AMBAC FINANCIAL GROUP, INC.
2017 ANNUAL REPORT
ABOUT AMBAC
Ambac Financial Group, Inc. (“Ambac” or “AFG”), 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 of obligations in both the public and private sectors
globally. AAC is a guarantor of public finance and structured
finance obligations. 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 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,” “plan,” “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.
DEAR FELLOW SHAREHOLDERS
“Our 2017 accomplishments
reflect our focus and commitment
to delivering long-term
shareholder value.”
CLAUDE LeBLANC
President and Chief Executive Officer
In January of 2017, we outlined our plans to build upon
Ambac’s strong foundation and position the company
for future growth. Throughout 2017, we executed on
these plans and successfully accomplished several key
financial, operational and regulatory objectives.
As part of these accomplishments, during the year
we laid the ground work for the successful execution
of a transformational restructuring transaction. As a
result of our efforts in 2017 we were able to conclude
the rehabilitation of AAC’s Segregated Account in
February 2018.
In addition, for the first time since 2008, Ambac
Financial Group’s 2017 audited financial statements were
filed without the expression of substantial doubt about
the company’s ability to continue as a going concern.
This is a strong indication of Ambac’s materially
improved financial health and further demonstrates
our commitment towards positioning the company for
future growth. As we move forward in 2018 we remain
focused on our targeted strategic priorities, including
successful risk management and implementing growth
strategies that will drive sustainable long-term value for
our shareholders.
MILESTONE RESTRUCTURING
TRANSACTION BENEFITS
n Creation of material value for
our shareholders
• Estimated increase to Pro forma
December 31, 2017 Book Value of
approximately $7.56 per share or a
25% increase over year-end reported
Book Value
n Greater financial and strategic flexibility
n A financially stronger AAC, making
full payment on all future policy claims
n Material reduction in ongoing
rehabilitation and restructuring costs
and other related expenses
1
Book Value/Share
Adjusted Book Value/Share (1)
4 9 % C A G R ( 4 )
$37.41
$37.94
$38.08
$31.09
$30.52
$40
$35
$30
$25
$20
$15
$10
$5
$0
$15.62
$6.38
June
2013
Dec
2013
Dec
2014
Dec
2015
Dec
2016
Dec
2017
Pro forma(5)
2017
+ $ 2 8 . 1 3
$28.15
$29.48
$24.34
$31.90
$15.01
$8.32
$3.77
June
2013
Dec
2013
Dec
2014
Dec
2015
Dec
2016
Dec
2017
Pro forma(5)
2017
40
$35
35
$30
30
$25
25
$20
20
$15
15
$10
10
$5
5
0
$0
35
30
25
20
15
10
5
0
KEY 2017 PERFORMANCE HIGHLIGHTS:
• Milestone achievement of the successful exit
from rehabilitation of AAC’s Segregated Account
• Decreased our insured portfolio(2) by 21%, from
$79.3 billion to $62.7 billion, and decreased ACCs
by 17% from $17.0 billion to $14.1 billion
• Opportunistically purchased $815.2 million of
Ambac-insured securities; we currently own
58% of AAC’s insured COFINA bonds and
29% of AAC-insured PRIFA bonds
• Reorganized operations and reduced costs-
significant headcount reductions and future annual
compensation savings of approximately 20%
• Strengthened public finance loss reserves,
resulting in a net loss of $(328.7) million,
or $(7.25) per diluted share, and an Adjusted
Loss (1) of $(165.1) million, or $(3.64) per
diluted share
• Ended 2017 with total AFG stockholders’
equity (“book value“) of $1.4 billion, or $30.52
per share, Adjusted Book Value (1) of $1.1 billion, or
$24.34 per share, Pro forma Book Value(5) of $1.7
billion or $38.08 per share and Pro forma Adjusted
Book Value(5) of $1.4 billion or $31.90 per share
• Accrued $30.5 million of tolling payments
resulting from the utilization of Net Operating
Losses (“NOLs”) at AAC, which will be paid to
AFG in May 2018, bringing AFG’s assets to
over $400 million
2
Ambac’s key business activities are focused on
risk management and stabilizing our insurance platform.
During the year we took significant steps to deliver on
this goal, reorganizing our Risk Group to sharpen and
expand our focus on risk remediation activities. Our
focus is not only on our Adversely Classified Credits
(“ACCs”) but also Watch List Credits. Watch List
Credits represent exposures for which there may be
heightened potential for future adverse development
based on qualitative and quantitative stress assumptions.
We will target ACCs and Watch List Credits in our efforts
to improve the overall quality of AAC’s insured portfolio
and balance sheet. We believe that a focus on the long-
term stability of our balance sheet and quality of our
book value is key to achieving our goal of delivering
long-term shareholder value.
Consistent with our strategic focus, during 2017
we successfully decreased our ACCs by 17% from $17.0
billion to $14.1 billion including through several targeted
de-risking initiatives.
Our actions drove the improvement of our overall
risk profile by decreasing our insured portfolio from
$79.3 billion to $62.7 billion, or 21%.
Notwithstanding our many achievements during
the year, Ambac and the financial guaranty sector
as a whole experienced increased uncertainty from
exposure to Puerto Rico, leading to downward pressure
on share prices.
believe much work remains to be done. The fundamental
requirements of and Congressional intent behind the
PROMESA law are the stabilization of Puerto Rico’s
financial and economic profile, institutionalization of fiscal
responsibility, and restoration of capital market access.
However, none of these objectives can be achieved
without increased transparency and accountability from
the Commonwealth and Oversight Board, respect for
lawful priorities and liens, and effective comprehensive
fiscal reform with a focus on economic growth.
Furthermore, the Commonwealth and Oversight Board
will need to make material changes to their approach
with creditors to avoid long and protracted litigation
which will come at the expense of the residents of
Puerto Rico and U.S. tax payers.
In 2018, we hope to see increased clarity around the
issues surrounding Puerto Rico. Ambac will continue to
actively pursue dialogue with local and federal officials
and progress all aspects of our strategy with respect to
mitigating losses on our Puerto Rico exposure.
Insured Portfolio (2)
SELECT DE-RISKING
ACTIVITIES
n Commuted certain interest rate swaps
between Augusta Funding Limited
IV and Ambac Financial Services
resulting in a gain of $43.4 million
and approximately $2.6 million in
accelerated premiums
n Facilitated an international asset-backed
issuer’s refinancing of £188.1 million
of Ambac-insured debt, resulting in
accelerated premiums to Ambac UK
of $11.2 million
n Terminated 20 RMBS transactions,
resulting in the reduction of adversely
classified net par exposure by
$422.5 million
n Realized a benefit of $91.6 million
as a result of the settlement between
Ballantyne and JPMorgan Investment
Management, Inc.
n Commuted/refinanced approximately
$220.1 million of net par exposure
related to several other distressed
exposures
While our exposure to Puerto Rico remains one of
our biggest challenges, we believe that we are better
positioned to manage our risk based on actions we have
taken. During the year, we increased our public finance
reserves largely as a result of developments related to
Puerto Rico, including Hurricane Maria. We are pleased
the Bipartisan Budget Act of 2018 provides for billions
in additional federal recovery aid to Puerto Rico and
requires the Governor of Puerto Rico to develop a 12-
and 24-month economic and disaster recovery plan with
periodic progress reports to Congress. However, we
$62.7 BILLION NET PAR
Reducing operating expenses was also a key priority
for us and in 2017 we took significant steps to implement
a corporate-wide reorganization to improve operational
effectiveness and reduce expenses. These actions
reduced headcount by 19%, which will result in future
annual compensation costs savings of approximately
3
InternationalPublic Finance51%27%Structured Finance22%
Insured Portfolio Net Par (2)
($ in billions)
Adversely Classified Credits Net Par (2),(3)
($ in billions)
$250
$200
$150
$100
$50
$0
# of Credits
6,000
Reduced by 21%
in 2017
4,000
2,000
0
June
2013
Dec
2013
Dec
2014
Dec
2015
Dec
2016
Dec
2017
PF
SF
Int’l
# of Credits
$35
250
$30
200
$25
150
$20
$15
100
$10
50
$5
$0
0
6000
4000
Reduced by 17%
in 2017
June
2013
Dec
2013
Dec
2014
Dec
2015
Dec
2016
Dec
2017
IA
II
III
IV
35
30
25
20
15
10
5
0
20% or $8.5 million. These initiatives were focused on
reducing expenses and taking other meaningful steps
to reorganize our operations and create a more
effectively-run platform. We also expect to see additional
material reductions in run-rate expenses relating to
regulatory and restructuring costs following the exit
from rehabilitation of AAC’s Segregated Account.
We will continue to pursue additional cost cutting
measures as we progress our portfolio runoff.
On the loss recovery side, we continued to progress
the prosecution of our RMBS-related litigation which
remains a key value-driver for our company and our
shareholders. We are confident in the strength of our
claims and will continue to pursue our cases through
trial if necessary.
Lastly, during 2017, management and the Board
completed a review of our long-term strategy. While
this strategy remained largely intact, we have updated
our strategic priorities based on our achievements and
future business plans.
As we consider potential new businesses we will
focus on opportunities that (i) are adjacent to our core
business, (ii) create additional long-term value with
attractive risk-adjusted returns (under certain acceptable
financial criteria) and (iii) are well positioned to create
value through synergies and utilization of Ambac’s net
operating loss carry-forwards.
AFG is expecting to receive an NOL tolling payment
from AAC for the third consecutive year under the terms
4
0
2000
of the intercompany Tax Sharing Agreement. The 2018
payment will be $30.5 million. Since Ambac’s emergence
from bankruptcy in 2013 the NOLs have preserved
approximately $691 million of value for shareholders and
have facilitated approximately $130.6 million of value
through paid and accrued tolling payments to AFG.
During the year, we remained proactively engaged
with our shareholders and in response to your feedback
continued to refine our compensation metrics to further
align them with the interests of our shareholders. A
revised compensation structure that is metrics driven was
implemented in 2017, determined by a mix of qualitative
and quantitative criteria as well as equity ownership
requirements for executives. We also made changes to
our non-employee director base compensation plan.
Starting in 2017 non-employee director cash retainer
and stock-based compensation, in the aggregate,
was reduced by 33% compared to 2016 with a higher
percentage of equity compared to cash compensation.
The exit from rehabilitation of the Segregated Account
also resulted in a simplified governance structure with
the removal of the requirement to have unaffiliated
directors on the AAC Board. In evaluating our needs
and Board composition post exit from rehabilitation we
considered the Board’s skill set and experience as well
as our diversity objectives. On March 1st we announced
the appointment of Ms. Joan Lamm-Tennant as a new
director at both the AFG and AAC Boards. Joan’s
extensive experience in the insurance industry and her
STRATEGIC PRIORITIES
n Active runoff of AAC and its
subsidiaries through transaction
terminations, policy commutations,
settlements and restructurings,
with a focus on our watch list and
adversely classified credits, that
we believe will improve our risk profile,
and maximizing the risk-adjusted
return on invested assets
n Ongoing rationalization of Ambac’s
and its subsidiaries’ capital and
liability structures
n Loss recovery through active
litigation management and exercise
of contractual and legal rights
n Ongoing review of organizational
effectiveness and efficiency of the
operating platform
n Evaluation of opportunities in certain
business sectors that meet acceptable
criteria and will generate long-term
stockholder value with attractive
risk-adjusted returns
entrepreneurial drive promise to serve us well as we move
forward post exit from rehabilitation. We are pleased to
welcome Ms. Lamm-Tennant to our Board.
Following the execution of our transformational
restructuring transaction we are excited about the
future and believe we are well positioned to explore
and advance the opportunities available to us within our
new operating paradigm.
We would like to thank our employees for their
ongoing commitment, support and dedication, which
is instrumental in helping us achieve our stated goals.
Looking ahead to 2018, we will remain focused on
advancing our strategic priorities to improve our risk
profile and quality of our book value in order to maximize
returns for shareholders. We remain steadfast in our
commitment to our shareholders and we will look to build
upon our momentum in 2018 with the goal to continue to
deliver long-term shareholder value.
Claude LeBlanc
President and
Chief Executive Officer
(1) Ambac reports two non-GAAP financial measures: Adjusted Earnings (Loss) and Adjusted Book Value. The most directly comparable GAAP measures are net income attributable to common stockholders for Adjusted Earnings (Loss) 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. Adjusted Earnings (Loss) 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 presented in Appendix A to this Annual Report.
(2) Par throughout this Annual Report includes capital appreciation bonds (“CABs”) which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bonds.
(3) Adversely Classified Credits: Class IA - Potential Problem with Risks to be Dimensioned; Class II - Substandard Requiring Intervention; Class III Doubtful with Clear Potential for Loss; Class IV – Imminent Default or Defaulted. See Ambac’s 2017 Form 10-K for further description of risk classifications.
(4) Compound Annual Growth Rate (“CAGR”).
(5) Pro forma information reflects unaudited adjustments attributable to the Rehabilitation Exit Transactions and Tier 2 Notes Issuance. See page 70 of this Annual Report for reconciliation.
5
BOARD OF DIRECTORS
EXECUTIVE OFFICERS
Claude LeBlanc
President and
Chief Executive Officer
David Trick
Executive Vice President,
Chief Financial Officer
and Treasurer
David Barranco
Senior Managing Director,
Head of Risk Management
and Corporate Development
Robert B. Eisman
Senior Managing Director,
Chief Accounting Officer
and Controller
Stephen M. Ksenak
Senior Managing Director
and General Counsel
Michael Reilly
Senior Managing Director,
Chief Information Officer and
Chief Administrative Officer
R. Sharon Smith
Senior Managing Director
and Chief of Staff
Jeffrey S. Stein (3)
Founder and Managing Partner
of Stein Advisors LLC
Chairman since 2015
Director since 2013
Alexander D. Greene(2), (3)*, (4)
Former Managing Partner and
Head of U.S. Private Equity at
Brookfield Asset Management
Director since 2015
Ian D. Haft (1), (2), (4)*
Founding Partner at
Cornwall Capital Management LP
Director since 2016
David L. Herzog (1)*, (4)
Former Chief Financial Officer of AIG
Director since 2016
C. James Prieur (1), (2)*, (3)
Former Chief Executive Officer
of CNO Financial Group, Inc.
Director since 2016
Claude LeBlanc
President and
Chief Executive Officer
Director since 2017
Joan Lamm-Tennant (1), (4)
Founder and
Chief Executive Officer of
Blue Marble Microinsurance
Director since 2018
(1) Member of Audit Committee
(2) Member of Compensation Committee
(3) Member of Governance and Nominating Committee
(4) Member of Strategy and Risk Policy Committee
*Chair of Committee
6
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, 2017
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 web site, 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, smaller reporting company, or an
emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company”and"emerging growth company" in Rule
12b-2 of the Exchange Act): (Check one):
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or
revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
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, 2017 was $785,107,730. As of
February 27, 2018, there were 45,278,480 shares of Common Stock, par value $0.01 per share, were outstanding.
Portions of the Registrant’s proxy statement for its 2018 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
[ THIS PAGE INTENTIONALLY LEFT BLANK ]
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 ...............................................................................................................................................................
Risk Management Group ..........................................................................................................................................
Insurance Regulatory Matters and Other Restrictions ..............................................................................................
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 ..............................................................................................................
Financial Guarantees in Force...................................................................................................................................
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 ...............................................................................................................................
Pro Forma Balance Sheet and Proforma Adjusted Book Value ................................................................................
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 .......................................................................................................................................
1
2
2
5
8
9
10
10
26
26
26
26
26
28
29
29
29
31
37
50
56
59
64
64
65
66
67
70
71
74
157
157
157
157
157
158
158
158
158
163
164
169
SIGNATURES......................................................................................................................................................................................
170
[ THIS PAGE INTENTIONALLY LEFT BLANK ]
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 the Company’s ability to achieve
value for holders of its securities, whether from Ambac Assurance
Corporation ("Ambac Assurance) or from transactions or
opportunities apart from Ambac Assurance; (3) adverse effects on
Ambac’s share price resulting from future offerings of debt or
equity securities that rank senior to Ambac’s common stock; (4)
potential of rehabilitation proceedings against Ambac Assurance;
(5) dilution of current shareholder value or adverse effects on
Ambac’s 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 or financial
results; (7) decisions made by Ambac Assurance's primary
insurance regulator for the benefit of policyholders that may result
in material adverse consequences for holders of the Company’s
securities or holders of securities issued or insured by Ambac
Assurance; (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) failure to recover claims paid on Puerto Rico exposures or
incurrence of losses in amounts higher than expected; (10) the
Company’s inability to realize the expected recoveries included in
its financial statements; (11) changes in Ambac Assurance’s
estimated representation and warranty recoveries or loss reserves
over time; (12) insufficiency or unavailability of collateral to pay
secured obligations; (13) credit risk throughout the Company’s
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; (14) credit risks related to
large single risks, risk concentrations and correlated risks; (15)
concentration and essentiality risk in connection with Military
Housing insured debt; (16) the risk that the Company’s risk
management policies and practices do not anticipate certain risks
and/or the magnitude of potential for loss; (17) risks associated
with adverse selection as the Company’s insured portfolio runs off;
(18) adverse effects on operating results or the Company’s financial
position resulting from measures taken to reduce risks in its insured
portfolio; (19) intercompany disputes or disputes with Ambac
Assurance's primary insurance regulator; (20) our inability to
mitigate or remediate losses, commute or reduce insured exposures
or achieve recoveries or investment objectives, or the failure of
any transaction intended to accomplish one or more of these
objectives to deliver anticipated results; (21) the Company’s
substantial indebtedness could adversely affect its financial
condition and operating flexibility; (22) the Company may not be
able to obtain financing or raise capital on acceptable terms or at
all due to its substantial indebtedness and financial condition; (23)
restrictive covenants in agreements and instruments may impair
the Company’s ability to pursue or achieve its business strategies;
(24) loss of control rights in transactions for which we provide
insurance due to a finding that Ambac Assurance has defaulted,
whether due to the Segregated Account rehabilitation proceedings
or otherwise; (25) the Company’s results of operation may be
adversely affected by events or circumstances that result in the
accelerated amortization of the Company’s insurance intangible
asset; (26) adverse tax consequences or other costs resulting from
the
the Segregated Account rehabilitation plan, or from
characterization of the Company’s surplus notes or other
obligations as equity; (27) risks attendant to the change in
composition of securities in the Company’s investment portfolio;
(28) changes in tax law; (29) changes in prevailing interest rates;
(30) changes on inter-bank lending rate reporting practices or the
method pursuant to which LIBOR rates are determined; (31)
factors that may influence the amount of installment premiums
paid to the Company, including the Segregated Account
rehabilitation proceedings; (32) default by one or more of Ambac
Assurance's portfolio
issuers or
investments,
counterparties; (33) market risks impacting assets in the
Company’s investment portfolio or the value of our assets posted
as collateral in respect of interest rate swap transactions; (34) risks
relating to determinations of amounts of impairments taken on
investments; (35) 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 the
Company’s business, operations, financial position, profitability
or cash flows; (36) actions of stakeholders whose interests are not
aligned with broader interests of the Company's stockholders; (37)
the Company’s inability to realize value from Ambac UK or other
subsidiaries of Ambac Assurance; (38) system security risks; (39)
market spreads and pricing on interest rate derivative insured or
issued by the Company; (40) the risk of volatility in income and
earnings, including volatility due to the application of fair value
accounting; (41) changes in accounting principles or practices that
may impact the Company’s reported financial results; (42)
legislative and regulatory developments, including intervention by
regulatory authorities; (43) the economic impact of “Brexit” may
have an adverse effect on the Company’s insured international
portfolio and the value of its foreign investments, both of which
insured
| Ambac Financial Group, Inc. 1 2017 FORM 10-K |
primarily reside with its subsidiary Ambac UK; (44) 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; (45) the Company’s
financial position that may prompt departures of key employees
and may impact the Company’s ability to attract qualified
executives and employees; (46) implementation of new tax
legislation signed into law on December 22, 2017 (commonly
known as the “Tax Cuts and Jobs Act”) may have unexpected
consequences for the Company and the value of its securities,
particularly its common shares; (47) implementation of the Tax
Cuts and Jobs Act may negatively impact the economic recovery
of Puerto Rico, which could result in higher loss severities or an
extended moratorium on debt service owed on Ambac Assurance-
insured bonds of Puerto Rico and its instrumentalities; (48)
implementation of the Tax Cuts and Jobs Act could have a negative
impact on municipal issuers of Ambac-insured bonds; and (49)
other risks and uncertainties that have not been identified at this
time.
PART I
Item 1. Business
INTRODUCTION
the
Ambac Financial Group, Inc. (“Ambac,” "AFG" or
“Company”), headquartered in New York City, is a financial
services holding company incorporated in the State of Delaware
on April 29, 1991.
Ambac’s provides financial guarantee policies through its principal
operating subsidiary, Ambac Assurance Corporation ("Ambac
Assurance" or "AAC") and its wholly owned subsidiary Ambac
Assurance UK Limited (“Ambac UK”), both of which have been
in runoff since 2008. Ambac has another wholly-owned subsidiary,
Everspan Financial Guarantee Corp. (“Everspan”), which has been
in runoff since its acquisition in 1997. Insurance policies issued
provide an unconditional and irrevocable guarantee which protects
the holder of a debt obligation against non-payment when due of
the principal and interest on the obligations guaranteed. Pursuant
to such guarantees, Ambac Assurance and its subsidiaries make
payments if the obligor responsible for making payments fails to
do so when scheduled. Revenues from financial guarantees consist
of: (i) premiums earned from insurance contracts, net of
reinsurance, whether received upfront or on an installment basis
and (ii) amendment and consent fees. Expenses from financial
guarantees consist of: (i) loss and commutation payments for credit
exposures; (ii) loss-related expenses, including those relating to
the remediation of problem credits; and (iii) insurance intangible
amortization.
Ambac Assurance has another wholly owned subsidiary, Ambac
Credit Products LLC (“ACP”) that issued credit derivative
contracts for which it collects fees over the contract term. Credit
derivative contract terms are substantially similar to financial
guarantee insurance. 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 Second Amended Plan of
Rehabilitation (as defined below) and orders of the Rehabilitation
Court (as defined below). See discussion of “Ambac Assurance
Liquidity” in Part II, Item 7 included in this Form 10-K for further
information.
Ambac Assurance and its subsidiaries have been working toward
reducing uncertainties within its insured portfolio through active
monitoring of key exposures such as municipal entities (including
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 applicable to the insurance entities, seeking to optimize
capital allocation in a challenging environment that includes long
duration obligations, and attempting to retain key employees.
The deterioration of the financial condition of Ambac Assurance
and Ambac UK beginning in 2007 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 and by regulatory, legal and contractual
restrictions. It is highly unlikely that Ambac Assurance will be able
to make dividend payments to Ambac for the foreseeable future.
Including Contractual
Refer
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.
"Dividend Restrictions,
to
Prior to the second quarter of 2017, Ambac had two reportable
business segments: i) the financial guarantee segment, which
consisted of financial guarantee insurance policies and credit
derivative contracts and ii) the financial services segment which
consisted of other financial products. In the second quarter of 2017,
the Company began reporting financial guarantee as its only
reportable business segment. Factors management took into
consideration when eliminating the financial services segment
included (i) significant swap commutations in June 2017, which
left the remaining interest rate swaps and other interest rate
derivatives as hedges against interest rate risk in the financial
guarantee and investment portfolios, (ii) the maturity of the last
investment agreement in March 2017, (iii) the immateriality of the
remaining conduit transactions, and (iv) the appointment of a new
Chief Executive Officer effective January 1, 2017. Management
now reviews financial information, allocates resources and
measures financial performance on a consolidated basis. All prior
period amounts and disclosures have been adjusted to reflect the
reportable segment change.
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 significant net
operating loss carry-forwards, of which $3.7 billion remain at
December 31, 2017.
Interest Rate Derivatives:
Interest rate derivative transactions are executed through Ambac
Financial Services (“AFS”), a wholly-owned subsidiary of Ambac
Assurance. As noted above, the primary activities of AFS is to
| Ambac Financial Group, Inc. 2 2017 FORM 10-K |
economically hedge interest rate risk in the financial guarantee and
Accordingly, these derivatives are
investment portfolios.
positioned to benefit from rising rates. Under 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 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 collateral and margin posting
requirements, previous termination payments and other cash
needs.
Ambac derives interest rate derivative revenues from (i) changes
in the fair value of the derivatives portfolio resulting from interest
rate fluctuations and (ii) the value of future contract terminations
or settlements which may differ from the carrying value of the
those contracts.
Credit risks relating to derivative positions primarily concern the
default of a counterparty. Ambac's interest rate derivatives
generally consist of centrally cleared swaps, US treasury futures
and some over-the-counter ("OTC") swaps with financial
guarantee customers or bank counterparties. Counterparty default
exposure is mitigated through the use of industry standard
collateral posting agreements or margin posting requirements.
Cleared swaps, futures and OTC derivatives with bank
counterparties require margin or collateral to be posted up to or in
excess of the market value of the derivatives. 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 risk management processes described in the Risk
Management Group section below. 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.
Investment Agreements:
issuers
through
Ambac Assurance issued investment agreements to structured
finance and municipal
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. The last investment
agreement matured in March 2017.
Funding Conduits:
A subsidiary of Ambac 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, 2017,
Ambac Assurance or Ambac UK 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.
Corporate Strategy:
In February 2018, Ambac achieved one of its key strategic
strategies, the exit from rehabilitation of Ambac Assurance’s
Segregated Account (as defined below). Having accomplished
this milestone, Ambac will continue to pursue and prioritize its
remaining key strategic priorities, namely:
• Active runoff of Ambac Assurance and its subsidiaries
through transaction terminations, policy commutations,
settlements and restructurings, with a focus on our watch list
credits and known and potential future adversely classified
credits, that we believe will improve our risk profile, and
maximizing the risk-adjusted return on invested assets;
• Ongoing rationalization of Ambac's and its subsidiaries'
capital and liability structures;
• Loss recovery through active litigation management and
exercise of contractual and legal rights;
• Ongoing
review of organizational effectiveness and
efficiency of the operating platform; and
• Evaluation of opportunities in certain business sectors that
meet acceptable criteria that will generate long-term
stockholder value with attractive risk-adjusted returns.
With respect to our new business strategy, we have identified
certain business sectors adjacent to Ambac's core business, in
which future opportunities will be evaluated. The evaluation will
be conducted through a measured and disciplined approach to
identify opportunities that are synergistic to Ambac, match
Ambac's core competencies, are rapidly scalable or available
through mergers and acquisitions and that may allow for the
utilization of Ambac's net operating loss carry-forwards. Although
we are exploring new business opportunities for Ambac, no
assurance can be given that we will be able to execute and/or obtain
the financial and other resources that may be required to finance
the acquisition or development of any new businesses or assets.
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 remains speculative.
The execution of Ambac’s strategy to increase the value of its
investment in Ambac Assurance is subject to the restrictions set
forth in the Settlement Agreement, dated as of June 7, 2010 (the
"Settlement Agreement"), by and among Ambac Assurance, ACP,
Ambac and certain counterparties to credit default swaps with ACP
| Ambac Financial Group, Inc. 3 2017 FORM 10-K |
that were guaranteed by Ambac Assurance, as well as the
Stipulation and Order (as defined in Note 1. Background and
Business Description to the Consolidated Financial Statements
included in Part II, Item 8 in this Form 10-K), each of which
requires OCI (and in the case of the Settlement Agreement, under
certain circumstances, holders of surplus notes issued pursuant to
the Settlement Agreement) to approve certain actions taken by or
in respect of Ambac Assurance. In exercising its rights under the
Stipulation and Order or Settlement Agreement, OCI will act for
the benefit of policyholders, and will not take into account the
interests of Ambac. 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.
Opportunities for remediating losses on poorly performing insured
transactions 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.
Segregated Account
In March 2010, Ambac Assurance established a segregated account
pursuant
to Wisconsin Stat. §611.24(2) (the “Segregated
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.
On September 25, 2017 the Rehabilitator filed a motion in the
Rehabilitation Court seeking entry of an order approving an
amendment to the Segregated Account Rehabilitation Plan (the
"Second Amended Plan of Rehabilitation"). Following the
conclusion of a Confirmation Hearing on January 22, 2018, the
Rehabilitation Court entered an order granting the Rehabilitator's
motion and confirming
the Second Amended Plan of
Rehabilitation. On February 12, 2018 (the "Effective Date"), the
Second Amended Plan of Rehabilitation became effective.
Consequently, the rehabilitation of the Segregated Account was
concluded. 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.
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 statements, which
articulate the Company's tolerance for certain risks and describes
the general types of risk that the Company accepts, within certain
parameters, or attempts to avoid.
While the Board of Directors has the ultimate oversight
the risk management process, various
responsibility for
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, Ambac's 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, particularly executive talent,
compensation structures that might lead to undue risk taking,
and disclosure of our executive compensation philosophies,
strategies and activities.
• 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 programs and practices and our
compliance therewith. 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 its 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
| Ambac Financial Group, Inc. 4 2017 FORM 10-K |
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 process that involves the Board of Directors,
management and other personnel in an integrated effort to identify,
assess and manage a broad range of risks (e.g., credit, financial,
legal, liquidity, market, model, operational, regulatory and
strategic), that may affect the Company’s ability to execute on its
corporate strategy and fulfill its business objectives. The Enterprise
Risk Committee (“ERC”), which is a management committee, 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.
Ambac management has established other committees to assist in
managing the risks embedded in the enterprise. These committees
will meet monthly or as needed on an ad hoc basis.
• The Asset Liability Management Committee's (“ALCO”)
objective is to foster an enterprise wide culture and approach
to liquidity management, asset management, asset valuation
and hedging. Members of ALCO include the Chief Executive
Officer, Chief Financial Officer and senior managers from
investment management and the Risk Management Group.
• The Risk Committee's objective
is establish an
interdisciplinary team of professionals from different parts of
the company to provide oversight of the key risk remediation
issues impacting Ambac. The purview of the committee is to
review and approve risk remediation activities for the
financial guarantee insured portfolio as well as review
changes to Ambac's adversely classified, survey and watch
list credits (as defined in Note 2. Basis of Presentation and
Significant Accounting Policies). This committee was
established in the fourth quarter of 2017. Previously, most
risk remediation activities were approved by ALCO.
Members of the Risk Committee include the Chief Executive
Officer, Head of Risk Management, Chief Financial Officer
and senior managers from throughout risk, corporate services
group, operations, investment management, legal and
finance.
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.
RISK MANAGEMENT GROUP
Financial guarantee insurance and credit derivatives ("financial
guarantees") were sold in three principal markets: U.S. public
finance, U.S. structured finance and international finance. 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. Please
refer to Item 7 “Management’s Discussion and Analysis of Financial
Condition and Results of Operations - Financial Guarantees in
Force” section below for details on the financial guarantee insured
portfolio.
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). Our ability to
execute certain risk management activities may be limited by the
restrictions set forth in the Settlement Agreement and the Stipulation
and Order. 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.
Ambac’s Risk Management Group ("RMG") has an organizational
structure designed around four primary areas of focus: Surveillance,
Risk Remediation, Credit Risk Management and Loss Reserving
and Analytics. The Head of Risk Management reports directly to
Ambac's Chief Executive Officer and regularly informs and updates
the Audit Committees of the Boards of Directors of Ambac and
Ambac Assurance with respect to risk-related topics in the insured
portfolio.
Surveillance
This group's focus is on the early identification of potential stress
or deterioration in connection with exposures in the insured portfolio
and the related credit analysis associated with these and other
insured portfolio exposures.
Analysts in this group perform periodic credit reviews of insured
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. In general, surveillance 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 analysts
| Ambac Financial Group, Inc. 5 2017 FORM 10-K |
to track single credit migration and industry credit and performance
trends.
The focus of a related credit 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. Please refer to Note 2. Basis of
Presentation and Significant Accounting Policies
the
Consolidated Financial Statements included in Part II, Item 8 in this
Form 10-K for further discussion of
the various credit
classifications. If a problem is detected, the Surveillance group will
then work with the Risk Remediation group on a loss mitigation
plan, as necessary.
to
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 reviews 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. Surveillance
analysts review these reports to monitor performance and, if
necessary, seek legal advice to ensure that reporting and application
of cash flows comply with transaction requirements.
Risk Remediation
This group’s focus is on risk remediation, loss mitigation and
restructuring related to the insured portfolio of Ambac Assurance.
Risk remediation helps to reduce exposure to credits that are
developing, have the potential for future adverse development or
are already adversely classified by, among other things, securing
rights and remedies, both of which help to mitigate losses in the
event of further deterioration or event of default, or, as available,
working with an issuer to refinance or retire debt.
Loss mitigation focuses on the analysis, implementation and
execution of commutation and related claims reduction or
defeasance strategies for policies with potential future claims. Loss
mitigation prioritizes policies, or portions thereof, for commutation,
refinancing or other claims reduction or defeasance strategies.
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.
For certain adversely classified, survey list and watch list credits,
Risk Remediation analysts will develop and implement a
remediation or loss mitigation plan that could include actions such
as 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. Other
actions could include working with bond holders and other
economic stakeholders to negotiate, structure and execute solutions,
such as commutations.
Adversely classified, survey list and watch list credits are tracked
closely by Surveillance analysts together with Risk Remediation
analysts as part of the Risk Remediation process and discussed at
regularly scheduled meetings with Credit Risk Management (see
discussion following in “Credit Risk Management”) and the Risk
Committee (see discussion following in "Risk Committee"). In
some cases, Risk Remediation 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 Risk Remediation, we have established cross-functional teams
in key areas of focus, comprised of personnel both within the RMG
and in other departments, to target proactive mitigation and
remediation of losses and potential future losses associated with
certain credits and sectors in the insured portfolio. Examples of such
efforts 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 or the potential for future material
adverse development to target and execute risk reduction,
restructuring and commutation strategies. Members of these cross-
functional teams will often work with external experts in the pursuit
of risk reduction efforts.
For RMBS servicing, the 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.
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 and an
assessment of whether a transfer of 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
implement 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 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 2. Basis of
Presentation and Significant Accounting Policies and Note 7.
Financial Guarantee Insurance Contracts to the Consolidated
| Ambac Financial Group, Inc. 6 2017 FORM 10-K |
Financial Statements included in Part II, Item 8 in this Form 10-K
for further discussion on this topic).
Loss Reserving and Analytics ("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 works with Surveillance and Risk
Remediation analysts responsible for a particular credit on the
development, review and implementation of loss reserve scenarios
and related analysis.
Credit Risk Management ("CRM")
CRM manages the decision process for all material matters that
affect credit exposures within the insured portfolio. While not
responsible for the credit analysis or execution of risk remediation
or loss mitigation strategies, CRM provides a forum for independent
assessments, reviews and approvals and drives consistency and
timeliness. The scope of credit matters under the purview of CRM
includes material amendments, waivers and consents, evaluation of
remediation or loss mitigation 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. In particular, formal plans or transactions that relate
to risk remediation, loss mitigation or restructuring may also require
Risk Committee approval. In addition, such plans or transactions
that have material asset liquidity implications may also require
ALCO approval.
Control Rights
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”). 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. By way of
the Second Amended Plan of
Rehabilitation and orders of the Rehabilitation Court, such
protections are intended to be continued after the consummation of
the Rehabilitation Exit Transactions (as defined in Note 1.
Background and Business Description to the Consolidated Financial
Statements, included in Part II, Item 8 in this Form 10-K).
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 Surveillance and Risk Remediation teams and discussed
at meetings with CRM. Adversely classified credit meetings include
members of CRM, Surveillance, Risk Remediation 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 the Credit Committee and Ambac’s and
Ambac Assurance’s Board of Directors no less than quarterly.
The insured portfolio contains exposures that are correlated and/or
concentrated. Risk Management'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, the impact
of tax reform on state and municipal bond issuers, 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
Surveillance group review, analyze and process all requests for
AWCs. All AWCs are initially screened for materiality in the
Surveillance group. Non-material AWCs require the approval of at
least the Surveillance analyst and the Surveillance 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
| Ambac Financial Group, Inc. 7 2017 FORM 10-K |
independent
parameters consistent with the exposure type.
judgments, are based upon underlying credit
Risk Committee
The Risk Committee is a management committee that was
established in the fourth quarter of 2017, as an interdisciplinary body
of expertise from different parts of the Ambac Assurance to provide
oversight of the key risk remediation, loss mitigation and
restructuring issues (collectively "risk remediation") impacting the
Company. The committee comprises the CEO, CFO, Head of Risk
Management, as chair, General Counsel, and other key personnel
from the Risk Management, Finance, Corporate Services and Legal
departments.
The mission of the committee is to: (i) to enhance, improve and
standardize the key impact metrics, including economic, financial,
and strategic, considered when making risk remediation decisions;
(ii) to ensure a timely, rigorous and thorough approach to risk
remediation at Ambac Assurance and the prudent and economically
accretive use of capital in support of these activities; and (iii) to
enhance enterprise-wide communication and cooperation in
connection with these core Ambac Assurance business strategies.
The purpose of the Risk Committee is to: (i) to review on a periodic
basis changes to Ambac Assurance internal credit classifications and
ratings of adversely classified credits, survey list credits, and watch
list credits after the aforementioned CRM process; (ii) to review and
approve risk remediation plans for adversely classified credits,
survey list credits and watch list credits; (iii) to provide oversight
and to review new risk remediation structures or approaches in
connection with risk remediation plans or anticipated transactions;
(iv) to review and approve proposed risk remediation transactions
whereby Ambac Assurance is making an economic contribution;
and (iv) other such risk remediation activities that Ambac Assurance
may delegate to the Risk Committee.
INSURANCE REGULATORY MATTERS AND
OTHER RESTRICTIONS
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.
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 regulatory restrictions.
In addition, pursuant to the terms of the Settlement Agreement and
the Stipulation and Order, Ambac Assurance must seek prior
approval by OCI of certain corporate actions. The Settlement
Agreement and Stipulation and Order include covenants which
restrict the operations of Ambac Assurance. The Settlement
Agreement will remain in force until the surplus notes issued
thereunder have been redeemed, repurchased or repaid in full. The
Stipulation and Order will remain in force for so long as OCI
determines it to be necessary. Certain of the restrictions in the
Settlement Agreement may be waived with the approval of the OCI
and/or the requisite percentage of holders of surplus notes issued
thereunder.
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
additional
those other EU
jurisdictions. 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 regulatory restrictions.
licensing or authorization
in
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.
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. 8 2017 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.
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 2018 without
certain approvals, including the prior consent of the OCI, which
is unlikely. Ambac Assurance’s ability to pay dividends is further
restricted by the Settlement Agreement, the Stipulation and Order
and the terms of its Auction Market Preferred Shares ("AMPS").
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.
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 Ambac
Assurance's surplus notes (other than junior surplus notes) would
also need to be redeemed at par.
The Stipulation and Order requires OCI approval for the payment
of any dividend or distribution on the common stock of Ambac
Assurance.
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.
INVESTMENTS AND INVESTMENT POLICY
As of December 31, 2017, the consolidated non-VIE investments
of Ambac had an aggregate fair value of approximately $5.74
billion. Investments are managed both 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, 2017, the Ambac Assurance and Everspan
non-VIE investment portfolio had an aggregate fair value of
approximately $4.86 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 the types and quality of investments imposed by
applicable insurance laws and regulations, which may be waived
by the applicable regulatory authority in certain instances. 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. 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, changes to Ambac
Assurance’s investment policies are subject to approval by OCI
pursuant to covenants made by Ambac Assurance in the Settlement
| Ambac Financial Group, Inc. 9 2017 FORM 10-K |
Agreement and Stipulation and Order. Such requirements could
adversely impact the performance of the investment portfolio.
As of December 31, 2017, the non-VIE Ambac UK investment
portfolio had an aggregate fair value of approximately $0.70
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 holder claims. Ambac UK purchases Ambac UK insured
securities given their relative risk/reward characteristics. 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, 2017, the non-VIE Ambac (parent company
only) investment portfolio had an aggregate fair value of
approximately $0.16 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. Additionally, as
of December 31, 2017, this portfolio has $0.20 billion in surplus
notes that were issued by Ambac Assurance or the Segregated
Account which are eliminated in consolidation.
The following table provide certain information concerning the
consolidated investments of Ambac:
2017
2016
Investment Category
($ in millions)
December 31,
Carrying
Value (2)
Weighted
Average
Yield (1)
Carrying
Value (2)
Weighted
Average
Yield (1)
Municipal obligations
$
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
Other investments (3)
780
860
27
85
—
2,251
649
4,652
657
432
5.5 % $
374
3.2 %
1.0 %
1.6 %
— %
14.1 %
7.3 %
9.3 %
1.3 %
— %
1,802
43
101
4
2,352
943
5,619
431
450
Total
$ 5,741
8.3% $ 6,500
3.9 %
2.8 %
1.2 %
1.2 %
0.6 %
9.1 %
4.5 %
5.7 %
0.6 %
— %
5.4%
(1) Yields are stated on a pre-tax basis, based on average amortized cost
for both long and short term investments.
(2)
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.
(3) Other investments include equity interests in pooled investment funds
which are classified as trading securities and Ambac's interests in an
unconsolidated trust created in connection with its sale of Segregated
Account junior surplus notes on August 28, 2014.
Ambac's exposure to RMBS in its investment portfolios is further
discussed 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, 2017, Ambac had 113 employees in the United
States and 11 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 or Note 14. Income Taxes
to the Consolidated Financial Statements included in Part II, Item 8
in this Form 10-K unless otherwise indicated.
Certain of the risk factors described below refer to Secured Notes
and Tier 2 Notes, which were issued in February 2018 in connection
with the transactions described in Note 1. Background and Business
Description and Note 17. Subsequent Events to the Consolidated
Financial Statements included in Part II, Item 8 in this Form 10-
K. Our risk factors are organized in the following sections.
Risks Related to Ambac Common Shares ....................
Risks Related to Insured Portfolio Losses ...................
Risks Related to Indebtedness......................................
Risks Related to Capital, Liquidity and Markets .........
Risks Related to the Company's Business....................
Risks Related to International Business ......................
Risks Related to Taxation.............................................
Changes in Political or Economic Conditions ............
Risks Related to Strategic Plan....................................
10
12
15
20
22
23
25
25
26
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, particularly with regards to concentrations of credit
risk, such as to Puerto Rico;
• changes to regulatory status;
| Ambac Financial Group, Inc. 10 2017 FORM 10-K |
• 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.
The value of Ambac's 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 intercompany 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; the receipt of dividends from Ambac
Assurance; and the receipt of payments on other investments.
There can be no assurance that Ambac will be able to realize
residual value in Ambac Assurance, which is in run-off. It is
unclear whether Ambac Assurance will be able to satisfy all of its
obligations to policyholders, holders of its surplus notes (including
junior surplus notes) and holders of its preferred stock, even if
Ambac Assurance is 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.
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 intercompany
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 OCI and limited to $4.0 million per annum. We
can provide no assurance as to whether OCI 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 junior surplus note plus interest thereon.
Ambac Assurance became the obligor under the junior surplus
notes on February 12, 2018 pursuant to the Second Amended Plan
of Rehabilitation. No payment of interest on or principal of a junior
surplus note may be made until all existing and future indebtedness
of Ambac Assurance, including senior ranking surplus notes,
policy claims and claims having statutory priority, have been paid
in full. All payments of principal and interest on junior surplus
notes are subject to the prior approval of OCI. If OCI does not
approve the payment of interest on 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
made when and to the extent that Ambac Assurance 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 or
pari-passu 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 or pari-passu 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 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
| Ambac Financial Group, Inc. 11 2017 FORM 10-K |
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.
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 insured portfolio of Ambac
Assurance or significant losses or other events resulting from
litigation against Ambac Assurance 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.
A group of entities allowed to participate in the confirmation
hearings for the Second Amended Plan of Rehabilitation for the
Segregated Account has indicated that it would appeal the order
approving the Second Amended Plan. We can provide no assurance
that an appeal of the approval order will not be successful and result
in the approval order being overturned or modified, or necessitate
changes to the Second Amended Plan. Ambac, Ambac Assurance
and their respective security holders would face substantial
uncertainty and risk if the appeal is successful. Among other
possibilities, Ambac Assurance may lose control rights in
transactions, which would expose the Company to significantly
increased risks and potential losses.
Even if the Second Amended Plan of Rehabilitation and/or the
related approval order of the Rehabilitation Court is not modified
or overturned, there can be no assurance that any level of capital
deemed sufficient by OCI to permit the conclusion of the
Segregated Account rehabilitation will be sufficient to cover all
future losses, whether currently anticipated or unanticipated.
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.
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 adversely classified. 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. 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 (on a probability weighted basis) reflecting the
significant uncertainty regarding future developments and
outcomes, our loss reserves may change materially based on future
developments. As a result of 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 Ambac Assurance
will retain control rights in respect of our insured portfolio.
However, according to the terms of relevant transaction
documents, Ambac Assurance may lose control rights in many
insured transactions if, among other things, Ambac Assurance is
the subject of delinquency proceedings and/or other regulatory
actions which could result from its deteriorated financial position.
If Ambac Assurance loses control rights, its ability to mitigate loss
severities and realize remediation recoveries will be compromised,
and actual ultimate losses in its insured portfolio could exceed
current loss reserves. The Second Amended Plan of Rehabilitation
of the Segregated Account and related orders of the Rehabilitation
Court seek to restrain actions adverse to Ambac Assurance based
on a loss of control rights due to the rehabilitation of the Segregated
Account or related events or circumstances. If the Second
Amended Plan of Rehabilitation and such orders do not
successfully preclude such actions, Ambac Assurance could lose
its control rights with respect to certain policies.
Some issuers of public finance obligations insured by Ambac
Assurance 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.
Some issuers of public finance obligations insured by Ambac
Assurance have reported or may report budget shortfalls,
significantly underfunded pensions or other fiscal stresses that
imperil their ability to pay debt service or 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 insured by Ambac
Assurance have declared a payment moratorium, defaulted or filed
for bankruptcy or similar debt adjustment proceedings, raising
concerns about their ultimate ability to service the debt insured by
Ambac Assurance and Ambac Assurance's ability to recover claims
paid in the future. If the issuers of the obligations in the 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 or for similar relief under other laws
that allow for the adjustment of debts, Ambac Assurance may
experience liquidity claims and/or ultimate losses on those
obligations, which could adversely affect the Company's business,
financial condition and results of operations.
| Ambac Financial Group, Inc. 12 2017 FORM 10-K |
Ambac Assurance insures obligations of Commonwealth of
Puerto Rico, including its authorities and public corporations,
that are either subject to a Title III bankruptcy protection
proceeding under the Puerto Rico Oversight, Management and
Stability Act ("PROMESA") or have otherwise suspended debt
service payments. 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. While we believe
our reserves are adequate to cover losses in the Puerto Rico
insured portfolio, there can be no assurance that Ambac
Assurance may not incur additional losses in the future,
particularly given the developing economic, political and legal
circumstances in Puerto Rico. Such losses may have a material
adverse effect on Ambac Assurance's results of operation and
financial condition.
Ambac Assurance has exposure to the Commonwealth of Puerto
Rico (the "Commonwealth"), including its authorities and public
corporations. Each has its own credit risk profile attributable to
discrete revenue sources, direct general obligation pledges and
general obligation guarantees. Overall, Ambac Assurance has
approximately $2.0 billion of net par exposure
the
Commonwealth and these instrumentalities. Components of the
overall 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 as opposed to the current accreted
value of the bond. The outstanding net insured amount including
accretion on capital appreciation bonds is approximately $2.7
billion. Total net insured lifetime debt service (net par and interest)
to the Commonwealth of Puerto Rico and its instrumentalities was
approximately $9.5 billion at December 31, 2017.
to
As a result of the developments described in these Risk Factors
and elsewhere in this 10-K (see Part II, Item 7, Management's
Discussion and Analysis of Financial Condition and Results of
Operations - Financial Guarantees in Force), the Commonwealth
of Puerto Rico and certain of its instrumentalities will continue to
default on 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 amount of monies
available for debt service, which is in turn affected by variability
in economic growth, tax revenues, essential services expense as
well as federal funding of Commonwealth needs. In addition, our
exposure to Puerto Rico is impacted by the significant damage to
the Commonwealth that was inflicted by Hurricane Maria, which
made landfall on September 20, 2017, as well as Hurricane Irma,
which passed just north of the island on September 6, 2017. The
longer term recovery of the economy of the Commonwealth and
its essential infrastructure will likely be highly dependent on the
amount, timing and effectiveness of Federal aid. There is historical
precedent for meaningful Federal support following other natural
disasters in the United States and its territories and, to date, some
Federal aid measures have been approved and have already started
to assist in the recovery. However, there can be no assurances as
to the sufficiency or ultimate level of the aid and as to the
effectiveness of the deployment of the aid in benefiting the long
term recovery of economic activity in Puerto Rico.
Substantial uncertainty also exists with respect to the ultimate
outcome for creditors in Puerto Rico due to legislation enacted by
the Commonwealth and the United States, including PROMESA,
as well as actions taken in reliance on such laws, including Title
III filings. Ambac Assurance is involved in multiple litigations
relating to such actions and other issues and may not be successful
in pursuing claims or protecting its interests. Ambac Assurance is
also participating in a mediation process with respect to potential
debt restructurings. Mediation may not be productive or may not
resolve Ambac Assurance's claims in a manner that avoids
significant losses.
Given the numerous uncertainties existing with respect to the
restructuring process and relevant litigations, no assurance can be
given that ultimate debt service discounts will not be severe and
cause Ambac to experience losses materially exceeding current
reserves. It is possible that certain restructuring process solutions,
together with associated legislation, budgetary, and/or public
policy proposals could be adopted and could significantly or
further impair our exposures. In addition, there are possible final
legal determinations, including failing to recognize or properly
differentiate legal structures and protections applicable to such
exposures, that could result in losses exceeding our current reserves
by a material amount and our loss reserves would need to be
increased. In particular, in a Title III process, should court-
approved plans of adjustment for the Commonwealth, COFINA,
Puerto Rico Highways and Transportation Authority ("PRHTA"),
or any other issuers of Ambac-insured debt that file for Title III
protection contemplate discounts to debt service implied by, or
even worse than, the Commonwealth’s Revised Fiscal and
Economic Growth Plan ("Revised FEGP"), the Fiscal Plan
Compliance Act be upheld, or Ambac receive unfavorable
judgments in the litigations to which it is a party, Ambac’s financial
condition could be materially adversely affected. It is also possible
that economic or demographic outcomes may be as, or worse than,
forecast under the Commonwealth’s Revised FEGP or under
proposals or plans promulgated by the Commonwealth or its
instrumentalities in or in connection with a Title III process or
otherwise. Even a negotiated restructuring to which Ambac agrees
as part of a Title VI, mediation or other process may involve
material losses in excess of current reserves. While our reserving
scenarios reflect a wide range of possible outcomes reflecting the
significant uncertainty regarding future developments and
outcomes, given our exposure to Puerto Rico and the economic,
fiscal, legal and political uncertainties associated therewith as well
as the uncertainties emanating from the damage caused by
hurricanes Maria and Irma, 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.
Implementation of the H.R. 1 (commonly known as the Tax Cuts
and Jobs Act) may negatively impact the economic recovery of
Puerto Rico, which could result in higher loss severities or an
extended moratorium on debt service owed on Ambac Assurance-
insured bonds of Puerto Rico and its instrumentalities.
The Tax Cuts and Jobs Act effectively treats Puerto Rico the same
as it does any other foreign tax jurisdiction and otherwise makes
it less attractive for U.S. taxpayers to move certain operations
abroad by, among other things, imposing U.S. federal income tax
on a current basis with respect to certain earnings of controlled
foreign corporations. This may diminish the Commonwealth of
Puerto Rico’s relative attractiveness as a location for foreign
| Ambac Financial Group, Inc. 13 2017 FORM 10-K |
activity of a U.S. multinational group, including those with
manufacturing facilities or other business on the island. The
legislation comes at a difficult time as the Commonwealth of
Puerto Rico recovers from hurricanes Maria and Irma and a multi-
year financial crisis. Consequently, the Tax Cuts and Jobs Act could
have an adverse impact on the ongoing recovery of the
Commonwealth of Puerto Rico by impeding much-needed
economic growth, job growth, and revenue generation, which
could potentially result in higher loss severities and/or an extended
debt service moratorium for Puerto Rico creditors, including the
Company.
Implementation of the Tax Cuts and Jobs Act could have a
negative impact on issuers of Ambac Assurance-insured
municipal bonds.
Under the Tax Cuts and Jobs Act individuals who itemize their
deductions on their Federal income tax returns will be limited to
$10,000 of deductions for state and local taxes paid in a given year.
In states with high income tax rates, such as New York,
Connecticut, New Jersey, Maryland, and California, there is a risk
that municipal bond issuers could be impacted by lower tax
revenues if there is significant out migration by residents to states
or municipalities with lower tax rates. Lower tax revenues in these
jurisdictions could lead to reduced financial flexibility, lower
overall economic activity and increased credit risk and thereby
potentially increasing risk to Ambac Assurance with respect to
affected issuers with bonds insured by Ambac Assurance.
the demand for municipal bond
In addition, the Tax Cuts and Jobs Act reduces the maximum
corporate federal income tax rate to 21% from 35%, which could
investments by
reduce
corporations, such as life insurance companies, banks, and credit
unions, which currently hold approximately 30% of all outstanding
municipal bonds. The impact of reduced demand could result in
higher borrowing costs for municipalities and/or reduced
refinancing flexibility for issuers of municipal bonds, thereby
potentially increasing risk to Ambac Assurance with respect to
issuers with municipal bonds insured by Ambac Assurance.
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 the Company's
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
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 our 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 and, specifically, trusts with securities insured by
Ambac Assurance have been subject to heightened Consumer
Finance Protection Bureau (CFPB) scrutiny and enforcement
action over servicing and collections practices and potential chain
of title issues and, consequently, any settlements, orders, consents
or penalties resulting from CFPB actions, or any failure on the part
of servicers or other parties asserting claims against delinquent
borrowers to establish title to the loans, could lead to increased
losses on securities we insure.
In addition, there can be no assurance that Ambac Assurance would
be successful, or that it 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
the Company's 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
process. 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
| Ambac Financial Group, Inc. 14 2017 FORM 10-K |
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 similar 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 the interpretation 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 recently concluded Segregated
Account rehabilitation. 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.
Risks Related to Indebtedness
The Secured Notes and Tier 2 Notes are secured primarily by
potential recoveries on Ambac Assurance’s RMBS litigations and
Ambac Assurance’s ability to obtain, and the timing of, any
recovery on the RMBS litigations is subject to significant
uncertainty.
The Secured Notes and Tier 2 Notes are primarily secured by
Ambac Assurance’s potential recoveries in respect of RMBS
litigations. The RMBS litigations arise from Ambac Assurance’s
claims of fraud and/or contractual breaches of representations and
warranties with respect to certain residential mortgage-backed
securities (“RMBS”) transactions insured by Ambac Assurance.
These claims are based on, among other things, representations
with respect to the characteristics of the securitized loans, the
absence of borrower fraud in the underlying loan pools or other
misconduct in the origination process, the compliance of loans with
the prevailing underwriting policies, and compliance of the RMBS
transaction counterparties with policies and procedures related to
loan origination and securitization. In such cases, where contract
claims are being pursued, the sponsor of the transaction is
contractually obligated to repurchase, cure or substitute collateral
for any loan that breaches the representations and warranties.
However, generally the sponsors have not honored those
obligations and have vigorously defended claims brought against
them.
The outcome of any litigation, including the RMBS litigations, is
inherently unpredictable, including because of risks intrinsic in the
adversarial nature of litigation. Subsequent court motions, appeals
and rulings, some of which could relate to the transactions
effectuated in connection with the conclusion of the Segregated
Account rehabilitation, and the issuance of the Secured Notes or
Tier 2 Notes, could delay or otherwise impact any recovery by
Ambac Assurance. Moreover, rulings that may be adverse to
Ambac Assurance (in any given RMBS litigation, as well as in
related matters) could affect Ambac Assurance’s ability to pursue
its claims or alter settlement dynamics with RMBS litigation
counterparties. There can be no assurance that Ambac Assurance
will be successful in prosecuting its claims in the RMBS litigations.
Any litigation award or settlement amount is subject to
counterparty credit risk, successor liability and other similar risks
of recovery, including that the sponsor is unable to honor its
contractual obligations or pay a judgment that Ambac Assurance
may obtain in litigation. Some sponsors against which Ambac
Assurance has claims have been acquired since the securitized
loans were originated and their successors may decline to honor
the sponsor’s obligations. Ambac Assurance may not be successful
in enforcing its claims against any successor entity. There can be
no assurance that Ambac Assurance will not have difficulties
recovering any damages it may be owed or that it will recover all
amounts to which it believes it is entitled or that any actual
recoveries will not differ materially from
the estimated
representation and warranty recoveries the Company has
accounted for in its financial statements.
In addition, while a policy issued by Ambac Assurance guarantees
all principal and interest payments (including mandatory
prepayments) in respect of the Secured Notes as and when such
payments become due and owing, such policy may not provide
adequate assurance that payments of principal and interest in
respect of the Secured Notes will be available in the event that
Ambac Assurance’s financial condition, including its capital and
liquidity, is materially adversely affected, including as a result of
the failure to recover expected damages and, as a result, Ambac
Assurance is unable to satisfy its policy obligations. In the event
that Ambac Assurance is unable to satisfy its obligations under the
Secured Notes policy, holders of the Secured Notes will have the
right to foreclose on the securities constituting collateral for the
Secured Notes and to sue Ambac Assurance for failure to make
payments under the Secured Notes policy; however, there can be
no assurance that the sale of the securities collateral will produce
proceeds in an amount sufficient to pay any or all amounts due on
the Secured Notes or that holders will be successful in any litigation
seeking payments pursuant to the Secured Notes policy.
Furthermore, holders of Secured Notes will not obtain any control,
consultation or direction rights in respect of the RMBS litigations
nor will holders be able to sell the Ambac Note or the right to
receive proceeds in respect of the RMBS litigations without the
prior consent of Ambac Assurance.
Holders of Secured Notes and Tier 2 Notes will have no authority
to make decisions in respect of the RMBS litigations, will need
to rely on Ambac Assurance to pursue the RMBS litigations and
| Ambac Financial Group, Inc. 15 2017 FORM 10-K |
may only receive limited information concerning the RMBS
litigations.
All decisions concerning the conduct of the RMBS litigations,
including as to strategy, settlement, pursuit and abandonment, will
be made by Ambac Assurance, in consultation with its legal
counsel. Holders of the Secured Notes and Tier 2 Notes will have
no control over any decisions related to the RMBS litigations and
will need to rely on Ambac Assurance to prosecute the underlying
claims. If holders do not agree with decisions by Ambac Assurance
with respect to the RMBS litigations, there is no recourse or ability
to object to such decision. Additionally, Ambac Assurance’s ability
to disclose potentially material details of the RMBS litigations on
a regular basis may be limited by litigation strategy and the inherent
nature and rules of judicial proceedings, including, among other
things, proceedings and filings that are sealed by the court, matters
involving attorney-client privilege and proceedings that are
conducted on a confidential basis by agreement of the parties. The
RMBS litigations could also be adversely affected if Ambac
Assurance does not have sufficient resources to actively prosecute
its claims or becomes subject to rehabilitation, liquidation,
conservation or dissolution, or otherwise impaired by actions of
OCI.
While Ambac Assurance may pursue negotiated settlements of
the RMBS litigations, the settlement discussions may not
materialize, may ultimately fail, may cause delays or may result
in settlements for less than the amount needed to pay the Secured
Notes and Tier 2 Notes.
Ambac Assurance may elect to engage in settlement negotiations
with the defendants of the RMBS litigations and may decide to
settle any or all of the RMBS litigations. The aggregate amount
of settlements may be for an amount less than the amount necessary
to pay the Secured Notes or less than the amount necessary to pay
the Tier 2 Notes, which could have a material adverse effect on its
financial condition or results of operations and make it more
difficult for Ambac Assurance to repay the Ambac Note (and
therefore make it more difficult for the issuer of the Secured Notes
to repay the Secured Notes) and/or the Tier 2 Notes, on a timely
basis or at all. Additionally, while Ambac Assurance may pursue
settlement negotiations, there can be no assurance that any
settlement negotiations will materialize or that any settlement
agreement can be reached on terms acceptable to Ambac
Assurance, or at all. If settlement discussions prior to trial fail with
respect to a particular case, Ambac Assurance could incur greater
expenses preparing for, and prosecuting, a trial in such case, and
Ambac Assurance’s recovery would be subject to the additional
risks inherent in any trial, which could adversely impact the value
of the Secured Notes and Tier 2 Notes.
Ambac Assurance may receive non-cash proceeds in respect of
the RMBS litigations and may need to liquidate such proceeds
for less than fair market value in order to make cash payments
on the Ambac Note and/or the Tier 2 Notes.
In connection with a settlement agreement or judgment, Ambac
Assurance may receive non-cash proceeds or indirect proceeds,
which are cash or non-cash proceeds received by others for the
benefit of Ambac Assurance. Ambac Assurance, however, will be
required to make payments on the Ambac Note, for the benefit of
the holders of Secured Notes, and on the Tier 2 Notes, in cash. In
the event that Ambac Assurance receives non-cash proceeds,
Ambac Assurance may need to liquidate the non-cash proceeds if
it does not have sufficient cash available to make a payment on the
Ambac Note or the Tier 2 Notes on the applicable payment date.
Market and economic conditions, governmental actions, the form
of non-cash proceeds and other factors may cause substantial
delays in the ability to liquidate any non-cash proceeds received.
Ambac Assurance may not be able to liquidate any non-cash
proceeds received for fair value or at all. If Ambac Assurance is
unable to liquidate non-cash proceeds at their fair value, Ambac
Assurance will still be required to make payments on the Ambac
Note and Tier 2 Notes and any payment made that is greater than
the amount received could have a material adverse effect on Ambac
Assurance’s financial condition, including its capital and liquidity.
If indirect proceeds are received, Ambac Assurance will also be
required to make payments on the Ambac Note, for the benefit of
the holders of Secured Notes, and on the Tier 2 Notes, in cash to
the extent of the fair value to Ambac Assurance of the indirect
proceeds. Any payments of cash on the Ambac Note and/or the
Tier 2 Notes as the result of receiving indirect proceeds may have
a material adverse effect on Ambac Assurance’s financial
condition, including its capital and liquidity.
There may not be sufficient collateral to pay any or all of the
Secured Notes or Tier 2 Notes.
In addition to Ambac Assurance’s right to representation and
warranty recoveries in respect of the RMBS litigations, which is
inherently uncertain, the Ambac Note is also secured by securities
having an estimated fair market value of approximately $350
million. However, no appraisal of the value of the securities has
been made and there can be no assurances that the fair market value
of these securities will not decrease, including significantly. The
value of the collateral in the event of liquidation will depend on
market and economic conditions, the availability of buyers and
other factors. Consequently, liquidating the securities collateral
securing the Ambac Note may not produce proceeds in an amount
sufficient to pay any or all amounts due on the Secured Notes.
The estimated fair market value of the securities collateral securing
the Ambac Note is subject to fluctuations based on factors that
include, among others, the financial condition of participants in
the financial guaranty insurance industry, the market for and
availability of financial guaranty insurance, the ability to sell the
collateral in an orderly sale, general economic conditions, the
availability of buyers and other factors. The amount to be received
upon a sale of the securities collateral would be dependent on
numerous factors, including, but not limited to, the actual fair
market value of the collateral at such time and the timing and the
manner of the sale, and the amount Ambac Assurance receives may
not equal or exceed the expected fair market value. Accordingly,
there can be no assurance that the collateral can be sold in a short
period of time or at all or at acceptable prices to Ambac Assurance.
In the event of rehabilitation, liquidation, conservation, dissolution
or other insolvency proceeding, Ambac Assurance cannot assure
holders that the proceeds from any sale or liquidation of the
securities collateral will be sufficient to pay any or all of Ambac
Assurance’s obligations under the Ambac Note.
In addition, in the event of any such proceeding, it is possible that
the rehabilitator, trustee, or competing creditors will assert that the
value of the collateral with respect to the Ambac Note or the Tier
2 Notes, including Ambac Assurance’s rights to recoveries in
respect of the RMBS litigations, is less than the then-current
| Ambac Financial Group, Inc. 16 2017 FORM 10-K |
principal amount outstanding under the Ambac Note and the
Secured Notes and/or the Tier 2 Notes on the date of the
rehabilitation filing. Upon a finding by the court overseeing an
Ambac Assurance rehabilitation that the Ambac Note and the
Secured Notes and/or the Tier 2 Notes are under-collateralized, the
claims in the rehabilitation proceeding with respect to the Ambac
Note, the Secured Notes or the Tier 2 Notes may be bifurcated
between a secured claim up to the value of the collateral and an
unsecured claim for any deficiency. As a result, the claim of the
holders of the Secured Notes or the Tier 2 Notes could be unsecured
in whole or in part. The ability of the holders of the Secured Notes
or Tier 2 Notes to realize upon any of the collateral securing the
Ambac Note and the Secured Notes or Tier 2 Notes, as the case
may be, may also be subject to bankruptcy and insolvency law
limitations or similar limitations applicable in insurance company
rehabilitation or liquidation proceedings.
Rights of holders of the Secured Notes in the RMBS litigations
and securities collateral and rights of holders of the Tier 2 Notes
in the RMBS litigations may be adversely affected by the failure
to perfect security interests in such collateral, and insolvency
considerations with respect to Ambac Assurance may have an
adverse effect on the ability of holders of the Secured Notes and
Tier 2 Notes to receive payments on the Secured Notes or Tier 2
Notes, respectively.
Applicable law provides that a security interest in certain tangible
and intangible assets can only be properly perfected and its priority
retained through certain actions undertaken by the secured party.
There can be no assurance that the collateral agent in respect of
the Secured Notes or Tier 2 Notes will have taken or will take all
actions necessary to create properly perfected security interests in
the proceeds from the RMBS litigations, which may result in the
loss of the priority of the security interest in favor of the holders
of the Secured Notes or the Tier 2 Notes, respectively, to which
they would otherwise have been entitled. In particular, in the event
of a rehabilitation, liquidation, conservation, dissolution or other
insolvency proceeding with respect to Ambac Assurance, if the
proceeds from the RMBS litigations received by Ambac Assurance
are determined not to be under the control of the Secured Notes
Issuer, a receiver or a creditor of Ambac Assurance may take the
position that the Secured Notes Issuer’s security interest in such
proceeds or a portion thereof is not perfected and therefore that
such proceeds do not secure the Ambac Note. With respect to the
Tier 2 Notes, in the event of a rehabilitation, liquidation,
conservation, dissolution or other insolvency proceeding with
respect to Ambac Assurance, if the proceeds from the RMBS
litigations received by Ambac Assurance are determined not to be
under the control of the collateral agent for the Tier 2 Notes, a
receiver or a creditor of Ambac Assurance may take the position
that such collateral agent’s security interest in such proceeds or a
portion thereof is not perfected and therefore that such proceeds
do not secure the Tier 2 Notes. Moreover, if the proceeds from the
RMBS
initiation of a
rehabilitation, liquidation, conservation, dissolution or other
insolvency proceeding with respect to Ambac Assurance, a
receiver or a creditor of Ambac Assurance may take the position
that such proceeds do not secure the Ambac Note or the Tier 2
Notes. If a court were to accept either of these positions, payments
under the Ambac Note or Tier 2 Notes, as applicable, may be
adversely affected and the Secured Notes or Tier 2 Notes, as the
case may be, may become worthless. In addition, a rehabilitation,
insolvency
liquidation, conservation, dissolution or other
litigations are received after
the
proceeding with respect to Ambac Assurance or the Secured Notes
Issuer, as applicable, could lead to delays in payments due on the
Secured Notes or Tier 2 Notes.
Fraudulent transfer laws may permit a court to void the Ambac
Note, and if that occurs, holders may not receive any payments
on the Secured Notes.
Fraudulent transfer and conveyance statutes may apply to the
issuance of the Ambac Note. Under state fraudulent transfer or
conveyance laws, which may vary from state to state, the Ambac
Note could be voided as a fraudulent transfer or conveyance if
Ambac Assurance (a) issued the Ambac Note with the intent to
hinder, delay or defraud creditors or (b) received less than
reasonably equivalent value or fair consideration in return for
issuing the Ambac Note and, in the case of (b) only, one of the
following is also true at the time thereof:
• Ambac Assurance was insolvent or rendered insolvent by
reason of the issuance of the Ambac Note;
• the issuance of the Ambac Note left Ambac Assurance with
an unreasonably small amount of capital or assets to carry on
its business; or
• Ambac Assurance intended to, or believed that it would, incur
debts beyond its ability to pay as they mature.
In addition, under Wisconsin insurance law, if the Ambac Note
were issued within one year prior to the filing of a successful
petition for rehabilitation or liquidation with respect to Ambac
Assurance, the Ambac Note could be voided as a fraudulent
transfer if Ambac Assurance issued the Ambac Note with the intent
to hinder, delay or defraud creditors or received less than fair
consideration in return for issuing the Ambac Note.
As a general matter, value is given for a transfer or an obligation
if, in exchange for the transfer or obligation, property is transferred
or a valid antecedent debt is satisfied.
Ambac Assurance cannot be certain as to the standards a court
would use to determine whether or not Ambac Assurance was
insolvent at the relevant time or, regardless of the standard that a
court uses, whether the Secured Notes would be subordinated to
Ambac Assurance’s other debt or policyholder claims. In general,
however, a court would deem an entity insolvent if:
• the sum of its debts, including contingent and unliquidated
liabilities, was greater than the fair saleable value of all of its
assets;
• the present fair saleable value of its assets was less than the
amount that would be required to pay its probable liability on
its existing debts, including contingent liabilities, as they
become absolute and mature; or
• it could not pay its debts as they became due.
If a court were to find that the issuance of the Ambac Note was a
fraudulent transfer or conveyance, the court could void the
payment obligations under the Ambac Note or could subordinate
the Ambac Note to presently existing and future indebtedness or
policy obligations of Ambac Assurance, and, as a result, holders
may not receive any payments on the Secured Notes.
| Ambac Financial Group, Inc. 17 2017 FORM 10-K |
We have substantial indebtedness, which could adversely affect
our financial condition, operational flexibility and our ability to
obtain financing in the future.
reasonable terms, or at all. Because of these and other factors
beyond our control, we may be unable to pay the principal, interest
or other amounts on our debt securities.
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 cash flow generation will depend on receipt of premiums,
investment returns, and potential litigation recoveries, offset by
policyholder claims, commutation payments and operating
expenses, which will be subject to prevailing economic conditions
and to financial, business and other factors, many of which are
beyond its control and many of which are event-driven. Our
substantial debt 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 claims, debt service requirements, acquisitions,
general corporate purposes or other purposes on satisfactory
terms or at all;
• 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 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.
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, its ability to make
scheduled payments on, or refinance, any such indebtedness may
depend on the ability of our subsidiaries to make distributions or
pay dividends, which in turn will depend on their future operating
performance and contractual, 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.
If we cannot pay policyholder claims or service debt, the Company
will have to take actions such as selling assets, restructuring or
refinancing debt or seeking additional capital. Any of these
remedies may not, if necessary, be effected on commercially
Ambac Assurance has ongoing obligations related to surplus
notes.
Subject to approval by OCI, Ambac Assurance is required to make
interest and principal (to the extent due) payments in cash on
surplus notes on an annual basis. Ambac Assurance will be required
to continue to make such payments, as and when approved by OCI,
until all of the surplus notes mature, are repaid in full or are
otherwise repurchased or retired. Ambac Assurance is also
obligated to make payments on junior surplus notes, subject to OCI
approval, after the senior surplus notes have been paid in full.
Ambac Assurance may not have the ability to borrow, raise or
otherwise have access to the funds necessary to pay such amounts
when due.
Surplus notes that were not exchanged and cancelled in the
Exchange Offers may be acquired, redeemed or repaid on terms
that may be viewed as more, or less, favorable than the terms of
the consideration offered in the Exchange Offers.
The Company may acquire, redeem or repay surplus notes that are
not exchanged and cancelled in the Exchange Offers through open
market purchases, privately negotiated transactions, other tender
or exchange offers, redemptions, repayment at maturity or such
other means as the Company deems appropriate, subject to the
restrictions in the Settlement Agreement, Stipulation and Order
and regulatory restrictions. Any such transactions will occur upon
the terms and at the prices as the Company may determine in its
sole discretion, which may be more or less favorable than the terms
of the Exchange Offers, and could be for cash or other
consideration. The Company may choose to pursue any or none
of these alternatives, or combinations thereof, in the future.
The surplus notes that remain outstanding following the
consummation of the Exchange Offers are subordinated in right
of payment to other claims, which could impair the right of the
holders of such notes to receive interest and principal in the event
of our insolvency or a similar occurrence.
The surplus notes are unsecured obligations of Ambac Assurance
and are expressly subordinated in right of payment to all of Ambac
Assurance’s existing and future indebtedness (other than junior
surplus notes) and policy claims. The surplus notes are subject to
provisions of Wisconsin insurance law, which establishes the
priority of distribution of claims from the estate of an insolvent
insurance company. In the event that Ambac Assurance becomes
subject to rehabilitation, liquidation, conservation or dissolution,
holders of Ambac Assurance’s senior indebtedness and policy
claims would be afforded a higher priority of distribution than
holders of the surplus notes, and accordingly would have the right
to be paid in full before holders of the surplus notes would be paid.
Due to the nature of Ambac Assurance’s business, the amount of
such higher priority claims in any rehabilitation, liquidation,
conservation or dissolution is likely to be many times greater than
any free and divisible surplus and it is likely that the holders of
surplus notes would not recover any payment
in such
circumstances. In addition, claims of holders of the surplus notes
will be subordinated to certain liabilities of the Company’s
subsidiaries that are guaranteed by Ambac Assurance.
| Ambac Financial Group, Inc. 18 2017 FORM 10-K |
Ambac Assurance has not made regular interest or principal
payments on surplus notes and may be unable to repay surplus
notes in full at maturity or ever.
Changes in inter-bank lending rate reporting practices or the
method pursuant to which LIBOR rates are determined may
adversely affect the value of LIBOR linked financial instruments.
On November 20, 2014, Ambac Assurance, with the approval of
OCI, redeemed surplus notes (other than junior surplus notes) in
an amount equal to 26.67% of the principal amount of the surplus
notes, plus accrued interest thereon, outstanding as of July 20,
2014, or approximately $396 million owned by third parties.
However, except for a one-time payment of approximately six
months of interest on the surplus notes (other than junior surplus
notes) outstanding immediately after the Exchange Offers, no other
interest or principal payments on the surplus notes have been
approved or made to date, and Ambac Assurance may not receive
approval from OCI to make payments as and when scheduled. As
a result, holders of surplus notes may not be paid in full at maturity
or ever. If OCI does not begin to approve regular payments on the
surplus notes (other than junior surplus notes) within the next
several years, the accretion of surplus notes may exceed our ability
to ever repay in full the surplus notes. If Ambac Assurance
becomes subject to a rehabilitation or liquidation under the
Wisconsin insurance law, prior to the repayment of surplus notes,
holders of surplus notes may not receive any recoveries on their
investments.
The effects of the amendments to the Settlement Agreement in
the recently completed consent solicitation done in connection
with the Exchange Offers could materially and adversely affect
the credit risk inherent in, and significantly reduce protections
afforded in, surplus notes not validly tendered and accepted or
received as consideration pursuant to the Exchange Offers.
including covenants
Holders of surplus notes that were not tendered and accepted or
were received as consideration pursuant to the Exchange Offers
will be subject to the terms of the Settlement Agreement as
modified, notwithstanding the fact that they did not deliver
consents in the related consent solicitation. Certain restrictive
covenants and other related provisions in the Settlement
Agreement,
regarding mergers and
consolidations and the incurrence of indebtedness, have been
modified or eliminated. As a result, holders of surplus notes no
longer are entitled to the benefit of such provisions, which existed
for the protection and benefit of holders of the surplus notes issued
pursuant to the Settlement Agreement. The Settlement Agreement,
as so amended, continues to govern the terms of all surplus notes
issued thereunder that remain outstanding after the consummation
of the Exchange Offers and Rehabilitation Exit Transactions.
Accordingly, we may take certain actions in the future previously
prohibited under the Settlement Agreement that could adversely
affect the market prices of the surplus notes and otherwise increase
the risks related to investments in the surplus notes.
Increases in interest rates will increase the cost of servicing our
debt could reduce our profitability and could result in a decrease
in the value of the Secured Notes.
The Secured Notes will bear interest at a variable rate. As a result,
increases in interest rates will increase the cost of servicing the
Secured Notes and could adversely affect our profitability and cash
flows. Each one percentage point increase in interest rates would
result in an $21.8 million increase in the annual cash interest
payments due on the Secured Notes.
Since February 1, 2014, the administration of LIBOR has been
undertaken by ICE Benchmark Administration Limited (“IBA”),
a subsidiary of Intercontinental Exchange Group. IBA, as the
administrator of LIBOR, may make changes in methodology that
could change the level of LIBOR, which in turn may adversely
affect the value of financial instruments linked to LIBOR,
including investment securities, swaps, and the Secured Notes.
Since 2014, the IBA published multiple papers and other literature,
including a “LIBOR Code of Conduct” relating to the setting of
LIBOR. IBA has the power to alter, discontinue or suspend
calculation or dissemination of LIBOR.
On July 27, 2017, the U.K. Financial Conduct Authority announced
that it will no longer persuade or compel banks to submit rates for
the calculation of LIBOR rates after 2021 (the “July 27th
Announcement”). The July 27th Announcement indicates that the
continuation of LIBOR on the current basis cannot and will not be
guaranteed after 2021. Consequently, at this time, it is not possible
to predict whether and to what extent banks will continue to provide
LIBOR submissions to the administrator of LIBOR or whether any
additional reforms to LIBOR may be enacted in the United
Kingdom or elsewhere. Similarly, it is not possible to predict what
rate or rates may become accepted alternatives to LIBOR of the
effect of any such alternatives on the value of LIBOR-linked
securities. Any of the above changes or any other consequential
changes to LIBOR or any alternative rate or benchmark as a result
of any international, national, or other proposals for reform or other
initiatives or investigations, or any further uncertainty in relation
to the timing and manner of implementation of such changes, could
have a material adverse effect on the value investments in our
investment portfolio, swaps we use for hedging, and the Secured
Notes.
The amount of interest payable on the Secured Notes is set only
once per interest period based on the three-month LIBOR rate
on the applicable interest determination date, which rate may
fluctuate substantially, and affect our ability to make payment
on the Secured Notes.
In the past, the level of the three-month LIBOR rate has
experienced significant fluctuations. Historical levels, fluctuations
and trends of the three-month LIBOR rate are not necessarily
indicative of future levels. Any historical upward or downward
trend in the three-month LIBOR rate is not an indication that the
three-month LIBOR rate is more or less likely to increase or
decrease at any time during an interest period for the Secured
Notes, and historical levels of the three-month LIBOR rate should
not be taken as an indication of its future performance. In addition,
although the actual three-month LIBOR rate on an interest payment
date or at other times during an interest period may be higher than
the
interest
determination date, the only relevant date for purposes of
determining the interest payable on the Secured Notes is the three-
month LIBOR rate as of the respective interest determination date.
Changes in the three-month LIBOR rates between interest
determination dates will not affect the interest payable on the
Secured Notes. As a result, changes in the three-month LIBOR rate
may not result in a comparable change in the market value of the
Secured Notes.
three-month LIBOR rate on
the applicable
| Ambac Financial Group, Inc. 19 2017 FORM 10-K |
The Secured Notes will bear interest at floating rates that could
rise significantly, increasing Ambac Assurance’s interest expense
and reducing its cash flow. If Ambac Assurance’s interest expense
increases significantly, whether due to changes in LIBOR or
increased borrowing costs when its refinances its current
indebtedness, Ambac Assurance may not be able to make payments
with respect to the Secured Notes or its other indebtedness.
Ambac’s representation and warranty recovery may change over
time, causing the value or the perceived value of the collateral
securing the Secured Notes and Tier 2 Notes to change and any
such changes may be material.
Ambac reevaluates its estimated representation and warranty
recoveries on a quarterly basis in connection with the preparation
of its financial statements. See “Critical Accounting Policies and
Estimates” in Part II, Item 7, 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 of this Form 10-K for the fiscal year
ended December 31, 2017. As a result of any reevaluation, the
amount of Ambac’s representation and warranty recovery may be
adjusted upward or downward due to, among other things, changes
in management's view of the value of such recoveries and/or
changes in the loss reserves related to such recoveries, and any
adjustment may be material. Changes in representation and
warranty recoveries may result in material changes in Ambac’s
financial condition, including its capital and liquidity. In addition,
any adjustment to representation and warranty recoveries may alter
the value or the perceived value of the collateral securing the
Secured Notes and Tier 2 Notes before payment on the Secured
Notes or Tier 2 Notes is made in full, which may affect the value
of, and trading market, if any, for, the Secured Notes or Tier 2
Notes. Management makes no
the
representation and warranty recoveries will not change, materially
or at all, including in the near term. There can be no assurance that
the apparent, or actual, value of the collateral securing the Secured
Notes and Tier 2 Notes will equal or exceed the principal amount
of the Secured Notes and Tier 2 Notes, respectively, at all times
prior to maturity.
representation
that
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 and the value of the
Secured Notes and Tier 2 Notes.
As of December 31, 2017, we have estimated representation and
warranty subrogation recoveries of $1,806.7 million (net of
reinsurance) included in our financial statements. These recoveries
are based on contractual claims arising from RMBS transactions
that Ambac Assurance has 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,
which could impede Ambac Assurance's 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, 2017 would decrease from $1,645.3 million to
$(161.4) 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 Ambac Assurance insures. 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 Ambac Assurance's interests, the performance of the
collateral and assets backing the obligations that Ambac Assurance
insures, the performance of servicers involved in securitizations
in which Ambac Assurance participates as insurer, and the effect
the Segregated Account
on Ambac Assurance's rights of
rehabilitation. Additionally, our ability to realize recoveries in
insured transactions may be impaired 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’s estimate of RMBS litigation recoveries is subject to
significant uncertainty and changes to the estimate could
adversely impact its liquidity, financial condition and results of
operations.
For Ambac’s current RMBS cases for which it records a
representation and warranty recovery in its financial statements,
Ambac has been provided access to loan files for all loans in the
relevant original pool and Ambac utilizes a “random sample”
approach to estimate such recoveries. Ambac does not include
estimates of damages attributed solely to fraudulent inducement
claims in its estimate of representation and warranty recoveries.
The amount estimated for purposes of Ambac’s representation and
warranty recovery and the amount Ambac may ultimately receive
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
recoveries, intervention by the OCI, which could impede Ambac’s
ability to take actions required to realize recoveries, and
uncertainties inherent in the assumptions used in estimating any
recoveries. In particular, Ambac’s assumptions regarding default
rates of the loans and Ambac’s expectations with respect to the
RMBS litigations have a significant impact on Ambac’s estimated
representation and warranty recoveries. If these assumptions,
expectations or estimates prove to be incorrect, or if an investor
were to use different assumptions, expectations or estimates to
predict recoveries, actual recoveries could differ materially from
those estimated. Actual recovery will ultimately depend on future
events and there can be no assurance that the assumed default rates
or estimated RMBS litigations recoveries will not differ from
actual events. Although Ambac believes that its methodology for
extrapolating estimated recoveries is appropriate for evaluating the
amount of potential recoveries, the methodologies Ambac uses to
estimate expected losses in general and for any specific obligation
in particular may not be similar to methodologies used by Ambac’s
competitors, counterparties or other market participants. The
determination of expected recovery is an inherently subjective
| Ambac Financial Group, Inc. 20 2017 FORM 10-K |
process
involving numerous estimates, assumptions and
judgments by management, using both internal and external data
sources with regard to frequency, economic projections and other
factors that affect credit performance. As a result, Ambac’s current
estimates may not reflect Ambac’s future ultimate recovery and
management makes no representation that the actual amount
recovered, if any, will not differ materially from those estimated.
The failure of Ambac’s actual recovery to meet or exceed its current
estimate could result in a material adverse effect on Ambac’s
financial condition, including its capital and liquidity.
The surplus notes that remain outstanding and that were received
by holders of Deferred Amounts from Ambac pursuant to the
Second Amended Plan of Rehabilitation may not be fungible with
the other surplus notes that remain outstanding following the
consummation of the Exchange Offers.
The surplus notes that were held by Supporting Holders but were
not accepted for tender and that remain outstanding following the
consummation of the Exchange Offers will accrue original issue
discount (“OID”) in a manner that differs from the accrual of OID
on the surplus notes received by holders of Deferred Amounts from
Ambac pursuant to the Second Amended Plan of Rehabilitation,
and, therefore, the surplus notes that were held by Supporting
Holders but were not accepted for tender and that remain
outstanding following the consummation of the Exchange Offers
will not be fungible with the surplus notes received by holders of
Deferred Amounts from AFG pursuant to the Second Amended
Plan of Rehabilitation for U.S. federal income tax purposes.
We may not be able to commute or reduce insured exposures.
In pursuing the objective of improving its financial position, we
are seeking to commute or reduce 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 in the future, or if it is, as to the timing, terms or
conditions of any such transaction. Even if we consummate 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.
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 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 may have future capital needs and may not be able to obtain
third-party financing or raise additional third-party capital on
acceptable terms, or at all.
An inability to obtain third-party debt financing or raise additional
third-party capital, when required by us or when business
conditions warrant, could have a material adverse effect on our
business, financial condition and results of operations. The
economic conditions affecting our industry, as well as other factors,
may constrain our financing abilities. Our ability to secure third-
party financing, if available, and to satisfy or refinance our
financial obligations under indebtedness outstanding from time to
time will depend upon regulatory conditions, our future operating
performance, the availability of credit generally, economic
conditions and financial, business and other factors, many of which
are beyond our control. The market conditions and the
macroeconomic conditions that affect our industry could have a
material adverse effect on our ability to secure third-party financing
on favorable terms, if at all.
If third-party financing is not available when needed, or is available
on unfavorable terms, we may be unable to take advantage of
business opportunities, respond to competitive pressures or
refinance our outstanding indebtedness, any of which could have
a material adverse effect on our business, financial condition and
results of operations.
Ambac Assurance may in the future report a policyholders’
deficit or become insolvent.
Our expected financial condition after the consummation of the
Rehabilitation Exit Transactions is based on various assumptions
concerning these transactions, including accounting and tax
treatment. There can be no assurance that the assumptions will
not differ materially from the ultimate results of such transactions
and any differences may be material. In addition, while the
Rehabilitation Exit Transactions and related transactions were
designed to improve our financial condition, we will continue to
be subject to risks and uncertainties that could materially affect
our financial position. Therefore, even following consummation
of the Rehabilitation Exit Transactions, circumstances may occur
that would cause Ambac Assurance to report a policyholders’
deficit or not comply in the future with the statutory minimum
policyholders’ surplus or undergo rehabilitation. In addition,
Ambac Assurance may become insolvent in the future. OCI has
prescribed or permitted additional accounting practices for Ambac
Assurance and Everspan 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. If Ambac Assurance
and Everspan are unable to utilize the permitted or prescribed
practices, we may not comply with the statutory minimum
policyholders’ surplus.
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
| Ambac Financial Group, Inc. 21 2017 FORM 10-K |
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.
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 debt obligations, or to meet Financial Services
liquidity needs due 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.
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
in
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. In addition, the Company from time
to time receives various regulatory inquiries and requests for
information. Please see Note 16. 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
against Ambac, Ambac Assurance or one or more other
subsidiaries 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.
The Settlement Agreement and Stipulation and Order contain
restrictive covenants that may impair our ability to pursue our
business strategies.
Pursuant to the terms of the Settlement Agreement and Stipulation
and Order, Ambac Assurance must seek prior approval by OCI of
certain corporate actions. The Settlement Agreement and
Stipulation and Order also include covenants which restrict the
operations of Ambac Assurance which, in the case of the Settlement
Agreement, remain in force until the surplus notes that were issued
pursuant to the Settlement Agreement have been redeemed,
repurchased or repaid in full, and, in the case of the Stipulation and
Order, remain in place until the OCI decides to relax such
restrictions. Certain of these restrictions may be waived with the
approval of holders of the surplus notes issued pursuant to the
Settlement Agreement and/or OCI. If we are unable to obtain the
required consents under the Settlement Agreement and/or
Stipulation and Order, we may not be able to execute our planned
business strategies.
OCI has certain enforcement rights with respect to the Settlement
Agreement and Stipulation and Order. 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. Any such
dispute could have material adverse effects on the Company,
proceedings,
whether
administrative
litigation,
through
| Ambac Financial Group, Inc. 22 2017 FORM 10-K |
supervisory orders, failure to execute transactions sought by
management, interference with corporate strategies, objectives or
prerogatives, inefficient decision-making or execution, forced
realignment of resources,
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.
increased costs, distractions
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
activities 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, 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 would 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
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
to provide any such approval.
| Ambac Financial Group, Inc. 23 2017 FORM 10-K |
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.
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 PRA continuing
to take no action 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 (“EU”) in June 2016, a
majority of those who voted approved the UK’s withdrawal from
the EU. As a result of the referendum, in March 2017 the UK
government gave the EU formal notification of its intent to leave
with the expectation of formal withdraw two years later on 29
March 2019. Also in March 2017 the UK began initial (or phase
one) negotiations with the EU regarding the terms of its departure
(“Brexit”). On 8 December 2017 the EU and UK jointly
announced, as set out in the Joint Report and Commission
Communication of 8 December (“Joint Report”), that “sufficient
progress” in phase one of the separation negotiations between the
parties had been made to permit Brexit negotiations to move on to
a more detailed phase two beginning in January 2018.
The Joint Report is “a summary of the negotiations toward the
legally binding withdrawal agreement” and is not itself legally
binding but rather is a position paper setting out current agreement
between the EU and the UK Government in three priority areas
(citizens’ rights, the financial settlement and the Irish border). It
also notes progress on other separation issues that have not yet
been settled. Further details of the negotiations are provided in the
House of Commons Briefing Paper Number 8183, 18 December
2017.
While phase two Brexit separation discussions commenced in
January 2018, these discussions will not include details of future,
post-Brexit, trade relations. What is envisaged in the Joint Report
next is “an agreement as early as possible in 2018 on transitional
arrangements”. A further, separate, mandate for negotiations on a
future post-transition trade framework is anticipated to begin by
summer 2018. It is envisaged negotiations on the future trade
framework will be concluded during the actual transitional phase,
and will be influenced by the nature of the transitional
arrangements agreed between the parties.
If no transitional arrangements or new agreements are put into
place, Brexit will mean that the activities in the EEA of UK
passporting insurers will become unlawful on 29 March 2019.
They will lose their legal authorization to serve clients who benefit
from policies issued by a UK incorporated insurer under freedom
of services passporting rights (and thereby maybe unable to legally
collect premiums or pay claims) and if they have branches in EEA
Member States they may be legally obliged to close them down
and no longer be legally represented in those jurisdictions.
In light of the materiality of the insurance sector to the UK economy
and taking into account the significant amount of insurance
business undertaken by EEA based insurers in the UK (which will
be similarly affected) it is expected that transition arrangements
will be put in place leading to insurers being able to continue to
service EU policies beyond 29 March 2019 for at least a transition
period and likely to their natural run-off in relation to policies
written prior to 29 March 2019. However, at this stage there is no
certainly that such a transition agreement can be reached between
the EU and the UK Government.
Ambac UK has seven policies in the EU written under current
passporting rights the aggregate par value of which as at
December 31, 2017 is $2.6 billion and as noted Ambac UK’s ability
to service these contracts beyond 29 March 2019 is currently
unclear until legally binding Brexit transition agreements are put
into place prior to that date.
In addition to the direct impact on insurers cited above, general
uncertainty and the perceptions as to the ultimate impact of Brexit
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
| Ambac Financial Group, Inc. 24 2017 FORM 10-K |
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 of Ambac Assurance
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 of
Ambac Assurance 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
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
Implementation of the Tax Cuts and Jobs Act may have
unexpected or adverse consequences for the Company and the
value of its securities, particularly its common shares.
On December 22, 2017, new tax legislation, the Tax Cuts and Jobs
Act, was signed into law. Amongst other things, the Tax Cuts and
Jobs Act implemented a sweeping overhaul of the U.S. tax laws
applicable to corporations. A major provision of the Tax Cuts and
Jobs Act was a reduction of the maximum corporate federal income
tax rate to 21% from 35%, which resulted in the Company reducing
the value of its net deferred tax asset, the impact of which was
offset by a change in valuation allowance. As a result of the
reduction in the corporate federal tax rate, the maximum amount
of future tolling payments AFG may receive from Ambac
Assurance, for tax years beginning with 2018, will also be reduced
to approximately $56 million from $97 million. The Tax Cuts and
Jobs Act also requires U.S. corporations to pay federal income tax
on previously untaxed foreign earnings accumulated under legacy
tax laws included in income, for the last taxable year beginning
before January 1, 2018. As a result of this and other provisions in
the Tax Cuts and Jobs Act, Ambac Assurance is expected to make
additional tax payments in 2017 related to alternative minimum
tax, which will be refundable in the future. The aforementioned as
well as other provisions of the Tax Cuts and Jobs Act, such as those
relating to the limitations on the deductibility of interest expense,
the Global Tax Intangible Low Taxed Income and Base Erosion
Anti-Abuse Tax, may also have an adverse impact on Ambac
Assurance’s and/or AFG’s future financial condition and results of
| Ambac Financial Group, Inc. 25 2017 FORM 10-K |
operations that is difficult to predict at this time. Any adverse
impact or the perception of an adverse impact may cause the value
of Ambac Assurance’s and/or AFG’s securities, particularly its
common shares, to decline.
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,
amongst other things, 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 financial condition of 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 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.
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 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
16. 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:
2017
2016
High
Low
High
Low
Fourth quarter
$
17.79
$
13.17
$
27.25
$
17.75
Third quarter
Second quarter
First quarter
Holders
22.02
20.28
23.55
16.75
15.67
17.39
19.35
17.77
17.32
15.42
14.42
11.92
On February 27, 2018, there were 29 stockholders of record of
Ambac’s common stock.
Item 1B. Unresolved Staff Comments
Dividends
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).
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.
The Company did not pay cash dividends on its common stock
during 2017 and 2016. 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
There were no repurchases of equity securities during the fourth
quarter of 2017. Ambac does not have a stock repurchase program.
| Ambac Financial Group, Inc. 26 2017 FORM 10-K |
Warrants
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,
2017, Ambac had repurchased 985,331 warrants at a cost of $8.1
million, leaving 4,053,670 warrants outstanding with an exercise
price of $16.67 per share and expiration of April 30, 2023. The
remaining aggregate authorization at December 31, 2017 is $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, 2017, with the Russell 2000 Index and S&P Completion Index. 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
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 Completion Index
December 31,
5/1/13
2013
2014
2015
2016
2017
$100
$100
$100
$123
$127
$123
$123
$134
$130
$70
$127
$124
$113
$148
$142
$80
$167
$165
| Ambac Financial Group, Inc. 27 2017 FORM 10-K |
Item 6.
Selected Financial Data
The following financial information for the five years ended December 31, 2017, has been derived from Ambac’s Consolidated Financial
Statements. Following Ambac’s emergence from bankruptcy on May 1, 2013, the consolidated financial statements reflect the application of
fresh start reporting (“Fresh Start”), incorporating, among other things, the discharge of debt obligations, issuance of new common stock and
fair value adjustments. The effects of the reorganization and Fresh Start adjustments are recorded in Predecessor Ambac’s Consolidated
Statement of Total Comprehensive Income for the period ended April 30, 2013. The financial results of the Company for the periods from
May 1, 2013 are referred to as “Successor” and the financial results for the periods through April 30, 2013 are referred to as “Predecessor”.
The 2013 Successor Period and the 2013 Predecessor Period are distinct reporting periods. As a result of the implementation of Fresh Start,
results and balances are not comparable between Successor Ambac and Predecessor Ambac. This information should be read in conjunction
with the Consolidated Financial Statements and related notes located in Part II, Item 8 in this Form 10-K.
($ in millions, except per share data)
2017
2016
2015
2014
Successor Ambac
Year Ended December 31,
Predecessor
Ambac
Period from
Jan 1
through
April 30,
2013
Period from
May 1
through
December 31,
2013
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
Net gains (losses) on interest rate derivatives
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 impairment
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:
$
(14.3) $
(53.8) $
(37.6) $
(288.3) $
(80.3)
$
175.3
361.0
(20.2)
5.4
16.4
59.6
4.9
19.7
513.2
241.5
150.9
—
—
197.3
313.4
(21.8)
39.3
20.1
(50.3)
4.8
(14.1)
(11.5)
238.0
174.6
—
—
(284.3)
105.0
(328.7)
(335.4)
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
(14.1)
130.0
116.7
(0.5)
53.3
(60.4)
(33.7)
—
426.6
(38.1)
75.6
—
—
(2,745.2)
3,348.0
3,349.0
3,523.9
Basic
Diluted
$
$
(7.25) $
(7.25) $
1.66
1.64
$
$
10.92
10.72
$
$
10.73
10.31
$
$
11.23
10.91
$
$
11.07
11.07
(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,
2017, 2016, 2015 and 2014, the eight months ended December 31, 2013 and the four months ended April 30, 2013 were $72.0 million, $(71.4) million,
$(303.6) million, $(481.7) million, $199.4 million, and $(61.6) million, respectively.
| Ambac Financial Group, Inc. 28 2017 FORM 10-K |
($ in millions) December 31
Balance Sheet Highlights:
2017
2016
2015
2014
2013
Total non-variable interest entity investments
$
5,740.8
$
6,500.2
$
5,644.7
$
5,507.0
$
6,523.7
Cash and cash equivalents
Premium receivable
Insurance intangible asset
Goodwill
Subrogation recoverable (1)
Deferred ceded premium
Total VIE assets
Total assets
Unearned premiums
Losses and loss expense reserve (1)
Obligations under investment agreements
Long-term debt (2)
Derivative liabilities
Total VIE liabilities
Total liabilities
Total stockholders’ equity
623.7
586.3
847.0
—
631.2
52.2
14,500.5
23,192.4
783.2
4,745.0
—
991.7
82.8
14,366.4
21,547.1
1,645.3
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
Total liabilities and stockholders' equity
$
23,192.4
$
22,635.7
$
23,728.1
$
25,159.9
$
27,092.5
(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 $1,834.4 million, $1,907.0 million, $2,829.6
million, $2,523.5 million and $2,206.6 million at December 31, 2017, 2016, 2015, 2014 and 2013, respectively.
(2) Long-term debt represents surplus notes issued to third parties by Ambac Assurance and the Segregated Account and secured borrowing obligations. 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. In 2015, Ambac entered into a $146.0 million secured borrowing transaction.
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 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 and our key strategies to achieve our primary goal
to maximize shareholder value.
EXECUTIVE SUMMARY
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
with Ambac's liability management and loss mitigation programs.
Management evaluates the potential impact of loss mitigation and
avoidance strategies in order to target and prioritize policies, or
portions thereof, for commutation, refinancing, restructuring or
other risk reduction or defeasance strategies.
Asset Management:
Investment portfolios are subject to internal investment guidelines,
as well as 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
relative risk/reward characteristics. The 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, insurance-linked securities and hedge
| Ambac Financial Group, Inc. 29 2017 FORM 10-K |
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 fixed income investments by asset class.
During the year ended December 31, 2017, Ambac (inclusive of
its subsidiaries) acquired $815.2 million of distressed Ambac-
insured securities, including $97.3 million of RMBS and $686.1
million of Puerto Rico securities. Future cash flows relating to
those invested assets include the sum of (i) the bond’s intrinsic
cash flows and (ii) the estimated Ambac claim payments. At
December 31, 2017, Ambac owned $2,242.3 million Ambac-
insured RMBS, which included approximately $1.6 billion, or 41%
of the total Deferred Amounts (as defined in the Segregated
Account Rehabilitation Plan) outstanding were attributable, and
approximately 29% of PRIFA and 58% of COFINA Ambac-
insured bonds. Subject to applicable internal and regulatory
guidelines and other constraints, Ambac will continue to
opportunistically purchase Ambac-insured securities.
Liability and Insured Exposure Management:
Ambac Assurance's Risk Management Group focuses on the
analysis, implementation and execution of commutations, risk
reduction or defeasance and loss recovery 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, restructuring or
other risk 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 the 2017, Ambac's successes included:
• On March 25, 2017, Ambac UK agreed in principle to a
confidential settlement of litigation brought by Ambac UK in
the name of Ballantyne Re plc (“Ballantyne”) against J.P.
Morgan Investment Management Inc. (“JPMIM”) relating to
the management of Ballantyne’s investment accounts, which
were funded with the proceeds of notes issued in 2006 in
connection with a structured reinsurance transaction and
guaranteed in part by Ambac UK. On April 11, 2017, Ambac
UK, Ballantyne and JPMIM signed a settlement agreement.
Pursuant to the settlement, Ballantyne received a payment in
return for releases of all claims by Ballantyne and Ambac UK.
Ambac realized a US GAAP benefit through losses and loss
expenses of approximately $91.6 million in 2017 as a result
of the settlement, which resulted from the reduction of loss
and loss expense reserves previously established in relation
to Ballantyne, and not from a direct cash payment to Ambac
UK.
• On June 27, 2017, Ambac Assurance entered into a
termination agreement with various parties, including a
special purpose entity Augusta Funding Limited IV
("Augusta"), in connection with the commutation of an
interest rate swap between Augusta and Ambac Assurance's
wholly-owned
subsidiary, Ambac Financial Services
("AFS"). During the second quarter, AFS made net settlement
payments of approximately $103.6 million, including $94.4
million under the termination agreement. At March 31, 2017,
Ambac had recorded a mark-to-market liability under this
swap transaction of $147.0 million (net of an Ambac
Assurance CVA of $42.9 million), resulting in a gain of
approximately $43.4 million during 2017. In July 2017,
Augusta redeemed its outstanding Ambac Assurance-insured
debt and Ambac recognized approximately $2.6 million in
accelerated premiums in 2017 relating to this redemption.
The Ambac-insured Augusta net par outstanding was $185
million at the time of redemption and was adversely classified.
• Ambac U.K. worked to facilitate an international asset-
backed issuer's refinancing of £188.1 million of insured debt
and which paid Ambac UK a termination premium of £12.6
million, resulting in accelerated premiums earned of $11.2
million in 2017;
• Ambac worked closely with servicers and owners of Master
Servicing Rights to exercise clean-up calls on 20 RMBS
transactions, resulting in a benefit in losses and loss expenses
of $21.8 million and reducing adversely classified net par
exposure by $422.5 million;
• Ambac Assurance commuted its policy on a long time
distressed municipality ($44.6 million of net par exposure);
aided in the refinancing of more than 50% ($144.7 million
of net par exposure) of its exposure to Chicago, IL Board of
Education general obligation bonds, resulting in an aggregate
losses and loss expenses benefit of $4.1 million; and
negotiated with a distressed domestic asset-backed VIE that
was previously consolidated by Ambac to settle all of their
assets and refinance its Ambac-insured debt ($30.8 million of
net par exposure).
During 2017, Ambac Assurance purchased the remaining $4.0
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 $1.1 million in
the Consolidated Statements of Total Comprehensive Income
(Loss).
On February 12, 2018, the Second Amended Plan of Rehabilitation
of the Segregated Account became effective and Ambac and
Ambac Assurance consummated a series of transactions that
generally involved (i) the exchange of certain surplus notes held
by holders of surplus notes that elected to participate in a voluntary
exchange transaction and (ii) the satisfaction and discharge of all
Deferred Amounts of the Segregated Account, in each case for an
effective consideration package comprised of cash, new Secured
Notes and certain existing surplus notes and (iii) the exit from
rehabilitation of the Segregated Account (the “Rehabilitation Exit
Transactions”). See Note 1. Background and Business Description
to the Consolidated Financial Statements, included in Part II, Item
8 in this Form 10-K for details regarding the Rehabilitation Exit
Transactions.
The following table provides a comparison of total and adversely
classified credits ("ACC") net par outstanding in the insured
portfolio at December 31, 2017 and 2016. Net par exposures within
the U.S. public finance market includes capital appreciation bonds
which are reported at the par amount at the time of issuance of the
insurance policy as opposed to the current accreted value of the
bonds.
| Ambac Financial Group, Inc. 30 2017 FORM 10-K |
($ in billions)
December 31,
2017
2016
$
Variance
%
Variance
Total
ACC
$
$
62.7
14.1
$
$
79.3
17.0
$
$
(16.6)
(2.9)
(21)%
(17)%
The overall reduction in total net par outstanding resulted from
scheduled maturities, amortizations, commutations, refundings,
refinancings and calls, including reductions as a result of the
activities of Ambac and its subsidiaries as noted above.
The decrease in adversely classified credit exposures are primarily
due to (i) calls, refundings, and paydowns or negotiated
refinancings and commutations with a large portion of the decrease
related to residential mortgage-backed securities and (ii) the
upgrade of several remediated public finance transactions,
partially offset by (iii) the downgrades of a Military Housing
transaction and an Italian sub-sovereign transaction. Although our
insured portfolio generally performed satisfactorily in 2017, we
continued to experience stress in certain sectors and insured
exposures, most notably within our approximately $2.0 billion of
exposure to Puerto Rico consisting of several different issuing
entities (all adversely classified). Each Puerto Rico issuing entity
has its own credit risk profile attributable to discreet revenue
sources, direct general obligation pledges and/or general
obligation guarantees. Refer to "Financial Guarantees in Force"
below in this Management Discussion and Analysis regarding the
different issuing entities that encompass Ambac's exposures to
Puerto Rico.
In 2017, Ambac established a new non-adversely classified credit
category of watch list. Watch list credits are currently fully
performing but demonstrate the potential for future material
adverse development due to such factors as long-term uncertainty
about a particular sector, a certain structural element related to the
issuer or
transaction, or overall financial and economic
sustainability. Total net par exposures of watch list credits are
$11.1 billion at December 31, 2017.
Ambac:
As of December 31, 2017 total cash and investments of Ambac
were $368.2 million, which include the following:
• Asset backed and short-term securities of $96.3 million
• Ambac-insured securities with a fair value of $5.9 million
• Ambac Assurance surplus notes with a fair value of $201.3
million, which are eliminated in consolidation
• Residual equity interest in the Corolla Trust that was created
in 2014 to monetize Ambac's ownership interest in junior
surplus notes issued by the Segregated Account. Ambac
carries this interest using the equity method. Additionally, at
December 31, 2017 Ambac held $35.0 million par amount of
the debt issued by this VIE. The total carrying value of
Ambac's equity and debt interests in Corolla Trust was $64.7
million at December 31, 2017. 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 the Corolla Trust.
During 2017, Ambac purchased ($101.8 million) and exchanged
Ambac-insured bonds (fair value of $79.3 million) to extinguish
(on a consolidated basis) $108.1 million par of Ambac Assurance
surplus notes and $39.1 million par of Segregated Account surplus
notes. Ambac recognized $3.8 million of gains on the
extinguishment of debt in the Consolidated Statements of Income
(Loss) as a result of these transactions during the year ended
December 31, 2017.
As a result of positive taxable income at Ambac Assurance in 2016,
Ambac received $28.7 million in tax tolling payments in May 2017.
As a result of filing its 2016 tax return, Ambac received an
additional $0.6 million of tolling payments in December 2017.
For the year ended December 31, 2017, $30.5 million of tolling
payments were accrued which are expected to be paid to Ambac
no later than forty-five days after April 15, 2018. There are no
assurances that Ambac Assurance will be able to generate taxable
income and therefore make tolling payments to Ambac in the
future, which may ultimately constrain Ambac's access to capital
and liquidity to support it operations and strategic initiatives.
Financial Statement Impacts of Foreign Currency:
The impact of foreign currency as reported in Ambac's
Consolidated Statement of Total Comprehensive Income for the
year ended December 31, 2017 included the following:
($ in millions)
Net income (1)
$
Changes in other comprehensive income:
Gain (losses) on foreign currency translation
Unrealized gains (losses) on non-functional
currency available-for-sale securities
Total changes in other comprehensive income
Impact on total comprehensive income (loss)
$
21.1
73.6
(19.7)
53.9
75.0
(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 (Loss). 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.
| Ambac Financial Group, Inc. 31 2017 FORM 10-K |
Management has identified the following critical accounting
policies and estimates: (i) valuation of loss and loss expense
reserves, (ii) valuation of certain 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 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 were not 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
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 but since Ambac
has little exposure ceded to reinsurers, the existing reinsurance
contracts are unlikely to have a significant effect on loss reserve
volatility. However, entrance into new reinsurance contracts may
impact loss reserve volatility. Loss reserve volatility will also be
materially impacted by changes in interest rates 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, 2017 and 2016:
($ in millions) December 31
RMBS
Domestic Public Finance
Student Loans
Ambac UK
All other credits
Loss expenses
Totals
2017
2016
Gross Par
Outstanding(1)(2)
Gross Loss and
Loss Expense
Reserves(1)(3)(4)(5)
Gross Par
Outstanding(1)(2)
Gross Loss and
Loss Expense
Reserves(1)(3)(4)(5)
$
$
5,243
$
4,265
701
941
537
—
2,598
$
816
308
286
17
89
6,756
$
4,410
728
939
567
—
2,394
547
279
388
13
75
11,687
$
4,114
$
13,400
$
3,696
(1) Ceded par outstanding on policies with loss reserves and ceded loss and loss expense reserves are $590 and $41, respectively, at December 31, 2017 and
$607 and $31, respectively at December 31, 2016. 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 as opposed
to the current accreted value of the bond.
(3) Loss and Loss Expense reserves at December 31, 2017 of $4,114 are included in the balance sheet in the following line items: Loss and loss expense
reserves: $4,745 and Subrogation recoverable: $631. 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.
(4) Included in Gross Loss and Loss Expense Reserves are unpaid claims of $3,867 and $3,656 at December 31, 2017 and 2016, respectively, related to policies
allocated to the Segregated Account, inclusive of accrued interest payable on Deferred Amounts of $840 and $662, respectively.
(5) 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 $1,834 and $1,907 at December 31, 2017 and 2016, respectively.
| Ambac Financial Group, Inc. 32 2017 FORM 10-K |
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 existing 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 the potential outcome of 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 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 expectation to commute additional exposure with other
counterparties.
RMBS Expected Loss Estimate
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
transaction’s underlying
loans' characteristics and status,
(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 projections and our
understanding of the transactions’ structures to identify and resolve
discrepancies. We also systematically review the vendor’s
identify material
published waterfall revisions
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 therefore need to be updated and reflected in our models
through time. As such, we conduct regular reviews of current
models, alternative models and the overall approach to loss
estimation. In particular, 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
model assumptions, improvements to modeling capabilities and
approaches and other factors.
Second-Lien Model:
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
| Ambac Financial Group, Inc. 33 2017 FORM 10-K |
performance and divides it into two parts: a borrower-behavior-
dependent stage and a servicer-behavior-dependent stage.
has a negligible benefit to loss reserves for the remaining three
transactions with pool-level mortgage insurance.
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 (e.g., a judicial
or statutory foreclosure state) 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.
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: Three of our mortgage-backed transactions
have active pool-level mortgage insurance; which consists of a
master policy issued to the mortgage securitization trust that
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
these
securitization trusts, payments by mortgage insurers of claims
presented by the securitization trusts have been inconsistent,
resulting in higher claims presented under Ambac Assurance’s
financial guarantee policies. The pool-level mortgage insurance
to
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.
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 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 student loan portfolio consists of credits collateralized
by private student loans. 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
| Ambac Financial Group, Inc. 34 2017 FORM 10-K |
performance (which is highly correlated to the economic
environment), interest rates, operating risks associated with the
issuer, servicers, special servicers, and administrators, investor
appetite for tendering or commuting insured obligations and, as
applicable, Ambac’s ability and willingness to commute policies.
In addition, we consider in our student loan loss projections the
potential impact, if any, of proposed or final regulatory actions or
orders, including by the Consumer Financial Protection Bureau
("CFPB"), affecting our insured transactions.
In evaluating our student loan portfolio, our losses are projected
using a cash flow modeling 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
one of the student loans deals is 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.
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 possible cash flows using more stressful
assumptions than the probability-weighted outcome recorded. The
possible net cash flows consider the highest stress scenario that
was utilized in the development of our probability-weighted
expected loss at December 31, 2017 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 possible to have worst case outcomes in all cases, it is 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 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 approach and/or model.
Additionally, our R&W actual subrogation recoveries could be
significantly lower than our estimate of $1,834 million as of
December 31, 2017 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 possible
stress case assumes a lower housing price appreciation projection,
which in turn drives higher defaults and severities. Using this
approach, the possible increase in loss reserves for RMBS credits
for which we have an estimate of expected loss at December 31,
2017 could be approximately $50 million. Combined with the
absence of any R&W subrogation recoveries, a possible increase
in loss reserves for RMBS could be approximately $1.9 billion.
Additionally, loss payments are sensitive to changes in interest
rates, increasing as interest rates rise. For example an increase in
interest rates of 0.50% could increase our estimate of expected
losses by approximately $60 million. There can be no assurance
that losses may not exceed such amounts.
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 of adjustment, 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
| Ambac Financial Group, Inc. 35 2017 FORM 10-K |
if they believe preferred outcomes for various creditor groups can
be achieved.
We expect municipal bankruptcies and defaults to continue to be
challenging to project given the unique political, economic, fiscal,
governance and public 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, resulting from reduced
or no access to alternative forms of credit (such as bank loans) or
other exogenous factors, such as the Tax Cuts and Jobs Act that
was signed into law on December 22, 2017, which could potentially
reduce municipal investor appetite for tax-exempt municipal bonds
by corporate investors and over the longer term could potentially
put additional pressure on issuers in states with high state and local
taxes. These factors could deprive issuers access to funding at a
level 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 uncertainty 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, loss of capital markets access and the severe
damage caused by hurricanes Irma and Maria. These factors, taken
together with the payment moratorium on debt payments of the
Commonwealth and its instrumentalities, ongoing Puerto Rico
Oversight, Management,
and Economic Stability Act
("PROMESA") Title III proceedings, and certain other provisions
under PROMESA, the potential for a restructuring of debt insured
by Ambac Assurance, either with or without its consent, and the
possibility of protracted litigation as a result of which its rights
may be materially impaired, may cause losses to exceed current
reserves in a material manner. See "Financial Guarantees in Force"
below for further details on the legal, economic and fiscal
developments that have impacted or may impact Ambac
Assurance’s insured Puerto Rico bonds.
For public finance credits, including Puerto Rico as well as other
issuers, for which we have an estimate of expected loss at
December 31, 2017, the possible increase in loss reserves could
be approximately $1.5 billion. However, there can be no assurance
that losses may not exceed such amount.
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. Such factors may include lower recoveries on
defaulted loans or additional losses on collateral or trust assets,
including as a result of any enforcement actions of the Consumer
Finance Protection Bureau. For student loan credits for which we
have an estimate of expected loss at December 31, 2017, the
possible increase in loss reserves could be approximately $100
million. Additionally, an increase in interest rates of 0.50% could
increase our estimate of expected losses by approximately $35
million. There can be no assurance that losses may not exceed
such amount.
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. For all other credits, including Ambac UK, for which
we have an estimate of expected loss, the sum of all the highest
stress case loss scenarios is approximately $250 million greater
than the loss reserves at December 31, 2017. However, there can
be no assurance that losses may not exceed such amount.
Valuation of Certain Financial Instruments:
The Fair Value Measurement Topic of the ASC requires financial
instruments to 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 to the Consolidated Financial 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.
Level 3 instruments are valued using models which use one or
more significant inputs or value drivers that are unobservable and
therefore require significant
judgment. Level 3 financial
instruments which are material include certain interest rate swaps,
investments in certain Ambac-insured fixed income securities, and
certain VIE assets and liabilities. Model-derived valuations of
certain Level 3 financial instruments incorporate estimates of the
effects of Ambac's own credit risk and/or counterparty credit risk,
which can be complex and judgmental. Level 2 instruments are
valued using quoted prices for similar instruments in active
markets, quoted prices for identical or similar instruments in
inactive markets and model-derived valuations where all the
significant inputs are observable in active markets. Certain Level
2 fixed income securities that have lower trading volumes, fewer
comparable securities in the market or less coverage by alternative
pricing sources with reasonable levels of price transparency may
require additional validation procedures and involve significant
judgment.
As a result of the increased judgment for the above-described Level
3 and Level 2 instruments, the actual trade value of the financial
instrument in the market, or exit value of the financial instrument
owned by Ambac, may be significantly different from its recorded
fair value.
Moreover, fixed income securities classified as “available-for-
sale” which have experienced declines in fair value below Ambac's
amortized cost must be evaluated for other-than-temporary
if
impairment ("OTTI"). An OTTI charge
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. Evaluating whether declines in fair value are other-than-
temporary is also inherently judgmental. For further information
on the OTTI evaluation process refer to Note 2. Basis of
is recognized
| Ambac Financial Group, Inc. 36 2017 FORM 10-K |
Presentation and Significant Accounting Policies
the
Consolidated Financial Statements included in Part II, Item 8 in
this Form 10-K.
to
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. In December 2017, H.R.1 (commonly known
as the Tax Cut and Jobs Act or"TCJA") was enacted and introduced
significant changes to the U.S. tax code, including to corporate tax
rates, business-related exclusions, and deductions and credits
effective January 1, 2018. In accordance with U.S. GAAP, the
effects of changes in tax rates and laws on current and deferred
tax balances must be recognized in the period in which the
legislation is enacted. As such, we incorporated the effects of the
TCJA in our valuation of deferred tax assets for the year ended
December 31, 2017. 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, which
relates to NOLs generated prior to the effective date of the TCJA,
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 14. Income Taxes for
additional information on the Company's deferred income taxes,
including the effects of the TCJA.
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, 2017 and
2016. 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 as opposed
to the current accreted value of the bonds. 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,
2017
2016
Public Finance
Structured Finance
International Finance
Total net par outstanding
$
$
32,088
$
13,816
16,812
62,716
$
45,062
16,951
17,333
79,346
Included in the above net par exposures at December 31, 2017 and
2016 are $326 million and $737 million, respectively, of exposures
that were executed in the form of credit derivatives. 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 introduces 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 $32,088
million, representing 51% of Ambac’s net par outstanding as of
December 31, 2017 and a 29% reduction from the amount
outstanding at December 31, 2016. 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 obligation and revenue, 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 and similar proceedings, 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
industry and socioeconomic
| Ambac Financial Group, Inc. 37 2017 FORM 10-K |
include not-for-profit hospitals, universities, associations and
charities.
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 $5.8 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 a 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
ongoing base essentiality, military deployments, the U.S.
government’s commitment to fund the BAH, marketability/
attractiveness of the on-base housing units versus off-base housing,
construction completion, environmental remediation, utility and
other operating costs, and housing management.
Puerto Rico
its
Ambac has exposure to the Commonwealth of Puerto Rico (the
"Commonwealth") and
instrumentalities 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. 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. Other
Ambac-insured Puerto bonds are not subject to acceleration.
Ambac Assurance's insurance policies do not insure against loss
of any acceleration payment, other than at the sole option of
Ambac.
Suspension of Debt Service Payments
In late 2015, due to the activation of the Commonwealth
Constitution's Priority Debt Provision, certain revenues pledged
for the repayment of debt issued by Puerto Rico Infrastructure
Financing Authority (“PRIFA”), Puerto Rico Highways and
Transportation Authority (“PRHTA”) and Puerto Rico Convention
Center District Authority (“PRCCDA”) were diverted by the
Commonwealth to be applied to the Commonwealth's debt
obligations and not applied to debt service on PRIFA, PRHTA and
PRCCDA debt obligations. Consequently, a default on debt
service due on certain PRIFA bonds insured by Ambac Assurance
occurred on January 1, 2016.
In April 2016, the Commonwealth became 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 PRHTA, PRIFA, PRCCDA, and other Puerto Rico
instrumentalities through January 31, 2017, and suspending
payment obligations on bonds issued by those entities, including
bonds insured by Ambac Assurance.
On January 29, 2017, current Governor Rosselló enacted Act 5 of
2017 known as the Puerto Rico Financial Emergency and Fiscal
Responsibility Act of 2017 (“Act 5”) which, among other things,
established an emergency period and declared executive orders
under Act 21, which suspended payments on General Obligation
debt and other debt, to continue in full force and effect until
amended, rescinded or superseded. On December 28, 2017, the
emergency period was extended to June 30, 2018 by Executive
Order 2017-76.
PROMESA Law
On June 30, 2016, the Puerto Rico Oversight, Management, and
Economic Stability Act ("PROMESA") was signed into law by the
President of the United States. PROMESA establishes a seven-
member federal financial oversight board (“Oversight Board”)
with authority to require that balanced budgets and fiscal plans be
adopted and implemented by Puerto Rico. PROMESA provides a
legal framework under which the debt of the Commonwealth and
its related authorities and public corporations may be voluntarily
restructured, and grants the Oversight Board the sole authority to
file restructuring petitions in a federal court to restructure the debt
of the Commonwealth and its related authorities and public
corporations if voluntary negotiations fail, provided that any such
restructuring must be in accordance with an Oversight Board
approved fiscal plan that respects the liens and priorities provided
under Puerto Rico law.
PROMESA provides that laws such as Act 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.
specifically
PROMESA is untested and many provisions are unique. There is
inherent uncertainty and risk both generally and for Ambac’s
exposures
interpretation and
regarding
implementation of PROMESA. Among other things, PROMESA
contains provisions that may permit consensual and non-
consensual
the
Commonwealth and its instrumentalities.
restructurings of debt obligations of
the
The following table shows Ambac's insured exposure to each issuer
segregated by whether such debt obligation is subject to the Priority
| Ambac Financial Group, Inc. 38 2017 FORM 10-K |
Debt Provision or "clawback." Ambac has initiated litigation
challenging the application of the "clawback" announced by
Governor Padilla, Puerto Rico's former governor, on December
1, 2015. A description of Ambac's legal challenge is provided in
Note 16. Commitments and Contingencies in the Consolidated
Financial Statements, included in Part II, Item 8 in this Form 10-
K.
Range of
Maturity
Ambac
Ratings (1)
Net Par
Outstanding (2)
Net Par and
Interest
Outstanding (3)(8)
Ever-to-Date
Net Claims
Paid(4)
($ in millions)
Exposures Subject to Priority Debt Provision (5)
PR Highways and Transportation Authority (1968
Resolution - Highway Revenue) (6)
PR Highways and Transportation Authority (1998
Resolution - Senior Lien Transportation Revenue) (6)
PR Infrastructure Financing Authority (Special Tax
Revenue) (7)
PR Convention Center District Authority (Hotel Occupancy
Tax)
Total
2018-2027
2018-2042
2018-2044
2018-2031
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
Total Net Exposure to The Commonwealth of Puerto
Rico and Related Entities
2018-2035
2047-2054
BIG
BIG
BIG
BIG
BIG
BIG
BIG
$
14
$
20
$
419
439
125
997
56
110
805
971
746
970
184
1,920
64
187
7,321
7,572
13
35
104
12
164
4
37
—
41
$
1,968
$
9,492
$
205
(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. 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 as opposed to the current
accreted value of the bonds. Accretion of the capital appreciation bonds would increase the related net par by $683 million at December 31, 2017.
(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)
In addition to ever-to-date net claims paid, Ambac made net claim payments of $26 million during January 2018.
(5) Commonly known as "clawback" provision pursuant to Section 8 of Article VI of the Constitution of the Commonwealth of Puerto Rico. Under this
provision, in case the available revenues (the Spanish version uses the term “resources”) including surplus for any fiscal year are insufficient to meet the
appropriations made for that year, interest on the public debt and amortization thereof shall first be paid, and other disbursements shall thereafter be made
in accordance with the order of priorities established by law. These exposures are also subject to Act No. 5-2017, as amended, also known as the Financial
Emergency and Fiscal Responsibility Act of 2017, which declares an emergency period that has been subsequently extended until June 30, 2018. Pursuant
to Act 5-2017, all executive orders issued under Act No. 21-2016 (as amended, known as the Puerto Rico Emergency Moratorium and Financial
Rehabilitation Act), shall continue in full force and effect until amended, rescinded or superseded.
(6) Certain Pledged Revenues for Highways and Transportation Revenue Bonds such as Toll Revenues and Investment Earnings are not subject to the Priority
Debt Provision.
(7) 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.
(8) Net Par and Interest Outstanding excludes the effects of a 10% current interest rate on $60 million net par of PR Public Building Authority ("PBA") bonds
with a maturity date of July 1, 2035, resulting from the absence of a remarketing. Should a remarketing not occur before the maturity of the bonds, the
Net Par and Interest Outstanding for PBA exposure would increase by $47.4 million.
PROMESA also confers significant powers and responsibilities on the
Oversight Board. Among other things, the Oversight Board is required to
certify any insolvency petitions that may be filed by Puerto Rico or its
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.
Title III Filings
In response to letter requests from Governor Rosselló, the
Oversight Board commenced a PROMESA Title III proceeding,
which is a proceeding for adjustments of debt, for the
Commonwealth of Puerto Rico on May 3, 2017, and for the Puerto
Rico Sales Tax Financing Corporation ("COFINA") on May 5,
2017, in the United States District Court for the District of Puerto
| Ambac Financial Group, Inc. 39 2017 FORM 10-K |
Rico. Subsequently, the Oversight Board commenced a Title III
proceeding for the Employees Retirement System ("ERS") and
PRHTA on May 21, 2017, and for the Puerto Rico Electric Power
Authority ("PREPA") on July 2, 2017. Ambac Assurance has not
issued any financial guaranty policies with respect to obligations
of ERS or PREPA.
Fiscal Plans
for
("FEGP")
to be paid by
On March 13, 2017, the Oversight Board certified the 10-year
Fiscal and Economic Growth Plan
the
Commonwealth. The certified FEGP, among other things, was
intended to provide Commonwealth creditors a base from which
to progress consensual negotiations under Title VI of PROMESA.
However, the certified FEGP implied a 77% discount to all debt
service due
its
instrumentalities covered by the FEGP over the ten-years of the
plan (FY2017-2026). The FEGP did not provide details regarding
its underlying assumptions and data, expense definitions, cause of
expense growth or accounting adjustments and did not include any
restructuring proposals. These deficiencies of the FEGP, when
combined with the absence of sufficient projected cash flows for
debt service, increased the uncertainty of whether successful
consensual negotiations can be reached or what creditor outcomes
might be under the Title III proceedings.
the Commonwealth and
As a result of the damage inflicted by Hurricane Maria in
September 2017, the anticipated influx of certain federal funds,
and other structural changes following the hurricane, the
Commonwealth drafted revised fiscal and economic growth plans
(the “Revised FEGPs”) for the Commonwealth and various
instrumentalities. On January 24, 2018, the Puerto Rico Fiscal
Agency and Financial Advisory Authority (“FAFAA”) released the
proposed Revised FEGPs for the Commonwealth, PREPA and
Puerto Rico Aqueduct and Sewer Authority (“PRASA”). The
proposed Revised FEGPs were also submitted to the Oversight
Board for review and certification. On February 5, 2018, the
Oversight Board issued a notice of violation with respect to each
of these Revised FEGPs. In the notice of violation for the Revised
FEGP for the Commonwealth, the Oversight Board required a more
detailed debt sustainability analysis over a 30-year period, among
other changes. The required changes and further clarifications to
the Commonwealth, PREPA, and PRASA FEGPs were submitted
to the Oversight Board on February 12, 2018. Subsequent review
and certification by the Oversight Board is intended to be complete
by March 30, 2018.
The Commonwealth’s proposed Revised FEGP submitted on
February 12, 2018, uses a six-year horizon, projects a six-year
cumulative decline in population of 20.0%, cumulative nominal
GNP growth of 16.7%, cumulative revenue growth of 3.1%, and
projects that by the Commonwealth's fiscal year 2023 there will
be an accumulated surplus of $3.4 billion. However, this proposed
Revised FEGP does not delineate expenses between essential and
non-essential services, does not define essential services, and does
not provide for any cash flows for debt service. This proposed
Revised FEGP also does not address permanent debt write-downs
and the extent of longer-term debt service, leaving uncertainty
about the Commonwealth’s future obligations.
If certified without meaningful changes from the current proposed
plans, the Revised FEGPs of the Commonwealth, PREPA, and
PRASA could perpetuate the uncertainty around the potential
timing and severity of any permanent losses on Ambac-insured
bonds of the Commonwealth and its instrumentalities and may lead
to further protracted resolution timelines between creditors and
debtors. Furthermore, if the Revised FEGPs, without meaningful
changes, became the sole or primary measure for determining
creditor outcomes, Ambac's financial condition,
including
liquidity, loss reserves and capital resources may suffer a materially
negative impact.
The proposed Revised FEGPs for the Government Development
Bank, the University of Puerto Rico, PRHTA and the COSSEC
(the savings and loan cooperatives regulators) are due to be
submitted March 9, 2018, which the Oversight Board intends to
review and certify by April 20, 2018. It is currently unclear what,
if anything, the revised fiscal plan for PRHTA will do to address
the restructuring of its debt obligations. However, any such
restructuring proposal may include material cuts to payment of
principal and interest on outstanding bonds of PRHTA, including
bonds insured by Ambac Assurance.
Hurricanes Irma and Maria
On September 6, 2017, Hurricane Irma, a Category 5 storm, passed
north of Puerto Rico leaving more than 1 million people without
electricity on the island. On September 20, 2017, Hurricane Maria,
a Category 4 storm at the time, made landfall in Puerto Rico,
causing severe damage to the island and its infrastructure,
including the destruction of a significant portion of the the
electrical transmission and distribution system on the the island.
The extensive damage and the disruption to the economy caused
by the hurricanes further stressed what was already a challenging
position for the Commonwealth highlighted by: (i) existing poor
economic and demographic trends, including fluctuating economic
activity levels and continued outmigration, (ii) weak debt and
contingent liability position, including unsustainable leverage and
high fixed costs for pensions; (iii) historically weak budgetary
performance and flexibility (Fiscal Year 2016 and prior structural
imbalances); and (iv) uncertain financial and economic prospects.
For at least the near-term, the Commonwealth faces uncertain
financial and economic prospects due to the scale of the damage
from the hurricanes as well as the uncertainty over the total amount,
timing, and impact of Federal aid for disaster recovery.
Federal Aid
On November 13, 2017, Governor Rosello submitted a formal
request for Federal disaster relief assistance of $94.4 billion to help
the Commonwealth recover and rebuild from hurricanes Irma and
Maria. It is unclear at this time how much of Governor Rosello's
request or in what form will ultimately be made available to assist
Puerto Rico.
To date, $4.9 billion is being made available to Puerto Rico and
the U.S. Virgin Islands as a Community Development Loan
("CDL") as part of a $36.5 billion disaster aid bill signed into law
on October 26, 2017. In addition, the Federal Emergency
Management Agency ("FEMA") reported that in the last three
months of 2017, its obligations under the Disaster Recovery Funds
("DRF") program for Puerto Rico for hurricanes Irma and Maria
totaled $6.7 billion with another $7.0 billion estimated for the nine
months ending September 30, 2018.
On February 9, 2018, the Bipartisan Budget Act of 2018 was signed
into law. There were several elements of this legislation that were
| Ambac Financial Group, Inc. 40 2017 FORM 10-K |
targeted to assist in the recovery of Puerto Rico, including $4.8
billion in Medicaid funding for two years; $11 billion for the U.S.
Housing and Urban Development's Community Development
Block Grant Disaster Relief program for housing, infrastructure
and economic development; additional funding for FEMA's DRF
program; and other disaster aid measures. In addition, the
legislation provides for an extension to 2022 of the rum excise tax
cover-over that provides increased rum tax rebates for Puerto Rico,
extends by one year deductions allowable with respect to income
attributable to domestic production activities in Puerto Rico under
U.S. Code Section 199, and also adds each low-income community
in Puerto Rico to be designated as a qualified opportunity zone
under Sec. 1400Z-1, which allows those areas to qualify for certain
tax incentives. The total value of all of the Puerto Rico-specific
elements of the legislation is unclear at this time and it is possible
that additional Federal aid packages may be approved during the
course of 2018.
of PROMESA, and one has been stayed by order of the United
States District Court for the District of Puerto Rico pending
resolution of an interpleader action related to COFINA funds (to
which interpleader action Ambac is also a party). The three active
litigations are proceeding as adversary proceedings under the Title
III process before the United States District Court for the District
of Puerto Rico. Accordingly, Ambac is unable to predict when and
how the issues raised in those cases will be resolved. If Ambac
Assurance is unsuccessful with any of these challenges, Ambac’s
financial condition, including liquidity, loss reserves and capital
resources may suffer a material negative impact.
Refer to Note 16. Commitments and Contingencies included in Part
II, Item 8 in this Form 10-K for further information about Ambac's
litigation relating to Puerto Rico.
Other Post-Title III Litigation Update
Tax Reform
See Item 1A. Risk Factors
Commonwealth Liquidity
for
and
liquidity
the Commonwealth
The publishing on January 19, 2018, by FAFAA of an updated
report on $6.8 billion of cash balances and the classification of
approximately 800 bank accounts originally addressed in FAFAA’s
initial December 18, 2017 report did not appear to provide for any
enhanced
its
instrumentalities, as the report claimed that much of this balance
had restricted uses or was tied up in ongoing litigation.
Consequently, this purported lack of access to a portion of these
funds could exacerbate existing liquidity constraints of the
Commonwealth and its instrumentalities for certain essential and
non-essential services and further strain timelines and potential
severities for creditors, including Ambac. In connection with the
report, the Oversight Board confirmed that it appointed an
independent forensic analysis team to compile a comprehensive
inventory of all government bank accounts, cash equivalents, and
investments along with their respective account balances.
Mediation
On June 14, 2017, Judge Laura Taylor Swain entered an order
appointing a team of mediators to facilitate confidential mediation
discussions in order to facilitate consensual resolution of certain
issues arising in the context of these Title III cases. The mediation
team is led by Chief Judge Barbara Houser of the United States
Bankruptcy Court for the Northern District of Texas, and consists
of Circuit Judge Thomas Ambro of the United States Court of
Appeals for the Third Circuit, Senior District Judge Nancy Atlas
of the United States District Court for the Southern District of
Texas, Bankruptcy Judge Christopher Klein of the United States
Bankruptcy Court for the Eastern District of California, and Senior
District Judge Victor Marrero of the United States District Court
for the Southern District of New York. Confidential mediation
proceedings are ongoing. No assurances can be given that
consensual resolutions will be achieved with respect to the
Commonwealth’s or COFINA’s obligations or those of any other
Puerto Rico instrumentality.
On January 30, 2018, the United States District Court for the
District of Puerto Rico issued two decisions in adversary
proceedings related
the
Commonwealth of Puerto Rico and certain of its instrumentalities.
the Title III restructuring of
to
In Assured Guaranty Corp., et al. v. Commonwealth of Puerto Rico,
et al. (No. 17-155), the court dismissed the plaintiff monoline
insurers’ complaint against the Commonwealth and the PRHTA
(among other defendants). The court ruled that the special revenues
provisions of the Bankruptcy Code do not require a debtor, post-
petition, to apply the special revenues to the bonds they secure.
The court also held that the plaintiffs were unable to show that
bondholders have an ownership interest, to the exclusion of
PRHTA, in the funds held in certain reserve accounts at PRHTA.
The court rejected the Commonwealth and Oversight Board’s
argument that Section 305 of PROMESA, a provision that reserves
the right of the Title III debtor to control its own governmental
powers and property, deprives the court of jurisdiction over certain
claims; instead, the court held that section 305 only limits the
court’s ability to order remedies that would interfere with the
debtor’s governmental powers or ability to control its property.
The court did not address whether the PRHTA bonds are secured
by a lien or security interest. Ambac Assurance brought similar
claims (among others) in Ambac Assurance Corporation v. Puerto
Rico, et al. (No. 1:17-ap-00159). The court has not yet ruled on
Ambac Assurance’s claims, but in light of its decision in the
Assured case, there is a substantial risk that the court will dismiss
such claims for the same reasons it dismissed the complaint of the
monoline insurers in Assured.
In ACP Master, Ltd., et al. v. Commonwealth of Puerto Rico, et al.
(No. 17-189), the court dismissed the plaintiff general obligation
(“GO”) bondholders’ complaint against the Commonwealth and
the Oversight Board. The court held that the GO bondholders’
effort to compel application of certain revenues to the payment of
GO bonds was barred by section 305 of PROMESA, as this ruling
would interfere with the governmental powers of the debtor (the
Commonwealth). The court further held that the remaining counts
of the plaintiffs’ complaint, which requested declarations as to the
legal status of the GO bonds could not be adjudicated because they
sought advisory opinions and therefore were not justiciable.
Ambac Post-Title III Litigation Update
Ambac Assurance is party to ten litigations related to its Puerto
Rico exposures. Six of these litigations are stayed under Title III
The court’s decisions that section 305 of PROMESA restricts the
court’s ability to order remedies that would interfere with the
debtor’s governmental powers or ability to control its property, if
| Ambac Financial Group, Inc. 41 2017 FORM 10-K |
not overturned on appeal, likely will limit the ability of Ambac
Assurance to successfully compel the payment of debt service on
its insured obligations during the pendency of the Title III cases
and may adversely impact the proposed terms applicable to such
obligations under any plan of adjustment proposed in Title III
proceedings. Any such proposed plan of adjustment would,
however, need to satisfy the requirements of PROMESA, including
consistency with certified fiscal plans, which are required to
respect lawful priorities or lawful liens, in order to be approved by
the court.
Accordingly, Ambac Assurance is unable to predict when and how
the issues raised in its cases will be resolved ultimately. If Ambac
Assurance is unsuccessful with any of its challenges, its financial
condition, including liquidity, loss reserves and capital resources,
may suffer a material negative impact.
Summary
As a result of the developments described in this 10-K, the
Commonwealth of Puerto Rico and certain of its instrumentalities
will continue to default on 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
amount of monies available for debt service, which is in turn
affected by variability in economic growth, tax revenues, essential
services expense as well as federal funding of Commonwealth
needs. In addition, our exposure to Puerto Rico is impacted by the
significant damage to the Commonwealth that was inflicted by
Hurricane Maria, which made landfall on September 20, 2017, as
well as Hurricane Irma, which passed just north of the island on
September 6, 2017. The longer term recovery of the economy of
the Commonwealth and its essential infrastructure will likely be
highly dependent on the amount, timing and effectiveness of
Federal aid. There is historical precedent for meaningful Federal
support following other natural disasters in the United States and
its territories and, to date, some Federal aid measures have been
approved and have already started to assist in the recovery.
However, there can be no assurances as to the sufficiency or
ultimate level of the aid and as to the effectiveness of the
deployment of the aid in benefiting the long term recovery of
economic activity in Puerto Rico. While our reserving scenarios
reflect a wide range of possible outcomes reflecting the significant
uncertainty regarding future developments and outcomes, given
our exposure to Puerto Rico and the economic, fiscal, legal and
political uncertainties associated therewith as well as the
uncertainties emanating from the damage caused by hurricanes
Maria and Irma, 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.
possible final
Given the numerous uncertainties existing with respect to the
restructuring process and relevant litigations, no assurance can be
given that ultimate debt service discounts will not be severe and
cause Ambac to experience losses materially exceeding current
reserves. It is possible that certain restructuring process solutions,
together with associated legislation, budgetary, and/or public
policy proposals could be adopted and could further impair our
exposures. In addition,
legal
there are
determinations, including failing to recognize or properly
differentiate legal structures and protections applicable to such
exposures, that could result in losses exceeding our current reserves
by a material amount and our loss reserves would need to be
increased. In particular, in a Title III process, should court-
approved plans of adjustment for the Commonwealth, COFINA,
PRHTA, or any other issuers of Ambac-insured debt that file for
Title III protection imply further discounts to debt service than
under the Commonwealth’s Revised FEGP, the Fiscal Plan
Compliance Act be upheld, or Ambac receive unfavorable
judgments in the litigations to which it is a party, Ambac’s financial
condition could be materially adversely affected. It is also possible
that economic or demographic outcomes may be worse than
forecast under the Commonwealth’s revised FEGP or under
proposals or plans promulgated by the Commonwealth or its
instrumentalities in or in connection with a Title III process or
otherwise. Even a negotiated restructuring to which Ambac agrees
as part of a Title VI or other process may involve material losses
in excess of current reserves.
Ambac has considered these developments and other factors in
evaluating its Puerto Rico loss reserves. During the year ended
December 31, 2017, Ambac had incurred losses associated with
its Domestic Public Finance insured portfolio of $476.3 million,
which was significantly impacted by the continued uncertainty and
volatility of the situation in Puerto Rico. While management
believes its reserves are adequate to cover losses in its Public
Finance insured portfolio, there can be no assurance that Ambac
may not incur additional losses in the future, particularly given the
developing economic, political, and legal circumstances in Puerto
Rico. Such additional losses may have a material adverse effect
on Ambac’s results of operations and financial condition.
| Ambac Financial Group, Inc. 42 2017 FORM 10-K |
The table below shows Ambac’s ten largest U.S. public finance exposures, by repayment source, as a percentage of total financial guarantee
net par outstanding at December 31, 2017:
($ in millions)
New Jersey Transportation Trust Fund Authority - Transportation System
Puerto Rico Sales Tax Financing Corporation - Senior Sales Tax Revenue (COFINA)
Massachusetts Commonwealth - GO
Mets Queens Baseball Stadium Project, NY, Lease Revenue
Hickam Community Housing LLC
Chicago, IL - GO
Puerto Rico Infrastructure Financing Authority, Special Tax Revenue
Puerto Rico Highways & Transportation Authority, Transportation Revenue
Bragg Communities, LLC
New Jersey Economic Development Authority - School Facilities Construction
Ambac
Ratings(1)
Net Par
Outstanding (2)
BBB+
$
1,642
BIG
AA
BBB
BBB
BBB-
BIG
BIG
A-
BBB+
805
802
564
473
439
438
433
430
400
% of Total
Net Par
Outstanding
2.6 %
1.3 %
1.3 %
0.9 %
0.8 %
0.7 %
0.7 %
0.7 %
0.7 %
0.6 %
Total
$
6,426
10.2%
(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. 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 as opposed to the current
accreted value of the bonds.
U.S. Structured Finance Portfolio
Ambac’s portfolio of U.S. structured finance exposures is $13,816
million, representing 22% of Ambac’s net par outstanding as of
December 31, 2017, and an 18% reduction from the amount
outstanding at December 31, 2016. This reduction in exposure was
primarily related
to residential mortgage-backed policies,
including commutations and other de-risking initiatives on certain
residential mortgage-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 rail car 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, 2017.
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
insolvency
originator becomes subject
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. 43 2017 FORM 10-K |
The following table presents the top five servicers by net par outstanding at December 31, 2017, for U.S. structured finance exposures:
Servicer
($ in millions)
Specialized Loan Servicing, LLC
Bank of America N.A.
Wells Fargo Bank
Pennsylvania Higher Education Assistance Agency
Ocwen Loan Servicing, LLC
Bond Type
Mortgage-backed
$
Mortgage-backed
Mortgage-backed
Student Loan
Mortgage-backed
Net Par
Outstanding
% of Total
Net Par
Outstanding
1,636
1,555
997
994
971
2.6%
2.5%
1.6%
1.6%
1.5%
The table below shows Ambac’s ten largest structured finance transactions, as a percentage of total financial guarantee net par outstanding at
December 31, 2017:
($ in millions)
Ballantyne Re Plc (2)
Progress Energy Carolinas, Inc.
Bond Type
Structured Insurance
Investor Owned Utility
Wachovia Asset Securitization Issuance II, LLC 2007-HE2
Mortgage Backed Securities
Timberlake Financial, LLC
Structured Insurance
Wachovia Asset Securitization Issuance II, LLC 2007-HE1
Mortgage Backed Securities
Consolidated Edison Company of New York
Investor Owned Utility
Option One Mortgage Loan Trust 2007-FXD1
Mortgage Backed Securities
CenterPoint Energy Inc.
Niagara Mohawk Power Corporation
Duke Energy Ohio, Inc.
Total
Investor Owned Utility
Investor Owned Utility
Investor Owned Utility
Ambac
Rating(1)
Net Par
Outstanding
% of Total
Net Par
Outstanding
$
BIG
A-
BIG
BBB
BIG
A
BIG
BBB+
A
BBB+
900
558
547
520
381
347
289
276
257
255
$
4,330
1.4 %
0.9 %
0.9 %
0.8 %
0.6 %
0.6 %
0.5 %
0.4 %
0.4 %
0.4 %
6.9%
(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. BIG denotes credits deemed below
investment grade.
(2)
Insurance policy issued by Ambac UK.
International Finance Insured Portfolio
Ambac’s portfolio of international finance insured exposures is
$16,812 million, representing 27% of Ambac’s net par outstanding
as of December 31, 2017 and a 3% reduction from the amount
outstanding at December 31, 2016. This reduction in exposure was
primarily the result of policy terminations within investor-owned
utilities and asset-backed securities partially offset by the
weakening of the US dollar. 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 has no 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, 2017.
Other European Union Exposures (“EU”)
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
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 $15,881 million net par outstanding in those markets at
December 31, 2017. The portfolio of
insured exposures
underwritten by Ambac UK is financially supported exclusively
by the assets of Ambac UK and no capital support arrangements
are in place with any other Ambac affiliate.
Ambac's international exposures are principally in the United Kingdom; however, we also have exposures with credit risk based in various
other EU member states, including Austria, France, Germany, Italy and Spain. Several of these countries have experienced significant economic,
fiscal and/or political strains such that the likelihood of default on such obligations is higher than when the policies were underwritten. The
Company’s exposures, net of reinsurance, to these countries are shown in the following table:
| Ambac Financial Group, Inc. 44 2017 FORM 10-K |
($ in millions)
Sub-sovereign
Infrastructure / operating asset backed
Investor-owned utility
Total
Total below investment grade
Austria
France
Germany
Italy
Spain
Total
$
$
$
— $
29
$
— $
817
$
— $
770
—
770
770
$
$
300
—
329
$
— $
—
39
39
39
$
$
60
—
877
$
— $
—
41
41
41
$
$
846
1,130
80
2,056
850
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 either undergoing restructuring processes designed to address
their performance issues (in the case of mini hydro-electric plant)
or have already been the subject of restructuring processes to
mitigate performance issues (wind farm). The other below
investment grade exposure
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-.
is a road
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. As a result of the referendum, in March 2017 the UK
government gave the EU formal notification of its intent to leave
with the expectation of a formal withdrawal two years later on
March 29, 2019. Also, in March 2017 the UK began initial (or
phase one) negotiations with the EU regarding the terms of its
departure (“Brexit”). On December 8, 2017, the EU and UK jointly
announced, as set out in the Joint Report and Commission
Communication of 8 December (“Joint Report”), that “sufficient
progress” in phase one of the separation negotiations between the
parties had been made to permit Brexit negotiations to move on to
a more detailed phase two beginning in January 2018.
If no transitional arrangements or new agreement are put into place,
Brexit will mean that the activities in the EEA of UK passporting
insurers will become unlawful on March 29, 2019. They will lose
their legal authorization to serve clients who benefit from policies
issued by a UK incorporated insurer under freedom of services
passporting rights (and thereby maybe unable to legally collect
premiums or pay claims) and if they have branches in EEA Member
States they may be legally obliged to close them down and no
longer be legally represented in those jurisdictions.
In addition to the direct impact on insurers cited above, general
uncertainty and the perceptions as to the ultimate impact of Brexit
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.
The table below shows our ten largest international finance transactions as a percentage of total financial guarantee net par outstanding at
December 31, 2017. 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)
Net Par
Outstanding
% of Total
Net Par
Outstanding
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
Anglian Water
Ostregion Investmentgesellschaft NR 1 SA (2)
Telereal Securitisation plc
National Grid Gas
RMPA Services plc
Total
UK-Utility
UK-Infrastructure
UK-Infrastructure
Italy-Sub-Sovereign
UK-Utility
Austria-Infrastructure
UK-Asset Securitizations
UK-Utility
UK-Infrastructure
A+
A-
BBB+
A-
BBB-
A-
BIG
AA
A-
BBB+
$
1,475
1,135
928
922
817
793
770
766
732
621
2.4 %
1.8 %
1.5 %
1.5 %
1.3 %
1.3 %
1.2 %
1.2 %
1.2 %
1.0 %
$
8,959
14.3%
(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
| Ambac Financial Group, Inc. 45 2017 FORM 10-K |
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. 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, 2017 is
approximately 10 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
2018
2019
2020
2021
2022
2018-2022
2023-2027
2028-2032
2033-2037
After 2037
Total
$
$
$
5,352
4,117
4,074
4,001
3,742
21,286
12,952
10,298
11,615
6,565
62,716
(1) Depicts amortization of existing guaranteed portfolio, assuming no
advance refundings, as of December 31, 2017. Expected maturities
will differ from contractual maturities because borrowers may have
the right to call or prepay guaranteed obligations.
| Ambac Financial Group, Inc. 46 2017 FORM 10-K |
Geographic Area
Ratings Distribution
The following table sets forth the geographic distribution of
Ambac's existing guaranteed net par outstanding as of
December 31, 2017:
Geographic Area
($ in millions)
Domestic:
Net Par
Amount
Outstanding
% of Total
Net Par
Amount
Outstanding
Mortgage and asset-backed (1)
$
California
New York
New Jersey
Colorado
Florida
Puerto Rico
Texas
Illinois
Massachusetts
Pennsylvania
Other domestic
Total Domestic
International:
United Kingdom
Italy
Austria
Australia
France
Internationally diversified (2)
Other international
Total International Finance
Total
7,710
6,351
3,658
3,237
2,537
1,992
1,968
1,890
1,668
1,412
1,316
12,165
45,904
12.3 %
10.1 %
5.8 %
5.2 %
4.0 %
3.2 %
3.1 %
3.0 %
2.7 %
2.3 %
2.1 %
19.4 %
73.2 %
877
770
608
329
368
306
16,812
62,716
$
1.4 %
1.2 %
1.0 %
0.5 %
0.6 %
0.5 %
26.8 %
100.0%
(1) Mortgage and asset-backed obligations includes guarantees with
multiple locations of risk within the United States and is primarily
comprised of residential mortgage and commercial asset-backed
securitizations.
The following tables provide a rating distribution of existing net
par outstanding based upon internal Ambac credit ratings at
December 31, 2017 and 2016 and a distribution by bond type of
Ambac's below investment grade net par exposures at December
31, 2017 and 2016. Below investment grade is defined as those
exposures with an internal credit rating below BBB-:
December 31,
Ambac Rating(1)
AAA
AA
A
BBB
BIG
Total
2017
2016
<1%
<1%
10
37
31
22
13
39
27
21
100%
100%
(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.
Bond Type ($ in millions)
Public Finance:
Lease and tax-backed (1)
General obligation (1)
Transportation
Housing (2)
Health care
Other
Net Par Outstanding -
December 31,
2017
2016
$
2,144
$
2,145
491
397
317
24
189
681
415
125
29
775
Total Public Finance
3,562
4,170
13,554
21.6 %
Summary of Below Investment Grade Exposure:
(2) Internationally diversified may include components of U.S.
Structured Finance:
exposure.
Exposure Currency
The table below shows the distribution by currency of Ambac's
existing guaranteed net par outstanding as of December 31, 2017:
Currency
($ in millions)
U.S. Dollars
British Pounds
Euros
Australian Dollars
A$
New Zealand Dollars NZ$
Net Par
Amount
Outstanding
in Base
Currency
Net Par
Amount
Outstanding
in U.S.
Dollars
Percentage
of Net Par
Amount
Outstanding
$
£
€
46,640
$
9,811
1,688
779
252
46,640
13,262
2,027
608
179
74.4 %
21.1 %
3.2 %
1.0 %
0.3 %
Total
$
62,716
100.0%
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
3,947
2,803
922
900
166
9
5,163
3,483
991
900
251
304
8,747
11,092
1,200
1,200
1,562
1,562
Total
$
13,509
$
16,824
(1) Tax-backed includes $1,802 and $1,871 of Puerto Rico net par at
December 31, 2017 and 2016, respectively. General obligation
includes $166 and $187 of Puerto Rico net par at December 31, 2017
and 2016, respectively. Puerto Rico net par outstanding includes
| Ambac Financial Group, Inc. 47 2017 FORM 10-K |
capital appreciation bonds which are reported at the par amount at
the time of issuance of the related insurance policy as opposed to the
current accreted value of the bonds.
(2)
Includes $317 and $125 of military housing net par at December 31,
2017 and 2016, respectively.
The decrease in below investment grade exposures is primarily
due to (i) upgrades of several public finance transactions, primarily
stadiums, in addition to runoff including commutations and claims
paid by Ambac Assurance, partially offset by a military housing
downgrade, (ii) reductions
to residential mortgage-backed
securities during the year as a result of prepayments by issuers,
commutations and claims presented to Ambac Assurance, (iii)
cancellation of certain asset backed bonds and (iv) the termination
of an international CDO transaction. Despite the decrease in below
investment grade net par, such exposure increased in relative
proportion to the aggregate insured portfolio to 22% at December
31, 2017, compared to 21% at December 31, 2016. Based on our
experience, below investment grade exposures typically run-off at
a slower pace than investment grade exposures and therefore
Ambac is subject to the risk that its insured portfolio will
increasingly become concentrated in higher risk below investment
grade exposures. This risk may result in greater volatility in our
results from operations and have adverse effects on our financial
condition.
U.S. residential mortgage-backed securities exposure
Ambac has exposure to the U.S. mortgage market primarily
through direct financial guarantees of RMBS,
including
transactions that contain risks to first and second liens.
The following tables provide, by vintage and type current net par outstanding of Ambac’s U.S. RMBS book of business:
December 31, 2017
December 31, 2016
Year of Issue
($ in millions)
1998-2001
2002
2003
2004
2005
2006
2007
Total
Second
Lien
$
2
1
3
223
305
1,124
1,149
$
300
107
151
130
493
325
289
First-
lien
Sub-
prime
First-
lien
Mid-
prime
Other(1)
Total
$ — $
126
$
$
First-
lien
Sub-
prime
344
291
411
245
572
379
311
$
First-
lien
Mid-
prime
1
26
154
271
1,028
523
868
Second
Lien
$
5
2
6
321
402
1,340
1,415
428
129
273
570
1,702
1,929
2,236
Other(1)
Total
$
169
$
519
322
651
838
2,040
2,297
2,716
3
80
1
38
55
122
468
21
119
217
872
434
694
—
—
—
32
46
104
308
$ 2,807
$ 1,795
$ 2,357
$
$ 7,267
$ 3,491
$ 2,553
$ 2,871
$
$ 9,383
% of Total RMBS Portfolio
38.6%
24.7%
32.4%
4.3%
100.0%
37.2%
27.2%
30.6%
5.0%
100.0%
% of Related Par Outstanding
rated below investment
grade (2)
99.9%
92.7%
96.3%
57.7%
95.2%
99.8%
93.4%
96.2%
57.2%
94.8%
(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.
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, 2017 and 2016:
($ in millions) December 31,
2017
2016
Investor-owned utilities
$
1,549
$
1,780
Healthcare
Student loans
Lease and tax-backed
Utility
Transportation
General Obligation
Other
Total
423
316
262
251
205
43
251
449
361
305
293
207
46
274
$
3,300
$
3,715
| Ambac Financial Group, Inc. 48 2017 FORM 10-K |
Reinsurance
Ceded Reinsurance:
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 $115.6 million from its reinsurers at
December 31, 2017. As of December 31, 2017, the aggregate
amount of insured par ceded by Ambac Assurance to reinsurers
under reinsurance agreements was $4,424 million, with the largest
reinsurer accounting for $3,668 million or 5.5% of gross par
outstanding at December 31, 2017.
reinsurer
The following table shows the distribution, by bond type, of Ambac
Assurance’s ceded guaranteed portfolio at December 31, 2017:
Bond Type ($ in millions)
Public Finance:
Housing revenue
General obligation
Lease and tax-backed revenue
Transportation revenue
Higher education
Utility revenue
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
Transportation
Asset-backed
Total International Finance
Total
$
Assumed Reinsurance:
Ceded Par
Amount
Outstanding
% of Gross
Par Ceded
$
968
837
719
221
131
86
46
104
3,112
438
414
87
42
192
1,173
4,285
98
25
16
139
4,424
13 %
12 %
6 %
10 %
7 %
4 %
5 %
12 %
9 %
26 %
11 %
1 %
9 %
12 %
8 %
9 %
2 %
2 %
1 %
1 %
7%
At December 31, 2017, assumed par outstanding was $219.1
million.
| Ambac Financial Group, Inc. 49 2017 FORM 10-K |
($ in millions) Year Ended December 31,
2017
2016
2015
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
Net gains (losses) on interest rate derivatives
Other income (expense)
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
$
175.3
$
197.3
$
361.0
(20.2)
5.4
16.4
59.6
(0.7)
19.7
513.2
150.9
121.5
119.9
—
44.5
—
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)
Net income (attributable to common shareholders)
$
(328.7) $
74.8
$
312.6
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)
493.4
The following paragraphs describe the consolidated results of
operations of Ambac and subsidiaries for 2017, 2016 and 2015 and
its financial condition as of December 31, 2017 and 2016.
Net Premiums Earned. Net premiums earned primarily represent
the amortization into income of insurance premiums. Net
premiums earned for the year ended December 31, 2017, decreased
by $22.0 million or 11.2% as compared to net premiums earned
for the year ended December 31, 2016. Net premiums earned for
the year ended December 31, 2016, decreased by $115.3 million
or 36.9% as compared to net premiums earned for the year ended
December 31, 2015.
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
revenue. For
extinguished, causing accelerated premium
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 $0.4 million, $7.6 million, and $5.1 million, for
the years ended December 31, 2017, 2016 and 2015, 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.
• Changes in the collectability of certain Structured Finance
premium receivables resulted in an increase in net premiums
earned of $0.3 million, $0.8 million and $0.5 million for the
years ended December 31, 2017, 2016 and 2015, respectively.
Changes in the collectability of a certain International Finance
premium receivable resulted in a decrease in net premiums
earned of $0.4 million for the year ended December 31, 2017.
• Pre-refundings of insured securities, primarily Public Finance
transactions. Since the maturity date of pre-refunded
securities is shortened (to a specified call date from its
previous legal maturity), normal net premiums earned will
increase over the remaining period of the related policy.
• The strengthening or weakening of the U.S. dollar relative to
the British Pound since Ambac's wholly-owned UK
subsidiary, Ambac UK, operates in the United Kingdom and
the British Pound is its functional currency.
Normal net premiums earned and accelerated premiums are
reconciled to total net premiums earned in the table below,
including a breakdown of net premiums earned by market:
($ in millions)
Year Ended December 31,
2017
2016
2015
Public finance
Structured finance
International finance
Total normal premiums
earned
Public Finance
Structured Finance
International Finance
Accelerated earnings
$
$
$
$
62.4
21.7
26.7
110.8
46.7
3.3
14.5
64.5
Total net premiums earned $
175.3
$
$
$
$
$
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
Net Investment Income. Net investment income primarily
consists of interest receipts and net discount accretion on fixed
| Ambac Financial Group, Inc. 50 2017 FORM 10-K |
income securities classified as available-for-sale, including $262.1
million, $195.4 million and $175.2 million in 2017, 2016 and 2015,
respectively related to investments in Ambac-insured securities.
Also, included in net investment income are net mark-to-market
gains of $18.2 million, $27.7 million and $12.6 million in years
ended 2017, 2016 and 2015, respectively, arising from pooled fund
investments and certain other investments that are classified as
trading securities with changes in market value recognized in
earnings. Most trading securities are in the Ambac UK portfolio
and consist of pooled fund investments in diversified asset classes
including equities, hedge funds, loans, insurance-linked securities
and property. Ambac Assurance has also invested in loan funds as
part of its overall portfolio allocation strategy. In 2017, Ambac
invested in debt instruments issued by Corolla Trust. 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 the Corolla Trust.
Net investment income increased $47.5 million for the year ended
December 31, 2017 compared to 2016 and $47.2 million for the
year ended December 31, 2016 compared to 2015. The increase
in income in 2017 is primarily due to greater allocation to higher-
yielding Ambac-insured securities, partially offset by lower net
gains on trading securities, Investment income on Ambac-insured
securities increased $66.7 million in 2017 compared to 2016,
including $40.9 million related to RMBS securities driven
primarily by reprojected cash flows for the restructuring of
deferred claims included in the Rehabilitation Exit Transactions
completed in the first quarter of 2018. Income from Ambac-
insured securities also reflects additional purchases of Puerto Rico
bonds over the course of 2017 and additional purchases by Ambac
UK of its insured bonds. Net income from trading securities
declined in 2017 primarily due to catastrophe-driven losses on
insurance-linked securities and lower returns on loans and equities,
net of foreign exchange effects. The strengthening British pound
sterling relative to the U.S. dollar in 2017 partially offset strong
equity market gains in Ambac UK's pooled fund holdings. This
compares to 2016 when the pound declined.
The increase net investment income in 2016 is attributable to
growth in the size of the portfolio and higher average returns.The
larger portfolio in 2016 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 $15.1 million from 2015, 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.
Net investment income will be significantly impacted in future
periods as a result of the Rehabilitation Exit Transactions as further
described in Note 1. Background and Business Description and
Note 17. Subsequent Events of the Consolidated Financial
Statements in Part II, Item 8 of this Form 10-K. See also the Pro
Forma Balance Sheet section included in Part II, Item 7 of this
Form 10-K.
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, 2017, 2016 and 2015 related to credit losses on
certain Ambac-wrapped securities stemming primarily from cash
flow projections and to the company’s intent to sell certain
securities that were in an unrealized loss position as of the
impairment evaluation dates. During the Segregated Account
Rehabilitation Proceedings, changes in the estimated timing of
claim payments resulted in adverse changes in projected cash flows
on certain impaired Ambac-wrapped securities. Ambac estimated
the timing of such claim payment receipts, but the actual timing
of such payments were at the sole discretion of the Rehabilitator.
Refer to Note 1. Background and Business Description to the
Consolidated Financial Statements for more information on the
Segregated Account and the Segregated Account Rehabilitation
Proceedings.
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 Realized Investment Gains. The following table provides a
breakdown of net realized gains, for the periods presented:
($ in millions)
Year Ended December 31,
2017
2016
2015
Net gains on securities sold
or called
Foreign exchange gains
(losses)
Total net realized gains
$
$
10.1
$
9.1
$
47.7
(4.7)
5.4
$
30.2
39.3
$
5.8
53.5
Net gains during the year ended December 31, 2017 included the
impact of sales of securities to fund the February 12, 2018
Rehabilitation Exit Transactions as further described in Note 1.
Background and Business Description of the Consolidated
Financial Statements in Part II, Item 8 of this Form 10-K. 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.
| Ambac Financial Group, Inc. 51 2017 FORM 10-K |
Change in Fair Value of Credit Derivatives. The gain from
change in fair value of credit derivatives for the year ended
December 31, 2017 was $16.4 million, as compared to the gains
of $20.1 million and $41.7 million for the years ended December
31, 2017, 2016 and 2015, respectively. The gain for 2017 was
mainly due to the reversal of unrealized losses from swap
terminations, including the remaining adversely classified credit
in the portfolio, in addition to reference obligation price
improvements. 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.
Realized gains and other settlements on credit derivative contracts
represent premiums received and accrued on such contracts
including termination fees. Realized gains and other settlements
were $1.6 million, $0.9 million and $2.8 million for 2017, 2016
and 2015, respectively. Included in realized gains and other
settlements on credit derivatives were fees received in connection
with transaction terminations of $1.0 million, $0.0 million and $1.3
million for the years 2017, 2016 and 2015, respectively. Excluding
the impact of termination fees, the declines over time are due to
continued runoff of the credit derivative portfolio.There were no
loss or settlement payments in the periods presented. Unrealized
gains (losses) on credit derivative contract reflect the impact of all
other factors on the overall change in fair value of credit derivatives
noted above.
See Note 9. Fair Value Measurements to the Consolidated Financial
Statements included in Part II, Item 8 in this Form 10-K for a further
description of Ambac’s methodology for determining the fair value
of credit derivatives. The table below indicates the impact of
incorporating Ambac’s own credit risk into the fair value of credit
derivatives as of December 31, 2017 and 2016:
($ in millions) December 31,
2017
2016
Mark-to-market liability of credit
derivatives, excluding CVA
CVA on credit derivatives
Credit derivative liability at fair value
$
$
0.7
(0.1)
0.6
$
$
17.2
(1.9)
15.3
Net Gain (Loss) on Interest Rate Derivatives. The interest rate
derivatives portfolio is positioned to benefit from rising rates as a
partial economic hedge against interest rate exposure in the
financial guarantee and investment portfolios. Results in Net gain
(loss) on interest rate derivatives generally reflect mark-to-market
gains (losses) in the portfolio caused by increases (declines) 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 gains for the year ended December 31, 2017 were $59.6
million, reflecting an improvement of $109.8 million as compared
to the net losses of $50.3 million for the year ended December 31,
2016. The net gain for 2017 was primarily driven by the June 2017
commutation of interest rate swaps with a structured finance
vehicle counterparty (the "Augusta swaps"). The net gains (losses)
on these swaps were $42.2 million for the year ended December
31, 2017. Results for 2017 also included gains from rising interest
rates and lower counterparty credit adjustments on certain
uncollateralized derivative assets,
Net losses reported in interest rate derivatives for the year ended
December 31, 2016 were $50.3 million, a deterioration of $7.7
million as compared to net losses of $42.5 million for the year
ended December 31, 2015. The interest rate derivatives 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.
Results for 2015 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 2015.
The fair value of derivatives include valuation adjustments to
reflect Ambac’s own credit risk and counterparty credit risk. Within
the interest rate 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.
For the periods presented, an Ambac CVA was applicable only to
the Augusta swaps that were terminated in June 2017 as discussed
above. Changes in the Ambac CVA on Augusta swaps is included
in the 2017 net gains from Augusta swaps described above.
Inclusion of the Ambac CVA in the valuation of interest rate
derivatives contributed (losses) gains of $(33.8) million and $14.2
million in 2016 and 2015, respectively. Counterparty credit
adjustments are generally applicable
for uncollateralized
derivative assets that may not be offset by derivative liabilities
under a master netting agreement. Inclusion of counterparty credit
adjustments in the valuation of interest rate derivatives resulted in
gains (losses) within Net gain (loss) on interest rate derivatives of
$4.1 million, $2.5 million and $(17.6) million for 2017, 2016 and
2015, respectively.
The table below indicates the impact of incorporating Ambac’s
own credit risk into the fair value of the derivative portfolio
(excluding credit derivatives) as of December 31, 2017 and 2016:
($ in millions) December 31,
2017
2016
Interest rate derivatives mark-to-market
liability, excluding CVA
CVA on interest rate derivatives portfolio
Interest rate derivatives portfolio
liability at fair value
$
$
82.2
$
348.8
—
(44.9)
82.2
$
303.9
Net Realized Gains (Losses) on Extinguishment of Debt. Net
realized gains on extinguishment of debt was $4.9 million for the
year ended December 31, 2017, compared to gains of $4.8 million
and $0.1 million for the years ended December 31, 2016 and 2015,
respectively. The gains for the years ended December 31, 2017
and 2016 included gains from the settlements of purchased surplus
notes below their carrying values and gains from the settlements
of certain residual obligations related to previously called surplus
notes. The gains for the year ended December 31, 2015 included
gains from the settlement of certain residual obligations related to
previously called surplus notes, partially offset by losses from
settlement of an investment agreement above its carrying value
| Ambac Financial Group, Inc. 52 2017 FORM 10-K |
and the accelerated recognition of the unamortized discount on
surplus notes purchased during the year.
Other Income. The table below summarizes other income.
($ in millions)
Year Ended December 31,
2017
2016
2015
Foreign exchange gain/(loss) $
(2.6) $
Other
1.9
7.8
9.7
Total other income (loss)
$
(0.7) $
17.4
$
$
(2.0)
9.2
7.2
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 fees,
primarily consent and waiver fees. In 2017, income from such fees
is partially offset by charges in connection with the Rehabilitation
Exit Transactions (as defined in Note 1. Background and Business
Description to the Consolidated Financial Statements included in
Part II, Item 8 in this Form 10-K). In addition to various fees for
the year ended December 31, 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 VIEs during the periods reported. Generally, the
Company’s consolidated VIEs are entities for which Ambac has
provided financial guarantees on all of or a portion of its assets or
liabilities. In consolidation, 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.
Income (loss) on variable interest entities was $19.7 million,
$(14.1) million and $31.6 million for the years ended December
31, 2017, 2016 and 2015, respectively. Income on variable interest
entities for year ended December 31, 2017 is due primarily to a
higher net asset value of a VIE related to an increase in projected
financial guarantee insurance premiums. Income (loss) on variable
interest entities for the years ended December31, 2016 and 2015
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 and
2015. 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 Segregated Account Rehabilitation Plan that were
discharged on February 12, 2018.
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 representation and
warranty subrogation recoveries, net of reinsurance, of $1.8 billion
and $1.9 billion at December 31, 2017 and 2016, 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, 2017, 2016 and 2015 were $513.2 million, $(11.5) million and
$(768.7) million, respectively. The following table provides
details, by bond type, for losses and loss expenses (benefit)
incurred for the periods presented:
($ in millions)
Year Ended December 31,
RMBS (1)
Domestic Public Finance
Student Loans
Ambac UK
All other credits
Interest on Deferred
Amounts
Totals (2)
2017
2016
2015
$
(40.8) $
(298.9) $
(721.1)
476.3
25.1
(128.3)
3.0
169.0
(111.9)
56.7
2.8
141.8
(251.1)
(94.5)
(5.7)
177.9
170.8
161.9
$
513.2
$
(11.5) $
(768.7)
(1) The loss and loss expense (benefit) associated with changes in
estimated representation and warranties for the year ended December
31, 2017, 2016 and 2015 was $72.0, $(71.4), and $(303.6),
respectively.
(2) Includes loss expenses incurred of $81.6 million, $51.9 million and
$32.8 million for the year ended December 31, 2017, 2016 and 2015,
respectively.
| Ambac Financial Group, Inc. 53 2017 FORM 10-K |
Losses and loss expenses for 2017 were driven by the following:
• Higher projected losses in domestic public finance largely
driven by adverse development on Puerto Rico and the
Military Housing sector;
• Interest on deferred amounts; partially offset by;
• Lower projected losses in the Ambac UK portfolio primarily
due to the confidential settlement of litigation brought by
Ambac UK in the name of Ballantyne against JPMIM and
from activities executed by the Ballantyne trust that indirectly
reduced future expected claims on the Ambac insured notes;
• Foreign exchange gains of $28.9 million. A portion of Ambac
UK's loss reserves are denominated in currencies other than
its functional currency of British Pounds resulting in incurred
losses
the British Pound depreciates
(appreciates);
(gains) when
• A $49.7 million benefit due to reimbursements of claims paid
with respect to two transactions that benefited from a
mortgage insurance settlement.
Losses and loss expenses (benefit) for 2016 were driven by the
following:
• Lower projected losses in the RMBS portfolio due to
improved deal performance, higher representation and
warranty subrogation recoveries and a 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 2016; partially offset by;
• Higher projected losses in domestic public finance for the
year ended December 31, 2016 largely driven by adverse
development in Puerto Rico;
• Interest on deferred amounts;
• 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.
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;
• 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 $24.8 million; partially offset by;
• Higher projected losses in domestic public finance for the
year ended December 31, 2015 largely driven by adverse
development in Puerto Rico;
• Interest on deferred amounts.
The following table provides details of net claims recorded, net of
reinsurance for the affected periods:
($ in millions)
Year Ended December 31,
Claims recorded (1)(2)(3)
Subrogation received (4)
Net Claims Recorded
2017
2016
2015
$
$
343.7
(244.0)
99.7
$
$
391.9
$
367.9
(1,355.4)
(308.4)
(963.5) $
59.5
(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
Segregated Account Rehabilitation Plan and associated rules and
guidelines. 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) Claims recorded includes claims paid (including commutation
payments) of $310.8, $365.5, and $345.0 for the year ended
December 31, 2017, 2016 and 2015, respectively.
(3) Claims recorded includes claims paid on Puerto Rico policies of
$142.5, $63.3 and $0 for the year ended December 31, 2017, 2016
and 2015, respectively.
(4) Subrogation received for the year ended December 31, 2017 includes
$49.7 ($49.8 gross of reinsurance) related to a reimbursement of
claims due to a mortgage insurance settlement. Subrogation received
for the year ended December 31, 2016 includes $992.8 ($995 gross
of reinsurance) received from the settlement of representation and
warranty related litigation with JP Morgan and $99.1 ($100.3 gross
of reinsurance) related to the Countrywide Investor Settlement.
Operating Expenses. Operating expenses consist of gross
operating expenses plus reinsurance commissions. The following
table provides details of operating expenses for the periods
presented:
($ in millions)
Year Ended December 31,
Gross operating expenses
Reinsurance commissions,
net
Total operating expenses
$
$
2017
2016
2015
121.1
$
112.1
$
102.3
0.4
1.6
0.4
121.5
$
113.7
$
102.7
Gross operating expenses for the year ended December 31, 2017
are $121.1 million, an increase of $9.0 million from gross operating
expenses for the year ended December 31, 2016. The increase was
primarily due to the following:
• Higher non-compensation costs primarily due to (i) $21.7
million incremental legal, consulting and advisory costs
related to the Rehabilitation Exit Transactions, (ii) $5.3
million incremental OCI legal and consulting costs primarily
| Ambac Financial Group, Inc. 54 2017 FORM 10-K |
in connection with the Rehabilitation Exit Transactions, and
(iii) $4.1 million increase in state taxes primarily due to a $2.3
million reduction of accrued state income taxes in 2016 due
to the final resolution of state insurance tax assessments.
These increased costs were partially offset by (i) a reduction
in litigation contingencies of $8.5 million and (ii) a reduction
in costs associated with stockholder activism of $5.9 million
in 2016.
• Lower compensation costs related
to salaries, post
employment costs, including severance, partially offset by
increased long term incentive compensation costs due to an
improvement
in performance factors. Although post-
employment costs have decreased from 2016, the Company
reduced headcount in 2017 resulting in severance charges.
These charges are lower than prior year due to 2016 including
severance costs related to the former CEO.
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 $10.0 million of litigation
contingencies, higher audit fees, increased outside services
in non-
and higher regulatory costs. The
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.
increase
As a consequence of the Segregated Account Rehabilitation
Proceedings, the Rehabilitator retained 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
$11.7 million, $6.4 million and $5.6 million for the years ended
December 31, 2017, 2016 and 2015, respectively. The increase in
2017 compared to 2016 is driven by higher advisor fees primarily
related to the Rehabilitation Exit Transactions. The increase in
2016 compared to 2015 is driven by an increase in monthly
consulting adviser fees and higher legal fees as a result of a change
in legal advisers.
Subsequent to the Segregated Account's effective exit from
rehabilitation, advisory services provided for the benefit of OCI
will be reduced, although certain advisors will receive transaction
or event based payments at the time of exit.
Interest Expense. Interest expense includes accrued interest on
surplus notes issued by Ambac Assurance and the Segregated
Account, secured borrowing notes outstanding, investment
agreements and fees on unfunded
lending commitments.
Additionally, interest expense includes discount accretion on
surplus notes as their carrying value is at a discount to par.
The following table provides details by type of obligation for the
periods presented:
($ in millions)
Year Ended December 31,
2017
2016
2015
Surplus notes
$
113.4
$
118.5
$
113.1
Investment agreements
Secured borrowing
Unfunded commitment fees
0.2
3.9
2.4
0.6
5.2
—
0.9
2.5
—
Total interest expense
$
119.9
$
124.3
$
116.5
The decrease in interest expense for the year ended December 31,
2017, compared to 2016 primarily results from the impact of
purchases of surplus notes during the first half of 2017 and reduced
debt balances resulting from amortization of the secured borrowing
notes outstanding. The decrease in interest expense was partially
offset by the impact of applying the level yield method as the
discount to the face value of the surplus note accretes over time.
The year ended December 31, 2017 also includes commitment fees
incurred for the Tier 2 Financing as part of the Rehabilitation Exit
Transactions. Refer to Note 1. Background and Business
Description to the Consolidated Financial Statements for
information relating to the Rehabilitation Exit Transactions and
Tier 2 Financing.
The increase in interest expense on surplus notes 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 the
secured borrowing transaction of Ambac Assurance (issued in July
2015).
Surplus note principal and interest payments require the approval
of OCI. Annually from 2011 through 2017, 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. 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. In
connection with the consummation of the Rehabilitation Exit
Transactions, Ambac Assurance received the approval of the OCI
to make a one-time current interest payment of $13.5 million on
surplus notes outstanding after the Rehabilitation Exit Transactions
(other than junior surplus notes) in 2018. Refer to Note 1.
Background and Business Description to the Consolidated
Financial Statements for information relating to the Rehabilitation
Exit Transactions
Total accrued and unpaid interest for surplus notes and junior
surplus notes outstanding to third parties were $345.3 million and
$99.5 million, respectively, at December 31, 2017. Principal and
interest payments on junior surplus notes, which became
obligations of AAC on February 12, 2018, cannot be made until
all Ambac Assurance surplus notes (other than other junior surplus
notes) are paid in full and after all future and existing senior
| Ambac Financial Group, Inc. 55 2017 FORM 10-K |
indebtedness of AAC, policy and other priority claims against AAC
have been paid in full.
Provision for Income Taxes. The provision for income taxes for
the year ended December 31, 2017, 2016 and 2015 was $44.5
million, $30.7 million, and $17.4 million, respectively. The income
tax for all periods include a provision (benefit) for federal AMT
taxes. The income tax for the year ended December 31, 2017
reflects an estimated net discrete cost of $1.9 million resulting from
the TCJA, further described in Note 14. Income Taxes. The income
tax for the year ended December 31, 2017 and 2016, includes a
current income tax provision for income tax due in respect of
Ambac UK of $40.6 million, and $26.2 million, respectively.
Ambac UK fully utilized operating losses brought forward from
prior periods in the first quarter of 2016, resulting in income tax
being payable.
At December 31, 2017 the Company had $3.7 billion of U.S.
Federal net ordinary operating loss carryforwards, including $1.4
billion at Ambac Financial Group and $2.3 billion at Ambac
Assurance.
LIQUIDITY AND CAPITAL RESOURCES
Ambac Financial Group, Inc. Liquidity. Ambac’s liquidity is
dependent on its cash and liquid investments of $96.3 million as
of December 31, 2017 and expense sharing and other arrangements
with Ambac Assurance. Ambac has an aggregated investment of
$207.2 million in Ambac Assurance insured RMBS and surplus
notes issued by Ambac Assurance and the Segregated Account.
These securities issued or insured by Ambac Assurance and the
Segregated Account are generally less liquid than investment grade
and other traded investments. Ambac's investments also include
$64.7 million of combined debt and equity interests in Corolla
Trust (as defined in the Executive Summary section of this
Management Discussion and Analysis).
Pursuant to the amended and restated tax sharing agreement among
Ambac, Ambac Assurance and certain affiliates (the “Amended
required, under certain
TSA"),
Ambac Assurance
is
circumstances, to make payments ("tolling payments") to Ambac
with respect to the utilization of net operating loss carry-forwards
(“NOLs”). Ambac received $100.8 million of tolling payments
based on NOLs used by Ambac Assurance through December 31,
2016, and Ambac has accrued an additional tolling payment of
$30.5 million that is expected to be paid to Ambac no later than
forty-five days after April 15, 2018. Additionally, under an inter-
company cost allocation agreement, Ambac is reimbursed for
certain operating costs and expenses.
It is highly unlikely that Ambac Assurance will be able to make
dividend payments to Ambac for the foreseeable future and
therefore cash and investments, payments under the intercompany
cost allocation agreement and future tolling payments, if any, will
be Ambac’s principal source of liquidity in the near term. Refer to
Part I, Item 1, “Insurance Regulatory Matters - Dividend
Restrictions, Including Contractual Restrictions” and Note 8.
Insurance Regulatory Restrictions to the Consolidated Financial
Statements included in Part II, Item 8, in this Form 10-K for more
information on dividend payment restrictions. The principal use
of liquidity is the payment of operating expenses, including costs
to explore opportunities to grow and diversify Ambac, and the
making of investments including securities issued or insured by
Ambac Assurance.
Contingencies could cause material liquidity strains.
The following table includes aggregated information about
contractual obligations for Ambac and its subsidiaries, excluding
variable interest entities consolidated as a result of Ambac
Assurance’s financial guarantee contracts. These obligations
include payments due under specified contractual obligations,
aggregated by type of contractual obligation, including claim
payments, principal and
interest payments under Ambac
Assurance’s surplus notes, and payments due under operating
leases. The table and commentary below reflect scheduled
payments and maturities based on the original payment terms
specified in the underlying agreements and contracts, or expected
required payment dates if earlier.
($ in millions)
Surplus note obligations(1)
Operating lease obligations(2)
Purchase obligations(3)
Postretirement benefits(4)
Loss and loss expenses(5)
Income taxes
Total
Payments Due by Period
Total
Less Than 1 Year
1 - 3 Years
3 - 5 Years
More Than 5
Years
$
4,054.2
$
368.9
$
831.8
$
— $
2,853.5
29.3
23.8
4.2
8,025.6
—
6.8
21.4
0.3
4,196.2
—
7.5
2.4
0.6
386.7
—
3.2
—
0.8
207.8
—
$
12,137.1
$
4,593.6
$
1,229.0
$
211.8
$
11.8
—
2.5
3,234.9
—
6,102.7
(1)
Includes principal of and interest on surplus notes (excluding junior surplus notes) on their scheduled maturity date. Also includes all principal and interest
on junior surplus notes on the date all future and existing senior indebtedness of Ambac Assurance, policy and other priority claims against Ambac
Assurance have been paid in full (included in the more than 5 years column). 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 2017, 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 $314.4 on the
next scheduled payment date of June 7, 2018.
(2) Amount represents future lease payments on lease agreements existing as of December 31, 2017. 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.
| Ambac Financial Group, Inc. 56 2017 FORM 10-K |
(3) Purchase obligations represent future expenditures for contractually scheduled fixed terms and amounts due for various technology-related maintenance
agreements and other outside services. Includes $18.3 million of success fees to various advisors in connection with the Rehabilitation Exit Transactions.
(4) Amount represents future payments relating to Ambac Assurance's postretirement medical reimbursement benefits for current retirees over the next 10
years.
(5) 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. Included in as an obligation
due in less than 1 year, are obligations related to the Segregated Account's unpaid claims of $3,027.0 and interest accrued on Deferred Amounts of $839.7
as of December 31, 2017. These obligations of the Segregated Account were subject to the Rehabilitation Exit Transactions, which were executed on
February 12, 2018. Refer to the Rehabilitation Exit Transactions section in 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.
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 and credit default swap contracts, principal and interest
payments from investments, sales of investments, proceeds from
repayment of affiliate loans, recoveries on claim payments 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,
commutation and related expenses payments on both insurance
and credit derivative contracts, ceded reinsurance premiums,
surplus note principal and interest payments, if approved by OCI,
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.
Ambac Assurance manages its liquidity risk by maintaining
comprehensive analyses of projected cash flows and maintaining
specified levels of cash and short-term investments at all times.
Pursuant to the injunctions issued by the Rehabilitation Court,
claims on policies allocated to the Segregated Account were not
permitted to be paid during the Segregated Account Rehabilitation
Proceedings until approved by the Rehabilitator. The Segregated
Account 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 Segregated Account Rehabilitation Plan and
associated rules and guidelines.
In addition, the Rehabilitator sought and received approval from
the Rehabilitation Court to make Supplemental Payments (i.e.,
cash payments in excess of 45% of the permitted policy claim
amount with respect to certain 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) and Special
Policy Payments (i.e., claims payments in excess of the then
applicable claims cash payment percentage, and/or payments of
all or portions of unpaid permitted policy claims with settlement
proceeds from RMBS remediation claims) with respect to certain
insured securities. During the years ended December 31, 2017 and
2016, the Segregated Account made, in aggregate, Supplemental
Payments and Special Policy Payments in respect of permitted
policy claims of $47.6 million and $84.3 million, respectively.
from
On February 12, 2018, Ambac and Ambac Assurance
consummated the Rehabilitation Exit Transactions. The cash
the Rehabilitation Exit Transactions was
outflow
approximately $1.4 billion. See Note 1. Background and Business
Description to the Consolidated Financial Statements included in
Part II, Item 8 in this Form 10-K for details regarding the
Rehabilitation Exit Transactions.
Ambac Assurance is limited in its ability to pay dividends to Ambac
pursuant to the terms of the Settlement Agreement, the Stipulation
and Order and its Auction Market Preferred Shares (“AMPS”).
• 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 surplus notes (other than junior
surplus notes) would also need to be redeemed at par.
• The Stipulation and Order requires OCI approval for the
payment of any dividend or distribution on the common stock
of Ambac Assurance.
The terms of the AMPS 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
this10-K for more information on dividend payment restrictions.
| Ambac Financial Group, Inc. 57 2017 FORM 10-K |
During the year ended December 31, 2017 and 2016, Ambac
Assurance received total subrogation of $244.0 million and
$1,355.4 million, respectively, net of reinsurance, primarily related
to RMBS.
• The year ended December 31, 2017 includes $49.7 million
($49.8 million gross of reinsurance) of subrogation recoveries
related to a reimbursement of claims due to a mortgage
insurance settlement.
Cash Flow Statement Discussion.
summarizes the net cash flows for the periods presented.
The following table
($ in million)
Year Ended December 31,
Cash provided by (used in):
2017
2016
2015
Operating activities
Investing activities
Financing activities
$
(212.8) $
843.5
$
91.8
928.8
(182.1)
(714.6)
(69.7)
(175.7)
46.9
• The year ended December 31, 2016
the
representation and warranty receipt from JP Morgan of $992.8
million ($995.0 million gross of reinsurance) and $99.1
million ($100.3 million gross of reinsurance) of subrogation
recoveries related to the Countrywide Investor Settlement.
includes
Our ability to realize representation and warranty 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 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.
Ambac Financial Services ("AFS") Liquidity. AFS provided
interest rate swaps to states, municipalities and their authorities,
asset-backed issuers and other entities in connection with their
financings. Additionally, AFS uses interest rate derivatives as an
economic hedge against the effects of rising interest rates
elsewhere in the Company, including on the financial guarantee
and investment portfolios. The principal uses of liquidity by AFS
are payments on intercompany loans, payments under derivative
contracts (primarily interest rate swaps and US Treasury futures),
collateral posting and operating expenses. Liquidity risk exists in
the derivative portfolios due to contract provisions which may
require collateral posting, daily settlements or early termination of
contracts. AFS 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.
In June 2017, AFS received a $94.4 million capital contribution
from Ambac Assurance that was used to commute the majority of
its remaining interest rate swaps with financial guarantee customer
counterparties effective June 27, 2017. This swap commutation
reduced, but does not eliminate, AFS's liquidity risk from potential
early terminations of uncollateralized derivatives. Management
believes that AFS’ short and long-term liquidity needs can be
funded from intercompany loans from Ambac Assurance and
receipts from derivative contracts.
Effect of foreign exchange
on cash and cash
equivalents
Net cash flow
Operating activities
$
$
(1.2) $
(3.9) $
(1.1)
532.7
$
55.3
$
(38.2)
The following represents the significant cash activities during the
years ended December 31, 2017, 2016 and 2015 :
• During the year ended December 31, 2017, Ambac made
payments of $94.4 million to commute interest rate swaps
with a special purpose entity, Augusta Funding Limited IV;
• During the year ended December 31, 2017, Ambac made
payments of $104.7 million to extinguish (on a consolidated
basis) principal and interest of surplus notes of Ambac
Assurance and the Segregated Account of Ambac Assurance
and settled certain residual obligations related to previously
called surplus notes ($69.5 million principal and $35.2 million
interest). The interest amount reduces operating cash flows
and the principal reduced financing cash flows; and
• During the years ended December 31, 2017, 2016 and 2015,
Ambac had net loss and loss expenses paid (recovered) of
$134.3 million, $(939.6) million and $1.1 million,
respectively. Included in the recoveries for the year ended
December 31, 2017 were the subrogation recoveries related
to a mortgage insurance settlement of $49.7 million ($49.8
million gross of reinsurance). Included in the recoveries for
the year ended December 31, 2016 were the representation
and warranty receipt from JP Morgan of $992.8 million and
$99.1 million of subrogation recoveries related to the
Countrywide Investor Settlement. Excluding subrogation
receipts, loss and loss expenses paid, including commutation
payments, were $378.3 million, $415.8 million, and $398.3
million for the years ended December 31, 2017, 2016 and
2015, respectively. Losses paid on Puerto Rico polices were
$142.5 million, $63.3 million and $0.0 million for the years
ended December 31, 2017, 2016 and 2015, respectively.
• During the year ended December 31, 2017 and 2016 tax
payments amounted to $40.3 million and $21 million,
respectively.
Future operating cash flows will primarily be impacted by the level
of premium collections, investment coupon receipts and claim or
commutation payments.
| Ambac Financial Group, Inc. 58 2017 FORM 10-K |
Financing Activities
Financing activities for the year ended December 31, 2017
included paydowns on a secured borrowing of $29.0 million,
payments for investment agreements of $82.4 million, payments
for extinguishment of surplus notes of $69.5 million; compared to
repayments of secured borrowing of $29.5 million, payment for
investment agreements of $18.0 million, payments for the
extinguishment of surplus notes of $19.6 million and the
acquisition of Ambac warrants of $2.7 million for the year ended
December 31, 2016.
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 agreements
of $63.9 million, payments for extinguishment of surplus notes of
$13.8 million and the acquisition of Ambac warrants of $5.0
million.
Principal and interest due on the debt issued in connection with
the Rehabilitation Exit Transactions as well as future payments on
the remaining surplus notes will impact Ambac's future cash flows.
Collateral
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 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 $120.6 million (cash and securities collateral of $20.9
million and $99.7 million, respectively), including independent
amounts, under these contracts at December 31, 2017.
Ambac Credit Products (“ACP”) is not required to post collateral
under any of its outstanding derivative contracts.
BALANCE SHEET
Total assets increased by approximately $557 million from
December 31, 2016 to $23.2 billion at December 31, 2017,
primarily due to higher variable interest entity assets as a result of
lower credit spreads and strengthening of the British Pound
Sterling receivable for securities, partially offset by (i)
consideration paid for Ambac's extinguishment of all Segregated
Account surplus notes and a portion of Ambac Assurance surplus
notes (cash and investments); (ii) amortization of the insurance
intangible asset during the period, (iii) payment of $94 million in
connection with interest rate swap commutations, (iv) lower
premium receivables, and (v) application of $71 million of
collateral receivable included in other assets as of December 31,
2016 as a reduction to derivative liabilities under new rules by our
central clearing party effective January 3, 2017 governing the
character of variation margin. Under the new rules, variation
margin payments are considered settlements of the associated
derivative balance and accordingly were removed from other assets
and recoded as a reduction to derivative liabilities. Refer to Note
11. Derivative Instruments in this Form 10-K located in Part II.
Item 8 for further information on the rule change.
Total liabilities increased by approximately $889 million from
December 31, 2016 to $21.5 billion as of December 31, 2017,
primarily as a result of (i) higher variable interest entity liabilities
as a result of lower credit spreads and strengthening of the British
Pound Sterling, (ii) higher loss and loss expense reserves and (iii)
higher deferred tax liabilities relating to Ambac's foreign
subsidiaries as a result of the Tax Cuts and Jobs Act enacted in
December 2017, partially offset by (i) the maturity of the last
remaining investment agreement, (ii) reductions to derivative
liabilities of $145 million related to terminated interest rate swaps
and $71 million associated with the characterization of variation
margin as noted above, (iv) reductions to long-term debt as a result
of the extinguishment of surplus notes and (v) lower unearned
premium revenue.
As of December 31, 2017 total stockholders’ equity was $1,645
million, compared with total stockholders’ equity of $1,978 million
at December 31, 2016. This decrease was primarily driven by Total
Comprehensive Loss during the period. Total Comprehensive Loss
during 2017 was driven by a net loss during the period and
unrealized losses on investment securities, partially offset by
translation gains related to Ambac's foreign subsidiaries.
As further discussed in Note 1. Background and Business
Description and Note 17. Subsequent Events of the Consolidated
Financial Statements in Part II, Item 8 of this Form 10-K, on
February 12, 2018, the Second Amended Plan of Rehabilitation
became effective and the Rehabilitation Exit Transactions were
consummated. The Rehabilitation Exit Transactions involved a
series of transactions which provided holders of beneficial interests
in Deferred Amounts (other than Ambac, but including Ambac
Assurance) a total effective consideration package, in full
satisfaction and discharge of each $1.00 of Deferred Amounts
(including accretion), of (i) $0.40 in cash, (ii) $0.41 in principal
amount of new Secured Notes and (iii) from certain holders of
surplus notes, $0.125 currently outstanding surplus notes. Such
consideration package thereby provided a discount of $0.065 (set
first against accretion of Deferred Amounts). Ambac received
$0.91 in principal amount of Secured Notes for each $1.00 of
Deferred Amounts (including accretion) that it held, and provided
a $0.09 discount in full satisfaction and discharge of its Deferred
Amount claims. Additionally, the Rehabilitation Exit Transactions
also involved a series of interrelated transactions involving the
exchange of certain surplus notes (collectively, the “Exchange
| Ambac Financial Group, Inc. 59 2017 FORM 10-K |
Offers”), pursuant to which, for each $1.00 of principal amount
outstanding and accrued and unpaid interest thereon, holders
effectively (i) received $0.40 in cash, (ii) received $0.41 in
principal amount of Secured Notes, (iii) retained $0.125 in
principal amount and accrued and unpaid interest thereon of
surplus notes and (iv) provided a discount of $0.065 in principal
amount and accrued and unpaid interest thereon. Ambac did not
participate in the Exchange Offers. See below "Pro Forma Balance
Sheet and Pro Forma Adjusted Book Value" in this Management
Discussion and Analysis for a depiction of the transactions on the
Consolidated Balance Sheet as if the Rehabilitation Exit
Transactions were consummated on December 31, 2017. This
transaction will have a significant impact on the comparability of
Ambac's financial results between 2018 and prior years.
Investment Portfolio. Ambac Assurance’s and Everspan's non-
VIE investment objective is to achieve the highest risk-adjusted
after-tax return on a diversified portfolio of primarily fixed income
investments while employing asset/liability management practices
to satisfy operating and strategic liquidity needs. Ambac
Assurance’s investment portfolio is subject to internal investment
guidelines and is subject to limits on types and quality of
investments imposed by the insurance laws and regulations of the
jurisdictions in which it is licensed, primarily the States of
Wisconsin and New York. Such guidelines set forth minimum
credit rating requirements and credit risk concentration limits.
Within these guidelines, which in certain instances may be
exceeded with the approval of the applicable regulatory authority,
Ambac Assurance opportunistically purchases Ambac Assurance
insured securities given their relative risk/reward characteristics.
Ambac Assurance’s investment policies are subject to oversight
by OCI pursuant to the Settlement Agreement and the Stipulation
and Order. The Board of Directors of Ambac Assurance approves
any changes to Ambac Assurance's investment policy.
Ambac UK’s non-VIE 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
policyholder claims. Ambac UK’s investment portfolio is
primarily fixed income investments and diversified holdings of
pooled investment funds. The portfolio is subject to internal
investment guidelines and may be subject to limits on types and
quality of investments imposed by the PRA as regulator of Ambac
UK. Ambac UK’s investment policy sets forth minimum credit
rating requirements and concentration limits, among other
restrictions. The Board of Directors of Ambac UK approves any
changes or exceptions to Ambac UK’s investment policy.
Ambac Financial Group, Inc.'s non-VIE investment portfolio's
primary objective is to preserve capital for strategic uses while
maximizing income, including investments in securities issued by
or guaranteed by Ambac Assurance.
Refer to Note 10. Investments in this Form 10-K in this Form 10-
K located in Part II. Item 8 for information about Ambac's
consolidated non-VIE investment portfolio.
The following table summarizes the composition of Ambac’s
investment portfolio, excluding VIE investments, at carrying value
at December 31, 2017 and 2016:
($ in millions)
December 31,
Fixed income securities
Short-term
Other investments
Fixed income securities pledged
as collateral
Total investments (1)
2017
2016
4,652.2
$
5,554.2
557.3
431.6
99.7
5,740.8
$
$
430.8
450.3
64.9
6,500.2
$
$
$
(1)
Includes investments denominated in non-US dollar currencies with
a fair value of £209.8 ($283.6) and €40.9 ($49.1) as of December 31,
2017 and £167.8 ($206.7) and €23.5 ($24.7) as of December 31, 2016.
Ambac invests in various asset classes in its fixed income securities
portfolio, including securities covered by guarantees issued by
Ambac Assurance and other financial guarantors ("insured
securities"). Refer to Note 10. Investments in this 10-K located in
Part II. Item 8 for information about insured securities by guarantor
and asset class. The following table represents the fair value of
mortgage and asset-backed securities at December 31, 2017 and
2016 by classification:
($ in millions)
December 31,
Residential mortgage-backed
securities:
2017
2016
RMBS—First-lien—Alt-A
$
1,029.4
$
1,044.3
RMBS—Second Lien
RMBS—First Lien—Sub Prime
Total residential mortgage-backed
securities
Other asset-backed securities
839.9
382.0
910.4
396.9
2,251.3
2,351.6
Military Housing
Student Loans
Structured Insurance
Credit Cards
Auto
Other
Total other asset-backed securities
243.4
152.1
137.6
33.0
31.6
0.2
597.9
236.6
151.4
118.8
164.1
137.8
20.1
828.8
Total (1)
$
2,849.2
$
3,180.4
(1)
Includes investments guaranteed by Ambac Assurance and Ambac
UK for both years presented. Refer to Note 10. Investments in this
10-K located in Part II. Item 8 for further details 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 is C and CCC as of December 31, 2017, and CC
and BB- as of December 31, 2016, respectively.
The following tables provide the ratings(1) distribution of the fixed
income investment portfolio based on fair value at December 31,
2017 and 2016.
| Ambac Financial Group, Inc. 60 2017 FORM 10-K |
_______________________________________
(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 64% and 45% of the 2017 and 2016 combined portfolio, respectively. The
increase in the percentage of not rated and below investment grade holdings since December 31, 2016 is driven by additional purchases of Ambac insured
bonds.
Premium Receivables. Ambac either received premium upfront at
time of issuance of the insurance policy or in installments over the
policy term. For installment premium transactions, a premium
receivable asset is established equal to the (i) present value of future
contractual premiums due 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. Ambac's premium receivables
decreased to $586 million at December 31, 2017 from $661 million
at December 31, 2016. As further discussed in Note 7. Financial
Guarantee Insurance Contracts, the decrease is due to premium
receipts, including the termination premium of £12.6 million
received in 2017, and adjustments for changes in expected and
contractual cash flows, partially offset by the impact of currency
exchange rates on non-US denominated future premiums and
accretion of premium receivable discount.
Premium receivables by payment currency were as follows:
Currency
(Amounts in millions)
U.S. Dollars
British Pounds
Euros
Australian Dollars
Total
Premium
Receivable in
Payment
Currency
Premium
Receivable in
U.S. dollars
$
£
€
A$
397.6
$
112.3
30.0
1.0
$
397.6
151.9
36.0
0.8
586.3
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, 2017 and 2016, the
insurance intangible amortization expense was $151 million and
$175 million, respectively. As of December 31, 2017 and 2016,
the gross carrying value of the insurance intangible asset was
$1,581 million and $1,534 million, respectively. The increase in
gross carrying value at December 31, 2017 from December 31,
2016 is solely impacted by translation gains (losses) from the
consolidation of Ambac's foreign subsidiary (Ambac UK).
Accumulated amortization of the insurance intangible asset was
$734 million and $572 million, as of December 31, 2017 and 2016,
respectively, resulting in a net insurance intangible asset of $847
million and $962 million, respectively.
Derivative Liabilities. The interest rate derivative portfolio is
positioned to benefit from rising rates as an economic hedge against
interest rate exposure in the financial guarantee and investment
portfolio. Derivative liabilities decreased from $319 million at
December 31, 2016 to $83 million as of December 31, 2017. The
decrease results primarily from the commutation of certain interest
rate swaps with a liability fair value of $145 million at December
31, 2016, continued runoff of the credit derivative portfolio and
the characterization of variation payments on centrally cleared
derivatives as settlements of the associated derivative balances
resulting from central clearing party rule changes that were
effective January 3, 2017. The amount of variation margin
included within "Other assets" on the Consolidated Balance Sheet
as of December 31, 2016 that was reclassified as a reduction to
derivative liabilities under the new CCP rules effective January 3,
2017 was $71 million. 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
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 $0.1 million
| Ambac Financial Group, Inc. 61 2017 FORM 10-K |
at December 31, 2017 and $46.9 million at December 31, 2016 to
incorporate the market’s view of Ambac’s credit quality. The lower
CVA as of December 31, 2017 is a function of the lower gross value
of the associated derivative liabilities relative to December 31,
2016, primarily driven by the above referenced interest rate swaps
commutation.
Loss and Loss Expense Reserves and Subrogation Recoverable.
Loss and loss expense reserves are based upon estimates of the
ultimate aggregate losses inherent in the non-derivative portfolio
issued
to beneficiaries,
insurance policies
for
including
unconsolidated VIEs. Loss and loss expense reserves include the
unpaid portion of interest accrued on Deferred Amounts
established pursuant to the Segregated Account Rehabilitation
Plan, which were discharged on February 12, 2018. The loss and
loss expense reserves net of subrogation recoverables and before
reinsurance as of December 31, 2017 and 2016 were $4,114 million
and $3,696 million, respectively. Loss and loss expense reserves
are included in the Consolidated Balance Sheets as follows:
($ in millions)
Balance Sheet Line Item
December 31, 2017:
Loss and loss expense reserves
Subrogation recoverable
Totals
December 31, 2016:
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)
$
$
$
$
2,412
615
3,027
2,411
583
2,994
$
$
$
$
668
172
840
530
132
662
$
$
$
$
2,855
102
2,957
2,681
68
2,749
$
$
$
$
(1,054) $
(136) $
(1,520)
—
(2,574) $
(136) $
(1,098) $
(143) $
(1,468)
—
(2,566) $
(143) $
4,745
(631)
4,114
4,381
(685)
3,696
(1)
(2)
Includes the present value of future recoveries include R&W subrogation recoveries of $1,834 and $1,907 at December 31, 2017 and 2016, respectively.
Includes Euro denominated gross loss and loss expense reserves. US dollar equivalents of such reserves were $21 (€18) and $21 (€20) at December 31,
2017 and 2016, respectively.
The evaluation process for determining the level of reserves is
subject to certain estimates and judgments. 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 87% of our ever-to-date insurance claims recorded with
RMBS comprising 82%. 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.
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, 2017 and 2016:
| Ambac Financial Group, Inc. 62 2017 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)
$
$
$
5,243
$
3,014
$
837
$
888
$
(2,120) $
(21) $
2,598
4,265
701
941
537
—
13
—
—
—
—
3
—
—
—
—
1,278
361
315
26
89
(403)
(40)
(11)
—
—
(75)
(13)
(18)
(9)
—
816
308
286
17
89
11,687
$
3,027
$
840
$
2,957
$
(2,574) $
(136) $
4,114
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
($ in millions)
December 31, 2017:
RMBS
Domestic Public Finance
Student Loans
Ambac UK
All other credits
Loss expenses
Totals
December 31, 2016:
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 $590 and $41, respectively, at December 31, 2017 and
$607 and $31, respectively at December 31, 2016. 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 as opposed
to the current accreted value of the bond.
(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,
which was settled in 2017. Please refer to Note 7. Financial Guarantee Insurance Contracts of the Consolidated Financial Statements in
Part II, Item 8 of this Form 10-K for additional information relating to this settlement.
RMBS
Ambac has exposure to the U.S. mortgage market primarily
including
through direct financial guarantees of RMBS,
transactions collateralized by first and second liens.
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 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, 2017 and 2016:
| Ambac Financial Group, Inc. 63 2017 FORM 10-K |
($ in millions)
December 31, 2017:
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, 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
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
$
1,065
$
735
$
— $
1,849
667
137
3,718
735
59
731
1,997
190
144
3,066
719
104
543
1,525
5,243
$
1,366
4,432
$
—
—
—
—
(1,272)
(79)
(483)
(1,834)
(1,834) $
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) $
735
1,997
190
144
3,066
(553)
25
60
(468)
2,598
679
1,901
231
138
2,949
(628)
18
55
(555)
2,394
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, 2017 as compared to December 31, 2016
was primarily related to adverse developments in Puerto Rico and
military housing. Total public finance gross loss reserves and
related gross par outstanding on Ambac insured obligations by
bond type were as follows:
($ in millions)
Issuer Type
December 31,
Lease and tax-backed
General obligation
Transportation revenue
Housing
Other
Total
2017
2016
Gross Par
Outstanding (1)
Gross Loss
Reserves
Gross Par
Outstanding (1)
Gross Loss
Reserves
$
$
2,201
$
1,053
495
449
67
650
$
60
64
31
11
2,114
$
1,422
516
179
179
4,265
$
816
$
4,410
$
395
78
62
9
3
547
(1) Gross Par Outstanding includes capital appreciation bonds, which are reported at the par amount at the time of issuance of the insurance policy as opposed
to the current accreted value of the bond.
SPECIAL PURPOSE AND VARIABLE INTEREST
ENTITIES
information regarding special purpose and variable interest
entities.
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
ACCOUNTING STANDARDS
Please refer to Note 2. Basis of Presentation and Significant
Accounting Policies to the Consolidated Financial Statements,
| Ambac Financial Group, Inc. 64 2017 FORM 10-K |
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, 2017 and 2016
was less than $104.1 million and higher by $17.3 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 was a
separate insurer from Ambac Assurance and accordingly was
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”). Ambac Assurance’s surplus as
regards to policyholders exceeded the Minimum Surplus Amount.
Ambac Assurance’s statutory policyholder surplus and qualified
statutory capital (defined as the sum of policyholders surplus and
mandatory contingency reserves) were $699.6 million and
$1,155.8 million at December 31, 2017, respectively, as compared
to $976.5 million and $1,368.3 million at December 31, 2016,
respectively. The Segregated Account’s statutory policyholder
surplus amount was $376.2 million and $381.3 million as of
December 31, 2017 and 2016, respectively.
Following the effectiveness of the Second Amended Plan of
Rehabilitation and in accordance with the Stipulation and Order,
Ambac Assurance is exempt from all filing requirements of the
OCI and National Association of Insurance Commissioners
regarding the Segregated Account that become due in or after the
calendar quarter immediately following the effective date of the
Second Amended Plan of Rehabilitation (second quarter of 2018).
Ambac Assurance’s decrease in policyholder surplus was
primarily due to decline in fair value of below investment grade
bond investments and contributions to contingency reserves,
partially offset by statutory net income. Statutory net income was
primarily due to premium earnings and investment income,
partially offset by loss and loss expenses incurred on Puerto Rico
insured exposures.
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, 2017.
Ambac Assurance’s statutory policyholder surplus includes $370.2
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 preference of $660.3 million, are
obligations that have claims on the resources of Ambac Assurance
which impact Ambac's ability to realize residual value from its
equity in Ambac Assurance.
increase
Ambac Assurance’s statutory surplus is sensitive to multiple
factors, including: (i) loss reserve development, (ii) approval by
OCI of interest payments on existing surplus notes, (iii) approval
by OCI of principal or interest payments on existing junior surplus
notes, (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
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 or resolutions 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 investment securities, and
(xi) future changes to prescribed SAP practices by the OCI.
statutory
loss
As of December 31, 2017, total unpaid interest, which will require
OCI approval for payment, for surplus notes outstanding to third
parties and junior surplus notes was $314.4 million and $86.3
million, respectively at the scheduled interest payment date of June
7, 2017. 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 binding commutation
contract is signed by the counterparty. Under GAAP, in
addition to the establishment of loss reserves for defaulted
obligations, loss reserves are established (net of GAAP basis
| Ambac Financial Group, Inc. 65 2017 FORM 10-K |
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
2.5%.
• 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 a
determination that the held reserves are deemed excessive.
to OCI approval and relate
• 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 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 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 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, 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.
• 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
required 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 £266.3 million at December 31, 2017 as
compared to £157.9 million at December 31, 2016. Ambac UK’s
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, including amounts
associated with Ballantyne's litigation settlement in April 2017. At
December 31, 2017, the carrying value of cash and investments
was £459.8 million, a decrease from £460.4 million at
December 31, 2016. The decrease in cash and investments is due
to loss expenses, tax payments and unrealized foreign exchange
losses on investments denominated in currencies other then Ambac
UK's functional currency (British Pounds) in the period, partially
offset by the continued receipt of premiums, investment coupons
from Ambac UK's investment portfolio and increases in the value
of investments in pooled funds.
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 4.42%) 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
| Ambac Financial Group, Inc. 66 2017 FORM 10-K |
weighted-average risk-free discount rate, currently at 1.6%
for Ambac UK related transactions.
• Investments in fixed income securities are stated at amortized
cost, subject
impairment
to an other-than-temporary
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.
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. The calculation of capital resources,
regulatory capital requirements and regulatory capital deficits
under Solvency II at December 31, 2017 will be be published on
Ambac's website.
Capital resources under Solvency II were a surplus of £55.1 million
at December 31, 2017 an improvement from a deficit of £67.1
million at January 1, 2017. The capital resources at December 31,
2017 and January 1, 2017 are in comparison to regulatory capital
requirements of £343.6 million and £334.9 million, respectively.
Ambac UK is therefore deficient in terms of compliance with
applicable regulatory capital requirements by £288.5 million and
£402.0 million at December 31, 2017 and January 1, 2017,
respectively. The regulators are aware of the deficiency in capital
resources as compared to capital requirements and dialogue
between Ambac UK management and its regulators remains
ongoing with respect to options for addressing the shortcoming,
although such options remain few.
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. 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,
we utilized a 0% effective tax rate for non-GAAP adjustments;
which is subject to change.
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 (Loss). Adjusted Earnings (Loss) is defined as
net income (loss) 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 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 contracts to be accounted for
consistent with the Financial Services – Insurance Topic of
ASC, whether or not they are subject to derivative accounting
rules.
• 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 the implementation of Fresh
Start reporting. These adjustments ensure that all financial
guarantee 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. This
adjustment eliminates the foreign exchange gains (losses) on
| Ambac Financial Group, Inc. 67 2017 FORM 10-K |
all assets, liabilities and transactions in non-functional
currencies, which 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.
• Fair value (gain) loss on interest rate derivative from Ambac
CVA: Elimination of the gains (losses) relating to Ambac’s
CVA on interest rate derivative contracts. 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,
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 interest rate derivatives from
Ambac CVA
2017
2016
2015
$ Amount
Per Diluted
Share
$ Amount
Per Diluted
Share
$ Amount
Per Diluted
Share
$
(328.7) $
(7.25) $
74.8
$
1.64
$
493.4
$
10.72
(10.9)
150.9
—
(21.3)
44.9
(0.24)
3.33
—
(0.47)
0.99
(7.5)
174.6
—
39.1
33.8
(0.16)
3.82
—
0.86
0.73
6.89
(36.7)
169.6
514.5
27.4
(14.2)
$
1,154.0
$
(0.80)
3.69
11.18
0.60
(0.31)
25.08
Adjusted Earnings (Loss)
$
(165.1) $
(3.64) $
314.8
$
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. Included
within Net income (loss) attributable to common stockholders of
these consolidated VIEs was $19.7 million, $(14.1) million, and
$31.6 million for the years ended December 31, 2017, 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 would have been $50.3
million, $147.6 million and $42.7 million for the years ended
December 31, 2017, 2016 and 2015, respectively. The net impact
of these different accounting bases on Net income attributable to
common stockholders (including per share amounts) was $30.7
million ($0.68 per share), $161.7 million ($3.54 per diluted share),
$11.1 million and ($0.24 per diluted share), for the years ended
December 31, 2017, 2016 and 2015, 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 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 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.
emergence
• Insurance intangible asset: Elimination of the financial
guarantee insurance intangible asset that arose as a result of
Ambac’s
the
from
implementation of Fresh Start reporting. This adjustment
ensures that all financial guarantee contracts are accounted
for within Adjusted Book Value consistent with the provisions
of the Financial Services—Insurance Topic of the ASC.
bankruptcy
and
• Ambac CVA on interest rate derivative liabilities: Elimination
of the gain relating to Ambac’s CVA on interest rate derivative
contracts. 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.
| Ambac Financial Group, Inc. 68 2017 FORM 10-K |
• 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
accumulated other
comprehensive income (“AOCI”). The AOCI component of
the fair value adjustment on the investment portfolio may
component of
as
a
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
$
1,381.1
$
30.52
$
1,713.9
$
37.94
2017
2016
Adjustments:
Non-credit impairment fair value losses on credit derivatives
Insurance intangible asset
Ambac CVA on interest rate derivative liabilities
Net unearned premiums and fees in excess of expected losses
Net unrealized investment (gains) losses in Accumulated Other
Comprehensive Income
Adjusted Book Value
0.6
(847.0)
—
597.3
(30.8)
0.01
(18.71)
—
13.20
(0.68)
11.4
(962.1)
(44.9)
732.2
(118.9)
$
1,101.3
$
24.34
$
1,331.7
$
0.25
(21.30)
(0.99)
16.21
(2.63)
29.48
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.
stockholders' equity of these consolidated VIEs was $134.1 million
and $132.4 million at December 31, 2017 and 2016, 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 $178.7
million and $139.2 million at December 31, 2017 and 2016,
respectively. The net change of these different accounting bases
(including per share amounts) was $44.6 million ($0.99 per share)
and $6.7 million ($0.15 per share), at December 31, 2017 and 2016,
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
decrease from December 31, 2016 to December 31, 2017 was
primarily driven by Adjusted earnings.
| Ambac Financial Group, Inc. 69 2017 FORM 10-K |
PRO FORMA BALANCE SHEET AND PRO FORMA ADJUSTED BOOK VALUE
The following unaudited pro forma consolidated balance sheet of Ambac as of December 31, 2017, is based on the historical consolidated
financial statements of Ambac giving effect to the Rehabilitation Exit Transactions as further described in Note 1. Background and Business
Description and Note 17. Subsequent Events of the Consolidated Financial Statements in Part II, Item 8 of this Form 10-K. The unaudited
pro forma consolidated balance sheet of Ambac includes unaudited pro forma adjustments that are driven by assumptions and factually
supportable information directly attributable to the Rehabilitation Exit Transactions and the Tier 2 Notes Issuance as if they occurred on
December 31, 2017 rather than February 12, 2018.
AMBAC FINANCIAL GROUP, INC.
PRO FORMA CONDENSED CONSOLIDATED GAAP BALANCE SHEET
(Unaudited)
December 31,
2017
Adjustments
Pro forma
December 31,
2017
(dollars in millions)
Assets:
Total non-variable interest entity investments, cash and cash equivalents
$
6,364
$
Subrogation recoverable
Other assets
Total VIE assets
Total assets
Liabilities and Stockholders' Equity:
Liabilities:
Loss and loss expense reserve
Long-term debt
Accrued interest payable
Other liabilities
Total VIE liabilities
Total liabilities
Stockholders' equity
$
$
631
1,696
14,501
23,192
$
4,745
$
992
437
1,007
14,366
21,547
1,645
(1)
(2)
(3)
(1,786)
1,312
(9)
—
(483)
(2,555)
1,952
(224)
(2)
(4)
(4)
—
—
(827)
344
(2)(5)(6)
Total liabilities and stockholders' equity
$
23,192
$
(483)
(1) The net cash and investment outflows reflects the distributions under the Rehabilitation Exit Transactions as follows:
(dollars in millions)
Cash payment to third parties for settlement of Deferred Amounts and Surplus Notes
Cash payment for unpaid claims presented after record date
Cash payment for one-time current interest payment on remaining surplus notes
Cash payment for remaining debt issuance costs
Receipt of Tier 2 proceeds
Receipt of Secured Notes issued by Ambac LSNI
Reduction in value of Ambac-insured RMBS securities held in the investment portfolio
$
$
$
$
$
$
4,578
1,943
1,687
14,501
22,710
2,190
2,944
213
1,007
14,366
20,720
1,989
22,710
(1,347)
(30)
(11)
(8)
240
764
(1,394)
(1,786)
(2) The transactions pursuant to the Second Amended Plan of Rehabilitation where Ambac is settling its unpaid claims at a discount is being accounted for
as an extinguishment, where the discount of approximately $287 is reflected in the pro forma consolidated balance sheet as an increase to Retained
Earnings. As a result of the settlement, future net cash flows on certain policies will become an asset and are reclassified to Subrogation recoverable.
(3) Reflects the reclass of previously capitalized costs directly associated with the issuance of the Ambac Notes or Tier 2 Notes to Long-term debt that will
be amortized as part of the effective yield calculation.
(4) The discount received in the other Rehabilitation Exit Transactions are being accounted for as a debt modification since the creditors before and after the
discount remain the same and the change in the terms is not considered substantial. A substantial change is considered to be a change in cash flows of
equal to or greater than 10% as a result of the modification of terms. As the change in cash flows is less than 10%, debt modification accounting is
appropriate. Under debt modification accounting, no gain or loss is recorded, and a new effective interest rate is established based on the Ambac Note
cash flows. Additionally, any consideration paid that is directly related to the issuance of the Ambac Note is capitalized and amortized as part of the
effective yield calculation. The net long-term debt increase reflects the impact of the Rehabilitation Exit Transactions as follows:
| Ambac Financial Group, Inc. 70 2017 FORM 10-K |
(dollars in millions)
Tier 2 Notes issuance
Ambac Note issuance
Cash payment for on-time current interest payment on remaining surplus notes
Deferred loss on Rehabilitation Exit Transactions and debt issuance costs
Reduction in carrying value of Surplus Notes
Long-term Debt
Accrued Interest
Payable
$
$
240
$
2,145
—
(20)
(413)
1,952
$
—
—
(11)
—
(213)
(224)
(5) As a result of the Rehabilitation Exit Transactions, Ambac will receive settlement of its ownership in Deferred Amounts and would realize a gain of $57
over the carrying value of the associated Ambac-insured RMBS as of December 31, 2017.
(6) This pro forma information does not incorporate any assumptions regarding taxes.
The following table reconciles total Ambac Financial Group, Inc. stockholders' equity to the non-GAAP measure Adjusted Book Value.
PROFORMA ADJUSTED BOOK VALUE
Reported
Pro Forma
Post Restructuring (1)
December 31, 2017
December 31, 2017
Change
($ in millions, except per share data)
$ Amount
Per Share
$ Amount
Per Share
$ Amount
Per Share
Total AFGI Shareholders' Equity
$
1,381.1
$
30.52
$
1,725.2
38.08
$
344.0
$
7.56
Adjustments:
Non-credit impairment unrealized fair value
losses on credit derivatives
Insurance intangible asset
Net unearned premiums and fees in excess of
expected losses
Net unrealized investment (gains) losses in
AOCI
Adjusted book value
Shares Outstanding (in millions)
0.6
(847.0)
0.01
(18.71)
0.6
(847.0)
0.01
(18.71)
597.3
13.20
597.3
13.20
(30.8)
(0.68)
(30.8)
(0.68)
—
—
—
—
—
—
—
—
$
1,101.3
$
24.34
$
1,445.3
$
31.90
$
344.0
$
7.56
45.3
45.3
(1) Pro forma amounts are estimates, subject to revisions and are not reflective of actual or future operating results.
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 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. 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, long-term debt and interest rate derivatives.
Fixed income investment securities that are guaranteed by Ambac
have interest rate risk 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.
Changes in fair value resulting from changes in interest rates are
driven primarily by the impact of interest rate shifts on the
investment portfolio (which produce net fair value losses as rates
increase) and long-term debt and the interest rate derivatives
portfolio (which produce net fair value gains as rates increase).
Interest rate increases would also have a negative economic impact
on expected future claim payments within the financial guarantee
portfolio. Ambac performs 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.
The interest rate derivatives portfolio is managed 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"). As a result of the commutation of certain
financial guarantee customer swaps in June 2017, the macro-hedge
encompasses the entire interest rate derivatives portfolio as of
December 31, 2017. The interest rate sensitivity of the interest
rate derivatives portfolio attributable to the macro-hedge position
would produce mark-to-market gains or losses of approximately
| Ambac Financial Group, Inc. 71 2017 FORM 10-K |
$0.8 million for a 1 basis point parallel shift in USD benchmark
interest rates up or down at December 31, 2017.
The following table summarizes the estimated change in fair value
(based primarily on the valuation methodology discussed in Note
9. Fair Value Measurements to the Consolidated Financial
Statements included in Part II, Item 8 in this Form 10-K) on these
financial instruments, assuming immediate changes in interest
rates at specified levels at December 31, 2017:
($ in millions)
Estimated change in net fair value
Estimated net fair value
(1)
Incorporates an interest rate floor of 0%
Change in Interest Rates
300 basis point
rise
200 basis point
rise
100 basis point
rise
Base scenario
100 basis point
decline(1)
200 basis point
decline(1)
$
$
181
871
121
811
60
750
—
690
(61)
629
(123)
567
Due to the low interest rate environment as of December 31, 2017,
stress scenarios involving interest rate declines greater than 200
basis points are not meaningful to Ambac's portfolios.
Credit Spread Risk:
Financial instruments that may be adversely affected by changes
in spreads include Ambac’s outstanding credit derivative contracts,
certain interest rate derivatives 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
($ in millions)
Estimated change in fair value
Estimated fair value
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 less than $0.1 million
reduction to the credit derivatives liability as of December 31,
2017. At December 31, 2017 the credit valuation adjustment
resulted in a 9.6% reduction of the credit derivative liability as
measured before considering Ambac credit risk. Refer to Note 9.
Fair Value Measurements
the Consolidated Financial
to
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 derivatives 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. As a result of the commutation of
certain derivatives in June 2017, there are no significant
liabilities as of
uncollateralized
rate derivative
interest
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 derivatives at December 31, 2017. It
is more likely that actual changes in credit spreads will vary by
obligor:
spreads
related
Change in Obligor Spreads
250 basis point
widening
50 basis point
widening
Base scenario
50 basis point
narrowing
250 basis point
narrowing
$
$
(23)
(33)
(5)
(15)
—
(10)
4
(6)
7
(3)
December 31, 2017.
Therefore, Ambac’s credit valuation
adjustment included in the fair value of interest rate derivatives
was $0.0 million as of December 31, 2017.
As a result of declines in uncollateralized interest rate and credit
default swap liabilities during 2017, changes in Ambac credit
spreads as much as 250 basis points would result in less than a $1
million impact to the fair value of derivatives at December 31,
2017.
Ambac’s fixed income investment portfolio contains securities
with different sensitivities to and volatility of spreads. Fixed
income securities that are guaranteed by Ambac and were
purchased in Ambac's investment portfolio have credit spread risk
characteristics that behave inversely to those associated with future
financial guarantee claim payments. Accordingly such securities
are excluded from the company's spread sensitivity measures. The
following table summarizes the estimated change in fair values of
Ambac’s fixed income investment portfolio assuming immediate
shifts in credit spreads across all holdings other than Ambac
guaranteed securities at December 31, 2017. It is more likely that
actual changes in credit spreads will vary by security:
($ 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
$
$
(149)
2,596
(30)
2,715
—
2,745
31
2,776
84
2,829
| Ambac Financial Group, Inc. 72 2017 FORM 10-K |
Foreign Currency Risk:
Ambac has financial instruments denominated in currencies other
than the U.S. dollar, primarily pounds sterling and euros. These
financial instruments are primarily invested assets of Ambac UK
and credit derivative contracts. 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, 2017.
($ in millions)
Estimated change in fair value
Change in Foreign Exchange Rates Against U.S. Dollar
20% Decrease
10% Decrease
10% Increase
20% Increase
$
(67) $
(34) $
34
$
67
| Ambac Financial Group, Inc. 73 2017 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 (Loss)......................................................................................................
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. Income Taxes......................................................................................................................................................................
Note 15. Employment Benefit Plans.................................................................................................................................................
Note 16. Commitments and Contingencies.......................................................................................................................................
Note 17. Subsequent Events..............................................................................................................................................................
Note 18. Quarterly Information (Unaudited) ....................................................................................................................................
Page
75
77
78
79
80
81
85
98
103
104
104
106
113
116
128
134
136
136
138
141
145
155
156
| Ambac Financial Group, Inc. 74 2017 FORM 10-K |
Report of Independent Registered Public Accounting Firm
The the Stockholders and Board of Directors
Ambac Financial Group, Inc.:
Opinion on Internal Control Over Financial Reporting
We have audited Ambac Financial Group, Inc. and subsidiaries' (the Company) internal control over financial reporting as of December 31,
2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations
of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee
of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the
consolidated balance sheets of the Company as of December 31, 2017 and 2016, the related consolidated statements of total comprehensive
income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related
notes and financial statement schedules (collectively, the consolidated financial statements), and our report dated February 28, 2018 expressed
an unqualified opinion on those consolidated financial statements.
Basis for Opinion
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 are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance
with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. 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 of
internal control over financial reporting 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.
Definition and Limitations of Internal Control Over Financial Reporting
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.
/s/ KPMG LLP
New York, New York
February 28, 2018
| Ambac Financial Group, Inc. 75 2017 FORM 10-K |
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Ambac Financial Group, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Ambac Financial Group, Inc. and subsidiaries (the Company) as of December
31, 2017 and 2016, the related consolidated statements of total comprehensive income (loss), stockholders’ equity, and cash flows for each of
the years in the three-year period ended December 31, 2017, and the related notes and financial statement schedules (collectively, the
consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial
position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the years in the
three-year period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the
Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated
Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 28,
2018 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to
be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of
the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our
audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to
error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding
the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and
significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe
that our audits provide a reasonable basis for our opinion.
/s/ KPMG LLP
We have served as the Company’s auditor since 1985.
New York, New York
February 28, 2018
| Ambac Financial Group, Inc. 76 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except share data) December 31,
2017
2016
Assets:
Investments:
Fixed income securities, at fair value (amortized cost of $4,614,623 and $5,435,385)
Fixed income securities pledged as collateral, at fair value (amortized cost of $99,719 and $64,833)
Short-term investments, at fair value (amortized cost of $557,476 and $430,827)
Other investments (includes $396,689 and $420,304 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
Current taxes
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 16)
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: 45,275,982 and 45,194,954
Additional paid-in capital
Accumulated other comprehensive income (loss)
Retained earnings
Treasury stock, shares at cost: 24,816 and 22,458
Total Ambac Financial Group, Inc. stockholders’ equity
Noncontrolling interest
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying Notes to Consolidated Financial Statements
$
$
$
$
$
$
$
4,652,172
99,719
557,270
431,630
5,740,791
623,703
11,177
16,532
586,312
40,997
52,195
631,213
10,358
73,199
11,803
846,973
46,614
2,914,145
978
11,529,384
54,877
1,123
23,192,374
783,155
4,745,015
37,876
—
33,659
—
991,696
436,984
82,782
67,583
1,932
589
12,160,544
2,205,264
37
21,547,116
—
453
199,560
(52,239)
1,233,845
(471)
1,381,148
264,110
1,645,258
23,192,374
$
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
| Ambac Financial Group, Inc. 77 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Total Comprehensive Income (Loss)
(Dollars in thousands, except share data) Year Ended December 31,
2017
2016
2015
$
175,277
$
197,287
$
312,595
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 (losses)
Change in fair value of credit derivatives:
Realized gains and other settlements
Unrealized gains (losses)
Net change in fair value of credit derivatives
Net gains (losses) on interest rate derivatives
Net realized gains (losses) on extinguishment of debt
Other income (expense)
Income (loss) on variable interest entities
Total revenues
Expenses:
Losses and loss expenses (benefit)
Insurance intangible amortization
Operating expenses
Interest expense
Goodwill impairment
Total expenses
Pre-tax income (loss)
Provision for income taxes
Net income (loss)
Less: net gain (loss) attributable to noncontrolling interest
Net income (loss) attributable to common shareholders
Other comprehensive income (loss), after tax:
Net income (loss)
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 (loss)
Less: comprehensive (loss) gain attributable to the noncontrolling interest:
Net gain (loss)
Currency translation adjustments
Total comprehensive income (loss) attributable to Ambac Financial Group, Inc.
Net income (loss) attributable to Ambac Financial Group, Inc. common
shareholders
Basic
Diluted
See accompanying Notes to Consolidated Financial Statements
$
$
$
$
$
337,774
23,179
360,953
(54,625)
34,454
(20,171)
5,366
1,589
14,783
16,372
59,565
4,920
(706)
19,670
621,246
513,186
150,854
121,516
119,941
—
905,497
(284,251)
44,464
(328,715)
—
(328,715) $
(328,715) $
(81,520)
73,586
1,273
(6,661)
(335,376)
—
—
(335,376) $
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
30,709
74,317
(526)
74,843
74,317
67,900
(122,128)
23
(54,205)
20,112
(526)
—
20,638
(7.25) $
(7.25) $
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
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
| Ambac Financial Group, Inc. 78 2017 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 (Loss)
Preferred
Stock
Common
Stock
Additional
Paid-in
Capital
Common
Stock Held
in Treasury,
at Cost
Noncontrolling
Interest
Balance at January 1, 2017
$ 1,978,024
$ 1,557,681
$
(38,990) $
— $
452
$
195,267
$
(496) $
264,110
—
—
—
—
25
—
—
—
—
—
—
—
—
(471) $
—
264,110
(118) $
273,547
—
—
—
(378)
—
—
—
—
(496) $
(526)
(6,442)
—
—
—
—
(2,469)
—
264,110
(56) $
274,630
—
—
(62)
—
(1,083)
—
—
—
—
(118) $
—
273,547
$
$
$
$
$
Total comprehensive income
(335,376)
(328,715)
Adjustment to initially apply
ASU 2018-02
Adjustment to initially apply
ASU 2016-09
Stock-based compensation
Cost of shares (acquired) issued
under equity plan
Cost of warrants acquired
—
6,588
(137)
4,293
(137)
—
(1,547)
(1,572)
—
—
Issuance of common stock
1
Balance at December 31, 2017 $ 1,645,258
—
$ 1,233,845
Balance at January 1, 2016
$ 1,958,346
$ 1,478,439
(6,661)
(6,588)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
4,293
—
—
—
(52,239) $
—
— $
1
453
—
199,560
$
15,215
$
— $
450
$
190,813
$
$
Total comprehensive income
20,112
74,843
(54,205)
—
—
—
—
—
2
—
—
452
$
$
—
—
5,253
—
(801)
—
—
2
195,267
189,138
—
3,105
—
(1,433)
3
190,813
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) $
—
— $
220,283
$
— $
450
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)
493,403
(205,068)
—
(312)
(3,942)
—
—
—
—
—
—
—
—
—
—
—
Warrants exercised
3
Balance at December 31, 2015 $ 1,958,346
—
$ 1,478,439
$
—
15,215
$
—
— $
—
450
$
See accompanying Notes to Consolidated Financial Statements
| Ambac Financial Group, Inc. 79 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
2017
2016
2015
$
(328,715) $
74,843
$
(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
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
Derivative assets and liabilities
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:
Net proceeds received from a secured borrowing
Paydowns of a secured borrowing
Payments for investment agreement draws
Payments for extinguishment of long-term debt
Tax payments related to shares withheld for share-based compensation plans
Proceeds from warrant exercises
Cost of warrants acquired
Net cash 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
$
| Ambac Financial Group, Inc. 80 2017 FORM 10-K |
—
(328,715)
992
—
(182,997)
4,293
31,939
(26,272)
(168,208)
399,982
(4,653)
9,425
76,900
49,969
150,854
(14,783)
(5,366)
20,171
(4,920)
(19,670)
(223,247)
21,538
(212,768)
2,138,936
813,990
(2,053,693)
349,799
(299,424)
(126,891)
(6,198)
122,844
(10,594)
928,769
—
(28,992)
(82,358)
(69,499)
(1,268)
—
—
(182,117)
(1,206)
532,678
91,025
623,703
(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
(7,625)
(27,896)
843,540
867,882
1,317,215
(2,574,285)
131,703
(281,570)
(206,002)
1,046
27,372
1,996
(714,643)
—
(29,482)
(17,964)
(19,550)
—
2
(2,717)
(69,711)
(3,905)
55,281
35,744
91,025
$
$
493,403
(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)
9,352
80,296
91,809
996,427
1,029,026
(2,374,441)
178,474
(128,186)
134,423
508
(6,833)
(5,143)
(175,745)
143,430
(13,533)
(63,872)
(13,752)
—
3
(5,375)
46,901
(1,124)
(38,159)
73,903
35,744
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 “Reorganization 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 Reorganization Effective Date. 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
Reorganization 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 Reorganization Effective Date was cancelled on the Reorganization 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 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)).
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 Reorganization Effective Date, the Company was generally discharged and released from all pre-Reorganization 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, 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 Reorganization
Effective Date.
| Ambac Financial Group, Inc. 81 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Business Description:
Ambac’s provides financial guarantee insurance policies through its principal operating subsidiary, Ambac Assurance Corporation (“Ambac
Assurance” or "AAC") 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 subsidiary, Everspan Financial Guarantee Corp. (“Everspan”),
which has been in runoff since its acquisition in 1997. 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
(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 the Stipulation and Order (described below). It is highly unlikely that Ambac
Assurance will be able to make dividend payments to Ambac for the foreseeable future.
Ambac also provides other financial products through subsidiaries of Ambac Assurance. These products consist of interest rate swaps, funding
conduits and investment agreements (until the first quarter of 2017) that were provided principally to clients that were also provided financial
guarantee policies. These financial products have been in active runoff since 2007.
Prior to the second quarter of 2017, Ambac had two reportable business segments: i) the financial guarantee segment, which consisted of
financial guarantee insurance policies and credit derivative contracts and ii) the financial services segment which consisted of the other financial
products discussed above. With respect to the financial services segment, there were significant swap commutations in June 2017. The remaining
interest rate swaps, along with other interest rate derivatives, are managed to economically hedge interest rate risk in the financial guarantee
and investment portfolios. The last remaining investment agreement matured in March 2017 and the remaining conduit transactions are not
material. The significant wind-down of these financial products, along with the appointment of a new Chief Executive Officer effective January
1, 2017, has resulted in a change in how the Company manages its business. Management now reviews financial information, allocates resources
and measures financial performance on a consolidated basis. As a result, beginning with the second quarter of 2017, the Company has a single
reportable segment. All prior period amounts and disclosures have been adjusted to reflect the reportable segment change.
In February 2018, Ambac achieved one of its key strategic priorities, the exit from rehabilitation of the Segregated Account. Having
accomplished this milestone, Ambac will continue to pursue and prioritize its remaining key strategic priorities, namely:
• Active runoff of Ambac Assurance and its subsidiaries through transaction terminations, policy commutations, settlements and
restructurings, with a focus on our watch list credits and known and potential future adversely classified credits, that we believe will
improve our risk profile, and maximizing the risk-adjusted return on invested assets;
• Ongoing rationalization of Ambac's and its subsidiaries' capital and liability structures;
• Loss recovery through active litigation management and exercise of contractual and legal rights;
• Ongoing review of organizational effectiveness and efficiency of the operating platform; and
• Evaluation of opportunities in certain business sectors that meet acceptable criteria that will generate long-term stockholder value with
attractive risk-adjusted returns.
With respect to our new business strategy, we have identified certain business sectors adjacent to Ambac's core business in which future
opportunities will be evaluated. The evaluation will be conducted through a measured and disciplined approach to identify opportunities that
are synergistic to Ambac, match Ambac's core competencies, are rapidly scalable or available through mergers and acquisitions and that may
allow for the utilization of Ambac's net operating loss carry-forwards. Although we are exploring new business opportunities, no assurance
can be given that we will be able to execute, or obtain the financial and other resources that may be required to finance, the acquisition or
development of any new businesses or assets. Furthermore, the execution of Ambac’s strategy to increase the value of its investment in Ambac
Assurance is subject to the rights of OCI under the Stipulation and Order, which requires OCI to approve certain actions taken by or in respect
of Ambac Assurance. Opportunities for remediating losses on poorly performing insured transactions 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. Decisions by OCI 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. 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 remains speculative.
The Segregated Account
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 OCI 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
| Ambac Financial Group, Inc. 82 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
of the Wisconsin Insurers Rehabilitation and Liquidation Act. 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. Net par exposure as of
December 31, 2017 for policies allocated to the Segregated Account was $9,246,357. Policy obligations not allocated to the Segregated
Account remained in the General Account of Ambac Assurance, and such policies in the General Account were not subject to and, therefore,
were not directly impacted by the Segregated Account Rehabilitation Plan.
Rehabilitation Exit Transactions
On July 19, 2017, Ambac Assurance and Ambac entered into an agreement (as amended as of September 21, 2017, the “Rehabilitation Exit
Support Agreement”) with holders or beneficial owners (the “Supporting Holders”) of surplus notes issued by Ambac Assurance and beneficial
interests in Deferred Amounts (as defined in the Segregated Account Rehabilitation Plan) of the Segregated Account with respect to a transaction
which, subject to the conditions precedent set forth in the Rehabilitation Exit Support Agreement, and if consummated, would generally involve
(i) the exchange of certain surplus notes held by holders of surplus notes that elect to participate in a voluntary exchange transaction and (ii)
the satisfaction and discharge of all Deferred Amounts, in each case for an effective consideration package comprised of cash and new Secured
Notes (as defined below) and certain existing surplus notes and (iii) the exit from rehabilitation of the Segregated Account and the merger of
the Segregated Account with and into Ambac Assurance (the “Rehabilitation Exit Transactions”).
On September 25, 2017 the Rehabilitator filed a motion in the Rehabilitation Court seeking entry of an order approving an amendment to the
Segregated Account Rehabilitation Plan (the "Second Amended Plan of Rehabilitation"). Following the conclusion of a Confirmation Hearing
on January 22, 2018, the Rehabilitation Court entered an order granting the Rehabilitator's motion and confirming the Second Amended Plan
of Rehabilitation. On February 12, 2018 (the "Effective Date"), the Second Amended Plan of Rehabilitation became effective and the
Rehabilitation Exit Transactions were consummated.
The Rehabilitation Exit Transactions involved a series of transactions which provided holders of beneficial interests in Deferred Amounts
(other than Ambac, but including Ambac Assurance) a total effective consideration package, in full satisfaction and discharge of each $1.00
of Deferred Amounts (including accretion), of (i) $0.40 in cash, (ii) $0.41 in principal amount of new Secured Notes (as defined below) and
(iii) from certain holders of surplus notes, $0.125 currently outstanding surplus notes. Such consideration package thereby provided a discount
of $0.065 (applied first against accretion of Deferred Amounts). Ambac received $0.91 in principal amount of Secured Notes for each $1.00
of Deferred Amounts (including accretion) that it held, and provided a $0.09 discount in full satisfaction and discharge of its Deferred Amount
claims.
In accordance with the Rehabilitation Exit Support Agreement, the Rehabilitation Exit Transactions also involved a series of interrelated
transactions involving the exchange of certain surplus notes (collectively, the “Exchange Offers”), pursuant to which, for each $1.00 of
principal amount outstanding and accrued and unpaid interest thereon, holders effectively (i) received $0.40 in cash, (ii) received $0.41 in
principal amount of Secured Notes, (iii) retained $0.125 in principal amount and accrued and unpaid interest thereon of surplus notes and (iv)
provided a discount of $0.065 in principal amount and accrued and unpaid interest thereon. Ambac did not participate in the Exchange Offers.
An aggregate of 99.6% of the surplus notes held by the Supporting Holders and parties other than Ambac and Ambac Assurance participated
both in the Rehabilitation Exit Transactions and in the Exchange Offers.
As part of the Rehabilitation Exit Transactions, Ambac and Ambac Assurance received consents from holders of surplus notes to a waiver and
amendment (the “BSA Waiver and Amendment”) of certain provisions of the Settlement Agreement. The BSA Waiver and Amendment
included a waiver of compliance with any and all restrictions, limitations and other provisions set forth in Section 3.04 of the Settlement
Agreement that could have directly or indirectly prohibited, restricted or limited in any manner the consummation or effectiveness of the
Rehabilitation Exit Transactions regardless of whether such a waiver was actually required in order to consummate or effect such transactions.
Among other provisions, the BSA Waiver and Amendment also includes amendments to the Settlement Agreement that eliminate the
requirement for Ambac Assurance to have Unaffiliated Qualified Directors on its Board of Directors; eliminate the prohibition on new business;
modify the restrictions on the incurrence of indebtedness and other material obligations; modify the restrictions on liens securing permitted
indebtedness; modify restrictions applicable to junior surplus notes; and modify restrictions on mergers or similar transactions. After giving
effect to the BSA Waiver and Amendment, the Settlement Agreement continues to limit certain activities of Ambac Assurance and its
subsidiaries, such as issuing indebtedness; engaging in mergers and similar transactions; disposing of assets; making restricted payments;
creating or permitting liens; engaging in transactions with affiliates; modifying or creating tax sharing agreements; and taking certain actions
with respect to surplus notes (among other restrictions and limitations). The Settlement Agreement includes certain allowances with respect
to these activities and generally requires the approval of OCI and, in some cases, holders of surplus notes issued pursuant to the Settlement
Agreement, for consents, waivers or amendments.
As contemplated by the Rehabilitation Exit Support Agreement and as a portion of the consideration received by holders of beneficial interests
in Deferred Amounts (including Ambac Assurance) in satisfaction and discharge of their claims pursuant to the Second Amended Plan of
Rehabilitation and by holders of surplus notes pursuant to the Exchange Offers (as specified above), a newly formed special purpose entity
(Ambac LSNI, LLC) issued new secured notes (the “Secured Notes”), secured by all assets of the special purpose entity, which include a note
issued by Ambac Assurance to the special purpose entity (the "Ambac Note"), which note is secured by a pledge of Ambac Assurance’s right,
| Ambac Financial Group, Inc. 83 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
title and interest in up to the first $1,400,000 of proceeds (net of reinsurance) from certain litigations in which Ambac Assurance seeks redress
for breaches of representations and warranties and/or fraud related to residential mortgage-backed securitizations (the “RMBS Litigations”).
In addition, the Ambac Note is secured by securities having a market value of approximately $350,000. Ambac Assurance also pledged for
the benefit of the holders of Secured Notes (other than Ambac Assurance) the proceeds of the Secured Notes held by Ambac Assurance from
time to time, and issued a financial guaranty insurance policy to a trustee for the benefit of holders of Secured Notes irrevocably guarantying
all principal and interest payments in respect of the Secured Notes as and when such payments become due and owing.
Until the earlier of (i) June 8, 2020 and (ii) the date on which at least 25% of the principal amount of surplus notes (other than junior surplus
notes) are no longer outstanding, Ambac has agreed to hold and not sell surplus notes (other than junior surplus notes) which, as of June 30,
2017, have an aggregate of $60,000 of principal amount and accrued and unpaid interest outstanding.
In connection with the Rehabilitation Exit Transactions, certain documents and instruments relating to the operation of the Segregated Account
or the rights of the Segregated Account and the Rehabilitator were terminated, including the Plan of Operation for the Segregated Account;
the Secured Note issued by Ambac Assurance to the Segregated Account; the Aggregate Excess of Loss Reinsurance Agreement between
Ambac Assurance, as reinsurer, and the Segregated Account; the Management Services Agreement between Ambac Assurance and the
Segregated Account; the Cooperation Agreement among Ambac Assurance, Ambac, the Segregated Account and the Rehabilitator; and the
Mediation Agreement dated September 21, 2011 among Ambac, Ambac Assurance, the Segregated Account, the Rehabilitator, OCI and the
official committee of unsecured creditors of Ambac.
Surplus Note Interest Payment
In connection with the consummation of the Rehabilitation Exit Transactions, Ambac Assurance received the approval of the OCI to make a
one-time current interest payment of $13,501 on the surplus notes (other than junior surplus notes) outstanding immediately following the
Effective Date. On February 12, Ambac Assurance notified the fiscal agent for the surplus notes that the record date for such interest payment
would be February 28, 2018 and the payment date would be March 1, 2018.
Tier 2 Financing
On the Effective Date, Ambac Assurance issued $240,000 of senior notes (the “Tier 2 Notes”) secured by Ambac Assurance’s rights, title and
interest in the cash and non-cash proceeds (net of reinsurance) above $1,600,000 received in connection with the RMBS Litigations.
Following the consummation of the Rehabilitation Exit Transactions, Ambac Assurance will seek to further improve its financial condition
by continuing to pursue asset monetizations; loss recoveries; restructurings, purchases, modifications or exchanges of certain outstanding
obligations; extinguishment or modification of certain contractual restrictions; and/or commuting or reducing insured exposures. Separately
from or in connection with the actions described above, we may seek to further optimize our capital and corporate structure to unlock shareholder
value.
Stipulation and Order
A Stipulation and Order, the terms of which were agreed between OCI, Ambac and Ambac Assurance, became effective upon the Effective
Date (the "Stipulation and Order") and provides as follows:
• Ambac Assurance shall maintain a level of surplus and contingency reserves as regards policyholders which provides reasonable security
against contingencies affecting its financial position that are not otherwise fully covered by reserves or reinsurance, such that the
Commissioner may continue to determine that Ambac Assurance’s surplus and contingency reserves are reasonably in excess of a level
that would constitute a financially hazardous condition.
• Statutory surplus may not reflect the benefit of any reserve discounting, except to the extent approved by the Commissioner.
• Ambac Assurance may not enter any transactions with affiliates, including the payment of a dividend or other distribution, without the
approval of the Commissioner, subject to limited exceptions.
• Ambac Assurance may not change its business plan or that of Everspan, including but not limited to the writing of new business, unless
approved by the Commissioner.
• Ambac Assurance must obtain OCI approval with respect to the exercise of certain control rights in connection with policies that had
been allocated to the Segregated Account.
• Ambac Assurance must obtain OCI approval with respect to any transaction Ambac Assurance proposes to enter into other than in ordinary
course of business with non-affiliated counterparties where the aggregate consideration to be paid by Ambac Assurance is equal to or
greater than $100,000.
• Ambac Assurance must obtain OCI approval for any change to its Investment Policy or Derivative Use Plan.
• Ambac Assurance must provide OCI with a monthly report of financial information, the scope of which is to be determined.
| Ambac Financial Group, Inc. 84 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
• Ambac Assurance shall provide, and Ambac shall also provide, notice to the Commissioner within ten (10) days of receipt of any
communication from any governmental authority, government-sponsored enterprise, or lender to Ambac Assurance, Ambac, or any
affiliates which pertains to a circumstance, event or issue which would be reasonably likely to have a material adverse effect on the
financial condition or operations of Ambac Assurance and its subsidiaries taken as whole.
• Ambac Assurance shall provide notice as soon as practicable of any development in any litigation, including any delay in RMBS litigation,
involving Ambac Assurance or any affiliate of Ambac Assurance which would or would be reasonably likely to have a material adverse
effect on Ambac Assurance.
• Ambac Assurance shall provide notice to the Commissioner of the occurrence, or failure to occur, of any event which would or would
be reasonably likely to cause a material adverse effect to the business, assets, properties, operations, or condition, financial or otherwise,
or, insofar as can reasonably be foreseen, prospects, financial or otherwise, of Ambac Assurance, an affiliate of Ambac Assurance, or
Ambac Assurance and all affiliates taken as a whole. A material adverse effect shall be conclusively presumed if the effect results, or
reasonably could result, in a reduction of more than 10% in Ambac Assurance’s surplus as regards policyholders.
• Ambac Assurance shall disclose, and Ambac shall disclose, to the Commissioner any instance of fraud or any significant change to the
internal control environment incurred by Ambac Assurance, any of its subsidiaries, or Ambac.
• If Ambac Assurance proposes to make any changes in the assumptions or vendors utilized in determining statutory loss reserves from
the prior year’s statutory loss reserves which would cause the difference (whether positive or negative) between (a) Ambac Assurance’s
statutory reserves determined with such proposed changes and (b) Ambac Assurance’s statutory reserves determined without such proposed
changes to exceed the lesser of (i) $200,000 or (ii) 10% of Ambac Assurance’s statutory loss reserves without such proposed changes,
Ambac Assurance shall notify the Commissioner.
• Ambac shall use its best efforts to preserve use of net operating loss carry-forwards for the benefit of Ambac Assurance and its subsidiaries,
including but not limited to, refraining from taking any action that would result in, and taking such affirmative steps as are appropriate
to avoid, any deconsolidation event.
• Ambac shall provide the Commissioner and Ambac Assurance its full cooperation in relation to any issues that Ambac Assurance or its
subsidiaries may have relative to the United States Internal Revenue Service, including efforts to obtain a private letter ruling, pre-filing
agreement, or other form of guidance or clarification.
The Commissioner reserves the right to modify or terminate the Stipulation and Order in a manner consistent with the interests of policyholders,
creditors and the public generally, and recognizes that Ambac Assurance may request the Commissioner to do so periodically as conditions
warrant.
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 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. 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. An entity that is deemed the primary
beneficiary of a VIE is required to consolidate the VIE. Refer to Note 3. Special Purpose Entities, Including Variable Interest Entities, for a
| Ambac Financial Group, Inc. 85 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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, 2017 and 2016 and for the years ended
December 31, 2017, 2016 and 2015. Investments in subsidiaries are accounted for using the equity method of accounting.
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 non-VIE 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. 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 fixed income 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 that were allocated to the Segregated Account, the estimate of Ambac Assurance claim
payments included interest on Deferred Amounts, which were discharged on February 12, 2018. Ambac estimated the timing of claim payment
| Ambac Financial Group, Inc. 86 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
receipts on all Ambac-insured securities owned, but the actual timing of such amounts for Segregated Account securities was at the sole
discretion of the Rehabilitator. Refer to Note 1. Background and Business Description for more information on the Segregated Account and
the Segregated Account Rehabilitation Proceedings. 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, 2017 and 2016, was 2.5%.
and 2.6%, respectively, and the weighted average period of future premiums used to estimate the premium receivable at December 31, 2017
and 2016, was 9.8 years and 9.0 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. 87 2017 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
economically hedge interest rate risk in the financial guarantee and investment portfolios. 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 all interest rate derivatives are recorded in net gains (losses) on interest rate derivatives 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. Effective January 3, 2017, as a result of rule changes by the central clearing party ("CCP"),
variation payments are considered settlements of the associated derivative balance and are reflected as a reduction to derivative liabilities on
the Consolidated Balance Sheet at December 31, 2017. For periods presented prior to this rule change, variation payments were included in
"Other assets" on the Consolidated Balance Sheet. 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, including details of the CCP rule change. 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 reporting unit to which goodwill was assigned. 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 where we estimated the fair value of the 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 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 reporting unit's fair value and substantial increases in the fair value of its net assets. The fair value
of the reporting unit decreased significantly due to a material decrease in Ambac's market capitalization components (described above). The
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.
| Ambac Financial Group, Inc. 88 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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. The carrying values of our financial
guarantee insurance and reinsurance contracts 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 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 above. 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 Segregated Account Rehabilitation Plan. Refer to Note 1. Background and Business Description for
further discussion of the 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, which is discussed further in the “RMBS Representation and Warranty Subrogation Recoveries”
section below, (iii) excess spread within the underlying transaction's cash flow structure, and (iv) other subrogation recoveries, including
expected receipts from third parties within the underlying transaction's cash flow structure. 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 ongoing review of
the financial guarantee credit portfolio. Active surveillance of the insured portfolio enables Ambac’s Risk Management Group ("RMG") 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 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 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 RMG using the following guidelines:
| Ambac Financial Group, Inc. 89 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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. Through ongoing surveillance, Ambac may also designate Class I credits into one or more of the following categories:
•
Survey list - credits that may lack information or demonstrate a weakness but further deterioration is not expected.
• Watch list - credits that demonstrate the potential for future material adverse development due to such factors as long-term uncertainty
about a particular sector, a certain structural element related to the issuer or transaction or overall financial and economic sustainability.
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 certain
of 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 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 RMG 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 RMG 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 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.
| Ambac Financial Group, Inc. 90 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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 a RMBS transaction provided representations and
warranties with respect to the securitized loans, including representations and warranties with respect to loan characteristics, the absence of
borrower fraud in the underlying loan pools and 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. 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.
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
| Ambac Financial Group, Inc. 91 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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.
The approach used 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. 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.
Obligations under Investment Agreements:
Ambac's investment agreements were written principally to asset-backed and structured finance issuers, states, municipalities and municipal
authorities, and required 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 was included in Net investment income
on the Consolidated Statements of Total Comprehensive Income. The principal amount outstanding under investment agreements of $82,358,
with a variable interest rate of 0.94%, at December 31, 2016 was repaid during the first quarter of 2017.
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 or redeems
its long-term debt, 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.
Noncontrolling Interest:
At December 31, 2016 and 2017, Ambac Assurance had 26,411 shares of issued and outstanding auction rate preferred shares with a liquidation
preference of $660,300 (reported as noncontrolling interest of $264,110 on Ambac's balance sheet). The auction occurs every 28 days. Due
to the dislocation in the auction rate markets and the Company’s financial condition, the dividend rate on the auction market preferred has
continuously been reset at the maximum rate of one-month LIBOR plus 200 basis points.
Under the terms of the preferred stock, dividends may not be paid on the common stock of Ambac Assurance unless all accrued and unpaid
dividends on the preferred stock 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 preferred stock become cumulative until the date that all accumulated and unpaid dividends have been paid on the
preferred stock. Ambac Assurance has not paid dividends on its preferred stock since 2010.
| Ambac Financial Group, Inc. 92 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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.
Incentive Compensation:
Incentive compensation is a key component of our compensation strategy. Our incentive compensation awards generally have two components:
short term incentive compensation (consisting of an annual cash bonus and deferred stock units for certain officers) and long term incentive
plan awards (consisting of cash awards and performance stock units). Annual decisions with regard to incentive compensation are generally
made in the first quarter of each year and are based on Company performance and individual and business unit performance of the prior year.
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.
Prior to the adoption of ASU 2016-09 (as noted below), Ambac recognized compensation costs for all equity classified awards granted at
fair value with an estimation of forfeitures for all unvested shares. As a result of the adoption of ASU 2016-09 in 2017, Ambac recognizes
compensation costs for all equity classified awards granted at fair value and records forfeitures for unvested shares only when they occur.
• Deferred stock units granted vest upon grant and will settle and convert to Ambac common stock annually over a two-year period (50%
on the first anniversary of the grant date and 50% on the second anniversary of the grant date). The fair value of these grants is recognized
as compensation expense on the date of grant since no future service is required.
• Restricted stock units granted only require future service and accordingly the respective fair value is amortized into compensation expense
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.
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 (Loss)
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 $21,116,
$(39,128) and $(17,010) for the years ended December 31, 2017, 2016 and 2015, 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 $28,939, $(77,578) and $(24,838) for the years
ended December 31, 2017, 2016 and 2015, respectively;
| Ambac Financial Group, Inc. 93 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
• Realized gain (loss) from the sale 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 $(4,769), $30,179 and $5,816 for the years ended December 31, 2017, 2016
and 2015, respectively;
• Remeasurement of premium receivables, classified in Other income, in the amount of $(1,904), $8,003 and $(2,555) for the years ended
December 31, 2017, 2016 and 2015, respectively; and
• Remeasurement of credit derivative liabilities, classified in Net change in fair value of credit derivative, in the amount of $(1,150), $32
and $3,981 for the years ended December 31, 2017, 2016 and 2015, respectively.
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). Current tax assets and liabilities are recognized for taxes refundable or payable for the current year. 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 current and
deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. In December 2017, the
Tax Cut and Jobs Act ("TCJA") was enacted that introduces significant changes that impact U.S. corporate tax rates, business-related exclusions,
and deductions and credits effective January 1, 2018. As such, we incorporated the effects of the TCJA in our current and deferred tax evaluation
for the year ended December 31, 2017.
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 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 14. Income
Taxes for further discussion of the Company's tax positions, including the impact of the TCJA.
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.
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 and 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 used for basic earnings per share 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, vested and unvested options, unvested restricted stock units and unvested performance stock
units granted under employee and director compensation plans.
Supplemental Disclosure of Cash Flow Information:
(Dollars in thousands) Year Ended December 31,
2017
2016
2015
Cash paid during the period for:
Income taxes
Interest on long-term debt and investment agreements
Non-cash financing activities:
$
40,334
$
39,112
21,437
$
4,537
16,969
1,847
Decrease in long-term debt as a result of an exchange for investment securities
55,426
—
—
Reclassifications:
Reclassifications may have been made to prior years' amounts to conform to the current year's presentation.
| Ambac Financial Group, Inc. 94 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Recently Adopted Accounting Standards:
Effective December 31, 2017, Ambac early adopted the following accounting standard:
Reclassification of Shareholders' Equity items related to the TCJA
In February 2018, the FASB issued ASU 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220) - Reclassification of
Certain Tax Effects from Accumulated Other Comprehensive Income. Current GAAP requires the effect of a change in tax laws or rates which
impact deferred tax assets and liabilities to be recorded as income tax expense within net income. This guidance is applicable even in situations
where the related income tax effects of items in accumulated other comprehensive income ("AOCI") were originally charged or credited
directly to AOCI as required by GAAP. As a result, when tax laws or rates change, the tax effects of certain items (referred to as "stranded
tax effects") in AOCI may not reflect the appropriate tax rate. This ASU eliminates the stranded tax effects by allowing a reclassification of
those items from AOCI to retained earnings that resulted from the recently enacted TCJA. Ambac early adopted this standard effective
December 31, 2017. Adoption of this ASU resulted in a decrease to AOCI of $6,588 and offsetting increase to retained earnings of $6,588
with no change to total shareholders' equity.
Effective January 1, 2017, Ambac adopted the following accounting standards:
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 previous 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. Adoption of this ASU did not have an impact on
Ambac's financial statements.
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) for purposes of accruing compensation
costs, allowing companies to make an accounting policy election to either: a) estimate forfeitures or b) account for forfeitures as they occur,
which Ambac elected to do upon adoption, (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. Adoption of this ASU did 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. Adoption of this ASU
did not have an 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.
Previous accounting rules required 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. Adoption of this ASU did not have an impact on
Ambac's financial statements.
Future Application of Accounting Standards:
Equity-linked instruments with down round features
In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260) and Derivatives and Hedging (Topic 815) - Accounting for
Certain Financial Instruments with Down Round Features. Equity-linked instruments, such as warrants and convertible instruments may
contain down round features that result in the strike price being reduced on the basis of the pricing of future equity offerings. Under the ASU,
| Ambac Financial Group, Inc. 95 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
a down round feature will no longer require a freestanding equity-linked instrument (or embedded conversion option) to be classified as a
liability that is remeasured at fair value through the income statement (i.e. marked-to-market). However, other features of the equity-linked
instrument (or embedded conversion option) must still be evaluated to determine whether liability or equity classification is appropriate. Equity
classified instruments are not marked-to-market. For earnings per share ("EPS") reporting, the ASU requires companies to recognize the effect
of the down round feature only when it is triggered by treating it as a dividend and as a reduction of income available to common shareholders
in basic EPS. The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning
after December 15, 2018. Early adoption is permitted, including adoption in any interim period. Ambac will adopt this ASU on January 1,
2019. The adoption of this ASU is not expected to have a consequential impact on Ambac's financial statements.
Stock Compensation--Scope of Modification Accounting
In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718) - Scope of Modification Accounting. The ASU
provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification
accounting. Entities will apply the modification accounting guidance if the value, vesting conditions or classification of the award changes.
The current disclosure requirements in Topic 718 apply regardless of whether an entity is required to apply modification accounting under the
amendments in this ASU. The amendments in this ASU are effective for all entities for annual periods, and interim periods within those annual
periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period for which financial statements
have not yet been issued. Ambac will adopt this ASU on January 1, 2018. The adoption of this ASU is not expected to have a consequential
impact on Ambac's financial statements.
Premium Amortization on Callable Debt Securities
In March 2017, the FASB issued ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20) - Premium Amortization
on Purchased Callable Debt Securities. The ASU shortens the amortization period for the premium on callable debt securities to the earliest
call date. Under current GAAP, a reporting entity generally amortizes the premium as yield adjustment over the contractual life (i.e. maturity)
of the debt security and if that debt security is called, the entity would record a loss equal to the unamortized premium. The ASU does not
change the accounting for callable debt securities held at a discount, which will continue to be amortized to maturity. ASU 2017-08 is effective
for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The ASU
must be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of
the period of adoption. Ambac will adopt this ASU on January 1, 2019 and we are evaluating its impact on Ambac's financial statements.
Net Periodic Pension and Postretirement Costs
In March 2017, the FASB issued ASU 2017-07, Compensation-Retirement Benefits (Topic 715) - Improving the Presentation of Net Periodic
Pension Cost and Net Periodic Postretirement Benefit Cost. The objective of the ASU is to increase transparency in the reporting of net
pension cost and net postretirement cost (collectively "net benefit cost"). The ASU requires that the service cost component of net benefit cost
be reported on the same line item as other compensation costs arising from services rendered by employees. It further requires that the other
components of net benefit costs (i.e. interest costs, amortization of prior service cost, etc.) be presented separately from the service cost
component and outside the subtotal of income from operations, if one is presented. ASU 2017-09 is effective for fiscal years beginning after
December 15, 2017 and interim periods within those fiscal years, with early adoption permitted. Ambac will adopt this ASU on January 1,
2018. The adoption of this ASU is not expected to have a consequential impact on Ambac's financial statements.
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. The adoption of this ASU is not expected to have a
consequential impact on Ambac's financial statements.
| Ambac Financial Group, Inc. 96 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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 will adopt this ASU on January 1,
2018 and we are 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 will adopt this ASU on January 1, 2018. Adoption of this ASU is not expected
to have a consequential impact on Ambac's financial statements.
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.
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
interim periods within those fiscal years. The transition guidance requires lessees to recognize and measure leases at the beginning of the
| Ambac Financial Group, Inc. 97 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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. Ambac will adopt all provisions of this ASU on January 1, 2018.
Ambac has elected the fair value option for all VIE financial assets and financial liabilities with net fair value changes reported in Income
(loss) on variable interest entities in the Consolidated Statements of Total Comprehensive Income. Upon implementation of ASU 2016-01,
the credit component of fair value changes in VIE liabilities will be reported in Accumulated other comprehensive income. We are still
evaluating the transition adjustment impact of the ASU, which will be a reclassification between Retained earnings and Accumulated other
comprehensive income, with no net change to Total stockholders' equity. Subsequent to adoption, because the credit component of fair value
changes in VIE liabilities will be reported in other comprehensive income, we will likely have greater volatility in net income (specifically
the Income (loss) on variable interest entities line item).
Revenue recognition
In May 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. This ASU
does not apply to insurance contracts and most financial instruments and therefore did not have an impact on Ambac's financial statements.
3.
SPECIAL PURPOSE ENTITIES, INCLUDING VARIABLE INTEREST ENTITIES
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 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
| Ambac Financial Group, Inc. 98 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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,
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. As further discussed in Note 1.
Background and Business Description, the OCI requires Ambac Assurance to obtain its approval with respect to the exercise of certain control
rights in connection with policies that had been allocated to the Segregated Account. Accordingly management expects the number of additional
VIEs that may be consolidated as a result of the Segregated Account's exit from rehabilitation will be reduced and possibly eliminated. A VIE
is deconsolidated in the period that Ambac no longer has such control, which could occur in connection with the 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 (Loss).
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 (Loss).
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.
As of December 31, 2017 consolidated FG VIE assets and liabilities relating to 11 consolidated entities were $14,500,507 and $14,366,434,
respectively. 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, 2017, eight and three consolidated FG VIEs related to transaction insured by Ambac UK and
Ambac Assurance and eight and four as of December 31, 2016. As of December 31, 2017 FG VIE assets and liabilities of $14,160,152 and
$14,026,704 and as of December 31, 2016, FG VIE assets and liabilities of $12,950,009 and $12,833,466 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 these 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. 99 2017 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
2017
2016
2015
$
$
19,670
—
19,670
$
$
(14,093) $
—
(14,093) $
30,997
572
31,569
Ambac deconsolidated one, one and two VIEs for the years ended December 31, 2017, 2016 and 2015, respectively. These VIEs were
deconsolidated as a result of guaranteed bond retirements or financial guarantee policy terminations that eliminated Ambac's controlling interest
in the entities. The deconsolidations occurring in 2017 and 2016 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, 2017 and
2016:
December 31,
Investments:
Corporate obligations
Total variable interest entity assets: fixed income securities
2017
2016
$
$
2,914,145
2,914,145
$
$
2,622,566
2,622,566
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, 2017 and 2016:
December 31, 2017:
Loans
Long-term debt
December 31, 2016:
Loans
Long-term debt
Ambac Sponsored VIEs:
Estimated fair
value
Unpaid principal
balance
$
11,529,384
$
12,160,544
10,658,963
$
11,155,936
$
8,168,651
9,387,884
7,641,756
8,854,530
A subsidiary of Ambac transferred financial assets to a special purpose entity. The business purpose of this entity was to provide certain
financial guarantee clients with funding for their debt obligations. This special purpose entity was established as a separate legal entity,
demonstrably distinct from Ambac and that Ambac, its affiliates or its agents could not unilaterally dissolve. The permitted activities of this
entity 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. Ambac does not consolidate this entity
because Ambac Assurance’s policies issued to it were allocated to the Segregated Account, thereby limiting Ambac’s control over the entity's
most significant economic activities. Pursuant to the Stipulation and Order (described in Note 1. Background and Business Description),
Ambac's exercise of certain control rights with respect to former Segregated Account policies will continue to be subject to approval by OCI.
Ambac has elected to account for its equity interest in this entity 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 this entity 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 this entity. At December 31, 2017 and 2016 the fair value of this entity was $5,979 and $7,382, respectively, and is reported within
Other assets on the Consolidated Balance Sheets.
• Total principal amount of debt outstanding was $420,600 and $388,950 at December 31, 2017 and 2016, respectively. In each case,
Ambac sold assets to this entity. The assets are composed of utility obligations with a weighted average rating of BBB+ at December 31,
2017 and weighted average life of 3.1 years. The purchase by this entity of financial assets was financed through the issuance of 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 entity for economic hedging purposes only. Derivative positions were
established at the time MTNs were issued to purchase financial assets. As of December 31, 2017, all fixed-income securities owned,
MTNs outstanding and payments due under derivative contracts were guaranteed under financial guarantee insurance policies issued by
Ambac Assurance or Ambac UK.
| Ambac Financial Group, Inc. 100 2017 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 and Ambac UK by this entity 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 (Loss). 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). Although the Securities were legally sold to the Trust, the Securities will remain in fixed income securities
on the Consolidated Balance Sheets. The Securities had par and fair value of $293,409 and $346,212 as of December 31, 2017, respectively.
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 $73,993 and $102,403 as of December 31, 2017 and 2016, 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 and an owner trust certificate, which represents Ambac's right to residual cash
flows from the junior surplus notes. 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 (Loss). The equity investment had a carrying value of $34,941
and $30,003 as of December 31, 2017 and 2016, respectively. Additionally, at December 31, 2017 Ambac held $35,000 of the debt issued by
this VIE.
| Ambac Financial Group, Inc. 101 2017 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, 2017 and
2016:
Carrying Value of Assets and Liabilities
Maximum
Exposure
To Loss (1)
Insurance
Assets (2)
Insurance
Liabilities (3)
Net Derivative
Assets
(Liabilities) (4)
December 31, 2017:
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, 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
$
35,555
$
169
$
1
$
12,766,685
2,266,610
987,797
2,513,304
18,569,951
25,629,816
619,848
23,405
30,413
60,086
733,921
335,347
3,218,356
328,732
35,976
306,457
3,889,522
371,056
44,199,767
$
1,069,268
$
4,260,578
$
(15)
—
—
—
10,311
10,296
(551)
9,745
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
$
48,271,212
$
1,223,037
$
4,261,578
$
—
—
—
13,347
(132,055)
(8,827)
(140,882)
$
$
(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. 102 2017 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, 2017:
Beginning Balance
Other comprehensive income before reclassifications
Amounts reclassified from accumulated other
comprehensive income
Adjustment to initially adopt ASU 2018-02
Net current period other comprehensive income
Balance at December 31, 2017
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 (loss)
Balance at December 31, 2016
$
$
$
$
9,367
$
2,625
(167,220) $
73,586
118,863
$
(96,325)
14,805
(6,588)
(88,108)
(1,352)
—
1,273
30,755
$
10,640
$
50,963
$
85,378
(17,478)
67,900
9,344
$
1,041
(1,018)
23
—
—
73,586
(93,634) $
(45,092) $
(122,128)
—
(122,128)
(38,990)
(20,114)
13,453
(6,588)
(13,249)
(52,239)
15,215
(35,709)
(18,496)
(54,205)
(38,990)
118,863
$
9,367
$
(167,220) $
(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,
2017
2016
Affected Line Item in the
Consolidated Statement of
Total Comprehensive Income
$
$
$
$
14,805
—
14,805
$
$
(963) $
(389)
(1,352)
—
(1,352)
13,453
$
(17,478) Net realized investment gains
— Tax (expense) benefit
(17,478) Net of tax and noncontrolling interest (3)
(666) Underwriting and operating expenses (2)
(352) Underwriting and operating expenses (2)
(1,018) Total before tax
— Tax (expense) benefit
(1,018) Net of tax and noncontrolling interest (3)
(18,496) 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.
| Ambac Financial Group, Inc. 103 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
5.
NET INCOME PER SHARE
On May 1, 2013, pursuant to the Second Modified Fifth Amended Plan of Reorganization of Ambac (the "Reorganization Plan"), 45,000,000
shares of new common stock at par value of $0.01 per share and 5,047,138 warrants were issued. Warrants entitled 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, 2017, 2016 and 2015, 0, 136, and 740, warrants, respectively, were exercised, resulting in an issuance of 0, 136 and 236
shares of common stock.
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 a $10,000 increase to the warrant repurchase
program. For the year ended December 31, 2017, Ambac repurchased 0 warrants at a cost of $0. As of December 31, 2017, Ambac had
repurchased 985,331 warrants at a cost of $8,092, (average cost of $8.21 per warrant), leaving 4,053,670 warrants outstanding. The remaining
aggregate authorization at December 31, 2017 is $11,939.
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(1):
Warrants
Stock options
Restricted stock units
Performance stock units
2017
2016
2015
45,367,932
45,212,414
45,173,542
—
—
—
—
312,619
447
116,105
81,939
809,834
5,313
14,221
3,117
Diluted weighted average shares outstanding
45,367,932
45,723,524
46,006,027
Anti-dilutive shares excluded from the above reconciliation
Stock options
Warrants
Restricted stock units
Performance stock units (2)
126,667
4,053,670
68,654
322,943
110,000
110,000
—
—
—
—
—
—
(1) For the year ended December 31, 2017, Ambac has a net loss and accordingly excluded all potentially dilutive securities from the determination of diluted
loss per share as their impact was anti-dilutive.
(2) Performance stock units are reflected herein at their target issuance amounts. Vesting of these units is contingent upon meeting certain performance
metrics. Although a portion of these performance metrics have been achieved as of the respective period end, it is possible that awards may no longer
meet the metric at the end of the performance period.
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 as opposed to the current accreted value of the bonds.
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 $67,140,000 and $86,373,000 at December 31, 2017 and 2016, respectively. The
par amount of financial guarantees outstanding, net of reinsurance, was $62,716,000 and $79,346,000 at December 31, 2017 and 2016,
respectively.
| Ambac Financial Group, Inc. 104 2017 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, 2017 and 2016, 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
Housing revenue
General obligation
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
2017
2016
$
11,893,000
$
15,688,000
6,312,000
6,257,000
2,212,000
2,002,000
1,642,000
807,000
963,000
6,508,000
9,867,000
4,298,000
3,860,000
2,339,000
1,484,000
1,018,000
32,088,000
45,062,000
7,267,000
3,274,000
1,238,000
443,000
33,000
1,561,000
13,816,000
5,696,000
5,664,000
2,609,000
1,777,000
246,000
—
820,000
16,812,000
$
62,716,000
$
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
79,346,000
(1) At December 31, 2017 and 2016, all asset-backed net par amounts outstanding relate to commercial asset-based transactions.
As of December 31, 2017 and 2016, the International Finance guaranteed portfolio by location of risk was as outlined in the table below:
Net Par Outstanding December 31,
United Kingdom
Italy
Austria
Australia
France
Internationally diversified (1)
Other international
Total International Finance
2017
2016
$
13,554,000
$
12,798,000
877,000
770,000
608,000
329,000
368,000
306,000
898,000
696,000
1,393,000
286,000
648,000
614,000
$
16,812,000
$
17,333,000
(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 $108,550,000 and $137,745,000 at December 31, 2017 and 2016, respectively.
Net financial guarantees in force (after giving effect to reinsurance) were $101,223,000 and $126,306,000 as of December 31, 2017 and 2016,
respectively.
In the United States, California, New York and New Jersey were the states with the highest aggregate net par amounts in force, accounting
for 10.1%, 5.8% and 5.2% of the total at December 31, 2017, respectively. No other state accounted for more than 5.0%. The highest single
insured risk represented 2.6% of the aggregate net par amount guaranteed.
| Ambac Financial Group, Inc. 105 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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)
2017
2016
2015
$
661,337
$
831,575
$
1,000,607
(81,597)
(30,334)
16,162
(141)
20,885
(77,038)
(78,528)
18,637
6,054
(39,363)
$
586,312
$
661,337
$
(108,029)
(64,740)
24,628
2,540
(23,431)
831,575
(1) Gross premium receivable includes premiums to be received in foreign denominated currencies most notably in British Pounds and Euros. At December
31, 2017, 2016 and 2015 premium receivables include British Pounds of $151,852 (£112,342), $177,878 (£144,393) and $226,994 (£154,135), respectively,
and Euros of $36,001 (£29,976), $34,866 (€33,108) and $43,451 (€40,014), respectively.
In structured finance transactions, the priority for the payment of financial guarantee premiums to Ambac, as required by bond indentures of
insured structured finance obligations, is generally senior in the waterfall. Additionally, trustees and other parties are required under the Second
Amended Plan of Rehabilitation 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. Uncollectable premiums are determined on a policy
basis and utilize a combination of historical premium collection data in addition to cash flow analysis to determine if an impairment in the
related policy's premium receivables exist. At December 31, 2017 and 2016, $9,331 and $9,186 respectively, of premium receivables were
deemed uncollectable. As of December 31, 2017 and 2016, approximately 22% and 25%, respectively, of the premium receivables relate to
transactions with non-investment grade internal ratings, comprised mainly of structured finance transactions, which comprised 16% and 16%
of total premium receivables at December 31, 2017 and 2016, respectively. Past due premiums on policies insuring non-investment grade
obligations amounted to less than $500 at December 31, 2017.
The effect of reinsurance on premiums written and earned was as follows:
2017
2016
2015
Year Ended December 31,
Written
Earned
Written
Earned
Written
Earned
Direct
Assumed
Ceded
Net premiums
$
$
(14,313) $
190,496
$
(53,837) $
215,564
$
(37,572) $
336,025
—
(2,104)
106
15,325
—
(8,772)
85
18,362
—
(3,001)
(12,209) $
175,277
$
(45,065) $
197,287
$
(34,571) $
87
23,517
312,595
Ambac’s accelerated premium revenue for retired obligations for the years ended December 31, 2017, 2016 and 2015, was $64,494, $52,416
and $137,400, respectively.
The following table summarizes net premiums earned by location of risk:
Year Ended December 31,
United States
United Kingdom
Other international
Total
2017
2016
2015
$
$
134,099
$
168,646
$
32,928
8,250
24,470
4,171
175,277
$
197,287
$
229,658
68,799
14,138
312,595
| Ambac Financial Group, Inc. 106 2017 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, 2017:
Three months ended:
March 31, 2018
June 30, 2018
September 30, 2018
December 31, 2018
Twelve months ended:
December 31, 2019
December 31, 2020
December 31, 2021
December 31, 2022
Five years ended:
December 31, 2027
December 31, 2032
December 31, 2037
December 31, 2042
December 31, 2047
December 31, 2052
December 31, 2057
Total
Future
Premiums
to be
Collected (1)
Future
Premiums
to be
Earned Net of
Reinsurance (1)
$
16,923
$
13,801
14,779
13,282
55,203
52,282
45,848
43,678
193,190
150,385
82,597
29,169
13,599
3,586
92
17,561
17,294
16,604
16,150
61,368
57,263
52,149
48,447
197,446
131,682
72,520
24,833
12,694
4,651
298
$
728,414
$
730,960
(1) Future premiums to be collected are undiscounted and are used to derive the discounted premium receivable asset recorded on Ambac's balance sheet.
Future premiums to be earned, net of reinsurance relate to the unearned premiums 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 further described in Note 2. Basis of Presentation and Significant Accounting Policies. This 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 may result 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, 2017 and 2016:
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, 2017:
Loss and loss expense reserves
Subrogation recoverable
Totals
December 31, 2016:
Loss and loss expense reserves
Subrogation recoverable
Totals
$
$
$
$
2,411,632
615,391
3,027,023
2,411,105
583,042
2,994,147
$
$
$
$
667,988
171,755
839,743
529,703
132,139
661,842
$
$
$
$
2,855,010
102,171
2,957,181
2,681,198
68,419
2,749,617
$
$
$
$
(1,054,113) $
(135,502) $
4,745,015
(1,520,530)
—
(631,213)
(2,574,643) $
(135,502) $
4,113,802
(1,098,096) $
(143,141) $
4,380,769
(1,468,331)
—
(684,731)
(2,566,427) $
(143,141) $
3,696,038
| Ambac Financial Group, Inc. 107 2017 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.
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)
2017
2016
2015
3,696,038
30,767
3,665,271
$
$
2,858,813
44,059
2,814,754
$
$
3,798,733
100,355
3,698,378
5,691
507,495
513,186
825
133,427
134,252
28,939
6,675
(18,164)
(11,489)
5,371
(944,955)
(939,584)
(77,578)
4,073,144
40,658
4,113,802
$
$
3,665,271
30,767
3,696,038
$
$
1,183
(769,890)
(768,707)
—
90,086
90,086
(24,831)
2,814,754
44,059
2,858,813
$
$
$
$
(1) Total losses and loss expenses (benefit) includes $(20,348), $5,421 and $47,085 for the years ended December 31, 2017, 2016 and 2015, respectively,
related to ceded reinsurance.
(2) Ambac records the impact of estimated recoveries related to securitized loans in RMBS transactions that breached certain R&Ws 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, 2017, 2016 and 2015 was $72,003, $(71,369) and $(303,633), 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 $339, $(349) and $(60) as of December 31, 2017, 2016 and 2015, respectively, related to previously
presented loss and loss expenses and subrogation.
(4)
Includes Euro denominated gross loss and loss expense reserves of $21,116 (€17,582), $21,375 (€20,297) and $19,019 (€17,515) at December 31, 2017,
2016 and 2015, respectively.
For 2017, the net adverse development in prior years was primarily the result of negative development in certain public finance transactions,
including Puerto Rico, and interest accrued on Deferred Amounts partially offset by positive developments in certain Ambac UK transactions,
including a benefit related to a confidential settlement of litigation brought by Ambac UK in the name of Ballantyne Re plc ("Ballantyne").
•
Puerto Rico
Ambac has exposure to the Commonwealth of Puerto Rico (the "Commonwealth") and its instrumentalities 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 Commonwealth of Puerto Rico and certain of its instrumentalities have and will continue to
default on 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 amount of monies available
for debt service, which is in turn affected by variability in economic growth, tax revenues, essential services expense as well as
federal funding of Commonwealth needs. In addition, our exposure to Puerto Rico is impacted by the significant damage to the
Commonwealth that was inflicted by Hurricane Maria, which made landfall on September 20, 2017, as well as Hurricane Irma,
which passed just north of the island on September 6, 2017. The longer term recovery of the economy of the Commonwealth and
its essential infrastructure will likely be highly dependent on the amount, timing and effectiveness of Federal aid.
Substantial uncertainty also exists with respect to the ultimate outcome for creditors in Puerto Rico due to legislation enacted by
the Commonwealth and the United States, including PROMESA, as well as actions taken in reliance on such laws, including Title
III filings. Ambac Assurance is involved in multiple litigations relating to such actions and other issues and may not be successful
in pursuing claims or protecting its interests. Ambac Assurance is also participating in a mediation process with respect to potential
debt restructurings. Mediation may not be productive or may not resolve Ambac Assurance's claims in a manner that avoids significant
losses. It is possible that certain restructuring process solutions, together with associated legislation, budgetary, and/or public policy
proposals could be adopted and could significantly or further impair our exposures.
While our reserving scenarios reflect a wide range of possible outcomes reflecting the significant uncertainty regarding future
developments and outcomes, given our exposure to Puerto Rico and the economic, fiscal, legal and political uncertainties associated
| Ambac Financial Group, Inc. 108 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
therewith as well as the uncertainties emanating from the damage caused by hurricanes Maria and Irma, 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.
Ambac has considered these developments and other factors in evaluating its Puerto Rico loss reserves. During the year ended
December 31, 2017, Ambac had incurred losses associated with its Domestic Public Finance insured portfolio of $476,303, which
was significantly impacted by the continued uncertainty and volatility of the situation in Puerto Rico. While management believes
its reserves are adequate to cover losses in its Public Finance insured portfolio, there can be no assurance that Ambac may not incur
additional losses in the future, particularly given the developing economic, political, and legal circumstances in Puerto Rico. Such
additional losses may have a material adverse effect on Ambac’s results of operations and financial condition. For public finance
credits, including Puerto Rico, as well as other issuers, for which Ambac has an estimate of expected loss at December 31, 2017,
the possible increase in loss reserves under stress or other adverse conditions and circumstances was estimated to be approximately
$1,500,000. However, there can be no assurance that losses may not exceed such amount.
•
Ballantyne Litigation
On March 25, 2017, Ambac UK agreed in principle to a confidential settlement of litigation brought by Ambac UK in the name of
Ballantyne against J.P. Morgan Investment Management Inc. ("JPMIM") relating to the management of Ballantyne’s investment
accounts, which were funded with the proceeds of notes issued in 2006 in connection with a structured reinsurance transaction and
guaranteed in part by Ambac UK. On April 11, 2017, Ambac UK, Ballantyne and JPMIM signed a settlement agreement. Pursuant
to the settlement, Ballantyne received a payment of $325,600 from JPMIM in return for releases of all claims by Ballantyne and
Ambac UK. As a result of the settlement, Ambac recognized an incremental benefit through a reduction in losses and loss expenses
of approximately $91,600 in the first quarter of 2017. Ambac had previously included an estimated benefit through a reduction of
loss and loss expense reserves of approximately $53,000 related to our probability weighted estimate of the value of the litigation.
The total $144,600 benefit recognized from the settlement of the litigation will reduce the ultimate Ballantyne claims Ambac UK
is expecting to pay and not result in a direct cash payment to Ambac UK.
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.
| Ambac Financial Group, Inc. 109 2017 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, 2017 and 2016. Gross par exposures include capital appreciation bonds which are reported at the par amount at
the time of issuance of the insurance policy as opposed to the current accreted value of the bond. The weighted average risk-free rate used to
discount loss reserves at December 31, 2017 and 2016 was 2.5% and 2.7%, respectively.
Number of policies
Remaining weighted-average contract
period (in years) (1)
Gross insured contractual payments
outstanding:
Principal
Interest
Total
Gross undiscounted claim liability (2)
Discount, gross claim liability
Gross claim liability before all subrogation
and before reinsurance
Less:
Gross RMBS subrogation (3)
Discount, RMBS subrogation
Discounted RMBS subrogation, before
reinsurance
Less:
Gross other subrogation (4)
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 (5)
$
$
$
I
IA
Surveillance Categories as of December 31, 2017
V
III
IV
II
26
10
20
23
26
10
22
24
179
13
Total
277
17
4
4
$ 1,046,267
$
531,190
$ 1,199,909
$ 1,998,861
$ 6,862,281
531,657
584,098
413,045
7,182,715
2,469,765
$ 1,577,924
4,434
$
$ 1,115,288
56,659
$
$ 1,612,954
77,289
$
$ 9,181,576
$ 1,412,976
$ 9,332,046
$ 6,409,340
$
$
$
48,562
$11,687,070
16,332
64,894
64,863
11,197,612
$22,884,682
$ 8,025,561
(465)
(13,095)
(12,250)
(643,897)
(616,559)
(4,739)
(1,291,005)
$
3,969
$
43,564
$
65,039
$
769,079
$ 5,792,781
$
60,124
$ 6,734,556
—
—
—
—
—
—
—
—
—
—
—
—
— (1,857,502)
—
23,115
— (1,857,502)
—
23,115
— (1,834,387)
— (1,834,387)
(7,990)
5,169
(9,371)
2,550
(53,070)
(743,456)
(13,191)
(827,078)
8,349
67,045
3,709
86,822
(2,821)
(6,821)
(44,721)
(676,411)
(9,482)
(740,256)
3,969
$
40,743
$
58,218
$
724,358
$ 3,281,983
$
50,642
$ 4,159,913
(2,126)
16,116
17,959
202
$
$
(9,990)
3,242
33,995
4,894
$
$
(12,238)
665
46,645
9,424
$
$
(46,086)
13,331
691,603
(64,786)
(276)
(135,502)
56,037
$ 3,273,234
$
—
50,366
89,391
$ 4,113,802
38,465
$
(11,988) $
— $
40,997
(1) Remaining weighted-average contract period is weighted based on projected gross claims over the lives of the respective policies.
(2) 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.
(3) RMBS subrogation represents Ambac’s estimate of subrogation recoveries from RMBS transaction sponsors for representation and warranty ("R&W")
breaches.
(4) Other subrogation represents subrogation related to excess spread and other contractual cash flows on public finance and structured finance transactions
including RMBS.
(5) Reinsurance recoverable reported on Balance Sheet includes reinsurance recoverables of $40,658 related to future loss and loss expenses and $339 related
to presented loss and loss expenses and subrogation.
| Ambac Financial Group, Inc. 110 2017 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) (1)
Gross insured contractual payments
outstanding:
Principal
Interest
Total
Gross undiscounted claim liability (2)
Discount, gross claim liability
Gross claim liability before all subrogation
and before reinsurance
Less:
Gross RMBS subrogation (3)
Discount, RMBS subrogation
Discounted RMBS subrogation, before
reinsurance
Less:
Gross other subrogation (4)
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 (5)
$
$
$
$
$
Surveillance Categories as of December 31, 2016
I
IA
II
III
IV
V
Total
19
9
22
8
26
30
43
17
169
14
3
5
282
16
$
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)
— (1,926,165)
—
19,130
—
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)
(1,807)
(49,578)
6,621
7,352
120
$
$
339
18,464
6,063
$
$
777
159,512
2,737
$
$
(31,785)
11,036
(57,194)
56,089
(383)
(143,141)
—
74,862
479,752
$ 2,982,666
$
48,292
$ 3,696,038
39,352
$
(17,854) $
— $
30,418
(1) Remaining weighted-average contract period is weighted based on projected gross claims over the lives of the respective policies.
(2) 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.
(3) RMBS subrogation represents Ambac’s estimate of subrogation recoveries from RMBS transaction sponsors for R&W breaches.
(4) Other subrogation represents subrogation related to excess spread and other contractual cash flows on public finance and structured finance transactions,
including RMBS.
(5) 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.
Representation and Warranty Recoveries:
Ambac records estimated subrogation recoveries for breaches of R&Ws by sponsors of certain RMBS transactions. For a discussion of the
approach utilized to estimate R&W subrogation recoveries, see Note 2. Basis of Presentation and Significant Accounting Policies. 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 below table.
Ambac has recorded R&W subrogation recoveries of $1,834,387, ($1,806,736 net of reinsurance) and $1,907,035, ($1,878,740 net of
reinsurance) at December 31, 2017 and 2016, respectively. The balance of R&W subrogation recoveries and the related loss reserves at
December 31, 2017 and 2016, are as follows:
| Ambac Financial Group, Inc. 111 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
At December 31, 2017
At December 31, 2016
Gross loss
reserves before
subrogation
recoveries (1)
$
$
1,366,483
1,351,640
$
$
Subrogation
recoveries (2)(3)
Gross loss
reserves after
subrogation
recoveries
(1,834,387) $
(467,904)
(1,907,035) $
(555,395)
(1) Amount represents gross loss reserves for policies that have established a representation and warranty subrogation recovery. 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 future cash flows for each policy. To the extent losses have been paid but not yet fully recovered, the recorded amount of R&W 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.
Below is the rollforward of R&W subrogation for the affected periods:
Year ended December 31,
Discounted RMBS subrogation (gross of reinsurance) at beginning of year
Impact of sponsor actions (1)
All other changes (2)
Discounted RMBS subrogation (gross of reinsurance) at end of year
2017
2016
2015
$
$
1,907,035
$
2,829,575
$
2,523,540
—
(72,648)
(995,000)
72,460
1,834,387
$
1,907,035
$
—
306,035
2,829,575
(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 this table.
Assumed Reinsurance:
Assumed par outstanding was $219,100 and $243,700 at December 31, 2017 and 2016, respectively.
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 $93,192 at
December 31, 2017. Credit exposure existed at December 31, 2017 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, 2017, there were ceded
reinsurance balances payable of $37,876 offsetting this credit exposure.
| Ambac Financial Group, Inc. 112 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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 $115,561 from its reinsurers at December 31, 2017. As of December 31, 2017, the aggregate amount of insured par ceded by
Ambac Assurance to reinsurers under reinsurance agreements was $4,424,000 with the largest reinsurer accounting for $3,668,000 or 5.5%
of gross par outstanding at December 31, 2017. The following table represents the percentage ceded to reinsurers and reinsurance recoverable
at December 31, 2017 and its rating levels obtained from each reinsurers website as of February 27, 2018:
Reinsurers
Assured Guaranty Re Ltd
Assured Guaranty Corporation
Sompo Japan Nipponkoa Insurance, Inc.
Total
Moody’s
Rating
Percentage
Ceded Par
Net Unsecured
Reinsurance
Recoverable(1)
NR
A3
A1
82.9%
9.2
7.9
100%
$
$
—
—
—
—
(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 (Loss). For the years ended December 31, 2017, 2016 and 2015, the insurance intangible amortization expense was
$150,854, $174,608 and $169,557, respectively. As of December 31, 2017 and 2016, the gross carrying value of the insurance intangible asset
was $1,581,156 and $1,534,419, respectively. Accumulated amortization of the insurance intangible asset was $734,183 and $572,339, as of
December 31, 2017 and 2016, respectively, resulting in a net insurance intangible asset of $846,973 and $962,080, respectively.
The estimated future amortization expense for the net insurance intangible asset is as follows:
Future Insurance Intangible Amortization (1)
2018
2019
2020
2021
2022
Thereafter
$
76,638
$
69,082
$
63,892
$
58,207
$
53,908
$
525,246
(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 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.
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.
As the principal, or domiciliary, regulator of Ambac Assurance and Everspan, OCI has primary regulatory authority, including with respect to
the 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 and
Everspan are not subject to risk-based capital requirements, since they are financial guarantee insurers. Ambac Assurance 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.
| Ambac Financial Group, Inc. 113 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
In addition, pursuant to the terms of the Settlement Agreement and the Stipulation and Order, Ambac Assurance must seek prior approval by
OCI of certain corporate actions. The Settlement Agreement and Stipulation and Order include covenants which restrict the operations of Ambac
Assurance. The Settlement Agreement will remain in force until the surplus notes that were issued pursuant to the Settlement Agreement have
been redeemed, repurchased or repaid in full. The Stipulation and Order will remain in force for so long as OCI determines it to be necessary.
Certain of the restrictions in the Settlement Agreement may be waived with the approval of the OCI and/or the requisite percentage of holders
of surplus notes issued in connection with the Settlement Agreement.
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, 2017, 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 for 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 $699,614 at December 31, 2017, as compared to $976,477 as of December 31, 2016. 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, 2017 and 2016 was lower by $104,097 and higher by $17,290, 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, 2017 and 2016 were 9.52% and 7.63%, 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
| Ambac Financial Group, Inc. 114 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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 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. As a result of the exit of the Segregated Account from rehabilitation on February 12, 2018, this prescribed practice will no longer
be applicable.
• 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 (i.e., $100,000. 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 Aggregate
Excess of Loss Reinsurance Agreement between Ambac Assurance (as reinsurer) and the Segregated Account were not capped. As a result
of the exit of the Segregated Account from rehabilitation on February 12, 2018, this prescribed practice will no longer be applicable.
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 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.
• Effective upon the exit of the Segregated Account from Rehabilitation and the merger of the Segregated Account with Ambac Assurance,
Ambac Assurance received permission from OCI to restate its unassigned funds (surplus) balance to $100,000 with an offsetting reduction
to gross paid-in and contributed surplus such that total surplus remains unchanged.
United Kingdom
The Prudential Regulatory Authority (“PRA”) and Financial Conduct Authority (“FCA”) (and their predecessor regulator the Financial Services
Authority (“FSA”)) are 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.
These regulators 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 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 2018 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 the Stipulation
and Order. 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
| Ambac Financial Group, Inc. 115 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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. 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 Ambac Assurance's surplus notes 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.
The Stipulation and Order requires OCI approval for the payment of any dividend or distribution on the common stock of Ambac Assurance.
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 investments in fixed income securities representing
municipal, asset-backed and corporate obligations, certain interest rate swap contracts, 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, certain uncollateralized 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. 116 2017 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, 2017 and 2016,
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
December 31, 2017:
Financial assets:
Fixed income securities:
Municipal obligations
Corporate obligations
Foreign obligations
U.S. government 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 (1)
Cash and cash equivalents
Loans
Derivative assets:
Interest rate swaps—asset position
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:
$
$
779,834
860,075
26,543
85,408
2,251,333
51,037
597,942
99,719
557,270
431,630
623,703
10,358
73,199
5,979
779,834
860,075
26,543
85,408
2,251,333
51,037
597,942
99,719
557,270
413,977
623,703
10,284
73,199
5,979
2,914,145
2,914,145
978
978
11,529,384
11,529,384
$
— $
450
$
779,834
859,625
—
—
—
—
736,017
—
72,540
—
—
17,288
—
10,284
61,374
5,979
928
—
1,515,316
51,037
525,402
—
167,971
29,750
8,630
—
11,825
—
—
—
—
2,914,145
—
11,529,384
25,615
85,408
—
—
—
99,719
389,299
56,498
615,073
—
—
—
—
978
—
54,877
20,853,695
$
54,877
20,835,968
$
$
—
1,173,321
$
54,877
4,005,195
$
—
15,347,011
Long term debt, including accrued interest
1,428,680
1,369,499
Derivative liabilities:
Credit derivatives
Interest rate swaps—asset position
Interest rate swaps—liability position
Futures contracts
Liabilities for net financial guarantees written (2)
Variable interest entity liabilities:
Long-term debt
Derivative liabilities:
566
(627)
81,495
1,348
566
(627)
81,495
1,348
3,435,438
4,842,402
12,160,544
12,160,544
—
—
—
—
1,348
—
—
1,046,511
322,988
—
(627)
81,495
—
—
566
—
—
—
4,842,402
9,402,856
2,757,688
Interest rate swaps—liability position
Total financial liabilities
2,205,264
19,312,708
$
2,205,264
20,660,491
$
$
—
1,348
$
2,205,264
12,735,499
$
—
7,923,644
| Ambac Financial Group, Inc. 117 2017 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, 2016:
Financial assets:
Fixed income securities:
Municipal obligations
Corporate obligations
Foreign obligations
U.S. government obligations
U.S. agency obligations
$
374,368
$
374,368
$
— $
374,368
$
1,802,165
1,802,165
43,135
36,186
4,060
43,135
36,186
4,060
Residential mortgage-backed securities
2,351,595
2,351,595
Collateralized debt obligations
Other asset-backed securities
Fixed income securities, pledged as collateral:
U.S. government obligations
Short term investments
Other investments (1)
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
Derivative assets:
Currency swaps-asset position
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
113,923
828,783
64,905
430,788
450,307
91,025
4,160
77,206
—
536
7,382
113,923
828,783
64,905
430,788
435,237
91,025
4,066
77,206
—
536
7,382
2,622,566
2,622,566
4,873
4,873
80,407
10,658,963
20,047,333
82,358
1,536,352
$
$
80,407
10,658,963
20,032,169
82,333
1,494,340
$
$
$
$
15,349
(61,839)
365,776
15,349
(61,839)
365,776
Liabilities for net financial guarantees written (2)
3,009,943
4,490,070
Variable interest entity liabilities:
Long-term debt
Derivative liabilities:
11,155,936
11,155,936
Interest rate swaps—liability position
2,078,601
2,078,601
Currency swaps—liability position
—
—
—
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
—
—
—
—
—
80,407
1,147,728
—
(61,839)
220,587
—
—
—
—
—
—
696,713
—
65,990
—
—
14,934
—
4,066
60,256
—
—
7,382
2,622,566
—
—
82,333
346,612
15,349
—
145,189
4,490,070
8,573,716
2,582,220
2,078,601
—
—
—
650,457
$
4,914,330
$
14,130,870
—
10,658,963
— $
— $
Total financial liabilities
$
18,182,476
$
19,620,566
$
— $
11,958,793
$
7,661,773
(1) Excluded from the fair value measurement categories in the table above are investment funds of $310,441 and $336,513 as of December 31, 2017 and
2016, respectively, which are measured using NAV per share as a practical expedient.
| Ambac Financial Group, Inc. 118 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
(2) 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.
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. 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 values for financial instruments. 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 mainly 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 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. 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 calculate fair value. Such prices generally consider a variety of
factors, including recent trades of the same and similar securities. In those cases, the items are classified within Level 2. 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. 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. 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. At December 31, 2017, approximately 6%, 79%, and 15% 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, 2016, approximately 5%, 82%, and 13% of the fixed income
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. Among the investments valued using internal valuation models are
Ambac insured securities for which projected cash flows consist solely of Deferred Amounts and interest thereon. These securities are internally
valued based upon the valuation of Ambac Assurance's surplus notes and comprise 13% and 12% of the portfolio at December 31, 2017 and
2016, 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: A portion of these securities are guaranteed under policies that were subject to the Segregated Account
Rehabilitation Plan and had 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 $709,950 and $696,713 at December 31, 2017 and 2016, respectively. Fair value
| Ambac Financial Group, Inc. 119 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
was calculated based on the valuation of Ambac Assurance surplus notes which, under the terms of the Segregated Account Rehabilitation
Plan effective in 2017, were to be redeemed in proportion with the payment of Deferred Amounts on or about the dates when such payments
are made. Following the consummation of the Rehabilitation Exit Transactions on February 12, 2018, under which surplus notes tendered
did receive consideration equal that paid to settle Deferred Amounts, remaining surplus notes outstanding will no longer be treated pari passu
with payments on insurance obligations. Refer to Note 1. Background and Business Description for further details of the Rehabilitation Exit
Transactions.
The remaining portion of Level 3 residential mortgage-backed securities are an Ambac-insured re-REMIC containing distressed mortgage-
backed securities as collateral, the fair value of which was $26,067 at December 31, 2017. There were $0 such securities classified as Level
3 as of December 31, 2016. 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, 2017 were as follows:
December 31, 2017:
a. Coupon rate:
2.05%
b. Average Life:
0.65 years
c. Yield:
10.00%
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 $72,540 and $65,990 at December 31, 2017 and 2016, 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, 2017 and 2016 include the following weighted averages:
December 31, 2017:
a. Coupon rate:
5.97%
b. Average Life:
17.02 years
c. Yield:
12.00%
Other Investments:
December 31, 2016:
a. Coupon rate:
5.93%
b. Average Life:
17.74 years
c. Yield:
13.50%
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. Refer to Note 10. Investments for additional information about such investments in pooled funds
that are reported at fair value using NAV as a practical expedient.
Other investments also includes Ambac's equity 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. 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 derivatives and other liabilities. The fair value of credit derivative liabilities was reduced by $60 and $1,924 at December 31,
2017 and 2016, respectively, as a result of incorporating an Ambac CVA into the valuation model for these contracts. Interest rate swaps may
also require an adjustment to fair value to reflect Ambac’s credit risk. During the three months ended June 30, 2017, interest rate swaps that
had incorporated an Ambac CVA into the valuation were terminated. As a result, derivative liabilities are no longer reduced as a result of
Ambac CVA at December 31, 2017 compared to $44,973 at December 31, 2016. 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 derivative 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.
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, for which we generally utilize vendor-developed models. These models provide the net present value of
| Ambac Financial Group, Inc. 120 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
the derivatives based on contractual terms and observable market data. Downgrades of Ambac Assurance, as guarantor of the 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 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 subject to collateral posting agreements. Counterparty credit risk related to such customer derivative
assets is included in our fair value adjustments. The valuation of such derivatives is generally classified as Level 3.
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 hypothetical transfer cost of the contract calculated
as the difference between the net present value of the projected fees receivable under the CDS and our estimate of the fees a financial guarantor
of comparable credit quality would charge to provide the same protection at the balance sheet date. Financial guarantee contracts, including
CDS, are typically priced to capture some portion of the spread that would be observed in the capital markets for the underlying (insured)
obligation. 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 the valuation of our credit derivatives include the balance of unpaid notional, expected term, fair values of the underlying
reference obligations, reference obligation credit ratings and the CVA applied against Ambac Assurance liabilities by market participants.
Notional balances, expected remaining term and reference obligation credit ratings are monitored and determined by Ambac’s Risk Management
group. Fair values of the underlying reference obligations are obtained from broker quotes when available or are estimated internally using
the same methodologies used to value Ambac’s fixed income securities in its investment portfolio.
Ambac reflects changes in reference obligation credit ratings within the fair value of its CDS contracts by changing the percentage of the
obligation's market spread (over LIBOR) that would be captured as a CDS fee at the valuation date. We adjust this percentage (“relative
change ratio”) in our valuations based on internal rating changes such that the resulting fair value liability of the CDS contract, excluding the
effect of Ambac's own credit risk, will increase up to the full amount of the unrealized loss on the reference obligation as the credit rating
declines. Ambac incorporates its own credit risk into the valuation of its CDS liabilities by applying a CVA to the calculations described
above. The Ambac CVA represents the difference between the present value of the hypothetical fees discounted at LIBOR compared to discount
rates that incorporate Ambac credit risk.
Information about the above described model inputs used to determine the fair value 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, 2017 and 2016 is summarized
below:
December 31,
Number of CDS transactions
Notional outstanding
Weighted average reference obligation price
Weighted average life (WAL) in years
Weighted average credit rating
Weighted average relative change ratio
CVA percentage
Fair value of derivative liabilities
2017
2016
2
$
325,890
$
99.3
6.5
A
23.6%
9.64%
8
737,380
93.5
5.2
A-
31.6%
11.14%
$
566
$
15,349
The maximum potential amount of future payments under Ambac’s credit derivative contracts is generally the notional outstanding amount
included in the above table plus future interest payments 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 are recorded in “Net change in fair value of credit derivatives” on the Consolidated Statements of Total Comprehensive
Income (Loss). 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 Risk Management group tracks credit migration of CDS contracts’ reference
obligations from period to period. Credits are assigned risk classifications by the Risk Management group. As of December 31, 2017, there
| Ambac Financial Group, Inc. 121 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
are no CDS contracts on Ambac’s adversely classified credit listing. As of December 31, 2016, there were two CDS contracts on Ambac’s
adversely classified credit listing, with a net derivative liability fair value of $6,123 and total notional outstanding of $67,783.
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 includes future: (i) installment premium receipts, (ii) 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 was at the sole discretion of the Rehabilitator until the
Segregated Account rehabilitation was concluded on February 12, 2018. For ceded reinsurance contracts, net cash flows for each policy
includes future: (i) installment ceded premium payments, (ii) ceding commission receipts, (iii) ceded claim receipts, and (iv) ceded subrogation
payments. For each assumed,or 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. 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 discount rates used for contracts in a net liability position are
derived from the rates implicit in the fair value of surplus notes and guaranteed securities with future cash flows that are highly dependent
upon Ambac financial guarantee payments. 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
Assurance’s credit quality is writing or otherwise obtaining financial guarantee business (e.g. reinsurance or novation of policies from other
insurers) we do not have access to observable pricing data points and (ii) certain segments of Ambac's financial guarantees were allocated to
the Segregated Account and timing of the payments of such liabilities were at the sole discretion of the Rehabilitator.
Long-term Debt:
Long-term debt includes surplus notes issued by Ambac Assurance, surplus notes issued by the Segregated Account of Ambac Assurance,
which became obligations of Ambac Assurance when the Rehabilitation Exit Transactions were effectuated on February 12, 2018, and notes
outstanding to third parties arising from Ambac Assurance's secured borrowing transaction. The fair values of Ambac Assurance surplus notes
and the secured borrowing notes are based on market prices received from dealer quotes or alternative pricing sources with reasonable levels
of price transparency. The fair value of Segregated Account surplus notes were classified as Level 3 and are internally estimated considering
market transactions when available and internally developed discounted cash flow models. Internal valuation estimates of Segregated Account
surplus notes considered differences in contractual accrued interest and seniority of payment relative to Ambac Assurance surplus notes.
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
| Ambac Financial Group, Inc. 122 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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 $2,757,688 and $2,551,278 at December 31, 2017
and 2016, 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, 2017 and 2016 include the following weighted averages:
December 31, 2017
a. Coupon rate: 0.40%
b. Maturity:
15.28 years
c. Yield:
4.82%
December 31, 2016
a. Coupon rate: 0.46%
b. Maturity:
16.16 years
c. Yield:
4.95%
US Commercial ABS transaction: The fair value of such obligations classified as Level 3 was $0 and $30,942 at December 31, 2017 and 2016,
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, when applicable, discounted at a rate that incorporates Ambac’s own credit risk. As a result of a negotiated settlement to refinance
this Ambac-insured debt, the final paydown of the bond occurred in October 2017.
Significant inputs for the valuation at December 31, 2016, include the following weighted averages:
December 31, 2016
a. Coupon rate: 5.88%
b. Maturity:
20.85 years
c. Yield:
5.86%
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, 2017 and 2016 were developed using
vendor-developed models and do not use significant unobservable inputs.
The fair value of VIE assets are obtained from market quotes when available. Typically VIE 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 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 3.1% and 3.6% at December 31, 2017 and 2016, 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 for Financial Assets and Liabilities Accounted for at Fair Value:
The following tables present the changes in the Level 3 fair value category for the periods presented in 2017, 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.
| Ambac Financial Group, Inc. 123 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Level-3 Financial Assets and Liabilities Accounted for at Fair Value
Year Ended December 31, 2017
Investments
Other
Assets
Derivatives
Investments
Loans
Long-term
Debt
Total
Balance, beginning of period
$
762,703
$
7,382
$
(100,282) $ 2,622,566
$ 10,658,963
$ (2,582,220) $ 11,369,112
VIE Assets and Liabilities
Total gains/(losses) realized and
unrealized:
Included in earnings
65,195
(1,403)
62,847
70,928
550,021
35,009
782,597
Included in other comprehensive
income
Purchases
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
6,392
35,781
(79,319)
(29,963)
47,768
—
—
—
—
—
—
—
—
—
—
—
—
253,429
1,004,284
(254,093)
1,010,012
—
—
—
—
—
—
35,781
(79,319)
98,243
(32,778)
(683,884)
43,616
(604,766)
—
—
—
—
—
—
—
—
—
—
—
—
47,768
—
—
$
808,557
$
5,979
$
60,808
$ 2,914,145
$ 11,529,384
$ (2,757,688) $ 12,561,185
$
— $
(1,403) $
8,913
$
70,928
$
547,004
$
36,851
$
662,293
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
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
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. 124 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Level-3 Financial Assets and Liabilities Accounted for at Fair Value
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
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
(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)
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,
Balance, beginning of period
Total gains/(losses) realized and unrealized:
Included in earnings
Included in other comprehensive income
Purchases
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
2017
Non-
Agency
RMBS
Total
investments
Other asset
backed
securities
2016
Non-
Agency
RMBS
Total
investments
$
65,990
$
696,713
$
762,703
$
— $
488,884
$
488,884
1,433
6,130
—
—
(1,013)
—
—
63,762
262
35,781
(79,319)
(28,950)
47,768
—
65,195
6,392
35,781
(79,319)
(29,963)
47,768
—
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
—
72,540
$
736,017
$
808,557
$
65,990
$
696,713
$
762,703
— $
— $
— $
— $
— $
—
$
$
| Ambac Financial Group, Inc. 125 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Level-3 Investments by Class
Year Ended December 31, 2015
Balance, beginning of period
Total gains/(losses) realized and unrealized:
Included in earnings
Included in other comprehensive income
Purchases
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
2015
Other asset
backed
securities
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
— $
— $
— $
—
Level-3 Derivatives by Class
Year Ended December 31,
Balance, beginning of period
Total gains/(losses) realized and unrealized:
2017
2016
Interest
rate
swaps
Credit
derivatives
Total
derivatives
Interest
rate
swaps
Credit
derivatives
Total
derivatives
$
(84,933) $
(15,349) $
(100,282) $
(64,649) $
(34,543) $
(99,192)
Included in earnings
46,475
16,372
62,847
(35,480)
20,106
(15,374)
Included in other comprehensive income
Purchases
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
$
$
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
99,832
(1,589)
98,243
15,196
(912)
14,284
—
—
—
—
—
—
—
—
—
—
—
—
61,374
$
(566) $
60,808
$
(84,933) $
(15,349) $
(100,282)
6,716
$
2,197
$
8,913
$
(35,480) $
19,129
$
(16,351)
| Ambac Financial Group, Inc. 126 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Level-3 Derivatives by Class
Year Ended December 31,
Balance, beginning of period
Total gains/(losses) realized and unrealized:
Included in earnings
Included in other comprehensive income
Purchases
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
2015
Interest
rate
swaps
Credit
derivatives
Total
derivatives
$
(141,887) $
(73,459) $
(215,346)
(25,130)
41,701
16,571
—
—
—
14,150
88,218
—
—
—
—
(2,785)
—
—
—
—
—
11,365
88,218
—
$
$
(64,649) $
(34,543) $
(99,192)
(25,130) $
(850) $
(25,980)
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. Non-agency RMBS
securities transferred into Level 3 in 2017 consist of an Ambac-insured re-REMIC collateralized by distressed mortgage-backed securities
and certain Ambac-insured RMBS for which projected cash flows consist solely of Deferred Amounts and interest thereon. Non-agency
RMBS transferred into Level 3 in 2016 consist of certain investments in Ambac-wrapped RMBS securities for which projected cash flows
consist solely of Deferred Amounts and interest thereon. 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. 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.
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
Unrealized
gains or
(losses) on
credit
derivative
contracts
Net
investment
income
Interest
rate
swaps
Income
(loss) on
variable
interest
entities
Other
income
or (loss)
Year Ended December 31, 2017
Total gains or losses included in earnings for the period
65,195
1,589
14,783
46,475
655,956
(1,403)
Changes in unrealized gains or losses relating to the
assets and liabilities still held at the reporting date
—
—
2,197
6,716
654,783
(1,403)
Year Ended December 31, 2016
Total gains or losses included in earnings for the period
$
54,600
$
912
$
19,194
$
(35,480) $
833,023
$
(1,314)
Changes in unrealized gains or losses relating to the
assets and liabilities still held at the reporting date
—
—
19,129
(35,480)
833,023
(1,314)
Year Ended December 31, 2015
Total gains or losses included in earnings for the period
$
30,083
$
2,785
$
38,916
$
(25,130) $
(590,327) $
(1,635)
Changes in unrealized gains or losses relating to the
assets and liabilities still held at the reporting date
—
—
(850)
(25,130)
(579,620)
(1,635)
| Ambac Financial Group, Inc. 127 2017 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 non-VIE 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 include Ambac's interests 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, 2017 and 2016
were as follows:
Amortized
cost
Gross
unrealized
gains
Gross
unrealized
losses
Estimated
fair value
Non-Credit
Other-
than-
temporary
Impairments (1)
December 31, 2017
Fixed income securities:
Municipal obligations
Corporate obligations
Foreign obligations
U.S. government 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
$
845,778
$
3,456
$
69,400
$
779,834
$
858,774
26,245
86,900
2,214,512
50,754
531,660
4,614,623
557,476
5,172,099
99,719
99,719
6,772
409
261
67,303
283
66,899
145,383
3
145,386
—
—
—
—
—
—
5,471
111
1,753
860,075
26,543
85,408
30,482
2,251,333
23,832
—
617
107,834
209
108,043
—
—
51,037
597,942
4,652,172
557,270
5,209,442
99,719
99,719
—
—
23,832
—
23,832
—
—
Total available-for-sale investments
$
5,271,818
$
145,386
$
108,043
$
5,309,161
$
23,832
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
$
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
(1) Represents the amount of non-credit other-than-temporary impairment losses remaining in accumulated other comprehensive income on securities that
also had a credit impairment. These losses are included in gross unrealized losses as of December 31, 2017 and 2016.
| Ambac Financial Group, Inc. 128 2017 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, 2017, 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
$
714,761
$
556,370
376,420
827,341
2,474,892
2,214,512
50,754
531,660
714,507
556,387
376,686
761,269
2,408,849
2,251,333
51,037
597,942
$
5,271,818
$
5,309,161
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 on Fixed Income Securities:
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, 2017 and 2016:
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, 2017
Fixed income securities:
Municipal obligations
Corporate obligations
Foreign obligations
U.S. government obligations
Residential mortgage-backed
securities
Other asset-backed securities
Short-term
Total temporarily impaired
securities
$
667,335
$
68,578
$
32,525
$
822
$
699,860
$
69,400
292,028
8,122
74,188
668,524
26,655
1,736,852
251,926
3,377
81
1,653
12,524
58
86,271
209
87,272
1,700
5,525
418,617
88,023
633,662
—
2,094
30
100
17,958
559
21,563
—
379,300
9,822
79,713
1,087,141
114,678
2,370,514
251,926
5,471
111
1,753
30,482
617
107,834
209
$
1,988,778
$
86,480
$
633,662
$
21,563
$
2,622,440
$
108,043
| Ambac Financial Group, Inc. 129 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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
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
$
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
Management has determined that the unrealized losses reflected in the tables above are temporary in nature as of December 31, 2017 and 2016
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 outflow 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, the fair value
of other securities that are available for sale and in an unrealized gain position, trading securities plus the scheduled maturities 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. 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, 2017, 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, 2017, $1,855,694 of the total fair value and $100,503 of the unrealized loss related to below investment grade and non-rated
securities. 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 and non-rated securities. As discussed further below, most of the securities in a gross
unrealized loss position that are below investment grade or non-rated are guaranteed by Ambac Assurance. 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. If that judgment changes, Ambac may ultimately record a charge for other-than-temporary impairment in future
periods.
Municipal obligations
The gross unrealized losses on municipal obligations as of December 31, 2017 are primarily the result of the price declines on Ambac-insured
Puerto Rico bonds, especially Puerto Rico Sales Tax Financing Corporation's Senior Sales Tax Revenue bonds. These bonds are below
investment grade, long-dated zero coupon securities subject to higher than average price volatility that suffered additional downward price
movement in late 2017 following the hurricanes that impacted Puerto Rico. Management has the ability and intent to hold these bonds and
by virtue of the Ambac financial guarantee, believes that it is probable that all amounts due on the bonds will be paid timely and in full.
| Ambac Financial Group, Inc. 130 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Corporate obligations
The gross unrealized losses on corporate obligations as of December 31, 2016 and to a lesser extent at December 31, 2017 resulted from an
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 $30,482 of unrealized losses on residential mortgage-backed securities, $30,482 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 since either the
purchase date or Fresh Start Reporting Date of April 30, 2013 for securities owned prior to such date. 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 were allocated to the Segregated Account,
expected future cash flows included assumptions about the timing and amount of Ambac Assurance claim payments, including interest on
Deferred Amounts, although the actual timing of such payments were at the sole discretion of the Rehabilitator. These assumptions are used
to project future cash flows for each security and at December 31, 2017 incorporate the 6.5% discount on the settlement of Deferred Amounts
as part of the Rehabilitation Exit Transactions described in Note 1. Management considered this analysis in making our determination that
a credit loss has not occurred at December 31, 2017 on these transactions.
Realized Gains and Losses and Other-Than-Temporary Impairments:
The following table details amounts included in net realized gains (losses) 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)
2017
2016
2015
29,080
$
17,344
$
(18,945)
(4,769)
(8,239)
30,179
5,366
$
39,284
$
(20,171) $
(21,819) $
58,218
(10,558)
5,816
53,476
(25,659)
$
$
$
(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. Future changes in our
estimated liquidity needs could result in a determination that Ambac no longer has the ability to hold securities that are in an unrealized loss
position, which could result in additional other-than-temporary impairment charges.
The following table presents a roll-forward of Ambac’s cumulative credit losses on debt securities held as of December 31, 2017 and 2016
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
Balance, end of period
2017
2016
2015
52,070
$
31,176
$
14,062
3,310
11,705
3,572
17,322
67,085
$
52,070
$
10,900
6,214
31,176
$
$
Counterparty Collateral, Deposits with Regulators and Other Restrictions:
Ambac routinely pledges and receives collateral related to certain transactions. Ambac pledges cash and securities it holds in its investment
portfolio to investment agreement (prior to repayment in March 2017) and derivative counterparties, as collateral. Securities pledged to
investment agreement counterparties were not to 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”.
| Ambac Financial Group, Inc. 131 2017 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 collateral owned by Ambac that was pledged to investment agreement and derivative counterparties at December
31, 2017 and 2016:
December 31, 2017:
Pledged cash and securities owned by Ambac
December 31, 2016:
Pledged cash and securities owned by Ambac
Fair value of
cash and
securities
pledged to
investment
agreement
counterparties
Fair value of
cash and
securities
pledged to
derivative
counterparties
Fair value of
cash and
underlying
securities
120,645
$
— $
120,645
291,545
$
88,940
$
202,605
$
$
Securities carried at $5,974 and $5,872 at December 31, 2017 and 2016, 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 $346,212 and $360,759 at December 31, 2017 and 2016, respectively, were held by a bankruptcy remote trust to
collateralize and fund repayment of debt issued through a securitization transaction. The securities may not be sold or repledged by the trust.
These assets are held and the secured debt is issued by entities that qualify as VIEs and are consolidated in Ambac’s consolidated financial
statements. Refer to Note 3. Special Purpose Entities, Including Variable Interest Entities for a further description of this transaction.
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). 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, 2017 and 2016, respectively:
Municipal
obligations
Corporate
obligations
Mortgage
and asset-
backed
securities
Weighted
Average
Underlying
Rating (1)
Total
December 31, 2017:
Ambac Assurance Corporation (2)
National Public Finance Guarantee
Corporation
Assured Guaranty Municipal Corporation
Total
December 31, 2016:
Ambac Assurance Corporation (2)
National Public Finance Guarantee
Corporation
Assured Guaranty Municipal Corporation
MBIA Insurance Corporation
Total
$
$
$
$
706,715
$
32,660
$
2,702,887
$
3,442,262
20,733
5,998
—
—
—
—
20,733
5,998
733,446
$
32,660
$
2,702,887
$
3,468,993
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
CC
BBB-
BBB+
CC
CC
A-
AA
BBB+
CC
(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 corporate obligations and asset-backed securities with a fair value of $170,280 and $118,813 at December 31, 2017 and 2016, respectively,
insured by Ambac UK.
| Ambac Financial Group, Inc. 132 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Equity Interests:
Ambac's investment portfolio includes equity interests in various pooled investment funds, which are classified as trading. The fair value and
additional information about such investments in pooled funds, by investment type, is summarized in the table below. Except as noted in the
table, fair value reported is determined using NAV per share 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)
Interest rate products (3) (7)
Illiquid investments (4)
Insurance-linked investments (5)
Equity market investments (6) (7)
December 31,
2017
December 31,
2016
Redemption frequency
Redemption notice period
$
33,154
$
33,303
quarterly
53,054
136,603
67,787
22,666
53,675
10 business days
15 - 30 days
53,985
semi-monthly
261,315
daily, weekly or monthly
0 - 30 days
39,068
quarterly
— quarterly
32,633
daily
180 days
90-120 days
0 days
Total equity investments in pooled funds
$
366,939
$
420,304
(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 term, 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.
(5) This class aims to provide returns from the insurance and reinsurance markets through investments in catastrophe bonds, life insurance and other insurance
linked investments. Redemption periods are quarterly, subject to 90-day notice for January/July redemption dates and 120-day notice for April/October
redemption dates with redemptions greater than 3.5% during the first five years following share issuance subject to redemption fees.
(6)
Investments represent a diversified exposure to global equity market returns through holdings of various regional market index funds.
(7) Interest rate products include $2,823 at December 31, 2017 and $51,158 at December 31, 2016 and equity market investments include $53,675 at December
31, 2017 and $32,633 at December 31, 2016 that have readily determinable fair.
Ambac also holds interests in an unconsolidated trust created in connection with the 2014 sale of Segregated Account junior surplus notes.
The investment in debt securities is accounted for as trading and the equity interest is accounted for under the equity method and included in
Other Investments on the Consolidated Balance Sheets.
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
2017
2016
2015
$
337,454
$
288,554
$
257,404
7,898
520
(8,098)
337,774
23,179
1,505
337
(9,347)
281,049
32,318
$
360,953
$
313,367
$
299
420
(8,786)
249,337
16,952
266,289
Net investment income from Other investments primarily represents changes in fair value on securities classified as trading or under the fair
value option plus, income from Ambac's interests in an unconsolidated trust created in connection with its sale of Segregated Account junior
surplus notes. 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 (losses) recognized during the period on trading securities
Less: net gains (losses) recognized during the reporting period on trading securities sold
during the period
Unrealized gains (losses) recognized during the reporting period on trading securities
still held at the reporting date
$
$
2017
2016
2015
18,242
$
27,654
$
12,615
4,854
7,474
13,388
$
20,180
$
4,966
7,649
| Ambac Financial Group, Inc. 133 2017 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, 2017 and 2016.
December 31, 2017:
Derivative Assets:
Interest rate swaps
Total non-VIE derivative assets
Derivative Liabilities:
Credit derivatives
Interest rate swaps
Futures contracts
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, 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
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
$
$
73,826
73,826
566
81,495
1,348
627
627
$
— $
627
—
$
$
73,199
73,199
566
80,868
1,348
—
— $
— $
79,912
1,348
73,199
73,199
566
956
—
83,409
$
627
$
82,782
$
81,260
$
1,522
54,877
54,877
2,205,264
2,205,264
139,045
536
139,581
15,349
365,776
381,125
80,407
80,407
2,078,601
2,078,601
$
$
$
$
$
$
$
$
$
$
$
—
— $
54,877
54,877
— $
— $
2,205,264
2,205,264
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
$
$
$
$
$
$
$
$
$
$
$
—
— $
54,877
54,877
— $
— $
2,205,264
2,205,264
— $
—
— $
— $
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
$
$
$
$
$
$
$
$
$
$
$
$
$
$
Effective January 3, 2017, the central clearing party ("CCP") for certain of Ambac's derivative contracts changed its rules governing the
character of variation payments. Under the new CCP rules, variation payments are considered settlements of the associated derivative balance.
Prior to the rule change such variation payments were considered to be margin and were not offset against the fair value of the derivatives,
but were recognized as collateral receivable or payable. The amount of variation margin included within "Other assets" on the Consolidated
Balance Sheet as of December 31, 2016, and was applied as a reduction to derivative liabilities effective January 3, 2017 under the new CCP
rules is $71,023. 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 $20,926 and $137,701 as of December 31, 2017 and 2016, respectively.
There were no amounts held representing an obligation to return cash collateral as of December 31, 2017 and 2016.
The following tables summarize the location and amount of gains and losses of derivative contracts in the Consolidated Statements of Total
Comprehensive Income (Loss) for the year ended December 31, 2017 and 2016:
| Ambac Financial Group, Inc. 134 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Location of gain (loss) recognized
in Consolidated Statements of
Total Comprehensive Income (Loss)
Amount of gain (loss) recognized in Consolidated
Statement of Total Comprehensive Income (Loss) –
Year Ended December 31,
2017
2016
2015
Net change in fair value of credit derivatives
$
16,372
$
20,106
$
41,701
Net gains (losses) on interest rate derivatives
Net gains (losses) on interest rate derivatives
Income (loss) on variable interest entities
Income (loss) on variable interest entities
48,870
10,695
59,565
(25,530)
(126,664)
(152,194)
(50,082)
(191)
(50,273)
58,990
(574,554)
(515,564)
$
(76,257) $
(545,731) $
(41,177)
(1,367)
(42,544)
103,757
168,003
271,760
270,917
Non-VIEs:
Credit derivatives
Non VIE derivatives:
Interest rate swaps
Futures contracts
Total non-VIE derivatives
Variable Interest Entities:
Currency swaps
Interest rate swaps
Total Variable Interest Entities
Total derivative contracts
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. Credit derivatives issued are insured by Ambac Assurance.
None of the outstanding credit derivative transactions at December 31, 2017 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 summarizes the gross principal notional outstanding for CDS
contracts, by Ambac rating as of December 31, 2017 and 2016:
Ambac Rating
December 31,
AAA
AA
A
BBB (1)
Below investment grade (2)
Total
2017
2016
— $
175,765
—
150,125
—
325,890
$
—
315,201
227,146
127,250
67,783
737,380
$
$
(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.
Interest Rate Derivatives:
Ambac, through its subsidiary Ambac Financial Services (“AFS”), provides interest rate swaps to counterparties and as of December 31, 2017
and 2016 the notional amounts of its derivatives are as follows:
Type of derivative
Interest rate swaps—receive-fixed/pay-variable
Interest rate swaps—pay-fixed/receive-variable
US Treasury futures contracts—short
Notional - December 31,
2017
2016
$
379,497
$
1,428,264
1,655,000
973,130
1,874,678
195,000
| Ambac Financial Group, Inc. 135 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
On June 27, 2017, Ambac entered into a termination agreement with various parties, including Augusta, in connection with the commutation
of interest rate swaps between Augusta and AFS. Ambac paid $94,407 under the termination agreement and reported a gain on the Augusta
swaps of $43,443.
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, 2017 and 2016 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,
2017
2016
$
1,483,491
$
2,479,244
394,541
12,100
1,352,010
2,300,584
312,357
12,059
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
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, 2017 and 2016, the net liability fair value of derivative instruments with contingent features linked to Ambac’s own credit
risk was $79,912 and $82,944, respectively, related to which Ambac had posted cash and securities as collateral with a fair value of $111,391
and $128,754, 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 such contracts terminated on December 31, 2017,
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 market 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 $20,184 and $4,873 at December 31, 2017 and 2016, respectively. The interest rate on
these loans ranged from 0.00% to 4.58% at December 31, 2017 and were 4.53% December 31, 2016. The maturity date of these loans ranged
from June 2026 to December 2046 as of December 31, 2017 and were June 2026 as of December 31, 2016. 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, 2017 and 2016.
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
2017
2016
$
$
$
668,667
$
—
249,036
73,993
991,696
12,160,544
$
$
730,648
33,107
248,247
102,403
1,114,405
11,155,936
| Ambac Financial Group, Inc. 136 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Surplus Notes, General Account
Ambac Assurance surplus notes, with a par amount of $754,811 and $862,945 at December 31, 2017 and 2016, respectively, are reported in
long-term debt on the Consolidated Balance Sheet and have a scheduled maturity of June 7, 2020. In 2017 and 2016, Ambac purchased
$108,134 and $11,804 par amount of these surplus notes, respectively. The gains on these repurchases were $3,603 and $1,677, 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, 2017 and 2016, 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 these surplus notes are subject to the prior approval of the
OCI. If the OCI does not approve the payment of interest on these 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 $0 and $39,102 at December 31, 2017 and 2016, respectively, are reported in
long-term debt on the Consolidated Balance Sheets and have a scheduled maturity of June 7, 2020. In 2017, Ambac purchased $39,102 par
amount of these surplus notes. The gains on these repurchases were $212 and recognized in Net realized gains (losses) on extinguishment of
debt of the Consolidated Statements of Total Comprehensive Income. These surplus notes were recorded at their fair value at the date of
issuance. The discount on these notes was 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 these surplus notes are subject to the prior approval of the OCI. If the OCI does not approve the
payment of interest on these 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. Pursuant to the Second Amended Plan of
Rehabilitation, Ambac Assurance became the obligor under the Segregated Account surplus notes as of February 12, 2018.
Junior Surplus Notes, Segregated Account
The Segregated Account junior surplus notes, with a par value of $370,237 and $374,036 at December 31, 2017 and 2016, 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. Pursuant to the Second Amended Plan of Rehabilitation, Ambac Assurance became the obligor under the junior surplus notes as
of February 12, 2018. Principal and interest payments on these junior surplus notes cannot be made until all Ambac Assurance surplus notes
(other than junior surplus notes) are paid in full and after all of Ambac Assurance's future and existing senior indebtedness, policy and other
priority claims have been paid in full. All payments of principal and interest on these 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, 2017 and 2016 includes $20,237 and $24,037, 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 $3,799 and $4,002 during 2017 and 2016, respectively, 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, 2017 and 2016 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 dated September 21, 2011 among Ambac, Ambac
Assurance, the Segregated Account, the Rehabilitator, the OCI and the Official Committee of Unsecured Creditors of Ambac, 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 $73,993 and $102,986 at December 31, 2017 and 2016, 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.
| Ambac Financial Group, Inc. 137 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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 $9,387,884 and $8,854,530 as of December 31, 2017 and 2016, 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, 2017 and 2016. As of December 31, 2017 and 2016, the interest rates on these VIEs’ long-term debt ranged from 0.96% to
8.35% and from 0.82% to 13.00%, respectively. Final maturities of VIE long-term debt for each of the five years following December 31,
2017 are as follows: 2018-$141,327; 2019-$307,915; 2020-$44,100; 2021-$94,024; 2022-$0.
14.
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 subsidiaries
operate and the earliest tax years subject to examination:
Jurisdiction
United States
New York State
New York City
United Kingdom
Italy
Tax Year
2010
2013
2014
2014
2013
On December 22, 2017, H.R. 1. (commonly referred to as the Tax Cut and Jobs Act or "TCJA") was enacted and significantly changed the
tax code effective January 1, 2018. We incorporated the effects of the TCJA in our current and deferred tax evaluation for the year ended
December 31, 2017. Given the complexity of the TCJA and the limited time between its enactment and the filing of year-end financial
statements, the SEC issued guidance (SAB 118), which provides a one-year measurement period for companies to finalize the accounting for
the impact of the TCJA. Ambac has recorded the income tax effect of those aspects of the TCJA for which the accounting is completed and
recorded provisional amounts for those aspects for which the accounting is incomplete.
In connection with our preliminary analysis of the TCJA, Ambac recorded an estimated discrete current benefit of $29,581 (net of an estimated
6.6% Congressional budget sequestration haircut) related to the repeal of the Alternative Minimum Tax ("AMT") and deferred taxes of $31,418
attributable to Ambac UK, including the effect of the TCJA changes relating to unrealized gains on investments, resulting in an estimated net
cost of $1,886. The AMT credit will be refunded in installments through 2021 or sooner based upon taxable income.
Ambac has not completed its accounting analysis of the TCJA's impact on moving to a new quasi-territorial worldwide tax system, the primary
effect of which is a mandatory repatriation of Ambac UK's historical earnings. Accordingly, the provisions related to these international tax
changes have been recorded as estimates. Ambac has also not completed the accounting analysis on provisions related to executive compensation
and, therefore, recorded these amounts as estimates.
As of December 31, 2017 Ambac had U.S. federal net operating loss tax carryforwards of approximately $3,694,844, which, if not utilized,
will begin expiring in 2029, and will fully expire in 2032.
| Ambac Financial Group, Inc. 138 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The tax effects of temporary differences that give rise to significant portions of the deferred tax liabilities and deferred tax assets at December
31, 2017 and 2016 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
Compensation
AMT Credits
Other
Subtotal deferred tax assets
Valuation allowance
Total deferred tax assets
Net deferred tax (liability)
2017
2016
$
177,864
$
336,728
22,817
28,798
51,485
—
9,402
46,343
38,656
68,682
30,699
4,276
290,366
525,384
775,917
236,237
5,585
—
2,140
1,019,879
763,172
256,707
(33,659)
1,409,565
224,553
4,759
31,532
11,967
1,682,376
1,158,712
523,664
(1,720)
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. With respect to Ambac's domestic subsidiaries subject to
U.S. tax, 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 maintains a full valuation
allowance. The remaining net deferred tax liability of $33,659 is attributable to Ambac U.K.
U.S. and foreign components of pre-tax income (loss) were as follows:
Year Ended December 31,
U.S.
Foreign
Total
The components of the provision (benefit) for income taxes were as follows:
Year Ended December 31,
Current taxes
U. S. federal
U.S. state and local
Foreign
Current taxes
Deferred taxes
Deferred taxes - foreign
Provision for income taxes
2017
2016
2015
(450,978) $
166,727
(284,251) $
77,161
27,865
105,026
$
$
337,753
172,305
510,058
2017
2016
2015
(29,581) $
3,934
$
16,893
2,013
40,613
13,045
707
26,088
30,729
31,419
44,464
$
(20)
30,709
$
182
2
17,077
287
17,364
$
$
$
$
| Ambac Financial Group, Inc. 139 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The total effect of income taxes on net income and stockholders’ equity for the years ended December 31, 2017, 2016 and 2015 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
2017
2016
2015
44,464
$
30,709
$
17,364
(30,838)
25,776
446
4,616
41,602
(58,527)
3,278
13,647
44,464
$
30,709
$
(55,906)
(15,628)
(240)
71,774
17,364
$
$
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 $
(99,488)
35.0 % $
36,759
35.0 % $
178,521
35.0 %
2017
2016
2015
Changes in expected tax resulting from:
Tax-exempt interest
Goodwill impairment
Foreign taxes
Substantiation adjustment
Valuation allowance
Change in Tax Law
Other, net
(6,004)
—
(17,742)
36,124
127,675
1,886
2,013
2.1 %
— %
6.2 %
(12.7 )%
(44.9 )%
(0.7 )%
(0.7 )%
(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 %
— %
(340,133)
(66.7)%
—
63
Tax expense on income from continuing operations
$
44,464
(15.6)% $
30,709
29.2 % $
17,364
A reconciliation of the beginning and ending amount of unrecognized tax benefits for 2017, 2016 and 2015 is 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
2017
2016
2015
$
$
— $
—
—
— $
— $
—
—
— $
— %
— %
3.4 %
—
—
—
—
Included in these balances at December 31, 2017, 2016 and 2015 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, 2017, 2016 and 2015, 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, 2017, 2016 and
2015, respectively.
NOL Usage
Pursuant to the amended and restated tax sharing agreement among Ambac, Ambac Assurance and certain affiliates (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 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. Pursuant to the Closing Agreement between Ambac and the Internal Revenue Service ("IRS"), the IRS will receive
12.5% of Tier C and 17.5% of Tier D payments, if made.
| Ambac Financial Group, Inc. 140 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
NOL Usage Table
NOL Usage
Tier
A
B
C
D
Allocated NOLs
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%
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 utilized all of its current post determination date NOLs generated from September 30, 2011 through December 31,
2017, generating cumulative taxable income of $1,367,795. 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 two years ended December 31, 2016, Ambac Assurance utilized all of the $479,000 Tier A NOL and $607,124 of the $1,057,000 Tier
B NOL resulting in Tolling Payments , net of applicable credits, of $100,145, of which $71,454 was paid to Ambac in 2016 and $28,691 was
paid in 2017. During the year ended December 31, 2017, Ambac Assurance recorded additional estimated Tolling Payments of $31,133, which
includes $637 of additional tolling resulting from the filing Ambac's 2016 tax return that was paid in December 2017. The balance of $30,496
will be paid to Ambac in May 2018.
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, to the extent Ambac Assurance generates post-determination date income in excess of the $3,650,000,
Allocated NOLs, Ambac Assurance may utilize the remaining NOLs, previously reserved for usage by Ambac, in exchange for a payment of
25% of the federal income tax liability that Ambac Assurance would have been paid had Ambac's NOLs not been 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, 2017, the remaining balance of the $3,650,000 NOL allocated to Ambac Assurance was $2,282,205. As of December 31,
2017 Ambac's NOL was $1,412,639.
15.
EMPLOYMENT BENEFIT PLANS
Postretirement Health Care and Other Benefits:
Ambac provides postretirement and postemployment / severance benefits, including health and life benefits for certain employees who meet
certain age and service requirements. None of the plans are currently funded. Postretirement and postemployment benefits expenses, including
severance benefits paid, was $4,164, $8,846 and $2,570 for the years ended December 31, 2017, 2016 and 2015, respectively.
Effective August 1, 2005, new employees were not eligible for postretirement benefits. The current postretirement benefit requires retirees to
purchase their own medical insurance policy with a portion of their premium being reimbursed by Ambac. The unfunded accumulated
postretirement benefit obligation was $7,820 as of December 31, 2017. The assumed health care cost trend rates range from 5.6% in 2018,
decreasing ratably to 4.5% in 2025. 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, 2017, by $182 and the 2017 benefit expense by $11. 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, 2017 by $258 and the 2017 benefit expense by $17.
The following table sets forth projected benefit payments from Ambac’s postretirement plan over the next ten years for current retirees:
2018
2019
2020
2021
2022
2023-2027
Total
$
282
$
311
$
327
$
353
$
387
$
2,452
$
4,112
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 plan. The rates used for the projected plan benefit obligations at
the measurement date for December 31, 2017 and 2016 were 3.50% and 4.00%, 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 up to an additional 2% of compensation, subject to limits set by the Internal Revenue Code. The total
cost of the Savings Incentive Plan was $691, $911 and $1,042 for the years December 31, 2017, 2016 and 2015, respectively.
| Ambac Financial Group, Inc. 141 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Incentive Compensation - Stock Units and Cash:
Incentive compensation is a key component of our compensation strategy. Our incentive compensation awards generally have two components:
short term incentive compensation or annual bonuses and long term incentive plan awards. Annual decisions with regard to incentive
compensation are generally made in the first quarter of each year and are based on Company performance and individual and business unit
performance of the previous year. For all employees, an allocation of incentive compensation is made between annual bonuses and LTIP
awards. Beginning for the 2016 performance year, the annual bonus was settled via cash and vested restricted stock units for certain employees.
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 2,793,323 shares are available for future grant as of December 31, 2017.
In March 2014, Ambac developed a long term incentive compensation plan (“LTIP”) as a sub-plan of the 2013 Plan. The LTIP is intended to
be an annual program that allows for both cash and equity performance awards to certain US employees. Beginning with grants issued in
2017, the entire LTIP award was issued as equity performance awards to 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 $2,159, $283 and $253
for the years ended December 31, 2017, 2016 and 2015, respectively.
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 (2) (3)
Total stock-based compensation
Total stock-based compensation (after-tax)
2017 (1)
2016
2015
— $
— $
1,640
2,653
4,293
4,293
$
$
3,463
1,790
5,253
5,194
$
$
956
1,257
892
3,105
3,105
$
$
$
(1) As discussed in Note 2. Basis of Presentation and Significant Accounting Policies , we adopted ASU 2016-09 as of January 1, 2017. One of the provisions
of this ASU requires entities to make an accounting policy election with respect to forfeitures of share-based payment awards. We elected to account for
forfeitures as they occur and adopted this provision of ASU 2016-09 using a modified retrospective approach resulting in recording a cumulative-effect
adjustment to equity of $137.
(2) Represents expense related to performance stock units portion of performance awards. Certain performance awards are split evenly between performance
stock units and cash. Cash based compensation expense related to performance awards granted to US employees was $1,565, $1,790 and $892 for the
years ended December 31, 2017, 2016 and 2015, respectively.
(3) 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 the former Chief Executive Officer in 2015 (vested January 1, 2016), 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 2016 or 2017.
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
| Ambac Financial Group, Inc. 142 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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 2017 is as follows:
Year Ended December 31, 2017
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)
143,334
$
—
—
(16,667)
126,667
126,667
$
$
23.64
—
—
20.63
24.03
24.03
$
$
—
—
1.23
1.23
All stock options granted were fully vested as of December 31, 2017. Total unrecognized compensation costs related to unvested stock options
granted were $0 as of December 31, 2017. No stock options were exercised during the years ended December 31, 2017, 2016 and 2015,
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, with certain accelerated vesting features. 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 respective Executive's continued service
with Ambac through the applicable vesting date.
In 2017, RSU awards were granted to certain employees as consideration for a portion of their annual bonus. These awards vest upon grant,
but settlement, other than for employment tax withholdings, occurs in two equal installments on March 2, 2018 and 2019, or upon termination
if earlier.
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.
As of December 31, 2017, 221,803 RSUs remained outstanding, of which (i) 68,654 units required future service as a condition to the delivery
of the underlying shares of common stock and (ii) 153,149 units did not require future service and are deferred for future settlement. 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
(ii) 57,950 units did not require future service and are deferred for future settlement.
| Ambac Financial Group, Inc. 143 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
A summary of RSU activity for 2017 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
264,230
$
70,432
(112,859)
—
221,803
$
16.47
20.22
13.96
—
18.93
(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, 2017, Ambac purchased 56,410 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 2017, 2016 and 2015 was $20.22, $14.34 and $23.71, respectively. As of
December 31, 2017, there was $478 of total unrecognized compensation costs related to unvested RSUs granted. These costs are expected to
be recognized over a weighted average period of 0.6 years. The fair value for RSUs vested and delivered during the year ended December 31,
2017, 2016 and 2015 was $2,536, $2,965 and $864, respectively.
Performance Stock Awards ("PSUs"):
Performance awards granted vest in 3 years and 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 pre-tax income.
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 and 2017 grants 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 the 2015 and 2016 performance awards shall be within 60 days after the end of the performance period, including those
with a partial vesting. The 2017 performance awards shall be within 75 days after the end of the performance period, including those with a
partial vesting.
In 2015, a performance award was granted to the former Chief Executive Officer. This award will vest on February 12, 2018 upon the
emergence of the Segregated Account from rehabilitation.
A summary of PSU activity for 2017 is as follows:
Outstanding at beginning of period
Granted (1)
Delivered (2)
Forfeited (1)
Performance adjustment (3)
Outstanding at end of period
Shares
Weighted Average
Grant Date
Fair Value
227,073
$
153,317
(38,464)
(26,378)
7,395
322,943
$
21.29
22.35
29.78
20.26
29.78
21.06
(1) Represents performance share units at 100% of units granted for LTIP Awards.
(2) Reflects the number of performance shares attributable to the performance goals attained over the completed performance period and for which service
conditions have been met.
(3) Represents the increase (decrease) in shares issued for awards granted in 2014 based upon the attainment of performance metrics at the end of the
performance period.
As of December 31, 2017 there was $3,523 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 1.6 years.
| Ambac Financial Group, Inc. 144 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
16.
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 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:
2018
2019
2020
2021
2022
Thereafter
Total
$
6,794
$
5,563
$
1,929
$
1,566
$
1,569
$
11,765
$
29,186
Ambac rent expense for the aforementioned leases amounted to $2,717, $3,008 and $5,746 for the years ended December 31, 2017, 2016 and
2015, respectively. Beginning in 2016, rent expense is reduced by the reduction in junior surplus notes discussed above.
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 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 (the “October 24 Order”). 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 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. On December 14, 2017, the Wisconsin Court of Appeals, District IV, issued a decision affirming the October 24 Order.
On September 25, 2017, the Rehabilitator filed in the Rehabilitation Court a Motion to Further Amend The Plan of Rehabilitation Confirmed
on January 24, 2011 To Facilitate An Exit from Rehabilitation. The evidentiary Confirmation Hearing was held on January 4, 2018, and
continued on January 22, 2017. On January 22, 2018, the Rehabilitation Court entered an order granting the Rehabilitator’s motion and
| Ambac Financial Group, Inc. 145 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
confirming the Second Amended Plan of Rehabilitation (the "Confirmation Order"), which became effective on February 12, 2018. Pursuant
to the Confirmation Order, the Rehabilitation Court also ruled that, contrary to allegations made by certain parties to certain military housing
litigations (the "MHPI Projects"), the Rehabilitation Court did not previously enter any order that could form the predicate for a claim of
“Ambac Default” and confirmed Section 6.13 of the Second Amended Plan of Rehabilitation which, among other things, provided that any
such default is deemed not to have existed or to be cured.
On January 25, 2018,the MHPI Projects submitted a letter to the Rehabilitation Court objecting to the Rehabilitator's interpretation of Section
6.8 of the Second Amended Plan of Rehabilitation and requesting briefing on the issue and a conference with the Rehabilitation Court. On
February 7, 2018, pursuant to the request of the Rehabilitator, the Rehabilitation Court issued an order denying the request for briefing and a
conference and overruled the objection set forth in the letter of January 25th. On February 7, 2018, the Rehabilitator filed a motion with the
Rehabilitation Court requesting injunctive relief against the MHPI Projects that would, among other things, enjoin the MHPI Projects from
taking further actions or making further arguments, in any court or otherwise, in contravention of the Confirmation Order, the findings contained
in the Confirmation Order or the provisions of the Second Amended Plan of Rehabilitation. On the same day, the Rehabilitation Court issued
an order granting the Rehabilitator's February 7th motion (the "February 7 Order"). On February 26, 2018, the MHPI Projects filed a Notice
of Motion and Motion for Reconsideration as well as a Notice of Motion and Motion for Expedited Hearing in the Rehabilitation Court,
requesting reconsideration of the February 7 Order on an expedited basis. Briefing on the motions is expected to be completed by March 29,
2018 with a hearing to follow on a date to be determined. The Company expects the MHPI Projects to appeal the Confirmation Order and one
or both of the orders issued by the Rehabilitation Court on February 7, 2018.
Litigation Against Ambac
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. On April
26, 2017, the court granted a motion by Meade to amend its complaint to add a new count that Ambac had allegedly "unreasonably
withheld" consent to a proposed Out-Year Development plan submitted by Meade to Ambac for approval. On April 28, 2017, Ambac
Assurance filed a motion for summary judgment on all counts of the original Meade complaint. On April 28, 2017, Meade filed a motion
for partial summary judgment on two counts of the complaint and certain Ambac Assurance affirmative defenses. On June 2, 2017, the
parties filed oppositions to the summary judgment motions. The parties filed reply briefs in support of their motions on June 16, 2017.
On July 14, 2017, the parties cross-moved for summary judgment on the additional count added to the amended complaint on April 26,
2017. The court heard oral argument on all motions for summary judgment on September 1, 2017. On October 20, 2017, the court granted
Meade's motion for summary judgment that the statute of limitations had run on Ambac Assurance's counterclaim for specific performance
and that this ruling was sufficient to fully resolve Meade's claims and Ambac's counterclaims concerning the debt service reserve surety
bond. On November 27, 2017, Ambac Assurance filed a notice of appeal of the circuit court’s decision. On January 22, 2018, the court
granted Meade's motion for summary judgment finding that Ambac Assurance lacked standing on the basis that there had been an "Ambac
Default" by virtue of certain orders of the Rehabilitation Court. On January 26, 2018, Ambac Assurance filed a Motion to Alter or Amend
Judgment with the Maryland Court arguing that the Rehabilitation Court's January 22 Confirmation Order constituted grounds for altering
the judgment to award summary judgment on the "Ambac Default" issue for Ambac Assurance. On February 7, 2018, the Rehabilitation
Court entered a further order enjoining Meade from continuing to argue that an Ambac Default occurred by virtue of the Rehabilitation
Court's prior orders and requiring Meade to file that order with the Maryland Court. On February 8, 2018, Meade complied and filed
the January 22nd and February 7th Rehabilitation Court orders with the Maryland court. On February 12, 2018, the Maryland Court
granted Ambac's motion to stay enforcement of the Court's January 22nd amended order concerning "Ambac Default" and granting Meade
an extension until March 14, 2018 to oppose Ambac's Motion to Alter or Amend Judgment.
• 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. On March 30, 2017, Ambac Assurance filed a motion for summary judgment on all counts of the Monterey Bay complaint. On
March 30, 2017, Monterey Bay filed a motion for partial summary judgment on two counts of the complaint and certain Ambac Assurance
affirmative defenses. The parties filed their opposition briefs on June 2, 2017 and reply briefs on June 9, 2017. On June 19, 2017, the
court issued a preliminary order that partially granted Monterey Bay's motion for summary judgment and ruled that the California statute
of limitations had run on Ambac Assurance's claim for specific performance, subject to Ambac Assurance's defense of equitable tolling.
The court also partially granted Ambac Assurance's motion for summary judgment on certain of Monterey Bay's declaratory judgment
claims. On June 23, 2017, Ambac Assurance withdrew its defense of equitable tolling. The parties agreed that the court's summary
judgment ruling on the statute of limitations was sufficient to end the case at the trial court level and submitted final orders to the court
for approval. The court signed the final orders on July 13, 2017. On September 14, 2017, Ambac Assurance filed a notice of appeal.
| Ambac Financial Group, Inc. 146 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The Company believes that it has substantial defenses to the claims raised in these lawsuits and intends to defend itself vigorously; however,
the Company is not able to predict the outcome of these actions.
Monterey Bay Military Housing, LLC, et al. v. Ambac Assurance Corporation, et al. (United States District Court, Northern District of
California, San Jose Division, Case No. 17-cv-04992-BLF, filed August 28, 2017). Plaintiffs-the corporate developers of various military
housing projects-filed an amended complaint on October 27, 2017 asserting claims for (i) violation of 18 U.S.C §§ 1962(c) and 1962(d) (civil
Racketeer Influenced and Corrupt Organizations Act (“RICO”) and conspiracy to commit civil RICO), (ii) breach of fiduciary duty, (iii) aiding
and abetting breach of fiduciary duty, (iv) fraudulent misrepresentation, (v) fraudulent concealment and (vi) conspiracy to commit fraud.
Ambac Assurance and a former employee of Ambac Assurance are included in the named defendants. The claims relate to bonds and debt
certificates (insured by Ambac Assurance) that were issued to finance the renovation and construction of housing at certain military bases.
Plaintiffs allege that defendants secretly conspired to overcharge plaintiffs for the financing of the projects and directed the excess profits to
themselves. Plaintiffs allege defendants generated these excess profits by supposedly charging inflated interest rates, manipulating “shadow
ratings,” charging unnecessary fees, rigging the Guaranteed Investment Contract (“GIC”) bidding process, and hiding evidence of their alleged
wrongdoing. Plaintiffs seek, among other things, compensatory damages, disgorgement of profits and fees, punitive damages, trebled damages
and attorneys’ fees. On September 21, 2017, Ambac Assurance filed a motion to transfer venue to the United States District Court for the
Southern District of New York, which motion plaintiffs opposed on October 5, 2017. The Court heard oral argument on November 30, 2017
and requested additional briefing from both parties. After the submission of the additional briefing, the Court denied Ambac’s motion to
transfer on January 2, 2018. Ambac and the other defendants filed motions to dismiss the amended complaint on November 13, 2017, which
Plaintiffs opposed on December 15, 2017. The motions are fully briefed and a hearing is scheduled on the motions for April 12, 2018. Ambac
believes the lawsuit is without merit.
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 or Joined 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
| Ambac Financial Group, Inc. 147 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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. The plan of
adjustment was confirmed on February 7, 2017 and became effective on June 15, 2017. Accordingly, the parties filed a stipulation agreeing
to dismiss the appeal with prejudice with the Bankruptcy Appellate Panel on June 25, 2017. The bankruptcy appellate panel dismissed the
appeal on July 13, 2017.
Puerto Rico:
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 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. PROMESA’s litigation stay expired on May 2, 2017. On May 3, 2017, a petition under Title III of PROMESA was filed
on behalf of the Commonwealth of Puerto Rico. On May 16, 2017, Defendants filed a statement requesting that the court take notice of the
stay resulting from the Commonwealth’s Title III filing. On May 17, 2017, the court issued an order staying this case until further order of
the court.
Ambac Assurance Corporation v. Puerto Rico Highways and Transportation Authority (United States District Court, District of Puerto Rico,
No. 16-cv-1893, filed May 10, 2016). 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. PROMESA’s litigation stay expired on May 2, 2017. The Commonwealth and Oversight
Board have stated to Ambac Assurance that they believe this action is stayed due to the Commonwealth’s Title III filing. Subsequent to that
statement, on May 21, 2017, a petition under Title III of PROMESA was filed on behalf of PRHTA. On May 24, 2017, the court issued an
order staying this case until further order of the court.
Lex Claims, LLC et al. v. Alejandro Garcia Padilla et al. (United States District Court, District of Puerto Rico, No. 16-2374, filed July 20,
2016). On October 7, 2016, certain General Obligation bondholder Plaintiffs in an action to which Ambac Assurance was not then a party
filed a motion for leave to amend their complaint and for partial relief from the PROMESA stay. Plaintiffs’ proposed second amended complaint
added the Puerto Rico Sales Tax Financing Corporation (COFINA), COFINA’s executive director, and the trustee for the COFINA bonds as
Defendants, and asserted 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. Plaintiffs contended that many of the claims
| Ambac Financial Group, Inc. 148 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
challenging COFINA are not subject to PROMESA’s litigation stay provisions. On October 24, 2016, 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. 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, government Defendants sought to stay the case. On February 17, 2017, the
court granted the motions to intervene of Ambac Assurance and certain other parties. The court also denied Defendants’ motion to stay,
rejecting the arguments in support of the stay filed by Defendants and the intervenors, including Ambac Assurance. On March 20, 2017, Ambac
Assurance filed in the district court an answer to the second amended complaint and a motion to dismiss Plaintiffs’ claim against COFINA,
to strike certain portions of the second amended complaint, or, in the alternative, to certify the question of COFINA’s constitutionality to the
Supreme Court of Puerto Rico. Certain other intervenors also filed answers and various motions in the district court. On April 4, 2017, the
U.S. Court of Appeals for the First Circuit reversed the district court’s decision concerning the application of the PROMESA stay, which had
the effect of reinstating the stay. PROMESA’s litigation stay expired on May 2, 2017. On May 3, 2017, a petition under Title III of PROMESA
was filed on behalf of the Commonwealth of Puerto Rico. On May 16, 2017, Defendants filed a statement requesting that the court take notice
of the stay resulting from the Commonwealth’s Title III filing. On May 17, 2017, the court issued an order staying this case until further order
of the court.
Ambac Assurance Corporation v. Puerto Rico, et al. (United States District Court, District of Puerto Rico, No. 17-1567, filed May 2, 2017).
On May 2, 2017, Ambac Assurance filed a complaint seeking a declaration that the Commonwealth’s Fiscal and Economic Growth Plan (the
FEGP) and a recently enacted statute called the “Fiscal Plan Compliance Law” are unconstitutional and unlawful because they violate the
Contracts, Takings, and Due Process Clauses of the U.S. Constitution, are preempted by PROMESA, and are unlawful transfers of property
from COFINA to the Commonwealth in violation of PROMESA. The complaint further seeks an injunction against the filing of any Title III
petitions, an injunction against the enactment or enforcement of any future legislation, rules, budgets, or restructuring plans premised on the
FEGP, and a declaration that the Commonwealth is liable for any funds unlawfully transferred to it from COFINA. The complaint also seeks
a declaration that the FEGP and Fiscal Plan Compliance Law violate covenants made by the Commonwealth and COFINA in the COFINA
Resolution, which constitute Events of Default under the COFINA Resolution. On May 3, 2017, a petition under Title III of PROMESA was
filed on behalf of the Commonwealth of Puerto Rico, and on May 5, 2017, a petition under Title III of PROMESA was filed on behalf of
COFINA. On May 15, 2017, the Oversight Board filed a statement requesting that the court take notice of the stays resulting from these Title
III filings. On May 17, 2017, the court issued an order staying this case until further order of the court.
Ambac Assurance Corporation v. Puerto Rico, et al. (United States District Court, District of Puerto Rico, No. 17-1568, filed May 2, 2017).
On May 2, 2017, Ambac Assurance filed a complaint alleging that various moratorium laws and executive orders enacted by the Commonwealth
to claw back funds from the PRIFA, PRHTA, and PRCCDA bonds violate the Contracts, Takings, and Due Process Clauses of the U.S.
Constitution, are preempted by PROMESA, and unlawfully transfer PRHTA, PRCCDA, and PRIFA property to the Commonwealth. The
complaint further seeks a declaration that the Commonwealth is liable for any funds unlawfully transferred to it from COFINA, an injunction
against enforcement of the moratorium laws and executive orders, an injunction against the filing of any Title III petitions, and an injunction
against the enactment or enforcement of any future legislation, rules, budgets, or restructuring plans premised on the FEGP. On May 3, 2017,
a petition under Title III of PROMESA was filed on behalf of the Commonwealth of Puerto Rico. On May 15, 2017, the Oversight Board
filed a statement requesting that the court take notice of the stay resulting from the Commonwealth’s Title III filing. On May 17, 2017, the
court issued an order staying this case until further order of the court.
Ambac Assurance Corporation v. U.S. Department of Treasury et al. (United States District Court, District of Columbia, No. 17-809, filed
May 2, 2017). On May 2, 2017, Ambac Assurance filed a complaint against the U.S. Department of Treasury and Steven Mnuchin, in his
official capacity as Secretary of the Treasury, alleging that Puerto Rico’s ongoing diversion of rum taxes from PRIFA violates the Contracts,
Takings, and Due Process Clauses of the U.S. Constitution, and seeking an equitable lien on all rum taxes possessed by the U.S. Treasury, and
an injunction preventing their transfer to the Commonwealth, in order to prevent further dissipation of those funds by the Commonwealth.
On May 24, 2017, the Oversight Board filed a statement requesting that the court take notice of the stay resulting from the Commonwealth’s
Title III filing. On May 25, 2017, the court issued an order staying this case pending the final disposition of the Title III proceedings.
Ambac Assurance Corporation v. Bank of New York Mellon (United States District Court, Southern District of New York. No. 1:17-cv-03804,
filed May 2, 2017). On May 2, 2017, Ambac Assurance filed a complaint in New York State Supreme Court, New York County, against the
trustee for the COFINA bonds, Bank of New York Mellon (BNY), alleging breach of fiduciary, contractual, and other duties for failing to
adequately and appropriately protect the holders of certain Ambac Assurance-insured senior COFINA bonds. The complaint seeks money
damages; a declaration that BONY breached its fiduciary, contractual, and other duties; a declaration compelling BNY to recognize an event
of default under the COFINA Resolution and accelerate the COFINA debt; an injunction to prevent BNY from making payments to holders
of subordinate COFINA bonds; and forced replacement of BNY as trustee. On May 19, 2017, BNY filed a notice of removal of this action
from New York state court to the United States District Court for the Southern District of New York. On May 30, 2017, the United States
District Court for the District of Puerto Rico entered an order in an adversary proceeding brought by BNY (No. 1:17-ap-00133) staying this
litigation pending further order of the court.
| Ambac Financial Group, Inc. 149 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Bank of New York Mellon v. COFINA, et al. (United States District Court, District of Puerto Rico, No. 1:17-ap-00133, filed May 16, 2017).
On May 16, 2017, BNY filed an adversary complaint in COFINA’s Title III case for an order to show cause why the court should not: (i)
grant an interpleader of funds that BNY is holding for future interest payments to holders of COFINA bonds; (ii) stay pending and future
litigation against BNY related to its role as trustee for COFINA bonds, including the action by Ambac Assurance against BNY; and (iii)
discharge BNY from any liability in association with the interpleaded funds. BNY filed this interpleader action against COFINA and certain
creditors of COFINA, including Ambac Assurance, that have made competing claims of entitlement to funds held by BNY in order to determine
the parties’ respective entitlements to the funds. On May 30, 2017, the court granted BNY’s motion to interplead, and on June 6, 2017, the
court set a schedule for discovery and briefing. Discovery and briefing are ongoing; summary judgment briefing is scheduled to conclude on
December 1, 2017. An ad hoc group of general obligation bondholders and the Official Committee of Unsecured Creditors for the
Commonwealth of Puerto Rico (the Creditors’ Committee) each moved to intervene (respectively) on May 23 and July 31, 2017; these motions
to intervene were denied (respectively) on July 6 and August 1, 2017. On August 29, 2017, the Creditors’ Committee moved to intervene
again, this time in its capacity as Commonwealth Agent. Multiple parties objected to the motion, including Ambac Assurance. Oral argument
was heard in front of Magistrate Judge Dein on September 15, 2017. On September 27, 2017, Judge Dein issued an opinion and order denying
the motion to intervene but holding that the Creditors’ Committee may renew its request to intervene as a statutory committee, rather than as
Commonwealth Agent. Fact stipulations among the parties were entered and so-ordered on September 26 and October 12, 2017, obviating
the need for certain depositions. On November 6, 2017, a number of parties, including Ambac Assurance, filed motions for summary judgment;
Ambac Assurance argued that the Commonwealth’s and COFINA’s pre-petition actions constituted defaults under the COFINA bond resolution,
and these defaults have ripened into events of default resulting in the senior COFINA bondholders’ absolute priority to the funds in BNY’s
possession. Briefing on the summary judgment motions was completed on January 5, 2018.
Peaje Investments LLC v. Puerto Rico Highways and Transportation Authority, et al. (United States District Court, District of Puerto Rico,
No. 1:17-ap-00151, filed May 31, 2017). On June 15, 2017, Ambac Assurance moved to intervene in an adversary proceeding brought by
Peaje Investments (Peaje), a holder of 1968 Bonds issued by PRHTA, against PRHTA. On May 31, 2017, Peaje filed a complaint seeking
relief with respect to its ownership of the 1968 Bonds, including a declaration that the toll road revenues pledged to the 1968 Bonds are “special
revenues” under Section 922 of the Bankruptcy Code, an injunction preventing the diversion of toll revenues to the Commonwealth and
ordering the application of the toll revenues to the 1968 Bonds, and various declarations and injunctions related thereto. Peaje also filed a
motion for a temporary restraining order and preliminary injunction on the same day, seeking to enjoin PRHTA from diverting the toll revenues
to the Commonwealth. A hearing on the motion for a temporary restraining order was held on June 5, 2017, at which time Peaje withdrew
the motion for a temporary restraining order. In its motion to intervene, Ambac Assurance argued that issues in this case will have a significant
impact on Ambac’s own interests with respect to PRHTA bonds. On July 21, 2017, the court denied Ambac Assurance's motion to intervene.
On September 8, 2017, the court denied Peaje’s motion for a preliminary injunction, finding that Peaje had not demonstrated either (i) a
likelihood of success on the merits of its underlying claim that the 1968 bonds are secured by a statutory lien, or (ii) that it would be irreparably
harmed in the absence of a preliminary injunction. Peaje has appealed this denial of the preliminary injunction to the U.S. Court of Appeals
for the First Circuit; the First Circuit has not yet ruled on this appeal. On October 10, 2017, Peaje filed an amended complaint; Defendants
filed answers to the amended complaint on November 17, 2017.
Ambac Assurance Corporation v. Puerto Rico, et al. (United States District Court, District of Puerto Rico, No. 1:17-ap-00159, filed June 8,
2017). On June 8, 2017, Ambac Assurance filed an adversary complaint in the Commonwealth’s Title III case against the Commonwealth,
PRHTA, the Oversight Board, AAFAF, and other Commonwealth government officers. The complaint seeks declarations that (i) various
moratorium laws ("Moratorium Legislation") enacted by the Commonwealth and executive orders ("Moratorium Orders") issued by the
Governor to claw back funds from the PRIFA, PRHTA, and PRCCDA bonds and (ii) the FEGP and Fiscal Plan Compliance Act violate the
Contracts, Takings, and Due Process Clauses of the U.S. Constitution, are preempted by PROMESA, and unlawfully transfer PRHTA, PRCCDA,
and PRIFA property to the Commonwealth. The complaint further seeks a declaration that revenues pledged to the PRHTA bonds are “special
revenues” under Sections 922 and 928 of the Bankruptcy Code, and an injunction compelling Defendants to remit the pledged special revenues
to PRHTA for payment of the PRHTA bonds. On July 7, 2017, Ambac Assurance filed an amended complaint that added an additional claim
for relief: a declaration that the funds held in the PRHTA reserve accounts are property of the PRHTA bondholders. On August 3, 2017, the
court entered an order, to which all parties stipulated, providing that BNYM, as fiscal agent for PRHTA bondholders, shall continue to hold
the funds in the reserve accounts established under PRHTA’s governing bond documents until further order of the court. On October 27, 2017,
the court ordered that the Creditors’ Committee is entitled to “limited intervention,” in the proceeding. On July 28, 2017, Defendants moved
to dismiss Ambac Assurance’s complaint; briefing on the motion to dismiss concluded on October 31, 2017, and oral argument on the motion
was held on November 21, 2017. On February 27, 2018, the court granted Defendants’ motion to dismiss. As to certain of the claims, the
court found that it lacks subject matter jurisdiction (i) to the extent the claims seek to invalidate the certification of the FEGP and prohibit
certain actions under PROMESA due to alleged non-compliance with PROMESA requirements that are predicates to certification of the FEGP,
or (ii) to the extent Ambac Assurance sought a determination of its lien rights over the PRHTA reserve accounts. As to other claims, the court
found that Ambac Assurance had failed to state a claim upon which the court could grant relief, including that (i) as to constitutional issues,
Ambac Assurance had failed to plead facts sufficient to allow the court to draw a reasonable inference that the Moratorium Legislation,
Moratorium Orders, and Fiscal Plan Compliance Act were “unreasonable or unnecessary to effectuate an important government purpose” and
had failed to allege plausibly that the FEGP is an exercise of Commonwealth legislative power, (ii) Ambac Assurance had failed to plead facts
sufficient to show that the Moratorium Legislation and Moratorium Orders prohibited the payment of principal and interest or purported to
bind creditors to any reduction of the outstanding obligations and therefore would have been preempted by PROMESA under PROMESA
Section 303(1), and Ambac Assurance failed to plead plausible, ripe claims that the Moratorium Orders are unlawful under PROMESA section
| Ambac Financial Group, Inc. 150 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
303(3), (iii) the automatic stay is currently in effect and renders unavailable any cause of action pursuant to Section 407 of PROMESA,
including claims by PRHTA bondholders that PRHTA should be compensated for any pledged special revenues transferred away from it in
violation of applicable law, (iv) the court is not required or empowered under PROMESA or the Bankruptcy Code to order the payment of
pledged special revenues to the PRHTA bondholders, and (v) Ambac Assurance had failed to plead facts sufficient to show that the PRHTA
reserve accounts are the property of the bondholders. Finally, the court held that PROMESA section 305 prevented it from ordering any relief
on Ambac’s claim that the PRHTA reserve accounts are held in trust for bondholders.
Official Committee of Unsecured Creditors v. Whyte (United States District Court, District of Puerto Rico, No. 1:17-ap-00257, filed September
8, 2017). On August 10, 2017, the court approved a stipulation between the Oversight Board, the Commonwealth, COFINA, and certain
creditor parties, including Ambac Assurance, to resolve the Commonwealth-COFINA dispute regarding entitlement to sales and use taxes.
The stipulation contemplates separate agents for each of COFINA and the Commonwealth, which agents will litigate the dispute, while
preserving the ability of interested parties, including Ambac Assurance, to participate in the litigation. The court order names Ms. Bettina
Whyte as the agent for COFINA, and names the Creditors’ Committee as the agent for the Commonwealth. On September 8, 2017, pursuant
to a stipulation and scheduling order entered by the court, the Creditors’ Committee, as Commonwealth Agent, filed an adversary proceeding
against Bettina Whyte, as COFINA Agent. The thirteen-count complaint for declaratory relief alleges (a) that COFINA’s enabling legislation
did not, and could not, transfer present ownership of the future Sales and Use Tax revenues to COFINA, (b) that this purported transfer is
governed by Article 9 of the Uniform Commercial Code and is not enforceable, was never perfected, and is avoidable and (c) that the COFINA
structure is unconstitutional because the COFINA enabling legislation was designed to evade the constitutional debt limit, the constitutional
priority of payment granted to Puerto Rico’s public debtholders, and the balanced budget provision. The Creditors’ Committee filed a revised
complaint on October 25, 2017, making technical corrections to the original complaint; the COFINA Agent filed an answer to this amended
complaint on October 30, 2017. On November 6, 2017, Ambac Assurance filed a notice of intervention, together with an answer and
counterclaims; other interested parties named in the stipulation governing the Commonwealth-COFINA dispute similarly filed answers and
counterclaims. On November 13, 2017, Ambac Assurance and certain other interested parties filed motions seeking to enforce the stipulated
scope of the Commonwealth-COFINA dispute. Ambac Assurance moved to strike the Commonwealth Agent’s fourth through thirteenth causes
of action as beyond the stipulated scope of the dispute, which is narrowly focused on whether the Pledged Sales Taxes are the property of
COFINA. On December 21, 2017, the District Court dismissed all but the first and second causes of action in the Commonwealth Agent’s
complaint as outside the scope of the Commonwealth-COFINA dispute, ruling that the stipulation governing such dispute contemplates a
narrow focus on the ownership of the Pledged Sales Taxes. On January 4, 2018, the Commonwealth Agent filed a motion to clarify the District
Court’s December 21 scope order, seeking reconsideration of the dismissal of the Commonwealth’s Agent’s constitutional claims or leave to
amend its complaint such that its constitutional claims might fall within the permitted scope. Ambac Assurance objected to this motion on
January 8, 2018. On January 10, 2018, the District Court denied the Commonwealth Agent’s motion to reconsider, but permitted the
Commonwealth Agent to move to amend its complaint in a manner consistent with the December 21 scope order. The Commonwealth Agent
moved to file an amended complaint on January 11, 2018, which motion Ambac Assurance opposed on January 12, 2018; the District Court
granted the Commonwealth Agent’s motion on January 13, 2018, and the Commonwealth Agent filed its amended complaint on January 16,
2018; the COFINA Agent, Ambac Assurance, and other parties filed answers and counterclaims to the amended complaint on January 30,
2018. The Commonwealth and other parties filed answers to these counterclaims on February 13 and 14, 2018. Motions for summary judgment
were filed on February 21, 2018, with a hearing on those motions scheduled for April 10, 2018.
In re Financial Oversight and Management Board for Puerto Rico as representative of Puerto Rico Electric Power Authority (United States
District Court, District of Puerto Rico, No. 1:17-bk-04780, filed July 2, 2017). On January 31, 2018, the Oversight Board filed an urgent
motion for approval of a post-petition revolving loan from the Commonwealth to PREPA in an initial amount of $550 million, up to $1.3
billion (which figure later was lowered to $1.0 billion in amended filings on February 12, 2018). On February 2, 2018, Ambac Assurance
filed an objection to the urgent motion. A hearing on the urgent motion was held on February 15, 2018, at the conclusion of which the Court
ruled that the Oversight Board had not established the need for or the legality of the requested $1.0 billion facility, but held the motion in
abeyance without prejudice to amendment. On February 16, 2018, the Oversight Board filed a revised request for a $300 million loan; on
February 19, 2018, the Court entered an order approving the $300 million loan from the Commonwealth to PREPA.
Student Loans Exposure:
CFPB v. Nat’l Collegiate Master Student Loan Trust (United States District Court, District of Delaware, Case No. 1:17-cv-01323, filed
September 18, 2017). The Consumer Financial Protection Bureau (“CFPB”) filed a complaint against fifteen National Collegiate Student Loan
Trusts, regarding alleged improprieties and deficiencies in servicing practices. Simultaneous with the filing of its complaint, CFPB also filed
a motion for entry of a proposed consent judgment that would grant monetary damages and injunctive relief against the Trusts. Ambac guaranteed
certain securities issued by three of the Trusts and indirectly insures six other Trusts. Ambac filed a motion to intervene in the action on
September 20, 2017. On November 1, 2017, CFPB and the entities purporting to act on behalf of the Trusts filed briefs in response to Ambac’s
motion to intervene stating that they do not oppose Ambac’s motion. Ambac filed a reply brief in further support of its motion to intervene
on November 20, 2017. Ambac’s motion remains pending.
Nat’l Collegiate Master Student Loan Trust v. Pa. Higher Education Assistance Agency (PHEAA) (Delaware Court of Chancery, C.A. No.
12111-VCS, filed March 21, 2016). Plaintiffs purporting to act on behalf of fifteen National Collegiate Student Loan Trusts filed a lawsuit
against PHEAA, a servicer of loans in the Trusts, alleging improprieties and deficiencies in servicing practices and seeking an order compelling
PHEAA to submit to an emergency audit. PHEAA submitted papers contesting the validity of certain transfers to Plaintiffs of beneficial
| Ambac Financial Group, Inc. 151 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
ownership interests in the Trusts. In addition, the Owner Trustee of the Trusts, Wilmington Trust Company, WTC, citing irreconcilable
differences with Plaintiffs, has resigned from its role as Owner Trustee and moved for appointment of a successor Owner Trustee. On October
9, 2017, the court directed the parties to meet and confer to develop a process for selecting an interim Owner Trustee. Ambac guaranteed
certain securities issued by three of the Trusts and indirectly insures certain securities in six other Trusts. Ambac filed a motion to intervene
in the action on October 23, 2017, for the limited purpose of being heard regarding the appointment of a successor Owner Trustee and regarding
WTC’s contractual commitment and obligation to remain in that role until such appointment is made. Plaintiffs opposed Ambac’s motion to
intervene on October 27, 2017. On October 30, 2017, the court denied without prejudice a stipulation filed by Plaintiffs and WTC purporting
to address the Owner Trustee issue, and instructed that all interested parties be given notice and an opportunity to participate in discussions
to formulate a process for selecting a successor Owner Trustee. Ambac filed a reply brief in further support of its motion to intervene on
November 3, 2017. On November 7, 2017, the court ruled in Plaintiffs’ favor and confirmed the validity of the ownership transfers that
PHEAA had disputed. On January 12, 2018, Plaintiffs filed a motion for injunctive or declaratory relief requiring WTC, as Owner Trustee,
and GSS Data Services, Inc., as Administrator, to resume processing for payment bills submitted by lawyers purporting to act on the Trusts’
behalf. Oppositions to Plaintiffs’ motion are due on March 1, 2018. Negotiations regarding the selection of a new or interim Owner Trustee
are ongoing.
Military Housing:
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. Defendants have asserted, among other things, that Ambac Assurance's claims are barred
by the doctrine of laches, that Ambac Assurance lacks standing on the basis that there has been an “Ambac Default” or "Credit Enhancer
Default" and that Ambac Assurance is not entitled to specific performance pursuant to the terms of the 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. On September 29, 2017, Ambac
Assurance filed a motion for summary judgment on all counts of the Complaint and most of Riley's affirmative defenses. On September
29, 2017, Riley filed a motion for partial summary judgment on two of its affirmative defenses, including statute of limitations and "Credit
Enhancer Default" by virtue of certain orders of the Rehabilitation Court. The parties filed their oppositions to the summary judgment
motions on October 27 and replies November 10, 2017. Due to the Rehabilitation Court’s January 22 Order, on January 24, 2018, Ambac
Assurance filed a Notice of Events Subsequent and Supplemental Brief in support of its Motion for Summary Judgment arguing that the
Rehabilitation Court's January 22 order constituted further grounds for entering summary judgment for Ambac Assurance on the "Credit
Enhancer Default" argument.
• 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. On March 17, 2017, the court granted Fort Leavenworth's motion to dismiss for lack of subject matter jurisdiction.
On March 28, 2017, Ambac re-filed the case in state court in Shawnee County, Kansas. The re-filed case is styled Ambac Assurance
Corporation v. Fort Leavenworth Frontier Heritage Communities II, LLC (District Court, Shawnee County, Kansas, No. 2017-cv-000216).
• 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. Defendant
filed a motion for summary judgment on November 16, 2017 on two of its affirmative defenses, including statute of limitations and
"Credit Enhancer Default" by virtue of certain orders of the Rehabilitation Court. Ambac Assurance filed a consolidated (i) opposition
to Fort Bliss/White Sands’ motion for summary judgment and (ii) counter-motion for partial summary judgment on December 13, 2017.
Defendant filed its opposition on January 22, 2018. Ambac Assurance filed its reply brief on January 30, 2018 arguing, among other
things, that the Rehabilitation Court’s January 22 Order constituted further grounds for entering summary judgment for Ambac Assurance
on the "Credit Enhancer Default" argument. Oral argument on the summary judgment motions has been scheduled for April 27, 2018.
On February 7, 2018, the Rehabilitation Court entered a further order enjoining Bliss (among others) from continuing to argue that an
Ambac Default occurred by virtue of the Rehabilitation Court's prior orders and requiring Bliss to file that order with the Texas Court.
On February 8, 2018, Bliss filed the Rehabilitation Court's January 22 and February 7 orders with the Texas court.
| Ambac Financial Group, Inc. 152 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
RMBS Litigation:
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. On May 16, 2017, the First Department issued rulings in both appeals, reversing a number of rulings that the trial court
had made and affirming other rulings. On June 15, 2017, Ambac Assurance filed a motion with the First Department for leave to appeal
certain rulings in the May 16, 2017 decision to the Court of Appeals, which Countrywide opposed. On July 25, 2017 the First Department
granted Ambac Assurance’s motion. The briefing for the appeal has been completed and oral argument is expected in 2018.
• 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. On March 27, 2017, Nomura appealed the June 2015
decision to the extent it denied its motion to dismiss and filed its opening appellate brief. Ambac Assurance opposed that appeal. On
December 7, 2017, the First Department affirmed the trial court’s June 3, 2015 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
| Ambac Financial Group, Inc. 153 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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 trial court’s 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 was argued on February 28, 2017. On June 30, 2017, the Wisconsin Supreme Court reversed the decision of the Wisconsin
Court of Appeals and remanded the case to the Wisconsin Court of Appeals for further proceedings. On December 14, 2017, the Wisconsin
Court of Appeals affirmed the trial court’s July 2, 2015 decision dismissing the case for lack of personal jurisdiction. On January 16,
2018, Ambac Assurance filed a petition with the Supreme Court of Wisconsin for review of the December 14, 2017 decision. On January
30, 2018, Countrywide opposed the petition. 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. On February 23, 2017, plaintiffs filed a second amended complaint to
reflect a revised settlement offer, and also filed a motion for a preliminary injunction, which U.S. Bank opposed. On March 9, 2017,
U.S. Bank filed a motion to dismiss the second amended complaint, which plaintiffs opposed. The court heard oral argument on plaintiffs’
motion for a preliminary injunction and U.S. Bank’s motion to dismiss on April 24, 2017. On June 1, 2017, the court denied U.S. Bank’s
motion to dismiss and denied plaintiffs’ motion for a preliminary injunction. U.S. Bank filed a motion for reconsideration of the court’s
denial of its motion to dismiss, which plaintiffs opposed. On December 6, 2017, the court granted the motion for reconsideration and
granted U.S. Bank’s motion to dismiss, and on January 18, 2018, the court issued an opinion memorializing the reasons for its decision.
On March 6, 2017, U.S. Bank filed a trust instruction proceeding in Minnesota state court concerning the proposed settlement, which is
captioned, In the matter of HarborView Mortgage Loan Trust 2005-10, No. 27-TR-CV-17-32 (the “Minnesota Action”). On April 5,
2017, Ambac Assurance filed a motion to dismiss the Minnesota Action. On June 12, 2017, U.S. Bank filed an amended petition in the
Minnesota Action and on July 7, 2017, Ambac Assurance renewed its motion to dismiss, which U.S Bank opposed. On November 13,
2017, the court denied the motion to dismiss the proceeding. On February 7, 2018, Ambac Assurance appealed this dismissal. Additionally,
certain certificate holders have objected or otherwise responded to the petition filed by U.S. Bank.
• 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-02614, filed April 11, 2017). Ambac Assurance alleges claims
for breach of contract, breach of fiduciary duty, declaratory judgment, and violation of the Streit Act in connection with defendant’s
failure to enforce rights and remedies and defendant’s treatment of trust recoveries, as trustee of five residential mortgage-backed
securitizations for which Ambac Assurance issued insurance policies. On September 15, 2017, U.S. Bank filed a motion to dismiss, which
Ambac Assurance opposed on October 13, 2017. Oral argument on that motion was held on November 17, 2017. The motion remains
pending.
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. The presiding
judge approved the settlement in August of 2014. A fair fund has been established to distribute the $285,000 (plus $2,550 received from a
related proceeding). RCB Fund Services (the “Distribution Agent”) has been appointed as distribution agent for the fund and has invited
| Ambac Financial Group, Inc. 154 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
investor participants in the CDO transaction to provide information regarding their investments in the CDO transaction. Ambac Assurance
filed a submission with the requested information on February 28, 2018. The Distribution Agent, in consultation with the SEC, will then
develop a distribution plan for the fair fund, which will be filed with the Court and will be subject to a comment period. While there can be
no assurance as what the Distribution Plan will provide, or the timing or substance of what the Court 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
17.
SUBSEQUENT EVENTS
As more fully discussed in Note 1. Background and Business Description, on February 12, 2018:
• the Second Amended Plan of Rehabilitation became effective and a series of transactions were consummated which provided holders of
beneficial interests in Deferred Amounts (other than Ambac, but including Ambac Assurance) a total effective consideration package, in
full satisfaction and discharge of each $1.00 of Deferred Amounts (including accretion), of (i) $0.40 in cash, (ii) $0.41 in principal amount
of new Secured Notes and (iii) from certain holders of surplus notes, $0.125 currently outstanding surplus notes. Such consideration
package provided a discount of $0.065 (set first against accretion of Deferred Amounts). Ambac received $0.91 in principal amount of
Secured Notes for each $1.00 of Deferred Amounts (including accretion) that it held, and provided a $0.09 discount in full satisfaction
and discharge of its Deferred Amount claims. This transaction is being accounted for as an extinguishment of Deferred Amounts and the
discount of approximately $288,000 from the settlement will be reflected as a benefit to loss and loss expenses in the Consolidated
Statements of Comprehensive Income (Loss) in the quarter ended March 31, 2018.
• the Exchange Offers were consummated, pursuant to which holders of surplus notes received the same effective package as holders of
beneficial interests in Deferred Amounts, including the discount of $0.065 in principal amount and accrued and unpaid interest on the
surplus notes tendered; resulting in Ambac Assurance's cancellation of $809,520 of principal and accrued and unpaid interest of general
account surplus notes. The Exchange Offers will be accounted for as a debt modification since the creditors before and after the discount
remain the same and the change in the terms is not considered substantial. A substantial change is considered to be a change in cash flows
of equal to or greater than 10% as a result of the modification of terms. As the change in cash flows is less than 10%, debt modification
accounting is appropriate. Under debt modification accounting, no gain or loss is recorded, and a new effective interest rate is established
based on the cash flows of the Ambac Note, which secures the Secured Notes issued as part of the Exchange Offers. Additionally, any
consideration paid that is directly related to the issuance of the Ambac Note is capitalized and amortized as part of the effective yield
calculation.
• in connection with the Rehabilitation Exit Transactions, Ambac Assurance is making a one-time current interest payment on remaining
surplus notes (other than junior surplus notes) of $13,501, of which $2,618 will be received by Ambac.
• Ambac Assurance issued $240,000 of new debt secured by certain of Ambac Assurance’s rights to representation and warranty subrogation
recoveries above $1,600,000 ("Tier 2 Notes"). The proceeds received from this issuance were used to fund the cash portion of the
consideration paid pursuant to the Second Amended Plan of Rehabilitation and Exchange Offers.
• Ambac will incur operating expenses in the first quarter of 2018 for its and the OCI's financial advisors that is approximately $14,000.
In order to execute these transactions, Ambac established a special purpose entity, Ambac LSNI, LLC, for the sole purpose of the issuance of
Secured Notes. Ambac Assurance will not consolidate Ambac LSNI, LLC and will receive $768,464 par amount of the Secured Notes, which
will be held in Ambac's investment portfolio.
Ambac's invested assets and cash will be reduced by the total cash outflow of approximately $1,353,560 and Ambac will experience reductions
in the value of Ambac-insured RMBS securities held in the investment portfolio.
Ambac Assurance will record the principal amount of long-term debt for the Ambac Note of $2,154,351 and the Tier 2 Notes of $240,000.
The key terms of these instruments are as follows:
• The Ambac Note (and Secured Notes) will accrue interest at a per annum rate of 3-month U.S. Dollar LIBOR plus 5.00%, subject to a
1.00% LIBOR floor. Accrued and unpaid interest will be paid in cash on each payment date (quarterly on the last day of each quarter
beginning with June 30, 2018) until the maturity date. The maturity date for the Secured Notes and the Ambac Note will be the earlier
of (x) February 12, 2023, and (y) if the Secured Notes are then outstanding, the date that is five business days prior to the date for which
OCI has approved the repayment of the outstanding principal amount of the surplus notes (other than junior surplus notes) issued by
Ambac Assurance. Promptly, and in any event within four business days after the receipt (whether directly or indirectly) of any
representation and warranty subrogation recoveries, Ambac Assurance shall (i) apply an amount (the “Mandatory Redemption Amount”)
equal to the lesser of (a) the amount of such RMBS proceeds and (b) all outstanding principal and accrued and unpaid interest on the
Ambac Note to redeem the Ambac Note, in whole or in part, as applicable; provided, that any non-cash RMBS proceeds shall be deemed
to be received upon the receipt of the applicable appraisal. Redemptions or prepayments of the Ambac Note will result in corresponding
redemptions or prepayments of the Secured Notes.
| Ambac Financial Group, Inc. 155 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
• The Tier 2 Notes will mature in 2055 and shall bear interest at a rate of 8.50% per annum, calculated on a 30/360 basis. Interest payments
will not be made in cash on interest payment dates and shall be paid-in-kind and compounded on the last day of each calendar quarter,
unless (i) funds are available to make such payments in cash as a result of receiving recoveries in respect of the representation and warranty
subrogation recoveries in excess of $1,600,000 or (ii) interest is paid in cash on surplus notes (other than in connection with the Exchange
Offers and Second Amended Plan of Rehabilitation). The Tier 2 Notes may not be redeemed or repaid prior to December 17, 2020, unless
Ambac Assurance pays a make-whole premium. Thereafter, the Tier 2 Notes may be redeemed, in whole or in part, at the option of Ambac
Assurance, at a price equal to 100% of the aggregate principal amount redeemed, plus accrued and unpaid interest, if any.
18.
QUARTERLY INFORMATION (Unaudited)
Net gains (losses) on interest rate derivatives
(1,514)
34,068
($ in thousands)
Gross premiums written
Net premiums earned
Net investment income
Net other than temporary impairment losses
Net realized investment gains (losses)
Net change in fair value of credit derivatives
Net realized gains (losses) on extinguishment
of debt
Income (loss) on Variable Interest Entities
Losses and loss expenses (benefit)
Insurance intangible amortization
Operating expenses
Interest expense
Pre-tax income (loss)
Net income (loss) attributable to Common
Shareholders
Net income (loss) per share:
2017
2016
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
$
5,584
$
6,928
$ (24,696) $
(2,129) $ (24,780) $
(4,041) $ (10,543) $ (14,473)
47,613
81,559
(3,942)
(4,896)
1,052
43,152
85,160
52,989
87,177
31,523
107,057
52,800
60,821
41,402
70,758
53,218
90,917
49,867
90,871
(1,763)
(13,510)
(9,334)
(7,441)
(2,853)
(2,191)
4,180
6,624
6,150
179
3,984
(956)
(68)
8,517
23,027
1,102
12,866
14,897
3,955
11,749
1,733
(83,424)
(36,331)
(14,510)
2,741
3,701
135,011
37,525
27,980
31,572
(105,860)
2,179
(1,219)
66,100
33,471
31,051
28,234
13,992
—
—
1,235
(4,049)
21,237
(27,163)
3,586
8,987
24
2,057
209,806
102,269
(105,281)
(52,496)
(69,204)
215,492
45,690
33,791
29,145
34,168
28,694
30,990
(185,466)
(6,917)
50,890
28,009
30,430
12,854
39,013
27,995
30,709
61,511
44,553
21,466
31,493
40,152
36,190
31,712
116,720
(86,059)
$ (125,441) $
7,110
$ (190,905) $ (19,479) $
9,415
$
58,647
$ 101,474
$ (94,693)
11,536
1,552
83,992
—
2,026
Basic
Diluted
$
$
(2.77) $
(2.77) $
0.16
0.16
$
$
(4.20) $
(0.43) $
(4.20) $
(0.43) $
0.21
0.21
$
$
1.30
1.29
$
$
2.24
2.22
$
$
(2.09)
(2.09)
| Ambac Financial Group, Inc. 156 2017 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,
2017 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, 2017,
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, 2017 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.
Changes in Internal Control Over Financial Reporting. There
were no changes in the Company’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 2017 that
have materially affected, or are reasonably likely to materially
affect, Ambac's internal control over financial reporting.
Item 9B. Other Information
Appointment of New Director. The Board of Directors of the
Company appointed Joan Lamm-Tennant to both the Ambac Board
and Ambac Assurance Board effective March 1, 2018. A copy of
the Company’s press release announcing this information is being
filed as exhibit 99.5 to this Annual Report on Form 10-K. Ms.
Lamm-Tennant has also been appointed as a member of the Audit
Committee and Strategy and Risk Policy Committee of the Board.
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 2018 Annual
Meeting of Stockholders which will be filed within 120 days of
the end of our fiscal year ended December 31, 2017 (the “2018
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
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 2018 Proxy Statement and is
incorporated herein by reference.
| Ambac Financial Group, Inc. 157 2017 FORM 10-K |
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 2018 Proxy Statement and is incorporated herein by reference.
Equity Compensation Plan Information
The following table provides information as of December 31, 2017 regarding securities issued under our 2013 Incentive Compensation Plan.
Equity compensation plans approved by security
holders
Equity compensation plans not approved by
security holders
Total
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)
959,356 (2) (3)
---
959,356 (2) (3)
$24.03 (4)
---
$24.03 (4)
2,793,323
---
2,793.323
(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, 2017, 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 15. 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. This amount
includes 221,803 restricted stock units, 126,667 options and 610,886 performance stock units which are based on the maximum number of shares potentially
payable under the awards.
(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.
(4) Reflects the weighted-average price of all outstanding options that had been granted but not forfeited, expired or exercised. Performance shares and
restricted stock units are not included in determining the weighted-average price as they have no exercise price.
Item 13.
Transactions, and Director Independence.
Certain Relationships
and
Information relating to Ambac with respect to certain relationships
and related transactions and director independence will be in the
2018 Proxy Statement and is incorporated herein by reference.
related
Item 14.
Principal Accountant Fees and Services.
Information relating to principal accountant fees and services will
be in the 2018 Proxy Statement and is incorporated herein by
reference.
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
| Ambac Financial Group, Inc. 158 2017 FORM 10-K |
(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
4.13
4.14
4.15
4.16
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,
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 10.3 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).
Indenture (including the form of Notes), dated as of February 12, 2018, between Ambac LSNI, LLC and The Bank of New York
Mellon, as trustee and note collateral agent, providing for the issuance of insured secured notes (filed as exhibit 4.1 to Ambac
Financial Group, Inc.'s Current Report on Form 8-K filed February 15, 2018 and incorporated herein by reference).
Indenture (including the form of Notes), dated as of February 12, 2018, between Ambac LSNI, LLC and The Bank of New York
Mellon, as trustee and note collateral agent, providing for the issuance of insured secured notes (filed as exhibit 4.2 to Ambac
Financial Group, Inc.'s Current Report on Form 8-K filed February 15, 2018 and incorporated herein by reference).
Indenture (including the form of Notes), dated as of February 12, 2018, between Ambac Assurance Corporation and The Bank of
New York Mellon, as trustee and note collateral agent providing for the issuance of senior notes secured by certain interests in
proceeds of certain RMBS litigation (filed as exhibit 4.3 to Ambac Financial Group, Inc.'s Current Report on Form 8-K filed
February 15, 2018 and incorporated herein by reference).
Supplemental Fiscal Agency Agreement, dated as of February 12, 2018, among the Segregated Account of Ambac Assurance
Corporation, Ambac Assurance Corporation and The Bank of New York Mellon, as fiscal agent (filed as exhibit 4.4 to Ambac
Financial Group, Inc.'s Current Report on Form 8-K filed February 15, 2018 and incorporated herein by reference).
(10) Material contract and management compensation plans and arrangements:
10.1
10.2
10.3
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. 159 2017 FORM 10-K |
(b)
Exhibits
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
10.21
10.22
10.23
10.24
10.25+
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 DEF 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
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
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, 2009 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, 2009 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, 2009 and incorporated herein by reference).
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, 2009 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 (filed as Exhibit 10.27 to Ambac Financial Group, Inc.'s Annual Report on Form 10-K
for the year ended December 31, 2016 and incorporated herein by reference).
Form of 2017 Long-Term Incentive Compensation Agreement between Ambac Financial Group, Inc. and each of the
Company's executive officers.
| Ambac Financial Group, Inc. 160 2017 FORM 10-K |
(b)
Exhibits
10.26
10.27
10.28
10.29
10.30
10.31
10.32
10.33
10.34
10.35
10.36
10.37
10.38
10.39
10.40
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).
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).
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).
Rehabilitation Exit Support Agreement, by and among Ambac Assurance Corporation, Ambac Financial Group, Inc. and
certain holders of Ambac Assurance Corporation’s 5.1% Surplus Notes due 2020 and certain holders of Ambac Assurance
Corporation’s deferred payment obligations, dated as of July 19, 2017 (filed as Exhibit 10.1 to Ambac Financial Group,
Inc.’s Current Report on Form 8-K filed on July 19, 2017 and incorporated herein by reference).
Tier 2 Commitment Letter, dated as of July 19, 2017 from funds affiliated with or managed by investors party thereto
(filed as Exhibit 10.2 to Ambac Financial Group, Inc.’s Current Report on Form 8-K filed on July 19, 2017 and
incorporated herein by reference).
First Amendment to the Rehabilitation Exit Support Agreement, by and among Ambac Assurance Corporation, Ambac
Financial Group, Inc. and certain holders of Ambac Assurance Corporation’s 5.1% Surplus Notes due 2020 and certain
holders of Ambac Assurance Corporation’s deferred payment obligations, dated as of September 21, 2017 (filed as
Exhibit 10.1 to Ambac Financial Group, Inc.’s Current Report on Form 8-K filed on September 26, 2017 and incorporated
herein by reference).
Financial Guaranty Insurance Policy, dated February 12, 2018, issued by Ambac Assurance Corporation (filed as exhibit 10.1 to
Ambac Financial Group, Inc.'s Current Report on Form 8-K filed February 15, 2018 and incorporated herein by reference).
Collateral Agreement, dated as of February 12, 2018, made by Ambac LSNI, LLC in favor of The Bank of New York Mellon, as note
collateral agent, trustee and paying agent for the secured parties (filed as exhibit 10.2 to Ambac Financial Group, Inc.'s Current
Report on Form 8-K filed February 15, 2018 and incorporated herein by reference).
Pledge Agreement, dated as of February 12, 2018, made by Ambac Assurance Corporation in favor of The Bank of New York
Mellon, as note collateral agent, trustee and paying agent (filed as exhibit 10.3 to Ambac Financial Group, Inc.'s Current Report on
Form 8-K filed February 15, 2018 and incorporated herein by reference).
Collateral Agreement, dated as of February 12, 2018, made by Ambac Assurance Corporation in favor of The Bank of New York
Mellon, as note collateral agent, trustee and paying agent for the secured parties (filed as exhibit 10.4 to Ambac Financial Group,
Inc.'s Current Report on Form 8-K filed February 15, 2018 and incorporated herein by reference).
Waiver and Amendment, dated as of February 12, 2018, among Ambac Assurance Corporation, Ambac Credit Products, LLC,
Ambac Financial Group, Inc. and the other signatories party thereto (filed as exhibit 10.5 to Ambac Financial Group, Inc.'s Current
Report on Form 8-K filed February 15, 2018 and incorporated herein by reference).
Second Amended Plan of Rehabilitation of the Segregated Account of Ambac Assurance Corporation dated September
25, 2017, and effective as of February 12, 2018.
Order Granting the Rehabilitator’s Motion to Further Amend the Plan of Rehabilitation and confirming the Second
Amended Plan of Rehabilitation, as amended, Case No. 10-CV-1576 (Dane County, Wisconsin) dated January 22,
2018.
Stipulation and Order - Office of the Commissioner of Insurance of the State of Wisconsin, in the Matter of the
Rehabilitation of the Segregated Account of Ambac Assurance Corporation effective as of February 12, 2018.
(99) Additional exhibits
99.1
99.2
99.3
99.4
99.5
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.)
Press Release dated February 28, 2018, announcing the appointment of Joan Lamm-Tennant, effective March 1, 2018,
to the the Board of Directors of Ambac Financial Group, Inc.
| Ambac Financial Group, Inc. 161 2017 FORM 10-K |
(b)
Exhibits
Other exhibits, filed or furnished, as indicated:
12.1+
21.1+
23.1+
24.1+
31.1+
31.2+
32.1++
101.INS
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.
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.
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 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE I — SUMMARY OF INVESTMENTS
Other Than Investments in Related Parties
December 31, 2017
Type of Investment
($ in Thousands)
Municipal obligations
Corporate obligations
Foreign obligations
U.S. government 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
$
845,778
$
779,834
$
858,774
26,245
186,619
860,075
26,543
185,127
779,834
860,075
26,543
185,127
2,214,512
2,251,333
2,251,333
50,754
531,660
557,476
396,689
51,037
597,942
557,270
431,630
51,037
597,942
557,270
431,630
$
5,668,507
$
5,740,791
$
5,740,791
| Ambac Financial Group, Inc. 163 2017 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,
2017
2016
Assets:
Fixed income securities, at fair value (amortized cost: 2017—$239,476 and 2016—$220,749)
$
230,055
$
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:
45,275,982 and 45,194,954
Additional paid-in capital
Accumulated other comprehensive income (loss)
Retained earnings
Treasury stock, shares at cost: 24,816 and 22,458
Total Ambac Financial Group, Inc. stockholders’ equity
Total liabilities and stockholders’ equity
69,531
64,691
364,277
3,949
968,392
329
29,576
14,946
214,023
66,570
30,003
310,596
32,251
1,340,442
272
28,722
4,132
$
1,381,469
$
1,716,415
321
321
—
453
199,560
(52,239)
1,233,845
(471)
1,381,148
$
1,381,469
$
2,501
2,501
—
452
195,267
(38,990)
1,557,681
(496)
1,713,914
1,716,415
(1) Of these amounts, $30,496 and $28,691 receivable from the Registrant's wholly-owned subsidiary, Ambac Assurance Corporation, pursuant to the Amended
TSA.
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the following notes.
| Ambac Financial Group, Inc. 164 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE II— CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (PARENT COMPANY ONLY)
Condensed Statement of Comprehensive Income
($ in thousands) Year Ended December 31,
2017
2016
2015
Revenues:
Investment income
Other than temporary impairments
Net realized gains (losses)
Total revenues
Expenses:
Operating expenses
Total expenses
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 (loss) of subsidiaries
Net income (loss)
Other comprehensive income (loss), after tax:
Net income (loss)
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 (loss) attributable to Ambac Financial Group, Inc.
$
24,411
$
13,493
$
(550)
(6,575)
17,286
3,913
3,913
13,373
(29,398)
42,771
(371,486)
(289)
(7)
13,197
11,486
11,486
1,711
(28,739)
30,450
44,393
$
$
$
(328,715) $
74,843
$
(328,715) $
74,843
$
(81,520)
73,586
1,273
(6,661)
67,900
(122,128)
23
(54,205)
(335,376) $
20,638
$
9,826
(155)
(27)
9,644
8,922
8,922
722
(70,811)
71,533
421,870
493,403
493,403
(159,730)
(44,651)
(687)
(205,068)
288,335
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 2017 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
Common
Stock Held
in
Treasury,
at Cost
Additional
Paid-in
Capital
Balance at January 1, 2017
$ 1,713,914
$ 1,557,681
$
(38,990) $
— $
452
$
195,267
$
(496)
Total comprehensive income (loss)
(335,376)
(328,715)
Adjustment to initially apply ASU 2018-02
Adjustment to initially apply ASU 2016-09
Stock-based compensation
Cost of shares (acquired) issued under
equity plan
Issuance of common stock
—
(137)
4,293
6,588
(137)
—
(1,547)
(1,572)
1
—
Balance at December 31, 2017
$ 1,381,148
$ 1,233,845
Balance at Balance at January 1, 2016
$ 1,684,799
$ 1,478,439
Total comprehensive income
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
20,638
6,442
5,253
(505)
(2,717)
2
2
74,843
6,442
—
(127)
(1,916)
—
—
Balance at December 31, 2016
$ 1,713,914
$ 1,557,681
Balance at January 1, 2015
$ 1,399,105
$ 989,290
$
$
$
$
(6,661)
(6,588)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
1
—
—
—
4,293
—
—
(52,239) $
— $
453
$
199,560
15,215
$
— $
450
$
190,813
(54,205)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
2
—
—
—
5,253
—
(801)
—
2
(38,990) $
— $
452
$
195,267
220,283
$
— $
450
$
189,138
$
$
$
$
Total comprehensive income
Stock-based compensation
Cost of shares (acquired) issued under
equity plan
Cost of warrants acquired
Warrants exercised
288,335
493,403
(205,068)
3,105
—
(374)
(5,375)
3
(312)
(3,942)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
3,105
—
(1,433)
3
Balance at December 31, 2015
$ 1,684,799
$ 1,478,439
$
15,215
$
— $
450
$
190,813
$
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the following notes.
—
—
—
—
25
—
(471)
(118)
—
—
—
(378)
—
—
—
(496)
(56)
—
—
(62)
—
—
(118)
| Ambac Financial Group, Inc. 166 2017 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 (loss)
2017
2016
2015
$
(328,715) $
74,843
$
493,403
Adjustments to reconcile net income loss to net cash used in operating activities:
Equity in undistributed net (income) loss of non-debtor subsidiaries
Amortization of bond premium and discount
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
Change in other investments
Other, net
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Cost of warrants acquired
Proceeds from warrant exercise
Net cash (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
371,486
(16,724)
550
6,575
(854)
4,293
(57)
(10,814)
(9,960)
15,780
186,747
(195,853)
(2,961)
(34,688)
2,673
(44,082)
—
—
—
(28,302)
32,251
(44,393)
(7,208)
289
7
42,126
5,253
(149)
646
5,814
77,228
269,459
(279,582)
(18,491)
(4,664)
(9,009)
(42,287)
(2,717)
2
(2,715)
32,226
25
3,949
$
32,251
$
(421,870)
(4,690)
155
27
(71,069)
3,105
(69)
991
549
532
347,539
(312,419)
(25,143)
(5,253)
—
4,724
(5,375)
3
(5,372)
(116)
141
25
784
$
635
$
394
$
$
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 2017 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, 2017 and 2016 and
for the three years in the period ended December 31, 2017, should be read in conjunction with the consolidated financial statements of Ambac
Financial Group, Inc. and Subsidiaries and the notes thereto included in this 2017 Annual Report on Form 10-K for the year ended December 31,
2017.
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, 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.
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, 2017 Ambac had a U.S. loss carryforwards totaling
$3,694,844, which, if not utilized, will begin expiring in 2029, and will fully expire in 2032. The NOL allocable to AFG as of December 31,
2017 is $1,412,639.
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, 2017
(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 $1,367,795, which utilized all of the $479,000 allocated Tier A NOL
and $888,795 of the $1,057,000 allocated Tier B NOL and resulted in accrued Tolling Payments, net of applicable credits. At December 31,
2017, $30,496 of Tolling Payments are due to Ambac no later than forty-five days after April 15, 2018. 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 $10,000 of Tier A and Tier B credits.
| Ambac Financial Group, Inc. 168 2017 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE IV— REINSURANCE
Years Ended December 31, 2017, 2016 and 2015
Insurance Premiums Written
($ in Thousands)
Gross
Amount
Ceded to Other
Companies
Assumed from
Other
Companies
Net
Amount
Percentage of
Amount
Assumed to
Net
Year Ended December 31, 2017
$
(14,313) $
(2,104) $
— $
(12,209)
—%
Year Ended December 31, 2016
(53,837)
(8,772) $
Year Ended December 31, 2015
(37,572)
(3,001)
—
—
(45,065)
—%
(34,571)
—%
| Ambac Financial Group, Inc. 169 2017 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, 2018
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, 2018
Jeffrey S. Stein
/S/ CLAUDE LEBLANC
President, Chief Executive Officer and Director
February 28, 2018
Claude LeBlanc
(Principal Executive Officer)
/S/ DAVID TRICK
Executive Vice President and Chief Financial Officer
February 28, 2018
David Trick
(Principal Financial Officer)
/S/ ROBERT B. EISMAN
Senior Managing Director and Chief Accounting Officer
February 28, 2018
Robert B. Eisman
(Principal Accounting Officer)
/S/ ALEXANDER D. GREENE*
Director
February 28, 2018
Alexander D. Greene
/S/ IAN D. HAFT*
Director
Ian D. Haft
/S/ DAVID L. HERZOG*
Director
David L. Herzog
February 28, 2018
February 28, 2018
/S/ C. JAMES PRIEUR*
Director
February 28, 2018
C. James Prieur
/S/ STEPHEN M. KSENAK
*By: Stephen M. Ksenak
Attorney-in-fact
February 28, 2018
| Ambac Financial Group, Inc. 170 2017 FORM 10-K |
Appendix A
Non-GAAP Financial Measures
Ambac reports two non-GAAP financial measures: Adjusted Earnings and 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. 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. Below are reconciliations of net income (loss) attributable
to common shareholders to the non-GAAP measure of Adjusted Earnings (Losses) and Total Ambac Financial Group, Inc. stockholders’ equity
per share ("Book Value") to the non-GAAP measure of Adjusted Book Value per share. Each of the reconciling items is more fully defined
in our 2017 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.
Adjusted Earnings (Loss) ($ in millions)
May-June
2013
Year Ended December 31,
2014
2015
2016
Net income (loss) attributable to common shareholders
$
505
$
484 $
493 $
75 $
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 interest rate derivatives from Ambac CVA
(166)
100
—
(24)
47
(17)
152
—
34
(16)
(37)
170
515
27
(14)
(8)
175
—
39
34
2017
(329)
(11)
151
—
(21)
45
Adjusted earnings (loss) (2)
$
462
$
637 $
1,154 $
315 $
(165)
Book Value Per Share / Adjusted Book Value Per Share
June 30,
2013
December 31,
2013
2014
2015
2016
Total AFGI Stockholders' Equity per share
$
6.38
$
15.62 $
31.09 $
37.41 $
37.94 $
Adjustments:
Non-credit impairment fair value losses on credit derivatives
Insurance intangible asset and goodwill
Ambac CVA on interest rate derivative liabilities
Net unearned premiums and fees in excess of expected losses
Net unrealized investment (gains) losses in Accumulated Other
Comprehensive Income
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
1.24
(42.78)
(1.43)
31.57
0.42
(26.91)
(1.75)
20.11
0.25
(21.30)
(0.99)
16.21
0.93
(4.68)
(1.13)
(2.63)
$
8.32 $
15.01 $
28.15 $
29.48 $
2017
30.52
0.01
(18.71)
—
13.20
(0.68)
24.34
(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 statement 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 adjustment 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
Lisa A. Kampf
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 18, 2018,
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 505000
Louisville, KY, 40233
Inside the USA call 1-800-662-7232
Outside the USA call 1-781-575-4238
Hearing impaired call 1-800-952-9245
www.computershare.com/investor
or overnight correspondence
can be sent to:
COMPUTERSHARE
462 South 4th Street, Suite 1600
Louisville, KY, 40202
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 2017
Annual Report on Form 10-K.
1
AMBAC FINANCIAL GROUP, INC.
One State Street Plaza, New York, NY 10004
www.ambac.com