// About Ambac
Ambac Financial Group, Inc. (“Ambac”), headquartered in New York City, is a holding
company whose subsidiaries, including its principal operating subsidiaries, Ambac
Assurance Corporation (“AAC”), Everspan Financial Guarantee Corp. and Ambac
Assurance UK Limited (“Ambac UK”), provide financial guarantees and other financial
services to clients in both the public and private sectors globally. AAC, including the
Segregated Account of AAC (in rehabilitation), is a guarantor of public finance and
structured finance obligations. Ambac’s primary goal is to maximize stockholder value
by executing the following key strategies: active runoff of AAC and its subsidiaries
through transaction terminations, policy commutations, settlements and restructurings
that we believe will improve our risk profile, and maximizing the risk adjusted return
on invested assets; loss recovery through litigation and exercise of contractual and
legal rights; improved cost effectiveness and efficiency of the operating platform;
rationalization of AAC’s capital and liability structures, enabling simplification of
corporate governance and facilitating the successful rehabilitation of the Segregated
Account; and selective business transactions offering attractive risk adjusted returns
that, among other things, may permit utilization of Ambac’s tax net operating loss
carry forwards. Ambac‘s common stock trades on the NASDAQ Global Select Market
under the symbol “AMBC”. The Amended and Restated Certificate of Incorporation
of Ambac contains substantial restrictions on the ability to transfer Ambac’s common
stock. Subject to limited exceptions, any attempted transfer of common stock shall
be prohibited and void to the extent that, as a result of such transfer (or any series of
transfers of which such transfer is a part), any person or group of persons shall become
a holder of 5% or more of Ambac’s common stock or a holder of 5% or more of Ambac’s
common stock increases its ownership interest. Ambac is committed to providing timely
and accurate information to the investing public, consistent with our legal and regulatory
obligations. To that end, we use our website to convey information about our businesses,
including the anticipated release of quarterly financial results, quarterly financial,
statistical and business related information, and the posting of updates to the status of
certain primary residential mortgage backed securities litigations. For more information,
please go to www.ambac.com.
Forward-Looking Statements
In this Annual Report, 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. Words such as “estimate,” “project,” “plan,”
“believe,” “anticipate,” “intend,” “potential” and similar expressions, or future or conditional verbs such as “will,” “should,”
“would,” “could,” and “may,” or the negative of those expressions or verbs, identify forward looking statements. We caution
readers that these statements are not guarantees of future performance. Forward looking statements are not historical facts
but instead represent only our beliefs regarding future events, which, may by their nature be inherently uncertain and some of
which may be outside our control. These statements may relate to plans and objectives with respect to the future, among other
things which may change. We are alerting you to the possibility that our actual results may differ, possibly materially, from the
expected objectives or anticipated results that may be suggested, expressed or implied by 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 our most recently filed quarterly or annual report
with the SEC.
Ambac Financial Group, Inc. 2016 Annual Report
“We are committed to creating
long-term value for our shareholders.”
CLAUDE LeBLANC
President and Chief Executive Officer
// Dear Fellow Shareholders,
In my first letter to you since joining Ambac as President and Chief
Executive Officer in January 2017, I want to highlight the significant
progress the Company has made in the last few years and outline my
plans to build on that strong momentum.
One of my first priorities in my new role has been
• Took action to reduce our future operating
to actively engage in discussions with our investors,
analysts, regulators, and several other key constituencies
to enhance my understanding of their perspectives on
the Company. It is clear from these discussions that this
is an important time in Ambac’s history and I am honored
to have the opportunity to lead the Company at such
a critical time. While several challenges remain, I see
substantial opportunities for Ambac to build upon its
strong foundation to unlock and create future value
for shareholders.
Ambac achieved several significant key results and
milestones in 2016:
• Delivered solid earnings despite a challenging
year, reporting net income of $75 million, or
$1.64 per diluted share, and Adjusted Earnings (1)
of $315 million, or $6.89 per diluted share
• Finished the year with book value of $1.7
billion, or $37.94 per share, and Adjusted
Book Value (1) of $1.3 billion, or $29.48
per share
• Decreased our insured portfolio net par (2)
by 27%, from $108 billion to $79 billion, and
Adversely Classified Credits (2) , ( 3) (“ACCs”) by
17% from over $20 billion down to $17 billion
• Negotiated and received, in early 2016, a $995
million cash settlement with JP Morgan as part
of our residential mortgage-backed securities
(“RMBS”) representation and warranty litigation
costs, including annual compensation costs,
by approximately 13%, or $7.5 million
• Accrued an additional $28.7 million in Net
Operating Loss (“NOL”) tolling payments
expected to be received by Ambac Financial
Group, Inc. (“AFG”) in May of 2017
• Opportunistically purchased $659 million
of Ambac-insured securities
During 2016 we also added three highly qualified
and experienced directors, Jim Prieur, Ian Haft and
David Herzog, further strengthening and expanding the
core skillset of our Board. For 2017, we made important
modifications to management’s compensation structure,
including increasing the equity component to further
align management’s interests with our shareholders,
and implementing additional objective metrics to help
determine incentive compensation in accordance with
our pay-for-performance philosophy. In addition,
we adopted new compensation policies, including a
recoupment policy and an executive stock ownership
and retention policy. We also reduced the aggregate
amount of director compensation while increasing the
percentage of equity in director pay.
Looking forward to 2017, we will be initiating a
comprehensive review of the company’s strategy as
well as increasing our focus on overall risk remediation
activities to improve our company’s risk profile. As
we strive to progress our strategic objectives, we will
1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2016
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 1-10777
Ambac Financial Group, Inc.
(Exact name of Registrant as specified in its charter)
Delaware
(State of incorporation)
One State Street Plaza, New York, New York
(Address of principal executive offices)
13-3621676
(I.R.S. employer identification no.)
10004
(Zip code)
212-658-7470
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes
No
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes
No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files). Yes
No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III in this Form 10-K or any amendment to
this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See
definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes
No
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes
No
The aggregate market value of voting stock held by non-affiliates of the Registrant as of the close of business on June 30, 2016 was $742,702,392. As of
February 24, 2017, there were 45,228,945 shares of Common Stock, par value $0.01 per share, were outstanding.
Portions of the Registrant’s proxy statement for its 2017 annual meeting of stockholders are incorporated by reference in this Form 10-K in response to
Part III Items 10, 11, 12, 13, and 14.
Documents Incorporated By Reference
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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995 .................................................
PART I
Item 1.
Business..............................................................................................................................................................................
Introduction ...................................................................................................................................................................
Financial Guaranty Segment.........................................................................................................................................
Financial Services Segment ..........................................................................................................................................
Investments and Investment Policy...............................................................................................................................
Employees .....................................................................................................................................................................
Item 1A. Risk Factors........................................................................................................................................................................
Item 1B. Unresolved Staff Comments ..............................................................................................................................................
Properties............................................................................................................................................................................
Item 2.
Item 3.
Legal Proceedings ..............................................................................................................................................................
Item 4. Mine Safety Disclosures .....................................................................................................................................................
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ........
Item 6.
Selected Financial Data ......................................................................................................................................................
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations .............................................
Company Overview ......................................................................................................................................................
Executive Summary ......................................................................................................................................................
Critical Accounting Policies and Estimates ..................................................................................................................
Results of Operations ....................................................................................................................................................
Liquidity and Capital Resources ...................................................................................................................................
Balance Sheet................................................................................................................................................................
Special Purpose Entities Including Variable Interest Entities .......................................................................................
Accounting Standards ...................................................................................................................................................
Ambac Assurance Statutory Basis Financial Results....................................................................................................
Ambac Assurance UK Limited Financial Results Under UK Accounting Principles ..................................................
Non-GAAP Financial Measures ...................................................................................................................................
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ...........................................................................................
Financial Statements and Supplementary Data ..................................................................................................................
Item 8.
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure ............................................
Item 9A. Controls and Procedures .....................................................................................................................................................
Item 9B. Other Information ...............................................................................................................................................................
PART III
Item 10. Directors, Executive Officers and Corporate Governance .................................................................................................
Executive Compensation ....................................................................................................................................................
Item 11.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ..........................
Item 13. Certain Relationships and Related Transactions, and Director Independence ...................................................................
Principal Accountant Fees and Services .............................................................................................................................
Item 14.
PART IV
Item 15.
Exhibits, Financial Statement Schedules ............................................................................................................................
Schedule I—Summary of Investments Other Than Investments in Related Parties .....................................................
Schedule II—Condensed Financial Information of Registrant (Parent Company Only) .............................................
Schedule IV—Reinsurance ...........................................................................................................................................
PAGE
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SIGNATURES..........................................................................................................................................................................................
170
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to
(13) adverse effects on operating results or our financial position
resulting from measures taken to reduce risks in our insured
portfolio; (14) intercompany disputes or disputes with the
rehabilitator of the Segregated Account; (15) our inability to
monetize assets, restructure or exchange outstanding debt and
insurance obligations, or commute or reduce insured exposures,
or the failure of any such transaction to deliver anticipated results;
(16) our substantial indebtedness could adversely affect our
financial condition, operating flexibility and ability to obtain
financing in the future; (17) restrictive covenants in agreements
and instruments may impair our ability to pursue or achieve our
business strategies; (18) loss of control rights in transactions for
which we provide insurance due to a finding that Ambac Assurance
has defaulted, whether due
the Segregated Account
rehabilitation proceedings or otherwise; (19) our results of
operation may be adversely affected by events or circumstances
that result in the accelerated amortization of our insurance
intangible asset; (20) adverse tax consequences or other costs
resulting from the Segregated Account rehabilitation plan, from
rules and procedures governing the payment of permitted policy
claims, or from the characterization of our surplus notes as equity;
(21) risks attendant to the change in composition of securities in
our investment portfolio; (22) changes in tax law; (23) changes in
prevailing interest rates; (24) factors that may influence the amount
of installment premiums paid to Ambac, including the Segregated
Account rehabilitation proceedings; (25) default by one or more
of Ambac Assurance’s portfolio investments, insured issuers or
counterparties; (26) market risks
in our
investment portfolio or the value of our assets posted as collateral
in respect of investment agreements and interest rate swap
transactions; (27) risks relating to determinations of amounts of
impairments taken on investments; (28) the risk of litigation and
regulatory inquiries or investigations, and the risk of adverse
outcomes in connection therewith, which could have a material
adverse effect on our business, operations, financial position,
profitability or cash flows; (29) our inability to realize value from
Ambac Assurance UK Limited or other subsidiaries of Ambac
Assurance; (30) system security risks; (31) market spreads and
pricing on derivative products insured or issued by Ambac or its
subsidiaries; (32) the risk of volatility in income and earnings,
including volatility due to the application of fair value accounting;
(33) changes in accounting principles or practices that may impact
Ambac’s reported financial results; (34) legislative and regulatory
developments; (35) the economic impact of “Brexit” may have an
adverse effect on Ambac’s insured international portfolio and the
value of its foreign investments, both of which primarily reside
with its subsidiary Ambac UK; (36) operational risks, including
with respect to internal processes, risk and investment models,
systems and employees, and failures in services or products
provided by third parties; (37) Ambac’s financial position and the
Segregated Account rehabilitation proceedings that may prompt
departures of key employees and may impact our ability to attract
qualified executives and employees; and (38) other risks and
uncertainties that have not been identified at this time.
impacting assets
CAUTIONARY STATEMENT PURSUANT TO THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995
In this Annual Report, 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. Words such as “estimate,” “project,” “plan,”
“believe,” “anticipate,” “intend,” “planned,” “potential” and
similar expressions, or future or conditional verbs such as “will,”
“should,” “would,” “could,” and “may,” or the negative of those
expressions or verbs, identify forward-looking statements. We
caution readers that these statements are not guarantees of future
performance. Forward-looking statements are not historical facts
but instead represent only our beliefs regarding future events,
which, may by their nature be inherently uncertain and some of
which may be outside our control. These statements may relate to
plans and objectives with respect to the future, among other things
which may change. We are alerting you to the possibility that our
actual results may differ, possibly materially, from the expected
objectives or anticipated results that may be suggested, expressed
or implied by 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 this
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 incorrect and are based on
management’s current belief or opinions. Ambac’s actual results
may vary materially, and there are no guarantees about the
performance of Ambac’s securities. Among events, risks,
uncertainties or factors that could cause actual results to differ
materially are: (1) the highly speculative nature of Ambac’s
common stock and volatility in the price of Ambac’s common
stock; (2) uncertainty concerning our ability to achieve value for
holders of Ambac securities, whether from Ambac Assurance
Corporation (“Ambac Assurance”) or from transactions or
opportunities apart from Ambac Assurance; (3) adverse effects on
our share price resulting from future offerings of debt or equity
securities that rank senior to our common stock; (4) potential of
rehabilitation proceedings against Ambac Assurance; (5) dilution
of current shareholder value or adverse effects on our share price
resulting from the issuance of additional shares of common stock;
(6) inadequacy of reserves established for losses and loss expenses
and possibility that changes in loss reserves may result in further
volatility of earnings; (7) decisions made by the rehabilitator of
the Segregated Account of Ambac Assurance Corporation (the
“Segregated Account”) for the benefit of policyholders that may
result in material adverse consequences for holders of Ambac’s
securities or holders of securities issued or insured by Ambac
Assurance or the Segregated Account; (8) increased fiscal stress
experienced by issuers of public finance obligations or an increased
incidence of Chapter 9 filings or other restructuring proceedings
by public finance issuers; (9) our inability to realize the expected
recoveries included in our financial statements; (10) credit risk
throughout our business, including but not limited to credit risk
related to residential mortgage-backed securities, student loan and
other asset securitizations, collateralized loan obligations, public
finance obligations and exposures to reinsurers; (11) the risk that
our risk management policies and practices do not anticipate
certain risks and/or the magnitude of potential for loss; (12) risks
associated with adverse selection as our insured portfolio runs off;
| Ambac Financial Group, Inc. 1 2016 FORM 10-K |
PART I
Item 1. Business
INTRODUCTION
Ambac Financial Group, Inc. (“Ambac” or the “Company”),
headquartered in New York City, is a financial services holding
company incorporated in the State of Delaware on April 29, 1991.
On May 1, 2013, Ambac emerged from Chapter 11 bankruptcy
protection when the Second Modified Fifth Amended Plan of
Reorganization became effective. Upon emergence Ambac had
no outstanding debt at the holding company and approximately $5
billion of net operating loss carry-forwards, of which $4.0 billion
remain at December 31, 2016.
Ambac’s primary goal is to maximize stockholder value by
executing the following key strategies:
• Active runoff of Ambac Assurance and its subsidiaries
through transaction terminations, policy commutations,
settlements and restructurings that we believe will improve
our risk profile, and maximizing the risk-adjusted return
on invested assets;
•
•
•
•
Loss recovery through litigation and exercise of contractual
and legal rights;
Improved cost effectiveness and efficiency of the operating
platform;
Rationalization of Ambac's and its subsidiaries' capital and
liability structures, enabling simplification of corporate
governance and facilitating the successful rehabilitation of
the Segregated Account; and
Selective business transactions offering attractive risk-
adjusted returns that, among other things, may permit
utilization of Ambac’s net operating loss carry-forwards.
In March 2010, Ambac Assurance established a segregated account
to Wisconsin Stat. §611.24(2) (the “Segregated
pursuant
Account”) to segregate certain segments of Ambac Assurance’s
liabilities. The Office of the Commissioner of Insurance for the
State of Wisconsin (“OCI” (which term shall be understood to refer
to such office as regulator of Ambac Assurance and to refer to the
Commissioner of Insurance for the State of Wisconsin as
rehabilitator of the Segregated Account (the “Rehabilitator”), as
the context requires)) commenced rehabilitation proceedings in
the Wisconsin Circuit Court for Dane County (the “Rehabilitation
Court”) with respect to the Segregated Account (the “Segregated
Account Rehabilitation Proceedings”) in order to permit OCI to
facilitate an orderly run-off and/or settlement of the liabilities
allocated to the Segregated Account pursuant to the provisions of
the Wisconsin Insurers Rehabilitation and Liquidation Act. Ambac
Assurance is not, itself, in rehabilitation proceedings.
On October 8, 2010, OCI filed a plan of rehabilitation for the
Segregated Account (the “Segregated Account Rehabilitation
Plan”) in the Rehabilitation Court. The Rehabilitation Court
confirmed the Segregated Account Rehabilitation Plan on
January 24, 2011. On June 11, 2014, the Rehabilitation Court
approved amendments to the Segregated Account Rehabilitation
Plan and the Segregated Account Rehabilitation Plan, as amended,
became effective on June 12, 2014. Following the effective date
of the Segregated Account Rehabilitation Plan, as amended, the
interim payment percentage (“IPP”) for permitted policy claims
increased from 25% to 45% with effect from July 21, 2014. As
with previously permitted policy claims, the remaining portion of
the unpaid permitted policy claims (in this case, 55%) will remain
outstanding as Deferred Amounts (as defined in the Segregated
Account Rehabilitation Plan) and, subject to the adjustment for
Undercollateralized Bonds (as defined in the Segregated Account
Rehabilitation Plan), will accrue interest at 5.1% per annum. These
Deferred Amounts, together with interest thereon, may be paid
from time to time in the future at the sole discretion of the
Rehabilitator.
Ambac Assurance is evaluating the possibility of entering into one
or more transactions to improve the financial condition of Ambac
Assurance which may, subject to OCI approval, lead to the
conclusion of the Segregated Account Rehabilitation Proceedings.
In pursuing this objective, Ambac Assurance is considering the
possibility of monetizing certain assets, restructuring or
exchanging certain outstanding debt and insurance obligations,
and/or commuting or reducing insured exposures. Ambac
Assurance is also discussing with OCI potential options for
addressing outstanding Segregated Account and other obligations.
From time to time Ambac Assurance has also discussed, and
intends to continue discussing, with counterparty creditors and
OCI a potential transaction pursuant to which outstanding Deferred
Amounts and surplus notes, in each case including accrued interest,
would be exchanged for or satisfied by indebtedness, or other
instruments which may include securities, and cash or other assets.
In evaluating potential transactions, we understand that OCI
intends to consider, among other things, their impact on the
company and policyholders, and we intend to consider, among
other things, their impact on the company and our stakeholders,
including, in each case, their legal, regulatory and tax implications.
However, Ambac Assurance has not reached any agreement on the
terms of any such transaction, and we cannot provide any assurance
that any such transaction will be consummated by Ambac
Assurance in the future, or if it is, as to the timing, terms or
conditions of any such transaction, or as to whether it could lead
to the conclusion of the Segregated Account Rehabilitation
Proceedings. Any such transaction proposed by Ambac Assurance
would be subject to the prior approval of the board of directors of
Ambac Assurance, OCI and the Rehabilitation Court and may
require third-party consents, which may not be obtained. OCI has
not indicated a course of action to address Segregated Account or
other obligations or to conclude the Segregated Account
Rehabilitation Proceedings. As stated in the Supplement (as
defined below), the goal of the SDC (as defined below) is to provide
additional directional guidance regarding the status of the
Segregated Account rehabilitation during the first quarter of 2017,
barring any unforeseen developments that might impede that
effort. The terms, conditions, and timing of a potential conclusion
of the Segregated Account Rehabilitation Proceedings are in the
sole discretion of OCI, and subject to the approval of the
Rehabilitation Court. This discretion includes the authority to
address Segregated Account obligations without the agreement of
Ambac Assurance or its board of directors. Moreover, even if the
Segregated Account Rehabilitation Proceedings could be brought
to a successful conclusion, there can be no assurance that any level
of capital deemed sufficient by OCI to permit such conclusion will
be sufficient to cover all future losses, whether currently
anticipated or unanticipated.
| Ambac Financial Group, Inc. 2 2016 FORM 10-K |
On July 12, 2016, the Special Deputy Commissioner ("SDC") for
the Segregated Account met with policy beneficiaries and holders
of surplus notes of Ambac Assurance and the Segregated Account
during which the SDC stated (i) that at present, the Rehabilitator
does not have any plans to increase the interim payment percentage
(“IPP”) on Segregated Account policy claims, commenting that
the Rehabilitator and his advisors would need to feel highly
confident that any change to the IPP would be sustainable and fair
to all policyholders; (ii) that the Rehabilitator reserves the right to
amend the Segregated Account Rehabilitation Plan or take such
other action as he deems necessary or appropriate to adjust the rate
of accretion on Deferred Amounts from time to time based on such
factors as he considers relevant and, as such, the accretion rate
remains under review; and (iii) his objective of seeking an exit of
the Segregated Account from rehabilitation, and further stated that
although his preferred goal would be to achieve an exit from
rehabilitation through a consensual plan, he would advise the
Rehabilitator to use all tools available to accomplish a successful
and durable conclusion that enhances Ambac Assurance's long-
term claims-paying ability.
that
the Supplement,
On December 16, 2016, the Rehabilitator filed with the
Rehabilitation Court a supplement to his 2016 Annual Report dated
June 1, 2016 relating to the Segregated Account Rehabilitation
Proceedings (the “Supplement”). In
the
Rehabilitator reiterated his goal of achieving a successful and
durable conclusion to the Segregated Account Rehabilitation
Proceedings. The Rehabilitator also stated in the Supplement that
at the present time and absent further actions, Ambac Assurance
has insufficient capital to demonstrate to the satisfaction of the
the Segregated Account Rehabilitation
Rehabilitator
Proceedings could be concluded and leave Ambac Assurance with
sufficient financial resources to meet all policy obligations, as
projected by the Rehabilitator (in his sole discretion) under
a varying range of base and stress case scenarios. The
Rehabilitator further stated in the Supplement that given such
requirements, any transaction facilitating the conclusion of the
Segregated Account Rehabilitation Proceedings will need to
provide for an increase in Ambac Assurance’s existing surplus
capital, as determined and defined by OCI in its sole discretion.
We cannot provide assurance that the terms of any possible
transaction will satisfy OCI or the Rehabilitator that Ambac
Assurance has, or will have, sufficient capital to meet all policy
obligations after the conclusion of the Segregated Account
Rehabilitation Proceedings.
The execution of Ambac’s strategy to actively run off Ambac
Assurance and its subsidiaries is subject to the authority of the
Rehabilitator to control the management of the Segregated
Account. In exercising such authority, the Rehabilitator will act
for the benefit of policyholders, and will not take into account the
interests of Ambac. The Rehabilitator's authority includes, but is
not limited to, sole discretion over the rate at which the Segregated
Account pays claims and the accretion rate on Deferred Amounts.
Similarly, by operation of the contracts executed in connection
with the establishment, and subsequent rehabilitation, of the
Segregated Account, the Rehabilitator retains rights to oversee and
approve certain actions taken by or in respect of Ambac Assurance.
Accordingly, oversight by the Rehabilitator could impair Ambac’s
ability to execute certain of its strategies. Opportunities for
transaction terminations, policy commutations, settlements and
restructurings also depend on market conditions, including the
perception of Ambac Assurance’s creditworthiness, the structure
of the underlying risk and associated policy as well as other
counterparty specific factors. Ambac Assurance's ability to
commute policies or purchase certain investments may also be
limited by available liquidity.
Refer to Note 1. Background and Business Description to the
Consolidated Financial Statements included in Part II, Item 8 in
this Form 10-K, for more information on the Segregated Account
and the Segregated Account Rehabilitation Proceedings.
Although we are exploring selective business transactions for
Ambac, no assurance can be given that we will be able to execute
the acquisition or development of any new businesses or assets.
In addition, there can be no assurance that we will be able to obtain
the financial and other resources that may be required to finance
the acquisition or development of new businesses or assets that
may permit utilization of Ambac’s net operating loss carry-
forwards. Due to these factors, as well as uncertainties relating to
the ability of Ambac Assurance to deliver value to Ambac, the
value of our securities is highly speculative.
Ambac has two reportable business segments: Financial Guarantee
and Financial Services.
Ambac’s Financial Guarantee business segment is conducted
through its primary operating subsidiary, Ambac Assurance and its
wholly owned subsidiary Ambac Assurance UK Limited (“Ambac
UK”), both of which have been in runoff since 2008. Insurance
policies insured by Ambac Assurance and Ambac UK generally
guarantee payment when due of the principal and interest on the
obligations guaranteed. Ambac Assurance also has another
wholly-owned financial guarantee subsidiary, Everspan Financial
Guarantee Corp. (“Everspan”), which has been in runoff since its
acquisition in 1997. The deterioration of the financial condition of
Ambac Assurance and Ambac UK has prevented these companies
from being able to write new business. An inability to write new
business has and will continue to negatively impact Ambac’s future
operations and financial results. Ambac Assurance’s ability to pay
dividends and, as a result, Ambac’s liquidity, have been
significantly restricted by the deterioration of Ambac Assurance’s
financial condition, by the rehabilitation of the Segregated Account
and by the terms of the Settlement Agreement, dated as of June 7,
2010 (the "Settlement Agreement"), by and among Ambac
Assurance, Ambac Credit Products LLC (“ACP”), Ambac and
certain counterparties to credit default swaps with ACP that were
guaranteed by Ambac Assurance. Ambac Assurance is also
restricted in its ability to pay dividends pursuant to the terms of its
Auction Market Preferred Shares. It is highly unlikely that Ambac
Assurance will be able to make dividend payments to Ambac for
the foreseeable future. Refer to "Dividend Restrictions, Including
Contractual Restrictions" below and Note 8. Insurance Regulatory
Restrictions to the Consolidated Financial Statements included in
Part II, Item 8 in this Form 10-K, for more information on dividend
payment restrictions.
Ambac Assurance and its subsidiaries have been working toward
reducing uncertainties within its insured portfolio through active
monitoring and management of key exposures such as Puerto Rico,
asset-backed securities (including residential mortgage-backed
(RMBS) and student loans) and municipal entities with stressed
financial conditions. Additionally, Ambac Assurance and its
subsidiaries are actively prosecuting legal claims (including
RMBS related lawsuits), managing the regulatory framework and
| Ambac Financial Group, Inc. 3 2016 FORM 10-K |
other aspects of the Segregated Account, seeking to optimize
capital allocation in a challenging environment that includes long
duration obligations and attempting to retain key employees.
Ambac’s Financial Services business segment is operated by
subsidiaries of Ambac Assurance. This segment provides financial
and investment products, including investment agreements,
funding conduits and interest rate swaps, principally to the clients
of its financial guarantee business. The Financial Services business
also maintains interest rate derivatives to mitigate exposure to
floating rate insured obligations in the Financial Guarantee
segment. Ambac Assurance insured all of the obligations of its
financial services subsidiaries. The financial services businesses
are in runoff, which is being effectuated by transaction
terminations,
scheduled
amortization of contracts.
assignments
settlements,
and
Enterprise Risk Management
The Company's policies and procedures relating to risk assessment
and risk management are overseen by its Board of Directors. The
Board takes an enterprise-wide approach to risk management
oversight that is designed to support the Company's business plans
at a reasonable level of risk. A fundamental part of risk assessment
and risk management is not only understanding the risks the
Company faces and what steps management is taking to manage
those risks, but also understanding what level of risk is appropriate
for the Company. The Board of Directors annually reviews the
Company's business plan, factoring risk management into account.
It also approves the Company's risk appetite statement, which
articulates the Company's tolerance for risk and describes the
general types of risk that the Company accepts or attempts to avoid.
While the Board of Directors has the ultimate oversight
responsibility for
the risk management process, various
committees of the Board also have responsibilities related to risk
assessment and risk management, and management has
responsibility for managing the risks to which the Company is
exposed and reporting on such matters to the Board of Directors
and applicable Board committees.
The Audit Committee oversees the management of risks associated
with the integrity of Ambac’s financial statements and its
compliance with legal and regulatory requirements. In addition,
the Audit Committee discusses policies with respect to risk
assessment and risk management, including major financial risk
exposures and the steps management has taken to monitor and
control such exposures. The Audit Committee reviews with
management, internal auditors, and external auditors Ambac's
accounting policies, our system of internal controls over financial
reporting, and the quality and appropriateness of disclosure and
content in the financial statements and other external financial
communications.
The Compensation Committee oversees the management of risk
primarily associated with our ability to attract, motivate and retain
quality
talent, compensation
structures that might lead to undue risk taking, and disclosure of
our executive compensation philosophies, strategies and activities.
talent, particularly executive
The Governance and Nominating Committee oversees the
management of risk primarily associated with Ambac’s ability to
attract and retain quality directors, Ambac’s corporate governance
therewith.
programs and practices and our compliance
Additionally,
the Governance and Nominating Committee
oversees the processes for evaluation of the performance of the
Board, its committees and management each year and considers
risk management effectiveness as part of their evaluation. The
Governance and Nominating Committee also performs oversight
of the business ethics and compliance program, and reviews
compliance with Ambac’s Code of Business Conduct.
The Strategy and Risk Policy Committee oversees the management
of risk and risk appetite primarily with respect to strategic plans
and initiatives, oversight of Ambac’s capital structure, financing
and treasury matters and oversight of management's process for
the identification, evaluation and mitigation of Ambac’s financial
and commercial-related risks.
The full Board also receives quarterly updates from Board
committees, and the Board provides guidance to individual
committee activities as appropriate.
In order to assist the board of directors in overseeing Ambac’s risk
management, Ambac uses enterprise risk management, a
company-wide initiative that involves the Board of Directors,
management and other personnel in an integrated effort to identify,
assess and manage risks that may affect the Company’s ability to
execute on its corporate strategy and fulfill its business objectives.
These activities entail the identification, prioritization and
assessment of a broad range of risks (e.g., credit, financial, legal,
liquidity, market, model, operational, regulatory and strategic), and
the formulation of plans to manage these risks or mitigate their
effects.
The Enterprise Risk Committee (“ERC”) is a management
committee which is comprised of senior level management
responsible for assisting in the management of the Company’s risks
on an individual and aggregate basis. The ERC produces the
relevant risk management information for senior management, the
Board of Directors and applicable Board committees.
Common Stock Restrictions
Ambac’s Amended and Restated Certificate of Incorporation limits
voting and transfer rights of stockholders in significant ways.
Article IV contains voting restrictions applicable to any person
owning at least 10% of Ambac’s common stock so that such person
(including any group consisting of such person and any other
person with whom such person or any affiliate or associate of such
person has any agreement, contract, arrangement or understanding
with respect to acquiring, voting, holding or disposing of Ambac’s
common stock) shall not be entitled to cast votes in excess of one
vote less than 10% of the votes entitled to be cast by all common
stock holders, except as otherwise approved by OCI.
There are substantial restrictions on the ability to transfer Ambac’s
common stock set forth in Article XII of Ambac’s Amended and
Restated Certificate of Incorporation. In order to preserve certain
tax benefits, subject to limited exceptions, any attempted transfer
of common stock shall be prohibited and void to the extent that,
as a result of such transfer (or any series of transfers of which such
transfer is a part), either (i) any person or group of persons shall
become a holder of 5% or more of the Company’s common stock
or (ii) the percentage stock ownership interest in Ambac of any
holder of 5% or more of the Company’s common stock shall be
increased (a “Prohibited Transfer”). These restrictions shall not
apply to an attempted transfer if the transferor or the transferee
| Ambac Financial Group, Inc. 4 2016 FORM 10-K |
obtains the written approval of Ambac’s Board of Directors to such
transfer. A purported transferee of a Prohibited Transfer shall not
be recognized as a stockholder of Ambac for any purpose
whatsoever in respect of the securities which are the subject of the
Prohibited Transfer (the “Excess Securities”). Until the Excess
Securities are acquired by another person in a transfer that is not
a Prohibited Transfer, the purported transferee of a Prohibited
Transfer shall not be entitled with respect to such Excess Securities
to any rights of stockholders of Ambac, including, without
limitation, the right to vote such Excess Securities and to receive
dividends or distributions, whether liquidating or otherwise, in
respect thereof, if any. Once the Excess Securities have been
acquired in a transfer that is not a Prohibited Transfer, the securities
shall cease to be Excess Securities. If the Board determines that a
transfer of securities constitutes a Prohibited Transfer then, upon
written demand by Ambac, the purported transferee shall transfer
or cause to be transferred any certificate or other evidence of
ownership of the Excess Securities within the purported
transferee’s possession or control, together with any distributions
paid by Ambac with respect to such Excess Securities, to an agent
designated by Ambac. Such agent shall thereafter sell such Excess
Securities and the proceeds of such sale shall be distributed as set
forth in the Amended and Restated Certificate of Incorporation. If
the purported transferee of a Prohibited Transfer has resold the
Excess Securities before receiving such demand, such person shall
be deemed to have sold the Excess Securities to Ambac’s agent
and shall be required to transfer to such agent the proceeds of such
sale, which shall be distributed as set forth in the Amended and
Restated Certificate of Incorporation.
Available Information
Our Internet address is www.ambac.com. We make available free
of charge, through the investor relations section of our web site,
annual reports on Form 10-K, quarterly reports on Form 10-Q and
current reports on Form 8-K, and any amendments to those reports,
filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934, as amended, as well as proxy
statements, as soon as reasonably practicable after we
electronically file such material with, or furnish it to, the U.S.
Securities and Exchange Commission. Our Investor Relations
Department can be contacted at Ambac Financial Group, Inc., One
State Street Plaza, New York, New York 10004, Attn: Investor
Relations, telephone: 212-208-3222 email: ir@ambac.com. The
reference to our website address does not constitute inclusion or
incorporation by reference of the information contained on our
website in this Form 10-K or other filings with the SEC, and the
information contained on our website is not part of this document.
Financial information concerning our business segments for each
of 2016, 2015 and 2014 is set forth in “Management’s Discussion
and Analysis of Financial Condition and Results of Operations,”
“Quantitative and Qualitative Disclosures About Market Risk,”
and the Consolidated Financial Statements and the Notes thereto,
included elsewhere in this Form 10-K.
FINANCIAL GUARANTEE SEGMENT
The Financial Guarantee segment includes insurance policies and
credit derivative contracts provided by Ambac Assurance and its
subsidiaries. Generally,
financial guarantees provide an
unconditional and irrevocable guarantee which protects the holder
of a debt obligation against non-payment when due. Pursuant to
such guarantees, Ambac Assurance and its subsidiaries make
payments if the obligor responsible for making payments fails to
do so when scheduled. Credit derivatives also permit certain
counterparties to assert mark-to-market termination claims under
certain conditions; however, the assertion of such mark-to-market
claims has been enjoined by the Rehabilitation Court. See
discussion of “Ambac Assurance Liquidity” in Part II, Item 7
included in this Form 10-K for further information.
Ambac’s financial guarantee insurance policies and credit
derivative contracts expose the Company to the direct credit risk
of the assets and/or obligor supporting the guaranteed obligation.
In addition, insured transactions expose Ambac to indirect risks
that may increase our overall risk, such as credit risk separate from,
but correlated with, our direct credit risk, market, model, economic,
natural disaster and mortality or other non-credit type risks.
Ambac Assurance derives financial guarantee revenues from:
(i) premiums earned from insurance contracts, net of reinsurance;
(ii) net investment income; (iii) fees from credit derivative
transactions; (iv) net realized gains and losses from sales of
investment securities; and (v) amendment and consent fees.
Financial guarantee expenses include: (i) loss and commutation
payments for credit exposures; (ii) loss-related expenses,
including those relating to the remediation of problem credits; (ii)
insurance intangible amortization and (iv) operating expenses.
Premiums for financial guarantees were received either upfront or
on an installment basis from the cash flows generated by the
underlying assets (typical of structured finance obligations).
Despite not underwriting new business, Ambac continues to collect
premiums on its existing portfolio of guarantees that pay premiums
on an installment basis. See “Management’s Discussion and
Analysis of Financial Condition and Results of Operations”
included in Part II, Item 7 in this Form 10-K for further
information.
Risk Management
The Asset Liability Management Committee (“ALCO”) is a
management committee with the objective to implement and foster
an enterprise wide culture and approach to liquidity management,
asset valuation, hedging, and risk remediation. Members of ALCO
include the Chief Executive Officer, Chief Financial Officer and
senior managers from investment management, capital markets
and the Risk Management Group. ALCO has scheduled monthly
meetings and will also meet on an ad hoc basis to consider, for
example, the commutation of distressed financial guarantee
exposures.
The Risk Management group is primarily responsible for the
development, implementation and oversight of loss mitigation
strategies, surveillance and remediation of the insured financial
guarantee portfolio (including through the pursuit of recoveries in
respect of paid claims and commutations of policies). As a
consequence of
the Segregated Account Rehabilitation
Proceedings, the Rehabilitator retains operational control and
decision-making authority with respect to all matters related to the
Segregated Account, including surveillance, remediation and loss
mitigation. The Rehabilitator operates the Segregated Account
through a management services contract executed between Ambac
Assurance and the Segregated Account pursuant to which the Risk
Management group and other personnel provide surveillance,
remediation and loss mitigation services to the Segregated
Account. Furthermore, by virtue of the contracts executed between
Ambac Assurance and the Segregated Account, the Rehabilitator
| Ambac Financial Group, Inc. 5 2016 FORM 10-K |
retains the discretion to oversee and approve certain actions taken
by Ambac Assurance in respect of assets and liabilities that have
not been allocated to the Segregated Account. Refer to Note 1.
Background and Business Description to the Consolidated
Financial Statements included in Part II, Item 8 in this Form 10-
K, for more information on the contracts between Ambac
Assurance and the Segregated Account. As such, the following
discussion of Ambac’s risk management practices is qualified by
reference to the Rehabilitator’s exercise of any of its rights to alter
or eliminate any of these risk management practices.
Ambac’s Risk Management group has an organizational structure
designed around three primary areas of focus: Portfolio Risk
Management and Analysis, Credit Risk Management and Loss
Reserving and Analytics. The senior manager responsible for
these groups reports directly to Ambac's Chief Executive Officer
and regularly informs and updates the Audit Committees of the
Board of Directors of Ambac and Ambac Assurance with respect
to risk-related topics in the insured portfolio.
Portfolio Risk Management and Analysis ("PRM")
This group’s focus is on remediation, loss mitigation, risk
reduction, restructuring and surveillance. Proactive credit
remediation can help to reduce exposure and/or reduce risk in the
insured portfolio by securing rights and remedies, both of which
help to mitigate losses in the event of default. Restructuring or
workout is the focused and active process of minimizing claims
and maximizing recoveries typically following an event of default.
The emphasis on reducing risk is centered on reducing enterprise-
wide exposure on a prioritized basis.
PRM personnel perform periodic surveillance reviews of
exposures according to a schedule based on the risk profile of the
guaranteed obligations or as necessitated by specific credit events
or other macro-economic variables. Risk-adjusted surveillance
strategies have been developed for each bond type with review
periods and scope of review based upon each bond type’s risk
profile. The risk profile is assessed regularly in response to our
own experience and judgments or external factors such as the
economic environment and industry trends. Monitoring activities
are designed to detect deterioration in credit quality or changes in
the economic, regulatory or political environment which could
adversely impact the portfolio. Active surveillance enables PRM
to track single credit migration and industry credit and performance
trends. The focus of the surveillance review is to assess
performance, identify credit trends and recommend appropriate
credit classifications, ratings and changes to a transaction or bond
type’s review period and surveillance requirements. If a problem
is detected, the group focuses on loss mitigation by recommending
appropriate action and working with the issuer, trustee, bond
counsel, servicer and other interested parties in an attempt to
remediate the problem and minimize Ambac Assurance’s exposure
to potential loss. Those credits that are either in default or have
developed problems that eventually may lead to a default or claim
payment are tracked closely by the appropriate surveillance team
and senior risk managers as part of the restructuring or workout
process and discussed at regularly scheduled meetings with Credit
Risk Management (see discussion following in “Credit Risk
Management”). In some cases, PRM will engage restructuring or
workout experts, attorneys and / or other consultants with
appropriate expertise in the targeted loss mitigation area to assist
management in examining the underlying contracts or collateral,
providing industry specific advice and/or executing strategies.
In structured transactions, including structured public finance
transactions, Ambac Assurance often is the control party as a result
of insuring the transaction’s senior class or tranche. The control
party may direct specified parties, usually the trustee, to take or
not take certain actions following contractual defaults or trigger
events. Control rights and the scope of direction and remedies vary
considerably among our insured transactions. Because Ambac
Assurance is party to and/or has certain rights in documents
supporting transactions in the insured portfolio, Ambac Assurance
frequently receives requests for amendments, waivers and
consents (“AWCs”). As discussed below under “Credit Risk
Management,” Ambac Assurance’s risk management personnel
review, analyze and process all requests for AWCs. As a part of
the Segregated Account Rehabilitation Proceedings,
the
Rehabilitation Court enjoined certain actions by other parties to
preserve Ambac Assurance’s control rights that could otherwise
have lapsed or been compromised.
Surveillance for collateral dependent transactions, including, but
not limited to, residential mortgage-backed securities (“RMBS”),
asset-backed securities (“ABS”) and student loan transactions,
focuses on review of the underlying asset cash flows and, if
applicable, the performance of servicers or collateral managers.
Ambac Assurance generally receives periodic reporting of
transaction performance from issuers or trustees. Risk analysts
review these reports to monitor performance and, if necessary, seek
legal or accounting advice to ensure that reporting and application
of cash flows comply with transaction requirements.
Cross-functional teams have been established, across PRM and
other groups as necessary given the targeted strategy to promote
active mitigation and remediation of losses associated with certain
credits and sectors in the insured portfolio. Examples of such teams
include teams of professionals focused on (i) the review and
enforcement of contractual representations and warranties in
RMBS policies, (ii) RMBS servicing and (iii) the analysis and
prioritization of policies with projected claims to target and execute
risk reduction and commutation strategies. The establishment and
purview of cross-functional teams is targeted to address our highest
risk exposures. Members of such teams work with both internal
and external experts in the pursuit of risk reduction on all fronts.
The RMBS servicing team focuses on servicer oversight and
remediation. Analysts monitor the performance of servicers
through a combination of (i) regular reviews of servicer
performance; (ii) compliance certificates received from servicer
management; (iii) independent rating agency information; (iv)
reviews of servicer financial information; and (v) onsite servicing
diligence. Servicer performance reviews typically include a review
including comparisons against
of collateral performance,
benchmarks, as well as the processes of collection, default
management, and loss mitigation. Ambac Assurance may require
a back-up servicer or require “term-to-term” servicing which
provides for limited, renewable servicing terms in order to provide
greater flexibility regarding the servicing arrangements of a
particular transaction.
In some transactions, Ambac Assurance has the right to direct a
transfer of RMBS and other servicing to an alternative servicer,
upon certain events and subject to certain conditions. The decision
to exercise this right is made based on various factors, including
an assessment of the performance of the existing servicer as
outlined above, and an assessment of whether a transfer of
| Ambac Financial Group, Inc. 6 2016 FORM 10-K |
servicing may improve the performance of the collateral and
reduce risk to Ambac Assurance. In the case of RMBS, Ambac
Assurance has developed relationships with preferred servicers.
Preferred servicers are selected through a formalized servicer
review process that determines, among other key factors, the
servicer’s ability and willingness to actively manage intense and
proven loss mitigation activities on RMBS. Ambac Assurance may
decide to exercise its rights to direct the transfer of servicing to a
preferred servicer where such rights are available. The transfer of
servicing is done with the objectives of (i) minimizing losses and
distress levels by deploying targeted and enhanced loss mitigation
programs; (ii) increasing visibility to Ambac Assurance of all
servicing activities that impact overall deal performance;
(iii) better aligning the servicer’s financial interest to the
performance of the underlying deal through the utilization of
performance based incentives; and (iv) reducing the risk of servicer
underperformance due to servicer financial difficulty.
Ambac Assurance believes that the improved loss mitigation
activities, alignment of interests and close monitoring of servicers
constitute credible means of minimizing risks and losses related
to insured RMBS.
A team of professionals is focused on recoveries from sponsors
where Ambac Assurance believes material breaches of
representations and warranties have occurred with respect to
certain RMBS policies. The team engages with experienced
consultants to perform the re-underwriting of loan files and
consults with internal and external legal counsel with regard to
loan putbacks as well as settlement and litigation strategies (refer
to Note 7. Financial Guarantee Insurance Contracts to the
Consolidated Financial Statements included in Part II, Item 8 in
this Form 10-K for further discussion on this topic).
PRM focuses on the analysis, implementation and execution of
commutation and related claims reduction or defeasance strategies
for policies with projected claims. Analysts evaluate the estimated
timing and severity of such projected policy claims as well as the
potential impact of other loss mitigation strategies in order to target
and prioritize policies, or portions thereof, for commutation, bond
purchase, refinancing or other claims reduction or defeasance
strategies. For targeted policies, analysts will engage with
bondholders, issuers and other economic stakeholders to negotiate,
structure, and execute such strategies.
Credit Risk Management ("CRM")
CRM manages the decision process for all material matters that
affect credit exposures within the insured portfolio. While PRM is
responsible for the credit analysis and the recommendation and
execution of credit remediation strategies, CRM provides a forum
for independent assessments and approvals and drives consistency
and timeliness. Strategic level credit and restructuring issues may
also involve the CEO and other executive management to augment
the CRM process in the interest of achieving best outcomes. The
scope of credit matters under the purview of CRM includes
material amendments, waivers and consents, remediation plans,
credit review scheduling, adverse credit classification and below
investment grade rating designations, adversely classified credit
reviews, sector reviews and overall portfolio review. The CRM
decision process may involve a review of structural, legal, political
and credit issues and also includes determining the proper level of
approval, which varies based on the nature and materiality of the
matter. Decisions that also have material asset, liability, and
liquidity implications, such as commutations, bond purchases and
refinancings may also require ALCO approval. Please refer to Note
2. Basis of Presentation and Significant Accounting Policies to the
Consolidated Financial Statements included in Part II, Item 8 in
this Form 10-K for further discussion of the various credit
classifications.
Adversely Classified Credit Review
Credits that are either in default or have developed problems that
eventually may lead to a default are tracked closely by the
appropriate PRM surveillance team and discussed at meetings with
CRM. Adversely classified credit meetings include members of
CRM, PRM and legal, as necessary. As part of the review, relevant
information, along with the plan for corrective actions and a
reassessment of the credit’s rating and credit classification is
considered. Internal and/or external counsel generally review the
documents underlying any problem credit and, if applicable, an
analysis is prepared outlining Ambac Assurance’s rights and
potential remedies, the duties of all parties involved and
recommendations for corrective actions. Ambac Assurance also
meets with relevant parties to the transaction as necessary. The
review schedule for adversely classified credits is tailored to the
remediation plan to track and prompt timely action and proper
internal and external resourcing. A summary of developments
regarding adversely classified credits and credit trends is also
provided to Ambac’s and Ambac Assurance’s Board of Directors
no less than quarterly.
The insured portfolio contains exposures that are correlated and/
or concentrated. Ambac’s surveillance includes identifying these
types of exposures and identifying the risks that would or could
trigger credit deterioration across the related exposures. When such
risks occur, adverse credit classification may be warranted across
many of the correlated and/or concentrated exposures. This is the
case with student loans and RMBS, for example, which have
several correlations including those associated with consumer
lending, unemployment and home prices. In the past, our not-for-
profit healthcare and our leveraged lease exposures experienced
periods of stress arising from their concentrated and/or correlated
risks, when there were major changes to healthcare reimbursement
programs especially Medicaid, or significant weakness in
consumer and business travel, in the case of the former and the
latter, respectively. In the future, Ambac’s portfolio may be subject
to similar credit deterioration arising from concentrated and/or
correlated risks. Examples of other such risks that could impact
our portfolio, and that our surveillance is designed to monitor
include the impact of potential municipal bankruptcy contagion or
the impact of large scale domestic military cutbacks on our military
housing portfolio or event risk such as natural disasters or other
regional stresses. Most such risks cannot be predicted, and may
materialize unexpectedly or develop rapidly. Although our
surveillance allows us to connect the event and stress to the related
exposures and assign an adverse credit classification and estimate
losses across the affected credits, when necessary, we may not have
adequate resources or contractual rights and remedies to mitigate
loss arising from such risks.
Amendment, Waiver and Consent Review / Approval
The decision to approve or reject AWCs is based upon certain credit
factors, such as the issuer’s ability to repay the bonds and the bond’s
security features and structure. Members of Ambac Assurance’s
PRM group review, analyze and process all requests for AWCs.
| Ambac Financial Group, Inc. 7 2016 FORM 10-K |
All AWCs are initially screened for materiality in the surveillance
groups. Non-material AWCs require the approval of at least a PRM
surveillance analyst and a portfolio risk manager. Material AWCs
are within the purview of CRM, as noted above. For material
AWCs, CRM has established minimum requirements that may be
modified to require more or varied approvals depending upon the
matter’s complexity, size or other characteristics.
Ambac Assurance assigns internal credit ratings to individual
exposures as part of the AWC process and at surveillance reviews.
These internal credit ratings, which represent Ambac Assurance’s
independent judgments, are based upon underlying credit
parameters consistent with the exposure type.
Loss Reserving and Analytics Group ("LRA")
LRA manages the quarterly loss reserving process for insured
portfolio credits with projected policy claims. It also supports the
development, operation and/or maintenance of various analytical
models used in the loss reserving process as well as in other risk
management functions. LRA will work together with PRM
analysts responsible for a particular credit on the development,
review and implementation of loss reserve scenarios and related
analysis.
Financial Guarantees in Force
Financial guarantee products were sold in three principal markets:
U.S. public finance, U.S. structured finance and international
finance. The following table provides a breakdown of guaranteed
net par outstanding by market sector at December 31, 2016 and
2015. Net par exposures within the U.S. public finance market
include capital appreciation bonds which are reported at the par
amount at the time of issuance of the insurance policy. Guaranteed
net par outstanding includes the exposures of policies that insure
variable interest entities (“VIEs”) consolidated by Ambac.
Guaranteed net par outstanding excludes the exposures of policies
that insure bonds which have been refunded or pre-refunded:
($ in millions) December 31,
2016
2015
Public Finance
Structured Finance
International Finance
Total net par outstanding
$
$
45,062
$
16,951
17,333
65,436
21,814
21,049
79,346
$
108,299
Included in the above net par exposures at December 31, 2016 and
2015 are $737 million and $971 million, respectively, of exposures
that were executed in the form of credit derivatives, primarily
collateralized loan exposures. See Part II, Item 7, “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations” and Item 8, “Financial Statements and Supplementary
Data” for further discussion of credit derivative exposures.
Certain guaranteed bonds were issued as floating rate debt,
including Auction Rate Securities and Variable Rate Demand
Obligations, which may introduce interest rate risk to Ambac
Assurance. Refer to Auction Rate Securities and Variable Rate
Demand Obligation Exposures below for further discussion.
U.S. Public Finance Insured Portfolio
Ambac’s portfolio of U.S. public finance exposures is $45,062
million, representing 57% of Ambac’s net par outstanding as of
December 31, 2016 and a 31% reduction from the amount
outstanding at December 31, 2015. This reduction in exposure was
mainly due to normal exposure runoff in addition to early
terminations (calls, refundings and pre-refundings). While
Ambac’s U.S. public finance portfolio consists predominantly of
municipal bonds such as general and revenue obligations and lease
and tax-backed obligations of state and local government entities,
the portfolio also comprises a wide array of non-municipal types
of bonds, including financings for not-for-profit entities and
transactions with public and private elements, which generally
finance infrastructure, housing and other public interests. See Note
6. Financial Guarantees in Force to the Consolidated Financial
Statements, included in Part II, Item 8 in this Form 10-K for
exposures by bond type.
Municipal bonds are generally supported directly or indirectly by
the issuer’s taxing authority or by public sector fees and
assessments which may or may not be specifically pledged. Risk
factors in these transactions derive from the municipal issuer,
including its fiscal management, politics, and economic position,
as well as its ability and willingness to continue to pay its debt
service. Municipal bankruptcies, while still relatively uncommon,
have occurred, exposing Ambac to the risk of liquidity claims and
ultimate losses if issuers cannot successfully adjust their liabilities
without impairing creditors.
Not-for-profit transactions are generally supported by the not-for-
profit entities’ net revenues and may also include specific pledges,
liens and/or mortgages. The entity typically serves a well-defined
market and promulgates a public purpose mission. These
transactions may afford Ambac contractual protections such as
financial covenants and control rights in the event of issuer
breaches and defaults. Risk factors in these transactions derive
from the creditworthiness of the issuer, including but not limited
to, its financial condition, leverage, management, business mix,
competitive position,
trends,
government programs, etc. Examples of these types of transactions
include not-for-profit hospitals, universities, associations and
charities.
industry and socioeconomic
Public/private transactions are generally structured to achieve their
targeted public interest objective without direct support from the
public sector. Some examples of this type of financing include
affordable housing, private education, and privatized military and
student housing. Protections within these financings provided to
Ambac usually include the strength of the financed asset’s
essentiality and public purpose and may include financial
covenants, collateral and control rights. Risk factors include
financial underperformance, event risk and a shift in the asset’s
mission or essentiality. One example of this type of financing is
U.S. military housing. Ambac insures approximately $5.9 billion
net par of privatized military housing debt. The debt was issued to
finance the construction and/or renovation of housing units for
military personnel and their families on domestic U.S. military
bases. Debt service is not directly paid or guaranteed by the U.S.
Government. Rather, the bonds are serviced from the cash flow
generated in most cases by rental payments deposited by the
military directly into lockbox accounts as part of each service
personnel’s Basic Allowance for Housing (BAH). In small number
of cases rental payments are also coming from civilians, including
retired service personnel, living on a particular base. Collateral for
these transactions includes the BAH payments as well as an interest
in the ground lease. Risk factors affecting these transactions
include the ongoing base essentiality, military deployments, the
the
U.S. government’s commitment
the BAH,
to fund
| Ambac Financial Group, Inc. 8 2016 FORM 10-K |
marketability/attractiveness of the on-base housing units versus
off base housing, construction completion, environmental
remediation, utility and other operating costs, and housing
management.
governor, on December 1, 2015. A description of Ambac's legal
challenge is provided in Note 17. Commitments and Contingencies
in the Consolidated Financial Statements, included in Part II,
Item 8 in this Form 10-K.
Puerto Rico
Ambac has exposure to Puerto Rico across several different issuing
entities. Each has its own credit risk profile attributable to discrete
revenue sources, direct general obligation pledges and general
obligation guarantees. The following table shows Ambac's insured
exposure to each issuer segregated by whether such debt obligation
is subject to the Priority Debt Provision or "clawback." Ambac
has initiated litigation challenging the application of the
"clawback" announced by Governor Padilla, Puerto Rico's former
Most Puerto Rico bonds insured by Ambac Assurance are not
subject
to acceleration. The Ambac-insured Puerto Rico
Convention Center District Authority (Hotel Occupancy Tax)
bonds may be accelerated only with the consent of, or at the
direction of, Ambac Assurance. The Ambac-insured Puerto Rico
Sales Tax Financing Corporation's Senior Sales Tax Revenue
bonds may be accelerated only with the consent of Ambac
Assurance, subject to the Ambac financial guaranty insurance
policy being in full force and effect.
($ in millions)
Exposures Subject to Priority Debt Provision (4)
Range of
Maturity
Ambac
Ratings (1)
Net Par
Outstanding (2)
Net Par and
Interest
Outstanding (3)
Ever-to-Date
Net Claims
Paid
PR Highways and Transportation Authority (1968 Resolution -
Highway Revenue) (4)
PR Highways and Transportation Authority (1998 Resolution -
Senior Lien Transportation Revenue) (5)
PR Infrastructure Financing Authority (Special Tax Revenue) (6)
2017-2027
2017-2042
2017-2044
PR Convention Center District Authority (Hotel Occupancy Tax)
2017-2031
Total
Exposures Not Subject to Priority Debt Provision
Commonwealth of Puerto Rico - General Obligation Bonds
2019-2023
PR Public Buildings Authority - Guaranteed by the
Commonwealth of Puerto Rico
PR Sales Tax Financing Corporation - Senior Sales Tax Revenue
(COFINA)
Total
2017-2035
2047-2054
BIG
BIG
BIG
BIG
BIG
BIG
BIG
$
27
$
34
$
431
471
137
1,066
56
131
805
992
790
1,022
202
2,048
67
214
7,321
7,602
Total Net Exposure to The Commonwealth of Puerto Rico
and Related Entities
$
2,058
$
9,650
$
—
—
52
—
52
1
10
—
11
63
(1)
Internal 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 Assurance 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 Assurance credit ratings are subject to revision at any time and do not constitute investment
advice. Ambac Assurance, or one of its affiliates, has guaranteed the obligations listed and may also provide other products or services to the issuers of
these obligations for which Ambac Assurance may have received premiums or fees. “BIG” denotes credits deemed below investment grade.
(2) Net Par includes capital appreciation bonds, which are reported at the par amount at the time of issuance of the insurance policy. Accretion of the capital
appreciation bonds would increase the related net par by $616 million at December 31, 2016.
(3) Net par and interest outstanding ("P&I") represents the total insured future debt service remaining over the lifetime of the bonds. P&I for capital appreciation
bonds does not represent the accreted amount as noted in footnote (2) but rather the amount due at respective maturity dates.
(4) Commonly known as "clawback" provision pursuant to Section 8 of Article VI of the Constitution of the Commonwealth of Puerto Rico.
(5) Pledged Revenues for Highway and Transportation Revenue Bonds include Toll Revenues and Investment Earnings which are not subject to the Priority
Debt Provision.
(6) Payable from and secured by proceeds from a federal excise tax imposed on all items produced in Puerto Rico and sold on the mainland of the United
States. Currently, rum is the only product from Puerto Rico subject to this federal excise tax.
to
implement
In November and December 2015, former Governor Padilla issued
certain executive orders purporting
the
Commonwealth Constitution’s Priority Debt Provision for Fiscal
Year 2016, due to his claim that there are insufficient revenues to
pay all appropriations for the year. The executive orders called for
the "clawback" of certain revenues that would otherwise have been
transferred to the Puerto Rico Highways and Transportation
Authority (“HTA”), the Puerto Rico Infrastructure Financing
Authority (“PRIFA”) and the Puerto Rico Convention Center
District Authority (“PRCCDA”) to be transferred instead for
application to the Commonwealth’s public debt. As a result, such
revenues were not available to pay debt service owed by those
entities, including on bonds insured by Ambac Assurance. Ambac
has filed a lawsuit in U.S. District Court, District of Puerto Rico,
asserting that the executive orders and diversion of revenues
violate the U.S. Constitution. Refer to Note 17. Commitments and
Contingencies to the Consolidated Financial Statements included
in Part II, Item 8 in this Form 10-K for a further discussion of this
lawsuit.
In June 2016, the United States enacted the Puerto Rico Oversight,
Management, and Economic Stability Act (“PROMESA”).
Among other things, PROMESA provides for a temporary stay on
| Ambac Financial Group, Inc. 9 2016 FORM 10-K |
litigation concerning
the debt obligations of
certain
the
Commonwealth and its instrumentalities. The federal district court
overseeing various creditor lawsuits in the District of Puerto Rico
has held that the PROMESA litigation stay applies broadly, and
the U.S. Court of Appeals for the First Circuit has affirmed the
district court's denial of one plaintiff's attempt to lift the litigation
stay. These rulings may limit Ambac Assurance's ability to engage
in certain aspects of loss mitigation in the short term. The litigation
stay, which was originally set to expire on February 15, 2017, has
been extended until May 1, 2017.
On October 28, 2016, Ambac Assurance opted not to contest the
application of the PROMESA litigation stay to its lawsuit
challenging the "clawback" orders, while reserving the right to
seek to lift the stay in the future. As a result, there may be additional
delay in obtaining a ruling on the merits of the claims asserted in
this lawsuit.
Since April 2016, the Commonwealth has been subject to an
emergency moratorium, known as "Law 21," on debt payments of
the Commonwealth and its instrumentalities. Beginning in April
2016, and culminating on June 30, 2016, former Governor Padilla
issued additional executive orders under Law 21 declaring states
of emergency at HTA, PRIFA, PRCCDA, and other Puerto Rico
instrumentalities through January 31, 2017, and suspending
payment obligations on bonds issued by those entities, including
bonds
the
insured by Ambac Assurance. Subsequent
implementation of the moratorium, the Commonwealth defaulted
on approximately $0.9 billion out of $2.0 billion of debt service
due on July 1, 2016, including certain Puerto Rico bonds insured
by Ambac Assurance. On January 29, 2017, current Governor
Rosello signed the Financial Emergency and Fiscal Responsibility
Act, which extends the emergency moratorium period until May
1, 2017, with an option to extend another three months until August
1, 2017.
to
PROMESA provides that laws such as Law 21 are not binding on
any non-consenting creditor to the extent they prohibit the payment
of principal or interest. The practical effect of this provision is
unknown and therefore Ambac is at risk to the ongoing execution,
interpretation and ultimate enforcement of this provision.
PROMESA also provides that unlawful executive orders are
preempted under PROMESA, but there is no procedure for
determining whether a particular executive order is unlawful,
creating uncertainty in general and with specific regards to how
the preemption provision will be implemented towards Ambac’s
exposures.
On October 7, 2016, certain holders of Puerto Rico’s GO bonds
requested leave of court to file an amended complaint that, among
other things, challenges the structure of the Puerto Rico Sales Tax
Financing Corporations ("COFINA") and seeks injunctive relief
requiring the sales and use tax proceeds securing the bonds issued
by COFINA to be transferred to the Commonwealth treasury for
payment of GO bonds. On October 26, 2016, Ambac filed a motion
to intervene in that lawsuit and argued that the proposed claims
are subject to PROMESA’s litigation stay. The Court granted the
GO plaintiffs’ motion to file an amended complaint on November
4, 2016. On February 17, 2017, the Court issued an opinion and
order granting Ambac’s motion to intervene and denying the
request to stay the litigation under PROMESA. The Court clarified
that claims asserted under PROMESA, which could not have been
commenced before the enactment of the statute, are not subject to
the litigation stay. If successful, the GO plaintiffs’ challenge
against COFINA, and any similar claims that could be asserted by
other plaintiffs in the future, could have a significant negative
impact on Ambac’s liquidity, loss reserves and capital resources.
As noted above, PROMESA creates a new federal legislative
framework for Puerto Rico. It is untested and many provisions are
unique. There is inherent uncertainty and risk both generally and
for Ambac’s exposures specifically regarding the interpretation
and implementation of PROMESA. Among other things,
PROMESA contains provisions that may permit consensual and
non-consensual restructurings of debt obligations of
the
Commonwealth and its instrumentalities. PROMESA also confers
significant powers and responsibilities on the oversight board
created thereunder (the “Oversight Board”). Among other things,
the Oversight Board is required to certify any insolvency petitions
that may be filed by Puerto Rico instrumentalities under Title III
of PROMESA, any proposed plans of adjustment in such
proceedings, and any voluntary restructuring agreement among
creditors under Title VI of PROMESA (which has the potential to
bind non-consenting creditors). The Oversight Board is also
required to approve fiscal plans and budgets submitted by the
Commonwealth and monitor compliance with those plans and
budgets, and to approve any debt issuances or modifications by
the Commonwealth or its instrumentalities. Ambac is unable to
predict to what extent debt restructurings will be proposed or
implemented under PROMESA, and how its insured obligations
will fare in any such restructurings.
On October 14, 2016, former Governor Padilla presented the
Commonwealth’s Fiscal and Economic Growth Plan (“FEGP”) to
PROMESA oversight board members. The FEGP lays out various
economic scenarios in which Puerto Rico incurs significant deficits
over the next 10 years. These range from $58.7 billion, if Puerto
Rico loses Affordable Care Act money from the federal
government in 2018 and other revenue shortfall assumptions, to
$5.7 billion, if Puerto Rico excludes all debt service payments over
the next 10 years in isolation. These scenarios implied that
significant cuts to debt service obligations are required in order to
balance budgets and eliminate fiscal deficits. The Oversight Board
did not certify this FEGP prior to end of Governor Padilla's term
in December 2016.
Current Governor Rosello has agreed to provide a proposed FEGP
to the Oversight Board by February 28, 2017. The Oversight Board
expects that the FEGP will be certified by March 31, 2017. The
Oversight Board has requested that the proposed FEGP includes,
among other things, $3 billion in cuts to healthcare, University of
Puerto Rico and pensions, and $1.5 billion
in revenue
enhancements by Fiscal Year 2019. It is currently unclear what, if
anything, the proposed FEGP will do to address the restructuring
of debt obligations of the Commonwealth or its instrumentalities.
However, any such restructuring proposal may include material
cuts to payment of principal and interest on debts insured by Ambac
Assurance.
| Ambac Financial Group, Inc. 10 2016 FORM 10-K |
The table below shows Ambac’s ten largest U.S. public finance exposures, by repayment source, as a percentage of total financial guarantee
net par outstanding at December 31, 2016:
($ in millions)
Ambac
Ratings(1)
Net Par
Outstanding (2)
% of Total
Net Par
Outstanding
New Jersey Transportation Trust Fund Authority - Transportation System
BBB+
$
California State - GO
Puerto Rico Sales Tax Financing Corporation - Senior Sales Tax Revenue (COFINA)
Massachusetts Commonwealth - GO
Mets Queens Baseball Stadium Project, NY, Lease Revenue
Chicago, IL - GO
Hickam Community Housing LLC
Puerto Rico Infrastructure Financing Authority, Special Tax Revenue
Puerto Rico Highways & Transportation Authority, Transportation Revenue
Bragg Communities, LLC
Total
A
BIG
AA
BIG
BBB-
BBB
BIG
BIG
A-
1,646
1,162
805
802
572
572
476
471
458
437
$
7,401
2.1 %
1.5 %
1.0 %
1.0 %
0.7 %
0.7 %
0.6 %
0.6 %
0.6 %
0.6 %
9.3%
(1)
Internal 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 Assurance 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 Assurance credit ratings are subject to revision at any time and do not constitute investment
advice. Ambac Assurance, or one of its affiliates, has guaranteed the obligations listed and may also provide other products or services to the issuers of
these obligations for which Ambac Assurance may have received premiums or fees. “BIG” denotes credits deemed below investment grade.
(2) Net Par includes capital appreciation bonds, which are reported at the par amount at the time of issuance of the insurance policy.
U.S. Structured Finance Portfolio
Ambac’s portfolio of U.S. structured finance exposures is $16,951
million, representing 21% of Ambac’s net par outstanding as of
December 31, 2016 and a 22% reduction from the amount
outstanding at December 31, 2015. This reduction in exposure was
the result of normal exposure runoff, primarily related to residential
mortgage-backed policies, in addition to terminations and
commutations of student loan and asset backed policies. Insured
exposures include securitizations of mortgage loans, home equity
loans, student loans, leases, operating assets, collateralized debt
obligations ("CDO"), collateralized loan obligations (“CLO”), and
other asset-backed financings, in each case where the majority of
the underlying collateral risk is situated in the United States.
Included within the lease securitization sector are pooled aircraft
and railcar transactions. Additionally, Ambac’s structured finance
insured portfolio includes secured and unsecured debt issued by
investor-owned utilities, structured insurance transactions and
aircraft equipment trust certificates. See Note 6. Financial
Guarantees in Force to the Consolidated Financial Statements,
included in Part II, Item 8 included in this Form 10-K, for
exposures by bond type as of December 31, 2016.
Structured finance exposures generally entail three forms of risk:
(i) asset risk, which relates to the amount and quality of the
underlying assets; (ii) structural risk, which relates to the extent to
which the transaction’s legal structure and credit support provide
protection from loss; and (iii) servicer risk, which is the risk that
poor performance at the servicer or manager level contributes to
a decline in cash flow available to the transaction. Ambac
Assurance seeks to mitigate and manage these risks through its
risk management practices.
Structured securities are usually designed to help protect the
investors and, therefore, the guarantor from the bankruptcy or
insolvency of the entity that originated the underlying assets as
well as from the bankruptcy or insolvency of the servicer of those
assets. The servicer of the assets is typically responsible for
collecting cash payments on the underlying assets and forwarding
such payments, net of servicing fees, to a trustee for the benefit of
the issuer. One potential issue is whether the sale of the assets by
the originator to the issuer would be upheld in the event of the
bankruptcy or insolvency of the originator and whether the servicer
of the assets may be permitted or stayed from remitting to investors
cash collections held by it or received by it after the servicer or the
originator becomes subject
insolvency
proceedings. Another potential issue is whether the originator sold
ineligible assets to the securitization transaction that subsequently
deteriorated, and, if so, whether the originator has the willingness
or financial wherewithal to meet its contractual obligations to
repurchase those assets out of the transaction. Structural protection
in a transaction, such as control rights that are typically held by
the senior note holders, or guarantor in insured transactions, will
determine the extent to which underlying asset performance can
be influenced upon non-performance to improve the revenues
available to cover debt service.
to bankruptcy or
| Ambac Financial Group, Inc. 11 2016 FORM 10-K |
The following table presents the top five servicers by net par outstanding at December 31, 2016 for U.S. structured finance exposures:
Servicer
($ in millions)
Specialized Loan Servicing, LLC
Bank of America N.A.
Ocwen Loan Servicing, LLC
Wells Fargo Bank
Pennsylvania Higher Education Assistance Agency
Bond Type
Mortgage-backed
$
Mortgage-backed
Mortgage-backed
Mortgage-backed
Student Loan
Net Par
Outstanding
% of Total
Net Par
Outstanding
2,336
2,102
1,311
1,178
1,086
2.9%
2.6%
1.7%
1.5%
1.4%
The table below shows Ambac’s ten largest structured finance transactions, as a percentage of total financial guarantee net par outstanding at
December 31, 2016:
1.1 %
0.8 %
0.7 %
0.7 %
0.6 %
0.5 %
0.4 %
0.4 %
0.3 %
0.3 %
5.9%
Ambac
Rating(1)
Net Par
Outstanding
% of Total
Net Par
Outstanding
($ in millions)
Ballantyne Re Plc (2)
Wachovia Asset Securitization Issuance II, LLC 2007-HE2 (3) Mortgage Backed Securities
Structured Insurance
Bond Type
Timberlake Financial, LLC
Structured Insurance
Progress Energy Carolinas, Inc.
Wachovia Asset Securitization Issuance II, LLC 2007-HE1 (3) Mortgage Backed Securities
Investor Owned Utility
CenterPoint Energy Inc.
Consolidated Edison Company of New York
Option One Mortgage Loan Trust 2007-FXD1 (3)
Countrywide Asset-Backed Certificates Trust 2005-16 (3)
Impac CMB Trust Series 2005-7 (3)
Investor Owned Utility
Investor Owned Utility
Mortgage Backed Securities
Mortgage Backed Securities
Mortgage Backed Securities
$
BIG
BIG
BBB
A-
BIG
BBB+
A
BIG
BIG
BIG
900
641
573
558
450
376
347
311
274
264
Total
$
4,694
(1)
Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance, and
for Ambac UK related transactions, based on the view of Ambac UK. In cases where Ambac Assurance or Ambac UK 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
Assurance and Ambac UK credit ratings are subject to revision at any time and do not constitute investment advice. Ambac Assurance, or one of its
affiliates, has guaranteed 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. “BIG” denotes credits deemed below investment grade.
(2)
Insurance policy issued by Ambac UK.
(3) Ambac Assurance has allocated the policies relating to these transactions to the Segregated Account.
dynamics, foreign exchange issues and the degree of governmental
support. Ambac continues to assess these risks through its ongoing
risk management.
Ambac UK, which is regulated in the United Kingdom (“UK”),
had been Ambac Assurance’s primary vehicle for directly issuing
financial guarantee policies in the UK and the European Union
with $15,082 million net par outstanding in those markets at
insured exposures
December 31, 2016. The portfolio of
underwritten by Ambac UK is financially supported exclusively
by the assets of Ambac UK and no capital support arrangements
are in place with any other Ambac affiliate.
International Finance Insured Portfolio
Ambac’s portfolio of international finance insured exposures is
$17,333 million, representing 22% of Ambac’s net par outstanding
as of December 31, 2016 and an 18% reduction from the amount
outstanding at December 31, 2015. This reduction in exposure was
primarily the result of the strengthening of the US dollar, exposure
runoff including reduction of certain aircraft leasing obligations
and other policy terminations. Ambac’s international finance
insured exposures include a wide array of obligations in the
international markets, including infrastructure financings, asset-
securitizations, utility obligations, and whole business
securitizations (e.g. securitizations of substantially all of the
operating assets of a corporation). Ambac no longer has insured
exposure related to emerging markets. See Note 6. Financial
Guarantees in Force to the Consolidated Financial Statements,
included in Part II, Item 8 included in this Form 10-K, for
exposures by bond type as of December 31, 2016.
When underwriting transactions in the international markets,
Ambac considered the specific risks related to the particular
country and region that could impact the credit of the issuer. These
risks include the legal and political environment, capital markets
| Ambac Financial Group, Inc. 12 2016 FORM 10-K |
Other European Union Exposures (“EU”)
Ambac's international exposures are principally in the United Kingdom; however, we also have exposures with credit risk based in various
other EU member states, including Austria, France, Germany, Italy and Spain. Several of these countries have experienced significant economic,
fiscal and/or political strains such that the likelihood of default on such obligations is higher than when the policies were underwritten. The
Company’s exposures, net of reinsurance, to these countries are shown in the following table:
($ in millions)
Sub-sovereign
Infrastructure / operating ABS
Investor-owned utility
Total
Total below investment grade
Austria
France
Germany
Italy
Spain
Total
$
$
$
— $
32
$
— $
696
—
696
696
$
$
254
—
286
$
— $
—
41
41
41
$
$
740
158
—
898
$
— $
$
— $
—
39
39
39
$
$
772
1,108
80
1,960
776
Ambac does not guarantee any sovereign bonds of the above EU
countries. However, the exposures classified as sub sovereign may
be impacted should there be adverse financial developments in the
EU. Those exposures classified as infrastructure/operating asset
backed are concession based where the underlying assets
independently generate cash flow without operational reliance on
the sovereign. Of the below investment grade exposures, the
investor-owned utilities (wind farm and mini hydro-electric plant)
are undergoing restructuring processes designed to address their
performance issues. The other below investment grade exposure
is a road transaction, where performance has been poorer than
anticipated due to lower than forecast traffic volumes, however
performance is improving. Below investment grade is defined as
those exposures with a credit rating below BBB-.
Brexit:
In a non-binding referendum on the United Kingdom’s (“UK”)
membership in the European Union ("EU") in June 2016, a
majority of those who voted approved the UK’s withdrawal from
the EU. Withdrawal by the UK from the EU (“Brexit”) would occur
after, or possibly concurrently with, a process of negotiation
regarding the future terms of the UK’s relationship with the EU,
which could result in the UK losing access to certain aspects of
the single EU market and the global trade deals negotiated by the
EU on behalf of its members. The Brexit vote and the perceptions
as to the impact of the withdrawal of the UK may adversely affect
business activity, political stability and economic conditions in the
UK, the Eurozone, the EU and elsewhere. The economic outlook
could be further adversely affected by (i) the risk that one or more
other EU countries could come under increasing pressure to leave
the EU, (ii) the risk of a greater demand for independence by
Scottish nationalists or for unification in Ireland, or (iii) the risk
that the Euro as the single currency of the Eurozone could cease
to exist. Any of these developments, or the perception that any of
these developments are likely to occur, could have a material
adverse effect on economic growth or business activity in the UK,
the Eurozone, and the EU, and could result in the relocation of
businesses, cause business interruptions, lead to economic
recession or depression, and impact the stability of the financial
markets, the availability of credit, political systems or financial
institutions and the financial and monetary system. Consequently
the medium and longer term impact on the UK generally, and
Ambac UK specifically, is uncertain.
The vote caused volatility in global stock markets and currency
exchange rate fluctuations that resulted in the strengthening of the
U.S. dollar against foreign currencies, particularly the British
Pound and to a lesser extent the Euro. Ambac's wholly-owned UK
subsidiary, Ambac UK, operates in the United Kingdom and the
British Pound is its functional currency. Ambac UK conducts a
portion of its business in currencies other than its functional
currency, predominately the Euro and US Dollar. Refer to
"Executive Summary - Foreign Currency Impacts" included in Part
II, Item 7 in this Form 10-K, for more information on the economic
and financial statement impact of such changes to foreign currency
exchange rates.
Since the referendum vote, there has been a reduction in net par
outstanding of insured exposures denominated in British Pounds
and Euro of $2,678 million, primarily due to the strengthening of
the US dollar. As of December 31, 2016 insured exposures
denominated in British Pounds totaled £10,136 million and in
Euros €1,831 million.
| Ambac Financial Group, Inc. 13 2016 FORM 10-K |
The table below shows our ten largest international finance transactions as a percentage of total financial guarantee net par outstanding at
December 31, 2016. Except where noted, all international finance transactions included in the table below are insured by Ambac UK:
($ in millions)
Country-Bond Type
Ambac
Rating(1)
Mitchells & Butlers Finance plc-UK Pub Securitisation
UK-Asset Securitizations
National Grid Electricity Transmission
Aspire Defence Finance plc
Capital Hospitals plc (2)
Posillipo Finance II S.r.l
Telereal Securitisation plc
Ostregion Investmentgesellschaft NR 1 SA (2)
Anglian Water
National Grid Gas
RMPA Services plc
Total
UK-Utility
UK-Infrastructure
UK-Infrastructure
Italy-Sub-Sovereign
UK-Asset Securitizations
Austria-Infrastructure
UK-Utility
UK-Utility
UK-Infrastructure
A+
A-
BBB+
A-
BBB-
AA
BIG
A-
A-
BBB+
Net Par
Outstanding
$
1,443
997
864
833
740
738
696
696
642
580
% of Total
Net Par
Outstanding
1.8 %
1.3 %
1.1 %
1.0 %
0.9 %
0.9 %
0.9 %
0.9 %
0.8 %
0.7 %
$
8,229
10.4%
(1)
Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance, and
for Ambac UK related transactions, based on the view of Ambac UK. In cases where Ambac Assurance or Ambac UK 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
Assurance and Ambac UK credit ratings are subject to revision at any time and do not constitute investment advice. Ambac Assurance, or one of its
affiliates, has guaranteed 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. “BIG” denotes credits deemed below investment grade.
(2) A portion of this transaction is insured by an insurance policy issued by Ambac Assurance.
Additional Insured Portfolio Information
Average Life of Insured Portfolio
Ambac underwrote and priced financial guarantees based on the
assumption that the guarantees would remain in force until the
maturity of the underlying bonds. Ambac estimates that the average
life of its guarantees on par in force at December 31, 2016 is
approximately 11 years. The average life is determined by applying
a weighted average calculation, using the remaining years to
expected maturity of each guaranteed bond, and weighting them
on the basis of the remaining net par guaranteed. Except for RMBS
policies, no assumptions are made for non-contractual reductions,
refundings or terminations of insured issues. RMBS policies
incorporate assumptions on expected voluntary and involuntary
prepayments over the remaining life of the insured obligation. The
table below depicts amortization of existing guaranteed net par
outstanding:
Net Par Outstanding Amortization (1)
($ in millions)
Estimated Net
Amortization
2017
2018
2019
2020
2021
2017-2021
2022-2026
2027-2031
2032-2036
After 2036
Total
$
$
$
6,269
5,787
4,681
4,498
4,377
25,612
17,491
13,470
13,250
9,523
79,346
(1) Depicts amortization of existing guaranteed portfolio, assuming no
advance refundings, as of December 31, 2016. Expected maturities
will differ from contractual maturities because borrowers may have
the right to call or prepay guaranteed obligations.
| Ambac Financial Group, Inc. 14 2016 FORM 10-K |
Summary of Below Investment Grade Exposure:
Bond Type ($ in millions)
Public Finance:
Lease and tax-backed (1)
General obligation (1)
Transportation
Housing (2)
Health care
Other
Total Public Finance
Structured Finance:
Residential mortgage-backed and home equity—first lien
Residential mortgage-backed and home equity—second lien
Student loans
Structured Insurance
Mortgage-backed and home equity—other
Other
Total Structured Finance
International Finance:
Other
Total International Finance
Total
Net Par Outstanding - December 31,
2016
2015
$
2,145
$
2,168
681
415
125
29
775
4,170
5,163
3,483
991
900
251
304
11,092
1,562
1,562
$
16,824
$
746
432
126
6
766
4,244
6,055
4,374
1,426
1,037
251
525
13,668
1,880
1,880
19,792
(1) Tax-backed includes $1,871 and $1,916 of Puerto Rico net par at December 31, 2016 and 2015, respectively. General obligation includes $187 and $247
of Puerto Rico net par at December 31, 2016 and 2015, respectively. Puerto Rico net par outstanding includes capital appreciation bonds which are
reported at the par amount at the time of issuance of the related insurance policy.
(2)
Includes $125 of military housing net par at December 31, 2016 and 2015.
The decrease in below investment grade exposures is primarily
due to (i) commutations of student loan policies, (ii) reductions to
residential mortgage-backed securities during the year as a result
of both prepayments by issuers and claims presented to Ambac
Assurance and (iii) cancellation of certain asset backed bonds.
Despite the decrease in below investment grade net par, such
exposure increased in relative proportion to the aggregate insured
portfolio to 21% at December 31, 2016 compared to 18% at
December 31, 2015. Based on our experience, below investment
grade exposures typically run-off at a slower pace than investment
grade exposures and therefore Ambac is subject to the risk that its
insured portfolio will increasingly become concentrated in higher
risk below investment grade exposures. This risk may result in
greater volatility in our results from operations and have adverse
effects on our financial condition.
U.S. residential mortgage-backed securities exposure
Ambac has exposure to the U.S. mortgage market primarily
including
through direct financial guarantees of RMBS,
transactions that contain risks to first and second liens.
Ambac classifies its insured first-lien RMBS exposure principally
into two broad credit risk classes: mid-prime (including Alt-A,
interest only, and negative amortization) and sub-prime. Mid-
prime loans were typically made to borrowers who had stronger
credit profiles relative to sub-prime loans, but weaker than prime
loans. Compared with mid-prime loans, sub-prime loans typically
had higher loan-to-value ratios, reflecting the greater difficulty that
sub-prime borrowers have in making down payments and the
propensity of these borrowers to extract equity during refinancing.
The mid-prime category includes:
•
•
Loans with specific payment features that afforded
borrowers the option to have lower payments in the early
years with potential resets after several years. For example,
so-called interest only loans have monthly payments
comprised of interest but no principal. So called negative
amortization loans permit borrowers to defer interest and
principal in the early years and then make higher payments
in the period after the reset. Both types may also have lower
interest rates in the early years. Increases in monthly
payments, commonly called payment shock, raise the
probability of delinquencies and defaults given the decline
in house prices that has caused many borrowers’ loan
balances to exceed their homes’ market value.
for
agency
Loans backed by borrowers who typically did not meet
documentation
guidelines
standard
requirement, property type or loan-to-value ratio. These are
typically higher-balance loans made to individuals who
might have past credit problems that were not severe
enough to warrant “sub-prime” classification, or borrowers
who chose not to obtain a prime mortgage due to
documentation requirements.
| Ambac Financial Group, Inc. 16 2016 FORM 10-K |
Ambac's second lien insured RMBS transactions are collateralized
predominantly by second-lien mortgage loans such as closed-end
seconds and home equity lines of credit. A second-lien mortgage
loan is a type of loan in which the borrower uses the equity in their
home as collateral and the second-lien loan is subordinate to the
first-lien loan outstanding on the home. The borrower is obligated
to make monthly payments on both their first and second-lien loans.
If the borrower defaults on the payments due under these loans and
the property is subsequently liquidated, the liquidation proceeds
are first utilized to pay off the first-lien loan (as well as costs due
the servicer) and any remaining funds are applied to pay off the
second-lien loan. As a result of this subordinate position to the
first-lien loan, second-lien loans carry a significantly higher
severity in the event of a loss, typically at or above 100% in the
current housing market.
The following tables provide, by vintage and type current net par outstanding of Ambac’s U.S. RMBS book of business:
Year of Issue
($ in millions)
1998-2001
2002
2003
2004
2005
2006
2007
(cid:55)(cid:82)(cid:87)(cid:68)(cid:79)
% of Total RMBS
Portfolio
% of Related Par
Outstanding rated below
investment grade (2)
Total Net Par Outstanding - December 31, 2016
Total Net Par Outstanding - December 31, 2015
Second
Lien
First-lien
Sub-
prime
First-lien
Mid-
prime
Other(1)
Total
Second
Lien
First-lien
Sub-
prime
First-lien
Mid-
prime
Other(1)
Total
$
169
$
$
236
$
$
5
2
6
321
402
1,340
1,415
$
344
291
411
245
572
379
311
$
1
26
154
271
1,028
523
868
519
322
651
838
2,040
2,297
2,716
$
11
7
10
451
544
1,615
1,765
$
386
340
488
289
664
438
336
$
1
31
187
336
1,211
617
1,055
3
80
1
38
55
122
(cid:23)(cid:25)(cid:27)
634
383
789
1,083
2,463
2,735
3,300
5
104
7
44
65
144
(cid:25)(cid:19)(cid:24)
(cid:7) (cid:22)(cid:15)(cid:23)(cid:28)(cid:20)
(cid:7) (cid:21)(cid:15)(cid:24)(cid:24)(cid:22)
(cid:7) (cid:21)(cid:15)(cid:27)(cid:26)(cid:20)
(cid:7)
(cid:7) (cid:28)(cid:15)(cid:22)(cid:27)(cid:22)
(cid:7) (cid:23)(cid:15)(cid:23)(cid:19)(cid:22)
(cid:7) (cid:21)(cid:15)(cid:28)(cid:23)(cid:20)
(cid:7) (cid:22)(cid:15)(cid:23)(cid:22)(cid:27)
(cid:7)
(cid:7) (cid:20)(cid:20)(cid:15)(cid:22)(cid:27)(cid:26)
37.2%
27.2%
30.6%
5.0%
100.0%
38.7%
25.8%
30.2%
5.3%
100.0%
99.8%
93.4%
96.2%
57.2%
94.8%
99.4%
93.1%
95.9%
45.1%
93.8%
(1) Other primarily includes manufactured housing and lot loan exposures
(2) Ambac’s below investment grade internal ratings reflect bonds which are of speculative grade credit quality with the adequacy of future margin levels for
payment of interest and repayment of principal potentially adversely affected by major ongoing uncertainties or exposure to adverse conditions. Ambac
Assurance’s below investment grade category includes transactions on which claims have been submitted.
issuers. As such, we do not expect that our student loan exposure
will be significantly reduced via refinancing in the near term.
Auction Rate Securities (“ARS”) and Variable Rate Demand
Obligations (“VRDO”):
Ambac insures variable rate obligations including ARS and
VRDOs, both of which have rate resets and may have experienced
liquidity and / or credit stress during the financial crisis. While
market conditions have improved and most of Ambac’s exposures
have stabilized or been refinanced away, there are still some issuers
paying higher rates, and in the case of some VRDOs, both higher
rates and faster amortization than expected due to failed
remarketings. Many of Ambac’s ARS exposures are paying at
failed auction rates that are relatively low in the current market
and remain attractive to issuers. The following table sets forth
Ambac Assurance’s financial guarantee net par exposure
outstanding, by bond type, relating to such variable rate exposures
at December 31, 2016 and 2015:
Student Loans
Student loan net par outstanding was $1,388 million and $2,323
million at December 31, 2016 and 2015, respectively. Ambac
Assurance’s student loan portfolio consists primarily of securitized
private student loans in addition to a minimal amount of federally
guaranteed loans under the Federal Family Education Loan
Program (“FFELP”). Whereas FFELP loans are guaranteed for a
minimum of 97% of defaulted principal and interest, private loans
have no government guarantee and, therefore, are subject to credit
risk as with other types of unguaranteed credits. Higher than
expected defaults of private student loans have contributed to the
significant deterioration in the performance of some of our
transactions. Additionally, due to the failure of the auction rate
markets, the interest rates on some student loan securities have
increased significantly to punitive levels pursuant to the transaction
terms. Such increases have contributed to the collateralization ratio
in these transactions deteriorating on an accelerated basis due to
negative excess spread and/or the use of principal receipts to pay
current interest. The combined increase in defaults and the penalty
rate on the auction rate securities continue to erode the
collateralization levels in many of the trusts we insure. This impact
has been offset modestly by the current low interest rate
environment.
New private student loan capital market transactions require a
significant amount of equity which makes the refinancing of
Ambac insured transactions backed by private loans difficult for
| Ambac Financial Group, Inc. 17 2016 FORM 10-K |
($ in millions) December 31,
2016
2015
Investor-owned utilities
$
1,780
$
2,277
The following table shows the distribution, by bond type, of Ambac
Assurance’s ceded guaranteed portfolio at December 31, 2016:
Healthcare
Student loans
Lease and tax-backed
Utility
Transportation
General Obligation
Other
Total
Reinsurance
Ceded Reinsurance:
449
361
305
293
207
46
274
533
464
500
293
459
49
375
$
3,715
$
4,950
Ambac Assurance has reinsurance in place pursuant to surplus
share treaties and facultative agreements. As a primary financial
guarantor, Ambac Assurance is required to honor its obligations to
its policyholders whether or not its reinsurers perform their
obligations under these reinsurance agreements. For exposures
reinsured, Ambac Assurance withholds a ceding commission to
defray its underwriting and operating expenses. To minimize its
exposure to losses from reinsurers, Ambac Assurance (i) monitors
the financial condition of its reinsurers; (ii) is entitled to receive
collateral from its reinsurance counterparties in certain reinsurance
contracts; and (iii) has certain cancellation rights that can be
exercised by Ambac Assurance in the event of rating agency
downgrades of a
(among other events and
circumstances). Ambac Assurance held letters of credit and
collateral amounting to $122.9 million from its reinsurers at
December 31, 2016. As of December 31, 2016, the aggregate
amount of insured par ceded by Ambac Assurance to reinsurers
under reinsurance agreements was $7,027 million, with the largest
reinsurer accounting for $6,086 million or 7.0% of gross par
outstanding at December 31, 2016.
reinsurer
Bond Type ($ in millions)
Public Finance:
Ceded Par
Amount
Outstanding
% of Gross
Par Ceded
Lease and tax-backed revenue
$
General obligation
Housing revenue
Transportation revenue
Utility revenue
Higher education
Health care revenue
Other
Total Public Finance
Structured Finance:
Student loan
Investor-owned utilities
Mortgage-backed and home equity
Asset-backed
Other
Total Structured Finance
Total Domestic
International Finance:
Investor-owned and public utilities
Asset-backed
Transportation
CDOs
Total International Finance
Total
$
Assumed Reinsurance:
1,218
1,201
978
786
571
263
178
106
5,301
482
427
117
51
212
1,289
6,590
350
26
23
38
437
7,027
7 %
11 %
13 %
17 %
12 %
10 %
11 %
9 %
11 %
26 %
10 %
1 %
8 %
11 %
7 %
10 %
5 %
1 %
2 %
17 %
2 %
8%
At December 31, 2016, assumed par outstanding was $243.7
million. On March 24, 2010, all assumed reinsurance agreements
with third parties were allocated to the Segregated Account, which
will not allow for cancellations without the approval of the
Rehabilitator.
| Ambac Financial Group, Inc. 18 2016 FORM 10-K |
Insurance Regulatory Matters
United States
Ambac Assurance and Everspan are domiciled in the State of
Wisconsin and, as such, are subject to the insurance laws and
regulations of the State of Wisconsin (the “Wisconsin Insurance
Laws”) and are regulated by the OCI. In addition, Ambac
Assurance and Everspan are subject to the insurance laws and
regulations of the other jurisdictions in which they are licensed.
Under Wisconsin insurance law, the Segregated Account is a
separate insurer for purposes of the Segregated Account
Rehabilitation Proceedings. The Segregated Account is separately
licensed in the State of Wisconsin but not elsewhere, and is under
the control of, and is overseen by, the Rehabilitator.
Insurance laws and regulations applicable to financial guarantee
insurers vary by jurisdiction. The laws and regulations generally
require financial guarantors to maintain minimum standards of
business conduct and solvency; to meet certain financial tests; and
to file policy forms, premium rate schedules and certain reports
with regulatory authorities, including information concerning
capital structure, ownership, financial condition and enterprise
risk. Regulated insurance companies are also required to file
quarterly and annual statutory financial statements with the
National Association of Insurance Commissioners (“NAIC”), and
in each jurisdiction in which they are licensed. The level of
supervisory authority that may be exercised by non-domiciliary
insurance regulators varies by jurisdiction. Generally, however,
non-domiciliary regulators are authorized to suspend or revoke the
insurance license they issued and to impose restrictions on that
license in the event that laws or regulations are breached by a
regulated insurance company or in the event that continued or
unrestricted licensing of the regulated insurance company
constitutes a “hazardous condition” in the opinion of the regulator.
to
the
respect
including with
As the principal, or domiciliary, regulator of Ambac Assurance,
the Segregated Account and Everspan, OCI has primary regulatory
authority,
initiation and
administration of rehabilitation or liquidation proceedings.
Additionally, the accounts and operations of Ambac Assurance and
Everspan are subject to periodic comprehensive examinations by
the OCI. Wisconsin Insurance Laws require regulated insurance
companies to maintain minimum standards of business conduct,
maintain minimum surplus to policyholders, meet certain financial
tests, and file certain reports, including information concerning
their capital structure, ownership, financial condition and
enterprise risk. Ambac Assurance, the Segregated Account, and
Everspan are not subject to risk-based capital requirements, since
they are financial guarantee insurers. Ambac Assurance, the
Segregated Account and Everspan are in compliance with
minimum surplus levels. Wisconsin Insurance Laws also require
prior approval by OCI of certain transactions between Ambac
Assurance or Everspan and their respective affiliates. As described
in Note 1. Background and Business Description to the
Consolidated Financial Statements included in Part II, Item 8 in
this Form 10-K, the Rehabilitator of the Segregated Account has
imposed certain constraints upon Ambac Assurance through
contractual covenants made for the benefit of the Segregated
Account and has assumed the authority to control the management
of the Segregated Account.
In addition, pursuant to the terms of the Settlement Agreement,
Ambac Assurance must seek prior approval by OCI of certain
corporate actions. The Settlement Agreement includes covenants
which generally restrict the operations of Ambac Assurance and
remain in force until the surplus notes that were issued to the
counterparties by Ambac Assurance pursuant to the Settlement
Agreement have been redeemed, repurchased or repaid in full.
Certain of these restrictions may be waived with the approval of a
majority of Unaffiliated Qualified Directors (described below), the
OCI, and/or the requisite percentage of holders of surplus notes
issued in connection with the Settlement Agreement. Pursuant to
the Settlement Agreement, Ambac Assurance amended its articles
of incorporation to require that at least one-third (and, in any event,
not less than three members) of the board of directors of Ambac
Assurance must be Unaffiliated Qualified Directors (as defined in
the Settlement Agreement). If at any time Ambac Assurance does
not have the requisite number of Unaffiliated Qualified Directors
to authorize an action that is otherwise restricted by the Settlement
Agreement, it will need to seek the approval of OCI to take such
action.
New York’s comprehensive financial guarantee insurance law
defines the scope of permitted financial guarantee insurance and
governs the conduct of business of all financial guarantors licensed
to do business in New York, including Ambac Assurance and
Everspan. The New York financial guarantee insurance law also
establishes single risk and aggregate limits with respect to
obligations insured by financial guarantee insurers. Such single
risk limits are specific to the type of insured obligation (for
example, municipal or asset-backed). Under the aggregate limits,
policyholders’ surplus and contingency reserves must at least equal
a percentage of aggregate net liability that is equal to the sum of
various percentages of aggregate net liability for various categories
of specified obligations. At December 31, 2016, Ambac Assurance
is in compliance with applicable aggregate risk limits but not in
compliance with applicable single risk limits. Through run-off of
the portfolio, Ambac Assurance will continue to seek the reduction
in its exposure to maintain its compliance with applicable single
and aggregate risk limits, but may not be able to do so. Everspan
is in compliance with all of such limits.
United Kingdom
The Prudential Regulatory Authority ("PRA") and Financial
Conduct Authority ("FCA") (and their predecessor regulator the
Financial Services Authority (“FSA”)) have exercised significant
oversight of Ambac UK since 2008, after Ambac, Ambac
Assurance and Ambac UK began experiencing financial stress. In
2009, Ambac UK’s license to write new business was curtailed by
the FSA and the insurance license was limited to undertaking only
run-off related activity. As such, Ambac UK is authorized to run-
off its insurance portfolio in the United Kingdom, and to do the
same through a branch in Milan, Italy, and a number of other EU
countries. EU legislation has allowed Ambac UK to conduct
business in EU states other than the United Kingdom through a
“passporting” arrangement, which eliminates the necessity of
those other EU
additional
jurisdictions.
licensing or authorization
in
Ambac UK remains subject to regulation by the PRA and FCA in
the conduct of its business. The PRA and FCA are the dual statutory
regulators responsible for regulating the financial services industry
in the United Kingdom, with the purpose of maintaining
confidence in the U.K. financial system, providing public
understanding of the system, securing the proper degree of
protection for consumers and helping to reduce financial crime. In
| Ambac Financial Group, Inc. 19 2016 FORM 10-K |
addition, the regulatory regime in the United Kingdom must
comply with certain EU legislation binding on all EU member
states.
Applicable rules require that non-life insurance companies such
as Ambac UK maintain a margin of solvency at all times in respect
of the liabilities of the insurance company, the calculation of which
depends on the type and amount of insurance business a company
writes. These solvency requirements have been amended in order
to implement the European Union’s “Solvency II” directive on
risk-based capital. The requirements of the Solvency II directive
became effective on January 1, 2016.
Notwithstanding the foregoing, Ambac UK is deficient in terms of
compliance with the applicable regulatory capital requirements as
of December 31, 2016 under the Solvency II directive. The PRA
and FCA are aware of the same, and dialogue between Ambac UK
management and its regulators remains ongoing with respect to
options for addressing the shortcoming, although such options
remain few.
Regulations over change in control
Under Wisconsin law applicable to insurance holding companies,
any acquisition of control of Ambac, and any other direct or indirect
control of Ambac Assurance and Everspan, requires the prior
approval of the OCI. “Control” is defined as the direct or indirect
power to direct or cause the direction of the management and
policies of a person. Any purchaser of 10% or more of the
outstanding voting stock of a corporation is presumed to have
acquired control of that corporation and its subsidiaries unless the
OCI, upon application, determines otherwise. For purposes of this
test, Ambac believes that a holder of common stock having the
right to cast 10% or more of the votes which may be cast by the
holders of all shares of common stock of Ambac would be deemed
to have control of Ambac Assurance and Everspan within the
meaning of the Wisconsin Insurance Laws. The United Kingdom
has similar requirements applicable in respect of Ambac, as the
ultimate holding company of Ambac UK.
Dividend Restrictions, Including Contractual Restrictions
Due to contractual and regulatory restrictions, Ambac Assurance
has been unable to pay common dividends to Ambac since 2008
and will be unable to pay common dividends in 2017 without
certain approvals, including the prior consent of the OCI, which
is unlikely. See Note 8. Insurance Regulatory Restrictions to the
Consolidated Financial Statements included in Part II, Item 8 in
this Form 10-K for further information on dividends.
Ambac Assurance’s ability to pay dividends is further restricted
by the Settlement Agreement and by certain covenants made for
the benefit of the Segregated Account. See Note 1. Background
and Business Description to the Consolidated Financial Statements
included in Part II, Item 8 in this Form 10-K for further information
about covenants made for the benefit of the Segregated Account.
As a result of these restrictions, Ambac Assurance is not expected
to pay dividends to Ambac for the foreseeable future.
Ambac UK is not expected to pay any dividends to Ambac
Assurance for the foreseeable future. While the UK insurance
regulatory laws impose no statutory restrictions on an insurer’s
ability to declare a dividend, the PRA’s and FCA’s capital
requirements in practice act as a restriction on the payment of
dividends, where a firm has a lower level of regulatory capital than
its regulatory capital requirement as is the case for Ambac UK.
Further, the FSA amended Ambac UK’s license in 2010 such that
the PRA must specifically approve (“non-objection”) any transfer
of value and/or assets from Ambac UK to Ambac Assurance or any
other Ambac group company, other than in respect of certain
disclosed contracts between the two parties (such as in respect of
a management services agreement between Ambac Assurance and
Ambac UK).
Pursuant to the Settlement Agreement, Ambac Assurance may not
make any “Restricted Payment” (which includes dividends from
Ambac Assurance to Ambac) in excess of $5 million in the
aggregate per annum, other than Restricted Payments from Ambac
Assurance to Ambac in an amount up to $7.5 million per annum
solely to pay operating expenses of Ambac. Concurrent with
making any such Restricted Payment, a pro rata amount of the
surplus notes issued by Ambac Assurance under the Settlement
Agreement would also need to be redeemed at par.
Under the terms of Ambac Assurance’s Auction Market Preferred
Shares (“AMPS”), dividends may not be paid on the common stock
of Ambac Assurance unless all accrued and unpaid dividends on
the AMPS for the then current dividend period have been paid,
provided, that dividends on the common stock may be made at all
times for the purpose of, and only in such amounts as are necessary
for, enabling Ambac (i) to service its indebtedness for borrowed
money as such payments become due or (ii) to pay its operating
expenses. If dividends are paid on the common stock as provided
in the prior sentence, dividends on the AMPS become cumulative
until the date that all accumulated and unpaid dividends have been
paid on the AMPS.
FINANCIAL SERVICES SEGMENT
Ambac’s Financial Services business segment is conducted
through subsidiaries of Ambac Assurance, which provide financial
and investment products, including investment agreements,
funding conduits and interest rate swaps, principally to the clients
of its financial guarantee business. Ambac Assurance insures all
of the obligations of its financial services subsidiaries. These
businesses are in active runoff, which is being effectuated by
transaction terminations, settlements, and scheduled amortization
of contracts. The Financial Services business also maintains
interest rate derivatives to mitigate exposure to floating rate insured
obligations in the Financial Guarantee segment.
The principal factors that may affect the Financial Services
Segment results include: (1) availability of counterparties for
economic hedging transactions; (2) investment returns; (3) the
value of future contract terminations or settlements which may
differ from carrying value of the those contracts; (4) collateral
posting requirements; (5) the availability of liquidity from Ambac
Assurance; (6) changes in the fair value of the derivatives portfolio
resulting from interest rate fluctuations; (7) timing of investment
agreement withdrawals; and (8) restrictions imposed upon Ambac
Assurance by the contracts executed with the Segregated Account
and the Settlement Agreement, and, to the extent that policies
allocated to the Segregated Account are implicated, the authority
of the Rehabilitator of the Segregated Account to control the
management of the Segregated Account.
| Ambac Financial Group, Inc. 20 2016 FORM 10-K |
Investment Agreements
Ambac’s investment agreements were issued to structured finance
and municipal issuers through its wholly-owned subsidiary,
Ambac Capital Funding. Investment agreements were customized
for each investor to provide guaranteed interest and return of
principal in accordance with their requirements. Each investment
agreement was insured by Ambac Assurance through a financial
guarantee insurance policy.
As of December 31, 2016, all investment agreement principal and
accrued interest outstanding of $82.4 million was collateralized.
Funding for the collateral and previous early terminations was
supported in part through loans between Ambac Capital Funding
and Ambac Assurance. Ambac Capital Funding's last remaining
investment agreement matures in March 2017.
See “Liquidity and Capital Resources” of the Management’s
Discussion and Analysis of Financial Condition and Results of
Operations” included in Part II, Item 7 and Note 14. Obligations
Under Investment Agreements to the Consolidated Financial
Statements included in Part II, Item 8 in this Form 10-K for further
information on investment agreements.
Derivative Products
The primary activities in the derivative products business are to
manage the runoff of derivatives with financial guarantee clients
and to facilitate the mitigation of interest rate exposure for the
Financial Guarantee segment via swaps and exchange traded U.S.
treasury futures. Derivative transactions are executed through
Ambac Financial Services (“AFS”), a wholly-owned subsidiary of
Ambac Assurance. The derivative products portfolio is positioned
to benefit from rising rates as an economic hedge against interest
rate exposure in the financial guarantee insurance portfolio. This
hedge position may have a significant impact on the results of the
Financial Services segment. Under the agreements governing the
derivative positions, AFS generally must post collateral or margin
in excess of the market value of the swaps and futures contracts.
In addition, most of AFS’s counterparties currently possess the
right to terminate their transactions with AFS and in the event of
a full rehabilitation of Ambac Assurance, some of AFS’s swaps
could automatically terminate. A sudden termination of AFS’s
derivatives, whether voluntarily or automatically, could result in
losses. AFS has borrowed cash and securities from Ambac
Assurance, to help support its incremental collateral and margin
posting requirements, previous termination payments and other
cash needs.
Credit risks relating to derivative positions primarily concern the
default of a counterparty. Counterparty default exposure is
mitigated through the use of industry standard collateral posting
agreements. For counterparties subject to such collateral posting
agreements, collateral is posted when a derivative counterparty’s
credit exposure exceeds contractual limits. Derivative contracts
entered into with financial guarantee customers are not subject to
collateral posting agreements. Credit risk associated with such
customer derivatives, including credit derivatives, is managed
through the financial guarantee portfolio risk management
processes described in the Financial Guarantee Segment noted
above. In some cases, derivatives between Ambac and financial
guarantee customers are placed through a third party financial
intermediary and similarly do not require collateral posting.
AFS manages a variety of market risks inherent in its businesses,
including credit, market, liquidity, operational and legal. These
risks are identified, measured, and monitored through a variety of
control mechanisms, which are in place at different levels
throughout the organization. See “Quantitative and Qualitative
Disclosures About Market Risk” included in Part II, Item 7A in
this Form 10-K for further information.
Funding Conduits
A subsidiary of Ambac has previously transferred financial assets
to two special purpose entities. The business purpose of these
entities was to provide certain financial guarantee clients with
funding for their debt obligations. The activities of the special
purpose entities are contractually limited to purchasing assets from
Ambac, issuing medium-term notes (“MTNs”) to fund such
purchases, executing derivative hedges and obtaining financial
guarantee policies with respect to indebtedness incurred. As of
December 31, 2016, Ambac Assurance had financial guarantee
insurance policies issued for all assets, MTNs and derivative
contracts owned and outstanding by the entities. Ambac does not
consolidate these entities under the relevant accounting guidance
for consolidation of variable interest entities. See Note 2. Basis of
Presentation and Significant Accounting Policies and Note 3.
Special Purpose Entities, Including Variable Interest Entities to
the Consolidated Financial Statements included in Part II, Item 8
in this Form 10-K for further information.
INVESTMENTS AND INVESTMENT POLICY
As of December 31, 2016, the consolidated non-VIE investments
of Ambac had an aggregate fair value of approximately $6.5 billion.
Investments are managed internally by officers of Ambac, who are
experienced investment managers, and by external investment
managers. All investments are made in accordance with the general
objectives, policies, and guidelines for investments reviewed or
overseen by Ambac Assurance and Ambac UK’s respective Boards
of Directors. These policies and guidelines include liquidity, credit
quality, diversification and duration objectives and are periodically
reviewed and revised as appropriate. Additionally, senior credit
personnel monitor the portfolio on a continuous basis. Credit
monitoring of the investment portfolio includes procedures on
residential mortgage-backed securities consistent with those
utilized to assess the risk of our insured RMBS exposures.
As of December 31, 2016, the Ambac Assurance and Everspan
non-VIE investment portfolio had an aggregate fair value of
approximately $5.5 billion. Ambac Assurance’s and Everspan’s
investment objectives are to achieve the highest risk-adjusted after-
tax return on a diversified portfolio consistent with Ambac
Assurance’s and Everspan’s risk tolerance while employing active
asset/liability management practices to satisfy all operating and
strategic liquidity needs. In addition to internal investment policies
and guidelines, Ambac Assurance’s investment portfolio is subject
to limits on types and quality of investments imposed by applicable
insurance laws and regulations. The Board of Directors of Ambac
Assurance approves any changes
to Ambac Assurance's
investment policy. Ambac Assurance purchases Ambac Assurance
insured securities given their relative risk/reward characteristics.
Ambac Assurance financial guarantee policies related to most of
these securities have been allocated to the Segregated Account. As
described in Note 1. Background and Business Description to the
Consolidated Financial Statements included in Part II, Item 8 in
this Form 10-K, Ambac Assurance’s investment policies are
| Ambac Financial Group, Inc. 21 2016 FORM 10-K |
subject to certain covenants made for the benefit of the Segregated
Account and, therefore, such policies may be subject to restrictions
outside the control of management. Such covenants could
adversely impact the performance of the investment portfolio.
As of December 31, 2016, the non-VIE Ambac UK investment
portfolio had an aggregate fair value of approximately $0.6 billion.
Ambac UK’s investment policy is designed with the primary
objective of ensuring that Ambac UK is able to meet its financial
obligations as they fall due, in particular with respect to policy
holders and meeting their claims. Ambac UK’s investment
portfolio is subject to internal investment guidelines and may be
subject to limits on types and quality of investments imposed by
its regulator. The Board of Directors of Ambac UK approves any
changes or exceptions to Ambac UK’s investment policy.
As of December 31, 2016, the non-VIE Financial Services
investment portfolio had an aggregate fair value of approximately
$0.1 billion. The primary investment objective is to invest in a
diversified portfolio of high-grade securities that produce
sufficient cash flow to satisfy all investment agreement liabilities
while meeting the related collateral requirements. The investment
portfolio is subject to internal investment guidelines. Such
guidelines set forth minimum credit rating requirements and credit
risk concentration limits.
As of December 31, 2016, the non-VIE Corporate investment
portfolio had an aggregate fair value of approximately $0.3 billion.
The primary investment objective is to preserve capital for strategic
uses while maximizing income. The investment portfolio is subject
to internal investment guidelines. Such guidelines set forth
minimum credit rating requirements and credit risk concentration
limits.
The following tables provide certain information concerning the investments of Ambac:
Investment Category
($ in thousands) December 31,
Long-term investments:
Taxable bonds
Tax-exempt bonds
Total long-term investments
Short-term investments
Other investments (3)
Total
2016
2015
Carrying
Value (1)
Weighted
Average
Yield (2)
Carrying
Value (1)
Weighted
Average
Yield (2)
$
5,507,467
111,653
5,619,120
430,788
450,307
5.76 % $
4.66 %
5.74 %
0.55 %
—
4,998,076
110,255
5,108,331
225,789
310,600
$
6,500,215
5.36% $
5,644,720
5.76 %
4.08 %
5.72 %
0.28 %
—
5.49%
(1)
Includes investments guaranteed by Ambac Assurance and Ambac UK. Refer to Note 10. Investments of the Consolidated Financial Statements included
in Part II, Item 8 in this Form 10-K for further discussion of Ambac insured securities held in the investment portfolio.
(2) Yields are stated on a pre-tax basis, based on average amortized cost for both long and short term investments.
(3) Other investments include equity interests in pooled investment funds which are classified as trading securities and Ambac's equity interest in an
unconsolidated trust created in connection with its sale of Segregated Account junior surplus notes on August 28, 2014.
Investment Category
($ in thousands) December 31,
Municipal obligations (2)
Corporate securities
Foreign obligations
U.S. government obligations
U.S. agency obligations
Residential mortgage-backed securities
Asset-backed securities
Total long-term investments
Short-term investments (2)
Other investments (3)
Total
2016
2015
Carrying
Value
Weighted
Average
Yield (1)
Carrying
Value
Weighted
Average
Yield (1)
$
374,368
1,802,165
43,135
101,091
4,060
2,351,595
942,706
5,619,120
430,788
450,307
3.90 % $
2.80 %
1.23 %
1.17 %
0.58 %
9.13 %
4.52 %
5.74 %
0.55 %
—
420,770
1,593,669
96,306
91,242
4,212
1,977,338
924,794
5,108,331
225,789
310,600
$
6,500,215
5.36% $
5,644,720
3.71 %
2.81 %
1.07 %
1.06 %
0.58 %
10.07 %
3.46 %
5.72 %
0.28 %
—
5.49%
(1) Yields are stated on a pre-tax basis, based on average amortized cost for both long and short term investments.
(2)
Includes taxable and tax-exempt investments.
(3) Other investments include equity interests in pooled investment funds which are classified as trading securities and Ambac's equity interest in an
unconsolidated trust created in connection with its sale of Segregated Account junior surplus notes on August 28, 2014.
| Ambac Financial Group, Inc. 22 2016 FORM 10-K |
Ambac has RMBS exposure in its investment portfolios. Please refer to the tables in Part II, Item 7 “Management’s Discussion and Analysis
of Financial Condition and Results of Operations - Balance Sheet” section below for a discussion of the fair value of mortgage and asset-
backed securities by classification.
EMPLOYEES
As of December 31, 2016, Ambac had 141 employees in the United
States and 13 employees in the UK. Ambac considers its employee
relations to be satisfactory.
Item 1A. Risk Factors
References in the risk factors to “Ambac” are to Ambac Financial
Group, Inc. References to “we,” “our,” “us” and “Company” are
to Ambac and its subsidiaries, as the context requires. Capitalized
terms used but not defined in this section shall have the meanings
ascribed thereto in Part I, Item 1 in this Form 10-K or in Note 1.
Background and Business Description to the Consolidated
Financial Statements included in Part II, Item 8 in this Form 10-
K unless otherwise indicated.
Risks Related to Ambac Common Shares
Investments in Ambac's common stock are highly speculative
and the price per share of Ambac's common stock may be subject
to a high degree of volatility, including significant price declines.
Ambac's common stock, which was issued pursuant to its
Reorganization Plan, began trading on the NASDAQ Global
Market on May 1, 2013. Although Ambac's common stock is listed
on NASDAQ, there can be no assurance as to the liquidity of the
trading market or the price at which such shares can be sold. The
price of the shares may decline substantially in response to a
number of events or circumstances, including but not limited to:
•
•
•
•
•
•
•
adverse developments in our financial condition or results
of operations;
changes in the actual or perceived risk within our insured
portfolio;
changes to regulatory status;
changes in investors’ or analysts’ valuation measures for
our stock;
market trends unrelated to our stock;
market and industry perception of our success, or lack
thereof, in pursuing our business strategy; and
results and actions of other participants in our industry.
In addition, the price of Ambac's shares may be affected by the
additional risks described below, including risks associated with
Ambac Assurance’s ability to deliver value to Ambac. Investments
in Ambac's common stock should be considered highly speculative
and may be subject to a high degree of volatility.
Ambac may not be able to realize value from Ambac Assurance
or generate earnings apart from Ambac Assurance.
Because Ambac is a holding company, the value of its stock is
dependent upon the residual value of its main operating subsidiary,
Ambac Assurance, the receipt of payments to be made by Ambac
Assurance pursuant to the Amended TSA and the Cost Allocation
Agreement, the receipt of payments on the Owner Trust Certificate
issued to Ambac by Corolla Trust (the "Owner Trust Certificate"),
the receipt of payments on investments made on securities issued
or insured by Ambac Assurance or the Segregated Account, and
the receipt of dividends from Ambac Assurance. There can be no
assurance that Ambac will be able to realize residual value in
Ambac Assurance, which is in run-off. In addition, the Segregated
to
Account of Ambac Assurance Corporation
rehabilitation proceedings and under
the
Rehabilitator, as further described below. It is unclear whether
Ambac Assurance and the Segregated Account will be able to
satisfy all of their respective obligations to policyholders, holders
of their respective surplus notes and holders of Ambac Assurance’s
preferred stock, even if Ambac Assurance and the Segregated
Account are successful in achieving recoveries and mitigating
losses. Our ability to achieve recoveries and mitigate losses is
subject to significant risks and uncertainties, including as a result
of varying potential perceptions of the value of Ambac Assurance’s
guarantees and securities.
is subject
the control of
Due to the above considerations, as well as applicable legal and
contractual restrictions described elsewhere herein, it is highly
unlikely that Ambac Assurance will be able to pay Ambac any
dividends for the foreseeable future. Furthermore, the payments to
be made to Ambac under the Amended TSA and the Cost Allocation
Agreement are subject to contingencies that are difficult to predict,
making the amount and timing, if any, of such payments uncertain.
Payments to be made under the Amended TSA, in particular,
depend on the generation of future taxable income by Ambac
Assurance above certain thresholds. Ambac Assurance’s ability to
generate taxable income above such thresholds is uncertain. Due
to these factors, there can be no assurance as to the amounts that
Ambac will receive from Ambac Assurance under the Amended
TSA. Moreover, the Cost Allocation Agreement provides that
Ambac Assurance's reimbursement of Ambac's operating expenses
after 2017 is subject to the approval of the Rehabilitator and limited
to $4.0 million per annum. We can provide no assurance as to
whether the Rehabilitator will approve such reimbursement or any
portion thereof.
It is also uncertain whether and to what extent Ambac will realize
value from the Owner Trust Certificate. The Owner Trust
Certificate is subordinated to $299.2 million of senior secured
notes issued by Corolla Trust. Such notes and the Owner Trust
Certificate are collateralized by and payable solely from a $350.0
million face amount Segregated Account junior surplus note plus
interest thereon. No payment of interest on or principal of a
Segregated Account junior surplus note may be made until all
existing and future indebtedness of the Segregated Account,
including Segregated Account surplus notes, policy claims and
claims having statutory priority, and all existing and future senior
ranking surplus notes, contribution notes or similar obligations of
Ambac Assurance, have been paid in full. All payments of principal
and interest on Segregated Account junior surplus notes are subject
to the prior approval of OCI. If OCI does not approve the payment
of interest on Segregated Account junior surplus notes, such
interest will accrue and compound annually until paid. Payments
on the senior secured notes issued by Corolla Trust will only be
| Ambac Financial Group, Inc. 23 2016 FORM 10-K |
made when and to the extent that the Segregated Account makes
payments on the junior surplus note held by Corolla Trust. The
senior secured notes must be paid in full before any payments will
be made on the Owner Trust Certificate. If Corolla Trust has failed
to pay all interest and principal outstanding on the senior secured
notes within three business days of August 28, 2039, the senior
secured noteholders may also take possession of and sell the junior
surplus note. If such a sale were to occur, it is uncertain whether
and to what extent there would be any value for the Owner Trust
Certificate after satisfaction of the senior secured notes.
The value of Ambac's common stock may also depend upon the
ability of Ambac to generate earnings apart from Ambac
Assurance. As noted below, Ambac is selectively exploring
potential business opportunities that, among other things, may
permit utilization of Ambac’s net operating loss carry-forwards,
but there are no assurances regarding its ability to find or execute
such business opportunities or the prospects of any such
opportunities.
Future offerings of debt or equity securities that rank senior to
Ambac's common stock may adversely affect the market price of
its common stock.
If Ambac decides to issue debt or additional equity securities in
the future that rank senior to its common stock, it is likely that they
will be governed by an indenture or other instrument containing
covenants restricting Ambac's operating flexibility. Additionally,
any convertible or exchangeable securities issued in the future may
have rights, preferences and privileges more favorable than those
of common stock and may result in dilution to owners of common
stock. Because Ambac's decision to issue debt or equity securities
in any future offering will depend on market conditions, it cannot
predict or estimate the amount, timing or nature of future offerings.
Holders of common stock bear the risk of future offerings reducing
the market price of Ambac's common stock and diluting the value
of their stock holdings in the Company.
The occurrence of certain events could result in the initiation of
rehabilitation proceedings against Ambac Assurance, with
resulting adverse consequences to holders of our securities.
Increased loss development in the General Account of Ambac
Assurance or the Segregated Account or significant losses or other
events resulting from litigation against Ambac Assurance or the
Segregated Account may prompt OCI to determine that it is in the
best interests of policyholders to initiate rehabilitation proceedings
with respect to Ambac Assurance, either preemptively or in
response to any such event, and in addition to the Segregated
Account Rehabilitation Proceedings.
If, as a result of the occurrence of any such event(s), OCI decides
to initiate rehabilitation proceedings with respect to Ambac
Assurance, adverse consequences may result, including, without
limitation and absent enforceable protective injunctive relief, the
assertion of damages by counterparties (including mark-to-market
claims with respect to insured transactions executed in ISDA
format), the acceleration of losses based on early termination
triggers and the loss of control rights in insured transactions. Any
such consequences may reduce the residual value of Ambac
Assurance. Additionally, the Rehabilitator would assume control
of all of Ambac Assurance’s assets and management of Ambac
Assurance. In exercising control, the Rehabilitator would act for
the benefit of policyholders, and would not take into account the
interests of our securityholders. Such actions may result in material
adverse consequences for our securityholders.
The issuance of new common stock may dilute current
shareholder value or have adverse effects on the market price of
Ambac's common stock.
If Ambac raises capital through the issuance of additional shares
of common stock, whether for select business transactions, general
corporate purposes, or in exchange for other securities, the value
of current shareholders’ interests may be diluted as Ambac is not
required to offer any such shares to existing stockholders on a
preemptive basis.
Ambac cannot predict the effect, if any, of future sales of its
common stock, or the availability of shares for future sales, on the
market price of its common stock. Sales of substantial amounts of
common stock or the perception that such sales could occur may
adversely affect the prevailing market price for its common stock.
Risks Related to Insured Portfolio Losses
Loss reserves may not be adequate to cover potential losses;
changes in loss reserves may result in further volatility of net
income and comprehensive income.
Loss reserves are established when management has observed
credit deterioration, in most cases, when the underlying credit is
considered below investment grade. Loss reserves established with
respect to our non-derivative financial guarantee insurance policies
are based upon estimates and judgments by management, including
estimates and judgments with respect to the probability of default,
the severity of loss upon default, management’s ability to execute
policy commutations, and estimated remediation recoveries for,
among other things, breaches by RMBS issuers of representations
and warranties. Furthermore, the objective of establishing loss
reserve estimates is not to, and our loss reserves do not, reflect the
worst possible outcome. While our reserving scenarios reflect a
wide range of possible outcomes reflecting the significant
uncertainty regarding future developments and outcomes, our loss
reserves may change materially based on future developments. As
a result of the inherent uncertainties in the estimates and judgments
made to determine loss reserves, there can be no assurance that
either the actual losses in our financial guarantee insurance
portfolio will not exceed such reserves or that our reserves will not
increase or decrease materially over time as circumstances, our
assumptions, or our models change.
Additionally, inherent in our estimates of loss severities and
remediation recoveries is the assumption that we will retain control
rights in respect of our insured portfolio. However, according to
the terms of relevant transaction documents, we may lose our
control rights in many insured transactions if, among other things,
we are the subject of delinquency proceedings and/or other
regulatory actions which could result from our deteriorated
financial position. If we lose control rights, our ability to mitigate
loss severities and realize remediation recoveries will be
compromised, and actual ultimate losses in our insured portfolio
could exceed our loss reserves. The Rehabilitation Court issued
an injunction restraining certain actions by holders of policies in
the Segregated Account and other parties, including actions based
on the loss of control rights. If this injunction does not successfully
preclude such actions, Ambac Assurance could lose its control
rights with respect to certain policies in the Segregated Account.
| Ambac Financial Group, Inc. 24 2016 FORM 10-K |
Some issuers of public finance obligations we insure are
experiencing fiscal stress that could result in increased losses on
those obligations or increased liquidity claims, including losses
or claims resulting from payment defaults, Chapter 9 bankruptcy
or other restructuring proceedings or loss of market access.
We have historically experienced low levels of defaults in our
public finance insured portfolio, including during the financial
crisis that began in mid-2007. However, some issuers of public
finance obligations we insure continue to report budget shortfalls,
significantly underfunded pensions or other fiscal stresses that will
require them to significantly raise taxes and/or cut spending in
order to satisfy their obligations. Government entities may also
take other actions that may impact their own creditworthiness or
the creditworthiness of related issuers. Some issuers of obligations
we insure have declared a payment moratorium, defaulted or filed
for bankruptcy, raising concerns about their ultimate ability to
service the debt we insure and our ability to recover claims paid
in the future. If the issuers of the obligations in our public finance
portfolio are unable to raise taxes, cut spending, or receive federal
or state assistance, or if such issuers default or file for bankruptcy
under Chapter 9, we may experience liquidity claims and/or
ultimate losses on those obligations, which could adversely affect
our business, financial condition and results of operations.
We insure obligations of several issuers that have filed for
bankruptcy protection under Chapter 9. The consequences of such
proceedings for creditors remain uncertain. For example, the
treatment of general obligation debt in relation to other obligations
remains in flux, with Detroit's 2014 precedent unfavorable for debt
creditors. If
their
obligations to bondholders and financial guarantors, other issuers
may be encouraged to default or file for Chapter 9 protection and
seek similar adjustments to their debt. These events could
materially increase losses in Ambac’s insured portfolio of
municipal credits.
in materially adjusting
issuers succeed
Loss of market access is a risk embedded in our municipal
exposures. From time to time the municipal bond market evidences
heightened investor concerns overall or for select sectors or issuers,
as has been the case with Puerto Rico. Such adverse market
conditions may trigger a loss of market liquidity for affected
issuers, which in turn may significantly raise their cost of
alternative financing or cause a liquidity crisis and potential for
default on debt service payments we guarantee.
As of December 31, 2016, we had $2.1 billion of net par exposure
to the Commonwealth of Puerto Rico, including its affiliates and
public corporations. Components of Puerto Rico net par
outstanding include capital appreciation bonds that are reported at
the par amount at the time of issuance of the related insurance
policy. The Commonwealth has announced that it cannot meet its
obligations and that it intends to impair some or all of its creditors.
In April 2016, the Commonwealth enacted the Puerto Rico
Emergency Moratorium and Financial Rehabilitation Act, which
the then Governor of Puerto Rico invoked to, among other things,
prevent the payment of debt service owed by several issuers. The
Commonwealth and certain of its instrumentalities have defaulted
on a portion of their debt service payments, including payments
owed on bonds insured by Ambac Assurance. Ambac Assurance
may be required to make significant amounts of policy payments
over the next several years, the recoverability of which is subject
to great uncertainty, which may lead to material permanent losses.
Our exposure to Puerto Rico is impacted by the Puerto Rico
economy, which may be impacted by factors such as perceptions
regarding its ability to maintain appropriate infrastructure
standards. Given our exposure to Puerto Rico and the economic,
legal and political uncertainties associated therewith, our loss
reserves may ultimately prove to be insufficient to cover our losses,
potentially by a material amount, and may be subject to material
volatility.
The Commonwealth has proposed to restructure and renegotiate
its obligations and those of certain of its affiliates and public
corporations. Alternatives could be proposed or adopted that could
significantly impair our exposures, including by failing to
recognize or properly differentiate legal structures and protections
applicable to such exposures, such that our loss reserves would
need to be increased. In June 2016, the United States enacted the
Puerto Rico Oversight, Management, and Economic Stability Act
(“PROMESA”). Among other things, PROMESA contains
provisions that may permit consensual and non-consensual
restructurings of debt obligations of the Commonwealth and its
instrumentalities under the auspices of an oversight board created
thereunder, subject to compliance with PROMESA. At this time,
Ambac is unable to predict to what extent debt restructurings will
be proposed or implemented under PROMESA, and what such
restructurings or renegotiations would entail. PROMESA also
contains a temporary stay on litigation, which has been extended
to May 1, 2017, thus potentially limiting Ambac Assurance’s
ability to engage in loss mitigation. Litigation challenging the legal
protections on which Ambac Assurance and its insured exposures
rely is likely to intensify, which may materially increase our risk
of loss. On October 7, 2016, certain holders of Puerto Rico’s GO
bonds requested leave of court to file an amended complaint that,
among other things, challenges the structure of the Puerto Rico
Sales Tax Financing Corporations ("COFINA") and seeks
injunctive relief requiring the sales and use tax proceeds securing
the bonds issued by COFINA to be transferred to the
Commonwealth treasury for payment of GO bonds. On October
26, 2016, Ambac filed a motion to intervene in that lawsuit in order
to argue that the proposed claims are subject to PROMESA’s
litigation stay, and reserving the right to move to dismiss the claims
should the Court determine they are not stayed. On February 17,
2017, the Court granted Ambac's motion to intervene and ruled
that the claims challenging the COFINA structure are not subject
to litigation stay. If successful, the GO plaintiffs’ challenge against
COFINA, and any similar claims that could be asserted by other
plaintiffs in the future, could have a significant negative impact on
Ambac’s liquidity, loss reserves and capital resources. While our
reserving scenarios reflect a wide range of possible outcomes
reflecting
future
developments and outcomes, there could be material variability in
our loss reserves for the foreseeable future given the fluid and
unpredictable situation concerning the debts of Puerto Rico and its
instrumentalities.
significant uncertainty
regarding
the
We are subject to credit risk and other risks in our insured
portfolio, including related to RMBS and securities backed by
student loans. We are also subject to risks associated with adverse
selection as our insured portfolio runs off. Measures taken to
reduce such risks may have an adverse effect on operating results
or financial position.
Performance of our insured transactions, including (but not limited
to) RMBS transactions and those involving securities backed by
student loans, can be adversely affected by general economic
| Ambac Financial Group, Inc. 25 2016 FORM 10-K |
conditions, such as recession, rising unemployment rates,
underemployment, home prices that decline or do not increase in
the patterns assumed in our models, increasing foreclosure rates
and unavailability of consumer credit, mortgage product attributes,
such as interest rate adjustments and balloon payment obligations,
borrower and/or originator fraud, mortgage and student loan
servicer performance or underperformance and financial difficulty,
such as risks related to whether the servicer may be required to
delay the remittance of any cash collections held by it or received
by it after the time it becomes subject to bankruptcy or insolvency
proceedings.
While further deterioration in the performance of consumer assets,
including mortgage-related assets and student loans, may occur,
the timing, extent and duration of any future deterioration of the
credit markets is unknown, as is the impact on potential claim
payments and ultimate losses on the securities within Ambac
Assurance’s portfolio. In addition, there can be no assurance that
any governmental or private sector initiatives designed to address
such credit deterioration in the markets will be successful or inure
to the benefit of the transactions we insure. For example, any
initiative which permits the discharge of student loan debt in
bankruptcy may adversely affect our portfolio. Similarly, servicer
settlements with governmental authorities regarding foreclosure
or servicing irregularities are generally designed to protect
borrowers and may increase losses on securities we insure. In
particular, the student loan industry has been subject to heightened
Consumer Finance Protection Bureau (CFPB) scrutiny over
servicing and collections practices and, consequently, any
settlements resulting from this scrutiny could lead to increased
losses on securities we insure.
In addition, there can be no assurance that we would be successful,
or that we would not be delayed, in enforcing the subordination
provisions, credit enhancements or other contractual provisions of
the RMBS that Ambac Assurance insures.
As the runoff of the insured portfolio continues, the proportion of
exposures we rate as below investment grade relative to the
aggregate insured portfolio is likely to continue to increase, leaving
the portfolio increasingly concentrated in higher risk exposures.
This risk may result in greater volatility or have adverse effects on
our results from operations and on our financial condition.
One of our primary goals is to create shareholder value through
transaction terminations, policy commutations, settlements and
restructurings that we believe will improve our risk profile. As we
take such actions to reduce known and potential risks, such actions
may negatively impact our operating results or financial position
in one or more reporting periods.
Our credit risk management policies and practices may not
adequately identify significant risks.
As described in Part I, Item 1, “Risk Management” in this Form
10-K, we have established risk management policies and practices
which seek to mitigate our exposure to credit risk in our insured
portfolio. Ongoing surveillance of credit risks in our insured
portfolio is an important component of our risk management. These
policies and practices in the past have not insulated us from risks
that were unforeseen and which had unanticipated loss severity,
and such policies and practices may not do so in the future. There
can be no assurance that these policies and practices will be
adequate to avoid future losses. If we are not able to identify
significant risks, we may not be able to timely remediate such risks,
thereby increasing the amount of losses to which we are exposed.
An inability to identify significant risks could also result in the
failure to establish loss reserves that are sufficient in relation to
such risks.
We use analytical models to assist our projection of performance
of our insured obligations and our investment portfolio but actual
results could differ materially from the model outputs and related
analyses.
We rely on internally and externally developed complex financial
models, including default models related to RMBS and waterfall
modeling provided by a nationally recognized vendor for RMBS
and student loan exposures, to project performance of our insured
obligations and related securities in our investment portfolio.
These models assume various conditions, probability scenarios,
facts and circumstances, and there can be no assurance that such
models accurately predict or measure the quantum of losses, loss
reserves and timing of losses. Differences in the models that we
employ, and/or uncertainties and/or flaws in these financial models
and/or faulty assumptions inherent in these financial models and
those determined by management, could lead to material changes
in projected outcomes, and could include increased losses, loss
reserves and/or other than temporary investment impairments.
Moreover, modeled estimates of transaction performance depend
in part on our interpretations of contracts and other bases of our
legal rights. Such interpretations may prove to be incorrect or
different interpretations may be employed by bond trustees and
other transaction participants and, ultimately courts, which could
lead to increased losses, loss reserves and/or investment
impairments.
Potential outcome of litigation relating to certain military
housing credit exposures could adversely affect Ambac.
Ambac Assurance is a party to a number of litigations relating to
military housing securitization credits, where opposing parties
contend that, among other things, Ambac Assurance has lost its
control rights due to the existence of an “Ambac Default” caused
by, among other things, the Segregated Account Rehabilitation
Proceedings. If Ambac Assurance is found to have lost control
rights in these transactions, our ability to mitigate losses could be
significantly compromised, and actual ultimate losses in these
military housing transactions could exceed our current loss
reserves. Moreover, an adverse outcome relating to the assertion
of an “Ambac Default” could prompt other counterparties to make
similar assertions, which would increase the risk of losing control
rights in other transactions.
Risk Related to Segregated Account Rehabilitation
Actions of the Rehabilitator could adversely affect Ambac,
including impacting our ability to realize our remediation
recoveries.
As a consequence of the Segregated Account Rehabilitation
Proceedings, the Rehabilitator retains operational control and
decision-making authority with respect to all matters related to the
Segregated Account, including surveillance, remediation, loss
mitigation and efforts to recover losses in the Segregated Account,
including recovery efforts in respect of breaches of representations
and warranties by sponsors of Ambac-insured RMBS. Similarly,
by virtue of the contracts executed between Ambac Assurance and
the Segregated Account in connection with the establishment, and
subsequent rehabilitation, of the Segregated Account, the
| Ambac Financial Group, Inc. 26 2016 FORM 10-K |
Rehabilitator retains the discretion to oversee and approve certain
actions taken by Ambac Assurance in respect of assets and
liabilities that remain in Ambac Assurance. Moreover, the
Rehabilitator retains the sole discretion to adjust claim payments,
to make payments on Deferred Amounts and, with regulatory
approval, to make payments on or redeem Segregated Account
surplus notes (which would require Ambac Assurance to make
proportionate payments on or proportionately redeem its surplus
notes). As a result, certain efforts to remediate losses, and certain
other actions taken by Ambac Assurance, are subject to the
approval of the Rehabilitator, as are decisions about the timing of
payments of significant liabilities of the Segregated Account. In
exercising such authority, the Rehabilitator will act for the benefit
of policyholders, and will not take into account the interests of our
securityholders. Decisions made by the Rehabilitator for the
benefit of policyholders may result
in material adverse
consequences for our securityholders. In addition, we are not able
to predict the impact such decisions will have on the remediation
of losses, and, in particular, on our efforts to recover losses
attributable to breaches of representations and warranties by
sponsors of Ambac-insured RMBS, our ability to commute
outstanding policies and purchase insured bonds or surplus notes,
or how vigorously the Rehabilitator will pursue risk remediation
in general. We are similarly unable to predict the decisions of the
Rehabilitator as to claims payments or payments on Deferred
Amounts or, with regulatory approval, payments on or redemptions
of Segregated Account surplus notes, the timing and impact of
which may negatively affect our financial condition or results of
operations. Furthermore, any negative consequences resulting
from payments on or redemptions of Segregated Account surplus
notes would be magnified due to the fact that the Rehabilitator’s
decision to make such payments would, as a result of the terms of
the Settlement Agreement, dated as of June 7, 2010 (the
"Settlement Agreement"), by and among Ambac Assurance,
Ambac Credit Products LLC (“ACP”), Ambac and certain
counterparties to credit default swaps with ACP that were
guaranteed by Ambac Assurance, require Ambac Assurance to
make proportionate payments on its surplus notes.
Changes to the Segregated Account Rehabilitation Plan could
adversely affect the holders of securities issued or insured by
Ambac Assurance or the Segregated Account.
The Rehabilitator retains discretion to pursue modifications to the
Segregated Account Rehabilitation Plan, subject to the approval
of the Rehabilitation Court. Such modifications could include,
among others, an adjustment to the rate of accretion on Deferred
Amounts, which the Rehabilitator has stated is under review. Any
such changes could have an adverse effect on the interests of
holders, or a subset of holders, of securities issued or insured by
Ambac Assurance or the Segregated Account.
Intercompany disputes or disputes with OCI may arise, which
may have material adverse effects on the Company.
The Segregated Account, Ambac Assurance, Ambac and other
affiliates have entered into agreements that govern certain
activities of such entities. OCI has certain enforcement rights with
respect to such agreements and, as regulator of Ambac Assurance
and as Rehabilitator of the Segregated Account, has further
authority over the activities of Ambac Assurance and the
Segregated Account. Disputes may arise over the interpretation of
such agreements, the exercise or purported exercise of rights
thereunder, or the performance of or failure or purported failure to
perform obligations thereunder. Disputes may also arise over
certain actions taken or proposed to be taken by OCI in reliance
on its contractual or legal rights or in reaction to actions taken or
to be taken by the Company. In taking such actions or reacting to
actions or decisions of the Company, the Rehabilitator will act for
the benefit of policyholders, and will not take into account the
interests of our securityholders. Any such dispute could have
material adverse effects on the Company, whether through
litigation, failure to execute transactions sought by management,
interference with corporate strategies, objectives or prerogatives,
inefficient decision-making or execution, forced realignment of
resources, increased costs, distractions to management, strained
working relationships or otherwise. Such effects would also
increase the risk that OCI would seek to initiate rehabilitation
proceedings against Ambac Assurance.
Risks Related to Capital, Liquidity and Markets
Our inability to realize the expected recoveries included in our
financial statements could adversely impact our liquidity,
financial condition and results of operations.
As of December 31, 2016, we have estimated representation and
warranty subrogation recoveries of $1,878.7 million (net of
reinsurance) included in our financial statements. These recoveries
are based on contractual claims arising from RMBS transactions
that we have insured, and represent a probability-weighted
estimate of amounts we expect to recover under various possible
scenarios, and do not represent the best or the worst possible
outcomes with respect to any particular transaction or group of
transactions. Our ability to recover these amounts and the time of
the recoveries, if any, is subject to significant uncertainty, including
risks inherent in litigation, collectability of such amounts from
counterparties and/or their respective parents and affiliates, timing
of receipt of any such recoveries, intervention by OCI or the
Rehabilitator which could impede our ability to take the actions
required to realize such recoveries, and uncertainties inherent in
the assumptions used in estimating such recoveries. The amount
of these subrogation recoveries is significant and if we were unable
to recover such amounts, our stockholders’ equity as of
December 31, 2016 would decrease from $1,978.0 million to $99.3
million.
We expect to recover material amounts of claims payments through
remediation measures including the litigation described above as
well as through cash flows in the securitization structures of
transactions that we insure. Realization of such expected
recoveries is subject to various risks and uncertainties, including
the rights and defenses of other parties with interests that conflict
with our interests, the performance of the collateral and assets
backing the obligations that we insure, the performance of servicers
involved in securitizations in which we participate as insurer, and
the effect on our rights of the Segregated Account Rehabilitation
Plan and orders of the Rehabilitation Court. Additionally, the
Segregated Account Rehabilitation Proceedings may impair our
ability to realize recoveries in insured transactions if orders of the
Rehabilitation Court are not effective.
Adverse developments with respect to such variables may cause
our recoveries to fall below expectations, which could have a
material adverse effect on our financial condition, including our
capital and liquidity.
| Ambac Financial Group, Inc. 27 2016 FORM 10-K |
We may not be able to successfully monetize assets, restructure
or exchange certain outstanding debt and insurance obligations,
or commute or reduce insured exposures.
Ambac Assurance is evaluating the possibility of entering into one
or more transactions to improve the financial condition of Ambac
Assurance which may, subject to OCI approval, lead to the
conclusion of the Segregated Account Rehabilitation Proceedings.
In pursuing this objective, Ambac Assurance is considering the
possibility of monetizing certain assets, restructuring or
exchanging certain outstanding debt and insurance obligations,
and/or commuting or reducing insured exposures. Transactions of
this nature may not be feasible or economically viable. We cannot
provide any assurance that any such transaction will be
consummated by Ambac Assurance in the future, or if it is, as to
the timing, terms or conditions of any such transaction, or as to
whether it could lead to the conclusion of the Segregated Account
Rehabilitation Proceedings. OCI has not indicated a course of
action to address Segregated Account or other obligations or to
conclude the Segregated Account Rehabilitation Proceedings. The
terms, conditions, and timing of a potential conclusion of the
Segregated Account Rehabilitation Proceedings are in the sole
discretion of OCI, and subject to the approval of the Rehabilitation
Court. This discretion includes the authority to address Segregated
Account obligations without the agreement of Ambac Assurance
or its board of directors. Even if Ambac Assurance consummates
one or more such transactions, doing so may ultimately prove to
be unsuccessful in creating value for any or all of our stakeholders
and may adversely affect our operating results or financial position.
Moreover, any such transaction would be subject to the prior
approval of the board of directors of Ambac Assurance, OCI and
the Rehabilitation Court and may require third-party consents,
which may not be obtained.
that
The Rehabilitator recently filed with the Rehabilitation Court a
supplement to his 2016 Annual Report dated June 1, 2016 relating
to the Segregated Account Rehabilitation Proceedings (the
“Supplement”). In the Supplement, the Rehabilitator stated that at
the present time and absent further actions, Ambac Assurance
has insufficient capital to demonstrate to the satisfaction of the
the Segregated Account Rehabilitation
Rehabilitator
Proceedings could be concluded and leave Ambac Assurance with
sufficient financial resources to meet all policy obligations, as
projected by the Rehabilitator (in his sole discretion) under
a varying range of base and stress case scenarios. The
Rehabilitator further stated in the Supplement that given such
requirements, any transaction facilitating the conclusion of the
Segregated Account Rehabilitation Proceedings will need to
provide for an increase in Ambac Assurance’s existing surplus
capital, as determined and defined by OCI in its sole discretion.
We cannot provide assurance that the terms of any possible
transaction will satisfy OCI or the Rehabilitator that Ambac
Assurance has, or will have, sufficient capital to meet all policy
obligations after the conclusion of the Segregated Account
Rehabilitation Proceedings. The terms, conditions, and timing of
a potential conclusion of the Segregated Account Rehabilitation
Proceedings are in the sole discretion of OCI, and subject to the
approval of the Rehabilitation Court. Even if the Segregated
Account Rehabilitation Proceedings could be brought to a
successful conclusion, there can be no assurance that any level of
capital deemed sufficient by OCI to permit such conclusion will
be sufficient to cover all future losses, whether currently
anticipated or unanticipated.
Revenues and cash flow would be adversely impacted by a decline
in realization of installment premiums.
Due to the installment nature of a significant percentage of its
premium income, Ambac Assurance has an embedded future
revenue stream. The amount of installment premiums actually
realized by Ambac Assurance could be reduced in the future due
to factors such as early termination of insurance contracts,
accelerated prepayments of underlying obligations or insufficiency
of cash flows (by the premium paying entity). Additionally, the
Segregated Account Rehabilitation Proceedings may result in the
loss of installment premium income from such insured transactions
if orders of the Rehabilitation Court are not effective. Such
reductions would result in lower revenues.
The change in composition of the securities in our investment
portfolio exposes us to greater risk.
Each of Ambac Assurance and Ambac Assurance UK Limited
(“Ambac UK”) maintains a portion of its investment portfolio in
lower-rated securities and/or “alternative assets” in order to
increase the risk-adjusted return on its portfolio. Investments in
lower-rated securities and “alternative assets” could expose Ambac
and/or Ambac UK to greater earnings volatility, increased losses
and decreased liquidity in the investment portfolio.
We have substantial indebtedness, which could adversely affect
our financial condition, operational flexibility and our ability to
obtain financing in the future.
We have a substantial amount of indebtedness. Our substantial
level of indebtedness and other financial obligations as well as the
performance of our insured portfolio, which is driven to an extent
by events outside our control, increase the possibility that we may
be unable to generate cash sufficient to pay, when due, the principal
of, interest on, or other amounts due, in respect of our indebtedness.
Our substantial debt and events outside our control could also have
other significant consequences. For example, it could:
•
•
•
•
•
•
•
increase our vulnerability to general adverse economic,
competitive and industry conditions;
limit our ability to obtain additional financing in the future
for working capital, capital expenditures, payment of
policyholder
requirements,
debt
acquisitions, general corporate purposes or other purposes
on satisfactory terms or at all;
claims,
service
require us to dedicate a substantial portion of our cash flow
from operations to the payment of our indebtedness,
thereby reducing the funds available to us for operations
and to fund the execution of our key strategies;
limit or restrict us from making strategic acquisitions or
cause us to make non-strategic divestitures;
limit our ability or increase the costs to refinance
indebtedness or ever repay such indebtedness due to
ongoing interest accretion;
limit our ability to attract and retain key employees; and
limit our ability to enter into hedging transactions by
reducing the number of counterparties with whom we can
enter into such transactions, as well as the volume of those
transactions.
| Ambac Financial Group, Inc. 28 2016 FORM 10-K |
Despite current indebtedness levels, we and our subsidiaries may
incur additional debt. While restrictive covenants in certain of our
contracts currently provide limits on the amount of additional
indebtedness Ambac Assurance may incur, we may obtain a waiver
of those restrictions and incur additional indebtedness in the future.
In addition, if Ambac incurred indebtedness, it would depend on
our subsidiaries to distribute funds to it so that Ambac could pay
its obligations and expenses, including satisfying its indebtedness.
Ambac’s ability to make scheduled payments on, or refinance, any
such indebtedness would depend on the ability of our subsidiaries
to made distributions or dividends, which in turn will depend on
their future operating performance and legal and regulatory
restrictions on the payment of distributions or dividends to which
they may be subject. There can be no assurance that any such
dividends or distributions would be made. This could further
exacerbate the risks associated with our substantial leverage.
The determination of the amount of other-than temporary
impairments taken on our investments is highly subjective and
could materially impact our results of operations or financial
position.
The determination of the amount of impairments on our
investments varies by investment type and is based upon our
periodic evaluation and assessment of known and inherent risks
associated with the respective asset class. Such evaluations and
assessments are revised as conditions change and new information
becomes available. Management updates its evaluations regularly
and reflects changes in impairments as such evaluations are
revised. There can be no assurance that our management has
accurately assessed the level of impairments taken in our financial
statements. Furthermore, additional impairments may need to be
taken in the future. Historical trends may not be indicative of future
impairments. In particular, we use externally developed financial
models to project impairments with respect to RMBS held in our
investment portfolio, including Ambac Assurance guaranteed
RMBS. Differences in the models we employ and/or flaws in these
models and/or faulty assumptions inherent in these models and
those determined by management, could lead to increased
impairments with respect to RMBS in our investment portfolio.
Risks Related to the Financial and Credit Markets
Changes in prevailing interest rate levels and market conditions
could adversely impact our business results and prospects.
liquidity needs due
Increases in prevailing interest rate levels can adversely affect the
value of our investment portfolio and, therefore, our financial
strength. In the event that investments must be sold in order to pay
claims, to pay Deferred Amounts, to redeem surplus notes, or to
meet Financial Services
to contract
terminations or collateral posting requirements, such investments
would likely be sold at discounted prices. Additionally, increasing
interest rates would have an adverse impact on our insured
portfolio. For example, increasing interest rates could result in
higher claim payments in respect of defaulted obligations that bear
interest at floating rates of interest. Higher interest rates can also
lead to increased credit stress on consumer asset-backed
transactions (as the securitized assets supporting a portion of these
exposures are floating rate consumer obligations), slower
prepayment speeds and resulting “extension risk” relative to such
consumer asset-backed transactions in our insured and investment
portfolios, and decreased refinancing activity.
Decreasing interest rates could result in early terminations of
financial guarantee insurance policies in respect of which we are
paid on an installment basis and do not receive a termination
premium, thus reducing premium earned for these transactions.
Decreases in prevailing interest rates may also limit growth of or
reduce investment income and may adversely impact our interest
rate swap portfolio.
Our investment portfolio may also be adversely affected by credit
rating downgrades, ABS and RMBS prepayment speeds, foreign
exchange movements, spread volatility, and credit losses.
We are subject to credit risk throughout our businesses, including
large single risks, risk concentrations, correlated risks and
reinsurance counterparty credit risk.
in
We are exposed to the risk that issuers of debt which we have
insured (or with respect to which we have written credit
derivatives), issuers of debt which we hold in our investment
portfolio, reinsurers and other contract counterparties (including
derivative counterparties) may default
their financial
obligations, whether as the result of insolvency, lack of liquidity,
operational failure, fraud or other reasons. These credit risks could
cause increased losses and loss reserves, and/or estimates of credit
impairments and mark-to-market losses with respect to credit
derivatives in our financial guarantee business; and we could
experience losses and decreases in the value of our investment
portfolio and, therefore, our financial strength. Such credit risks
may be in the form of large single risk exposures to particular
issuers, reinsurers or counterparties; losses caused by catastrophic
events (including terrorist acts and natural disasters); losses caused
by increases in municipal defaults; or losses in respect of different,
but correlated, credit exposures.
Risks Related to the Company's Business
We are subject to the risk of litigation and regulatory inquiries
or investigations, and the outcome of proceedings we are or may
become involved in could have a material adverse effect on our
business, operations, financial position, profitability or cash
flows.
Ambac Assurance is defending various lawsuits relating to its
financial guarantee business. Ambac is defending a putative
securities class action lawsuit. In addition, the Company from time
to time receives various regulatory inquiries and requests for
information. Please see Note 17. Commitments and Contingencies
to the Consolidated Financial Statements included in Part II, Item 8
in this Form 10-K for information on these various proceedings.
It is not possible to predict whether additional suits will be filed
or whether additional regulatory inquiries or requests for
information will be made, and it is also not possible to predict the
outcome of litigation, inquiries or requests for information. It is
possible that there could be unfavorable outcomes in these or other
proceedings. Management is unable to make a meaningful estimate
of the amount or range of loss that could result from unfavorable
outcomes or of the expenses that will be incurred in defending
these lawsuits. Under some circumstances, adverse results in any
such proceedings and/or the incurring of significant litigation
expenses could be material to our business, operations, financial
position, profitability or cash flows.
| Ambac Financial Group, Inc. 29 2016 FORM 10-K |
The Settlement Agreement contains restrictive covenants that
may impair our ability to pursue our business strategies.
Pursuant to the terms of the Settlement Agreement, Ambac
Assurance must seek prior approval by OCI of certain corporate
actions. The Settlement Agreement also includes covenants which
generally restrict the operations of Ambac Assurance and remain
in force until the surplus notes that were issued to the counterparties
by Ambac Assurance pursuant to the Settlement Agreement have
been redeemed, repurchased or repaid in full. Certain of these
restrictions may be waived with the approval of a majority of
Unaffiliated Qualified Directors (as defined in the Settlement
Agreement), certain holders of our surplus notes and/or OCI. If we
are unable to obtain the required consents under the Settlement
Agreement, we may not be able to execute our planned business
strategies.
System security risks, data protection breaches and cyber-attacks
could adversely affect our business and results of operations.
We rely on our information technology systems for many
enterprise-critical functions and a prolonged failure or interruption
of these systems for any reason could cause significant disruption
to our operations and have a material adverse effect on our business,
financial condition and operating results. Our information
technology and application systems may be vulnerable to threats
from computer viruses, natural disasters, unauthorized access,
cyber attack and other similar disruptions. Computer hackers may
be able to penetrate our network’s system security and
misappropriate or compromise confidential information, create
system disruptions or cause shutdowns. In addition to our own
confidential information, we sometimes receive and are required
to protect confidential information from third parties. To the extent
any disruption or security breach results in a loss or damage to our
data, or inappropriate disclosure of our confidential information
or that of others, it could cause significant financial losses that are
either not, or not fully, insured against, damage to our reputation,
affect our relationships with third parties, lead to claims against
us, result in regulatory action, or otherwise have a material adverse
effect on our business or results of operations. In addition, we may
be required to incur significant costs to mitigate the damage caused
by any security breach, or to protect against future damage.
Moreover, although we have disaster recovery and business
continuity plans in place, we may not be able to adequately execute
these plans in a timely fashion in the event of a disruption to our
information technology and application systems.
We may incur losses resulting from operational risk due to
inadequate or failed internal processes, breakdown of settlement
or communication systems, or from external events leading to
disruption of our business. Events subject to operational risk
include:
•
•
•
Internal Fraud-misappropriation of assets, intentional
mismarking of positions
External Fraud-theft of information, third-party theft and
forgery
Clients, Products, & Business Practice-improper trade,
fiduciary breaches
• Damage to Physical Assets
•
•
Business Disruption & System Failures-software failures,
hardware failures; and
Execution, Delivery, & Process Management-data entry
errors, accounting errors, failed mandatory reporting,
settlement errors, and negligence.
We may be adversely affected by failures in services or products
provided by third parties.
We have outsourced and may continue to outsource certain
segments of our operations and business, and rely upon third-party
vendors for other essential services and information, such as the
provision of data used in setting loss reserves and the provision of
risk management information and services. A material failure by
an external service or information provider or a material defect in
the products, services or information provided thereby could
adversely affect our financial condition and results of operations.
Our inability to attract and retain qualified executives and
employees or the loss of any of these personnel could negatively
impact our business.
Our ability to execute on our business strategies depend on the
retention and recruitment of qualified executives and other
professionals. We rely substantially upon the services of our
current executive team. In addition to these officers, we require
key staff with risk mitigation, structured finance, insurance, credit,
investment, accounting, finance, legal and technical skills. As a
result of Ambac’s financial situation and the rehabilitation
proceedings for the Segregated Account, there is a higher risk that
executive officers and other key staff will leave the Company and
replacements may not be motivated to join the Company. The loss
of the services of members of our senior management team or our
inability to hire and retain other talented personnel could delay or
prevent us from succeeding in executing our strategies, which
could further negatively impact our business.
Our business could be negatively affected by actions of
stakeholders whose interests may not be aligned with the broader
interests of our stockholders.
Ambac could be negatively affected as a result of actions by
stakeholders whose interests may not be aligned with the broader
interests of our stockholders, and responding to any such actions
could be costly and time-consuming, disrupt operations and divert
the attention of management and employees. Such activities could
interfere with our ability to execute on our strategic plans.
Risks Related to International Business
Actions of the PRA and FCA could reduce the value of Ambac
UK realizable by Ambac, which could adversely affect our
securityholders.
Ambac’s international business is operated by Ambac UK, which
is regulated by the Prudential Regulation Authority (“PRA”) for
prudential purposes and the Financial Conduct Authority (“FCA”)
for conduct purposes. Under the Financial Services and Markets
Act 2000 (“FSMA”), the PRA authorized Ambac UK to carry out
financial guaranty insurance business in the UK and in the EU by
way of the EU’s passporting regime (although this may change
following Brexit), subject to the terms and conditions of the
permission granted by the PRA and consented to by the FCA.
However, the terms of Ambac UK’s regulatory authority are now
restricted and Ambac UK is in run-off. Among other things, Ambac
UK may not write any new business, and, with respect to any entity
| Ambac Financial Group, Inc. 30 2016 FORM 10-K |
within the Ambac group of affiliates, commute, vary or terminate
any existing financial guaranty policy, transfer certain assets, or
pay dividends, without the prior approval of the PRA and FCA.
The PRA and FCA act generally in the interests of Ambac UK
policyholders and will not take into account the interests of
securityholders of Ambac or Ambac Assurance when considering
Accordingly,
whether
determinations made by the PRA and FCA, in their capacity as
Ambac UK’s regulator, could potentially result in adverse
consequences for our securityholders and also reduce the value
realizable by Ambac for Ambac UK.
to provide any such approval.
Regulatory uncertainty in relation to Ambac UK’s capital
position could adversely affect the value of Ambac UK and affect
our securityholders.
Under applicable regulatory capital rules (“Solvency II”) Ambac
UK remains significantly deficient in terms of capital. Ambac UK
does not have a remedial plan other than to build its assets over
time by on-going premium collections and earned investment
income, as well as attempting to accelerate the run-off of its
exposures. Further, there currently is no prospect of any capital
support from the Ambac group of affiliates. The PRA is well aware
of Ambac UK’s position and prospects. The PRA supervisory
statement SS7/15 “Supervision of firms in difficulty or run-off”
notes that “there are many circumstances in which a run-off
strategy is in the best interests of policyholders” and notes that the
PRA will review such firms and that they “may be permitted to
continue activities necessary to carry out existing contracts in a
manner, and for so long as, the PRA considers necessary in order
to afford an appropriate degree of protection to policyholders”.
AUK clearly falls into this category and therefore AUK’s current
run off approach remains at all times subject to the continuing
forbearance of the PRA in relation to its capital deficit and related
Solvency II requirements. Alternative courses of action open to the
PRA could adversely impact the anticipated run-off trajectory of
Ambac UK and impact its value.
Uncertainty regarding the economic impact of “Brexit” may have
an adverse effect on Ambac’s insured international portfolio and
the value of its foreign investments, both of which primarily
reside with its subsidiary Ambac UK.
In a non-binding referendum on the United Kingdom’s (“UK”)
membership in the European Union in June 2016, a majority of
those who voted approved the UK’s withdrawal from the European
Union (“EU”). As a result of the referendum, the British
government has announced that it intends to commence negotiating
the terms of the UK’s withdrawal from the EU (“Brexit”) and of
its future relationship with the EU in March 2017, with the
expectation of withdrawing two years later. The terms of the future
relationship between the EU and the UK are uncertain at this time
and may be so for some time to come, and could result in the UK
losing access to certain aspects of the single EU market and the
global trade deals negotiated by the EU on behalf of its members.
The Brexit vote, subsequent uncertainty, and the perceptions as to
the ultimate impact of the withdrawal of the UK may adversely
affect business activity, political stability and economic conditions
in the UK, the Eurozone, the EU and elsewhere. The economic
outlook could be further adversely affected by (i) the risk that one
or more other EU countries could come under increasing pressure
to leave the EU, (ii) the risk of a greater demand for independence
by Scottish nationalists or for unification in Ireland and its impact
on the United Kingdom, or (iii) the risk that the Euro as the single
currency of the Eurozone could cease to exist. Any of these
developments, or the perception that any of these developments
are likely to occur, could have a material adverse effect on
economic growth or business activity in the UK, the Eurozone,
and/or the EU, and could result in the relocation of businesses,
cause business interruptions, lead to economic recession or
depression, and impact the stability of the financial markets, the
availability of credit, political systems or financial institutions and
the financial and monetary system.
These economic conditions, particularly a recession or depression,
may have a material adverse effect on Ambac’s international
insured exposures particularly in the UK and Europe, the majority
of which reside in Ambac UK. The creditworthiness of Ambac’s
international insured exposures is subject to risks associated with,
among other matters, lower asset values related to collateral
backing transactions, depressed demand for services resulting in
lower operating cash flows and reduced access to the capital
markets and other sources of financing or refinancing. In addition,
such conditions may have a material adverse effect on the value
and volatility of investments, including investments in UK
property funds and equities that Ambac maintains, mainly through
Ambac UK, in markets and currencies outside of the U.S.
Collectively, these effects may have a negative impact on Ambac’s
operating results and financial condition resulting from unexpected
credit, investment and foreign exchange losses, volatile asset
values, reduced liquidity and lost revenues.
The uncertainty concerning the timing and terms of the Brexit
could result in additional volatility in the equity, foreign exchange,
real property, bond and other markets, which could adversely
impact the UK economy and Ambac's results of operations and
financial condition over the near and long term.
Risks Related to Taxation
Certain surplus notes or other obligations issued by either Ambac
Assurance or the Segregated Account may be characterized as
equity of Ambac Assurance and as a result, Ambac Assurance
may no longer be a member of the U.S. federal income tax
consolidated group of which Ambac is the common parent.
It is possible that certain surplus notes or other obligations issued
by either Ambac Assurance or the Segregated Account may be
characterized as equity of Ambac Assurance for U.S. federal
income tax purposes. If such surplus notes or other obligations are
characterized as equity of Ambac Assurance that is taken into
account for tax affiliation purposes and it is determined that such
“equity” represented more than twenty percent of the total value
of the stock of Ambac Assurance, Ambac Assurance may no longer
be characterized as an includable corporation that is affiliated with
Ambac. As a result, Ambac Assurance would no longer be
characterized as a member of the U.S. federal income tax
consolidated group of which Ambac is the common parent (the
“Ambac Consolidated Group”) and Ambac Assurance would be
required to file a separate consolidated tax return as the common
parent of a new U.S. federal income tax consolidated group
including Ambac Assurance as the new common parent and Ambac
Assurance’s affiliated subsidiaries (the “Ambac Assurance
Consolidated Tax Group”).
To the extent Ambac Assurance is no longer a member of the
Ambac Consolidated Group, Ambac Assurance’s NOLs (and
certain other available tax attributes of Ambac Assurance and the
| Ambac Financial Group, Inc. 31 2016 FORM 10-K |
other members of the Ambac Assurance Consolidated Tax Group)
may no longer be available for use by the Ambac Assurance
Consolidated Tax Group or any of the remaining members of the
Ambac Assurance Consolidated Tax Group to reduce the U.S.
federal income tax liabilities of the Ambac Assurance Consolidated
Tax Group. Ambac, Ambac Assurance and their affiliates entered
into a tax sharing agreement that would require Ambac to make
certain tax elections that could mitigate the loss of NOLs and other
tax attributes resulting from a deconsolidation of Ambac Assurance
from the Ambac Consolidated Group. However, in the event of a
deconsolidation, certain other benefits resulting from U.S. federal
income tax consolidation may no longer be available to the Ambac
Consolidated Group including certain favorable rules relating to
transactions occurring between members of
the Ambac
Consolidated Group and members of the Ambac Assurance
Consolidated Tax Group.
If surplus notes or other obligations are characterized as equity
of Ambac Assurance, the Ambac Assurance NOLs (and certain
other tax attributes or tax benefits of the Ambac Consolidated
Group) may be subject to limitation under Section 382 of the Tax
Code.
It is possible that certain surplus notes or other obligations may be
characterized as equity of Ambac Assurance for U.S. federal
income tax purposes. Such characterization could result in an
“ownership change” of Ambac Assurance for purposes of
Section 382 of the Tax Code. If such an ownership change were
to occur, the value and amount of the Ambac Assurance NOLs
would be substantially impaired, increasing the U.S. federal
income tax liability of Ambac Assurance and materially reducing
the value of Ambac Assurance’s stock owned by Ambac and the
potential of future cash tolling or dividend payments from Ambac
Assurance to Ambac.
Deductions with respect to interest accruing on certain surplus
notes may be eliminated or deferred until payment.
To the extent certain surplus notes are characterized as equity for
U.S. federal income tax purposes, accrued interest will not be
deductible by Ambac Assurance. In addition, even if such surplus
notes are characterized as debt for U.S. federal income tax
purposes, the deduction of interest accruing on such surplus notes
may be deferred until paid or eliminated in part depending upon
(i) the terms of any deferral and payment provisions provided in
such surplus notes, (ii) whether such surplus notes have
“significant original issue discount,” and (iii) the yield to maturity
of surplus notes. To the extent deductions with respect to interest
are eliminated or deferred, the U.S. federal income tax of the
members of the Ambac Consolidated Group or the members of the
Ambac Assurance Consolidated Tax Group as the case may be,
could be increased reducing the amount of cash available to pay
its obligations.
Changes in Political or Economic Conditions
New U.S. Administration’s proposed tax reform may have
adverse consequences for the Company.
The recent presidential and congressional elections in the United
States could result in significant changes in, and uncertainty with
respect to, legislation, regulation and government policy. While it
is not possible to predict whether and when any such changes will
occur, changes at the local, state or federal level could significantly
impact our business and the insurance industry.
In particular, significant changes in the U.S. federal tax code are
possible. One potential proposal is to reduce the U.S. federal
corporate income tax rate to 15%. Any reduction to the federal
corporate income tax rate will reduce the value of Ambac’s and
Ambac Assurance’s NOLs. This potential loss of value includes
the prospects of lower tolling payments to be made by Ambac
Assurance to Ambac. In addition, the effects of lower corporate
tax rates, when coupled with other economic expectations (such
as higher inflation) may adversely impact the pricing and valuation
of fixed-income securities, including those in our investment
portfolio.
A reduction in the U.S. federal corporate tax rates may also
adversely affect municipal issuers’ funding costs and market
access. A lower corporate tax rate could make tax-exempt
indebtedness issued by municipal issuers less attractive, possibly
resulting in a re-pricing of the municipal bond market. Any such
re-pricing may result in lower re-fundings of our municipal
exposures than projected, and/or increased losses in our municipal
credit portfolio.
In addition, there can be no certainty that the proposed tax reforms
will not also limit or abolish the income tax exemption for
municipal bond interest. Such a reform could potentially place
further stress on municipal issuers’ ability to fund their operations,
with the potential for increased defaults on debt service payments.
We are also currently unable to predict whether other reform
discussions will meaningfully change existing legislative and
regulatory environments relevant for our business, or if any such
changes would have a net positive or negative impact on our
business. To the extent that such changes have a negative impact
on us, including as a result of related uncertainty, these changes
may materially and adversely impact our business, financial
condition, results of operations and cash flows.
Risks Related to Strategic Plan
Ambac is exploring select business opportunities which may
permit utilization of Ambac’s net operating loss carry-forwards;
however, such business opportunities may not be consummated,
or if consummated, may not create value and may negatively
impact our financial results.
Ambac is exploring select business opportunities which may
permit utilization of its net operating loss carry-forwards. Such
business opportunities, may involve the acquisition of assets or
existing businesses or the development of businesses through new
or existing subsidiaries. It is not possible at this time to predict the
future prospects or other characteristics of any such business
opportunities. Although we intend to conduct business, financial
and legal due diligence in connection with the evaluation of any
future business or acquisition opportunities, there can be no
assurance our due diligence investigations will identify every
matter that could have a material adverse effect on us. Efforts to
pursue select business opportunities may be unsuccessful or
require significant financial or other resources, which could have
a negative impact on our financial condition. No assurance can be
given that Ambac will be able to complete such business
opportunities, generate any earnings or be able to successfully
integrate any such business into our current operating structure.
Moreover, Ambac’s ability to enter new businesses, including new
businesses apart from Ambac Assurance, is also subject to
significant doubt, given the condition and circumstances of the
| Ambac Financial Group, Inc. 32 2016 FORM 10-K |
Segregated Account and Ambac Assurance, the difficulty of
leveraging or monetizing Ambac’s other assets, and the uncertainty
of its ability to raise capital. Due to these factors, as well as those
relating to Ambac Assurance as described in this Item 1A. Risk
Factors, the value of our securities is highly speculative.
Ambac’s current strategy and initiatives have been derived from,
and created as a consequence of, the company’s current financial
condition and circumstances. Should changes in Ambac’s
circumstances or financial condition or in the political, economic
and/or legal environment occur, there can be no assurances that all
or any part of such strategy and/or initiatives will not be abandoned
or amended to take account of such changes. Any such adjustment
or abandonment may have an adverse effect on our securities.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Properties
The executive office of Ambac is located at One State Street Plaza,
New York, New York 10004, which consists of 103,484 square feet
of office space, under lease agreements that expire in September
2019 (77,613 square feet) and December 2029 (25,871 square feet).
This office houses operations for all reportable business segments.
The lease expiring in September 2019 has a provision that can
extend the lease to December 2029. Ambac leases additional space
outside of New York for its data center at a secure facility under a
lease agreement that expires in March 2019.
Ambac UK maintain an office in London, England, which consist
of 3,514 square feet of office space, under a lease agreement that
expires in October 2020.
Additionally, Ambac maintains a disaster recovery site as part of
its Disaster Recovery Plan, which is located approximately 100
miles from One State Street Plaza under a lease that expires in
September 2019. This remote warm-back-up facility is complete
with user work stations, phone system, data center, internet
connectivity and a power generator, capable of serving the needs
of the disaster recovery team to support all business segment
operations. The plan, facility and systems are revised and upgraded
where necessary, and user tested annually to confirm their
readiness.
Item 3.
Legal Proceedings
Refer to Notes to the Consolidated Financial Statements—Note
17. Commitments and Contingencies included in Part II, Item 8
in this Form 10-K for a discussion on legal proceedings against
Ambac and its subsidiaries.
Item 4.
Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for Registrant's Common Equity,
Related Stockholder Matters and Issuer Purchases of
Equity Securities
Market Information
The Company's common stock is listed on NASDAQ under the
symbol “AMBC.” The high and low common stock prices per
share were as follows:
2016
2015
High
Low
High
Low
Fourth quarter
$
27.25
$
17.75
$
17.39
$
12.72
Third quarter
Second quarter
First quarter
Holders
19.35
17.77
17.32
15.42
14.42
11.92
19.17
25.91
27.53
14.22
16.44
23.99
On February 24, 2017, there were 34 stockholders of record of
Ambac’s common stock.
Dividends
The Company did not pay cash dividends on its common stock
during 2016 and 2015. Information concerning restrictions on the
payment of dividends from Ambac's insurance subsidiaries is set
forth in Item 1 above under the caption “Dividend Restrictions,
Including Contractual Restrictions" and in Note 8. Insurance
Regulatory Restrictions to the Consolidated Financial Statements
included in Part II, Item 8 in this Form 10-K.
Purchases of Equity Securities By the Issuer and Affiliated Purchasers
The following table summarizes Ambac’s activity of share purchases during the fourth quarter of 2016. When restricted stock unit awards
issued by Ambac become taxable compensation to employees, shares may be withheld to cover the employee’s withholding taxes. In December
2016, Ambac purchased shares from employees that settled restricted stock units to meet employee tax withholdings.
October 2016
November 2016
December 2016
(cid:41)(cid:82)(cid:88)(cid:85)(cid:87)(cid:75) (cid:52)(cid:88)(cid:68)(cid:85)(cid:87)(cid:72)(cid:85) (cid:21)(cid:19)(cid:20)(cid:25)
Total Shares
Purchased (1)
Average Price
Paid Per Share
— $
—
22,458
(cid:21)(cid:21)(cid:15)(cid:23)(cid:24)(cid:27)
(cid:7)
—
—
22.07
(cid:21)(cid:21)(cid:17)(cid:19)(cid:26)
Total Number of
Shares Purchased
as Part of Publicly
Announced Plan (1)
Maximum
Number of Shares
That May Yet Be
Purchased Under
the Plan
—
—
—
(cid:178)
—
—
—
(cid:178)
(1) There were no other repurchases of equity securities made during the three months ended December 31, 2016. Ambac does not have a
stock repurchase program.
| Ambac Financial Group, Inc. 33 2016 FORM 10-K |
On June 30, 2015, the Board of Directors of Ambac authorized the
establishment of a warrant repurchase program that permits the
repurchase of up to $10 million of warrants. On November 3, 2016,
the Board of Directors of Ambac authorized an additional $10
million to the warrant repurchase program. As of December 31,
2016, Ambac had repurchased 985,331 warrants at a cost of $8.1
million, leaving 4,053,670 warrants outstanding, bringing the
remaining aggregate authorization to $11.9 million.
Stock Performance Graph
The following graph compares the performance of an investment in our common stock from the close of business on May 1, 2013, the date
we emerged from bankruptcy through December 31, 2016, with the Russell 2000 Index, S&P 500 Financials Index and S&P Completion
Index. The S&P Completion Index has been added in 2016 since it includes other Financial Guaranty companies and similarly sized companies
to Ambac, as measured by market capitalization. The graph assumes $100 was invested on May 1, 2013 in our common Stock at the closing
price of $20 per share and at the closing price for the Russell 2000 Index, S&P 500 Financials Index and S&P Completion Index. It also
assumes that dividends (if any) were reinvested on the date of payment without payment of any commissions. The performance shown in the
graph represents past performance and should not be considered an indication of future performance.
Ambac Financial Group, Inc.
Russell 2000 Index
S&P 500 Financials Index
S&P Completion Index
December 31,
5/1/13
2013
2014
2015
2016
$100
$100
$100
$100
$123
$127
$117
$123
$123
$134
$130
$130
$70
$127
$129
$124
$113
$148
$141
$142
| Ambac Financial Group, Inc. 34 2016 FORM 10-K |
Item 6.
Selected Financial Data
The following financial information for the five years ended December 31, 2016, has been derived from Ambac’s Consolidated Financial
Statements. Following the Company’s emergence from bankruptcy on May 1, 2013, the consolidated financial statements reflect the application
of fresh start reporting (“Fresh Start”), incorporating, among other things, the discharge of debt obligations, issuance of new common stock
and fair value adjustments. The effects of the reorganization and Fresh Start adjustments are recorded in Predecessor Ambac’s Consolidated
Statement of Total Comprehensive Income for the period ended April 30, 2013. The financial results of the Company for the periods from
May 1, 2013 are referred to as “Successor” and the financial results for the periods through April 30, 2013 are referred to as “Predecessor”.
The 2013 Successor Period and the 2013 Predecessor Period are distinct reporting periods. As a result of the implementation of Fresh Start,
results and balances are not comparable between Successor Ambac and Predecessor Ambac. This information should be read in conjunction
with the Consolidated Financial Statements and related notes located in Part II, Item 8 in this Form 10-K.
($ in millions, except per share data)
2016
2015
2014
Year Ended December 31,
Period from
May 1 through
December 31,
2013
Period from
Jan 1 through
April 30,
2013
Year Ended
December 31,
2012
Successor Ambac
Predecessor Ambac
Total Comprehensive Income Highlights:
Gross premiums written
Net premiums earned
Net investment income
Other than temporary impairment losses
Net realized investment gains
Net change in fair value of credit derivatives
Derivative products revenue
Net realized (losses) gains on extinguishment of debt
Income (loss) on Variable Interest Entities ("VIEs")
Losses and loss expenses (benefit) (1)
Interest and underwriting and operating expenses
Insurance intangible amortization
Goodwill amortization
Reorganization items
Pre-tax income (loss)
Net income (loss) attributable to Common
Shareholders
Total comprehensive income attributable to Ambac
Financial Group, Inc.
Net income (loss) per share:
$
(53.8) $
(37.6) $
(288.3) $
(80.3)
$
(14.1) $
(277.5)
197.3
313.4
(21.8)
39.3
20.1
(50.3)
4.8
(14.1)
(11.5)
238.0
174.6
—
—
105.0
74.8
20.6
312.6
266.3
(25.7)
53.5
41.7
(42.5)
0.1
31.6
(768.7)
219.2
169.6
514.5
—
510.1
493.4
288.3
246.4
300.9
(25.8)
58.8
23.9
(181.1)
(74.7)
(32.2)
(545.6)
229.0
151.8
—
0.2
493.3
484.1
692.7
213.5
146.4
(46.8)
4.5
192.9
114.8
—
(48.6)
(185.1)
153.7
99.7
—
0.5
512.3
505.2
516.9
130.0
116.7
(0.5)
53.3
(60.4)
(33.7)
—
426.6
(38.1)
75.6
—
—
(2,745.2)
3,348.0
414.6
382.9
(6.0)
72.1
(9.2)
(125.0)
(177.6)
27.8
683.6
251.3
—
—
7.2
(256.5)
3,349.0
(256.7)
3,523.9
(94.6)
Basic
Diluted
$
$
1.66
1.64
$
$
10.92
10.72
$
$
10.73
10.31
$
$
11.23
10.91
$
$
11.07
11.07
$
$
(0.85)
(0.85)
(1) Ambac records the impact of estimated recoveries related to securitized loans in RMBS transactions that breached certain representations and warranties
within losses and loss expenses (benefit). The expense (benefit) associated with changes to our estimated recoveries for the years ended December 31,
2016, 2015 and 2014, the eight months ended December 31, 2013, the four months ended April 30, 2013 and the year ended December 31, 2012 were
$(71.4). $(303.6) million, $(481.7) million, $199.4 million, $(61.6) million, and $195.2 million, respectively.
| Ambac Financial Group, Inc. 35 2016 FORM 10-K |
($ in millions) December 31,
Balance Sheet Highlights:
Successor Ambac
Predecessor
Ambac
2016
2015
2014
2013
2012
Total non-variable interest entity investments
$
6,500.2
$
5,644.7
$
5,507.0
$
6,523.7
$
6,329.9
Cash and cash equivalents
Premium receivable
Insurance intangible asset
Goodwill
Subrogation recoverable (1)
Deferred ceded premium
Total VIE assets
Total assets
Liabilities subject to compromise
Unearned premiums
Loss and loss expense reserve (1)
Obligations under investment agreements
Long-term debt (2)
Derivative liabilities
Total VIE liabilities
Total liabilities
Total stockholders’ equity (deficit)
Total liabilities and stockholders' equity
91.0
661.3
962.1
—
684.7
69.6
13,367.8
22,635.7
—
967.3
4,380.8
82.4
1,114.4
319.3
13,235.4
20,657.7
1,978.0
35.7
831.6
1,212.1
—
1,229.3
96.8
14,288.5
23,728.1
—
1,280.3
4,088.1
100.4
1,125.0
353.4
14,259.8
21,769.7
1,958.3
73.9
1,000.6
1,410.9
514.5
953.3
123.3
15,126.1
25,159.9
—
1,673.8
4,752.0
160.1
971.1
406.9
15,085.7
23,486.1
1,673.7
77.4
1,453.0
1,598.0
514.5
498.5
145.5
15,988.7
27,092.5
—
2,255.7
5,968.7
359.1
963.2
253.9
15,872.8
26,114.1
978.4
43.8
1,620.6
—
—
497.3
177.9
17,841.9
27,085.3
1,704.9
2,778.4
6,619.5
362.0
150.2
531.3
17,661.7
30,332.2
(3,247.0)
$
22,635.7
$
23,728.1
$
25,159.9
$
27,092.5
$
27,085.3
(1) Ambac records as a component of its loss reserves and subrogation recoverable, estimated recoveries related to securitized loans in RMBS transactions
that breached certain representations and warranties. Ambac has recorded gross estimated recoveries of $1,907.0 million, $2,829.6 million, $2,523.5
million, $2,206.6 million and $2,523.2 million at December 31, 2016, 2015, 2014, 2013 and 2012, respectively.
(2) Long-term debt represents surplus notes issued to third parties by Ambac Assurance and the Segregated Account. In 2014, Ambac sold a $350.0 million
junior surplus note issued to it by the Segregated Account to a newly formed Trust in exchange for cash of $224.3 million and a subordinated owner trust
certificate issued by the Trust. Long-term debt for all years excludes the portion of long-term debt associated with variable interest entities. Long-term
debt associated with Ambac is included under liabilities subject to compromise in Predecessor Ambac.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) contains certain financial measures,
in particular the presentation of Adjusted Earnings and Adjusted Book Value, which are not presented in accordance with accounting principles
generally accepted in the United States (“GAAP”). We are presenting these non-GAAP financial measures because they provide greater
transparency and enhanced visibility into the underlying drivers of our business. We do not intend for these non-GAAP financial measures to
be a substitute for any GAAP financial measures and they may differ from similar reporting provided by other companies. Readers of this
Form 10-K should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures. Adjusted
Earnings and Adjusted Book Value are non-GAAP financial measures that adjust for the impact of certain non-recurring or non-economic
GAAP accounting requirements and include the addition of certain items that the Company has or expects to realize in the future, but that are
not reported under GAAP. We also provide reconciliations to the most directly comparable GAAP measures; Adjusted Earnings to Net income
attributable to common stockholders and Adjusted Book Value to Total Ambac Financial Group, Inc. stockholders’ equity.
COMPANY OVERVIEW
See Note 1. Background and Business Description for a description
of the Company, our business segments and our key strategies to
achieve our primary goal to maximize shareholder value.
with Ambac's liability management and loss mitigation programs.
Management evaluates the potential impact of loss mitigation
strategies in order to target and prioritize policies, or portions
thereof, for commutation, refinancing or other claims reduction or
defeasance strategies.
EXECUTIVE SUMMARY
Asset Management:
Ambac Assurance and subsidiaries:
A key strategy for Ambac is to increase the value of its investment
in Ambac Assurance by actively managing its assets and liabilities.
Asset management primarily entails maximizing the risk adjusted
return on non-VIE invested assets and managing liquidity to help
ensure resources are available to meet operational and strategic
cash needs. These strategic cash needs include activities associated
Investment portfolios are subject to internal investment guidelines,
including limits on types and quality of investments imposed by
applicable insurance laws and regulations. As part of its investment
strategy, and in accordance with the aforementioned guidelines,
Ambac Assurance and Ambac Assurance UK Limited ("Ambac
UK") purchase distressed Ambac-insured securities based on their
risk/reward characteristics. During 2016, Ambac
relative
| Ambac Financial Group, Inc. 36 2016 FORM 10-K |
(inclusive of its subsidiaries) acquired $658.5 million of distressed
Ambac-insured securities, including $494.4 million of insured
RMBS and $128.1 million of insured student loan securities with
policies allocated to the Segregated Account and $36.0 of other
insured securities. Future cash flows relating to those invested
assets allocated to the Segregated Account include the sum of
(i) the bond’s intrinsic cash flows and (ii) the estimated Ambac
Assurance claim payments, including Deferred Amounts (as
defined in the Segregated Account Rehabilitation Plan). At the
end of 2016, Ambac owned approximately $1.5 billion, or 41% of
the total Deferred Amounts outstanding. Ambac will continue to
The
opportunistically purchase Ambac-insured securities.
investment portfolios of Ambac Assurance and Ambac UK also
hold fixed income securities and funds that include a variety of
other assets including, but not limited to, corporate bonds, asset
backed and mortgage backed securities, municipal bonds, high
yield bonds, leveraged loans, equities, real estate and hedge funds.
Refer to Note 10. Investments to the Consolidated Financial
Statements, included in Part II, Item 8 in this Form 10-K for further
details of investments by asset class.
Liability and Insured Exposure Management:
Ambac Assurance's Risk Management Group focuses on the
analysis, implementation and execution of commutation and
related claims reduction or defeasance strategies. Analysts
evaluate the estimated timing and severity of projected policy
claims as well as the potential impact of loss mitigation or
remediation strategies in order to target and prioritize policies, or
portions thereof, for commutation, refinancing or other claims
reduction or defeasance strategies. For targeted policies, analysts
will engage with bondholders, issuers and other economic
stakeholders to negotiate, structure and execute such strategies.
During 2016, Ambac recognized improvements in the performance
of certain Ambac insured RMBS transactions. Ambac reached the
following settlements: (i) $995 million received in January 2016
in connection with a representation and warranty settlement with
JP Morgan; and (ii) future estimated recoveries valued at $51.6
million ($51.4 million net of reinsurance) at December 31, 2016
in connection with a settlement outside of litigation and unrelated
to Ambac's R&W subrogation recoveries. Separately, Ambac
Assurance received $100.3 million ($99.1 million net of
reinsurance) of subrogation recoveries related to an omnibus
settlement with investors in Countrywide securitizations, that was
announced in June 2011 by Bank of New York Mellon, as Trustee,
whereby Bank of America agreed to pay $8.5 billion across
approximately 530 RMBS
trusts (“Countrywide Investor
Settlement”). The Countrywide Investor Settlement was included
in previous loss reserve estimates as other subrogation.
During 2016, Ambac Assurance purchased $9.6 million of unpaid
accrued interest related to certain surplus notes that were
previously repurchased under call options. Ambac recognized a
realized gain on these purchases of $3.1 million in the Consolidated
Statements of Total Comprehensive Income. In addition, Ambac
Assurance purchased $18.6 million of its surplus notes during
2016. Ambac recognized realized gains on these purchases of $1.7
million in the Consolidated Statements of Total Comprehensive
Income.
The following table provides a comparison of both total and below
investment grade ("BIG") net par outstanding in the insured
portfolio at December 31, 2016 and 2015. Net par exposures within
the U.S. public finance market include capital appreciation bonds
which are reported at the par amount at the time of issuance of the
insurance policy.
($ in billions)
December 31,
2016
2015
$
Variance
%
Variance
Total
BIG
$
79.3
16.8
$
108.3
$
(29.0)
19.8
(3.0)
(27)%
(15)%
The overall reduction in total net par outstanding resulted from
scheduled maturities, amortizations, refundings, refinancings and
calls accelerated by several company-led initiatives, including an
overall $935 million reduction of student loan net par exposure,
including commutations of $387 million net par of National
Collegiate Student Loan Trust bonds; and the $458 million
cancellation of net par exposure to Local Insight Media ("LIM").
The reduction in below investment grade net par outstanding was
primarily due to (i) the aforementioned commutations of student
loan policies, (ii) reductions to residential mortgage-backed
securities during the year as a result of both prepayments by issuers
the
and claims presented
aforementioned cancellation of the LIM insured bonds.
to Ambac Assurance and (iii)
Although our insured portfolio has performed satisfactorily over
the course of 2016, we have experienced stress within our
approximately $2.1 billion of exposures to Puerto Rico consisting
of several different issuing entities (all below investment grade).
Each issuing entity has its own credit risk profile attributable to
discreet revenue sources, direct general obligation pledges and
general obligation guarantees. Refer to Part I, Item 1 in this Form
10-K for a further discussion of our exposures
the
Commonwealth of Puerto Rico.
to
Ambac:
As of December 31, 2016 total cash and investments of Ambac
were $342.8 million, which include the following:
•
•
•
•
Liquid investments in asset backed and short-term
securities of $212.1 million
Investments in Ambac-insured securities with a fair value
of $86.4 million
Investments in Ambac Assurance surplus notes with a fair
value of $14.3 million, which is eliminated in consolidation
Residual interest in a VIE Trust that was created in 2014
to monetize Ambac's ownership interest in junior surplus
notes issued by the Segregated Account. Ambac's carrying
value, utilizing the equity method, of this investment was
$30.0 million at December 31, 2016. Refer to Note 3.
Special Purpose Entities, Including Variable Interest
Entities to the Consolidated Financial Statements included
in Part II, Item 8 in this Form 10-K, for more information
on this transaction.
During 2015, the Board of Directors of Ambac authorized the
establishment of a warrant repurchase program that permits the
repurchase of up to $10 million of warrants. On November 3, 2016,
the Board of Directors of Ambac authorized an additional $10
million to the warrant repurchase program. As of December 31,
2016, Ambac had repurchased 985,331 warrants at a cost of $8.1
million, leaving 4,053,670 warrants outstanding, bringing the
| Ambac Financial Group, Inc. 37 2016 FORM 10-K |
remaining aggregate authorization to $11.9 million. Ambac will
opportunistically consider additional purchases in the future.
As a result of positive taxable income at Ambac Assurance in 2015,
Ambac received $70.9 million in tax tolling payments in May 2016
and $0.5 million in November 2016. Additionally, based on Ambac
Assurance's 2016 taxable income, Ambac is expected to receive
approximately $28.7 million in tax tolling payments by June 2017
(subject to Rehabilitator review).
Foreign Currency Impacts:
The strengthening of the U.S. dollar since the Brexit referendum
vote impacted Ambac's economic position. Specifically, the
impact of using March 31, 2016 currency rates against the current
balance sheet, excluding VIEs, provides for an approximate loss
of $68 million, as follows:
•
•
•
A reduction of investments and loan values held in British
Pounds and Euros of approximately $37.2 million. As of
December 31, 2016 Ambac held British Pound and Euro
loans and investments of £171.2 million and €23.5 million,
respectively. All but £3.4 million of these amounts were
held by Ambac UK. Included within the British Pound
portfolio is £27.0 million invested in a UK property fund.
Since the referendum vote, there have been reduced
valuations of commercial real estate and a number
of such funds suspended redemptions. The UK
property fund that Ambac UK has invested in has
not suspended redemptions as of this date.
A reduction in premiums receivable denominated in British
Pounds and Euros of $32.5 million. As of December 31,
2016 premium receivables in British Pounds totaled £144.4
million and Euros totaled €33.1 million.
A decrease in the carrying value of loss reserves related to
policies where loss payments will be made in currencies
other than the US dollar of $1.7 million. As of
December 31, 2016, loss and loss expense reserves for
British Pounds totaled zero and Euros totaled €20.3 million.
Financial Statement Impacts:
The impact of foreign currency as reported in Ambac's
Consolidated Statement of Total Comprehensive Income for the
year ended December 31, 2016 included the following:
($ in millions)
Net income (1)
$
Gain (losses) on foreign currency translation
Unrealized gains (losses) on non-functional
currency available-for-sale securities
(cid:44)(cid:80)(cid:83)(cid:68)(cid:70)(cid:87) (cid:82)(cid:81) (cid:87)(cid:82)(cid:87)(cid:68)(cid:79) (cid:70)(cid:82)(cid:80)(cid:83)(cid:85)(cid:72)(cid:75)(cid:72)(cid:81)(cid:86)(cid:76)(cid:89)(cid:72) (cid:76)(cid:81)(cid:70)(cid:82)(cid:80)(cid:72) (cid:11)(cid:79)(cid:82)(cid:86)(cid:86)(cid:12)
(cid:7)
(39.1)
(122.1)
25.4
(cid:11)(cid:20)(cid:22)(cid:24)(cid:17)(cid:27)(cid:12)
(1) A portion of Ambac UK's, and to a lesser extent Ambac Assurance's,
assets and liabilities are denominated in currencies other than its
functional currency and accordingly, we recognized net foreign
currency transaction gains/(losses) as a result of changes to foreign
currency rates through our Consolidated Statement of Total
Comprehensive Income. Refer to Note 2. Basis of Presentation and
Significant Accounting Policies to the Consolidated Financial
Statements included in Part II, Item 8 in this Form 10-K for further
details on transaction gains and losses.
Future changes to currency rates may adversely affect our financial
results. Refer to Part II, Item 7A "Quantitative and Qualitative
Disclosures about Market Risk" for further information on the
impact of future currency rate changes on Ambac's financial
instruments.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Ambac's Consolidated Financial Statements have been prepared
in accordance with GAAP. This section highlights accounting
estimates management views as critical because they require
management to make difficult and subjective judgments regarding
matters that are inherently uncertain and subject to change. These
estimates are evaluated on an on-going basis based on historical
developments, market conditions, industry trends and other
information that is reasonable under the circumstances. There can
be no assurance that actual results will conform to estimates and
that reported results of operations will not be materially adversely
affected by the need to make future accounting adjustments to
reflect changes in these estimates from time to time.
Management has identified the following critical accounting
policies and estimates: (i) valuation of loss and loss expense
reserves, (ii) valuation of financial instruments and (iii) valuation
of deferred tax assets. Management has discussed each of these
critical accounting policies and estimates with the Audit
Committee, including the reasons why they are considered critical,
and how current and anticipated future events impact those
determinations. Additional information about these policies can be
found in Note 2. Basis of Presentation and Significant Accounting
Policies to the Consolidated Financial Statements included in Part
II, Item 8 in this Form 10-K.
Valuation of Losses and Loss Expense Reserves:
The loss and loss expense reserves ("loss reserves") discussed in
this section relate only to Ambac’s non-derivative financial
guarantee business for insurance policies issued to beneficiaries,
including unconsolidated VIEs. Ambac's loss reserves include loss
reserve components of an insurance policy, including unpaid
claims and the present value ("PV") of expected net cash flows
required to be paid under an insurance contract. Unpaid claims,
which include accrued interest, represent claims that have not yet
been paid for policies allocated to the Segregated Account. The
PV of expected net cash flows represents the PV of expected cash
outflows less the PV of expected cash inflows discounted at a risk-
free discount rate. While unpaid claims are known and therefore
not a subjective estimate, expected future losses, net of expected
future recoveries, are inherently uncertain. As such, the remaining
discussion is limited to addressing expected future losses, net of
expected future recoveries.
The evaluation process for expected future losses is subject to
certain estimates and judgments regarding the probability of
default by the issuer of the insured security, probability of
remediation and settlement outcomes (which may include
commutation, litigation settlements, refinancings and/or other
settlement outcomes), probability of a restructuring outcome
(which may include payment moratoriums, debt haircuts and/or
subsequent recoveries) and the expected loss severity of credits for
each insurance contract.
As the probability of default for an individual credit increases and/
or the severity of loss given a default increases, our loss reserve
| Ambac Financial Group, Inc. 38 2016 FORM 10-K |
for that insured obligation will also increase. Political, economic,
credit or other unforeseen events could have an adverse impact on
default probabilities and loss severities. The loss reserves for many
transactions are derived from the issuer’s creditworthiness. For
public finance issuers, loss reserves will consider not only
creditworthiness but also political dynamics and economic status
and prospects. The loss reserves for other transactions which have
no direct issuer support, such as most structured finance exposures,
including RMBS and student loan exposures, are derived from the
default activity and loss given default of underlying collateral
supporting the transactions. In addition, many transactions have a
combination of issuer/entity and collateral support. Loss reserves
reflect our assessment of the transaction’s overall structure, support
and expected performance. Loss reserve volatility will be a direct
result of the credit performance of our insured portfolio, including
the number, size, bond types and quality of credits included in our
loss reserves as well as our ability to execute workout strategies
and commutations. The number and severity of credits included in
our loss reserves depend to a large extent on transaction specific
attributes, but will generally increase during periods of economic
stress and decline during periods of economic prosperity.
Reinsurance contracts mitigate our loss reserve. Since Ambac has
little exposure ceded to reinsurers, it is unlikely to have a significant
effect on loss reserve volatility. Loss reserve volatility will also be
materially impacted by changes in interest rate projections from
period to period.
The table below indicates the gross par outstanding and gross loss
reserves (including loss expenses) related to policies in Ambac’s
loss and loss expense reserves at December 31, 2016 and 2015:
($ in millions) December 31
RMBS
Domestic Public Finance
Student Loans
Ambac UK
All other credits
Loss expenses
Totals
2016
2015
Gross par
outstanding(1)
Gross Loss and
Loss Expense
Reserves(1)(2)(3)(4)
Gross par
outstanding(1)
Gross Loss and
Loss Expense
Reserves(1)(2)(3)(4)
$
$
6,756
$
4,410
728
939
567
—
2,394
$
8,067
$
1,401
547
279
388
13
75
5,246
1,207
943
513
—
470
486
420
9
73
13,400
$
3,696
$
15,976
$
2,859
(1) Ceded par outstanding on policies with loss reserves and ceded loss and loss expense reserves are $607 and $31, respectively, at December 31, 2016 and
$847 and $44, respectively at December 31, 2015. Ceded loss and loss expense reserves are included in Reinsurance recoverable on paid and unpaid
losses.
(2) Loss and Loss Expense reserves at December 31, 2016 of $3,696 are included in the balance sheet in the following line items: Loss and loss expense
reserves: $4,381 and Subrogation recoverable: $685. Loss and Loss Expense reserves at December 31, 2015 of $2,859 are included in the balance sheet
in the following line items: Loss and loss expense reserves: $4,088 and Subrogation recoverable: $1,229.
(3)
Included in Gross Loss and Loss Expense Reserves are unpaid claims of $3,656 and $3,459 at December 31, 2016 and 2015, respectively, related to
policies allocated to the Segregated Account, inclusive of accrued interest payable on Deferred Amounts of $662 and $491, respectively.
(4) Ambac records as a component of its loss and loss expense reserves, estimated recoveries related to securitized loans in RMBS transactions that breached
certain representations and warranties. Ambac has recorded gross estimated recoveries of $1,907 and $2,830 at December 31, 2016 and 2015, respectively.
See Note 2. Basis of Presentation and Significant Accounting
Policies for a description of the cash flow and statistical
methodologies used to develop loss reserves. Most of our reserved
credits with large loss reserves utilize the cash flow method of
reserving. Alternative cash flow scenarios are developed to
represent the range of possible outcomes and resultant future
claims payments and timing. Scenarios and probabilities are
adjusted regularly to reflect changes in status, outlook and our
analysis and views. Significant judgment is used to develop the
cash flow assumptions, and there can be no certainty that the
modeled scenarios or probabilities will not deviate materially from
ultimate outcomes.
In some cases, such as RMBS and student loans, which are
described more fully below, cash flow projections include the
modeling of an issuer or transaction’s future revenues and expenses
to determine the resources available to pay debt service on our
insured obligations. In other cases, such as many public finance
exposures including our Puerto Rico exposures, we do not
specifically forecast resources available to pay debt service in the
cash flow model itself. Rather, we consider the issuers’ overall
ability and willingness to pay, including the fiscal, economic, legal
and political framework. We then develop multiple scenarios
where issuer debt service is paid, missed and/or haircut with claims
paid then modeled for any recovery amount and timing. In our
experience, this has been an effective approach to loss reserving
these types of credits, but there is no certainty our assumptions as
to scenarios or probabilities will not be subject to material changes
as developments occur or that this method will be as effective in
the future as it has been in the past.
In estimating loss reserves, we also incorporate scenarios which
represent remediation strategies. Remediation scenarios may
include the following; (i) a potential refinancing of the transaction
by the issuer; (ii) the issuer’s ability to redeem outstanding
securities at a discount, thereby increasing the structure’s ability
to absorb future losses; and (iii) our ability to terminate or
restructure the policy in whole or in part (e.g., commutation). The
remediation scenarios and the related probabilities of occurrence
vary by policy depending on on-going and expected discussions
and negotiations that are underway with issuers and/or investors.
In addition to commutation negotiations that are underway with
various counterparties in various forms, our reserve estimates may
also include scenarios which incorporate our ability and/or
| Ambac Financial Group, Inc. 39 2016 FORM 10-K |
expectation
counterparties.
to commute additional exposure with other
model assumptions, improvements to modeling capabilities and
approaches and other factors.
RMBS Expected Loss Estimate
Second-Lien Model:
Ambac insures RMBS transactions collateralized by first-lien
mortgages. Ambac classifies its insured first-lien RMBS exposure
principally into two broad credit risk classes: mid-prime (including
Alt-A, interest only, and negative amortization) and sub-prime.
Mid-prime loans were typically made to borrowers who had credit
profiles stronger than sub-prime loans, but weaker than prime
loans. Compared with mid-prime loans, sub-prime loans typically
had higher loan-to-value ratios, reflecting the greater difficulty that
sub-prime borrowers have in making down payments and the
propensity of these borrowers to extract equity during refinancing.
Ambac has also insured RMBS transactions collateralized
predominantly by second-lien mortgage loans such as closed-end
seconds and home equity lines of credit. A second-lien mortgage
loan is a type of loan in which the borrower uses the equity in their
home as collateral and the second-lien loan is subordinate to the
first-lien loan outstanding on the home. Borrowers are obligated
to make monthly payments on both their first and second-lien loans.
If the borrower defaults on the payments due under these loans and
the property is subsequently liquidated, the liquidation proceeds
are first utilized to pay off the first-lien loan (as well as other costs)
and any remaining funds are applied to pay off the second-lien
loan. As a result of this subordinate position to the first-lien loan,
second-lien loans carry a significantly higher severity in the event
of a loss, approaching or exceeding 100%.
Ambac primarily utilizes a statistically based cash flow model
(“RMBS cash flow model”) to develop estimates of projected
losses for both our first and second lien transactions. The RMBS
cash flow model projects collateral performance utilizing: (i) the
loans' characteristics and status,
transaction’s underlying
(ii) projected home price appreciation (“HPA”) and (iii) projected
interest rates. We source HPA projections from a market accepted
vendor and interest rate projections are developed from market
sources. We generally utilize waterfall projections from a market
accepted vendor which models securitization deal structures. In
some cases, we may utilize an alternative waterfall structure when
our legal and commercial analysis of the transaction’s payment
structure differs from the vendor’s waterfall structure.
We compare monthly claims submitted against the trustees’
reports,
third-party provided waterfall models and our
understanding of the transactions’ structures to identify and resolve
discrepancies. We also systematically review the vendor’s
published waterfall revisions
identify material
discrepancies. Resolving discrepancies is challenging and may
take place over an extended period of time. Moreover, transaction
documents are subject to interpretation, and our interpretation or
that of the vendor and as reflected in our loss reserves may prove
to be incorrect and/or not consistent with trustees directing cash
flows in the future.
to further
In our experience, market performance and model characteristics
change and are updated through time and a regular review of
current models, alternative models and the overall approach to loss
estimation is beneficial. The RMBS cash flow model is subject to
ongoing refinements and/or replacement resulting from industry
research as well as performance analysis that may better inform
The RMBS cash flow model estimates mortgage loan collateral
performance, the effect of such collateral cash flows within the
transaction waterfall and the liability structure we insure.
Collateral performance is frequently modeled at the deal level
given the paucity of mortgage loan level data for second-lien
transactions. In the absence of specific loan-level information, the
deal-level approach evaluates a loan pool as if it were a single loan,
selecting certain aggregated deal-level characteristics to then
perform a series of statistical analyses. We use three HPA
projection scenarios to develop a base case as well as stress and
upside cases. The highest probability is assigned to the base case,
with lower probabilities to the stress and upside cases. This deal-
level approach takes relatively complicated monthly collateral
performance and divides it into two parts: a borrower-behavior-
dependent stage and a servicer-behavior-dependent stage.
The borrower-behavior-dependent stage is designed to forecast the
probability of a loan’s present delinquency status transitioning to
any of eight future statuses. The deal-level approach projects
performance using a roll-rate that evaluates the possible future state
of a loan based on its current status and three variables: average
FICO (credit score), average current consolidated loan to value
ratio (“CLTV”) and an overall quality indicator. The servicer-
behavior-dependent stage governs a loan’s life cycle after it reaches
180 or more days delinquent. This stage evaluates the servicer’s
propensity to foreclose or pursue a short sale, the speed of the
foreclosure process, and the speed of the post-foreclosure
distressed property liquidation. The transition probabilities
between stages are assumed by the model to depend upon how
long a loan has already been in a particular status, as well as on
the servicer-specific and state-specific liquidation timeline factors.
First-Lien Model:
For most first-lien transactions, the RMBS cash flow model utilizes
mortgage loan level data from recognized market sources to
calculate probability of default and prepayment based on loan
characteristics. The loan-level approach of the RMBS cash flow
model uses results of a regression analysis to project prepayment
and default vectors on a monthly basis. For first-lien transactions
that do not have loan-level data available, we use the deal-level
approach of the model that is described in the Second-Lien section
above.
There are three general stages with the loan-level approach of the
model: current, prepayment or default. The model then looks
beyond the stages to assess a set of loans based on a number of
individual characteristics that are distinct to that set of loans. The
model will project performance based on the borrower’s given
probability of transitioning that month. Servicer behavior is a
variable in the loan-level approach; computing the impact of
servicing on the associated collateral. Consistent with the second-
lien modeling, we consider three HPA scenarios in the RMBS cash
flow model to develop a base case as well as stress and upside
cases. The highest probability is assigned to the base case, with
lower probabilities to the stress and upside cases.
| Ambac Financial Group, Inc. 40 2016 FORM 10-K |
Other RMBS Factors:
Additional factors that may impact ultimate RMBS second-lien
and first-lien losses include, but may not be limited to, mortgage
insurance, servicer intervention and third-party settlements.
Mortgage insurance: Five of our mortgage-backed transactions
have pool-level mortgage insurance remaining. Pool mortgage
insurance is a master policy issued to the mortgage securitization
trust, which indemnifies the trust either on a first loss or mezzanine
basis in the event that covered mortgage loans in the trust default.
The mortgage insurance master policy includes various conditions
such as exclusions, conditions for notification of loans in default
and claims settlement. We have noted with regard to these
transactions that payment by mortgage insurers of claims presented
by the mortgage trusts has been inconsistent, resulting in higher
claims presented under Ambac Assurance’s financial guarantee
policies. Additionally, much of the mortgage insurance coverage
has been exhausted. As a result, the benefit of mortgage insurance
on our loss reserve estimate is negligible.
Servicer Intervention: We include in our modeling the steps which
Ambac is taking to address shortcomings in servicing performance.
Ambac has initiated programs with selected servicers that we
believe will mitigate losses on such transactions through
intervention strategies such as loan modifications, improved
liquidation timelines and short sales. Ambac believes these are the
principal controllable factors that will result in reduced losses over
time. Given the uncertainty in initiating additional programs of this
nature, we give credit in our models only on exposures that have
already transferred servicing or entered into special servicing
agreements.
Third party settlements: To the extent that we are aware of
settlements between issuers and investors or trustees which may
provide for recoveries within certain insured RMBS trusts, we have
incorporated in our modeling of collateral losses our estimate of
the probable amount and timing of these settlements. As of
December 31, 2016, we are not aware of any undistributed
settlements between issuers and investors or trustees which may
provide for future recoveries within our insured RMBS trusts.
Expected Representation and Warranty Subrogation Recoveries
Ambac records as a component of its loss reserve estimate,
subrogation recoveries related to securitized loans in RMBS
transactions that breached certain representations and warranties
("R&W") described herein. Generally, the sponsor of an RMBS
transaction provided representations and warranties with respect
to the securitized loans, including representations with respect to
the loan characteristics, the absence of borrower fraud in the
underlying loan pools or other misconduct in the origination
process and attesting to the compliance of loans with the prevailing
underwriting policies. In such cases, the sponsor of the transaction
is contractually obligated to repurchase, cure or substitute
collateral for any loan that breaches the representations or
warranties
The RMBS R&W subrogation recovery estimate is subject to
significant uncertainty, including risks inherent in litigation,
collectability of such amounts from counterparties and/or their
respective parents and affiliates, timing of receipt of any such
recoveries, intervention by OCI which could impede our ability to
take actions required to realize such recoveries and uncertainties
inherent in the assumptions used in estimating such recoveries.
Refer to Note 2. Basis of Presentation and Significant Accounting
Policies and Note 7. Financial Guarantee Insurance Contracts to
the Consolidated Financial Statements included in Part II, Item 8
in this Form 10-K for more information regarding the estimation
process for representation and warranty subrogation recoveries.
Student Loan Expected Loss Estimate
The significant majority of our student loan portfolio consists of
credits collateralized by private student loans, with a small portion
collateralized by federally guaranteed loans under the Federal
Family Education Loan Program (“FFELP”).
The calculation of loss reserves for our student loan portfolio
involves evaluating numerous factors that can impact ultimate
losses. The factor which contributes the greatest degree of
uncertainty in ascertaining appropriate loss reserves is the long
final legal maturity date of the insured bonds. Most of the student
loan bonds which we insure were issued with original terms of 20
to 40 years until final maturity. Since our policy covers timely
interest and ultimate principal payment, our loss projections must
make assumptions for many factors covering a long time horizon.
Key assumptions that will impact ultimate losses include, but are
not limited to, the following: collateral performance (which is
highly correlated to the economic environment), interest rates,
operating risks associated with
issuer, servicers and
administrators, investor appetite for tendering or commuting
insured obligations and, as applicable, Ambac’s ability and
willingness to commute policies.
the
In evaluating our student loan portfolio, our losses are projected
using a cash flow approach. In order to project collateral
performance under the cash flow approach, we use an internally
developed default projection tool that constructs lifetime cohort
default curves based on loan and deal-level historical performance
data. To determine ultimate losses on the transactions, the cohort
default curves are used to extrapolate future default behavior.
Additionally, a regression-based model is used to estimate
recoveries on defaulted loans. This regression-based recovery
forecast is grounded in deal-level performance data. Losses for a
portion of deals are forecast using internal loss estimations to
project transaction-level assumptions such as defaults, recoveries
and prepayments based on analysis of historical experience
adjusted for current economic conditions and changes to collateral
composition since origination. In both approaches where collateral
performance is projected, the transaction losses are incorporated
into a third party waterfall model to develop loss estimates for our
exposures. This waterfall model allows us to capture the impact of
each transaction’s specific structure (e.g., the waterfall priority of
payments, triggers, redemption priority) to generate our specific
projected claims profile in various base, upside and downside
scenarios.
We develop and assign probabilities to multiple cash flow scenarios
based on each transaction’s unique characteristics. Probabilities
assigned are based on available data related to the credit,
information from contact with the issuer (if applicable), and any
economic or market information that may impact the outcomes of
the various scenarios being evaluated. Our base case usually
projects deal performance out to maturity using expected loss
assumptions. As appropriate, we also develop other cases that
incorporate various upside and downside scenarios that may
include changes to defaults and recoveries.
| Ambac Financial Group, Inc. 41 2016 FORM 10-K |
Variability of Expected Losses and Recoveries
Ambac’s management believes that the estimated future loss
component of loss reserves are adequate to cover future claims
presented, but there can be no assurance that the ultimate liability
will not be higher than such estimates.
It is possible that our estimated future loss assumptions for
insurance policies discussed above could be understated. We have
attempted to identify reasonably possible cash flows using more
stressful assumptions than the probability-weighted outcome
recorded. The reasonably possible net cash flows consider the
highest stress scenario that was utilized in the development of our
probability-weighted expected loss at December 31, 2016 and
assumes an inability to execute any commutation transactions with
issuers and/or investors. Such stress scenarios are developed based
on management’s view about all possible outcomes. In arriving
at such view, management makes considerable judgments about
the possibility of various future events. Although we do not believe
it is reasonably possible to have worst case outcomes in all cases,
it is reasonably possible we could have worst case outcomes in
some or even many cases.
RMBS Variability:
Changes to assumptions that could make our reserves under-
estimated include an increase in interest rates, deterioration in
housing prices, poor servicing, the effect of a weakened economy
characterized by growing unemployment and wage pressures, and/
or illiquidity of the mortgage market. We utilize a complex model
to project losses in our RMBS exposures and changes to reserves,
either upward or downward are not unlikely if we used a different
model or methodology to project losses. We regularly assess
models and methodologies and may change our approaches and/
or model. Additionally, our R&W actual subrogation recoveries
could be significantly lower than our estimate of $1,907 million
as of December 31, 2016 if the sponsors of these transactions:
(i) fail to honor their obligations to repurchase the mortgage loans,
(ii) successfully dispute our breach findings, (iii) no longer have
the financial means to fully satisfy their obligations under the
transaction documents, or (iv) our pursuit of recoveries is otherwise
unsuccessful.
In the case of both first and second-lien exposures, the reasonably
possible stress case assumes a lower housing price appreciation
projection, which in turn drives higher defaults and severities.
Using this approach, the reasonably possible increase in loss
reserves for RMBS credits for which we have an estimate of
expected loss at December 31, 2016 could be approximately $78
million. Combined with the absence of any R&W subrogation
recoveries, a possible increase in loss reserves for RMBS could be
approximately $1,985 million.
Public Finance Variability:
It is possible our loss reserves for public finance credits may be
under-estimated if issuers are faced with prolonged exposure to
adverse political, economic, fiscal or socioeconomic events or
trends.
Our experience with the city of Detroit in its bankruptcy proceeding
was not favorable and renders future outcomes with other public
finance issuers even more difficult to predict and may increase the
risk that we may suffer losses that could be sizable. We agreed to
settlements regarding our insured Detroit general obligation bonds
that provide better treatment of our exposures than the city planned
to include in its plan, but nevertheless required us to incur a loss
for a significant portion of our exposure. An additional troubling
precedent in the Detroit case, as well as other municipal
bankruptcies, is the preferential treatment of certain creditor
classes, especially the public pensions. The cost of pensions and
the need to address frequently sizable unfunded or underfunded
pensions is often a key driver of stress for many municipalities and
their related authorities, including entities to whom we have
significant exposure, such as Chicago, its school district, the State
of New Jersey and many others. Less severe treatment of pension
obligations in bankruptcy may lead to worse outcomes for
traditional debt creditors. In addition, cities may be more inclined
to use bankruptcy to resolve their financial stresses if they believe
preferred outcomes for various creditor groups can be achieved.
We currently consider high severity outcomes to be outlying and
therefore generally assign low or remote probabilities to such
outcomes in our current loss reserves unless the situation develops
adversely. We expect municipal bankruptcies and defaults to
continue to be challenging to project given the unique political,
governance and policy differences among municipalities as well
as the complexity, long duration and relative infrequency of the
cases themselves in forums with a scarcity of legal precedent.
Another potentially adverse development that could cause the loss
reserves on our public finance credits to be underestimated is
deterioration in the municipal bond market that deprives issuers
of access to funding necessary to avoid defaulting on their
obligations. While our loss reserves consider our judgment
regarding issuers’ financial flexibility to adapt to adverse markets,
they may not adequately capture sudden, unexpected or protracted
market volatility that adversely affects market conditions.
Our exposures to the Commonwealth of Puerto Rico are under
stress arising from the Commonwealth’s poor financial condition,
weak economy and loss of capital markets access. The
Commonwealth has indicated it cannot afford to pay its debts and
has announced plans to improve its financial position and prospects
including the restructuring of debt obligations.
Since April 2016, the Commonwealth has been subject to an
emergency moratorium, known as "Law 21", on debt payments
of the Commonwealth and its instrumentalities. Beginning in April
2016, and culminating on June 30, 2016, former Governor Padilla
issued additional executive orders under Law 21 declaring states
of emergency at HTA, PRIFA, PRCCDA, and other Puerto Rico
instrumentalities through January 31, 2017, and suspending
payment obligations on bonds issued by those entities, including
the
insured by Ambac Assurance. Subsequent
bonds
implementation of the moratorium, the Commonwealth defaulted
on approximately $0.9 billion out of $2.0 billion of debt service
due on July 1, 2016, including certain Puerto Rico bonds insured
by Ambac Assurance. On January 29, 2017, current Governor
Rosello signed the Financial Emergency and Fiscal Responsibility
Act, which extends the emergency moratorium period until May
1, 2017, with an option to extend another three months until August
1, 2017.
to
In June 2016, the United States enacted the Puerto Rico Oversight,
Management, and Economic Stability Act ("PROMESA"), which
provides for, among other things, a framework for consensually
negotiated modifications of Puerto Rico obligations ("Title VI
| Ambac Financial Group, Inc. 42 2016 FORM 10-K |
Creditor Collective Action") and, if this and other measures do not
succeed, non-consensual debt adjustments ("Title III Adjustments
of Debt") . In addition, while PROMESA provides that laws such
as Law 21 are not binding on any non-consenting creditor to the
extent they prohibit the payment of principal and interest, the
practical effect of this provision is unknown and Ambac is at risk
to the ongoing execution, interpretation and ultimate enforcement
of this provision. PROMESA also provides for a temporary stay
on litigation, which may delay any judicial determination
regarding the application of this provision. The litigation stay,
which was set to expire on February 15, 2017, has been extended
now to May 1, 2017.
As a result of the distressed situation in Puerto Rico coupled with
the aforementioned payment moratorium on debt payments of the
Commonwealth and certain provisions under PROMESA, the
potential for a restructuring of debt insured by Ambac Assurance,
either with or without our consent, and the possibility of protracted
litigation as a result of which our rights may be materially impaired,
losses may exceed current reserves in a material manner. The
possible outcomes could shift quickly and materially in an adverse
manner as this volatile situation continues to develop.
For public finance credits, including Puerto Rico as well as other
issuers, for which we have an estimate of expected loss at
December 31, 2016, the reasonably possible increase in loss
reserves could be approximately $1,143 million.
Student Loan Variability:
Changes to assumptions that could make our reserves under-
estimated include, but are not limited to, increases in interest rates,
default rates and loss severities on the collateral due to economic
or other factors. For student loan credits for which we have an
estimate of expected loss at December 31, 2016, the reasonably
possible increase in loss reserves could be approximately $175
million.
Other Credits, including Ambac UK, Variability:
It is possible our loss reserves on other types of credits, including
those insured by Ambac UK, may be under-estimated because of
various risks that vary widely, including the risk that we may not
be able to recover or mitigate losses through our remediation
processes such as litigation, depending upon the nature of the
exposure. For all other credits, including Ambac UK, for which
we have an expected loss, the sum of all the highest stress case loss
scenarios is $376 million greater than the current loss reserve at
December 31, 2016.
Valuation of Financial Instruments:
instruments
that are reported on
Ambac’s financial
the
Consolidated Balance Sheets at fair value and subject to valuation
estimates include investments in fixed income securities, equity
interests in pooled investment funds, VIE loan assets, VIE long-
term debt and derivative instruments.
The Fair Value Measurement Topic of the ASC requires reporting
entities to maximize the use of observable inputs and minimize the
use of unobservable inputs when measuring fair value. This Topic
also requires financial instruments be classified within a three-
level fair value hierarchy. The fair value hierarchy, the financial
instruments classified within each level, our valuation methods,
inputs, assumptions and the review and validation procedures
over quoted and modeled pricing are further detailed in Note 9.
Fair Value Measurements
the Consolidated Financial
to
Statements included in Part II, Item 8 in this Form 10-K.
The level of judgment in estimating fair value is largely dependent
on the amount of observable market information available to fair
value a financial instrument, which is also determinative of where
the financial instrument is classified in the fair value hierarchy.
Instruments valued using models which use one or more significant
inputs or value drivers that are unobservable and are therefore
classified as Level 3 of the fair value hierarchy, require greater
judgment than for those instruments classified as Level 1 and 2.
Level 3 financial instruments reported on the Consolidated Balance
Sheets at fair value include, but are not limited to, credit
derivatives, certain interest rate swaps, investments in certain
Ambac-insured fixed income securities, and certain VIE assets and
financial
liabilities. Model-derived valuations of certain
instruments incorporate estimates of the effects of Ambac's own
credit risk and/or counterparty credit risk, which can be complex
and judgmental. In addition, internal valuation models for certain
highly structured instruments, such as credit default swaps, require
assumptions about markets in which there has been a negligible
amount of trading activity for several years.
As a result of these factors, the actual trade value of a financial
instrument in the market, or exit value of a financial instrument
owned by Ambac, may be significantly different from its recorded
fair value.
Impairment Evaluation of Fixed Income Securities
In addition to valuation estimates described above, another
estimate requiring significant judgment relates to the evaluation
for other-than-temporary impairments ("OTTI") for fixed income
securities (excluding VIE investments) classified as “available-
for-sale”. Securities which have experienced declines in fair value
below Ambac's amortized cost must be evaluated for OTTI. An
OTTI charge is recognized if management assesses it either (i) has
the intent to sell the security or (ii) more likely than not will be
required to sell the security before the anticipated recovery of its
amortized cost basis less any current period credit loss. This
impairment assessment also involves determining whether an
actual credit loss exists for the security.
The OTTI evaluation of securities is a quantitative and qualitative
process, which is subject to risks and uncertainties and is intended
to determine whether, and to what extent, declines in the fair value
of investments should be recognized in current period earnings.
The risks and uncertainties include changes in general economic
conditions, the issuer’s or guarantor’s financial condition and/or
future prospects, the impact of regulatory actions on the investment
portfolio, the performance of the underlying collateral, the effects
of changes in interest rates or credit spreads and the expected
recovery period. With respect to all Ambac insured securities
owned, future cash flows used to measure credit impairment
represents the sum of (i) the bond’s intrinsic cash flows and (ii) the
estimated Ambac Assurance or Ambac U.K. claim payments. For
Ambac-insured securities owned and guaranteed under policies
allocated to the Segregated Account ("Segregated Account
securities"), the estimate of Ambac Assurance claim payments
includes interest on Deferred Amounts. Ambac estimates the
timing of claim payment receipts on all Ambac-insured securities
owned, but the actual timing of such amounts for Segregated
Account securities are at the sole discretion of the Rehabilitator.
| Ambac Financial Group, Inc. 43 2016 FORM 10-K |
Further modifications to the Segregated Account Rehabilitation
Plan or to the rules and guidelines promulgated thereunder, orders
from the Rehabilitation Court or actions by the Rehabilitator with
respect to the form, amount and timing of satisfying permitted
policy claims, or making payments on Deferred Amounts or
surplus notes, may have a material effect on the fair value of
Segregated Account securities and future recognition of OTTI.
Refer to Note 1. Background and Business Description to the
Consolidated Financial Statements in Part II, Item 8 of this Form
10-K for information relating to the amended Segregated Account
Rehabilitation Plan.
There is also significant judgment in determining whether Ambac
intends to sell securities or will continue to have the ability to hold
temporarily impaired securities until recovery. Future events could
occur that were not reasonably foreseen at the time management
rendered its judgment on the Company’s intent to sell or ability to
hold securities until recovery. Examples of such events include,
but are not limited to, the deterioration in the issuer’s or guarantor’s
creditworthiness, a change
in regulatory requirements or
modifications to the Segregated Account Rehabilitation Plan or to
the rules and guidelines promulgated thereunder, orders from the
Rehabilitation Court or actions by the Rehabilitator with respect
to the form, amount and timing of satisfying permitted policy
claims, or making payments on Deferred Amounts or surplus notes.
If management’s judgment with respect to these factors changes,
Ambac may ultimately record a charge for OTTI in future periods.
Valuation of Deferred Tax Assets:
Our provision for taxes is based on our income, statutory tax rates
and tax planning opportunities available to us in the jurisdictions
in which we operate. Tax laws are complex and subject to different
interpretations by the taxpayer and respective governmental taxing
authorities. Significant judgment is required in determining our
tax expense and in evaluating our tax positions. We review our tax
positions quarterly and adjust the balances as new information
becomes available. Deferred tax assets arise because of temporary
differences between the financial reporting and tax bases of assets
and liabilities, as well as from net operating loss ("NOL") and tax
credit carry forwards. More specifically, deferred tax assets
represent a future tax benefit (or receivable) that results from losses
recorded under GAAP in a current period which are only deductible
for tax purposes in future periods and NOL carry forwards.
The NOL carryforward component of the deferred tax asset will
expire if not utilized within certain periods. Valuation allowances
are established to reduce deferred tax assets to an amount that
“more likely than not” will be realized. All available evidence, both
positive and negative, needs to be identified and considered in
making the determination with significant weight given to
evidence that can be objectively verified. The level of deferred
tax asset recognition is influenced by management’s assessment
of future expected taxable income, which depends on the existence
of sufficient taxable income of the appropriate character (ordinary
vs. capital) within the carry forward periods available under the
tax law. As a result of the risks and uncertainties associated with
future operating results, management believes it is more likely than
not that the Company will not generate sufficient taxable income
to recover the deferred tax asset and therefore has a full valuation
allowance. See Note 15. Income Taxes for additional information
on the Company's deferred income taxes.
($ in millions) Year Ended December 31,
2016
2015
2014
RESULTS OF OPERATIONS
Revenues:
Net premiums earned
Net investment income
Net other-than-temporary impairment losses
Net realized investment gains
Change in fair value of credit derivatives
Derivative product revenues
Other income
Income (loss) on variable interest entities
Expenses:
Losses and loss expenses (benefit)
Insurance intangible amortization
Operating expenses
Interest expense
Goodwill impairment
Provision for income taxes
Less: Net income attributable to the noncontrolling interest
$
197.3
$
312.6
$
313.4
(21.8)
39.3
20.1
(50.3)
17.4
(14.1)
(11.5)
174.6
113.7
124.3
—
30.7
(0.5)
266.3
(25.7)
53.5
41.7
(42.5)
7.2
31.6
(768.7)
169.6
102.7
116.5
514.5
17.4
(0.7)
Net income (attributable to common shareholders)
$
74.8
$
493.4
$
246.4
300.9
(25.8)
58.8
23.9
(181.1)
12.5
(32.2)
(545.6)
151.8
101.5
127.5
—
9.6
(0.4)
484.1
The following paragraphs describe the consolidated results of
operations of Ambac and subsidiaries for 2016, 2015 and 2014 and
its financial condition as of December 31, 2016 and 2015.
Net Premiums Earned. Net premiums earned primarily represent
the amortization into income of collected insurance premiums. Net
premiums earned for the year ended December 31, 2016 decreased
by $115.3 million or 36.9% as compared to net premiums earned
| Ambac Financial Group, Inc. 44 2016 FORM 10-K |
for the year ended December 31, 2015. Net premiums earned for
the year ended December 31, 2015 increased by $66.2 million or
26.9% as compared to net premiums earned for the year ended
December 31, 2014.
We present accelerated premiums, which result from calls and
other accelerations of insured obligations separate from normal net
premiums earned. When an insured bond has been retired, any
remaining unearned premium revenue ("UPR") is recognized at
that time to the extent the financial guarantee contract is legally
extinguished, causing accelerated premium
revenue. For
installment premium paying transactions, we offset the recognition
of any remaining UPR by the reduction of the related premium
receivable to zero (as it will not be collected as a result of the
retirement), which may cause negative accelerated premium
revenue. Included within accelerated premiums, were negative
accelerations of $7.6 million, $5.1 million, and $47.4 million, for
the years ended December 31, 2016, 2015 and 2014, respectively.
Normal net premiums earned are impacted by the following:
•
•
•
•
The runoff of the insured portfolio occurring through
transaction terminations, calls and scheduled maturities,
which had a negative impact.
in
Changes
the collectability of certain premium
receivables, primarily within Structured Finance. These
changes resulted in an increase in net premiums earned of
$0.8 million, $0.5 million and $2.2 million for the years
ended December 31, 2016, 2015 and 2014, respectively.
Pre-refundings of insured securities, primarily Public
Finance transactions. Since the maturity date of pre-
refunded securities is shortened (to a specified call date
from its previous legal maturity), normal net premiums
earned will increase over the remaining period of the
related policy.
The strengthening or weakening of the U.S. dollar relative
to the British Pound since Ambac's wholly-owned UK
subsidiary, Ambac UK, operates in the United Kingdom
and the British Pound is its functional currency.
Normal net premiums earned and accelerated premiums are
reconciled to total net premiums earned in the table below and are
included in the Financial Guarantee segment. The following table
provides a breakdown of net premiums earned by market:
($ in millions)
Year Ended December 31,
Public Finance
Structured Finance
International Finance
Total normal premiums
earned
Public Finance
Structured Finance
International Finance
Accelerated earnings
Total net premiums earned
2016
2015
2014
$
$
$
$
$
84.8
27.7
32.4
144.9
52.5
3.6
(3.7)
52.4
197.3
$
$
$
$
$
97.1
34.2
43.9
175.2
97.3
1.1
39.0
137.4
312.6
$
104.8
39.7
71.9
216.4
57.5
(4.9)
(22.6)
30.0
246.4
$
$
$
$
Net Investment Income. The following table provides details of
net investment income by segment for the periods presented:
($ in millions)
Year Ended December 31,
2016
2015
2014
Financial Guarantee
$
300.1
$
256.6
$
298.0
Financial Services
Corporate
0.8
12.5
0.6
9.1
1.1
1.8
Total net investment income
$
313.4
$
266.3
$
300.9
Included in Financial Guarantee net investment income are net
mark-to-market gains of $27.7 million, $12.6 million and $6.7
million in years ended 2016, 2015 and 2014, respectively, arising
from pooled fund investments that are classified as trading
securities with changes in market value recognized in earnings.
Ambac Assurance has invested in high-yield loan funds beginning
in 2015 as part of its overall portfolio allocation strategy. Ambac
UK's pooled fund investments consist of diversified asset classes
including equities, hedge funds, loans, CLOs and property.
Financial Guarantee net investment income increased $43.5
million for the year ended December 31, 2016 compared to 2015,
due to growth in the size of the portfolio and higher average returns.
The larger portfolio primarily resulted from the receipt of $995
million in January 2016 in connection with a representation and
warranty settlement with JP Morgan. Higher average portfolio
returns in 2016 reflect higher allocations to Ambac insured RMBS,
other securities guaranteed by Ambac Assurance or Ambac UK
and pooled funds. Net investment income from pooled funds in
2016 increased $15.0 million from the prior year, due primarily to
new investments in high-yield loan funds which performed well
during the year and stronger returns in equity markets and asset
backed strategies, partially offset by lower gains from property and
hedge funds.
The decrease in Financial Guarantee net investment income of
$41.4 million for the year ended December 31, 2015 compared to
2014 reflects a lower asset base, partially offset by a higher average
rate of return on the portfolio. The lower asset levels in 2015
resulted from sales and maturities of select securities to fund the
partial redemption of surplus notes in November 2014 and the
equalizing payment of Deferred Amounts of the Segregated
Account in December 2014. The higher average rate of return on
the portfolio in 2015 resulted from higher allocations to Ambac
insured securities, corporate bonds and, in the Ambac UK
portfolio, pooled funds consisting of diversified asset classes
including equities, loans, hedge funds and property. Ambac UK
pooled fund investments experienced higher overall returns in
2015 primarily as a result of improved hedge fund performance
and property value increases. The increase in income from higher
allocation to Ambac insured securities was partially offset by the
impact of positive performance on certain of these bonds in 2014
and the adverse impact of the amended Segregated Account
Rehabilitation Plan on projected cash flows. Refer to Note 1.
Background and Business Description to the Consolidated
Financial Statements, included in Part II, Item 8 in this Form 10-
K for further discussion of the partial surplus note redemptions of
Ambac Assurance and the Segregated Account and the equalizing
payments of Deferred Amounts.
Financial Services investment income increased in 2016 compared
to 2015 due to the impact of higher rates on floating rate securities.
| Ambac Financial Group, Inc. 45 2016 FORM 10-K |
The investment portfolio continues to decrease as investment
agreements runoff. The decrease in income in 2015 compared to
2014 reflects the smaller size of the portfolio.
Corporate investment income relates to Ambac’s investment
portfolio. Higher investment income for the year ended December
31, 2016 compared to 2015 resulted from a larger portfolio
allocation to Ambac Assurance insured RMBS and a larger asset
base as Ambac received tax tolling payments from Ambac
Assurance in April 2016. Investment income for the year ended
December 31, 2015 increased over 2014 as a result of the
investment of proceeds from Ambac's August 2014 sale of its
Segregated Account junior surplus note and the yield associated
with the related equity interest in unconsolidated subsidiaries.
Net Other-Than-Temporary Impairment Losses. Net other-than-
temporary impairment losses recorded in earnings include only
credit related impairment amounts on securities to the extent
management does not intend to sell and it is not more likely than
not that the Company will be required to sell before recovery of
the amortized cost basis. Non-credit related impairment amounts
are recorded in other comprehensive income. Alternatively, non-
credit related impairment is reported through earnings as part of
net other-than-temporary impairment losses if management
intends to sell securities or it is more likely than not that the
Company will be required to sell before recovery of amortized cost
less any current period credit impairment.
Ambac's other-than-temporary impairments for the years ended
December 31, 2016, 2015 and 2014 related to credit losses on
certain Ambac-wrapped securities stemming primarily from cash
flow timing and to the company’s intent to sell certain securities
($ in millions)
December 31, 2016
Net gains on securities sold or called
Foreign exchange gains
Total net realized gains
December 31, 2015
Net gains on securities sold or called
Foreign exchange gains
Total net realized gains
December 31, 2014
Net gains on securities sold or called
Foreign exchange gains
Total net realized gains
that were in an unrealized loss position as of the impairment
evaluation dates.
Since commencement of the Segregated Account Rehabilitation
Proceedings, changes in the estimated timing of claim payments
have resulted in adverse changes in projected cash flows on certain
impaired Ambac-wrapped securities. Ambac estimates the timing
of such claim payment receipts, but the actual timing of such
payments are at the sole discretion of the Rehabilitator. Further
modifications to the Segregated Account Rehabilitation Plan or to
the rules and guidelines promulgated thereunder, orders from the
Rehabilitation Court or actions by the Rehabilitator with respect
to the form, amount and timing of satisfying permitted policy
claims, or making payments on Deferred Amounts or surplus notes,
may have a material effect on the fair value of Ambac-wrapped
securities and future recognition of other-than-temporary
impairments. Refer to Note 1. Background and Business
Description to the Consolidated Financial Statements for
information relating
the amended Segregated Account
Rehabilitation Plan. Ambac’s assessment about whether a decline
in value is other-than-temporary reflects management’s current
judgment regarding facts and circumstances specific to a security
and the factors noted above, including Ambac's intention to sell
securities and ability to hold temporarily impaired securities until
recovery. If that judgment changes, Ambac may ultimately record
a charge for other-than-temporary impairment in future periods.
to
Net Realized Investment Gains. The following table provides a
breakdown of net realized gains, by business segment, for the
periods presented:
Financial
Guarantee
Financial
Services
Corporate
Total
$
$
$
$
$
$
9.1
30.2
39.3
47.6
5.8
53.4
53.3
5.2
58.5
$
$
$
$
$
$
— $
—
— $
0.1
—
0.1
0.3
—
0.3
$
$
$
$
— $
—
— $
— $
—
— $
— $
—
— $
9.1
30.2
39.3
47.7
5.8
53.5
53.6
5.2
58.8
Net gains during the year ended December 31, 2016 included
foreign exchange related gains of $22.7 million on short-term and
trading securities held by Ambac UK and denominated in non-
functional currencies (primarily US dollars and euros) and $8.3
million of realized currency gains related to available-for-sale
securities that were sold by Ambac UK during the year. Net gains
during year ended December 31, 2015 arose primarily from the
sale of Ambac insured student loan securities in connection with
a financial guarantee commutation transaction. Net gains during
the year ended December 31, 2014 arose primarily from the sale
of assets received pursuant to Ambac's remediation activities and
net gains on securities sold in connection with the reallocation of
the investment portfolio and to raise liquidity for the anticipated
payment of Deferred Amounts and surplus notes in the fourth
quarter of 2014.
Change in Fair Value of Credit Derivatives. The valuation of
credit derivative liabilities is impacted by the market’s view of
Ambac Assurance’s credit quality. We reflect Ambac’s own credit
quality in the fair value of such liabilities by including a credit
| Ambac Financial Group, Inc. 46 2016 FORM 10-K |
valuation adjustment (“CVA”) in the determination of fair value.
The gain from change in fair value of credit derivatives for the year
ended December 31, 2016 was $20.1 million, as compared to the
gain of $41.7 million for the year ended December 31, 2015. The
gain for 2016 reflects increased pricing levels and a stronger credit
assessment on an adversely classified credit in the portfolio,
partially offset by the impact of lower Ambac CVA discount rates.
The gain for 2015 was primarily due to the reversal of unrealized
losses on adversely classified student loan credit default swaps in
connection with termination of the contracts in addition to the
positive impacts of other portfolio runoff, currency exchange rates
and higher Ambac CVA discount rates. The net gain in 2014
resulted from gains from runoff and reference obligation price
improvements, partially offset by declining Ambac CVA discount
rates, especially in the first half of the year.
Realized gains and other settlements on credit derivative contracts
represent premiums received and accrued on such contracts.
Realized gains and other settlements were $0.9 million, $2.8
million and $3.0 million for 2016, 2015 and 2014, respectively.
The declines over time are due to reduced premium receipts
resulting from continued runoff of the credit derivative portfolio.
Included in realized gains and other settlements on credit
derivatives were fees received in connection with transaction
terminations of $0.0 million, $1.3 million and $0.5 million for the
years 2016, 2015 and 2014, respectively. There were no loss or
settlement payments in the periods presented. Unrealized gains
(losses) on credit derivative contract reflect the impact of all other
factors on the overall change in fair value of credit derivatives
noted above.
See Note 9. Fair Value Measurements to the Consolidated Financial
Statements included in Part II, Item 8 in this Form 10-K for a further
description of Ambac’s methodology for determining the fair value
of credit derivatives. The table below indicates the impact of
incorporating Ambac’s own credit risk into the fair value of credit
derivatives as of December 31, 2016 and 2015:
($ in millions) December 31,
2016
2015
Mark-to-market liability of credit
derivatives, excluding CVA
CVA on credit derivatives
$
Net credit derivative liability at fair value
$
17.2
(1.9)
15.3
$
$
44.6
(10.1)
34.5
Derivative Product Revenues. The derivative products portfolio
is positioned to benefit from rising rates as an economic hedge
against interest rate exposure throughout the Company, including
the financial guarantee portfolio. Results in derivative product
revenues reflect mark-to-market (losses) gains in the portfolio
caused by (declines) increases in forward interest rates during the
periods, the carrying cost of the net liability position of the
portfolio, and the impact of the Ambac CVA and counterparty
credit adjustments as discussed below. Net losses reported in
derivative product revenues for the year ended December 31, 2016
were $50.3 million, reflecting a decline of $7.8 million as compared
to the net losses of $42.5 million for the year ended December 31,
2015. The derivative product loss for 2016 was primarily driven
by the impact lower credit spreads that reduced the Ambac CVA
on derivative liabilities and the carrying cost of the portfolio.
Despite substantial interest rate movements within 2016, the
overall change in rates from the beginning to the end of the year
did not have a significant impact on full year results.
Net losses reported in the derivative product revenues for the year
ended December 31, 2015 were $42.5 million, an improvement of
$138.6 million as compared to net losses of $181.1 million for the
year ended December 31, 2014. Results for both periods reflect
mark-to-market losses caused by declines in forward interest rates,
net of the impact of the Ambac CVA as discussed below.
Additionally, counterparty credit valuation adjustments on certain
interest rate swap assets increased the overall mark-to-market
losses for the year ended December 31, 2015.
The fair value of derivative liabilities includes a valuation
adjustment to reflect Ambac’s own credit risk. Within the financial
services derivatives portfolio, an Ambac CVA is generally
applicable for uncollateralized derivative liabilities that may not
be offset by derivative assets under a master netting agreement.
Inclusion of an Ambac CVA in the valuation of financial services
derivatives resulted in gains (losses) within derivative products
revenues of $(33.8) million, $14.2 million and $16.1 million, for
the years ended December 31, 2016, 2015, and 2014, respectively.
The impact of changes to the CVA reflects the market’s view of
Ambac Assurance’s credit quality estimated based on relevant
market data points, as well as the amount of underlying liabilities,
which generally decline as interest rates increase. Market data
indicated that the market's view of Ambac Assurance's credit
quality generally improved in 2016, declined in 2015 and improved
in 2014. The table below indicates the impact of incorporating
Ambac’s own credit risk into the fair value of the derivative
products portfolio (excluding credit derivatives) as of December
31, 2016 and 2015:
($ in millions) December 31,
2016
2015
Derivative products mark-to-market liability,
excluding CVA
$
271.1
$
312.5
CVA on derivative products portfolio
(44.9)
(78.7)
Net derivative products portfolio liability
at fair value
$
226.2
$
233.8
Net Realized Gains (Losses) on Extinguishment of Debt. Net
realized gains on extinguishment of debt was $4.8 million for the
year ended December 31, 2016, compared to net gains (losses) of
$0.1 million and $(74.7) million for the years ended December 31,
2015 and 2014, respectively. The net gains for the year ended
December 31, 2016 included gains from the settlement of certain
residual obligations related to previously called surplus notes and
settlements of repurchased surplus notes below their carrying
values. The gains for the year ended December 31, 2015 included
gains from the settlement of certain residual obligations related to
previously called surplus notes, partially offset by losses from
settlement of an investment agreement above its carrying value
and the accelerated recognition of the unamortized discount on
surplus notes purchased during the year.
As described in Note 1. Background and Business Description to
the Consolidated Financial Statements included in Part II, Item 8
in this Form 10-K, the Rehabilitator redeemed certain Segregated
Account surplus notes (excluding junior surplus notes) on
November 20, 2014 at a redemption price that included an amount
equal to principal and accrued interest on such redeemed surplus
notes. Such redemption also triggered similar proportionate
redemption payments on Ambac Assurance's surplus notes. The
redemption of surplus notes resulted in a charge representing the
accelerated recognition of the unamortized discount on the
redeemed surplus notes, which amounted to $74.7 million.
| Ambac Financial Group, Inc. 47 2016 FORM 10-K |
Other Income. The table below summarizes other income.
($ in millions)
Year Ended December 31,
Foreign exchange gain/(loss)
Other
Total other income (loss)
2016
2015
2014
$
$
7.8
9.7
17.4
$
$
(2.0) $
(3.9)
9.2
7.2
$
16.4
12.5
Foreign exchange gains/(losses) are unrelated to investments or
loss reserves but include gains/(losses) relating to foreign currency
changes on present value of premium receivables denominated in
a subsidiary's non-functional currency, in addition to foreign
exchange gains/(losses) on cash. Other includes various financial
guarantee segment fees, primarily consent and waiver fees.
Additionally, in 2016, other includes insurance recoveries on a
partially cancelled asset-backed transaction which is consolidated
as a VIE, interest recoveries related to previously paid legal fees
related to a disputed premium receivable partially offset by a loss
mitigation payment on an international investor-owned utility
transaction which is consolidated as a VIE.
Income (loss) on Variable Interest Entities. Included within
Income (loss) on variable interest entities are income statement
amounts relating to VIEs consolidated under the Consolidation
Topic of the ASC as a result of Ambac's variable interest arising
from financial guarantees written by Ambac's subsidiaries,
including gains or losses attributable to consolidating or
deconsolidating such VIEs during the periods reported. Generally,
the Company’s consolidated VIEs are entities for which Ambac
has provided financial guarantees on its assets or liabilities. In
consolidation, most assets and liabilities of the VIEs are reported
at fair value and the related insurance assets and liabilities are
eliminated. However, the amount of VIE net assets (liabilities) that
remain in consolidation generally result from the net positive
(negative) present value of projected cash flows from (to) the VIEs
which are attributable to Ambac’s insurance subsidiaries in the
form of financial guarantee insurance premiums, fees and losses.
In the case of VIEs with net negative projected cash flows, the net
liability is generally to be funded by Ambac’s insurance
subsidiaries through insurance claim payments. Differences
between the net carrying value of the insurance accounts under the
Financial Services—Insurance Topic of the ASC and the carrying
value of the consolidated VIE’s net assets or liabilities are recorded
through income at the time of consolidation or deconsolidation.
The portion of Income (loss) on variable interest entities arising
from the impact of consolidating and deconsolidating VIEs was
$0.0 million, $0.6 million, and $0.0 million for the years ended
December 31, 2016, 2015 and 2014, respectively.
Income (loss) on variable interest entities was $(14.1) million,
$31.6 million and $(32.2) million for the years ended December
31, 2016, 2015 and 2014, respectively. Income (loss) on variable
interest entities for all three years reflected an increase (decrease)
in the fair value of net assets primarily due to the increase (decrease)
in the CVA applied to certain VIE note liabilities that include
significant projected financial guarantee claims. Other than those
transactions involving significant projected financial guarantee
claims, the fair value of VIE net assets increased producing net
gains in 2016, 2015 and 2014. Refer to Note 3. Special Purpose
Entities, Including Variable Interest Entities to the Consolidated
Financial Statements included in Part II, Item 8 in this Form 10-
K for further information on the accounting for VIEs.
Losses and Loss Expenses. Losses and loss expenses are based
upon estimates of the aggregate losses inherent in the non-
derivative financial guarantee portfolio for insurance policies
issued to beneficiaries, including unconsolidated VIEs. Losses
and loss expenses include interest on Deferred Amounts pursuant
to the amended Segregated Account Rehabilitation Plan, which
became effective June 12, 2014. The amendments to the
Segregated Account Rehabilitation Plan primarily modified the
mechanism for handling Segregated Account claims. Instead of
the combination of cash payments and interest-bearing surplus
notes originally contemplated by the Segregated Account
Rehabilitation Plan, holders of permitted policy claims have
received and will receive an initial interim cash payment for a
portion of such policy claim (“Interim Payment”), together with
the right to receive a deferred payment equal to the balance of the
unpaid policy claim (“Deferred Amount”). The amended
Segregated Account Rehabilitation Plan requires that Deferred
Amounts generally accrue and compound interest at an annual
effective rate of 5.1%. Losses and loss expenses for the year ended
December 31, 2014 include interest accruals from the beginning
of the accrual periods through December 31, 2014.
Ambac records as a component of its loss reserve estimate,
subrogation recoveries related to securitized loans in RMBS
transactions with respect to which Ambac Assurance is pursuing
claims for breaches of representations and warranties described
herein. Ambac does not include potential recoveries attributed
solely to fraudulent inducement claims in our litigations in our
estimate of subrogation recoveries. Generally, the sponsor of an
RMBS transaction provided representations and warranties with
respect to the securitized loans, including representations with
respect to the loan characteristics, the absence of borrower fraud
in the underlying loan pools or other misconduct in the origination
process and attesting to the compliance of loans with the prevailing
underwriting policies. Ambac has recorded RMBS subrogation
recoveries, net of reinsurance, of $1.9 billion and $2.8 billion at
December 31, 2016 and 2015, respectively. Refer to Note 2. Basis
of Presentation and Significant Accounting Policies to the
Consolidated Financial Statements included in Part II, Item 8 in
this Form 10-K for more information regarding the estimation
process for representation and warranty subrogation recoveries.
Losses and loss expenses (benefit) for the year ended December
31, 2016, 2015, and 2014 were $(11.5) million, $(768.7) million
and $(545.6) million, respectively.The following table provides
details, by bond type, for losses and loss expenses (benefit)
incurred for the periods presented:
($ in millions)
Year Ended December 31,
RMBS (1)
Domestic Public Finance
Student Loans
Ambac UK
All other credits
Interest on Deferred Amounts
Totals (2)
2016
2015
2014
$
(298.9) $
(721.1) $
(842.9)
169.0
(111.9)
56.7
2.8
170.8
141.8
(251.1)
(94.5)
(5.7)
161.9
67.5
(87.7)
(14.8)
(79.4)
411.7
$
(11.5) $
(768.7) $
(545.6)
(1) Ambac records the impact of estimated recoveries related to
securitized loans in RMBS transactions that breached certain
representations and warranties within loss and loss expenses
(benefit). The loss and loss expense (benefit) associated with changes
in estimated representation and warranties for the year ended
| Ambac Financial Group, Inc. 48 2016 FORM 10-K |
December 31, 2016, 2015, and 2014 was $(71.4), $(303.6), and
$(481.7), respectively.
(2) Includes loss expenses incurred of $51.9 million, $32.8 million and
$44.6 million for the year ended December 31, 2016, 2015, and 2014,
respectively.
Losses and loss expenses for 2016 were driven by the following:
continuous efforts and ongoing assessments of the value
of our claims;
•
Partially offset by $411.7 million of interest expense on
Deferred Amounts accrued from the beginning of the
accrual periods through December 31, 2014
•
•
Lower projected losses in the RMBS portfolio due to
improved deal performance, higher representation and
warranty subrogation recoveries and a second quarter
settlement of a non-representation and warranty dispute
with regards to an Ambac insured RMBS transaction;
The positive impact of executed commutations and an
improved outlook with regards to our risk remediation
efforts on student loan policies primarily associated with
student loan bonds acquired during the third quarter;
• Higher projected losses in domestic public finance for the
year ended December 31, 2016 largely driven by negative
development in Puerto Rico.
•
Increased projected losses in the Ambac UK portfolio for
the year ended December 31, 2016 primarily due to foreign
exchange losses of $77.6 million partially offset by lower
interest rates. The majority of Ambac UK's loss reserves
are denominated in currencies other than its functional
currency of British Pounds resulting in incurred losses
(gains) when the British Pound depreciates (appreciates).
Losses and loss expenses (benefit) for 2015 were driven by the
following:
•
•
Lower projected losses in the RMBS portfolio due to
improved deal performance, lower interest rates and
increases in our estimate of RMBS subrogation recoveries
as a result of continuous efforts and ongoing assessments
of the value of our claims;
The positive impact of executed commutations, an
improved outlook with regards to our risk remediation
efforts and lower interest rates on student loan policies;
• Higher projected losses in domestic public finance for the
year ended December 31, 2015 largely driven by negative
development in Puerto Rico.
• Decrease in projected losses for the year ended December
31, 2015 due to reduced claim expectations for an Ambac
UK transaction resulting from proactive remediation
efforts and lower interest rates, partially offset by foreign
exchange losses of $24.8 million. The majority of Ambac
UK's loss reserves are denominated in currencies other than
its functional currency of British Pounds resulting in
incurred losses (gains) when the British Pound depreciates
(appreciates).
Losses and loss expenses (benefit) for 2014 were driven by the
following:
•
Lower projected losses in the RMBS portfolio due to
improved deal performance and increases in our estimate
of RMBS subrogation recoveries as a result of
The following table provides details of net claims recorded, net of
reinsurance for the affected periods:
($ in millions)
Year Ended December 31,
Claims recorded (1)
Subrogation received (2)
Net Claims Recorded
2016
2015
2014
$
$
391.9
$
367.9
(1,355.4)
(308.4)
(963.5) $
59.5
$
$
463.7
(500.5)
(36.8)
(1) Claims recorded include (i) claims paid, including commutation
payments, and (ii) changes to claims presented and not yet presented
through the balance sheet date for policies which were allocated to
the Segregated Account. Item (ii) includes permitted policy claims
for policies allocated to the Segregated Account that were presented
and approved by the Rehabilitator of the Segregated Account, but not
paid through to the balance sheet date in accordance with the amended
Segregated Account Rehabilitation Plan and associated rules and
guidelines as discussed in Note 1. Background and Business
Description to the Consolidated Financial Statements included in
Part II, Item 8 in this Form 10-K. Amounts recorded for claims not
yet presented and/or permitted are based on management’s judgment.
Claims recorded exclude interest accrued on Deferred Amounts.
(2) Subrogation received for the year ended December 31, 2016 includes
$992.8 million ($995 million gross of reinsurance) received from the
settlement of representation and warranty related litigation with JP
Morgan and $99.1 million ($100.3 million gross of reinsurance)
related to the Countrywide Investor Settlement.
Operating Expenses. Operating expenses consist of gross
operating expenses plus reinsurance commissions. Reinsurance
commissions are included in Financial Guarantee segment results.
The following table provides details of operating expenses for the
periods presented:
($ in millions)
Year Ended December 31,
Gross operating expenses
Reinsurance commissions, net
Total operating expenses
2016
2015
2014
$
$
112.1
1.6
113.7
$
$
102.3
0.4
102.7
$
$
100.1
1.4
101.5
Gross operating expenses for the year ended December 31, 2016
are $112.1 million, an increase of $9.8 million from gross operating
expenses for the year ended December 31, 2015. The increase was
primarily due to the following:
• Higher compensation costs related to severance and post
employment costs, due to changes in CEO and reductions
in staff partially offset by reduced salary and bonus
expense.
• Higher non-compensation costs related to stockholder
activism, the establishment of $10 million of litigation
contingencies, higher audit fees, increased outside services
and higher regulatory costs. The increase in non-
compensation costs were partially offset by reductions in
premises costs and premium taxes. Costs associated with
stockholder activism amounted to $5.9 million and include
legal, consulting and outside services fees.
| Ambac Financial Group, Inc. 49 2016 FORM 10-K |
redemption of approximately 26% of surplus notes (other than
junior surplus notes) in November 2014. This decline is offset by
the impact of the July 2015 secured borrowing transaction
described above and a full year of interest recognized following
the sale of a junior surplus note originally issued to Ambac by the
Segregated Account to a third party trust in August 2014.
Subsequent to the sale, the junior surplus note is reflected as debt
on Ambac's balance sheet along with other surplus notes and junior
surplus notes held by third parties.
Surplus note principal and interest payments require the approval
of OCI. Annually from 2011 through 2016, OCI issued its
disapproval of the requests of Ambac Assurance and the
Rehabilitator of the Segregated Account, acting for and on behalf
of the Segregated Account, to pay interest on outstanding surplus
notes issued by Ambac and the Segregated Account on the annual
scheduled interest payment date of June 7th. If OCI approves
interest payments on surplus notes in the future, Ambac Assurance
will also be required to pay interest accrued on certain repurchased
surplus notes through the call option exercise dates. The amount
of such unpaid interest on repurchased surplus notes is $4.0 million
at December 31, 2016.
Neither Ambac Assurance nor the Rehabilitator of the Segregated
Account, acting for and on behalf of the Segregated Account, have
requested to pay interest on any junior surplus notes since their
issuance. The interest of the outstanding surplus notes and junior
surplus notes were accrued for and Ambac is accruing interest on
the interest amounts following each scheduled interest payment
date.
Total accrued interest for surplus notes and junior surplus notes
outstanding to third parties were $348.4 million and $78.0 million,
respectively, at December 31, 2016. Principal and interest
payments on junior surplus notes cannot be made until all Ambac
Assurance (General Account) and Segregated Account surplus
notes are paid in full and after all Segregated Account future and
existing senior indebtedness, policy and other priority claims have
been paid in full.
Provision for Income Taxes. The provision for income taxes for
the year ended December 31, 2016, 2015, and 2014 was $30.7
million, $17.4 million, and $9.6 million, respectively. The income
tax for all periods include (i) a provision for federal AMT taxes;
(ii) a provision for pre-tax profits in Ambac UK’s Italian branch,
which cannot be offset by losses in other jurisdictions. The income
tax for the year ended December 31, 2016 includes a provision for
income tax due in respect of Ambac UK where operating losses
brought forward from prior periods were fully utilized in the first
quarter of 2016, resulting in income tax now being payable.
At December 31, 2016 the Company had $4.0 billion of U.S.
Federal net ordinary operating loss carryforwards, including $1.4
billion at Ambac Financial Group and $2.6 billion at Ambac
Assurance.
Gross operating expenses for the year ended December 31, 2015
are $102.3 million, an increase of $2.2 million from gross operating
expenses for the year ended December 31, 2014. The increase was
primarily due to the following:
• Higher compensation costs related to long term incentive
compensation accruals, partially offset by lower salaries
and medical benefits.
• Higher non-compensation costs associated with the
investigation of a potential recapitalization of Ambac
Assurance and outside services fees partially offset by
lower directors' fees, premium taxes and subscriptions and
data access costs. Costs associated with the recapitalization
of Ambac Assurance amounted to $4.8 million, an increase
of $4.0 million from the year ended December 31, 2014.
Lower directors' fees are primarily related to a special
issuance of equity awards granted in December 2013 that
vested in April 2014.
As a consequence of the Segregated Account Rehabilitation
Proceedings, the Rehabilitator retains operational control and
decision-making authority with respect to all matters related to the
Segregated Account, including the hiring of advisers. Legal and
consulting services provided for the benefit of OCI amounted to
$6.4 million, $5.6 million and $6.5 million for the years ended
December 31, 2016, 2015 and 2014, respectively. The increase in
2016 compared to 2015 is driven by an increase in monthly
consulting adviser fees and higher legal fees as a result of a change
in legal advisers. The decrease in 2015 as compared to 2014 is
primarily driven by a reduction in monthly legal adviser fees.
Interest Expense. Interest expense includes accrued interest on
investment agreements, secured borrowing notes outstanding, and
surplus notes issued by Ambac Assurance and the Segregated
Account. Additionally, interest expense includes discount
accretion on surplus notes as their carrying value is at a discount
to par.
The following table provides details by type of obligation for the
periods presented:
($ in millions)
Year Ended December 31,
2016
2015
2014
Surplus notes
$
118.5
$
113.1
$
125.9
Investment agreements
Secured borrowing
0.6
5.2
0.9
2.5
1.6
—
Total interest expense
$
124.3
$
116.5
$
127.5
The increase in interest expense for the year ended December 31,
2016, compared to 2015 primarily results from the impact of
applying the level yield method as the discount to the face value
of surplus notes accretes over time. The year ended December
31, 2016 also includes a full year of interest on a floating rate note
issued on July 24, 2015 as part of a secured borrowing transaction
of Ambac Assurance. The note is secured by certain Ambac
Assurance-wrapped RMBS securities that were deposited in a
bankruptcy remote trust. The trusts used to effectuate this
transaction qualify as VIEs and are consolidated by Ambac.
The decrease in interest expense on surplus notes for the year ended
December 31, 2015, compared to 2014 primarily results from the
net reduction to the balance of outstanding notes from the
| Ambac Financial Group, Inc. 50 2016 FORM 10-K |
LIQUIDITY AND CAPITAL RESOURCES
Ambac Financial Group, Inc. Liquidity. Ambac’s liquidity is
primarily dependent on its cash and liquid investments of $212.1
million as of December 31, 2016 and expense sharing and other
arrangements with Ambac Assurance. Ambac also has investments
of $100.7 million in Ambac Assurance insured RMBS and surplus
notes issued by Ambac Assurance, which, while less liquid than
other investments, may be sold. Pursuant to the Mediation
Agreement, Amended TSA and Cost Allocation Agreement (as
each such term is defined in Note 1. Background and Business
Description to the Consolidated Financial Statements included in
Part II, Item 8 in this Form 10-K, the following are potential
additional sources of liquidity for Ambac:
limit until March 2017.
• According to the Cost Allocation Agreement, Ambac
Assurance is required to reimburse reasonable operating
expenses incurred by Ambac, subject to an annual $5.0
Future expense
million
reimbursements are at
the
rehabilitator subject to a $4.0 million per year limit. In
addition, Ambac Assurance and Ambac are required to
reimburse each other for certain operating costs and
expenses associated with
their respective business
operations in accordance with prescribed allocation
procedures outlined the the Cost Allocation Agreement.
the sole discretion of
• According to the Amended TSA, Ambac Assurance is
required, under certain circumstances, to make payments
to Ambac with respect to the utilization of net operating
loss carry-forwards (“NOLs”). Any expected receipts with
regard to the utilization of NOLs will only occur after
Ambac Assurance utilizes NOLs generated after
September 30, 2011. Ambac Assurance has utilized all of
those NOLs and as a result of taxable income at Ambac
Assurance in 2015, Ambac received $70.9 million in tax
tolling payments in April 2016 and $0.5 million in
November 2016. Additionally, based on Ambac
Assurance's 2016 results, Ambac is expected to receive
approximately $28.7 million in tax tolling payments by
May 2017 (subject to Rehabilitator review). Future taxable
income of Ambac Assurance will be subject to additional
payments under the Amended TSA, after certain credits;
provided that if Ambac Assurance generates NOLs in the
future, the Amended TSA would permit it to utilize such
NOLs without payment to Ambac.
On August 28, 2014, Ambac deposited $350.0 million face amount
of a junior surplus note issued to it by the Segregated Account,
plus accrued but unpaid interest thereon, into a statutory trust (the
"Trust") in exchange for net proceeds of $224.3 million and a
subordinated owner
(the “Owner Trust
trust certificate
Certificate”) issued by the Trust in the face amount of $74.8
million. Proceeds from the transaction are expected to be used to
fund select business transactions at Ambac offering attractive risk-
adjusted returns that, among other things, may permit utilization
of Ambac’s tax net operating loss carry-forwards, select Ambac
Assurance liability management activities and for general
corporate purposes. The Trust funded the cash portion of its
purchase of the junior surplus note with proceeds of the private
placement of $299.2 million face amount of senior secured notes
(the "Notes") to third party investors. The Notes have a final
maturity of August 28, 2039. Interest on the Notes accrues at 5.1%
per annum and compounds annually on June 7th of each year up
to and including the maturity date. Payments on the Notes will be
made when and to the extent that the Segregated Account makes
payments on the junior surplus note. The Notes must be paid in
full before any payments will be made on the Owner Trust
Certificate. The Notes and Owner Trust Certificate are non-
recourse to Ambac, Ambac Assurance and the Segregated Account,
but are collateralized by the junior surplus note. It is uncertain
whether and to what extent Ambac will realize value from the
Owner Trust Certificate.
It is highly unlikely that Ambac Assurance will be able to make
dividend payments to Ambac for the foreseeable future and
therefore current cash and investments and future payments under
the Cost Allocation Agreement and the Amended TSA will be
Ambac’s principal source of liquidity in the near term. Refer to
Part I, Item 1, “Insurance Regulatory Matters - Dividend
Restrictions, Including Contractual Restrictions” and Note 8.
Insurance Regulatory Restrictions to the Consolidated Financial
Statements included in Part II, Item 8, in this Form 10-K for more
information on dividend payment restrictions. The principal use
of liquidity is the payment of operating expenses, including costs
to explore select business transactions and occasional warrant
repurchases. Contingencies could cause material liquidity strains.
The following table includes aggregated information about
contractual obligations for Ambac and its subsidiaries, excluding
variable interest entities consolidated as a result of Ambac
Assurance’s financial guarantee contracts. These obligations
include payments due under specified contractual obligations,
aggregated by type of contractual obligation, including claim
payments, principal and
interest payments under Ambac
the Segregated Account’s surplus notes,
Assurance’s and
investment agreement obligations, and payments due under
operating leases. The table and commentary below reflect
scheduled payments and maturities based on the original payment
terms specified in the underlying agreements and contracts, or
expected required payment dates if earlier.
| Ambac Financial Group, Inc. 51 2016 FORM 10-K |
($ in millions)
Surplus note obligations(1)
Investment agreement obligations(2)
Operating lease obligations(3)
Purchase obligations(4)
Postretirement benefits(5)
Loss and loss expenses(6)
Income taxes
Total
Payments Due by Period
Total
Less Than 1 Year
1 - 3 Years
3 - 5 Years
$
1,941.2
$
379.3
$
92.0
$
1,469.9
$
82.6
37.2
6.6
3.9
7,860.8
14.3
82.6
7.0
3.2
0.3
4,042.3
14.3
—
12.7
3.0
0.6
434.7
—
—
3.5
0.4
0.7
286.4
—
$
9,946.6
$
4,529.0
$
543.0
$
1,760.9
$
More Than 5
Years
—
—
14.0
—
2.3
3,097.4
—
3,113.7
(1)
Includes principal of and interest on surplus notes (excluding junior surplus notes) when due. All payments of principal and interest on surplus notes are
subject to the prior approval of the OCI. If the OCI does not approve the payment of interest on the surplus notes, such interest will accrue and compound
annually until paid. Annually from 2011 through 2016, OCI disapproved scheduled interest payments. Amounts in the table assume future approval by
OCI for surplus notes (excluding junior surplus notes) for all principal and interest payments, including payment of previously deferred interest totaling
$317.4 million on the next scheduled payment date of June 7, 2017. Additionally, all principal and interest payments on junior surplus notes (excluding
part of the notes subject to periodically reduction as rent payments are made, as further described in Note 13. Long-term Debt to the Consolidated Financial
Statements included in Part II, Item 8 in this Form 10-K) assume to be paid at legal maturity in 2020.
(2)
Includes principal of and interest on obligations using current rates for floating rate obligations.
(3) Amount represents future lease payments on lease agreements existing as of December 31, 2016. Ambac Assurance's lease with One State Street Plaza
has a provision where Ambac Assurance can extend the lease of certain floors past the termination date of September 2019 to December 2029. The above
table does not reflect payments on those certain floors after the related lease expiry date of September 2019.
(4) Purchase obligations represent future expenditures for contractually scheduled fixed terms and amounts due for various technology-related maintenance
agreements and other outside services.
(5) Amount represents future payments relating to Ambac Assurance's postretirement medical reimbursement benefits for current retirees over the next 10
years.
(6) The timing of expected claim payments is based on deal specific cash flows, excluding expected recoveries. These deal specific cash flows are based on
the expected cash flows of the underlying transactions (e.g. for RMBS credits we model estimated future claim payments). The timing of expected claim
payments for credits with reserves that were established using our statistical loss reserve method is determined based on the weighted average expected
life of the exposure. Refer to the Loss Reserves section in Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial
Statements included in Part II, Item 8 in this Form 10-K for further discussion of our statistical loss reserve method. The timing of these payments may
vary significantly from the amounts shown above, especially for credits that are based on our statistical loss reserve method. As further described in Note
1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K, following the effective
date of the Segregated Account Rehabilitation Plan, as amended, the percentage of the initial cash Interim Payment for permitted policy claims increased
from 25% to 45% with effect from July 21, 2014. The Segregated Account will continue to make cash payments of 45% of each policy claim submitted
and permitted in accordance with the Segregated Account Rehabilitation Plan, as amended (plus, in certain cases, Supplemental Payments or Special
Policy Payments), subject to any further orders of the Rehabilitation Court or decisions of the Rehabilitator. As with previously permitted policy claims,
the remaining portion of the unpaid permitted policy claims (in this case, 55%) will remain outstanding as Deferred Amounts and, subject to the adjustment
for Undercollateralized Bonds, will accrue interest at 5.1% per annum. These Deferred Amounts, together with interest thereon, may be paid from time
to time in the future at the sole discretion of the Rehabilitator. Unpaid claims include deferred policy claims of $2,994.1 and accrued interest on Deferred
Amounts of $661.8 at December 31, 2016. We have included such unpaid amounts as obligations due in 2017. Additionally, all future claim payments
are included in their respective year at the estimated permitted claim amount.
Ambac Assurance Liquidity. Ambac Assurance’s liquidity is
dependent on the balance of liquid investments and, over time, the
net impact of sources and uses of funds. The principal sources of
Ambac Assurance’s liquidity are gross installment premiums on
insurance policies, principal and
interest payments from
investments, sales of investments, proceeds from repayment of
affiliate loans, recoveries on claim payments, litigation proceeds
and reinsurance recoveries. Termination of installment premium
policies on an accelerated basis may adversely impact Ambac
Assurance’s liquidity. The principal uses of Ambac Assurance’s
liquidity are the payment of operating expenses, claim and
commutation payments on both insurance and credit derivative
contracts, loss expenses, ceded reinsurance premiums, surplus note
principal and interest payments (including Junior Surplus Notes),
additional loans to affiliates and tax payments to Ambac, including
tolling payments due under the Amended TSA. Interest and
principal payments on surplus notes are subject to the approval of
OCI, which has full discretion over payments regardless of the
liquidity position of Ambac Assurance. The level of claims paid
by the Segregated Account is subject to the sole discretion of the
Rehabilitator, subject
the
Rehabilitation Court.
required approval of
to any
Ambac Assurance manages its liquidity risk (by currency) by
maintaining comprehensive analyses of projected cash flows and
maintaining specified level of cash and short-term investments at
all times.
As more fully described in Note 1. Background and Business
Description to the Consolidated Financial Statements included in
Part II, Item 8 in this Form 10-K:
•
the Rehabilitator has sought and received approval from
the Rehabilitation Court to make Supplemental Payments
and Special Policy Payments with respect to certain insured
securities. During the years ended December 31, 2016 and
2015,
the Segregated Account made Supplemental
Payments and Special Policy Payments of $84.3 million
| Ambac Financial Group, Inc. 52 2016 FORM 10-K |
•
•
and $96.9 million, respectively in respect of permitted
policy claims.
pursuant to the injunctions issued by the Rehabilitation
Court, claims on policies allocated to the Segregated
Account are not permitted to be paid during the Segregated
Account Rehabilitation Proceedings until approved by the
Rehabilitator. The Segregated Account is, and was,
obliged to make Interim Payments of 45% of each
permitted policy claim to be paid on or after July 21, 2014
in accordance with the amended Segregated Account
Rehabilitation Plan and associated rules and guidelines.
Under the Segregated Account Rehabilitation Plan the
unpaid balance of Deferred Amounts will accrue interest
until such outstanding policy obligations are paid in full.
Interest on the Deferred Amounts currently accrue at 5.1%,
is
compounded annually. The Segregated Account
responsible for Deferred Amounts and unpaid accrued
interest of $2,994.1 million and $661.8 million,
respectively at December 31, 2016. Permitted policy
claims, including Deferred Amounts together with interest
thereon, will be material uses of future liquidity.
the Segregated Account will establish Junior Deferred
Amounts in respect of general claims, instead of issuing
junior surplus notes as originally contemplated. Junior
Deferred Amounts will generally accrue and compound
interest at an annual effective rate of 5.1% and will be
payable, as and when determined by the Rehabilitator, in
his sole discretion.
Annually from 2011 through 2016, OCI issued its disapproval of
the requests of Ambac Assurance and the Rehabilitator of the
Segregated Account, acting for and on behalf of the Segregated
Account, to pay interest on outstanding surplus notes issued by
Ambac and the Segregated Account on the annual scheduled
interest payment date of June 7th. Neither Ambac Assurance nor
the Rehabilitator of the Segregated Account, acting for and on
behalf of the Segregated Account, have requested to pay interest
on any junior surplus notes since their issuance. Ambac Assurance
and the Segregated Account are responsible for unpaid interest on
surplus and junior surplus notes of $426.4 million through
December 31, 2016.
Furthermore, as more fully described in Note 1. Background and
Business Description to the Consolidated Financial Statements
included in Part II, Item 8 in this Form 10-K, on November 20,
2014 the Rehabilitator early redeemed a portion of the surplus notes
issued by the Segregated Account, together with interest thereon,
which resulted in a proportionate redemption by Ambac Assurance
of its surplus notes. Additionally, on December 22, 2014, the
Segregated Account made equalizing payments of Deferred
Amounts, together with interest thereon. The aggregate amount
of payments for the partial redemption of Segregated Account and
Ambac Assurance surplus notes owned by third parties, including
accrued interest, was $413.6 million in the aggregate and the
equalizing payments of Deferred Amounts was $1,137.2 million.
Ambac Assurance is limited in its ability to pay dividends pursuant
to the terms of its Auction Market Preferred Shares (“AMPS”),
which state that dividends may not be paid on the common stock
of Ambac Assurance unless all accrued and unpaid dividends on
the AMPS for the then current dividend period have been paid,
provided that dividends on the common stock may be made at all
times for the purpose of, and only in such amounts as are necessary
for enabling Ambac (i) to service its indebtedness for borrowed
money as such payments become due or (ii) to pay its operating
expenses. If dividends are paid on the common stock for such
purposes, dividends on the AMPS become cumulative until the
date that all accumulated and unpaid dividends have been paid on
the AMPS. Ambac Assurance has not paid dividends on the AMPS
since 2010. Refer to Part I, Item 1, “Insurance Regulatory Matters
- Dividend Restrictions, Including Contractual Restrictions” and
Note 8. Insurance Regulatory Restrictions to the Consolidated
Financial Statements included in Part II, Item 8, in this Form 10-
K for more information on dividend payment restrictions.
During the year ended December 31, 2016, Ambac Assurance
received total subrogation of $1,355.4 million, net of reinsurance.
Our ability to realize future R&W subrogation recoveries is subject
to significant uncertainty, including risks inherent in litigation,
collectability of such amounts from counterparties (and/or their
respective parents and affiliates), timing of receipt of any such
recoveries, intervention by the Rehabilitator or OCI which could
impede our ability to take actions required to realize such
recoveries and uncertainty inherent in the assumptions used in
estimating such recoveries. The amount of these subrogation
recoveries is significant and if we are unable to recover any
amounts, our future available liquidity to pay claims would be
reduced materially. In January 2016, Ambac Assurance settled its
RMBS-related disputes and litigation against JP Morgan Chase &
Co. and certain of its affiliates (collectively "JP Morgan"). Pursuant
to the settlement, JP Morgan paid Ambac Assurance $995.0 million
($992.8 million net of reinsurance) in cash in return for releases
of all of Ambac Assurance's claims against JP Morgan arising from
certain RMBS transactions insured by Ambac Assurance. Ambac
Assurance also is entitled to other subrogation amounts relating to
RMBS transactions and other contractual recoveries on public and
structured finance policies. Included within other subrogation
were estimated recoveries on certain insurance policies which were
included in an omnibus settlement with investors in Countrywide
securitizations, that was announced in June 2011 by Bank of New
York Mellon, as Trustee, whereby Bank of America agreed to pay
$8.5 billion across approximately 530 RMBS trusts (“Countrywide
Investor Settlement”). Ambac received $100.3 million ($99.1
million net of reinsurance) related to the Countrywide Investor
Settlement.
swaps
various
(“CDS”) with
A wholly-owned subsidiary of Ambac Assurance is a party to credit
default
commercial
counterparties. Ambac Assurance guarantees its subsidiary’s
payment obligations under such CDS. The terms of such CDS
include events of default or termination events based on the
occurrence of certain events, or the existence of certain
circumstances, relating to the financial condition of Ambac
Assurance, including the commencement of an insolvency,
rehabilitation or like proceeding. If such an event of default or
termination event were to occur, the CDS counterparties could
claim the contractual right to terminate the CDS and require Ambac
Assurance, as
termination
payments. Ambac Assurance estimates
that such potential
termination payments amount to $47.8 million as of December 31,
2016. However, the Rehabilitation Court has issued an injunction
barring the early termination of contracts based on the occurrence
of events or the existence of circumstances like those described
above. As a result, Ambac Assurance does not expect to make early
financial guarantor,
to make
| Ambac Financial Group, Inc. 53 2016 FORM 10-K |
termination payments in respect of CDS where such amounts are
claimed based on the occurrence of events, or the existence of
circumstances, relating to the financial condition of Ambac
Assurance.
transaction
terminations, policy
As described in Part I, Item 1, "Introduction" of this Form 10-K,
one of Ambac's primary goals is to create shareholder value
commutations,
through
settlements and restructurings effected at Ambac Assurance that
we believe will improve the Company's risk profile. As Ambac
Assurance takes such actions to reduce known and potential risks,
liquidity may be materially affected. Furthermore, such actions
may negatively impact our operating results or financial position
in one or more reporting periods.
intercompany
Financial Services Liquidity. The principal uses of liquidity by
Financial Services subsidiaries are payments on investment
agreement obligations, payments on
loans,
payments under derivative contracts (primarily interest rate swaps
and US Treasury futures), collateral posting and operating
expenses. Management believes that its Financial Services’ short
and long-term liquidity needs can be funded from net investment
coupon receipts; the maturity of invested assets; sales of invested
assets; intercompany loans from Ambac Assurance; and receipts
from derivative contracts.
As of December 31, 2016, Ambac had a $82.4 million contingent
withdrawal investment agreement outstanding related to a
structured credit-linked note ("CLN"). This one remaining
investment agreement matures on March 20, 2017 and will be
funded by asset sales.
While meaningful progress has been made in unwinding the
Financial Services businesses, liquidity risk exists in the derivative
portfolios due to contract provisions which may require collateral
posting or early termination of contracts. Both the investment
agreement and swap businesses borrows cash and securities from
Ambac Assurance to meet liquidity needs when such borrowing is
determined to be most economically beneficial to Ambac
Assurance. Intercompany loans are made under established
lending agreements with defined borrowing limits that have
received non-disapproval from OCI.
Cash Flow Statement Discussion.
summarizes the net cash flows for the periods presented.
The following table
($ in million)
Year Ended December 31,
Cash provided by (used in):
2016
2015
2014
Operating activities
$
843.5
$
91.8
$
(967.8)
(714.6)
(69.7)
(175.7)
1,271.7
46.9
(307.1)
Investing activities
Financing activities
Effect of foreign exchange
on cash and cash
equivalents
Net cash flow
$
55.3
$
(38.2) $
(3.9)
(1.1)
(0.3)
(3.5)
Operating activities
The principal sources of Ambac's operating cash flows are gross
installment premiums on insurance contracts, fees on credit default
swap contracts, investment coupon receipts, subrogation and
reinsurance recoveries. The principal uses of Ambac's liquidity are
the payment of operating and loss expenses, claim and
commutation payments on insurance contracts, ceded reinsurance
premiums and tax payments. During the years ended December
31, 2016, 2015 and 2014, Ambac had net loss and loss expense
(recoveries) payments of $(939.6) million, $1.1 million and
$1,067.3 million, respectively, inclusive of interest payments on
Deferred Amounts of $82.5 million during the year ended
December 31, 2014. In addition, during the year ended December
31, 2016, 2015 and 2014, gross premium collection and credit
derivative receipts by Ambac were $78.0 million, $110.9 million
and $129.1 million, respectively.
Future operating cash flows will primarily be impacted by the level
of premium collections, investment coupon receipts and claim
payments (including further payments of Deferred Amounts and
interest thereon) and payments under credit default swap contracts.
Additional increases to Interim Payments, which are at the sole
discretion of the Rehabilitator, will have an adverse effects on
Ambac's future cash flows.
Financing Activities
Financing activities for the year ended December 31, 2016
included paydowns on a secured borrowing of $29.5 million,
payments for investment agreement draws of $18.0 million,
payments for extinguishment of long-term debt of $19.6 million
and the acquisition of Ambac warrants of $2.7 million. Financing
activities for the year ended December 31, 2015 included proceeds
of $129.9 million (net of repayments during the year ended
December 31, 2015) received from a secured borrowing, partially
offset by payments for investment agreement draws of $63.9
million, payments for extinguishment of long-term debt of $13.8
million and the acquisition of Ambac warrants of $5.0 million.
Financing activities for the year ended December 31, 2014
included redemption payments on surplus notes of $331.4 million
and repayments of investment agreements of $200.0 million,
partially offset by proceeds from Ambac's sale of its Segregated
Account junior surplus note in the amount of $224.3 million.
Credit Ratings and Collateral. Ambac Assurance is no longer rated
by Moody’s and S&P, which resulted in the triggering of required
cure provisions in investment agreements. At December 31, 2016
Ambac posted collateral of $88.9 million in connection with its
outstanding investment agreements.
Ambac Financial Services, LLC (“AFS”) provides interest rate
swaps for states, municipalities, asset-backed issuers and other
entities in connection with their financings. AFS hedges interest
rate risk of these instruments, as well as a portion of the interest
rate risk in the financial guarantee portfolio, with standardized
derivative contracts, including financial futures contracts, which
contain collateral or margin requirements. Under these hedge
agreements, AFS is required to post collateral or margin to its
counterparties and futures commission merchants to cover
unrealized losses. In addition, AFS is required to post collateral or
margin in excess of the amounts needed to cover unrealized losses.
All AFS derivative contracts containing ratings-based downgrade
triggers that could result in collateral or margin posting or a
termination have been triggered. If terminations were to occur,
AFS would be required to make termination payments but would
also receive a return of collateral or margin in the form of cash,
U.S. Treasury or U.S. government agency obligations with market
values equal to or in excess of market values of the swaps and
futures contracts. In most cases, AFS will look to re-establish hedge
| Ambac Financial Group, Inc. 54 2016 FORM 10-K |
positions that are terminated early. This may result in additional
collateral or margin obligations. The amount of additional
collateral or margin posted on derivatives contracts will depend
on several variables including the degree to which counterparties
exercise their termination rights (or agreements terminate
automatically) and the terms on which hedges can be replaced. All
collateral and margin obligations are currently met. Collateral and
margin posted by AFS totaled a net amount of $202.6 million,
including
these contracts at
December 31, 2016.
independent amounts, under
Ambac Credit Products (“ACP”) entered into credit derivative
contracts. ACP is not required to post collateral under any of its
contracts.
BALANCE SHEET
Total assets decreased by approximately $1,092 million from
December 31, 2015 to $22.6 billion at December 31, 2016,
primarily due to (i) declines in VIE assets primarily as a result of
devaluation of assets denominated in British Pounds; (ii) lower
premium receivables from the runoff, including early terminations,
of the insured portfolio; (iii) amortization of the insurance
intangible asset and (iv) lower subrogation recoveries; partially
offset by an increase in investments and cash receipts from R&W
settlements of $995 million and from the Countrywide Investor
Settlement of $100.3 million that exceeded amounts previously
included as a component of Subrogation recoverable assets.
Total liabilities decreased by approximately $1,112 million from
December 31, 2015 to $20.7 billion as of December 31, 2016,
primarily as a result of (i) declines in VIE liabilities primarily as
a result of devaluation of liabilities denominated in British Pounds;
(ii) lower unearned premium reserves; partially offset by higher
accrued interest payables on Surplus Notes and higher loss and
loss expense reserves, resulting primarily from the impact of the
R&W recovery noted above on loss and loss expense reserves.
As of December 31, 2016 total stockholders’ equity was $1,978
million, compared with total stockholders’ equity of $1,958 million
at December 31, 2015. This increase was primarily due to Other
Comprehensive Income during the period. Other Comprehensive
Income during 2016 was driven by net income and unrealized gains
on investment securities partially offset by unrealized losses from
foreign currency translations.
Investment Portfolio.
The following table summarizes the composition of Ambac’s
investment portfolio, excluding VIE investments, at fair value by
segment at December 31, 2016 and 2015:
($ in millions)
December 31, 2016:
(cid:41)(cid:76)(cid:91)(cid:72)(cid:71) (cid:76)(cid:81)(cid:70)(cid:82)(cid:80)(cid:72) (cid:86)(cid:72)(cid:70)(cid:88)(cid:85)(cid:76)(cid:87)(cid:76)(cid:72)(cid:86)
(cid:54)(cid:75)(cid:82)(cid:85)(cid:87)(cid:16)(cid:87)(cid:72)(cid:85)(cid:80)
(cid:50)(cid:87)(cid:75)(cid:72)(cid:85) (cid:76)(cid:81)(cid:89)(cid:72)(cid:86)(cid:87)(cid:80)(cid:72)(cid:81)(cid:87)(cid:86)
(cid:41)(cid:76)(cid:91)(cid:72)(cid:71) (cid:76)(cid:81)(cid:70)(cid:82)(cid:80)(cid:72) (cid:86)(cid:72)(cid:70)(cid:88)(cid:85)(cid:76)(cid:87)(cid:76)(cid:72)(cid:86) (cid:83)(cid:79)(cid:72)(cid:71)(cid:74)(cid:72)(cid:71) (cid:68)(cid:86) (cid:70)(cid:82)(cid:79)(cid:79)(cid:68)(cid:87)(cid:72)(cid:85)(cid:68)(cid:79)
Total investments
Percent total
December 31, 2015:
(cid:41)(cid:76)(cid:91)(cid:72)(cid:71) (cid:76)(cid:81)(cid:70)(cid:82)(cid:80)(cid:72) (cid:86)(cid:72)(cid:70)(cid:88)(cid:85)(cid:76)(cid:87)(cid:76)(cid:72)(cid:86)
(cid:54)(cid:75)(cid:82)(cid:85)(cid:87)(cid:16)(cid:87)(cid:72)(cid:85)(cid:80)
(cid:50)(cid:87)(cid:75)(cid:72)(cid:85) (cid:76)(cid:81)(cid:89)(cid:72)(cid:86)(cid:87)(cid:80)(cid:72)(cid:81)(cid:87)(cid:86)
(cid:41)(cid:76)(cid:91)(cid:72)(cid:71) (cid:76)(cid:81)(cid:70)(cid:82)(cid:80)(cid:72) (cid:86)(cid:72)(cid:70)(cid:88)(cid:85)(cid:76)(cid:87)(cid:76)(cid:72)(cid:86) (cid:83)(cid:79)(cid:72)(cid:71)(cid:74)(cid:72)(cid:71) (cid:68)(cid:86) (cid:70)(cid:82)(cid:79)(cid:79)(cid:68)(cid:87)(cid:72)(cid:85)(cid:68)(cid:79)
Total investments
Percent total
Financial
Guarantee (1)
Financial
Services
Corporate
Total
5,265.2
$
89.3
$
199.7
$
5,554.2
363.3
420.3
64.9
0.9
—
—
66.6
30.0
—
430.8
450.3
64.9
6,113.7
$
90.2
$
296.3
$
6,500.2
94.0%
1.4%
4.6%
100%
4,758.7
$
109.3
$
175.8
$
5,043.8
177.5
285.3
64.5
0.2
—
—
48.1
25.3
—
225.8
310.6
64.5
5,286.0
$
109.5
$
249.2
$
5,644.7
93.7%
1.9%
4.4%
100%
$
$
$
$
(1)
Includes investments denominated in non-US dollar currencies with a fair value of £167.8 ($206.7) and €23.5 ($24.7) as of December 31, 2016 and £198.1
($291.7) and €32.7 ($35.5) as of December 31, 2015:.
| Ambac Financial Group, Inc. 55 2016 FORM 10-K |
Ambac invests in various asset classes in its available-for-sale investment portfolio. Refer to Note 10. Investments for details of all investments
by asset class. The following table represents the fair value of mortgage and asset-backed securities at December 31, 2016 and 2015 by
classification:
Financial
Guarantee (1)
Financial
Services
Corporate
Total
($ in millions)
December 31, 2016:
Residential mortgage-backed securities:
RMBS—First-lien—Alt-A
RMBS—Second Lien
RMBS—First Lien—Sub Prime
Total residential mortgage-backed securities
Other asset-backed securities
Military Housing
Credit Cards
Student Loans
Auto
Structured Insurance
Other
Total other asset-backed securities
Total
December 31, 2015:
Residential mortgage-backed securities:
RMBS—First-lien—Alt-A
RMBS—Second Lien
RMBS—First Lien—Sub Prime
Total residential mortgage-backed securities
Other asset-backed securities
Military Housing
Credit Cards
Student Loans
Auto
Structured Insurance
Other
Total other asset-backed securities
Total
$
959.2
$
— $
85.1
$
909.1
396.9
2,265.2
236.6
43.5
151.4
67.9
118.8
19.9
638.1
2,903.3
$
—
—
—
—
89.3
—
—
—
—
1.3
—
86.4
—
31.3
—
69.9
—
0.2
89.3
89.3
$
101.4
187.8
$
772.1
$
— $
75.1
$
$
$
814.0
314.9
1,901.0
238.2
50.9
19.8
192.6
119.8
31.3
652.6
$
2,553.6
$
—
—
—
—
104.8
—
4.5
—
—
109.3
109.3
$
1.2
—
76.3
—
22.4
—
54.1
—
2.1
78.6
1,044.3
910.4
396.9
2,351.6
236.6
164.1
151.4
137.8
118.8
20.1
828.8
3,180.4
847.2
815.2
314.9
1,977.3
238.2
178.1
19.8
251.2
119.8
33.4
840.5
154.9
$
2,817.8
(1)
Includes investments guaranteed by Ambac Assurance and Ambac UK. Refer to Note 10. Investments of the Consolidated Financial Statements included
in Part II Item 8 for further discussion of Ambac-insured securities held in the investment portfolio.
The weighted average rating, which is based on the lower of
Standard & Poor’s or Moody’s ratings, of the mortgage and asset-
backed securities portfolios is CC and BB- as of December 31,
2016, and CC and BBB- as of December 31, 2015, respectively.
Ambac’s fixed income portfolio includes securities covered by
guarantees issued by Ambac Assurance and other financial
guarantors (“insured securities”), which may from time to time
include bonds issued by the Commonwealth of Puerto Rico or its
agencies or instrumentalities. The published rating agency ratings
on these securities reflect the higher of the financial strength rating
of the financial guarantor or the rating of the underlying issuer.
Rating agencies do not always publish separate underlying ratings
(those ratings excluding the insurance by the financial guarantor)
because the insurance cannot be legally separated from the
underlying security by the insurer. In the event these underlying
ratings are not available from the rating agencies, Ambac will
assign an internal rating. Refer to Note 10. Investments to the
Consolidated Financial Statements included in Part II, Item 8 in
this Form 10-K for further details on securities insured by Ambac
Assurance.
| Ambac Financial Group, Inc. 56 2016 FORM 10-K |
The following table provides the ratings(1) distribution of the fixed income investment portfolio based on fair value at December 31, 2016 and
2015 by segment:
Ratings (1)
December 31, 2016
AAA
AA
A
BBB
Below investment grade
Not rated
Total
December 31, 2015
AAA
AA
A
BBB
Below investment grade
Not rated
Total
Financial
Guarantee
Financial
Services
Corporate
Combined (2)
9 %
100 %
60 %
13 %
8
16
17
41
9
—
—
—
—
—
4
3
1
32
—
8
16
16
39
8
100%
100%
100%
100%
11 %
100 %
66 %
15 %
10
19
14
38
8
—
—
—
—
—
—
—
—
34
—
9
18
14
37
7
100%
100%
100%
100%
(1) Ratings are based on the lower of Moody’s or S&P ratings. If ratings are unavailable from Moody's or S&P, Fitch ratings are used. If guaranteed, rating
represents the higher of the underlying or guarantor’s financial strength rating.
(2) Below investment grade and not rated bonds insured by Ambac represent 45% and 41% of the 2016 and 2015 combined portfolio, respectively.
The increase in the percentage of not rated and below investment grade holdings since December 31, 2015 is driven by additional purchases
of Ambac insured bonds.
| Ambac Financial Group, Inc. 57 2016 FORM 10-K |
The following table summarizes, for all available-for-sale securities in an unrealized loss position as of December 31, 2016 and 2015, the
aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position:
($ in millions)
December 31,
Municipal obligations in continuous unrealized loss for:
Less than 12 months
Greater than 12 months
Corporate obligations in continuous unrealized loss for:
Less than 12 months
Greater than 12 months
Foreign government obligations in continuous unrealized loss for:
Less than 12 months
Greater than 12 months
U.S. government obligations in continuous unrealized loss for:
Less than 12 months
Greater than 12 months
U.S. agency obligations in continuous unrealized loss for:
Less than 12 months
Greater than 12 months
Residential mortgage-backed securities in continuous unrealized
loss for:
Less than 12 months
Greater than 12 months
Collateralized debt obligations in continuous unrealized loss for:
Less than 12 months
Greater than 12 months
Other asset-backed securities in continuous unrealized loss for:
Less than 12 months
Greater than 12 months
Short term securities in continuous unrealized loss for:
Less than 12 months
Greater than 12 months
2016
2015
Estimated
Fair Value (1)
Gross
Unrealized Losses
Estimated
Fair Value (1)
Gross
Unrealized Losses
$
98.2
$
122.9
221.1
963.5
6.5
970.0
5.1
—
5.1
6.0
5.1
11.1
4.0
—
4.0
226.9
550.8
777.7
7.0
25.8
32.8
115.6
77.7
193.3
65.2
—
65.2
2.0
5.2
7.2
20.3
0.3
20.6
0.1
—
0.1
0.1
—
0.1
—
—
—
7.2
36.6
43.8
—
0.2
0.2
0.2
7.4
7.6
—
—
—
$
117.0
$
114.7
231.7
938.9
92.6
1,031.5
34.9
8.6
43.5
67.5
10.6
78.1
—
4.2
4.2
584.7
213.3
798.0
77.6
—
77.6
450.7
19.3
470.0
10.0
—
10.0
2.1
6.1
8.2
21.3
3.0
24.3
1.0
0.8
1.8
0.1
0.2
0.3
—
—
—
53.4
11.2
64.6
1.5
—
1.5
3.5
—
3.5
—
—
—
Total
$
2,280.3
$
79.6
$
2,744.6
$
104.2
(1) Since the table is presented in millions, securities with market values and unrealized losses that are less than $0.1 will be shown as zero.
Management has determined that the unrealized losses in
available-for-sale securities are primarily driven by increases in
interest rates and shifts in market risk and liquidity premiums
demanded by fixed income investors. Ambac has concluded that
unrealized losses reflected in the table above are temporary in
nature based upon (a) there being no unexpected principal and
interest payment defaults on these securities; (b) an analysis of the
creditworthiness of the issuer and financial guarantor, as
applicable, and analysis of projected defaults on the underlying
collateral; (c) management having no intent to sell these securities;
and (d) it being not more likely than not that Ambac will be required
to sell these debt securities before the anticipated recovery of its
amortized cost basis.
| Ambac Financial Group, Inc. 58 2016 FORM 10-K |
The following table summarizes amortized cost and fair value for all available-for-sale securities in an unrealized loss position as of December
31, 2016 and 2015, by contractual maturity date:
2016
2015
Amortized
Cost
Estimated
Fair Value
Amortized
Cost
Estimated
Fair Value
$
— $
— $
2.2
$
($ in millions)
December 31,
Municipal obligations:
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Corporate obligations:
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Foreign government obligations:
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
U.S. government obligations:
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
U.S. agency obligations:
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Residential mortgage-backed securities
Collateralized debt obligations
Other asset-backed securities
Short term securities
Total
47.7
113.4
67.2
228.3
12.2
559.0
386.4
33.0
990.6
—
1.6
3.6
—
5.2
5.0
6.0
0.2
—
46.9
110.0
64.2
221.1
12.2
552.6
373.9
31.3
970.0
—
1.6
3.5
—
5.1
5.0
5.9
0.2
—
11.2
11.1
4.0
—
—
—
4.0
821.5
33.0
200.9
65.2
4.0
—
—
—
4.0
777.7
32.8
193.3
65.2
62.3
135.6
39.8
239.9
46.1
521.3
425.3
63.1
2.2
60.7
129.6
39.2
231.7
46.0
514.0
411.3
60.2
1,055.8
1,031.5
—
12.1
30.0
3.2
45.3
—
76.1
2.3
—
78.4
—
4.2
—
—
4.2
862.6
79.1
473.5
10.0
—
11.3
29.3
2.9
43.5
—
75.8
2.3
—
78.1
—
4.2
—
—
4.2
798.0
77.6
470.0
10.0
$
2,359.9
$
2,280.3
$
2,848.8
$
2,744.6
| Ambac Financial Group, Inc. 59 2016 FORM 10-K |
The following table summarizes, for all securities sold at a loss during 2016, 2015 and 2014, the aggregate fair value and realized loss by
length of time those securities were continuously in an unrealized loss position prior to the sale date:
2016
2015
2014
Fair
Value
Gross
Realized
Losses
Fair
Value
Gross
Realized
Losses
Fair
Value
Gross
Realized
Losses
($ in millions)
Year Ended December 31,
Municipal obligations in continuous unrealized loss for:
Less than 12 months
Greater than 12 months
Corporate obligations in continuous unrealized loss for:
Less than 12 months
Greater than 12 months
Foreign government obligations in continuous
unrealized loss for:
Less than 12 months
Greater than 12 months
U.S. government obligations in continuous unrealized
loss for:
Less than 12 months
Greater than 12 months
Residential mortgage-backed securities in continuous
unrealized loss for:
Less than 12 months
Greater than 12 months
Other asset-backed securities in continuous unrealized
loss for:
Less than 12 months
Greater than 12 months
Short term securities in continuous unrealized loss for:
Less than 12 months
Greater than 12 months
$
21.7
$
7.8
29.5
91.7
13.4
105.1
5.1
—
5.1
22.8
—
22.8
—
—
—
126.9
—
126.9
0.8
—
0.8
0.4
0.2
0.6
3.6
1.6
5.2
—
—
—
0.4
—
0.4
—
—
—
0.1
—
0.1
—
—
—
$
55.9
$
—
55.9
70.9
7.6
78.5
6.9
7.6
14.5
21.4
0.5
21.9
—
—
—
53.9
—
53.9
14.8
—
14.8
1.0
—
1.0
6.8
0.5
7.3
0.3
—
0.3
0.2
—
0.2
—
—
—
0.1
—
0.1
—
—
—
$
49.1
$
—
49.1
119.4
32.5
151.9
32.6
32.3
64.9
16.0
1.1
17.1
84.7
—
84.7
202.1
—
202.1
25.9
—
25.9
Total
$
290.2
$
6.3
$
239.5
$
8.9
$
595.7
$
Insurance Intangible Asset. At the Fresh Start Reporting Date,
an insurance intangible asset was recorded which represented the
difference between the fair value and aggregate carrying value of
the financial guarantee insurance and reinsurance assets and
liabilities. For the year ended December 31, 2016 and 2015, the
insurance intangible amortization expense was $175 million and
$170 million, respectively. As of December 31, 2016 and 2015,
the gross carrying value of the insurance intangible asset was
$1,534 million and $1,627 million, respectively. The decrease in
gross carrying value at December 31, 2016 from December 31,
2015 was due to changes in foreign currency related to the
insurance intangible at consolidated companies with functional
currencies other than the US dollar. Accumulated amortization
of the insurance intangible asset was $572 million and $414
million, as of December 31, 2016 and 2015, respectively, resulting
in a net insurance intangible asset of $962 million and $1,212
million, respectively.
Derivative Liabilities. The interest rate derivative products
portfolio is positioned to benefit from rising rates as an economic
hedge against interest rate exposure in the Company, including the
financial guarantee portfolio. Derivative liabilities decreased from
$353 million to $319 million primarily due to increases in interest
rates during 2016. The valuation of derivative liabilities (credit
derivatives and interest rate swaps) is impacted by the market’s
view of Ambac Assurance’s credit quality. We reflect Ambac’s
credit quality in the fair value of such liabilities by including a
| Ambac Financial Group, Inc. 60 2016 FORM 10-K |
0.4
—
0.4
1.5
0.7
2.2
0.6
1.6
2.2
—
—
—
0.2
—
0.2
2.0
—
2.0
—
—
—
7.0
CVA in the determination of fair value, whereas a lower (higher)
CVA, in isolation, would result in an increase (decrease) in the
liability. Ambac reduced its derivative liabilities by $46.9 million
at December 31, 2016 and $88.8 million at December 31, 2015 to
incorporate the market’s view of Ambac’s credit quality. The lower
CVA as of December 31, 2016 is a function of (i) changes to the
underlying derivative liabilities before considering Ambac's credit
quality and (ii) the market’s view that Ambac’s credit quality
improved during the year ended December 31, 2016.
Loss and Loss Expense Reserves. Loss and loss expense reserves
are based upon estimates of the ultimate aggregate losses inherent
in the non-derivative financial guarantee portfolio for insurance
policies issued to beneficiaries, including unconsolidated VIEs.
Loss and loss expense reserves include the unpaid portion of
interest accrued on Deferred Amounts established pursuant to the
amended Segregated Account Rehabilitation Plan. The evaluation
process for determining the level of reserves is subject to certain
estimates and judgments.
The loss and loss expense reserves net of subrogation recoverables
and before reinsurance as of December 31, 2016 and 2015 were
$3,696 million and $2,859 million, respectively.
Loss and loss expense reserves are included in the Consolidated
Balance Sheets as follows:
($ in millions)
Balance Sheet Line Item
December 31, 2016:
Loss and loss expense reserves
Subrogation recoverable
Totals
December 31, 2015:
Loss and loss expense reserves
Subrogation recoverable
Totals
Unpaid Claims
Claims
Accrued
Interest
Present Value of Expected
Net Cash Flows
Claims and
Loss
Expenses
Recoveries (1)
Unearned
Premium
Revenue
Gross Loss
and Loss
Expense
Reserves (2)
$
$
$
$
2,411
583
2,994
2,139
829
2,968
$
$
$
$
530
132
662
350
141
491
$
$
$
$
2,681
68
2,749
3,265
208
3,473
$
$
$
$
(1,098) $
(143) $
(1,468)
—
(2,566) $
(143) $
4,381
(685)
3,696
(1,476) $
(190) $
(2,407)
—
(3,883) $
(190) $
4,088
(1,229)
2,859
(1) Present value of future recoveries include RMBS representation and warranty recoveries of $1,907 and $2,830 at December 31, 2016 and 2015, respectively.
(2)
Includes Euro denominated gross loss and loss expense reserves. US dollar equivalents of such reserves were $21 (€20) and $19 (€18) at December 31,
2016 and 2015, respectively.
Please refer to the "Critical Accounting Policies and Estimates"
and “Results of Operations” sections of this Management’s
Discussion and Analysis of Financial Condition and Results of
Operations in addition to Basis of Presentation and Significant
Accounting Policies and Loss Reserves sections included in Note
2. Basis of Presentation and Significant Accounting Policies and
Note 7. Financial Guarantee Insurance Contracts, respectively of
the Consolidated Financial Statements included in Part II, Item 8
in this Form 10-K for further information on loss and loss expenses.
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 significant claims. The bond types
that have experienced significant claims, including through
commutations, are
residential mortgage-backed securities
(“RMBS”) and student loan securities. These two bond types
represent 89% of our ever-to-date insurance claims recorded with
RMBS comprising 84%. Although historically RMBS and student
loan securities have been the largest source of claim activity there
are reserves on Public Finance and Ambac UK credits that may
result in significant claim payments in the future. We have observed
that, with respect to certain bond types, it is reasonably possible
that a material change in actual loss severities and defaults could
occur over time. In the future, our experience may differ with
respect to the types of guaranteed bonds affected or the magnitude
of the effect. Refer to the "Critical Accounting Policies and
Estimates" section of this Management’s Discussion and Analysis
of Financial Condition and Results of Operations for further
discussion of the potential variability of expected future loss and
recoveries.
The table below indicates gross par outstanding and the
components of gross loss and loss expense reserves related to
policies in Ambac’s gross loss and loss expense reserves at
December 31, 2016 and 2015:
| Ambac Financial Group, Inc. 61 2016 FORM 10-K |
Unpaid Claims
Gross Par
Outstanding (1)(2)
Claims
Accrued
Interest
Present Value of Expected
Net Cash Flows
Claims and
Loss
Expenses
Recoveries
Unearned
Premium
Revenue
Gross Loss
and Loss
Expense
Reserves (1)(3)
$
$
$
6,756
$
2,982
$
660
$
1,073
$
(2,295) $
(26) $
2,394
4,410
728
939
567
—
12
—
—
—
—
2
—
—
—
—
822
337
416
26
75
(216)
(45)
(10)
—
—
(73)
(13)
(18)
(13)
—
547
279
388
13
75
13,400
$
2,994
$
662
$
2,749
$
(2,566) $
(143) $
3,696
8,067
$
2,957
$
490
$
1,364
$
(3,376) $
(34) $
1,401
5,246
1,207
943
513
—
11
—
—
—
—
1
—
—
—
—
993
559
460
24
73
(456)
(39)
(12)
—
—
(79)
(34)
(28)
(15)
—
470
486
420
9
73
$
15,976
$
2,968
$
491
$
3,473
$
(3,883) $
(190) $
2,859
($ in millions)
December 31, 2016:
RMBS
Domestic Public Finance
Student Loans
Ambac UK (4)
All other credits
Loss expenses
Totals
December 31, 2015:
RMBS
Domestic Public Finance
Student Loans
Ambac UK (4)
All other credits
Loss expenses
Totals
(1) Ceded par outstanding on policies with loss reserves and ceded loss and loss expense reserves are $607 and $31, respectively, at December 31, 2016 and
$847 and $44, respectively at December 31, 2015. Ceded loss and loss expense reserves are included in Reinsurance recoverable on paid and unpaid
losses.
(2) Gross Par Outstanding includes capital appreciation bonds, which are reported at the par amount at the time of issuance of the insurance policy.
(3) Loss reserves are included in the balance sheet as Loss and loss expense reserves or Subrogation recoverable dependent on if a policy is in a net liability
or net recoverable position.
(4) Present value of Expected Net Cash Flows is reduced by estimated recoveries from the Ambac UK v. J.P. Morgan Investment Management litigation.
RMBS
Ambac has exposure to the U.S. mortgage market primarily
through direct financial guarantees of RMBS,
including
transactions collateralized by first and second liens. Gross loss
and loss expense reserves increased primarily due to the reduction
in estimated future recoveries as a result of collections from
settlements with JP Morgan (R&W) and Countrywide (investor
settlement) as well as other RMBS subrogation receipts. This was
partially offset by an increase in estimated future recoveries related
to a settlement reached, outside of litigation, of a dispute with
regards to an Ambac insured RMBS transaction.
We established a representation and warranty subrogation recovery
as further discussed in "Critical Accounting Policies and
Estimates" section of this Management’s Discussion and Analysis
of Financial Condition and Results of Operations in addition to the
Basis of Presentation and Significant Accounting Policies and Loss
Reserves sections included in Note 2. Basis of Presentation and
Significant Accounting Policies and Note 7. Financial Guarantee
Insurance Contracts, respectively, of the Consolidated Financial
Statements included in Part II, Item 8 in this Form 10-K. Our
ability to realize RMBS representation and warranty recoveries is
subject to significant uncertainty, including risks inherent in
litigation, collectability of such amounts from counterparties (and/
or their respective parents and affiliates), timing of receipt of any
such recoveries, intervention by the Rehabilitator or OCI which
could impede our ability to take actions required to realize such
recoveries, and uncertainty inherent in the assumptions used in
estimating such recoveries.
The table below distinguishes between RMBS credits for which
we have not established a representation and warranty subrogation
recovery and those for which we have, providing in both cases the
gross par outstanding, gross loss reserves before representation
and warranty subrogation recoveries, and gross loss reserves net
of representation and warranty subrogation recoveries for all
RMBS exposures for which Ambac established reserves at
December 31, 2016 and 2015:
| Ambac Financial Group, Inc. 62 2016 FORM 10-K |
($ in millions)
December 31, 2016:
Second-lien
First-lien Mid-prime
First-lien Sub-prime
Other
Total Credits Without Subrogation
Second-lien
First-lien Mid-prime
First-lien Sub-prime
Total Credits With Subrogation
Total
December 31, 2015:
Second-lien
First-lien-Mid-prime
First-lien-Sub-prime
Other
Total Credits Without Subrogation
Second-lien
First-lien Mid-prime
First-lien Sub-prime
Total Credits With Subrogation
Total
Public Finance
Gross Loss
Reserves Before
Representation
and Warranty
Subrogation
Recoveries
Representation
and Warranty
Subrogation
Recoveries
Gross Loss
Reserves Net of
Representation
and Warranty
Subrogation
Recoveries
Gross Par
Outstanding
$
1,169
$
679
$
— $
2,226
1,194
201
4,790
1,045
72
849
1,966
6,756
$
1,901
231
138
2,949
705
97
550
1,352
4,301
$
—
—
—
—
(1,333)
(79)
(495)
(1,907)
(1,907) $
1,261
$
423
$
— $
$
$
2,594
1,401
193
5,449
1,520
116
982
2,618
$
8,067
$
1,575
250
132
2,380
921
424
506
1,851
4,231
$
—
—
—
—
(2,072)
(260)
(498)
(2,830)
(2,830) $
679
1,901
231
138
2,949
(628)
18
55
(555)
2,394
423
1,575
250
132
2,380
(1,151)
164
8
(979)
1,401
Ambac’s U.S. public finance portfolio consists predominantly of
municipal bonds such as general and revenue obligations and lease
and tax-backed obligations of state and local government entities;
however, the portfolio also comprises a wide array of non-
municipal types of bonds, including financings for not-for-profit
entities and transactions with public and private elements, which
generally finance infrastructure, housing and other public purpose
facilities and interests. The increase in public finance gross loss
reserves at December 31, 2016 as compared to December 31, 2015
was primarily related to adverse developments in Puerto Rico
partially offset by claim payments during the year Total public
finance gross loss reserves and related gross par outstanding on
Ambac insured obligations by bond type were as follows:
($ in millions)
December 31,
Issue Type
Lease and tax-backed
General obligation
Transportation revenue
Housing
Other
Total
2016
2015
Gross Par
Outstanding (1)
Gross Loss
Reserves
Gross Par
Outstanding (1)
Gross Loss
Reserves
$
$
2,114
$
1,422
516
179
179
395
$
78
62
9
3
2,277
$
2,039
603
192
135
4,410
$
547
$
5,246
$
284
99
62
24
1
470
(1) Gross Par Outstanding includes capital appreciation bonds, which are reported at the par amount at the time of issuance of the insurance policy.
Student Loan
Total student loan gross loss reserves and related gross par
outstanding on Ambac insured obligations were $279 and $728
and $486 and $1,207, at December 31, 2016 and 2015, respectively.
Gross loss reserves declined in 2016 primarily as a result of
executed commutations and increased probabilities of prospective
commutations. Gross par in the amount of $431 (net par $387)
was commuted in 2016.
| Ambac Financial Group, Inc. 63 2016 FORM 10-K |
SPECIAL PURPOSE AND VARIABLE INTEREST
ENTITIES
Segregated Account as well as the operative documents between
Ambac Assurance and the Segregated Account.
Please refer to Note 2. Basis of Presentation and Significant
Accounting Policies and Note 3. Special Purpose Entities,
Including Variable Interest Entities to the Consolidated Financial
Statements, included in Part II, Item 8 in this Form 10-K, for
information regarding special purpose and variable interest
entities.
ACCOUNTING STANDARDS
Please refer to Note 2. Basis of Presentation and Significant
Accounting Policies to the Consolidated Financial Statements,
included in Part II, Item 8 in this Form 10-K, for a discussion of
the impact of recent accounting pronouncements on Ambac’s
financial condition and results of operations.
AMBAC ASSURANCE STATUTORY BASIS FINANCIAL
RESULTS
Ambac Assurance, Everspan and the Segregated Account’s
statutory financial statements are prepared on the basis of
accounting practices prescribed or permitted by the OCI. OCI
recognizes only statutory accounting practices prescribed or
permitted by the State of Wisconsin (“SAP”) for determining and
reporting the financial condition and results of operations of an
insurance company for determining its solvency under Wisconsin
Insurance Law. The National Association of
Insurance
Commissioners (“NAIC”) Accounting Practices and Procedures
manual (“NAIC SAP”) has been adopted as a component of
prescribed practices by the State of Wisconsin. OCI has prescribed
or permitted additional accounting practices for Ambac Assurance,
Everspan and the Segregated Account which are described in Note
8. Insurance Regulatory Restrictions to the Consolidated Financial
Statements included in Part II, Item 8 in this Form 10-K. As a
result of these prescribed and permitted practices, Ambac
Assurance’s policyholder surplus at December 31, 2016 and 2015
was higher by $17.3 million and $21.3 million, respectively, than
if Ambac Assurance and the Segregated Account had reported such
amounts in accordance with NAIC SAP.
Under Wisconsin insurance law, the Segregated Account is a
separate insurer from Ambac Assurance and accordingly is subject
to all of the filing and statutory reporting requirements of
Wisconsin domiciled insurers. The total assets, total liabilities,
and total surplus of the Segregated Account are reported as discrete
components of Ambac Assurance’s assets, liabilities, and surplus
in Ambac Assurance’s statutory basis financial statements.
Accordingly, Ambac Assurance’s statutory financial statements
include the results of Ambac Assurance’s general account and, to
the extent allowable under a prescribed accounting practice by
OCI, the Segregated Account. Pursuant to this prescribed practice,
the results of the Segregated Account are not fully included in
Ambac Assurance’s statutory financial statements if Ambac
Assurance’s surplus is (or would be) less than $100.0 million
(“Minimum Surplus Amount”). Maintaining the Minimum
Surplus Amount could result in a reduction in the liabilities
assumed by Ambac Assurance from the Segregated Account.
Please refer to Note 1. Background and Business Description of
the Consolidated Financial Statements in Part II, Item 8 of this
Form 10-K for additional information on the establishment of the
Ambac Assurance’s statutory policyholder surplus and qualified
statutory capital (defined as the sum of policyholders surplus and
mandatory contingency reserves) were $976.5 million and
$1,368.3 million at December 31, 2016, respectively, as compared
to $624.8 million and $1,015.7 million at December 31, 2015,
respectively. The Segregated Account’s statutory policyholder
surplus amount was $381.3 million and $387.6 million as of
December 31, 2016 and 2015, respectively. At December 31, 2016
and 2015, Ambac Assurance’s surplus as regards to policyholders
exceeds the Minimum Surplus Amount. In the event that Ambac
Assurance does not maintain surplus in excess of the Minimum
Surplus Amount, the Segregated Account would experience a
shortfall in funds available to pay its liabilities. Any such shortfall
would be a consideration for the Rehabilitator in the determination
of whether any changes to the Segregated Account Rehabilitation
Plan (as defined above) and/or the amount of partial policy claim
payments are necessary or appropriate or whether to institute
general rehabilitation proceedings against Ambac Assurance.
Ambac Assurance’s increase in policyholder surplus was primarily
due to statutory net income. Statutory net income was primarily
due to positive loss development, premium earnings and
investment income which was partially offset by the accrual of
interest on Deferred Amounts.
The Segregated Account’s decrease in policyholder surplus was
primarily due to a reduction in junior surplus notes as a result of
rent payments made by Ambac Assurance during the year ended
December 31, 2016.
Ambac Assurance’s statutory policyholder surplus includes $374.0
million of junior surplus notes issued by the Segregated Account,
including $350.0 million that Ambac deposited into a statutory
trust (as further discussed within Liquidity and Capital Resources
in this Management's Discussion and Analysis). These junior
surplus notes, as well as preferred stock issued by Ambac
Assurance with a liquidation value of $660.3 million, are
obligations that have claims on the resources of Ambac Assurance
and the Segregated Account which impact Ambac's ability to
realize residual value from its equity in Ambac Assurance.
Ambac Assurance’s statutory surplus is sensitive to multiple
factors, including: (i) loss reserve development (inclusive of
Segregated Account reserves and interest on Deferred Amounts),
(ii) approval by OCI of interest payments on existing surplus notes
issued by Ambac Assurance or
the Segregated Account,
(iii) approval by OCI of principal or interest payments on existing
junior surplus notes issued by the Segregated Account, (iv)
deterioration in the financial position of Ambac Assurance
subsidiaries that have their obligations guaranteed by Ambac
Assurance, (v) first time payment defaults of insured obligations,
which increase statutory loss reserves, (vi) commutations of
insurance policies or credit derivative contracts at amounts that
differ from the amount of liabilities recorded, (vii) reinsurance
contract terminations at amounts that differ from net assets
recorded, (viii) changes to the fair value of investments carried at
fair value, (ix) settlements of representation and warranty breach
claims at amounts that differ from amounts recorded, including
failures to collect such amounts, (x) realized gains and losses,
including losses arising from other than temporary impairments of
| Ambac Financial Group, Inc. 64 2016 FORM 10-K |
investment securities, and (xi) future changes to prescribed SAP
practices by the OCI.
As of December 31, 2016, total unpaid interest, which will require
OCI approval for payment, for surplus notes outstanding to third
parties and junior surplus notes was $313.3 million and $65.3
million, respectively at the scheduled interest payment date of June
7, 2016. Additionally, if OCI approves interest payments on
current Ambac Assurance surplus notes in the future, Ambac
Assurance will be required to pay interest on certain repurchased
surplus notes through their call option exercise dates. The amount
of such unpaid interest on repurchased surplus notes is $4.0 million
at December 31, 2016. Under SAP, these amounts will be recorded
as a liability once approval for payment has been granted by OCI.
The significant differences between GAAP and SAP are that under
SAP:
•
Loss reserves are only established for losses on guaranteed
obligations that have defaulted in an amount that is
sufficient to cover the present value of the anticipated
defaulted debt service payments over the expected period
of default, less estimated recoveries under subrogation
rights (5.1% as prescribed by OCI). Loss reserves are
established for non-defaulted policies on the date when a
the
binding commutation contract
counterparty.
the
Under GAAP,
establishment of loss reserves for defaulted obligations,
loss reserves are established (net of GAAP basis unearned
premium revenue) for obligations that have experienced
credit deterioration, but have not yet defaulted using a
weighted-average risk-free discount rate, currently at
2.7%.
is signed by
to
in addition
• Mandatory contingency reserves are required based upon
the type of obligation insured, whereas GAAP does not
require such a reserve. Releases of the contingency reserves
are generally subject to OCI approval and relate to a
determination that the held reserves are deemed excessive.
•
Investment grade fixed income investments are stated at
amortized cost and certain below investment grade fixed
income investments are reported at the lower of amortized
cost or fair value. Under GAAP, all fixed income
investments are reported at fair value.
• Wholly owned subsidiaries are not consolidated; rather, the
equity basis of accounting is utilized and the carrying
values of these investments are subject to admissibility
tests. When Ambac Assurance’s share of the subsidiaries’
losses exceeds the related carrying amounts of the wholly
owned
subsidiary, Ambac Assurance discontinues
applying the equity method and the investment is reduced
to zero. For those subsidiaries that have insufficient claims
paying resources and whose obligations are guaranteed by
Ambac Assurance, Ambac Assurance records an estimated
impairment for probable losses which are in excess of the
subsidiaries’ claims paying resources.
• Variable interest entities are not required to be assessed for
consolidation. Under GAAP, a reporting entity that has both
the following characteristics is required to consolidate the
VIE: a) the power to direct the activities of the VIE that
impact
the VIE’s
significantly
most
economic
performance; and b) the obligation to absorb losses of the
VIE or the right to receive benefits from the VIE that could
potentially be significant to the VIE. Ambac generally has
the obligation to absorb losses of VIEs that could
potentially be significant to the VIE as the result of its
guarantee of insured obligations issued by VIEs. For
certain VIEs Ambac Assurance has the power to direct the
most significant activities of the VIE and accordingly
consolidates the related VIEs under GAAP.
• All payments of principal and interest on the surplus notes
are subject to the approval of the OCI. Unpaid interest due
on the surplus notes is expensed when the approval for
payment of interest has been granted by the OCI. Under
GAAP, interest on surplus notes is accrued regardless of
OCI approval.
• Upfront premiums written are earned on a basis
proportionate to the remaining scheduled debt service to
the original total principal and interest insured. Installment
premiums are reflected in income pro-rata over the period
covered by the premium payment. When an insurance
policy has been legally defeased, the related portion of
unearned premium revenue is accelerated and recognized
as premiums earned. Under GAAP, premium revenues for
both upfront and installment premiums are earned over the
life of the financial guarantee contract in proportion to the
insured principal amount outstanding at each reporting
date. When an insured bond has been retired, any remaining
UPR is recognized at that time to the extent the financial
guarantee contract
legally extinguished, causing
accelerated premium revenue. For installment premium
paying transactions, we offset the recognition of any
remaining UPR by the reduction of the related premium
receivable to zero, which may cause negative accelerated
premium revenue. For bonds that are legally defeased,
generally through a refunding or a pre-refunding, the
remaining unearned premium revenue is not accelerated
but is recognized over the remaining life of the defeasance
period.
is
•
Fresh start financial statement reporting is not a concept
within SAP. Under GAAP, Ambac determined that fresh
start financial statement reporting was to be applied upon
our emergence from Chapter 11. Fresh start financial
reporting requires Ambac to adjust the historical carrying
of its assets and liabilities to fair value, including an
insurance intangible asset which represented the difference
between the fair value and aggregate carrying value of the
financial guarantee insurance and reinsurance assets and
liabilities. This insurance intangible asset is amortized as
an expense on a level yield basis over the life of the related
insurance risks.
AMBAC UK FINANCIAL RESULTS UNDER UK
ACCOUNTING PRINCIPLES
Ambac UK is required to prepare financial statements under FRS
102 "The Financial Reporting Standard applicable in the UK and
Republic of Ireland." Ambac UK’s shareholder funds under
UK GAAP were £112.0 million at December 31, 2016 as
compared to £47.8 million at December 31, 2015. Ambac UK’s
| Ambac Financial Group, Inc. 65 2016 FORM 10-K |
improvement in shareholders’ funds was primarily due to net
income arising from the receipt of premiums, investment return in
the period and reduction in loss provisions. At December 31, 2016,
the carrying value of cash and investments was £436.6 million, an
increase from £384.7 million at December 31, 2015. The increase
in cash and investments is due to the continued receipt of
premiums, investment coupons from Ambac UK's investment
portfolio and increases in the value of investments in pooled funds.
The increase in the value of investments in pooled funds were
partially due to upward revaluations of Ambac UK's foreign
currency investments following the fall in the value of the British
Pound as compared to the US Dollar since a portion of the
investments are denominated in US Dollars.
The significant differences between U.S. GAAP and UK GAAP
are that under UK GAAP:
•
•
•
Loss reserves are only established for losses on guaranteed
obligations when, in the judgment of management, a
monetary default in the timely payment of debt service is
likely to occur, which would result in Ambac UK incurring
a loss. A loss provision is established in an amount that is
sufficient to cover the present value (currently using a
discount rate of 3.45%) of the anticipated defaulted debt
service payments over the expected period of default, less
estimated recoveries under subrogation rights. The
discount rate is equal to the lower of the rate of return on
invested assets for either the current year or the period
covering the current year plus the four previous years.
Under U.S. GAAP, loss reserves are established (net of U.S.
GAAP basis unearned premium revenue) for obligations
that have experienced credit deterioration, but have not yet
defaulted using a weighted-average risk-free discount rate,
currently at 1.8% for Ambac UK related transactions.
Investments in fixed income securities are stated at
amortized cost, subject
to an other-than-temporary
impairment evaluation. Under U.S. GAAP, all bonds are
reported at fair value.
Purchases of Ambac UK insured securities are bifurcated
into an intrinsic and an Ambac UK claim based value. The
intrinsic value is recorded as an investment whereas the
Ambac UK claim based value is recorded as a claim
payment with an accompanying reduction in Ambac UK
loss reserves. Under U.S. GAAP, purchases of Ambac UK
insured securities are reported as investments and do not
reduce loss reserves.
• Variable interest entities (“VIE”) are not required to be
assessed for consolidation. Under U.S. GAAP, a reporting
entity that has both the following characteristics is required
to consolidate the VIE: a) the power to direct the activities
of the VIE that most significantly impact the VIE’s
economic performance; and b) the obligation to absorb
losses of the VIE or the right to receive benefits from the
VIE that could potentially be significant to the VIE. Ambac
generally has the obligation to absorb losses of VIEs that
could potentially be significant to the VIE as the result of
its guarantee of insured obligations issued by VIEs. For
certain VIEs Ambac UK has the power to direct the most
significant activities of
the VIE and accordingly
consolidates the related VIEs under U.S. GAAP.
• Upfront premiums written are earned on a basis
proportionate to the remaining scheduled debt service to
the total principal and interest insured. Installment
premiums are reflected in income pro-rata over the period
covered by the premium payment. Under U.S. GAAP,
premium revenues for both upfront and installment
premiums are earned over the life of the financial guarantee
contract in proportion to the insured principal amount
outstanding at each reporting date.
Beginning January 1, 2016 Ambac UK is also required to prepare
financial information in accordance with the Solvency II Directive.
The basis of preparation of this information is significantly
different from both US GAAP and UK GAAP. Capital resources
under Solvency II were a deficit of £112.8 million at September 30,
2016 as compared to £89.8 million at January 1, 2016. The deficit
at September 30, 2016 and January 1, 2016 are in comparison to
a regulatory capital requirement of £381.2 million and £361.1
million as of September 30, 2016 and January 1, 2016,
respectively. Ambac UK is therefore deficient in terms of
compliance with applicable regulatory capital requirements by
£494.0m million and £451.0 million at September 30, 2016 and
January 1, 2016, respectively. The regulators are aware of this
deficiency and dialogue between Ambac UK management and its
regulators remains ongoing with respect to options for addressing
the shortcoming, although such options remain few.
The capital resources and capital requirements of Ambac UK as
calculated in accordance with the Solvency II Directive at
December 31, 2016 will be made available by May 20, 2017 on
Ambac’s website.
NON-GAAP FINANCIAL MEASURES
In addition to reporting the Company’s quarterly financial results
in accordance with GAAP, the Company reports two non-GAAP
financial measures: Adjusted Earnings and Adjusted Book Value.
The most directly comparable GAAP measures are net income
attributable to common stockholders for Adjusted earnings and
Total Ambac Financial Group, Inc. stockholders’ equity for
Adjusted Book value. A non-GAAP financial measure is a
numerical measure of financial performance or financial position
that excludes (or includes) amounts that are included in (or
excluded from) the most directly comparable measure calculated
and presented in accordance with GAAP. We are presenting these
non-GAAP financial measures because they provide greater
transparency and enhanced visibility into the underlying drivers
of our business and the impact of certain items that the Company
believes will reverse from GAAP book value over time through
the GAAP statements of comprehensive income. Adjusted
Earnings and Adjusted Book Value are not substitutes for the
Company’s GAAP reporting, should not be viewed in isolation and
may differ from similar reporting provided by other companies,
which may define non-GAAP measures differently.
Ambac has a significant U.S. tax net operating loss (“NOL”) that
is offset by a full valuation allowance in the GAAP consolidated
financial statements. As a result of this and other considerations,
for purposes of non-GAAP measures, we utilized a 0% effective
tax rate; which is subject to change.
In response to a recent comment letter received from the Division
the Securities and Exchange
of Corporation Finance of
| Ambac Financial Group, Inc. 66 2016 FORM 10-K |
Commission, Ambac has implemented the following changes to
its non-GAAP measures effective December 31, 2016:
ASC, whether or not they are subject to derivative
accounting rules.
• Operating Earnings - Ambac has changed the name of its
non-GAAP measure “Operating Earnings” to “Adjusted
Earnings”.
•
Financial guarantee variable interest entities (“VIEs”) -
Ambac no longer eliminates the effects of VIEs in the
calculation of its non-GAAP measures for Adjusted
Earnings and Adjusted Book Value. However, Ambac has
separately disclosed the effects of VIEs on its GAAP
financial statements that were previously included as
adjustments to its non-GAAP measures. These disclosures
can be found below the Adjusted Earnings and Adjusted
Book Value non-GAAP reconciliation tables in this section.
For comparative purposes, prior period amounts have been recast
in the non-GAAP reconciliation tables shown below to conform
to the new presentation. For further information regarding how
our non-GAAP measures were reported prior to December 31,
2016 please refer to our September 30, 2016 Form 10-Q and
previous Form 10-Q and Form 10-K filings.
The following paragraphs define each non-GAAP financial
measure and describe why it is useful. A reconciliation of the non-
GAAP financial measure and the most directly comparable GAAP
financial measure is also presented below.
Adjusted Earnings. Adjusted Earnings is defined as net income
attributable to common stockholders, as reported under GAAP,
adjusted on an after-tax basis for the following:
•
Non-credit impairment fair value (gain) loss on credit
derivatives: Elimination of the non-credit impairment fair
value gains (losses) on credit derivatives, which is the
amount in excess of the present value of the expected
estimated credit losses. Such fair value adjustments are
heavily affected by, and in part fluctuate with, changes in
market factors such as interest rates and credit spreads,
including the market’s perception of Ambac’s credit risk
(“Ambac CVA”), and are not expected to result in an
economic gain or loss. These adjustments allow for all
financial guarantee segment contracts to be accounted for
consistent with the Financial Services – Insurance Topic of
•
•
Insurance intangible amortization and impairment of
goodwill: Elimination of the amortization of the financial
guarantee insurance intangible asset and impairment of
goodwill that arose as a result of Ambac’s emergence from
bankruptcy and the implementation of Fresh Start
reporting. These adjustments ensure that all financial
guarantee segment contracts are accounted for consistent
with the provisions of the Financial Services – Insurance
Topic of the ASC.
Foreign exchange (gains) losses: Elimination of the
foreign exchange gains (losses) on the re-measurement of
assets, liabilities and transactions in non-functional
currencies. For periods prior to 2016, we eliminated the
foreign exchange gains (losses) on the re-measurement of
net premium receivables and loss and loss expense reserves
in non-functional currencies. Given the long-duration of
a significant portion of these premium receivables and loss
reserves, the foreign exchange re-measurement gains
(losses) are not necessarily indicative of the total foreign
exchange gains (losses) that Ambac will ultimately
recognize. Beginning in 2016, we have eliminated the
foreign exchange gains (losses) on all assets, liabilities and
transactions in non-functional currencies. Expanding this
adjustment to include all foreign exchange gains (losses)
enables users of our financial statements to better view the
business results without the impact of fluctuations in
foreign currency exchange rates, particularly as assets held
in non-functional currencies have grown, and facilitates
period-to-period comparisons of Ambac's operating
performance. Note that we have not recast prior period
adjustments to conform to the methodology as such
amounts were not material.
•
Fair value (gain) loss on derivative products from Ambac
CVA: Elimination of the gains (losses) relating to Ambac’s
CVA on derivative contracts other than credit derivatives.
Similar to credit derivatives, fair values include the
market’s perception of Ambac’s credit risk and this
adjustment only allows for such gain or loss when realized.
The following table reconciles net income attributable to common stockholders to the non-GAAP measure, Adjusted Earnings on a total dollar
amount and per diluted share basis, for all periods presented:
($ in millions, except per share data)
Year Ended December 31,
$ Amount
Per Diluted
Share
$ Amount
Per Diluted
Share
$ Amount
Per Diluted
Share
Net income attributable to common shareholders
$
74.8
$
1.64
$
493.4
$
10.72
$
484.1
$
10.31
2016
2015
2014
Adjustments:
Non-credit impairment fair value (gain) loss on credit
derivatives
Insurance intangible amortization
Impairment of goodwill
Foreign exchange (gains) losses (1)
Fair value (gain) loss on derivative products from
Ambac CVA
Adjusted Earnings
(7.5)
174.6
—
39.1
33.8
$
314.8
$
(0.16)
3.82
—
0.86
0.73
6.89
(36.7)
169.6
514.5
27.4
(0.80)
3.69
11.18
0.60
(17.1)
151.8
—
34.6
(14.2)
(0.31)
(16.1)
$
1,154.0
$
25.08
$
637.2
$
(0.37)
3.24
—
0.74
(0.34)
13.58
| Ambac Financial Group, Inc. 67 2016 FORM 10-K |
(1) Refer to the description of the foreign exchange (gain) loss adjustment above this table for a discussion of the change in methodology that was effective
for the three and nine months ended September 30, 2016.
Net income (loss) effects of financial guarantee VIE consolidation:
VIEs that were consolidated as a result of financial guarantees
provided by Ambac are accounted for on a fair value basis. The
impact on Net income attributable to common stockholders of
these consolidated VIEs was $(14.1) million, $31.6 million , and
$(32.2) million for the years ended December 31, 2016, 2015 and
2014, respectively. Had these financial guarantee VIEs been
accounted for under the provisions of the Financial Services -
Insurance Topic of the ASC, the impact on Net income attributable
to common stockholders would have been $147.6 million, $42.7
million, and $13.2 million for the years ended December 31, 2016,
2015 and 2014, respectively. The net impact of these different
accounting bases on Net income attributable to common
stockholders (including per share amounts) was $161.7 million
($3.54 per diluted share), $11.1 million ($0.24 per diluted share),
and $45.4 million ($0.96 per diluted share), for the years ended
December 31, 2016, 2015 and 2014, respectively. This is
supplemental information only and is not a component of Adjusted
Earnings.
Adjusted Book Value. Adjusted Book Value is defined as Total
Ambac Financial Group, Inc. stockholders’ equity as reported
under GAAP, adjusted for after-tax impact of the following:
•
Non-credit impairment fair value losses on credit
derivatives: Elimination of the non-credit impairment fair
value loss on credit derivatives, which is the amount in
excess of the present value of the expected estimated
economic credit loss. GAAP fair values are heavily affected
by, and in part fluctuate with, changes in market factors
such as interest rates, credit spreads, including Ambac’s
CVA that are not expected to result in an economic gain or
loss. These adjustments allow for all financial guarantee
segment contracts to be accounted for within Adjusted
Book Value consistent with the provisions of the Financial
Services—Insurance Topic of the ASC, whether or not they
are subject to derivative accounting rules.
•
Insurance intangible asset: Elimination of the financial
guarantee insurance intangible asset that arose as a result
the
of Ambac’s emergence from bankruptcy and
•
•
•
implementation of Fresh Start reporting. This adjustment
ensures that all financial guarantee segment contracts are
accounted for within Adjusted Book Value consistent with
the provisions of the Financial Services—Insurance Topic
of the ASC.
Ambac CVA on derivative product liabilities (excluding
credit derivatives): Elimination of the gain relating to
Ambac’s CVA embedded in the fair value of derivative
contracts other than credit derivatives. Similar to credit
derivatives, fair values include the market’s perception of
Ambac’s credit risk and this adjustment only allows for
such gain when realized.
Net unearned premiums and fees in excess of expected
losses: Addition of the value of the unearned premium
revenue ("UPR") on financial guarantee contracts, in
excess of expected losses, net of reinsurance. This non-
GAAP adjustment presents the economics of UPR and
expected losses for financial guarantee contracts on a
consistent basis. In accordance with GAAP, stockholders’
equity reflects a reduction for expected losses only to the
extent they exceed UPR. However, when expected losses
are less than UPR for a financial guarantee contract, neither
expected losses nor UPR have an impact on stockholders’
equity. This non-GAAP adjustment adds UPR in excess of
expected losses, net of reinsurance, to stockholders’ equity
for financial guarantee contracts where expected losses are
less than UPR.
Net unrealized investment (gains) losses in Accumulated
Other Comprehensive Income: Elimination of
the
unrealized gains and losses on the Company’s investments
that are recorded as a component of accumulated other
comprehensive income (“AOCI”). The AOCI component
of the fair value adjustment on the investment portfolio
may differ from realized gains and losses ultimately
recognized by the Company based on the Company’s
investment strategy. This adjustment only allows for such
gains and losses in Adjusted Book Value when realized.
The following table reconciles Total Ambac Financial Group, Inc. stockholders’ equity to the non-GAAP measure Adjusted Book Value on a
total dollar amount and per share basis, for all periods presented:
($ in millions, except per share data) December 31,
$ Amount
Per Share
$ Amount
Per Share
Total Ambac Financial Group, Inc. stockholders’ equity
$
1,713.9
$
37.94
$
1,684.8
$
37.41
2016
2015
Adjustments:
Non-credit impairment fair value losses on credit derivatives
Insurance intangible asset
Ambac CVA on derivative product liabilities (excluding credit
derivatives)
Net unearned premiums and fees in excess of expected losses
Net unrealized investment (gains) losses in Accumulated Other
Comprehensive Income
Adjusted Book Value
11.4
(962.1)
(44.9)
732.2
(118.9)
0.25
(21.30)
(0.99)
16.21
(2.63)
19.0
(1,212.1)
(78.7)
905.7
(51.0)
$
1,331.7
$
29.48
$
1,267.6
$
0.42
(26.91)
(1.75)
20.11
(1.13)
28.15
| Ambac Financial Group, Inc. 68 2016 FORM 10-K |
Stockholders' equity effects of
financial guarantee VIE
consolidation: VIEs that were consolidated as a result of financial
guarantees provided by Ambac are accounted for on a fair value
basis. The impact on Total Ambac Financial Group, Inc. ("AFG")
stockholders' equity of these consolidated VIEs was $132.4 million
and $28.7 million at December 31, 2016 and 2015, respectively.
Had these financial guarantee VIEs been accounted for under the
provisions of the Financial Services Insurance Topic of the ASC,
the impact on AFG stockholders' equity would have been $139.2
million and $(123.1) million at December 31, 2016 and 2015,
respectively. The net impact of these different accounting bases on
AFG stockholders' equity (including per share amounts) was $6.7
million ($0.15 per share) and $(151.8) million ($3.37 per share),
at December 31, 2016 and 2015, respectively. This is supplemental
information only and is not a component of Adjusted Book Value.
Factors that impact changes to Adjusted Book Value include many
of the same factors that impact Adjusted Earnings, including the
majority of revenues and expenses, but generally exclude
components of premium earnings since they are embedded in prior
period's Adjusted Book Value through the net unearned premiums
and fees in excess of expected losses adjustment. Net unearned
premiums and fees in excess of expected losses will affect Adjusted
Book Value for (i) changes to future premium assumptions (e.g.
expected term, interest rates, foreign currency rates, time passage)
and (ii) changes to expected losses for policies which do not exceed
their related unearned premiums. The Adjusted Book Value
increase from December 31, 2015 to December 31, 2016 was
primarily driven by Adjusted earnings, partially offset, as was
shareholders' equity, by foreign exchange losses resulting
primarily as a consequence of the Brexit referendum vote.
Item 7A. Quantitative and Qualitative Disclosures
about Market Risk
Market risk represents the potential for losses that may result from
changes in the value of a financial instrument as a result of changes
in market conditions. The primary market risks that would impact
the value of Ambac’s financial instruments are interest rate risk,
credit spread risk and foreign currency exchange risk. Below we
discuss each of these risks and the specific types of financial
instruments impacted. Senior managers are responsible for
developing and applying methods to measure risk. The estimation
of potential losses arising from adverse changes in market
conditions is a key element in managing market risk. Ambac
utilizes various systems, models and sensitivity scenarios to
monitor and manage market risk. These models include estimates,
made by management, which utilize current and historical market
information. The valuation results from these models could differ
materially from amounts that would actually be realized in the
market. Financial instruments of VIEs that are consolidated as a
result of Ambac's financial guarantees are excluded from the
market risk measures below.
Interest Rate Risk:
Financial instruments for which fair value may be affected by
changes in interest rates consist primarily of fixed income
investment securities, loans, investment agreements, long-term
debt and interest rate derivatives. Interest rate increases
(decreases)would also have a negative (positive) economic
impact on expected future claim payments within the financial
guarantee portfolio. Fixed income investment securities that are
guaranteed by Ambac have interest rate characteristics that
behave inversely to those associated with future financial
guarantee claim payments. Accordingly, such securities are
excluded from the interest rate sensitivity table below.
The following table summarizes the estimated change in fair value
(based primarily on the valuation methodology discussed in Note
9. Fair Value Measurements to the Consolidated Financial
Statements included in Part II, Item 8 in this Form 10-K) on these
financial instruments, assuming immediate changes in interest
rates at specified levels at December 31, 2016:
($ in millions)
Estimated change in net fair value
Estimated net fair value
(1)
Incorporates an interest rate floor of 0%
Change in Interest Rates (2)
300 Basis Point
Rise
200 Basis Point
Rise
100 Basis Point
Rise
Base Scenario
100 Basis Point
Decline(1)
200 Basis Point
Decline(1)
$
$
122
1,856
90
1,824
50
1,784
—
1,734
(62)
1,672
(146)
1,588
(2) Due to the low interest rate environment as of December 31, 2016, stress scenarios involving interest rate declines greater than 200 basis points are not
meaningful to Ambac's portfolios.
Changes in fair value resulting from changes in interest rates are
driven primarily by the impact of interest rate shifts on the
investment portfolio and loans (which declines in value as rates
increase) and the interest rate swap portfolio, long-term debt and
investment agreements (which increases in value as rates increase).
The interest rate derivatives portfolio is managed with the goal of
retaining some interest rate sensitivity as an economic hedge
against the effects of rising interest rates elsewhere in the Company,
including on Ambac’s financial guarantee exposures (the “macro-
hedge”). The interest rate sensitivity of the interest rate swap
portfolio attributable to the macro-hedge position would produce
mark-to-market gains or losses of approximately $0.6 million for
a 1 basis point parallel shift in USD swap rates up or down at
December 31, 2016. The impact of the macro-hedge is included
in the interest rate sensitivity table above.
The estimation of potential losses arising from adverse changes in
market relationships, known as “Value-at-Risk” (“VaR”), is a
consideration in management’s monitoring of interest rate risk for
the interest rate swap portfolio. Ambac has developed a VaR
methodology to estimate potential losses using a one day time
horizon and a 99% confidence level. This means that Ambac would
expect to incur losses due to changes in interest rates greater than
that predicted by VaR estimates only once in every 100 trading
days, or about 2.5 times a year. Ambac’s methodology estimates
VaR using a 300-day historical “look back” period. This means
that changes in market values are simulated using market inputs
from the past 300 days. For the year ended December 31, 2016,
Ambac’s
interest rate derivative portfolio VaR averaged
approximately $15.2 million, and ranged from a high of $16.2
million to a low of $14.3 million. These VaR measures are intended
| Ambac Financial Group, Inc. 69 2016 FORM 10-K |
to focus on the impact of observable market rates and therefore
exclude fair value adjustments made by management to
risk. Ambac
incorporate Ambac or counterparty credit
supplements its VaR methodology, which it believes is a good risk
management tool in normal markets, by performing scenario
testing to measure the potential for losses in volatile markets. These
scenario tests include parallel and non-parallel shifts in the
benchmark interest rate curve.
Credit Spread Risk:
Financial instruments that may be adversely affected by changes
in spreads include Ambac’s outstanding credit derivative contracts,
certain interest rate swap contracts and investment assets. Changes
in spreads are generally caused by changes in the market’s
perception of the credit quality of the underlying obligor. Market
liquidity and prevailing risk premiums demanded by market
participants are also reflected in spreads and impact valuations.
The following table summarizes the estimated change in fair values
on Ambac’s net derivative liabilities assuming immediate parallel
shifts in reference obligation credit spreads related to written credit
derivatives and counterparty credit
to
uncollateralized interest rate swaps at December 31, 2016. It is
more likely that actual changes in credit spreads will vary by
obligor:
spreads
related
($ in millions)
Estimated change in fair value
Estimated fair value
Change in Obligor Spreads
250 Basis Point
Widening
50 Basis Point
Widening
Base Scenario
50 Basis Point
Narrowing
250 Basis Point
Narrowing
$
$
(37)
(279)
(7)
(249)
—
(242)
7
(235)
29
(213)
Also included in the fair value of credit derivative liabilities is the
effect of Ambac’s creditworthiness, which reflects market
perception of Ambac’s ability to meet its obligations. Incorporating
estimates of Ambac’s credit valuation adjustment into the
determination of fair value has resulted in a $1.9 million reduction
to the credit derivatives liability as of December 31, 2016. At
December 31, 2016 the credit valuation adjustment resulted in a
11.1% reduction of the credit derivative liability as measured
before considering Ambac credit risk. Refer to Note 9. Fair Value
Measurements to the Consolidated Financial Statements included
in Part II, Item 8 in this Form 10-K for further information on
measurement of the credit valuation adjustment.
The fair value of interest rate swaps may also be affected by
changes to the credit valuation adjustment attributable to the risk
of Ambac non-performance. Generally, the need for an Ambac
credit valuation adjustment is mitigated by the existence of
collateral posting agreements under which adequate collateral has
been posted. Derivative contracts entered into with credit exposure
to financial guarantee customers are not typically subject to
collateral posting agreements. Estimates of Ambac’s credit
valuation adjustment included in the fair value of interest rate
swaps reduced the derivative liability fair value by $44.9 million
as of December 31, 2016.
The following table summarizes the estimated change in fair values
on Ambac's credit derivative and interest rate swap net liabilities
assuming immediate shifts in Ambac credit spreads used to
determine the CVA at December 31, 2016:
($ in millions)
Estimated change in fair value
Estimated fair value
Change in Ambac Credit Spreads
250 Basis Point
Widening
50 Basis Point
Widening
Base Scenario
50 Basis Point
Narrowing
250 Basis Point
Narrowing
$
$
24
(218)
6
(236)
—
(242)
(4)
(246)
(31)
(273)
Ambac’s fixed income investment portfolio contains securities
with different sensitivities to and volatility of spreads. Fixed
income securities that are guaranteed by Ambac and are in Ambac's
investment portfolio are excluded from the company's spread
sensitivity measures. The following table summarizes the
estimated change in fair values of Ambac’s fixed income
investment portfolio assuming immediate shifts in credit spreads
across all holdings at December 31, 2016. It is more likely that
actual changes in credit spreads will vary by security:
($ in millions)
Estimated change in fair value
Estimated fair value
Change in Spreads
250 Basis Point
Widening
50 Basis Point
Widening
Base Scenario
50 Basis Point
Narrowing
250 Basis Point
Narrowing
$
$
(281)
3,152
(56)
3,377
—
3,433
58
3,491
289
3,722
| Ambac Financial Group, Inc. 70 2016 FORM 10-K |
Foreign Currency Risk:
Ambac has financial instruments denominated in currencies other
than the U.S. dollar, primarily Pounds Sterling, Euros and
Australian dollars. These financial instruments are primarily
invested assets of Ambac UK and credit derivatives. The following
table summarizes the estimated net change in fair value of these
financial instruments assuming immediate shifts in spot foreign
exchange rates to U.S. dollars as of December 31, 2016.
($ in millions)
Estimated change in fair value
Change in Foreign Exchange Rates Against U.S. Dollar
20% Decrease
10% Decrease
10% Increase
20% Increase
$
(44) $
(22) $
22
$
44
| Ambac Financial Group, Inc. 71 2016 FORM 10-K |
Item 8.
Financial Statements and Supplementary Data
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firm ..................................................................................................................
Consolidated Balance Sheets...................................................................................................................................................................
Consolidated Statements of Total Comprehensive Income.....................................................................................................................
Consolidated Statements of Stockholders’ Equity...................................................................................................................................
Consolidated Statements of Cash Flows..................................................................................................................................................
Notes to Consolidated Financial Statements ...........................................................................................................................................
Note 1. Background and Business Description.....................................................................................................................................
Note 2. Basis of Presentation and Significant Accounting Policies......................................................................................................
Note 3. Special Purpose Entities, Including Variable Interest Entities.................................................................................................
Note 4. Comprehensive Income............................................................................................................................................................
Note 5. Net Income Per Share...............................................................................................................................................................
Note 6. Financial Guarantees in Force..................................................................................................................................................
Note 7. Financial Guarantee Insurance Contracts.................................................................................................................................
Note 8. Insurance Regulatory Restrictions ...........................................................................................................................................
Note 9. Fair Value Measurements.........................................................................................................................................................
Note 10. Investments.............................................................................................................................................................................
Note 11. Derivative Instruments ...........................................................................................................................................................
Note 12. Loans ......................................................................................................................................................................................
Note 13. Long-term Debt ......................................................................................................................................................................
Note 14. Obligations Under Investment Agreements ...........................................................................................................................
Note 15. Income Taxes..........................................................................................................................................................................
Note 16. Employment Benefit Plans.....................................................................................................................................................
Note 17. Commitments and Contingencies...........................................................................................................................................
Note 18. Segment Information..............................................................................................................................................................
Note 19. Quarterly Information (Unaudited) ........................................................................................................................................
Page
73
75
76
77
78
80
86
100
105
105
107
108
114
117
131
137
140
140
141
142
144
148
154
156
| Ambac Financial Group, Inc. 72 2016 FORM 10-K |
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Ambac Financial Group, Inc.:
We have audited Ambac Financial Group, Inc. and subsidiaries' (the “Company” or “Ambac”) internal control over financial reporting as of
December 31, 2016, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying
Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.
Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides
a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A
company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors
of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition
of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Ambac maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on
criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated
balance sheets of Ambac as of December 31, 2016 and 2015, and the related consolidated statements of comprehensive income, stockholders’
equity, and cash flows for each of the years in the three-year period ended December 31, 2016, and our report dated February 28, 2017, expressed
an unqualified opinion on those consolidated financial statements. The opinion refers to Note 1, which describes factors that raise substantial
doubt about Ambac’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The
consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
/s/ KPMG
New York, New York
February 28, 2017
| Ambac Financial Group, Inc. 73 2016 FORM 10-K |
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Ambac Financial Group, Inc.:
We have audited the accompanying consolidated balance sheets of Ambac Financial Group, Inc. and subsidiaries (the “Company”) as of
December 31, 2016 and 2015, and the related consolidated statements of comprehensive income, stockholders’ equity and cash flows for each
of the years in the three-year period ended December 31, 2016. In connection with our audits of the consolidated financial statements, we
also have audited the related financial statement schedules in this Form 10-K. These consolidated financial statements and financial statement
schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial
statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Ambac
Financial Group, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of
the the years in the three-year period ended December 31, 2016 in conformity with U.S. generally accepted accounting principles. Also in our
opinion, the related financial statement schedules, when considered in relation to the consolidated financial statements taken as a whole, present
fairly, in all material respects, the information set forth therein.
The accompanying consolidated financial statements and financial statement schedules have been prepared assuming that the Company will
continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the significant deterioration of the guaranteed
portfolio has adversely impacted the financial condition of the Company’s operating subsidiary, Ambac Assurance Corporation resulting in
significant regulatory oversight by the Office of the Commissioner of Insurance of the State of Wisconsin, including the rehabilitation of a
segregated account of Ambac Assurance Corporation. This raises substantial doubt about the Company’s ability to continue as a going concern.
Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements and financial statement
schedules do not include any adjustments that might result from the outcome of these uncertainties.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's
internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework
(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 28, 2017
expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
/s/ KPMG
New York, New York
February 28, 2017
| Ambac Financial Group, Inc. 74 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except share data) December 31,
2016
2015
Assets:
Investments:
Fixed income securities, at fair value (amortized cost of $5,435,385 and $4,992,756)
Fixed income securities pledged as collateral, at fair value (amortized cost of $64,833 and $64,612)
Short-term investments, at fair value (amortized cost of $430,827 and $225,789)
Other investments (includes $420,303 and $285,261 at fair value)
Total investments
Cash and cash equivalents
Receivable for securities
Investment income due and accrued
Premium receivables
Reinsurance recoverable on paid and unpaid losses
Deferred ceded premium
Subrogation recoverable
Loans
Derivative assets
Insurance intangible asset
Other assets
Variable interest entity assets:
Fixed income securities, at fair value
Restricted cash
Loans, at fair value
Derivative assets
Other assets
Total assets
Liabilities and Stockholders’ Equity:
Liabilities:
Unearned premiums
Loss and loss expense reserves
Ceded premiums payable
Obligations under investment agreements
Deferred taxes
Current taxes
Long-term debt
Accrued interest payable
Derivative liabilities
Other liabilities
Payable for securities purchased
Variable interest entity liabilities:
Accrued interest payable
Long-term debt, at fair value
Derivative liabilities
Other liabilities
Total liabilities
Commitments and contingencies (see Note 18)
Stockholders’ equity:
Preferred stock, par value $0.01 per share; 20,000,000 shares authorized shares; issued and outstanding
shares—none
Common stock, par value $0.01 per share; 130,000,000 shares authorized; issued and outstanding shares:
45,194,954 and 45,044,222
Additional paid-in capital
Accumulated other comprehensive income (loss)
Retained earnings
Treasury stock, shares at cost: 22,458 and 8,202
Total Ambac Financial Group, Inc. stockholders’ equity
Noncontrolling interest
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying Notes to Consolidated Financial Statements
| Ambac Financial Group, Inc. 75 2016 FORM 10-K |
$
$
$
$
$
$
$
5,554,215
64,905
430,788
450,307
6,500,215
91,025
2,090
26,023
661,337
30,418
69,624
684,731
4,160
77,742
962,080
158,423
2,622,566
4,873
10,658,963
80,407
1,025
22,635,702
967,258
4,380,769
42,529
82,358
1,720
14,280
1,114,405
421,975
319,286
76,589
1,084
859
11,155,936
2,078,601
29
20,657,678
—
452
195,267
(38,990)
1,557,681
(496)
1,713,914
264,110
1,978,024
22,635,702
$
5,043,776
64,555
225,789
310,600
5,644,720
35,744
44,030
25,264
831,575
43,999
96,758
1,229,293
5,206
84,995
1,212,112
185,877
2,588,556
5,822
11,690,324
—
3,795
23,728,070
1,280,282
4,088,106
53,494
100,358
2,205
5,835
1,124,950
355,536
353,358
61,134
84,690
3,230
12,327,960
1,928,403
183
21,769,724
—
450
190,813
15,215
1,478,439
(118)
1,684,799
273,547
1,958,346
23,728,070
(Dollars in thousands, except share data) Year Ended December 31,
2016
2015
2014
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Total Comprehensive Income
$
197,287
$
312,595
$
246,360
Revenues:
Net premiums earned
Net investment income:
Securities available-for-sale and short-term
Other investments
Total net investment income
Other-than-temporary impairment losses:
Total other-than-temporary impairment losses
Portion of other-than-temporary impairment recognized in other comprehensive income
Net other-than-temporary impairment losses recognized in earnings
Net realized investment gains
Change in fair value of credit derivatives:
Realized gains and other settlements
Unrealized gains (losses)
Net change in fair value of credit derivatives
Derivative products
Net realized gains (losses) on extinguishment of debt
Other income
Income (loss) on variable interest entities
Total revenues before expenses and reorganization items
Expenses:
Losses and loss expenses (benefit)
Insurance intangible amortization
Operating expenses
Interest expense
Goodwill impairment
Total expenses (benefit) before reorganization items
Pre-tax income before reorganization items
Reorganization items
Pre-tax income
Provision for income taxes
Net income
Less: net gain (loss) attributable to noncontrolling interest
Net income attributable to common shareholders
Other comprehensive income, after tax:
Net income
Unrealized gains (losses) on securities, net of deferred income taxes of $0
Gains (losses) on foreign currency translation, net of deferred income taxes of $0
Changes to postretirement benefit, net of tax of $0
Total other comprehensive income (loss), net of tax
Total comprehensive income
Less: comprehensive (loss) gain attributable to the noncontrolling interest:
Net gain (loss)
Currency translation adjustments
Total comprehensive income attributable to Ambac Financial Group, Inc.
Net income per share attributable to Ambac Financial Group, Inc. common shareholders
Basic
Diluted
See accompanying Notes to Consolidated Financial Statements
$
$
$
$
$
281,049
32,318
313,367
(89,700)
67,881
(21,819)
39,284
912
19,194
20,106
(50,273)
4,845
17,445
(14,093)
506,149
(11,489)
174,608
113,660
124,344
—
401,123
105,026
—
105,026
30,709
74,317
(526)
74,843
74,317
67,900
(122,128)
23
(54,205)
20,112
(526)
—
20,638
1.66
1.64
$
$
$
$
$
249,337
16,952
266,289
(66,692)
41,033
(25,659)
53,476
2,785
38,916
41,701
(42,544)
81
7,150
31,569
644,658
(768,707)
169,557
102,702
116,537
514,511
134,600
510,058
—
510,058
17,364
492,694
(709)
493,403
492,694
(159,730)
(45,025)
(687)
(205,442)
287,252
(709)
(374)
288,335
10.92
10.72
$
$
$
$
$
292,838
8,108
300,946
(26,632)
838
(25,794)
58,777
3,043
20,863
23,906
(181,087)
(74,724)
12,498
(32,212)
328,670
(545,574)
151,830
101,474
127,476
—
(164,794)
493,464
211
493,253
9,557
483,696
(375)
484,071
483,696
252,603
(43,599)
(816)
208,188
691,884
(375)
(434)
692,693
10.73
10.31
| Ambac Financial Group, Inc. 76 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
(Dollars in thousands)
Total
Ambac Financial Group, Inc.
Retained
Earnings
Accumulated
Other
Comprehensive
Income
Preferred
Stock
Common
Stock
Additional
Paid-in
Capital
Common
Stock Held
in Treasury,
at Cost
Noncontrolling
Interest
Balance at January 1, 2016
$ 1,958,346
$ 1,478,439
$
15,215
$
— $
450
$
190,813
$
(118) $
273,547
Total comprehensive income
20,112
74,843
(54,205)
Adjustment to initially apply
ASU 2014-13
Stock-based compensation
Cost of shares (acquired) issued
under equity plan
Cost of warrants acquired
Issuance of common stock
Deconsolidation of a variable
interest entity
—
5,253
(505)
(2,717)
2
(2,469)
6,442
—
(127)
(1,916)
—
—
Warrants exercised
2
Balance at December 31, 2016 $ 1,978,024
—
$ 1,557,681
Balance at January 1, 2015
$ 1,673,735
$
989,290
$
$
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(38,990) $
—
— $
—
—
—
—
—
2
—
—
452
220,283
$
— $
450
493,403
(205,068)
Total comprehensive income
Stock-based compensation
Cost of shares (acquired) issued
under equity plan
Cost of warrants acquired
287,252
3,105
(374)
(5,375)
—
(312)
(3,942)
Warrants exercised
3
Balance at December 31, 2015 $ 1,958,346
—
$ 1,478,439
Balance at January 1, 2014
$
978,422
$
505,219
Total comprehensive income
691,884
484,071
Stock-based compensation
Cost of shares acquired
3,450
(37)
—
—
Warrants exercised
16
Balance at December 31, 2014 $ 1,673,735
$
—
989,290
See accompanying Notes to Consolidated Financial Statements
—
—
—
—
15,215
11,661
208,622
—
—
—
220,283
$
$
$
$
$
$
—
—
—
—
—
— $
—
—
—
—
—
450
— $
450
—
—
—
—
— $
—
—
—
—
450
—
—
5,253
—
(801)
—
—
2
195,267
189,138
—
3,105
—
(1,433)
3
190,813
185,672
—
3,450
—
16
189,138
$
$
$
$
$
$
$
$
$
$
—
—
—
(378)
—
—
—
—
(496) $
(526)
(6,442)
—
—
—
—
(2,469)
—
264,110
(56) $
274,630
—
—
(62)
—
(1,083)
—
—
—
—
(118) $
—
273,547
(19) $
275,439
—
—
(37)
(809)
—
—
—
(56) $
—
274,630
| Ambac Financial Group, Inc. 77 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands) Year Ended December 31,
Cash flows from operating activities:
Net income (loss) attributable to common shareholders
Noncontrolling interest in subsidiaries’ earnings
Net income (loss)
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization
Impairment of goodwill
Amortization of bond premium and discount
Reorganization items
Share-based compensation
Deferred income taxes
Current income taxes
Unearned premiums, net
Losses and loss expenses, net
Ceded premiums payable
Investment income due and accrued
Premium receivables
Accrued interest payable
Amortization of insurance intangible assets
Net mark-to-market (gains) losses
Net realized investment gains
Other-than-temporary impairment charges
(Gain) loss on extinguishment of debt
Variable interest entity activities
Other, net
Net cash provided by (used in) operating activities
Cash flows from investing activities:
Proceeds from sales of bonds
Proceeds from matured bonds
Purchases of bonds
Proceeds from sales of other invested assets
Purchases of other invested assets
Change in short-term investments
Loans, net
Change in cash collateral receivable
Other, net
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Proceeds from the sale of Junior Surplus Notes of the Segregated Account
Net proceeds received from a secured borrowing
Paydowns of a secured borrowing
Payments for investment agreement draws
Payments for extinguishment of long-term debt
Proceeds from warrant exercises
Cost of warrants acquired
Net cash provided by (used in) financing activities
Effect of foreign exchange on cash and cash equivalents
Net cash flow
Cash and cash equivalents at beginning of period
Cash and cash equivalents end of period
See accompanying Notes to Consolidated Financial Statements
2016
2015
2014
$
74,843
$
493,403
$
(526)
74,317
1,220
—
(150,061)
—
5,253
(485)
9,727
(289,140)
853,978
(10,965)
(750)
172,331
66,439
174,608
(19,194)
(39,284)
21,819
(4,845)
14,093
(35,521)
843,540
867,882
1,317,215
(2,574,285)
131,703
(281,570)
(206,002)
1,046
27,372
1,996
(714,643)
(709)
492,694
3,215
514,511
(129,584)
—
3,104
126
134
(372,907)
(799,399)
(6,942)
(280)
174,918
51,397
169,557
(38,916)
(53,476)
25,659
(81)
(31,569)
89,648
91,809
996,427
1,029,026
(2,374,441)
178,474
(128,186)
134,423
508
(6,833)
(5,143)
(175,745)
—
—
(29,482)
(17,964)
(19,550)
2
(2,717)
(69,711)
(3,905)
55,281
35,744
91,025
$
—
143,430
(13,533)
(63,872)
(13,752)
3
(5,375)
46,901
(1,124)
(38,159)
73,903
35,744
$
$
484,071
(375)
483,696
3,582
—
(79,183)
211
3,450
(120)
4,963
(576,018)
(1,652,854)
(10,526)
12,647
470,191
9,322
151,830
(20,863)
(58,777)
25,794
74,724
32,212
157,899
(967,820)
3,120,592
1,402,904
(2,937,744)
49,271
(133,928)
(87,554)
465
(153,853)
11,574
1,271,727
224,262
—
—
(199,970)
(331,419)
16
—
(307,111)
(263)
(3,467)
77,370
73,903
| Ambac Financial Group, Inc. 78 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (continued)
(Dollars in thousands) Year Ended December 31,
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income taxes
Interest on secured borrowing
Interest on investment agreements
Interest on surplus notes
Cash payments related to reorganization items:
Professional fees paid for services rendered in connection with the Chapter 11 proceeding
See accompanying Notes to Consolidated Financial Statements
2016
2015
2014
$
21,437
$
16,969
$
3,923
614
—
—
1,506
341
—
—
4,400
—
518
82,168
272
| Ambac Financial Group, Inc. 79 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
1. BACKGROUND AND BUSINESS DESCRIPTION
Background:
Ambac Financial Group, Inc. (“Ambac” or the “Company”), headquartered in New York City, is a financial services holding company that
was incorporated in the state of Delaware on April 29, 1991. On May 1, 2013 (the “Effective Date”), Ambac emerged from Chapter 11
bankruptcy protection when the Second Modified Fifth Amended Plan of Reorganization of Ambac Financial Group, Inc. (the “Reorganization
Plan”) became effective. On December 26, 2013, the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy
Court”) entered an order of final decree closing Ambac’s Chapter 11 case. Ambac filed a voluntary petition for relief under Chapter 11 of the
United States Bankruptcy Code (the “Bankruptcy Code”) in the Bankruptcy Court on November 8, 2010 as a result of losses incurred since
the beginning of the financial crisis in 2007.
As provided for in the Reorganization Plan, Ambac’s Amended and Restated Certificate of Incorporation and revised Bylaws became effective
on the Effective Date. On February 28, 2014, Ambac’s Bylaws were amended, primarily to (i) revise the advance notice provisions for
stockholders proposing business or nominating directors; (ii) add procedural and disclosure requirements for stockholders proposing business
or nominating directors, calling special meetings or taking action by written consent; (iii) add a forum selection clause specifying state or
federal courts located in the State of Delaware as the sole and exclusive forum for proceedings which, among other things, (A) are brought
on behalf of Ambac, (B)claim breaches of fiduciary duty, (C) involve claims arising under Ambac’s governing documents or the Delaware
General Corporation Law, or (D) are governed by the internal affairs doctrine; and (iv) update other bylaw provisions, including revisions
related to the use of electronic communication technologies. Pursuant to the Amended and Restated Certificate of Incorporation of Ambac,
Ambac is authorized to issue 150,000,000 shares of capital stock, consisting of 130,000,000 shares of common stock, par value $0.01 per
share and 20,000,000 shares of preferred stock, par value $0.01 per share. Pursuant to the Reorganization Plan, Ambac distributed 45,000,000
shares of new common stock on May 1, 2013 and distributed warrants to holders of allowed general unsecured claims and subordinated debt
securities, which as of the Effective Date entitled such holders to acquire an additional 5,047,138 shares of new common stock of the Company
at an exercise price of $16.67 per share at any time on or prior to April 30, 2023. The new common stock and warrants are listed on NASDAQ
and trade under the symbols “AMBC” and “AMBCW,” respectively. All such common stock and warrants were issued without registration
under the Securities Act of 1933, as amended or state securities laws, in reliance on Section 1145 of the United States Bankruptcy Code. The
common stock of the Company in existence prior to the Effective Date was cancelled on the Effective Date.
Ambac’s Amended and Restated Certificate of Incorporation limits voting and transfer rights of stockholders in significant ways. Article IV
contains voting restrictions applicable to any person owning at least 10% of Ambac’s common stock so that such person (including any group
consisting of such person and any other person with whom such person or any affiliate or associate of such person has any agreement, contract,
arrangement or understanding with respect to acquiring, voting, holding or disposing of Ambac’s common stock) shall not be entitled to cast
votes in excess of one vote less than 10% of the votes entitled to be cast by all common stock holders, except as otherwise approved by OCI.
There are substantial restrictions on the ability to transfer Ambac’s common stock set forth in Article XII of Ambac’s Amended and Restated
Certificate of Incorporation. In order to preserve certain tax benefits, subject to limited exceptions, any attempted transfer of common stock
shall be prohibited and void to the extent that, as a result of such transfer (or any series of transfers of which such transfer is a part), either
(i) any person or group of persons shall become a holder of 5% or more of the Company’s common stock or (ii) the percentage stock ownership
interest in Ambac of any holder of 5% or more of the Company’s common stock shall be increased (a “Prohibited Transfer”). These restrictions
shall not apply to an attempted transfer if the transferor or the transferee obtains the written approval of Ambac’s Board of Directors to such
transfer. A purported transferee of a Prohibited Transfer shall not be recognized as a stockholder of Ambac for any purpose whatsoever in
respect of the securities which are the subject of the Prohibited Transfer (the “Excess Securities”). Until the Excess Securities are acquired by
another person in a transfer that is not a Prohibited Transfer, the purported transferee of a Prohibited Transfer shall not be entitled with respect
to such Excess Securities to any rights of stockholders of Ambac, including, without limitation, the right to vote such Excess Securities and
to receive dividends or distributions, whether liquidating or otherwise, in respect thereof, if any. Once the Excess Securities have been acquired
in a transfer that is not a Prohibited Transfer, the securities shall cease to be Excess Securities. If the Board determines that a transfer of
securities constitutes a Prohibited Transfer then, upon written demand by Ambac, the purported transferee shall transfer or cause to be transferred
any certificate or other evidence of ownership of the Excess Securities within the purported transferee’s possession or control, together with
any distributions paid by Ambac with respect to such Excess Securities, to an agent designated by Ambac. Such agent shall thereafter sell such
Excess Securities and the proceeds of such sale shall be distributed as set forth in the Amended and Restated Certificate of Incorporation. If
the purported transferee of a Prohibited Transfer has resold the Excess Securities before receiving such demand, such person shall be deemed
to have sold the Excess Securities for Ambac’s agent and shall be required to transfer to such agent the proceeds of such sale, which shall be
distributed as set forth in the Amended and Restated Certificate of Incorporation.
As of the Effective Date, the Company was generally discharged and released from all pre-Effective Date debts, liabilities, claims, causes of
action and interests in accordance with the provisions of the Reorganization Plan. Holders of claims and equity interests are also generally
barred from commencing or continuing any action or proceeding relating to such claims, causes of action or interests. The Reorganization
Plan also provides for broad exculpation and releases of the Company, Ambac Assurance, the Segregated Account (as defined below), OCI,
| Ambac Financial Group, Inc. 80 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
the Rehabilitator, the board of directors and board committees of the Company and Ambac Assurance, all individual directors, officers and
employees of the Company and Ambac Assurance, the Creditors’ Committee and the individual members thereof, and each of the respective
representatives of such parties, for actions or omissions that occurred on or prior to the Effective Date.
Business Description:
Ambac has two reportable business segments: Financial Guarantee and Financial Services.
Ambac’s financial guarantee business segment is conducted through its primary operating subsidiary, Ambac Assurance Corporation (“Ambac
Assurance”), and its wholly owned subsidiary, Ambac Assurance UK Limited (“Ambac UK”), both of which have been in runoff since 2008.
Insurance policies issued by Ambac Assurance and Ambac UK generally guarantee payment when due of the principal and interest on the
obligations guaranteed. Ambac Assurance also has another wholly-owned financial guarantee subsidiary, Everspan Financial Guarantee Corp.
(“Everspan”), which has been in runoff since its acquisition in 1997. The deterioration of Ambac Assurance’s financial condition resulting
from losses in its insured portfolio since 2007 has prevented Ambac Assurance from being able to write new business. An inability to write
new business has and will continue to negatively impact Ambac’s future operations and financial results. Ambac Assurance’s ability to pay
dividends and, as a result, Ambac’s liquidity, have been significantly restricted by the deterioration of its financial condition, by the rehabilitation
of the Segregated Account (as defined below) and by the terms of the Settlement Agreement, dated as of June 7, 2010 (the "Settlement
Agreement"), by and among Ambac Assurance, Ambac Credit Products LLC (“ACP”), Ambac and certain counterparties to credit default
swaps with ACP that were guaranteed by Ambac Assurance. Ambac Assurance is also restricted in its ability to pay dividends pursuant to
regulatory restrictions, the terms of its Auction Market Preferred Shares, and the terms of agreements entered into with the Segregated Account.
It is highly unlikely that Ambac Assurance will be able to make dividend payments to Ambac for the foreseeable future.
Ambac’s financial services business segment is currently conducted through subsidiaries of Ambac Assurance, which provide financial and
investment products, including investment agreements, funding conduits and interest rate swaps, principally to the clients of its financial
guarantee business. Ambac Assurance insures all of the obligations of its financial services subsidiaries. These businesses are in active runoff,
which is being effectuated by transaction terminations, settlements, and scheduled amortization of contracts. The Financial Services business
also maintains interest rate derivatives to mitigate exposure to floating rate insured obligations in the Financial Guarantee segment.
Ambac’s primary goal is to maximize shareholder value through executing the following key strategies:
• Active runoff of Ambac Assurance and its subsidiaries through transaction terminations, policy commutations, settlements and
restructurings that we believe will improve our risk profile, and maximizing the risk-adjusted return on invested assets;
•
•
•
•
Loss recovery through litigation and exercise of contractual and legal rights;
Improved cost effectiveness and efficiency of the operating platform;
Rationalization of Ambac's and its subsidiaries' capital and liability structures, enabling simplification of corporate governance and
facilitating the successful rehabilitation of the Segregated Account (as defined below); and
Selective business transactions offering attractive risk-adjusted returns that, among other things, may permit utilization of Ambac’s
net operating loss carry-forwards.
Ambac Assurance is evaluating the possibility of entering into one or more transactions to improve the financial condition of Ambac Assurance
which may, subject to OCI approval, lead to the conclusion of the Segregated Account Rehabilitation Proceedings. In pursuing this objective,
Ambac Assurance is considering the possibility of monetizing certain assets, restructuring or exchanging certain outstanding debt and insurance
obligations, and/or commuting or reducing insured exposures. Ambac Assurance is also discussing with OCI potential options for addressing
outstanding Segregated Account and other obligations. From time to time Ambac Assurance has also discussed, and intends to continue
discussing, with counterparty creditors and OCI a potential transaction pursuant to which outstanding Deferred Amounts and surplus notes,
in each case including accrued interest, would be exchanged for or satisfied by indebtedness, or other instruments which may include securities,
and cash or other assets. In evaluating potential transactions, we understand that OCI intends to consider, among other things, their impact on
the company and policyholders, and we intend to consider, among other things, their impact on the company and our stakeholders, including,
in each case, their legal, regulatory and tax implications.
However, Ambac Assurance has not reached any agreement on the terms of any such transaction, and we cannot provide any assurance that
any such transaction will be consummated by Ambac Assurance in the future, or if it is, as to the timing, terms or conditions of any such
transaction, or as to whether it could lead to the conclusion of the Segregated Account Rehabilitation Proceedings. Any such transaction
proposed by Ambac Assurance would be subject to the prior approval of the board of directors of Ambac Assurance, OCI and the Rehabilitation
Court and may require third-party consents, which may not be obtained. OCI has not indicated a course of action to address Segregated
Account or other obligations or to conclude the Segregated Account Rehabilitation Proceedings. As stated in the Supplement (as defined
below), the goal of the SDC (as defined below) is to provide additional directional guidance regarding the status of the Segregated Account
rehabilitation during the first quarter of 2017, barring any unforeseen developments that might impede that effort. The terms, conditions, and
| Ambac Financial Group, Inc. 81 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
timing of a potential conclusion of the Segregated Account Rehabilitation Proceedings are in the sole discretion of OCI, and subject to the
approval of the Rehabilitation Court. This discretion includes the authority to address Segregated Account obligations without the agreement
of Ambac Assurance or its board of directors. Moreover, even if the Segregated Account Rehabilitation Proceedings could be brought to a
successful conclusion, there can be no assurance that any level of capital deemed sufficient by OCI to permit such conclusion will be sufficient
to cover all future losses, whether currently anticipated or unanticipated.
The execution of Ambac’s strategy to actively runoff of Ambac Assurance and its subsidiaries is subject to the authority of the Rehabilitator
(as defined below) to control the management of the Segregated Account. In exercising such authority, the Rehabilitator will act for the benefit
of policyholders, and will not take into account the interests of Ambac. The Rehabilitator's authority includes, but is not limited to, sole
discretion over the rate at which the Segregated Account pays claims and the accretion rate on Deferred Amounts. Similarly, by operation of
the contracts executed in connection with the establishment, and subsequent rehabilitation, of the Segregated Account, the Rehabilitator retains
rights to oversee and approve certain actions taken by or in respect of Ambac Assurance. Accordingly, oversight by the Rehabilitator could
impair Ambac’s ability to execute certain of its strategies. Ambac Assurance's ability to commute policies or purchase certain investments
may also be limited by available liquidity. Opportunities for transaction terminations, policy commutations, settlements and restructurings
also depend on market conditions, including the perception of Ambac Assurance’s creditworthiness, the structure of the underlying risk and
associated policy as well as other counterparty specific factors.
Although we are exploring selective business transactions that may permit utilization of Ambac’s tax net operating loss carry-forwards, such
as the acquisition or development of new businesses or assets, no assurance can be given that we will be able to execute any such transactions.
In addition, there can be no assurance that we will be able to obtain the financial and other resources that may be required to finance such
transactions. Due to these factors, as well as uncertainties relating to the ability of Ambac Assurance to deliver value to Ambac, the value of
our securities is speculative.
As discussed in the Segregated Account of Ambac Assurance Corporation section below, the Rehabilitator has modified Ambac’s original
policy obligations allocated to the Segregated Account under the Rehabilitation Plan such that policyholders receive cash for a portion of their
claims and the right to receive Deferred Amounts on the unpaid balance of their claims. Such Deferred Amounts will be paid at the sole
discretion of the Rehabilitator. Furthermore, management’s ability to execute transactions to conclude the Rehabilitation Proceedings is also
subject to the sole discretion of the Rehabilitator. As a result of uncertainties associated with the oversight by the Rehabilitator of the Segregated
Account, management has concluded that there is substantial doubt about Ambac's ability to continue as a going concern within one year after
the date the financial statements are issued. Ambac’s financial statements as of and for the periods ending December 31, 2016 and 2015,
respectively, are prepared assuming Ambac continues as a going concern and do not include any adjustment that might result from its inability
to continue as a going concern.
Chapter 11 Reorganization of Ambac:
The Reorganization Plan reflects a resolution of certain issues (the “Amended Plan Settlement”) among the Company, the statutory committee
of creditors appointed by the United States Trustee on November 17, 2010 (the “Creditors’ Committee”), Ambac Assurance, the Segregated
Account and OCI related to (i) the net operating loss carry forwards (“NOLs”) of the consolidated tax group of which the Company is the
parent and Ambac Assurance is a member (the “Ambac Consolidated Group”), (ii) certain tax refunds received in respect thereof and (iii) the
sharing of expenses between the Company and Ambac Assurance. The terms of the Amended Plan Settlement are memorialized in that certain
Mediation Agreement dated September 21, 2011 (the “Mediation Agreement”) among such parties. In accordance with the Amended Plan
Settlement, the Company shall use its best efforts to preserve the use of NOLs as contemplated by the Amended Plan Settlement.
Pursuant to the Amended Plan Settlement, (i) the Company, Ambac Assurance and certain affiliates entered into an amended and restated tax
sharing agreement (the “Amended TSA”), (ii) the Company, Ambac Assurance and certain affiliates entered into an expense sharing and cost
allocation agreement (the “Cost Allocation Agreement”) and (iii) the Company, Ambac Assurance, the Segregated Account and OCI entered
into an amendment of the Cooperation Agreement (as defined below) (the “Cooperation Agreement Amendment”).
The Amended TSA addresses certain intercompany tax issues including, but not limited to, the allocation and use of NOLs by the Company,
Ambac Assurance and their respective subsidiaries. Refer to Note 15. Income Taxes for further discussion of the Amended TSA.
The Cost Allocation Agreement provides for the allocation of costs and expenses among the Company, Ambac Assurance and certain affiliates.
Additionally, the Cost Allocation Agreement requires Ambac Assurance to reimburse reasonable operating expenses incurred by the Company,
subject to an annual $5,000 limit until March 2017. From March 2017 such expense reimbursement provision can be extended in the sole
discretion of the rehabilitator subject to a $4,000 per year limit.
The Cooperation Agreement Amendment provides for the Rehabilitator to have certain rights as described below.
Segregated Account of Ambac Assurance Corporation:
In March 2010, Ambac Assurance established a Segregated Account pursuant to Wisc. Stat. §611.24 (2) (the “Segregated Account”) to segregate
certain segments of Ambac Assurance’s liabilities, and the Office of the Commissioner of Insurance for the State of Wisconsin (“OCI” (which
term shall be understood to refer to such office as regulator of Ambac Assurance and to refer to the Commissioner of Insurance for the State
| Ambac Financial Group, Inc. 82 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
of Wisconsin as rehabilitator of the Segregated Account (the “Rehabilitator”), as the context requires)) commenced rehabilitation proceedings
in the Dane County, Wisconsin Circuit Court (the “Rehabilitation Court”) with respect to the Segregated Account (the “Segregated Account
Rehabilitation Proceedings”) in order to permit OCI to facilitate an orderly run-off and/or settlement of the liabilities allocated to the Segregated
Account pursuant to the provisions of the Wisconsin Insurers Rehabilitation and Liquidation Act. Net par exposure as of December 31, 2016
for policies allocated to the Segregated Account was $11,884,751. Policy obligations not allocated to the Segregated Account remain in the
General Account of Ambac Assurance, and such policies in the General Account are not subject to and, therefore, are not directly impacted
by the Segregated Account Rehabilitation Plan (as defined below).
The Segregated Account is operated in accordance with a plan of operation (the “Plan of Operation”) and certain operative documents relating
thereto (which include the Secured Note (defined below), the Reinsurance Agreement (defined below), the Management Services Agreement,
dated as of March 24, 2010, by and between the Segregated Account and Ambac Assurance (the “Management Services Agreement”), the
Cost Allocation Agreement and the Cooperation Agreement, dated as of March 24, 2010, by and between the Segregated Account and Ambac
Assurance, as amended pursuant to the Cooperation Agreement Amendment (the “Cooperation Agreement”). Pursuant to such operative
documents, Ambac Assurance entered into certain covenants for the benefit of the Segregated Account as described below.
Pursuant to the Plan of Operation, Ambac Assurance allocated to the Segregated Account (1) certain policies insuring or relating to credit
default swaps; (2) residential mortgage-backed securities (“RMBS”) policies; (3) certain policies insuring debt obligations backed by student
loans; and (4) other policies insuring obligations with substantial projected impairments or relating to transactions which have contractual
triggers based upon Ambac Assurance’s financial condition or the commencement of rehabilitation, which triggers are potentially damaging
(collectively, the “Segregated Account Policies”). The policies described in (4) above include (a) certain types of securitizations, including
commercial asset-backed transactions, consumer asset-backed transactions and other types of structured transactions; (b) the policies relating
to Las Vegas Monorail Company; (c) policies relating to debt securities purchased by, and the debt securities issued by, Juneau Investments,
LLC (“Juneau”), which is a finance company owned by Ambac Assurance and allocated to the Segregated Account as described below;
(d) policies relating to leveraged lease transactions; and (e) certain policies relating to interest rate and other swap transactions. Ambac
Assurance also allocated the following to the Segregated Account: (i) all remediation claims, defenses, offsets, and/or credits (except with
respect to recoveries arising from remediation efforts or reimbursement or collection rights), if any, in respect of the Segregated Account
Policies, (ii) Ambac Assurance’s limited liability interests in ACP, Ambac Conduit Funding LLC and Juneau and (iii) all of Ambac Assurance’s
liabilities as reinsurer under reinsurance agreements (except for reinsurance assumed from Everspan).
In 2010, Ambac Assurance issued a $2,000,000 secured note due in 2050 (the “Secured Note”) to the Segregated Account. Interest on the
Secured Note accrued at the rate of 4.5% per annum, and accrued interest was capitalized and added to outstanding principal quarterly. The
Segregated Account had the ability to demand payment under the Secured Note from time to time to pay claims and other liabilities. In 2014,
the Secured Note, including capitalized interest since the date of issuance, was fully drawn. Following the exhaustion of the Secured Note,
the Segregated Account has the ability to demand payment from time to time under an aggregate excess of loss reinsurance agreement provided
by Ambac Assurance (the “Reinsurance Agreement”) to pay claims and other liabilities. In addition, certain operating and administrative costs
and expenses of the Segregated Account are now reimbursable by Ambac Assurance pursuant to the Cooperation Agreement. Ambac Assurance
secured its obligations under the Secured Note and the Reinsurance Agreement by granting to the Segregated Account a security interest in
all of Ambac Assurance’s right, title and interest in (i) installment premiums received in respect of the Segregated Account Policies;
(ii) reinsurance premiums received in respect of assumed reinsurance agreements with respect to which the liabilities of Ambac Assurance
have been allocated to the Segregated Account; (iii) recoveries under third party reinsurance agreements in respect of the Segregated Account
Policies; and (iv) any recoveries arising from remediation efforts or reimbursement or collection rights with respect to policies allocated to
the Segregated Account.
Ambac Assurance is not obligated to make payments under the Reinsurance Agreement or Cooperation Agreement if its surplus as regards to
policyholders is less than $100,000 (the “Minimum Surplus Amount”). As long as the surplus as regards to policyholders is not less than the
Minimum Surplus Amount, payments by Ambac Assurance to the Segregated Account under the Reinsurance Agreement and Cooperation
Agreement are not capped. At December 31, 2016 and 2015, Ambac Assurance’s surplus as regards to policyholders exceeds the Minimum
Surplus Amount. In the event that Ambac Assurance does not maintain surplus in excess of the Minimum Surplus Amount, the Segregated
Account would experience a shortfall in funds available to pay its liabilities. Any such shortfall would be a consideration for the Rehabilitator
in the determination of whether any changes to the Segregated Account Rehabilitation Plan (as defined above) and/or the amount of partial
policy claim payments are necessary or appropriate or whether to institute general rehabilitation proceedings against Ambac Assurance.
During the Segregated Account Rehabilitation Proceedings, the Rehabilitator controls the management of the Segregated Account and possesses
ultimate decision-making authority with respect to all matters relating to the policies allocated to the Segregated Account. Ambac Assurance
provides certain management and administrative services to the Segregated Account and the Rehabilitator pursuant to the Management Services
Agreement, including information technology services, credit exposure management, treasury, accounting, tax, management information, risk
management, loss management, internal audit services and business continuity services. Services are provided at cost, subject to mutual
agreement of the Segregated Account and Ambac Assurance. Either party may terminate the Management Services Agreement for cause upon
120 days written notice (or such shorter period as the Rehabilitator may determine) and the Segregated Account may terminate without cause
at any time upon at least 30 days prior notice. If the Segregated Account elects to terminate the Management Services Agreement, Ambac
Assurance will not have the right to consent to the replacement services provider.
| Ambac Financial Group, Inc. 83 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Pursuant to the Secured Note and the Reinsurance Agreement, Ambac Assurance has made certain covenants to the Segregated Account,
including covenants that Ambac Assurance will not, (i) without the Segregated Account’s consent (not to be unreasonably withheld), amend
its investment policies if doing so would have a material adverse effect on Ambac Assurance’s ability to perform its obligations under the
Secured Note, the Reinsurance Agreement and the documents relating thereto or under any other material agreement to which it is a party, (ii)
without the prior approval of the OCI, directly or indirectly make any distribution to its shareholder or redeem any of its securities and, (iii)
without the Segregated Account’s consent (not to be unreasonably withheld), enter into any transaction other than pursuant to the reasonable
requirements of Ambac Assurance’s business and which Ambac Assurance reasonably believes are fair and reasonable terms and provisions.
Pursuant to the Cooperation Agreement, Ambac Assurance and the Segregated Account have agreed to certain matters related to decision-
making, information sharing, tax compliance and allocation of expenses, including an agreement by Ambac Assurance to reimburse the
Segregated Account for specified expenses, subject to the Minimum Surplus Amount. Ambac Assurance has made certain covenants to the
Segregated Account pursuant to the Cooperation Agreement, including an agreement to not enter into any transaction involving consideration
or other proceeds of more than $5,000 (or such higher amount as determined by the Rehabilitator) without the Segregated Account’s prior
written consent (other than policy claim payments made in the ordinary course of business and investments in accordance with Ambac
Assurance’s investment policy), and providing the Segregated Account with an annual operating expense budget for Ambac Assurance and
its subsidiaries, as well as quarterly analyses of variances. The Cooperation Agreement also addresses Ambac Assurance’s rights in the event
Ambac Assurance is no longer the management and administrative services provider to the Segregated Account as described above. The
Cooperation Agreement Amendment made each of the Company and the Rehabilitator a party to the Cooperation Agreement and provides the
Rehabilitator with certain additional approval rights with respect to (a) the tax positions taken by the Company in its consolidated tax return;
(b) the acceptance by Ambac Assurance of the repayment of intercompany loans or the modification of the terms thereof; (c) changes by
Ambac Assurance in the assumptions or vendors utilized in determining loss reserves determined in accordance with Statutory Accounting
Principles; and (d) changes to Ambac Assurance’s investment policy and transfer of the investment management function for Ambac Assurance’s
investment portfolio.
On October 8, 2010, OCI filed a plan of rehabilitation for the Segregated Account (the “Segregated Account Rehabilitation Plan”) in the
Rehabilitation Court. The Rehabilitation Court confirmed the Segregated Account Rehabilitation Plan on January 24, 2011, although it did
not become effective at such time. The confirmed Segregated Account Rehabilitation Plan also made permanent the injunctions issued by the
Rehabilitation Court on March 24, 2010. On June 4, 2012, the Rehabilitation Court approved a motion made by the Rehabilitator to make
partial interim policy claim payments to Segregated Account policyholders. In accordance with such approval, on August 1, 2012, the
Rehabilitator promulgated Rules Governing the Submission, Processing and Partial Payment of Policy Claims in accordance with the June 4,
2012 Interim Cash Payment Order (the “Policy Claim Rules”). Pursuant to the Policy Claim Rules, effective from August 1, 2012, holders of
policies allocated to the Segregated Account were allowed to submit policy claims for review and partial payment equating to 25% of the
permitted policy claim amount, and on or about September 20, 2012, the Segregated Account commenced paying 25% of each permitted
policy claim that arose since the commencement of the Segregated Account Rehabilitation Proceedings.
On July 11, 2013 the Rehabilitator filed a motion with the Rehabilitation Court seeking approval from the Rehabilitation Court for the Segregated
Account to make cash payments in excess of 25% of the permitted policy claim amount (“Supplemental Payments”) with respect to certain
policies (the “SP Policies”) so that cash flow in the related securitization trusts that would have been available to reimburse Ambac Assurance
had it paid claims in full under such policies is not diverted to uninsured holders who would not have received such cash flow if claims had
been paid in full. Without making such Supplemental Payments, Ambac Assurance would likely realize lower levels of reimbursements and
subrogation recoveries as cash flow that would have been available for the benefit of Ambac Assurance in relation to the SP Policies would
be lost to such uninsured holders. A hearing on such motion was held on August 2, 2013, following which the Rehabilitation Court granted
such motion and entered an order permitting Supplemental Payments to be made with respect to the SP Policies. As a result, the Segregated
Account has been making Supplemental Payments on SP Policies since August 2013. On February 13, 2014, the Rehabilitator also received
approval from the Rehabilitation Court for the Rehabilitator and the Segregated Account to disburse settlement proceeds from RMBS
remediation claims as permitted policy claim payments, with such distributions to include (i) paying claims payments in excess of the then
applicable claims cash payment percentage, and/or (ii) paying all or portions of unpaid permitted policy claims (such policy claim payments,
“Special Policy Payments”).
On January 17, 2014, the Rehabilitator filed a motion to obtain court approval to disburse settlement proceeds as permitted policy claim
payments to specific policyholders as required by a settlement entered into with Residential Capital, LLC and related debtors in bankruptcy
proceedings in the U.S. Bankruptcy Court for the Southern District of New York (the “ResCap Settlement”). In addition to seeking this approval
with respect to the ResCap Settlement, the motion sought the court’s confirmation of the Rehabilitator’s authority to distribute proceeds from
settlements of RMBS remediation claims as he deems appropriate and in the best interests of the Segregated Account and such distributions
may include (i) paying claims by making payments in excess of the then applicable claims cash payment percentage, and/or (ii) paying all or
portions of unpaid permitted policy claims. On February 7, 2014, three RMBS trustees jointly filed a partial objection to the motion. On
February 13, 2014, the Rehabilitation Court heard argument on this motion and issued an order approving the Rehabilitator’s motion.
On June 11, 2014, the Rehabilitation Court approved amendments to the Segregated Account Rehabilitation Plan that had been proposed by
the Rehabilitator, and the Segregated Account Rehabilitation Plan, as amended, became effective on June 12, 2014. The amendments to the
Segregated Account Rehabilitation Plan primarily modified the mechanism for handling claims. Instead of the combination of cash payments
| Ambac Financial Group, Inc. 84 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
and interest-bearing surplus notes originally contemplated by the Segregated Account Rehabilitation Plan, under the amended Segregated
Account Rehabilitation Plan holders of permitted policy claims have received and will receive an initial interim cash payment for a portion
of such policy claim (“Interim Payment”), together with the right to receive a deferred payment equal to the balance of the unpaid policy
claim, as may be adjusted from time to time pursuant to the terms of the amended Segregated Account Rehabilitation Plan (“Deferred Amount”).
Payments of Deferred Amounts will be made at such times as the Rehabilitator deems appropriate in his sole discretion. The Segregated
Account will also establish junior deferred amounts (“Junior Deferred Amounts”) with respect to permitted general claims instead of issuing
junior surplus notes to the holders of such claims as contemplated under the original Segregated Account Rehabilitation Plan.
Under the amended Segregated Account Rehabilitation Plan, Deferred Amounts and Junior Deferred Amounts generally accrue and compound
interest at an annual effective rate of 5.1%. However, in the case of insured bonds whose outstanding principal balance is not reduced by the
unpaid portion of permitted policy claims (such bonds, “Undercollateralized Bonds”), the 5.1% effective annual interest rate on the Deferred
Amount will be reduced by the bond interest rate applicable to such Undercollateralized Bonds. In the case of permitted policy claims relating
to transactions that pay monthly, interest will begin to accrue on Deferred Amounts from the first distribution date (under the transaction
documents for the relevant bond) after the date on which the Interim Payment in respect of such permitted policy claim was made. For permitted
policy claims relating to transactions that do not pay monthly, interest will begin to accrue on Deferred Amounts from the first Payment Date
(as defined in the Segregated Account Rehabilitation Plan, as amended) to occur after the date on which the Interim Payment in respect of
such permitted policy claim was made.
Following the effective date of the Segregated Account Rehabilitation Plan, as amended, the IPP for permitted policy claims increased from
25% to 45% with effect from July 21, 2014. As with previously permitted policy claims, the remaining portion of the unpaid permitted policy
claims (in this case, 55%) will remain outstanding as Deferred Amounts and, subject to the adjustment for Undercollateralized Bonds, will
accrue interest at 5.1% per annum. These Deferred Amounts, together with interest thereon, may be paid from time to time in the future at the
sole discretion of the Rehabilitator. As further described in Note 17. Commitments and Contingencies, on February 10, 2016, certain investors
filed a motion in the Rehabilitation Court requesting an order directing the Rehabilitator to show cause why the Interim Payment percentage
should not be substantially increased. The motion was denied.
A portion of Deferred Amounts outstanding as of July 20, 2014 (the “Reconciliation Date”) (together with interest thereon), if still outstanding,
was paid on December 22, 2014 (the "Deferred Payment Date") in accordance with the Segregated Account Rehabilitation Plan, as amended,
such that those policyholders that received 25% (and not 45%) cash Interim Payments in respect of their permitted policy claims were generally
entitled to receive equalizing payments in cash of 26.67% of their Deferred Amounts (including accrued interest thereon) outstanding as of
the Reconciliation Date. Policyholders were entitled to receive an equalizing payment of their Deferred Amounts equal to the lower of (i) their
outstanding Deferred Amounts on December 22, 2014, and (ii) 26.67% of their Deferred Amounts as of the Reconciliation Date, even if they
had received a Supplemental Payment and/or a Special Policy Payment. The aggregate amount of equalizing payments for Deferred Amounts
(including interest thereon) paid on the Deferred Payment Date was $1,137,202.
In addition, the Segregated Account was required, pursuant to the terms of the amended Segregated Account Rehabilitation Plan, to early
redeem a portion of its surplus notes (excluding junior surplus notes) on or about the Deferred Payment Date. The redemption amount of the
Segregated Account surplus notes was equal to 26.67% of the sum of par and accrued interest on such Segregated Account surplus notes, in
each case, outstanding as at the Reconciliation Date. Pursuant to the terms of the Settlement Agreement, Ambac Assurance is also required
to make a proportionate redemption of its surplus notes when the Segregated Account redeems Segregated Account surplus notes (excluding
junior surplus notes). Therefore, the Segregated Account and Ambac Assurance were both required to make redemptions of surplus notes
(excluding any junior surplus notes) on or about the Deferred Payment Date in an amount equal to 26.67% of the sum of par and accrued
interest outstanding on such surplus notes as at the Reconciliation Date, which was $413,587 in respect of those surplus notes owned by third
parties. Ambac Assurance, for and on behalf of itself and as the management services provider for the Segregated Account, sought and received
the approval of the Commissioner of Insurance of the State of Wisconsin to effect these redemptions of surplus notes on November 20, 2014,
rather than the Deferred Payment Date, to save interest expense. Such approval was granted on October 13, 2014.
On July 12, 2016, the Special Deputy Commissioner ("SDC") for the Segregated Account met with policy beneficiaries and holders of surplus
notes of Ambac Assurance and the Segregated Account during which the SDC stated (i) that at present, the Rehabilitator does not have any
plans to increase the interim payment percentage (“IPP”) on Segregated Account policy claims, commenting that the Rehabilitator and his
advisors would need to feel highly confident that any change to the IPP would be sustainable and fair to all policyholders; (ii) that the
Rehabilitator reserves the right to amend the Segregated Account Rehabilitation Plan or take such other action as he deems necessary or
appropriate to adjust the rate of accretion on Deferred Amounts from time to time based on such factors as he considers relevant and, as such,
the accretion rate remains under review; and (iii) his objective of seeking an exit of the Segregated Account from rehabilitation, and further
stated that although his preferred goal would be to achieve an exit from rehabilitation through a consensual plan, he would advise the Rehabilitator
to use all tools available to accomplish a successful and durable conclusion that enhances Ambac Assurance's long-term claims-paying ability.
On December 16, 2016, the Rehabilitator filed with the Rehabilitation Court a supplement to his 2016 Annual Report dated June 1, 2016
relating to the Segregated Account Rehabilitation Proceedings (the “Supplement”). In the Supplement, the Rehabilitator reiterated his goal of
achieving a successful and durable conclusion to the Segregated Account Rehabilitation Proceedings. The Rehabilitator also stated in the
Supplement that at the present time and absent further actions, Ambac Assurance has insufficient capital to demonstrate to the satisfaction
| Ambac Financial Group, Inc. 85 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
of the Rehabilitator that the Segregated Account Rehabilitation Proceedings could be concluded and leave Ambac Assurance with sufficient
financial resources to meet all policy obligations, as projected by the Rehabilitator (in his sole discretion) under a varying range of
base and stress case scenarios. The Rehabilitator further stated in the Supplement that given such requirements, any transaction facilitating
the conclusion of the Segregated Account Rehabilitation Proceedings will need to provide for an increase in Ambac Assurance’s existing
surplus capital, as determined and defined by OCI in its sole discretion. We cannot provide assurance that the terms of any possible transaction
will satisfy OCI or the Rehabilitator that Ambac Assurance has, or will have, sufficient capital to meet all policy obligations after the conclusion
of the Segregated Account Rehabilitation Proceedings.
United Kingdom Referendum
In a non-binding referendum on the United Kingdom’s (“UK”) membership in the European Union in June 2016, a majority of those who
voted approved the UK’s withdrawal from the European Union (“EU”). A withdrawal by the UK from the European Union (“Brexit”) may
occur after, or possibly concurrently with, a process of negotiation regarding the future terms of the UK’s relationship with the EU, which
could result in the UK losing access to certain aspects of the single EU market and the global trade deals negotiated by the EU on behalf of
its members. The Brexit vote and the perceptions as to the impact of the withdrawal of the UK may adversely affect business activity, political
stability and economic conditions in the UK, the Eurozone, the EU and elsewhere. The economic outlook could be adversely affected by (i)
the risk that one or more other EU countries could come under increasing pressure to leave the EU, (ii) the risk of a greater demand for
independence by Scottish nationalists or for unification in Ireland, or (iii) the risk that the Euro as the single currency of the Eurozone could
cease to exist. Any of these developments, or the perception that any of these developments are likely to occur, could have a material adverse
effect on economic growth or business activity in the UK, the Eurozone, or the EU, and could result in the relocation of businesses, cause
business interruptions, lead to economic recession or depression, and impact the stability of the financial markets, the availability of credit,
political systems or financial institutions and the financial and monetary system. Consequently the medium and longer term impact on the
UK generally, and Ambac Assurance UK Limited ("Ambac UK") specifically, is uncertain. The immediate impact on the UK included a
decline in the value of the British Pound against major currencies and greater asset volatility.
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Ambac’s consolidated financial statements have been prepared on the basis of U.S. generally accepted accounting principles (“GAAP”). The
preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues, expenses and disclosures of contingent assets and liabilities. Such estimates that are particularly
susceptible to change are used in connection with certain fair value measurements, the evaluation of other than temporary impairments on
investments, loss reserves for non-derivative insurance policies, the evaluation of the need for an impairment of goodwill or valuation allowance
on the deferred tax asset, any of which individually could be material.
Consolidation:
The consolidated financial statements include the accounts of Ambac and all other entities in which Ambac (directly or through its subsidiaries)
has a controlling financial interest, including variable interest entities (“VIEs”) for which Ambac or an Ambac subsidiary is deemed the primary
beneficiary in accordance with the Consolidation Topic of the Accounting Standards Codification ("ASC"). All significant intercompany
balances have been eliminated. The usual condition for a controlling financial interest is ownership of a majority of the voting interests of an
entity. However, a controlling financial interest may also exist in entities, such as VIEs, through arrangements that do not involve controlling
voting interests. The primary beneficiary of a VIE is the party that has both the following characteristics: a) the power to direct the activities
of the VIE that most significantly impact the VIE’s economic performance and b) the obligation to absorb losses of the VIE that could potentially
be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. An entity that is deemed
the primary beneficiary of a VIE is required to consolidate the VIE.
A VIE is an entity: a) that lacks enough equity investment at risk to permit the entity to finance its activities without additional subordinated
financial support from other parties; or b) where the group of equity holders does not have: (1) the power, through voting rights or similar
rights, to direct the activities of an entity that most significantly impact the entity’s economic performance; (2) the obligation to absorb the
entity’s expected losses; or (3) the right to receive the entity’s expected residual returns. The determination of whether a variable interest holder
is the primary beneficiary involves performing a qualitative analysis of the VIE that includes, among other factors, its capital structure,
contractual terms including the rights of each variable interest holder, the activities of the VIE, whether the variable interest holder has the
power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, whether the variable interest holder
has the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that
could potentially be significant to the VIE, related party relationships and the design of the VIE. Refer to Note 3. Special Purpose Entities,
Including Variable Interest Entities, for a detailed discussion of Ambac’s involvement in VIEs, Ambac’s methodology for determining whether
Ambac is required to consolidate a VIE and the effects of VIEs being consolidated.
Ambac Unconsolidated Financial Information:
Financial information of Ambac is presented in Schedule II to this Form 10-K as of December 31, 2016 and 2015 and for the years ended
December 31, 2016, 2015 and 2014. Investments in subsidiaries are accounted for using the equity method of accounting.
| Ambac Financial Group, Inc. 86 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Investments:
The Investments - Debt and Equity Securities Topic of the ASC requires that all debt instruments and certain equity instruments be classified
in Ambac’s Consolidated Balance Sheets according to their purpose and, depending on that classification, be carried at either cost or fair
market value. Ambac’s non-VIE investment portfolio is accounted for on a trade-date basis and consists primarily of investments in fixed
income securities that are considered available-for-sale as defined by the Investments - Debt and Equity Securities Topic of the ASC. Available-
for-sale securities are reported in the financial statements at fair value with unrealized gains and losses, net of deferred taxes, reflected in
Accumulated Other Comprehensive Income in Stockholders’ Equity and computed using amortized cost as the basis. For purposes of computing
amortized cost, premiums and discounts are accounted for using the effective interest method over the remaining term of the securities. For
structured securities with a large underlying pool of homogenous loans, such as mortgage-backed and asset-backed securities, premiums and
discounts are adjusted for the effects of actual and anticipated prepayments on a retrospective basis. For other fixed income securities, such
as corporate and municipal bonds, premiums and discounts are amortized or accreted over the remaining term of the securities even if they
are callable.
Ambac’s investment portfolio also includes equity interests in pooled investment funds. Such equity interests in the form of common stock
or in-substance common stock are classified as trading securities. Equity interests in pooled funds organized as limited liability companies
are recorded under the fair value option in accordance with the Financial Instruments Topic of the ASC Topic 825. Investments classified
either as trading or fair value option securities are reported as Other investments on the Consolidated Balance Sheet at fair value with changes
in fair value reported through Net investment income on the Statement of Comprehensive Income. Investments in pooled funds have been
classified as trading or fair value option securities so that any undistributed earnings of the funds may be reflected in Net investment income
as they occur.
Fair value is based primarily on quotes obtained from independent market sources. When quotes are not available or cannot be reasonably
corroborated, valuation models are used to estimate fair value. These models include estimates, made by management, which utilize current
market information. The quotes received or modeled valuations could differ materially from amounts that would actually be realized in the
market. Realized gains and losses on the sale of investments are determined on the basis of specific identification.
VIE investments in fixed income securities are carried at fair value under the fair value option. For additional information about VIE investments,
including fair value by asset-type, see Note 3. Special Purpose Entities, Including Variable Interest Entities.
Ambac has a formal impairment review process for available for sale securities in its investment portfolio. Ambac conducts a review each
quarter to identify and evaluate investments that have indications of impairment that may be other than temporary in accordance with the
Investments - Debt and Equity Securities Topic of the ASC. Factors considered to identify and assess securities for other than temporary
impairment include: (i) fair values that have declined by 20% or more below amortized cost; (ii) market values that have declined by 5% or
more but less than 20% below amortized cost for a continuous period of at least six months; (iii) recent downgrades by rating agencies; (iv) the
financial condition of the issuer and financial guarantor, as applicable, and an analysis of projected defaults on the underlying collateral;
(v) scheduled interest payments are past due; (vi) whether Ambac has the intent to sell the security; and (vii) whether it is more likely than
not that Ambac will be required to sell a security before the anticipated recovery of its amortized cost basis. If we believe a decline in the fair
value of a particular investment is temporary, we record the decline as an unrealized loss net of tax in Accumulated Other Comprehensive
Income in Stockholders’ Equity on our Consolidated Balance Sheets. If management either: (i) has the intent to sell its investment in a debt
security or (ii) determines that the Company more likely than not will be required to sell the debt security before its anticipated recovery of
the amortized cost basis less any current period credit impairment, then an other-than-temporary impairment charge is recognized in earnings,
with the amortized cost of the security being written-down to fair value. If these conditions are not met, but it is determined that a credit loss
exists, the credit impairment loss is recognized in earnings, and the other-than-temporary amount related to all other factors is recognized in
other comprehensive income. For fixed income securities that have other-than-temporary impairments in a period, the previous amortized cost
of the security less the amount of the other-than-temporary impairment recorded through earnings becomes the investment’s new cost basis.
Ambac accretes the new cost basis to par or to the estimated future cash flows to be recovered over the expected remaining life of the security.
The evaluation of securities for impairment is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended
to determine whether, and to what extent, declines in the fair value of investments should be recognized in current period earnings. The risks
and uncertainties include changes in general economic conditions, the issuer’s or guarantor’s financial condition and/or future prospects, the
impact of regulatory actions on the investment portfolio, the performance of the underlying collateral, the effects of changes in interest rates
or credit spreads and the expected recovery period. With respect to Ambac insured securities owned, future cash flows used to measure credit
impairment represents the sum of (i) the bond’s intrinsic cash flows and (ii) the estimated Ambac Assurance claim payments. For Ambac-
insured securities owned and guaranteed under policies allocated to the Segregated Account, the estimate of Ambac Assurance claim payments
includes interest on Deferred Amounts. Ambac estimates the timing of claim payment receipts on all Ambac-insured securities owned, but the
actual timing of such amounts for Segregated Account securities are at the sole discretion of the Rehabilitator. Further modifications to the
Segregated Account Rehabilitation Plan or to the rules and guidelines promulgated thereunder, orders from the Rehabilitation Court or actions
by the Rehabilitator with respect to the form, amount and timing of satisfying permitted policy claims, or making payments on Deferred
Amounts or surplus notes, may have a material effect on the fair value of Segregated Account securities and future recognition of other-than-
temporary impairments. Refer to Note 1. Background and Business Description for information relating to the amended Segregated Account
| Ambac Financial Group, Inc. 87 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Rehabilitation Plan. Ambac’s assessment about whether a decline in value is other-than-temporary reflects management’s current judgment
regarding facts and circumstances specific to a security and the factors noted above, including Ambac's intention to sell securities and ability
to hold temporarily impaired securities until recovery. If that judgment changes, Ambac may ultimately record a charge for other-than-temporary
impairment in future periods.
Net Premiums:
Gross premiums are received either upfront or in installments. For premiums received upfront, an unearned premium revenue (“UPR”) liability
is established, which is initially recorded as the cash amount received. For installment premium transactions, a premium receivable asset and
offsetting UPR liability is initially established in an amount equal to: (i) the present value of future contractual premiums due (the “contractual”
method) or (ii) if the underlying insured obligation is a homogenous pool of assets which are contractually prepayable, the present value of
premiums to be collected over the expected life of the transaction (the “expected” method). An appropriate risk-free rate corresponding to the
weighted average life of each policy and currency is used to discount the future premiums contractually due or expected to be collected. For
example, U.S. dollar exposures are discounted using U.S. Treasury rates while exposures denominated in a foreign currency are discounted
using the appropriate risk-free rate for the respective currency. The weighted average risk-free rate at December 31, 2016 and 2015, was 2.6%.
and 2.7%, respectively, and the weighted average period of future premiums used to estimate the premium receivable at December 31, 2016
and 2015, was 9.0 years and 9.2 years, respectively.
Insured obligations consisting of homogeneous pools for which Ambac uses expected future premiums to estimate the premium receivable
and UPR include residential mortgage-backed securities. As prepayment assumptions change for homogenous pool transactions, or if there is
an actual prepayment for a “contractual” method installment transaction, the related premium receivable and UPR are adjusted in equal and
offsetting amounts with no immediate effect on earnings using new premium cash flows and the then current risk-free rate corresponding to
the initial weighted average life of the related policy.
For both upfront and installment premium policies, premium revenues are earned over the life of the financial guarantee contract in proportion
to the insured principal amount outstanding at each reporting date (referred to as the level-yield method). For installment paying policies, the
premium receivable discount, equating to the difference between the undiscounted future installment premiums and the present value of future
installment premiums, is accreted as premiums earned in proportion to the premium receivable balance at each reporting date.
Similar to gross premiums, premiums ceded to reinsurers are paid either upfront or in installments. For premiums paid upfront, a deferred
ceded premium asset is established which is initially recorded as the cash amount paid. For installment premiums, a ceded installment premiums
payable liability and offsetting deferred ceded premium asset are initially established in an amount equal to: i) the present value of future
contractual premiums due or ii) if the underlying insured obligation is a homogenous pool of assets which are contractually pre-payable, the
present value of expected premiums to be paid over the life of the transaction. An appropriate risk-free rate corresponding to the weighted
average life of each policy and exposure currency is used to discount the future premiums contractually due or expected to be collected.
Premiums ceded to reinsurers reduce the amount of premiums earned by Ambac from its financial guarantee insurance policies. For both
upfront and installment premiums, ceded premiums written are primarily recognized in earnings in proportion to and at the same time as the
related gross premium revenue is recognized. For premiums paid to reinsurers on an installment basis, Ambac records the present value of
future ceding commissions as an offset to ceded premiums payable, using the same assumptions noted above for installment premiums.
When a bond issue insured by Ambac has been retired early, typically due to an issuer call, any remaining UPR is recognized at that time to
the extent the financial guarantee contract is legally extinguished, causing accelerated premium revenue. For installment premium paying
transactions, we offset the recognition of any remaining UPR by the reduction of the related premium receivable to zero (as it will not be
collected as a result of the retirement), which may cause negative accelerated premium revenue. Certain obligations insured by Ambac have
been legally defeased whereby government securities are purchased by the issuer with the proceeds of a new bond issuance, or less frequently
with other funds of the issuer, and held in escrow. The principal and interest received from the escrowed securities are then used to retire the
Ambac-insured obligations at a future date either to their maturity date (a refunding) or a specified call date (a pre-refunding). Ambac has
evaluated the provisions in policies issued on these obligations and determined those insurance policies have not been legally extinguished.
For policies with refunding securities, premium revenue recognition is not impacted as the escrowed maturity date is the same as the previous
legal maturity date. For policies with pre-refunding securities, the maturity date of the pre-refunded security has been shortened from its
previous legal maturity. Although premium revenue recognition has not been accelerated in the period of the pre-refunding, it results in an
increase in the rate at which the policy's remaining UPR is to be recognized.
Loans:
Loans are reported at either their outstanding principal balance less unamortized discount or at fair value. For loans reported at their outstanding
principal balance less unamortized discount (non-VIE loans), interest income is earned using the effective interest method based upon interest
accrued on the unpaid principal balance adjusted for accretion of discounts. A loan is considered impaired when, based on the financial
condition of the borrower, it is probable that Ambac will be unable to collect all principal and interest due according to the contractual terms
of the loan agreement. Loans held by VIEs consolidated as required under the Consolidation Topic of the ASC are carried at fair value, with
changes in fair value recorded in Income (loss) on variable interest entities on the Consolidated Statements of Total Comprehensive Income.
| Ambac Financial Group, Inc. 88 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Derivative Contracts:
The Company has entered into derivative contracts both for trading purposes and to hedge certain economic risks inherent in its financial asset
and liability portfolios. None of Ambac’s derivative contracts are designated as hedges under the Derivatives and Hedging Topic of the ASC.
Ambac's derivatives consist primarily of credit derivatives, interest rate swaps and futures contracts. Ambac’s credit derivative contracts are
accounted for at fair value since they do not qualify for the financial guarantee scope exception under the Derivatives and Hedging Topic of
the ASC. Changes in fair value of credit derivatives are recorded in Net change in fair value of credit derivatives on the Consolidated Statements
of Total Comprehensive Income. Ambac maintains a derivatives portfolio consisting primarily of interest rate swaps and futures contracts to
mitigate exposure to floating rate insured obligations in the financial guarantee portfolio. This portfolio also includes legacy interest rate
swaps with asset-backed securitization issuers, states, municipalities and their authorities which were written in connection with their financings.
Changes in fair value of these interest rate derivatives are recorded in Derivative product revenue on the Consolidated Statements of Total
Comprehensive Income. VIEs consolidated under the Consolidation Topic of the ASC entered into derivative contracts to meet specified
purposes within their securitization structure. Changes in fair value of consolidated VIE derivatives are included within Income (loss) on
variable interest entities on the Consolidated Statements of Total Comprehensive Income.
All derivatives are recorded on the Consolidated Balance Sheets at fair value on a gross basis; assets and liabilities are netted by counterparty
only when a legal right of offset exists. Ambac has determined that the amounts recognized for the right to reclaim cash collateral or the
obligation to return cash collateral may not be used to offset amounts due under the derivative instruments in the normal course of settlement.
Therefore, such amounts are not offset against fair value amounts recognized for derivative instruments executed with the same counterparty
under the same master netting arrangement. Refer to Note 11. Derivative Instruments for further discussion of the Company’s use of derivative
instruments and their impact of the consolidated financial statements. Refer to Note 9. Fair Value Measurements for further description of the
methodologies used to determine the fair value of derivative contracts, including model inputs and assumptions where applicable.
Goodwill:
Under the Reorganization Topic of the ASC, the Company determined that fresh start financial statement reporting was to be applied upon
our emergence from Chapter 11 because (i) the reorganization value of the emerging entity was less than total post-petition liabilities and
allowed claims, and (ii) the holders of existing voting shares immediately before the confirmation of the Reorganization Plan received less
than 50% of the voting shares of the emerging entity. Specifically, fresh start reporting was applied upon confirmation of the Reorganization
Plan by the Bankruptcy Court and the satisfaction of the remaining material contingencies necessary to complete implementation of the
Reorganization Plan. All conditions required for the adoption of fresh start reporting were satisfied by the Company on April 30, 2013 (“Fresh
Start Reporting Date”) when Ambac executed a closing agreement with the United States Internal Revenue Service (the "IRS") to conclude
the settlement of a dispute. As such, fresh start financial statement reporting ("Fresh Start") was adopted by the Company on April 30, 2013,
incorporating, among other things, the discharge of debt obligations, issuance of new common stock and fair value adjustments. At the Fresh
Start Reporting Date, we revalued our assets and liabilities to current estimated fair value. The excess reorganization value which could not
be attributed to the fair value of specific identified tangible and intangible assets ("fair value of net assets") was recorded as goodwill. Pursuant
to the Intangibles - Goodwill and Other Topic of the ASC, goodwill is not amortized but is subject to annual impairment testing.
We tested goodwill for impairment as of October 1st of each year. Goodwill is also tested more frequently if indicators of impairment exist
for each reporting unit. During the third quarter of 2015, Ambac determined sufficient indicators of potential impairment existed to perform
an interim goodwill impairment evaluation for the Financial Guarantee reporting unit. Those indicators included the trading values of Ambac
stock and changes in Ambac credit spreads. In conducting the goodwill impairment analysis, we performed step one of the goodwill impairment
test for the Financial Guarantee reporting unit. We estimated the fair value of the Financial Guarantee reporting unit using a market approach,
which was derived using: i) Ambac’s common stock and warrant market capitalization, ii) fair value estimates of Ambac Assurance preferred
shares (reported as noncontrolling interests on Ambac's balance sheet) and iii) an estimated control premium. Step one of the impairment test
indicated the Financial Guarantee reporting unit's carrying value exceeded its fair value.
Accordingly, the Company performed step two of the impairment test, which indicated the implied fair value of goodwill was zero. This was
the result of substantial decreases in the Financial Guarantee reporting unit's fair value and substantial increases in the fair value of its net
assets. The fair value of the Financial Guarantee reporting unit decreased significantly due to a material decrease in Ambac's market
capitalization components (described above). The Financial Guarantee reporting unit's fair value of net assets increased significantly primarily
as a result of a decrease in the estimated fair value of financial guarantee liabilities and, to a lesser extent, a decrease in the fair value of long-
term debt. The fair value decrease in financial guarantee liabilities, which is a Level 3 estimate, was primarily driven by wider Ambac credit
spreads and positive loss and loss expense reserves development. Please refer to Note 9. Fair Value Measurements for further discussion on
the fair value model for financial guarantee liabilities. The fair value decrease in long-term debt was driven by lower market pricing on surplus
notes and junior surplus notes.
As a result, the Company recorded a full non-cash, non-tax deductible goodwill impairment charge of $514,511 in 2015. The following is a
summary of activity in goodwill that was all assigned to the Financial Guarantee reporting unit:
| Ambac Financial Group, Inc. 89 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
December 31,
Beginning balance
Impairment loss
Ending Balance
Insurance Intangible Asset:
2016
2015
2014
$
$
— $
—
— $
514,511
$
514,511
(514,511)
—
— $
514,511
At the Fresh Start Reporting Date, an insurance intangible asset was recorded which represented the difference between the fair value and
aggregate carrying value of the financial guarantee insurance and reinsurance assets and liabilities. The carrying values of our financial
guarantee insurance and reinsurance contracts will continue to be reported and measured in accordance with existing accounting policies.
Pursuant to the Financial Services-Insurance Topic of the ASC, the insurance intangible is to be measured on a basis consistent with the related
financial guarantee insurance and reinsurance contracts. The insurance intangible asset is amortized using a level yield method based on par
exposure of the related financial guarantee insurance or reinsurance contracts and is applied to groups of contracts with similar characteristics.
Restricted Cash:
Cash that we do not have the right to use for general purposes is recorded as restricted cash in our consolidated balance sheets. Restricted cash
includes consolidated variable interest entity cash restricted to fund the obligations of the consolidated VIEs.
Loss and Loss Expenses:
The loss and loss expense reserve (“loss reserve”) policy for financial guarantee insurance relates only to Ambac’s non-derivative insurance
business for insurance policies issued to beneficiaries, including VIEs, for which we do not consolidate the VIE. 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
policy for derivative contracts is discussed in the “Derivative Contracts” section below. A loss reserve is recorded on the balance sheet on a
policy-by-policy basis. Loss reserve components of an insurance policy include unpaid claims and the present value ("PV") of expected net
cash flows required to be paid under an insurance contract, further described below:
• Unpaid claims represent the sum of (i) claims not yet paid for policies allocated to the Segregated Account, including Deferred Amounts
(as defined in Note 1. Background and Business Description) and (ii) accrued interest on Deferred Amounts (generally at an effective
rate of 5.1%.) as required by the amended Segregated Account Rehabilitation Plan that became effective on June 12, 2014. Refer to
Note 1. Background and Business Description for further discussion of the amended Segregated Account Rehabilitation Plan. Unpaid
claims are measured based on the cost of settling the claims, which is principal plus accrued interest.
•
The PV of expected net cash flows represents the PV of expected cash outflows less the PV of expected cash inflows. The PV of
expected net cash flows are impacted by: (i) expected future claims to be paid under an insurance contract, including the impact of
potential settlement outcomes upon future installment premiums, (ii) expected recoveries from contractual breaches of RMBS
representations and warranties by transaction sponsors, (iii) excess spread within the underlying transaction's cash flow structure, and
(iv) other subrogation recoveries. Expected receipts from third parties within the underlying transaction's cash flow structure relating
to contractual breaches in non-RMBS securitizations may also reduce expected future claims. Ambac’s approach to resolving disputes
involving contractual breaches by transaction sponsors or other third parties has included negotiations and/or pursuing litigation. Ambac
does not include potential recoveries attributed solely to fraudulent inducement claims in our estimate of subrogation recoveries, since
any remedies under such claims would be non-contractual.
Net cash outflow policies represent contracts where the sum of unpaid claims plus the PV of expected cash outflows are greater than the PV
of expected cash inflows. For such policies, a “Loss and loss expense reserves” liability is recorded for the sum of: (i) unpaid claims plus (ii)
the excess of the PV of expected net cash outflows over the unearned premium revenue. Net cash inflow policies represent contracts where
losses have been paid, but not yet recovered, such that the PV of expected cash inflows are greater than the sum of unpaid claims plus the PV
of expected cash outflows. For such policies, a “Subrogation recoverable” asset is recorded for the difference between (i) the PV of expected
net cash inflows and (ii) unpaid claims.
The approaches used to estimate expected future losses and recoveries considers the likelihood of all possible outcomes. The evaluation process
for determining expected losses is subject to certain judgments based on our assumptions regarding the probability of default by the issuer of
the insured security, probability of settlement outcomes (which may include commutation settlements, refinancing and/or other settlement
outcomes) and expected severity of credits for each insurance contract. Ambac’s loss reserves are based on management’s on-going review
of the financial guarantee credit portfolio. Active surveillance of the insured portfolio enables Ambac’s Portfolio Risk Management ("PRM")
group to track credit migration of insured obligations from period to period and update internal classifications and credit ratings for each
transaction. Non-adversely classified credits are assigned a Class I or Survey List (“SL”) rating while adversely classified credits are assigned
a rating of Class IA through Class V. The criteria for an exposure to be assigned an adversely classified credit rating includes the deterioration
of an issuer’s financial condition, underperformance of the underlying collateral (for collateral dependent transactions such as mortgage-
backed or student loan securitizations), poor performance by the servicer of the underlying collateral and other adverse economic events or
trends. The servicer of the underlying collateral of an insured securitization transaction is a consideration in assessing credit quality because
| Ambac Financial Group, Inc. 90 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
the servicer’s performance can directly impact the performance of the related issue. For example, a servicer of a mortgage-backed securitization
that does not remain current in its collection loss mitigation efforts could cause an increase in the delinquency and potential default of the
underlying obligation. Similarly, loss severities increase when a servicer does not effectively handle loss mitigation activities such as (i) the
advancing of delinquent principal and interest and of default related expenses which are deemed to be recoverable by the servicer, (ii) pursuit
of loan charge-offs which maximize cash flows from the mortgage loan pool, and (iii) foreclosure and real estate owned disposition strategies
and timelines. All credits are assigned risk classifications by PRM group using the following guidelines:
CLASS I - “Fully Performing - Meets Ambac Criteria with Remote Probability of Claim” - Credits that demonstrate adequate security and
structural protection with a strong capacity to pay interest, repay principal and perform as underwritten. Factors supporting debt service
payment and performance are considered unlikely to change and any such change would not have a negative impact upon the fundamental
credit quality.
SURVEY LIST - “Investigation of Specific Condition or Weakness Underway” - Credits that require additional analysis to determine if adverse
classification is warranted. These credits may lack information or demonstrate a weakness but further deterioration is not expected.
CLASS IA - “Potential Problem with Risks to be Dimensioned” - Credits that are fully current and monetary default or claims-payment are
not anticipated. The payor’s or issuer’s financial condition may be deteriorating or the credits may lack adequate collateral. A structured
financing may also evidence weakness in its fundamental credit quality as evidenced by its under-performance relative to its modeled projections
at underwriting, issues related to the servicer’s ability to perform or questions about the structural integrity of the transaction. While these
credits may still retain an investment grade rating, they usually have experienced or are vulnerable to a ratings downgrade. Further investigation
is required to dimension and correct any deficiencies. A complete legal review of documents may be required. An action plan should be
developed with triggers for future classification changes upward or downward.
CLASS II - “Substandard Requiring Intervention” - Credits whose fundamental credit quality has deteriorated to the point that timely payment
of debt service may be jeopardized by adversely developing trends of a financial, economic, structural, managerial or political nature. No
claim payment is currently foreseen but the probability of loss or claim payment over the life of the transaction is now existent (generally 10%
or greater probability). Class II credits may be border-line or below investment grade (BBB- to B). Prompt and sustained action must be taken
to execute a comprehensive loss mitigation plan and correct deficiencies.
CLASS III - “Doubtful with Clear Potential for Loss” - Credits whose fundamental credit quality has deteriorated to the point that timely
payment of debt service has been or will be jeopardized by adverse trends of a financial, economic, structural, managerial or political nature
which, in the absence of positive change or corrective action, are likely to result in a loss. The probability of monetary default or claims paying
over the life of the transaction is generally 50% or greater. Full exercise of all available remedial actions is required to avert or minimize
losses. Class III credits will generally be rated below investment grade (B to CCC).
CLASS IV - “Imminent Default or Defaulted” - Monetary default or claim payments have occurred or are expected imminently. Class IV
credits are generally rated D.
CLASS V - “Fully Reserved” - The credit has defaulted and payments have occurred. The claim payments are scheduled and known, reserves
have been established to fully cover such claims, and no claim volatility is expected.
The population of credits evaluated in Ambac’s loss reserve process are: (i) all adversely classified credits (Class IA through V) and ii) non-
adversely classified credits (Class I and SL) which had an internal Ambac rating downgrade since the transaction’s inception. One of two
approaches is then utilized to estimate losses to ultimately determine if a loss reserve should be established. The first approach is a statistical
expected loss approach, which considers the likelihood of all possible outcomes. The “base case” statistical expected loss is the product of:
(i) the par outstanding on the credit; (ii) internally developed historical default information (taking into consideration internal ratings and
average life of an obligation); (iii) internally developed loss severities; and (iv) a discount factor. The loss severities and default information
are based on rating agency information, are specific to each bond type and are established and approved by senior PRM officers. For certain
credit exposures, Ambac’s additional monitoring, loss remediation efforts and probabilities of potential settlement outcomes may provide
information relevant to adjust this estimate of “base case” statistical expected losses. Analysts may accept the “base case” statistical expected
loss as the best estimate of expected loss or assign multiple probability weighted scenarios to determine an adjusted statistical expected loss
that better reflects management’s view of a given transaction’s expected losses, as well as the potential for additional remediation activities
(i.e. commutations).
The second approach entails the use of cash-flow based models to estimate expected losses (future claims, net of potential recoveries, expected
to be paid to the holder of the insured financial obligation). Ambac’s PRM group will consider the likelihood of all possible outcomes and
develop appropriate cash flow scenarios. This approach can include the utilization of internal or third party models to project future losses
and resultant claim payment estimates. We utilize cash flow models for residential mortgage-backed (RMBS), student loan, and other exposures.
RMBS and student loan models use historical performance of the collateral pools in order to then derive future performance characteristics,
such as default and voluntary prepayment rates, which in turn determine projected future claim payments. In other cases, such as many public
finance exposures including our Puerto Rico exposures, we do not specifically forecast resources available to pay debt service in the cash flow
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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
model itself. Rather, we consider the issuers’ overall ability and willingness to pay, including the fiscal, economic, legal and political framework.
In this approach a probability-weighted expected loss estimate is developed based on assigning probabilities to multiple claim payment scenarios
and applying an appropriate discount factor. Additionally, we assign a probability to the issuer’s ability to refinance an insured issue and/or
Ambac’s ability to execute a potential settlement (i.e. commutation) of the insurance policy, including the impact on future installment premiums.
The commutation scenarios and the related probabilities of occurrence vary by transaction, depending on our view of the likelihood of
negotiating such a transaction with issuers and/or investors.
The estimated expected recovery component of expected losses include: (i) recoveries related to contractual breaches of RMBS representations
and warranties by transaction sponsors, which is discussed further in the “RMBS Representation and Warranty Subrogation Recoveries”
section below, (ii) excess spread within an RMBS transaction's cash flow structure, and (iii) other recoveries, including other litigation
recoveries. Ambac does not include expected recoveries from litigation attributed solely to fraudulent inducement claims in our estimate of
representation and warranty subrogation recoveries, since any remedies under such claims would be non-contractual.
The discount factor applied to the statistical expected loss approach is based on a risk-free discount rate corresponding to the remaining
expected weighted-average life of the exposure and the exposure currency. For the cash flow scenario approach, discount factors are applied
based on a risk-free discount rate term structure and correspond to the date of each respective cash flow payment or recovery and the exposure
currency. Discount factors are updated for the current risk-free rate each reporting period.
Ambac establishes loss expense reserves based on our estimate of expected net cash outflows for loss expenses, such as legal and consulting
costs.
RMBS Representation and Warranty Subrogation Recoveries:
Ambac records as a component of its loss reserve estimate, subrogation recoveries related to securitized loans in RMBS transactions that
breached certain representations and warranties described herein. Generally, the sponsor of an RMBS transaction provided representations
and warranties with respect to the securitized loans, including representations with respect to the loan characteristics, the absence of borrower
fraud in the underlying loan pools, or other misconduct in the origination process and attesting to the compliance of loans with the prevailing
underwriting policies. In such cases, the sponsor of the transaction is contractually obligated to repurchase, cure or substitute collateral for
any loan that breaches the representations and warranties. Ambac or its counsel have engaged consultants with significant mortgage underwriting
experience to review the underwriting documentation for mortgage loans underlying certain insured RMBS transactions which exhibited
exceptionally poor performance. Factors which Ambac believes to be indicative of poor performance include (i) increased levels of early
payment defaults, (ii) significant numbers of loan liquidations or charge-offs and resulting high levels of losses, and (iii) rapid elimination of
credit protections inherent in the transactions’ structures. With respect to item (ii), “loan liquidations” refers to loans for which the servicer
has liquidated the related collateral and the securitization has realized losses on the loan; “charge-offs” refers to loans which have been written
off as uncollectible by the servicer, generating no recoveries to the securitization, and may also refer to the unrecovered balance of liquidated
loans. In either case, the servicer has taken actions to recover against the collateral, and the securitization has incurred losses to the extent
such actions did not result in full repayment of the borrower’s obligations.
Generally, subsequent to the forensic exercise of examining loan files to ascertain whether the loans conformed to the representations and
warranties, we submit nonconforming loans for repurchase to the contractual counterparty bearing the repurchase obligation, which is typically
the transaction sponsor. To effect a repurchase, depending on the transaction, the sponsor is obligated to repurchase the loan at (a) for loans
which have not been liquidated or charged off, either (i) the current unpaid principal balance of the loan, (ii) the current unpaid principal
balance plus accrued unpaid interest, or (iii) the current unpaid principal balance plus accrued interest plus unreimbursed servicer advances/
expenses and/or trustee expenses resulting from the breach of representations and warranties that trigger the repurchase, and (b) for a loan
that has already been liquidated or charged-off, the amount of the realized loss (which in certain cases may exclude accrued unpaid interest).
In cases where loans are repurchased by a sponsor, the effect is typically to offset current period losses and then to increase the over-
collateralization of the securitization, depending on the extent of loan repurchases and the structure of the securitization. Specifically, the
repurchase price is paid by the sponsor to the securitization trust which holds the loan. The cash becomes an asset of the trust, replacing the
loan that was repurchased by the sponsor. On a monthly basis the cash received related to loan repurchases by the sponsor is aggregated with
cash collections from the underlying mortgages and applied in accordance with the trust indenture payment waterfall. This payment waterfall
typically includes principal and interest payments to the note holders, various expenses of the trust and reimbursements to Ambac, as financial
guarantor, for previously paid claims. Notwithstanding the reimbursement of previous claim payments, to the extent there continues to be
insufficient cash in the waterfall in the current month to make scheduled principal and interest payments to the note holders, Ambac is required
to make additional claim payments to cover this shortfall. Ambac may also receive payments directly from transaction sponsors in settlement
of their repurchase obligations pursuant to negotiated settlement agreements or otherwise as a result of related litigation.
Ambac’s approach in estimating subrogation recoveries is a function of the population of loan files the sponsor makes available for review.
In transactions where Ambac has been provided access to loans files for all loans in the original loan pool, we utilize a “random sample”
approach to estimate subrogation recoveries. Prior to the June 30, 2014 reporting period, in transactions where Ambac had only obtained loan
files for seriously delinquent or defaulted loans, we utilized an “adverse sample” approach to estimate subrogation recoveries. Beginning with
the June 30, 2014 reporting period, as a result of gaining further access to loan files, the random sample approach has been utilized for all
transactions which were previously evaluated using the adverse sample approach. Both approaches are described in further detail below. We
| Ambac Financial Group, Inc. 92 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
do not include estimates of damages attributed solely to fraudulent inducement claims in our estimate of subrogation recoveries under either
approach.
While the obligation by sponsors to repurchase loans with material breaches is clear, generally the sponsors have not yet honored those
obligations without actual or threatened litigation. Ambac has utilized the results of the above described loan file examinations to make demands
for loan repurchases from sponsors or their successors and, in certain instances, as a part of the basis for litigation. Ambac’s approach to
resolving these disputes has included negotiating with individual sponsors at the transaction level and in some cases at the individual loan
level and has resulted in the repurchase of some loans. Ambac has initiated and will continue to pursue lawsuits seeking compliance with the
repurchase obligations in the securitization documents.
Ambac has performed the above-mentioned, detailed examinations on a variety of second-lien and first-lien transactions that have experienced
exceptionally poor performance. However, the loan file examinations and related estimated recoveries we have reviewed and recorded to date
have been limited to only those transactions whose sponsors (or their successors) are subsidiaries of large financial institutions, all of which
carry an investment grade rating from at least one nationally recognized rating agency, or are otherwise deemed to have the financial wherewithal
to live up to their repurchase obligations. While our contractual recourse is generally to the sponsor/subsidiary, rather than to the parent, each
of these large institutions has significant financial resources and may have an ongoing interest in mortgage finance, and we therefore believe
that the financial institution/parent would ultimately assume financial responsibility for these obligations if the sponsor/subsidiary is unable
to honor its contractual obligations or pay a judgment that we may obtain in litigation. Additionally, in the case of successor institutions, we
are not aware of any provisions that explicitly preclude or limit the successors’ ability to honor the obligations of the original sponsor. Certain
successor financial institutions have made significant payments to certain claimants to settle breaches of representations and warranties
perpetrated by sponsors that have been acquired by such financial institutions. In addition, Ambac received a significant payment in 2016
from JP Morgan to settle RMBS-related litigation. As a result of these factors, we did not make significant adjustments to our estimated
subrogation recoveries with respect to the credit risk of these sponsors or their successors.
Our ability to recover the RMBS subrogation recoveries is subject to significant uncertainty, including risks inherent in litigation, collectability
of such amounts from counterparties and/or their respective parents and affiliates, timing of receipt of any such recoveries, intervention by
OCI which could impede our ability to take actions required to realize such recoveries and uncertainties inherent in the assumptions used in
estimating such recoveries.
Random sample approach:
The random sample approach to estimate subrogation recoveries is based on obtaining a random sample of the original loans in the pool, using
a protocol developed by a statistical expert. In this approach, the ratio of: (a) loans identified in the sample as having materially breached
representations and warranties to (b) the total loan sample size, is applied (extrapolated) to the sum of realized and estimated future collateral
pool losses to determine an estimated repurchase obligation. We limit the estimated repurchase obligation by ever-to-date incurred losses, with
respect to the remaining steps in this approach.
Multiple probability-weighted scenarios are developed by applying various realization factors to the estimated repurchase obligation. The
realization factors in these scenarios were developed using Ambac’s own assumptions about the likelihood of outcomes based on all the
information available to it including, but not limited to, (i) discussions with external legal counsel and their views on ultimate settlement and/
or litigation outcomes, (ii) experience with loan put back negotiations where the existence of a material breach was debated and negotiated at
the loan level, (iii) the pervasiveness of the breach rates and (iv) experience in settling similar claims. The probability weightings are developed
based on the unique facts and circumstances for each transaction. The sum of these probability-weighted scenarios represents the undiscounted
subrogation recovery, which is then discounted using a factor derived from a risk-free discount rate term structure that corresponds to the date
of each respective recovery. Discount factors are updated for the current risk-free rate each reporting period.
Adverse sample approach:
The adverse sample approach was used in transactions where Ambac was only given access by the sponsor to impaired loan files, meaning
loans greater than 90 days past due, charged off, or in foreclosure, REO or bankruptcy. This limitation precluded us from selecting a valid
random sample from the entire loan pool. Consequently, the adverse sample approach utilized the following subsets of loans to estimate a
repurchase obligation: (i) loans identified as breaching representations and warranties (i.e. adverse loans) taken from a sample of impaired
loans and (ii) transactions identified where the underlying loans have similar attributes, including but not limited to type, vintage and
composition, to loans that were included in RMBS settlements between the same sponsor and other parties, and where the transactions had
substantially similar representations and warranties (i.e. “prototype transactions”). The calculation of subrogation recovery with respect to the
adverse loan subset was based on the original principal balance of the loans in the adverse sample.
Multiple probability-weighted scenarios were then developed by applying various realization factors to the estimated repurchase obligations
under both subsets of loans. The realization factors in these scenarios were developed using assumptions similar to those discussed in the
random sample approach above, as well as an internal analysis of previous RMBS settlements. The sum of these probability-weighted scenarios
represents the undiscounted subrogation recovery, which is then discounted using a factor derived from a risk-free discount rate term structure
that corresponds to the date of each respective recovery. Discount factors are updated for the current risk-free rate each reporting period.
| Ambac Financial Group, Inc. 93 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Obligations under Investment Agreements:
Ambac's investment agreements were written principally to asset-backed and structured finance issuers, states, municipalities and municipal
authorities, and require Ambac to pay an agreed-upon rate of interest based on funds deposited. Proceeds from these investment agreement
obligations were used to invest in fixed income investments. Interest income from these investments is included in Net investment income on
the Consolidated Statements of Total Comprehensive Income.
Obligations under investment agreements are reported as liabilities on the Consolidated Balance Sheets at their principal value less unamortized
discount. The carrying value of these obligations is adjusted for principal paid and interest credited to the account. Interest expense is computed
based upon daily outstanding liability balances at rates and periods specified in the agreements adjusted for accretion of discount, and is
included in Interest expense on the Consolidated Statements of Total Comprehensive Income.
Long-Term Debt:
Long-term debt issued by Ambac is carried at par value less unamortized discount. Accrued interest and discount accretion on long-term debt
is reported as Interest expense on the Consolidated Statements of Total Comprehensive Income. To the extent Ambac repurchases its long-
term debt or the Rehabilitator redeems Segregated Account surplus notes, which may also trigger a proportionate redemption in General
Account surplus notes, such repurchases or redemptions may be settled for an amount different than the carrying value of the obligation. Any
difference between the settlement payment and carrying value of the obligation is reported in Net realized gains (losses) on extinguishment
of debt on the Consolidated Statements of Total Comprehensive Income.
Long-term debt issued by VIEs consolidated as a result of Ambac's variable interest arising from financial guarantees written by Ambac's
subsidiaries, is carried at fair value with changes in fair value recorded as Income (loss) on variable interest entities on the Consolidated
Statements of Total Comprehensive Income.
Employee Benefits:
Postretirement and Postemployment Benefits:
Ambac provides postretirement and postemployment benefits, including health and life benefits covering employees who meet certain age
and service requirements. Ambac accounts for these benefits under the accrual method of accounting. Amounts related to the postretirement
health benefits liability are established and charged to expense based on actuarial determinations.
Long Term Incentive and Stock Compensation Plans:
Incentive compensation is a key component of our compensation strategy. Incentive compensation payouts are based on the execution of our
strategies at the Company, as well as business unit and individual performance. In January of each year a determination is made as to the total
amount of incentive compensation to be awarded, including amounts in the form of stock grants. The Ambac 2013 Incentive Compensation
Plan (the “Equity Plan”) provides for the granting of stock options, restricted stock, stock appreciation rights, restricted and performance units
and other awards that are valued or determined by reference to Ambac's common stock to employees and directors. In March 2014, Ambac
developed a long term incentive compensation plan (“LTIP”) as a sub-plan of the 2013 Plan. This LTIP allows for both cash and equity
performance awards to US employees. In 2015, Ambac UK 's Board of Directors adopted a long term incentive plan which provides cash
based performance awards to Ambac UK employees.
Ambac recognizes compensation costs for all equity classified awards granted at fair value with an estimation of forfeitures for all unvested
shares.
•
•
Stock options and restricted stock units granted only require future service and accordingly the respective fair value is amortized over
the relevant service period.
Performance stock units granted and performance cash awards require both future service and achieving specified performance targets
to vest and accordingly compensation costs are only recognized when the achievement of the performance conditions are considered
probable. Once deemed probable, such compensation costs are amortized over the relevant service period. Compensation costs are
initially based on the probable outcome of the performance conditions and adjusted for subsequent changes in the estimated or actual
outcome each reporting period as necessary. Changes in the estimated or actual outcome of a performance condition are recognized
by reflecting a retrospective adjustment to compensation cost in the current period.
Depreciation and Amortization:
Depreciation of furniture and fixtures and electronic data processing equipment is charged over the estimated useful lives of the respective
assets, ranging from three to five years, using the straight-line method. Amortization of leasehold improvements is charged over the remaining
term of the respective operating lease using the straight-line method.
| Ambac Financial Group, Inc. 94 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Foreign Currency:
Financial statement accounts expressed in foreign currencies are translated into U.S. dollars in accordance with the Foreign Currency Matters
Topic of the ASC. The functional currencies of Ambac's subsidiaries are the local currencies of the country where the respective subsidiaries
are based, which are also the primary operating environments in which the subsidiaries operate.
Foreign currency translation: Functional currency assets and liabilities of Ambac’s foreign subsidiaries are translated into U.S. dollars using
exchange rates in effect at the balance sheet dates and the related translation adjustments, net of deferred taxes, are included as a component
of Accumulated Other Comprehensive Income in Stockholders' Equity. Consolidated Statements of Total Comprehensive Income accounts
expressed in functional currencies are translated using average exchange rates.
Foreign currency transactions: The impact of non-functional currency transactions and the remeasurement of non-functional currency assets
and liabilities into the respective subsidiaries' functional currency (collectively "foreign currency transactions gains/(losses)") are $(39,128),
$(17,010) and $(25,483) for the years ended December 31, 2016, 2015 and 2014, respectively. Foreign currency transactions gains/(losses)
are primarily the result of remeasuring Ambac UK's assets and liabilities denominated in currencies other than its functional currency, primarily
the U.S. dollar and the Euro. The significant components of foreign currency transaction gains/(losses), including the respective classifications
in the Consolidated Statement of Total Comprehensive Income, are as follows:
•
•
•
•
Remeasurement of loss reserves, classified in Loss and loss expenses, in the amount of $(77,578), $(24,838) and $(30,079) for the
years ended December 31, 2016, 2015 and 2014, respectively;
Sales of investment securities and the unrealized gains (losses) of trading and short-term investment securities, classified in Net realized
investment gains, in the amount of $30,179, $5,816 and $5,235 for the years ended December 31, 2016, 2015 and 2014, respectively;
Remeasurement of premium receivables, classified in Other income, in the amount of $8,003, $(2,555) and $(4,470) for the years
ended December 31, 2016, 2015 and 2014, respectively; and
Remeasurement of credit derivative liabilities, classified in Net change in fair value of credit derivative, in the amount of $32, $3,981
and $3,234 for the years ended December 31, 2016, 2015 and 2014, respectively.
Reorganization items:
Entities operating in bankruptcy and expecting to reorganize under Chapter 11 of the Bankruptcy Code are subject to the additional accounting
and financial reporting guidance under the Reorganization Topic of the Accounting Standards Codification. For the purpose of presenting an
entity’s financial condition, the financial statements for periods including and after filing the Chapter 11 petition shall distinguish transactions
and events that are directly associated with the reorganization from the ongoing operations of the business. Professional advisory fees and
other costs directly associated with our reorganization are reported separately as reorganization items. The reorganization items in the
Consolidated Statements of Total Comprehensive Income consisted of professional fees of $204 and U.S. Trustee fees of $7 for the year ended
December 31, 2014.
Income Taxes:
Ambac files a consolidated U.S. Federal income tax return with its subsidiaries. Ambac UK files tax returns in both the United Kingdom and
Italy (for its Milan branch). Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the
enactment date.
Ambac evaluates our deferred income taxes quarterly to determine if valuation allowances are required. The Income Taxes Topic of the ASC
requires that companies assess whether valuation allowances should be established against their deferred tax assets based on the consideration
of all available evidence using a ‘more likely than not” standard. In making such judgments, significant weight is given to evidence that can
be objectively verified.
The level of deferred tax asset recognition is influenced by management’s assessment of future profitability, which depends on the existence
of sufficient taxable income of the appropriate character (ordinary vs. capital) within the carry forward periods available under the tax law.
We previously determined that we would not be able to realize all of our deferred tax assets in the future, and therefore we reduced such
amounts through a charge to the Statement of Total Comprehensive Income in the period in which that determination was made. Refer to Note
15. Income Taxes for further discussion of the Company's tax positions.
The Income Taxes Topic of the ASC provides a framework to determine the appropriate level of tax reserves for uncertain tax positions. This
framework prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected
to be taken in a tax return. Ambac also accrues interest and penalties related to these unrecognized tax benefits in the provision for income
taxes.
| Ambac Financial Group, Inc. 95 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Net Income Per Share:
Basic net income per share is computed by dividing net income attributable to common stockholders by the weighted-average number of
common shares outstanding, inclusive of unsettled vested restricted stock units. Diluted net income per share is computed by dividing net
income attributable to common stockholders by the weighted-average number of common shares outstanding plus all dilutive potential common
shares outstanding during the period. All dilutive potential common shares outstanding consider common stock deliverable pursuant to warrants
issued under the Reorganization Plan and those pursuant to stock options and non-vested restricted and performance stock units.
Reclassifications:
Certain reclassifications have been made to prior years' amounts to conform to the current year's presentation.
Recently Adopted Accounting Standards:
The following accounting standards were adopted by Ambac effective December 31, 2016:
Disclosure of Recently Issued Accounting Standards
Accounting Standard Update ("ASU") 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments - Equity Method
and Joint Ventures (Topic 323) - Amendments to SEC Paragraphs Pursuant to Staff Announcements at the September 22, 2016 and November
17, 2016 EITF Meetings was issued by the Financial Accounting Standards Board ("FASB") in January 2017 and is effective for the December
31, 2016 reporting period. The primary topic in the ASU relevant to Ambac is the FASB codification of a SEC Staff Announcement that
addresses disclosures the SEC expects to see for the following three accounting standards prior to their adoption: ASU 2014-09, Revenue
from Contracts with Customers; ASU 2016-02, Leases; and ASU 2016-13, Measurement of Credit Losses on Financial Instruments. In addition
to the disclosures already required by the SEC for new accounting standards not yet implemented, with respect to the aforementioned standards
the SEC expects companies to describe the status of its process to implement the new standards and the significant implementation matters
yet to be addressed. We have made the required disclosures for these new standards in the Future Application of Accounting Standards section
below.
Going Concern Assessment
ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity's Ability
to Continue as a Going Concern requires management to assess, at each interim period and annual reporting period, whether substantial doubt
exists about the company's ability to continue as a going concern within one year after the date that the financial statements are issued or
available to be issued. If management determines there is substantial doubt, it should also consider whether the substantial doubt is overcome
by management's plans, and provide certain disclosures based on facts and circumstances. Refer to Note 1. Background and Business Description
for management's disclosures regarding Ambac's ability to continue as a going concern.
The remaining accounting standards discussed in this section were adopted by Ambac effective January 1, 2016:
Disclosures about Short-Duration Contracts
ASC 2015-09, Financial Services - Insurance (Topic 944) - Disclosures about Short-Duration Contracts. The primary objective of this ASU
is to improve disclosures for insurance entities which issue short-duration contracts. The ASU made significant amendments to the Short-
Duration Contract disclosure section and limited amendments affecting the General disclosure section of Topic 944. Ambac, as a provider of
financial guarantee contracts, is subject to the General sections but not the Short-Duration Contract sections of Topic 944. The limited
amendments made to the General disclosure section did not effect Ambac's financial statement disclosures.
Eliminating Certain Fair Value Disclosures
ASU 2015-07, Fair Value Measurement (Topic 820) - Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share
(or Its Equivalent). Reporting entities are permitted to use net asset value ("NAV") as a practical expedient to measure the fair value of certain
investments. Under previous GAAP, investments that use the NAV practical expedient to measure fair value were categorized within the fair
value hierarchy as level 2 or level 3 investments depending on their redemption attributes, which has led to diversity in practice. This ASU
will remove the requirement to categorize within the fair value hierarchy all investments that use the NAV practical expedient for fair value
measurement purposes. Furthermore, the ASU will remove the requirement to make certain disclosures for all investments that are eligible
to be measured at fair value using the NAV practical expedient. Upon adoption Ambac applied this ASU retrospectively to all prior periods
presented, which was not material to Ambac's financial statements. Disclosures that were impacted by adoption of this ASU are shown in Note
9. Fair Value Measurements.
Debt Issuance Costs
ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30). This ASU simplifies the presentation of debt issuance costs by requiring
that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount
of that debt liability, consistent with debt discounts, rather than as a deferred asset. The recognition and measurement guidance for debt issuance
costs are not affected by the amendments in this ASU. The ASU requires retrospective application to all prior periods presented. Adoption
of this ASU did not have a material effect on Ambac’s financial statements.
| Ambac Financial Group, Inc. 96 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Consolidation of Variable Interest Entities - Various Changes
ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. This ASU makes changes to the variable interest
("VIE") model and voting interest ("VOE") model consolidation guidance. The main provisions of the ASU include the following: i) adding
a requirement that limited partnerships and similar legal entities must provide partners with either substantive kick-out rights or substantive
participating rights over the general partner to qualify as a VOE rather than a VIE; ii) eliminating the presumption that the general partner
should consolidate a limited partnership; iii) eliminating certain conditions that need to be met when evaluating whether fees paid to a decision
maker or service provider are considered a variable interest; iv) excluding certain fees paid to decision makers or service providers when
evaluating which party is the primary beneficiary of a VIE; and v) revising how related parties are evaluated under the VIE guidance. Lastly,
the ASU eliminates the indefinite deferral of FAS 167, which allowed reporting entities with interests in certain investment funds to follow
previous guidance in FIN 46 (R). However, the ASU permanently exempts reporting entities from consolidating registered money market
funds that operate in accordance with Rule 2a-7 of the Investment Company Act of 1940. Adoption of this ASU did not affect Ambac’s financial
statements.
Eliminating Concept of Extraordinary Items
ASU 2015-01, Income Statement - Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by
Eliminating the Concept of Extraordinary Items. Extraordinary items are defined as both unusual in nature and infrequent in occurrence.
Under previous guidance, a reporting entity was required to separately present and disclose extraordinary items. This ASU eliminates from
current U.S. GAAP the concept of extraordinary items. However, the ASU retains the presentation and disclosure guidance for items that are
unusual in nature or occur infrequently. Items that meet either or both of these criteria must be presented as a separate component on the face
of the income statement or, alternatively, disclosed in the notes to the financial statements. Adoption of this ASU did not affect Ambac’s
financial statements.
Hybrid Financial Instruments
ASU 2014-16, Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the
Form of a Share Is More Akin to Debt or to Equity. The objective of this ASU is to eliminate the existing diversity in practice in accounting
for hybrid financial instruments issued in the form of a share. A hybrid financial instrument consists of a “host contract” into which one or
more derivative terms have been embedded. The ASU requires an entity to consider the terms and features of the entire financial instrument,
including the embedded derivative features, in order to determine whether the nature of the host contract is more akin to debt or to equity.
Adoption of this ASU did not affect Ambac’s financial statements.
Consolidation of Collateralized Financing Entities
ASU 2014-13, Consolidation (Topic 810): Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized
Financing Entity. A collateralized financing entity ("CFE") is a variable interest entity with nominal or no equity that holds financial assets
and issues beneficial interests in those financial assets. The beneficial interests, which are financial liabilities of the CFE, have contractual
recourse only to the related assets of the CFE. Currently, a reporting entity that is required to consolidate a CFE may elect to measure the
financial assets and financial liabilities of the CFE at fair value. Under the ASU, a reporting entity may elect to measure such assets and
liabilities using either: i) the measurement principles in the Fair Value Measurement Topic of the ASC or ii) an alternative measurement
approach specified in the ASU. The alternative measurement approach uses the more observable of either the fair value of the financial assets
or financial liabilities to measure both. However, a reporting entity may not use the alternative measurement approach if it guarantees all or
a portion of the CFE's beneficial interests. Furthermore, entities that do not (or may not) use the alternative measurement approach may not
attribute any of the CFE's earnings to noncontrolling interests. The ASU is intended to address diversity in practice in accounting for the
measurement difference between financial assets and financial liabilities of CFEs. Most of the CFEs consolidated by Ambac are the result of
Ambac’s guarantee of the CFEs' respective beneficial interests. As a result, we may not apply the measurement alternative in this ASU to those
CFEs. Previously, Ambac had one consolidated CFE where we elected to measure the financial assets and financial liabilities at fair value
and where a portion of the CFEs earnings were attributed to noncontrolling interests. As a result, we have elected to use a modified retrospective
approach in adopting this ASU and have reclassified $6,442 related to this CFE from noncontrolling interest to retained earnings on the balance
sheet effective January 1, 2016. There was no impact on the Statement of Comprehensive Income.
Share -Based Payments
ASU 2014-12, Compensation - Stock Compensation (Topics 718) - Accounting for Share-Based Payments When the Terms of an Award Provide
That a Performance Target Could Be Achieved after the Requisite Service Period. Generally, share-based payment awards that require a
specific performance target to be met also require an employee to render service until the performance target is achieved. However, in some
cases, the terms of an award may provide that the performance target could be achieved after the employee completes the requisite service
period. Under previous U.S. GAAP, there was no explicit guidance on how to account for share-based payment awards with performance
targets that could be achieved after the requisite service period. This ASU is intended to resolve diversity in practice with respect to how the
performance target is considered in the grant-date fair value of the award, which impacts the amount of compensation cost recognized over
time. The ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated
as a performance condition. As a result, the performance target would not be reflected in estimating the fair value of the award at the grant
| Ambac Financial Group, Inc. 97 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
date. As Ambac previously followed the guidance in ASU 2014-12 for its share-based awards which have performance targets, the adoption
of this ASU had no impact on Ambac's financial statements.
Future Application of Accounting Standards:
Restricted Cash
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) - Restricted Cash. Current GAAP does not include
specific guidance on the cash flow classification and presentation of changes in restricted cash and restricted cash flow equivalents other than
limited guidance for non-for-profit entities. This ASU is intended to resolve diversity in practice in the classification of changes in restricted
cash and restricted cash flow equivalents on the statement of cash flows. The new guidance requires that restricted cash and restricted cash
equivalents be included with cash and cash equivalents when reconciling the beginning and ending period amounts on the statement of cash
flows, along with certain disclosures. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017 and interim periods within
those fiscal years. Early adoption is permitted, including adoption in an interim period. Amendments in the ASU should be applied
retrospectively to all periods presented. Ambac will adopt this ASU on January 1, 2018. We are currently evaluating the impact on Ambac's
financial statements.
Consolidation of Variable Interest Entities - Decision Makers
In October 2016, the FASB issued ASU 2016-17, Consolidation (Topic 810) - Interests Held through Related Parties That Are under Common
Control. The new guidance changes how a reporting entity that is a single decision maker for a VIE will consider its indirect interests in that
VIE when determining whether the reporting entity is the primary beneficiary and should consolidate the VIE. Under current GAAP, a single
decision maker in a VIE is required to consider an indirect interest held by a related party under common control in its entirety. Under the new
ASU, the single decision maker will consider the indirect interest on a proportionate basis. ASU 2016-17 is effective for fiscal years beginning
after December 15, 2016 and interim periods within those fiscal periods. Early adoption is permitted, including adoption in an interim period.
Ambac will adopt this ASU on January 1, 2017. Adoption of this ASU is not expected to have a consequential impact on Ambac's financial
statements.
Income Taxes
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740) - Intra-Entity Transfers of Assets Other Than Inventory. Current
GAAP prohibits the recognition of current and deferred income taxes for intercompany transfers of assets until the asset has been sold to an
outside party. The ASU will require companies to recognize the income tax effects of intercompany sales and transfers of assets other than
inventory, as income tax expense (or benefit) in the period in which the transfer occurs. ASU 2016-16 is effective for fiscal years beginning
after December 15, 2017 and interim periods within those fiscal years. Early adoption is permitted as of the beginning of an annual reporting
period for which financial statements (interim or annual) have not been issued. Ambac has not determined whether it will early adopt this
ASU and we are currently evaluating its impact on Ambac's financial statements.
Classification of Certain Cash Receipts and Cash Payments
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash
Payments. The ASU resolves diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement
of cash flows. Transactions addressed in the ASU that may impact Ambac are as follows:
• Debt prepayment or debt extinguishment costs - Such payments will be classified as a financing cash outflow.
•
Settlement of zero-coupon debt or other debt with coupon rates that are insignificant in relation to the effective interest rate of the
borrowing - The portion of the cash payment attributable to accreted interest will be classified as an operating cash outflow and the
portion attributable to the principal will be classified as a financing cash outflow.
• Distributions from equity-method investees - An entity will elect one of the two following approaches. Under the "cumulative earnings
approach": i) distributions received up to the amount of cumulative earnings recognized will be treated as returns on investments and
classified as cash inflows from operating activities and ii) distributions received in excess of earnings recognized will be treated as
returns of investments and classified as cash inflows from investing activities. Under the "nature of the distribution" approach,
distributions received will be classified based on the nature of the activity that generated the distribution (i.e. classified as a return on
investment or return of investment), when such information is available to the investor.
•
Beneficial interests in securitization transactions - Any beneficial interests obtained in financial assets transferred to an unconsolidated
securitization entity will be disclosed as a non-cash investing activity. Subsequent cash receipts from the beneficial interests in
previously transferred trade receivables will be classified as cash inflows from investing activities.
ASU 2016-15 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. Early adoption is
permitted, including adoptions within an interim period. Ambac has not determined whether it will early adopt this ASU. Adoption of this
ASU is not expected to have a consequential impact on Ambac's financial statements.
| Ambac Financial Group, Inc. 98 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326) - Measurement of Credit Losses on Financial
Instruments. This ASU significantly affects how reporting entities will measure credit losses for financial assets that are not accounted for at
fair value through net income, which include loans, debt securities, trade receivables, net investments in leases, and certain off-balance sheet
credit exposures. For financial assets measured at amortized cost, the ASU replaces the "incurred loss" model, which generally delayed
recognition of the full amount of credit losses until the loss was probable of occurring, with an "expected loss" model, which reflects an entity's
current estimate of all expected credit losses. Expected credit losses for amortized cost assets will be recorded as a valuation allowance, with
subsequent increases or decreases in the allowance reflected in the income statement each period. For available-for-sale debt securities, credit
losses under the ASU will be measured similarly to current GAAP. However, under the ASU, credit losses for available-for-sale securities will
be recorded as a valuation allowance (similar to the amortized cost assets approach described above), rather than as a direct write-down of
the security as is required under current GAAP. As a result, improvements to estimated credit losses for available-for-sale debt securities will
be recognized immediately in the income statement rather than as interest income over time. The ASU is effective for annual periods beginning
after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted as of the fiscal year beginning after
December 15, 2018. Ambac has not determined whether it will early adopt this ASU and we are currently evaluating its impact on Ambac's
financial statements. The significant implementation matters to be addressed include identifying the inventory of financial assets that will
be affected by this standard, identifying new data requirements and data sources for implementing the expected loss model for those instruments
not already using this model, and identifying and documenting accounting process changes, including related controls.
Improvements to Employee Share-Based Payment Accounting
In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718) - Improvements to Employee Share-Based
Payment Accounting. The objective of this ASU is to improve and simplify the accounting for employee share-based payment accounting.
The amendments are as follows: (i) recognizing excess tax benefits and tax deficiencies as income tax expense, (ii) recognizing excess tax
benefits regardless of whether it reduces taxes payable in the current period, (iii) classifying excess tax benefits related to share-based payments
along with other income tax cash flows as an operating activity on the statement of cash flows, (iv) allowing companies to make an accounting
policy election to either estimate forfeitures or account for forfeitures as they occur, for purposes of accruing compensation cost, (v) to qualify
for equity classification treatment, permitting tax withholding by employees up to the maximum statutory tax rate and (vi) classifying cash
paid by an employer to a taxing authority when directly withholding shares as a financing activity on the statement of cash flows. The ASU
is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods, with early adoption
permitted. Depending on the amendment, application will be prospective, retrospective or using a modified retrospective approach. Ambac
will adopt this ASU on January 1, 2017. Adoption of this ASU will not have a material impact on Ambac's financial statements.
Equity Method of Accounting
In March 2016, the FASB issued ASU 2016-07, Investments-Equity Method and Joint Ventures (Topic 323) - Simplifying the Transition to the
Equity Method of Accounting. This ASU eliminates the requirement that when an investment qualifies for use of the equity method as a result
of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and
retained earnings retroactively as if the equity method had been in effect during all previous periods that the investment had been owned. The
ASU will now require that at the date an available-for-sale equity security becomes qualified for the equity method of accounting, the reporting
entity will recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income. The ASU is effective
for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permitted. The
amendments should be applied prospectively upon adoption. Ambac will adopt this ASU on January 1, 2017. Adoption of this ASU is not
expected to have a consequential impact on Ambac's financial statements.
Contingent Put and Call Options in Debt Instruments
In March 2016, the FASB issued ASU 2016-06, Derivatives and Hedging (Topic 815) - Contingent Put and Call Options in Debt Instruments.
Current accounting rules require that embedded derivatives be separated from the host contract in a financial instrument and accounted for
separately as derivatives if certain criteria are met. One of these criteria is that the economic characteristics and risks of the embedded
derivatives are not "clearly and closely related" to the host contract. The objective of the ASU is to resolve diversity in practice in assessing
embedded contingent put and call options. The ASU clarifies what steps are required when assessing whether the economic characteristics
and risk of put and call options are clearly and closely related to their debt host contracts. The ASU is effective for fiscal years beginning
after December 15, 2016 and interim periods within those fiscal years, with early adoption permitted. The ASU must be applied on a modified
retrospective basis to existing debt instruments as of the beginning of the fiscal year for which the amendments are effective. Ambac will
adopt this ASU on January 1, 2017. Adoption of this ASU is not expected to have a consequential impact on Ambac's financial statements.
Leases
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The main difference between current U.S. GAAP and this ASU is the
recognition of lease assets and lease liabilities for those leases classified as operating leases. For operating leases, a lessee is required to: 1)
recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the balance sheet, 2) recognize
a single lease cost, calculated so that the cost is allocated over the lease term generally on a straight-line basis and 3) classify all cash payment
within operating activities in the statement of cash flows. The ASU is effective for fiscal years beginning after December 15, 2018, including
| Ambac Financial Group, Inc. 99 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
interim periods within those fiscal years. The transition guidance requires lessees to recognize and measure leases at the beginning of the
earliest period presented using a modified retrospective approach which include a number of optional practical expedients. We will adopt
ASU 2015-02 on January 1, 2019. We are evaluating the impact of this ASU, including the transitional practical expedients, on Ambac's
financial statements. We believe Ambac's office leases will be the most significantly impacted by this ASU. The significant implementation
matters to be addressed include identifying the remaining inventory of leases (i.e. equipment and other) that will be affected by this standard
and identifying and documenting accounting process changes, including related controls.
Recognition and Measurement of Financial Assets and Liabilities
In January 2016, the FASB issued ASC 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of
Financial Assets and Financial Liabilities. The ASU makes the following targeted changes for financial assets and liabilities: i) requiring
equity investments with readily determinable fair values to be measured at fair value with changes recognized in net income; ii) simplifying
the impairment assessment of equity securities without readily determinable fair values using a qualitative approach; iii) eliminating disclosure
of the method and significant assumptions used to fair value instruments measured at amortized cost on the balance sheet; iv) requiring use
of the exit price notion when measuring the fair value of instruments for disclosure purposes; v) for financial liabilities where the fair value
option has been elected, requiring the portion of the fair value change related to instrument-specific credit risk (which includes a Company's
own credit risk) to be separately reported in other comprehensive income; vi) requiring the separate presentation of financial assets and liabilities
by measurement category and form of financial asset (liability) on the balance sheet or accompanying notes; and vii) clarifying that the
evaluation of a valuation allowance on a deferred tax asset related to available-for-sale securities should be performed in combination with
the entity's other deferred tax assets. The ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within
those years Early adoption of item (v) above is permitted for financial statements (both annual and interim periods) that have not yet been
issued. We have not determined when we will adopt item (v) above of this ASU. We will adopt the remaining provisions of the ASU on
January 1, 2018. We are evaluating the impact of this ASU on Ambac's financial statements.
Revenue recognition
In May of 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) that amends the accounting guidance
for recognizing revenue for contracts with customers to transfer goods and contracts for the transfer of non-financial assets unless those
contracts are within the scope of other accounting standards. ASU 2015-14 deferred the effective date of ASU 2014-09 to annual periods
beginning after December 15, 2017, including interim periods within that reporting period. Ambac will adopt this ASU on January 1, 2018.
While we are still evaluating the ASU, it does not apply to insurance contracts and most financial instruments and is therefore is not expected
to have consequential impact on Ambac's financial statements. The significant implementation matters to be addressed include identifying
contracts the Company may have that will be affected by this standard and identifying and documenting accounting process changes, including
related controls.
3. SPECIAL PURPOSE ENTITIES, INCLUDING VARIABLE INTEREST ENTITIES ("VIEs")
Ambac, with its subsidiaries, has engaged in transactions with special purpose entities, including VIEs, in various capacities.
• Ambac most commonly provides financial guarantees, including credit derivative contracts, for various debt obligations issued by
special purpose entities, including VIEs ("FG VIEs").
• Ambac sponsors special purpose entities that issued medium-term notes to fund the purchase of certain financial assets.
• Ambac monetized its ownership of the junior surplus note issued to it by the Segregated Account by depositing the junior surplus note
into a newly formed VIE trust in exchange for cash and an owner trust certificate, which represents Ambac's right to residual cash
flows from the junior surplus note.
• Ambac is an investor in collateralized debt obligations, mortgage-backed and other asset-backed securities issued by VIEs and its
ownership interest is generally insignificant to the VIE and/or Ambac does not have rights that direct the activities that are most
significant to such VIE.
FG VIEs:
Ambac’s subsidiaries provide financial guarantees in respect of assets held or debt obligations of special purpose entities, including VIEs.
Ambac’s primary variable interest exists through this financial guarantee insurance or credit derivative contract. The transaction structures
provide certain financial protection to Ambac. This financial protection can take several forms; however, the most common are over-
collateralization, first loss and excess spread. In the case of over-collateralization (i.e., the principal amount of the securitized assets exceeds
the principal amount of the debt obligations guaranteed), the structure allows the transaction to experience defaults among the securitized
assets before a default is experienced on the debt obligations that have been guaranteed by Ambac’s subsidiaries. In the case of first loss, the
financial guarantee insurance policy or credit derivative contract only covers a senior layer of losses on assets held or debt issued by special
purpose entities, including VIEs. The first loss with respect to the assets is either retained by the asset seller or sold off in the form of equity
or mezzanine debt to other investors. In the case of excess spread, the securitized assets contributed to special purpose entities, including VIEs,
| Ambac Financial Group, Inc. 100 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
generate interest cash flows that are in excess of the interest payments on the related debt; such excess cash flow is applied to redeem debt,
thus creating over-collateralization. Generally, upon deterioration in the performance of a transaction or upon an event of default as specified
in the transaction legal documents, Ambac will obtain certain loss remediation rights. These rights may enable Ambac to direct the activities
of the entity that most significantly impact the entity’s economic performance.
We determined that Ambac’s subsidiaries generally have the obligation to absorb a FG VIE's expected losses given that they have issued
financial guarantees supporting the liabilities (and in certain cases assets). As further described below, we consolidated certain FG VIEs
because: (i) we determined for certain transactions that experienced the aforementioned performance deterioration, that Ambac’s subsidiaries
had the power, through voting rights or similar rights, to direct the activities that most significantly impact the VIE’s economic performance
because certain triggers had been breached in these transactions resulting in Ambac's subsidiaries' ability to exercise certain loss remediation
activities, or (ii) due to the passive nature of the VIEs’ activities, Ambac’s subsidiaries’ contingent loss remediation rights upon a breach of
certain triggers in the future is considered to be the power to direct the activities that most significantly impact the VIEs’ economic performance.
With respect to existing VIEs involving Ambac financial guarantees, Ambac is generally required to consolidate a VIE in the period that
applicable triggers result in Ambac having control over the VIE’s most significant economic activities. A VIE is deconsolidated in the period
that Ambac no longer has such control, which could occur in connection with insurance policies that are allocated to the Segregated Account,
execution of remediation activities on the transaction or amortization of insured exposure, any of which may reduce the degree of Ambac’s
control over a VIE. Assets and liabilities of FG VIEs that are consolidated are reported within Variable interest entity assets or Variable
interest entity liabilities on the Consolidated Balance Sheets. The net results from such FG VIEs are reported within Income (loss) on variable
interest entities in the Consolidated Statements of Total Comprehensive Income.
Upon initial consolidation of a FG VIE, we recognize a gain or loss in earnings for the difference between: (i) the fair value of the consideration
paid, the fair value of any non-controlling interests and the reported amount of any previously held interests and (ii) the net amount, as measured
on a fair value basis, of the assets and liabilities consolidated. Upon deconsolidation of a FG VIE, we recognize a gain or loss for the difference
between: (i) the fair value of any consideration received, the fair value of any retained non-controlling investment in the VIE and the carrying
amount of any non-controlling interest in the VIE and (ii) the carrying amount of the VIE’s assets and liabilities. Gains or losses from
consolidation and deconsolidation that are reported in earnings are reported within Income (loss) on variable interest entities on the Consolidated
Statements of Total Comprehensive Income.
The impact of consolidating such FG VIEs on Ambac’s balance sheet is the elimination of transactions between the consolidated FG VIEs
and Ambac’s operating subsidiaries and the inclusion of the FG VIE’s third party assets and liabilities. For a financial guarantee insurance
policy issued to a consolidated VIE, Ambac does not reflect the financial guarantee insurance policy in accordance with the related insurance
accounting rules under the Financial Services – Insurance Topic of the ASC. Consequently, upon consolidation, Ambac eliminates the insurance
assets and liabilities associated with the policy from the Consolidated Balance Sheets. Such insurance assets and liabilities may include
premium receivables, reinsurance recoverable, deferred ceded premium, subrogation recoverable, unearned premiums, loss and loss expense
reserves, ceded premiums payable and insurance intangible assets. For investment securities owned by Ambac that are debt instruments issued
by the VIE, the investment securities balance is eliminated upon consolidation. Ambac has not consolidated any VIEs during 2016, 2015 or
2014 solely as a result of purchases of the VIE’s debt instruments.
As of December 31, 2016 consolidated FG VIE assets and liabilities relating to 12 consolidated entities were $13,367,834 and $13,235,425,
respectively. As of December 31, 2015, consolidated FG VIE assets and liabilities relating to 13 consolidated entities were $14,288,497 and
$14,259,776, respectively. As of December 31, 2016, eight and four consolidated FG VIEs related to transaction insured by Ambac UK and
Ambac Assurance and nine and four as of December 31, 2015. As of December 31, 2016 FG VIE assets and liabilities of $12,950,009 and
$12,833,466 and as of December 31, 2015, FG VIE assets and liabilities of $13,769,985 and 13,636,628 related to transactions guaranteed by
Ambac UK. The remaining balance of consolidated FG VIE assets and liabilities are related to transactions guaranteed by Ambac Assurance.
Ambac is not primarily liable for, and generally does not guarantee all of the debt obligations issued by the VIEs. Ambac would only be
required to make payments on the VIE debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest
due and such obligation is guaranteed by Ambac. Additionally, Ambac’s general creditors, other than those specific policy holders which own
the VIE debt obligations, do not have rights with regard to the assets of the VIEs. Ambac evaluates the net income effects and earnings per
share effects to determine attributions between Ambac and non-controlling interests as a result of consolidating a VIE. Ambac has determined
that the net income and earnings per share effect of most consolidated FG VIEs are attributable to Ambac’s interests through financial guarantee
premium and loss payments with the VIE.
Below is a schedule detailing the change in fair value of the various financial instruments within the consolidated FG VIEs, along with gains
(losses) from consolidating and deconsolidating FG VIEs, that together comprise Income (loss) on variable interest entities for for the affected
periods:
| Ambac Financial Group, Inc. 101 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Year Ended December 31,
Income (loss) on changes related to:
Net fair value of VIE assets and liabilities
Deconsolidation
Income (loss) on Variable Interest Entities
2016
2015
2014
$
$
(14,093) $
—
(14,093) $
30,997
572
31,569
$
$
(32,212)
—
(32,212)
Ambac deconsolidated one, two and one VIEs for the years ended December 31, 2016, 2015 and 2014, respectively. These VIEs were
deconsolidated as a result of guaranteed bond retirements or financial guarantee policy terminations that eliminated Ambac's controlling
variable interest in the entities. The deconsolidations occurring in 2016 and 2014 were related to guaranteed bond retirements which resulted
in no gain or loss. The gain on deconsolidation in 2015 reflected the excess of fees receivable from a financial guarantee policy termination
for one VIE, representing Ambac's remaining non-controlling financial interest, over the fair value of net assets of the VIE at deconsolidation.
The table below provides the fair value of fixed income securities, by asset-type, held by consolidated VIEs as of December 31, 2016 and
2015:
December 31,
Investments:
Corporate obligations
Total variable interest entity assets: fixed income securities
2016
2015
$
$
2,622,566
2,622,566
$
$
2,588,556
2,588,556
The following table provides supplemental information about the loans held as assets and long-term debt associated with the VIEs for which
the fair value option has been elected as of December 31, 2016 and 2015:
December 31, 2016:
Loans
Long-term debt
December 31, 2015:
Loans
Long-term debt
Ambac Sponsored VIEs:
Estimated Fair
Value
Unpaid Principal
Balance
$
10,658,963
$
11,155,936
7,641,756
8,854,530
11,690,324
9,182,284
$
12,327,960
$
11,069,070
A subsidiary of Ambac transferred financial assets to two special purpose entities. The business purpose of these entities was to provide certain
financial guarantee clients with funding for their debt obligations. These special purpose entities were established as separate legal entities,
demonstrably distinct from Ambac and that Ambac, its affiliates or its agents could not unilaterally dissolve. The permitted activities of these
entities were contractually limited to purchasing assets from Ambac, issuing MTNs to fund such purchases, executing derivative hedges and
obtaining financial guarantee policies with respect to indebtedness incurred. Effective February 17, 2015, one of the special purpose entities
was liquidated as it no longer had any outstanding liabilities. Ambac has not consolidated these entities because Ambac Assurance’s policies
issued to these entities have been allocated to the Segregated Account, thereby limiting Ambac’s control over the entities’ most significant
economic activities. Ambac has elected to account for its equity interest in these entities at fair value under the fair value option in accordance
with the Financial Instruments Topic of the ASC. We believe that the fair value of the investments in these entities provides for greater
transparency for recording profit or loss as compared to the equity method under the Investments – Equity Method and Joint Ventures Topic
of the ASC. Refer to Note 9. Fair Value Measurements for further information on the valuation technique and inputs used to measure the fair
value of Ambac’s equity interest in these entities. At December 31, 2016 and 2015 the fair value of these entities are $7,382 and $8,696,
respectively, and is reported within Other assets on the Consolidated Balance Sheets.
•
Since their inception, there have been15 individual transactions with these entities, of which 3 transactions remain outstanding as of
December 31, 2016. Total principal amount of debt outstanding was $388,950 and $454,290 at December 31, 2016 and 2015,
respectively. In each case, Ambac sold assets to these entities. The assets are composed of utility obligations with a weighted average
rating of BBB at December 31, 2016 and weighted average life of 4.9 years. The purchase by these entities of financial assets was
financed through the issuance of medium-term notes (“MTNs”), which are cross-collateralized by the purchased assets. The MTNs
have the same expected weighted average life as the purchased assets. Derivative contracts (interest rate swaps) are used within the
entities for economic hedging purposes only. Derivative positions were established at the time MTNs were issued to purchase financial
assets. As of December 31, 2016 Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative
contracts owned and outstanding by the entities.
| Ambac Financial Group, Inc. 102 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
•
Insurance premiums paid to Ambac Assurance by these entities are earned in a manner consistent with other insurance policies, over
the risk period. Additionally, any losses incurred on such insurance policies are included in Ambac’s Consolidated Statements of Total
Comprehensive Income. Under the terms of an Administrative Agency Agreement, Ambac provides certain administrative duties,
primarily collecting amounts due on the obligations and making interest payments on the MTNs.
In July 2015, Ambac Assurance entered into a secured borrowing transaction whereby it sold 17 Ambac insured residential mortgage-backed
securities (the "Securities") and all rights associated therewith as of May 31, 2015, to a Delaware statutory trust (the "Trust") in exchange for
an equity certificate in the Trust, all financial guarantee claim payments associated with the Securities and cash of $146,000 (prior to expenses
associated with the transaction). The Securities had par and fair value of $331,035 and $360,759 as of December 31, 2016, respectively.
Although the Securities were legally sold to the Trust, the Securities will remain in Invested assets on the Consolidated Balance Sheets. Refer
to Note 10. Investments for further discussion of the restrictions on the invested assets. At the same time, a second Delaware statutory trust
(the "Issuer"), issued $146,000 of debt securities and used the proceeds, together with an equity certificate of the Issuer, to purchase from the
Trust a certificate secured by and entitling the Issuer to all principal and interest payments (other than financial guarantee claim payments) on
the Securities. Interest on the debt securities is payable monthly at an annual rate of one month LIBOR + 2.8% . Both the Trust and the Issuer
are consolidated VIEs because Ambac Assurance was involved in their design and holds a significant amount of the beneficial interests issued
by the VIEs or guaranteed the assets held by the VIEs. VIE debt outstanding to third parties under this secured borrowing transaction had a
carrying value of $102,403 and $130,571 as of December 31, 2016 and 2015, respectively, and is reported in Long-Term Debt on the Consolidated
Balance Sheets.
Variable Interests in Non-Consolidated VIEs
On August 28, 2014 Ambac monetized its ownership of the junior surplus note issued to it by the Segregated Account by depositing the junior
surplus note into a newly formed VIE trust in exchange for cash of $224,262 and a subordinated owner trust certificate (the "Owner Trust
Certificate"), which represents Ambac's right to residual cash flows from the junior surplus note. The Trust funded the cash portion of its
purchase of the junior surplus note with proceeds of the private placement of $299,175 face amount of notes to third party investors ("Notes"),
which amount equates to approximately 80% of par plus accrued and unpaid interest on the junior surplus note. The Notes have a final maturity
of August 28, 2039. Interest on the Notes will accrue at 5.1% per annum and compound annually on June 7th of each year up to and including
the maturity date. Payments on the Notes will be made when and to the extent that the Segregated Account makes payments on the junior
surplus note. The Notes must be paid in full before any payments will be made on the Owner Trust Certificate. The Notes and Owner Trust
Certificate are non-recourse to Ambac, Ambac Assurance and the Segregated Account, but are collateralized by the junior surplus note. Ambac
does not consolidate the VIE. Ambac reports its interest in the VIE as an equity investment within Other investments on the Consolidated
Balance Sheets with associated results from operations included within Net investment income: Other investments on the Consolidated
Statements of Total Comprehensive Income. The equity investment had a carrying value of $30,003 and $25,339 as of December 31, 2016
and 2015, respectively.
| Ambac Financial Group, Inc. 103 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The following table displays the carrying amount of the assets, liabilities and maximum exposure to loss of Ambac’s variable interests in non-
consolidated VIEs resulting from financial guarantee and derivative contracts by major underlying asset classes, as of December 31, 2016 and
2015:
December 31, 2016:
Global structured finance:
Collateralized debt obligations
Mortgage-backed—residential
Other consumer asset-backed
Other commercial asset-backed
Other
Total global structured finance
Global public finance
Total
December 31, 2015:
Global structured finance:
Collateralized debt obligations
Mortgage-backed—residential
Other consumer asset-backed
Other commercial asset-backed
Other
Total global structured finance
Global public finance
Total
Carrying Value of Assets and Liabilities
Maximum
Exposure
To Loss (1)
Insurance
Assets (2)
Insurance
Liabilities (3)
Net Derivative
Assets
(Liabilities) (4)
$
761,451
$
218
$
3,319
$
(145,402)
14,859,909
2,391,604
1,686,256
2,963,521
22,662,741
25,608,471
725,106
26,758
66,277
66,091
884,450
338,587
3,118,892
302,335
64,961
412,929
3,902,436
359,142
(cid:23)(cid:27)(cid:15)(cid:21)(cid:26)(cid:20)(cid:15)(cid:21)(cid:20)(cid:21)
(cid:7)
(cid:20)(cid:15)(cid:21)(cid:21)(cid:22)(cid:15)(cid:19)(cid:22)(cid:26)
(cid:7)
(cid:23)(cid:15)(cid:21)(cid:25)(cid:20)(cid:15)(cid:24)(cid:26)(cid:27)
(cid:7)
—
—
—
13,347
(132,055)
(8,827)
(cid:11)(cid:20)(cid:23)(cid:19)(cid:15)(cid:27)(cid:27)(cid:21)(cid:12)
980,935
$
264
$
3,639
$
(129,525)
(cid:7)
$
17,081,002
3,853,443
2,393,805
3,286,568
27,595,753
28,586,582
1,279,650
2,680,739
47,346
104,033
81,017
1,512,310
377,412
535,090
94,191
461,364
3,775,023
427,299
(cid:7)
(cid:24)(cid:25)(cid:15)(cid:20)(cid:27)(cid:21)(cid:15)(cid:22)(cid:22)(cid:24)
(cid:7)
(cid:20)(cid:15)(cid:27)(cid:27)(cid:28)(cid:15)(cid:26)(cid:21)(cid:21)
(cid:7)
(cid:23)(cid:15)(cid:21)(cid:19)(cid:21)(cid:15)(cid:22)(cid:21)(cid:21)
(cid:7)
—
—
—
15,410
(114,115)
(24,860)
(cid:11)(cid:20)(cid:22)(cid:27)(cid:15)(cid:28)(cid:26)(cid:24)(cid:12)
(1) Maximum exposure to loss represents the maximum future payments of principal and interest on insured obligations and derivative contracts plus Deferred
Amounts and accrued and unpaid interest thereon. Ambac’s maximum exposure to loss does not include the benefit of any financial instruments (such as
reinsurance or hedge contracts) that Ambac may utilize to mitigate the risks associated with these variable interests.
(2)
(3)
Insurance assets represent the amount recorded in “Premium receivables” and “Subrogation recoverable” for financial guarantee contracts on Ambac’s
Consolidated Balance Sheets.
Insurance liabilities represent the amount recorded in “Loss and loss expense reserves” and “Unearned premiums” for financial guarantee contracts on
Ambac’s Consolidated Balance Sheets.
(4) Net derivative assets (liabilities) represent the fair value recognized on credit derivative contracts and interest rate swaps on Ambac’s Consolidated Balance
Sheets.
| Ambac Financial Group, Inc. 104 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
4. COMPREHENSIVE INCOME
The following tables detail the changes in the balances of each component of accumulated other comprehensive income for the affected periods:
Unrealized Gains
(Losses) on
Available- for
Sale Securities (1)
Amortization of
Postretirement
Benefit (1)
Gain (Loss) on
Foreign Currency
Translation (1)
Total
Year Ended December 31, 2016:
Beginning Balance
Other comprehensive income before reclassifications
Amounts reclassified from accumulated other
comprehensive income
Net current period other comprehensive income
Balance at December 31, 2016
Year ended December 31, 2015:
Beginning Balance
Other comprehensive income before reclassifications
Amounts reclassified from accumulated other
comprehensive income
Net current period other comprehensive income (loss)
Balance at December 31, 2015
$
$
$
$
50,963
$
85,378
(17,478)
67,900
9,344
$
1,041
(1,018)
23
(45,092) $
(122,128)
—
(122,128)
118,863
$
9,367
$
(167,220) $
210,693
$
(131,976)
(27,754)
(159,730)
10,031
$
193
(880)
(687)
50,963
$
9,344
$
(441) $
(44,651)
—
(44,651)
(45,092) $
15,215
(35,709)
(18,496)
(54,205)
(38,990)
220,283
(176,434)
(28,634)
(205,068)
15,215
(1) All amounts are net of tax and noncontrolling interest. Amounts in parentheses indicate debits.
The following table details the significant amounts reclassified from each component of accumulated other comprehensive income for the
affected periods:
Details about Accumulated Other
Comprehensive Income Components
Unrealized Gains (Losses) on Available-for-Sale
Securities
Amortization of Postretirement Benefit
Prior service cost
Actuarial gains (losses)
Total reclassifications for the period
Amount Reclassified from Accumulated
Other Comprehensive Income (1)
Year Ended December 31,
2016
2015
Affected Line Item in the
Consolidated Statement of
Total Comprehensive Income
$
$
$
$
(17,478) $
(27,754) Net realized investment gains
—
(17,478) $
(666) $
(352)
(1,018)
—
(1,018)
(18,496) $
— Tax (expense) benefit
(27,754) Net of tax and noncontrolling interest (3)
(666) Underwriting and operating expenses (2)
(214) Underwriting and operating expenses (2)
(880) Total before tax
— Tax (expense) benefit
(880) Net of tax and noncontrolling interest (3)
(28,634) Net of tax and noncontrolling interest (3)
(1) Amounts in parentheses indicate debits to the Consolidated Statement of Comprehensive Income.
(2) These accumulated other comprehensive income components are included in the computation of net periodic benefit cost.
(3) Amount agrees with amount reported as reclassifications from AOCI in the disclosure about changes in AOCI balances.
5. NET INCOME PER SHARE
Pursuant to the Reorganization Plan, 45,000,000 shares of common stock at par value of $0.01 per share and 5,047,138 warrants were issued.
Warrants entitle such holders to acquire up to 5,047,138 shares of new common stock at an exercise price of $16.67 per share at any time on
or prior to April 30, 2023. For the years ended December 31, 2016, 2015 and 2014, 136, 740, and 949, warrants, respectively, were exercised,
resulting in an issuance of 136, 236 and 949 shares of common stock.
| Ambac Financial Group, Inc. 105 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
On June 30, 2015, the Board of Directors of Ambac authorized the establishment of a warrant repurchase program that permits the repurchase
of up to $10,000 of warrants. On November 3, 2016, the Board of Directors of Ambac authorized an additional $10,000 to the warrant
repurchase program. As of December 31, 2016, Ambac had repurchased 985,331 warrants at a cost of $8,092, leaving 4,053,670 warrants
outstanding, bringing the remaining aggregate authorization to $11,939.
Basic net income per share is computed by dividing net income attributable to common shareholders by the weighted-average number of
common shares outstanding and vested restricted stock units. Diluted net income per share is computed by dividing net income attributable
to common shareholders by the weighted-average number of common shares outstanding plus all potential dilutive common shares outstanding
during the period. All potential dilutive common shares outstanding consider common stock deliverable pursuant to warrants issued under
the Reorganization Plan and unvested options, restricted stock units and performance stock units granted under employee and director
compensation plans.
The following table provides a reconciliation of the common shares used for basic net income per share to the diluted shares used for diluted
net income per share:
Year Ended December 31,
Basic weighted average shares outstanding
Effect of potential dilutive shares:
Warrants
Stock options
Restricted stock units
Performance stock units
2016
2015
2014
45,212,414
45,173,542
45,093,304
312,619
447
116,105
81,939
809,834
5,313
14,221
3,117
1,786,804
9,807
37,812
5,526
Diluted weighted average shares outstanding
45,723,524
46,006,027
46,933,253
Antidilutive securities for both the year ended December 31, 2016 and 2015, included stock options to purchase 110,000 of common stock,
where the exercise price was greater than the average market price.
| Ambac Financial Group, Inc. 106 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
6. FINANCIAL GUARANTEES IN FORCE
Financial guarantees outstanding includes the exposures of policies that insure variable interest entities (“VIEs”) consolidated in accordance
with ASC Topic 810, Consolidation. Financial guarantees outstanding includes the exposure of policies that insure capital appreciation bonds
which are reported at the par amount at the time of issuance of the insurance policy. Financial guarantees outstanding exclude the exposures
of policies that insure bonds which have been called, pre-refunded or refunded. The gross par amount of financial guarantees outstanding was
$86,373,000 and $119,235,000 at December 31, 2016 and 2015, respectively. The par amount of financial guarantees outstanding, net of
reinsurance, was $79,346,000 and $108,299,000 at December 31, 2016 and 2015, respectively.
As of December 31, 2016 and 2015, the guarantee portfolio was diversified by type of guaranteed bond as shown in the following table:
Net Par Outstanding December 31,
Public Finance:
Lease and tax-backed revenue
General obligation
Housing revenue
Utility revenue
Transportation revenue
Higher education
Health care revenue
Other
Total Public Finance
Structured Finance:
Mortgage-backed and home equity
Investor-owned utilities
Student loan
Asset-backed (1)
CDOs
Other
Total Structured Finance
International Finance:
Investor-owned and public utilities
Sovereign/sub-sovereign
Asset-backed (1)
Transportation
Mortgage-backed and home equity
CDOs
Other
Total International Finance
Total
2016
2015
$
15,688,000
$
9,867,000
6,508,000
4,298,000
3,860,000
2,339,000
1,484,000
1,018,000
22,060,000
15,946,000
6,810,000
8,218,000
5,589,000
3,439,000
2,234,000
1,140,000
45,062,000
65,436,000
9,383,000
3,833,000
1,388,000
565,000
132,000
1,650,000
16,951,000
6,168,000
5,211,000
2,951,000
1,700,000
254,000
186,000
863,000
17,333,000
11,387,000
4,921,000
2,323,000
1,140,000
306,000
1,737,000
21,814,000
7,208,000
6,218,000
3,870,000
2,118,000
347,000
190,000
1,098,000
21,049,000
$
79,346,000
$
108,299,000
(1) At December 31, 2016 and 2015, all asset-backed net par amounts outstanding relate to commercial asset-based transactions.
As of December 31, 2016 and 2015, the International Finance guaranteed portfolio by location of risk was as outlined in the table below:
Net Par Outstanding December 31,
2016
2015
United Kingdom
Australia
Italy
Austria
France
Internationally diversified (1)
Other international
Total International Finance
$
12,798,000
$
1,393,000
898,000
696,000
286,000
648,000
614,000
15,494,000
1,851,000
948,000
737,000
288,000
974,000
757,000
$
17,333,000
$
21,049,000
| Ambac Financial Group, Inc. 107 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
(1)
Internationally diversified obligations represent pools of geographically diversified exposures which may include components of U.S. exposure.
Gross financial guarantees in force (principal and interest) were $137,745,000 and $188,853,000 at December 31, 2016 and 2015, respectively.
Net financial guarantees in force (after giving effect to reinsurance) were $126,306,000 and $171,000,000 as of December 31, 2016 and 2015,
respectively.
In the United States, California and New York were the states with the highest aggregate net par amounts in force, accounting for 13.0% and
5.4% of the total at December 31, 2016, respectively. No other state accounted for more than 5.0%. The highest single insured risk represented
2.1% of the aggregate net par amount guaranteed.
7. FINANCIAL GUARANTEE INSURANCE CONTRACTS
Amounts presented in this Note relate only to Ambac’s non-derivative insurance business for insurance policies issued to beneficiaries, including
VIEs, for which we do not consolidate the VIE.
Net Premiums Earned:
Below is the gross premium receivable roll-forward (direct and assumed contracts) for the affected periods:
Year Ended December 31,
Beginning premium receivable
Premium receipts
Adjustments for changes in expected and contractual cash flows
Accretion of premium receivable discount
Changes to uncollectable premiums
Other adjustments (including foreign exchange)
Ending premium receivable (1)
2016
2015
2014
$
831,575
$
1,000,607
$
1,453,021
(77,038)
(78,528)
18,637
6,054
(39,363)
(108,029)
(64,740)
24,628
2,540
(23,431)
(126,497)
(322,443)
36,651
(2,518)
(37,607)
$
661,337
$
831,575
$
1,000,607
(1) Gross premium receivable includes premiums to be received in foreign denominated currencies most notably in British Pounds and Euros. At December 31,
2016, 2015 and 2014 premium receivables include British Pounds of $177,878 (£144,393), $226,994 (£154,135) and $275,374 (£176,703), respectively, and
Euros of $34,866 (€33,108), $43,451 (€40,014) and $74,413 (€61,494), respectively.
In structured finance transactions, the priority for the payment of financial guarantee premiums to Ambac, as required by the bond indentures
of the insured obligations, is generally very senior in the waterfall. Additionally, in connection with the allocation of certain liabilities to the
Segregated Account, trustees are required under the Segregated Account Rehabilitation Plan and related court orders to continue to pay
installment premiums, notwithstanding the Segregated Account Rehabilitation Proceedings. In evaluating the credit quality of the premium
receivables, management evaluates the transaction waterfall structures and the internal ratings of the transactions underlying the premium
receivables. As of December 31, 2016 and 2015, approximately 25% and 27% of the premium receivables related to transactions with non-
investment grade internal ratings, comprised mainly of non-investment grade RMBS, student loan transactions and lease securitizations, which
comprised 8%, 3%, and 4% of the total premium receivables at December 31, 2016 and 8%, 5% and 5% of the total premium receivables at
December 31, 2015, respectively. At December 31, 2016 and 2015, $9,186 and $15,240 respectively, of premium receivables were deemed
uncollectable. Past due premiums on policies insuring non-investment grade obligations amounted to less than $500 at December 31, 2016.
The effect of reinsurance on premiums written and earned was as follows:
2016
2015
2014
Year Ended December 31,
Written
Earned
Written
Earned
Written
Earned
Direct
Assumed
Ceded
Net premiums
$
$
(53,837) $
215,564
$
(37,572) $
336,025
$
(288,310) $
261,634
—
(8,772)
85
18,362
—
(3,001)
87
23,517
—
(6,842)
(45,065) $
197,287
$
(34,571) $
312,595
$
(281,468) $
137
15,411
246,360
Ambac’s accelerated premium revenue for retired obligations for the years ended December 31, 2016, 2015 and 2014, was $52,416, $137,400
and $29,964, respectively.
| Ambac Financial Group, Inc. 108 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The table below summarizes the future gross undiscounted premiums to be collected and future premiums earned, net of reinsurance at
December 31, 2016:
Three months ended:
March 31, 2017
June 30, 2017
September 30, 2017
December 31, 2017
Twelve months ended:
December 31, 2018
December 31, 2019
December 31, 2020
December 31, 2021
Five years ended:
December 31, 2026
December 31, 2031
December 31, 2036
December 31, 2041
December 31, 2046
December 31, 2051
December 31, 2056
Total
Future Premiums
to be Collected (1)
Future
Premiums to
be Earned Net of
Reinsurance (1)
$
17,868
$
16,383
16,410
15,317
61,442
57,915
55,019
48,935
216,216
172,442
101,161
33,640
16,053
5,293
243
27,058
25,473
23,070
20,118
73,572
67,643
63,473
58,214
237,998
159,638
89,051
30,619
14,847
6,174
686
$
834,337
$
897,634
(1) Future premiums to be collected is undiscounted and relates to the discounted premium receivable asset recorded on Ambac's balance sheet. Future
premiums to be earned, net of reinsurance relate to the unearned premium liability and deferred ceded premium asset recorded on Ambac’s balance sheet.
The use of contractual lives for many bond types which do not have homogeneous pools of underlying collateral is required in the calculation of the
premium receivable as described in Note 2. Basis of Presentation and Significant Accounting Policies, results in a different premium receivable balance
than if expected lives were considered. If installment paying policies are retired or prepay early, premiums reflected in the premium receivable asset and
amounts reported in the above table for such policies may not be collected. Future premiums to be earned also considers the use of contractual lives for
many bond types which do not have homogeneous pools of underlying collateral, which results in different unearned premium than if expected lives were
considered. If those bonds types are retired early, premium earnings may be negative in the period of call or refinancing.
Loss and Loss Expense Reserves:
A loss reserve is recorded on the balance sheet on a policy-by-policy basis as further described in Note 2. Basis of Presentation and Significant
Accounting Policies. Below are the components of the Loss and loss expense reserves liability and the Subrogation recoverable asset at
December 31, 2016 and 2015:
Balance Sheet Line Item
Claims
Accrued
Interest
Claims and
Loss Expenses
Recoveries
Unearned
Premium
Revenue
Gross Loss and
Loss Expense
Reserves
Unpaid Claims
Present Value of Expected
Net Cash Flows
December 31, 2016:
Loss and loss expense reserves
Subrogation recoverable
Totals
December 31, 2015:
Loss and loss expense reserves
Subrogation recoverable
Totals
$
$
$
$
2,411,105
583,042
2,994,147
2,138,952
828,802
2,967,754
$
$
$
$
529,703
132,139
661,842
349,668
141,349
491,017
$
$
$
$
2,681,198
68,419
2,749,617
3,265,349
207,674
3,473,023
$
$
$
$
(1,098,096) $
(143,141) $
4,380,769
(1,468,331)
—
(684,731)
(2,566,427) $
(143,141) $
3,696,038
(1,476,276) $
(189,587) $
4,088,106
(2,407,118)
—
(1,229,293)
(3,883,394) $
(189,587) $
2,858,813
| Ambac Financial Group, Inc. 109 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Below is the loss and loss expense reserve roll-forward, net of subrogation recoverable and reinsurance, for the affected periods. Current year
represents activity related to policies with newly established loss and loss expense reserves. Prior years represents activity related to policies
with loss and loss expense reserves established in prior years.
Year Ended December 31,
Beginning gross loss and loss expense reserves
Reinsurance recoverable
Beginning balance of net loss and loss expense reserves
Losses and loss expenses (benefit) incurred:
Current year
Prior years
Total (1)(2)
Loss and loss expenses (recovered) paid:
Current year
Prior years
Total
Foreign exchange effect
Ending net loss and loss expense reserves
Reinsurance recoverable (3)
Ending gross loss and loss expense reserves (4)
2016
2015
2014
2,858,813
44,059
2,814,754
$
$
3,798,733
100,355
3,698,378
$
$
6,675
(18,164)
(11,489)
5,371
(944,955)
(939,584)
(77,578)
1,183
(769,890)
(768,707)
—
90,086
90,086
(24,831)
3,665,271
30,767
3,696,038
$
$
2,814,754
44,059
2,858,813
$
$
5,470,234
122,357
5,347,877
309
(545,883)
(545,574)
17
1,067,321
1,067,338
(36,587)
3,698,378
100,355
3,798,733
$
$
$
$
(1) Total losses and loss expenses (benefit) incurred includes $5,421, $47,085 and $21,164 or the years ended December 31, 2016, 2015 and 2014, respectively,
related to ceded reinsurance.
(2) Ambac records the impact of estimated recoveries related to securitized loans in RMBS transactions that breached certain representations and warranties
within losses and loss expenses (benefit). The losses and loss expense (benefit) incurred associated with changes in estimated representation and warranties
for the year ended December 31, 2016, 2015, and 2014 was $(71,369), $(303,633) and $(481,669), respectively.
(3) Represents reinsurance recoverable on future loss and loss expenses. Additionally, the Balance Sheet line "Reinsurance recoverable on paid and unpaid
losses" includes reinsurance recoverables (payables) of $(349), $(60) and $(517) as of December 31, 2016, 2015 and 2014, respectively, related to previously
presented loss and loss expenses and subrogation.
(4)
Includes Euro denominated gross loss and loss expense reserves of $21,375 (€20,297), $19,019 (€17,515) and $16,094 (€13,300) at December 31, 2016,
2015 and 2014, respectively.
For 2016, the net positive development in prior years was primarily the result of lower projected losses in the RMBS portfolio due to improved
deal performance and higher representation and warranty subrogation recoveries, and the impact of executed commutations in the student loan
portfolio. This is partially offset by negative development in Puerto Rico, the adverse impact of foreign currency rate movements on the
Ambac UK portfolio and interest accrued on Deferred Amounts.
For 2015, the net positive development in prior years was primarily due to increases in our estimate of RMBS R&W recoveries as a result of
continuous efforts and ongoing assessments of the value of our claims, as well as declines in interest rates on RMBS, student loans and Ambac
UK credits, reduced claims expectations for an Ambac UK transaction resulting from proactive remediation efforts and the impact of executed
commutations in the student loan portfolio. This was partially offset by negative development in Puerto Rico, the adverse impact of foreign
currency rate movements on the Ambac UK portfolio and interest accrued on Deferred Amounts.
For 2014, the net positive development in prior years was due to improved performance in all sectors, including RMBS, Student Loans,
international, municipal and other structured finance, partially offset by the addition of accrued interest on Deferred Amounts pursuant to the
amended Segregated Account Rehabilitation Plan.
| Ambac Financial Group, Inc. 110 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The tables below summarize information related to policies currently included in Ambac’s loss and loss expense reserves or subrogation
recoverable at December 31, 2016 and 2015. Gross par exposures include capital appreciation bonds which are reported at the par amount at
the time of issuance of the insurance policy. The weighted average risk-free rate used to discount loss reserves at December 31, 2016 and
2015 was 2.7% and 2.4%, respectively.
Number of policies
Remaining weighted-average contract
period (in years)
Gross insured contractual payments
outstanding:
Principal
Interest
Total
Gross undiscounted claim liability (1)
Discount, gross claim liability
Gross claim liability before all subrogation
and before reinsurance
Less:
Gross RMBS subrogation (2)
Discount, RMBS subrogation
Discounted RMBS subrogation, before
reinsurance
Less:
Gross other subrogation (3)
Discount, other subrogation
Discounted other subrogation, before
reinsurance
Gross claim liability, net of all subrogation
and discounts, before reinsurance
Less: Unearned premium revenue
Plus: Loss expense reserves
Gross loss and loss expense reserves
$
$
$
$
I/SL
IA
Surveillance Categories as of December 31, 2016
V
III
IV
II
19
9
22
8
26
30
43
17
169
14
Total
282
16
3
5
$
918,456
345,802
$ 1,264,258
3,439
(314)
$
$
$
733,036
$ 1,992,543
$ 1,779,889
$ 7,926,991
199,631
7,080,969
1,110,051
2,275,421
932,667
$ 9,073,512
$ 2,889,940
$10,202,412
21,175
$
547,550
$
861,455
$ 6,139,060
$
$
$
49,247
$13,400,162
14,185
11,026,059
63,432
$24,426,221
63,431
$ 7,636,110
(1,243)
(331,234)
(256,108)
(710,608)
(5,859)
(1,305,366)
3,125
$
19,932
$
216,316
$
605,347
$ 5,428,452
$
57,572
$ 6,330,744
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
— (1,926,165)
—
19,130
— (1,926,165)
—
19,130
— (1,907,035)
— (1,907,035)
(14,529)
(118,272)
(593,919)
(12,751)
(739,471)
6,526
13,426
56,273
3,854
80,079
(8,003)
(104,846)
(537,646)
(8,897)
(659,392)
3,125
$
19,932
$
208,313
$
500,501
$ 2,983,771
$
48,675
$ 3,764,317
(2,394)
6,621
(1,807)
(49,578)
339
777
(31,785)
11,036
(57,194)
56,089
(383)
(143,141)
—
74,862
7,352
$
18,464
$
159,512
$
479,752
$ 2,982,666
$
48,292
$ 3,696,038
Reinsurance recoverable reported on
Balance Sheet (4)
30,418
(1) Gross undiscounted claim liability includes unpaid claims, including accrued interest on Deferred Amounts, on policies allocated to the Segregated Account
(17,854) $
39,352
— $
6,063
2,737
120
$
$
$
$
$
and Ambac's estimate of expected future claims.
(2) RMBS subrogation represents Ambac’s estimate of subrogation recoveries from RMBS transaction sponsors for representation and warranty ("R&W")
breaches.
(3) Other subrogation primarily represents subrogation related to excess spread or other contractual cash flows on public finance and structured finance
transactions including RMBS.
(4) Reinsurance recoverable reported on Balance Sheet includes reinsurance recoverables of $30,767 related to future loss and loss expenses and $(349)
related to presented loss and loss expenses and subrogation.
| Ambac Financial Group, Inc. 111 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Number of policies
Remaining weighted-average contract
period (in years)
Gross insured contractual payments
outstanding:
Principal
Interest
Total
Gross undiscounted claim liability (1)
Discount, gross claim liability
Gross claim liability before all subrogation
and before reinsurance
Less:
Gross RMBS subrogation (2)
Discount, RMBS subrogation
Discounted RMBS subrogation, before
reinsurance
Less:
Gross other subrogation (3)
Discount, other subrogation
Discounted other subrogation, before
reinsurance
Gross claim liability, net of all subrogation
and discounts, before reinsurance
Less: Unearned premium revenue
Plus: Loss expense reserves
Gross loss and loss expense reserves
Reinsurance recoverable reported on
Balance Sheet (4)
$
$
$
$
$
Surveillance Categories as of December 31, 2015
I/SL
IA
II
III
IV
V
Total
33
9
14
17
23
26
63
19
157
13
3
6
293
15
$ 1,830,549
724,940
$ 2,555,489
6,188
(515)
$
$
$
263,288
$ 1,912,237
$ 2,972,615
$ 8,942,730
107,624
6,834,538
1,792,525
2,391,523
370,912
$ 8,746,775
$ 4,765,140
$11,334,253
5,632
$
173,930
$ 1,595,525
$ 6,339,537
$
$
$
54,590
$15,976,009
16,791
11,867,941
71,381
$27,843,950
71,381
$ 8,192,193
(652)
(96,218)
(458,805)
(770,694)
(6,779)
(1,333,663)
5,673
$
4,980
$
77,712
$ 1,136,720
$ 5,568,843
$
64,602
$ 6,858,530
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
— (2,841,291)
— (2,841,291)
—
11,716
—
11,716
— (2,829,575)
— (2,829,575)
(12,937)
(526,957)
(835,078)
(13,098)
(1,388,070)
3,961
198,643
127,669
3,978
334,251
(8,976)
(328,314)
(707,409)
(9,120)
(1,053,819)
5,673
$
4,980
$
68,736
$
808,406
$ 2,031,859
$
55,482
$ 2,975,136
(3,360)
(1,796)
(48,871)
—
2,313
642
$
$
66
3,250
880
$
$
629
20,494
85
$
$
(63,257)
15,090
(71,848)
57,479
(455)
(189,587)
—
73,264
760,239
$ 2,017,490
$
55,027
$ 2,858,813
59,503
$
(17,111) $
— $
43,999
(1) Gross undiscounted claim liability includes unpaid claims, including accrued interest on Deferred Amounts, on policies allocated to the Segregated Account
and Ambac's estimate of expected future claims.
(2) RMBS subrogation represents Ambac’s estimate of subrogation recoveries from RMBS transaction sponsors for R&W breaches.
(3) Other subrogation primarily represents subrogation related to excess spread or other contractual cash flows on public finance and structured finance
transactions, including RMBS.
(4) Reinsurance recoverable reported on Balance Sheet includes reinsurance recoverables of $44,059 related to future loss and loss expenses and $(60) related
to presented loss and loss expenses and subrogation.
Ambac records estimated subrogation recoveries for breaches of representations and warranties (R&W) by sponsors of certain RMBS
transactions. Prior to the June 30, 2014 reporting period, Ambac utilized the Adverse and Random Sample approaches to estimate R&W
subrogation recoveries for certain RMBS transactions. For a discussion of these subrogation recovery approaches, see Note 2. Basis of
Presentation and Significant Accounting Policies. Beginning with the June 30, 2014 reporting period, as a result of gaining further access to
loan files, the Random Sample approach has been utilized for all transactions which were previously evaluated using the Adverse Sample
approach. R&W subrogation may include estimates of potential sponsor settlements, but have not been subject to a sampling approach.
However, such estimates are not material to Ambac’s financial results and therefore are included in the Random Sample section of this table.
Ambac has recorded RMBS subrogation recoveries of $1,907,035, ($1,878,740 net of reinsurance) and $2,829,575, ($2,800,149 net of
reinsurance) at December 31, 2016 and 2015, respectively. The balance of RMBS subrogation recoveries and the related loss reserves, using
Random Samples as the estimation approach, at December 31, 2016 and 2015, are as follows:
| Ambac Financial Group, Inc. 112 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Random Samples Approach
At December 31, 2016
At December 31, 2015
Gross Loss
Reserves Before
Subrogation
Recoveries (1)
$
$
1,351,640
1,850,804
$
$
Subrogation
Recoveries (2)(3)
Gross Loss
Reserves After
Subrogation
Recoveries
(1,907,035) $
(555,395)
(2,829,575) $
(978,771)
(1)
Includes unpaid RMBS claims, including accrued interest on Deferred Amounts, on policies allocated to the Segregated Account.
(2) The amount of recorded subrogation recoveries related to each securitization is limited to ever-to-date paid and unpaid losses plus the present value of
expected cash flows for each policy. To the extent losses have been paid but not yet fully recovered, the recorded amount of RMBS subrogation recoveries
may exceed the sum of the unpaid claims and the present value of expected cash flows for a given policy. The net cash inflow for these policies is recorded
as a “Subrogation recoverable” asset. For those transactions where the subrogation recovery is less than the sum of unpaid claims and the present value
of expected cash flows, the net cash outflow for these policies is recorded as a “Loss and loss expense reserves” liability.
(3) The sponsor’s repurchase obligation may differ depending on the terms of the particular transaction and the status of the specific loan, such as whether it
is performing or has been liquidated or charged off. The estimated subrogation recovery for these transactions is based primarily on loan level data provided
through trustee reports received in the normal course of our surveillance activities or provided by the sponsor. While this data may not include all the
components of the sponsor’s contractual repurchase obligation we believe it is the best information available to estimate the subrogation recovery.
Below is the rollforward of RMBS subrogation, by estimation approach, for the affected periods:
Discounted RMBS subrogation (gross of reinsurance) at January 1, 2016
Changes recognized in 2016:
Impact of sponsor actions (1)
All other changes (2)
Discounted RMBS subrogation (gross of reinsurance) at December 31, 2016
Discounted RMBS subrogation (gross of reinsurance) at January 1, 2015
Changes recognized in 2015:
All other changes (2)
Discounted RMBS subrogation (gross of reinsurance) at December 31, 2015
Discounted RMBS subrogation (gross of reinsurance) at January 1, 2014
$
$
$
$
$
Changes recognized in 2014:
Additional transactions reviewed
Changes in estimation approach (3)
Impact of sponsor actions (1)
All other changes (2)
Random
Sample
Adverse
Sample
Total
2,829,575
$
— $
2,829,575
$
$
$
$
(995,000)
72,460
1,907,035
2,523,540
306,035
2,829,575
953,825
24,565
1,417,556
(146,270)
273,864
—
—
(995,000)
72,460
— $
1,907,035
— $
2,523,540
—
— $
306,035
2,829,575
1,252,773
$
2,206,598
—
(1,218,681)
—
(34,092)
24,565
198,875
(146,270)
239,772
Discounted RMBS subrogation (gross of reinsurance) at December 31, 2014
$
2,523,540
$
— $
2,523,540
(1) Sponsor actions include loan repurchases, direct payments to Ambac and other contributions from sponsors. In January 2016, Ambac Assurance settled
its RMBS-related disputes and litigation against JP Morgan Chase & Co. and certain of its affiliates (collectively "JP Morgan"). Pursuant to the settlement,
JP Morgan paid Ambac Assurance $995,000 in cash in return for releases of all of Ambac Assurance's claims against JP Morgan arising from certain
RMBS transactions insured by Ambac Assurance. Ambac Assurance also agreed to withdraw its objections to JP Morgan's global RMBS settlement with
RMBS trustees.
(2) All other changes which may impact R&W subrogation recoveries include changes in actual or projected collateral performance, changes in the
creditworthiness of a sponsor and/or the projected timing of recoveries. All other changes may also include estimates of potential sponsor settlements that
may not have been subject to a sampling approach or have been executed but the settlement amounts have not yet been received. Those that have not
been subject to a sampling approach are not material to Ambac’s financial results and therefore are included in the Random Sample column of this table.
(3) Represents estimated subrogation for those transactions previously evaluated using the Adverse Sample approach, which are evaluated using a Random
Sample approach beginning June 30, 2014. The amounts shown in the Random and Adverse Sample columns are different as a result of the differences
in estimation approaches.
| Ambac Financial Group, Inc. 113 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Assumed Reinsurance:
Assumed par outstanding was $243,700 and $245,900 at December 31, 2016 and 2015, respectively. On March 24, 2010, all assumed reinsurance
agreements with third parties were allocated to the Segregated Account, which will not allow for cancellations without the approval of the
Rehabilitator.
Ceded Reinsurance:
Ambac Assurance has reinsurance in place pursuant to surplus share treaty and facultative reinsurance agreements. The reinsurance of risk
does not relieve Ambac Assurance of its original liability to its policyholders. In the event that any of Ambac Assurance’s reinsurers are unable
to meet their obligations under reinsurance contracts, Ambac Assurance would, nonetheless, be liable to its policyholders for the full amount
of its policy.
Ambac Assurance’s reinsurance assets, including deferred ceded premiums and reinsurance recoverables on losses amounted to $100,042 at
December 31, 2016. Credit exposure existed at December 31, 2016 with respect to reinsurance recoverables to the extent that any reinsurer
may not be able to reimburse Ambac Assurance under the terms of these reinsurance arrangements. At December 31, 2016, there were ceded
reinsurance balances payable of $42,529 offsetting this credit exposure.
To minimize its credit exposure to losses from reinsurer insolvencies, Ambac Assurance (i) is entitled to receive collateral from its reinsurance
counterparties in certain reinsurance contracts; and (ii) has certain cancellation rights that can be exercised by Ambac Assurance in the event
of rating agency downgrades of a reinsurer (among other events and circumstances). Ambac Assurance held letters of credit and collateral
amounting to $122,912 from its reinsurers at December 31, 2016. As of December 31, 2016, the aggregate amount of insured par ceded by
Ambac Assurance to reinsurers under reinsurance agreements was $7,027,000 with the largest reinsurer accounting for $6,086,000 or 7.0%
of gross par outstanding at December 31, 2016. The following table represents the percentage ceded to reinsurers and reinsurance recoverable
at December 31, 2016 and its rating levels obtained from each reinsurers website as of February 24, 2017:
Reinsurers
Assured Guaranty Re Ltd
Sompo Japan Nipponkoa Insurance, Inc.
Assured Guaranty Corporation
Total
Moody’s
Rating
Percentage
Ceded Par
Net Unsecured
Reinsurance
Recoverable(1)
NR
A1
A3
86.6%
6.6
6.8
100%
$
$
—
—
3,879
3,879
(1) Represents reinsurance recoverables on paid and unpaid losses and deferred ceded premiums, net of ceded premium payables due to reinsurers, letters of
credit, and collateral posted for the benefit of Ambac Assurance.
Insurance intangible asset:
The insurance intangible amortization expense is included in insurance intangible amortization on the Consolidated Statements of Total
Comprehensive Income. For the years ended December 31, 2016, 2015 and 2014, the insurance intangible amortization expense was $174,608,
$169,557 and $151,830, respectively. As of December 31, 2016 and 2015, the gross carrying value of the insurance intangible asset was
$1,534,419 and $1,626,566, respectively. Accumulated amortization of the insurance intangible asset was $572,339 and $414,454, as of
December 31, 2016 and 2015, respectively, resulting in a net insurance intangible asset of $962,080 and $1,212,112, respectively.
The estimated future amortization expense for the net insurance intangible asset is as follows:
Future Insurance Intangible Amortization (1)
2017
2018
2019
2020
2021
Thereafter
$
94,815
$
81,469
$
72,967
$
67,115
$
60,621
$
585,093
(1) The insurance intangible asset will be amortized using a level yield method based on par exposure of the related financial guarantee insurance or reinsurance
contracts as described in Note 2. Basis of Presentation and Significant Accounting Policies. As exposures are called or prepay, amortization of the insurance
intangible asset will be recognized earlier and the timing will differ from the amounts provided in the table above.
8. INSURANCE REGULATORY RESTRICTIONS
United States
Ambac Assurance (exclusive of the Segregated Account which is under the control of OCI via the Segregated Account Rehabilitation Plan
and Segregated Account Rehabilitation Proceedings) and Everspan are subject to the insurance laws and regulations of each jurisdiction in
which it is licensed, some of which are described below. Failure to comply with applicable insurance laws and regulations (including, without
limitation, minimum surplus requirements, aggregate risk limits and single risk limits) could expose Ambac Assurance or Everspan to fines,
the loss or suspension of insurance licenses in certain jurisdictions, the imposition of orders by regulators with respect to the conduct of business
by Ambac Assurance or Everspan and/or the inability to pay dividends, all of which could have an adverse impact on our business results.
| Ambac Financial Group, Inc. 114 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
New York’s comprehensive financial guarantee insurance law defines the scope of permitted financial guarantee insurance and governs the
conduct of business of all financial guarantors licensed to do business in New York, including Ambac Assurance and Everspan. The New York
financial guarantee insurance law also establishes single risk and aggregate limits with respect to insured obligations insured by financial
guarantee insurers. Such single risk limits are specific to the type of insured obligation (for example, municipal or asset-backed). Under the
aggregate limits, policyholders’ surplus and contingency reserves must at least equal a percentage of aggregate net liability that is equal to the
sum of various percentages of aggregate net liability for various categories of specified obligations. At December 31, 2016, Ambac Assurance
is in compliance with applicable aggregate risk limits but not in compliance with applicable single risk limits. Through run-off of the portfolio,
Ambac Assurance will continue to seek the reduction in its exposure to maintain its compliance with applicable single and aggregate risk
limits, but may not be able to do so. Everspan is in compliance with all of such limits.
Ambac Assurance’s statutory financial statements are prepared on the basis of accounting practices prescribed or permitted by Wisconsin
Insurance law and OCI actions thereunder. A Wisconsin insurance company uses such statutory accounting practices prescribed or permitted
by the State of Wisconsin for determining and reporting its financial condition and results of operations, including for determining its solvency
under Wisconsin Insurance Law. The State of Wisconsin has adopted the applicable National Association of Insurance Commissioners (“NAIC”)
accounting practices and procedures manual (“NAIC SAP”) as a component of prescribed practices by the State of Wisconsin. Ambac
Assurance’s statutory policyholder surplus was $976,477 at December 31, 2016 as compared to $624,795 as of December 31, 2015. Statutory
policyholder surplus differs from stockholders’ equity determined under GAAP principally due to statutory accounting rules that treat loss
reserves, investments, consolidation of subsidiaries and variable interest entities, premiums earned and surplus notes differently.
The OCI has prescribed or permitted accounting practices for Ambac Assurance. As a result of the prescribed and permitted practices discussed
below, Ambac Assurance’s statutory surplus at December 31, 2016 and 2015 was higher by $17,290 and $21,260, respectively, than if Ambac
Assurance had reported such amounts in accordance with NAIC SAP.
Prescribed Accounting Practices:
• OCI has prescribed an accounting practice that differs from NAIC SAP. Paragraph 8 of Statement of Statutory Accounting Principles
No. 60 “Financial Guaranty Insurance” (“SSAP 60”) allows for a deduction from loss reserves for the time value of money by application
of a discount rate equal to the average rate of return on the admitted assets of the financial guaranty insurer as of the date of the
computation of the reserve. The discount rate shall be adjusted at the end of each calendar year. Additionally, in accordance with
paragraph 13.e of Statutory Accounting Principles No. 97 "Investments in Subsidiary, Controlled and Affiliated Entities" and paragraph
8 of Statutory Accounting Principles No. 5R “Liabilities, Contingencies and Impairments of Assets - Revised”, Ambac Assurance
records probable losses on its subsidiaries for which it guarantees their obligations. Ambac also discounts probable losses on guarantees
of subsidiary obligations using a discount rate equal to the average rate of return on its admitted assets. Ambac Assurance’s average
rates of return on its admitted assets at December 31, 2016 and 2015 were 7.63% and 8.06%, respectively. OCI has directed Ambac
Assurance to utilize a prescribed discount rate of 5.10% for the purpose of discounting both its loss reserves and its estimated impairment
losses on subsidiary guarantees.
• OCI has prescribed an additional accounting practice that differs from NAIC SAP. Paragraph 4 of Statement of Statutory Accounting
Principles No. 41 “Surplus Notes” (“SSAP 41”) states that proceeds received by the issuer of surplus notes must be in the form of cash
or other admitted assets having readily determinable values and liquidity satisfactory to the commissioner of the state of domicile.
Under the statutory accounting principles as generally applied, surplus notes issued in conjunction with commutations or the settlement
of claims would be valued at zero upon issuance pursuant to paragraph 4, SSAP 41. OCI has directed Ambac Assurance to record
surplus notes issued in connection with commutations or the settlement of claims at full par value upon issuance as in these instances
the surplus notes did not represent a contribution of capital, but rather a distribution of value from the common and preferred shareholders
of Ambac Assurance. The surplus notes issued in connection with commutations or settlement of claims has a claim against surplus
senior to the preferred and common shareholders.
• OCI had extended the preceding prescribed practice related to surplus notes to the evaluation of other-than-temporary impairments for
Ambac Assurance guaranteed securities held in the investment portfolio. Paragraph 35 of Statement of Statutory Accounting Principles
No. 43R ”Loan-backed and Structured Securities” states that when an other-than-temporary impairment has occurred, the amount of
the other-than-temporary impairment recognized as a realized loss shall equal the difference between the investment’s amortized cost
basis and the present value of cash flows expected to be collected, discounted at the loan-backed or structured security’s effective
interest rate. Under NAIC SAP, the present value of cash flows expected to be collected should include the fair value of surplus notes
received from the Segregated Account, as required under the originally confirmed Segregated Account Rehabilitation Plan. OCI had
prescribed an accounting practice that differed from NAIC SAP and has directed Ambac Assurance to utilize par value rather than fair
value of these surplus notes in this computation. As a result of the amended Segregated Account Rehabilitation Plan becoming effective
on June 12, 2014, this prescribed practice is no longer applicable. Ambac Assurance received a new prescribed practice from OCI
with regard to the carrying value of investments in Ambac Assurance insured securities with policies that were allocated to the Segregated
Account. The new prescribed practice, effective beginning June 11, 2014, exempts Ambac Assurance from evaluating such investments
for other than temporary impairments and requires all such investments be reported at amortized cost regardless of its NAIC risk
designation. This accounting determination is intended to recognize that Ambac Assurance continues to maintain statutory loss reserves
| Ambac Financial Group, Inc. 115 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
without adjustment for the economic effects of its ownership of the insured investment securities, improve transparency to the users
of the statutory financial statements and to minimize operational risks.
• OCI has prescribed an accounting practice related to the total liabilities and total surplus of the Segregated Account that are reported
as discrete components of Ambac Assurance’s liabilities and surplus reported in Ambac Assurance’s statutory basis financial statements.
Pursuant to this prescribed practice, the results of the Segregated Account are not included in Ambac Assurance’s financial statements
if Ambac Assurance’s surplus is (or would be) less than the Minimum Surplus Amount. As long as the surplus as regards to policyholders
is not less than the Minimum Surplus Amount, payments by Ambac Assurance to the Segregated Account under the Reinsurance
Agreement are not capped.
Permitted Accounting Practices:
• Wisconsin accounting practices for changes to contingency reserves differ from NAIC SAP. Under NAIC SAP, contributions to and
releases from the contingency reserve are recorded via a direct charge or credit to surplus. Under the Wisconsin Administrative Code,
contributions to and releases from the contingency reserve are to be recorded through underwriting income. Ambac Assurance received
permission from OCI to record contributions to and releases from the contingency reserve and the related tax and loss bond impact,
in accordance with NAIC SAP.
• Ambac Assurance received permission from OCI to report investment holdings of Ambac Assurance insured securities, with coverage
under financial guaranty policies that have been allocated to the Segregated Account, as a separate invested asset on the balance sheet
rather than combined with other bond investments. This permitted practice only impacts the balance sheet classification and has no
impact on the valuation of the securities to which it applies or to statutory surplus.
United Kingdom
The Prudential Regulatory Authority (“PRA”) and Financial Conduct Authority (“FCA”) (and their predecessor regulator the Financial Services
Authority (“FSA”)) have exercised significant oversight of Ambac UK since 2008, after Ambac, Ambac Assurance and Ambac UK began
experiencing financial stress. In 2009, Ambac UK’s license to write new business was curtailed by the FSA and the insurance license was
limited to undertaking only run-off related activity. As such, Ambac UK is authorized to run-off its credit, suretyship and financial guarantee
insurance portfolio in the United Kingdom, and to do the same through a branch in Milan, Italy, and a number of other European Union (“EU”)
countries. EU legislation has allowed Ambac UK to conduct business in EU states other than the United Kingdom through a “passporting”
arrangement, which eliminates the necessity of additional licensing or authorization in those other EU jurisdictions.
The PRA and FCA is the dual statutory regulator responsible for regulating the financial services industry in the United Kingdom, with the
purpose of maintaining confidence in the U.K. financial system, providing public understanding of the system, securing the proper degree of
protection for consumers and helping to reduce financial crime. In addition, the regulatory regime in the United Kingdom must comply with
certain EU legislation binding on all EU member states.
The PRA requires that non-life insurance companies such as Ambac UK maintain a margin of solvency at all times in respect of the liabilities
of the insurance company, the calculation of which depends on the type and amount of insurance business a company writes. These solvency
requirements were amended on January 1, 2016 in order to implement the European Union's "Solvency II" directive on risk-based capital.
Notwithstanding the foregoing, Ambac UK is deficient in terms of compliance with currently applicable regulatory capital requirements under
Solvency II directive. The PRA and FCA are aware of the same, and dialogue between Ambac UK management and its regulators remains
ongoing with respect to options for addressing the shortcoming, although such options remain few.
Dividend Restrictions, Including Contractual Restrictions
Due to losses experienced by Ambac Assurance, Ambac Assurance has been unable to pay common dividends to Ambac since 2008 and will
be unable to pay common dividends in 2017 without the prior consent of the OCI, which is unlikely. Ambac Assurance’s ability to pay
dividends is further restricted by the Settlement Agreement (as described below), by the terms of its AMPS (as described below) and by certain
covenants made for the benefit of the Segregated Account. See Note 1. Background and Business Description for further information.
Subject to the foregoing, pursuant to the Wisconsin Insurance Laws, Ambac Assurance and Everspan may declare dividends, subject to
restrictions in their respective articles of incorporation, provided that, after giving effect to the distribution, such dividends would not violate
certain statutory equity, solvency, income and asset tests. Board action authorizing a shareholder distribution by Ambac Assurance or Everspan
(other than stock dividends) must be reported to the OCI at least 30 days prior to payment, unless the distribution is no more than 15% larger
than for the corresponding period in the previous year. In addition, Wisconsin Insurance Laws restrict the payment of extraordinary dividends,
which is any distribution which, together with distributions in the prior 12 months, is greater than the lesser of (a) 10% of policyholders’
surplus as of the preceding December 31, and (b) the greater of (i) statutory net income (loss) for the calendar year preceding the date of the
dividend, minus realized capital gains for that calendar year or (ii) the aggregate of statutory net income (loss) for three calendar years preceding
the date of the dividend, minus realized capital gains for those calendar years and minus dividends paid or credited within the first two of the
three preceding calendar years. In connection with the termination of reinsurance contracts, OCI requires adjustments to the dividend calculation
| Ambac Financial Group, Inc. 116 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
for any surplus or net income gains recognized. Extraordinary dividends must be reported to OCI at least 30 days prior to payment and are
subject to disapproval by the OCI.
UK law prohibits Ambac UK from declaring a dividend to its shareholders unless it has “profits available for distribution.” The determination
of whether a company has profits available for distribution is based on its accumulated realized profits less its accumulated realized losses.
While the UK insurance regulatory laws impose no statutory restrictions on a general insurer’s ability to declare a dividend, the PRA’s and
FCA’s capital requirements in practice act as a restriction on the payment of dividends. Further, the FSA amended Ambac UK’s license in
2010 such that the PRA must specifically approve (“non-objection”) any transfer of value and/or assets from Ambac UK to Ambac Assurance
or any other Ambac group company, other than in respect of certain disclosed contracts between the two parties (such as in respect of a
management services agreement between Ambac Assurance and Ambac UK). Ambac UK is not expected to pay any dividends to Ambac
Assurance for the foreseeable future.
Pursuant to the Settlement Agreement Ambac Assurance may not make any “Restricted Payment” (which includes dividends from Ambac
Assurance to Ambac) in excess of $5,000 in the aggregate per annum, other than Restricted Payments from Ambac Assurance to Ambac in
an amount up to $7,500 per annum solely to pay operating expenses of Ambac. Concurrent with making any such Restricted Payment, a pro
rata amount of the surplus notes issued by Ambac Assurance under the Settlement Agreement would also need to be redeemed at par.
Under the terms of Ambac Assurance’s Auction Market Preferred Shares (“AMPS”), dividends may not be paid on the common stock of
Ambac Assurance unless all accrued and unpaid dividends on the AMPS for the then current dividend period have been paid, provided, that
dividends on the common stock may be made at all times for the purpose of, and only in such amounts as are necessary for, enabling Ambac
(i) to service its indebtedness for borrowed money as such payments become due or (ii) to pay its operating expenses. If dividends are paid
on the common stock as provided in the prior sentence, dividends on the AMPS become cumulative until the date that all accumulated and
unpaid dividends have been paid on the AMPS.
9. FAIR VALUE MEASUREMENTS
The Fair Value Measurement Topic of the ASC establishes a framework for measuring fair value and disclosures about fair value measurements.
Fair Value Hierarchy:
The Fair Value Measurement Topic of the ASC specifies a fair value hierarchy based on whether the inputs to valuation techniques used to
measure fair value are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while
unobservable inputs reflect Company-based assumptions. The fair value hierarchy prioritizes model inputs into three broad levels as follows:
Level 1
Level 2
Quoted prices for identical instruments in active markets. Assets and liabilities classified as Level 1 include US Treasury and
other foreign government obligations traded in highly liquid and transparent markets, exchange traded futures contracts, variable
rate demand obligations and money market funds.
Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are
not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active
markets. Assets and liabilities classified as Level 2 generally include direct investments in fixed income securities representing
municipal, asset-backed and corporate obligations, most financial services derivatives, and most long-term debt of variable
interest entities consolidated under the Consolidation Topic of the ASC.
Level 3 Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. This hierarchy
requires the use of observable market data when available. Assets and liabilities classified as Level 3 include credit derivative
contracts written as part of the financial guarantee business, certain financial services interest rate swap contracts, equity
interests in Ambac sponsored special purpose entities and certain investments in fixed income securities. Additionally, Level
3 assets and liabilities generally include fixed income securities, loan receivables, and certain long-term debt of variable interest
entities consolidated under the Consolidation Topic of the ASC.
| Ambac Financial Group, Inc. 117 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The following table sets forth the carrying amount and fair value of Ambac’s financial assets and liabilities as of December 31, 2016 and 2015,
including the level within the fair value hierarchy at which fair value measurements are categorized. As required by the Fair Value Measurement
Topic of the ASC financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair
value measurement.
Carrying
Amount
Total Fair
Value
Fair Value Measurements Categorized as:
Level 1
Level 2
Level 3
$
374,368
$
374,368
$
— $
374,368
$
December 31, 2016:
Financial assets:
Fixed income securities:
Municipal obligations
Corporate obligations
Foreign obligations
U.S. government obligations
U.S. agency obligations
Residential mortgage-backed securities
Collateralized debt obligations
Other asset-backed securities
Fixed income securities, pledged as collateral:
U.S. government obligations
Short term investments
Other investments (2)
Cash and cash equivalents
Loans
Derivative assets:
Interest rate swaps—asset position
Futures contracts
Other assets
Variable interest entity assets:
Fixed income securities:
Corporate obligations
Restricted cash
Loans
Derivative assets:
Currency swaps-asset position
Total financial assets
Financial liabilities:
Obligations under investment agreements
Long term debt, including accrued interest
Derivative liabilities:
Credit derivatives
Interest rate swaps—asset position
Interest rate swaps—liability position
Liabilities for net financial guarantees written (1)
Variable interest entity liabilities:
Long-term debt
Derivative liabilities:
1,802,165
1,802,165
43,135
36,186
4,060
2,351,595
113,923
828,783
64,905
430,788
450,307
91,025
4,160
77,206
536
7,382
43,135
36,186
4,060
2,351,595
113,923
828,783
64,905
430,788
435,237
91,025
4,066
77,206
536
7,382
2,622,566
4,873
2,622,566
4,873
10,658,963
10,658,963
$
$
80,407
20,047,333
82,358
1,536,352
$
$
80,407
20,032,169
82,333
1,494,340
$
$
15,349
(61,839)
365,776
15,349
(61,839)
365,776
3,009,943
4,490,070
11,155,936
11,155,936
—
42,212
36,186
—
—
—
—
64,905
371,367
83,791
46,587
—
—
536
—
—
4,873
—
1,802,165
923
—
4,060
1,654,882
113,923
762,793
—
59,421
—
44,438
—
16,950
—
—
—
—
—
—
650,457
$
80,407
4,914,330
$
—
14,130,870
— $
— $
1,147,728
—
(61,839)
220,587
—
—
—
—
—
—
—
8,573,716
2,582,220
—
—
—
—
—
696,713
—
65,990
—
—
14,934
—
4,066
60,256
—
7,382
2,622,566
—
10,658,963
82,333
346,612
15,349
—
145,189
4,490,070
Interest rate swaps—liability position
Total financial liabilities
2,078,601
18,182,476
$
2,078,601
19,620,566
$
$
—
— $
2,078,601
11,958,793
—
$
7,661,773
| Ambac Financial Group, Inc. 118 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Carrying
Amount
Total Fair
Value
Fair Value Measurements Categorized as:
Level 1
Level 2
Level 3
December 31, 2015:
Financial assets:
Fixed income securities:
Municipal obligations
Corporate obligations
Foreign obligations
U.S. government obligations
U.S. agency obligations
$
420,770
$
420,770
$
— $
420,770
$
1,593,669
1,593,669
96,306
26,687
4,212
96,306
26,687
4,212
Residential mortgage-backed securities
1,977,338
1,977,338
Collateralized debt obligations
Other asset-backed securities
Fixed income securities, pledged as collateral:
U.S. government obligations
Short term investments
Other investments (2)
Cash and cash equivalents
Loans
Derivative assets:
Interest rate swaps—asset position
Interest rate swaps—liability position
Futures contracts
Other assets
Variable interest entity assets:
Fixed income securities:
Corporate obligations
Restricted cash
Loans
Total financial assets
Financial liabilities:
Obligations under investment agreements
Long term debt, including accrued interest
Derivative liabilities:
Credit derivatives
Interest rate swaps—asset position
Interest rate swaps—liability position
84,267
840,527
64,555
225,789
310,600
35,744
5,206
84,886
—
109
8,696
84,267
840,527
64,555
225,789
298,095
35,744
5,128
84,886
—
109
8,696
2,588,556
2,588,556
5,822
11,690,324
20,064,063
100,358
1,481,045
$
$
5,822
11,690,324
20,051,480
101,400
1,235,721
$
$
$
$
34,543
(52,128)
370,943
34,543
(52,128)
370,943
Liabilities for net financial guarantees written (1)
2,033,484
2,325,859
Variable interest entity liabilities:
Long-term debt
Derivative liabilities:
12,327,960
12,327,960
Interest rate swaps—liability position
Currency swaps—liability position
1,965,265
1,965,265
(36,862)
(36,862)
—
87,808
26,687
—
—
—
—
64,555
197,398
45,745
35,744
—
—
—
109
—
—
5,822
—
1,593,669
8,498
—
4,212
1,488,454
84,267
840,527
—
28,391
—
—
—
21,848
—
—
—
—
—
—
—
—
—
—
—
488,884
—
—
—
—
12,834
—
5,128
63,038
—
—
8,696
2,588,556
—
11,690,324
463,868
$
4,490,636
$
14,857,460
— $
— $
101,400
—
—
—
—
—
—
—
—
132,837
1,102,884
—
(52,128)
243,256
—
34,543
—
127,687
2,325,859
9,147,790
3,180,170
1,965,265
(36,862)
—
—
Total financial liabilities
$
18,224,608
$
18,272,701
$
— $
11,400,158
$
6,872,543
(1) The carrying value of net financial guarantees written includes the following balance sheet items: Premium receivables; Reinsurance recoverable on paid
and unpaid losses; Deferred ceded premium; Subrogation recoverable; Insurance intangible asset; Unearned premiums; Loss and loss expense reserves;
Ceded premiums payable, premiums taxes payable and other deferred fees recorded in Other liabilities.
(2) Excluded from the fair value measurement categories in the table above are investment funds of $336,513 and $239,516 as of December 31, 2016 and
2015, respectively, which are measured using NAV per share as a practical expedient.
| Ambac Financial Group, Inc. 119 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Determination of Fair Value:
When available, Ambac uses quoted active market prices specific to the financial instrument to determine fair value, and classifies such items
within Level 1. Because many fixed income securities do not trade on a daily basis, pricing sources apply available market information through
processes such as matrix pricing to determine fair value. In those cases, the items are classified within Level 2. If quoted market prices are
not available, fair value is based upon models that use, where possible, current market-based or independently-sourced market parameters.
Items valued using valuation models are classified according to the lowest level input or value driver that is significant to the valuation. Thus,
an item may be classified in Level 3 even though there may be significant inputs that are readily observable.
The determination of fair value for financial instruments categorized in Level 2 or 3 involves significant judgment due to the complexity of
factors contributing to the valuation. Third-party sources from which we obtain independent market quotes also use assumptions, judgments
and estimates in determining financial instrument values and different third parties may use different methodologies or provide different prices
for securities. In addition, the use of internal valuation models may require assumptions about hypothetical or inactive markets. As a result of
these factors, the actual trade value of a financial instrument in the market, or exit value of a financial instrument position by Ambac, may be
significantly different from its recorded fair value.
Ambac’s financial instruments carried at fair value are comprised of investments in fixed income securities, equity interests in pooled investment
funds, derivative instruments, variable interest entity assets and liabilities and equity interests in Ambac sponsored special purpose entities.
Valuation of financial instruments is performed by Ambac’s finance group using methods approved by senior financial management with
consultation from risk management and portfolio managers as appropriate. Preliminary valuation results are discussed with portfolio managers
quarterly to assess consistency with market transactions and trends as applicable. Market transactions such as trades or negotiated settlements
of similar positions, if any, are reviewed quarterly to validate fair value model results. However many of the financial instruments valued
using significant unobservable inputs have very little or no observable market activity. Methods and significant inputs and assumptions used
to determine fair values across portfolios are reviewed quarterly by senior financial management. Other valuation control procedures specific
to particular portfolios are described further below.
We reflect Ambac’s own creditworthiness in the fair value of financial liabilities by including a credit valuation adjustment (“CVA”) in the
determination of fair value. A decline (increase) in Ambac’s creditworthiness as perceived by market participants will generally result in a
higher (lower) CVA, thereby lowering (increasing) the fair value of Ambac’s financial liabilities as reported.
Fixed Income Securities:
The fair values of fixed income investment securities are based primarily on market prices received from dealer quotes or alternative pricing
sources with reasonable levels of price transparency. Such quotes generally consider a variety of factors, including recent trades of the same
and similar securities. For those fixed income investments where quotes were not available or cannot be reasonably corroborated, fair values
are based on internal valuation models. Key inputs to the internal valuation models generally include maturity date, coupon and yield curves
for asset-type and credit rating characteristics that closely match those characteristics of the specific investment securities being valued. Longer
(shorter) expected maturities or higher (lower) yields used in the valuation model will, in isolation, result in decreases (increases) in fair value.
Generally, lower credit ratings or longer expected maturities will be accompanied by higher yields used to value a security. Certain investments
in Ambac insured securities for which projected cash flows consist solely of Deferred Amounts and interest thereon, are internally valued
based upon the valuation of Ambac Assurance's surplus notes. At December 31, 2016, approximately 5%, 82%, and 13% of the investment
portfolio (excluding variable interest entity investments) was valued using dealer quotes, alternative pricing sources with reasonable levels of
price transparency and internal valuation models, respectively. At December 31, 2015, approximately 9%, 82%, and 9% of the investment
portfolio (excluding variable interest entity investments) was valued using dealer quotes, alternative pricing sources with reasonable levels of
price transparency and internal valuation models, respectively.
Ambac performs various review and validation procedures to quoted and modeled prices for fixed income securities, including price variance
analyses, missing and static price reviews, overall valuation analyses by senior traders and finance managers and reviews associated with our
ongoing impairment analysis. Unusual prices identified through these procedures will be evaluated further against additional market data (if
available) and/or internally modeled prices, and the pricing source values will be challenged as necessary. Price challenges generally result
in the use of the pricing source’s quote as originally provided or as revised by the source following their internal diligence process. A price
challenge may result in a determination by either the pricing source or Ambac management that the pricing source cannot provide a reasonable
value for a security or cannot adequately support a quote, in which case Ambac would resort to using either other quotes or internal models.
Results of price challenges are reviewed by senior traders and finance managers.
Information about the valuation inputs for fixed income securities classified as Level 3 is included below:
Residential mortgage-backed securities: These securities are guaranteed under policies that are subject to the Segregated Account Rehabilitation
Plan and have projected future cash flows consisting solely of Deferred Amounts under such policies including interest thereon. The fair value
of such securities classified as Level 3 was $696,713 and $488,884 at December 31, 2016 and 2015, respectively. Fair value was calculated
based on the valuation of Ambac Assurance surplus notes which, under the terms of the Segregated Account Rehabilitation Plan, are to be
redeemed in proportion with the payment of Deferred Amounts on or about the dates when such payments are made. Refer to Note 1.
| Ambac Financial Group, Inc. 120 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Background and Business Description for further description of the Segregated Account Rehabilitation Plan and its impact on the payment of
Segregated Account policy claims and surplus note redemptions.
Other asset-backed securities: These securities are a subordinated tranche of a resecuritization collateralized by Ambac-insured military
housing bonds. The fair value of such securities classified as Level 3 was $65,990 and $0 at December 31, 2016 and 2015, respectively.
Fair value was calculated using a discounted cash flow approach with expected future cash flows discounted using a yield consistent with
the security type and rating. Significant inputs for the valuation at December 31, 2016 include the following weighted averages:
a. Coupon rate:
5.93%
b. Average Life:
17.74 years
c. Yield:
13.5%
Other Investments:
Other investments primarily relate to investments in pooled investment funds. The fair value of pooled investment funds is determined using
dealer quotes or alternative pricing sources when such investments have readily determinable fair values. When fair value is not readily
determinable, pooled investment funds are valued using the net asset value (“NAV”) per share as a practical expedient as permitted under the
Fair Value Measurement Topic of the ASC. Below is additional information about such investments in pooled funds that are reported at fair
value using NAV as a practical expedient. There are no unfunded commitments applicable to any of these investments for the periods disclosed.
Class of Funds
Real estate properties (1)
Diversified hedge fund strategies (2)
Credit products (3)
Illiquid investments (4)
Fair Value at December 31,
2016
2015
Redemption Frequency
Redemption Notice Period
$
33,303
$
59,719
quarterly
10 business days
53,985
210,157
39,068
35,464
semi-monthly
99,579
daily, weekly or monthly
44,754
quarterly
15 - 30 days
0 - 30 days
180 days
(1) Investments consist of UK property to generate income and capital growth.
(2) Investments seek diversified exposure to hedge fund core strategies to produce high risk-adjusted returns, with low long-term correlation to traditional
markets and with targeted volatility levels. Funds may have the right to defer redemptions under certain circumstances.
(3) This class of funds includes investments in a range of instruments including leveraged loans, CLOs, asset-backed securities and floating rate notes to
generate income and capital appreciation. Funds with less frequent redemption periods limit redemptions to as little as 15% per period. Funds with a
same day redemption notice period are redeemable only weekly, while funds that may be redeemed any business day have notice periods of 15-30 days.
(4) This class seeks to obtain high long-term total return through investments with low liquidity and defined terms, resulting in expected capital distributions
to subscribers between 2020 and 2023. Redemptions cannot occur prior to the expiration of the investment lock-up period in May 2018.
Other investments also includes Ambac's interest in a non-consolidated VIE, which is carried under the equity method. Valuation of this
equity interest is internally calculated using a discounted cash flow approach and is classified as Level 3.
Derivative Instruments:
Ambac’s derivative instruments primarily comprise interest rate and credit default swaps, and exchange traded futures contracts. Fair value
is determined based upon market quotes from independent sources, when available. For centrally cleared interest rate swaps, valuations are
determined using quotes from the central counterparty. 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. The valuation of certain interest rate as well as all credit derivative contracts also
require the use of data inputs and assumptions that are determined by management and are not readily observable in the market. Under the
Fair Value Measurement Topic of the ASC, Ambac is required to consider its own credit risk when measuring the fair value of derivative and
other liabilities. The fair value of credit derivative liabilities was reduced by $1,924 and $10,124 at December 31, 2016 and 2015, as a result
of incorporating a CVA into the valuation model for these transactions. Interest rate swaps and other derivative liabilities may also require an
adjustment to fair value to reflect Ambac’s credit risk. Derivative liabilities were reduced by $44,943 and $78,728 at December 31, 2016 and
2015, as a result of Ambac CVA adjustments to derivative contracts other than credit derivatives. Additional factors considered in estimating
the amount of any Ambac CVA on such contracts include collateral posting provisions, right of set-off with the counterparty, the period of
time remaining on the derivatives and the pricing of recent terminations.
As described further below, certain valuation models require other inputs that are not readily observable in the market. 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.
| Ambac Financial Group, Inc. 121 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Derivatives that are less complex may be valued primarily by reference to interest rates and yield curves that are observable and regularly
quoted, such as interest rate swaps, we generally utilize vendor-developed models. These models provide the net present value of the derivatives
based on contractual terms and observable market data. Downgrades of Ambac Assurance, as guarantor of the financial services derivatives,
have increased collateral requirements and triggered termination provisions in certain interest rate swaps. Termination activity since the initial
rating downgrades of Ambac Assurance provided additional information about the replacement and/or exit value of certain financial services
derivatives, which has been incorporated into the fair value of these derivatives as appropriate. Generally, the need for counterparty (or Ambac)
CVAs is mitigated by the existence of collateral posting agreements under which adequate collateral has been posted. Derivative contracts
entered into with financial guarantee customers are not typically subject to collateral posting agreements. Counterparty credit risk related to
such customer derivative assets is included in our fair value adjustments.
For derivatives that do not trade, or trade in less liquid markets such as credit derivatives, an internal model is generally used because such
instruments tend to be unique, contain complex or heavily modified and negotiated terms, and pricing information is not readily available in
the market. Derivative fair value models and the related assumptions are continuously re-evaluated by management and enhanced, as
appropriate, based on improvements in modeling techniques. Ambac has not made any significant changes to its modeling techniques or related
model inputs for the periods presented.
Credit Derivatives (“CDS”):
Fair value of Ambac’s CDS is determined using internal valuation models and represents the net present value of the difference between the
fees Ambac originally charged for the credit protection and our estimate of what a financial guarantor of comparable credit quality would
hypothetically charge to provide the same protection at the balance sheet date. Ambac competed in the financial guarantee market, which
differs from the credit markets where Ambac-insured obligations may trade. As a financial guarantor, Ambac assumes only credit risk; we do
not assume other risks and costs inherent in direct ownership of the underlying reference securities. Additionally, as a result of having the
ability to influence our CDS counterparty in certain investor decisions, financial guarantors generally have the ability to actively remediate
the credit, potentially reducing the loss given a default. Financial guarantee contracts, including CDS, issued by Ambac and its competitors
are typically priced to capture some portion of the spread that would be observed in the capital markets for the underlying (insured) obligation.
Such pricing was well established by historical financial guarantee fees relative to capital market spreads as observed and executed in competitive
markets, including in financial guarantee reinsurance and secondary market transactions. 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.
Key variables used in our valuation of substantially all of our credit derivatives include the balance of unpaid notional, expected term, fair
values of the underlying reference obligations, reference obligation credit ratings, assumptions about current financial guarantee CDS fee
levels relative to reference obligation spreads and the CVA applied against Ambac Assurance liabilities by market participants. Notional
balances, expected remaining term and reference obligation credit ratings are monitored or determined by Ambac’s Portfolio Risk Management
group. Fair values of the underlying reference obligations are obtained from broker quotes when available, or are estimated internally. Implicit
in the fair values we obtain on the underlying reference obligations are the market’s assumptions about default probabilities, default timing,
correlation, recovery rates and collateral values.
Fair values of reference obligations named in our CDS contracts are an input to determine the estimated fair value of the CDS and are
determined using the same methodologies used to value Ambac’s fixed income securities in its investment portfolio as described above. CDS
reference obligation fair values are based on market prices received from dealer quotes or alternative pricing sources with reasonable levels
of price transparency. When quotes for reference obligations are not available or cannot be reasonably corroborated, reference obligation prices
used in the valuation model are estimated internally based on available market prices or spreads for securities or indices with similar
characteristics such as underlying collateral, credit rating and expected life. Internal estimates may also consider historical quotes on the
reference obligation, updated for changes in market factors and security specific developments such as credit rating changes. Reference
obligation prices derived internally as described above were used in the determination of CDS fair values related to transactions representing
0% of CDS gross par outstanding and 0% of the CDS derivative liability as of December 31, 2016.
Ambac’s CDS fair value calculations are adjusted for changes in our estimates of expected loss on the reference obligations and observable
changes in financial guarantee market pricing. If no adjustment is considered necessary, Ambac maintains the same percentage of the credit
spread (over LIBOR) demanded in the market for the reference obligation as existed at the inception of the CDS. Therefore, absent changes
in expected loss on the reference obligations or financial guarantee CDS market pricing, the financial guarantee CDS fee used for a particular
contract in Ambac’s fair value calculations represent a consistent percentage, period to period, of the credit spread determinable from the
reference obligation value at the balance sheet date. This results in a CDS fair value balance that fluctuates in proportion with the reference
obligation value.
The amount of expected loss on a reference obligation is a function of the probability that the obligation will default and severity of loss in
the event of default. Ambac’s CDS transactions were all originally underwritten with extremely low expected losses. Both the reference
obligation spreads and Ambac’s CDS fees at the inception of these transactions reflected these low expected losses. When reference obligations
experience credit deterioration, there is an increase in the probability of default on the obligation and, therefore, an increase in expected loss.
Ambac reflects the effects of changes in expected loss on the fair value of its CDS contracts by increasing the percentage of the reference
| Ambac Financial Group, Inc. 122 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
obligation spread (over LIBOR) which would be captured as a CDS fee (“relative change ratio”) at the valuation date, resulting in a higher
mark-to-market loss on our CDS relative to any price decline on the reference obligation. The fundamental assumption is that financial guarantee
CDS fees will increase relative to reference obligation spreads as the underlying credit quality of the reference obligation deteriorates and
approaches payment default. For example, if the credit spread of an underlying reference obligation was 80 basis points at the inception of a
transaction and Ambac received a 20 basis point fee for issuing a CDS on that obligation, the relative change ratio, which represents the CDS
fee to cash market spread Ambac would utilize in its valuation calculation, would be 25%. If the reference obligation spread increased to 100
basis points in the current reporting period, absent any observable changes in financial guarantee CDS market pricing or credit deterioration,
Ambac’s current period CDS fee would be computed by multiplying the current reference obligation spread of 100 basis points by the relative
change ratio of 25%, resulting in a 25 basis point fee. Thus, the model indicates we would need to receive an additional 5 basis points (25
basis points currently less the 20 basis points contractually received) for issuing a CDS in the current reporting period for this reference
obligation. We would then discount the product of the notional amount of the CDS and the 5 basis point hypothetical CDS fee increase, over
the weighted average life of the reference obligation to compute the current period mark-to-market loss. Using the same example, if the
reference obligation spread increased to 100 basis points and there was credit deterioration as evidenced by an internal rating downgrade which
increased the relative change ratio from 25% to 35%, we would estimate a 15 basis point CDS fee increase in our model (35% of 100 basis
points reference obligation spread, or 35 basis points currently, less the 20 basis points contractually received). Therefore, we would record a
higher mark-to-market loss based on the computations described above absent any observable changes in financial guarantee CDS market
pricing.
We do not adjust the relative change ratio until an actual internal rating downgrade has occurred unless we observe new pricing on financial
guarantee CDS contracts. Since we have active surveillance procedures in place for our entire CDS portfolio, particularly for transactions at
or near a below investment grade threshold, we believe it is unlikely that an internal downgrade would lag the actual credit deterioration of a
transaction for any meaningful time period. The factors used to increase the relative change ratio are based on rating agency probability of
default percentages determined by management to be appropriate for the relevant bond type. That is, the probability of default associated with
the respective tenor and internal rating of each CDS transaction is utilized in the computation of the relative change ratio in our CDS valuation
model. The new relative change ratio in the event of an internal downgrade of the reference obligation is calculated as the weighted average
of: (i) a given transaction’s inception relative change ratio and (ii) a ratio of 100%. The weight given to the inception relative change ratio is
100% minus the current probability of default (the probability of non-default) and the weight given to using a 100% relative change ratio is
the probability of default. For example, assume a transaction having an inception relative change ratio of 33% is downgraded to B-during the
period, at which time it has an estimated remaining life of 8 years. If the estimated probability of default for an 8 year, B-rated credit of this
type is 60% then the revised relative change ratio will be 73.2%. The revised relative change ratio can be calculated as 33% x (100%-60%)
+100% x 60% = 73.2%.
As noted above, reference obligation spreads incorporate market perceptions of default probability and loss severity, as well as liquidity risk
and other factors. By increasing the relative change ratio in our calculations proportionally to default probabilities, Ambac incorporates into
its CDS fair value the higher expected loss on the reference obligation (probability of default x loss severity), by increasing the portion of
reference obligation spread that should be paid to the CDS provider.
Ambac incorporates its own credit risk into the valuation of its CDS liabilities by applying a CVA to the calculations described above. Under
our methodology, determination of the CDS fair value requires estimating hypothetical financial guarantee CDS fees for a given credit at the
valuation date and estimating the present value of those fees. Our approach begins with pricing in the risk of default of the reference obligation
using that obligation’s credit spread. The widening of the reference obligation spread results in a mark-to-market loss to Ambac, as the credit
protection seller, and a gain to the credit protection buyer because the current cost of credit protection on the reference obligation (ignoring
CDS counterparty credit risk) will be greater than the amount of the actual contractual CDS fees. The Ambac CVA represents the difference
between the present value of the hypothetical fees discounted at LIBOR compared to rates that incorporate Ambac credit risk. The discount
rates used to determine the Ambac CVA are estimated using relevant data points, including quoted prices of securities guaranteed by Ambac
Assurance which indicate the value placed by market participants on Ambac Assurance’s insurance obligations and the fair value of Ambac
Assurance surplus notes. The resulting Ambac CVA, as a percentage of the CDS mark-to-market liability determined by discounting at LIBOR,
was 11.1% and 22.7% as of December 31, 2016 and 2015, respectively. In instances where narrower reference obligation spreads result in a
CDS asset to Ambac, those hypothetical future CDS fees are discounted at a rate which incorporates our counterparty’s credit spread (i.e. the
discount rate used is LIBOR plus the current credit spread of the counterparty).
In addition, when there are sufficient numbers of new observable transactions, negotiated settlements or other market indications of a general
change in market pricing trends for CDS on a given bond type, management will adjust its assumptions about the percentage of reference
obligation spreads captured as CDS fees to match the current market. No such adjustments were made during the periods presented. Ambac
is not transacting CDS business currently and other guarantors have stated they have exited this product. Additionally, there have been no
negotiated settlements of CDS contracts during the periods presented.
Key variables which impact the “Realized gains and losses and other settlements” component of “Net change in fair value of credit derivatives”
in the Consolidated Statements of Total Comprehensive Income are the most readily observable variables since they are based solely on the
CDS contractual terms and cash settlements. Those variables include premiums received and accrued and losses paid and payable on written
credit derivative contracts for the appropriate accounting period. Losses paid and payable reported in “Realized gains and losses and other
| Ambac Financial Group, Inc. 123 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
settlements” include those arising after a credit event that requires a payment under the contract terms has occurred or in connection with a
negotiated termination of a contract. The remaining key variables described above impact the “Unrealized gains (losses)” component of “Net
change in fair value of credit derivatives.”
The net notional outstanding of Ambac’s CDS contracts were $737,380 and $970,883 at December 31, 2016 and 2015, respectively. Credit
derivative liabilities at December 31, 2016 and 2015 had a combined fair value of $15,349 and $34,543, respectively, and related to underlying
reference obligations that are classified as either collateralized loan obligations (“CLOs”) or Other. Information about the above described
model inputs used to determine the fair value of each class of credit derivatives, including the CVA as a percentage of the gross mark-to-
market liability before considering Ambac credit risk (“CVA percentage”), as of December 31, 2016 and 2015 is summarized below:
December 31,
Notional outstanding
Weighted average reference obligation price
Weighted average life (WAL) in years
Weighted average credit rating
Weighted average relative change ratio
CVA percentage
2016
2015
CLOs
Other
CLOs
Other (1)
$
123,052
$
614,328
$
295,253
$
617,148
99.5
1.8
AA
36.6%
7.47%
92.3
5.9
A-
30.6%
11.19%
98.4
1.1
AA
36.3%
8.34%
85.2
6.1
BBB+
33.3%
23.34%
Fair value of derivative liabilities
$
213
$
15,136
$
1,837
$
32,697
(1) Excludes contracts for which fair values are based on credit derivative quotes rather than reference obligation quotes. As of December 31, 2015, these
contracts had a combined notional outstanding of $58,482, WAL of 0.2 years and liability fair value of $9. Other inputs to the valuation of these transactions
at December 31, 2015 include weighted average quotes of less than 1% of notional, weighted average rating of A+ and Ambac CVA percentage of 0.09%.
Significant unobservable inputs for credit derivatives include WAL, internal credit rating, relative change ratio and CVA percentage. A longer
(shorter) WAL, lower (higher) reference obligation credit rating, higher (lower) relative change ratio or lower (higher) CVA, in isolation,
would result in an increase (decrease) in the fair value liability measurement. A change in an internal credit rating of a reference obligation in
our model will generally result in a directionally opposite change in the relative change ratio. Also, a shorter (longer) WAL will generally
correspond with a lower (higher) CVA percentage.
Financial Guarantees:
Fair value of net financial guarantees written represents our estimate of the cost to Ambac to completely transfer its insurance obligation to
another market participant of comparable credit worthiness. In theory, this amount should be the same amount that another market participant
of comparable credit worthiness would hypothetically charge in the market place, on a present value basis, to provide the same protection as
of the balance sheet date. This fair value estimate of financial guarantees is presented on a net basis and includes direct and assumed contracts
written, net of ceded reinsurance contracts.
The fair value estimate of financial guarantees is computed by utilizing cash flows calculated at the policy level. For direct and assumed
contracts, net cash flows for each policy included: (i) installment premium receipts, (ii) estimated future gross claim payments, (iii) subrogation
receipts, and (iv) unpaid claims on claims presented and not yet paid for policies allocated to the Segregated Account, including Deferred
Amounts and interest thereon. The timing of future claim payments of the Segregated Account are at the sole discretion of the Rehabilitator.
For ceded reinsurance contracts, net cash flows for each policy included: (i) installment ceded premium payments, (ii) ceding commission
receipts, (iii) ceded claim receipts, and (iv) ceded subrogation payments. For each direct, assumed, and ceded reinsurance contract, the respective
undiscounted cash flow components are aggregated to determine if we are in a net asset or net liability position. U.S. GAAP requires that the
nonperformance risk of a financial liability be included in the estimation of fair value, which includes considering Ambac Assurance’s own
credit risk. Accordingly, for each contract in a net liability position, we estimate the fair value using internally developed discount rates and
market pricing that incorporate Ambac’s own credit risk and subsequently apply a profit margin. This profit margin represents what another
market participant would require to assume the financial guarantee contracts. Given the unique nature of financial guarantees there is a lack
of observable market information to make this estimate. A profit margin was developed based on discussions with the third-party institutions
with valuation expertise, discussions with industry participants and yields on Ambac Assurance surplus notes. The profit margin is applied to
the present value of contracts in a net liability position. The discount rates used for contracts in a net liability position are derived from
guaranteed securities with future cash flows that are highly dependent upon Ambac financial guarantee payments as well as the rates implicit
in the fair value of Ambac Assurance's surplus notes, as applicable. For each contract in a net asset position, we estimate the fair value using
a discount rate that is commensurate with a hypothetical buyer’s cost of capital.
This methodology is based on management’s expectations of how a market participant would estimate net cash flows. We are aware of a
number of factors that may cause such fair or exit value to differ, perhaps materially. For example, (i) since no financial guarantor with Ambac’s
credit quality is writing new financial guarantee business we do not have access to observable pricing data points; (ii) although the fair value
accounting guidance for liabilities requires a company to consider the cost to completely transfer its obligation to another party of comparable
credit worthiness, our primary insurance obligation is irrevocable and thus there is no established active market for transferring such obligations;
| Ambac Financial Group, Inc. 124 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
and (iii) certain segments of Ambac's financial guarantees have been allocated to the Segregated Account and timing of the payments of such
liabilities are at the sole discretion of the Rehabilitator.
Long-term Debt:
The fair values of surplus notes issued by Ambac Assurance and the Segregated Account and classified as long-term debt is based on market
prices received from dealer quotes or alternative pricing sources with reasonable levels of price transparency, when available. The fair values
of surplus notes for which quotes are not available or cannot be reasonably corroborated are internally estimated considering market transactions
when available and internally developed discounted cash flow models. Notes outstanding to third parties arising from Ambac Assurance's
secured borrowing transaction are classified as long-term debt and valued using market prices received from dealer quotes.
Other Financial Assets and Liabilities:
The fair values of Ambac’s equity interest in Ambac sponsored special purpose entities (included in Other assets), Loans, and Obligations
under investment agreements are estimated based upon internal valuation models that discount expected cash flows using discount rates
consistent with the credit quality of the obligor after considering collateralization.
Variable Interest Entity Assets and Liabilities:
The financial assets and liabilities of VIEs consolidated under the Consolidation Topic of the ASC consist primarily of fixed income securities,
loans, derivative and debt instruments and are generally carried at fair value. These consolidated VIEs are securitization entities which have
liabilities and/or assets guaranteed by Ambac Assurance. The fair values of VIE debt instruments are determined using the same methodologies
used to value Ambac’s fixed income securities in its investment portfolio as described above. VIE debt fair value is based on market prices
received from dealer quotes or alternative pricing sources with reasonable levels of price transparency. Such quotes are considered Level 2
and generally consider a variety of factors, including recent trades of the same and similar securities. For those VIE debt instruments where
quotes were not available, the debt instrument fair values are considered Level 3 and are based on internal discounted cash flow models.
Comparable to the sensitivities of investments in fixed income securities described above, longer (shorter) expected maturities or higher (lower)
yields used in the valuation model will, in isolation, result in decreases (increases) in fair value liability measurement for VIE debt. VIE debt
instruments considered Level 3 include fixed rate, floating rate and zero coupon notes secured by various asset types, primarily European
ABS. Information about the valuation inputs for the various VIE debt categories classified as Level 3 is as follows:
European ABS transactions: The fair value of such obligations classified as Level 3 was $2,551,278 and $3,016,966 at December 31, 2016
and 2015, respectively. Fair values were calculated by using a discounted cash flow approach. The discount rates used were based on the rates
implied from the third party quoted values for comparable notes from the same securitization entity. Significant inputs for the valuation at
December 31, 2016 and 2015 include the following weighted averages:
December 31, 2016
a. Coupon rate: 0.46%
b. Maturity:
16.16 years
c. Yield:
4.95%
December 31, 2015
a. Coupon rate: 1.38%
b. Maturity:
16.44 years
c. Yield:
6.08%
US Commercial ABS transaction: The fair value of such obligations classified as Level 3 was $30,942 and $163,204 at December 31, 2016
and 2015, respectively. Fair values were calculated as the sum of the present value of expected future cash flows from the underlying VIE
assets plus the present value of the related Ambac financial guarantee cash flows. The discount rates applied to cash flows sourced from VIE
assets were based on interest rates for similar obligations. The fair value of financial guarantee cash flows include internal estimates of future
loss payments by Ambac discounted at a rate that incorporates Ambac’s own credit risk. Significant inputs for the valuation at December 31,
2016 and 2015, include the following weighted averages:
December 31, 2016
a. Coupon rate: 5.88%
b. Maturity:
20.85 years
c. Yield:
5.86%
December 31, 2015
a. Coupon rate: 5.88%
b. Maturity:
21.81 years
c. Yield:
9.14%
VIE derivative asset and liability fair values are determined using valuation models. When specific derivative contractual terms are available
and may be valued primarily by reference to interest rates, foreign exchange rates and yield curves that are observable and regularly quoted,
the derivatives are valued using vendor-developed models. Other derivatives within the VIEs that include significant unobservable valuation
inputs are valued using internally developed models. VIE derivative fair value balances at December 31, 2016 and 2015 were developed using
vendor-developed models and do not use significant unobservable inputs.
| Ambac Financial Group, Inc. 125 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The fair value of VIE assets are obtained from market quotes when available. Typically the asset fair values are not readily available from
market quotes and are estimated internally. The consolidated VIEs are securitization entities in which net cash flows from assets and derivatives
(after adjusting for financial guarantor cash flows and other expenses) will be paid out to note holders or equity interests. Our valuation of
VIE assets (fixed income securities or loans), therefore, are generally derived from the fair value of notes and derivatives, as described above,
adjusted for the fair value of cash flows from Ambac’s financial guarantee. The fair value of financial guarantee cash flows include: (i) estimated
future premiums discounted at a rate consistent with that implicit in the fair value of the VIE’s liabilities and (ii) internal estimates of future
loss payments by Ambac discounted at a rate that includes Ambac’s own credit risk. Estimated future premium payments to be paid by the
VIEs were discounted at a weighted average rate of 3.6% and 4.4% at December 31, 2016 and 2015, respectively. The value of future loss
payments to be paid by Ambac to the VIEs was adjusted to include an Ambac CVA appropriate for the term of expected Ambac claim payments.
Additional Fair Value Information:
The following tables present the changes in the Level 3 fair value category for the periods presented in 2016 and 2015. Ambac classifies
financial instruments in Level 3 of the fair value hierarchy when there is reliance on at least one significant unobservable input to the valuation
model. In addition to these unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of
inputs that are readily observable either directly or indirectly. Thus, the gains and losses presented below include changes in the fair value
related to both observable and unobservable inputs.
Level-3 Financial Assets and Liabilities Accounted for at Fair Value
Year Ended December 31, 2016
Investments
Other
Assets
Derivatives
Investments
Loans
Long-term
Debt
Total
Balance, beginning of period
$
488,884
$
8,696
$
(99,192) $ 2,588,556
$ 11,690,324
$ (3,180,170) $ 11,497,098
VIE Assets and Liabilities
Total gains/(losses) realized and
unrealized:
Included in earnings
54,600
(1,314)
(15,374)
508,873
1,166,898
(842,748)
870,935
Included in other comprehensive
income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Deconsolidation of VIEs
Balance, end of period
The amount of total gains/(losses) included
in earnings attributable to the change in
unrealized gains or losses relating to
assets and liabilities still held at the
reporting date
40,518
99,018
—
—
(28,682)
108,365
—
—
—
—
—
—
—
—
—
—
—
—
—
—
14,284
—
—
—
(474,863)
(1,944,821)
486,218
(1,892,948)
—
—
—
—
—
—
—
—
—
—
—
—
—
(253,438)
216,582
—
—
—
—
737,898
—
99,018
—
—
(51,254)
108,365
737,898
—
$
762,703
$
7,382
$
(100,282) $ 2,622,566
$ 10,658,963
$ (2,582,220) $ 11,369,112
$
— $
(1,314) $
(16,351) $
508,873
$ 1,166,898
$
(842,748) $
815,358
| Ambac Financial Group, Inc. 126 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Year Ended December 31, 2015
Investments
Other
Assets
Derivatives
Investments
Loans
Long-term
Debt
Total
Balance, beginning of period
$
198,201
$
12,036
$
(215,346) $ 2,743,050
$ 12,371,177
$ (1,263,664) $ 13,845,454
VIE Assets and Liabilities
Total gains/(losses) realized and
unrealized:
Included in earnings
30,083
(1,635)
16,571
(7,263)
569,617
(1,152,681)
(545,308)
Included in other comprehensive
income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Deconsolidations of VIEs
Balance, end of period
The amount of total gains/(losses) included
in earnings attributable to the change in
unrealized gains or losses relating to
assets and liabilities still held at the
reporting date
(73,559)
359,193
—
—
—
—
—
—
(25,034)
(1,705)
—
—
—
—
—
—
—
—
—
—
11,365
88,218
—
—
(147,231)
(612,941)
93,812
(739,919)
—
—
—
—
—
—
—
—
—
—
(312,406)
—
—
(325,123)
—
—
—
(17,085)
(840,552)
—
—
359,193
—
—
(344,865)
(752,334)
—
(325,123)
$
488,884
$
8,696
$
(99,192) $ 2,588,556
$ 11,690,324
$ (3,180,170) $ 11,497,098
$
— $
(1,635) $
(25,980) $
(7,263) $
589,634
$ (1,161,991) $
(607,235)
Year Ended December 31, 2014
Investments
Other
Assets
Derivatives
Investments
Loans
Long-term
Debt
Total
Balance, beginning of period
$
67,783
$
13,384
$
(186,934) $ 2,475,182
$ 13,398,895
$ (1,514,605) $ 14,253,705
VIE Assets and Liabilities
Total gains/(losses) realized and
unrealized:
Included in earnings
11,057
(1,348)
(45,392)
429,113
1,118,084
(290,457)
1,221,057
Included in other comprehensive
income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Deconsolidation of VIEs
Balance, end of period
The amount of total gains/(losses) included
in earnings attributable to the change in
unrealized gains or losses relating to
assets and liabilities still held at the
reporting date
(541)
54,013
—
(59,878)
(62,266)
188,241
(208)
—
—
—
—
—
—
—
—
—
—
—
—
—
16,980
—
—
—
(161,245)
(726,827)
66,515
(822,098)
—
—
—
—
—
—
—
70,000
—
—
—
—
—
124,013
—
(59,878)
(792,186)
433,896
(403,576)
—
—
(696,789)
—
4,096
36,891
188,241
3,888
(659,898)
$
198,201
$
12,036
$
(215,346) $ 2,743,050
$ 12,371,177
$ (1,263,664) $ 13,845,454
$
— $
(1,348) $
(53,509) $
429,113
$ 1,119,219
$
(286,405) $ 1,207,070
| Ambac Financial Group, Inc. 127 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The tables below provide roll-forward information by class of investments and derivatives measured using significant unobservable inputs.
Level-3 Investments by Class
Year Ended December 31, 2016
Balance, beginning of period
Total gains/(losses) realized and unrealized:
Included in earnings
Included in other comprehensive income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Balance, end of period
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains
or losses relating to assets and liabilities still held at the reporting date
Year Ended December 31, 2015
Balance, beginning of period
Total gains/(losses) realized and unrealized:
Included in earnings
Included in other comprehensive income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Balance, end of period
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains
or losses relating to assets and liabilities still held at the reporting date
Other Asset
Backed
Securities
Non-Agency
RMBS
Total
Investments
$
— $
488,884
$
488,884
1,908
(5,597)
—
—
—
(1,028)
70,707
—
52,692
46,115
99,018
—
—
(27,654)
37,658
—
54,600
40,518
99,018
—
—
(28,682)
108,365
—
65,990
$
696,713
$
762,703
— $
— $
—
Corporate
Obligations
Non-Agency
RMBS
Total
Investments
3,808
$
194,393
$
198,201
(19)
(286)
—
—
—
30,102
(73,273)
359,193
—
—
30,083
(73,559)
359,193
—
—
(3,503)
(21,531)
(25,034)
—
—
—
—
—
—
— $
488,884
$
488,884
— $
— $
—
$
$
$
$
$
| Ambac Financial Group, Inc. 128 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Year Ended December 31, 2014
Balance, beginning of period
Total gains/(losses) realized and unrealized:
Included in earnings
Included in other comprehensive income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Balance, end of period
The amount of total gains/(losses) included in earnings
attributable to the change in unrealized gains or losses
relating to assets and liabilities still held at the reporting
date
Level-3 Derivatives by Class
Other Asset
Backed
Securities
Corporate
Obligations
U.S. Agency
Obligations
Non-Agency
RMBS
Total
Investments
$
64,073
$
3,502
$
208
$
— $
67,783
6,994
(8,182)
—
—
(59,878)
(3,007)
—
—
(97)
403
—
—
—
—
—
—
—
—
—
—
—
—
—
(208)
4,160
7,238
54,013
—
—
(59,259)
188,241
—
11,057
(541)
54,013
—
(59,878)
(62,266)
188,241
(208)
— $
3,808
$
— $
194,393
$
198,201
— $
— $
— $
— $
—
$
$
Year Ended December 31,
Interest Rate
Swaps
Credit
Derivatives
Total
Derivatives
Interest Rate
Swaps
Credit
Derivatives
Total
Derivatives
Balance, beginning of period
$
(64,649) $
(34,543) $
(99,192) $
(141,887) $
(73,459) $
(215,346)
2016
2015
Total gains/(losses) realized and
unrealized:
Included in earnings
(35,480)
20,106
(15,374)
(25,130)
41,701
16,571
Included in other comprehensive
income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Balance, end of period
The amount of total gains/(losses)
included in earnings attributable to the
change in unrealized gains or losses
relating to assets and liabilities still
held at the reporting date
$
$
—
—
—
—
15,196
—
—
—
—
—
—
(912)
—
—
—
—
—
—
14,284
—
—
—
—
—
—
14,150
88,218
—
—
—
—
—
(2,785)
—
—
—
—
—
—
11,365
88,218
—
(84,933) $
(15,349) $
(100,282) $
(64,649) $
(34,543) $
(99,192)
(35,480) $
19,129
$
(16,351) $
(25,130) $
(850) $
(25,980)
| Ambac Financial Group, Inc. 129 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Year Ended December 31,
Balance, beginning of period
Total gains/(losses) realized and unrealized:
Included in earnings
Included in other comprehensive income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Balance, end of period
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains
or losses relating to assets and liabilities still held at the reporting date
2014
Interest Rate
Swaps
Credit
Derivatives
Total
Derivatives
$
(92,612) $
(94,322) $
(186,934)
(69,298)
23,906
(45,392)
—
—
—
—
—
—
—
—
—
—
—
—
20,023
(3,043)
16,980
—
—
—
—
—
—
(141,887) $
(73,459) $
(215,346)
(69,298) $
15,789
$
(53,509)
$
$
Invested assets and VIE long-term debt are transferred into Level 3 when internal valuation models that include significant unobservable inputs
are used to estimate fair value. All such securities that have internally modeled fair values have been classified as Level 3. Other Asset-backed
securities transferred into Level 3 in 2016 consist of a subordinated tranche of a resecuritization collateralized by Ambac-insured military
housing bonds. Non-agency RMBS transferred into Level 3 in 2014 and 2016 consist of certain investments in Ambac-wrapped RMBS
securities for which projected cash flows consist solely of Deferred Amounts and interest thereon. These invested assets were internally
valued as management could not corroborate the reasonableness of third party quotes. Derivative instruments are transferred into Level 3
when the use of unobservable inputs becomes significant to the overall valuation. Derivative instruments transferred into Level 3 in 2015
consisted of certain interest rate swap assets with counterparty credit adjustments. All transfers into and out of Level 3 represent transfers
between Level 3 and Level 2. There were no transfers between Level 1 and Level 2 for the periods presented. All transfers between fair value
hierarchy Levels 1, 2, and 3 are recognized at the beginning of each accounting period.
Gains and losses (realized and unrealized) relating to Level 3 assets and liabilities included in earnings for the affected periods are reported
as follows:
Realized
Gains or
(Losses) and
Other
Settlements
on Credit
Derivative
Contracts
Net
Investment
Income
54,600
—
912
—
Unrealized
Gains or
(Losses) on
Credit
Derivative
Contracts
Derivative
Products
Revenues
(Interest Rate
Swaps)
Income
(Loss) on
Variable
Interest
Entities
Other
Income
or (Loss)
19,194
(35,480)
833,023
(1,314)
19,129
(35,480)
833,023
(1,314)
$
30,083
$
2,785
$
38,916
$
(25,130) $
(590,327) $
(1,635)
—
—
(850)
(25,130)
(579,620)
(1,635)
$
11,057
$
3,043
$
20,863
$
(69,298) $
1,256,740
$
(1,348)
—
—
15,789
(69,298)
1,261,927
(1,348)
Year Ended December 31, 2016
Total gains or losses included in earnings for
the period
Changes in unrealized gains or losses relating
to the assets and liabilities still held at the
reporting date
Year Ended December 31, 2015
Total gains or losses included in earnings for
the period
Changes in unrealized gains or losses relating
to the assets and liabilities still held at the
reporting date
Year Ended December 31, 2014
Total gains or losses included in earnings for
the period
Changes in unrealized gains or losses relating
to the assets and liabilities still held at the
reporting date
| Ambac Financial Group, Inc. 130 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
10. INVESTMENTS
Ambac’s invested assets are primarily comprised of fixed income securities classified as available-for-sale and equity interests in pooled
investment funds. Such equity interests in the form of common stock or in-substance common stock are classified as trading securities and
are reported within Other investments on the Consolidated Balance Sheets. Other investments also includes Ambac's equity interest in an
unconsolidated trust created in connection with its sale of Segregated Account junior surplus notes on August 28, 2014.
The amortized cost and estimated fair value of available-for-sale investments, excluding VIE investments, at December 31, 2016 and 2015
were as follows:
December 31, 2016
Fixed income securities:
Municipal obligations
Corporate obligations
Foreign obligations
U.S. government obligations
U.S. agency obligations
Residential mortgage-backed securities
Collateralized debt obligations
Other asset-backed securities
Short-term
Fixed income securities pledged as collateral:
U.S. government obligations
Total collateralized investments
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
Non-Credit
Other-
than-
temporary
Impairments (1)
$
376,064
$
5,509
$
7,205
$
374,368
$
1,803,136
41,932
33,732
4,063
2,284,425
113,650
778,383
5,435,385
430,827
5,866,212
64,833
64,833
19,589
1,303
2,551
—
110,955
493
58,028
198,428
5
198,433
72
72
20,560
1,802,165
100
97
3
43,785
220
7,628
79,598
44
79,642
—
—
43,135
36,186
4,060
2,351,595
113,923
828,783
5,554,215
430,788
5,985,003
64,905
64,905
—
—
—
—
—
35,232
—
—
35,232
—
35,232
—
—
Total available-for-sale investments
$
5,931,045
$
198,505
$
79,642
$
6,049,908
$
35,232
December 31, 2015
Fixed income securities:
Municipal obligations
Corporate obligations
Foreign obligations
U.S. government obligations
U.S. agency obligations
Residential mortgage-backed securities
Collateralized debt obligations
Other asset-backed securities
Short-term
Fixed income securities pledged as collateral:
U.S. government obligations
Total collateralized investments
$
424,048
$
4,910
$
8,188
$
420,770
$
1,610,912
96,638
26,086
4,239
1,942,285
85,706
802,842
4,992,756
225,789
5,218,545
64,612
64,612
7,089
1,491
789
—
99,670
42
41,177
155,168
1
24,332
1,823
188
27
64,617
1,481
3,492
104,148
1
155,169
104,149
—
—
57
57
1,593,669
96,306
26,687
4,212
1,977,338
84,267
840,527
5,043,776
225,789
5,269,565
64,555
64,555
—
—
—
—
—
41,673
—
—
41,673
—
41,673
—
—
Total available-for-sale investments
$
5,283,157
$
155,169
$
104,206
$
5,334,120
$
41,673
(1) Represents the amount of non-credit other-than-temporary impairment losses remaining in accumulated other comprehensive loss on securities that also
had a credit impairment. These losses are included in gross unrealized losses as of December 31, 2016 and 2015.
| Ambac Financial Group, Inc. 131 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The amortized cost and estimated fair value of available-for-sale investments, excluding VIE investments, at December 31, 2016, by contractual
maturity, were as follows:
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Residential mortgage-backed securities
Collateralized debt obligations
Other asset-backed securities
Total
Amortized
Cost
Estimated
Fair Value
$
553,892
$
1,216,940
837,225
146,530
2,754,587
2,284,425
113,650
778,383
554,454
1,220,450
834,775
145,928
2,755,607
2,351,595
113,923
828,783
$
5,931,045
$
6,049,908
Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay certain obligations with or
without call or prepayment penalties.
Unrealized Losses:
The following table shows gross unrealized losses and fair values of Ambac’s available-for-sale investments, aggregated by investment category
and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2016 and 2015:
Less Than 12 Months
12 Months or More
Total
Fair Value
Gross
Unrealized
Loss
Fair Value
Gross
Unrealized
Loss
Fair Value
Gross
Unrealized
Loss
December 31, 2016
Fixed income securities:
Municipal obligations
Corporate obligations
Foreign government obligations
U.S. government obligations
U.S. agency obligations
Residential mortgage-backed
securities
Collateralized debt obligations
Other asset-backed securities
Short-term
Total temporarily impaired
securities
$
98,147
$
2,045
$
122,928
$
5,160
$
221,075
$
963,513
20,232
5,063
6,037
4,060
226,889
6,986
115,622
1,426,317
65,176
100
93
3
7,201
23
203
29,900
44
6,492
—
5,045
—
550,807
25,780
77,712
788,764
—
328
—
4
—
36,584
197
7,425
49,698
—
970,005
5,063
11,082
4,060
777,696
32,766
193,334
2,215,081
65,176
7,205
20,560
100
97
3
43,785
220
7,628
79,598
44
$
1,491,493
$
29,944
$
788,764
$
49,698
$
2,280,257
$
79,642
| Ambac Financial Group, Inc. 132 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
December 31, 2015
Fixed income securities:
Municipal obligations
Corporate obligations
Foreign government obligations
U.S. government obligations
U.S. agency obligations
Residential mortgage-backed
securities
Collateralized debt obligations
Other asset-backed securities
Short-term
Fixed Income securities, pledged as
collateral:
U.S. government obligations
Total collateralized investments
Total temporarily impaired
securities
Less Than 12 Months
12 Months or More
Total
Fair Value
Gross
Unrealized
Loss
Fair Value
Gross
Unrealized
Loss
Fair Value
Gross
Unrealized
Loss
$
117,008
$
2,070
$
114,708
$
6,118
$
231,716
$
938,916
34,904
2,938
—
584,699
77,538
450,690
2,206,693
9,982
2,216,675
64,555
64,555
21,331
1,018
18
—
53,367
1,481
3,456
82,741
1
82,742
57
57
92,581
8,584
10,658
4,212
213,303
—
19,274
463,320
—
463,320
—
—
3,001
1,031,497
805
170
27
11,250
—
36
21,407
—
21,407
43,488
13,596
4,212
798,002
77,538
469,964
2,670,013
9,982
2,679,995
—
—
64,555
64,555
8,188
24,332
1,823
188
27
64,617
1,481
3,492
104,148
1
104,149
57
57
$
2,281,230
$
82,799
$
463,320
$
21,407
$
2,744,550
$
104,206
Management has determined that the unrealized losses reflected in the tables above are temporary in nature as of December 31, 2016 and 2015
based upon (i) no unexpected principal and interest payment defaults on these securities; (ii) analysis of the creditworthiness of the issuer and
financial guarantor, as applicable, and analysis of projected defaults on the underlying collateral; (iii) management has no intent to sell these
investments in debt securities; and (iv) it is not more likely than not that Ambac will be required to sell these debt securities before the anticipated
recovery of its amortized cost basis. The assessment under (iv) is based on a comparison of future available liquidity from the investment
portfolio against the projected net cash flow from operating activities and debt service. For purposes of this assessment, available liquidity
from the investment portfolio is comprised of the fair value of securities for which management has asserted its intent to sell, trading securities
plus the projected principal and interest payments from the remaining securities in the portfolio. To the extent that securities that management
intends to sell are in an unrealized loss position, they would have already been considered other-than-temporarily impaired with the amortized
cost written down to fair value. For purposes of this analysis, residual cash flows are projected to be invested at current reinvestment rates
consistent with existing fixed income portfolio holdings. Because the above-described assessment indicates that future available liquidity
exceeds projected net cash outflow, it is not more likely than not that we would be required to sell securities in an unrealized loss position
before the recovery of their amortized cost basis. In the liquidity assessment described above, principal payments on securities pledged as
collateral are not considered to be available for other liquidity needs until the collateralized positions are projected to be settled. Projected
interest receipts on securities pledged as collateral generally belong to Ambac and are considered to be sources of available liquidity from the
investment portfolio.
As of December 31, 2016, for securities that have indications of possible other-than-temporary impairment but which management does not
intend to sell and will not more likely than not be required to sell, management compared the present value of cash flows expected to be
collected to the amortized cost basis of the securities to assess whether the amortized cost will be recovered. Cash flows were discounted at
the effective interest rate implicit in the security at the date of acquisition (or Fresh Start Reporting Date of April 30, 2013 for securities
purchased prior to that date) or for debt securities that are beneficial interests in securitized financial assets, at a rate equal to the current yield
used to accrete the beneficial interest. For floating rate securities, future cash flows and the discount rate used were both adjusted to reflect
changes in the index rate applicable to each security as of the evaluation date. Of the securities that were in a gross unrealized loss position
at December 31, 2016, $890,952 of the total fair value and $53,273 of the unrealized loss related to below investment grade securities and
non-rated securities. Of the securities that were in a gross unrealized loss position at December 31, 2015, $953,000 of the total fair value and
$69,214 of the unrealized loss related to below investment grade securities and non-rated securities. With respect to all Ambac insured securities
owned, future cash flows used to measure credit impairment represents the sum of (i) the bond’s intrinsic cash flows and (ii) the estimated
Ambac Assurance claim payments. For Ambac-insured securities owned guaranteed under policies allocated to the Segregated Account, the
estimate of Ambac Assurance claim payments includes interest on Deferred Amounts. Ambac estimates the timing of claim payment receipts
on all Ambac-insured securities owned, but the actual timing of such amounts for Segregated Account securities are at the sole discretion of
the Rehabilitator. Further modifications to the Segregated Account Rehabilitation Plan or to the rules and guidelines promulgated thereunder,
| Ambac Financial Group, Inc. 133 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
orders from the Rehabilitation Court or actions by the Rehabilitator with respect to the form, amount and timing of satisfying permitted policy
claims, or making payments on Deferred Amounts or surplus notes, may have a material effect on the fair value of Ambac insured securities
and future recognition of other-than-temporary impairments. Refer to Note 1. Background and Business Description for information relating
to the amended Segregated Account Rehabilitation Plan. Ambac’s assessment about whether a decline in value is other-than-temporary reflects
management’s current judgment regarding facts and circumstances specific to a security and the factors noted above, including Ambac's
intention to sell securities and ability to hold temporarily impaired securities until recovery. If that judgment changes, Ambac may ultimately
record a charge for other-than-temporary impairment in future periods.
Municipal and corporate obligations
The gross unrealized losses on municipal and corporate obligations as of December 31, 2016 are primarily the result of the increase in interest
rates since purchase (or the Fresh Start Reporting Date of April 30, 2013 if owned as of that date). These securities are primarily fixed-rate
securities with an investment grade credit rating. Management believes that the timely receipt of all principal and interest on these positions
is probable.
Residential mortgage-backed securities
Of the $43,785 of unrealized losses on residential mortgage-backed securities, $43,380 is attributable to Ambac insured securities. The
unrealized loss on these securities is primarily the result of discount accretion, which has exceeded the increase in fair value. As part of the
quarterly impairment review process, management estimates expected future cash flows from residential mortgage-backed securities. This
approach includes the utilization of market accepted software models in conjunction with detailed data of the historical performance of the
collateral pools, which assists in the determination of assumptions such as defaults, severity and voluntary prepayment rates that are largely
driven by home price forecasts as well as other macro-economic factors. Additionally, for Ambac insured securities that are allocated to the
Segregated Account, expected future cash flows include assumptions about the timing of Ambac Assurance claim payments, including interest
on Deferred Amounts, although the actual timing of such payments are at the sole discretion of the Rehabilitator. These assumptions are used
to project future cash flows for each security. Management considered this analysis in making our determination that a credit loss has not
occurred at December 31, 2016 on these transactions.
Realized Gains and Losses and Other-Than-Temporary Impairments:
The following table details amounts included in net realized gains and other-than-temporary impairments included in earnings for the affected
periods:
Year Ended December 31,
Gross realized gains on securities
Gross realized losses on securities
Foreign exchange (losses) gains
Net realized gains
Net other-than-temporary impairments (1)
2016
2015
2014
17,344
$
58,218
$
(8,239)
30,179
(10,558)
5,816
39,284
$
53,476
$
63,366
(9,824)
5,235
58,777
(21,819) $
(25,659) $
(25,794)
$
$
$
(1) Other-than-temporary impairments exclude impairment amounts recorded in other comprehensive income under ASC Paragraph 320-10-65-1, which
comprise non-credit related amounts on securities that are credit impaired but which management does not intend to sell and it is not more likely than not
that the company will be required to sell before recovery of the amortized cost basis.
Since commencement of the Segregated Account Rehabilitation Proceedings, changes in the estimated timing of claim payments have resulted
in adverse changes in projected cash flows on certain impaired Ambac insured securities. Such changes in estimated claim payments on Ambac
insured securities contributed to net other-than-temporary impairments for the periods presented in the table above. Further changes to the
timing of estimated claim payments could result in additional other-than-temporary impairment charges in the future. Ambac’s other-than-
temporary impairments also relate to the company’s intent to sell certain securities that were in an unrealized loss position as of the impairment
evaluation dates. Future changes in our estimated liquidity needs could result in a determination that Ambac no longer has the ability to hold
additional securities that are in an unrealized loss position, which could result in additional other-than-temporary impairment charges.
| Ambac Financial Group, Inc. 134 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The following table presents a roll-forward of Ambac’s cumulative credit losses on debt securities held as of December 31, 2016 and 2015
for which a portion of an other-than-temporary impairment was recognized in other comprehensive income:
Year Ended December 31,
Balance, beginning of period
Additions for credit impairments recognized on:
Securities not previously impaired
Securities previously impaired
Reductions for credit impairments previously recognized on:
Securities that matured or were sold during the period
Balance, end of period
2016
2015
2014
31,176
$
14,062
$
1,182
3,572
17,322
—
10,900
6,214
—
12,873
7
—
52,070
$
31,176
$
14,062
$
$
Counterparty Collateral, Deposits with Regulators and Other Restrictions:
Ambac routinely pledges and receives collateral related to certain business lines and/or transactions. Ambac pledges assets it holds in its
investment portfolio to investment agreement and derivative counterparties. Securities pledged to investment agreement counterparties may
not then be re-pledged to another entity. Ambac’s counterparties under derivative agreements have the right to pledge or rehypothecate the
securities and as such, these pledged securities are separately classified on the Consolidated Balance Sheets as “Fixed income securities pledged
as collateral, at fair value”.
The following table presents (i) the sources of collateral either received from various counterparties where Ambac is permitted to sell or re-
pledge the collateral or collateral held directly in the investment portfolio and (ii) how that collateral was pledged to various investment
agreement, derivative and repurchase agreement counterparties at December 31, 2016 and 2015:
December 31, 2016:
Sources of Collateral:
Cash and securities pledged directly from the investment portfolio
December 31, 2015:
Sources of Collateral:
Cash and securities pledged directly from the investment portfolio
$
$
Fair Value of
Cash and
Underlying
Securities
Fair Value of Cash
and Securities
Pledged to
Investment
Agreement
Counterparties
Fair Value of
Cash and
Securities
Pledged to
Derivative
Counterparties
291,545
$
88,940
$
202,605
338,007
$
108,379
$
229,628
Securities carried at $5,872 and $6,762 at December 31, 2016 and 2015, respectively, were deposited by Ambac Assurance and Everspan with
governmental authorities or designated custodian banks as required by laws affecting insurance companies.
Securities with fair value of $360,759 and $396,100 at December 31, 2016 and 2015, respectively, were held by a bankruptcy remote trust to
collateralize and fund repayment of debt issued through a secured borrowing transaction. The securities may not be sold or repledged by the
trust. These assets are held and the secured debt issued by entities that qualified as VIEs and were consolidated in Ambac’s consolidated
financial statements. Refer to Note 4. Special Purpose Entities, Including Variable Interest Entities for a further description of this transaction.
| Ambac Financial Group, Inc. 135 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Guaranteed Securities:
Ambac’s fixed income portfolio includes securities covered by guarantees issued by Ambac Assurance and other financial guarantors (“insured
securities”). The published rating agency ratings on these securities reflect the higher of the financial strength rating of the financial guarantor
or the rating of the underlying issuer. Rating agencies do not always publish separate underlying ratings (those ratings excluding the insurance
by the financial guarantor) because the insurance cannot be legally separated from the underlying security by the insurer. In the event these
underlying ratings are not available from the rating agencies, Ambac will assign an internal rating. The following table represents the fair
value, including the value of the financial guarantee, and weighted-average underlying rating, excluding the financial guarantee, of the insured
securities at December 31, 2016 and 2015, respectively:
December 31, 2016:
Ambac Assurance Corporation (2)
National Public Finance Guarantee
Corporation
Assured Guaranty Municipal
Corporation
MBIA Insurance Corporation
Total
December 31, 2015:
Ambac Assurance Corporation (2)
National Public Finance Guarantee
Corporation
Assured Guaranty Municipal
Corporation
MBIA Insurance Corporation
Municipal
Obligations
Corporate
Obligations
Mortgage
and Asset-
backed
Securities
Short-term
Total
Weighted
Average
Underlying
Rating (1)
$
81,651
$
— $
2,739,073
$
— $
2,820,724
$
$
38,687
25,660
—
—
—
2,630
—
—
—
—
—
—
38,687
25,660
2,630
145,998
$
2,630
$
2,739,073
$
— $
2,887,701
60,836
$
— $
2,216,317
$
— $
2,277,153
47,846
57,715
—
—
—
25,645
—
—
—
—
—
—
47,846
57,715
25,645
CC
A-
AA
BBB+
CC
CC
A-
A+
A+
Total
$
166,397
$
25,645
$
2,216,317
$
— $
2,408,359
CCC-
(1) Ratings are based on the lower of Standard & Poor’s or Moody’s rating. If unavailable, Ambac’s internal rating is used.
(2)
Includes asset-backed securities with a fair value of $118,813 and $119,802 at December 31, 2016 and 2015, respectively, insured by Ambac UK.
Investment Income:
Net investment income was comprised of the following for the affected periods:
Year Ended December 31,
Fixed income securities
Short-term investments
Loans
Investment expense
Securities available-for-sale and short-term
Other investments
Total net investment income
2016
2015
2014
$
288,554
$
257,404
$
299,694
1,505
337
(9,347)
281,049
32,318
299
420
(8,786)
249,337
16,952
$
313,367
$
266,289
$
3,092
529
(10,477)
292,838
8,108
300,946
Net investment income from Other investments primarily represents changes in fair value on securities classified as trading or under the fair
value option plus, for periods after August 28, 2014, income from Ambac's equity interest in an unconsolidated trust created in connection
with its sale of Segregated Account junior surplus notes on that date. The portion of net unrealized gains (losses) related to trading securities
still held at the end of each period is as follows:
Year Ended December 31,
Net gains recognized during the period on trading securities
Less: net gains and (losses) recognized during the reporting period on trading securities
sold during the period
(cid:56)(cid:81)(cid:85)(cid:72)(cid:68)(cid:79)(cid:76)(cid:93)(cid:72)(cid:71) (cid:74)(cid:68)(cid:76)(cid:81)(cid:86) (cid:68)(cid:81)(cid:71) (cid:11)(cid:79)(cid:82)(cid:86)(cid:86)(cid:72)(cid:86)(cid:12) (cid:85)(cid:72)(cid:70)(cid:82)(cid:74)(cid:81)(cid:76)(cid:93)(cid:72)(cid:71) (cid:71)(cid:88)(cid:85)(cid:76)(cid:81)(cid:74) (cid:87)(cid:75)(cid:72) (cid:85)(cid:72)(cid:83)(cid:82)(cid:85)(cid:87)(cid:76)(cid:81)(cid:74) (cid:83)(cid:72)(cid:85)(cid:76)(cid:82)(cid:71) (cid:82)(cid:81) (cid:87)(cid:85)(cid:68)(cid:71)(cid:76)(cid:81)(cid:74)
(cid:86)(cid:72)(cid:70)(cid:88)(cid:85)(cid:76)(cid:87)(cid:76)(cid:72)(cid:86) (cid:86)(cid:87)(cid:76)(cid:79)(cid:79) (cid:75)(cid:72)(cid:79)(cid:71) (cid:68)(cid:87) (cid:87)(cid:75)(cid:72) (cid:85)(cid:72)(cid:83)(cid:82)(cid:85)(cid:87)(cid:76)(cid:81)(cid:74) (cid:71)(cid:68)(cid:87)(cid:72)
$
(cid:7)
2016
2015
2014
27,654
$
12,615
$
7,474
4,966
(cid:21)(cid:19)(cid:15)(cid:20)(cid:27)(cid:19)
(cid:7)
(cid:26)(cid:15)(cid:25)(cid:23)(cid:28)
(cid:7)
6,713
(487)
(cid:26)(cid:15)(cid:21)(cid:19)(cid:19)
| Ambac Financial Group, Inc. 136 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
11. DERIVATIVE INSTRUMENTS
The following tables summarize the gross fair values of individual derivative instruments and the impact of legal rights of offset as reported
in the Consolidated Balance Sheets as of December 31, 2016 and 2015.
Gross
Amounts of
Recognized
Assets /
Liabilities
Gross
Amounts
Offset in the
Consolidated
Balance Sheet
Net Amounts
of Assets/
Liabilities
Presented
in the
Consolidated
Balance Sheet
Gross Amount
of Collateral
Received /
Pledged Not
Offset in the
Consolidated
Balance Sheet
Net Amount
December 31, 2016:
Derivative Assets:
Interest rate swaps
Futures contracts
Total non-VIE derivative assets
Derivative Liabilities:
Credit derivatives
Interest rate swaps
Total non-VIE derivative liabilities
Variable Interest Entities Derivative
Assets:
Currency swaps
Total VIE derivative assets
Variable interest entities derivative
liabilities:
Interest rate swaps
Total VIE derivative liabilities
December 31, 2015:
Derivative Assets:
Interest rate swaps
Futures contracts
Total non-VIE derivative assets
Derivative Liabilities:
Credit derivatives
Interest rate swaps
Total non-VIE derivative liabilities
Variable Interest Entities Derivative
Assets:
Currency swaps
Total VIE derivative assets
Variable Interest Entities Derivative
Liabilities:
Interest rate swaps
Currency swaps
Total VIE derivative liabilities
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
139,045
536
139,581
15,349
365,776
381,125
80,407
80,407
2,078,601
2,078,601
137,015
109
137,124
34,543
370,944
405,487
36,862
36,862
1,965,265
—
1,965,265
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
61,839
—
61,839
$
$
— $
61,839
61,839
$
— $
— $
77,206
536
77,742
15,349
303,937
319,286
80,407
80,407
— $
— $
2,078,601
2,078,601
— $
—
— $
— $
156,925
156,925
$
— $
— $
77,206
536
77,742
15,349
147,012
162,361
80,407
80,407
— $
— $
2,078,601
2,078,601
52,129
—
52,129
$
$
— $
52,129
52,129
$
36,862
36,862
$
$
84,886
109
84,995
34,543
318,815
353,358
— $
—
— $
— $
176,386
176,386
$
— $
— $
— $
— $
84,886
109
84,995
34,543
142,429
176,972
—
—
— $
1,965,265
36,862
(36,862)
36,862
$
1,928,403
$
$
— $
1,965,265
—
(36,862)
— $
1,928,403
Amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral are not offset against fair value amounts
recognized for derivative instruments on the Consolidated Balance Sheets. The amounts representing the right to reclaim cash collateral and
posted margin, recorded in “Other assets” were $137,701 and $165,073 as of December 31, 2016 and 2015, respectively. There were no
amounts held representing an obligation to return cash collateral as of December 31, 2016 and 2015.
| Ambac Financial Group, Inc. 137 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Location of Gain or (Loss)
Recognized in Consolidated
Statements of
Total Comprehensive Income
(Loss)
Amount of Gain or (Loss) Recognized in Consolidated
Statement of Total Comprehensive Income (Loss) –
Year Ended December 31,
2016
2015
2014
Net change in fair value of credit
derivatives
$
20,106
$
41,701
$
23,906
Derivative products
Derivative products
Income (loss) on variable interest
entities
Income (loss) on variable interest
entities
(50,082)
(191)
(50,273)
58,990
(574,554)
(515,564)
(41,177)
(1,367)
(42,544)
103,757
168,003
271,760
(cid:7)
(cid:11)(cid:24)(cid:23)(cid:24)(cid:15)(cid:26)(cid:22)(cid:20)(cid:12) (cid:7)
(cid:21)(cid:26)(cid:19)(cid:15)(cid:28)(cid:20)(cid:26)
(cid:7)
(173,615)
(7,472)
(181,087)
24,577
(452,434)
(427,857)
(cid:11)(cid:24)(cid:27)(cid:24)(cid:15)(cid:19)(cid:22)(cid:27)(cid:12)
Financial Guarantee:
Credit derivatives
(cid:41)(cid:76)(cid:81)(cid:68)(cid:81)(cid:70)(cid:76)(cid:68)(cid:79) (cid:54)(cid:72)(cid:85)(cid:89)(cid:76)(cid:70)(cid:72)(cid:86) (cid:71)(cid:72)(cid:85)(cid:76)(cid:89)(cid:68)(cid:87)(cid:76)(cid:89)(cid:72)(cid:86) (cid:83)(cid:85)(cid:82)(cid:71)(cid:88)(cid:70)(cid:87)(cid:86)(cid:29)
Interest rate swaps
Futures contracts
(cid:55)(cid:82)(cid:87)(cid:68)(cid:79) (cid:41)(cid:76)(cid:81)(cid:68)(cid:81)(cid:70)(cid:76)(cid:68)(cid:79) (cid:54)(cid:72)(cid:85)(cid:89)(cid:76)(cid:70)(cid:72)(cid:86) (cid:71)(cid:72)(cid:85)(cid:76)(cid:89)(cid:68)(cid:87)(cid:76)(cid:89)(cid:72) (cid:83)(cid:85)(cid:82)(cid:71)(cid:88)(cid:70)(cid:87)(cid:86)
Variable Interest Entities:
Currency swaps
Interest rate swaps
(cid:55)(cid:82)(cid:87)(cid:68)(cid:79) (cid:57)(cid:68)(cid:85)(cid:76)(cid:68)(cid:69)(cid:79)(cid:72) (cid:44)(cid:81)(cid:87)(cid:72)(cid:85)(cid:72)(cid:86)(cid:87) (cid:40)(cid:81)(cid:87)(cid:76)(cid:87)(cid:76)(cid:72)(cid:86)
Total derivative contracts
Financial Guarantee Credit Derivatives:
Credit derivatives, which are privately negotiated contracts, provide the counterparty with credit protection against the occurrence of a specific
event such as a payment default or bankruptcy relating to an underlying obligation. Upon a credit event, Ambac is required to make payments
equal to the difference between the scheduled debt service payment and the actual payment made by the issuer. Substantially all of Ambac’s
credit derivative contracts relate to structured finance transactions. Credit derivatives issued are insured by Ambac Assurance. None of the
outstanding credit derivative transactions at December 31, 2016 include ratings based collateral-posting triggers or otherwise require Ambac
to post collateral regardless of Ambac’s ratings or the size of the mark to market exposure to Ambac.
The portfolio of our credit derivatives were written on a “pay-as-you-go” basis. Similar to an insurance policy execution, pay-as-you-go
provides that Ambac pays interest shortfalls on the referenced transaction as they are incurred on each scheduled payment date, but only pays
principal shortfalls upon the earlier of (i) the date on which the assets designated to fund the referenced obligation have been disposed of and
(ii) the legal final maturity date of the referenced obligation.
Ambac maintains internal credit ratings on its guaranteed obligations, including credit derivative contracts, solely to indicate management’s
view of the underlying credit quality of the guaranteed obligations. Independent rating agencies may have assigned different ratings on the
credits in Ambac’s portfolio than Ambac’s internal ratings. The following tables summarize the gross principal notional outstanding for CDS
contracts, by Ambac rating, for each major category as of December 31, 2016 and 2015:
December 31,
Ambac Rating
AAA
AA
A
BBB (1)
Below investment grade (2)
CLO
2016
Other
Total
CLO
2015
Other
Total
$
— $
— $
— $
— $
— $
123,052
—
—
—
192,149
227,146
127,250
67,783
315,201
227,146
127,250
67,783
295,254
—
—
—
241,458
9,322
356,323
68,526
—
536,712
9,322
356,323
68,526
Total
$
123,052
$
614,328
$
737,380
$
295,254
$
675,629
$
970,883
(1) BBB internal ratings reflect bonds which are of medium grade credit quality with adequate capacity to pay interest and repay principal. Certain protective
elements and margins may weaken under adverse economic conditions and changing circumstances. These bonds are more likely than higher rated bonds
to exhibit unreliable protection levels over all cycles.
(2) Below investment grade internal ratings reflect bonds which are of speculative grade credit quality with the adequacy of future margin levels for payment
of interest and repayment of principal potentially adversely affected by major ongoing uncertainties or exposure to adverse conditions.
| Ambac Financial Group, Inc. 138 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The tables below summarize information by major category as of December 31, 2016 and 2015:
December 31,
Number of CDS transactions
Remaining expected weighted-average life
of obligations (in years)
CLO
3
1.8
2016
Other
5
5.9
Total
CLO
8
5.2
5
1.1
2015
Other
9
5.6
Total
14
4.3
Gross principal notional outstanding
Net derivative liabilities at fair value
$
$
123,052
213
$
$
614,328
15,136
$
$
737,380
15,349
$
$
295,254
1,837
$
$
675,629
32,706
$
$
970,883
34,543
The maximum potential amount of future payments under Ambac’s credit derivative contracts is generally the gross principal notional
outstanding amount included in the above table plus future interest payments payable by the derivative reference obligations. Since Ambac’s
credit derivatives typically reference obligations of or assets held by special purpose entities that meet the definition of a VIE, the amount of
maximum potential future payments for credit derivatives is included in the table in Note 3. Special Purpose Entities, Including Variable
Interest Entities.
Changes in fair value of Ambac’s credit derivative contracts are accounted for at fair value since they do not qualify for the financial guarantee
scope exception under the Derivatives and Hedging Topic of the ASC. Changes in fair value are recorded in “Net change in fair value of credit
derivatives” on the Consolidated Statements of Total Comprehensive Income. Although CDS contracts are accounted for at fair value, they
are surveilled similar to non-derivative financial guarantee contracts. As with financial guarantee insurance policies, Ambac’s Portfolio Risk
Management group tracks credit migration of CDS contracts’ reference obligations from period to period.
Adversely classified credits are assigned risk classifications by the Portfolio Risk Management group. As of December 31, 2016, there are
two credit derivative contracts on Ambac’s adversely classified credit listing, with a net derivative liability fair value of $6,123 and gross
notional principal outstanding of $67,783. As of December 31, 2015, there were two CDS contracts on Ambac’s adversely classified credit
listing, with a net derivative liability fair value of $19,820 and total notional principal outstanding of $68,526.
Financial Services Derivative Products:
Ambac, through its subsidiary Ambac Financial Services (“AFS”), provides interest rate swaps to states, municipalities and their authorities,
asset-backed issuers and other entities in connection with their financings. AFS manages its interest rate swaps business with the goal of
retaining some basis risk and excess interest rate sensitivity as an economic hedge against the effects of rising interest rates elsewhere in the
Company, including on Ambac’s financial guarantee exposures. As of December 31, 2016 and 2015 the notional amounts of AFS’s trading
derivative products are as follows:
Type of derivative
Interest rate swaps—receive-fixed/pay-variable
Interest rate swaps—pay-fixed/receive-variable
Interest rate swaps—basis swaps
Futures contracts
Notional - December 31,
2016
2015
$
973,130
$
1,874,678
—
195,000
773,072
1,429,644
38,965
100,000
Derivatives of Consolidated Variable Interest Entities
Certain VIEs consolidated under the Consolidation Topic of the ASC entered into derivative contracts to meet specified purposes within the
securitization structure. The notional for VIE derivatives outstanding as of December 31, 2016 and 2015 are as follows:
Type of VIE derivative
Interest rate swaps—receive-fixed/pay-variable
Interest rate swaps—pay-fixed/receive-variable
Currency swaps
Credit derivatives
Notional - December 31,
2016
2015
$
1,352,010
$
2,300,584
312,357
12,059
1,616,289
2,796,496
331,992
15,616
Contingent Features in Derivatives Related to Ambac Credit Risk
Ambac’s over-the-counter interest rate swaps are centrally cleared when eligible. Certain interest rate swaps remain with professional swap-
dealer counterparties and certain front-end counterparties. These non-cleared swaps are generally executed under standardized derivative
documents including collateral support and master netting agreements. Under these agreements, Ambac is required to post collateral in the
| Ambac Financial Group, Inc. 139 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
event net unrealized losses exceed predetermined threshold levels. Additionally, given that Ambac Assurance is no longer rated by an
independent rating agency, counterparties have the right to terminate the swap positions.
As of December 31, 2016 and 2015, the net liability fair value of all derivative instruments with contingent features linked to Ambac’s own
credit risk was $82,944 and $95,415, respectively, related to which Ambac had posted cash and securities as collateral with a fair value of
$128,754 and $147,974, respectively. All such ratings-based contingent features have been triggered as requiring maximum collateral levels
to be posted by Ambac while preserving counterparties’ rights to terminate the contracts. Assuming all contracts terminated on December 31,
2016, settlement of collateral balances and net derivative liabilities would result in a net receipt of cash and/or securities by Ambac. If
counterparties elect to exercise their right to terminate, the actual termination payment amounts will be determined in accordance with derivative
contract terms, which may result in amounts that differ from values as reported in Ambac’s financial statements.
12. LOANS
Loans had been extended: (i) by VIEs which are consolidated by Ambac under ASC Topic 810 as a result of Ambac’s financial guarantees of
the VIEs’ note liabilities and/or assets and (ii) to certain institutions in connection with various transactions.
Loans by consolidated VIEs are generally carried at fair value on the Consolidated Balance Sheets. See Note 3. Special Purpose Entities,
Including Variable Interest Entities for further information about VIEs for which the assets and liabilities are carried at fair value.
Other loans had an outstanding principal balance of $4,873 and $6,205 at December 31, 2016 and 2015, respectively. Interest rates on these
loans were 4.53% and 4.75% at December 31, 2016 and 2015, respectively. The maturity date of these loans were June 2026 as of December
31, 2016 and 2015. Collectability of these loans is evaluated on an ongoing basis; no loan has been considered impaired and as such no loan
impairments have been recorded as of December 31, 2016 and 2015.
13. LONG-TERM DEBT
The carrying value of long-term debt was as follows:
December 31,
Ambac Assurance:
5.1% surplus notes, general account, due 2020
5.1% surplus notes, segregated account, due 2020
5.1% junior surplus notes, segregated account, due 2020
Secured borrowing
Ambac Assurance long-term debt
Variable Interest Entities long-term debt
Surplus Notes, General Account
2016
2015
$
$
$
730,648
$
33,107
248,247
102,403
1,114,405
11,155,936
$
$
715,211
31,725
247,443
130,571
1,124,950
12,327,960
Ambac Assurance surplus notes, with a par amount of $862,945 and $881,496 at December 31, 2016 and 2015, respectively, are reported in
long-term debt on the Consolidated Balance Sheet and have a scheduled maturity of June 7, 2020. In 2016 and 2015, Ambac repurchased
$18,551 and $11,804 par amount of these surplus notes, respectively. The gains (losses) on these repurchases were $1,677 and $(1,246), and
recognized in Net realized gains (losses) on extinguishment of debt of the Consolidated Statements of Total Comprehensive Income for the
years ended December 31, 2016 and 2015, respectively. These surplus notes were issued in connection with the Settlement Agreement and
were recorded at their fair value at the date of issuance. The discount on these notes is currently being accreted into income using the effective
interest method at an imputed interest rate of of 10.5%. All payments of principal and interest on the Ambac Assurance surplus notes are
subject to the prior approval of the OCI. If the OCI does not approve the payment of interest on the Ambac Assurance surplus notes, such
interest will accrue and compound annually until paid. OCI disapproved the requests of Ambac Assurance to pay interest on the outstanding
Ambac Assurance surplus notes on their respective scheduled interest payment dates since their issuance.
Surplus Notes, Segregated Account
The Segregated Account surplus notes, with a par amount of $39,102 and $39,102 at December 31, 2016 and 2015, respectively, are reported
in long-term debt on the Consolidated Balance Sheets and have a scheduled maturity of June 7, 2020. These surplus notes were recorded at
their fair value at the date of issuance. The discount on these notes is currently being accreted into income using the effective interest method
at an imputed interest rate of 10.5%. All payments of principal and interest on the Segregated Account surplus notes are subject to the prior
approval of the OCI. If the OCI does not approve the payment of interest on the Segregated Account surplus notes, such interest will accrue
and compound annually until paid. OCI disapproved of the requests of the Rehabilitator of the Segregated Account, acting for and on behalf
of the Segregated Account, to pay interest on the outstanding Segregated Account surplus notes on their respective scheduled interest payment
dates since their issuance.
| Ambac Financial Group, Inc. 140 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
As described in Note 1. Background and Business Description, the Rehabilitator redeemed certain Segregated Account surplus notes (other
than junior surplus notes) on November 20, 2014 at a redemption price that included an amount equal to principal plus accrued interest on
such redeemed surplus notes. Such redemption also triggered similar proportionate redemption payments on Ambac Assurance surplus notes.
The redemption of surplus notes resulted in a charge representing the accelerated recognition of the unamortized discount on the redeemed
surplus notes. The unamortized discount on the redeemed portion of Segregated Account and General Account surplus notes was $3,134 and
$71,590, respectively, and recognized in Net realized gains (losses) on extinguishment of debt of the Consolidated Statements of Total
Comprehensive Income for the year ended December 31, 2014.
Junior Surplus Notes, Segregated Account
The Segregated Account junior surplus notes, with a par value of $374,036 and $378,039 at December 31, 2016 and 2015, respectively, are
reported in long-term debt on the Consolidated Balance Sheets and have a scheduled maturity of June 7, 2020, subject to the following
restrictions. Principal and interest payments on these junior surplus notes cannot be made until all Ambac Assurance (General Account) and
Segregated Account surplus notes are paid in full and after all Segregated Account future and existing senior indebtedness, policy and other
priority claims have been paid in full. All payments of principal and interest on the junior surplus notes are subject to the prior approval of
the OCI. If the OCI does not approve the payment of interest on the junior surplus notes, such interest will accrue and compound annually
until paid. No such approval has been sought or obtained to pay interest on junior surplus notes since their issuance.
•
•
Par value at December 31, 2016 and 2015 includes $24,037 and $28,039, respectively, of junior surplus notes issued in connection
with a settlement agreement (the “OSS Settlement Agreement”) entered into among Ambac, Ambac Assurance, the Segregated Account
and One State Street, LLC (“OSS”) with respect to the termination of Ambac’s office lease with OSS. Part of these junior surplus notes
($13,056 par value) will be reduced periodically as rent payments are made by Ambac Assurance beginning in January 2016. Par value
of these junior surplus notes have been reduced by $4,002 during 2016 as rent payments were made by Ambac Assurance. These junior
surplus notes were recorded at their fair value at the dates of issuance. The discount on these notes are currently being accreted into
income using the effective interest method at an imputed interest rate of 19.5%.
Par value at December 31, 2016 and 2015 includes $350,000 face amount of a junior surplus note originally issued to Ambac pursuant
to Ambac's Reorganization Plan in accordance with the Mediation Agreement and that Ambac sold to a Trust on August 28, 2014.
This junior surplus note was recorded at a discount to par based on its fair value on August 28, 2014. Ambac is accreting the discount
on this junior surplus note into earnings using the effective interest method, based on an imputed interest rate of 8.4%.
Secured Borrowing
The secured borrowing, with a par value of $102,986 and $132,467 at December 31, 2016 and 2015, respectively, is reported in long-term
debt on the Consolidated Balance Sheets and has a legal maturity of July 25, 2047. Interest on the secured borrowing is payable monthly at
an annual rate of one month LIBOR + 2.8%. Refer to Note 3. Special Purpose Entities, Including Variable Interest Entities for further discussion
on the secured borrowing transaction.
Variable Interest Entities, Long-term Debt
The variable interest entity notes were issued by consolidated VIEs. Ambac is the primary beneficiary of the VIEs as a result of providing
financial guarantees on certain of the the variable interest obligations. Consequently, Ambac has consolidated these variable interest entity
notes and all other assets and liabilities of the VIEs. Ambac is not primarily liable for the debt obligations of these entities. Ambac would only
be required to make payments on these debt obligations in the event that the issuer defaults on any principal or interest due and to the extent
such obligations are guaranteed by Ambac. The total unpaid principal amount of outstanding long-term debt associated with VIEs consolidated
as a result of the financial guarantee provided by Ambac was $8,854,530 and $10,803,729 as of December 31, 2016 and 2015, respectively.
The range of final maturity dates of the outstanding long-term debt associated with these VIEs is November 2018 to December 2047 as of
December 31, 2016 and 2015. As of December 31, 2016 and 2015, the interest rates on these VIEs’ long-term debt ranged from 0.82% to
13.00% and from 0.96% to 13.00%, respectively. Final maturities of VIE long-term debt for each of the five years following December 31,
2016 are as follows: 2017-$0; 2018-$128,801; 2019-$301,375; 2020-$46,848; 2021-$107,432.
14. OBLIGATIONS UNDER INVESTMENT AGREEMENTS
As of December 31, 2016 and 2015, the carrying value of obligations under investment agreements, including unamortized discounts or
premiums to principal, were $82,358 and $100,358, respectively. As of December 31, 2016 and 2015, the contractual variable interest rates
for these agreements, ranged from 0.94% to 0.94% and 0.43% to 0.43%, respectively. The remaining principal amount under investment
agreements is due during the year ending December 31, 2017.
| Ambac Financial Group, Inc. 141 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
15. INCOME TAXES
Ambac files a consolidated U.S. Federal income tax return with its subsidiaries. Ambac and its subsidiaries also file separate or combined
income tax returns in various states, local and foreign jurisdictions. The following are the major jurisdictions in which Ambac and its affiliates
operate and the earliest tax years subject to examination:
Jurisdiction
United States
New York State
New York City
United Kingdom
Italy
Tax Year
2010
2012
2012
2012
2011
As of December 31, 2016 Ambac had loss carryforwards totaling $4,027,329. This includes carryforwards of $74,094 relating to U.S. capital
losses and $3,953,235 relating to U.S. federal net operating losses, which, if not utilized, will begin expiring in 2029, and will fully expire in
2033.
The tax effects of temporary differences that give rise to significant portions of the deferred tax liabilities and deferred tax assets at December
31, 2016 and 2015 are presented below:
December 31,
Deferred tax liabilities:
Insurance intangible
Variable interest entities
Investments
Unearned premiums and credit fees
Unremitted foreign earnings
Other
Total deferred tax liabilities
Deferred tax assets:
Net operating loss and capital carryforward
Loss reserves
AMT Credits
Other
Sub total deferred tax assets
Valuation allowance
Total deferred tax assets
Net deferred tax asset (liability)
2016
2015
$
336,728
$
424,239
46,343
38,656
68,682
30,699
4,276
525,384
1,409,565
224,553
31,532
16,726
1,682,376
1,158,712
523,664
$
(1,720) $
10,053
66,278
98,945
—
34,025
633,540
1,504,569
122,635
27,252
12,752
1,667,208
1,035,873
631,335
(2,205)
In accordance with the Income Tax Topic of the ASC, a valuation allowance is recognized if, based on the weight of available evidence, it is
more-likely-than-not that some, or all, of the deferred tax asset will not be realized. As a result of the risks and uncertainties associated with
future operating results, management believes it is more likely than not that the Company will not generate sufficient taxable income to recover
the deferred tax operating asset and therefore has a full valuation allowance.
U.S. and foreign components of pre-tax income were as follows:
Year Ended December 31,
U.S.
Foreign
Total
2016
2015
2014
$
$
77,161
27,865
105,026
$
$
337,753
172,305
510,058
$
$
444,653
48,600
493,253
| Ambac Financial Group, Inc. 142 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The components of the provision for income taxes were as follows:
Year Ended December 31,
2016
2015
2014
Current taxes
U. S. federal
U.S. state and local
Foreign
Current taxes
Deferred taxes
Deferred taxes
Provision for income taxes
$
$
3,934
$
16,893
$
707
26,088
30,729
182
2
17,077
(20)
287
30,709
$
17,364
$
6,085
—
3,378
9,463
94
9,557
The total effect of income taxes on net income and stockholders’ equity for the years ended December 31, 2016, 2015 and 2014 is as follows:
Year Ended December 31,
Total income taxes charged to net income
Income taxes charged (credited) to stockholders’ equity:
Unrealized gains (losses) on investment securities
Unrealized gains (losses) on foreign currency translations
Change in retirement benefits
Valuation allowance to equity
Total effect of income taxes
2016
2015
2014
30,709
$
17,364
$
9,557
41,602
(58,527)
3,278
13,647
(55,906)
(15,628)
(240)
71,774
30,709
$
17,364
$
88,411
(15,108)
(285)
(73,018)
9,557
$
$
The tax provisions in the accompanying Consolidated Statements of Total Comprehensive Loss reflect effective tax rates differing from
prevailing Federal corporate income tax rates. The following is a reconciliation of these differences:
Year Ended December 31,
Amount
%
Amount
%
Amount
%
Tax on income from continuing operations at statutory rate $
36,759
35.0 % $
178,521
35.0 % $
172,639
35.0 %
2016
2015
2014
Changes in expected tax resulting from:
Tax-exempt interest
Goodwill impairment
Foreign taxes
Deferred tax substantiation adjustment
Valuation allowance
Other, net
(1,561)
—
26,183
(171,687)
139,584
1,431
(1.5)%
— %
24.9 %
(163.5)%
132.9 %
1.4 %
(1,454)
180,079
288
—
(0.3)%
35.3 %
0.1 %
— %
(6,811)
—
3,472
—
(1.4)%
— %
0.7 %
— %
(340,133)
(66.7)%
(159,661)
(32.4)%
63
— %
(82)
Tax expense on income from continuing operations
$
30,709
29.2 % $
17,364
3.4 % $
9,557
A reconciliation of the beginning and ending amount of unrecognized tax benefits for 2016, 2015 and 2014is as follows:
Year Ended December 31,
Balance, beginning of period
Increases related to prior year tax positions
Decreases related to prior year tax positions
Balance, end of period
2016
2015
2014
$
$
— $
—
—
— $
— $
—
—
— $
— %
1.9 %
—
—
—
—
Included in these balances at December 31, 2016, 2015 and 2014 are $0, $0 and $0, respectively, of unrecognized tax benefits that, if recognized,
would affect the effective tax rate. During the years ended December 31, 2016, 2015 and 2014, Ambac recognized interest of approximately
$0, $0 and $0, respectively. Ambac had approximately $0, $0 and $0, for the payment of interest accrued at December 31, 2016, 2015 and
2014, respectively.
NOL Usage
Pursuant to the Amended TSA, to the extent Ambac Assurance generates taxable income after September 30, 2011, which is offset with
"Allocated NOLs" of $3,650,000, it is obligated to make payments (“Tolling Payments”), subject to certain credits, to Ambac in accordance
| Ambac Financial Group, Inc. 143 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
with the following NOL usage table, where the “Applicable Percentage” is applied to the aggregate amount of federal income tax liability that
would have been paid if the Allocated NOLs were not available.
NOL Usage Table
NOL Usage
Tier
A
B
C
D
Allocated NOLs(1)
The first $479,000
The next $1,057,000 after Tier A
The next $1,057,000 after Tier B
The next $1,057,000 after Tier C
Applicable
Percentage
15%
40%
10%
15%
(1) Bankruptcy-related credits offset the first $5 million payment due under each of the NOL usage Tiers A, B and C. Pursuant to the Internal Revenue Service
closing agreement the United States Department of Treasury receives 12.5% of Tier C and 17.5% of Tier D Tolling Payments.
Any post determination date NOLs generated by Ambac Assurance are utilized prior to any Allocated NOLs for which Tolling Payments will
be due. Ambac Assurance has utilized all of its current post determination date NOLs generated from September 30, 2011 through December 31,
2015 and December 31, 2016, generating cumulative taxable income of $877,313 and $1,086,124, respectively. Additional post determination
date NOLs may be generated (and utilized prior to any Allocated NOLs for which Tolling Payments will be due) in the future. Of the bankruptcy
related credits available to offset the first $5,000 of payments due under each of the NOL usage Tiers A, B, and C, Ambac Assurance has fully
utilized the combined $10,000 of Tier A and Tier B credits. For the year ended December 31, 2015, Ambac Assurance utilized all of the
$479,000 Tier A NOL and $402,192 of the $1,057,000 Tier B NOL resulting in a Tolling Payment, net of applicable credits, of $71,454 that
was paid to Ambac in 2016. For the year ended December 31, 2016 , Ambac Assurance's utilization of $204,932, of the $1,057,000 allocated
Tier B NOL resulted in additional accrued Tolling Payments, net of applicable credits, of $28,691. Tolling Payments due as a result of 2016
taxable income will be paid to Ambac in May 2017 (subject to review by the Rehabilitator).
To the extent Ambac Assurance utilizes Allocated NOLs generated prior to September 30, 2011 greater than $3,650,000, beginning on the
fifth anniversary date subsequent to Ambac's May 1, 2013 emergence from bankruptcy, and subject to Ambac's consent, not to be unreasonably
withheld, Ambac Assurance may utilize Ambac's NOL in exchange for a payment to Ambac of 25% of the federal income tax liability that
Ambac Assurance would have been paid if the NOLs were not available.
After Ambac fully utilizes its Allocated NOLs it may utilize Ambac Assurance's then remaining Allocated NOLs in exchange for a payment
of 50% of the federal income tax liability that Ambac would have paid had Ambac Assurance's NOL not been available.
As of December 31, 2016, the remaining balance of the $3,650,000 NOL allocated to Ambac Assurance was $2,563,876. As of December 31,
2016 Ambac's NOL was $1,389,359.
16. EMPLOYMENT BENEFIT PLANS
Postretirement Health Care and Other Benefits:
Ambac provides postretirement and postemployment benefits, including health and life benefits for certain employees who meet certain age
and service requirements. None of the plans are currently funded. In addition, Ambac provides severance benefits. Postretirement and
postemployment benefits expenses, including severance benefits paid, was $8,846, $2,570 and $2,249 for the years ended December 31, 2016,
2015 and 2014, respectively.
Effective August 1, 2005, new employees were not eligible for postretirement benefits. In 2013, postretirement benefits offered to retirees
were amended such that Ambac would no longer sponsor a health plan beginning in 2014. This required retirees to purchase their own insurance
policy with a portion of their premium being reimbursed by Ambac. The unfunded accumulated postretirement benefit obligation was $9,958
as of December 31, 2016. The assumed health care cost trend rates range from 5.8% in 2017, decreasing ratably to 4.5% in 2023. Increasing
the assumed health care cost trend rate by one percentage point in each future year would increase the accumulated postretirement benefit
obligation at December 31, 2016, by $187 and the 2016 benefit expense by $13. Decreasing the assumed health care cost trend rate by one
percentage point in each future year would decrease the accumulated postretirement benefit obligation at December 31, 2016 by $260 and the
2016 benefit expense by $19.
The following table sets forth projected benefit payments from Ambac’s postretirement plan over the next ten years for current retirees:
2017
2018
2019
2020
2021
2022-2026
Total
$
270
$
295
$
318
$
332
$
353
$
2,269
$
3,837
| Ambac Financial Group, Inc. 144 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The discount rate used in determining the projected benefit obligations for the postretirement plan is selected by reference to the year-end
Citigroup pension liability index with similar duration to that of the benefit plans. The rate used for the projected plan benefit obligations at
the measurement date for December 31, 2016 and 2015 was 4.00% and 4.25%, respectively.
Savings Incentive Plan:
Substantially all employees of Ambac Assurance are covered by a defined contribution plan (the “Savings Incentive Plan”). Ambac Assurance
makes employer matching contributions equal 100% of the employees’ contributions, up to 3% of such participants’ compensation, as defined
in the plan, plus 50% of contributions to an additional 2% of compensation, subject to limits set by the Internal Revenue Code. The total cost
of the Savings Incentive Plan was $911, $1,042 and $1,056 for the years December 31, 2016, 2015 and 2014, respectively.
Incentive Compensation - Stock and Cash:
Incentive compensation is a key component of our compensation strategy. Incentive compensation payouts can be highly variable from year
to year and are generally based on the execution of our strategies at the Company, as well as business unit and individual performance. In
January of each year a determination is made as to the total amount of incentive compensation to be awarded. Employees, directors and
consultants of Ambac are eligible to participate in Ambac’s 2013 Incentive Compensation Plan (“2013 Plan”) subject to the discretion of the
compensation committee of Ambac’s Board of Directors. The 2013 Plan provides for incentives and rewards that are valued or determined
by reference to Ambac common stock as traded on the NASDAQ exchange. There are 4,000,000 shares of Ambac’s common stock authorized
for awards under the 2013 Plan of which 3,004,639 shares are available for future grant as of December 31, 2016.
In March 2014, Ambac developed a long term incentive compensation plan (“LTIP”) as a sub-plan of the 2013 Plan. The LTIP, approved by
the Compensation Committee of the Board of Directors, is a significant component of management’s compensation program that is intended
to strike an appropriate balance between short and long-term incentives aimed at fostering retention and aligning management's interest with
those of Ambac's stakeholders. Awards granted under the LTIP are designed to further the financial and operational objectives of both Ambac
and Ambac Assurance. The LTIP is intended to be an annual program that allows for both cash and equity performance awards to certain US
employees.
In 2015, Ambac UK 's Board of Directors adopted a long term incentive plan which provides cash based performance awards to Ambac UK
employees. Cash based compensation expense related to performance awards granted to Ambac UK employees was $283 and $253 for the
years ended December 31, 2016 and 2015, respectively.
For all employees, an allocation of incentive compensation is made between annual bonuses and LTIP awards. Beginning with the annual
bonus for Executive Officers payable in 2017, 25% was paid in restricted stock units of Ambac with a deferred settlement provision, and the
remainder was paid in cash. These deferred settlement restricted stock units will settle and convert into Ambac common stock annually over
a two year period; 50% on the first anniversary of the grant date and the remaining 50% on the second anniversary of the grant date (unless
settled earlier due to an employee’s departure from the Company (other than for cause)).
The amount of stock-based compensation expense and corresponding after-tax expense are as follows:
Year Ended December 31,
Stock options
Restricted stock units
Performance awards (1) (2)
Total stock-based compensation
Total stock-based compensation (after-tax)
2016
2015
2014
— $
956
$
3,463
1,790
5,253
5,194
$
$
1,257
892
3,105
3,105
$
$
444
2,816
190
3,450
3,450
$
$
$
(1) Represents expense related to performance stock units portion of performance awards. Performance awards are split evenly between
performance stock units and cash. Cash based compensation expense related to performance awards granted to US employees was
$1,790, $892 and $190 for the years ended December 31, 2016, 2015 and 2014, respectively.
(2) A performance award issued to Ambac's former Chief Executive Officer in the form of performance stock units has yet to be expensed
given the performance conditions have not been met.
Stock Options:
Stock options were awarded to directors in 2013 (vested on April 30, 2014) and to the former Chief Executive Officer in 2015 (vested January
1, 2016), all with an expiry term of seven years from the grant date, subject to earlier expiration upon the recipient's departure from the
Company. The Company intends to use Treasury shares first and then, if necessary, issue new shares to satisfy stock option exercises. No
stock options were awarded in 2014 or 2016.
| Ambac Financial Group, Inc. 145 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The Black-Scholes-Merton model was used to estimate the fair value of the service condition based stock options on the grant date. The
following assumptions were used in estimating the fair value of options awarded in 2015:
Year Ended December 31,
Risk-free interest rate
Expected volatility
Dividend yield
Expected life
Weighted-average grant-date fair value per share
2015
1.283%
42.8%
0.0%
4.13 years
$
8.69
The expected volatility is based on implied volatilities from traded options on Ambac’s stock, the historical volatility of Ambac’s stock and
the historical volatilities of our peer industry group. Peer group historical volatilities were considered due to the fact that Ambac stock had
been traded for a time period less than the expected life of the options. A zero dividend yield was assumed based on the uncertainty of Ambac
making dividend payments over the expected life of these options. The risk-free interest rate reflects the U.S. Treasury yield curve in effect
at the time of the grant. The expected life represents the period of time that options granted are expected to be outstanding and is based on
certain factors we believe will influence exercise behavior.
A summary of option activity for 2016 is as follows:
Year Ended December 31, 2016
Outstanding at beginning of period
Granted
Exercised
Forfeited or expired
Outstanding at end of period
Exercisable
Shares
Weighted Average
Exercise Price
Aggregate
Intrinsic Value
Weighted Average
Remaining
Contractual
Life ( in years)
176,668
$
—
—
(33,334)
143,334
143,334
$
$
23.07
—
—
20.63
23.64
23.64
$
$
62
62
1.99
1.99
All stock options granted were fully vested as of December 31, 2016. Total unrecognized compensation costs related to unvested stock options
granted were $0 as of December 31, 2016. No stock options were exercised during the years ended December 31, 2016, 2015 and 2014,
respectively.
Restricted Stock Units (“RSUs”):
RSUs were awarded to employees in 2013 that vested in two installments, 50% on the grant date and 50% on the first anniversary of the grant
date. These RSU awards provided for accelerated vesting upon change in control or death or disability. These employee RSUs settled and
converted into Ambac shares upon the earlier of (a) the employee’s termination of employment (other than for cause) and (b) the second
anniversary of the applicable vesting date.
In 2015 and 2016, RSU awards were granted to the former Chief Executive Officer. The 2015 award would vest in three equal installments
on January 1, 2016, 2017 and 2018. The 2016 award would vest in three equal installments on December 31, 2016, 2017 and 2018. The former
Chief Executive Officer departed the Company in 2016 and pursuant to the terms set forth in his settlement agreements and the RSU award
agreements, (i) the service requirement for the entire 2015 award was met and the entire RSU award vested in 2016 and (ii) the service
requirement for one-third of the 2016 RSU award was met and vested in 2016 with the remaining two-thirds of the 2016 RSU award forfeited.
In 2016, RSU awards were granted to certain Executive Officers. The awards vest in three equal installments on February 21, 2017, 2018 and
2019 ("Time-Based RSUs"). The vesting of the Time-Based RSUs are expressly conditioned upon the Executives continued service with
Ambac through the applicable vesting date.
RSUs are awarded annually to directors that vest on the last day of April of the following year. These RSUs will not settle until the respective
director’s termination from the board of directors or, if earlier, upon a change in control. All RSUs provide for accelerated vesting upon a
change in control, death or disability or involuntary removal other than for cause (not including removal pursuant to a shareholder vote at a
regularly scheduled annual meeting of shareholders). Upon termination (other than for cause), the RSUs shall vest as of the date of such
termination in an amount equal to the number of then outstanding RSUs multiplied by a fraction, the numerator of which shall be the number
of calendar days which have lapsed since the grant date and the denominator of which shall be the total number of calendar days of the original
vesting period.
| Ambac Financial Group, Inc. 146 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
As of December 31, 2016, 264,230 RSUs remained outstanding, of which (i) 102,794 units required future service as a condition to the delivery
of the underlying shares of common stock, (ii) 103,486 units vested on December 31, 2016 but were not settled until January 3, 2017 and (iii)
57,950 units did not require future service and are deferred for future settlement. As of December 31, 2015, 208,502 RSUs remained outstanding,
of which (i) 78,460 units required future service as a condition to the delivery of the underlying shares of common stock and (ii) 130,042 units
did not require future service.
A summary of RSU activity for 2016 is as follows:
Outstanding at beginning of period
Granted
Delivered or returned to plan (1)
Forfeited
Outstanding at end of period
Shares
Weighted Average
Grant Date
Fair Value
208,502
$
422,188
(159,488)
(206,972)
264,230
$
23.32
14.34
23.30
13.77
16.47
(1) When restricted stock unit awards issued by Ambac become taxable compensation to employees, shares may be withheld to cover the employee’s withholding
taxes. For the year ended December 31, 2016, Ambac purchased 23,148 of shares from employees that settled restricted stock units to meet the required
tax withholdings.
Ambac’s closing share price on the grant date was used to estimate the fair value of the service condition based RSU on the grant date. The
weighted average grant date fair value of RSUs granted during 2016, 2015 and 2014 was $14.34, $23.71 and $30.18, respectively. As of
December 31, 2016, there was $696 of total unrecognized compensation costs related to unvested RSUs granted. These costs are expected to
be recognized over a weighted average period of 1.1 years. The fair value for RSUs vested and delivered during the year ended December 31,
2016, 2015 and 2014 was $2,965, $864 and $37, respectively.
Performance Stock Awards ("PSUs"):
Performance awards were granted under the LTIP to certain employees ("LTIP Awards"). These grants vest in 3 years and are evenly split
between PSUs and cash. Actual awards will be based on performance at both Ambac and Ambac Assurance. Actual awards can payout 0%
to 200% of the number of units granted. Ambac performance will be evaluated relative to cumulative earnings before interest, taxes, depreciation
and amortization over the vesting period (exclusive of Ambac Assurance and its subsidiaries' earnings), which is intended to reward participants
on generating taxable income from new business development. Over the same period, Ambac Assurance performance will be evaluated
according to changes in a ratio or value of Ambac Assurance's assets relative to its insurance and financial obligations, which is intended to
reward participants for increases in the relative value of Ambac Assurance. Other than voluntary termination or involuntary termination for
cause, and provided that a participant's employment with the Company is not terminated within the first year of the performance period (reduced
to six months for the 2016 grant to employees other than executive officers), the performance awards shall partially vest as of the date of such
termination in the proportion of the number of calendar days which have lapsed since the grant date and the denominator of which shall be
the total number of calendar days of the original vesting period. Settlements of all performance awards shall be within 60 days after the end
of the performance period, including those that had a partial vesting.
In 2015, a performance award was granted to the former Chief Executive Officer. This award will vest upon the emergence of the Segregated
Account from rehabilitation (or a similar event as determined in the sole and absolute discretion of the Compensation Committee of Ambac's
Board of Directors), provided that such emergence occurs no later than December 31, 2018.
A summary of PSU activity for 2016 is as follows:
Outstanding at beginning of period
Granted
Delivered
Forfeited
Outstanding at end of period
Shares(1)
Weighted Average
Grant Date
Fair Value
130,545
$
201,480
—
(104,952)
227,073
$
25.91
16.27
—
17.40
21.29
(1) Represents performance share units at 100% of units granted for LTIP Awards.
As of December 31, 2016 there was $2,874 of total unrecognized compensation costs related to the PSU portion of unvested performance
awards, which are expected to be recognized over a weighted average period of 1.8 years.
| Ambac Financial Group, Inc. 147 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
17. COMMITMENTS AND CONTINGENCIES
Ambac is responsible for leases on the rental of office space. The executive office of Ambac is located in New York City under a lease agreement
that was modified and extended in 2015 to allow Ambac to remain in the same office space through September 2019 and on one floor through
the end of 2029, with an option to continue to occupy other currently leased floors through the end of 2029. Rent payments under this lease
made through September 2019 will result in the periodic reduction of Segregated Account Junior Surplus Notes that were previously issued
to the landlord, beginning in January 2016. Ambac leases additional space for its data center, disaster recovery site and for its international
location under lease agreements that expire periodically through October 2020. An estimate of future net minimum lease payments in each
of the next five years ending December 31, and the periods thereafter, is as follows:
2017
2018
2019
2020
2021
Thereafter
Total
$
6,951
$
6,972
$
5,691
$
1,933
$
1,630
$
14,019
$
37,196
Ambac rent expense for the aforementioned leases amounted to $3,008, $5,746 and $5,588 for the years ended December 31, 2016, 2015 and
2014, respectively.
The Segregated Account and Wisconsin Rehabilitation Proceeding
On March 24, 2010, Ambac Assurance established a segregated account (the “Segregated Account”) and allocated to the Segregated Account
certain financial guaranty insurance policies and other contingent liabilities, certain claims and other rights, and certain equity interests in
subsidiaries. An insurance rehabilitation proceeding (the “Rehabilitation Proceeding”) was commenced with respect to the Segregated Account
in the Wisconsin Circuit Court for Dane County (the “Rehabilitation Court”) on March 24, 2010 by the Commissioner of Insurance of the
State of Wisconsin (the “Commissioner”) and the Rehabilitation Court entered an order of rehabilitation for the Segregated Account, appointing
the Commissioner as Rehabilitator, and entered orders enjoining certain actions that could have an adverse effect on the financial condition
of the Segregated Account.
Various third parties filed motions or objections in the Rehabilitation Court and/or moved to intervene in the Segregated Account Rehabilitation
Proceeding. On January 24, 2011, the Rehabilitation Court issued its Decision and Final Order Confirming the Rehabilitator’s Plan of
Rehabilitation, with Findings of Fact and Conclusions of Law (the “Confirmation Order”). Notices of appeal from the Confirmation Order
were filed by various parties, including policyholders. These appeals challenged various provisions of the Segregated Account Rehabilitation
Plan and actions the Rehabilitator or the Wisconsin Commissioner of Insurance had taken in formulating the Segregated Account Rehabilitation
Plan. These appeals from the Confirmation Order were consolidated with earlier-filed appeals challenging, among other things, the issuance
of injunctive relief and a settlement between Ambac Assurance and various financial institutions. On October 24, 2013, the Wisconsin Court
of Appeals affirmed the Confirmation Order and the Rehabilitation Court’s rejection of the objections filed by various third parties before
entry of the Confirmation Order. On November 22, 2013, petitions seeking discretionary review of this ruling by the Wisconsin Supreme Court
were filed by various parties. The Rehabilitator responded by opposing further review by the Wisconsin Supreme Court. On March 17, 2014,
the Supreme Court of Wisconsin denied the petitions for review making the decision by the Wisconsin Court of Appeals final and controlling
law.
On June 9, 2014, the Rehabilitator filed in the Rehabilitation Court a motion to confirm and declare the reimbursement amounts due with
respect to cash claim payments made by Ambac Assurance and the Segregated Account on two policies. Certain investors filed objections to
the motion on July 2, 2014. On July 7, 2014, after a hearing on the motion, the Rehabilitation Court granted the Rehabilitator’s motion. On
August 20, 2014, a group of investors filed a notice of appeal. On March 4, 2016, the Wisconsin Court of Appeals affirmed the Rehabilitation
Court’s ruling. On March 24, 2016, a group of investors filed a motion for reconsideration asking the Wisconsin Court of Appeals to reverse
its decision. The motion for reconsideration was denied on March 30, 2016.
On February 10, 2016, certain investors filed a motion in the Rehabilitation Court requesting an order directing the Rehabilitator to show
cause why the Interim Payment Percentage as set forth in the Segregated Account Rehabilitation Plan, as amended, should not be substantially
increased and distributions promptly made to all holders. A hearing on the motion was held on March 29, 2016. On April 5, 2016, the
Rehabilitation Court entered an order denying the motion, granting the Rehabilitator’s motion to quash a related deposition notice, and requiring
interested parties in the proceedings to obtain leave of court before seeking any discovery.
On July 15, 2016, the Rehabilitator filed a motion to confirm and declare the nature of the Segregated Account Rehabilitation Proceedings in
order to avoid misunderstandings that may arise in litigation involving Ambac Assurance concerning certain military housing projects. Certain
parties to these military housing litigations filed an opposition to the Rehabilitator’s motion on September 30, 2016. On October 11, 2016 the
Rehabilitation Court held a hearing on the motion and on October 24, 2016, the Rehabilitation Court entered an order granting the Rehabilitator’s
motion. On November 7, 2016, the interested parties that had opposed the Rehabilitator’s motion filed a notice of appeal from the October
24 order, and filed their opening brief in support of this appeal on January 17, 2017. The Rehabilitator filed a response brief in the Wisconsin
Court of Appeals on February 15, 2017. On November 21, 2016, the Rehabilitator filed a motion to quash a subpoena served on the Wisconsin
Commissioner of Insurance by certain parties to the military housing litigations. The Rehabilitation Court granted the Rehabilitator’s motion
to quash on November 23, 2016. The interested parties that had served the subpoena filed an opposition to the Rehabilitator’s motion to quash
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Notes to Consolidated Financial Statements
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on November 23, 2016, and filed on November 28, 2016 a motion to reconsider the November 23 order, which the Rehabilitator opposed on
December 6, 2016. The Rehabilitation Court held a hearing on January 6, 2017 and entered an order on January 20, 2017 denying the motion
to reconsider and clarifying procedures for discovery relating to the Segregated Account Rehabilitation Proceedings.
Litigation Against Ambac
Ori Wilbush, individually and on behalf of all others similarly situated v. Ambac Financial Group, Inc., Diana N. Adams, David Trick, Jeffrey
S. Stein, Nader Tavakoli and Cathleen Matanle (United States District Court, Southern District of New York, Civil Action No. 16-cv-05076-
RMB, filed on June 28, 2016). A putative securities class action lawsuit was filed in June 2016 against Ambac and certain of its present and
former officers and directors, for alleged violations of the federal securities laws. The court appointed a lead plaintiff on October 11, 2016.
The lead plaintiff filed an Amended Class Action Complaint on November 23, 2016. The suit purports to be on behalf of purchasers of Ambac’s
securities from November 13, 2013 through November 17, 2015. It alleges, among other things, that defendants issued materially false and
misleading statements regarding Ambac’s (a) risk management and credit rating policies and procedures, (b) credit mitigation strategies, (c)
internal controls over financial reporting, and (d) loss exposures on its public finance bond portfolio. In particular, the suit alleges that defendants
did not sufficiently disclose Ambac’s exposure to bonds issued by the Commonwealth of Puerto Rico, despite allegedly being aware of
significant risks associated with those exposures. Defendants filed a motion to dismiss the amended complaint on February 27, 2017. Ambac
believes the lawsuit is without merit.
County of Alameda et al. v. Ambac Assurance Corporation et al. (Superior Court of the State of California, County of San Francisco, second
amended complaint filed on or about August 23, 2011) (“Alameda Complaint”); Contra Costa County et al. v. Ambac Assurance Corporation
et al. (Superior Court of the State of California, County of San Francisco, third amended complaint filed on or about October 21, 2011) (“Contra
Costa Complaint”); The Olympic Club v. Ambac Assurance Corporation et al. (Superior Court of the State of California, County of San
Francisco, fourth amended complaint filed on or about October 21, 2011) (“Olympic Club Complaint”). The Contra Costa Complaint was
brought on behalf of five California municipal entities and the non-profit Jewish Community Center of San Francisco. The Alameda Complaint
was brought on behalf of nineteen California municipal entities. The Olympic Club Complaint was brought on behalf of the non-profit Olympic
Club. The three actions make similar allegations against Ambac Assurance, various other financial guarantee insurance companies and
employees thereof (collectively with Ambac Assurance, the “Bond Insurer Defendants”), and, in the case of the Contra Costa Complaint and
the Olympic Club Complaint, the major credit rating agencies (the “Rating Agencies”). The actions allege that (1) Ambac Assurance and the
other Bond Insurer Defendants colluded with the Rating Agencies to perpetuate a “dual rating system” pursuant to which the Rating Agencies
rated the debt obligations of municipal issuers differently from corporate debt obligations, thereby keeping municipal ratings artificially low
relative to corporate ratings; (2) Ambac Assurance and the other Bond Insurer Defendants issued false and misleading financial statements
and failed to disclose the extent of the insurers’ respective exposures to mortgage-backed securities and collateralized debt obligations; and
(3) as a result of these actions, plaintiffs incurred higher interest costs and bond insurance premiums in respect of their respective bond issues.
Ambac Financial Group was originally a defendant in each of these actions, but on November 22, 2010, Ambac Financial Group was dismissed
without prejudice as a defendant by the plaintiffs in each of these actions. Ambac Assurance and the other Bond Insurer Defendants filed a
demurrer seeking dismissal of the current amended complaints on September 21, 2011, which was denied on October 20, 2011. On December 2,
2011, Ambac Assurance and the other Bond Insurer Defendants filed a special motion to strike the current amended complaints under California’s
Anti-SLAPP statute (Calif. Code of Civ. Proc. Section 425.16). A hearing on the motion was held on March 23, 2012. On May 1, 2012, the
Court ruled that the complaints were governed by the Anti-SLAPP statute to the extent they alleged conspiracy to influence the rating agencies’
rating methodologies, but not to the extent that the complaints alleged false or misleading statements or nondisclosures. After oral argument
on March 21, 2013, the court dismissed claims related to the conspiracy branch of the complaint under the California Antitrust Law (the
Cartwright Act) and after oral argument on April 22, 2013 denied defendants’ motion to dismiss claims under the California Unfair Competition
Law. The court entered an order to this effect on July 9, 2013. On February 18, 2016 the California Court of Appeal, First District, issued a
decision reversing the lower court’s dismissal of the Cartwright Act claim as against Ambac Assurance and otherwise affirming the lower
court’s decision as to Ambac Assurance. Discovery has commenced.
Ambac Assurance is defending several lawsuits in which borrowers have brought declaratory judgment actions claiming, among other things,
that Ambac Assurance’s claims for specific performance related to the construction and development of housing at various military bases to
replace or cash-fund a debt-service-reserve surety bond, as required under the applicable loan documents (see Litigation Filed By Ambac),
are time-barred or are barred by the doctrine of laches, that Ambac lacks standing on the basis that there has been an “Ambac Default,” and
that Ambac is not entitled to specific performance pursuant to the terms of the loan documents. Specifically, Ambac Assurance is a defendant
in the following actions:
• Meade Communities LLC v. Ambac Assurance Corporation (Circuit Court, Anne Arundel County, Maryland, Case No. C-02-
CV-15-003745). Plaintiff filed this action on December 2, 2015. Ambac Assurance’s answer was served on February 16, 2016.
•
Bragg Communities, LLC v. Ambac Assurance Corporation (General Court of Justice, Cumberland county, North Carolina, Case No.
15-CVS-9013). Plaintiff filed this action on December 4, 2015. Ambac Assurance filed a motion to dismiss on February 5, 2016,
which was granted on June 14, 2016. The court entered the dismissal of plaintiff’s complaint on June 24, 2016. Plaintiff’s time to
appeal the dismissal has expired.
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(Dollar Amounts in Thousands, Except Share Amounts)
• Monterey Bay Military Housing LLC and Monterey Bay Land LLC v. Ambac Assurance Corporation (Superior Court, Monterey
County, California, Case No. 15CV000599). Plaintiff filed this action on December 4, 2015. Ambac Assurance filed an answer on
January 19, 2016.
Ambac Assurance’s estimates of projected losses for RMBS transactions consider, among other things, the RMBS transactions’ payment
waterfall structure, including the application of interest and principal payments and recoveries, and depend in part on our interpretations of
contracts and other bases of our legal rights. From time to time, bond trustees and other transaction participants have employed different
contractual interpretations. It is not possible to predict whether additional disputes will arise, nor the outcomes of any potential litigation. It
is possible that there could be unfavorable outcomes in this or other disputes or proceedings and that our interpretations may prove to be
incorrect, which could lead to changes to our estimate of loss reserves.
Ambac Assurance has periodically received various regulatory inquiries and requests for information with respect to investigations and inquiries
that such regulators are conducting. Ambac Assurance has complied with all such inquiries and requests for information.
Ambac is involved from time to time in various routine legal proceedings, including proceedings related to litigation with present or former
employees. Although Ambac’s litigation with present or former employees is routine and incidental to the conduct of its business, such litigation
can result in large monetary awards when a civil jury is allowed to determine compensatory and/or punitive damages for, among other things,
termination of employment that is wrongful or in violation of implied contracts.
It is not reasonably possible to predict whether additional suits will be filed or whether additional inquiries or requests for information will
be made, and it is also not possible to predict the outcome of litigation, inquiries or requests for information. It is possible that there could be
unfavorable outcomes in these or other proceedings. Legal accruals for litigation against Ambac which are probable and reasonably estimable,
and management's estimated range of loss for such matters, are not material to the operating results or financial position of the Company. For
the litigation matters Ambac is defending that do not meet the “probable and reasonably estimable” accrual threshold and where no loss
estimates have been provided above, management is unable to make a meaningful estimate of the amount or range of loss that could result
from unfavorable outcomes. Under some circumstances, adverse results in any such proceedings could be material to our business, operations,
financial position, profitability or cash flows. The Company believes that it has substantial defenses to the claims above and, to the extent that
these actions proceed, the Company intends to defend itself vigorously; however, the Company is not able to predict the outcomes of these
actions.
Litigation Filed by Ambac
In the ordinary course of their businesses, certain of Ambac’s subsidiaries assert claims in legal proceedings against third parties to recover
losses already paid and/or mitigate future losses. The amounts recovered and/or losses avoided which may result from these proceedings is
uncertain, although recoveries and/or losses avoided in any one or more of these proceedings during any quarter or fiscal year could be material
to Ambac’s results of operations in that quarter or fiscal year.
Erste Europäische Pfandbriefund Kommunalkreditbank AG In Luxemburg and Ambac Assurance Corporation v. City of San Bernardino,
California (United States Bankruptcy Court, Central District of California, Riverside Division, Docket No. 15-1185, filed on January 7, 2015).
Plaintiffs commenced this adversary proceeding, which relates to the Debtor’s obligations under the Public Employees Retirement Law,
California Government Code Section 20000 et seq. (the “Retirement Law”), in connection with the City of San Bernardino’s bankruptcy
proceeding. In the complaint, plaintiffs seek a declaratory judgment that the Debtor is obligated to make equivalent payments to both the
holders of certain pension obligation bonds (the “Bonds”), a portion of which are insured by Ambac, and the California Public Employees
Retirement Systems (“CalPERS”) to fund pension and other retirement benefits. It is the plaintiffs’ position that they are entitled to declaratory
judgment because (i) when the City issue the Bonds, the City argued and a California court found, that the obligations under the Bonds were
of the same legal character as the City’s obligations to CalPERS and (ii) the amounts owed to the bondholders are to CalPERS are merely
separate portions of a single obligation owed by the Debtor under the Retirement Law. Plaintiffs therefore seek equivalent payment as to
CalPERS, whether such payment takes for the form of current payments during the bankruptcy proceeding and thereafter, payments otherwise
made in connection with the Retirement Law or any agreements entered into in accordance therewith, or distributions under a plan of adjustment.
On March 13, 2015, the City filed a motion to dismiss the complaint, which plaintiffs opposed. On May 11, 2015, the court heard oral argument
and granted the City’s motion to dismiss. On June 8, 2015, plaintiffs filed a notice of appeal of the court’s order granting the City’s motion to
dismiss with the Bankruptcy Appellate Panel for the Ninth Circuit and filed their appellate brief on January 5, 2016. The parties have reached
a settlement and pursuant to the settlement agreement dated March 28, 2016, the plaintiffs have agreed to dismiss the appeal with prejudice
upon confirmation of the City’s plan of adjustment by the bankruptcy judge and the plan of adjustment becoming effective.
Ambac UK v. J.P. Morgan Investment Management (Supreme Court of the State of New York, County of New York, filed May 4, 2009, No.
650259/2009). Ambac UK commenced this action against J.P. Morgan Investment Management asserting claims for breach of contract, breach
of fiduciary duty and gross negligence relating to defendant’s mismanagement of assets supporting bonds issued by Ballantyne Plc and insured
by Ambac UK that funded excess reserves for term life insurance required by regulation. (Pursuant to an agreement with Ballantyne Plc,
Ambac UK was given the authority to prosecute Ballantyne plc's claims against J.P. Morgan Investment Management.) On March 24, 2010,
the court granted defendant's motion to dismiss the complaint. Ambac UK appealed the March 2010 decision and on July 14, 2011, the
Appellate Division for the First Department reversed the decision and reinstated Ambac UK's claims in their entirety. Fact and expert discovery
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Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
have been completed. On January 22, 2016, Ambac UK filed a motion for partial summary judgment seeking a ruling that defendant breached
the Investment Management Agreement between JPMIM and Ballantyne plc under one of the asserted theories of liability. JPMIM opposed
the motion. On February 21, 2017, the court issued a decision that JPMIM had not complied with the contractual provision at issue in the
motion, but also decided that an issue of fact remained as to whether such breach violated the standard of care set forth in the investment
management agreement and, therefore, denied the motion. Trial is scheduled to begin in March 2017.
Assured Guaranty Corp., Assured Guaranty Municipal Corp., and Ambac Assurance Corporation v. Alejandro Garcia Padilla, et al. (United
States District Court, District of Puerto Rico No. 3:16-cv-01037, filed on January 7, 2016). Ambac Assurance, along with co-plaintiffs Assured
Guaranty Corp. and Assured Guaranty Municipal Corp., filed a complaint for declaratory and injunctive relief to protect its rights against the
illegal clawback of certain revenue by the Commonwealth of Puerto Rico. Defendants (including the Government Development Bank (“GDB”)
President but solely in her capacity as a member of the Working Group For The Fiscal and Economic Restoration of Puerto Rico) filed a
motion to dismiss for lack of subject matter jurisdiction on January 29, 2016. The GDB President, in her official capacity, moved to dismiss
for failure to state a claim upon which relief can be granted on January 29, 2016. Plaintiffs filed their oppositions to the motions on February
16, 2016 and defendants filed replies on February 23, 2016. This case was administratively consolidated with a similar case before the same
judge, Financial Guaranty Insurance Company v. Alejandro Garcia Padilla, et al. (United States District Court, District of Puerto Rico No.
3:16-cv-01095). On October 4, 2016, the court denied the Defendants’ and GDB President’s motions to dismiss with respect to all claims
asserted by Ambac Assurance and Assured. On October 14, 2016, Defendants filed a Notice of Automatic Stay, asserting that Plaintiffs’ claims
have been rendered moot and further asserting that the case is automatically stayed under section 405 of the Puerto Rico Oversight, Management
and Economic Stability Act (“PROMESA”). On October 28, 2016, Plaintiffs informed the court that neither party was currently challenging
the stay, and expressly reserved their right to seek to lift the stay at any time. Plaintiffs also objected to Defendants’ assertion that the case
should be dismissed as moot.
Ambac Assurance Corporation v. Puerto Rico Highways and Transportation Authority (United States District Court, District of Puerto Rico,
No. 16-cv-1893). Ambac Assurance filed a complaint against the Puerto Rico Highways and Transportation Authority (“PRHTA”) on May
10, 2016, alleging breach of fiduciary duty and breach of contract in connection with PRHTA’s extension of an existing toll road concession
agreement. The complaint alleges that it was inappropriate for PRHTA to enter into the extension agreement in its current state of financial
distress because PRHTA has no control over, and is unlikely to receive, the proceeds of the transaction. The complaint also seeks specific
performance of PRHTA’s contractual duty to provide information requested by Ambac Assurance under documents related to PRHTA bonds
insured by Ambac Assurance. Ambac Assurance filed related motions seeking the appointment of a provisional receiver for PRHTA and
expedited discovery. In addition to those remedies, Ambac Assurance seeks an order of the court that would, among other things, compel
PRHTA to allow Ambac Assurance to inspect PRHTA’s financial records on an ongoing basis and permanently enjoin PRHTA from committing
further breaches of its fiduciary and contractual duties. On July 1, 2016, PRHTA filed an Emergency Notice of Stay, asserting that the case
was automatically stayed under section 405 of PROMESA. Ambac Assurance filed a response on July 11, 2016, disagreeing that the PROMESA
stay applies but electing not to contest the stay at such time and reserving the right to challenge it or to seek to lift the stay in the future. Ambac
Assurance also asserted that PRHTA still is obligated to make available to Ambac Assurance certain information, notwithstanding the stay on
litigation and provided a proposed order for the court to issue. PRHTA filed a reply on July 18, 2016, contesting Ambac Assurance’s
characterization, and provided an alternative order for the court to issue. Ambac Assurance’s response was filed July 25, 2016. PRHTA also
filed an Urgent Motion to Exempt PRHTA from Outstanding Filings in the case during the pendency of the stay, which was granted. On August
23, 2016 the court issued an order staying the case, and requesting that Ambac Assurance and PRHTA notify the court whether each would
seek to assert cause to lift the stay. On August 26, 2016, both Ambac Assurance and PRHTA informed the court that neither was currently
seeking to lift the stay; however, Ambac Assurance expressly reserved its right to seek to lift the stay at any time.
Lex Claims, LLC et al. v. Alejandro Garcia Padilla et al. (United States District Court, District of Puerto Rico, No. 16-2374). On October 7,
2016, certain General Obligation bondholder plaintiffs in an action to which Ambac Assurance is not currently a party filed a motion for leave
to amend their complaint and for partial relief from the PROMESA stay. Plaintiffs’ proposed second amended complaint adds the Puerto Rico
Sales Tax Financing Corporation (“COFINA”), COFINA’s executive director, and the trustee for the COFINA bonds as defendants, and asserts
numerous claims that challenge the legal validity of the COFINA structure and seek injunctive relief requiring the sales and use tax proceeds
securing COFINA’s bonds to be transferred to the Puerto Rico Treasury. The plaintiffs contend that many of the claims challenging COFINA
are not subject to PROMESA’s litigation stay provisions. On October 24, 2016, the defendants filed an opposition to the motion for leave to
amend, arguing that the entire action is subject to the PROMESA stay. On October 26, 2016, Ambac Assurance filed a motion for leave to
intervene and in support of the PROMESA stay. Ambac Assurance seeks to intervene principally to argue that the claims challenging COFINA
are stayed by PROMESA, but also reserves the right to move to dismiss or otherwise defend against those claims should the court determine
they are not stayed. The court has not ruled yet on plaintiffs’ motion for leave to amend or Ambac Assurance’s motion to intervene. On
November 4, 2016, the Court granted Plaintiffs’ motion for leave to amend. Plaintiffs filed their second amended complaint that same day.
On November 7, 2016, the government defendants sought to stay the case. On November 29, 2016, the parties’ briefing on Ambac Assurance’s
motion to intervene was complete. Other putative intervenors filed motions to intervene. On February 17, 2017, the court granted the motions
to intervene by Ambac Assurance and some of the other movants. The court also denied the defendants’ motion to stay and the arguments in
support of the stay filed by the intervenors, including Ambac Assurance.
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Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Ambac Assurance has filed various lawsuits seeking specific performance of obligations of borrowers on loans related to the construction and
development of housing at various military bases to replace or cash-fund a debt-service-reserve surety bond provided by Ambac Assurance,
as required under the applicable loan documents. Specifically, Ambac Assurance has instituted the following actions:
• Ambac Assurance Corporation v. Riley Communities, LLC (District Court, Shawnee County Kansas, No. 2016-CV-00026). Ambac
Assurance filed this action on January 8, 2016. On February 2, 2016, defendant served its answer.
• Ambac Assurance Corporation v. Fort Leavenworth Frontier Heritage Communities, II, LLC (U.S. District Court, District of Kansas,
Index No. 15-CV-9596). Ambac Assurance filed this action on November 19, 2015. On January 4, 2016, defendant moved to dismiss
for failure to join an indispensable party, which Ambac Assurance opposed on January 25, 2016. On June 29, 2016, the court denied
defendant’s motion to dismiss and granted Ambac Assurance leave to file an amended complaint, which was filed on July 13, 2016.
On August 1, 2016, Defendant filed a motion to dismiss the amended complaint for lack of subject matter jurisdiction. Ambac Assurance
opposed the motion.
• Ambac Assurance Corporation v. Carlisle/ Picatinny Family Housing Limited Partnership (Court of Common Pleas, Cumberland
County, Pennsylvania, No. 2015-6348). Ambac Assurance filed a summons on December 15, 2015 and a complaint on January 11,
2016. On February 1, 2016, defendant served its answer.
• Ambac Assurance Corporation v. Fort Lee Commonwealth Communities, LLC (Circuit Court, Roanoke City, Virginia, No.
CL16000072-00). Ambac Assurance filed this action on January 7, 2016. Defendant served its answer on February 9, 2016.
• Ambac Assurance Corporation v. Fort Bliss/White Sands Missile Range Housing LP (District Court, El Paso County, Texas, Cause
No. 2016DCV0094). Ambac Assurance filed this action on January 8, 2016. Defendant served its answer on February 11, 2016.
In connection with Ambac Assurance’s efforts to seek redress for breaches of representations and warranties and fraud related to the information
provided by both the underwriters and the sponsors of various transactions and for failure to comply with the obligation by the sponsors to
repurchase ineligible loans, Ambac Assurance has filed various lawsuits:
• Ambac Assurance Corporation and The Segregated Account of Ambac Assurance Corporation v. First Franklin Financial Corporation,
Bank of America, N.A., Merrill Lynch, Pierce, Fenner & Smith Inc., Merrill Lynch Mortgage Lending, Inc., and Merrill Lynch Mortgage
Investors, Inc. (Supreme Court of the State of New York, County of New York, Case No. 651217/2012, filed April 16, 2012). Ambac
Assurance alleges breach of contract, fraudulent inducement, indemnification, reimbursement and requested the repurchase of loans
that breach representations and warranties as required under the contracts, as well as damages. Defendants filed a motion to dismiss
on July 13, 2012, which Ambac opposed on September 21, 2012. Oral argument was held on May 6, 2013. On July 18, 2013 the court
dismissed Ambac Assurance’s claims for indemnification and limited Ambac Assurance’s claim for breach of loan-level warranties to
the repurchase protocol, but did not dismiss Ambac Assurance’s other contractual claims or fraudulent inducement claim. On August 21,
2013, defendants filed a notice of appeal, and on August 30, 2013, Ambac Assurance filed a notice of cross-appeal. On April 22, 2014,
the parties filed a stipulation withdrawing defendants’ appeal and Ambac Assurance’s cross-appeal of the court’s July 18, 2013 decision.
Discovery is ongoing.
• Ambac Assurance Corporation and The Segregated Account of Ambac Assurance Corporation v. Countrywide Securities Corp.,
Countrywide Financial Corp. (a k.a. Bank of America Home Loans) and Bank of America Corp. (Supreme Court of the State of New
York, County of New York, Case No. 651612/2010, filed on September 28, 2010). Ambac Assurance filed an Amended Complaint on
September 8, 2011. Ambac Assurance alleged breach of contract, fraudulent inducement, indemnification and reimbursement, and
breach of representations and warranties, requested the repurchase of loans that breach representations and warranties as required under
the contracts, as well as damages, and asserted a successor liability claim against Bank of America. On May 28, 2013, Ambac Assurance
filed a Second Amended Complaint adding an alter ego claim against Bank of America alleging that, because Bank of America and
Countrywide are alter egos of one another, Bank of America is responsible for Countrywide’s liabilities to Ambac. The defendants
served their answers on July 31, 2013. Fact and expert discovery has ended. On May 1, 2015, Ambac Assurance filed motions for
partial summary judgment, which defendants opposed. Defendants also each filed motions for summary judgment, which Ambac
Assurance opposed. The court heard oral argument on July 15, 2015. On October 27, 2015, the court issued a decision dated October
22, 2015 granting in part and denying in part the parties’ respective summary judgment motions regarding Ambac Assurance’s claims
against Countrywide (primary-liability claims), and issued a second decision granting Ambac Assurance’s partial motion for summary
judgment and denying Bank of America’s motion for summary judgment regarding Ambac Assurance’s secondary-liability claims
against Bank of America. Ambac Assurance and Countrywide filed notices of appeal of the October 22, 2015 decision relating to
primary liability and Bank of America filed a notice of appeal of the October 27, 2015 decision relating to its secondary-liability to
the New York Appellate Division, First Department. These appeals are fully briefed and the First Department held oral argument on
January 26, 2017.
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(Dollar Amounts in Thousands, Except Share Amounts)
• Ambac Assurance Corporation and The Segregated Account of Ambac Assurance Corporation v. Nomura Credit & Capital, Inc. and
Nomura Holding America Inc. (Supreme Court of the State of New York, County of New York, Case No. 651359/2013, filed on April
15, 2013). Ambac Assurance alleges claims for material breach of contract and for the repurchase of loans that breach representations
and warranties under the contracts, as well as damages. Ambac Assurance has also asserted alter ego claims against Nomura Holding
America, Inc. Defendants filed a motion to dismiss on July 12, 2013, which Ambac Assurance opposed. The court held oral argument
on November 13, 2013. On September 22, 2014, plaintiffs filed an amended complaint alleging claims for fraudulent inducement,
material breach of contract and for the repurchase of loans that breach representations and warranties under the contracts, as well as
damages. On October 31, 2014 defendants filed a motion to strike the amended complaint. Ambac Assurance opposed that motion and
at the court’s recommendation also filed a cross motion for leave to amend the complaint on November 14, 2014, which the defendants
opposed. Defendants filed a motion to dismiss the fraudulent inducement claim, which Ambac Assurance opposed. The court heard
oral argument on the defendants’ motion to dismiss the fraudulent inducement claim on April 14, 2015. On June 3, 2015, the court
denied defendants’ July 2013 motion to dismiss Ambac’s claim for breaches of representations and warranties, but granted the
defendants’ motion to dismiss Ambac’s claims for breach of the repurchase protocol and for alter ego liability against Nomura Holding.
On December 29, 2016, the court issued a decision denying Nomura’s motion to strike Ambac’s amended complaint and its motion to
dismiss the fraudulent inducement claim. On January 31, 2017, Nomura filed a notice of appeal from that decision. Discovery is
ongoing.
•
The Segregated Account of Ambac Assurance Corporation and Ambac Assurance Corporation v. Countrywide Home Loans, Inc.
(Wisconsin Circuit Court for Dane County, Case No 14 CV 3511, filed on December 30, 2014). Ambac Assurance alleges a claim for
fraudulent inducement in connection with Ambac Assurance’s issuance of insurance policies relating to five residential mortgage-
backed securitizations that are not the subject of Ambac Assurance’s previously filed lawsuit against the same defendant. Defendant
filed a motion to dismiss the complaint on February 20, 2015, which Ambac Assurance opposed. The court heard oral argument on
two of Countrywide’s grounds for dismissal on June 23, 2015, and indicated that it would dismiss the Wisconsin Action without
prejudice for lack of personal jurisdiction. The court issued an order to that effect on July 2, 2015. Ambac Assurance appealed the July
2, 2015 order. On June 23, 2016, the Wisconsin Court of Appeals reversed the dismissal of the complaint, and on October 11, 2016,
the Wisconsin Supreme Court granted Countrywide’s petition for review of the June 23 decision by the Wisconsin Court of Appeals.
The Wisconsin Supreme Court appeal is fully briefed and scheduled for oral argument on February 28, 2017. On June 30, 2015,
plaintiffs filed a Summons with Notice in the Supreme Court of the State of New York, County of New York, No. 652321/15 (the
“2015 New York Action”), alleging claims identical to the Wisconsin Action. On July 21, 2015, plaintiffs filed a complaint in the 2015
New York Action and a motion to stay the 2015 New York Action pending appeal and litigation of the Wisconsin Action. On August
5, 2015, Countrywide filed its opposition to plaintiffs’ motion to stay and on August 10, 2015, Countrywide filed a motion to dismiss
the complaint, which Ambac opposed. The court held oral argument in November 2015 and on September 20, 2016 granted Ambac
Assurance’s motion to stay. Countrywide’s motion to dismiss the complaint is held in abeyance pending resolution of the Wisconsin
Action.
• Ambac Assurance Corporation and the Segregated Account of Ambac Assurance Corporation v. Countrywide Home Loans, Inc.,
Countrywide Securities Corp., Countrywide Financial Corp., and Bank of America Corp. (Supreme Court of the State of New York,
County of New York, Case No. 653979/2014, filed on December 30, 2014). Ambac Assurance alleges a claim for fraudulent inducement
in connection with Ambac Assurance’s issuance of insurance policies relating to eight residential mortgage-backed securitizations that
are not the subject of Ambac Assurance’s previously filed lawsuits against the same defendants. On February 20, 2015, the Countrywide
defendants filed a motion to dismiss the complaint, which Bank of America joined on February 23, 2015. Ambac Assurance opposed
the motion. On December 20, 2016, the court issued a decision denying the defendants’ motion to dismiss.. Discovery is ongoing.
• Ambac Assurance Corporation and The Segregated Account of Ambac Assurance Corporation v. U.S. Bank National Association
(United States District Court, Southern District of New York, Docket No. 17-cv-00446 (SHS), filed January 20, 2017). Ambac Assurance
commenced this action to enjoin the defendant from accepting a proposed settlement in a separate litigation that the defendant is
prosecuting, as trustee, in connection with a residential mortgage-backed securitization for which Ambac Assurance issued an insurance
policy. Ambac Assurance alleges claims for declaratory judgment, breach of contract, breach of fiduciary duty, and violation of the
Streit Act. On February 14, 2017, plaintiffs filed an amended complaint asserting additional claims for declaratory judgment and
breach of contract related to the defendant’s treatment of trust recoveries. The defendant has not yet responded to Ambac Assurance’s
amended complaint.
| Ambac Financial Group, Inc. 153 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Other Litigation
U.S. Securities and Exchange Commission (the “SEC”) v. Citigroup Global Markets Inc. (“Citigroup”) (United States District Court Southern
District of New York, Docket No. 11-CV-7387, filed in October 2011). This suit related to a collateralized debt obligation transaction arranged
by Citigroup where Ambac Credit Products, LLC (insured by Ambac Assurance) provided credit protection through a credit default swap to
a bank counterparty that was exposed to the transaction. The SEC and Citigroup reached a settlement of this action for $285,000. Judge Rakoff,
the presiding judge, approved the settlement in August of 2014. We have been informed by the SEC that they intend to make a motion to Judge
Rakoff for approval of the distribution of the funds to aggrieved parties. Judge Rakoff must approve the SEC’s proposed allocation. While
there can be no assurance as what the SEC’s proposed allocation will be or the timing or substance of what Judge Rakoff will decide, Ambac
Assurance expects to receive a significant portion of the settlement funds. Ambac has not recorded any receivable for its estimated portion of
these settlement funds.
18. SEGMENT INFORMATION
Ambac has two reportable segments, as follows: (i) Financial Guarantee, which provides financial guarantees (including credit derivatives)
for public finance, structured finance and international obligations; and (ii) Financial Services, which provides investment agreements, funding
conduits, and interest rate swaps, principally to clients of the financial guarantee business. Ambac’s reportable segments were strategic business
units that offered different products and services.
Ambac Assurance guarantees the swap and investment agreement obligations of its Financial Services subsidiaries. Additionally, Ambac
Assurance provides loans to the Financial Services businesses. Inter-segment revenues include the premiums and investment income earned
under those agreements.
Information provided below for unaffiliated “Corporate and Other” primarily relates to investment income on Ambac's investment portfolio.
Equity in net income of investees accounted for by the equity method relates to the Owner Trust Certificate received when Ambac deposited
its Segregated Account junior surplus note into a Trust (see Note 3. Special Purpose Entities, Including Variable Interest Entities for further
information relating to the sale by Ambac of a junior surplus note issued to it by the Segregated Account). Inter-segment for "Corporate and
Other" relates to amounts received by Ambac under the Mediation Agreement dated September 21, 2011 (as more fully described in Note 1.
Background and Business Description), including accrual of interest on the junior surplus notes issued by the Segregated Account prior to
Ambac's deposit into a Trust.
The following table is a summary of financial information by reportable segment for the affected periods:
Year Ended December 31, 2016
Revenues:
Unaffiliated customers (1)
Equity in net income of investees accounted for by
equity method
Inter-segment
Total revenues
Pre-tax income (loss):
Unaffiliated customers (1)(2)(3)
Equity in net income of investees accounted for by
equity method
Inter-segment
Pre-tax income (loss)
Total assets as of December 31, 2016
Net investment income
Insurance intangible amortization
Financial
Guarantee
Financial
Services
Corporate
and Other
Inter-segment
Eliminations
Consolidated
$
543,955
$
(49,434) $
6,964
$
— $
501,485
—
(19,552)
524,403
—
19,794
(29,640)
4,664
873
12,501
159,978
(52,013)
(7,603)
—
(23,106)
136,872
21,987,068
300,102
174,608
—
19,290
(32,723)
313,710
778
—
4,664
3,816
877
353,482
12,487
—
— $
—
(1,115)
(1,115)
—
—
—
—
4,664
—
506,149
100,362
4,664
—
105,026
(18,558)
22,635,702
—
—
— $
313,367
174,608
124,344
Interest expense
$
123,720
$
624
$
| Ambac Financial Group, Inc. 154 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Year Ended December 31, 2015
Revenues:
Unaffiliated customers (1)
Equity in net income of investees accounted for by
equity method
Inter-segment
Total revenues
Pre-tax income (loss):
Unaffiliated customers (1)(2)(3)
Equity in net income of investees accounted for by
equity method
Inter-segment
Pre-tax income (loss)
Total assets as of December 31, 2015
Net investment income
Insurance intangible amortization
Interest expense
Goodwill impairment
Year Ended December 31, 2014
Revenues:
Unaffiliated customers (1)
Equity in net income of investees accounted for by
equity method
Inter-segment
Total revenues
Pre-tax income (loss):
Unaffiliated customers (1) (2) (3)
Equity in net income of investees accounted for by
equity method
Inter-segment
Pre-tax income (loss)
Total assets as of December 31, 2014
Net investment income
Insurance intangible amortization
Interest expense
Reorganization items (4)
Financial
Guarantee
Financial
Services
Corporate
and Other
Inter-segment
Eliminations
Consolidated
$
679,662
$
(44,003) $
4,663
$
— $
640,322
—
349
—
(849)
680,011
(44,852)
4,336
645
9,644
560,332
(46,869)
(7,741)
—
(2,744)
557,588
23,108,387
256,636
169,557
115,630
—
(1,383)
(48,252)
348,130
548
—
907
4,336
4,127
722
268,388
9,105
—
—
—
(145)
(145)
—
—
—
—
4,336
—
644,658
505,722
4,336
—
510,058
3,165
23,728,070
$
514,511
$
— $
— $
— $
Financial
Guarantee
Financial
Services
Corporate
and Other
Inter-segment
Eliminations
Consolidated
$
506,559
$
(179,691) $
407
$
— $
327,275
—
1,243
507,802
—
(1,197)
(180,888)
1,395
23,299
25,101
—
(23,345)
(23,345)
—
—
—
—
—
—
—
—
—
—
266,289
169,557
116,537
514,511
1,395
—
328,670
491,858
1,395
—
493,253
300,946
151,830
127,476
211
14,730
25,159,864
684,750
(182,941)
(9,951)
—
(25,443)
659,307
24,448,346
298,020
151,830
125,892
—
(1,545)
(184,486)
412,510
1,123
—
1,584
1,395
26,988
18,432
284,278
1,803
—
—
$
— $
— $
211
$
— $
(1)
(2)
(3)
Included in both revenues from unaffiliated customers and in pre-tax income (loss) from continuing operations from unaffiliated customers is net investment
income.
Included in pre-tax income (loss) from continuing operations from unaffiliated customers is interest expense.
Included in pre-tax income (loss) from continuing operations from unaffiliated customers is amortization of intangible asset arising from financial guarantee
contracts that were set to fair value upon adoption of Fresh Start.
(4) Refer to Note 1. Background and Business Description, Chapter 11 Reorganization of Ambac for a further discussion of Ambac's Reorganization.
| Ambac Financial Group, Inc. 155 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The following table summarizes gross premiums written, net premiums earned and the net change in fair value of credit derivatives included
in the Financial Guarantee segment by location of risk for the affected periods:
2016
2015
2014
Year Ended
December 31,
Gross
Premiums
Written
Net
Premiums
Earned
Net
Change
in Fair
Value
of Credit
Derivatives
Gross
Premiums
Written
Net
Premiums
Earned
Net
Change
in Fair
Value
of Credit
Derivatives
Gross
Premiums
Written
Net
Premiums
Earned
Net
Change
in Fair
Value
of Credit
Derivatives
United States
$
(35,686) $
168,646
$
1,828
$
(13,028) $
229,658
$
39,633
$
(46,279) $
197,154
$
8,669
United Kingdom
Other international
10,892
(29,043)
24,470
4,171
—
3,652
18,278
(28,196)
68,799
14,138
—
(221,516)
2,068
(20,515)
31,672
17,534
—
15,237
Total
$
(53,837) $
197,287
$
20,106
$
(37,572) $
312,595
$
41,701
$ (288,310) $
246,360
$
23,906
19.
QUARTERLY INFORMATION (Unaudited)
($ in thousands)
Gross premiums written
Net premiums earned
Net investment income
2016
2015
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
$ (24,780) $
(4,041) $ (10,543) $ (14,473) $
1,062
$ (11,192) $
(8,710) $ (18,732)
52,800
60,821
41,402
70,758
53,218
90,917
49,867
90,871
Net other than temporary impairment losses
(9,334)
(7,441)
(2,853)
(2,191)
Net realized investment gains
Net change in fair value of credit derivatives
1,102
12,866
14,897
3,955
11,749
1,733
Derivative products revenue
(83,424)
(36,331)
(14,510)
Net realized gains (losses) on extinguishment
of debt
Income (loss) on Variable Interest Entities
1,235
(27,163)
3,586
8,987
24
2,057
11,536
1,552
83,992
—
2,026
65,718
72,983
(3,119)
54,101
(2,499)
(37,774)
(93)
6,962
60,879
64,753
(1,020)
(5,353)
10,293
50,999
(1,246)
52,603
71,535
64,195
114,463
64,358
(9,150)
(12,370)
2,106
36,952
(65,083)
2,622
(3,045)
9,314
1,420
—
(21,435)
(6,561)
Losses and loss expenses (benefit)
(105,281)
(52,496)
(69,204)
215,492
(150,952)
(147,477)
(133,213)
(337,065)
Insurance intangible amortization
Operating expenses
Interest expense
Goodwill impairment
Pre-tax income (loss)
Net income (loss) attributable to Common
Shareholders
Net income (loss) per share:
Basic
Diluted
$
$
$
50,890
28,009
30,430
—
39,013
27,995
30,709
—
44,553
21,466
31,493
—
40,152
36,190
31,712
—
37,432
24,523
27,908
—
38,088
25,873
28,173
39,680
25,006
29,899
— (514,511)
54,357
27,300
30,557
—
12,854
61,511
116,720
(86,059)
216,580
286,095
(388,193)
395,576
9,415
$
58,647
$ 101,474
$ (94,693) $ 214,711
$ 282,695
$ (390,987) $ 386,984
0.21
0.21
$
$
1.30
1.29
$
$
2.24
2.22
$
$
(2.09) $
(2.09) $
4.75
4.57
$
$
6.26
6.05
$
$
(8.66) $
(8.66) $
8.57
8.56
| Ambac Financial Group, Inc. 156 2016 FORM 10-K |
Item 9. Changes
Accountants on Accounting and Financial Disclosure.
in and Disagreements with
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures. Ambac’s
disclosure controls and procedures are designed to ensure that
information required to be disclosed under the Securities Exchange
Act of 1934, as amended, is recorded, processed, summarized and
reported within the time periods specified in the SEC’s rules and
forms, including without limitation that information required to be
disclosed by Ambac in its SEC filings is accumulated and
communicated to management, including the Chief Executive
Officer (CEO) and Chief Financial Officer (CFO) as appropriate
to allow for timely decisions regarding required disclosure.
Ambac’s Disclosure Committee assists the CEO and CFO in their
responsibilities to design, establish, maintain and evaluate the
effectiveness of disclosure controls and procedures. The
Disclosure Committee is responsible for, among other things, the
oversight, maintenance and implementation of the disclosure
controls and procedures, subject to the supervision and oversight
of the CEO and CFO. Ambac’s management, with the participation
of its CEO and CFO, has evaluated the effectiveness of Ambac’s
disclosure controls and procedures (as defined in Rule 13a-15(e)
under the Securities Exchange Act of 1934) as of December 31,
2016 and, the CEO and CFO have concluded that at that date
Ambac’s disclosure controls and procedures were effective at the
reasonable assurance level.
Management’s Report on Internal Control Over Financial
Reporting. Management of Ambac is responsible for establishing
and maintaining adequate internal control over financial reporting.
Ambac’s internal control over financial reporting is a process
designed under the supervision of the CEO and CFO and overseen
by Ambac’s Board of Directors to provide reasonable assurance
regarding the reliability of financial reporting and the preparation
of Ambac’s financial statements for external reporting purposes in
accordance with U.S. generally accepted accounting principles.
Ambac’s internal control over financial reporting includes those
policies and procedures that (i) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of assets of Ambac; (ii) provide
reasonable assurance that transactions are recorded as necessary
to permit preparation of financial statements in accordance with
U.S. generally accepted accounting principles, and that receipts
and expenditures of the company are being made only in
accordance with authorizations of management and directors of
Ambac; and (iii) provide reasonable assurance regarding the
prevention or timely detection and remediation of unauthorized
acquisition, use or disposition of Ambac’s assets that could have
a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
Ambac management conducted an assessment of the effectiveness
of Ambac’s internal control over financial reporting based on the
criteria established in the 2013 Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO).
Ambac management has concluded that, as of December 31, 2016,
our internal control over financial reporting was effective based
on the criteria articulated in the 2013 Internal Control - Integrated
Framework. The effectiveness of our internal control over financial
reporting as of December 31, 2016 has been audited by KPMG
LLP, an independent registered public accounting firm, as stated
in their report, which expressed an unqualified opinion on the
effectiveness of Ambac’s internal control over financial reporting.
Remediation of Prior Material Weakness in Internal Control
over Financial Reporting. During management’s evaluation of
disclosure controls and procedures as of December 31, 2015, a
material weakness in internal control over financial reporting was
identified. Specifically, management concluded that they did not
sufficiently evaluate the design and operating effectiveness of the
general information technology controls over modeling performed
by a third party service provider, of residential mortgage backed
collateral losses within certain securitizations that have insurance
policies issued by Ambac. This included the late receipt and
evaluation of the servicer’s annual Service Organization Control
report (“SOC-1 report”) attesting to the design and effectiveness
of the Service Organization’s general information technology
(“IT”) controls, subsequent to the issuance of our fiscal 2015
Annual Report on Form 10-K. As a result, our controls over the
estimate of loss reserves and subrogation recoverables, investment
income and assessing other than temporary impairment for
purchased residential mortgage backed securities were not
designed in a manner that would enable us to prevent or detect and
correct a potential material misstatement to the consolidated
financial statements at December 31, 2015.
Since the time of its identification, management has been actively
engaged in the implementation of remediation efforts to address
that material weakness. Remediation efforts included the timely
receipt of the servicer’s SOC-1 report as well as obtaining an
Ambac specific attestation report, both providing an unqualified
opinion from the servicer’s auditor, which allow Ambac to assess
the design and operating effectiveness of the servicer’s IT controls.
Additionally, Ambac enhanced its internal controls with the
addition of new controls and increasing the precision of certain
existing controls relating to the estimate of loss reserves and
subrogation recoverables, investment income and assessing other
than temporary impairment for purchased residential mortgage
backed securities. As of December 31, 2016, management
concluded, subject to the supervision and oversight of the CEO
and CFO, that the previously disclosed material weakness had been
remediated.
Changes in Internal Control Over Financial Reporting. Except
as noted above relative to the remediation of the prior year material
weakness, there were no changes in Ambac’s internal control over
financial reporting (as such term is defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) during the fourth quarter of
2016 that have materially affected, or are reasonably likely to
internal control over financial
materially affect, Ambac’s
reporting.
| Ambac Financial Group, Inc. 157 2016 FORM 10-K |
Item 9B. Other Information
None.
PART III
Item 10. Directors, Executive Officers and Corporate
Governance
Information relating to Ambac’s executive officers and directors,
including its audit committee and audit committee financial experts
will be in Ambac’s definitive Proxy Statement for its 2017 Annual
Meeting of Stockholders which will be filed within 120 days of
the end of our fiscal year ended December 31, 2016 (the “2017
Proxy Statement”) and is incorporated herein by reference.
Ambac has a Code of Business Conduct which promotes
management’s control philosophy and expresses the values which
govern employee behavior and help maintain Ambac’s
commitment to the highest standards of conduct. This code can be
found on Ambac’s website at www.ambac.com on the “Investor
Relations” page under “Corporate Governance.” Ambac will
Equity Compensation Plan Information
disclose on its website any amendment to, or waiver from, a
provision of its Code of Business Conduct that applies to its Chief
Executive Officer, Chief Financial Officer or Chief Accounting
Officer. Ambac’s corporate governance guidelines and the charters
for the committees of the Board of Directors are also available on
our website under the “Corporate Governance” page.
Item 11.
Executive Compensation.
Information relating to Ambac’s executive officer and director
compensation will be in the 2017 Proxy Statement and is
incorporated herein by reference.
Item 12.
Security Ownership of Certain Beneficial
Owners and Management and Related Stockholder
Matters.
Information relating to security ownership of certain beneficial
owners of Ambac’s common stock and information relating to the
security ownership of Ambac’s management will be in the 2017
Proxy Statement and is incorporated herein by reference.
The following table provides information as of December 31, 2016 regarding securities issued under our 2013 Incentive Compensation Plan.
Equity compensation plans approved by security
holders
Equity compensation plans not approved by
security holders
(cid:55)(cid:82)(cid:87)(cid:68)(cid:79)
Plan
Category
2013 Incentive
Compensation Plan (1)
None
Number of Securities
to be Issued Upon
Exercise of
Outstanding Options,
Warrants and Rights
Weighted-Average
Exercise Price of
Outstanding
Options,
Warrants and Rights
Number of Securities
Remaining Available
for Future Issuance
Under Equity
Compensation Plans
(Excluding Securities
Reflected in the
Third Column)
826,710 (2)
---
(cid:27)(cid:21)(cid:26)(cid:15)(cid:26)(cid:20)(cid:19) (cid:11)(cid:21)(cid:12)
$20.02 (3)
---
(cid:7)(cid:21)(cid:19)(cid:17)(cid:19)(cid:21) (cid:11)(cid:22)(cid:12)
3,004,639
---
(cid:22)(cid:15)(cid:19)(cid:19)(cid:23)(cid:15)(cid:25)(cid:22)(cid:28)
(1) Our 2013 Incentive Compensation Plan was approved by the stockholders of Ambac on December 18, 2013. The total number of shares of Ambac common
stock available for issuance under the 2013 Incentive Compensation Plan is 4,000,000.
(2) Represents, as of December 31, 2016, the number of outstanding restricted stock unit awards, stock options and the maximum number of performance
stock units that may be issued if certain performance goals are achieved. Refer to Note 16. Employment Benefit Plans to the Consolidated Financial
Statements included in Part II, Item 8 in this Form 10-K for a description of the grants made under the 2013 Incentive Compensation Plan.
(3) Each restricted stock unit, stock option and performance stock unit awarded under our 2013 Incentive Compensation Plan was granted at no cost to the
persons receiving them. Restricted stock units represent the contingent right to receive the equivalent number of shares of Ambac common stock and may
vest after the passage of time, or the achievement of a corporate goal, or both. Stock options represent the right to acquire an equivalent number of shares
of Ambac common stock at a specified exercise price. Performance stock units granted pursuant to the Company's Long Term Incentive Plan represent
the contingent right to receive a number of shares of Ambac common stock ranging from 0% to 200% of the number of units granted depending upon the
achievement of certain company-wide performance goals.
Item 13.
Certain Relationships and related Transactions, and Director Independence.
Information relating to Ambac with respect to certain relationships and related transactions and director independence will be in the 2017
Proxy Statement and is incorporated herein by reference.
Item 14.
Principal Accountant Fees and Services.
Information relating to principal accountant fees and services will be in the 2017 Proxy Statement and is incorporated herein by reference.
| Ambac Financial Group, Inc. 158 2016 FORM 10-K |
Item 15.
Exhibits, Financial Statement Schedules
(a)
Documents filed as a part of this report:
1. Financial Statements
PART IV
The consolidated financial statements included in Part II, Item 8 above are filed as part of this Annual Report on Form 10-K.
2. Financial Statement Schedules
The financial statement schedules filed herein, which are the only schedules required to be filed, are as follows:
Schedule I — Summary of Investments Other Than Investments in Related Parties ........................................................
Schedule II — Condensed Financial Information of Registrant (Parent Company Only) .................................................
Schedule IV — Reinsurance...............................................................................................................................................
Page
163
164
169
(b)
Exhibits
(3) Articles of Incorporation and bylaws:
3.1
3.2
Amended and Restated Certificate of Incorporation of Ambac Financial Group, Inc. (incorporated by reference to Exhibit
3.1 to Form 8-A, filed on May 1, 2013).
Amended By-laws of Ambac Financial Group, Inc. (filed as Exhibit 3.2 to Ambac Financial Group, Inc.’s Annual Report
on Form 10-K for the year ended December 31, 2013 and incorporated herein by reference).
(4) Instruments defining the rights of security holders, including indentures:
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
4.9
4.10
4.11
4.12
Specimen form of common stock certificate (incorporated by reference to Exhibit 4.1 to Form 8-A, filed on May 1, 2013).
Warrant Agreement between Ambac Financial Group, Inc. and Computershare Inc. (incorporated by reference to Exhibit
4.2 to Form 8-A, filed on May 1, 2013).
Specimen form of warrant certificate (included in Exhibit 4.2).
Junior Note Fiscal Agency Agreement, dated as of April 30, 2013, by and between the Segregated Account of Ambac
Assurance Corporation and The Bank of New York Mellon, as fiscal agent (filed as Exhibit 4.5 to Ambac Financial Group,
Inc.’s Annual Report on Form 10-K for the year ended December 31, 2013 and incorporated herein by reference).
5.1% Junior Surplus Note due June 7, 2020 in the aggregate amount of $350 million issued by the Segregated Account of
Ambac Assurance Corporation pursuant to the Junior Note Fiscal Agency Agreement, dated as of April 30, 2013 (filed
as Exhibit 4.6 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2013 and
incorporated herein by reference).
Form of 5.1% Non-Reducing Junior Surplus Note due June 7, 2020 issued by the Segregated Account of Ambac Assurance
Corporation (filed as Exhibit 4.7 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended
December 31, 2013 and incorporated herein by reference).
Form of 5.1% Bankruptcy Reducing Junior Surplus Note due June 7, 2020 issued by the Segregated Account of Ambac
Assurance Corporation (filed as Exhibit 4.8 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year
ended December 31, 2013 and incorporated herein by reference).
Form of 5.1% Reducing Junior Surplus Note due June 7, 2020, issued by the Segregated Account of Ambac Assurance
Corporation (filed as Exhibit 4.9 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended
December 31, 2013 and incorporated herein by reference).
Fiscal Agency Agreement, dated as of July 19, 2010, by and between the Segregated Account of Ambac Assurance
Corporation and The Bank of New York Mellon, as fiscal agent (filed as Exhibit 4.10 to Ambac Financial Group, Inc.’s
Annual Report on Form 10-K for the year ended December 31, 2013 and incorporated herein by reference).
Form of Surplus Note due June 7, 2020 issued by the Segregated Account of Ambac Assurance Corporation.(included in
Exhibit 4.9).
Fiscal Agency Agreement, dated as of June 7, 2010, by and between Ambac Assurance Corporation and The Bank of New
York Mellon, as fiscal agent (filed as Exhibit 10.2 to Ambac Financial Group, Inc.’s Current Report on Form 8-K filed
June 8, 2010 and incorporated herein by reference).
Amendment dated as of October 3, 2014 to Fiscal Agency Agreement dated as of June 7, 2010 by and between Ambac
Assurance Corporation and The Bank of New York Mellon, as fiscal agent (filed as Exhibit 4.1 to Ambac Financial Group,
Inc.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015 and incorporated herein by reference).
| Ambac Financial Group, Inc. 159 2016 FORM 10-K |
(10) Material contract and management compensation plans and arrangements:
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
10.17
10.18
10.19
10.20
Amended and Restated Trust Agreement dated as of August 28, 2014, among Ambac Financial Group, Inc., The Bank of
New York Mellon, and Wilmington Trust, National Association (filed as exhibit 99.2 to Ambac Financial Group, Inc.’s
Current Report on Form 8-K filed August 28, 2014 and incorporated herein by reference).
Long-Term Incentive Compensation Agreement dated as of May 9, 2014 between Ambac Financial Group, Inc. and David
Trick (filed as Exhibit 10.3 to Ambac Financial Group Inc.'s Quarterly Report on Form 10-Q for the quarter ended June
30, 2014 and incorporated herein by reference).
Long-Term Incentive Compensation Agreement dated as of May 9, 2014 between Ambac Financial Group, Inc. and Robert
B. Eisman (filed as Exhibit 10.4 to Ambac Financial Group, Inc.'s Quarterly Report on Form 10-Q for the quarter ended
June 30, 2014 and incorporated herein by reference).
Ambac Financial Group, Inc.'s Long-Term Incentive Compensation Plan (filed as Exhibit 10.1 to Ambac Financial Group,
Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014 and incorporated herein by reference).
Ambac Financial, Group, Inc.’s Incentive Compensation Plan (filed as Appendix A to Ambac Financial Group’s 2013
Definitive Proxy Statement on Schedule 14A filed on November 8, 2013 and incorporated herein by reference).
Form of Amended and Restated Restricted Stock Unit Award Letter for executive officers (filed as Exhibit 10.4 to Ambac
Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2013 and incorporated herein by
reference).
Form of Equity Award Letter for directors (filed as Exhibit 10.5 to Ambac Financial Group, Inc.’s Annual Report on Form
10-K for the year ended December 31, 2013 and incorporated herein by reference).
Closing Agreement between Ambac Financial, Group, Inc. and Commissioner of Internal Revenue, dated April 30, 2013
(filed as Exhibit 10.2 to Ambac Financial Group, Inc.’s Current Report on Form 8-K, filed on May 3, 2013 and incorporated
herein by reference).
Amendment No. 1, dated April 29 2013, to the Amended and Restated Tax Sharing Agreement among Ambac Financial
Group, Inc. and certain of its affiliates (filed as Exhibit 10.1 to Ambac Financial Group, Inc.’s Current Report on Form
8-K, filed on May 3, 2013 and incorporated herein by reference).
Tax Sharing Agreement dated March 14, 2012 among Ambac Financial Group, Inc. and certain of its affiliates (filed as
Exhibit 10.12 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2013 and
incorporated herein by reference).
Form of Amendment No. 1 to Cooperation Agreement between the Segregated Account of Ambac Assurance Corporation
and Ambac Assurance Corporation (filed as Exhibit 10.3 to Ambac Financial Group, Inc.’s Current Report on Form 8-K
filed September 27, 2011 and incorporated herein by reference).
Form of Expense Sharing and Cost Allocation Agreement among Ambac Assurance Corporation, Ambac Financial Group,
Inc. and their respective subsidiaries and affiliates (filed as Exhibit 10.2 to Ambac Financial Group, Inc.’s Current Report
on Form 8-K filed September 27, 2011 and incorporated herein by reference).
Mediation Agreement dated September 21, 2011 among Ambac Financial Group, Inc., Ambac Assurance Corporation, the
statutory committee of creditors appointed by the United States Trustee on November 17, 2010, the Segregated Account
of Ambac Assurance Corporation, the Rehabilitator of the Segregated Account, and OCI (filed as Exhibit 10.1 to Ambac
Financial Group, Inc.’s Current Report on Form 8-K filed September 27, 2011 and incorporated herein by reference).
Lease, dated as of March 1, 2011, by and between One State Street, LLC and Ambac Assurance Corporation (filed as
Exhibit 10.34 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2010 and
incorporated herein by reference).
Settlement, Discontinuance and Release Agreement, dated as of March 1, 2011, by and among One State Street, LLC,
Ambac Financial Group, Inc., Ambac Assurance Corporation and the Segregated Account of Ambac Assurance
Corporation (filed as Exhibit 10.33 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended
December 31, 2010 and incorporated herein by reference).
Settlement Agreement, dated as of June 7, 2010, by and among Ambac Assurance Corporation, Ambac Credit Products
LLC, Ambac Financial Group, Inc. and the parties listed on Schedule A thereto (filed as Exhibit 10.1 to Ambac Financial
Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by
reference).
Ambac Financial Group, Inc. Severance Pay Plan (Applicable to termination on or after January 1, 2010) (filed as Exhibit
10.26 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 and
incorporated herein by reference).
Management Services Agreement, dated as of March 24, 2010, by and between the Segregated Account of Ambac Assurance
Corporation and Ambac Assurance Corporation (filed as Exhibit 10.22 to Ambac Financial Group, Inc.’s Annual Report
on Form 10-K for the year ended December 31, 2010 and incorporated herein by reference).
Cooperation Agreement, dated as of March 24, 2010, by and between the Segregated Account of Ambac Assurance
Corporation and Ambac Assurance Corporation (filed as Exhibit 10.23 to Ambac Financial Group, Inc.’s Annual Report
on Form 10-K for the year ended December 31, 2010 and incorporated herein by reference).
Aggregate Excess of Loss Reinsurance Agreement, dated as of March 24, 2010, by and between the Segregated Account
of Ambac Assurance Corporation and Ambac Assurance Corporation (filed as Exhibit 10.24 to Ambac Financial Group,
Inc.’s Annual Report on Form 10-K for the year ended December 31, 2010 and incorporated herein by reference).
| Ambac Financial Group, Inc. 160 2016 FORM 10-K |
10.21
10.22
10.23
10.24
10.25
10.26
10.27+
10.28
10.29
10.30
10.31
10.32
10.33
Secured Note, dated as of March 24, 2010, from Ambac Assurance Corporation to the Segregated Account of Ambac
Assurance Corporation (filed as Exhibit 10.25 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the
year ended December 31, 2010 and incorporated herein by reference).
Employment Agreement dated as of January 4, 2016, by and among Ambac Financial Group, Inc. and Nader Tavakoli
(filed as Exhibit 10.1 to Ambac Financial Group, Inc.’s Current Report on Form 8-K filed on January 5, 2016 and
incorporated herein by reference).
Restricted Stock Unit Agreement dated as of January 4, 2016, by and between Ambac Financial Group, Inc. and Nader
Tavakoli (filed as Exhibit 10.2 to Ambac Financial Group, Inc.’s Current Report on Form 8-K filed on January 5, 2016
and incorporated herein by reference).
Long Term Compensation Agreement dated as of February 22, 2016, by and between Ambac Financial Group, Inc. and
Nader Tavakoli (filed as Exhibit 10.6 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q for the quarter
ended March 31, 2016 and incorporated herein by reference).
Lease Modification dated as of September 8, 2015 to the Lease dated as of March 1, 2011, by and between One State Street,
LLC and Ambac Assurance Corporation (filed as Exhibit 10.27 to Ambac Financial Group, Inc.’s Annual Report on Form
10-K for the year ended December 31, 2015 and incorporated herein by reference).
Form of 2015 Long-Term Incentive Compensation Agreement between Ambac Financial Group, Inc. and each of the
Company's executive officers (filed as Exhibit 10.28 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for
the year ended December 31, 2015 and incorporated herein by reference).
Form of 2016 Long-Term Incentive Compensation Agreement between Ambac Financial Group, Inc. and each of the
Company's executive officers
Voting Support Settlement Agreement, dated as of March 28, 2016, by and between Ambac Financial Group, Inc. and
Cornwall Master LP (filed as Exhibit 10.3 to Ambac Financial Group, Inc.’s Current Report on Form 8-K filed on March
29, 2016 and incorporated herein by reference).
Separation Agreement dated as of September 15, 2016, by and among Cathleen J. Matanle, Ambac Financial Group, Inc.
and Ambac Assurance Corporation (filed as Exhibit 10.1 to Ambac Financial Group, Inc.’s Current Report on Form 8-K
filed on September 16, 2016 and incorporated herein by reference).
Employment Agreement dated as of November 1, 2016 by and among Ambac Financial Group, Inc., Ambac Assurance
Corporation and David Trick (filed as Exhibit 10.2 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q for
the quarter ended September 30, 2016 and incorporated herein by reference).
Separation Agreement and General Release dated as of December 12, 2016, by and among Ambac Financial Group, Inc.
and Nader Tavakoli (filed as Exhibit 10.2 to Ambac Financial Group, Inc.’s Current Report on Form 8-K filed on December
13, 2016 and incorporated herein by reference).
Employment Agreement dated as of December 8, 2016, by and among Ambac Financial Group, Inc., Ambac Assurance
Corporation and Claude LeBlanc (filed as Exhibit 10.1 to Ambac Financial Group, Inc.’s Current Report on Form 8-K
filed on December 13, 2016 and incorporated herein by reference).
Employment Agreement dated as of January 4, 2017 by and among Ambac Financial Group, Inc., Ambac Assurance
Corporation and Stephen Ksenak (filed as Exhibit 10.1 to Ambac Financial Group, Inc.’s Current Report on Form 8-K
filed on January 6, 2017 and incorporated herein by reference).
Other exhibits, filed or furnished, as indicated:
12.1+
21.1+
23.1+
24.1+
31.1+
31.2+
Computation of Ratio of Earnings to Fixed Charges
List of Subsidiaries of Ambac Financial Group, Inc.
Consent of Independent Registered Public Accounting Firm
Power of Attorney for directors of Ambac Financial Group, Inc.
Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) Promulgated under the Securities
Exchange Act of 1934, as amended.
Certification of Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) Promulgated under the Securities
Exchange Act of 1934, as amended.
32.1++
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1
99.2
99.3
99.4
Amendment dated as June 12, 2014 to the Plan of Rehabilitation of the Segregated Account of Ambac Assurance Corporation
(filed as Exhibit 99.1 to Ambac Financial Group, Inc.'s Quarterly Report on Form 10-Q for the quarter ended September
30, 2014 and incorporated herein by reference.)
Second Modified Fifth Amended Plan of Reorganization of Ambac Financial Group, Inc., effective as of May 1, 2013
(filed as Exhibit 99.3 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31,
2013 and incorporated herein by reference).
Plan of Rehabilitation of the Segregated Account of Ambac Assurance Corporation. (Filed as Exhibit 99.2 to Ambac
Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2010 and incorporated herein by
reference.)
Plan of Operation of the Segregated Account of Ambac Assurance Corporation (Filed as Exhibit 99.1 to Ambac Financial
Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 and incorporated herein by reference.)
| Ambac Financial Group, Inc. 161 2016 FORM 10-K |
101.INS
XBRL Instance Document.
101.SCH XBRL Taxonomy Extension Schema Document.
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB XBRL Taxonomy Extension Label Linkbase Document.
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document.
101.DEF XBRL Taxonomy Extension Definition Linkbase Document.
+ Filed herewith.
++ Furnished herewith.
| Ambac Financial Group, Inc. 162 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE I — SUMMARY OF INVESTMENTS
Other Than Investments in Related Parties
December 31, 2016
Type of Investment
($ in Thousands)
Municipal obligations
Corporate obligations
Foreign obligations
U.S. government obligations
U.S. agency obligations
Residential mortgage-backed securities
Collateralized debt obligations
Other asset-backed securities
Short-term
Other
Total
Amortized
Cost
Estimated
Fair Value
Amount at Which
Shown in the
Balance Sheet
$
376,064
$
374,368
$
1,803,136
1,802,165
41,932
98,565
4,063
43,135
101,091
4,060
374,368
1,802,165
43,135
101,091
4,060
2,284,425
2,351,595
2,351,595
113,650
778,383
430,827
420,303
113,923
828,783
430,788
450,307
113,923
828,783
430,788
450,307
$
6,351,348
$
6,500,215
$
6,500,215
| Ambac Financial Group, Inc. 163 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE II— CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (PARENT COMPANY ONLY)
Condensed Balance Sheets
($ in thousands, except share data) December 31,
2016
2015
Assets:
Fixed income securities, at fair value (amortized cost: 2016—$220,749 and 2015—$203,709)
$
214,023
$
Short-term investments, at cost (approximates fair value)
Other investments
Total investments
Cash
Investment in subsidiaries
Investment income due and accrued
Current taxes receivable(1)
Other assets
Total assets
Liabilities and Stockholders' Equity:
Liabilities:
Accounts payable and other liabilities
Total liabilities
Stockholders’ equity:
Preferred stock, par value $0.01 per share; 20,000,000 shares authorized shares; issued and outstanding
shares—none
Common stock, par value $0.01 per share; 130,000,000 shares authorized; issued and outstanding shares:
45,194,954 and 45,044,222
Additional paid-in capital
Accumulated other comprehensive income (loss)
Retained earnings
Treasury stock, shares at cost: 22,458 and 8,202
Total Ambac Financial Group, Inc. stockholders’ equity
Total liabilities and stockholders’ equity
66,570
30,003
310,596
32,251
187,979
48,079
25,339
261,397
25
1,340,442
1,349,483
272
28,722
4,132
123
70,848
4,778
$
1,716,415
$
1,686,654
2,501
2,501
—
452
195,267
(38,990)
1,557,681
(496)
1,713,914
$
1,716,415
$
1,855
1,855
—
450
190,813
15,215
1,478,439
(118)
1,684,799
1,686,654
(1) Of this amount, $28,691 and $70,911 receivable from the Registrant's wholly-owned subsidiary, Ambac Assurance Corporation, pursuant to the Amended
TSA.
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the following notes.
| Ambac Financial Group, Inc. 164 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE II— CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (PARENT COMPANY ONLY)
Condensed Statement of Comprehensive Income
($ in thousands) Year Ended December 31,
2016
2015
2014
Revenues:
Investment income
Other than temporary impairments
Net realized gains (losses)
Total revenues
Expenses:
Operating expenses
Total expenses
Income (loss) before income taxes, reorganization costs and equity in undistributed net
loss of subsidiaries
Reorganization items
Income (loss) before income taxes and equity in undistributed net loss of subsidiaries
Federal income tax provision (benefit)
Income before equity in undistributed net income of subsidiaries
Equity in undistributed net income of subsidiaries
Net income
Other comprehensive income, after tax:
Net income
Unrealized gains (losses) on securities, net of deferred income taxes of $0
Gain (loss) on foreign currency translation, net of deferred income taxes of $0.
Changes to postretirement benefit, net of tax
Total other comprehensive income (loss)
Total comprehensive income attributable to Ambac Financial Group, Inc.
$
13,493
$
9,826
$
25,147
(289)
(7)
13,197
11,486
11,486
1,711
—
1,711
(28,739)
30,450
44,393
(155)
(27)
9,644
8,922
8,922
722
—
722
(70,811)
71,533
421,870
$
$
$
74,843
$
493,403
$
74,843
$
493,403
$
67,900
(122,128)
23
(54,205)
(159,730)
(44,651)
(687)
(205,068)
20,638
$
288,335
$
—
(46)
25,101
6,458
6,458
18,643
211
18,432
221
18,211
465,860
484,071
484,071
252,603
(43,165)
(816)
208,622
692,693
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the following notes.
| Ambac Financial Group, Inc. 165 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE II— CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (PARENT COMPANY ONLY)
Condensed Statement of Stockholders' Equity
($ in thousands)
Total
Retained
Earnings
Accumulated
Other
Comprehensive
Income
Preferred
Stock
Common
Stock
Additional
Paid-in
Capital
Common
Stock Held
in Treasury,
at Cost
Balance at January 1, 2016
$ 1,684,799
$ 1,478,439
$
15,215
$
— $
450
$
190,813
$
(118)
Total comprehensive income
20,638
74,843
(54,205)
Adjustment to initially apply ASU
2014-13
Stock-based compensation
Cost of shares (acquired) issued under
equity plan
Cost of warrants acquired
Issuance of common stock
Warrants exercised
6,442
5,253
(505)
(2,717)
2
2
6,442
—
(127)
(1,916)
—
—
Balance at December 31, 2016
$ 1,713,914
$ 1,557,681
Balance at Balance at January 1, 2015
$ 1,399,105
$
989,290
—
—
—
—
—
—
—
—
—
—
—
—
2
—
—
—
—
—
—
—
$
$
(38,990) $
— $
452
220,283
$
— $
450
Total comprehensive income
288,335
493,403
(205,068)
Stock-based compensation
3,105
—
Cost of shares (acquired) issued under
equity plan
Cost of warrants acquired
Warrants exercised
(374)
(5,375)
3
(312)
(3,942)
—
Balance at December 31, 2015
$ 1,684,799
$ 1,478,439
Balance at January 1, 2014
$
702,983
$
505,219
Total comprehensive income
692,693
484,071
Stock-based compensation
Cost of shares (acquired) issued under
equity plan
Warrants exercised
3,450
(37)
16
—
—
—
—
—
—
—
$
$
$
$
15,215
11,661
208,622
—
—
—
—
—
—
—
—
—
—
—
—
—
— $
450
— $
450
—
—
—
—
—
—
—
—
—
—
5,253
—
(801)
—
2
195,267
189,138
—
3,105
—
(1,433)
3
190,813
185,672
—
3,450
—
16
$
$
$
$
$
$
$
$
—
—
—
(378)
—
—
—
(496)
(56)
—
—
(62)
—
—
(118)
(19)
—
—
(37)
—
(56)
Balance at December 31, 2014
$ 1,399,105
$
989,290
$
220,283
$
— $
450
$
189,138
$
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the following notes.
| Ambac Financial Group, Inc. 166 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE II— CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (PARENT COMPANY ONLY)
Condensed Statements of Cash Flow
($ in thousands) Year Ended December 31,
Cash flows from operating activities:
Net income
2016
2015
2014
$
74,843
$
493,403
$
484,071
Adjustments to reconcile net income loss to net cash used in operating activities:
Equity in undistributed net income of non-debtor subsidiaries
Amortization of bond premium and discount
Reorganization items
Other-than-temporary impairment charges
Net realized gains (losses)
Increase (decrease) in current income taxes payable
Share-based compensation
Investment income due and accrued
(Increase) decrease in other assets
Other, net
Net cash provided by (used in) operating activities
Cash flows from investing activities:
Proceeds from matured bonds
Purchases of bonds
Change in short-term investments
Other, net
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Proceeds from the sale of Junior Surplus Notes of the Segregated Account
Cost of warrants acquired
Proceeds from warrant exercise
Net cash provided by (used in) financing activities
Net cash flow
Cash at beginning of period
Cash at end of period
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income taxes
Cash payments related to reorganization items:
(44,393)
(7,208)
—
289
7
42,126
5,253
(149)
646
5,814
77,228
269,459
(279,582)
(18,491)
(13,673)
(42,287)
—
(2,717)
2
(2,715)
32,226
25
(421,870)
(4,690)
—
155
27
(71,069)
3,105
(69)
992
(4,705)
(4,721)
347,539
(312,419)
(25,143)
—
9,977
—
(5,375)
3
(5,372)
(116)
141
$
$
32,251
$
25
$
— $
394
$
Professional fees paid for services rendered in connection with the Chapter 11 proceeding $
— $
— $
(465,860)
4
211
—
46
221
3,450
11,905
(834)
(36,628)
(3,414)
65,032
(271,181)
(14,617)
—
(220,766)
224,262
—
16
224,278
98
43
141
—
272
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the following notes.
| Ambac Financial Group, Inc. 167 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE II— CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (PARENT COMPANY ONLY)
Notes to Condensed Financial Information
(Dollar Amounts in Thousands)
The condensed financial information of Ambac Financial Group, Inc. (“Ambac” or the “Registrant”) as of December 31, 2016 and 2015 and
for the three years in the period ended December 31, 2016, should be read in conjunction with the consolidated financial statements of Ambac
Financial Group, Inc. and Subsidiaries and the notes thereto included in this 2016 Annual Report on Form 10-K for the year ended December 31,
2016.
Ambac, headquartered in New York City, is a financial services holding company incorporated in the state of Delaware on April 29, 1991. On
May 1, 2013 (the “Effective Date”), Ambac emerged from Chapter 11 bankruptcy protection when the Second Modified Fifth Amended Plan
of Reorganization of Ambac (the “Reorganization Plan”) became effective. On December 26, 2013, the United States Bankruptcy Court for
the Southern District of New York (the “Bankruptcy Court”) entered an order of final decree closing Ambac’s Chapter 11 case. Ambac filed
a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the Bankruptcy Court on November 8, 2010 as a
result of losses incurred since the beginning of the financial crisis in 2007.
Income Taxes
Ambac files a consolidated Federal income tax return with its U.S. subsidiaries. Ambac and its subsidiaries also file separate or combined
income tax returns in various states, local and foreign jurisdictions. As of December 31, 2016 Ambac had loss carryforwards totaling $4,027,329.
This includes carryforwards of $74,094 relating to U.S. capital losses and $3,953,235 relating to U.S. federal net operating losses, which, if
not utilized, will begin expiring in 2029, and will fully expire in 2033. The NOL allocable to AFG as of December 31, 2016 is $1,389,359.
As discussed more fully in Note 1. Background and Business Description — Chapter 11 Reorganization of Ambac, under the Amended Plan
Settlement, the Registrant, Ambac Assurance and certain affiliates entered into an amended and restated tax sharing agreement (the “Amended
TSA”). Pursuant to the Amended TSA, to the extent Ambac Assurance generated taxable income after September 30, 2011, which offset the
allocated $3,650,000 of NOLs, (or the proportionate amount of AMT NOL (as defined)), it is obligated to make payments (“Tolling Payments”),
subject to certain credits, to the Registrant in accordance with a four Tier, A through D, NOL usage table. NOLs in excess of the allocated
$3,650,000 may be utilized beginning in 2016, subject to the Registrant's consent, not to be unreasonably withheld, for a payment of 25% of
the benefit received.
Ambac Assurance has utilized all of its current post determination date NOLs generated from September 30, 2011 through December 31, 2016
(post determination date NOLs); however, additional post determination date NOLs may be generated in the future. During this time period,
Ambac Assurance's cumulative net taxable income was approximately $1,086,124, which utilized all of the $479,000 allocated Tier A NOL
and $607,124 of the $1,057,000 allocated Tier B NOL and resulted in accrued Tolling Payments, net of applicable credits. At December 31,
2016, $28,691 of Tolling Payments are due to Ambac no later than forty-five days after April 15, 2017 (subject to review by the Rehabilitator).
Of the bankruptcy related credits available to offset the first $5,000 of payments due under each of the NOL usage Tiers A, B, and C, Ambac
Assurance has fully utilized the combined $10,000 of Tier A and Tier B credits.
| Ambac Financial Group, Inc. 168 2016 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE IV— REINSURANCE
Years Ended December 31, 2016, 2015 and 2014
Insurance Premiums Written
($ in Thousands)
Gross
Amount
Ceded to Other
Companies
Assumed from
Other
Companies
Net
Amount
Percentage of
Amount
Assumed to
Net
Year Ended December 31, 2016
$
(53,837) $
(8,772) $
— $
(45,065)
—%
Year Ended December 31, 2015
(37,572)
(3,001) $
Year Ended December 31, 2014
(288,310)
(6,842)
—
—
(34,571)
—%
(281,468)
—%
| Ambac Financial Group, Inc. 169 2016 FORM 10-K |
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
AMBAC FINANCIAL GROUP, INC.
SIGNATURES
Dated: February 28, 2017
By:
/S/ DAVID TRICK
David Trick
Executive Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/S/ JEFFREY S. STEIN*
Chairman of the Board and Director
February 28, 2017
Jeffrey S. Stein
/S/ CLAUDE LEBLANC
President, Chief Executive Officer and Director
February 28, 2017
Claude LeBlanc
(Principal Executive Officer)
/S/ DAVID TRICK
Executive Vice President and Chief Financial Officer
February 28, 2017
David Trick
(Principal Financial Officer)
/S/ ROBERT B. EISMAN
Senior Managing Director and Chief Accounting Officer
February 28, 2017
Robert B. Eisman
(Principal Accounting Officer)
/S/ ALEXANDER D. GREENE*
Director
February 28, 2017
Alexander D. Green
/S/ IAN D. HAFT*
Director
Ian D. Haft
/S/ DAVID L. HERZOG*
Director
David L. Herzog
February 28, 2017
February 28, 2017
/S/ C. JAMES PRIEUR*
Director
February 28, 2017
C. James Prieur
/S/ STEPHEN M. KSENAK
*By: Stephen M. Ksenak
Attorney-in-fact
February 28, 2017
| Ambac Financial Group, Inc. 170 2016 FORM 10-K |
Appendix A
Non-GAAP Financial Measures
Ambac reports two non-GAAP financial measures: Adjusted Earnings and Adjusted Book Value. The most directly comparable GAAP measures are net income
attributable to common stockholders for Adjusted earnings and Total Ambac Financial Group, Inc. stockholders’ equity for Adjusted Book value. A non-GAAP
financial measure is a numerical measure of financial performance or financial position that excludes (or includes) amounts that are included in (or excluded
from) the most directly comparable measure calculated and presented in accordance with GAAP. We are presenting these non-GAAP financial measures because
they provide greater transparency and enhanced visibility into the underlying drivers of our business and the impact of certain items that the Company believes
will reverse from GAAP book value over time through the GAAP statements of comprehensive income. Adjusted Earnings and Adjusted Book Value are not
substitutes for the Company’s GAAP reporting, should not be viewed in isolation and may differ from similar reporting provided by other companies, which
may define non-GAAP measures differently. Each of the reconciling items is more fully defined in our 2016 Annual Report on Form 10-K within Management's
Discussion and Analysis of Financial Condition and Results of Operations under the heading “Non-GAAP Financial Measures."
Ambac has a significant U.S. tax net operating loss (“NOL”) that is offset by a full valuation allowance in the GAAP consolidated financial statements. As a
result of this and other considerations, for purposes of non-GAAP measures, we utilized a 0% effective tax rate; which is subject to change.
In response to a recent comment letter received from the Division of Corporation Finance of the Securities and Exchange Commission, Ambac has implemented
changes to its non-GAAP measures effective December 31, 2016: Ambac has changed the name of its non-GAAP measure “Operating Earnings” to “Adjusted
Earnings”. Ambac no longer eliminates the effects of VIEs in the calculation of its non-GAAP measures for Adjusted Earnings and Adjusted Book Value.
For comparative purposes, prior period amounts have been recast in the non-GAAP reconciliation tables shown below to conform to the new presentation. For
further information regarding how our non-GAAP measures were reported prior to December 31, 2016 please refer to our September 30, 2016 Form 10-Q and
previous Form 10-Q and Form 10-K filings.
Adjusted Earnings ($ in millions)
Net income (loss) attributable to common shareholders
Adjustments:
Non-credit impairment fair value (gain) loss on credit derivatives
Insurance intangible amortization
Impairment of goodwill
Foreign exchange (gains) losses (1)
Fair value (gain) loss on derivative products from Ambac CVA
Adjusted earnings (2)
May-Dec
2013
Year Ended December 31,
2014
2015
$
505
$
484
$
493
$
(166)
100
—
(24)
47
(17)
152
—
34
(16)
(37)
170
515
27
(14)
2016
75
(8)
175
—
39
34
$
462
$
637
$
1,154
$
315
Book Value Per Share / Adjusted Book Value Per Share
June 30,
December 31,
2013
2013
2014
2015
Total AFGI Shareholders' Equity per share
$
6.38
$
15.62
$
31.09
$
37.41
$
2016
37.94
Adjustments:
Non-credit impairment fair value losses on credit derivatives
Insurance intangible asset and goodwill
Ambac CVA on derivative product liabilities (excluding credit derivatives)
Net unearned premiums and fees in excess of expected losses
Net unrealized investment (gains) losses in AOCI
Adjusted book value per share (2)
4.19
(47.46)
(1.44)
40.08
2.02
3.77
$
$
1.62
(46.94)
(1.08)
38.17
0.93
8.32
1.24
0.42
0.25
(42.78)
(26.91)
(21.30)
(1.43)
31.57
(4.68)
(1.75)
20.11
(1.13)
(0.99)
16.21
(2.63)
$
15.01
$
28.15
$
29.48
(1) Elimination of the foreign exchange gains (losses) on the re-measurement of assets, liabilities and transactions in non-functional currencies. For periods
prior to 2016, we eliminated the foreign exchange gains (losses) on the re-measurement of net premium receivables and loss and loss expense reserves in
non-functional currencies. Given the long-duration of a significant portion of these premium receivables and loss reserves, the foreign exchange re-
measurement gains (losses) are not necessarily indicative of the total foreign exchange gains (losses) that Ambac will ultimately recognize. Beginning in
2016, we have eliminated the foreign exchange gains (losses) on all assets, liabilities and transactions in non-functional currencies. Expanding this
adjustment to include all foreign exchange gains (losses) enables users of our financial statements to better view the business results without the impact
of fluctuations in foreign currency exchange rates, particularly as assets held in non-functional currencies have grown, and facilitates period-to-period
comparisons of Ambac's operating performance. Note that we have not recast prior period adjustments to conform to the methodology as such amounts
were not material.
(2) Totals may not add due to rounding differences.
[This page intentionally left blank]
// Corporate Information
Corporate Office
Ambac Financial Group, Inc.
One State Street Plaza
New York, NY 10004
212-658-7470
www.ambac.com
Investor Relations
David J. Weissman
Managing Director, Investor Relations
Ambac Financial Group, Inc.
212-208-3222
ir@ambac.com
Common Stock Listing
The common stock of Ambac
Financial Group, Inc. trades on
the NASDAQ Global Select Market
under the symbol “AMBC”.
Independent Registered
Public Accounting Firm
KPMG, LLP
345 Park Avenue
New York, NY 10154
Annual Meeting of Stockholders
The Annual Meeting of Stockholders
will be held on Friday, May 19, 2017,
at 11:00 am Eastern Time at our
executive offices, One State Street
Plaza, New York, NY 10004.
Investor Services/Transfer Agent
Computershare
P.O. BOX 30170
College Station, TX 77842-3170
Inside the USA call 1-866-205-3621
Outside the USA call 1-201-680-6578
Hearing impaired call 1-800-952-9245
www.computershare.com/investor
or overnight correspondence
can be sent to:
Computershare
211 Quality Circle, Suite 210
College Station, TX 77845
Corporate Governance
Ambac is committed to maintaining
the independence of Ambac’s
Board of Directors and its committees
and the integrity of its corporate
governance processes. Our Corporate
Governance Guidelines, Code of
Business Conduct and charters that
govern our Board committees, all
of which are designed to keep Ambac
accountable to its shareholders,
can be found at
http://ir.ambac.com/governance.cfm.
Officer Certifications
The certifications of Ambac’s Chief
Executive Officer and Chief Financial
Officer, required under Section 302 of
the Sarbanes-Oxley Act of 2002, have
been filed as exhibits to Ambac’s 2016
Annual Report on Form 10-K.