within other (loss) income are deal structuring fees, commitment fees, aircraft revenues and equity earnings from Ambac’s Qualifying Special Purpose Entities (“QSPEs”). Included in the
three and nine months ended September 30, 2007 were ($2.6) million and $0.7 million, respectively, related to these QSPEs, compared to $2.0 million and $2.9 million for the three and nine months ended September 30, 2006, respectively.
During the first quarter of 2006, Ambac Assurance sold three aircraft from a previously reported defaulted enhanced equipment trust certificate. The gain on the sale amounted to $25.0 million. Also included within other income are structuring fee
revenues for the three and nine months ended September 30, 2007 of approximately $0.4 million and $1.5 million, respectively, compared to $0.4 million and $1.5 million in the three and nine months ended September 30, 2006,
40
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
respectively. Structuring fees are negotiated for certain domestic and international structured finance transactions, typically collected at inception of the
transactions, and are earned ratably over the life of the transactions. Ambac has approximately $14.4 million and $14.8 million of deferred structuring fees included in “Other liabilities” on the Consolidated Balance Sheets as of
September 30, 2007 and December 31, 2006, respectively.
Loss and Loss Expenses
.
Loss and loss expenses are based
upon estimates of the aggregate losses inherent in the non-derivative financial guarantee portfolio as of the reporting date. Loss and loss expenses for the three and nine months ended September 30, 2007 were $19.1 million and $47.6 million,
respectively, compared to ($2.5) million and $10.4 million for the three and nine months ended September 30, 2006. The increased loss provisions in 2007 are primarily the result of increases for domestic transportation and residential
mortgage-backed security sectors, partially offset by a reduction in the remaining Public Finance portfolio due to improved financial conditions.
The following table summarizes the changes in the total net loss reserves for the nine months ended September 30, 2007 and the year-ended December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions)
|
|
Nine Months Ended
September 30,
2007
|
|
|
Year Ended
December 31,
2006
|
|
|
Beginning balance of net loss reserves
|
|
$
|
215.0
|
|
|
$
|
300.6
|
|
|
Provision for losses and loss expenses
|
|
|
47.6
|
|
|
|
20.0
|
|
|
Losses paid
|
|
|
(17.7
|
)
|
|
|
(126.2
|
)
|
|
Recoveries of losses paid from reinsurers
|
|
|
1.9
|
|
|
|
3.9
|
|
|
Other recoveries, net of reinsurance
|
|
|
27.0
|
|
|
|
16.7
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance of net loss reserves
|
|
$
|
273.8
|
|
|
$
|
215.0
|
|
|
|
|
|
|
|
|
|
|
|
The following tables provide details of net losses paid, net of recoveries received for the nine
months ended September 30, 2007 and 2006 and gross case basis credit reserves and total gross loss reserves at September 30, 2007 and December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions)
|
|
Nine Months Ended
September 30,
2007
|
|
|
Nine Months Ended
September 30,
2006
|
|
|
Net losses (recovered)/ paid:
|
|
|
|
|
|
|
|
|
|
Public Finance
|
|
$
|
(7.4
|
)
|
|
$
|
5.9
|
|
|
Structured Finance
|
|
|
(0.6
|
)
|
|
|
23.0
|
|
|
International Finance
|
|
|
(3.2
|
)
|
|
|
(1.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
(11.2
|
)
|
|
$
|
27.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2007
|
|
December 31, 2006
|
|
(Dollars in millions)
|
|
Gross
Case Basis
Reserves
(1)(2)
|
|
Total Loss
Reserves
(3)
|
|
Gross
Case Basis
Reserves
(1)(2)
|
|
|
Total Loss
Reserves
(3)
|
|
Public Finance
|
|
$
|
51.1
|
|
$
|
179.7
|
|
$
|
45.7
|
|
|
$
|
195.0
|
|
Structured Finance
|
|
|
66.3
|
|
|
103.6
|
|
|
(0.2
|
)
|
|
|
21.6
|
|
International Finance
|
|
|
0
|
|
|
0.8
|
|
|
2.0
|
|
|
|
3.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
117.4
|
|
$
|
284.1
|
|
$
|
47.5
|
|
|
$
|
220.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Ambac discounts estimated
net payments using discount rates that approximate the average taxable equivalent yield on our investment portfolio. Discount rates applied to case basis credit reserves were 4.5% at September 30, 2007 and at December 31, 2006.
|
41
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
|
(2)
|
Reinsurance recoverables
on case basis credit reserves were $10.3 million and $5.0 million at September 30, 2007 and December 31, 2006, respectively.
|
|
(3)
|
Included in the calculation of active credit reserves at September 30, 2007
and December 31, 2006 was the consideration of $13.2 million and $5.0 million, respectively, of reinsurance which would be due to Ambac Assurance from the reinsurers, upon default of the insured obligations.
|
Active credit reserves were $166.7 million and $172.6 million at September 30, 2007 and December 31, 2006, respectively. The active credit
reserve at September 30, 2007 and December 31, 2006 was comprised of 48 and 55 credits with net par outstanding of $1,860 million and $3,831 million, respectively. The decrease in net par outstanding of credits within the active credit
reserve was driven primarily by upgrades in Hurricane Katrina-related credits, exposure paydowns, and transfers to case basis credit reserves, offset by downgrades in the residential mortgage-backed security sector. During 2007, five residential
mortgage-backed transactions defaulted. Net par outstanding for these transactions was $369.1 million at September 30, 2007.
Case
basis credit reserves at September 30, 2007 and December 31, 2006 were comprised of 10 credits and 7 credits with net par outstanding of $822.1 million and $668.4 million, respectively. The increase in case basis credit reserves net par is
primarily due to the default of several mortgage-backed transactions.
At September 30, 2007, the expected future claim payments on
credits that have already defaulted, totaled $199.3 million. Related future payments are $8.3 million, $29.4 million, $22.0 million, $16.7 million and $13.7 million for the remainder of 2007, 2008, 2009, 2010 and 2011, respectively.
Please refer to the “Critical Accounting Policies and Estimates” section of this Management’s Discussion and Analysis and to Note 3 of the
Consolidated Financial Statements for further background information on loss reserves, our policy and for further explanation of potential changes.
Underwriting and Operating Expenses
.
Underwriting and operating expenses for the three and nine months ended September 30, 2007 were $34.6 million and $104.4 million, respectively, an increase of 15% from $30.2 million in
the three months ended September 30, 2006 and an increase of 5% compared to $99.9 million in the nine months ended September 30, 2006, respectively. Underwriting and operating expenses consist of gross underwriting and operating expenses,
less the deferral to future periods of expenses and reinsurance commissions related to the acquisition of new insurance contracts, plus the amortization of previously deferred expenses and net reinsurance commissions. The following table provides
details of underwriting and operating expenses for the three and nine months ended September 30, 2007 and 2006:
42
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
(Dollars in Millions)
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Gross underwriting and operating expenses
|
|
$
|
50.6
|
|
|
$
|
45.7
|
|
|
$
|
148.7
|
|
|
$
|
144.1
|
|
|
Net reinsurance commissions received
(1)
|
|
|
(9.7
|
)
|
|
|
(6.9
|
)
|
|
|
(25.3
|
)
|
|
|
(17.9
|
)
|
|
Operating expenses and reinsurance commissions deferred
(1)
|
|
|
(17.4
|
)
|
|
|
(19.4
|
)
|
|
|
(53.0
|
)
|
|
|
(53.7
|
)
|
|
Amortization of previously deferred expenses
(1)
|
|
|
11.1
|
|
|
|
10.8
|
|
|
|
34.0
|
|
|
|
27.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Underwriting and operating expenses
|
|
$
|
34.6
|
|
|
$
|
30.2
|
|
|
$
|
104.4
|
|
|
$
|
99.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
The 2006 cancellations of reinsurance contracts disclosed above impacted the nine months net reinsurance commissions received by ($10.3) million and the amortization of previously
deferred expenses by $8.1 million.
|
The increases in gross underwriting expenses for the three and nine months ended
September 30, 2007 was primarily due to higher premium tax expenses driven by higher writings, particularly in jurisdictions with higher than average premium tax rates.
Financial Guarantee Exposure Draft (“ED”)
.
On April 18, 2007, the FASB issued an ED for public comment entitled
“Accounting for Financial Guarantee Insurance Contracts”, an interpretation of SFAS 60 “Accounting and Reporting by Insurance Enterprises”. The proposals contained within the ED are not considered final accounting guidance until
the FASB completes its public due process procedures, which is expected to conclude in the first quarter 2008. The FASB’s due process procedures include obtaining the comments from its constituency, including preparers of financial statements,
users of financial statements such as investors and rating agencies, and other interested parties such as auditors and regulators. The comment period ended on June 18, 2007 and a roundtable with interested parties was held on September 4,
2007.
Under the ED, Ambac would be required to recognize premium revenue, for both upfront and installment paying policies, in proportion
to the insured contractual principal and interest payments made by the issuer of the insured financial obligation, rather than being recognized over the term of each maturity for upfront paying policies, or over the installment period for such
policies. This change would generally result in a volatile revenue recognition pattern over the life of the insured obligation as premium would only be recognized as the insured obligation’s principal or interest is paid. Furthermore, for
certain bonds such as investor-owned utilities, CDOs and many other types of asset-backed securities that do not have periodic payments, this change would result in significantly slower revenue recognition. The volatility would be most evident for
insured securities whereby the principal payments are made at maturity but would also impact insured securities with customized amortization schedules. Furthermore, the majority of our insured public finance book of business has semi-annual
principal and interest payments, which would cause uneven revenue recognition throughout each calendar year. For installment paying policies, the ED requires that the discount, equating to the difference between gross installment premiums and the
present value of installment premiums, be recognized as investment income rather than premiums.
Ambac believes that the cumulative effect
of initially applying the revenue recognition provisions of this ED to our upfront paying policies would be material to our financial statements. Additionally, the revenue recognition for insurance transactions originated after the standard’s
effective date would be materially different than our current premium revenue recognition methodology. Ambac continues to evaluate the implications of the ED with regard to income recognition on installment paying policies, claim liabilities and
deferred acquisition costs on its financial statements.
43
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
Financial Services Segment
Through its Financial Services subsidiaries, Ambac provides financial and investment products including investment agreements, funding conduits, interest
rate swaps, currency swaps and total return swaps. The investment agreement business is managed with the goal of closely matching the cash flows of the investment agreement liabilities with the cash flows of the related investment portfolio. To
achieve this goal, derivative contracts may be used. The primary activities in the derivative products business are intermediation of interest rate and currency swap transactions and taking total return swap positions on certain fixed income
obligations. Most of the swap intermediation is done on a fully hedged basis with the exception of certain municipal interest rate swaps that are not hedged for the basis difference between taxable and tax-exempt interest rates. As such, changes in
the relationship between taxable and tax-exempt interest rates will result in mark-to-market gains or losses.
Revenues
.
Revenues for the three and nine months ended September 30, 2007 were $107.8 million and $336.3 million, a decrease of 7% from $115.4 million in the three months ended September 30, 2006 and a decrease of 6% from $357.6 million in the nine
months ended September 30, 2006.
The following table provides a breakdown of Financial Services revenues for the three and nine
months ended September 30, 2007 and 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
(Dollars in Millions)
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Investment income
|
|
$
|
120.6
|
|
|
$
|
107.5
|
|
|
$
|
334.5
|
|
|
$
|
287.5
|
|
|
Derivative products
|
|
|
1.2
|
|
|
|
3.0
|
|
|
|
7.3
|
|
|
|
10.9
|
|
|
Net realized investment gains
|
|
|
0.2
|
|
|
|
6.6
|
|
|
|
6.6
|
|
|
|
53.9
|
|
|
Net mark-to-market (losses) gains on total return swaps
|
|
|
(12.9
|
)
|
|
|
(0.5
|
)
|
|
|
(10.6
|
)
|
|
|
6.5
|
|
|
Net mark-to-market losses on non-trading derivative contracts
|
|
|
(1.3
|
)
|
|
|
(1.2
|
)
|
|
|
(1.5
|
)
|
|
|
(1.2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Financial Services revenue
|
|
$
|
107.8
|
|
|
$
|
115.4
|
|
|
$
|
336.3
|
|
|
$
|
357.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in investment income for the three and nine months ended September 30, 2007 was
driven by higher rates on a larger portfolio of floating rate investments in the investment agreement business. The total return swap portfolio has experienced net mark-to-market losses for the three and nine months ended September 30, 2007 as
a result of credit spread widening.
Prior to 2004, realized losses included an impairment write-down of $150.2 million related to
asset-backed notes issued by National Century Financial Enterprises, Inc (“NCFE”). These notes, which were backed by health care receivables and rated triple-A until October 25, 2002, defaulted and NCFE filed for protection under
Chapter 11 of the U.S. Bankruptcy Code in November 2002. The loss was specific to the NCFE notes and had no impact on other investments held. Ambac has received cash recoveries of $90.3 million through September 30, 2007 resulting from
distributions under the NCFE Bankruptcy Plan, payments made by a trust created under the Plan and litigation settlements. Included in those
44
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
recoveries are $0 and $6.2 million received during the three and nine months ended September 30, 2007, respectively, compared to $6.6 million and $50.8
million received during the three and nine months ended September 30, 2006, respectively.
Expenses
.
Expenses for the
three and nine months ended September 30, 2007 were $115.2 million and $321.7 million, respectively, up 15% from $100.2 million in the three months ended September 30, 2006 and up 18% from $272.6 million in the nine months ended
September 30, 2006. Included in the above are interest expenses related to investment and payment agreements of $112.0 million and $312.1 million for the three and nine months ended September 30, 2007, respectively, and $97.1 million and
$262.6 million for the three and nine months ended September 30, 2006, respectively. The increase was primarily related to higher rates on a larger portfolio of floating rate investment agreements, partially offset by runoff of fixed rate
investment agreements.
Corporate Items
Interest Expense
.
Interest expense for the three and nine months ended September 30, 2007 was $22.2 million and $63.6 million, respectively, up 14% from $19.5 million in the three months ended
September 30, 2006 and up 9% from $58.4 million in the nine months ended September 30, 2006. The increase is primarily attributable to the completed public offering of $400 million aggregate principal amount of Directly Issued Subordinated
Capital Securities (the “DISCs”) on February 12, 2007, partially offset by the October 2006 redemption of Ambac’s $200 million 7% debentures.
Provision for Income Taxes
.
Income taxes for the three and nine months ended September 30, 2007 were at an effective rate of 27.1% and 2.4%, respectively, compared to 28.1% and 27.3% for the three
and nine months ended September 30, 2006, respectively. The decreases in the 2007 effective tax rate is primarily due to the large unrealized mark-to-market losses recognized in the third quarter of 2007. The quarterly tax provision reflects
Ambac’s estimated annual effective tax rate. As a result, in the third quarter of 2007, Ambac recognized only nine months of the income tax benefit related to the unrealized mark-to-market loss. The remainder of the tax benefit is expected to
be recognized in the fourth quarter of 2007. The actual income tax benefit to be recognized will depend on the results of the fourth quarter mark-to-market adjustments.
Liquidity and Capital Resources
Ambac Financial Group, Inc. Liquidity
.
Ambac’s
liquidity, both on a short-term basis (for the next twelve months) and a long-term basis (beyond the next twelve months), is largely dependent upon: (i) Ambac Assurance’s ability to pay dividends or make other payments to Ambac; and
(ii) external financings. Pursuant to Wisconsin insurance laws, Ambac Assurance may pay dividends, provided that, after giving effect to the distribution, it would not violate certain statutory surplus, solvency and asset tests. Based upon
these tests, the maximum amount that will be available during 2007 for payment of dividends without regulatory approval by Ambac Assurance is $370.0 million. Additionally, no quarterly dividend may exceed the dividend paid in the corresponding
quarter of the preceding year by more than 15% without notifying the Wisconsin Insurance Commissioner 30 days in advance of payment. Ambac Assurance paid dividends of $142.7 million and $102.0 million during the nine months ended
45
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
September 30, 2007 and 2006. Ambac sought and obtained regulatory approval with respect to the dividends paid in each of the first,
second and third quarters of 2007, which exceeded by more than 15% the dividends paid in the first, second and third quarters of 2006, respectively. The increase was primarily necessitated by the issuance of the DISCs in February 2007.
Ambac’s principal uses of liquidity are for the payment of its operating expenses, income taxes, interest on its debt, dividends on its shares of
common stock, purchases of its common stock in the open market and capital investments in its subsidiaries.
Based on the amount of
dividends that it expects to receive from Ambac Assurance during 2007, management believes that Ambac will have sufficient liquidity to satisfy its needs over the next twelve months, including the ability to pay dividends on its common stock in
accordance with its dividend policy. Beyond the next twelve months, Ambac Assurance’s ability to declare and pay dividends to Ambac may be influenced by a variety of factors including adverse market changes, insurance regulatory changes and
changes in general economic conditions. Consequently, although management believes that Ambac will continue to have sufficient liquidity to meet its debt service and other obligations over the long term, no guarantee can be given that Ambac
Assurance will be able to dividend amounts sufficient to pay all of Ambac’s operating expenses, debt service obligations and dividends on its common stock.
A subsidiary of Ambac Financial Group provides a $360 million liquidity facility to a reinsurance company which acts as reinsurer with respect to a portfolio of life insurance policies. The liquidity facility, which
is guaranteed by Ambac Assurance, provides temporary funding in the event that the reinsurance company’s capital is insufficient to make payments under the reinsurance agreement. The reinsurance company is required to repay all amounts drawn
under the liquidity facility. No amounts have been drawn under this facility at September 30, 2007.
Ambac Assurance
Liquidity
. The principal uses of Ambac Assurance’s liquidity are the payment of operating expenses, claim payments, reinsurance premiums, taxes, dividends to Ambac and capital investments in its subsidiaries. Management believes that
Ambac Assurance’s operating liquidity needs can be funded exclusively from its operating cash flow. The principal sources of Ambac Assurance’s liquidity are gross premiums written, scheduled investment maturities, net investment income and
receipts from credit derivatives.
Financial Services Liquidity
.
The principal uses of liquidity by Financial Services
subsidiaries are payment of investment and payment agreement obligations pursuant to defined terms, net obligations under interest rate, total return and currency swaps, operating expenses and income taxes. Management believes that its Financial
Services liquidity needs can be funded from its operating cash flow, the maturity of its invested assets and from time to time, by short-term inter-company loans and repurchase agreement transactions. The principal sources of this segment’s
liquidity are proceeds from issuance of investment agreements, net investment income, maturities of securities from its investment portfolio and net receipts from interest rate, currency and total return swaps. The investment objectives with respect
to the investment agreement business are preservation of capital by maintaining a minimum average quality rating of AA on invested assets, maximize the net interest rate spread as compared to investment agreements issued and to maintain a liquid
floating rate investment portfolio, which
46
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
includes short-term investments, to minimize interest rate and liquidity risk. As of September 30, 2007, the investment agreement business floating rate
investment portfolio approximates $7.0 billion or 87% of the investment portfolio related to the investment agreement business.
Investment
agreements subject Ambac to liquidity risk associated with unscheduled withdrawals of principal allowed by the terms of the investment agreements. Ambac manages liquidity risk by characterizing our investment agreements into two broad categories,
contingent and fixed. Contingent draw transactions include contractual provisions that allow the investor to withdraw principal and require minimal notice to Ambac. The vast majority of these investment agreements can only be drawn in the event that
well-defined, observable events have occurred, primarily credit events. As of September 30, 2007, approximately $5.1 billion relates to contingent draw investment agreements. In addition, many of these contracts contain lock-out periods where
unscheduled withdrawals are restricted and provisions which compensate Ambac for break-costs resulting from early withdrawal. As of September 30, 2007, approximately $0.7 billion of contingent draw investment agreements include provisions where
our counterparty has the option to withdraw funds prior to maturity during 2007. Fixed draw investment agreements have few provisions for unscheduled withdrawals, however, if permitted, the events triggering the withdrawal are deemed to be remote,
require advance notification to Ambac and most often include provisions that compensate Ambac for break costs. As of September 30, 2007, approximately $3.4 billion relates to fixed draw investment agreements, of which $1.8 billion include
provisions where under remote circumstances our counterparty has the ability to withdraw funds during 2007.
Capital and Capital
Support
.
Our insurance companies currently have triple-A financial strength ratings from Moody’s Investors Service, Inc., Standard & Poor’s Rating Services and Fitch Inc. The objective of these ratings is to provide an
opinion on an insurer’s financial strength and its ability and intent to pay under its insurance policies and contracts in accordance with their terms. The rating is not specific to any particular policy or contract. Financial strength ratings
do not refer to an insurer’s ability to meet non-insurance obligations and are not a “market rating” or a recommendation to buy, hold or sell any security.
The ratings assigned by Moody’s, S&P, and Fitch are subject to periodic review and may be downgraded by one or more rating agencies as a result of: changes in the views of the rating agencies, adverse
developments in our financial condition or results of operations due to underwriting or investment losses. All triple-A ratings were reaffirmed in 2007. At September 30, 2007, Ambac Assurance had stockholder’s equity of $6.9 billion and
soft-capital facilities of $0.8 billion. Any downgrade in our financial strength rating, or the placement of our financial strength rating on negative credit watch, would have a material adverse effect on our competitive position and our prospects
for future business opportunities. Our results of operations and financial condition would be materially adversely affected by any reduction in its ratings.
Ambac Assurance has a series of perpetual put options on its own preferred stock. The counterparty to these put options are trusts established by a major investment bank. The trusts were created as a vehicle for
providing capital support to Ambac Assurance by allowing it to obtain immediate access to new capital at its sole discretion at any time through the exercise of the put option. If the put option were exercised, Ambac Assurance would receive up to
$800 million in return for the issuance of its own perpetual preferred stock, the proceeds of which may be used for any purpose, including the payment of claims. The preferred stock would give
47
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
investors the rights of an equity investor in Ambac Assurance. Such rights are subordinate to insurance claims, as well as to the general unsecured creditors
of Ambac Assurance. Dividend payments on the preferred stock are cumulative, subject to certain limited exceptions, only if Ambac Assurance pays dividends on its common stock. Each trust is restricted to holding high-quality short-term commercial
paper investments to ensure that it can meet its obligations under the put option. To fund these investments, each trust has issued its own auction market perpetual securities. The auction for these securities occurs every 28-days. Beginning in
August 2007, a disruption in the auction market caused the auction for these securities to fail. As a result, existing investors were required to maintain their position in the securities and the distribution rate on such securities increased to the
maximum rate (100 basis points over one month LIBOR). The impact of this failed auction on Ambac Assurance was an increase in the cost of the put option premium paid to the trusts. Due to the timing of each of the auctions the full impact of the
higher put option premium will not be realized until the fourth quarter of 2007. Each trust is rated AA/Aa2 by Standard & Poor’s and Moody’s, respectively. During the nine months ended September 30, 2007 and 2006, Ambac
Assurance incurred fees related to these perpetual put options of $2.9 million and $2.6 million, respectively. These fees are included as Corporate expenses on the Consolidated Statements of Operations. Each trust is rated AA/Aa2 by
Standard & Poor’s and Moody’s, respectively.
From time to time, Ambac accesses the capital markets to support the
growth of its businesses. In February 2006, Ambac filed a Form S-3 with the SEC utilizing a “shelf” registration process for well known seasoned issuers. Under this process, Ambac may issue through February 2009 an unlimited amount of the
securities described in the prospectus filed as part of the registration, namely, common stock, preferred stock, debt securities, and warrants of Ambac.
On February 12, 2007, Ambac Financial Group completed the public offering of $400 million aggregate principal amount of DISCs due 2087. The proceeds from the sale of the DISCs was used to repurchase $400 million
of Ambac’s common stock pursuant to an accelerated share repurchase program. The total number of common stock purchased under the agreement amounted to 4,459,223 shares.
In connection with the completion of the DISCs Offering, Ambac entered into a replacement capital covenant for the benefit of persons that buy, hold or
sell a specified series of long-term indebtedness of Ambac (“DISCs Covered Debt”).
The DISCs replacement capital covenant
provides that Ambac will not repay, redeem or purchase, and will cause its subsidiaries not to repay, redeem or purchase, all or any part of the DISCs on or before February 7, 2067, except, with certain limited exceptions, to the extent that,
during a specified period prior to the date of that repayment, redemption or purchase, Ambac has received proceeds from the sale of replacement capital securities.
Credit Ratings and Collateral
. In the event that Ambac Assurance is downgraded, Ambac may be required to post incremental collateral to its investment agreement and derivative counterparties, introducing
liquidity risk. In addition, most investment agreements provide certain remedies, including a termination of the investment agreement contract in the event of a downgrade of Ambac Assurance’s credit rating, typically to A1 by Moody’s or A+
by S&P. In most cases Ambac is permitted to post collateral or otherwise enhance its credit, prior to an actual draw on the investment agreement.
48
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
The financial services business executes a range of interest rate and cross-currency swaps to reduce
the market risk on investment agreements with Ambac’s derivatives subsidiary, Ambac Financial Services, LLC. In addition, Ambac Financial Services provides interest rate and currency swap transactions for states, municipalities, asset-backed
issuers and other entities in connection with their financings. Ambac Financial Services offsets most of the interest rate and currency risks in these instruments and incorporates these transactions under standardized derivative documents including
collateral support agreements. Under these agreements, Ambac could be required to post collateral to a swap dealer in the event unrealized losses exceed a predetermined threshold amount. Ambac has posted collateral of $0.0 million under these
contracts at September 30, 2007. Conversely, Ambac could receive collateral from the counterparty in the event unrealized gains exceed a predetermined threshold. Ambac has received collateral of $190.6 million under these contracts at
September 30, 2007. The thresholds afforded Ambac by the swap dealer would be reduced in the event of a downgrade of Ambac’s credit rating. The reduction in the threshold could result in Ambac posting additional amounts of collateral to
the counterparty.
Ambac Capital Services enters into total return swaps. All of our total return swaps have collateral support agreements
and would require us to pledge collateral as a result of a downgrade or in the event exposure limit losses exceed a predetermined threshold amount. In addition, a downgrade of our financial strength rating below specified levels would allow total
return swaps counterparties to terminate certain agreements, resulting in a possible payment of a settlement amount. At September 30, 2007, Ambac has not pledged collateral under any of its total return swap contracts.
Ambac Credit Products enters into credit derivative contracts. Ambac Credit Products is not required to post collateral under any of its contracts.
Ambac manages this liquidity risk through the maintenance of liquid collateral and bank liquidity facilities. Additionally, Ambac
generally has the right to re-hypothecate collateral that it receives under derivative contracts to counterparties.
Credit
Facilities
.
On July 30, 2007, Ambac and Ambac Assurance, as borrowers, extended its $400 million five year unsecured, committed revolving credit facility (the “Credit Facility”) with a group of highly rated banks (the
“Banks”) from July 28, 2011 to July 30, 2012. The Credit Facility provides for borrowings by Ambac and Ambac Assurance on a revolving basis up to an aggregate of $400 million at any one time outstanding, which maximum amount may,
at Ambac’s and Ambac Assurance’s request and subject to the terms and conditions of the facility, be increased up to $500 million.
Ambac and/or Ambac Assurance may borrow under the Credit Facility for general corporate purposes, including the payment of claims. Subject to the terms and conditions thereof, Ambac and/or Ambac Assurance may borrow under the Credit
Facility until the final maturity date. Loans may be denominated in U. S. Dollars or certain other currencies at the option of Ambac and/or Ambac Assurance. Ambac and/or Ambac Assurance has the option of selecting either (i) a Base Rate, a
fluctuating rate equal to the higher of Citibank’s Base Rate and the Federal Funds Rate plus 0.5%, plus the Applicable Margin (as defined in the Credit Facility) or (ii) a Eurocurrency Rate, a periodic fixed rate equal to LIBOR plus the
Applicable Margin. There are no outstanding loans under the Credit Facility. Neither Ambac nor Ambac Assurance have previously incurred any borrowing under this or prior similar facilities.
49
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
The Credit Facility contains customary representations, warranties and covenants for this type of
financing, including two financial covenants requiring Ambac to: (i) maintain as of the end of each fiscal quarter a debt-to-capital ratio, excluding debt consolidated under FIN 46, the DISCs and credit link notes, of not more than 30%, and
(ii) maintain at all times total stockholders’ equity equal to or greater than $2.9 billion. The stockholders’ equity financial covenant will increase annually, in an amount equal to 15% of the prior fiscal year’s net income and
15% of the net proceeds of any future equity issuances. The Credit Facility also provides for certain events of default with corresponding grace periods, including failure to pay any principal or interest when due, failure to comply with covenants,
any material representation or warranty made by Ambac or Ambac Assurance proving to be false in any material respect, certain bankruptcy, insolvency or receivership events affecting Ambac or Ambac Assurance, defaults relating to other indebtedness,
imposition of certain judgments and a change in ownership of Ambac and/or Ambac Assurance. Ambac and Ambac Assurance are in full compliance with the terms and conditions of the Credit Facility.
Balance Sheet
.
Total assets as of September 30, 2007 were $21.98 billion, up 8% compared to total assets of $20.27 billion at
December 31, 2006. The increase was driven by cash generated from operations during the period, partially offset by a decrease in unrealized gains in the investment portfolio due primarily to a decline in the fair values of mortgage-backed
securities. As of September 30, 2007, stockholders’ equity was $5.65 billion, a 9% decrease from year-end 2006 stockholders’ equity of $6.18 billion. The decrease was primarily the result of the $400 million share buyback mentioned
above and lower Accumulated Other Comprehensive Income driven by a decline in the fair values of mortgage-backed securities.
Ambac
Assurance’s investment objectives for the Financial Guarantee portfolio are to maintain an investment duration that closely approximates the expected duration of related financial guarantee liabilities and achieve the highest after-tax net
investment income. The Financial Guarantee investment portfolio is subject to internal investment guidelines. Such guidelines set forth minimum credit rating requirements and credit risk concentration limits.
The Financial Services investment portfolio consists primarily of assets funded with proceeds from the issuance of investment agreement liabilities. The
investment objectives with respect to investment agreements are to achieve the highest after-tax total return, subject to a minimum average credit quality rating of Aa/AA on invested assets, and to maintain cash flow matching of invested assets to
funded liabilities to minimize interest rate and liquidity exposure. The investment portfolio is subject to internal investment guidelines. Such guidelines set forth minimum credit rating requirements and credit risk concentration limits.
50
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
The amortized cost and estimated fair value of investments in fixed income securities and short-term
investments at September 30, 2007 and December 31, 2006 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2007
|
|
December 31, 2006
|
|
(Dollars in millions)
|
|
Amortized
Cost
|
|
Estimated
Fair
Value
|
|
Amortized
Cost
|
|
Estimated
Fair
Value
|
|
Fixed income securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Municipal obligations
|
|
$
|
8,426.5
|
|
$
|
8,592.8
|
|
$
|
7,891.4
|
|
$
|
8,126.8
|
|
Corporate obligations
|
|
|
769.8
|
|
|
785.3
|
|
|
692.0
|
|
|
719.6
|
|
Foreign obligations
|
|
|
303.9
|
|
|
321.1
|
|
|
269.8
|
|
|
276.8
|
|
U.S. government obligations
|
|
|
48.3
|
|
|
48.6
|
|
|
177.2
|
|
|
174.0
|
|
U.S. agency obligations
|
|
|
488.1
|
|
|
510.1
|
|
|
757.9
|
|
|
789.4
|
|
Mortgage-backed securities
|
|
|
4,654.6
|
|
|
4,536.8
|
|
|
3,653.0
|
|
|
3,646.2
|
|
Asset-backed securities
|
|
|
3,208.6
|
|
|
3,189.4
|
|
|
3,043.0
|
|
|
3,067.5
|
|
Short-term
|
|
|
686.1
|
|
|
686.1
|
|
|
311.8
|
|
|
311.8
|
|
Other
|
|
|
13.5
|
|
|
14.8
|
|
|
13.4
|
|
|
14.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18,599.4
|
|
|
18,685.0
|
|
|
16,809.5
|
|
|
17,126.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed income securities pledged as collateral:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government obligations
|
|
|
106.4
|
|
|
104.5
|
|
|
—
|
|
|
—
|
|
U.S. agency obligations
|
|
|
130.3
|
|
|
147.5
|
|
|
—
|
|
|
—
|
|
Mortgage-backed securities
|
|
|
110.1
|
|
|
108.8
|
|
|
311.5
|
|
|
307.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
346.8
|
|
|
360.8
|
|
|
311.5
|
|
|
307.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
18,946.2
|
|
$
|
19,045.8
|
|
$
|
17,121.0
|
|
$
|
17,433.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
51
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
The following table represents the fair value of mortgage-backed securities at September 30,
2007 and December 31, 2006 by classification:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions)
|
|
Financial
Guarantee
|
|
Financial
Services
|
|
Corporate
|
|
Total
|
|
September 30, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RMBS First Lien – Mid Prime
|
|
$
|
—
|
|
$
|
3,185.3
|
|
$
|
—
|
|
$
|
3,185.3
|
|
U.S. Government Sponsored Enterprise Mortgages
|
|
|
787.5
|
|
|
250.4
|
|
|
—
|
|
|
1,037.9
|
|
RMBS Second Lien
|
|
|
—
|
|
|
181.2
|
|
|
—
|
|
|
181.2
|
|
Other
|
|
|
7.0
|
|
|
234.2
|
|
|
—
|
|
|
241.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
794.5
|
|
$
|
3,851.1
|
|
$
|
—
|
|
$
|
4,645.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RMBS First Lien – Mid Prime
|
|
$
|
—
|
|
$
|
2,467.3
|
|
$
|
—
|
|
$
|
2,467.3
|
|
U.S. Government Sponsored Enterprise Mortgages
|
|
|
892.6
|
|
|
419.0
|
|
|
—
|
|
|
1,311.6
|
|
RMBS Second Lien
|
|
|
—
|
|
|
91.2
|
|
|
—
|
|
|
91.2
|
|
Other
|
|
|
8.1
|
|
|
75.1
|
|
|
—
|
|
|
83.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
900.7
|
|
$
|
3,052.6
|
|
$
|
—
|
|
$
|
3,953.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
52
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
The following table summarizes, for all securities in an unrealized loss position as of
September 30, 2007 and December 31, 2006, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2007
|
|
December 31, 2006
|
|
(Dollars in millions)
|
|
Estimated
Fair
Value
|
|
Gross
Unrealized
Losses
|
|
Estimated
Fair
Value
|
|
Gross
Unrealized
Losses
|
|
Municipal obligations in continuous unrealized loss for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0 – 6 months
|
|
$
|
805.3
|
|
$
|
6.7
|
|
$
|
658.5
|
|
$
|
3.4
|
|
7–12 months
|
|
|
628.5
|
|
|
13.9
|
|
|
69.9
|
|
|
0.6
|
|
Greater than 12 months
|
|
|
1,187.5
|
|
|
11.5
|
|
|
1,129.3
|
|
|
16.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,621.3
|
|
|
32.1
|
|
|
1,857.7
|
|
|
20.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate obligations in continuous unrealized loss for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0 – 6 months
|
|
|
113.2
|
|
|
2.1
|
|
|
34.6
|
|
|
0.1
|
|
7 – 12 months
|
|
|
58.1
|
|
|
1.6
|
|
|
33.2
|
|
|
0.2
|
|
Greater than 12 months
|
|
|
57.2
|
|
|
2.7
|
|
|
50.9
|
|
|
0.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
228.5
|
|
|
6.4
|
|
|
118.7
|
|
|
1.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign obligations in continuous unrealized loss for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0 – 6 months
|
|
|
32.5
|
|
|
0.4
|
|
|
78.8
|
|
|
0.9
|
|
7 – 12 months
|
|
|
42.3
|
|
|
0.2
|
|
|
26.5
|
|
|
0.3
|
|
Greater than 12 months
|
|
|
41.4
|
|
|
0.3
|
|
|
13.1
|
|
|
0.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
116.2
|
|
|
0.9
|
|
|
118.4
|
|
|
1.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government obligations in continuous unrealized loss for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0 – 6 months
|
|
|
59.4
|
|
|
1.4
|
|
|
23.1
|
|
|
0.1
|
|
7 – 12 months
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Greater than 12 months
|
|
|
32.2
|
|
|
0.5
|
|
|
128.4
|
|
|
3.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
91.6
|
|
|
1.9
|
|
|
151.5
|
|
|
3.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. agency obligations in continuous unrealized loss for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0 – 6 months
|
|
|
4.1
|
|
|
0.1
|
|
|
239.1
|
|
|
1.2
|
|
7 – 12 months
|
|
|
39.9
|
|
|
0.2
|
|
|
—
|
|
|
—
|
|
Greater than 12 months
|
|
|
54.3
|
|
|
0.8
|
|
|
234.1
|
|
|
5.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
98.3
|
|
|
1.1
|
|
|
473.2
|
|
|
6.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed securities in continuous unrealized loss for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0 – 6 months
|
|
|
3,220.1
|
|
|
93.8
|
|
|
368.7
|
|
|
1.4
|
|
7 – 12 months
|
|
|
512.3
|
|
|
18.3
|
|
|
52.1
|
|
|
0.3
|
|
Greater than 12 months
|
|
|
717.7
|
|
|
17.3
|
|
|
1,067.0
|
|
|
24.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,450.1
|
|
|
129.4
|
|
|
1,487.8
|
|
|
25.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset-backed securities in continuous unrealized loss for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0 – 6 months
|
|
|
1,586.1
|
|
|
23.9
|
|
|
58.2
|
|
|
0.5
|
|
7–12 months
|
|
|
125.9
|
|
|
6.2
|
|
|
23.4
|
|
|
0.3
|
|
Greater than 12 months
|
|
|
108.9
|
|
|
4.1
|
|
|
110.4
|
|
|
0.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,820.9
|
|
|
34.2
|
|
|
192.0
|
|
|
1.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other in continuous unrealized loss for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0 – 6 months
|
|
|
0.1
|
|
|
—
|
|
|
0.3
|
|
|
—
|
|
7–12 months
|
|
|
0.1
|
|
|
—
|
|
|
0.2
|
|
|
—
|
|
Greater than 12 months
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.2
|
|
|
—
|
|
|
0.5
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
9,427.1
|
|
$
|
206.0
|
|
$
|
4,399.8
|
|
$
|
59.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
53
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
Management has determined that the unrealized losses in fixed income securities at September 30,
2007 are primarily attributable to the current interest rate environment and the recent lack of liquidity in the mortgage-backed security market. These mortgage-backed securities are predominately rated AAA. Ambac has concluded that unrealized
losses are temporary in nature based upon (i) no principal and interest payment defaults on these securities; (ii) analysis of the creditworthiness of the issuers; and (iii) Ambac’s ability and current intent to hold these
securities until a recovery in fair value or maturity. Of the $9,427.1 million that were in a gross unrealized loss position at September 30, 2007, below investment grade securities and non-rated securities had a fair value of $0.1 million and
an unrealized loss of $0.01 million. Of the $4,399.8 million that were in a gross unrealized loss position at December 31, 2006, below investment grade securities and non-rated securities had a fair value of $0.5 million and an unrealized loss
of less than $0.1 million.
There were no impairment write-downs during the three and nine months ended September 30, 2007 and $0.0
and $0.1 million during the three and nine months ended September 30, 2006, respectively. The net realized investment gains were primarily the result of the NCFE impairment recoveries received in the nine months ended September 30, 2007
and 2006. Other net realized investment gains and losses in the nine months ended September 30, 2007 and 2006 were the result of security sales made in the ordinary course of business in order to achieve Ambac’s investment objectives for
the Financial Guarantee and Financial Services investment portfolios.
The following table provides the ratings distribution of the fixed
income investment portfolio at September 30, 2007 and December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
Rating
(1)
:
September 30, 2007:
|
|
Financial
Guarantee
|
|
|
Financial
Services
|
|
|
Combined
|
|
|
AAA
|
|
88
|
%
|
|
91
|
%
|
|
89
|
%
|
|
AA
|
|
11
|
|
|
4
|
|
|
8
|
|
|
A
|
|
1
|
|
|
5
|
|
|
3
|
|
|
BBB
|
|
<1
|
|
|
—
|
|
|
<1
|
|
|
Below investment grade
|
|
—
|
|
|
<1
|
|
|
<1
|
|
|
Not Rated
|
|
<1
|
|
|
—
|
|
|
<1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
AAA
|
|
87
|
%
|
|
91
|
%
|
|
89
|
%
|
|
AA
|
|
11
|
|
|
3
|
|
|
8
|
|
|
A
|
|
1
|
|
|
5
|
|
|
3
|
|
|
BBB
|
|
<1
|
|
|
1
|
|
|
<1
|
|
|
Below investment grade
|
|
—
|
|
|
<1
|
|
|
<1
|
|
|
Not Rated
|
|
<1
|
|
|
—
|
|
|
<1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Ratings represent Standard & Poor’s classifications. If unavailable, Moody’s rating is used.
|
54
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
|
Ambac’s fixed income portfolio includes securities covered by guarantees issued by Ambac
Assurance (“insured securities”). The published ratings on these securities are triple-A by the major rating agencies as a result of the Ambac Assurance insurance policy and are reflected in the above table as AAA. Rating agencies
generally do not publish separate underlying ratings (those ratings excluding the Ambac Assurance insurance) because the insurance cannot be legally separated from the underlying security by the insurer. Ambac obtains underlying ratings through
ongoing dialog with rating agencies. In the event these underlying ratings are not available from the rating agencies, Ambac will assign an internal rating. At September 30, 2007, securities with a total carrying value of $666.3 million
representing 3% of the investment portfolio with a weighted-average underlying rating of BBB was insured by Ambac. In determining this BBB rating, approximately $130.5 million of the securities were assigned internal ratings by Ambac.
Special Purpose and Variable Interest Entities
.
Information regarding special purpose and variable interest entities can be found in the
Notes to the Unaudited Consolidated Financial Statements of this Form 10-Q.
Cash Flows
.
Net cash provided by operating
activities was $827.9 million and $671.5 million during the nine months ended September 30, 2007 and 2006, respectively. These cash flows were primarily provided by Financial Guarantee operations. The increase in cash provided by operating
activities is primarily due to net claim recoveries in 2007 and higher net insurance premium receipts, partially offset by the proceeds from the 2006 sale of three aircraft. Future net cash provided by operating activities will be impacted by the
level of premium collections and claim payments.
Net cash provided by financing activities was $1,104.5 million and $511.1 million during
the nine months ended September 30, 2007 and 2006, respectively. Financing activities for the nine months ended September 30, 2007 included $846.3 million in net investment and payment agreements issued (net of investment and payment
agreement draws paid) and the proceeds of the issuance of DISCs of $393.3 million, partially offset by purchases of treasury shares of $449.4 million. Financing activities for the nine months ended September 30, 2006 included $511.3 million in
net investment and payment agreements issued (net of investment and payment agreements draws paid) and purchases of treasury shares of $67.2 million.
Net cash used in investing activities was $1,937.5 million during the nine months ended September 30, 2007, of which $3,361.0 million, $374.4 million and $245.2 million, was used to purchase bonds, short-term
securities and loans, respectively, partially offset by proceeds from sales and maturities of bonds of $1,765.9 million. For the nine months ended September 30, 2006, $1,169.6 million was used in investing activities, of which $3,936.9 million
was used to purchase bonds, partially offset by the proceeds and maturities of bonds of $2,261.2 million.
Net cash (used in) provided by
operating, investing and financing activities was ($5.1) million and $13.0 million during the nine months ended September 30, 2007 and 2006, respectively.