ONE
VISION
CULTURE
MISSION
PURPOSE
COMPANY
AMBAC.
2018 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.
MISSION
VISION
VALUES
n Optimize our business and its
components to achieve maximum
return for shareholders
n Aggressively pursue financially
sound strategies to reduce risk
and decrease the size of the
insured portfolio
n Transition to a growth-oriented
platform sufficiently capitalized
to support businesses that are
synergistic with Ambac’s core
competencies
n Culture of respect, inclusion,
collaboration and transparency
n Attract, retain and reward
top performers who meet
standards of excellence,
integrity and collaboration
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,” “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 our most recently filed
quarterly or annual report with the SEC.
3
DEAR FELLOW SHAREHOLDERS
“ 2018 was another milestone
year for Ambac driven by the
successful execution of our
key strategic priorities.”
CLAUDE LeBLANC
President and Chief Executive Officer
2018 was another milestone year for Ambac driven by
the successful execution of our key strategic priorities
that we outlined last year. Ambac reported full year
2018 net income of $267 million, net income to common
shareholders of $186 million or $3.99 per diluted share
and Adjusted Earnings(1) of $301 million or $6.47 per
diluted share. Our performance was positively impacted
by the successful close of a holistic restructuring
transaction at the beginning of 2018, resulting in
the exit from rehabilitation of AAC’s Segregated Account
(the “Segregated Account”). The execution of this
transaction together with the exit from rehabilitation of
the Segregated Account was the culmination of several
years of hard work and created substantial value for our
shareholders by significantly increasing Book Value and
Adjusted Book Value. Execution of this transaction also
provided several material benefits for Ambac including
the simplification of our capital structure, greater financial
and strategic flexibility, materially improved financial
strength at AAC, significant reduction in operating costs
and a unified corporate governance structure.
KEY ACCOMPLISHMENTS FOR THE YEAR:
n Successfully executed a transformational holistic
restructuring transaction resulting in the Segregated
Account’s exit from rehabilitation, increasing Book
Value per share by approximately $7.00
n Significantly decreased our insured risk portfolio
from year-end 2017 by 25% to $46.9 billion
n Decreased Adversely Classified Credits by 23% to
$10.9 billion and Watch List Credits by 19% to $9.0
billion through proactive efforts and runoff
n Negotiated and executed a consensual agreement
which served as the foundation for the COFINA
Plan of Adjustment which became effective on
February 12, 2019
n Executed an Auction Market Preferred Shares
(“AMPS”) exchange transaction, capturing a
discount of approximately $250 million to the
liquidation preference
n Executed additional headcount and other cost
reductions which, together with measures implemented
in late 2017, resulted in a 27% reduction in headcount
and a lower run-rate for operating expenses
n Refined our compensation program to create further
alignment with shareholders
1
The completion of the holistic restructuring transaction also allowed us to accelerate other key priorities to create
and unlock additional material shareholder value, including active de-risking initiatives, ongoing rationalization of our
capital and liability structures, loss recovery through active litigation management, ongoing review of the effectiveness
and efficiency of our operating platform and increased focus on future growth initiatives.
HOLISTIC RESTRUCTURING TRANSACTION - Segregated Account Exit from Rehabilitation
BENEFIT
OUTCOME
> SIMPLIFIED CAPITAL STRUCTURE AND PROVIDES
FOR GREATER FINANCIAL AND STRATEGIC FLEXIBILITY
> GREATER FINANCIAL STRENGTH AT AAC
n Discharge of all outstanding deferred payment
obligations (“DPOs”) of the Segregated Account,
totaling approximately $3.9 billion, including accretion
n Cancellation of $810 million in principal plus
accrued and unpaid interest of AAC general account
surplus notes
n Receipt of $240 million in new capital via the issuance
of a Tier 2 note, backed by certain RMBS representation
and warranty litigation recoveries
n Merger of AAC’s Segregated Account into its
general account
n Created approximately $7.00 of Book Value per share
n Full payment on all policy claims following the merger
of the Segregated Account into AAC’s general account
n Realization of an effective discount of 6.5% on the
accreted value of DPOs and the outstanding amount
of principal and accrued and unpaid interest on
general account surplus notes
> MATERIAL REDUCTION IN ONGOING REHABILITATION AND
RESTRUCTURING COSTS AND OTHER RELATED EXPENSES
n Regulatory and other costs related to the rehabilitation
of the Segregated Account decreased $21 million for
the year ended December 31, 2018 from the prior year
> UNIFIED CORPORATE GOVERNANCE STRUCTURE
n Interlocking Boards at AAC and AFG
We are extremely pleased with the outcome of this
transaction and I believe that the resulting enhanced
flexibility provides us with the opportunity to move to a
growth trajectory with expanded tools and resources to
pursue opportunities focused on creating significant
long-term value for our shareholders.
During the year we also continued to aggressively
pursue Ambac’s key business activity, the active risk
management and stabilization of our insurance platform.
We took proactive steps to reduce and mitigate
potential adverse development in our insured portfolio,
which improves the quality of our Book Value and
increases the optionality of our platform. Our targeted
activities included, among other things, the execution of
commutation transactions, risk transfer via reinsurance
transactions with multiple counterparties and the
proactive facilitation of refinancing transactions and
policy terminations. Our focus included both Adversely
Classified Credits and Watch List Credits, which represent
exposures for which there may be heightened potential
for future adverse development based on qualitative and
quantitative stress assumptions.
Our efforts, together with natural runoff, resulted in a
25% reduction of the insured portfolio to $46.9 billion net
par outstanding at December 31, 2018 from $62.7 billion
at December 31, 2017. In addition, Adversely Classified
2
BOOK VALUE/SHARE
ADJUSTED BOOK VALUE/SHARE (1)
R ( 2 )
G
A
8 % C
1
$37.41
$37.94
$35.12
$30.52
$31.09
$15.62
$40
$35
$30
$25
$20
$15
$10
$5
$0
Dec
2013
Dec
2014
Dec
2015
Dec
2016
Dec
2017
Dec
2018
Credits decreased 23% or $3.2 billion, to $10.9 billion
net par outstanding at December 31, 2018 from $14.1
billion at December 31, 2017, and Watch List Credits
decreased 19% or $2.1 billion, to $9.0 billion net par
outstanding at December 31, 2018 from $11.1 billion at
December 31, 2017. We continue to believe that focusing
on the long-term stability of our balance sheet and the
quality of our Book Value are the key drivers of long-term
value for our shareholders.
One of the major de-risking initiatives that we pursued
during 2018 related to the sales and use tax securitization
debt issued by COFINA, AAC’s largest insured exposure
to Puerto Rico. In 2018, we were actively involved in
crafting the terms of a consensual agreement which later
became the basis of the COFINA Plan of Adjustment.
The COFINA Plan of Adjustment, which became effective
on February 12, 2019, provided for the restructuring of
over $17.6 billion of bonds and addressed 78% of Ambac’s
total Puerto Rico exposure.
In connection with the implementation of the
COFINA Plan of Adjustment, 75% of AAC insured COFINA
bondholders elected to commute their insurance policies
in exchange for cash and new COFINA bonds. As a result,
AAC’s insured COFINA exposure decreased by $5.5
billion, based on insured net debt service outstanding
as of December 31, 2018. This is an excellent outcome
for AAC and we believe the momentum from this debt
restructuring and our ongoing de-risking strategy will
help accelerate consensual, favorable outcomes for AAC’s
remaining insured Puerto Rico-related exposures. With
COFINA behind us, we will continue to actively progress
all aspects of our strategy with respect to mitigating
losses on our other exposures in Puerto Rico.
During the year we also made significant strides in our
remaining RMBS litigations. We will continue to actively
progress our recovery efforts in order to recoup losses
relating back to the financial crisis.
6
9 . 2
1
$
+
$28.15
$29.48
$27.58
$24.34
$15.01
$8.32
Dec
2013
Dec
2014
Dec
2015
Dec
2016
Dec
2017
Dec
2018
$35
40
$30
35
30
$25
25
$20
20
$15
15
$10
10
$5
$0
5
0
35
30
25
20
15
10
5
0
SUMMARY OF SELECT DE-RISKING ACTIVITIES
n Reinsured approximately $138 million of structured
finance exposure and the full amount of certain
public finance exposures totaling $1.5 billion of
performing par exposure (principal and interest
of $3.4 billion), mostly comprised of policies on
non-callable capital appreciation bonds, including
$232 million par of Watch List and Adversely
Classified Credit exposures
n Negotiated with counterparties to expedite
refundings or restructurings of Ambac UK insured
international bonds that resulted in the termination
of several international RMBS and asset-backed
policies on £182 million and £548 million of net
par exposure, respectively
n Worked closely with servicers and owners of
master servicing rights to exercise clean-up calls
on 11 RMBS transactions, reducing adversely
classified net par exposure by $284 million
n Coordinated with issuers and investors of
Ambac-insured debt to commute $484 million
of net par exposure, including $127 million of
adversely classified student loan exposures
n Partnered with issuers and other transaction
counterparties to expedite refundings or calls
across a number of Ambac domestic public
finance bonds, resulting in a reduction of watch
list and adversely classified net par exposure of
approximately $1.0 billion
n Facilitated the refinancing of a defaulted Ambac UK
insured utility, reducing adversely classified
net par exposure by $36 million
n Reduced Ambac exposure to Puerto Rico COFINA
bonds by 75%, or $603 million, to $202 million
(based on December 31, 2018 net par outstanding)
through commutations as a result of the
COFINA Plan of Adjustment which became
effective in early 2019
3
“ Our continued focus on
executing our key strategic
priorities makes Ambac
well-positioned to advance
its near- and long-term goal
to create material long-term
shareholder value.”
INSURED PORTFOLIO (3)
International
Public Finance
29%
50%
$46.9 BILLION
NET PAR
21%
Structured Finance
With the added flexibility resulting from the execution
of the holistic restructuring transaction and the exit
from rehabilitation of the Segregated Account, we took
further steps to rationalize our capital structure and
strengthen our balance sheet, including full redemption
of RMBS secured borrowings of $74 million and principal
paydowns of $214 million on the secured notes issued in
connection with the holistic restructuring transaction.
Another major accomplishment in 2018 that further
streamlined our capital structure was the execution of an
exchange transaction for AAC’s auction market preferred
shares. The AMPS exchange transaction successfully
closed during the latter half of 2018 with participation
by over 84% of our AMPS holders, resulting in a discount
capture of approximately $250 million. This transaction
further delevered our balance sheet and improved
the quality of Book Value and Adjusted Book Value.
Additional transaction benefits included added clarity
with respect to Ambac’s corporate governance structure
and increased flexibility with respect to future potential
capital distributions.
During the year we also took steps that significantly
reduced our core operating costs tied to reductions
in regulatory oversight expenses and relief from costs
related to the rehabilitation exit transactions. In addition,
we also made further headcount reductions of 9% this
year, the savings of which, once realized, will augment
the benefit from the 19% headcount reduction we made
last year and provide for additional reductions of run-rate
compensation costs. We will continue to evaluate and,
where appropriate, take further steps to reduce operating
costs and expenses as we focus on long-term growth
for the company.
WELL POSITIONED TO DELIVER
LONG-TERM VALUE
Our continued focus on executing our key strategic
priorities makes Ambac well-positioned to advance its
near- and long-term goal to create material long-term
shareholder value. As we turn our sights towards a longer
term growth strategy we have taken significant steps to
improve the effectiveness and risk profile of our operating
platform, and are also focused on shaping the firm’s
“One Ambac” vision by fostering a culture of respect,
inclusion, collaboration and transparency among our
employees who are vital to what we do.
Our goal is to transition to a long-term growth-
oriented strategy where we can leverage our core
competencies in credit and insurance, as well as
our resiliency and expertise in managing complex
transactions, to transform our platform into one that
we believe will deliver sustainable long-term value to
our shareholders.
We have increased our focus on exploring and,
where appropriate, pursuing potential new business
opportunities where we can deploy capital that we
believe will be accretive and increase shareholder value.
We have been exploring various types of transactions
and strategic opportunities in industries that are
synergistic and adjacent to our current business with
a targeted focus on credit, asset management and
fee-based businesses.
Finally, during the year we took additional steps to
create further alignment with our shareholders through
the addition of a relative total shareholder return metric
to our Long Term Incentive Plan that will be applicable
starting with Ambac’s 2019 plan. We believe that
4
35
30
25
20
15
10
5
0
INSURED PORTFOLIO NET PAR (3)
($ in billions)
$250
$200
$150
$100
$50
$0
# of Credits
6,000
4,000
Reduced by
25% in 2018
2,000
0
Dec
2013
Dec
2014
Dec
2015
Dec
2016
Dec
2017
Dec
2018
ADVERSELY CLASSIFIED CREDITS NET PAR (3) (4)
($ in billions)
$35
$30
$25
$20
$15
$10
$5
$0
250
200
150
100
50
0
Dec
2013
Reduced by
23% in 2018
Dec
2014
Dec
2015
Dec
2016
Dec
2017
Dec
2018
6000
4000
2000
0
PF
SF
Int’l
# of Credits
IA
II
III
IV
AMBAC’S
KEY COMPONENTS OF VALUE
1.
2.
3.
4.
Holding company assets of $455 million
consisting of cash, investments and
receivables
Net operating losses of $3.4 billion
that can be utilized organically as well
as in strategic transactions, leveraging
Ambac’s underlying resources in a
public company holding structure with a
substantial operating infrastructure
Expertise in credit, risk management,
public finance, structured finance and
financial services, as well as decades
of experience in managing distressed
transactions, event-driven situations,
workouts and restructurings
Materially improved and strengthened
capital and liability structure following
the execution of the holistic restructuring
transaction resulting in the Segregated
Account’s exit from rehabilitation
the addition of this metric more accurately captures
the event-driven nature of our business and, based
on feedback from our shareholders, creates greater
shareholder alignment.
CONCLUSION
Ambac’s improved fundamentals and enhanced flexibility
positions us well to pursue opportunities to increase
shareholder value for the long term. I would like to
thank our dedicated employees for their hard work
and ongoing support in helping us deliver on our
commitment to our shareholders. I would also like to
thank our shareholders for your tremendous support and
feedback during the year. Each year brings with it new
opportunities and new challenges and I am sure 2019
will be no different. We will embrace those opportunities
and meet those challenges with the same drive and
determination that has propelled us thus far as we
continue to execute on our strategic priorities. We look
forward to updating you on our progress.
Sincerely,
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) Compound Annual Growth Rate (“CAGR”).
(3) 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.
(4) 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 2018 Form 10-K
for further description of risk classifications.
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)
Chairman
Founder and Managing Partner
of Stein Advisors LLC
ALEXANDER D. GREENE (2)*, (3), (4)
Former Managing Partner and
Head of U.S. Private Equity at
Brookfield Asset Management
IAN D. HAFT
(1), (2), (4)*
Managing Partner and
Chief Executive Officer
of Surgis Capital LLC
DAVID L. HERZOG
(1)*, (4)
Former Chief Financial Officer
of AIG
JOAN LAMM-TENNANT
(1), (4)
Founder and
Chief Executive Officer of
Blue Marble Microinsurance
CLAUDE LeBLANC
President and
Chief Executive Officer
C. JAMES PRIEUR (1), (2), (3)*
Former Chief Executive Officer
of CNO Financial Group, Inc.
(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, 2018
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 every Interactive Data File required to be submitted 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 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, 2018 was $899,844,448. As of
February 25, 2019, there were 45,341,834 shares of Common Stock, par value $0.01 per share, were outstanding.
Portions of the Registrant’s proxy statement for its 2019 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
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995 ...........................................................
1
Page
Item Number
Page
65
67
139
PART II (CONTINUED)
7A Quantitative and Qualitative Disclosures about
Market Risk ................................................................
8
9
Financial Statements and Supplementary Data ..........
Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure.........................
9A Controls and Procedures.............................................
139
9B Other Information.......................................................
139
PART III
10 Directors, Executive Officers and Corporate
Governance.................................................................
139
11 Executive Compensation............................................
139
12 Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters...
13
Certain Relationships and Related Transactions, and
Director Independence ...............................................
140
140
14 Principal Accountant Fees and Services.....................
140
PART IV
15 Exhibits, Financial Statement Schedules....................
140
Schedule I—Summary of Investments Other Than
Investments in Related Parties.................................
Schedule II—Condensed Financial Information of
Registrant (Parent Company Only) .........................
145
146
Schedule IV—Reinsurance......................................
151
SIGNATURES ..................................................................
152
Item Number
PART I
1
Business......................................................................
Introduction..............................................................
Risk Management Group.........................................
Insurance Regulatory Matters and Other
Restrictions ..............................................................
Investments and Investment Policy .........................
Employees................................................................
1A Risk Factors................................................................
1B Unresolved Staff Comments ......................................
2
3
Properties....................................................................
Legal Proceedings ......................................................
4 Mine Safety Disclosures.............................................
PART II
5
6
7
Market for Registrant’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities ....................................................................
Selected Financial Data ..............................................
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 and Variable Interest Entities ........
Accounting Standards..............................................
Ambac Assurance Statutory Basis Financial
Results .....................................................................
Ambac UK Financial Results Under UK
Accounting Principles..............................................
Non-GAAP Financial Measures ..............................
2
2
5
7
8
9
9
25
25
26
26
26
28
29
29
29
31
37
47
53
56
61
61
61
62
63
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) changes in Ambac
Assurance’s estimated representation and warranty recoveries or
loss reserves over time; (4) failure to recover claims paid on Puerto
Rico exposures or incurrence of losses in amounts higher than
expected; (5) adverse effects on Ambac’s share price resulting from
future offerings of debt or equity securities that rank senior to
Ambac’s common stock; (6) potential of rehabilitation proceedings
against Ambac Assurance; (7) dilution of current shareholder value
or adverse effects on Ambac’s share price resulting from the
issuance of additional shares of common stock; (8) 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; (9) 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; (10) the Company's inability to realize the expected
recoveries included in its financial statements; (11) insufficiency
or unavailability of collateral to pay secured obligations; (12) 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, public finance
obligations (including obligations of the Commonwealth of Puerto
Rico and its instrumentalities and agencies as well as obligations
relating to privatized military housing projects) and exposures to
reinsurers; (13) credit risks related to large single risks, risk
concentrations and correlated risks; (14) the risk that the
Company’s risk management policies and practices do not
anticipate certain risks and/or the magnitude of potential for loss;
(15) risks associated with adverse selection as the Company’s
insured portfolio runs off; (16) adverse effects on operating results
or the Company’s financial position resulting from measures taken
to reduce risks in its insured portfolio; (17) disagreements or
disputes with Ambac Assurance's primary insurance regulator;
(18) 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; (19)
the Company’s substantial indebtedness could adversely affect its
financial condition and operating flexibility; (20) 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; (21) the Company may not be able to generate the
significant amount of cash needed to service its debt and financial
obligations, and may not be able to refinance its indebtedness; (22)
restrictive covenants in agreements and instruments may impair
the Company’s ability to pursue or achieve its business strategies;
(23) loss of control rights in transactions for which we provide
insurance due to a finding that Ambac Assurance has defaulted;
(24) 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; (25)
adverse tax consequences or other costs resulting from the
characterization of the Company’s surplus notes or other
obligations as equity; (26) risks attendant to the change in
composition of securities in the Company’s investment portfolio;
(27) changes in tax law; (28) changes in prevailing interest rates;
(29) changes on inter-bank lending rate reporting practices or the
method pursuant to which LIBOR rates are determined; (30)
factors that may influence the amount of installment premiums
paid to the Company; (31) default by one or more of Ambac
Assurance's portfolio
issuers or
investments,
counterparties; (32) 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; (33) risks
relating to determinations of amounts of impairments taken on
investments; (34) 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; (35) actions of stakeholders whose interests are not
aligned with broader interests of the Company's stockholders; (36)
the Company’s inability to realize value from Ambac UK or other
subsidiaries of Ambac Assurance; (37) system security risks; (38)
market spreads and pricing on interest rate derivatives insured or
issued by the Company; (39) the risk of volatility in income and
earnings, including volatility due to the application of fair value
accounting; (40) changes in accounting principles or practices that
may impact the Company’s reported financial results; (41)
legislative and regulatory developments, including intervention by
regulatory authorities; (42) the economic impact of “Brexit”; (43)
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; (44) 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; (45) fluctuations in foreign currency
insured
| Ambac Financial Group, Inc. 1 2018 FORM 10-K |
exchange rates could adversely impact the insured portfolio in the
event of loss reserves or claim payments denominated in a currency
other than US dollars and the value of non-US dollar denominated
securities in our investment portfolio; and (46) 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. 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 $3.5
billion remain at December 31, 2018.
Management reviews financial information, allocates resources
and measures financial performance on a consolidated basis. As a
result, the Company has a single reportable segment.
Financial Guarantee Insurance:
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; (ii) loss-
related expenses, including those relating to the remediation of
problem credits; and (iii) insurance intangible amortization.
securities
(including
Ambac Assurance and its subsidiaries have been working toward
reducing uncertainties within their insured portfolios through
active monitoring of key exposures such as municipal entities with
stressed financial conditions (including Puerto Rico) and asset-
residential mortgage-backed
backed
securities ("RMBS") and student
loan-backed securities).
Additionally, Ambac Assurance and its subsidiaries are actively
prosecuting legal claims (including RMBS related lawsuits),
managing the regulatory frameworks applicable to the insurance
entities, seeking to optimize capital allocation in a challenging
environment
long duration obligations, and
that
attempting to retain key employees.
includes
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.
Refer
Including Contractual
Restrictions" below and Note 8. Insurance Regulatory Restrictions
to the Consolidated Financial Statements included in Part II, Item 8
in this Form 10-K, for more information on dividend payment
restrictions.
"Dividend Restrictions,
to
Derivatives:
Interest rate derivative transactions are executed through Ambac
Financial Services (“AFS”), a wholly-owned subsidiary of Ambac
Assurance. The primary activity of AFS is to economically hedge
interest rate risk in the financial guarantee and investment
portfolios. Accordingly, interest rate derivatives are positioned to
benefit from rising rates. Under agreements governing interest
rate 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.
Credit derivative contracts were executed through Ambac Credit
Products LLC (“ACP”), a wholly owned subsidiary of Ambac
Assurance, for which fees are collected 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 based on the Segregated Account Rehabilitation
Proceedings (as defined below) and related circumstances 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 derives derivative revenues from (i) changes in the fair
value of the derivatives portfolio resulting from interest rate or
credit changes 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 interest rate derivative positions primarily
relate to 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
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 interest rate derivatives.
customers or bank
| Ambac Financial Group, Inc. 2 2018 FORM 10-K |
Interest rate derivative contracts entered into with financial
guarantee customers are not subject to collateral posting
agreements. Credit risk associated with customer derivatives,
including credit derivatives, is managed through the risk
management processes described in the Risk Management Group
section below. In some cases, interest rate derivatives between
Ambac and financial guarantee customers are placed through a
third party financial intermediary and similarly do not require
collateral posting.
Ambac 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.
Corporate Strategy:
In February 2018, Ambac achieved one of its key strategic
objectives: the exit from rehabilitation of Ambac Assurance’s
Segregated Account (as defined below). Having accomplished
this milestone, Ambac continues to pursue and prioritize its
remaining key strategic priorities, namely:
• Active runoff of Ambac Assurance and its subsidiaries
through transaction terminations, policy commutations,
reinsurance, 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 the effectiveness and efficiency of
Ambac's 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. We have been evaluating
strategic opportunities in credit, insurance, asset management and
other financial services that we believe would be synergistic to
Ambac and would leverage our core competencies. We will
continue to be measured and disciplined in our approach as we
pursue opportunities to deploy our capital with the goal of creating
sustainable long-term shareholder value. Although we are
exploring new business opportunities for Ambac, no assurance can
be given that we will be able to identify or execute a suitable
transaction 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
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 of this Form 10-K) and in the indenture
for the Tier 2 Notes (as defined in Note 1. Background and Business
Description to the Consolidated Financial Statements included in
Part II, Item 8 of this Form 10-K), each of which requires OCI (as
defined below) and, under certain circumstances, holders of the
debt instruments benefiting from such restrictions, to approve
certain actions taken by or in respect of Ambac Assurance. In
exercising its approval rights, 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 Everspan 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, itself, did not enter 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
| Ambac Financial Group, Inc. 3 2018 FORM 10-K |
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 of Directors take 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 periodically
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
responsibility for
the risk management process, various
committees of the Board also have responsibilities related to risk
assessment and risk management, and management has
responsibility for managing the risks to which the Company is
exposed and reporting on such matters to the Board of Directors
and applicable Board committees.
• The Audit Committee oversees the management of risks
associated with the integrity of Ambac’s financial statements
and its compliance with legal and regulatory requirements. In
addition, the Audit Committee discusses policies with respect
to risk assessment and risk management, including major
financial risk exposures and the steps management has taken
to monitor and control such exposures. The Audit Committee
reviews with management, internal auditors and external
auditors Ambac's accounting policies, 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 of Directors and its
committees 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
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 of Directors also receive 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
to 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 Assurance's adversely classified, survey
and watch list credits (as defined in Note 2. Basis of
Presentation
and Significant Accounting Policies).
Additionally, the Risk Committee will provide oversight and
review new risk remediation structures or approaches in
connection with risk remediation plans or anticipated
transactions. 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, operations,
investment management, legal and finance.
• The Disclosure Committee's objective is to assist the CEO
and CFO in their responsibilities to design, establish, maintain
and evaluate the effectiveness of disclosure controls and
procedures.
| Ambac Financial Group, Inc. 4 2018 FORM 10-K |
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 was 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, the Stipulation
and Order and the indenture for the Tier 2 Notes. 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.
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. Additionally, surveillance will evaluate
the impact of changes in the economic, regulatory or political
environment on the insured portfolio.
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. Active surveillance enables
analysts to track single credit migration and industry credit and
performance trends.
The focus of a 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
utilized by Ambac. 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 have
current negative developing trends, have the potential for future
adverse development or are already adversely classified by, among
other things, securing rights and remedies, both of which may 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 trying
to minimize claims and maximize 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
| Ambac Financial Group, Inc. 5 2018 FORM 10-K |
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 are 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
("R&W") supporting RMBS policies, (ii) RMBS servicing and
remediation 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 insured exposures, the team focuses on servicer
oversight and transaction 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 addition, the team actively works
with servicers and other RMBS transaction sponsors to facilitate the
exercise of clean-up calls and other risk and exposure reducing
transactions, sometimes with Ambac Assurance financial support.
Ambac Assurance believes that the close monitoring of servicers,
including measures to better align the interests, and other loss
mitigation activities, 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 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
Financial Statements included in Part II, Item 8 in this Form 10-K
for further discussion on this topic).
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, credit
classifications, rating designations, review of watch list or adversely
classified credits, sector reviews and overall portfolio reviews.
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 certain structured public
finance transactions, Ambac Assurance may be the control party as
a result of insuring the transaction’s senior class or tranche of debt
obligations. 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. Pursuant to the Second Amended
Plan of Rehabilitation and orders of the Rehabilitation Court, such
protections continue after the conclusion of the Segregated Account
Rehabilitation Proceedings.
Watch List Credits
Credits that demonstrate the potential for long-term material adverse
development, represent significant size or sector concentration, or
have certain structural, credit or other complexities, but are
otherwise currently performing, may be designated as a watch list
credit as part of the CRM process. Watch list credits are closely
monitored by the Surveillance for potential adverse development
and are targets for proactive risk reduction efforts by the Risk
Remediation group.
Adversely Classified Credits
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
| Ambac Financial Group, Inc. 6 2018 FORM 10-K |
and proper internal and external resourcing. A summary of
developments regarding adversely classified credits and credit
trends is also provided to the Risk 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 activities include
identifying these types of exposures and identifying the risks that
would or could trigger credit deterioration across these related
exposures. When such risks materialize, an adverse credit
classification may be designated across these 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' 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
independent
judgments, are based upon underlying credit
parameters consistent with the exposure type.
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.
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, the
Stipulation and Order and the indenture for the Tier 2 Notes, Ambac
Assurance must seek prior approval by OCI of certain corporate
actions. The Settlement Agreement, Stipulation and Order and
indenture for the Tier 2 Notes 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.
The indenture for the Tier 2 Notes will remain in force until the
Tier 2 Notes have been redeemed, repurchased or repaid in full.
Certain of the restrictions in the Settlement Agreement and
indenture for the Tier 2 Notes may be waived with the approval of
the OCI and/or the requisite percentage of holders of debt securities
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 Item 1A. Risk Factors in Part I, Item 1A and
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
| Ambac Financial Group, Inc. 7 2018 FORM 10-K |
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
the 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.
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 2019 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,
the indenture for the Tier 2 Notes 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.
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). As a result, Ambac UK is not
expected to pay any dividends to Ambac Assurance for the
foreseeable future.
Pursuant to the Settlement Agreement and the indenture for the
Tier 2 Notes, 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. Any such payment on surplus notes would require either
payment or collateralization of a proportional amount of the Tier
2 Notes (or interest thereon) in accordance with the terms of the
Tier 2 Note indenture.
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 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, 2018, the consolidated non-VIE investments
of Ambac had an aggregate fair value of approximately $3.9 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's Board of Directors or the Board
of Directors of the applicable subsidiary. 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, 2018, the Ambac Assurance and Everspan
non-VIE investment portfolio had an aggregate fair value of
approximately $2.9 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
Agreement, the Stipulation and Order and the indenture for the
Tier 2 Notes. Such requirements could adversely impact the
performance of the investment portfolio.
As of December 31, 2018, the non-VIE Ambac UK investment
portfolio had an aggregate fair value of approximately $0.7 billion.
| Ambac Financial Group, Inc. 8 2018 FORM 10-K |
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, 2018, the non-VIE Ambac (parent company
only) investment portfolio had an aggregate fair value of
approximately $0.3 billion. The primary investment objective is
to preserve capital for strategic uses while maximizing income.
The investment portfolio is subject to internal investment
guidelines. Such guidelines set forth minimum credit rating
requirements and credit risk concentration limits. Ambac invests
in securities insured or issued by Ambac Assurance, including
surplus notes ($0.06 billion fair value at December 31, 2018) and
AMPS issued by Ambac Assurance that are eliminated in
consolidation.
The following table provide certain information concerning the
consolidated investments of Ambac:
2018
2017
Investment Category
($ in millions)
December 31,
Municipal obligations
Corporate securities
Foreign obligations
U.S. government
obligations
Residential mortgage-
backed securities
Asset-backed securities
Total long-term
investments
Short-term investments
Other investments (3)
Carrying
Value (2)
$
880
1,278
31
94
259
574
3,116
430
391
Weighted
Average
Yield (1)
Carrying
Value (2)
Weighted
Average
Yield (1)
5.6 % $
5.6 %
1.1 %
1.9 %
10.2 %
7.9 %
6.2 %
2.5 %
— %
780
860
27
185
2,251
649
4,752
557
432
5.5 %
3.2 %
1.0 %
1.4 %
14.1 %
7.3 %
9.1 %
1.3 %
— %
8.3%
Total
$ 3,937
5.7% $ 5,741
(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, 2018, Ambac had 102 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 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 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 Financial and Credit Markets...........
Risks Related to the Company's Business....................
Risks Related to International Business ......................
Risks Related to Taxation.............................................
Risks Related to Strategic Plan....................................
Page
9
11
14
19
21
22
23
24
25
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 principal business is in run-off and faces significant risks
and uncertainties described elsewhere in Part I, Item 1A. Risk
Factors. 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 in Puerto Rico;
• actual or perceived adverse developments with regards to
Ambac Assurance's RMBS litigations;
• changes to regulatory status;
• changes in investors’ or analysts’ valuation measures for our
stock;
• market trends unrelated to our stock;
| Ambac Financial Group, Inc. 9 2018 FORM 10-K |
• 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.
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 or significant
losses or other events resulting from litigation, including the failure
to achieve expected recoveries from existing litigations concerning
insured residential mortgage-backed securities ("RMBS"), 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.
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 any residual value of Ambac
Assurance. Additionally, the rehabilitator would assume control of
all of Ambac Assurance’s assets and management of Ambac
Assurance. In exercising control, the rehabilitator would act for
the benefit of policyholders, and would not take into account the
interests of our securityholders. Such actions may result in material
adverse consequences for our securityholders.
The issuance of additional shares of Ambac, including shares of
Ambac common stock underlying issued and outstanding
warrants, may dilute current shareholder value or have adverse
effects on the market price of Ambac’s common stock.
If Ambac issues additional shares of common stock to raise capital,
whether for select business transactions, general corporate
purposes, in exchange for other securities, or in connection with
the exercise of issued and outstanding warrants, the value of current
stockholders’ interests may be diluted as Ambac is not required to
offer any such shares to existing stockholders on a preemptive
basis.
Ambac cannot predict the effect, if any, of future sales of its
common stock, or the availability of shares for future sales, on the
market price of its common stock. Sales of substantial amounts
of common stock or the perception that such sales could occur may
adversely affect the prevailing market price for its common stock.
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
intercompany tax sharing agreement (the "Amended TSA") and
the intercompany expense sharing and cost allocation agreement
(the "Cost Allocation Agreement"); the receipt of payments on the
Owner Trust Certificate issued to Ambac by Corolla Trust (the
"Owner Trust Certificate"), which was created in 2014 to monetize
Ambac's ownership interest in junior surplus notes issued by the
Segregated Account; the receipt of payments on investments made
in 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. There is a risk that Ambac Assurance will not be able to satisfy
all of its obligations to policyholders, holders of its indebtedness
(including surplus notes, junior surplus notes, the Ambac Note and
the Tier 2 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 and, in certain instances, to OCI approval,
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 plus interest thereon. 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 (but not
limited to) 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
| Ambac Financial Group, Inc. 10 2018 FORM 10-K |
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.
Risks Related to Insured Portfolio Losses
Loss reserves may not be adequate to cover potential losses, and
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/or restructurings, 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.
transaction documents, Ambac Assurance or
Additionally, inherent in our estimates of loss severities and
remediation recoveries is the assumption that Ambac Assurance
or its subsidiaries, as applicable, will retain control rights in respect
of our insured portfolio. However, according to the terms of
relevant
its
subsidiaries, as applicable, may lose control rights in many insured
transactions if, among other things, the relevant insurer is the
subject of delinquency proceedings and/or other regulatory
actions. If Ambac Assurance or its subsidiaries lose control rights,
their ability to mitigate loss severities and realize remediation
recoveries will be compromised, and actual ultimate losses in the
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.
Catastrophic environmental events, particularly those associated
with hurricanes, earthquakes, wildfires and drought, that result
in loss of human life, significant property damage, and/or
material disruption of economic activity can have a material
negative impact on the financial performance of issuers of public
finance, investor owned utility, privatized military housing and
other obligations insured by Ambac Assurance. Such stresses
could result in liquidity claims or permanent losses on those
obligations.
Ambac Assurance insures the obligations of a number of issuers
that have been substantially affected by environmental events in
2017 and 2018, including certain municipalities in Texas as a result
of flooding related to Hurricane Harvey in September 2017,
| Ambac Financial Group, Inc. 11 2018 FORM 10-K |
various obligations of the Commonwealth of Puerto Rico and the
U.S. Virgin Islands impacted by hurricanes Irma and Maria in
September and October 2017, certain California issuers affected
by wildfires in 2017 and 2018, and an issuer in Florida impacted
by Hurricane Michael in October 2018.
The short and long term impact of catastrophic environmental
events on issuers and their obligations is by its very nature uncertain
and is determined by a number of factors including, but not limited
to, the level of Federal Government support via emergency disaster
relief funding measures, both related to FEMA and otherwise,
flood insurance, low interest loans, hazard mitigation, the level of
state government support, the magnitude of commercial insurance
recoveries, and the outcome of certain socio-economic variables.
Consequently, if issuers affected by such catastrophic events do
not receive adequate measures of support or realize the appropriate
level of economic recovery, it could impact their ultimate ability
to service the debt insured by Ambac Assurance and Ambac
Assurance's ability to recover claims paid in the future.
In addition, certain catastrophic environmental events, notably
wildfires, can result in significant potential liabilities for issuers
such as investor owned utilities that increase bankruptcy risk and
the potential default on obligations of the issuer, including
obligations insured by Ambac Assurance. For example, Ambac
Assurance insures approximately $32 million of obligations of
Pacific Gas & Electric Company, which filed for bankruptcy
protection on January 29, 2019, in part due to potentially significant
liabilities associated with wildfires in 2017 and 2018 in its area of
operations in California.
Ambac Assurance insures obligations of the Commonwealth of
Puerto Rico, including certain of 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 has made
and may continue to 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 on Puerto Rico insured bonds, 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,
as applicable, discrete revenue sources, direct general obligation
pledges and/or general obligation guarantees. Ambac Assurance
had approximately $1.9 billion of net par exposure to the
Commonwealth and these instrumentalities at December 31, 2018.
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 bonds. The outstanding net insured
amount including accretion on capital appreciation bonds is
approximately $2.6 billion at December 31, 2018. Total net insured
lifetime debt service (net par and interest) to the Commonwealth
of Puerto Rico and its instrumentalities was approximately $9.3
billion at December 31, 2018.
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, and Note 7. Financial
Guarantee Insurance Contracts to the Consolidated Financial
Statements included in Part II, Item 8 in this Form 10-K), the
Commonwealth of Puerto Rico and certain of its instrumentalities
may continue to default on debt service payments, including
payments owed on bonds insured by Ambac Assurance. Ambac
Assurance has made, and may continue to 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 a number of factors including
variability in economic growth and demographic trends, tax
revenues, essential services expense as well as federal funding of
Commonwealth needs.
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
has been 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.
On February 15, 2019, the United States Court of Appeals for the
First Circuit issued an opinion in the consolidated appeals brought
by certain parties who argued that the members of the Financial
Oversight and Management Board for Puerto Rico (the "Oversight
Board") were appointed in violation of the U.S. Constitution’s
Appointments Clause. The First Circuit ruled that the Oversight
Board members (other than the ex-officio Member) must be, and
were not, appointed in compliance with the Appointments Clause.
The First Circuit declined to dismiss the Oversight Board’s Title
III petitions and did not render ineffective any otherwise valid
actions of the Oversight Board prior to the issuance of the ruling.
The First Circuit stated that the ruling will not take effect for 90
days, “so as to allow the President and the Senate to validate the
currently defective appointments or reconstitute the Board in
accordance with the Appointments Clause." During the 90-day stay
period, the Oversight Board may continue to operate as it had prior
to the ruling. It is unclear how this ruling, both during the 90-day
stay period and thereafter, will impact the restructuring process,
mediation discussions and relevant litigation with respect to our
Puerto Rico exposures. Certain parties to the litigation may petition
the U.S. Supreme Court for a writ of certiorari, seeking a review
of the First Circuit’s decision.
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
| Ambac Financial Group, Inc. 12 2018 FORM 10-K |
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 further increases to our loss reserves. In
particular, in a Title III process, should court-approved plans of
adjustment for the Commonwealth, 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, forecasted in 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 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 P.L. 115-97, commonly referred to as the Tax
Cuts and Jobs Act of 2017, 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
activity of a U.S. multinational group, including those with
manufacturing facilities or other business on the island. The
legislation was implemented in December 2017, at a difficult time
as the Commonwealth of Puerto Rico was recovering from
Hurricane Maria in October 2017, and, moreover, was amidst a
multi-year financial crisis that is still ongoing. 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 of 2017 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, 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 reduced the maximum
corporate federal income tax rate to 21% from 35%, which could
reduce
investments by
corporations, such as 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
| Ambac Financial Group, Inc. 13 2018 FORM 10-K |
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, reinsurance,
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 and tools to assist our projection of
performance of our insured obligations and our investment
portfolio but actual results could differ materially from the model
and tool outputs and related analyses.
We rely on internally and externally developed complex financial
models, including default models related to RMBS and a waterfall
tool 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 and tools assume various conditions, probability
scenarios, facts and circumstances, and there can be no assurance
that such models or tools accurately predict or measure the
quantum of losses, loss reserves and timing of losses. Differences
in the models and tools that we employ, uncertainties or flaws in
these financial models and tools, or faulty assumptions inherent in
these financial models and tools or 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, 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.
Political developments may materially adversely affect our
insured portfolio.
Our insured exposures and our results of operations can be
materially affected by political developments at the federal, state
and/or local government levels. Government shutdowns, trade
disputes, political turnover, judicial decisions, adverse changes in
federal funding, or poor public policy decision making could
disrupt the national and local economies where we have insured
exposures. In addition, we are exposed to correlation risk as a result
of the possibility that multiple credits may concurrently and/or
consecutively experience losses or increased stress as a result of
any such event or series of events.
Risks Related to Indebtedness
Ambac Assurance's ability to generate the significant amount of
cash needed to service its debt and financial obligations and its
ability to refinance all or a portion of its indebtedness or obtain
additional financing depends on many factors beyond our
control.
Ambac Assurance is highly leveraged and has greater indebtedness
outstanding following consummation of the Rehabilitation Exit
Transactions and the AMPS Exchange. Ambac Assurance’s ability
to make payments on and refinance its debt, including surplus notes
(which continue to accrete based on compounding interest when
interest has not been paid), and other financial obligations and to
fund its operations will depend on its ability to generate substantial
operating cash flow and on the performance of the insured
portfolio. Ambac Assurance’s cash flow generation will depend
on receipt of premiums, investment returns, earnings from
subsidiaries and potential
litigation recoveries offset by
policyholder claims, commutation payments, operating and loss
adjustment expenses, and interest expense, which will be subject
to prevailing economic conditions and to financial, business and
other factors, many of which are beyond our control and many of
which are event-driven.
As of December 31, 2018, Ambac Assurance had approximately
$2,198.9 million of indebtedness outstanding (the Tier 2 Notes
and the Ambac Note) that are senior to its surplus notes. Ambac
Assurance had $573.8 million principal balance of surplus notes
(other than junior surplus notes) outstanding plus $366.6 million
principal balance of junior surplus notes outstanding as of
December 31, 2018. The Tier 2 Notes and the Ambac Note are
secured by potential litigation recoveries (and in the case of the
Ambac Note, other assets), the receipt of which is highly uncertain,
as more fully discussed in Part I, Item 1A. Risk Factors. Failure
to achieve litigation recoveries in an amount sufficient to repay the
Tier 2 Notes and the Ambac Note would materially weaken Ambac
Assurance’s ability to service its indebtedness.
If Ambac Assurance cannot pay its policyholders’ claims or service
its debt, it will have to take actions such as selling assets,
restructuring or refinancing its debt or seeking additional capital.
Any of these remedies may not, if necessary, be effected on
commercially reasonable terms, or at all. Because of these and
| Ambac Financial Group, Inc. 14 2018 FORM 10-K |
other factors beyond our control, Ambac Assurance may be unable
to pay the principal, interest or other amounts on its indebtedness
when due or ever.
We have substantial indebtedness, which could adversely affect
our financial condition, operational flexibility and our ability to
obtain financing in the future.
Our substantial indebtedness could have significant consequences
for our financial condition and operational flexibility. 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 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.
The Secured Notes and Tier 2 Notes are primarily secured 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. Ambac Assurance's ability to obtain such recoveries
and the timing of receipt of any such recoveries are subject to
significant risks and uncertainty, as described below in Risks
Related to Capital, Liquidity and Markets.
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
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.
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
| Ambac Financial Group, Inc. 15 2018 FORM 10-K |
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 ("R&W") 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
$210 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 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
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 issuer of the
Secured Notes, 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,
liquidation, conservation, dissolution or other
insolvency
proceeding with respect to Ambac Assurance or the issuer of the
Secured Notes, as applicable, could lead to delays in payments due
on the Secured Notes or Tier 2 Notes.
litigations are received after
the
| Ambac Financial Group, Inc. 16 2018 FORM 10-K |
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.
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 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 and other indebtedness 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 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 consummated in
February 2018 (the "Exchange Offers").
The Company may acquire, redeem or repay surplus notes 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,
indenture for the Tier 2 Notes 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.
Surplus notes 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.
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 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.
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 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
| Ambac Financial Group, Inc. 17 2018 FORM 10-K |
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 done
in connection with the Exchange Offers could materially and
adversely affect the credit risk inherent in, and significantly
reduce protections afforded in, outstanding surplus notes.
Holders of outstanding surplus notes are subject to the terms of the
Settlement Agreement as modified. Certain restrictive covenants
and other related provisions in the Settlement Agreement,
including covenants regarding mergers and consolidations and the
incurrence of indebtedness, were modified or eliminated in
connection with the Exchange Offers. As a result, holders of
surplus notes are not 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 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 $19.4 million increase in the annual cash interest
payments due on the Secured Notes.
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.
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 or 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 of 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
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 estimated R&W recovery may change over time, causing
the perceived value of the collateral securing the Secured Notes
and Tier 2 Notes to change, and any such change may be material.
Ambac reevaluates its estimated R&W 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, 2018.
As a result of any reevaluation, the estimated amount of Ambac’s
R&W recovery may be adjusted upward or downward due to,
among other things, changes in management's view of such
estimated recoveries and/or changes in the loss reserves related to
such recoveries, and any adjustment may be material. Changes in
estimated R&W recoveries may result in material changes in
Ambac’s financial condition, including its capital and liquidity. In
addition, any adjustment to estimated R&W recoveries may alter
| Ambac Financial Group, Inc. 18 2018 FORM 10-K |
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 representation that the estimated R&W recoveries will
not change, materially or at all, including in the near term. There
can be no assurance that the estimated R&W recoveries 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.
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
our securities, including the Secured Notes and Tier 2 Notes.
Ambac Assurance is pursuing claims in litigation with respect to
certain RMBS transactions that it insured. 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.
As of December 31, 2018, we have estimated RMBS R&W
subrogation recoveries of $1,744.2 million (net of reinsurance)
included in our financial statements. These estimated recoveries
are based on the contractual claims brought in the aforementioned
litigations and represent a probability-weighted estimate of
amounts we expect to recover under various possible scenarios.
The estimated recoveries we have recorded do not represent the
best or the worst possible outcomes with respect to any particular
transaction or group of transactions.
There can be no assurance that Ambac Assurance will be successful
in prosecuting its claims in the RMBS litigations. The outcome of
any litigation, including the RMBS litigations, is inherently
unpredictable, including because of risks intrinsic in the
adversarial nature of litigation. Motions made to the court, rulings
and appeals could delay or otherwise impact any recovery by
Ambac Assurance. Moreover, rulings that may be adverse to
Ambac Assurance (in any of its RMBS litigations, as well as in
other RMBS cases in which it is not a party) could affect Ambac
Assurance’s ability to pursue its claims or alter settlement
dynamics with RMBS litigation defendants. For example, as
described in Note 16. Commitments and Contingencies to the
Consolidated Financial Statements included in Part II, Item 8 in
this Form 10-K, the defendants in Ambac Assurance’s case against
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) are pursuing appeals of rulings issued in
December 2018 on several pre-trial motions filed by defendants
in August 2018 and October 2018. If the appeals were decided
adversely to Ambac Assurance, in whole or in part, our ability to
recover on our claims could be materially impaired. Furthermore,
the timing of the decision on the appeals may significantly prolong
the timetable of any recovery. The timing of decisions by trial
courts and appellate courts is uncertain, and courts may take longer
than expected to issue decisions. A trial court may take longer than
expected to schedule a trial in a case due to the schedule of the
judge and the need or desire of the court to decide, or await the
decision by an appellate court of, outstanding issues in the case.
Any litigation award or settlement may be for an amount less than
the amount necessary to pay the Secured Notes or the Tier 2 Notes,
which could have a material adverse effect on our 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 and/or Ambac Assurance’s
outstanding surplus 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. Depending on the
length of time required to resolve these litigations, either through
settlement or at trial, Ambac Assurance could incur greater
litigation expenses than currently projected. If a case is brought to
trial, Ambac Assurance’s ultimate recovery would be subject to the
additional risks inherent in any trial, including adverse findings or
determinations by the trier of fact or the court, which could
adversely impact the value of our securities, including the Secured
Notes and Tier 2 Notes.
Any litigation award is subject to risks of recovery, including that
the sponsor is unable pay a judgment that Ambac Assurance may
obtain in litigation. In some instances, Ambac Assurance also has
claims against a parent or an acquirer of the counterparty. However,
Ambac Assurance may not be successful in enforcing its claims
against any successor entity.
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.
Our ability to realize the estimated RMBS R&W subrogation
recoveries included in our financial statements and the time of the
recoveries, if any, is subject to significant uncertainty, including
the risks described above 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 all such amounts, our stockholders’ equity as of
December 31, 2018 would decrease from $1,633.1 million to
$(111.1) 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
in
the performance of servicers
insures, and
involved
| Ambac Financial Group, Inc. 19 2018 FORM 10-K |
securitizations in which Ambac Assurance participates as insurer.
Additionally, our ability to realize recoveries in insured
transactions may be impaired if the continuing 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, and may result in adverse consequences such
as impairing the ability of Ambac Assurance to honor its financial
obligations; the initiation of rehabilitation proceedings against
Ambac Assurance; decreased likelihood of Ambac Assurance
delivering value to Ambac, through dividends or otherwise; and a
significant drop in the value of securities issued or insured by
Ambac or Ambac Assurance, including the Secured Notes and Tier
2 Notes.
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 RMBS cases for which it records an RMBS R&W
subrogation recovery in its financial statements, Ambac has
obtained loan files from the relevant original pool and has
conducted loan file reunderwriting to derive a breach rate that is
extrapolated to estimate the damages Ambac expects to recover.
Ambac does not estimate an RMBS R&W subrogation recovery
for litigations where its sole claim is for fraudulent inducement.
The amount estimated for purposes of Ambac’s RMBS R&W
subrogation recovery and the amount Ambac may ultimately
receive is subject to significant uncertainty, as described in the
immediately preceding risk factor. Ambac’s findings and
assumptions regarding collateral performance and Ambac’s
expectations with respect to the outcome of the RMBS litigations
have a significant impact on Ambac’s estimated RMBS R&W
subrogation recovery. If these findings, assumptions or estimates
prove to be incorrect or otherwise do not support our claims, actual
recoveries could differ materially from those estimated. Actual
recoveries will ultimately depend on future events and there can
be no assurance that our view of collateral performance or our
estimated RMBS R&W subrogation recoveries will not differ from
actual events. Although Ambac believes that its methodology for
estimating recoveries is appropriate, the methodologies Ambac
uses to estimate expected collateral losses and specific transaction
performance may not be similar to methodologies used by Ambac’s
competitors, counterparties or other market participants. The
determination of expected RMBS R&W subrogation recoveries is
an inherently subjective and complex process involving numerous
estimates and assumptions and judgments by management, using
both internal and external data sources to derive a specific
transaction's cash flows. As a result, Ambac’s current estimates
may not reflect Ambac’s ultimate recovery, and management
makes no representation that the actual amounts recovered, if any,
will not differ materially from those estimated. The failure of
Ambac’s actual recoveries to meet or exceed its current estimates
could result in a material adverse effect on Ambac’s financial
condition, including its capital and liquidity.
AMPS that were not exchanged and cancelled in the AMPS
Exchange may be acquired, redeemed or repaid on terms that
may be viewed as more, or less, favorable than the terms of the
applicable consideration offered in the AMPS Exchange.
Ambac or Ambac Assurance may acquire, redeem or repay AMPS
that were not exchanged and cancelled in the AMPS Exchange
through open market purchases, privately negotiated transactions,
other tender or exchange offers, redemptions under the AMPS, or
such other means as Ambac or Ambac Assurance (as the case may
be) deems appropriate, subject to the restrictions in its governing
documents, the restrictive covenants in its contracts and any
applicable regulatory restrictions. Any such transactions will occur
upon the terms and at the prices as Ambac or Ambac Assurance
(as the case may be) may determine in its sole discretion, which
may be more or less favorable than the terms of the AMPS
Exchange, and in any case could be for cash or other consideration.
Ambac or Ambac Assurance may choose to pursue any or none of
these alternatives, or combinations thereof, in the future.
We may not be able to commute or reduce insured exposures.
In pursuing the objective of improving our financial position, we
are seeking to commute or reduce insured exposures. De-risking
transactions 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 of 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 the
continuing orders of the Rehabilitation Court are not effective.
Such reductions would result in lower revenues.
The composition of the securities in our investment portfolio
exposes us to greater risk than before we invested in "alternative
assets."
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
Assurance 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
| Ambac Financial Group, Inc. 20 2018 FORM 10-K |
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.
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
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 financial models and tools to
project impairments with respect to RMBS held in our investment
portfolio,
including Ambac Assurance guaranteed RMBS.
Differences in the models and tools we employ and/or flaws in
these models and tools and/or faulty assumptions inherent in these
models and tools 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, to meet collateral posting
requirements or to meet other liquidity needs, 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
floating rates of interest. Higher interest rates can also lead to
increased credit stress on consumer asset-backed transactions (as
the securitized assets supporting a portion of these exposures are
floating rate consumer obligations), slower prepayment speeds and
resulting “extension risk” relative to such consumer asset-backed
transactions in our insured and investment portfolios, and
decreased refinancing activity.
Decreasing interest rates could result in early terminations of
financial guarantee insurance policies in respect of which we are
paid on an installment basis and do not receive a termination
premium, thus reducing premium earned for these transactions.
Decreases in prevailing interest rates may also limit growth of, or
reduce, investment income and may adversely impact our interest
rate swap portfolio.
Our investment portfolio may also be adversely affected by credit
rating downgrades, ABS and RMBS prepayment speeds, foreign
exchange movements, spread volatility, and credit losses.
We are subject to credit risk throughout our businesses, including
large single risks, risk concentrations, correlated risks and
reinsurance counterparty credit risk.
in
We are exposed to the risk that issuers of debt which we have
insured (or with respect to which we have written credit
derivatives), issuers of debt which we hold in our investment
portfolio, reinsurers and other contract counterparties (including
derivative counterparties) may default
their financial
obligations, whether as the result of insolvency, lack of liquidity,
operational failure, fraud or other reasons. These credit risks could
cause increased losses and loss reserves, and/or estimates of credit
impairments and mark-to-market losses with respect to credit
derivatives in our financial guarantee business; and we could
experience losses and decreases in the value of our investment
portfolio and, therefore, our financial strength. Such credit risks
may be in the form of large single risk exposures to particular
issuers, reinsurers or counterparties; losses caused by catastrophic
events (including terrorist acts and natural disasters); losses caused
by increases in municipal defaults; or losses in respect of different,
but correlated, credit exposures.
| Ambac Financial Group, Inc. 21 2018 FORM 10-K |
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, Stipulation and Order and Indenture
for the Tier 2 Notes contain restrictive covenants that may impair
our ability to pursue our business strategies.
Pursuant to the terms of the Settlement Agreement, Stipulation and
Order and indenture for the Tier 2 Notes, Ambac Assurance must
seek prior approval by OCI of certain corporate actions. The
Settlement Agreement, Stipulation and Order and indenture for the
Tier 2 Notes also include covenants which restrict the operations
of Ambac Assurance which, (i) 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, (ii) in the case of the Stipulation and
Order, remain in place until the OCI decides to relax such
restrictions, and (iii) in the case of the indenture for the Tier 2
Notes, remain in force until the Tier 2 Notes have been redeemed,
repurchased or repaid in full. Certain of these restrictions may be
waived with the approval of holders of the applicable debt
securities and/or OCI. If we are unable to obtain the required
consents under the Settlement Agreement, the Stipulation and
Order and/or the indenture for the Tier 2 Notes, 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,
whether
proceedings,
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
increased costs, distractions
administrative
litigation,
through
effects would also increase the risk that OCI would seek to initiate
rehabilitation proceedings against Ambac Assurance.
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, cause 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.
| Ambac Financial Group, Inc. 22 2018 FORM 10-K |
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 depends 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
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.
The Government of the United Kingdom (“UK”) continues to
contend with inconclusively finding resolution in the UK
Parliament and with the European Union (“EU”) for the terms of
the UK’s departure from the EU (“Brexit”). Current Brexit
discussions do not include details of future post-Brexit trade
relations. Current negotiations are designed to reach agreement on
transitional arrangements covering the UK’s exit from the EU,
lasting only for a relatively brief period, currently mooted to endure
from March 29, 2019, the anticipated date of formal UK departure
from the EU, and end on December 31, 2020. Assuming a transition
agreement is reached, a further, separate, negotiation on a
future post-transition trade framework must then begin. It is
envisaged that negotiation on the future trade framework would
be concluded during the transitional phase, and would be
influenced by the nature of the transitional arrangements agreed
between the parties.
However there is a material risk that transitional Brexit
negotiations are inconclusive so that on March 29, 2019 the UK
automatically exits the EU without any transitional arrangement
(a “no deal Brexit”), and also with no certain path to negotiating
a future trade relationship with the EU.
Absent action by the EU or member states, in the event of a no
deal Brexit the activities in the European Economic Area (“EEA”)
of UK passporting insurers, including Ambac UK, will become
unlawful on March 29, 2019. They will lose their legal
authorization to serve clients who benefit from policies issued by
UK incorporated insurers under freedom of services passporting
rights (and thereby may be unable to legally collect premiums or
pay claims).
At December 31, 2018, Ambac UK’s insured portfolio included
six policies in the EU written under current passporting rights, with
an aggregate par value of $2.4 billion. In respect of these six
policies, there is premium receivable of $61 million and loss and
loss expense reserves (net of subrogation recoverable) of $271
million. Absent legally binding transitional arrangements Ambac
UK may be unable to collect these premiums or pay the claims to
which these premiums receivable and loss and loss expense
reserves relate after March 29, 2019. Ambac UK’s ability to
restructure these policies to mitigate this risk is limited.
Nonpayment of claims under any of the affected policies could
lead to the loss of control rights in the related transaction(s), which
would expose Ambac UK to greater risk of loss. In addition, under
applicable English law, a court may hold that Ambac UK has an
enforceable obligation to pay claims irrespective of the EU
regulatory position in law. Consequently Ambac UK could find
itself in a position where it was not in receipt of premium on a
relevant deal but chose to pay claims to avoid loss of control rights
and/or other consequences of non-payment, notwithstanding the
EU regulatory characterization in law.
Additionally, if UK insurers have branches in EEA Member States
they may be legally obliged to either capitalize them, as a so-called
third country branch from an institution whose home state is
outside the EEA, or close them down and no longer be legally
represented in those EU jurisdictions. Ambac UK has a branch in
Italy, with one remaining policy issued from the branch. The branch
is not capitalized separately from Ambac UK. In the event of a
no-deal Brexit, the future nature and status of the branch is unclear,
particularly with respect to the need for capitalization to support
the one remaining branch policy. Given that Ambac UK is under
capitalized in terms of applicable regulatory capital rules it will be
difficult for the UK regulator to agree to assets leaving the company
for this purpose.
then be
There is a risk that absent agreement with the Italian regulator
regarding the future of the branch, under law the Italian regulator
could institute insolvent winding up proceedings against the branch
as an unlicensed insurance business. In this scenario the one branch
policy would
law
notwithstanding the prejudicial outcome to policy holders. This
chain of events could in turn trigger cross defaults with a
consequential loss by Ambac UK of its controlling creditor rights
in many or all transactions. This would greatly inhibit Ambac UK’s
ability to exercise its rights in transactions generally, and in
particular with respect to mitigating potential or actual loss in those
transactions.
terminated by operation of
In light of no deal Brexit risk, the UK financial regulatory authority
has been actively encouraging regulated firms to put into place
contingency plans, as have been EU and EU member states’
financial regulatory bodies.
However on February 19, 2019, the European Insurance and
Occupational Pensions Authority (“EIOPA”) made a series of
recommendations to EU insurance regulators in light of Brexit.
that
include
These recommendations
regulatory authorities apply legal frameworks that facilitate the
orderly run off (without time limit) branch operations and of
insurance policies issued in EEA member states by UK insurers
the recommendation
| Ambac Financial Group, Inc. 23 2018 FORM 10-K |
prior to March 30, 2019 that terminate after this date. The
recommendations will require to be incorporated into EEA member
states legal and regulatory frameworks in an appropriate manner
to bring them into effect. We can provide no assurance as to the
manner or timing of such regulatory changes.
The Company is in discussion with the PRA and other relevant
regulatory authorities to enable the continued orderly run off of
its policies issued in the EEA under passporting rights as well as
the Italian branch operation in line with this recommendation.
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, foreign
exchange rates and economic conditions in the UK, the Eurozone,
and the EU.
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
whether
Accordingly,
determinations made by the PRA and FCA, in their capacity as
Ambac UK’s regulator, could potentially result in adverse
consequences for our securityholders and also reduce the value
realizable by Ambac for Ambac UK.
to provide any such approval.
Regulatory uncertainty in relation to Ambac UK’s capital
position could adversely affect the value of Ambac UK and affect
our securityholders.
Under applicable regulatory capital rules (“Solvency II”) Ambac
UK remains significantly deficient in terms of capital. Ambac UK
does not have a remedial plan other than to build its assets over
time by on-going premium collections and earned investment
income, as well as attempting to accelerate the run-off of its
exposures. Further, there currently is no prospect of any capital
support from the Ambac group of affiliates. The PRA is 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”.
Ambac UK clearly falls into this category and therefore Ambac
UK’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.
Risks Related to Taxation
Surplus notes received in the AMPS Exchange and by holders
of Deferred Amounts pursuant to the Second Amended Plan of
Rehabilitation along with other debt reissued by Ambac may not
be fungible for U.S. federal income tax purposes with other
surplus notes and debt currently outstanding.
Surplus notes received in the AMPS Exchange and by holders of
Deferred Amounts pursuant to the Second Amended Plan of
Rehabilitation along with other debt reissued by Ambac (together
"Reissued Debt") have different issue prices for U.S. federal
income tax purposes than the originally issued outstanding surplus
notes and other debt and, therefore, are expected to accrue original
issue discount (“OID”) in an amount that differs from the amounts
of OID accruing on the originally issued surplus notes and other
debt currently outstanding, as the case may be. Therefore, Reissued
Debt may not be fungible with the other outstanding surplus notes
and debt, as applicable, for U.S. federal income tax purposes.
Because Reissued Debt has the same CUSIP numbers as other
related surplus notes and debt currently outstanding, the Reissued
Debt will not be readily distinguishable from the other outstanding
surplus notes and debt, as applicable. This could create uncertainty
in the market and could adversely affect the liquidity and/or trading
values of surplus notes and other debt.
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 net operating
loss carry-forwards ("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
| Ambac Financial Group, Inc. 24 2018 FORM 10-K |
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.
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 into 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.
Item 1B. Unresolved Staff Comments — No matters
require disclosure.
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).
Ambac will relocate in the third quarter of 2019 and has entered
into a sublease agreement at One World Trade Center, New York,
New York 10007, which consists of 46,927 square feet that will
expire January 2030. Ambac has sublet the remaining 25,871
square feet of space at One State Street Plaza through its expiration
date.
Ambac leases additional space outside of New York for its data
center at a secure facility under a lease agreement that expires in
March 2020.
Additionally, Ambac maintains a disaster recovery site as part of
its Disaster Recovery Plan, which is located approximately 100
miles from New York City under a lease that expires in September
2020. 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.
Ambac UK maintains an office in London, England, which consists
of 3,514 square feet of office space, under a lease agreement that
expires in October 2020.
| Ambac Financial Group, Inc. 25 2018 FORM 10-K |
Item 3. Legal Proceedings
Warrants
Each warrant represents the right to purchase one share of Ambac
common stock. The warrants are exercisable for cash at any time
on or prior to April 30, 2023 at an exercise price of $16.67 per
share. The warrants also have a cashless exercise provision.
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,
2018, Ambac had repurchased 985,331 warrants at a cost of $8.1
million The remaining aggregate authorization at December 31,
2018 is $11.9 million.
In connection with the AMPS Exchange, Ambac issued 824,307
of the repurchased warrants on August 3, 2018, leaving 4,877,783
warrants outstanding. Refer to Note 1. Background and Business
Description to the Consolidated Financial Statements included in
Part II, Item 8 in this Form 10-K for further discussion of the AMPS
Exchange.
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.”
Holders
On February 25, 2019, there were 25 stockholders of record of
Ambac’s common stock.
Dividends
The Company did not pay cash dividends on its common stock
during 2018 and 2017. Information concerning restrictions on the
payment of dividends from Ambac's insurance subsidiaries is set
forth in Item 1 above under the caption “Dividend Restrictions,
Including Contractual Restrictions" and in Note 8. Insurance
Regulatory Restrictions to the Consolidated Financial Statements
included in Part II, Item 8 in this Form 10-K.
Purchases of Equity Securities By the Issuer and Affiliated
Purchasers
The following table summarizes Ambac's share purchases during
the fourth quarter of 2018. When restricted stock unit awards
issued by Ambac vest or settle, they become taxable compensation
to employees. For certain awards, shares may be withheld to cover
the employee's portion of withholding taxes. In the fourth quarter
of 2018, Ambac purchased shares from employees that settled
restricted stock units to meet employee tax withholdings.
October
2018
Novembe
r 2018
Decembe
r 2018
Fourth
Quarter
2018
2,067
$
20.42
—
—
—
2,067
— $
20.42
—
—
—
—
—
—
—
—
Total Shares
Purchased (1)
Average Price
Paid Per Share
Total Number of
Shares
Purchased as
Part of Publicly
Announced
Plan (1)
Maximum
Number of
Shares That may
Yet be Purchased
Under the Plan
(1) There were no other repurchases of equity securities made during the
three months ended December 31, 2018. Ambac does not have a
stock repurchase program.
| Ambac Financial Group, Inc. 26 2018 FORM 10-K |
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, 2018, 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
2018
$100
$100
$100
$123
$127
$123
$123
$134
$130
$70
$127
$124
$113
$148
$142
$80
$167
$165
$86
$147
$147
| Ambac Financial Group, Inc. 27 2018 FORM 10-K |
Item 6.
Selected Financial Data
The following financial information for the five years ended December 31, 2018, has been derived from Ambac’s Consolidated Financial
Statements. This information should be read in conjunction with the Consolidated Financial Statements and related notes located in Part II,
Item 8 in this Form 10-K.
($ in millions, except per share data)
Total Comprehensive Income Highlights:
Gross premiums written
Net premiums earned
Net investment income (2)
Other than temporary impairment losses
Net realized investment gains
Net gains (losses) on derivative contracts
Net realized (losses) gains on extinguishment of debt (2)
Income (loss) on Variable Interest Entities ("VIEs")
Loss and loss expenses (benefit) (1) (2)
Operating expenses (2)
Interest expense (2)
Insurance intangible amortization
Goodwill impairment
Pre-tax income (loss)
Net income (loss)
Net income (loss) attributable to Common Shareholders
Total comprehensive income attributable to Ambac Financial Group, Inc.
Net income (loss) per share:
Basic
Diluted
Year Ended December 31,
2018
2017
2016
2015
2014
$
(23.8) $
(14.3) $
(53.8) $
(37.6) $
(288.3)
111.1
272.7
(3.2)
111.6
7.0
3.1
3.4
(223.6)
112.2
242.3
107.3
—
272.5
267.4
185.7
192.1
175.3
361.0
(20.2)
5.4
75.9
4.9
19.7
513.2
122.4
119.9
150.9
—
(284.3)
(328.7)
(328.7)
(335.4)
197.3
313.4
(21.8)
39.3
(30.2)
4.8
(14.1)
(11.5)
114.3
124.3
174.6
—
105.0
74.3
74.8
20.6
312.6
266.3
(25.7)
53.5
(0.8)
0.1
31.6
(768.7)
102.7
116.5
169.6
514.5
510.1
492.7
493.4
288.3
$
$
4.07
3.99
$
$
(7.25) $
(7.25) $
1.66
1.64
$
$
10.92
10.72
$
$
246.4
300.9
(25.8)
58.8
(157.2)
(74.7)
(32.2)
(545.6)
101.5
127.5
151.8
—
493.3
483.7
484.1
692.7
10.73
10.31
(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,
2018, 2017, 2016, 2015 and 2014 were $62.5 million, $72.0 million, $(71.4) million, $(303.6) million, and $(481.7) million, respectively.
(2) On February 12, 2018, Ambac Assurance executed the Rehabilitation Exit Transactions. These transactions directly resulted in: (i) a Loss and loss expense
benefit of $288 million; (ii) operating expenses of $17 million and (iii) realized gains on extinguishment of debt of $3 million. Additionally, changes to
the investment portfolio and to the composition of long-term debt arising from the transactions significantly impacted net investment income and interest
expense for 2018 compared to prior years. Refer to Results of Operations included in Item 7 of this Form 10-K for a further discussion of the Rehabilitation
Exit Transactions and their impact on financial results in 2018.
| Ambac Financial Group, Inc. 28 2018 FORM 10-K |
($ in millions) December 31
Balance Sheet Highlights:
2018
2017
2016
2015
2014
Total non-variable interest entity investments
$
3,937.2
$
5,740.8
$
6,500.2
$
5,644.7
$
5,507.0
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
63.1
495.4
718.9
—
1,933.0
61.1
7,093.3
14,588.7
630.0
1,826.1
—
2,928.9
76.7
6,981.2
12,955.6
1,633.1
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
Total liabilities and stockholders' equity
$
14,588.7
$
23,192.4
$
22,635.7
$
23,728.1
$
25,159.9
(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 $1,770.5 million, $1,834.4 million, $1,907.0
million, $2,829.6 million, and $2,523.5 million at December 31, 2018, 2017, 2016, 2015 and 2014, respectively.
(2) Long-term debt includes surplus notes issued to third parties by Ambac Assurance, notes outstanding to third parties arising from Ambac Assurance's
secured borrowing transaction and the Ambac Note and Tier 2 Notes issued in connection with the Rehabilitation Exit Transactions in 2018. 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.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) contains certain financial measures,
in particular the presentation of Adjusted Earnings and Adjusted Book Value, which are not presented in accordance with accounting principles
generally accepted in the United States (“GAAP”). We are presenting these non-GAAP financial measures because they provide greater
transparency and enhanced visibility into the underlying drivers of our business. We do not intend for these non-GAAP financial measures to
be a substitute for any GAAP financial measures and they may differ from similar reporting provided by other companies. Readers of this
Form 10-K should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures. Adjusted
Earnings and Adjusted Book Value are non-GAAP financial measures that adjust for the impact of certain non-recurring or non-economic
GAAP accounting requirements and include the addition of certain items that the Company has or expects to realize in the future, but that are
not reported under GAAP. We 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.
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 pooled funds that include a variety of other assets
including, but not limited to, corporate bonds, asset backed and
| Ambac Financial Group, Inc. 29 2018 FORM 10-K |
mortgage backed securities, municipal bonds, high yield bonds,
leveraged loans, equities, real estate, insurance-linked securities
and hedge funds. Refer to Note 10. Investments to the Consolidated
Financial Statements, included in Part II, Item 8 in this Form 10-
K for further details of fixed income investments by asset class.
During the year ended December 31, 2018, Ambac (inclusive of
its subsidiaries) did not acquire a significant amount of distressed
Ambac-insured securities. As a result of the Rehabilitation Exit
Transactions (as defined in Note 1. Background and Business
Description), Ambac discharged all Deferred Amount (as defined
in Note 1. Background and Business Description) obligations for
an effective consideration package comprised of cash, new Secured
Notes (as defined in Note 1. Background and Business Description)
and certain existing surplus notes, including those held by Ambac,
and accordingly Ambac's ownership of Ambac-insured RMBS
declined significantly. Furthermore, Ambac sold certain Ambac-
insured RMBS securities during 2018 in connection with re-
balancing the investment portfolio and certain Ambac-insured
student loan securities in connection with a commutation
transaction. At December 31, 2018, Ambac owned $254 million
of Ambac-insured RMBS and approximately 37% of outstanding
Puerto Rico Infrastructure Financing Authority ("PRIFA") and
58% of outstanding Ambac-insured bonds issued by the Puerto
Rico Sales Tax Financing Corporation ("COFINA"). 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 ("RMG") focuses
on the analysis, implementation and execution of risk reduction,
remediation and loss recovery strategies for the insured portfolio.
Analysts evaluate the estimated timing and severity of projected
policy claims as well as the potential impact of loss mitigation or
remediation measures in order to target and prioritize policies, or
portions thereof, for commutation, reinsurance, 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 2018, Ambac's successes included:
• Working closely with servicers and owners of Master
Servicing Rights to exercise clean-up calls on 11 RMBS
transactions, reducing adversely classified net par exposure
by $284 million;
• Proactively working with issuers to expedite refundings or
restructurings of Ambac-insured international bonds. During
2018, Ambac negotiated with counterparties that resulted in
the termination of several international RMBS and asset-
backed policies on £182 million and £548 million of net par
exposure, respectively;
• Working with issuers and other transaction counterparties to
expedite refundings or calls across a number of Ambac
domestic public finance bonds, resulting in a reduction of
watch list and adversely classified net par of approximately
$1.0 billion;
• Working with issuers and investors of Ambac-insured debt to
commute $484 million of net par exposure, including $127
million of adversely classified student loan exposures; and
• Facilitating the refinancing of a defaulted Ambac UK insured
debt, reducing adversely classified net par exposure by $36
million;
• Sculpting the risk profile of the insured portfolio through
quota share reinsurance. This included ceding approximately
$138 million of structured finance exposure and the full
amount of certain public finance exposures totaling $1.5
billion of performing par exposure (principal and interest of
$3.4 billion), which was mostly comprised of policies on non-
callable capital appreciation bonds and included $232 million
par of watch list and adversely classified credits.
The following table provides a comparison of total, adversely
classified credits ("ACC") and watch list net par outstanding in the
insured portfolio at December 31, 2018 and 2017. Net par
exposures within the U.S. public finance market includes capital
appreciation bonds which are reported at the par amount at the time
of issuance of the insurance policy as opposed to the current
accreted value of the bonds.
($ in billions)
December 31,
Total
ACC
Watch List
2018
2017
Variance
$
$
$
46.9
10.9
9.0
$
$
$
62.7
14.1
11.1
$
$
$
(15.8)
(3.2)
(2.1)
(25)%
(23)%
(19)%
The overall reduction in total net par outstanding resulted from
scheduled maturities, amortizations, commutations, reinsurance,
refundings, refinancings and calls, including reductions as a result
of the activities of Ambac and its subsidiaries as noted above.
The decreases in adversely classified credit exposures and watch
list credit exposures are primarily due to (i) results of active risk
reductions; (ii) paydowns or calls by issuers; and (iii) for adversely
classified credits, the improved credit profile of certain residential
mortgage-backed securities and their upgrade from the adversely
classified credit listing.
Although our insured portfolio generally performed satisfactorily
in 2018, we continue to experience stress in certain insured
exposures, particularly within our approximately $1.9 billion of
exposure to Puerto Rico, consisting of several different issuing
entities (all below investment grade). Each issuing entity has its
own credit risk profile attributable to. as applicable, discrete
revenue sources, direct general obligation pledges and/or general
obligation guarantees. On February 4, 2019, the COFINA Plan of
Adjustment ("POA") was confirmed by the United States District
Court for the District of Puerto Rico and became effective on
February 12, 2019. Several parties are presently appealing the
confirmation of the POA and no assurances can be given regarding
the results of such appeals. The POA and certain related
commutation transactions resulted in a reduction of Ambac
Assurance's insured exposure to COFINA by approximately 75%
or $603 million to $202 million and a reduction in overall Puerto
Rico exposure to $1.3 billion from $1.9 billion at December 31,
2018. Refer to Part II, Item 7. Financial Guarantees in Force in
this Annual Report on Form 10-K for additional information
regarding the different issuing entities that encompass Ambac's
exposures to Puerto Rico as well as the COFINA POA.
| Ambac Financial Group, Inc. 30 2018 FORM 10-K |
Ambac's RMG had additional successes in the first quarter of 2019
as follows:
($ in millions)
Net income (1)
$
• Additional clean-up calls on two RMBS transactions on the
watch list with net par outstanding at December 31, 2018 of
$48 million;
• Worked with the issuer of two watch list asset backed
securitizations to expedite the refunding of the bonds with
net par outstanding of $95 million at December 31, 2018; and
• Worked with an issuer to commute, via a first quarter 2019
refunding, an adversely classified public finance transaction
with net par outstanding of $350 million at December 31,
2018.
During 2018, Ambac repaid the remaining December 31, 2017
balance of the Secured Borrowing (as defined and described in
Note 3. Variable Interest Entities) of $74 million and made partial
paydowns of the Ambac Note (as defined in Note 1. Background
and Business Description) by $214 million.
Ambac:
As of December 31, 2018 cash, investments and receivables of
Ambac were $455 million.
($ in millions)
Cash and short-term investments
Other investments (1)
Receivables (2)
Total
$
$
208
202
45
455
(1)
(2)
Includes corporate securities and securities insured or issued by
Ambac Assurance, including surplus notes (fair value of $57 million)
and AMPS issued by Ambac Assurance that are eliminated in
consolidation.
Includes accruals for tolling payments from Ambac Assurance in
accordance with the intercompany Tax Sharing Agreement ($44
million), investment income due and accrued and other receivables.
Tolling payments are subject to review and approval by OCI as
summarized below.
As a result of positive taxable income at Ambac Assurance in 2017,
Ambac accrued approximately $30 million in tax tolling payments.
In May 2018, Ambac executed a waiver under the intercompany
Tax Sharing Agreement pursuant to which Ambac Assurance was
relieved of the requirement to make this payment by June 1, 2018.
Ambac also agreed to continue to defer the tolling payment for the
use of net operating losses in 2017 by Ambac Assurance until such
time as OCI (as defined in Note 1. Background and Business
Description) consents to the payment.
For the year ended December 31, 2018, Ambac Assurance
recognized taxable income and accordingly Ambac has accrued
$14 million of tolling payments. Pursuant to the Stipulation and
Order, Ambac's tax positions are subject to review by the OCI,
which may lead to the adoption of positions that reduce the amount
of tolling payments otherwise available to Ambac.
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, 2018 included the following:
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)
$
(7)
(48)
12
(36)
(43)
(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, including as a result of a no deal
Brexit, 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 are most
important to the portrayal of the Company's financial condition;
and require management to make difficult and subjective
judgments regarding matters that are inherently uncertain and
subject to change. These estimates are evaluated on an on-going
basis based on historical developments, market conditions,
industry trends and other information that is reasonable under the
circumstances. There can be no assurance that actual results will
conform to estimates and that reported results of operations will
not be materially adversely affected by the need to make future
accounting adjustments to reflect changes in these estimates from
time to time.
Management has identified the following critical accounting
policies and estimates: (i) valuation of loss and loss expense
reserves, (ii) valuation of 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 (including
Subrogation Recoverables):
The loss and loss expense reserves, including subrogation
recoverables ("loss reserves"), discussed in this section relate only
to
to Ambac’s non-derivative
beneficiaries, including unconsolidated VIEs. Ambac's loss
reserves include loss reserve components of an insurance policy,
consisting of the present value ("PV") of expected net cash flows
to be paid (or received) under an insurance contract and unpaid
insurance policies
issued
| Ambac Financial Group, Inc. 31 2018 FORM 10-K |
claims. The PV of expected net cash flows represents the PV of
expected cash outflows (future losses) less the PV of expected cash
inflows (future recoveries) discounted at a risk-free discount rate.
Unpaid claims represents claims that were not paid for policies
allocated to the Segregated Account (as defined in Note 1.
Background and Business Description in the Notes to Consolidated
Financial Statements included in this Report on Form 10-K),
including Deferred Amounts (as defined in Note 1. Background
and Business Description in the Notes to Consolidated Financial
Statements included in this Report on Form 10-K) and accrued
interest. In 2018, all Deferred Amounts were settled via the
(as defined in Note 1.
Rehabilitation Exit Transactions
Background and Business Description in the Notes to Consolidated
Financial Statements included in this Report on Form 10-K);
therefore, unpaid claims are no longer included as a component of
loss reserves. Refer to Note 1. Background and Business
Description in the Notes to Consolidated Financial Statements
included in this Form 10-K for further information on the
Rehabilitation Exit Transactions. While unpaid claims were
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 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
currently has minimal exposure ceded to reinsurers on credits with
loss reserves, the existing reinsurance contracts are unlikely to have
a significant effect on 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, 2018 and 2017:
($ in millions) December 31
RMBS
Domestic Public Finance
Student Loans
Ambac UK and Other Credits
Loss expenses
Totals
2018
2017
Gross Par
Outstanding(1)(2)
Gross Loss and
Loss Expense
Reserves(1)(3)(4)
Gross Par
Outstanding(1)(2)
Gross Loss and
Loss Expense
Reserves(1)(3)(4)(5)
$
$
3,716
$
(1,313) $
5,243
$
2,598
3,987
530
1,170
—
639
228
273
66
4,265
701
1,478
—
816
308
303
89
9,403
$
(107) $
11,687
$
4,114
(1) Ceded par outstanding on policies with loss reserves and ceded loss and loss expense reserves are $540 and $23, respectively, at December 31, 2018 and
$590 and $41, respectively at December 31, 2017. 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, 2018 of $(107) are included in the balance sheet in the following line items: Loss and loss expense
reserves: $1,826 and Subrogation recoverable: $1,933. 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.
(4) Ambac records as a component of its loss and loss expense reserves, estimated recoveries related to securitized loans in RMBS transactions that breached
certain representations and warranties. Ambac has recorded gross estimated recoveries of $1,771 and $1,834 at December 31, 2018 and 2017, respectively.
(5)
Included in Gross Loss and Loss Expense Reserves are unpaid claims of $3,867 at December 31, 2017 related to policies allocated to the Segregated
Account of Ambac Assurance (as defined in Note 1. Background and Business Description in the Notes to Consolidated Financial Statements included
in this Report on Form 10-K), inclusive of accrued interest payable on Deferred Amounts of $840.
| Ambac Financial Group, Inc. 32 2018 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 of each
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 related probabilities, 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; (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
insured RMBS
Ambac insures RMBS transactions collateralized by first-lien
transactions
mortgages. Ambac has also
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 may
carry a significantly higher severity in the event of a loss,
approaching or exceeding 100%.
Ambac primarily utilizes a cash flow model (“RMBS cash flow
model”) to develop estimates of projected losses for both our first
and second lien transactions. First, 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.
Depending in the amount of collateral information available for
each transaction, we project such performance either at the loan-
level or the deal-level. 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. 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. Projected servicer-level behavior may also have
an impact on transaction performance.
We source HPA projections from a market accepted vendor and
interest rate projections are developed from market sources. 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.
For the liabilities of the transaction which we insure, we generally
utilize waterfall projections generated from a tool provided by a
market accepted vendor. 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.
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
| Ambac Financial Group, Inc. 33 2018 FORM 10-K |
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 does not estimate an RMBS R&W subrogation
recovery for litigations where its sole claim is for fraudulent
inducement, since any remedies under such claims would be non-
contractual.
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.
Failure to realize RMBS R&W subrogation recoveries for any
reason or the realization of RMBS R&W subrogation recoveries
materially below the amount recorded on Ambac's consolidated
balance sheet would have a material adverse effect on our results
of operations and financial condition and may result in adverse
consequences such as impairing the ability of Ambac Assurance
to honor its financial obligations; the initiation of rehabilitation
proceedings against Ambac Assurance; decreased likelihood of
Ambac Assurance delivering value to Ambac, through dividends
or otherwise; and a significant drop in the value of securities issued
or insured by Ambac or Ambac Assurance. 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 RMBS
R&W subrogation recoveries, and to Part I, Item 1A. Risk Factors
for more information about risks relating to our RMBS R&W
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
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 a 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. The
then
incorporated into a waterfall tool to develop loss estimates for our
exposures. This waterfall tool 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.
losses are
transaction
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 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 losses for insurance policies
discussed above could be understated, or that our estimated future
recoveries could be overstated. We have attempted to identify
possible cash flows related to losses and recoveries 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, 2018 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 relating to losses
and recoveries. 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. See “Risk Factors” in Part
I, Item 1A of this Form 10-K for further discussion of the risks
relating to future losses and recoveries that could result in more
highly stressed outcomes. The occurrence of these stressed
outcomes individually or collectively would have a material
adverse effect on our results of operations and financial condition
and may result in materially adverse consequence for the Company,
including (without limitation) impairing the ability of Ambac
Assurance to honor its financial obligations; the initiation of
rehabilitation proceedings against Ambac Assurance; decreased
likelihood of Ambac Assurance delivering value to Ambac,
through dividends or otherwise; and a significant drop in the value
of securities issued or insured by Ambac or Ambac Assurance.
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
| Ambac Financial Group, Inc. 34 2018 FORM 10-K |
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 were to use a different
model or methodology to project losses. We regularly assess
models and methodologies and may change our approach and/or
model at any time. Additionally, our RMBS R&W actual
subrogation recoveries could be significantly lower than our
estimate of $1,744.2 million as of December 31, 2018 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,
2018 could be approximately $30 million. Combined with the
absence of any RMBS R&W subrogation recoveries, a possible
increase in loss reserves for RMBS could be approximately $1.8
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 $30 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 unfavorable 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
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 contributed in
part to the overall 21.6% decline in municipal issuance volume in
2018. The primary contributor of the Tax Cuts and Jobs Act to
lower municipal volumes in 2018 was the elimination of tax-
exempt advance refundings. In addition, the Tax Cuts and Jobs
Act 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, limited capital markets access, political risk and
aftereffects of the damage caused by hurricanes Irma and Maria.
These factors, taken together with the payment moratorium on
its
certain debt payments of
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.
the Commonwealth and
On February 4, 2019, the COFINA Plan of Adjustment ("POA")
under Title III was confirmed by the United States District Court
for the District of Puerto Rico and became effective on February
12, 2019. Several parties are presently appealing the confirmation
of the POA and no assurances can be given regarding the outcome
of such appeals. The POA, which emerged from a consensually
negotiated Plan Support Agreement executed in August 2018,
resolved the COFINA Title III case and restructuring. Among other
things, the POA and certain related commutation transactions
resulted in a reduction of Ambac Assurance's insured exposure to
COFINA by approximately 75% and provided for a nominal initial
recovery amount in new COFINA bonds and cash equivalent to
approximately 93% of the Petition Date (May 5, 2017) claim
amount on the remaining approximately 25% non-commuted
policy portion of Ambac Assurance's insured exposure to
COFINA. The Ambac Assurance-insured COFINA bonds that
comprise such non-commuted exposure, together with such
remaining policy portion of Ambac Assurance's COFINA
exposure, have been deposited into a trust, as have the non-
commuted bondholders' portion of the new bonds issued by
COFINA and cash paid by COFINA under the POA, in exchange
for which
the non-commuted Ambac-insured bondholders
received units of the trust in return representing undivided
fractional interests in the trust property. Cash flows from the new
COFINA bonds and cash will be passed through to unit-holders
over time and will reduce amounts owed under the Ambac
Assurance policy with respect to the Ambac Assurance-insured
COFINA bonds. There are no assurances that future debt
| Ambac Financial Group, Inc. 35 2018 FORM 10-K |
restructurings for other Ambac Assurance-insured Puerto Rico
instrumentalities subject to Title III proceedings or otherwise will
reach a similar negotiated structure and outcome; any such
restructurings could therefore cause losses to exceed current
reserves in a material manner.
See "Financial Guarantees in Force" below for further details on
the legal, economic, fiscal, and political developments that have
impacted or may impact Ambac Assurance’s insured Puerto Rico
bonds.
Material additional losses caused by the above-described factors
would have a material adverse effect on our results of operations
and financial condition. For public finance credits, including
Puerto Rico as well as other issuers, for which we have an estimate
of expected loss at December 31, 2018, the possible increase in
loss reserves could be approximately $1.0 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, 2018, the
possible increase in loss reserves could be approximately $25
million. Additionally, an increase in interest rates of 0.50% could
increase our estimate of expected losses by approximately $25
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 $170 million greater
than the loss reserves at December 31, 2018. 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
judgment. Level 3 financial
therefore require significant
instruments which are material include uncollateralized interest
rate swaps, investments and loan receivables of consolidated VIEs
and certain VIE debt obligations. Model-derived valuations of
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. Furthermore, Level 3 loan
receivables of consolidated VIEs incorporate estimates of Ambac's
financial guarantee cash flows, including future premiums and
losses. Such cash flow estimates require judgments regarding
prepayments of VIE debt, loss probabilities and loss severities, all
of which are inherently uncertain.
All models and related assumptions are continuously re-evaluated
by management and enhanced, as appropriate, based on
improvements in information and modeling techniques. The re-
evaluation process includes a quarterly meeting of senior Finance
personnel to review and approve changes to models and key
assumptions.
As a result of the significant judgment for the above-described
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.
Valuation of Deferred Tax Assets:
Our provision for taxes is based on our income, statutory tax rates
and tax planning opportunities available to us in the jurisdictions
in which we operate. Tax laws are complex and subject to different
interpretations by the taxpayer and respective governmental taxing
authorities. Significant judgment is required in determining our
tax expense and in evaluating our tax positions. We review our tax
positions quarterly and adjust the balances as new information
becomes available. Deferred tax assets arise because of temporary
differences between the financial reporting and tax bases of assets
and liabilities, as well as from net operating loss ("NOL") and tax
credit carry forwards. More specifically, deferred tax assets
represent a future tax benefit (or receivable) that results from losses
recorded under GAAP in a current period which are only deductible
for tax purposes in future periods and NOL carry forwards.
The Tax Cut and Jobs Act ("TCJA") was enacted in December
2018 and introduced significant changes to the U.S. tax code
effective January 1, 2018. The U.S. NOL component of the
deferred tax asset expires if not utilized 20 years from when the
NOL was generated. However, NOLs generated from non-
insurance activity after the effective date of the TCJA are carried
forward indefinitely. Valuation allowances are established to
reduce deferred tax assets to an amount that “more likely than not”
will be realized. On a quarterly basis, management identifies and
considers all available evidence, both positive and negative, in
making the determination with significant weight given to
evidence that can be objectively verified. Negative evidence
includes the potential for unrecognized future insurance losses;
uncertainty regarding timing and magnitude of RMBS R&W
litigation recoveries; no new financial guarantee business and
execution risk of any new business venture. Positive evidence
includes the Segregated Account's exit from rehabilitation further
described in Note 1. Background and Business Description in the
Notes to Consolidated Financial Statements included in this
Report on Form 10-K.
| Ambac Financial Group, Inc. 36 2018 FORM 10-K |
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 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 U.S. deferred tax asset and therefore has a full valuation
allowance. To the extent significant uncertainties such as Puerto
Rico losses, RMBS R&W litigation and new business ventures are
resolved, Ambac may have the ability to establish a history of
making reliable estimates of future income which could ultimately
result in a reduction to the deferred tax asset 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
The following table provides a breakdown of guaranteed net par
outstanding by market sector at December 31, 2018 and 2017. 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,
Public Finance (1)(2)
Structured Finance
International Finance
Total net par outstanding
2018
2017
$
$
23,442
$
9,947
13,538
46,927
$
32,088
13,816
16,812
62,716
(1) Includes $5,759 and $5,829 of Military Housing net par outstanding
at December 31, 2018 and 2017, respectively.
(2) Includes $1,880 and $1,968 of Puerto Rico net par outstanding at
December 31, 2018 and 2017, respectively. Components of Puerto
Rico net par outstanding includes capital appreciation bonds which
are reported at the par amount at the time of issuance of the related
insurance policy as opposed to the current accreted value of the bonds.
As discussed below under Puerto Rico, the COFINA POA was
confirmed by the United States District Court for the District of Puerto
Rico on February 4, 2019 and became effective on February 12, 2019.
The POA and certain related commutation transactions resulted in a
reduction of Ambac Assurance's insured exposure to COFINA by
approximately 75% or $603 to $202.
U.S. Public Finance Insured Portfolio
Ambac’s portfolio of U.S. public finance exposures is $23,442
million, representing 50% of Ambac’s net par outstanding as of
December 31, 2018 and a 27% reduction from the amount
outstanding at December 31, 2017. This reduction in exposure was
due to additional reinsurance acquired, exposure runoff, and early
terminations (calls, refundings and pre-refundings). While
Ambac’s U.S. public finance portfolio consists predominantly of
municipal bonds such as general obligation, revenue, and lease and
tax-backed obligations of state and local government entities, the
portfolio also comprises a wide array of non-municipal types of
bonds, including financings for not-for-profit entities and
transactions with public and private elements, which generally
finance infrastructure, housing and other public interests. See Note
6. Financial Guarantees in Force to the Consolidated Financial
Statements, included in Part II, Item 8 in this Form 10-K for
exposures by bond type.
Municipal bonds are generally supported directly or indirectly by
the issuer’s taxing authority or by public sector fees and
assessments which may or may not be specifically pledged. Risk
factors in these transactions derive from the municipal issuer,
including its fiscal management, politics, and economic position,
as well as its ability and willingness to continue to pay its debt
service. Municipal bankruptcies 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,
trends,
competitive position,
government programs and other factors. Examples of these types
of transactions include not-for-profit hospitals, universities,
associations and charities.
industry and socioeconomic
Public/private transactions are generally structured to achieve their
targeted public interest objective without direct support from the
public sector. Some examples of this type of financing include
affordable housing, private education, privatized military housing
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 $6 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 also come
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,
environmental
remediation, utility and other operating costs and housing
management.
construction
completion,
| Ambac Financial Group, Inc. 37 2018 FORM 10-K |
Puerto Rico
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, as applicable, discrete revenue sources, direct
general obligation pledges and/or general obligation guarantees.
its
Fiscal Plans
On October 18, 2018, the Oversight Board certified the COFINA
Fiscal Plan, which anticipated a resolution of the Commonwealth-
COFINA dispute litigated in adversary proceeding no. 1:17-
ap-00257. The COFINA Fiscal Plan reflects a sharing of the sales
and use tax, which historically has provided security and debt
service for COFINA bonds, between COFINA and
the
Commonwealth (53.65% / 46.35% of the statutory pledged sales
tax base amount, respectively, with first dollars going to COFINA)
and the issuance of new COFINA bonds backed by the COFINA
portion of these taxes.
On October 23, 2018, the Oversight Board certified a revised fiscal
plan for the Commonwealth of Puerto Rico (the “Revised
Commonwealth Fiscal Plan”). Among other revisions from earlier
certified fiscal plans in May and June 2018, the Revised
Commonwealth Fiscal Plan projected a new cumulative 30-year
surplus, post-measures and structural reforms, of approximately
$19 billion, which is net of 30 years of expected debt service
payments on the new COFINA bonds (as described below and
totaling $32.3 billion). The new surplus projection is based on
various revised assumptions including a higher amount of federal
disaster relief funding, 2018 actual tax collections and budgetary
performance, and updated demographic data. As per the Revised
Commonwealth Fiscal Plan, budget surpluses in the near-term are
driven by assumptions regarding fiscal measures and structural
reforms, along with federal aid and enhanced revenue actuals. The
Revised Commonwealth Fiscal Plan also shows long-term budget
deficits which appear to be driven by Oversight Board and/or
Commonwealth assumptions regarding healthcare costs that
outpace Gross National Product ("GNP") growth, a lack of robust
structural reforms, a phase out of disaster relief funding, and
declining revenues from the Act 154 excise tax paid by
multinationals operating in the Commonwealth.
However, as was the case with prior fiscal plans for the
Commonwealth of Puerto Rico, the Revised Commonwealth
Fiscal Plan lacks a high degree of transparency regarding the
underlying data, assumptions and rationales supporting those
assumptions, making reconciliation and due diligence difficult. As
a result, it is difficult to assess the possible impacts the changes
and new assumptions may have on creditor outcomes or Ambac's
financial condition, including liquidity, loss reserves and capital
resources.
It is also unclear if and when the Oversight Board will certify
revised fiscal plans for Puerto Rico Highways and Transportation
Authority ("PRHTA") and other Puerto Rico instrumentalities that
have debt outstanding that is insured by Ambac Assurance. It is
unknown if and when other Puerto Rico instrumentalities, which
have debt outstanding insured by Ambac Assurance, will be filed
under Title III and what effect their fiscal plans may have on
Ambac's financial position. No assurances can be given that
Ambac's financial profile will not suffer a materially negative
impact as an ultimate result of the Revised Commonwealth Fiscal
Plan or any future changes to the Revised Commonwealth Fiscal
Plan or fiscal plans for PRHTA or other Puerto Rico
instrumentalities.
Federal Aid
In the October 23, 2018 Revised Commonwealth Fiscal Plan, the
assumption for total projected federal disaster relief aid spending
from fiscal years 2018 through 2032 is $74 billion. This consists
of $45.8 billion in projected FEMA Public Assistance program
spending through FEMA’s Disaster Relief Fund (DRF). The
Revised Commonwealth Fiscal Plan also projects $20 billion in
spending from the U.S. Department of Housing and Urban
Development’s Community Development Block Grant - Disaster
Recovery (CDBG-DR) program, which has allocated aid funding
to Puerto Rico for recovery and mitigation. In addition, the Revised
Commonwealth Fiscal Plan projects $3.2 billion spending from
the FEMA Individual Assistance program , which provides support
to individuals and families who have sustained uncovered losses
due to disasters, and $5 billion in other federal funding. In addition,
the Commonwealth of Puerto Rico continues to benefit from other
federal government programs for infrastructure improvement
initiatives or recovery efforts.
While these federal funds are expected to support economic
recovery and growth in Puerto Rico, there can be no assurances as
to the certainty, timing, usage, efficacy or magnitude of benefits
to creditor outcomes related to disaster aid and ensuing economic
growth, if any.
Tax Reform
See Part I, Item 1A. Risk Factors in this Form 10-K for a description
of the risks to Ambac's Puerto Rico exposures due to tax reform.
Commonwealth Liquidity
The Oversight Board announced on February 9, 2018 that it
retained Duff & Phelps, LLC to conduct an independent forensics
analysis of the Commonwealth of Puerto Rico's government bank
accounts. It has been publicly disclosed that Duff & Phelps, LLC
and the Puerto Rico Fiscal Agency and Financial Advisory
Authority ("FAFAA") have participated in discussions to
coordinate this process. On February, 15, 2019, the Oversight
Board filed a complaint in the United States District Court for the
District of Puerto Rico to compel the Puerto Rico Senate to provide
its bank account balances. The Oversight Board stated that the
Puerto Rico Senate bank account balance is a necessary element
of a forensic investigation into the liquidity of the Puerto Rico
government and its instrumentalities and entities, led by Duff &
Phelps, LLC. The related Oversight Board press release disclosed
that except for the Puerto Rico Senate, all 163 public entities which
received requests for account balance and financial information
have responded and provided data, including the Puerto Rico
House of Representatives and the judicial branch. The progress of
the analysis by Duff & Phelps, LLC and any related findings and
financial information have not yet been made public.
As of the December 31, 2018 bank account report published by
FAFAA, the balances of bank accounts for various Puerto Rico
government entities and instrumentalities totaled $12.1 billion.
According to the report, various account balances are considered
restricted for different government entities or due to Title III
proceedings. However, it is unclear if these restricted designations
are inaccurate or outdated since any legal analysis that may have
| Ambac Financial Group, Inc. 38 2018 FORM 10-K |
been conducted to determine the restricted or unrestricted nature
of funds in non-Treasury Single Account bank accounts has not
been made publicly available. Consequently, the purported lack of
access to restricted funds could limit the financial flexibility of the
Commonwealth and its instrumentalities to provide essential and
non-essential services. More generally, the lack of clear, consistent
and complete information regarding account balances could
further strain debt resolution timelines and potential severities for
creditors, including Ambac.
As of February 1, 2019, the Treasury Single Account cash position,
as reported by the Puerto Rico Treasury Department, was $4.2
billion and above the $1.1 billion threshold to access Community
Disaster Loan financing. While details regarding final Community
Disaster Loan terms are not known by Ambac, what is known is
that the federal government has agreed to extend a credit line to
the Commonwealth of Puerto Rico up to a maximum amount of
$2.2 billion until March 31, 2020 to be used to meet any future
liquidity emergency as determined by the Commonwealth of
Puerto Rico. However, in order to access the credit line, the fund
balance in the Treasury Single Account needs to be less than $1.1
billion.
COFINA Debt Restructuring
On October 19, 2018, following the certification of the COFINA
Fiscal Plan, the Oversight Board filed the COFINA Plan of
Adjustment ("POA") and Disclosure Statement as part of the
COFINA Title III case. The Oversight Board also filed a Rule 9019
Motion in the Commonwealth Title III case to approve the
settlement of the Commonwealth-COFINA dispute. The filing of
the COFINA POA and Disclosure Statement as well as the
settlement motion followed the execution of a settlement
agreement between the Oversight Board and the COFINA Agent.
That settlement agreement was based on the previously announced
agreement in principle developed by the COFINA Agent and the
Commonwealth Agent. The COFINA POA was based on the
settlement agreement as well as the preliminary agreement among
COFINA bondholders announced August 8, 2018 and the
subsequent Plan Support Agreement and term sheet among the
Oversight Board, FAFAA, COFINA, bond insurers (including
Ambac Assurance), as well as certain COFINA and General
Obligation creditors.
Under the COFINA POA, the Pledged Sales Tax Base Amount
("PSTBA) is split with 53.65% allocated on a first-dollars basis to
COFINA through and including 2058 and 46.35% allocated to the
Commonwealth. The COFINA POA contemplated exchanging all
existing COFINA senior and subordinate bonds for cash as well
as new COFINA current interest and capital appreciation bonds
("new COFINA bonds"). The cash and new COFINA bonds
allocated to senior bondholders equaled approximately 93%
(considering the new COFINA bonds at par) of such senior
bondholders’ allowed claim, in the amount of the COFINA senior
bond accreted value, as of, but not including, May 5, 2017 (the
COFINA Title III Petition Date).
Pursuant to the COFINA POA, each holder of Ambac Assurance-
insured senior COFINA bonds had the option to elect by January
11, 2019 to either (i) commute their rights in respect of the Ambac
Assurance insurance policy associated with the existing senior
COFINA bonds, which bonds would be discharged and Ambac
Assurance policy obligations with respect thereto would be
released, in exchange for new COFINA bonds, cash amounts to be
paid by COFINA, plus additional cash consideration provided by
Ambac Assurance equal to 5.25% of the accreted value of the
Ambac Assurance-insured senior COFINA bonds as of the
COFINA Petition Date or (ii) agree to deposit their Ambac
Assurance-insured senior COFINA bonds into a a trust in exchange
for units issued by the trust (the "COFINA Class 2 Trust"), which
trust would receive the new COFINA bonds and the cash amounts
to be paid by COFINA that such bondholders would have otherwise
received to the extent they had elected the recovery under clause
(i) above (thereby entitling the COFINA Class 2 Trust to receive
debt service payments from COFINA with respect to the new
COFINA bonds deposited into the trust), plus any accelerated
policy payments (made solely at Ambac Assurance's own
discretion) or claim payments due under the existing Ambac
Assurance insurance policy for the deficiency relating to the
existing senior COFINA bonds at the relevant scheduled payment
dates (2047 through 2054). Any claims payable under the existing
Ambac Assurance policy for the Ambac Assurance-insured senior
COFINA bonds held in the trust will be reduced by all amounts
distributed or deemed distributed from the trust to the holders of
the trust units from the new COFINA bonds and cash as well as
accelerated policy payments made by Ambac Assurance at its own
discretion. Ambac makes no representation and can give no
assurances that the new COFINA bonds or COFINA Class 2 Trust
units, both of which are not insured by Ambac Assurance, will
trade at par or any other price. Under the COFINA POA, Ambac
Assurance-insured bondholders who did not affirmatively elect the
trust option in clause (ii) above were deemed to have elected the
commutation option described in clause (i) above. As of the
January 11, 2019 election date, 74.9% of Ambac Assurance-
insured senior COFINA bondholders, by measure of insured par,
elected the commutation option or did not affirmatively elect to
exchange their bonds for units of the COFINA Class 2 Trust.
On January 16-17, 2019, the hearings for the confirmation of the
COFINA POA and the Commonwealth 9019 motion were held.
On February 4, 2019, the COFINA Plan of Adjustment was
confirmed and the Commonwealth 9019 motion was approved by
Judge Laura Taylor Swain of the U.S. District Court for the District
of Puerto Rico. On February 12, 2019, the COFINA POA went
effective, concurrent with the completion of the commutation
described above. Several parties are presently appealing the
confirmation of the POA. As a result, Ambac Assurance's insured
COFINA bond exposure decreased by $603 million net par to
approximately $202 million net par (a reduction of $5.5 billion of
net principal and interest to $1.8 billion of net principal and
interest). Ambac Assurance's remaining policy obligation of $202
million net par is an asset of the COFINA Class 2 Trust, which
holds a ratable distribution of cash and new COFINA bonds, which
can be used to partially offset Ambac’s remaining insurance
liability.
Several parties are presently appealing the confirmation of the POA
and no assurances can be given regarding the results of such
appeals. At this time, it is unclear what impact the COFINA
restructuring will have on the prospective recoveries of Ambac
Assurance's other insured Puerto Rico instrumentalities.
Mediation
The status, timing and subject of any current or future mediation
discussions have not been officially disclosed. No assurances can
| Ambac Financial Group, Inc. 39 2018 FORM 10-K |
be given that negotiations will be successfully concluded, that
Commonwealth, Oversight Board and creditor parties will reach
definitive agreements on additional debt restructurings, that any
additional negotiated transaction debt restructuring, definitive
agreement or Plan of Adjustment will be approved by the court
and completed, or that any transaction or Plan of Adjustment will
not have an adverse impact on Ambac's financial conditions or
results.
Other Developments
On February 15, 2019, the United States Court of Appeals for the
First Circuit issued an opinion in the consolidated appeals brought
by certain parties who argued that the members of the Financial
Oversight and Management Board for Puerto Rico (the "Oversight
Board") were appointed in violation of the U.S. Constitution’s
Appointments Clause. The First Circuit ruled that the Oversight
Board members (other than the ex-officio Member) must be, and
were not, appointed in compliance with the Appointments Clause.
The First Circuit declined to dismiss the Oversight Board’s Title
III petitions and did not render ineffective any otherwise valid
actions of the Oversight Board prior to the issuance of the ruling.
The First Circuit stated that the ruling will not take effect for 90
days, “so as to allow the President and the Senate to validate the
currently defective appointments or reconstitute the Board in
accordance with the Appointments Clause." During the 90-day stay
period, the Oversight Board may continue to operate as it had prior
to the ruling. It is unclear how this ruling will impact, whether
during or after such 90-day stay period, the restructuring process,
mediation discussions and relevant litigation with respect to our
Puerto Rico exposures.
Ambac Post-COFINA Title III Litigation Update
Ambac Assurance is party to ten litigations related to its Puerto
Rico exposures, and is currently seeking to intervene in an
eleventh. Three of these litigations are COFINA-related cases that
have been, or will soon be, dismissed by operation of the COFINA
Plan of Adjustment (“POA”) that was confirmed on February 4,
2019, and became effective on February 12, 2019. Several parties
are presently appealing the confirmation of the POA. A fourth is
another COFINA-related case that had been stayed pending
resolution of an interpleader action related to COFINA funds, but
which will be permitted to proceed by operation of the POA now
that the interpleader action has been resolved. The two remaining
active litigations are an appeal relating to the Puerto Rico
Highways and Transportation Authority pending before the United
States Court of Appeals for the First Circuit, and an adversary
proceeding relating to the Puerto Rico Public Buildings Authority
pending before the United States District Court for the District of
Puerto Rico. The remainder of these litigations are stayed under
Title III of PROMESA. Ambac is unable to predict when and how
the issues raised in these cases (other than those already dismissed
by operation of the POA) will be resolved. If Ambac Assurance is
unsuccessful in any of these proceedings, Ambac’s financial
condition, including liquidity, loss reserves and capital resources
may suffer a material negative impact.
Refer to Note 16. Commitments and Contingencies to the
Consolidated Financial Statements, included in Part II, Item 8 in
this Form 10-K, for further information about Ambac's litigation
relating to Puerto Rico.
Summary
Ambac has considered these developments and other factors in
evaluating its Puerto Rico loss reserves. During the year ended
December 31, 2018, Ambac had incurred losses associated with
its Domestic Public Finance insured portfolio of $36.7 million,
which was significantly impacted by the continued uncertainty and
volatility of the situation in Puerto Rico. While management
believes its reserves are adequate to cover losses in its Public
Finance insured portfolio, there can be no assurance that Ambac
may not incur additional losses in the future, particularly given the
developing economic, political, and legal circumstances in Puerto
Rico. Such additional losses may have a material adverse effect
on Ambac’s results of operations and financial condition.
| Ambac Financial Group, Inc. 40 2018 FORM 10-K |
The following table shows Ambac's insured exposure to each issuer segregated by whether such debt obligation is subject to the Priority Debt
Provision or "clawback." Ambac has initiated litigation challenging the application of the "clawback" announced by Governor Padilla, Puerto
Rico's former governor, on December 1, 2015. A description of Ambac's legal challenge is provided in Note 16. Commitments and
Contingencies in the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K.
Range of
Maturity
Ambac
Ratings (1)
Net Par
Outstanding (2)
Net Par and
Interest
Outstanding (3)(8)
Ever-to-Date
Net Claims
Paid(4)
($ 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
2021-2027
2019-2042
2019-2044
2019-2031
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) (9)
2019-2035
2047-2054
Total
Total Net Exposure to The Commonwealth of
Puerto Rico and Related Entities
BIG
BIG
BIG
BIG
BIG
BIG
BIG
$
4
$
10
$
410
403
113
930
56
89
805
950
704
918
165
1,797
61
159
7,321
7,541
23
78
156
31
288
7
67
—
74
$
1,880
$
9,338
$
362
(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 $753 at December 31, 2018.
(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 $25 during January 2019.
(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 re-extended until June 30, 2019 from
its prior December 31, 2018 deadline. 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 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 $44.7.
(9) As mentioned above, the COFINA POA was confirmed by the United States District Court for the District of Puerto Rico on February 4, 2019 and became
effective on February 12, 2019. The POA and certain related commutation transactions resulted in a reduction of Ambac Assurance's insured net par
exposure to COFINA by approximately 75% or $603 to $202 (net par and interest reduction of $5,525 to $1,797).
| Ambac Financial Group, Inc. 41 2018 FORM 10-K |
The table below shows Ambac’s ten largest U.S. public finance exposures, by repayment source, as a percentage of total financial guarantee
net par outstanding at December 31, 2018:
($ in millions)
Puerto Rico Sales Tax Financing Corporation - Senior Sales Tax
Revenue (COFINA) (3)
New Jersey Transportation Trust Fund Authority - Transportation
System
Massachusetts Commonwealth - GO
Mets Queens Baseball Stadium Project, NY, Lease Revenue
Hickam Community Housing LLC
Bragg Communities, LLC
Puerto Rico Highways & Transportation Authority, Transportation
Revenue
Puerto Rico Infrastructure Financing Authority, Special Tax Revenue
New Jersey Economic Development Authority - School Facilities
Construction
Bond Type
Lease and Tax-backed
Revenue
Lease and Tax-backed
Revenue
General Obligation
Stadium
Housing Revenue
Housing Revenue
Lease and Tax-backed
Revenue
Lease and Tax-backed
Revenue
Lease and Tax-backed
Revenue
Ambac
Ratings (1)
BIG
Net Par
Outstanding (2)
805
$
BBB+
AA
BBB
BBB
A-
BIG
BIG
BBB+
783
586
557
469
422
414
403
400
Massachusetts Port Authority Special Facility Revenue Bonds
Transportation Revenue
BIG
Total
350
5,189
$
% of Total
Net Par
Outstanding
1.7%
1.7%
1.2%
1.2%
1.0%
0.9%
0.9%
0.9%
0.9%
0.7%
11.1%
(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.
(3) As mentioned above, the COFINA POA was confirmed by the United States District Court for the District of Puerto Rico on February 4, 2019 and became
effective on February 12, 2019. The POA and certain related commutation transactions resulted in a reduction of Ambac Assurance's insured net par
exposure to COFINA by approximately 75% or $603 to $202.
U.S. Structured Finance Portfolio
Ambac’s portfolio of U.S. structured finance exposures is $9,947
million, representing 21% of Ambac’s net par outstanding as of
December 31, 2018, and a 28% reduction from the amount
outstanding at December 31, 2017. This reduction in exposure was
primarily related to residential mortgage-backed securities
("RMBS") policies, which was attributable to continued
prepayments and claims presented on insured RMBS bonds as well
as commutations and clean-up calls, both negotiated and non-
negotiated, of certain RMBS transactions with less than 10% of
their original mortgage pool balances remaining. In addition, the
refinancing of various investor-owned utility exposures and
commutation and reinsurance of other structured finance
transactions contributed to this overall reduction in U.S. structured
finance exposure.
Current insured exposures include securitizations of mortgage
loans, home equity loans, student loans, leases, operating assets,
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. Additionally,
Ambac’s structured finance insured portfolio includes secured and
unsecured debt issued by investor-owned utilities. It also includes
structured insurance transactions, including transactions providing
insurance on the notes of trusts that were established in connection
with the reinsurance of defined blocks of life insurance and that
were used to fund regulatory reserves associated with level
premium term life insurance policies (commonly referred to as
Regulation XXX reserves).
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, 2018.
Structured finance securitization 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.
Securitized 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
| Ambac Financial Group, Inc. 42 2018 FORM 10-K |
to bankruptcy or
originator becomes subject
insolvency
proceedings. Another potential issue is whether the originator sold
ineligible assets to the securitization transaction that subsequently
deteriorated, and, if so, whether the originator has the willingness
or financial wherewithal to meet its contractual obligations to
repurchase those assets out of the transaction. Structural protection
in a transaction, such as control rights that are typically held by
the senior note holders, or guarantor in insured transactions, will
determine the extent to which underlying asset performance can
be influenced upon non-performance to improve the revenues
available to cover debt service.
Ambac has exposure to the U.S. mortgage market primarily
including
through direct financial guarantees of RMBS,
transactions that contain risks to first and second lien mortgages.
Ambac's total net par exposure to RMBS at December 31, 2018
was approximately $5.5 billion ($3.2 billion, $2.1 billion, $0.2
billion are first lien, second lien and other respectively), a decrease
of 24% during 2018. At December 31, 2018, 85% of RMBS net
par exposure relates to securitizations issued during 2005 through
2007.
The following table presents the top five servicers by net par outstanding at December 31, 2018, for U.S. structured finance exposures:
Servicer
($ in millions)
Specialized Loan Servicing, LLC
Bank of America N.A.
Wells Fargo Bank
Ocwen Loan Servicing, LLC
Pennsylvania Higher Education Assistance Agency
Bond Type
Mortgage-backed
$
Mortgage-backed
Mortgage-backed
Mortgage-backed
Student Loan
Net Par
Outstanding
% of Total
Net Par
Outstanding
1,219
1,188
828
808
793
2.6%
2.5%
1.8%
1.7%
1.7%
The table below shows Ambac’s ten largest structured finance transactions, as a percentage of total financial guarantee net par outstanding at
December 31, 2018:
1.9%
1.0%
1.0%
1.0%
0.7%
0.5%
0.5%
0.4%
0.4%
0.4%
7.7%
Ambac
Rating(1)
Net Par
Outstanding
% of Total
Net Par
Outstanding
($ in millions)
Ballantyne Re Plc (2)
Timberlake Financial, LLC
Bond Type
Structured Insurance
Structured Insurance
Wachovia Asset Securitization Issuance II, LLC 2007-HE2
Mortgage Backed Securities
Progress Energy Carolinas, Inc.
Investor Owned Utility
Wachovia Asset Securitization Issuance II, LLC 2007-HE1
Mortgage Backed Securities
Option One Mortgage Loan Trust 2007-FXD1
Mortgage Backed Securities
Terwin Mortgage Trust Asset-Backed Certificates, Series
2006-6
Impac CMB Trust Series 2005-7
Mortgage Backed Securities
Mortgage Backed Securities
Countrywide Asset-Backed Certificates Trust 2005-16
Mortgage Backed Securities
Ownit Mortgage Trust 2006-OT1
Mortgage Backed Securities
$
BIG
BBB
BBB
A-
BBB
BIG
BIG
BIG
BIG
BIG
900
465
458
450
317
235
214
204
198
182
Total
$
3,623
(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
$13,538 million, representing 29% of Ambac’s net par outstanding
as of December 31, 2018 and a 19% reduction from the amount
outstanding at December 31, 2017. This reduction in exposure was
primarily the result of policy terminations within investor-owned
utilities and asset-backed securities as well as a strengthening 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, whole business securitizations (e.g., securitizations of
substantially all of the operating assets of a corporation) and sub-
sovereign credit. 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, 2018.
When underwriting transactions in the international markets,
Ambac considered the specific risks related to the particular
| Ambac Financial Group, Inc. 43 2018 FORM 10-K |
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.
Agreement") setting out the terms of a transition period to apply
to the UK between March 29, 2019 and December 31, 2020. The
effect of the withdrawal agreement, if ratified, will be to retain the
rights and obligations between the UK and the EU within this
transition period.
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 $13,193 million net par outstanding in those markets at
December 31, 2018, of which $900 million relates to a structured
insurance US risk transaction. 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.
Other European Union Exposures (“EU”)
Ambac's international net par exposures are principally in the
United Kingdom ($10,965 million); however, we also have
exposures with credit risk based in various other EU member states,
including Austria, France, Germany and Italy ($1,564 million).
Italy, with net par exposures of $811 million, in particular has
experienced economic, fiscal and political strains since the 2008
global financial crisis such that the likelihood of default on an
insured sub-sovereign obligation in that country is higher than
when the policy was underwritten.
Ambac does not guarantee any sovereign bonds of the above EU
countries.
Brexit:
In March 2017 the UK government gave the European Union
(“EU”) formal notification of its intention to leave the EU with the
expectation of formal withdrawal two years later on March 29,
2019 (“Brexit”). In November 2018 the UK Government and EU
agreed upon the terms of a legal binding treaty ("Withdrawal
The withdrawal agreement remains subject to ratification by the
UK Parliament, EU Council and EU Parliament. If the withdrawal
agreement is not ratified and no transitional arrangement is put into
place, Brexit may mean that the activities in the EEA of UK
passporting insurers may become unlawful on March 29, 2019.
They may lose their legal authorization to serve clients who benefit
from policies issued by a UK incorporated insurer under freedom
of services and freedom of establishment 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.
the recommendation
However on February 19, 2019, the European Insurance and
Occupational Pensions Authority (“EIOPA”) made a series of
recommendations to EU insurance regulators in light of Brexit.
These recommendations
that
include
regulatory authorities apply legal frameworks that facilitate the
orderly run off (without time limit) of branch operations and of
insurance policies issued in EEA member states by UK insurers
prior to March 30, 2019 that terminate after this date. The
recommendations will require to be incorporated into EEA member
states legal and regulatory frameworks in an appropriate manner
to bring them into effect. If introduced as expected, these measures
will retain Ambac UK's right to collect premium and pay claims
on policies issued under EU passporting rights.
As of December 31, 2018 Ambac UK's insured portfolio included
6 financial guarantee obligations with a gross par outstanding of
$2.4 billion issued under EU passporting rules.
The table below shows our ten largest international finance transactions as a percentage of total financial guarantee net par outstanding at
December 31, 2018. Except where noted, all international finance transactions included in the table below are insured by Ambac UK:
($ in millions)
Mitchells & Butlers Finance plc-UK Pub Securitisation
Capital Hospitals plc (2)
Aspire Defence Finance plc
Anglian Water
Posillipo Finance II S.r.l
National Grid Gas
Ostregion Investmentgesellschaft NR 1 SA (2)
RMPA Services plc
Catalyst Healthcare (Manchester) Financing plc (2)
National Grid Gas
Total
Country-Bond Type
UK-Asset Securitizations
UK-Infrastructure
UK-Infrastructure
UK-Utility
Italy-Sub-Sovereign
UK-Utility
Austria-Infrastructure
UK-Infrastructure
UK-Infrastructure
UK-Utility
Ambac
Rating(1)
A+
A-
BBB+
A-
BBB-
A-
BIG
BBB+
BBB-
A-
Net Par
Outstanding
$
1,337
871
855
772
753
713
712
570
525
478
% of Total
Net Par
Outstanding
2.8%
1.9%
1.8%
1.6%
1.6%
1.5%
1.5%
1.2%
1.1%
1.0%
$
7,586
16.2%
(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) A portion of this transaction is insured by an insurance policy issued by Ambac Assurance.
| Ambac Financial Group, Inc. 44 2018 FORM 10-K |
Additional Insured Portfolio Information
Geographic Area
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,
2018 is approximately 11 years. The average life is determined
by applying a weighted average calculation, using the remaining
years to expected maturity of each guaranteed bond, and
weighting them on the basis of the remaining net par guaranteed.
Except for RMBS policies, no assumptions are made for non-
contractual reductions, refundings or terminations of insured
issues. RMBS policies incorporate assumptions on expected
prepayments over the remaining life of the insured obligation.
The following table depicts amortization of existing guaranteed
net par outstanding:
Net Par Outstanding Amortization (1)
($ in millions)
Estimated Net
Amortization
2019
2020
2021
2022
2023
2019-2023
2024-2028
2029-2033
2034-2038
After 2038
Total
$
$
3,318
3,280
3,202
3,013
2,038
14,851
10,001
7,091
9,803
5,181
$
46,927
(1) Depicts amortization of existing guaranteed portfolio, assuming no
advance refundings, as of December 31, 2018. Expected maturities
will differ from contractual maturities because borrowers may have
the right to call or prepay guaranteed obligations.
The following table sets forth the geographic distribution of
Ambac's existing guaranteed net par outstanding as of
December 31, 2018:
Geographic Area
($ in millions)
Domestic:
Net Par
Amount
Outstanding
% of Total
Net Par
Amount
Outstanding
Mortgage and asset-backed (1)
$
California
New York
Colorado
New Jersey
Puerto Rico (2)
Texas
Illinois
Florida
Pennsylvania
Massachusetts
Other domestic
Total Domestic
International:
United Kingdom
Italy
Austria
Australia
France
Internationally diversified (3)
Other international
Total International Finance
Total
5,747
3,719
2,577
2,430
2,051
1,880
1,543
1,174
1,161
1,157
1,132
8,818
33,389
12.2%
7.9%
5.5%
5.2%
4.4%
4.0%
3.3%
2.5%
2.5%
2.5%
2.4%
18.8%
71.2%
10,965
23.4%
811
712
384
312
213
141
13,538
46,927
$
1.7%
1.5%
0.8%
0.7%
0.5%
0.3%
28.8%
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.
(2) As mentioned above, the COFINA POA was confirmed by the United
States District Court for the District of Puerto Rico on February 4,
2019 and became effective on February 12, 2019. The POA and
certain related commutation transactions resulted in a reduction of
Ambac Assurance's insured net par exposure to COFINA by 75% or
$603 to $202.
(3) Internationally diversified may include components of U.S.
exposure.
| Ambac Financial Group, Inc. 45 2018 FORM 10-K |
Exposure Currency
The table below shows the distribution by currency of Ambac's
existing guaranteed net par outstanding as of December 31, 2018:
Currency
($ in millions)
U.S. Dollars
British Pounds
Euros
Net Par
Amount
Outstanding
in Base
Currency
Net Par
Amount
Outstanding
in U.S.
Dollars
Percentage
of Net Par
Amount
Outstanding
$
£
€
34,024
$
8,387
1,592
545
34,024
10,695
1,824
384
72.5%
22.8%
3.9%
0.8%
Australian Dollars
A$
Total
$
46,927
100.0%
Ratings Distribution
The following tables provide a rating distribution of existing net
par outstanding based upon internal Ambac credit ratings at
December 31, 2018 and 2017 and a distribution by bond type of
Ambac's below investment grade ("BIG") net par exposures at
December 31, 2018 and 2017. BIG is defined as those exposures
with an internal credit rating below BBB-:
Note: AAA is less than 1% in both periods.
(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.
Summary of Below Investment Grade Exposure:
Bond Type ($ in millions)
Public Finance:
Lease and tax-backed (1)
General obligation (1)
Transportation
Housing (2)
Health care
Other
Total Public Finance
Structured Finance:
RMBS
Structured Insurance
Student loans
Other
Total Structured Finance
International Finance:
Other
Total International Finance
Net Par Outstanding -
December 31,
2018
2017
$
2,025
$
2,144
434
378
314
25
146
491
397
317
24
189
3,322
3,562
4,205
900
714
53
5,872
924
924
6,916
900
922
9
8,747
1,200
1,200
Total
$
10,118
$
13,509
(1) Tax-backed includes $1,735 and $1,802 of Puerto Rico net par at
December 31, 2018 and 2017, respectively. General obligation
includes $145 and $166 of Puerto Rico net par at December 31, 2018
and 2017, respectively. Puerto Rico net par outstanding includes
capital appreciation bonds which are reported at the par amount at
the time of issuance of the related insurance policy as opposed to the
current accreted value of the bonds. As mentioned above the COFINA
POA was confirmed by the United States District Court for the District
of Puerto Rico on February 4, 2019 and became effective on February
12, 2019. The POA and certain related commutation transactions
resulted in a reduction of Ambac Assurance's insured net par exposure
to COFINA by approximately 75% or $603 to $202 (included in tax-
backed).
(2)
Includes $314 and $317 of military housing net par at December 31,
2018 and 2017, respectively.
The decrease in below investment grade exposures is primarily
due to reductions to residential mortgage-backed securities during
the year as a result of prepayments by issuers, clean-up calls,
commutations and claims presented to Ambac Assurance. Despite
the decrease in below investment grade net par, such exposure
remained flat in relative proportion to the aggregate insured
portfolio of 22% at December 31, 2018 and December 31, 2017.
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
| Ambac Financial Group, Inc. 46 2018 FORM 10-K |
volatility in our results from operations and have adverse effects
on our financial condition.
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 $114.3 million from its reinsurers at
December 31, 2018. As of December 31, 2018, the aggregate
amount of insured par ceded by Ambac Assurance to reinsurers
under reinsurance agreements was $5,128 million, with the largest
reinsurer accounting for $3,076 million or 5.9% of gross par
outstanding at December 31, 2018.
reinsurer
The following table shows the distribution, by bond type, of Ambac
Assurance’s ceded guaranteed portfolio at December 31, 2018:
Bond Type ($ in millions)
Public Finance:
Ceded Par
Amount
Outstanding
% of Gross
Par Ceded
General obligation
$
1,402
Lease and tax-backed revenue
Housing revenue
Higher education
Utility revenue
Transportation revenue
Health care revenue
Other
Total Public Finance
Structured Finance:
Student loan
Investor-owned utilities
Asset-backed
Mortgage-backed and home
equity
Other
Total Structured Finance
Total Domestic
International Finance:
Investor-owned and public
utilities
Transportation
Asset-backed
Total International Finance
961
958
228
210
208
13
104
4,084
357
226
167
63
172
985
5,069
24
22
12
58
Total
$
5,127
25%
11%
13%
16%
15%
11%
3%
12%
15%
28%
11%
41%
1%
11%
9%
13%
1%
1%
1%
1%
10%
RESULTS OF OPERATIONS
2018
2017
2016
($ in millions)
Year Ended December 31,
Revenues:
Net premiums earned
$
Net investment income
Net other-than-temporary
impairment losses
Net realized investment
gains (losses)
Net gains (losses) on
derivative contracts
Other (2)
Income (loss) on variable
interest entities
Expenses:
Insurance intangible
amortization
Operating expenses
Interest expense
Provision for income taxes
Net income (loss)
Less: Net income
attributable to the
noncontrolling interest
Less: exchange of auction
market preferred
shares (1)
Net income (loss)
attributable to common
stockholders
$
$
Losses and loss expenses
(benefit)
(224)
111
273
(3)
112
7
8
3
107
112
242
5
267
—
$
$
175
361
(20)
5
76
5
20
513
151
122
120
44
(329)
197
313
(22)
39
(30)
23
(14)
(11)
175
114
124
31
74
—
(1)
82
$
— $
186
$
(329) $
—
75
(1)
In connection with the AMPS Exchange, the difference between the
fair value of consideration provided to AMPS holders and the carrying
amount of the AMPS has been reflected as a reduction to Net income
attributable to common stockholders in the third quarter of 2018 for
approximately $82. Refer to Note 1. Background and Business
Description for a discussion of the AMPS Exchange.
(2)
Includes Net gain (losses) on the extinguishment of debt and other
income (expense).
The following paragraphs describe the consolidated results of
operations of Ambac and subsidiaries for 2018, 2017 and 2016.
Some amounts may not add due to rounding.
Rehabilitation Exit Transactions. On February 12, 2018, Ambac
Assurance executed the following Rehabilitation Exit Transactions
(as more fully discussed in Note 1. Background and Business
Description in the Notes to Consolidated Financial Statements
included in this Annual Report:
(other
• The Second Amended Plan of Rehabilitation became
effective and a series of transactions were consummated
which provided holders of beneficial interests in Deferred
Amounts
including Ambac
than Ambac, but
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) $0.125
currently outstanding surplus notes (from certain holders of
| Ambac Financial Group, Inc. 47 2018 FORM 10-K |
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 was accounted for as an extinguishment of
Deferred Amounts and the discount of approximately $288
million from the settlement was reflected as a benefit to loss
and loss expenses in the Consolidated Statements of
Comprehensive Income (Loss) in 2018. In connection with
these transactions, Ambac Assurance received $196 million
of principal and accrued and unpaid interest on general
account surplus notes. Ambac Assurance recognized a gain
on the extinguishment of these surplus notes of $3 million.
• Exchanges were consummated pursuant to which holders of
surplus notes received the same effective package as holders
of beneficial interests in Deferred Amounts, including a
discount of $0.065 for each $1.00 of principal amount and
accrued and unpaid interest on the surplus notes tendered.
These exchanges resulted in Ambac Assurance's cancellation
of $809.5 million of principal and accrued and unpaid interest
of general account surplus notes. These exchanges were
accounted for as a debt modification since the creditors before
and after the discount remained the same and the change in
the terms were 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 was less than 10%, debt
modification accounting was appropriate. Under debt
modification accounting, no gain or loss was recorded, and a
new effective interest rate was established based on the cash
flows of the Ambac Note, which secures the Secured Notes
issued.
• Ambac Assurance issued $240 million of new debt secured
by certain of Ambac Assurance’s rights to RMBS R&W
subrogation recoveries above $1.6 billion ("Tier 2 Notes").
The proceeds received from this issuance were used to help
fund the cash portion of the consideration paid pursuant to
the Second Amended Plan of Rehabilitation and exchanges
noted above. Refer to Note 13. Long-term Debt to the
Consolidated Financial Statements,
the
Company’s Annual Report on Form 10-K for the year ended
December 31, 2018.
included
in
• Ambac incurred operating expenses for the year ended
December 31, 2018, including for AAC and OCI financial
advisors, of approximately $17 million.
In order to execute these transactions, Ambac established a special
purpose entity, Ambac LSNI, LLC, for the sole purpose of the
issuance of $2,154 million of Secured Notes, of which Ambac
Assurance received $644 million and Ambac received $125
million. Ambac does not consolidate Ambac LSNI, LLC;
therefore, the full amount of the debt is included in long term debt
and Secured Notes currently held by Ambac and Ambac Assurance
are included in invested assets on the consolidated balance sheet.
Net Premiums Earned. Net premiums earned primarily represent
the amortization into income of insurance premiums. Net
premiums earned for the year ended December 31, 2018, decreased
by $64 million or 36.6% as compared to net premiums earned for
the year ended December 31, 2017. Net premiums earned for the
year ended December 31, 2017, decreased by $22 million or 11.2%
as compared to net premiums earned for the year ended
December 31, 2016.
We present accelerated premiums, which result from calls and
other accelerations of insured obligations separate from normal net
premiums earned. When an insured bond has been retired, any
remaining unearned premium revenue ("UPR") is recognized at
that time to the extent the financial guarantee contract is legally
extinguished, causing accelerated premium
revenue. For
installment premium paying transactions, we offset the recognition
of any remaining UPR by the reduction of the related premium
receivable to zero (as it will not be collected as a result of the
retirement), which may cause negative accelerated premium
revenue. Included within accelerated premiums, were negative
accelerations of $2 million, $1 million, and $8 million, for the years
ended December 31, 2018, 2017 and 2016, respectively.
Normal net premiums earned are impacted by the following:
• The runoff of the insured portfolio occurring through
transaction terminations, calls and scheduled maturities,
which had a negative impact.
• Pre-refundings of insured securities, primarily Public Finance
transactions. Since the maturity date of pre-refunded
securities is shortened (to a specified call date from its
previous legal maturity), normal net premiums earned will
increase over the remaining period of the related policy.
• New ceded reinsurance of insurance risk which reduces
normal net premiums earned over the remaining period of the
related policies.
• The strengthening or weakening of the U.S. dollar relative to
the British Pound since Ambac's wholly-owned UK
subsidiary, Ambac UK, operates in the United Kingdom and
the British Pound is its functional currency.
Normal net premiums earned and accelerated premiums are
reconciled to total net premiums earned in the table below,
including a breakdown of net premiums earned by market:
($ in millions)
Year Ended December 31,
2018
2017
2016
Public finance
Structured finance
International finance
Total normal premiums
earned
Public Finance
Structured Finance
International Finance
Accelerated earnings
$
$
$
$
Total net premiums earned $
37
17
23
77
29
5
1
35
111
$
$
$
$
$
62
22
27
111
47
3
15
65
175
$
$
$
$
$
85
28
32
145
53
4
(4)
52
197
Net Investment Income. Net investment income primarily
consists of interest and net discount accretion on fixed income
securities classified as available-for-sale, including investments in
Ambac-insured securities.
in Ambac-insured
securities are made opportunistically based on their risk/reward
characteristics. As described further below, investment income
Investments
| Ambac Financial Group, Inc. 48 2018 FORM 10-K |
from holdings of Ambac-insured securities for the periods
presented have primarily been driven by RMBS and Puerto Rico
bonds insured by Ambac Assurance and, in 2018, the Secured
Notes issued by Ambac LSNI. Also, included in net investment
income are net gains and (losses) on pooled investment funds and
certain other investments that are classified as trading securities
with changes in fair value recognized in earnings. Trading
securities are included in Other investments on the Consolidated
Balance Sheets. 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.
Net investment income from Ambac-insured securities, available
for sale and short-term securities other than Ambac-insured and
Other investments is summarized the table below:
2018
2017
2016
$
220
$
262
$
195
($ in millions)
Year Ended December 31,
Securities available-for-sale:
Ambac-insured (including
Secured Notes)
Securities available-for-sale
and short-term other than
Ambac-insured
Other investments (includes
trading securities)
Net investment income
$
273
$
361
$
51
2
76
23
86
32
313
Net investment income decreased $88 million for the year ended
December 31, 2018 compared to 2017 and increased $48 million
for the year ended December 31, 2017 compared to 2016. Net
investment income for the year ended December 31, 2018 was
significantly impacted by the Rehabilitation Exit Transactions
which reduced the overall size of the investment portfolio as a
result of: (i) net cash paid on the transactions and (ii) the decline
in carrying value of investments in Ambac-insured RMBS due to
the settlement of embedded deferred claims, partially offset by
Secured Notes received. Primarily as a result of these changes in
the portfolio, 2018 investment income from all securities available
for sale declined compared to 2017. These declines were partially
offset by income earned in 2018 on Secured Notes. The year ended
December 31, 2018 also included higher income on Ambac-
insured Puerto Rico bonds due to Ambac's higher average holdings
as most of these bonds were purchased over the course of 2017.
The decline in net performance on trading securities in 2018
compared to 2017 arose primarily from losses on Ambac UK hedge
fund and equity index fund investments. Other asset classes held
in trading also underperformed relative to 2017.
The increase in income in 2017 was due to a greater allocation to
higher-yielding Ambac-insured securities, partially offset by lower
net gains on trading securities. Investment income increased on
Ambac-insured RMBS securities driven primarily by reprojected
cash flows in the fourth quarter of 2017 reflecting the anticipated
Rehabilitation Exit Transactions. 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
in 2017 partially offset strong equity market gains in Ambac UK's
pooled fund holdings compared to 2016, when results were
favorably impacted by the declining British pound.
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, 2018, 2017 and 2016 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 (as defined in Note 1. Background and
Business Description in the Notes to Consolidated Financial
Statements included in this Report on Form 10-K), 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 (as defined in Note 1. Background
and Business Description in the Notes to Consolidated Financial
Statements included in this Report on Form 10-K). 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,
Net gains on securities sold
or called
Foreign exchange gains
(losses)
Total net realized gains
$
$
2018
2017
2016
105
$
10
$
7
112
$
(5)
5
$
9
30
39
Net gains during the year ended December 31, 2018 were primarily
from sales of Ambac-insured RMBS. Additionally, 2018 gains
included a $27 million recovery from a class-action settlement
relating to certain RMBS securities previously held in the
investment portfolio.
| Ambac Financial Group, Inc. 49 2018 FORM 10-K |
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.
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 $(2) million, $4 million, and $3 million
for 2018, 2017and 2016, respectively.
Net gains during the year ended December 31, 2016 included
foreign exchange related gains of $23 million on short-term and
trading securities held by Ambac UK and denominated in non-
functional currencies (primarily US dollars and euros) and $8
million of realized currency gains related to available-for-sale
securities that were sold by Ambac UK during the year.
Net Gains (Losses) on Derivative Contracts. Net gains (losses)
on derivative contracts includes results from the Company's
interest rate derivatives portfolio and its runoff credit derivatives
portfolio as presented in the following table:
($ in millions)
Year Ended December 31,
Net gains (losses) on interest
rate derivatives
Net gains (losses) on credit
derivatives
Total net gains (losses)
$
$
2018
2017
2016
7
$
60
$
(50)
—
7
$
16
76
$
20
(30)
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 on interest rate derivatives for the year ended
December 31, 2018 were $7 million, compared to the net gain
of $60 million for the year ended December 31, 2017. While
interest rates rose in both 2018 and 2017, overall gains for
2018 were lower as a result of $42 million of gains realized
in 2017 on certain swaps commuted with a structured finance
vehicle, higher carrying costs in 2018 and an increase in
counterparty credit adjustments on certain uncollateralized
derivative assets compared to decreases in 2017.
• The interest rate derivatives loss for 2016 was primarily
driven by the impact of 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.
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.
Inclusion of the Ambac CVA in the valuation of interest rate
derivatives contributed (losses) gains of $(34) million in 2016.
Counterparty credit adjustments are generally applicable for
uncollateralized derivative assets that may not be offset by
The net gain/(loss) from change in fair value of credit derivatives
for the year ended December 31, 2018 was less than $(1) million,
as compared to the gains of $16 million and $20 million for the
years ended December 31, 2017 and 2016, 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, $1.0 million of termination fees received
and 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.
Net Realized Gains (Losses) on Extinguishment of Debt. Net
realized gains on extinguishment of debt was $3 million for the
year ended December 31, 2018, compared to gains of $5 million
and $5 million for the years ended December 31, 2017 and 2016,
respectively. The gains for the year ended December 31, 2018
related to surplus notes received by Ambac Assurance in settlement
of Deferred Amounts held in its investment portfolio in connection
with the Rehabilitation Exit Transactions. 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.
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.
Additionally, terminations or other changes to Ambac's financial
guarantee insurance policies that impact projected cash flows
between a consolidated VIE and Ambac could result in gains or
losses, even if such policy changes do not result in deconsolidation
of the VIE.
Income (loss) on variable interest entities was $3 million, $20
million and $(14) million for the years ended December 31, 2018,
2017 and 2016, respectively.
| Ambac Financial Group, Inc. 50 2018 FORM 10-K |
• Income on variable interest entities for the year ended
December 31, 2018 included gains on deconsolidation of
VIEs as a result of financial guarantee policy terminations
and discount accretion on remaining VIE net assets.
• Income on variable interest entities for the 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.
• Loss on variable interest entities for the year ended
December 31, 2016 reflected a decrease in the fair value of
net assets primarily due to the decrease in the CVA applied
to certain VIE note liabilities that included significant
projected financial guarantee claims. Other than those
transactions
financial
guarantee claims, the fair value of VIE net assets increased
producing net gains in 2016.
involving significant projected
Refer to Note 3. 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 (Benefit). 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 (as defined
in Note 1. Background and Business Description in the Notes to
Consolidated Financial Statements included in this Report on
Form 10-K) pursuant to the Segregated Account Rehabilitation
Plan (as defined in Note 1. Background and Business Description
in the Notes to Consolidated Financial Statements included in this
Report on Form 10-K) 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 estimate an RMBS R&W subrogation
recovery where its sole claim is for fraudulent inducement.
Generally, the sponsor of an RMBS transaction provided
representations and warranties with respect to the securitized loans,
including representations with respect to the loan characteristics,
the absence of borrower fraud in the underlying loan pools or other
misconduct in the origination process and attesting to the
compliance of loans with the prevailing underwriting policies.
Ambac has recorded RMBS R&W subrogation recoveries, net of
reinsurance, of $1.744 billion and $1.807 billion at December 31,
2018 and 2017, 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 RMBS R&W
subrogation recoveries.
Losses and loss expenses (benefit) for the year ended December
31, 2018, 2017 and 2016 were $(224) million, $513 million and
$(12) million, respectively. The following table provides details,
by bond type, for losses and loss expenses (benefit) incurred for
the periods presented:
($ in millions)
Year Ended December 31,
RMBS (1)
Domestic Public Finance
Student Loans
Ambac UK and Other
Credits
Interest on Deferred
Amounts
2018
2017
2016
$
(8) $
(41) $
37
(4)
19
21
476
25
(125)
178
Discount on Rehabilitation
Exit Transaction
Totals (2)
$
$
(288) $
(224) $
— $
513
$
(299)
169
(112)
60
171
—
(12)
(1) The loss and loss expense (benefit) associated with changes in
estimated representation and warranties for the year ended December
31, 2018, 2017 and 2016 was $62 million, $72 million, and $(71)
million, respectively.
(2) Includes loss expenses incurred of $92 million, $82 million and $52
million for the year ended December 31, 2018, 2017 and 2016,
respectively.
Losses and loss expenses for 2018 were driven by the following:
• Discount achieved pursuant to the Rehabilitation Exit
Transactions, partially offset by interest on Deferred Amounts
through the Rehabilitation Exit Transactions effective date;
• Higher projected losses in domestic public finance largely
driven by Military Housing loss expenses incurred and
adverse development on a certain general obligation and
transportation risks;
• Favorable RMBS credit development, partially offset by a
decrease in RMBS R&W subrogation recoveries, and loss
expenses incurred;
• $15 million of foreign exchange losses related to Ambac UK
loss reserves denominated in currencies other than its
functional currency of British Pounds, resulting in incurred
losses
the British Pound depreciates
(appreciates).
(gains) when
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;
• 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;
• $30 million of foreign exchange gains related to Ambac UK
loss reserves denominated in currencies other than its
functional currency of British Pounds resulting in incurred
losses
the British Pound depreciates
(appreciates);
(gains) when
• A $50 million benefit due to reimbursements of claims paid
with respect to two transactions that benefited from a
mortgage insurance settlement.
| Ambac Financial Group, Inc. 51 2018 FORM 10-K |
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 RMBS R&W 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;
• Higher projected losses in domestic public finance largely
driven by adverse development in Puerto Rico;
• Interest on Deferred Amounts;
• Increased projected losses in the Ambac UK portfolio
primarily due to foreign exchange losses of $78 million
partially offset by lower interest rates.
The following table provides details of net claims recorded, net of
reinsurance for the affected periods:
($ in millions)
Year Ended December 31,
Claims recorded (1)(2)
Subrogation received (3)(4)
Net Claims Recorded
2018
2017
2016
$
$
384
(140)
243
$
$
344
(244)
100
$
$
392
(1,355)
(964)
(1) Claims recorded include (i) claims paid, including commutation
payments and (ii) changes in claims not yet paid for policies allocated
to the Segregated Account, including Deferred Amounts and changes
in unpresented claims. Item (ii) includes permitted policy claims for
policies allocated to the Segregated Account that were presented and
approved by the Rehabilitator of the Segregated Account, but not paid
through to the balance sheet date in accordance with the amended
Segregated Account Rehabilitation Plan and associated rules and
guidelines. Claims recorded exclude interest accrued on Deferred
Amounts. On February 12, 2018, the rehabilitation of the Segregated
Account was concluded and all Deferred Amounts, including accrued
interest, were settled. Subsequent to the Rehabilitation Exit
Transactions, claims are paid in full.
(2) Claims recorded includes claims paid on Puerto Rico policies of $157,
$143 and $63 for the years ended December 31, 2018, 2017 and 2016,
respectively.
(3) Subrogation received declined due to the continuous runoff of the
RMBS insured portfolio and the impact of higher interest rates on
excess spread.
(4) Subrogation received for the year ended December 31, 2017 includes
$50 ($50 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 $993 ($995 gross of
reinsurance) received from the settlement of representation and
warranty related litigation with JP Morgan and $99 ($100 gross of
reinsurance) related to the Countrywide Investor Settlement.
Operating Expenses. Operating expenses consist of gross
operating expenses plus reinsurance commissions. The following
table provides details of operating expenses for the periods
presented:
($ in millions)
Year Ended December 31,
Compensation
$
Non-compensation
Gross operating expenses (1)
Reinsurance commissions,
net
2018
2017
2016
$
55
56
111
1
$
54
68
122
—
61
52
113
2
114
Total operating expenses
$
112
$
122
$
(1) Includes expenses related to Rehabilitation Exit Transactions of $10,
$25, and $3 for the years ended December 31, 2018, 2017 and 2016,
respectively, and expenses related to the AMPS Exchange of $8, $0
and $0 for the years ended December 31, 2018, 2017 and 2016,
respectively.
Gross operating expenses for the year ended December 31, 2018
are $111 million, a decrease of $11 million from gross operating
expenses for the year ended December 31, 2017. The decrease
was primarily due to the following:
• Lower non-compensation costs primarily due to a $21 million
reduction in legal, consulting and advisory costs related to the
exit from rehabilitation of the Segregated Account, of which
$5 million relates to advisory services provided for the benefit
of OCI, partially offset by costs of $8 million associated with
the August 2018 AMPS Exchange.
• Slightly higher compensation costs related to higher incentive
compensation costs driven by (i) an improvement in
performance metrics; (ii) granting of incentive awards related
to the Rehabilitation Exit Transactions; (iii) the timing of
recognition of equity based compensation in lieu of cash
bonuses; and (iv) amounts related to the settlement of a
previously granted performance based restricted stock unit
award issued to the former CEO that vested upon the
Segregated Account's exit from rehabilitation; partially offset
by lower salaries and post employment costs, including
severance as a result of reduced headcount.
Gross operating expenses for the year ended December 31, 2017
were $122 million, an increase of $9 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) $22
million incremental legal, consulting and advisory costs
related to the Rehabilitation Exit Transactions, (ii) $5 million
incremental OCI legal and consulting costs primarily in
connection with the Rehabilitation Exit Transactions, and (iii)
$4 million increase in state taxes primarily due to a $2 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 million and (ii) a reduction in
costs associated with stockholder activism of $6 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
in performance factors. Although post-
improvement
employment costs have decreased from 2016, the Company
reduced headcount in 2017 resulting in severance charges.
| Ambac Financial Group, Inc. 52 2018 FORM 10-K |
These charges are lower than prior year due to 2016 including
severance costs related to the former CEO.
With the conclusion of the Segregated Account rehabilitation, the
duties of the Wisconsin Insurance Commissioner as rehabilitator
of the Segregated Account have been discharged. Legal and
consulting services provided for the benefit of OCI amounted to
$7 million, $12 million and $6 million for the years ended
December 31, 2018, 2017 and 2016, respectively. Subsequent to
the Segregated Account's exit from rehabilitation, advisory
services for the benefit of OCI will continue, but at a reduced level.
Interest Expense. Interest expense primarily includes accrued
interest on the Ambac Note, Tier 2 Notes, secured borrowing notes
and surplus notes issued by Ambac Assurance. Additionally,
interest expense includes discount accretion when the debt
instrument carrying value is at a discount to par.
The following table provides details by type of obligation for the
periods presented:
($ in millions)
Year Ended December 31,
Surplus notes
Ambac note
Tier 2 notes (1)
Secured borrowing
Other
2018
2017
2016
$
80
$
113
$
119
139
22
1
—
—
2
4
—
—
—
5
1
Total interest expense
$
242
$
120
$
124
(1) The amounts include unfunded commitment fees applicable prior to
the issuance of the Tier 2 notes of $1 million, $2 million and $0
million, respectively, for the years ended December 31, 2018, 2017
and 2016.
The increase in interest expense for the year ended December 31,
2018, compared to 2017 primarily reflects the impact of the
Rehabilitation Exit Transactions that resulted in the issuance of the
Ambac Note and Tier 2 Notes partially offset by reduced surplus
note balances. Surplus notes outstanding increased in the second
half of 2018 due to surplus notes issued by Ambac Assurance in
connection with the AMPS Exchange and Ambac sales of notes to
the market. On June 22, 2018, the secured borrowing notes were
fully redeemed. Refer to Note 13. Long-term Debt to the
Consolidated Financial Statements for further information on the
Ambac Note and Tier 2 Notes.
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.
Surplus note principal and interest payments require the approval
of OCI. Except for a one-time payment of approximately six
months of interest on the outstanding surplus notes (excluding the
junior surplus notes) immediately after the Rehabilitation Exit
Transactions, annually from 2011 through 2018, OCI issued its
disapproval of the requests of Ambac Assurance to pay the full
interest on outstanding surplus notes issued by Ambac on the
annual scheduled interest payment date of June 7th. Ambac
Assurance has not requested to pay interest on any junior surplus
notes since their issuance. The interest on the outstanding surplus
notes and junior surplus notes were accrued for and Ambac is
accruing interest on the interest amounts following each scheduled
interest payment date. Total accrued and unpaid interest for surplus
notes and junior surplus notes outstanding to third parties were
$262 million and $122 million, respectively, at December 31, 2018.
Provision for Income Taxes. The provision for income taxes for
the year ended December 31, 2018, 2017 and 2016 was $5 million,
$44 million, and $31 million, respectively. The income tax
provision for these periods included AMT of $(2) million, $(29)
million, $4 million, respectively. The income tax for the year ended
December 31, 2018, and 2017 reflect discrete benefit of $2 million,
and a discrete estimated cost of $2 million, respectively, resulting
from the TCJA, further described in Note 14. Income Taxes. The
income tax for the year ended December 31, 2018, 2017 and 2016,
includes provisions for income tax due in respect of Ambac UK
of $5 million, $72 million, and $26 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, 2018 the Company had $3.5 billion of U.S.
Federal net ordinary operating loss carryforwards, including $1.3
billion at Ambac Financial Group and $2.2 billion at Ambac
Assurance.
LIQUIDITY AND CAPITAL RESOURCES
Ambac Financial Group, Inc. Liquidity. Ambac’s liquidity is
dependent on its cash, investments and receivables totaling $455
million as of December 31, 2018 and expense sharing and other
arrangements with Ambac Assurance.
Ambac's investments include securities directly and indirectly
issued by and/or insured by Ambac Assurance some of which are
eliminated in consolidation. Securities issued or insured by Ambac
Assurance are generally less liquid than investment grade and other
traded investments.
Pursuant to the amended and restated tax sharing agreement among
Ambac, Ambac Assurance and certain affiliates (the "Amended
TSA"), Ambac Assurance is required to make payments ("tolling
payments") to Ambac with respect to the utilization of net operating
loss carry-forwards (“NOLs”). Ambac has accrued $30 million of
tolling payments based on NOLs used by Ambac Assurance in
2017. In May 2018, Ambac executed a waiver under the
intercompany tax sharing agreement pursuant to which Ambac
Assurance was relieved of the requirement to make this payment
by June 1, 2018. Ambac has also agreed to defer the tolling
payment for the use of net operating losses by Ambac Assurance
in 2017 until such time as OCI consents to the payment. Ambac
has accrued $14 million of additional tolling payments in 2018,
subject to OCI's review of Ambac's 2018 tax positions.
| Ambac Financial Group, Inc. 53 2018 FORM 10-K |
Under an inter-company cost allocation agreement, Ambac is
reimbursed by Ambac Assurance for a portion of certain operating
costs and expenses and, if approved by OCI, entitled to an
additional payment of up to $4 million per year to cover expenses
not otherwise reimbursed.
It is highly unlikely that Ambac Assurance will be able to make
dividend payments to Ambac for the foreseeable future and
therefore cash and investments, payments under the intercompany
cost allocation agreement and future tolling payments, if any, will
be Ambac’s principal source of liquidity in the near term. Refer
to Part I, Item 1, “Insurance Regulatory Matters — Dividend
Restrictions, Including Contractual Restrictions” in this Annual
Report on Form 10-K, and Note 8. Insurance Regulatory
Restrictions to the Consolidated Financial Statements included in
Part II, Item 8, in this Annual Report on Form 10-K, for more
information on dividend payment restrictions.
The principal use of liquidity is the payment of operating expenses,
including costs to explore opportunities to grow and diversify
Ambac, and the making of investments, including securities issued
or insured by Ambac Assurance. Future uses of liquidity may
include the acquisition or capitalization of new businesses.
Contingencies could cause material liquidity strains.
The following table includes aggregated information about contractual obligations for Ambac and its subsidiaries at December 31, 2018,
excluding variable interest entities consolidated as a result of Ambac Assurance’s financial guarantee contracts. These obligations include
payments due under specified contractual obligations, aggregated by type of contractual obligation, including claim payments, principal and
interest payments under Ambac Assurance’s surplus notes, the Ambac Note and Tier 2 Notes and payments due under operating leases. The
table and commentary below reflect scheduled payments and maturities based on the original payment terms specified in the underlying
agreements and contracts, or expected required payment dates if earlier.
($ in millions)
Surplus note obligations(1)
Ambac note obligations(2)
Tier 2 note obligations(3)
Operating lease obligations(4)
Purchase obligations(5)
Postretirement benefits(6)
Loss and loss expenses(7)
Income taxes
Total
Total
Less Than 1 Year
1 - 3 Years
3 - 5 Years
More Than 5
Years
Payments Due by Period
$
3,827
$
2,563
5,394
23
3
4
3,448
—
$
279
151
—
6
3
—
309
—
558
303
—
4
—
—
201
—
$
— $
2,109
—
3
—
1
160
—
$
15,262
$
748
$
1,066
$
2,273
$
2,990
—
5,394
10
—
2
2,778
—
11,174
(1) Amounts on surplus notes (excluding junior surplus notes) include principal on their scheduled maturity date and interest on scheduled payment date,
including payment of previously deferred interest totaling $239 million on the next scheduled payment date of June 7, 2019. 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. 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 Rehabilitation Exit Transactions, annually from 2011 through 2018, OCI disapproved scheduled interest payments.
(2)
(3)
Includes principal on Ambac note as of December 31, 2018 to be paid on its legal maturity date of February 12, 2023, and scheduled interest payments.
Interest amounts on this variable rate debt are projected at a rate of 7.80% which is based on the index rate in effect at the balance sheet date. These notes
are subject to mandatory redemption provisions that could significantly accelerate the timing of required payments, as described further in Note 13. Long-
Term Debt to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K.
Includes principal and compounded paid-in-kind interest on Tier 2 notes to be paid on their legal maturity date of February 12, 2055. These notes are
subject to mandatory redemption provisions that could significantly accelerate the timing of required payments, as described further in Note 13. Long-
Term Debt to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K.
(4) Amount represents future lease payments on lease agreements existing as of December 31, 2018. In January 2019 Ambac entered into a sub-lease agreement
for office space at One World Trade Center, New York, NY set to expire in January 2030 which includes future lease payments of approximately $27
million.
(5) Purchase obligations represent future expenditures for contractually scheduled fixed terms and amounts due for various technology-related maintenance
agreements and other outside services.
(6) Amount represents future payments relating to Ambac Assurance's postretirement medical reimbursements to current retirees over the next 10 years.
(7) 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.
| Ambac Financial Group, Inc. 54 2018 FORM 10-K |
Ambac Assurance Liquidity. Ambac Assurance’s liquidity is
dependent on the balance of liquid investments and, over time, the
net impact of sources and uses of funds. The principal sources of
Ambac Assurance’s liquidity are gross installment premiums on
insurance policies, principal and
interest payments from
investments, sales of investments, proceeds from repayment of
affiliate loans, recoveries on claim payments, including from
litigation 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 and loss adjustment expenses, claims, commutation
and related expense payments on insurance policies, ceded
reinsurance premiums, principal and interest payments on the
Ambac Note, surplus note principal and interest payments, Tier 2
Note payments, additional loans to affiliates and tolling payments
due to Ambac 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. Any such payment on surplus notes
would require either payment or collateralization of a portion of
the Tier 2 Notes under the terms of the Tier 2 Note indenture. See
Note 13. Long-term Debt to the Consolidated Financial
Statements, included in Part II, Item 8 in this Form 10-K for further
discussion of the payment terms and conditions of the Tier 2 Notes.
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.
Ambac Assurance is limited in its ability to pay dividends pursuant
to the terms of its Auction Market Preferred Shares (“AMPS”),
which state that dividends may not be paid on the common stock
of Ambac Assurance unless all accrued and unpaid dividends on
the AMPS for the then current dividend period have been paid,
provided that dividends on the common stock may be made at all
times for the purpose of, and only in such amounts as are necessary
for enabling Ambac (i) to service its indebtedness for borrowed
money as such payments become due or (ii) to pay its operating
expenses. If dividends are paid on the common stock for such
purposes, dividends on the AMPS become cumulative until the
date that all accumulated and unpaid dividends have been paid on
the AMPS. Refer to Note 1. Background and Business Description
for a discussion of the August 2018 AMPS Exchange that reduced
the liquidation preference of the AMPS from $660.3 million at
June 30, 2018 to $102.9 million as of August 1, 2018. 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” in this Annual
Report on Form 10-K, and Note 8. Insurance Regulatory
Restrictions to the Consolidated Financial Statements included in
Part II, Item 8, in this Annual Report on Form 10-K, for more
information on dividend payment restrictions.
Our ability to realize RMBS R&W subrogation recoveries is
subject to significant uncertainty, including risks inherent in
litigation, collectability of such amounts from counterparties (and/
or their respective parents and affiliates), timing of receipt of any
such recoveries, intervention by the OCI, which could impede our
ability to take actions required to realize such recoveries, and
uncertainty inherent in the assumptions used in estimating the
amount of such recoveries. The amount of these subrogation
recoveries is significant and if we are unable to recover any
amounts or recover materially less than our estimated recoveries,
our future available liquidity to pay claims and meet our other
obligations would be reduced materially. See Part I, Item 1A. Risk
Factors in this Annual Report on Form 10-K for more information
about risks relating to our RMBS R&W subrogation recoveries.
Ambac Financial Services ("AFS") Liquidity. AFS uses interest
rate derivatives as an economic hedge against the effects of rising
interest rates elsewhere in the Company, including on Ambac’s
financial guarantee exposures. These derivatives include, interest
rate swaps previously provided to states, municipalities and their
authorities, asset-backed issuers and other entities in connection
with their financings. 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. AFS borrows cash and
securities from Ambac Assurance to meet liquidity needs under an
established lending agreement with defined borrowing limits that
has received non-disapproval from OCI.
Cash Flow Statement Discussion.
summarizes the net cash flows for the periods presented.
The following table
($ in million)
Year Ended December 31,
Cash provided by (used in):
Operating activities
Investing activities
Financing activities
Effect of foreign exchange
on cash and cash
equivalents
2018
2017
2016
$
(1,543) $
1,588
(221) $
1,163
(585)
(412)
—
(1)
830
(453)
(319)
(4)
54
Net cash flow
$
(541) $
529
$
Operating activities
The following represents the significant cash activities during the
years ended December 31, 2018, 2017 and 2016 :
• Cash outflow from the Rehabilitation Exit Transactions to
third parties was $1,354 million of which $1,162 million is
included in operating activities and $191 is included in
financing activities as it related to payments for surplus note
principal. 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;
• During the year ended December 31, 2018, Ambac made
payment of interest on long-term debt of $143 million,
including $11 million on surplus notes made in connection
with the Rehabilitation Exit Transactions, $130 million on the
Ambac Note and $2 million on the secured borrowing which
was fully repaid in June 2018;
• During the year ended December 31, 2017, Ambac made
payments of $94 million to commute interest rate swaps with
a special purpose entity;
• During the year ended December 31, 2017, Ambac made
payments of $105 million to extinguish (on a consolidated
basis) principal and interest of surplus notes and settled
certain residual obligations related to previously called
surplus notes ($69 million principal and $35 million interest).
| Ambac Financial Group, Inc. 55 2018 FORM 10-K |
The interest amount reduces operating cash flows and the
principal reduced financing cash flows; and
• Net loss and loss expenses paid, including commutation
payments, during the years ended December 31, 2018, 2017
and 2016 are detailed below:
($ in million)
Year Ended
December 31,
Net losses paid (1)
Net subrogation
received
2018
2017
2016
$
344
$
311
$
365
Net loss expenses paid
Net cash flow
$
(140)
117
321
(244)
67
(1,355)
50
$
134
$
(940)
(1) Net losses paid includes claims paid on Puerto Rico policies of
$157, $143 and $63 million for the year ended December 31,
2018, 2017 and 2016, respectively.
• During the year ended December 31, 2018, 2017 and 2016
tax payments amounted to $35 million, $40 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.
Financing Activities
Financing activities for the year ended December 31, 2018
included proceeds from the issuance of Tier 2 Notes of $240
million, paydowns of Ambac Note of $214 million, repayments
of the Secured Borrowing of $74 million, payments for the
extinguishment of surplus notes of $191 million (in connection
with the Rehabilitation Exit Transactions) and paydowns of VIE
debt obligations of $349 million.
Financing activities for the year ended December 31, 2017
included paydowns on a secured borrowing of $29 million,
payments for investment agreements of $82 million, payments for
extinguishment of surplus notes of $69 million and paydowns of
VIE debt obligations of $230 million.
Financing Activities for the year ended December 31, 2016
included repayments of secured borrowing of $29 million,
payments for investment agreements of $18 million, payments for
the extinguishment of surplus notes of $20 million, acquisition of
Ambac warrants of $3 million, and paydowns of VIE debt
obligations of $249 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 hedges a portion of the interest rate risk in the financial
guarantee and investment portfolio, along with legacy customer
interest rate swaps, 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 or U.S. Treasury obligations
with market values equal to or in excess of market values of the
swaps and futures contracts. AFS may look to re-establish hedge
positions that are terminated early, resulting 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 $103 million (cash and securities classified as cash
equivalents),
these
contracts at December 31, 2018.
independent amounts, under
including
Ambac Credit Products (“ACP”) is not required to post collateral
under any of its outstanding derivative contracts.
BALANCE SHEET
Total assets decreased by approximately $8,604 million from
December 31, 2017 to $14,589 million at December 31, 2018,
primarily due to (i) the deconsolidation of four VIEs during 2018
(causing a reduction in assets of $6,620 million) and (ii) the net
impact of the Rehabilitation Exit Transactions as discussed below.
Other significant changes during 2018 were lower VIE assets as a
result of currency changes (weakening of the British Pound), lower
intangible assets as a result of amortization, and lower invested
assets due to claim payments and debt redemptions.
Total liabilities decreased by approximately $8,592 million from
December 31, 2017 to $12,956 million as of December 31, 2018,
primarily as a result of (i) the deconsolidation of four VIEs during
2018 (causing a reduction in liabilities of $6,600 million), (ii) the
Rehabilitation Exit Transactions as discussed below and (iii) the
AMPS Exchange transaction which increased the carrying value
of surplus notes and the related accrued interest by an aggregate
of $286 million, respectively. Other significant changes during
2018 were lower VIE liabilities as a result of currency changes,
lower unearned premiums from the runoff of the insured portfolio,
lower loss reserves due to claim payments, the full redemption of
the Secured Borrowing transaction on June 22, 2018 and partial
paydowns on the Ambac Note, partially offset by higher accrued
interest payable on surplus notes and new debt.
As of December 31, 2018 total stockholders’ equity was $1,633
million, compared with total stockholders’ equity of $1,645 million
at December 31, 2017. This decrease was primarily driven by the
AMPS Exchange transaction which reduced total stockholders'
equity by $297 million and translation losses related to Ambac's
foreign subsidiaries, partially offset by net income and unrealized
gains on investment securities.
Rehabilitation Exit Transactions. As more fully discussed in Note
1. Background and Business Description to the Consolidated
Financial Statements, included in Part II, Item 8 in 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 had a significant impact on the comparability of
| Ambac Financial Group, Inc. 56 2018 FORM 10-K |
Ambac's financial results between 2018 and prior years. The
Rehabilitation Exit Transactions impacted the following balance
sheet accounts:
• Invested assets and cash were reduced by a total of $1,801
million driven by (i) a cash outflow of $1,354 million and
(ii) the settlement of Ambac-insured RMBS securities held
in the investment portfolio of $1,455 million, partially offset
by the receipt of $768 million par amount of the Secured Notes
and proceeds from the issuance of Tier 2 notes of $240 million.
• Loss Reserves and Subrogation Recoverable were reduced
and increased, respectively, as a result of the settlement of
unpaid claims of the Segregated Account, which were
approximately $3,867 million, including $840 million of
accrued interest at December 31, 2017 ($3,857 million at
February 12, 2018). Loss Reserves included $3,080 million
of unpaid claims and accrued interest at December 31, 2017.
Subrogation Recoverable was net of $787 million of unpaid
claims and accrued interest at December 31, 2017. Following
the settlement of Deferred Amounts, Loss Reserves decreased
$2,555 million and Subrogation Recoverable increased
$1,312 million. As a result of the settlement of unpaid claims,
certain policies which were previously in a liability position
have transitioned to an asset position with a recoverable of
$525 million at December 31, 2017.
• Long-term debt was increased by $1,748 million driven by
(i) the Ambac Note issued to Ambac LSNI with an initial
carrying value of approximately $2,146 million and (ii) the
issuance of Tier 2 Notes with an initial carrying value of
the
approximately $231 million, partially offset by
consolidated reduction of surplus notes principal and interest
with a carrying value of approximately $629 million. Refer
to Note 13. Long-term Debt to the Consolidated Financial
Statements, included in Part II, Item 8 in this Form 10-K for
further information regarding Ambac's debt obligations.
Investment Portfolio. Ambac Assurance’s 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, the Stipulation and
Order and the indenture for the Tier 2 Notes. The Board of Directors
of Ambac Assurance approves any changes to Ambac Assurance's
investment policy.
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
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 investment portfolio's primary
objective is to preserve capital and liquidity for strategic uses,
including investments in securities issued by or guaranteed by
Ambac Assurance, while maximizing income.
Refer to Note 10. Investments in this Form 10-K located in Part
II. Item 8 for information about Ambac's consolidated investment
portfolio. Ambac's investment polices and objectives do not apply
to the assets of VIEs consolidated as a result of financial guarantees
written by its insurance subsidiaries.
The following table summarizes the composition of Ambac’s
investment portfolio, excluding VIE investments, at carrying value
at December 31, 2018 and 2017:
($ in millions)
December 31,
Fixed income securities
Short-term
Other investments
2018
2017
$
3,116
$
4,652
430
391
—
557
432
100
3,937
$
5,741
Fixed income securities pledged as collateral
Total investments (1)
$
(1)
Includes investments denominated in non-US dollar currencies with
a fair value of £204 ($259) and €14 ($16) as of December 31, 2018
and £210 ($284) and €41 ($49) as of December 31, 2017.
Ambac invests in various asset classes in its fixed income securities
portfolio, including securities covered by guarantees issued by
Ambac Assurance and Ambac UK and other financial guarantors
("insured securities"). Other investments include diversified
equity interests in pooled funds. Refer to Note 10. Investments in
this 10-K located in Part II. Item 8 for information about insured
securities by guarantor and fixed income and equity interests by
asset class. The following table represents the fair value of
mortgage and asset-backed securities at December 31, 2018 and
2017 by classification:
($ in millions)
December 31,
Residential mortgage-backed securities:
RMBS—Second Lien
RMBS—First-lien—Alt-A
RMBS—First Lien—Sub Prime
Total residential mortgage-backed securities
Other asset-backed securities
Military Housing
Structured Insurance
Student Loans
Auto
Credit Cards
2018
2017
$
136
$
840
1,029
382
2,251
243
138
152
32
33
598
93
31
259
241
145
32
20
5
442
701
Total other asset-backed securities
Total (1)
$
$
2,849
| Ambac Financial Group, Inc. 57 2018 FORM 10-K |
(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 CC and CCC- as of December 31, 2018, and C
and CCC as of December 31, 2017, respectively.
The following tables provide the ratings(1) distribution of the fixed
income investment portfolio based on fair value at December 31,
2018 and 2017.
(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 57% and 64% of the 2018 and 2017 combined portfolio,
respectively. The decrease in the percentage of not rated and below
investment grade holdings since December 31, 2017 is driven by
the
reductions
in Ambac-insured RMBS
resulting
from
Rehabilitation Exit Transactions and subsequent sales, partially offset
by the receipt of Secured Notes issued by Ambac LSNI.
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 $495 million at December 31, 2018 from $586 million
at December 31, 2017. As further discussed in Note 7. Financial
Guarantee Insurance Contracts, the decrease is due to premium
receipts, adjustments for changes in expected and contractual cash
flows and the impact of currency exchange rates on non-US
denominated future premiums, partially offset by 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$
333
103
27
1
$
$
333
131
31
—
495
Reinsurance Recoverable on Paid and Unpaid Losses. Ambac
Assurance has reinsurance in place pursuant to surplus share treaty
and facultative agreements. 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 under 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
reinsurer (among other events and circumstances). Ambac
Assurance benefited from letters of credit and collateral amounting
to approximately $114 million from its reinsurers at December 31,
2018. Collateral is based on reinsurance contracts, but generally
includes reinsurers share of loss and loss expense reserves and
statutory unearned premiums and contingency reserves, amongst
other considerations. As of December 31, 2018 and 2017,
reinsurance recoverable on paid and unpaid losses were $23
million and $41 million, respectively. The decrease was primarily
a result of the commutation of student loan exposures.
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 net intangible asset at December 31, 2018 and 2017
was $719 million and $847 million, respectively. The decrease
was primarily driven by amortization expense of $107 million and
translation losses from the consolidation of Ambac's foreign
subsidiary (Ambac UK).
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
| Ambac Financial Group, Inc. 58 2018 FORM 10-K |
issued
to beneficiaries,
insurance policies
for
including
unconsolidated VIEs. For periods prior to February 12, 2018, loss
and loss expense reserves included the unpaid portion of interest
accrued on Deferred Amounts established pursuant to the
Segregated Account Rehabilitation Plan. The loss and loss expense
reserves net of subrogation recoverables and before reinsurance as
of December 31, 2018 and 2017 were $(107) million and $4,114
million, respectively. Loss and loss expense reserves are included
in the Consolidated Balance Sheets as follows:
($ in millions)
Balance Sheet Line Item
December 31, 2018:
Loss and loss expense reserves
Subrogation recoverable
Totals
December 31, 2017:
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
$
$
$
$
— $
—
— $
2,412
615
3,027
$
$
— $
—
— $
668
172
840
$
$
2,246
176
2,422
2,855
102
2,957
$
$
$
$
(313) $
(107) $
(2,109)
—
(2,422) $
(107) $
1,826
(1,933)
(107)
(1,054) $
(136) $
(1,520)
—
(2,574) $
(136) $
4,745
(631)
4,114
(1) Present value of future recoveries include R&W subrogation recoveries of $1,771 and $1,834 at December 31, 2018 and 2017, 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 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”), student loan securities and public finance bond types.
These bond types represent 93% of our ever-to-date insurance
claims recorded with RMBS comprising 79%.
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, 2018 and 2017:
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)
$
$
$
$
3,716
$
— $
— $
696
$
(1,995) $
(14) $
(1,313)
3,987
530
1,170
—
—
—
—
—
—
—
—
—
1,095
271
294
66
(383)
(39)
(5)
—
(73)
(4)
(16)
—
639
228
273
66
9,403
$
— $
— $
2,422
$
(2,422) $
(107) $
(107)
5,243
$
3,014
$
837
$
888
$
(2,120) $
(21) $
2,598
4,265
701
1,478
—
13
—
—
—
3
—
—
—
1,278
361
341
89
(403)
(40)
(11)
—
(75)
(13)
(27)
—
816
308
303
89
11,687
$
3,027
$
840
$
2,957
$
(2,574) $
(136) $
4,114
($ in millions)
December 31, 2018:
RMBS
Domestic Public Finance
Student Loans
Ambac UK and Other Credits
Loss expenses
Totals
December 31, 2017:
RMBS
Domestic Public Finance
Student Loans
Ambac UK and Other Credits
Loss expenses
Totals
| Ambac Financial Group, Inc. 59 2018 FORM 10-K |
(1) Ceded par outstanding on policies with loss reserves and ceded loss and loss expense reserves are $540 and $23 respectively, at December 31, 2018 and
$590 and $41, respectively at December 31, 2017. 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.
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. The decrease
in RMBS gross loss reserves was primarily related to the settlement
of Deferred Amounts and interest accrued on Deferred Amounts
in connection with the Rehabilitation Exit Transactions executed
on February 12, 2018.
We established an RMBS R&W 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 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 R&W subrogation
recoveries is subject to significant uncertainty, including risks
inherent in litigation, collectability of such amounts from
counterparties (and/or their respective parents and affiliates),
timing of receipt of any such recoveries, intervention by the 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. See Part I, Item 1A. Risk Factors in
this Annual Report on Form 10-K for more information about risks
relating to our RMBS R&W subrogation recoveries.
Public Finance
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 decrease in public finance gross loss
reserves at December 31, 2018 as compared to December 31, 2017
was primarily related to the payment of claims, primarily Puerto
Rico. 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
2018
2017
Gross Par
Outstanding (1)
Gross Loss
Reserves
Gross Par
Outstanding (1)
Gross Loss
Reserves
$
$
2,062
$
528
$
904
471
445
105
24
49
26
12
2,201
$
1,053
495
449
67
3,987
$
639
$
4,265
$
650
60
64
31
11
816
(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.
Long-term Debt:
Long-term debt consists of senior and junior surplus notes issued
by Ambac Assurance, the Ambac Note and Tier 2 Notes issued in
connection with the Rehabilitation Exit Transactions and the
Secured Borrowing obligation. The carrying value of each of these
as of December 31, 2018 and 2017 is below:
($ in millions)
Surplus notes
Ambac note
Tier 2 notes
Secured borrowing
Total Long-term Debt
December 31,
2018
December 31,
2017
$
$
737
$
1,940
252
—
2,929
$
918
—
—
74
992
The increase in long-term debt from December 31, 2017 is
primarily due to the impact of the Rehabilitation Exit Transactions
that resulted in the issuance of the Ambac Note and Tier 2 Note
and the redemption of a portion of the senior surplus notes then
outstanding. Through December 31, 2018 the Ambac Note was
partially reduced by redemptions of $214 million and the Tier 2
notes balance increased due to paid-in-kind interest and discount
accretion. Surplus notes outstanding increased subsequent to the
Rehabilitation Exit Transactions due to issuances by Ambac
Assurance in connection with the third quarter 2018 AMPS
Exchange and Ambac's resales of notes to the market. The Secured
Borrowing was fully repaid in 2018.
| Ambac Financial Group, Inc. 60 2018 FORM 10-K |
SPECIAL PURPOSE AND VARIABLE INTEREST
ENTITIES
Please refer to Note 2. Basis of Presentation and Significant
Accounting Policies and Note 3. Variable Interest Entities to the
Consolidated Financial Statements, included in Part II, Item 8 in
this Form 10-K, for information regarding special purpose and
variable interest entities.
ACCOUNTING STANDARDS
Please refer to Note 2. Basis of Presentation and Significant
Accounting Policies to the Consolidated Financial Statements,
included in Part II, Item 8 in this Form 10-K, for a discussion of
the impact of recent accounting pronouncements on Ambac’s
financial condition and results of operations.
AMBAC ASSURANCE STATUTORY BASIS FINANCIAL
RESULTS
Ambac Assurance and Everspan'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 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. As a
result of these prescribed and permitted practices, Ambac
Assurance’s policyholder surplus at December 31, 2018 and 2017
was less than NAIC SAP by $42 million and $104 million,
respectively.
Ambac Assurance’s statutory policyholder surplus and qualified
statutory capital (defined as the sum of policyholders surplus and
mandatory contingency reserves) were $1,152 million and $1,648
million at December 31, 2018, respectively, as compared to $700
million and $1,156 million at December 31, 2017, respectively.
The drivers to the net increase were Ambac Assurance’s statutory
net income and reclassifications of $361 million of surplus notes
from liabilities to a component of policyholders surplus partially
offset by a decline in fair value of below investment grade bond
investments of $72 million and contributions to contingency
reserves.
Ambac Assurance’s statutory policyholder surplus includes $367
million of junior surplus notes. These junior surplus notes, as well
as preferred stock issued by Ambac Assurance with a liquidation
preference of $137.5 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.
As further discussed in Financial Guarantees in Force above in the
Management Discussion and Analysis section of this Form 10-K,
pursuant to the COFINA Plan of Adjustment that was effective on
February 12. 2019, each holder of Ambac Assurance-insured
senior COFINA bonds had the option to elect to either (i) commute
their rights in respect of the Ambac Assurance insurance policy
associated with the existing senior COFINA bonds, which bonds
would be discharged and Ambac policy obligations with respect
thereto would be released, in exchange for new COFINA bonds,
cash amounts to be paid by COFINA, plus additional cash
consideration provided by Ambac Assurance equal to 5.25% of the
accreted value of the Ambac Assurance-insured senior COFINA
bonds as of the COFINA petition date or (ii) exchange their senior
COFINA bonds for units issued by a trust (the "COFINA Class 2
Trust"), which trust would receive the new COFINA bonds and
the cash amounts to be paid by COFINA that such holders would
have otherwise received to the extent they had elected the recovery
under clause (i) above (thereby entitling the trust to receive debt
service payments from COFINA with respect to the new COFINA
bonds deposited into the trust).
• The commutation transactions resulted in a reduction of
Ambac Assurance's insured exposure to COFINA by
approximately 75% and an incurred loss of $37.3 million in
2019, which will be offset by accelerated earned premiums
of $29.6 million on the insured exposures being commuted.
• The non-commuted portion of Ambac Assurance's policy
(approximately 25%) or net par exposure of $202 million will
remain in force. This remaining policy portion of Ambac
Assurance's COFINA exposure together with old COFINA
bonds have been deposited into a trust together with the new
COFINA bonds and cash and the non-commuted Ambac-
insured bondholders receiving units of the trust in return.
Cash flows from the new COFINA bonds and cash will be
passed through to unit-holders over time and will reduce
amounts owed under the remaining Ambac Assurance policy.
Ambac Assurance’s statutory surplus is sensitive to multiple
factors, including: (i) loss reserve development, (ii) approval by
OCI of principal or 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 increase statutory loss reserves,
(vi) commutations of insurance policies or credit derivative
contracts at amounts that differ from the amount of liabilities
recorded, (vii) reinsurance contract terminations at amounts that
differ from net assets recorded, (viii) changes to the fair value of
investments carried at fair value, (ix) settlements 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.
As of December 31, 2018, total unpaid interest, which will require
OCI approval for payment, for surplus notes outstanding to third
parties and junior surplus notes was $239 million and $108 million,
respectively, at the scheduled interest payment date of June 7, 2018.
Under SAP, these amounts will be recorded as a liability once
approval for payment has been granted by OCI.
| Ambac Financial Group, Inc. 61 2018 FORM 10-K |
The significant differences between GAAP and SAP are that under
SAP:
• Loss reserves are only established for losses on guaranteed
obligations that have experienced a payment default 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 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 2.8%.
• 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
to a
generally subject
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.
• 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.
• 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 £262.7 million at December 31, 2018 as
compared to £266.3 million at December 31, 2017. The reduction
in Ambac UK’s shareholders’ funds was primarily due to the
increase in loss provisions over the year driven by a lower discount
rate, offset by net income arising from the receipt of premiums and
investment return in the period. At December 31, 2018, the
carrying value of cash and investments was £498 million, an
increase from £460 million at December 31, 2017. The increase in
cash and investments is due to the continued receipt of premiums,
investment returns from Ambac UK's investment portfolio,
unrealized foreign exchange gains on investments denominated in
currencies other then Ambac UK's functional currency (British
Pounds) in the period, offset by loss expenses, tax and overhead
payments.
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 2.46%) of the anticipated defaulted debt
service payments over the expected period of default, less
estimated recoveries under subrogation rights. The discount
rate is equal to the lower of the rate of return on invested assets
for either the current year or the period covering the current
year plus the four previous years. Under U.S. GAAP, loss
reserves are established (net of U.S. GAAP basis unearned
premium revenue) for obligations that have experienced
credit deterioration, but have not yet defaulted using a
weighted-average risk-free discount rate, currently at 2.8%
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.
| Ambac Financial Group, Inc. 62 2018 FORM 10-K |
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, 2018 will be be published on
Ambac's website during March. Final annual Solvency II data and
Ambac UK's annual Solvency and Financial Condition Report will
be published on Ambac's website on April 22, 2019.
Available capital resources under Solvency II were a surplus of
£110.2 million at December 31, 2018 (based on the quarterly
Solvency II filing made on February 11, 2019 which may be subject
to update in the final annual Solvency II filing noted above) an
improvement from a surplus of £55.1 million at January 1, 2018.
Of these available capital resources the value eligible to meet
solvency capital requirements at December 31, 2018 was £110.2
million in comparison to £17.0 million as at January 1, 2018.
Eligible capital resources at December 31, 2018 and January 1,
2018 are in comparison to regulatory capital requirements of
£357.4 million and £346.3 million, respectively. Ambac UK is
therefore deficient in terms of compliance with applicable
regulatory capital requirements by £247.2 million and £329.3
million at December 31, 2018 and January 1, 2018, 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: Elimination of the
amortization of the financial guarantee insurance intangible
asset 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
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.
| Ambac Financial Group, Inc. 63 2018 FORM 10-K |
• 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,
$ Amount
Per Diluted
Share
$ Amount
Per Diluted
Share
$ Amount
Per Diluted
Share
Net income (loss) attributable to common stockholders
$
186
$
3.99
$
(329) $
(7.25) $
75
$
1.64
2018
2017
2016
Adjustments:
Non-credit impairment fair value (gain) loss on credit
derivatives
Insurance intangible amortization
Foreign exchange (gains) losses
Fair value (gain) loss on interest rate derivatives from
Ambac CVA
1
107
7
—
0.02
2.30
0.16
—
(11)
151
(21)
45
(0.24)
3.33
(0.47)
0.99
(8)
175
39
34
Adjusted Earnings (Loss)
$
301
$
6.47
$
(165) $
(3.64) $
315
$
(0.16)
3.82
0.86
0.73
6.89
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 $3 million, $20 million, and $(14)
million for the years ended December 31, 2018, 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 would have been $20 million, $50 million
and $148 million for the years ended December 31, 2018, 2017
and 2016, respectively. The net impact of these different
accounting bases on Net income attributable to common
stockholders (including per share amounts) was $16 million ($0.35
per share), $31 million ($0.68 per diluted share) and $162 million
($3.54 per diluted share), for the years ended December 31, 2018,
2017 and 2016, 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.
• Insurance intangible asset: Elimination of the financial
guarantee insurance intangible asset that arose as a result of
emergence
bankruptcy
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.
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.
a
as
component of
• 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
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.
| Ambac Financial Group, Inc. 64 2018 FORM 10-K |
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:
2018
2017
($ in millions, except per share data) December 31,
$ Amount
Per Share
$ Amount
Per Share
Total Ambac Financial Group, Inc. stockholders’ equity
$
1,592
$
35.12
$
1,381
$
30.52
Adjustments:
Non-credit impairment 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 Accumulated Other Comprehensive Income
1
(719)
462
(86)
0.03
(15.87)
10.19
(1.89)
1
(847)
597
(31)
Adjusted Book Value
$
1,251
$
27.58
$
1,101
$
0.01
(18.71)
13.20
(0.68)
24.34
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, most notably for RMBS and student loan policies.
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"). 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
$0.9 million for a 1 basis point parallel shift in USD benchmark
interest rates up or down at December 31, 2018.
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 $112 million
and $134 million at December 31, 2018 and 2017, 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 $148
million and $179 million at December 31, 2018 and 2017,
respectively. The net change of these different accounting bases
(including per share amounts) was $36 million ($0.79 per share)
and $45 million ($0.99 per share), at December 31, 2018 and 2017,
respectively. This is supplemental information only and is not a
component of Adjusted Book Value.
Factors that impact changes to Adjusted Book Value include many
of the same factors that impact Adjusted Earnings, including the
majority of revenues and expenses, but generally exclude
components of premium earnings since they are embedded in prior
period's Adjusted Book Value through the net unearned premiums
and fees in excess of expected losses adjustment. Net unearned
premiums and fees in excess of expected losses will affect Adjusted
Book Value for (i) changes to future premium assumptions (e.g.
expected term, interest rates, foreign currency rates, time passage)
and (ii) changes to expected losses for policies which do not exceed
their related unearned premiums. The Adjusted Book Value
increase from December 31, 2017 to December 31, 2018 was
primarily driven by Adjusted earnings.
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.
| Ambac Financial Group, Inc. 65 2018 FORM 10-K |
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, 2018:
spreads as much as 250 basis points would result in less than a $1
million impact to the fair value of derivatives at December 31,
2018. Refer to Note 9. Fair Value Measurements to the
Consolidated Financial Statements included in Part II, Item 8 in
this Form 10-K for further information on measurement of the
credit valuation adjustment.
($ in millions)
300 Basis Point Rise
200 Basis Point Rise
100 Basis Point Rise
Base Scenario
100 Basis Point Decline(1)
200 Basis Point Decline(1)
Estimated
Change in
Net Fair
Value
Estimated
Net Fair
Value
$
$
265
179
91
—
(94)
(191)
(701)
(787)
(875)
(966)
(1,060)
(1,157)
(1)
Incorporates an interest rate floor of 0%
Due to the low interest rate environment as of December 31, 2018,
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
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, 2018. It
is more likely that actual changes in credit spreads will vary by
obligor:
spreads
related
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, 2018. It is more likely that
actual changes in credit spreads will vary by security:
($ in millions)
Estimated
Change in
Net Fair
Value
Estimated
Net Fair
Value
250 Basis Point Widening
$
(104) $
50 Basis Point Widening
Base Scenario
50 Basis Point Narrowing
250 Basis Point Narrowing
Foreign Currency Risk:
(21)
—
20
74
2,581
2,664
2,685
2,705
2,759
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.
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,
2018.
Estimated
change in
fair value
$
(56)
(28)
28
56
($ in millions)
Estimated
Change in
Net Fair
Value
Estimated
Net Fair
Value
($ in millions)
Change in Foreign Exchange Rates Against U.S.
Dollar
250 Basis Point Widening
$
(17) $
50 Basis Point Widening
Base Scenario
250 Basis Point Narrowing
(4)
—
3
(34)
(21)
(17)
(5)
20% Decrease
10% Decrease
10% Increase
20% Increase
Also included in the fair value of derivatives is the effect of
Ambac’s creditworthiness, which reflects market perception of
Ambac’s ability to meet its obligations. 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 runoff of
uncollateralized interest rate and credit default swap liabilities,
Ambac’s credit valuation adjustment included in the determination
of fair value has resulted in $0.1 million reduction to derivative
liabilities as of December 31, 2018. An increase in Ambac credit
| Ambac Financial Group, Inc. 66 2018 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..................................................................................................................
68
Consolidated Financial Statements
Consolidated Balance Sheets..................................................
Consolidated Statements of Total Comprehensive Income
(Loss)......................................................................................
Notes to Consolidated Financial Statements
Note 1. Background and Business Description ...................
Note 2. Basis of Presentation and Significant Accounting
Policies
Note 3. 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 ...............
70
71
74
77
89
93
94
95
96
Consolidated Statements of Stockholders’ Equity .................
Consolidated Statements of Cash Flows ................................
72
73
Note 10. Investments ...........................................................
116
Note 11. Derivative Instruments..........................................
121
Note 12. Loans.....................................................................
124
Note 13. Long-term Debt.....................................................
124
Note 14. Income Taxes ........................................................
126
Note 15. Employment Benefit Plans ...................................
128
Note 16. Commitments and Contingencies .........................
131
Note 8. Insurance Regulatory Restrictions ..........................
103
Note 17. Quarterly Information (Unaudited).......................
138
Note 9. Fair Value Measurements........................................
106
| Ambac Financial Group, Inc. 67 2018 FORM 10-K |
Report of Independent Registered Public Accounting Firm
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, 2019
To the Stockholders and Board of Directors
Ambac Financial Group, Inc.:
Opinion on Internal Control Over Financial Reporting
Inc. and
We have audited Ambac Financial Group,
subsidiaries' (the Company) internal control over financial
reporting as of December 31, 2018, 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, 2018, 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, 2018 and 2017, 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, 2018, and the related notes and financial statement
schedules (collectively, the consolidated financial statements), and
our report dated February 28, 2019 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.
| Ambac Financial Group, Inc. 68 2018 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
Basis for Opinion
We have audited the accompanying consolidated balance sheets of
Ambac Financial Group, Inc. and subsidiaries (the Company) as
of December 31, 2018 and 2017, 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, 2018, 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, 2018 and 2017, and the results of
its operations and its cash flows for each of the years in the three-
year period ended December 31, 2018, 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, 2018, 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, 2019 expressed an unqualified
opinion on the effectiveness of the Company’s internal control over
financial reporting.
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.
financial
statements are
We conducted our audits in accordance with the standards of the
PCAOB. Those standards require that we plan and perform the
audit
the
to obtain reasonable assurance about whether
consolidated
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, 2019
| Ambac Financial Group, Inc. 69 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except share data) December 31,
2018
2017
Assets:
Investments:
Fixed income securities, at fair value (amortized cost of $3,020,744 and $4,614,623)
Fixed income securities pledged as collateral, at fair value (amortized cost of $0 and $99,719)
Short-term investments, at fair value (amortized cost of $430,405 and $557,476)
Other investments (includes $351,049 and $396,689 at fair value)
Total investments
Cash and cash equivalents
Restricted cash
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
Deferred 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 shares: 45,365,170 and
45,275,982
Additional paid-in capital
Accumulated other comprehensive income (loss)
Retained earnings
Treasury stock, shares at cost: 28,892 and 24,816
Total Ambac Financial Group, Inc. stockholders’ equity
Noncontrolling interest
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying Notes to Consolidated Financial Statements
$
$
$
$
$
$
$
3,115,675
—
430,331
391,217
3,937,223
63,089
19,405
3,351
11,576
495,391
23,133
61,134
1,932,960
9,913
59,468
47,040
718,931
112,788
2,737,286
999
4,287,664
66,302
1,058
14,588,711
629,971
1,826,078
32,913
40,130
2,928,929
375,808
76,699
62,085
1,707
556
5,268,596
1,712,062
30
12,955,564
—
454
219,429
(48,715)
1,421,302
(473)
1,591,997
41,150
1,633,147
14,588,711
$
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
| Ambac Financial Group, Inc. 70 2018 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,
2018
2017
2016
$
111,089
$
175,277
$
197,287
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)
Net gains (losses) on derivative contracts
Net realized gains on extinguishment of debt
Other income
Income (loss) on variable interest entities
Total revenues
Expenses:
Losses and loss expenses (benefit)
Insurance intangible amortization
Operating expenses
Interest expense
Total expenses
Pre-tax income (loss)
Provision for income taxes
Net income (loss)
Less: net gain (loss) attributable to noncontrolling interest
Less: loss on exchange of auction market preferred shares
Net income (loss) attributable to common stockholders
Other comprehensive income (loss), after tax:
Net income (loss)
Unrealized gains (losses) on securities, net of income tax provision (benefit) of $2,366,
$0 and $0
Gains (losses) on foreign currency translation, net of income tax provision (benefit) of
$0, $0 and $0
Credit risk changes of fair value option liabilities, net of income tax provision (benefit)
of $161, $0 and $0
Changes to postretirement benefit, net of income tax provision (benefit) of $0, $0 and $0
Total other comprehensive income (loss), net of income tax
Total comprehensive income (loss)
Less: comprehensive (loss) gain attributable to the noncontrolling interest:
Net gain
Less: loss on exchange of auction market preferred shares
Total comprehensive income (loss) attributable to common stockholders
Net income (loss) per share attributable to common stockholders:
Basic
Diluted
See accompanying Notes to Consolidated Financial Statements
$
$
$
$
$
270,525
2,192
272,717
(3,260)
22
(3,238)
111,624
6,990
3,121
4,922
3,436
510,661
(223,613)
107,281
112,204
242,256
238,128
272,533
5,134
267,399
—
81,686
185,713
267,399
55,148
337,774
23,179
360,953
(54,625)
34,454
(20,171)
5,366
75,937
4,920
214
19,670
622,166
513,186
150,854
122,436
119,941
906,417
(284,251)
44,464
(328,715)
—
—
281,049
32,318
313,367
(89,700)
67,881
(21,819)
39,284
(30,167)
4,845
18,070
(14,093)
506,774
(11,489)
174,608
114,285
124,344
401,748
105,026
30,709
74,317
(526)
—
$
$
(328,715) $
74,843
(328,715) $
(81,520)
74,317
67,900
(47,893)
73,586
(122,128)
935
(1,766)
6,424
273,823
—
81,686
192,137
4.07
3.99
$
$
$
—
1,273
(6,661)
(335,376)
—
—
—
23
(54,205)
20,112
(526)
—
(335,376) $
20,638
(7.25) $
(7.25) $
1.66
1.64
| Ambac Financial Group, Inc. 71 2018 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
$ 1,645,258
$ 1,233,845
$
(52,239) $
— $
453
$
199,560
$
(471) $
264,110
Balance at January 1, 2018
Total comprehensive income
Adjustment to initially apply
ASU 2016-01
Stock-based compensation
Cost of shares (acquired) issued
under equity plan
Issuance of common stock
Exchange of auction market
preferred shares
273,823
267,399
—
11,854
2,900
—
(1,158)
(1,156)
1
—
(296,634)
(81,686)
Warrants exercised
Balance at December 31, 2018 $ 1,633,147
3
—
$ 1,421,302
Balance at January 1, 2017
$ 1,978,024
$ 1,557,681
$
$
6,424
(2,900)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
1
—
—
(48,715) $
— $
454
(38,990) $
— $
Total comprehensive income
(335,376)
(328,715)
(6,661)
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
—
6,588
(6,588)
(137)
4,293
(137)
—
(1,547)
(1,572)
—
—
—
—
—
—
—
—
1
Issuance of common stock
Balance at December 31, 2017 $ 1,645,258
—
$ 1,233,845
Balance at January 1, 2016
$ 1,958,346
$ 1,478,439
$
$
—
(52,239) $
—
— $
—
—
11,854
—
—
8,012
3
219,429
195,267
$
$
—
—
—
4,293
—
—
199,560
$
452
—
—
—
—
—
1
453
15,215
$
— $
450
$
190,813
Total comprehensive income
20,112
74,843
(54,205)
Adjustment to initially apply
ASU 2014-13
Stock-based compensation
Cost of shares (acquired) issued
under equity plan
Cost of warrants acquired
Issuance of common stock
Deconsolidation of a variable
interest entity
Warrants exercised
—
5,253
(505)
(2,717)
2
(2,469)
2
6,442
—
(127)
(1,916)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
2
—
—
—
—
5,253
—
(801)
—
—
2
$
$
$
$
—
—
—
(2)
—
—
—
—
—
—
—
—
(222,960)
—
(473) $
41,150
(496) $
264,110
—
—
—
—
25
—
—
—
—
—
—
(471) $
—
264,110
(118) $
273,547
—
—
—
(378)
—
—
—
—
(526)
(6,442)
—
—
—
—
(2,469)
—
Balance at December 31, 2016 $ 1,978,024
$ 1,557,681
$
(38,990) $
— $
452
$
195,267
$
(496) $
264,110
See accompanying Notes to Consolidated Financial Statements
| Ambac Financial Group, Inc. 72 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
2018
2017
2016
$
$
185,713
—
81,686
267,399
(328,715) $
—
—
(328,715)
(Dollars in thousands) Year Ended December 31,
Cash flows from operating activities:
Net income (loss) attributable to common stockholders
Noncontrolling interest in subsidiaries’ earnings
Exchange for auction market preferred shares
Net income (loss)
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization
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 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
Change in cash collateral receivable
Proceeds from paydowns of consolidated VIE assets
Other, net
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Net proceeds from issuance of Tier 2 notes
Proceeds from issuance of surplus notes
Paydowns of Ambac Note
Paydowns of a secured borrowing
Payments for investment agreement draws
Payments for extinguishment of surplus notes
Payments for debt issuance costs
Payments for auction market preferred shares
Tax payments related to shares withheld for share-based compensation plans
Proceeds from warrant exercises
Cost of warrants acquired
Payments of consolidated VIE liabilities
Net cash used in financing activities
Effect of foreign exchange on cash and cash equivalents
Net cash flow
Cash, cash equivalents, and restricted cash at beginning of period
Cash, cash equivalents, and restricted cash at end of period
See accompanying Notes to Consolidated Financial Statements
$
| Ambac Financial Group, Inc. 73 2018 FORM 10-K |
74,843
(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)
(41,130)
830,306
867,882
1,317,215
(2,574,285)
131,703
(281,570)
(206,002)
27,372
261,556
3,042
(453,087)
—
—
—
(29,482)
(17,964)
(19,550)
—
—
—
2
(2,717)
(249,271)
(318,982)
(3,905)
54,332
41,566
95,898
699
(136,772)
11,854
6,572
(35,498)
(162,542)
(1,633,203)
(4,963)
4,967
91,300
9,168
107,281
893
(111,624)
3,238
(3,121)
(3,436)
(17,488)
62,013
(1,543,263)
1,247,506
431,736
(528,156)
158,846
(140,338)
126,742
(57,736)
348,873
383
1,587,856
240,000
24,190
(214,062)
(73,993)
—
(191,258)
(9,221)
(11,048)
(1,116)
3
—
(348,873)
(585,378)
(403)
(541,188)
624,681
83,493
$
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)
13,036
(221,270)
2,138,936
813,990
(2,053,693)
349,799
(299,424)
(126,891)
122,844
234,670
(16,792)
1,163,439
—
—
—
(28,992)
(82,358)
(69,499)
—
—
(1,268)
—
—
(230,063)
(412,180)
(1,206)
528,783
95,898
624,681
$
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
1.
BACKGROUND AND BUSINESS DESCRIPTION
Ambac Financial Group, Inc. (“Ambac” or the “Company”),
headquartered in New York City, is a financial services holding
company incorporated in the state of Delaware on April 29, 1991.
Ambac 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”). 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., which has been
in runoff since its acquisition in 1997. The deterioration of Ambac
Assurance’s financial condition resulting from losses in its insured
portfolio since 2007 has prevented Ambac Assurance and Ambac
UK from being able to write new business. The 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 the terms of the Settlement Agreement,
dated as of June 7, 2010, as amended (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 Stipulation and
Order among the Office of the Commissioner of Insurance for the
State of Wisconsin (“OCI”), Ambac and Ambac Assurance that
became effective on February 12, 2018, as amended (the
“Stipulation and Order”), the terms of the indenture for the Tier 2
Notes (as defined below), which are substantially similar to the
terms of the Settlement Agreement in this regard, and the terms of
its Auction Market Preferred Shares ("AMPS"). It is highly
unlikely that Ambac Assurance will be able to make dividend
payments to Ambac for the foreseeable future.
Management reviews financial information, allocates resources
and measures financial performance on a consolidated basis. As a
result, the Company has a single reportable segment.
Limitations on Voting and Transfer of Common Stock
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 OCI. Article
XII contains substantial restrictions on the ability to transfer
Ambac’s common stock. 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.
On October 11, 2018, Ambac received a Private Letter Ruling
(“PLR”) from the U.S. Internal Revenue Service (“IRS”) with
regard to certain aspects of Section 382 of the Internal Revenue
Code of 1986, as amended. Section 382 generally limits the use of
a corporation’s net operating loss carryforwards when an
ownership change occurs. An ownership change results if there is
a cumulative increase of more than 50 percentage points in the
amount of stock held by one or more “5% shareholders” of the
corporation during a three-year testing period. A group of persons
who have a formal or informal understanding to make a
coordinated acquisition of stock is treated as a single entity for
these purposes.
The PLR addresses the ownership of Ambac’s common stock by
three separate groups of funds and accounts managed by three
separate investment advisors. In the PLR the IRS ruled that, based
on certain facts and representations, for purposes of Section 382
each investment advisor will not be treated as the owner of the
shares which it holds on behalf of the funds and accounts it advises,
and each group of funds and accounts will not be treated as a single
entity. The conclusions in the PLR are based on the particular facts
and circumstances set forth in Ambac’s request for the PLR,
| Ambac Financial Group, Inc. 74 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
including those set forth in representations provided in writing by
the investment advisors to Ambac, such as the current and expected
future investment strategies of the funds and accounts managed by
these investment advisors, the current and expected manner in
which the funds and accounts, and the investment decisions
regarding Ambac’s common stock, are managed by these investor
advisors, and the current and expected tax classification of the
funds managed by these investment advisors. The PLR does not
address the application of Section 382 to any Ambac shareholder
other than those specifically addressed in the PLR. Ambac reserves
all rights under its Charter regarding transfers and voting of its
stock and other securities, including those unrelated to Section 382.
Furthermore, receipt of the PLR does not affect any voting or
ownership restrictions that may apply to holders of Ambac’s
common stock pursuant to applicable law.
As a result of the PLR, neither the investment advisors specifically
addressed therein nor the funds and accounts they advise will be
treated by Ambac as 5% shareholders for purposes of Article XII
of the Charter unless any representation provided to Ambac by an
investment advisor ceases to be true, including that no individual
fund or account owns 5% or more of Ambac’s common stock.
Strategies to Enhance Shareholder Value
Ambac’s primary goal is to maximize shareholder value through
executing the following key strategies:
• Active runoff of Ambac Assurance and its subsidiaries
through transaction terminations, policy commutations,
reinsurance, 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 the effectiveness and efficiency of
Ambac's 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. We have been evaluating
strategic opportunities in credit, insurance, asset management and
other financial services that we believe would be synergistic to
Ambac and would leverage our core competencies. We will be
measured and disciplined in our approach as we consider and
pursue opportunities to deploy our capital with the goal of creating
sustainable long-term shareholder value. Although we are
exploring new business opportunities for Ambac, no assurance can
be given that we will be able to identify or execute a suitable
transaction and/or obtain the financial and other resources that may
be required to finance the acquisition or development of any new
businesses or assets.
The execution of Ambac’s objective 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, as well
as restrictions in the Settlement Agreement and in the indenture
for the Tier 2 Notes. Opportunities for remediating losses on poorly
performing insured transactions also depend on market conditions,
including
its
subsidiaries' 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 perception of Ambac Assurance’s and
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 the Wisconsin Insurance Commissioner, acting as
rehabilitator (the "Rehabilitator") 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
the Wisconsin Insurers Rehabilitation and
provisions of
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, which
was confirmed 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. 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
the Segregated Account
Rehabilitation Plan.
impacted by
On February 12, 2018, the rehabilitation of the Segregated Account
was concluded pursuant to an amendment to the Segregated
Account Rehabilitation Plan (the "Second Amended Plan of
Rehabilitation"). The conclusion of the rehabilitation followed the
successful completion of Ambac's surplus note exchange offers
and consent solicitation, which, together with the satisfaction of
all conditions precedent to the effectiveness of the Second
Amended Plan of Rehabilitation, including the discharge of all
unpaid policy claims of the Segregated Account, including
accretion amounts thereon ("Deferred Amounts"), completed the
restructuring transactions (the "Rehabilitation Exit Transactions")
announced by Ambac on July 19, 2017.
In exchange for an effective consideration package of 40% cash,
41% Secured Notes (as defined below) and 12.5% General
Account Surplus Notes (as defined below), paid in respect of
outstanding Deferred Amounts and General Account Surplus
| Ambac Financial Group, Inc. 75 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Notes. Ambac Assurance received the following benefits as a result
of the completion of the Rehabilitation Exit Transactions:
• Satisfaction and discharge of all outstanding Deferred
Amounts (including accretion) of the Segregated Account,
totaling $3,856,992;
• Cancellation of $552,320 in principal amount outstanding,
plus accrued and unpaid interest of $257,200 thereon, of
Ambac Assurance's 5.1% surplus notes due 2020 (the
"General Account Surplus Notes"); and
• An effective discount of 6.5% on Deferred Amounts (applied
first against accretion) and on the outstanding amount of
principal and accrued and unpaid interest on tendered General
Account Surplus Notes.
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. Ambac did not participate in the
voluntary surplus note exchange offers. Until the earlier of (i) June
8, 2020 and (ii) the date on which at least 25% of the principal
amount of General Account Surplus Notes (other than junior
surplus notes) are no longer outstanding, Ambac has agreed to
hold and not sell General Account Surplus Notes (other than junior
surplus notes) which, as of June 30, 2017, had an aggregate of
$60,000 of principal amount and accrued and unpaid interest
outstanding.
A newly formed special purpose entity, Ambac LSNI, LLC
("Ambac LSNI") issued $2,154,332 of 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 is secured by a
pledge of Ambac Assurance’s right, 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 cash and securities having
a market value of $209,983 as of December 31, 2018. 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.
Prior to the Rehabilitation Exit Transactions, Ambac and Ambac
Assurance owned securities that were insured by Ambac Assurance
and allocated to the Segregated Account. As a result of the
Rehabilitation Exit Transactions, Ambac and Ambac Assurance
received $124,881 and $643,583, respectively, of par amount of
Secured Notes issued by Ambac LSNI. The current holdings of
these secured notes are reported in Investments in the Consolidated
Balance Sheets at their fair value.
Stipulation and Order
Upon consummation of the Rehabilitation Exit Transactions, the
Stipulation and Order became effective. The Stipulation and Order
includes affirmative covenants, as well as restrictions on certain
business activities and transactions, of Ambac and Ambac
Assurance. The Stipulation and Order has no fixed term and may
be terminated or modified only with the approval of OCI. OCI
reserved the right to modify or terminate the Stipulation and Order
in a manner consistent with the interests of policyholders, creditors
and the public generally.
Tier 2 Financing
On the effective date of the Rehabilitation Exit Transactions,
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.
The indenture for the Tier 2 Notes limits certain activities of Ambac
Assurance and its subsidiaries, such as issuing indebtedness;
engaging in mergers and similar transactions; disposing of assets;
making restricted payments; and creating or permitting liens
(among other restrictions and limitations). The indenture for the
Tier 2 Notes includes certain allowances with respect to these
activities and generally requires the approval of OCI and, in some
cases, holders of the Tier 2 Notes, for consents, waivers or
amendments.
Bank Settlement Agreement Waiver and Amendment
As part of the Rehabilitation Exit Transactions, Ambac and Ambac
Assurance received sufficient consents from holders of General
Account Surplus Notes for a waiver and amendment (the "BSA
Waiver and Amendment") of the Settlement Agreement. Among
other provisions, the BSA Waiver and Amendment includes
amendments to the Settlement Agreement that (i) eliminate the
requirement for Ambac Assurance to have "unaffiliated qualified
directors" on its Board of Directors; (ii) eliminate the prohibition
on new business activities; (iii) modify the restrictions on the
incurrence of indebtedness and other material obligations; (iv)
modify the restrictions on liens securing permitted indebtedness;
(v) modify restrictions applicable to junior surplus notes; and (vi)
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.
Final Decree and Order
On June 22, 2018, the Rehabilitation Court entered the Final
Decree and Order discharging
Insurance
Commissioner as Rehabilitator and
the Special Deputy
Commissioner for the Segregated Account and formally closing
the case that was commenced by OCI in the Rehabilitation Court
in 2010.
the Wisconsin
| Ambac Financial Group, Inc. 76 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
August 2018 AMPS Exchange
At June 30, 2018, Ambac Assurance had 26,411 shares of issued
and outstanding AMPS with a liquidation preference of $660,275
(reported as noncontrolling interest of $264,110 on Ambac's
balance sheet).
On July 3, 2018, Ambac and Ambac Assurance commenced an
offer to exchange (the “AMPS Exchange”) all of Ambac
Assurance’s outstanding AMPS for General Account Surplus
Notes and, from Ambac, cash and warrants to purchase Ambac's
common stock. Concurrently with the AMPS Exchange, Ambac
Assurance solicited proxies (each a “Proxy” and together the
“Proxies”) from the holders of the AMPS to vote in favor of a
resolution to be passed at a special meeting (“Special Meeting”)
of Ambac Assurance’s shareholders (the “Proxy Solicitation”). The
General Account Surplus Notes offered in the AMPS Exchange
have the same terms as other outstanding surplus notes of Ambac
Assurance (other than junior surplus notes). The offering period
for the AMPS Exchange expired on August 1, 2018 and the
transaction closed on August 3, 2018 (the "Settlement Date").
In exchange for each $25 of liquidation preference (i.e., per share),
AMPS holders received from Ambac Assurance General Account
Surplus Notes with a total outstanding amount (including accrued
and unpaid interest thereon through on June 22, 2018 (the "Signing
Date")) equal to $13.875 (the “Repurchase”). AMPS holders who
tendered on or before July 17, 2018, representing 22,096 of the
AMPS, also received from Ambac $0.500 in cash and 37.3076
warrants (rounded down to the nearest whole warrant) to purchase
an equivalent number of shares of common stock of Ambac at an
exercise price of $16.67 per share (the “AFG Purchase” and,
together with the Repurchase, the “Purchases”).
As a result of the completion of the Purchases, Ambac:
1) Repurchased 84.4% or 22,296 AMPS with an aggregate
liquidation preference of $557,400, including $34,650 in
aggregate liquidation preference in the AFG Purchase;
2) Captured a nominal discount of approximately $227,000
(a discount of approximately $253,000 on a fair market
value basis) on $557,400 of the total outstanding
liquidation preference of AMPS; and
3)
Issued, in aggregate, $212,740 in current principal amount
of General Account Surplus Notes with accrued interest
thereon on Settlement Date of $98,366, issued 824,307
warrants and paid $11,048 in cash.
The AMPS are reported on the balance sheet within non-
controlling interests and are carried at their fair value at the date
Ambac emerged from bankruptcy in April 2013, which is lower
than the fair value of the total consideration provided to the AMPS
holders in the Purchases. The difference between the fair value of
consideration provided to AMPS holders and the carrying amount
of the AMPS was reflected as a reduction to Net income attributable
to common stockholders in the third quarter of 2018 for
approximately $81,686.
Concurrently with the offering of the AMPS Exchange, Ambac
Assurance launched the Proxy Solicitation to approve (i) for the
holders of AMPS only, the Purchases and (ii) an amendment to
Ambac Assurance’s Restated Articles of Incorporation to delete
Section 7(c) of the Fifth Article, which provided for the purported
right of holders of AMPS to elect Ambac Assurance directors in
certain circumstances (the “Charter Amendment” and together
with the Purchases, the “Transactions”). The affirmative vote of
the holders of at least two-thirds in aggregate liquidation
preference of AMPS was required for the Purchases and the Charter
Amendment to be operative. Additionally, the affirmative vote of
at least two-thirds of the outstanding shares of Ambac Assurance
common stock entitled to vote at the Special Meeting was required
for the Charter Amendment to be operative. The Special Meeting
was held on July 18, 2018, at which the Transactions were duly
approved. The Charter Amendment became effective on the
Settlement Date.
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. Such estimates that are
particularly susceptible to change are used in connection with
certain fair value measurements, valuation of loss reserves for non-
derivative insurance policies and the 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
| Ambac Financial Group, Inc. 77 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
of the VIE. An entity that is deemed the primary beneficiary of a
VIE is required to consolidate the VIE. Refer to Note 3. Variable
Interest Entities, for a detailed discussion of Ambac’s involvement
in VIEs, Ambac’s methodology for determining whether Ambac
is required to consolidate a VIE and the effects of VIEs being
consolidated.
Ambac Unconsolidated Financial Information:
Financial information of Ambac is presented in Schedule II to this
Form 10-K as of December 31, 2018 and 2017 and for the years
ended December 31, 2018, 2017 and 2016. Investments in
subsidiaries are accounted for using the equity method of
accounting.
Investments:
The Investments - Debt Securities Topic of the ASC requires that
all debt 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 debt 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 Securities Topic of the ASC. Available-
for-sale debt 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 debt 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 which are accounted for in
accordance with the Investments - Equity Securities Topic of the
ASC. Such equity interests 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.
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.
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 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 amortized cost basis. Ambac accretes the new
amortized 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. Prior to
the discharge and settlement of the Segregated Account's claim
obligations on February 12, 2018, the estimate of Ambac's
Segregated Account claim payments, including interest on
Deferred Amounts, was an important consideration in the
evaluation of other than temporary impairment as such payments
were 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
| Ambac Financial Group, Inc. 78 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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, 2018 and 2017, was 2.7%. and 2.5%, respectively,
and the weighted average period of future premiums used to
estimate the premium receivable at December 31, 2018 and 2017,
was 8.7 years and 9.8 years, respectively.
Insured obligations consisting of homogeneous pools for which
Ambac uses expected future premiums to estimate the premium
receivable 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 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, 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.
• 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 under
the fair value option election 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. 79 2018 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.
• 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
within Net gains (losses) on derivative contracts on the
Consolidated Statements of Total Comprehensive Income.
• Ambac maintains a 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 within net gains
(losses) on derivative contracts 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. Variation
payments on centrally cleared swaps and futures contracts are
considered settlements of the associated derivative balances and
are reflected as a reduction to derivative liabilities or assets on the
Consolidated Balance Sheets. For other derivatives, 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 and are included in "Other assets" on
the Consolidated Balance Sheets. Refer to Note 11. Derivative
Instruments for further discussion of the Company’s use of
derivative instruments and their impact of the consolidated
financial statements. Refer to Note 9. Fair Value Measurements
for further description of the methodologies used to determine the
fair value of derivative contracts, including model inputs and
assumptions where applicable.
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
their 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 support 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 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 and (ii) accrued interest on Deferred
Amounts (generally at an effective rate of 5.1%.) as required
by the Segregated Account Rehabilitation Plan that became
effective on June 12, 2014. Unpaid claims are measured based
on the cost of settling the claims, which is principal plus
accrued interest. As a result of the Rehabilitation Exit
Transactions, as of February 12, 2018, all unpaid claims for
policies allocated to the Segregated Account were fully
satisfied and discharged. Subsequent to the Rehabilitation
Exit Transactions, unpaid claims are no longer included as a
component of loss reserves. Refer to Note 1. Background and
Business Description for further discussion of the Segregated
Account rehabilitation.
• 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 other litigation recoveries
and 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
| Ambac Financial Group, Inc. 80 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
negotiations and/or pursuing litigation. Ambac does not
estimate recoveries for litigations where its sole claim is for
fraudulent inducement, 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.
from period
to period and update
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
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:
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
fundamental credit quality. Through ongoing
surveillance, Ambac may also designate Class I credits into one or
more of the following categories:
the
• 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 or concern related to the issuer or transaction or the
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.
| Ambac Financial Group, Inc. 81 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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
(e.g.,
for
potential
commutations).
remediation
additional
activities
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 and tools to project future losses and resultant claim
payment estimates. We utilize cash flow models for residential
mortgage-backed (RMBS), student loan, Puerto Rico 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
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, Ambac’s ability
to execute a potential settlement (i.e., commutation) of the
insurance policy, including the impact on future installment
premiums, and/or other restructuring scenarios. 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.
loss estimate
The discount factor applied to the statistical expected loss approach
is based on a risk-free discount rate corresponding to the remaining
expected weighted-average life of the exposure and the exposure
currency. For the cash flow scenario approach, discount factors are
applied based on a risk-free discount rate term structure and
correspond to the date of each respective cash flow payment or
recovery and the exposure currency. Discount factors are updated
for the current risk-free rate each reporting period.
Ambac establishes loss expense reserves based on our estimate of
expected net cash outflows for loss expenses, such as legal and
consulting costs.
RMBS Representation and Warranty Subrogation Recoveries:
Ambac records, as a component of its loss reserve estimate,
subrogation recoveries related to securitized loans in RMBS
transactions that breached certain representations and warranties
described herein. Generally, the sponsor of an RMBS transaction
provided representations and warranties with respect to the
securitized loans, including representations 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 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) high 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.
to
loans conformed
to ascertain whether
Generally, subsequent to the forensic exercise of examining loan
files
the
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 loans 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
| Ambac Financial Group, Inc. 82 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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 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
above-mentioned, detailed
the
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. For example, Ambac received a significant payment
in 2016 from JP Morgan to settle RMBS-related litigation. As a
result of these factors, we do not make significant adjustments to
our estimated subrogation recoveries with respect to the credit risk
of these sponsors or their successors.
Our ability to realize RMBS R&W subrogation recoveries is
subject to significant uncertainty, including risks inherent in
litigation, collectability of such amounts from counterparties (and/
or their respective parents and affiliates), timing of receipt of any
such recoveries, intervention by 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. Failure to realize RMBS R&W subrogation recoveries
for any reason or the realization of RMBS R&W subrogation
recoveries materially below the amount recorded on Ambac's
consolidated balance sheet would have a material adverse effect
on our results of operations and financial condition and may result
in adverse consequences such as impairing the ability of Ambac
Assurance to honor its financial obligations; the initiation of
rehabilitation proceedings against Ambac Assurance; decreased
likelihood of Ambac Assurance delivering value to Ambac,
through dividends or otherwise; and a significant drop in the value
of securities issued or insured by Ambac or Ambac Assurance.
The approach used to estimate RMBS R&W subrogation
recoveries is based on obtaining loan files from the original pool
and conducting loan file re-underwriting to derive a breach rate to
be extrapolated to determine an estimated repurchase obligation.
We limit the estimated repurchase obligation by ever-to-date
incurred losses.
Multiple probability-weighted scenarios are developed by
applying various realization factors to the estimated repurchase
obligation. The realization factors in these scenarios reflect
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) assessment of
the strength of the specific case and (iii) experience in settling
similar claims. The probability weightings are developed based on
the unique facts and circumstances for each transaction. The sum
of
the
undiscounted RMBS R&W 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.
these probability-weighted
represents
scenarios
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
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.
| Ambac Financial Group, Inc. 83 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Noncontrolling Interest:
At December 31, 2018 and 2017, Ambac Assurance had 4,115 and
26,411 shares of issued and outstanding AMPS with a liquidation
preference of $102,875 and $660,275 (reported as noncontrolling
interest of $41,150 and $264,110 on Ambac's balance sheet),
respectively. 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.
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 awards of deferred stock units for certain
officers) and long term incentive plan awards (consisting of cash
awards and restricted 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 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.
The types of awards granted to employees are as follows:
• 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 recognized as
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 recognized as
compensation expense 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. Functional currencies operating
results of foreign subsidiaries 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
| Ambac Financial Group, Inc. 84 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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.
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 in
2013, vested and unvested options, unvested restricted stock units
and unvested performance stock units granted under employee and
director compensation plans.
gains/(losses)") are $(7,155), $21,116 and $(39,128) for the years
ended December 31, 2018, 2017 and 2016, of which $(15,448),
$28,939, and $(77,578) relate to the remeasurement of loss
reserves, classified in Loss and loss expenses, respectively.
Foreign currency transaction 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.
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 introduced 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.
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.
Supplemental Disclosure of Cash Flow Information:
(Dollars in thousands)
Year Ended December 31,
Cash paid during the period for:
Income taxes
Interest on long-term debt and investment agreements
Non-cash financing activities:
Increase in long-term debt in exchange for auction market preferred shares
Decrease in long-term debt as a result of an exchange for investment securities
Rehabilitation exit transaction discharge of all Deferred Amounts and cancellation of certain General Account
Surplus Notes
Reconciliation of cash, cash equivalents, and restricted cash reported within the Consolidated Balance
Sheets to the Consolidated Statements of Cash Flow:
Cash and cash equivalents
Restricted cash
Variable Interest Entity Restricted cash
2018
2017
2016
$
34,980
$
40,334
$
21,437
231,734
39,112
4,537
187,220
—
—
55,426
$1,918,561
$
— $
—
—
—
$
63,089
$ 623,703
$
91,025
19,405
999
—
978
—
4,873
Total cash, cash equivalents, and restricted cash shown on the Consolidated Statements of Cash Flows
$
83,493
$ 624,681
$
95,898
| Ambac Financial Group, Inc. 85 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Reclassifications:
Reclassifications may have been made to prior years' amounts to
conform to the current year's presentation.
Recently Adopted Accounting Standards:
Effective January 1, 2018, Ambac adopted the following
accounting standards:
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
the
apply modification accounting.
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 adoption of this ASU did not have an impact on
Ambac's financial statements.
Entities will apply
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.
Prior to adoption of this ASU, Ambac reported all postretirement
costs in Operating expenses on the Consolidated Statements of
Total Comprehensive Income (Loss). Adoption of this ASU
resulted in a reclassification of other non-service related amounts
from Operating expenses to Other income (expense) resulting in
an increase to both Operating expenses and Other income
(expense) of $920 and $625 for the years ended December 31, 2017
and 2016, respectively.
Restricted Cash
In November 2016, the FASB issued ASU 2016-18, Statement of
Cash Flows (Topic 230) - Restricted Cash. Prior to the effective
date of this ASU, GAAP did 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 ASU 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. Adoption of this ASU resulted in the inclusion of
restricted cash activity related to consolidated VIEs on the
Consolidated Statements of Cash Flows for all periods presented.
Also refer to the Supplemental Disclosure of Cash Flow
Information section above for the reconciliation of cash, cash
equivalents, and restricted cash reported on the Consolidated
Statement of Position that sum to the total of the same such amounts
on the Consolidated Statements of Cash Flows.
Income Taxes
In October 2016, the FASB issued ASU 2016-16, Income Taxes
(Topic 740) - Intra-Entity Transfers of Assets Other Than
Inventory. Prior to the effective date of this ASU, GAAP prohibited
the recognition of current and deferred income taxes for
intercompany transfers of assets until the asset had been sold to an
outside party. The ASU requires 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. The adoption of this ASU did
not have an 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 are potentially relevant to Ambac include the
following:
• 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.
After further evaluating the potentially relevant items, we
determined the adoption of this ASU did not have an impact on
Ambac's financial statements.
| Ambac Financial Group, Inc. 86 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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) requires equity investments with readily determinable
fair values to be measured at fair value with changes recognized
in net income; ii) simplifies the impairment assessment of equity
securities without readily determinable fair values using a
qualitative approach; iii) eliminates disclosure of the method and
significant assumptions used to fair value instruments measured
at amortized cost on the balance sheet; iv) requires the 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, requires the portion of the fair value
change related to instrument-specific credit risk, to be separately
reported in other comprehensive income; vi) requires 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) clarifies 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.
With respect to item v) above, Ambac has elected the fair value
option for all VIE financial liabilities. For these VIE liabilities this
ASU has resulted in a cumulative-effect reclassification of $2,900,
net of deferred tax of $590, between Retained earnings and
Accumulated other comprehensive income, with no net change to
Total stockholders' equity as of January 1, 2018. Going forward,
the instrument-specific credit risk of fair value changes in VIE
liabilities will be reported in Accumulated other comprehensive
income in accordance with this ASU, with all other fair value
changes continuing to be reported through net income. There was
no material impact on Ambac's financial statements for the other
provisions of this ASU.
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. As this ASU does not apply to insurance contracts and
most financial instruments, management determined there was no
impact on Ambac's financial statements.
Future Application of Accounting Standards:
VIE Related Party Guidance
In October 2018, the FASB issued ASU 2018-17, Consolidation
(Topic 810) - Targeted Improvements to Related Party Guidance
for Variable Interest Entities. To determine whether a decision-
making fee is a variable interest, under the new guidance a
reporting entity must consider indirect interests held through
related parties under common control on a proportional basis rather
than as a direct interest in its entirety (as currently required in
GAAP). These amendments create alignment between
determining whether a decision making fee is a variable interest
and determining whether a reporting entity within a related party
group is the primary beneficiary of a VIE. ASU 2018-17 is effective
for fiscal years, and interim periods within those fiscal years,
beginning after December 15, 2019, with early adoption permitted.
Ambac will adopt this ASU on January 1, 2020. The ASU is not
expected to have a consequential impact on Ambac's financial
statements.
Cloud Computing Arrangement Service Contracts
In August 2018, the FASB issued ASU 2018-15, Intangibles—
Goodwill and Other— Internal-Use Software (Subtopic 350-40) -
Customer’s Accounting for Implementation Costs Incurred in a
Cloud Computing Arrangement That Is a Service Contract. The
new guidance requires a customer in a cloud computing
arrangement that is a service contract to capitalize certain
implementation costs as if the arrangement was an internal-use
software project. The internal-use software guidance requires the
capitalization of certain costs incurred only during the application
development stage (e.g., costs of integration with on-premises
software, coding, configuration, customization). That guidance
also requires entities to expense costs during the preliminary
project and post-implementation stages (e.g., costs of project
planning, training, maintenance after implementation, data
conversion) as they are incurred. ASU 2018-15 is effective for
fiscal years, and interim periods within those fiscal years,
beginning after December 15, 2019, with early adoption permitted.
The ASU may be applied either retrospectively or prospectively
to all implementation costs incurred after the date of adoption.
Ambac will adopt this ASU on January 1, 2020. The ASU is not
expected to have a consequential impact on Ambac's financial
statements.
Defined Benefit and Other Postretirement Plans Disclosures
In August 2018, the FASB issued ASU 2018-14, Compensation -
Retirement Benefits - Defined Benefit Plans - General (Subtopic
715-20) - Disclosure Framework - Changes to the Disclosure
Requirements for Defined Benefit Plans. The ASU modifies
various disclosure requirements for employers that sponsor
defined benefit pension or other postretirement plans. Relevant
disclosures that will be removed are: i) amounts in accumulated
other comprehensive income expected to be recognized as net
periodic benefit cost over the next fiscal year, and ii) the effects of
a one percentage point change in assumed health care cost trend
rates on the (a) aggregate of the service and interest cost
components of the net periodic pension cost and (b) benefit
obligation for postretirement healthcare benefits. Relevant
disclosures that will be added are an explanation of the reasons for
significant gains and losses related to changes in the benefit
obligations for the period. ASU 2018-14 is effective for fiscal
years ending after December 15, 2020, with early adoption
permitted. The modified disclosures must be applied on a
retrospective basis for all periods presented. Ambac has not
determined whether it will early adopt this ASU. The ASU is not
expected to have a consequential impact on Ambac's financial
statements.
Fair Value Measurement Disclosures
In August 2018, the FASB issued ASU 2018-13, Fair Value
Measurement (Topic 820) - Disclosure Framework - Changes to
the Disclosure Requirements for Fair Value Measurement. The
| Ambac Financial Group, Inc. 87 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
ASU modifies various disclosure requirements on fair value
measurements. Relevant disclosures that will be removed,
modified and added are as follows:
• Removals: 1) Amount of and reasons for transfers between
Level 1 and Level 2 of the fair value hierarchy, 2) Policy for
timing of transfers between levels, and 3) Valuation processes
for Level 3 fair value measurements.
• Modifications: 1) For investments in certain entities that
calculate net asset value, disclosures are only required for the
timing of liquidation of an investee's assets and the date when
restrictions from redemption might lapse, only if the investee
has communicated the timing to the reporting entity or
publicly announced it, and 2) Clarification that the
measurement uncertainty disclosure is to communicate
information about the uncertainty in measurement as of the
reporting date and not possible future changes.
• Additions: 1) Changes in unrealized gains and losses for the
period included in other comprehensive income ("OCI") for
recurring Level 3 fair value measurements held at the end of
the reporting period and 2) Range and weighted average of
significant unobservable inputs used to develop Level 3 fair
value measurements. Alternatively, an entity may disclose
other quantitative information (such as the median or
arithmetic average) if it determines that it is a more reasonable
and rational method to reflect the distribution of unobservable
inputs used.
ASU 2018-13 is effective for fiscal years, and interim periods
within those fiscal years, beginning after December 15, 2019, with
early adoption permitted. Disclosure amendments related to
changes in unrealized gains and losses included in OCI for level
3 instruments, the range and weighted average of significant
unobservable inputs, and the narrative description of measurement
uncertainty should be applied prospectively only for the most
recent interim or annual period presented. All other disclosure
amendments should be applied retrospectively to all periods
presented. Ambac has not determined whether it will early adopt
this ASU. The ASU is not expected to have a consequential impact
on Ambac's financial statements.
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, 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 stockholders 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 and it will not 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 a 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 it will not 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 debt 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, with early adoption permitted. Ambac
will adopt this ASU on January 1, 2020 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
| Ambac Financial Group, Inc. 88 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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). This ASU was subsequently amended by ASU 2016-02, Land
Easement Practical Expedient; ASU 2010-10, Codification
Improvements
to Topic 842; ASU 2018-11, Targeted
Improvements; and ASU 2018-20, Narrow-Scope Improvements
for Lessors (collectively the "New Lease Standard"). The primary
difference between current U.S. GAAP and the New Lease
Standard is the recognition of lease assets and lease liabilities for
those leases classified as operating leases with a term longer than
12 months. For those operating leases, a lessee is required to: 1)
recognize a right-of-use asset ("ROU") and a lease liability,
initially measured at the present value of the lease payments, on
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. For leases classified as
finance leases under the New Lease Standard, the balance sheet
presentation and expense recognition pattern is similar to capital
leases under current GAAP.
The New Lease Standard is effective for fiscal years beginning
after December 15, 2018, including interim periods within those
fiscal years. Under the transition guidance, a reporting entity must
use a modified retrospective approach and may choose to initially
apply the New Lease Standard either at (1) the beginning of the
earliest comparative period presented, which is January 1, 2017 or
(2) its effective date, which is January 1, 2019 . If a reporting entity
chooses the first option it must recast its comparative period
financial statements and provide disclosures for those comparative
periods. Ambac has chosen the second option and will initially
apply the New Lease Standard on January 1, 2019. Consequently
financial information and disclosures will not be provided for dates
and periods prior to January 1, 2019.
There are a number of optional practical expedients that can be
elected at transition. We expect to elect the ‘package of practical
expedients’, which permits us not to reassess under the new
standard our prior conclusions about lease identification, lease
classification and initial direct costs. We do not expect to elect the
use-of-hindsight or the practical expedient pertaining to land
easements; the latter not being applicable to us.
We do not expect that the New Lease Standard will have a material
effect on our financial statements. While we continue to assess all
of the effects of adoption, we currently believe the most significant
effects relate to (1) the recognition of new ROU assets and lease
liabilities on our balance sheet for our office and equipment
operating leases and (2) providing significant new disclosures
about our leasing activities. We do not expect a significant change
in our leasing activities between now and adoption.
On adoption, we currently expect to recognize lease liabilities
ranging from $15,000 to $25,000, with corresponding ROU assets
within a similar range.
The New Lease Standard also provides practical expedients for a
reporting entity’s ongoing accounting. We currently expect to elect
the short-term lease recognition exemption for all leases that
qualify. For those leases that qualify for that exemption, we will
not recognize ROU assets or lease liabilities, and this includes not
recognizing ROU assets or lease liabilities for existing short-term
leases of those assets in transition. We also currently expect to elect
the practical expedient to not separate lease and non-lease
components for all of our leases.
Other significant implementation matters we are currently
addressing are identifying and documenting accounting process
changes, including related controls.
3.
VARIABLE INTEREST ENTITIES
Ambac, with its subsidiaries, has engaged in transactions with
variable interest entities ("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
investors for various purposes; and
• 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 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. 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 control rights that enable Ambac to remediate losses. 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 certain
liabilities (and in some cases certain assets). As further
described below, Ambac consolidated certain FG VIEs
because we also had the power to direct the activities that
most significantly impact the VIE’s economic performance
due to either: (i) the transaction experiencing deterioration
and breaching performance triggers, giving Ambac the ability
to exercise certain control rights or (ii) the transaction not
experiencing deterioration, however due to the passive nature
of the VIE, Ambac's contingent control rights upon a future
breach of performance triggers is considered to be the power
over the most significant activity. FG VIEs which are
consolidated include recourse liabilities and, in some cases,
may include non-recourse liabilities. FG VIEs' liabilities that
are insured by the Company are with recourse, because the
| Ambac Financial Group, Inc. 89 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Company guarantees the payment of principal and interest to
the extent there is a shortfall in the FG VIEs' assets. FG VIEs'
liabilities that are not insured by the Company are without
recourse, because the payment of principal and interest of
these liabilities is wholly dependent on the performance of
the FG VIEs' assets. The Company’s exposure to consolidated
FG VIEs is limited to the financial guarantees issued for
recourse liabilities and any additional variable interests held
by Ambac.
• A VIE is deconsolidated in the period that Ambac no longer
has such control rights, which could occur in connection with
the execution of remediation activities on the transaction or
amortization of insured exposure, either 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.
• Ambac has elected the fair value option for all FG VIE
liabilities which are
financial
financial assets and
consolidated. The total fair value changes in the financial
assets of such FG VIEs are reported within Income (loss) on
variable interest entities in the Consolidated Statements of
Total Comprehensive Income (Loss). Prior to January 1,
2018, the total fair value changes in the financial liabilities
of such FG VIEs were also reported within Income (loss) on
variable interest entities. As further described in Note 2. Basis
of Presentation and Significant Accounting Policies, effective
January 1, 2018, Ambac adopted ASU 2016-01. Under this
ASU, for financial liabilities where fair value option has been
elected, the portion of the total change in fair value caused
by changes in the instrument-specific credit risk is presented
separately in Other 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
the Consolidated Statements of Total
entities on
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.
In connection with the exit from rehabilitation of the Segregated
Account, as further described in Note 1. Background and Business
Description, Ambac evaluated the consolidation of certain VIEs.
Under the Stipulation and Order, the OCI retained the authority
requiring Ambac Assurance to obtain their approval with respect
to the exercise of certain control rights in connection with policies
that had previously been allocated to the Segregated Account.
Accordingly, Ambac did not consolidate any additional VIEs as a
result of the Segregated Account's exit from rehabilitation.
As of December 31, 2018 consolidated FG VIE assets and
liabilities relating to 7 consolidated entities were $7,093,309 and
$6,981,244, respectively. 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, 2018, seven and zero consolidated FG VIEs related
to transaction insured by Ambac UK and Ambac Assurance,
respectively. As of December 31, 2017, and eight and three
consolidated FG VIEs related to transaction insured by Ambac UK
and Ambac Assurance, respectively. As of December 31, 2018,
FG VIE assets and liabilities of $7,093,309 and $6,981,244, and
as of December 31, 2017, FG VIE assets and liabilities of
$14,160,152 and $14,026,704 related to transactions guaranteed
by Ambac UK. The remaining balance of consolidated FG VIE
assets and liabilities at December 31, 2017 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. 90 2018 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,
2018
2017
2016
Income (loss) on changes
related to:
Net change in fair value of
VIE assets and liabilities
Less: Credit risk changes of
fair value liabilities
Deconsolidation
Income (loss) on Variable
Interest Entities
$
2,782
$
19,670
$ (14,093)
(1,170)
1,824
—
—
—
—
$
3,436
$
19,670
$ (14,093)
Ambac deconsolidated four, one and one VIEs for the years ended
December 31, 2018, 2017 and 2016, respectively. These VIEs
were deconsolidated as a result of guaranteed bond retirements or
loss mitigation activities that eliminated or reduced Ambac's
control rights that previously required Ambac to consolidate these
entities. During 2018, one deconsolidation was related to
guaranteed bond retirement and three deconsolidations were due
to loss mitigation activities and resulted in the gains on
deconsolidation noted in the above table. The 2018 balance sheet
impact of these deconsolidations were a decline to total
consolidated assets and liabilities by $6,619,857 and $6,599,925
from December 31, 2017
to December 31, 2018. The
deconsolidations occurring in 2017 and 2016 were related to
guaranteed bond retirements which resulted in no gain or loss.
The table below provides the fair value of fixed income securities,
by asset-type, held by consolidated VIEs as of December 31, 2018
and 2017:
December 31,
Investments:
2018
2017
Corporate obligations
$ 2,737,286
$ 2,914,145
Total variable interest entity assets:
fixed income securities
$ 2,737,286
$ 2,914,145
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, 2018 and 2017:
December 31, 2018:
Loans
Long-term debt
December 31, 2017:
Loans
Long-term debt
Estimated
Fair Value
Unpaid
Principal
Balance
$ 4,287,664
$ 3,402,413
5,268,596
4,552,643
11,529,384
8,168,651
$12,160,544
$ 9,387,884
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, 2018 and
2017:
December 31, 2018:
Global structured finance:
Collateralized debt obligations
Mortgage-backed—residential (5)
Other consumer asset-backed
Other commercial asset-backed
Other
Total global structured finance
Global public finance
Total
Carrying Value of Assets and Liabilities
Maximum
Exposure
To Loss (1)
Insurance
Assets (2)
Insurance
Liabilities (3)
Net Derivative
Assets
(Liabilities) (4)
$
9,787
$
— $
— $
6,713,437
1,700,984
873,343
2,122,648
11,420,199
24,145,956
1,859,121
15,435
20,735
53,462
1,948,753
309,071
546,682
238,234
12,264
301,260
1,098,440
335,437
$
35,566,155
$
2,257,824
$
1,433,877
$
(2)
—
—
—
7,170
7,168
(1,457)
5,711
| Ambac Financial Group, Inc. 91 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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
Carrying Value of Assets and Liabilities
Maximum
Exposure
To Loss (1)
Insurance
Assets (2)
Insurance
Liabilities (3)
Net Derivative
Assets
(Liabilities) (4)
$
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
(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.
(5) On February 12, 2018, Deferred Amounts and Interest Accrued on Deferred Amounts in the amount of $3,000,158 and $856,834, respectively were settled.
This settlement impacted both insurance assets and insurance liabilities in the table above.
Ambac Sponsored VIEs:
Consolidated VIEs:
In July 2015, Ambac Assurance entered into a secured borrowing
transaction (the "Secured Borrowing") 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 remained in Invested
assets on the Consolidated Balance Sheets until they were sold to
redeem the outstanding Notes. 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 was payable monthly at an annual rate of one
month LIBOR + 2.8%. Both the Trust and the Issuer were
consolidated VIEs because Ambac Assurance was involved in their
design and holds a significant amount of the beneficial interests
issued by the VIEs and guaranteed the assets held by the VIEs. On
June 22, 2018, Ambac Assurance exercised its right to terminate
this structure though its right to sell a sufficient quantity of
Securities to redeem the remaining outstanding Notes of the Issuer
at par plus accrued interest. Accordingly, proceeds from the sale
of Securities were used to redeem the outstanding Notes. VIE debt
outstanding to third parties under this secured borrowing
transaction had a carrying value of $0 and $73,993 as of December
31, 2018 and 2017, respectively, and is reported in Long-Term
Debt on the Consolidated Balance Sheets.
Non-Consolidated VIEs:
A subsidiary of Ambac transferred financial assets to a VIE. The
business purpose of this entity was to provide certain financial
guarantee clients with funding for their debt obligations. This VIE
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 this entity
were allocated to the Segregated Account and, as discussed above,
the exercise of related control rights in such policies remain subject
to OCI approval under the Stipulation and Order. Ambac 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, 2018 and
2017 the fair value of this entity was $4,516 and $5,979,
respectively, and is reported within Other assets on the
Consolidated Balance Sheets.
| Ambac Financial Group, Inc. 92 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
• Total principal amount of debt outstanding was $393,010 and
$420,600 at December 31, 2018 and 2017, 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, 2018 and weighted average
life of 2.1 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, 2018 Ambac
Assurance had financial guarantee insurance policies issued
for all assets, MTNs and derivative contracts owned and
outstanding by the entity.
• Insurance premiums paid to Ambac Assurance 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.
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 note. Ambac
does not consolidate the VIE since it does not have a variable
interest in the trust. Ambac reports its owner trust certificate 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 $40,168 and $34,941
as of December 31, 2018 and 2017, respectively. Additionally, at
December 31, 2018 and 2017 Ambac held $0 and $35,000 of the
debt issued by this VIE.
On February 12, 2018, Ambac formed a VIE, Ambac LSNI, to
issue Secured Notes in connection with the Rehabilitation Exit
Transactions described further in Note 1. Background and Business
Description. Ambac does not consolidate the VIE since it does
not have a variable interest in the trust. Ambac reports its holdings
of Secured Notes within Fixed Income Securities in the
Consolidated Balance Sheets. The carrying values of Secured
Notes held by Ambac Assurance and Ambac as of December 31,
2018 were $584,622 and $71,851, respectively. Ambac's debt
obligation to the VIE (the Ambac Note) had a carrying value of
$1,940,289 and is reported within Long-Term Debt on the
Consolidated Balance Sheets.
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)
Credit Risk
Changes of Fair
Value Option
Liabilities (1) (2)
Total
Year Ended December 31, 2018:
Beginning Balance
$
30,755
$
10,640
$
(93,634) $
— $
(52,239)
Adjustment to opening balance,
net of taxes (3)
Adjusted balance, beginning of period
Other comprehensive income before
reclassifications
Amounts reclassified from accumulated
other comprehensive income
Net current period other comprehensive
income
Balance at December 31, 2018
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 (loss)
$
$
—
30,755
135,903
(80,755)
55,148
85,903
$
—
10,640
(556)
(1,210)
(1,766)
—
(93,634)
(47,893)
—
(47,893)
(2,900)
(2,900)
—
935
935
8,874
$
(141,527) $
(1,965) $
(2,900)
(55,139)
87,454
(81,030)
6,424
(48,715)
118,863
$
9,367
$
(167,220) $
— $
(38,990)
(96,325)
14,805
(6,588)
(88,108)
2,625
(1,352)
—
1,273
73,586
—
—
73,586
—
—
—
—
(20,114)
13,453
(6,588)
(13,249)
(52,239)
Balance at December 31, 2017
$
30,755
$
10,640
$
(93,634) $
— $
| Ambac Financial Group, Inc. 93 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
(1) All amounts are net of tax and noncontrolling interest. Amounts in parentheses indicate reductions to Accumulated Other Comprehensive Income.
(2) Represents the changes in fair value attributable to instrument-specific credit risk of liabilities for which the fair value option is elected.
(3) Beginning in 2018, credit risk changes of fair value option liabilities are reflected as a component of Accumulated Other Comprehensive Income pursuant
to the adoption of ASU 2016-01. Refer to Note 2. Basis of Presentation and Significant Accounting Policies for further information regarding this change.
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)
Credit Risk Changes of Fair Value Option Liabilities
Total reclassifications for the period
Amount Reclassified from Accumulated
Other Comprehensive Income (1)
Year Ended December 31,
2018
2017
Affected Line Item in the
Consolidated Statement of
Total Comprehensive Income
$
$
$
$
$
$
$
(81,665) $
14,805 Net realized investment gains (loses)
910
(80,755) $
(963) $
(247)
(1,210)
—
— Provision for income taxes
14,805 Net of tax and noncontrolling interest (3)
(963) Other income (2)
(389) Other income (2)
(1,352) Total before tax
— Provision for income taxes
(1,210) $
(1,352) Net of tax and noncontrolling interest (3)
1,096
(161)
935
$
$
(81,030) $
—
Credit risk changes of fair value option
liabilities
— Provision for income taxes
— Net of tax and noncontrolling interest
13,453 Net of tax and noncontrolling interest (3)
(1) Amounts in parentheses indicate debits to the Consolidated Statement of Comprehensive Income.
(2) These accumulated other comprehensive income components are included in the computation of net periodic benefit cost.
(3) Amount agrees with amount reported as reclassifications from AOCI in the disclosure about changes in AOCI balances.
5.
NET INCOME PER SHARE
As of December 31, 2018, 45,336,278 shares of Ambac's common
stock (par value $0.01) and warrants entitling holders to acquire
up to 4,877,783 shares of new common stock at an exercise price
of $16.67 per share were outstanding. For the three years ended
December 31, 2018, 2017 and 2016, 194, 0 and 136 warrants were
exercised, respectively, resulting in an issuance of 194, 0 and 136
shares of common stock, respectively.
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 years ended December
31, 2018 and 2017, Ambac did not repurchase any warrants. As
of December 31, 2018, Ambac had repurchased 985,331 warrants
at a total cost of $8,092, (average cost of $8.21 per warrant). The
remaining aggregate authorization at December 31, 2018 was
$11,939. In connection with the AMPS Exchange, Ambac issued
824,307 of the repurchased warrants at a price of $9.72 per warrant
on August 3, 2018. Refer to Note 1. Background and Business
Description for further discussion of the AMPS Exchange.
| Ambac Financial Group, Inc. 94 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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 (2)
Diluted weighted
average shares
outstanding
Anti-dilutive shares
excluded from the
above reconciliation
Stock options
Warrants
Restricted stock units
Performance stock
units (2)
2018
2017
2016
45,665,883
45,367,932
45,212,414
441,104
—
77,572
375,276
—
—
—
—
312,619
447
116,105
81,939
46,559,835
45,367,932
45,723,524
16,667
126,667
110,000
—
—
—
4,053,670
68,654
322,943
—
—
—
(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 that are dilutive are reflected based on the
performance metrics through the balance sheet date. Performance
stock units that are anti-dilutive are reflected 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 $52,055,000 and
$67,140,000 at December 31, 2018 and 2017, respectively. The
par amount of financial guarantees outstanding, net of reinsurance,
was $46,927,000 and $62,716,000 at December 31, 2018 and 2017,
respectively.
As of December 31, 2018 and 2017, the guarantee portfolio was
diversified by type of guaranteed bond as shown in the following
table:
Net Par Outstanding December 31,
2018
2017
Public Finance:
Lease and tax-backed revenue
Housing revenue (1)
General obligation
Transportation revenue
Utility revenue
Higher education
Health care revenue
Other
Total Public Finance
Structured Finance:
$ 7,565,000
$11,893,000
6,159,000
6,312,000
4,214,000
6,257,000
1,754,000
2,002,000
1,178,000
2,212,000
1,168,000
1,642,000
459,000
945,000
807,000
963,000
23,442,000
32,088,000
Mortgage-backed and home equity
5,510,000
7,267,000
Investor-owned utilities
Structured Insurance
Student loan
Asset-backed (2)
Other
1,754,000
3,274,000
1,365,000
1,420,000
934,000
237,000
147,000
1,238,000
443,000
174,000
Total Structured Finance
9,947,000
13,816,000
International Finance:
Sovereign/sub-sovereign
5,250,000
5,664,000
Investor-owned and public utilities
4,499,000
5,696,000
Transportation
Asset-backed (2)
Mortgage-backed and home equity
Other
1,613,000
1,777,000
1,550,000
2,609,000
—
626,000
246,000
820,000
Total International Finance
13,538,000
16,812,000
Total
$46,927,000
$62,716,000
(1)
Includes $5,759,000 and $5,829,000 of Military Housing net par at
December 31, 2018 and 2017, respectively.
(2) At December 31, 2018 and 2017, all asset-backed net par amounts
outstanding relate to commercial asset-based transactions.
As of December 31, 2018 and 2017, the International Finance
guaranteed portfolio by location of risk was as outlined in the table
below:
Net Par Outstanding December 31,
2018
2017
United Kingdom
$10,965,000
$13,554,000
Italy
Austria
Australia
France
Internationally diversified (1)
Other international
811,000
712,000
384,000
312,000
213,000
141,000
877,000
770,000
608,000
329,000
368,000
306,000
Total International Finance
$13,538,000
$16,812,000
(1)
Internationally diversified obligations
represent pools of
geographically diversified exposures which may include components
of U.S. exposure.
| Ambac Financial Group, Inc. 95 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Gross financial guarantees in force (principal and interest) were
$87,543,000 and $108,550,000 at December 31, 2018 and 2017,
respectively. Net financial guarantees in force (after giving effect
to reinsurance) were $77,972,000 and $101,223,000 as of
December 31, 2018 and 2017, respectively.
In the United States, California, New York and Colorado were the
states with the highest aggregate net par amounts in force,
accounting for 7.9%, 5.5% and 5.2% of the total at December 31,
2018, respectively. No other state accounted for more than 5.0%.
The highest single insured risk represented 2.8% of the aggregate
net par amount guaranteed.
7.
FINANCIAL GUARANTEE INSURANCE
CONTRACTS
Amounts presented in this Note relate only to Ambac’s non-
derivative insurance business for insurance policies issued to
beneficiaries, including VIEs, for which we do not consolidate the
VIE.
Net Premiums Earned:
Below is the gross premium receivable roll-forward (direct and
assumed contracts) for the affected periods:
Year Ended
December 31,
Beginning premium
receivable
2018
2017
2016
$
586,312
$
661,337
$
831,575
Premium receipts
(56,441)
(81,597)
(77,038)
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)
(41,762)
(30,334)
(78,528)
14,668
16,162
18,637
2,167
(141)
6,054
(9,553)
20,885
(39,363)
$
495,391
$
586,312
$
661,337
(1) Gross premium receivable includes premiums to be received in
foreign denominated currencies most notably in British Pounds and
Euros. At December 31, 2018, 2017 and 2016 premium receivables
include British Pounds of $131,458 (£103,088), $151,852 (£112,342)
and $177,878 (£144,393), respectively, and Euros of $30,597
(€26,708), $36,001 (€29,976) and $34,866 (€33,108), 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. 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, 2018 and 2017, $7,136 and
$9,331 respectively, of premium receivables were deemed
uncollectable. As of December 31, 2018 and 2017, approximately
20% and 22%, respectively, of the premium receivables, net of
uncollectible premiums, related to transactions with non-
investment grade internal ratings, mainly structured finance
transactions. Past due premiums on policies insuring non-
investment grade obligations amounted to less than $100 at
December 31, 2018.
The effect of reinsurance on premiums written and earned was as
follows:
Year Ended
December 31,
Direct
Assumed
Ceded
Net
Premiums
2018:
Written
Earned
2017:
Written
Earned
2016:
Written
Earned
$ (23,828) $
— $ 16,860
$ (40,688)
118,977
79
7,967
$ 111,089
(14,313)
190,496
(53,837)
215,564
—
106
—
85
(2,104) $ (12,209)
15,325
$ 175,277
(8,772) $ (45,065)
18,362
$ 197,287
Ambac’s accelerated premium revenue for retired obligations for
the years ended December 31, 2018, 2017 and 2016, was $32,482,
$64,494 and $52,416, respectively.
The following table summarizes net premiums earned by location
of risk:
Year Ended
December 31,
United States
United Kingdom
Other international
2018
2017
2016
$
87,539
$
134,099
$
168,646
18,580
4,970
32,928
8,250
24,470
4,171
Total
$
111,089
$
175,277
$
197,287
| Ambac Financial Group, Inc. 96 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
(1) Future premiums to be collected are undiscounted and are used to
derive the discounted premium receivable asset recorded on Ambac's
balance sheet.
(2) 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.
The table below summarizes the future gross undiscounted
premiums to be collected and future premiums earned, net of
reinsurance at December 31, 2018:
Future
Premiums
to be
Collected (1)
Future
Premiums
to be
Earned Net of
Reinsurance (2)
Three months ended:
March 31, 2019
June 30, 2019
September 30, 2019
December 31, 2019
Twelve months ended:
December 31, 2020
December 31, 2021
December 31, 2022
December 31, 2023
Five years ended:
December 31, 2028
December 31, 2033
December 31, 2038
December 31, 2043
December 31, 2048
December 31, 2053
December 31, 2058
$
14,616
$
11,795
12,262
12,121
48,030
41,828
39,867
38,268
168,545
127,753
64,142
24,907
11,335
2,251
31
12,179
12,504
12,458
12,321
47,064
43,285
40,692
37,994
156,237
104,420
54,562
20,764
10,965
3,310
82
Total
$
617,751
$
568,837
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, 2018 and 2017:
Unpaid Claims
Present Value of Expected
Net Cash Flows
Balance Sheet Line Item
Claims
Accrued
Interest
Claims and
Loss Expenses
Recoveries
Unearned
Premium
Revenue
Gross Loss and
Loss Expense
Reserves
December 31, 2018:
Loss and loss expense reserves
Subrogation recoverable
Totals
December 31, 2017:
Loss and loss expense reserves
Subrogation recoverable
Totals
$
$
$
$
— $
—
— $
— $
2,246,335
—
175,694
— $
2,422,029
2,411,632
615,391
3,027,023
$
$
667,988
171,755
839,743
$
$
2,855,010
102,171
2,957,181
$
$
$
$
(313,595) $
(106,662) $
1,826,078
(2,108,654)
—
(1,932,960)
(2,422,249) $
(106,662) $
(106,882)
(1,054,113) $
(135,502) $
4,745,015
(1,520,530)
—
(631,213)
(2,574,643) $
(135,502) $
4,113,802
| Ambac Financial Group, Inc. 97 2018 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
2018
2017
2016
$ 4,113,802
$ 3,696,038
$ 2,858,813
Reinsurance recoverable
40,658
30,767
44,059
$ 4,073,144
$ 3,665,271
$ 2,814,754
Beginning balance of net
loss and loss expense
reserves
Losses and loss
expenses (benefit)
incurred:
Current year
Prior years (3)
Total (1)(2)
Loss and loss expenses
(recovered) paid:
Current year
Prior years (3)
Total
4,884
(228,497)
(223,613)
204
3,963,341
3,963,545
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)
Foreign exchange effect
(15,491)
Ending net loss and loss
expense reserves
Reinsurance recoverable
(4)
Ending gross loss and
loss expense
reserves (5)
$ (129,505) $ 4,073,144
$ 3,665,271
22,623
40,658
30,767
$ (106,882) $ 4,113,802
$ 3,696,038
(1) Total losses and loss expenses (benefit) includes $1,657, $(20,348)
and $5,421 for the years ended December 31, 2018, 2017 and 2016,
respectively, related to ceded reinsurance.
(2) Ambac records the impact of estimated recoveries related to
securitized loans in RMBS transactions that breached certain
representations and warranties within losses and loss expenses
(benefit). The losses and loss expense (benefit) incurred associated
with changes in estimated representation and warranty recoveries for
the year ended December 31, 2018, 2017 and 2016 was $62,493,
$72,003 and $(71,369), respectively.
(3) 2018 loss and loss expenses (recovered) paid includes the settlement
of Deferred Amounts and Interest Accrued on Deferred Amounts in
the amount of $3,000,158 and $856,834, respectively in connection
with the Rehabilitation Exit Transactions through a combination of
cash, surplus notes and secured notes. 2018 loss and loss expenses
incurred includes a $288,204 loss and loss expense benefit on these
settled Deferred Amounts.
(4) 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 $510, $339 and $(349) as of December 31, 2018, 2017 and 2016,
respectively, related to previously presented loss and loss expenses
and subrogation.
(5)
Includes Euro denominated gross loss and loss expense reserves of
$3,328 (€2,905), $21,116 (€17,582) and $21,375 (€20,297) at
December 31, 2018, 2017 and 2016, respectively.
For 2018, the net positive development in prior years was primarily
a result of the discount recorded on the Rehabilitation Exit
Transactions partially offset by negative development in the Public
Finance portfolio and interest accrued on Deferred Amounts prior
to the Rehabilitation Exit Transactions.
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 of $144,600
related to a confidential settlement of litigation brought by Ambac
UK in the name of Ballantyne Re plc ("Ballantyne") that will
reduce the ultimate Ballantyne claims Ambac UK is expecting to
pay.
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 RMBS R&W subrogation
recoveries 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. 98 2018 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, 2018 and 2017. 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, 2018 and 2017 was 2.8% and 2.5%, respectively.
Number of policies
Remaining weighted-average contract
period (in years) (1)
Gross insured contractual payments
outstanding:
Principal
Interest
Total
Gross undiscounted claim liability
Discount, gross claim liability
Gross claim liability before all subrogation
and before reinsurance
Less:
Gross RMBS subrogation (2)
Discount, RMBS subrogation
Discounted RMBS subrogation, before
reinsurance
Less:
Gross other subrogation (3)
Discount, other subrogation
Discounted other subrogation, before
reinsurance
Gross claim liability, net of all subrogation
and discounts, before reinsurance
Less: Unearned premium revenue
Plus: Loss expense reserves
Gross loss and loss expense reserves
Reinsurance recoverable reported on
Balance Sheet (4)
$
$
$
$
$
I
IA
Surveillance Categories as of December 31, 2018
V
III
IV
II
21
9
28
19
18
9
16
22
145
14
Total
231
16
3
3
$
916,530
$
708,249
487,702
631,708
$ 1,404,232
$ 1,339,957
4,019
$
63,712
$
$
$
622,820
$ 1,705,464
$ 5,407,202
293,293
6,979,130
2,177,539
916,113
$ 8,684,594
$ 7,584,741
36,000
$
992,019
$ 2,295,968
$
$
$
43,140
$ 9,403,405
13,401
10,582,773
56,541
$19,986,178
56,510
$ 3,448,228
(481)
(13,008)
(3,069)
(433,709)
(637,548)
(4,143)
(1,091,958)
3,538
$
50,704
$
32,931
$
558,310
$ 1,658,420
$
52,367
$ 2,356,270
—
—
—
—
—
—
—
—
—
(10,816)
7,318
(3,498)
—
—
—
—
—
—
— (1,809,937)
—
39,391
— (1,809,937)
—
39,391
— (1,770,546)
— (1,770,546)
(136,541)
(624,654)
(12,880)
(784,891)
67,008
55,088
3,774
133,188
(69,533)
(569,566)
(9,106)
(651,703)
3,538
$
47,206
$
32,931
$
488,777
$ (681,692) $
43,261
$
(65,979)
(943)
1,369
3,964
367
$
$
(10,073)
4,253
41,386
7,285
$
$
(5,085)
2,564
30,410
4,223
$
$
(36,365)
(5,926)
(53,987)
63,499
(209)
—
(106,662)
65,759
446,486
$ (672,180) $
43,052
$ (106,882)
26,096
$
(14,838) $
— $
23,133
(1) Remaining weighted-average contract period is weighted based on projected gross claims over the lives of the respective policies.
(2) RMBS subrogation represents Ambac’s estimate of subrogation recoveries from RMBS transaction sponsors for representation and warranty ("R&W")
breaches.
(3) Other subrogation represents subrogation related to excess spread and other contractual cash flows on public finance and structured finance transactions
including RMBS.
(4) Reinsurance recoverable reported on Balance Sheet includes reinsurance recoverables of $22,623 related to future loss and loss expenses and $510 related
to presented loss and loss expenses and subrogation.
| Ambac Financial Group, Inc. 99 2018 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, 2017
I
IA
II
III
IV
V
Total
26
10
20
23
26
10
22
24
179
13
4
4
277
17
$ 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
$ 1,115,288
$ 1,612,954
$ 9,181,576
$ 9,332,046
4,434
$
56,659
$
77,289
$ 1,412,976
$ 6,409,340
$
$
$
48,562
$11,687,070
16,332
11,197,612
64,894
$22,884,682
64,863
$ 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)
— (1,857,502)
—
23,115
—
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)
(12,238)
3,242
33,995
4,894
$
$
665
46,645
9,424
$
$
(46,086)
13,331
(64,786)
56,037
(276)
(135,502)
—
89,391
691,603
$ 3,273,234
$
50,366
$ 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 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.
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, as applicable, discrete revenue sources, direct
general obligation pledges and/or general obligation guarantees.
The Commonwealth of Puerto Rico and certain of
its
instrumentalities have defaulted and may 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 claim payments over the next several
years, the recoverability of which is subject to great uncertainty,
which may lead to a material increase in permanent losses, causing
a material adverse impact on our results of operations and financial
condition. Our exposure to Puerto Rico is impacted by the amount
of monies available for debt service, which is in turn affected by
a number of factors including demographic trends, economic
growth, tax policy and revenues, impact of reforms, fiscal plans,
government actions, budgetary performance and flexibility,
weather events, litigation outcomes, as well as federal funding of
Commonwealth needs. In the near term, the financial and economic
outlook for Puerto Rico is dependent upon a still fragile
infrastructure, heightening its vulnerability to additional weather
events. The longer term recovery of the Commonwealth economy
and its essential infrastructure will likely be dependent on, amongst
other factors, the management, usage and efficacy of federal
resources.
Also important to Puerto Rico's economic growth, government
reform and creditor outcomes is the revised fiscal plan for the
Commonwealth of Puerto Rico ("Revised Commonwealth Fiscal
Plan"), certified by the Financial Oversight and Management
| Ambac Financial Group, Inc. 100 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Board for Puerto Rico ("Oversight Board") on October 23, 2018.
The Revised Commonwealth Fiscal Plan outlines a series of
reforms, projects the fiscal and economic impact of those reforms,
and provides forecasts of resulting budgetary surpluses over a
fiscal year series. However, as was the case with prior
Commonwealth Fiscal Plans, the Revised Commonwealth Fiscal
Plan lacks a high degree of transparency regarding the underlying
data, assumptions and rationales supporting those assumptions,
making reconciliation and due diligence difficult. As a result, it is
difficult to predict the long-term capacity and willingness of the
Puerto Rico government and its instrumentalities to pay debt
service on bonded debt and how their debt burden and financial
flexibility might affect Ambac Assurance's claim potential, risk
profile and long-term financial strength.
Substantial uncertainty exists with respect to the ultimate outcome
for creditors in Puerto Rico, such as Ambac Assurance, due to,
amongst other matters, legislation enacted by the Commonwealth
and the federal government, including PROMESA, as well as
actions taken pursuant to 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. As a result of litigation or other
aspects of the restructuring processes, the difference among the
credits insured by Ambac Assurance may not be respected.
COFINA Debt Restructuring
On October 19, 2018, following the certification of the COFINA
Fiscal Plan, the Oversight Board filed the COFINA Plan of
Adjustment ("POA") and Disclosure Statement as part of the
COFINA Title III case. The Oversight Board also filed a Rule 9019
Motion in the Commonwealth Title III case to approve the
settlement of the Commonwealth-COFINA dispute. The filing of
the COFINA POA and Disclosure Statement as well as the
settlement motion followed the execution of a settlement
agreement between the Oversight Board and the COFINA Agent.
That settlement agreement is based on the previously announced
agreement in principle developed by the COFINA Agent and the
Commonwealth Agent. The COFINA POA is based on the
settlement agreement as well as the preliminary agreement among
COFINA bondholders announced August 8, 2018 and the
subsequent Plan Support Agreement and term sheet among the
Oversight Board, FAFAA, COFINA, bond insurers (including
Ambac Assurance), as well as certain COFINA and General
Obligation creditors.
The COFINA POA contemplated exchanging all existing COFINA
senior and subordinate bonds for cash as well as new COFINA
current interest and capital appreciation bonds ("new COFINA
bonds"). The cash and new COFINA bonds allocated to senior
bondholders equaled approximately 93% (considering the new
COFINA bonds at par) of such senior bondholders’ allowed claim,
in the amount of the COFINA senior bond accreted value, as of,
but not including, May 5, 2017 (the COFINA Title III Petition
Date).
Pursuant to the COFINA POA, each holder of Ambac Assurance-
insured senior COFINA bonds had the option to elect by January
11, 2019 to either (i) commute their rights in respect of the Ambac
Assurance insurance policy associated with the existing senior
COFINA bonds, which bonds would be discharged and Ambac
Assurance policy obligations with respect thereto would be
released, in exchange for new COFINA bonds, cash amounts to be
paid by COFINA, plus additional cash consideration provided by
Ambac Assurance equal to 5.25% of the accreted value of the
Ambac Assurance-insured senior COFINA bonds as of the
COFINA Petition Date or (ii) agree to deposit their Ambac
Assurance-insured senior COFINA bonds into a a trust in exchange
for units issued by the trust (the "COFINA Class 2 Trust"), which
trust would receive the new COFINA bonds and the cash amounts
to be paid by COFINA that such bondholders would have otherwise
received to the extent they had elected the recovery under clause
(i) above (thereby entitling the COFINA Class 2 Trust to receive
debt service payments from COFINA with respect to the new
COFINA bonds deposited into the trust), plus any accelerated
policy payments (made solely at Ambac Assurance's own
discretion) or claim payments due under the existing Ambac
Assurance insurance policy for the deficiency relating to the
existing senior COFINA bonds at the relevant scheduled payment
dates (2047 through 2054). Any claims payable under the existing
Ambac Assurance policy for the Ambac Assurance-insured senior
COFINA bonds held in the trust will be reduced by all amounts
distributed or deemed distributed from the trust to the holders of
the trust units from the new COFINA bonds and cash as well as
accelerated policy payments made by Ambac Assurance at its own
discretion. Ambac makes no representation and can give no
assurances that the new COFINA bonds or COFINA Class 2 Trust
units, both of which are not insured by Ambac Assurance, will
trade at par or any other price. Under the COFINA POA, Ambac
Assurance-insured bondholders who did not affirmatively elect the
trust option in clause (ii) above were deemed to have elected the
commutation option described in clause (i) above. As of the
January 11, 2019 election date, 74.9% of Ambac Assurance-
insured senior COFINA bondholders, by measure of insured par,
elected the commutation option or did not affirmatively elect to
exchange their bonds for units of the COFINA Class 2 Trust.
On February 4, 2019, the COFINA Plan of Adjustment was
confirmed and the Commonwealth 9019 motion was approved by
Judge Laura Taylor Swain of the U.S. District Court for the District
of Puerto Rico. On February 12, 2019, the COFINA POA went
effective, concurrent with the completion of the commutation
described above. Several parties are presently appealing the
confirmation of the POA and no assurances can be given regarding
the results of such appeals. As a result, Ambac Assurance's insured
COFINA bond exposure decreased significantly and Ambac
Assurance's remaining policy obligation shall be an asset of the
COFINA Class 2 Trust, which holds a ratable distribution of cash
and new COFINA bonds, which can be used to partially offset
Ambac’s remaining insurance liability.
At this time, it is unclear what impact the COFINA restructuring
will have on the prospective recoveries of Ambac Assurance's other
insured Puerto Rico instrumentalities.
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 aftereffects of the damage caused by hurricanes Maria and Irma,
our loss reserves may ultimately prove to be insufficient to cover
| Ambac Financial Group, Inc. 101 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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 RMBS 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 $219,100 at December
31, 2018 and 2017, 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
$84,267 at December 31, 2018. Credit exposure existed at
December 31, 2018 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, 2018, there were ceded reinsurance balances
payable of $32,913 offsetting this credit exposure.
To minimize its credit exposure to losses from reinsurer
insolvencies, Ambac Assurance (i) is entitled to receive collateral
from its reinsurance counterparties in certain reinsurance
contracts; and (ii) has certain cancellation rights that can be
exercised by Ambac Assurance in the event of rating agency
(among other events and
downgrades of a
circumstances). Ambac Assurance held letters of credit and
collateral amounting
its reinsurers at
December 31, 2018. As of December 31, 2018, the aggregate
amount of insured par ceded by Ambac Assurance to reinsurers
under reinsurance agreements was $5,128,000 with the largest
reinsurer accounting for $3,076,000 or 5.9% of gross par
outstanding at December 31, 2018.
to $114,294 from
reinsurer
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, 2018, Ambac had incurred losses associated with
its Domestic Public Finance insured portfolio of $36,674, which
was primarily impacted by the continued uncertainty and volatility
of the situation in Puerto Rico, partially offset by an increase in
loss reserve discount rates. 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, 2018, the
possible increase in loss reserves under stress or other adverse
conditions and circumstances was estimated to be approximately
$1,000,000. This possible increase in loss reserves under stress or
other adverse conditions is significant and if we were to experience
such
losses, our stockholders’ equity as of
December 31, 2018 would decrease from $1,633,147 to $633,147.
incremental
However, there can be no assurance that losses may not exceed
such amount.
Representation and Warranty Recoveries:
Ambac records estimated RMBS R&W subrogation recoveries for
breaches of R&W by sponsors of certain RMBS transactions. For
a discussion of the approach utilized to estimate RMBS R&W
subrogation recoveries, see Note 2. Basis of Presentation and
Significant Accounting Policies. RMBS 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 RMBS R&W subrogation recoveries of
$1,770,546, ($1,744,243 net of reinsurance) and $1,834,387,
($1,806,736 net of reinsurance) at December 31, 2018 and 2017,
respectively.
Below is the rollforward of RMBS R&W subrogation for the
affected periods:
Year ended December 31,
2018
2017
2016
Discounted RMBS
subrogation recovery
(gross of reinsurance) at
beginning of year
Impact of sponsor
actions (1)
All other changes (2)
Discounted RMBS
subrogation recovery
(gross of reinsurance) at
end of year
$1,834,387
$1,907,035
$2,829,575
—
—
(995,000)
(63,841)
(72,648)
72,460
$1,770,546
$1,834,387
$1,907,035
(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
| Ambac Financial Group, Inc. 102 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
The following table represents the percentage ceded to reinsurers
and reinsurance recoverable at December 31, 2018 and its rating
levels obtained from each reinsurers website as of February 25,
2019:
Reinsurers
Percentage
Ceded Par
Net Unsecured
Reinsurance
Recoverable (1)
Assured Guaranty Re Ltd
60.0%
$
—
Build America Mutual Assurance
Company (2)
Assured Guaranty Corporation
Sompo Japan Nipponkoa Insurance,
Inc.
28.2
7.1
4.7
18,815
—
—
Total
100%
$
18,815
(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.
(2) Build America Mutual Assurance Company has an S&P rating of AA.
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, 2018, 2017 and 2016, the insurance intangible
amortization expense was $107,281, $150,854 and $174,608,
respectively. As of December 31, 2018 and 2017, the gross
carrying value of the insurance intangible asset was $1,551,576
and $1,581,156, respectively. Accumulated amortization of the
insurance intangible asset was $832,645 and $734,183, as of
December 31, 2018 and 2017, respectively, resulting in a net
insurance intangible asset of $718,931 and $846,973, respectively.
The estimated future amortization expense for the net insurance
intangible asset is as follows:
Amortization expense (1)
2019
2020
2021
2022
2023
Thereafter
$
63,665
58,755
53,419
49,681
46,342
447,069
(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. Future
amortization considers the use of contractual lives for many bond
types which do not have homogeneous pools of underlying collateral.
Actual maturities will differ from contractual maturities because
borrowers may have the right to call or prepay certain obligations. If
those bonds types are retired early, amortization expense may differ
in the period of call or refinancing 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
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.
information concerning
In addition, pursuant to the terms of the Settlement Agreement, the
Stipulation and Order and the indenture for the Tier 2 Notes, Ambac
Assurance must seek prior approval by OCI of certain corporate
actions. The Settlement Agreement, Stipulation and Order and
indenture for the Tier 2 Notes 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. The indenture for the
Tier 2 Notes will remain in force until the Tier 2 Notes have been
redeemed, repurchased or repaid in full. Certain of the restrictions
in the Settlement Agreement and the indenture for the Tier 2 Notes
| Ambac Financial Group, Inc. 103 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
may be waived with the approval of the OCI and/or the requisite
percentage of holders of the related debt securities.
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, 2018, 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 $1,152,346 at
December 31, 2018, as compared to $699,614 as of December 31,
2017. 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, 2018 and 2017 was lower by $41,814 and lower by
$104,097, respectively, than if Ambac Assurance had reported such
amounts in accordance with NAIC SAP.
Prescribed Accounting Practices:
OCI has prescribed the following accounting practice that differ
from NAIC SAP for Ambac Assurance:
• Paragraph 8 of Statement of Statutory Accounting Principles
No. 60 “Financial Guaranty Insurance” 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 Assurance 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, 2018 and 2017 were 5.87% and 9.52%,
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.
• 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 statutory accounting principles,
surplus notes issued in conjunction with commutations or the
settlement of obligations would be valued at zero upon
issuance pursuant to paragraph 4, SSAP 41. OCI has directed
the Company to record surplus notes issued in connection
with commutations or the settlement of obligations at full par
value upon issuance. The surplus notes issued have a claim
against surplus senior to the preferred and common
shareholders.
• 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 ("OTTI")
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.
Beginning June 11, 2014, as a result of the amended
Segregated Account Rehabilitation Plan, OCI has directed the
Company to not evaluate investments in Ambac Assurance
insured securities with policies that were allocated to the
Segregated Account for OTTI and require all such
investments be reported at amortized cost regardless of its
NAIC risk designation. This accounting determination was
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.
Effective February 12, 2018, with the Segregated Account's
exit from Rehabilitation, this prescribed practice is no longer
applicable for OTTI evaluations going forward.
• 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 in Ambac Assurance’s statutory basis
financial statements. Pursuant to this prescribed practice, the
results of the Segregated Account were not included in Ambac
Assurance’s financial statements if Ambac Assurance’s
| Ambac Financial Group, Inc. 104 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
surplus is (or would be) less than $100,000 (the “Minimum
Surplus Amount”). As long as the surplus as regards to
policyholders was not less than the Minimum Surplus
Amount, payments by Ambac Assurance to the Segregated
Account under agreements between the parties are not
capped. Effective February 12, 2018 with the Segregated
Account's exit from rehabilitation, this prescribed practice is
no longer applicable.
Permitted Accounting Practices:
OCI has allowed the following permitted practices that differ from
NAIC SAP for Ambac Assurance:
• 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, 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
and into 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.
• In connection with the AMPS Exchange in 2018, Ambac
Assurance received permission from OCI of a permitted
practice to account for the exchange of AMPS for 5.1%
surplus notes in a manner that ensures compliance with certain
state insurance regulations that require a minimum surplus
level. Accordingly, Ambac Assurance recorded the excess of
the consideration paid over the par value of the AMPS as
follows: i) first as a reduction to gross paid-in and contributed
surplus up to an amount that resulted in a gross paid-in and
contributed surplus balance of not less than $75,000 and ii)
for any remaining excess, as a reduction to unassigned
surplus. This permitted practice only impacts the balance
sheet classification and has no impact on statutory surplus.
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 2019 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 indenture for the Tier 2
Notes (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 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,
| Ambac Financial Group, Inc. 105 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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
9.
FAIR VALUE MEASUREMENTS
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. The indenture
for the Tier 2 Notes contains a similar restrictive covenant and
further requires a proportional payment of the Tier 2 Notes (or
interest thereon) when payments are made on the surplus notes.
Under the terms of Ambac Assurance’s 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.
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
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.
Level 2
Level 3
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 financial
guarantee variable interest entities consolidated under the Consolidation Topic of the ASC.
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 include fixed income securities,
loan receivables, and certain long-term debt of financial guarantee variable interest entities consolidated under the Consolidation
Topic of the ASC.
| Ambac Financial Group, Inc. 106 2018 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, 2018 and 2017,
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, 2018:
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
Short term investments
Other investments (1)
Cash, cash equivalents and restricted cash
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:
Long term debt, including accrued interest
Derivative liabilities:
Credit derivatives
Interest rate swaps—liability position
Futures contracts
Other contracts
Liabilities for net financial guarantees written (2)
Variable interest entity liabilities:
Long-term debt
Derivative liabilities:
$
879,919
$
879,919
$
— $
879,919
$
1,278,122
1,278,122
30,834
94,394
258,607
131,356
442,443
430,331
391,217
82,494
9,913
59,468
4,516
30,834
94,394
258,607
131,356
442,443
430,331
367,315
82,494
11,620
59,468
4,516
2,737,286
2,737,286
999
999
4,287,664
4,287,664
66,302
11,185,865
3,304,737
$
$
66,302
11,163,670
3,259,966
$
$
$
$
1,459
71,861
3,379
—
1,459
71,861
3,379
—
(718,388)
558,824
5,268,596
5,268,596
—
29,922
94,394
—
—
—
304,880
71,108
52,661
—
—
—
—
999
—
—
1,278,122
912
—
258,607
131,356
370,372
125,451
—
29,833
—
12,008
—
—
—
—
66,302
553,964
$
3,152,882
— $
2,909,272
$
$
—
—
—
—
—
—
72,071
—
16,266
—
11,620
47,460
4,516
2,737,286
—
4,287,664
—
7,176,883
350,694
1,459
—
—
558,824
—
71,861
—
—
—
—
—
3,379
—
—
—
—
5,051,504
217,092
1,712,062
—
Interest rate swaps—liability position
1,712,062
1,712,062
Total financial liabilities
$
9,643,706
$
10,876,147
$
3,379
$
9,744,699
$
1,128,069
| Ambac Financial Group, Inc. 107 2018 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, 2017:
Financial assets:
Fixed income securities:
Municipal obligations
Corporate obligations
Foreign obligations
U.S. government obligations
$
779,834
$
779,834
$
— $
779,834
$
860,075
26,543
85,408
860,075
26,543
85,408
Residential mortgage-backed securities
2,251,333
2,251,333
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:
Long term debt, including accrued interest
Derivative liabilities:
Credit derivatives
Interest rate swaps—asset position
Interest rate swaps—liability position
Futures contracts
Other contracts
51,037
597,942
99,719
557,270
431,630
623,703
10,358
73,199
5,979
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
54,877
20,953,414
1,428,680
$
$
$
$
54,877
20,935,687
1,369,499
$
$
566
(627)
81,495
1,348
—
566
(627)
81,495
1,348
—
Liabilities for net financial guarantees written (2)
3,435,438
4,842,402
Variable interest entity liabilities:
Long-term debt
Derivative liabilities:
12,160,544
12,160,544
Interest rate swaps—liability position
2,205,264
2,205,264
450
25,615
85,408
—
—
—
99,719
389,299
56,498
615,073
—
—
—
—
978
—
—
859,625
928
—
1,515,316
51,037
525,402
—
167,971
29,750
8,630
—
11,825
—
—
—
—
54,877
1,273,040
$
4,005,195
— $
1,046,511
$
$
—
—
—
—
736,017
—
72,540
—
—
17,288
—
10,284
61,374
5,979
2,914,145
—
11,529,384
—
15,347,011
322,988
566
—
—
—
—
4,842,402
—
(627)
81,495
—
—
—
—
—
—
1,348
—
—
—
—
9,402,856
2,757,688
2,205,264
—
Total financial liabilities
$
19,312,708
$
20,660,491
$
1,348
$
12,735,499
$
7,923,644
(1) Excluded from the fair value measurement categories in the table above are investment funds of $279,941 and $310,441 as of December 31, 2018 and
2017, respectively, which are measured using NAV per share as a practical expedient.
(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.
| Ambac Financial Group, Inc. 108 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Determination of Fair Value:
When available, Ambac uses quoted active market prices specific
to the financial instrument to determine fair value, and classifies
such items within Level 1. The determination of fair value for
financial instruments categorized in Level 2 or 3 involves 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, 2018, approximately 8%, 90%, and 2% of the
investment portfolio
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, 2017,
approximately 6%, 79%, and 15% 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.
(excluding variable
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 were 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. As described in Note 1.
Background and Business Description, upon consummation of the
Rehabilitation Exit Transactions on February 12, 2018, all
Deferred Amounts have been settled. The fair value of such
securities classified as Level 3 was $0 and $709,950 at December
31, 2018 and 2017, respectively. Fair value 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.
The remaining portion of Level 3 residential mortgage-backed
securities as of December 31, 2017 was an Ambac-insured re-
REMIC containing distressed mortgage-backed securities as
collateral. The security was transfered from Level 3 to Level 2
| Ambac Financial Group, Inc. 109 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
during 2018. The fair value of this security was $26,067 as of
December 31, 2017. 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, 2018 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 $72,071 and $72,540 at December 31, 2018 and
2017, 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, 2018 and 2017
include the following weighted averages:
December 31, 2018:
a. Coupon rate.............................................. 5.97%
b. Average Life ............................................ 16.29 years
c. Yield......................................................... 12.00%
December 31, 2017:
a. Coupon rate.............................................. 5.97%
b. Average Life ............................................ 17.02 years
c. Yield......................................................... 12.00%
Other Investments:
Other investments primarily relate to investments in pooled
investment funds. The fair value of pooled investment funds is
determined using dealer quotes or alternative pricing sources when
such investments have readily determinable fair values. When fair
value is not readily determinable, pooled investment funds are
valued using the net asset value (“NAV”) per share as a practical
expedient as permitted under the Fair Value Measurement Topic
of the ASC. 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
swaps, 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. 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. The fair value of credit
derivative liabilities was reduced by $138 and $60 at December
31, 2018 and 2017, respectively, as a result of incorporating an
Ambac CVA into the valuation model for these contracts. Interest
rate swap liabilities are collateralized and are not adjusted with an
Ambac CVA at December 31, 2018 and 2017.
Interest rate swaps that are not centrally cleared are valued using
vendor-developed models that incorporate interest rates and yield
curves that are observable and regularly quoted. These models
provide the net present value of the derivatives based on contractual
terms and observable market data. Generally, the need for
counterparty (or Ambac) CVAs on interest rate derivatives is
mitigated by the existence of collateral posting agreements under
which adequate collateral has been posted. Certain of these
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.
Ambac's remaining credit derivatives ("CDS") are valued using an
internal model that uses traditional financial guarantee CDS
pricing to calculate the fair value of the derivative contract based
on the reference obligation's current pricing, remaining life and
credit rating and Ambac's own credit risk. The model calculates
the difference between the 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. Unobservable inputs
used include Ambac's internal reference obligation credit ratings
and expected life, estimates of fees that would be charged to assume
the credit derivative obligation and Ambac's CVA. Ambac is party
to only two remaining credit derivatives with internal credit ratings
of AA or better at December 31, 2018. Ambac has not made any
significant changes to its modeling techniques or related model
inputs for the periods presented.
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
| Ambac Financial Group, Inc. 110 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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 and discussions with industry participants. The discount
rates used for contracts in a net liability position are derived from
the rates implicit in the fair value of 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, 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.
Long-term Debt:
Long-term debt includes Ambac Assurance senior surplus notes
and junior surplus notes, notes outstanding to third parties arising
from Ambac Assurance's Secured Borrowing
transaction
(redeemed in June 2018) and the Ambac Note and Tier 2 Notes
issued in connection with the Rehabilitation Exit Transactions. The
fair values of senior surplus notes, the Secured Borrowing notes,
the Ambac Note and Tier 2 Notes are classified as Level 2. The
fair value of junior surplus notes are classified as Level 3.
Other Financial Assets and Liabilities:
The fair values of Loans and Ambac’s equity interest in Ambac
sponsored VIEs (included in Other assets) are estimated based
upon internal valuation models and are classified as Level 3.
Variable Interest Entity Assets and Liabilities:
The financial assets and liabilities of VIEs consolidated under the
Consolidation Topic of the ASC consist primarily of fixed income
securities, loans, derivative and debt instruments and are generally
carried at fair value. These consolidated VIEs are securitization
entities which have liabilities and/or assets guaranteed by Ambac
Assurance. The fair values of VIE debt instruments are determined
using the same methodologies used to value Ambac’s fixed income
securities in its investment portfolio as described above. VIE debt
fair value is based on market prices received from dealer quotes
or alternative pricing sources with reasonable levels of price
transparency. Such quotes are considered Level 2 and generally
consider a variety of factors, including recent trades of the same
and similar securities. For those VIE debt instruments where quotes
were not available, the debt instrument fair values are considered
Level 3 and are based on internal discounted cash flow models.
Comparable to the sensitivities of investments in fixed income
securities described above, longer (shorter) expected maturities or
higher (lower) yields used in the valuation model will, in isolation,
result in decreases (increases) in fair value liability measurement
for VIE debt. VIE debt instruments considered Level 3 include
notes secured primarily by 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 $217,092 and $2,757,688 at December
31, 2018 and 2017, 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, 2018 and 2017
include the following weighted averages:
December 31, 2018
a. Coupon rate.............................................. 2.20%
b. Maturity ................................................... 18.93 years
c. Yield......................................................... 3.18%
December 31, 2017
a. Coupon rate.............................................. 0.40%
b. Maturity ................................................... 15.28 years
c. Yield......................................................... 4.82%
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, 2018 and 2017 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
| Ambac Financial Group, Inc. 111 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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
3.1% at December 31, 2018 and 2017, 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 2018, 2017 and 2016. Ambac classifies
financial instruments in Level 3 of the fair value hierarchy when there is reliance on at least one significant unobservable input to the valuation
model. In addition to these unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of
inputs that are readily observable either directly or indirectly. Thus, the gains and losses presented below include changes in the fair value
related to both observable and unobservable inputs.
Level-3 Financial Assets and Liabilities Accounted for at Fair Value
Year Ended December 31, 2018
Investments
Other
Assets
Derivatives
Investments
Loans
Long-term
Debt
Total
Balance, beginning of period
$
808,557
$
5,979
$
60,808
$ 2,914,145
$11,529,384
$ (2,757,688) $12,561,185
VIE Assets and Liabilities
Total gains/(losses) realized and unrealized:
Included in earnings
Included in other comprehensive income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
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
$
$
36,222
(52,908)
—
—
—
(714,491)
—
(5,309)
—
(1,463)
(9,142)
16,010
(201,482)
(158,333)
(469,665)
189,438
90,901
29,583
(590,005)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(5,665)
(34,536)
(624,108)
22,905
(1,355,895)
—
—
—
—
—
—
—
—
—
—
(5,309)
— (5,946,465)
2,237,352
(3,709,113)
—
—
—
—
—
—
—
—
72,071
$
4,516
$
46,001
$ 2,737,286
$ 4,287,664
$ (217,092) $ 6,930,446
— $
(1,463) $
(9,530) $
16,010
$
(62,653) $
46,761
$
(10,875)
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
Included in other comprehensive income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Balance, end of period
The amount of total gains/(losses) included in
earnings attributable to the change in
unrealized gains or losses relating to assets
and liabilities still held at the reporting date
65,195
6,392
35,781
—
(79,319)
(29,963)
47,768
—
(1,403)
62,847
70,928
550,021
35,009
782,597
—
—
—
—
—
—
—
—
—
—
—
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
| Ambac Financial Group, Inc. 112 2018 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, 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
Included in other comprehensive income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Balance, end of period
The amount of total gains/(losses) included in
earnings attributable to the change in
unrealized gains or losses relating to assets
and liabilities still held at the reporting date
54,600
40,518
99,018
—
—
(28,682)
108,365
—
(1,314)
(15,374)
508,873
1,166,898
(842,748)
870,935
—
—
—
—
—
—
—
—
—
—
—
14,284
—
—
(474,863)
(1,944,821)
486,218
(1,892,948)
—
—
—
—
—
—
—
—
—
—
—
—
99,018
—
—
(253,438)
216,582
(51,254)
—
—
—
737,898
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
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
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Balance, end of period
The amount of total gains/(losses) included in earnings
attributable to the change in unrealized gains or losses
relating to assets and liabilities still held at the reporting
date
Other Asset
Backed
Securities
2018
Non-
Agency
RMBS
Total
Investments
Other Asset
Backed
Securities
2017
Non-
Agency
RMBS
Total
Investments
$
72,540
$
736,017
$
808,557
$
65,990
$
696,713
$
762,703
1,495
(770)
34,727
(52,138)
36,222
(52,908)
—
—
—
—
—
—
—
—
—
1,433
6,130
—
—
—
(1,194)
(713,297)
(714,491)
(1,013)
—
—
—
—
(5,309)
(5,309)
—
—
63,762
262
35,781
—
(79,319)
(28,950)
47,768
—
65,195
6,392
35,781
—
(79,319)
(29,963)
47,768
—
72,071
$
— $
72,071
$
72,540
$
736,017
$
808,557
— $
— $
— $
— $
— $
—
$
$
| Ambac Financial Group, Inc. 113 2018 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, 2016
Balance, beginning of period
Total gains/(losses) realized and unrealized:
Included in earnings
Included in other comprehensive income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Balance, end of period
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or
losses relating to assets and liabilities still held at the reporting date
Other Asset
Backed
Securities
Non-
Agency
RMBS
Total
Investments
$
— $
488,884
$
488,884
1,908
(5,597)
—
—
—
(1,028)
70,707
—
52,692
46,115
99,018
—
—
(27,654)
37,658
—
54,600
40,518
99,018
—
—
(28,682)
108,365
—
$
$
65,990
$
696,713
$
762,703
— $
— $
—
Level-3 Derivatives by Class
Year Ended December 31,
Balance, beginning of period
Total gains/(losses) realized and unrealized:
2018
2017
Interest
Rate
Swaps
Credit
Derivatives
Total
Derivatives
Interest
Rate
Swaps
Credit
Derivatives
Total
Derivatives
$
61,374
$
(566) $
60,808
$
(84,933) $
(15,349) $
(100,282)
Included in earnings
(8,637)
(505)
(9,142)
46,475
16,372
62,847
Included in other comprehensive income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Balance, end of period
The amount of total gains/(losses) included in earnings
attributable to the change in unrealized gains or losses
relating to assets and liabilities still held at the reporting
date
$
$
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(5,277)
(388)
(5,665)
99,832
(1,589)
98,243
—
—
—
—
—
—
—
—
—
—
—
—
47,460
$
(1,459) $
46,001
$
61,374
$
(566) $
60,808
(8,637) $
(893) $
(9,530) $
6,716
$
2,197
$
8,913
| Ambac Financial Group, Inc. 114 2018 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, 2016
Balance, beginning of period
Total gains/(losses) realized and unrealized:
Included in earnings
Included in other comprehensive income
Purchases
Issuances
Sales
Settlements
Transfers into Level 3
Transfers out of Level 3
Balance, end of period
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or
losses relating to assets and liabilities still held at the reporting date
Interest
Rate
Swaps
Credit
Derivatives
Total
Derivatives
$
(64,649) $
(34,543) $
(99,192)
(35,480)
20,106
(15,374)
—
—
—
—
—
—
—
—
—
—
—
—
15,196
(912)
14,284
—
—
—
—
—
—
(84,933) $
(15,349) $
(100,282)
(35,480) $
19,129
$
(16,351)
$
$
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
from Level 2 into Level 3 in 2017, and out of Level 3 into Level
2 in 2018, include an Ambac-insured re-REMIC collateralized by
distressed mortgage-backed securities. Non-agency RMBS
transferred into Level 3 in 2017 and 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 either could not obtain or 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. There were no transfers of derivative instruments into
or out of Level 3 in the periods disclosed.
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:
Net
Investment
Income
Net Gains
(Losses) on
Derivative
Contracts
Income (Loss)
on Variable
Interest
Entities
Other
Income
(Expense)
Year Ended December 31, 2018
Total gains (losses) included in earnings for the period
$
36,222
$
(9,142) $
3,966
$
(1,463)
Changes in unrealized gains (losses) relating to financial instruments still held at
the reporting date
—
(9,530)
118
(1,463)
Year Ended December 31, 2017
Total gains (losses) included in earnings for the period
$
65,195
$
62,847
$
655,956
$
(1,403)
Changes in unrealized gains (losses) relating to financial instruments still held at
the reporting date
—
8,913
654,753
(1,403)
Year Ended December 31, 2016
Total gains (losses) included in earnings for the period
$
54,600
$
(15,374) $
833,023
$
(1,314)
Changes in unrealized gains (losses) relating to financial instruments still held at
the reporting date
—
(16,351)
833,023
(1,314)
| Ambac Financial Group, Inc. 115 2018 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 debt (at December
31, 2017 only) and equity 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, 2018 and 2017 were as follows:
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
Non-Credit
Other-
than-
temporary
Impairments (1)
December 31, 2018
Fixed income securities:
Municipal obligations
Corporate obligations (2)
Foreign obligations
U.S. government obligations
Residential mortgage-backed securities
Collateralized debt obligations
Other asset-backed securities
Short-term
$
882,631
$
14,364
$
17,076
$
879,919
$
1,288,882
30,496
93,636
221,825
133,075
370,199
3,020,744
430,405
6,444
399
1,371
37,575
8
72,868
133,029
23
17,204
1,278,122
61
613
793
1,727
624
38,098
97
30,834
94,394
258,607
131,356
442,443
3,115,675
430,331
Total available-for-sale investments
$
3,451,149
$
133,052
$
38,195
$
3,546,006
$
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
(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, 2018 and 2017.
(2)
Includes Ambac's holdings of the secured notes issued by Ambac LSNI in connection with the Rehabilitation Exist Transactions.
| Ambac Financial Group, Inc. 116 2018 FORM 10-K |
5
—
—
27
—
—
32
—
32
—
—
—
—
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, 2018, 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
$
508,478
$
1,094,712
301,303
821,557
2,726,050
221,825
133,075
370,199
508,138
1,093,945
296,305
815,212
2,713,600
258,607
131,356
442,443
$
3,451,149
$
3,546,006
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, 2018 and 2017:
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, 2018
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
Total
$
537,904
$
15,878
$
28,533
$
1,198
$
566,437
$
306,506
1,161
5,643
34,852
123,848
13,813
1,023,727
115,374
8,634
1
135
793
1,727
33
27,201
97
190,273
5,163
58,495
—
—
77,479
359,943
—
8,570
60
478
—
—
591
10,897
—
496,779
6,324
64,138
34,852
123,848
91,292
1,383,670
115,374
17,076
17,204
61
613
793
1,727
624
38,098
97
$
1,139,101
$
27,298
$
359,943
$
10,897
$
1,499,044
$
38,195
| Ambac Financial Group, Inc. 117 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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
Less Than 12 Months
12 Months or More
Total
Fair Value
Gross
Unrealized
Loss
Fair Value
Gross
Unrealized
Loss
Fair Value
Gross
Unrealized
Loss
$
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
Management has determined that the unrealized losses reflected
in the tables above are temporary in nature as of December 31,
2018 and 2017 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, 2018, 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, 2018, $660,063 of the total fair value and $17,838
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, 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. 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, 2018 are primarily on Puerto Rico bonds that are
guaranteed by Ambac Assurance. Management assessed whether
these securities suffered credit impairment as of December 31,
2018 based on the value of cash and securities received in the
February 2019 commutation transactions executed in connection
with the COFINA Plan of Adjustment. Management has
determined that the amortized cost bases of these securities are
fully recoverable.
Corporate obligations
The gross unrealized losses on corporate obligations as of
December 31, 2018 are primarily the result of the increase in
interest rates since purchase. 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.
| Ambac Financial Group, Inc. 118 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Realized Gains and Losses and Other-Than-Temporary
Impairments:
Counterparty Collateral, Deposits with Regulators and
Other Restrictions:
Ambac routinely pledges and receives collateral related to certain
transactions. Cash, cash equivalents and securities held directly
in Ambac’s investment portfolio with a combined fair value of
$102,904 and $120,645 at December 31, 2018 and 2017,
respectively, were pledged to derivative counterparties. Ambac’s
derivative counterparties have the right to re-pledge the investment
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”. There was no cash
or securities received from other counterparties that were re-
pledged by Ambac.
Securities carried at $5,975 and $5,974 at December 31, 2018 and
2017, 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 $0 and $346,212 at December 31, 2018
and 2017, 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 were held and the secured debt
was issued by entities that qualified as VIEs and are consolidated
in Ambac’s consolidated financial statements. Refer to Note 3.
Variable Interest Entities for a further description of this
transaction.
As further discussed in Note 1. Background and Business
Description, Ambac LSNI, an unconsolidated VIE, issued Secured
Notes in connection with the Rehabilitation Exit Transactions of
February 12, 2018. Securities with a fair value of $209,983 at
December 31, 2018 were pledged as collateral and as sources of
funding to repay the Secured Notes. The securities may not be
transferred or repledged by Ambac LSNI. Collateral may be sold
to fund redemptions of the Secured Notes. 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. The amount of such proceeds from the
December 31, 2018 interest payment and partial redemption of
Secured Notes held by Ambac Assurance was $19,405 and is
included in Restricted cash on the Consolidated Balance Sheet at
December 31, 2018.
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
2018
2017
2016
$
111,417
$
29,080
$
17,344
(6,511)
(18,945)
(8,239)
Net realized gains
$
111,624
$
5,366
$
6,718
(4,769)
30,179
39,284
Net other-than-
temporary
impairments (1)
$
(3,238) $
(20,171) $
(21,819)
(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.
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 insured securities. Such changes in estimated claim
payments on Ambac insured securities contributed to net other-
than-temporary impairments for the years ended December 31,
2017 and 2016 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, 2018 and
2017 for which a portion of an other-than-temporary impairment
was recognized in other comprehensive income:
Year Ended
December 31,
Balance, beginning of
period
Additions for credit
impairments
recognized on:
Securities not
previously impaired
Securities previously
impaired
Reductions for credit
impairments
previously
recognized on:
Securities that
matured or were
sold during the
period
2018
2017
2016
$
67,085
$
52,070
$
31,176
1,210
3,310
3,572
226
11,705
17,322
(56,067)
—
—
Balance, end of period
$
12,454
$
67,085
$
52,070
| Ambac Financial Group, Inc. 119 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Guaranteed Securities:
Ambac’s fixed income portfolio includes securities covered by guarantees issued by Ambac Assurance and other financial guarantors (“insured
securities”). The published rating agency ratings on these securities reflect the higher of the financial strength rating of the financial guarantor
or the rating of the underlying issuer. Rating agencies do not always publish separate underlying ratings (those ratings excluding the insurance
by the financial guarantor). 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, 2018 and 2017, respectively:
December 31, 2018:
Ambac Assurance Corporation (2)
National Public Finance Guarantee
Corporation
Total
December 31, 2017:
Ambac Assurance Corporation (2)
National Public Finance Guarantee
Corporation
Assured Guaranty Municipal Corporation
Total
$
$
$
$
Municipal
obligations
Corporate
obligations (3)
Mortgage
and asset-
backed
securities
Weighted
Average
Underlying
Rating (1)
Total
833,241
$
656,473
$
599,185
$
2,088,899
CC
15,600
—
—
15,600
848,841
$
656,473
$
599,185
$
2,104,499
BBB-
CC
706,715
$
32,660
$
2,702,887
$
3,442,262
CC
20,733
5,998
—
—
—
—
20,733
5,998
733,446
$
32,660
$
2,702,887
$
3,468,993
BBB-
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 $144,672 and $170,280 at December 31, 2018 and 2017, respectively,
insured by Ambac UK.
(3) 2018 includes Ambac's holdings of the secured notes issued by Ambac LSNI in connection with the Rehabilitation Exit Transactions. These secured
notes are insured by Ambac Assurance.
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,
2018
December 31,
2017
Redemption frequency
Redemption notice period
$
16,123
$
33,154
quarterly
—
177,357
84,297
29,318
43,954
10 business days
15 - 30 days
53,054
semi-monthly
136,603
daily, weekly or monthly
0 - 30 days
67,787
quarterly
22,666
quarterly
53,675
daily
180 days
90-120 days
0 days
Total equity investments in pooled funds
$
351,049
$
366,939
(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. Ambac sold its position in this
fund in 2018.
(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 were not able to 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.
| Ambac Financial Group, Inc. 120 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
(6)
Investments represent a diversified exposure to global equity market returns through holdings of various regional market index funds.
(7) Interest rate products include $27,154 at December 31, 2018 and $2,823 at December 31, 2017 and equity market investments include $43,954 at December
31, 2018 and $53,675 at December 31, 2017 that have readily determinable fair values priced through pricing vendors.
Ambac also holds an equity interest in an unconsolidated trust
created in connection with the 2014 sale of Segregated Account
junior surplus notes that is accounted for under the equity method.
At December 31, 2017, Ambac also held debt securities issued by
the trust that were accounted for as trading.
Investment Income:
Net investment income was comprised of the following for the
affected periods:
Year Ended
December 31,
2018
2017
2016
Fixed income securities
$
265,380
$
337,454
$
288,554
Short-term investments
Loans
Investment expense
Securities available-for-
sale and short-term
Other investments
Total net investment
income
11,014
730
(6,599)
7,898
520
1,505
337
(8,098)
(9,347)
270,525
2,192
337,774
23,179
281,049
32,318
$
272,717
$
360,953
$
313,367
11.
DERIVATIVE INSTRUMENTS
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
2018
2017
2016
$
(3,035) $
18,242
$
27,654
615
4,854
7,474
$
(3,650) $
13,388
$
20,180
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, 2018 and 2017.
December 31, 2018:
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
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
$
$
$
$
$
$
$
$
59,768
59,768
1,459
72,161
3,379
76,999
66,302
66,302
1,712,062
1,712,062
$
$
$
$
$
$
$
$
300
300
$
$
— $
300
—
300
$
— $
— $
59,468
59,468
1,459
71,861
3,379
76,699
66,302
66,302
— $
— $
1,712,062
1,712,062
$
$
$
$
$
$
$
$
— $
— $
— $
67,126
3,379
70,505
$
59,468
59,468
1,459
4,735
—
6,194
— $
— $
66,302
66,302
— $
— $
1,712,062
1,712,062
| Ambac Financial Group, Inc. 121 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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
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
83,409
54,877
54,877
2,205,264
2,205,264
$
$
$
$
$
$
$
$
627
627
$
$
— $
627
—
627
$
— $
— $
73,199
73,199
566
80,868
1,348
82,782
54,877
54,877
— $
— $
2,205,264
2,205,264
$
$
$
$
$
$
$
$
— $
— $
— $
79,912
1,348
73,199
73,199
566
956
—
81,260
$
1,522
— $
— $
54,877
54,877
— $
— $
2,205,264
2,205,264
Amounts recognized for the right to reclaim cash and cash equivalents collateral or the obligation to return cash and cash equivalents 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 and cash equivalents collateral and posted margin, recorded in “Other assets” were $102,904 and $20,926 as of
December 31, 2018 and 2017, respectively. There were no amounts held representing an obligation to return cash and cash equivalents collateral
as of December 31, 2018 and 2017.
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, 2018 and 2017:
Non-VIE derivatives:
Change in fair value of credit derivatives:
Realized gains and other settlements
Unrealized gains (losses)
Credit derivatives
Interest rate swaps
Currency swaps
Futures contracts
Other derivatives
Total non-VIE derivatives
Variable Interest Entities:
Currency swaps
Interest rate swaps
Total Variable Interest Entities
Total derivative contracts
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,
2018
2017
2016
Net gains (losses) on derivative contracts
Net gains (losses) on derivative contracts
Net gains (losses) on derivative contracts
Net gains (losses) on derivative contracts
Net gains (losses) on derivative contracts
Income (loss) on variable interest entities
Income (loss) on variable interest entities
$
388
$
1,589
$
(893)
(505)
600
—
6,895
—
6,990
14,783
16,372
48,870
—
10,695
—
75,937
11,425
493,203
504,628
(25,530)
(126,664)
(152,194)
912
19,194
20,106
(50,082)
—
(191)
—
(30,167)
58,990
(574,554)
(515,564)
$
511,113
$
(59,885) $
(525,625)
| Ambac Financial Group, Inc. 122 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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, 2018 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 a financial guarantee 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, 2018 and 2017:
Ambac Rating
December 31,
AAA
AA
A
BBB (1)
Below investment grade (2)
2018
2017
$
— $
—
295,342
175,765
—
—
—
—
150,125
—
Total
$
295,342
$
325,890
(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”),
uses interest rate swaps and US Treasury futures contracts to
provide an economic hedge against the effects of rising interest
rates elsewhere in the Company, including on Ambac’s financial
guarantee exposures. Additionally, AFS provided interest rate
swaps to states, municipalities and their authorities, asset-backed
issuers and other entities in connection with their financings. As
of December 31, 2018 and 2017 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
Notional - December 31,
2018
2017
$
493,368
$
379,497
1,121,532
1,428,264
US Treasury futures contracts—short
1,760,000
1,655,000
On June 27, 2017, Ambac entered into a termination agreement
with various parties in connection with the commutation of interest
rate swaps between an asset-backed issuer and AFS. Ambac paid
$94,407 under the termination agreement and reported a gain on
the terminated swaps of $43,443 within net gains (losses) on
derivative contracts on the Consolidated Statements of Total
Comprehensive Income (Loss).
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 their securitization structure. The notional for VIE
derivatives outstanding as of December 31, 2018 and 2017 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,
2018
2017
$ 1,399,532
$ 1,483,491
1,176,748
2,479,244
344,992
10,254
394,541
12,100
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, 2018 and 2017, the net liability fair value of
derivative instruments with contingent features linked to Ambac’s
own credit risk was $67,071 and $79,912, respectively, related to
which Ambac had posted cash, cash equivalents and securities as
collateral with a fair value of $92,657 and $111,391, 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, 2018,
settlement of collateral balances and net derivative liabilities would
result in a net receipt of cash and/or securities by Ambac. If
| Ambac Financial Group, Inc. 123 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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 extended by consolidated VIEs are generally carried at fair
value on the Consolidated Balance Sheets. See Note 3. 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 $19,191 and
$20,184 at December 31, 2018 and 2017, respectively. The
effective interest rate on these loans ranged from 6.51% to 8.60%
and 6.51% to 8.07% at December 31, 2018 and 2017, respectively.
The maturity date of these loans ranged from June 2026 to
December 2046 as of December 31, 2018. 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, 2018 and 2017.
13.
LONG-TERM DEBT
The carrying value of long-term debt was as follows:
December 31,
Ambac Assurance:
2018
2017
5.1% surplus notes due 2020
$
487,110
$
668,667
5.1% junior surplus notes due
2020
Ambac Note
Tier 2 Notes
249,785
1,940,289
251,745
249,036
—
—
Secured borrowing
—
73,993
Ambac Assurance long-term debt
$
2,928,929
$
991,696
Variable Interest Entities long-
term debt
$
5,268,596
$ 12,160,544
Surplus Notes
Ambac Assurance surplus notes, with a par amount of $530,744
and $754,811 at December 31, 2018 and 2017, respectively have
a scheduled maturity of June 7, 2020. On February 12, 2018, the
Rehabilitation Exit Transactions were consummated, resulting in
a $463,624 reduction of consolidated surplus notes par
outstanding. On August 3, 2018, in connection with the AMPS
Exchange, Ambac Assurance issued surplus notes with a par
amount of $212,740. Also, during the year ended December 31,
2018, sales of surplus notes held by Ambac and other transactions
resulted in additional net issuance of $26,817 Ambac Assurance
surplus note par value. In 2017, Ambac purchased $147,236 par
amount of these surplus notes. The retirement of certain notes as
part of the Rehabilitation Exit Transactions in 2018 and Ambac
purchases in 2017 resulted in gains of $3,121 and $3,815 for the
years ended December 31, 2018 and 2017, respectively,
recognized in Net realized gains (losses) on extinguishment of debt
on the Consolidated Statements of Total Comprehensive Income.
Surplus notes outstanding are recorded at their fair value at the
date of issuance. The discount on surplus notes is accreted into
income using the effective interest method based on projected cash
flows at the date of issuance. The weighted average imputed
interest rate on surplus notes outstanding as of December 31, 2018
is 10.1%. All payments of principal and interest on these surplus
notes are subject to the prior approval of the OCI. Annually from
2011 through 2018, OCI issued its disapproval of the requests of
Ambac Assurance to pay the full interest on outstanding surplus
notes on the annual scheduled interest payment date of June 7th.
If the OCI does not approve the payment of interest on these surplus
notes, such interest will accrue and compound annually until paid.
In connection with the Rehabilitation Exit Transactions, Ambac
Assurance made a one-time current interest payment on remaining
surplus notes (other than junior surplus notes) of $13,501, of which
$2,618 was received by Ambac for surplus notes that it owned and
that are considered extinguished for accounting purposes.
Refer to Note 1. Background and Business Description for further
discussion of both the Rehabilitation Exit Transactions and the
AMPS Exchange.
Junior Surplus Notes
The junior surplus notes have a par value of $366,644 and $370,237
at December 31, 2018 and 2017, respectively. Pursuant to the
Second Amended Plan of Rehabilitation, Ambac Assurance
became the obligor under the junior surplus notes (originally issued
by the Segregated Account) as of February 12, 2018. These junior
surplus notes have a scheduled maturity of June 7, 2020, subject
to the following restrictions. Principal and interest payments on
these junior surplus notes cannot be made until all Ambac
Assurance 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, 2018 and 2017 includes $16,644
and $20,237, 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 ($1,661 current par
value at December 31, 2018) are reducing periodically as rent
payments under the replacement lease (beginning in January
2016) are made by Ambac Assurance. Par value of these junior
surplus notes was reduced by $3,593 and $3,799 during the
year ended December 31, 2018 and 2017, respectively, as rent
payments were made by Ambac Assurance. These junior
surplus notes were recorded at their fair value at the date of
issuance. The discount on these notes are currently being
| Ambac Financial Group, Inc. 124 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
accreted into income using the effective interest method at an
imputed interest rate of 19.5%.
• Par value at December 31, 2018 and 2017 includes $350,000
face amount of a junior surplus note originally issued to
Ambac pursuant to Ambac's Chapter 11 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%.
Ambac Note
The Ambac Note, issued in connection with the Rehabilitation Exit
Transactions on February 12, 2018, as more fully described in Note
1. Background and Business Description, has a par value of
$1,940,289 at December 31, 2018, and has a legal maturity of
February 12, 2023. Interest on the Ambac Note is payable quarterly
(on the last day of each quarter beginning with June 30, 2018) at
an annual rate of 3-month U.S. Dollar LIBOR + 5.00%, subject to
a 1.00% LIBOR floor. During the year ended December 31, 2018,
$214,062 par value of the Ambac Note was redeemed. The
maturity date for the Ambac Note is 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
representation and warranty subrogation recoveries 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 representation and
warranty subrogation recoveries shall be deemed to be received
upon the receipt of the applicable appraisal.
The portion of the Ambac Note issued in connection with the
exchange of surplus notes ("Ambac Note A") was accounted for
as a debt modification since the creditors before and after the
exchange remained the same and the change in terms was not
considered substantial. A substantial change is considered to be a
change in cash flows of equal to or greater than 10%, and because
the change in cash flows was less than 10%, debt modification
accounting is appropriate. Under debt modification accounting,
Ambac Note A was recorded at a discount to par based on the
carrying value of the surplus notes less the cash consideration paid.
Furthermore, no gain or loss was recorded on the surplus note
exchange and a new effective interest rate was established based
on the cash flows of Ambac Note A. Any consideration paid
directly related to the issuance of Ambac Note A was expensed as
incurred. The portion of the Ambac Note issued in connection with
the exchange of Deferred Amounts ("Ambac Note B") was
recorded at fair value. The Deferred Amount exchange was
accounted for as an extinguishment of the Deferred Amounts with
the gain reflected as a benefit to loss and loss expenses. Any
consideration paid directly related to the issuance of Ambac Note
B was capitalized and amortized as part of the effective yield
calculation. The aggregate discount on the entire Ambac Note
(portions A and B) was accreted into earnings from the date of
issuance through September 30, 2018 using the effective interest
method, based on an imputed interest rate of 7.6%. As of
December 31, 2018 the discount on the Ambac Note has been fully
amortized.
Tier 2 Notes
The Tier 2 Notes, issued in connection with the Rehabilitation Exit
Transactions on February 12, 2018, with a par value of $258,585
(including paid-in-kind interest of $18,585) at December 31, 2018
have a legal maturity of February 12, 2055. Interest on the Tier 2
Notes is at an annual rate of 8.50%. Other than upon payment of
principal at redemption or maturity, 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. The Tier
2 Notes were recorded at a discount to par as any consideration
paid that was directly related to the issuance of the Tier 2 Notes
was capitalized and is part of the effective yield calculation. Ambac
is accreting the discount on the Tier 2 Notes into earnings using
the effective interest method, based on an imputed interest rate of
9.9%.
The Tier 2 Notes are subject to mandatory redemption triggers
upon: (i) receipt of subject representation and warranty subrogation
recoveries in excess of $1,600,000 ("Tier 2 Net Proceeds") or (ii)
payment of principal or interest on Ambac Assurance surplus notes
(other than junior surplus notes). Promptly, and in any event within
five business days after the receipt (whether directly or indirectly)
of Tier 2 Net Proceeds, Ambac Assurance shall deposit an amount
equal to the Tier 2 Net Proceeds to a collateral account, provided,
that any non-cash representation and warranty subrogation
recoveries shall be deemed to be received upon the receipt of the
applicable appraisal. Similarly, within five business dates after a
surplus note payment (other than in connection with the
Rehabilitation Exit Transactions), Ambac Assurance shall deposit
an amount based on the percentage of surplus notes paid applied
to the outstanding balance of the Tier 2 Notes to a collateral
account. In both cases, the amount deposited shall not be in excess
of the amount required to redeem all outstanding Tier 2 Notes.
Also, such amounts shall be used to initiate a redemption.
The Tier 2 Notes may also be redeemed, in whole or in part, at the
option of Ambac Assurance. Both mandatory and optional
redemptions may be made at a price equal to 100% of the aggregate
principal amount redeemed, plus accrued and unpaid interest, if
any, plus a make-whole premium. Make-whole premiums are
calculated based on future interest payments through the
contractual call date ("Initial Call Date"). The Initial Call Date at
issuance of December 17, 2020 extends ratably beginning the first
anniversary of issuance to September 17, 2021 by the second
anniversary, and to March 17, 2022 by the third anniversary of
issuance. There are no extensions of the Initial Call Date beyond
March 17, 2022. The Initial Call Date for redemptions is
determined based on the date the applicable amounts are deposited
to the collateral account.
| Ambac Financial Group, Inc. 125 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
In connection with our preliminary analysis of the TCJA, during
2017 Ambac recorded an estimated discrete current benefit of
$29,581 related to the repeal of the Alternative Minimum Tax
("AMT") and a deferred tax expense of $31,418 attributable to
Ambac UK, resulting in an estimated net cost of $1,886.
Ambac completed its accounting of the TCJA during 2018,
including the mandatory repatriation of Ambac UK's historical
earnings and the limitations on executive compensation, which had
previously been disclosed as estimates. A discrete benefit for the
TCJA of $1,902 was recorded during 2018 related to the repeal of
AMT. Upon the filing of its 2018 through 2021 federal income
tax returns, Ambac will receive a total $37,019 of AMT refunds,
inclusive of $5,536 of payments relating to the filing of its 2017
tax return.
Consolidated Pretax Income (Loss)
U.S. and foreign components of pre-tax income (loss) were as
follows:
Year Ended
December 31,
U.S.
Foreign
Total
2018
2017
2016
$
264,089
$ (450,978) $
77,161
8,444
166,727
27,865
$
272,533
$ (284,251) $
105,026
Provision (Benefit) for Income Taxes
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
Total current taxes
Deferred taxes
Foreign
Total deferred taxes
Provision for income
taxes
$
$
2018
2017
2016
$
(1,902) $
(29,581) $
3,934
2,480
(835)
(257)
5,391
5,391
5,134
$
$
2,013
40,613
13,045
31,419
31,419
44,464
$
$
707
26,088
30,729
(20)
(20)
30,709
Secured Borrowing
The secured borrowing, with a par value of $0 and $73,993 at
December 31, 2018 and 2017, respectively had a legal maturity of
July 25, 2047. Interest on the secured borrowing was payable
monthly at an annual rate of one month LIBOR + 2.8%. On June
22, 2018, the Secured Borrowing was fully redeemed. Refer to
Note 3. Variable Interest Entities for further discussion on the
secured borrowing transaction.
Variable Interest Entities, Long-term Debt
The variable interest entity notes were issued by consolidated
VIEs. Ambac is the primary beneficiary of the VIEs as a result of
providing financial guarantees on certain of the 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 $4,552,643 and
$9,387,884 as of December 31, 2018 and 2017, respectively. As
of December 31, 2018 and 2017, the ranges of final maturity dates
of the outstanding long-term debt associated with these VIEs were
September 2019 to December 2047 as of December 31, 2018, and
November 2018 to December 2047 as of December 31, 2017. As
of December 31, 2018 and 2017, the interest rates on these VIEs’
long-term debt ranged from 1.36% to 7.93% and from 0.96% to
8.35%, respectively. Final maturities of VIE long-term debt for
each of the five years following December 31, 2018 are as follows:
2019-$255,040; 2020-$0; 2021-$0; 2022-$0; 2023-$124,233.
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
U.S. Tax Reform
Tax Year
2010
2013
2014
2015
2014
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. Given the
complexity of the TCJA and the limited time between its enactment
and the filing of the 2017 financial statements, the SEC issued
guidance (SAB 118), which provided a one-year measurement
period for companies to finalize the accounting for the impact of
the TCJA.
| Ambac Financial Group, Inc. 126 2018 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, 2018, 2017 and 2016 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
Credit Risk Changes to Fair Value Options
Valuation allowance to equity
Total charged to stockholders’ equity:
Total effect of income taxes
2018
2017
2016
$
5,134
$
44,464
$
30,709
11,832
—
(371)
161
(9,095)
2,527
(30,838)
25,776
446
—
4,616
—
41,602
(58,527)
3,278
—
13,647
—
$
7,661
$
44,464
$
30,709
Reconciliation of U.S. Federal Statutory Income Tax Rate to Actual Income Tax Rate
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
$
57,232
21.0 % $
(99,488)
35.0 % $
36,759
35.0 %
2018
2017
2016
Changes in expected tax resulting from:
Tax-exempt interest
Foreign taxes
Substantiation adjustment
Valuation allowance
Change in Tax Law
Other, net
(6,850)
10,494
(2.5)%
3.9 %
(60,077)
(22.0)%
5,278
(1,902)
959
1.9 %
(0.7)%
0.4 %
(6,004)
(17,742)
36,124
127,675
1,886
2,013
2.1 %
6.2 %
(12.7 )%
(44.9 )%
(0.7 )%
(0.7 )%
Tax expense on income from continuing operations
$
5,134
1.9 % $
44,464
(15.7)% $
30,709
(1,561)
26,183
(1.5)%
24.9 %
(171,687)
(163.5)%
139,584
132.9 %
—
1,431
— %
1.4 %
29.2 %
Unrecognized Tax Positions
A reconciliation of the beginning and ending amount of
unrecognized tax benefits for 2018, 2017 and 2016 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
2018
2017
2016
$
— $
— $
—
—
—
—
Balance, end of period
$
— $
— $
—
—
—
—
Included in these balances at December 31, 2018, 2017 and 2016
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, 2018, 2017 and 2016, 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, 2018, 2017 and 2016, respectively.
| Ambac Financial Group, Inc. 127 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Deferred Income Taxes
NOL Usage Table
The tax effects of temporary differences that give rise to significant
portions of the deferred tax liabilities and deferred tax assets at
December 31, 2018 and 2017 are presented below:
NOL Usage
Tier
December 31,
Deferred tax liabilities:
Insurance intangible
Debentures
Variable interest entities
Investments
Unearned premiums and credit fees
Other
2018
2017
$
150,975
$
177,864
—
19,051
26,145
48,121
7,649
28,387
22,817
28,798
51,485
9,402
Total deferred tax liabilities
251,941
318,753
Deferred tax assets:
Net operating loss and capital
carryforward
Loss reserves
Debentures
Compensation
Other
Subtotal deferred tax assets
Valuation allowance
Total deferred tax assets
718,978
227,401
22,564
9,500
1,818
980,261
768,450
211,811
775,917
264,624
—
5,585
2,140
1,048,266
763,172
285,094
Net deferred tax liability
$
40,130
$
33,659
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 asset
and therefore maintains a full valuation allowance. The remaining
net deferred tax liability of $40,130 is attributable to Ambac U.K.
NOL Usage
Pursuant to the intercompany tax sharing agreement, 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.
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%
A
B
C
D
Any net operating loss carryforwards ("NOLs") generated by
Ambac Assurance after September 30, 2011 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,
2018, generating cumulative taxable income of $1,486,879. 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. Through December 31, 2018, Ambac
Assurance utilized all of the $479,000 Tier A NOL and $1,007,879
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. For the tax years
ended December 31, 2017 and 2018, Ambac Assurance recorded
additional estimated Tolling Payments of $30,496, and $13,885,
respectively. In May 2018 Ambac executed a waiver under the
intercompany tax sharing agreement pursuant to which Ambac
Assurance was relieved of the requirement to make $30,496
payment by June 1, 2018. Ambac has also agreed to continue to
defer the tolling payment for the use of net operating losses by
Ambac Assurance until such time as OCI consent to the payment.
The 2018 accrued tolling payment of $13,885 is also subject to
OCI's review and consent.
As of December 31, 2018 Ambac had U.S. federal net operating
loss tax carryforwards of approximately $3,423,704, which, if not
utilized, will begin expiring in 2029, and will fully expire in 2032.
The remaining balance of the NOL allocated to Ambac Assurance
was $2,163,121 and Ambac was $1,260,583.
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 $936, $5,223 and
$9,465 for the years ended December 31, 2018, 2017 and 2016,
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
$8,720 as of December 31, 2018. The assumed health care cost
trend rates range from 5.4% in 2019, decreasing ratably to 4.5%
in 2025. Increasing the assumed health care cost trend rate by one
| Ambac Financial Group, Inc. 128 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
percentage point in each future year would increase the
accumulated postretirement benefit obligation at December 31,
2018, by $170 and the 2018 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, 2018 by $237 and the 2018
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:
2019
2020
2021
2022
2023
2024-2028
Total
$
$
364
364
377
404
429
2,464
4,402
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, 2018
and 2017 were 4.00% and 3.50%, 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 $1,029, $691 and $911 for the years December 31, 2018,
2017 and 2016, respectively.
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 1,972,068 shares are available for
future grant as of December 31, 2018.
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
$1,096, $2,159 and $283 for the years ended December 31, 2018,
2017 and 2016, 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
2018
2017 (1)
2016
$
— $
— $
—
6,234
5,620
$ 11,854
1,640
2,653
4,293
4,293
$
$
3,463
1,790
5,253
5,194
$
$
compensation (after-tax)
$ 11,854
(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
$1,453, $1,565 and $1,790 for the years ended December 31, 2018,
2017 and 2016, respectively.
(3) A performance award issued to Ambac's former Chief Executive
Officer in the form of performance stock units was expensed during
2018.
Stock Options:
Stock options were awarded in years prior to 2016 to directors that
had 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.
| Ambac Financial Group, Inc. 129 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
A summary of stock option activity for 2018 is as follows:
A summary of RSU activity for 2018 is as follows:
Weighted
Average
Exercise
Price
Aggregate
Intrinsic
Value
Shares
Weighted
Average
Remaining
Contractual
Life
(in years)
126,667
$
24.03
—
—
—
—
(110,000)
24.55
16,667
16,667
$
$
20.63
20.63
$
$
—
—
1.97
Outstanding at
beginning of
period
Granted
Exercised
Forfeited or
expired
Outstanding at
end of period
Exercisable
All stock options granted were fully vested as of December 31,
2018. Total unrecognized compensation costs related to unvested
stock options granted were $0 as of December 31, 2018. No stock
options were exercised during the years ended December 31, 2018,
2017 and 2016, respectively.
Restricted Stock Units (“RSUs”):
RSUs are awarded annually to certain employees for (i) a portion
of their annual bonus and special awards for exceptional
performance and (ii) a portion of their long term incentive
compensation. For those granted in connection with (i) above,
awards vest upon grant, but settlement is deferred, other than for
employment tax withholdings, into two equal installments
generally on the first and second anniversary date of the grant. For
those granted in connection with (ii) above, awards generally vest
in equal installments over a three year period. Such vesting is
expressly conditioned upon the respective employees continued
service with Ambac through the applicable vesting date.
RSUs are awarded annually to directors that vest on the last day
of April of the following year. These RSUs will not settle until the
respective director’s termination from the board of directors or, if
earlier, upon a change in control. All RSUs provide for accelerated
vesting upon a change in control, death or disability or involuntary
removal other than for cause (not including removal pursuant to a
shareholder vote at a regularly scheduled annual meeting of
shareholders). Upon termination (other than for cause), the
unvested RSUs shall partially vest as of the date of such termination
in an amount equal to the number of then outstanding unvested
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, 2018, 645,028 RSUs remained outstanding,
of which (i) 209,093 units required future service as a condition
to the delivery of the underlying shares of common stock and (ii)
435,935 units did not require future service and are deferred for
future settlement. 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.
Weighted
Average
Grant Date
Fair Value
Shares
Outstanding at beginning of period
221,803
$
Granted
Delivered or returned to plan (1)
Forfeited
461,116
(36,454)
(1,437)
Outstanding at end of period
645,028
$
18.93
16.35
17.53
15.09
17.17
(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,
2018, Ambac purchased 22,929 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
2018, 2017 and 2016 was $16.35, $20.22 and $14.34, respectively.
As of December 31, 2018, there was $1,760 of total unrecognized
compensation costs related to unvested RSUs granted. These costs
are expected to be recognized over a weighted average period of
1.8 years. The fair value for RSUs vested and delivered during the
year ended December 31, 2018, 2017 and 2016 was $609, $2,536
and $2,965, 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 the participant meets certain minimum service
requirements, 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. Settlement of the 2016 performance award shall
be within 60 days after the end of the performance period, including
those with a partial vesting. 2017 and 2018 performance awards,
shall be settled 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 vested on February 12, 2018 upon
the emergence of the Segregated Account from rehabilitation.
| Ambac Financial Group, Inc. 130 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
A summary of PSU activity for 2018 is as follows:
Weighted
Average
Grant Date
Fair Value
Shares
Outstanding at beginning of period
322,943
$
Granted (1)
Delivered (2)
Forfeited (1)
Performance adjustment (3)
302,002
(121,690)
(15,573)
29,317
Outstanding at end of period
516,999
$
21.06
15.09
24.63
18.20
24.66
17.02
(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. When performance
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, 2018, Ambac
purchased 50,297 of shares from employees that settled performance
based restricted stock units to meet the required tax withholdings.
(3) Represents the increase (decrease) in shares issued for awards granted
in 2015 based upon the attainment of performance metrics at the end
of the performance period.
As of December 31, 2018 there was $4,313 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 1.7 years.
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. Ambac will relocate its
executive office in the third quarter of 2019 and in January 2019,
has entered into a sublease agreement at One World Trade Center,
New York. In January 2019, Ambac has sublet the remaining
space at One State Street Plaza through its expiration date of 2029.
Rent payments under the One State Street Plaza 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:
2019
2020
2021
2022
2023
Thereafter
Total
$
$
5,651
2,101
1,562
1,565
1,568
10,167
22,614
Ambac rent expense for the aforementioned leases amounted to
$2,466, $2,717 and $3,008 for the years ended December 31, 2018,
2017 and 2016, respectively.
Litigation Against Ambac
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 against Ambac Assurance, a former employee of Ambac
Assurance, and certain unaffiliated persons and entities, 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. 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. Ambac and the other defendants filed
motions to dismiss the amended complaint on November 13, 2017.
On July 17, 2018, the court granted Ambac Assurance’s and the
other defendants’ motion to dismiss the first amended complaint
without prejudice. On December 17, 2018, Plaintiffs filed a second
amended complaint. Ambac and the other defendants filed a
motion to dismiss the second amended complaint on February 15,
2019.
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 and have
commenced, or threatened to commence, litigation to resolve these
differences. 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.
requests
Ambac Assurance has periodically received various regulatory
inquiries and
to
investigations and inquiries that such regulators are conducting.
Ambac Assurance has complied with all such inquiries and
requests for information.
information with
respect
for
The Company is involved from time to time in various routine legal
proceedings, including proceedings related to litigation with
| Ambac Financial Group, Inc. 131 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
present or former employees. Although the Company’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 the Company 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 the Company 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
from unfavorable outcomes. Under some
circumstances, adverse results in any such proceedings could be
material
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.
to our business, operations,
result
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.
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 moved
to dismiss on January 29, 2016. On October 4, 2016, the court
denied the Defendants’ motions to dismiss. 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 was 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, the Financial Oversight and Management
Board for the Commonwealth of Puerto Rico (the “Oversight
Board”) filed a petition to adjust the Commonwealth’s debts under
Title III of PROMESA, resulting in an automatic stay of litigation
against the Commonwealth. 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. Ambac Assurance also filed related
motions seeking the appointment of a provisional receiver for
PRHTA and expedited discovery. On May 21, 2017, the Oversight
Board filed a petition to adjust PRHTA’s debts under Title III of
PROMESA, resulting in an automatic stay of litigation against
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 an existing
complaint, adding
the Puerto Rico Sales Tax Financing
Corporation ("COFINA"), COFINA’s executive director, and the
trustee for the COFINA bonds as Defendants, and asserting
numerous claims that challenged 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. On February 17, 2017, the court permitted Ambac
Assurance to intervene. 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, resulting in an automatic stay of
litigation against the Commonwealth and COFINA (respectively).
On May 17, 2017, the court issued an order staying this case until
further order of the court. On October 19, 2018, the Oversight
Board filed (i) a disclosure statement and a plan of adjustment for
COFINA (the “COFINA Plan”) in the COFINA Title III case
incorporating a
the
Commonwealth and COFINA concerning entitlement to sales and
use taxes (the “Commonwealth-COFINA Dispute”), and (ii) a
motion under Bankruptcy Rule 9019 in the Commonwealth Title
III case for approval of the settlement of the Commonwealth-
COFINA Dispute (the “9019 Motion”). On February 4, 2019 the
District Court granted the 9019 Motion and confirmed the
COFINA Plan, which resolves the dispute in this case. The
COFINA Plan became effective on February 12, 2019. Following
confirmation of the COFINA Plan, several parties filed notices of
appeal of the District Court’s confirmation order.
the dispute between
resolution of
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
| Ambac Financial Group, Inc. 132 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
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. 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,
resulting in an automatic stay of litigation against COFINA. On
May 17, 2017, the court issued an order staying this case until
further order of the court. On February 4, 2019, the District Court
granted the 9019 Motion and confirmed the COFINA Plan. The
COFINA Plan became effective on February 12, 2019. Following
confirmation of the COFINA Plan, several parties filed notices of
appeal of the District Court’s confirmation order. Ambac
Assurance anticipates that this case will be voluntarily dismissed
in the near future given the effectiveness of the COFINA Plan.
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 Puerto
Rico Infrastructure Financing Authority ("PRIFA"), PRHTA, and
Puerto Rico Convention Center District Authority ("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. On May 3, 2017, a petition under Title III of
PROMESA was filed on behalf of the Commonwealth of Puerto
Rico and on May 21, 2017, a petition under Title III of PROMESA
was filed on behalf of PRHTA, resulting in an automatic stay of
litigation against the Commonwealth and PRHTA (respectively).
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. On May 3, 2017, a petition
under Title III of PROMESA was filed on behalf of the
Commonwealth of Puerto Rico. 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. 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. The COFINA Plan became effective on February
12, 2019, and, pursuant to the District Court’s confirmation order,
this litigation is permitted to continue, with Ambac’s claims against
BNYM being limited to those for gross negligence, willful
misconduct and intentional fraud. Following confirmation of the
COFINA Plan, several parties filed notices of appeal of the District
Court’s confirmation order.
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 interpleader action styled
as an adversary proceeding 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. BNY
also sought a release of liability in association with the COFINA
funds in its possession.. On September 27, 2018, the court
terminated competing motions for summary judgment without
prejudice in light of the pending agreement in principle between
the agent for COFINA and the agent for the Commonwealth in
adversary proceeding no. 1:17-ap-00257 (the “Commonwealth-
COFINA Dispute,” discussed below). On October 19, 2018, the
Oversight Board filed (i) a disclosure statement and the COFINA
Plan in the COFINA Title III case incorporating a resolution of the
Commonwealth-COFINA Dispute, and (ii) the 9019 Motion in the
Commonwealth Title III case for approval of the settlement of the
Commonwealth-COFINA Dispute. On February 4, 2019 the
District Court granted the 9019 Motion and confirmed the
COFINA Plan, which resolves the dispute in this case. The
COFINA Plan became effective on February 12, 2019. Following
confirmation of the COFINA Plan, several parties filed notices of
appeal of the District Court’s confirmation order. On February 20,
2019, on the joint motion of BNY and COFINA, the District Court
dismissed this case with prejudice.
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. Ambac Assurance
challenges the Commonwealth’s clawback of funds from the
PRIFA, PRHTA, and PRCCDA bonds under the Contracts,
Takings, and Due Process Clauses of the U.S. Constitution and
under PROMESA. 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 July 28, 2017, Defendants moved to dismiss
Ambac Assurance’s complaint, which Ambac Assurance opposed.
| Ambac Financial Group, Inc. 133 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
On February 27, 2018, the District Court granted Defendants’
motion to dismiss. On March 9, 2018, Ambac Assurance appealed
this ruling to the First Circuit Court of Appeals. Oral argument was
held before the First Circuit on January 15, 2019.
Official Committee of Unsecured Creditors v. Whyte (United
States District Court, District of Puerto Rico, No. 1:17-ap-00257,
filed September 8, 2017) (the Commonwealth-COFINA Dispute).
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 provided that separate agents for
COFINA and the Commonwealth would litigate the dispute while
preserving the ability of interested parties, to participate in the
litigation. On September 8, 2017, the Commonwealth Agent filed
an adversary proceeding against the COFINA Agent challenging
the COFINA structure on various grounds. The Commonwealth
Agent filed a revised complaint on October 25, 2017, making
technical corrections to the original complaint. Ambac Assurance
made a motion to intervene in this action, which the court granted
on November 21, 2017. The Commonwealth Agent filed an
amended complaint on January 16, 2018, largely re-stating its
original causes of action to fall within the parameters of the dispute
set by the court. After extensive motion practice, on September
27, 2018, the court terminated competing summary judgment
motions without prejudice in light of a pending agreement in
principle between the Commonwealth Agent and COFINA Agent.
On October 19, 2018, the Oversight Board filed (i) a disclosure
statement and the COFINA Plan in the COFINA Title III case
incorporating a resolution of the Commonwealth-COFINA
Dispute, and (ii) a the 9019 Motion in the Commonwealth Title III
case for approval of the settlement of the Commonwealth-COFINA
Dispute. On February 4, 2019, the District Court granted the 9019
Motion and confirmed the COFINA Plan, which resolves the
dispute in this case. The COFINA Plan became effective on
February 12, 2019. Following confirmation of the COFINA Plan,
several parties filed notices of appeal of the District Court’s
confirmation order.
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 Assurance guaranteed
certain securities issued by three of the Trusts and indirectly insures
six other Trusts. Ambac Assurance filed a motion to intervene in
the action on September 20, 2017. On September 20, 2018, the
case was reassigned to a new judge, who invited additional letter
submissions from the parties. Ambac Assurance submitted a letter
on September 28, 2018, reiterating its request to intervene in the
action. The CFPB also submitted a letter, which asserted that the
court can resolve the outstanding intervention motions on the
papers. In additional submissions, the CFPB and a firm purporting
to represent the Defendant Trusts argued that the court should
resolve a dispute relating to the payment of counsel fees out of
Trust assets, so that the Trusts can secure representation for the
case. On October 19, 2018, the court granted Ambac’s motion to
intervene. On November 29, 2018, following submissions from
the parties regarding the CFPB’s motion for entry of the proposed
consent judgment and regarding discovery necessary to respond
to the motion, the court set a bifurcated discovery and briefing
schedule. Discovery is now proceeding as to certain threshold
issues, to be followed by briefing on the CFPB’s motion to approve
the consent judgment.
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 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 Assurance guaranteed certain securities issued by three of
the Trusts and indirectly insures certain securities in six other
Trusts. Ambac Assurance 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. 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. 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. At a hearing
on April 3, 2018, the court denied Plaintiffs’ motion without
prejudice and on April 16, 2018 entered an order memorializing
its oral ruling. The court also granted Ambac Assurance’s motion
to intervene on April 10, 2018 and Ambac Assurance filed its
complaint in intervention on April 16, 2018.
On June 15, 2018, the Owner Trustee filed a stipulation and
proposed order addressing the selection of a Successor Owner
Trustee. Among other provisions, the stipulation calls for the
appointment of a Special Master to adjudicate disputes regarding
Owner Instructions, and raises the annual expense caps that apply
to the Owner Trustee and Indenture Trustee. The court heard
arguments on the stipulation on September 21, 2018, ruled that a
Special Master would be appointed, and invited the parties to
submit a revised stipulation and proposed order to conform to the
court’s rulings at the hearing. After considering competing draft
orders submitted by the Owner Trustee and Plaintiffs, on
| Ambac Financial Group, Inc. 134 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
November 14, 2018, the court issued an order appointing Hon.
Joseph J. Farnan, Jr. as Special Master and granting him authority
to resolve non-dispositive disputes among the parties, including
disputes concerning instructions to the Owner Trustee.
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 has
asserted claims for breach of contract, fraudulent inducement,
indemnification, reimbursement and has requested the
repurchase of loans that breach representations and warranties
as required under the contracts. On July 18, 2013 the court
granted in part and denied in part Defendants’ motion to
dismiss (filed on July 13, 2012). 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 denied dismissal of Ambac
Assurance’s other contractual claims and fraudulent
inducement claim. 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’s Second Amended Complaint, filed on May 28,
2013, asserted claims against Countrywide and Bank of
America (as successor to Countrywide’s liabilities) for breach
of contract, fraudulent inducement, indemnification and
reimbursement, and breach of representations and warranties.
Ambac Assurance also requested the repurchase of loans that
breach representations and warranties as required under the
contracts. On May 1, 2015, the parties filed motions for partial
summary judgment regarding Ambac Assurance’s claims
against Countrywide (primary-liability claims) and its
secondary-liability claims against Bank of America. In
decisions issued on October 27, 2015, the court granted in
part and denied in part the parties’ respective summary
judgment motions regarding Ambac Assurance’s claims
against Countrywide and granted Ambac Assurance’s motion
for partial summary judgment on its secondary-liability
claims against Bank of America and denied Bank of
America’s motion for summary judgment regarding this
claim. Each party appealed certain aspects of the court’s
decisions 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 sought leave from the First
Department to appeal certain rulings in its May 16, 2017
decision to the Court of Appeals, which the First Department
granted on July 25, 2017. On June 27, 2018, the Court of
Appeals denied Ambac Assurance’s appeal and affirmed the
rulings of the First Department. Defendants filed certain pre-
trial motions on August 22, 2018 seeking to (1) strike Ambac
Assurance’s jury demand for its fraudulent inducement claim;
(2) strike Ambac Assurance’s jury demand for its successor
liability claim; (3) bifurcate the trials for Ambac Assurance’s
primary and successor liability claims; (4) limit the loans for
which Ambac Assurance may seek to recover damages; and
(5) preclude Ambac Assurance from using sampling to prove
liability or damages for breach of contract. On October 2,
2018 Countrywide moved to dismiss Ambac Assurance’s
fraudulent-inducement claim as duplicative of its contract
claim. On December 30, 2018, the court denied all six of
Defendants’ pre-trial motions in their entirety. Defendants
filed notices of appeal of the court's December 30, 2018
decisions. On January 24, 2019, the court ordered that trial
be put off until the First Department resolves Defendants’
appeals from the court’s denial of their pre-trial motions, on
the condition that the appeals are perfected for the May 2019
Term at the First Department. Defendants filed their opening
appeal briefs in the First Department on February 19, 2019.
• 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
has asserted claims for material breach of contract and has
requested the repurchase of loans that breach representations
and warranties under the contracts. Ambac Assurance also
asserted alter ego claims against Nomura Holding America,
Inc. Defendants filed a motion to dismiss on July 12, 2013.
On September 22, 2014, plaintiffs filed an amended complaint
which added (in addition to the claims previously asserted) a
claim for fraudulent inducement. On October 31, 2014
defendants filed a motion to strike the amended complaint
and on November 10, 2014 also filed a motion to dismiss the
fraudulent-inducement claim. On June 3, 2015, the court
denied defendants’ July 2013 motion to dismiss Ambac
Assurance’s claim for breaches of representations and
warranties, but granted the defendants’ motion to dismiss
Ambac Assurance’s claims for breach of the repurchase
protocol and for alter ego liability against Nomura Holding.
On December 29, 2016, the court denied Nomura’s motion
to strike Ambac Assurance’s amended complaint and its
motion to dismiss the fraudulent-inducement claim. Nomura
appealed the June 2015 decision to the extent it denied its
motion to dismiss, filing its opening appellate brief on March
23, 2017. On December 7, 2017, the First Department
affirmed the trial court’s June 3, 2015 decision. Discovery is
ongoing.
• Ambac Assurance Corporation and the Segregated Account
of Ambac Assurance Corporation v. Countrywide Home
Loans, Inc. (Supreme Court of the State of New York, County
of New York, Case No. 652321/2015, filed on June 30, 2015).
On June 30, 2015, Ambac Assurance and the Segregated
Account filed a Summons with Notice in New York Supreme
| Ambac Financial Group, Inc. 135 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
Court (the “2015 New York Action”), asserting claims
identical to claims they asserted in a litigation filed on
December 30, 2014 in Wisconsin Circuit Court for Dane
County, Case No 14 CV 3511 (the “Wisconsin Action”).
Specifically, in each action Ambac Assurance asserted a claim
for fraudulent inducement in connection with its 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. 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. Countrywide opposed plaintiffs’ motion to stay and
on August 10, 2015, Countrywide filed a motion to dismiss
the complaint. On September 20, 2016, the court granted
Ambac Assurance’s motion to stay and held Countrywide’s
motion to dismiss in abeyance pending resolution of the
Wisconsin Action. Following the dismissal of the Wisconsin
Action on March 13, 2018, the court in the 2015 New York
Action vacated its stay on March 30, 2018, and restored
Countrywide’s motion to dismiss to the calendar. The parties
submitted supplemental letter briefs on April 11, 2018
addressing newly-issued relevant authority.
• 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 asserted 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. On December 20, 2016, the court denied
defendants’ motion to dismiss. Discovery is ongoing.
• Ambac Assurance Corporation v. U.S. Bank National
Association (United States District Court, Southern District
of New York, Docket No. 18-cv-5182 (LGS), filed June 8,
2018 (the “SDNY Action”)); In the matter of HarborView
Mortgage Loan Trust 2005-10 (Minnesota state court, Docket
No. 27-TR-CV-17-32 (the “Minnesota Action”)). These two
actions relate to U.S. Bank National Association’s (“U.S.
Bank”) acceptance of a proposed settlement in a separate
litigation that U.S. Bank is prosecuting, as trustee, related to
the Harborview Mortgage Loan Trust, Series 2005-10
(“Harborview 2005-10”), a residential mortgage-backed
securitization for which Ambac Assurance
issued an
insurance policy. On March 6, 2017, U.S. Bank filed a petition
commencing the Minnesota Action, a trust instruction
proceeding in Minnesota state court concerning the proposed
settlement, and on June 12, 2017, U.S. Bank filed an amended
petition. Ambac Assurance filed a motion to dismiss the
Minnesota Action. On November 13, 2017, the court denied
Ambac Assurance’s motion to dismiss the Minnesota Action.
On February 7, 2018, Ambac Assurance appealed this
decision, and on September 4, 2018, the Minnesota Court of
Appeals affirmed the lower court's decision. On September
17, 2018, Ambac Assurance filed a petition for review with
the Minnesota Supreme Court, which was denied on
November 13, 2018. On February 11, 2019, Ambac
Assurance filed a petition for certiorari with the United States
Supreme Court. On September 6, 2018, the court granted
U.S. Bank's motion for leave to file a Second Amended
Petition seeking approval of its acceptance of a proposed
settlement to settle the separate litigation being prosecuted by
U.S. Bank, as Trustee. On September 6, 2018, U.S. Bank
filed its Second Amended Petition, and Ambac Assurance and
certain other certificateholders objected to, or otherwise
responded to, the petition. Discovery in the Minnesota Action
is ongoing. On June 8, 2018, Ambac Assurance filed the
SDNY Action asserting claims arising out of U.S. Bank’s
acceptance of the proposed settlement and treatment of trust
recoveries. Ambac Assurance asserts claims for declaratory
judgment, breach of contract, and breach of fiduciary duty.
On November 20, 2018, U.S. Bank filed a motion to dismiss
the complaint, which Ambac Assurance opposed on
December 18, 2018. The motion remains pending. Discovery
in the SDNY Action is stayed.
• 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 has asserted 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. On June 29, 2018, the court granted in part and
denied in part U.S. Bank’s motion to dismiss. The court
dismissed the breach-of-fiduciary duty claim in part as
duplicative of the breach-of-contract claim; dismissed the
breach-of-contract claim as untimely only to the extent that
it was premised on U.S. Bank's obligation to certify that
mortgage documents were properly delivered to the Trusts;
dismissed the Streit Act claims; and otherwise denied the
motion to dismiss. Discovery is ongoing.
• In re application of Deutsche Bank National Trust Company
as Trustee of the Harborview Mortgage Loan Trust Mortgage
Loan Pass-Through Certificates, Series 2006-9 (Supreme
Court of the State of New York, County of New York, No.
654208/2018), filed August 23, 2018 (the “Trust Instruction
Proceeding”). This action relates to Deutsche Bank National
Trust Company’s (“DBNT”) proposed settlement of claims
related to the Harborview Mortgage Loan Trust Series 2006-9
(“Harborview 2006-09”). On August 23, 2018, DBNT filed
a Petition commencing the Trust Instruction Proceeding,
seeking judicial instruction pursuant to CPLR Article 77, inter
alia, to accept the proposed settlement with respect of claims
relating to Harborview 2006-9. On September 6, 2018, the
court entered an Order to Show Cause, setting out procedures
for DBNT to give notice of the proceedings and for interested
persons to appear. On November 2, 2018, Ambac Assurance
and other interested persons filed notices of intention to
appear and answers to DBNT’s petition, and on November
29, 2018 various parties filed responses to answers. In its
| Ambac Financial Group, Inc. 136 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
answer, Ambac Assurance opposed DBNT’s request for an
order instructing it to accept the proposed settlement on the
basis that DBNT breached its obligations by failing to
investigate and enforce breaches of representations and
warranties in Harborview 2006-09, failing to immediately
reject the proposed settlement, and instituting an inadequate
certificateholder approval process. Ambac sought a period
of discovery before resolution on the merits.
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 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, is to develop
a distribution plan for the fair fund, which will be filed with the
Court and will be subject to a comment period. The SEC filed a
status report on August 13, 2018 to update the court on the process
relating to the distribution plan. The Distribution Agent stated that
it intended to complete its review of the submissions it received
from investors by the end of 2018. Following completion of its
review, the Distribution Agent will formulate a plan of distribution,
which will then be reviewed by the SEC prior to being filed with
the court. The submission states that Distribution Agent expects
to file the plan of distribution and distribute the funds in the first
quarter of 2019. There is no guarantee that there will actually be
a first quarter 2019 distribution as it depends on whether any
objections are filed to the plan of distribution and court approval.
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.
NECA-IBEW Health & Welfare Fund v. Goldman, Sachs & Co.,
et al., (United States District Court for Southern District of New
York, No. 1:08-cv-10783-LAP) and Police and Fire Retirement
System of the City of Detroit v. Goldman, Sachs & Co. et
al. (United States District Court for the Southern District of New
York, No. 10 Civ. 4429-LAP). In this class action, Plaintiffs
alleged that the offering documents for various residential
mortgage-backed securities sold by Goldman Sachs entities in
2007 and 2008 contained false and misleading statements. The
parties to the litigation reached a negotiated settlement for
$272,000. The settlement class approved by the court included all
persons who prior to December 11, 2008 purchased or otherwise
acquired any of the securities at issue in the actions and were
damaged
its subsidiaries
purchased or otherwise acquired certain securities at issue in the
class action and were thereby included in the settlement class.
Ambac submitted a claim form and in November 2018 received a
distribution of approximately $26,721.
Ambac Assurance and
thereby.
| Ambac Financial Group, Inc. 137 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
17. QUARTERLY INFORMATION (Unaudited)
2018 Quarters
2017 Quarters
First
Second
Third
Fourth
First
Second
Third
Fourth
$
4,261
$
(611) $ (22,954) $
(4,524) $
5,584
$
6,928
$ (24,696) $
(2,129)
($ in thousands)
Gross premiums written
Net premiums earned
Net investment income
Net other than temporary impairment losses
(299)
(1,014)
(266)
30,883
110,240
25,836
66,662
25,640
58,332
Net realized investment gains (losses)
Net gains (losses) on derivative contracts
Net realized gains (losses) on extinguishment
of debt
Income (loss) on Variable Interest Entities
4,862
25,191
3,115
574
Losses and loss expenses (benefit)
(247,395)
Insurance intangible amortization
Operating expenses
Interest expense
Pre-tax income (loss)
Net income (loss)
Net income (loss) attributable to Common
Shareholders
Net income (loss) per share:
Basic
Diluted
28,636
36,434
48,073
308,309
305,704
$ 305,704
$
$
6.72
6.70
$
$
$
47,148
8,932
6
577
32,579
23,242
26,063
62,446
6,308
4,313
28,730
37,483
(1,659)
29,413
(44,716)
—
454
47,613
81,559
(3,942)
(4,896)
(462)
2,741
3,701
(42,298)
135,011
28,982
21,339
66,064
37,525
28,124
31,572
30,201
17,583
—
1,831
33,501
26,421
28,368
65,673
43,152
85,160
52,989
87,177
(1,763)
(13,510)
6,150
4,163
31,523
107,057
(956)
(68)
31,544
4,180
40,692
2,179
(1,219)
66,100
33,471
31,304
28,234
13,992
—
—
(4,049)
21,237
209,806
102,269
45,690
34,074
29,145
34,168
28,934
30,990
(185,466)
(6,917)
(19,948)
(22,136)
(105,860)
(22,159)
(20,459)
(125,441)
7,110
(190,905)
(19,479)
4,313
$ (103,845) $ (20,459) $ (125,441) $
7,110
$ (190,905) $ (19,479)
0.09
0.09
$
$
(2.27) $
(0.45) $
(2.77) $
(2.27) $
(0.45) $
(2.77) $
0.16
0.16
$
$
(4.20) $
(4.20) $
(0.43)
(0.43)
| Ambac Financial Group, Inc. 138 2018 FORM 10-K |
Item 9. Changes in and Disagreements with
Accountants on Accounting and Financial
Disclosure — No matters require disclosure.
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,
2018 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, 2018,
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, 2018 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 2018 that
have materially affected, or are reasonably likely to materially
affect, Ambac's internal control over financial reporting.
Item 9B. Other Information — No matters require
disclosure.
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 2019 Annual
Meeting of Stockholders which will be filed within 120 days of
the end of our fiscal year ended December 31, 2018 (the “2019
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 2019 Proxy Statement and is
incorporated herein by reference.
| Ambac Financial Group, Inc. 139 2018 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 2019 Proxy Statement and is incorporated herein by reference.
Equity Compensation Plan Information
The following table provides information as of December 31, 2018 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)
1,695,693 (2) (3)
---
1,695,693 (2) (3)
$20.63 (4)
---
$20.63 (4)
1,972,068
---
1,972.068
(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, 2018, 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 645,028 restricted stock units, 16,667 options and 1,033,998 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. 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 at the end of a specified performance period.
(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. Certain Relationships and Related
Item 14. Principal Accountant Fees and Services
Transactions, and Director Independence
Information relating to Ambac with respect to certain relationships
and related transactions and director independence will be in the
2019 Proxy Statement and is incorporated herein by reference.
Information relating to principal accountant fees and services will
be in the 2019 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
145
146
151
| Ambac Financial Group, Inc. 140 2018 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
Specimen form of common stock certificate (incorporated by reference to Exhibit 4.1 to Form 8-A, filed on May 1, 2013).
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
Warrant Agreement between Ambac Financial Group, Inc. and Computershare Inc. (incorporated by reference to Exhibit
4.2 to Form 8-A, filed on May 1, 2013).
Specimen form of warrant certificate (included in Exhibit 4.2).
Junior Note Fiscal Agency Agreement, dated as of April 30, 2013, by and between the Segregated Account of Ambac
Assurance Corporation and The Bank of New York Mellon, as fiscal agent (filed as Exhibit 4.5 to Ambac Financial Group,
Inc.’s Annual Report on Form 10-K for the year ended December 31, 2013 and incorporated herein by reference).
5.1% Junior Surplus Note due June 7, 2020 in the aggregate amount of $350 million issued by the Segregated Account
of Ambac Assurance Corporation pursuant to the Junior Note Fiscal Agency Agreement, dated as of April 30, 2013 (filed
as Exhibit 4.6 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2013 and
incorporated herein by reference).
Form of 5.1% Non-Reducing Junior Surplus Note due June 7, 2020 issued by the Segregated Account of Ambac Assurance
Corporation (filed as Exhibit 4.7 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended
December 31, 2013 and incorporated herein by reference).
Form of 5.1% Bankruptcy Reducing Junior Surplus Note due June 7, 2020 issued by the Segregated Account of Ambac
Assurance Corporation (filed as Exhibit 4.8 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year
ended December 31, 2013 and incorporated herein by reference).
Form of 5.1% Reducing Junior Surplus Note due June 7, 2020, issued by the Segregated Account of Ambac Assurance
Corporation (filed as Exhibit 4.9 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended
December 31, 2013 and incorporated herein by reference).
Fiscal Agency Agreement, dated as of July 19, 2010, by and between the Segregated Account of Ambac Assurance
Corporation and The Bank of New York Mellon, as fiscal agent (filed as Exhibit 4.10 to Ambac Financial Group, Inc.’s
Annual Report on Form 10-K for the year ended December 31, 2013 and incorporated herein by reference).
Form of Surplus Note due June 7, 2020 issued by the Segregated Account of Ambac Assurance Corporation.(included in
Exhibit 4.9).
Fiscal Agency Agreement, dated as of June 7, 2010, by and between Ambac Assurance Corporation and The Bank of New
York Mellon, as fiscal agent (filed as Exhibit 10.3 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 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).
4.16+
Promissory Note and Security Agreement dated as of February 12, 2018, of Ambac Assurance Corporation in favor of
Ambac LSNI, LLC
(10) Material contract and management compensation plans and arrangements:
10.1
10.2
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).
| Ambac Financial Group, Inc. 141 2018 FORM 10-K |
(b)
Exhibits
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
10.17
10.18
10.19
10.20
10.21
10.22
10.23
Long-Term Incentive Compensation Agreement dated as of May 9, 2014 between Ambac Financial Group, Inc. and Robert
B. Eisman (filed as Exhibit 10.4 to Ambac Financial Group, Inc.'s Quarterly Report on Form 10-Q for the quarter ended
June 30, 2014 and incorporated herein by reference).
Ambac Financial Group, Inc.'s Long-Term Incentive Compensation Plan (filed as Exhibit 10.1 to Ambac Financial Group,
Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014 and incorporated herein by reference).
Ambac Financial, Group, Inc.’s Incentive Compensation Plan (filed as Appendix A to Ambac Financial Group’s 2013
Definitive Proxy Statement on Schedule 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).
Lease, dated as of March 1, 2011, by and between One State Street, LLC and Ambac Assurance Corporation (filed as
Exhibit 10.34 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2010 and
incorporated herein by reference).
Settlement, Discontinuance and Release Agreement, dated as of March 1, 2011, by and among One State Street, LLC,
Ambac Financial Group, Inc., Ambac Assurance Corporation and the Segregated Account of Ambac Assurance
Corporation (filed as Exhibit 10.33 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended
December 31, 2010 and incorporated herein by reference).
Settlement Agreement, dated as of June 7, 2010, by and among Ambac Assurance Corporation, Ambac Credit Products
LLC, Ambac Financial Group, Inc. and the parties listed on Schedule A thereto (filed as Exhibit 10.1 to Ambac Financial
Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by
reference).
Ambac Financial Group, Inc. Severance Pay Plan (Applicable to termination on or after January 1, 2010) (filed as Exhibit
10.26 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 and
incorporated herein by reference).
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).
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 (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).
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).
| Ambac Financial Group, Inc. 142 2018 FORM 10-K |
(b)
Exhibits
10.24
10.25
10.26
10.27
10.28
10.29
10.30
10.31
10.32
10.33
10.34
10.35
10.36
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. (filed as Exhibit 10.38 to Ambac Financial Group, Inc.'s Annual Report
on Form 10-K for the year ended December 31, 2017 and incorporated herein by reference).
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.
(filed as Exhibit 10.39 to Ambac Financial Group, Inc.'s Annual Report on Form 10-K for the year ended December 31,
2017 and incorporated herein by reference).
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. (filed as
Exhibit 10.40 to Ambac Financial Group, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2017 and
incorporated herein by reference).
10.37+
Amendment No. 1 to the 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.
10.38
10.39
10.40
10.41
Form of 2018 Restricted Stock Unit Award Agreement between Ambac Financial Group, Inc. and Messrs. LeBlanc, Trick
and Ksenak (filed as Exhibit 10.1 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q, filed on May 9, 2018
and incorporated herein by reference).
Form of 2018 Restricted Stock Unit Award Agreement between Ambac Financial Group, Inc. and Messrs. Barranco,
Eisman, Reilly and Ms. Smith (filed as Exhibit 10.2 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q,
filed on May 9, 2018 and incorporated herein by reference).
Form of 2018 Performance Stock Unit Award Agreement between Ambac Financial Group, Inc. and Messrs. LeBlanc,
Trick and Ksenak (filed as Exhibit 10.3 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q, filed on
May 9, 2018 and incorporated herein by reference).
Form of 2018 Performance Stock Unit Award Agreement between Ambac Financial Group, Inc. and Messrs. Barranco,
Eisman, Reilly and Ms. Smith (filed as Exhibit 10.4 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q,
filed on May 9, 2018 and incorporated herein by reference).
| Ambac Financial Group, Inc. 143 2018 FORM 10-K |
(b)
Exhibits
10.42
10.43
Form of 2018 Deferred Stock Unit Award Agreement between Ambac Financial Group, Inc. and each of the Company’s
executive officers (filed as Exhibit 10.5 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q, filed on May
9, 2018 and incorporated herein by reference).
Preferred Stock Repurchase and Support Agreement dated as of June 22, 2018, by and among Ambac Assurance
Corporation (“AAC”), Ambac Financial Group, Inc. and the holders of one or more series of the AAC’s outstanding
Auction Market Preferred Shares (filed as Exhibit 10.1 to Ambac Financial Group, Inc.’s Current Report on Form 8-K,
filed on June 25, 2018 and incorporated herein by reference).
(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 Board of Directors of Ambac Financial Group, Inc. (filed as Exhibit 99.5 to Ambac Financial Group, Inc.'s Annual
Report on Form 10-K for the year ended December 31, 2017 and incorporated herein by reference).
Other exhibits, filed or furnished, as indicated:
21.1+
23.1+
24.1+
31.1+
31.2+
32.1++
101.INS
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
Certification of Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) Promulgated under the Securities
Exchange Act of 1934
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. 144 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE I — SUMMARY OF INVESTMENTS
Other Than Investments in Related Parties
December 31, 2018
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
Cost
Estimated
Fair Value
Amount at Which
Shown in the
Balance Sheet
$
882,631
$
879,919
$
1,288,882
1,278,122
30,496
93,636
221,825
133,075
370,199
430,405
362,847
30,834
94,394
258,607
131,356
442,443
430,331
391,217
879,919
1,278,122
30,834
94,394
258,607
131,356
442,443
430,331
391,217
$
3,813,996
$
3,937,223
$
3,937,223
| Ambac Financial Group, Inc. 145 2018 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,
2018
2017
Assets:
Fixed income securities, at fair value (amortized cost: 2018—$151,007 and 2017—$239,476)
$
148,194
$
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 shares: 45,365,170 and
45,275,982
Additional paid-in capital
Accumulated other comprehensive income (loss)
Retained earnings
Treasury stock, shares at cost: 28,892 and 24,816
Total Ambac Financial Group, Inc. stockholders’ equity
Total liabilities and stockholders’ equity
192,996
40,168
381,358
14,942
1,147,883
820
44,353
3,205
230,055
69,531
64,691
364,277
3,949
968,392
329
29,576
14,946
$
1,592,561
$
1,381,469
564
564
—
454
219,429
(48,715)
1,421,302
(473)
1,591,997
$
1,592,561
$
321
321
—
453
199,560
(52,239)
1,233,845
(471)
1,381,148
1,381,469
(1) As of December 31, 2018, and December 31, 2017, $44,381, and $30,496 , respectively, relate to receivables from the Registrant's wholly-owned subsidiary,
Ambac Assurance Corporation, pursuant to the intercompany tax sharing agreement, with the difference being state income taxes.
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the following notes.
| Ambac Financial Group, Inc. 146 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE II— CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (PARENT COMPANY ONLY)
Condensed Statement of Comprehensive Income
($ in thousands) Year Ended December 31,
2018
2017
2016
Revenues:
Investment income
Other 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 income tax provision (benefit) of $2,366,
$0 and $0
Gains (losses) on foreign currency translation, net of income tax provision (benefit) of
$0, $0 and $0
Credit risk changes of fair value option liabilities, net of income tax provision (benefit)
of $161, $0 and $0
Changes to postretirement benefit, net of income tax provision (benefit) of $0, $0 and
$0
Total other comprehensive income (loss)
$
27,525
$
24,411
$
13,493
35
(918)
(933)
25,709
8,315
8,315
17,394
(11,102)
28,496
157,217
—
(550)
(6,575)
17,286
3,913
3,913
13,373
(29,398)
42,771
(371,486)
185,713
$
(328,715) $
—
(289)
(7)
13,197
11,486
11,486
1,711
(28,739)
30,450
44,393
74,843
185,713
$
(328,715) $
74,843
55,148
(81,520)
67,900
(47,893)
73,586
(122,128)
935
(1,766)
6,424
—
1,273
(6,661)
—
23
(54,205)
20,638
Total comprehensive income (loss) attributable to Ambac Financial Group, Inc.
$
192,137
$
(335,376) $
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. 147 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE II— CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (PARENT COMPANY ONLY)
Condensed Statement of Stockholders' Equity
($ in thousands)
Total
Retained
Earnings
Accumulated
Other
Comprehensive
Income
Preferred
Stock
Common
Stock
Additional
Paid-in
Capital
Common
Stock Held
in Treasury,
at Cost
Balance at January 1, 2018
$ 1,381,148
$ 1,233,845
$
(52,239) $
— $
453
$
199,560
$
(471)
Total comprehensive income (loss)
192,137
185,713
Adjustment to initially apply ASU
2016-01
Stock-based compensation
Cost of shares (acquired) issued
under equity plan
Issuance of common stock
Issuance of warrants
Warrants exercised
—
11,854
2,900
—
(1,158)
(1,156)
1
8,012
3
—
—
—
6,424
(2,900)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
1
—
—
—
—
11,854
—
—
8,012
3
—
—
—
(2)
—
—
—
Balance at December 31, 2018
$ 1,591,997
$ 1,421,302
$
(48,715) $
— $
454
$
219,429
$
(473)
Balance at Balance at January 1,
2017
$ 1,713,914
$ 1,557,681
$
(38,990) $
— $
452
$
195,267
$
(496)
—
—
—
—
25
—
(471)
(118)
—
—
—
(378)
—
—
—
(496)
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
Issuance of common stock
—
6,588
(137)
4,293
(137)
—
(1,547)
(1,572)
1
—
Balance at December 31, 2017
$ 1,381,148
$ 1,233,845
Balance at January 1, 2016
$ 1,684,799
$ 1,478,439
$
$
(6,661)
(6,588)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
1
(52,239) $
— $
453
15,215
$
— $
Total comprehensive income
20,638
74,843
(54,205)
Adjustment to initially apply ASU
2014-13
Stock-based compensation
Cost of shares (acquired) issued
under equity plan
Cost of warrants acquired
Issuance of common stock
Warrants exercised
6,442
5,253
(505)
(2,717)
2
2
6,442
—
(127)
(1,916)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
$
$
—
—
—
4,293
—
—
199,560
190,813
—
—
5,253
—
(801)
—
2
$
$
450
—
—
—
—
—
2
—
Balance at December 31, 2016
$ 1,713,914
$ 1,557,681
$
(38,990) $
— $
452
$
195,267
$
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. 148 2018 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)
2018
2017
2016
$
185,713
$
(328,715) $
74,843
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
Purchase of auction market preferred shares of Ambac Assurance
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
Non-cash financing activity:
Issuance of warrants in connection with purchase of auction market preferred shares of
Ambac Assurance
(157,217)
(7,284)
918
933
(14,776)
11,854
(491)
11,741
247
31,638
230,448
(136,534)
(123,465)
24,523
(11,048)
(4,572)
(20,648)
—
3
3
10,993
3,949
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
$
$
$
14,942
$
3,949
$
3,674
$
784
$
8,012
$
— $
(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
32,251
635
—
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. 149 2018 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, 2018 and 2017 and
for the three years in the period ended December 31, 2018, should be read in conjunction with the consolidated financial statements of Ambac
Financial Group, Inc. and Subsidiaries and the notes thereto included in this 2018 Annual Report on Form 10-K for the year ended December 31,
2018.
Ambac, headquartered in New York City, is a financial services holding company incorporated in the state of Delaware on April 29, 1991.
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, 2018 Ambac had a U.S. loss carryforwards totaling
$3,423,704, which, if not utilized, will begin expiring in 2029, and will fully expire in 2032. The net operating loss carryforwards ("NOLs")
allocable to AFG as of December 31, 2018 were $1,260,583.
Pursuant to the intercompany tax sharing agreement, 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, 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, 2018
(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 $1,486,879, which utilized all of the $479,000 allocated Tier A NOL
and $1,007,879 of the $1,057,000 allocated Tier B NOL and resulted in accrued Tolling Payments, net of applicable credits. Of the 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.
At December 31, 2018, $44,381 of tolling payments are owed by Ambac Assurance to Ambac. In May 2018 Ambac executed a waiver under
the intercompany tax sharing agreement pursuant to which Ambac Assurance was relieved of the requirement to make the $30,496 payment
for the 2017 tax year by June 1, 2018 until such time as OCI consents to the payment. The 2018 accrued tolling payment of $13,885 is also
subject to OCI's consent.
| Ambac Financial Group, Inc. 150 2018 FORM 10-K |
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE IV— REINSURANCE
Years Ended December 31, 2018, 2017 and 2016
Insurance Premiums Written
($ in Thousands)
Gross
Amount
Ceded to Other
Companies
Assumed from
Other
Companies
Net
Amount
Percentage of
Amount
Assumed to
Net
Year Ended December 31, 2018
$
(23,828) $
16,860
$
— $
(40,688)
—%
Year Ended December 31, 2017
(14,313)
(2,104) $
Year Ended December 31, 2016
(53,837)
(8,772)
—
—
(12,209)
—%
(45,065)
—%
| Ambac Financial Group, Inc. 151 2018 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, 2019
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, 2019
Jeffrey S. Stein
/S/ CLAUDE LEBLANC
President, Chief Executive Officer and Director
February 28, 2019
Claude LeBlanc
(Principal Executive Officer)
/S/ DAVID TRICK
Executive Vice President and Chief Financial Officer
February 28, 2019
David Trick
(Principal Financial Officer)
/S/ ROBERT B. EISMAN
Senior Managing Director and Chief Accounting Officer
February 28, 2019
Robert B. Eisman
(Principal Accounting Officer)
/S/ ALEXANDER D. GREENE*
Director
February 28, 2019
Alexander D. Greene
/S/ IAN D. HAFT*
Director
Ian D. Haft
/S/ DAVID L. HERZOG*
Director
David L. Herzog
February 28, 2019
February 28, 2019
/S/ C. JAMES PRIEUR*
Director
February 28, 2019
C. James Prieur
/S/ JOAN LAMM-TENNANT*
Director
February 28, 2019
Joan Lamm-Tennant
/S/ STEPHEN M. KSENAK
*By: Stephen M. Ksenak
Attorney-in-fact
February 28, 2019
| Ambac Financial Group, Inc. 152 2018 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 stockholders 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 2018 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-
December
2013
Year Ended December 31,
2014
2015
2016
2017
Net (loss) income attributable to common stockholders
$
505
$
484
$
493
$
75
$
(329)
$
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
Adjusted earnings (losses) (2)
(166)
100
—
(24)
47
(17)
152
—
35
(16)
(37)
170
515
27
(14)
(8)
175
—
39
34
(11)
151
(21)
45
$
462
$
637
$
1,154
$
315
$
(165)
$
Book Value Per Share / Adjusted Book Value Per Share
June 30,
2013
2013
2014
2015
2016
2017
December 31,
Total Ambac Financial Group, Inc. Shareholders' Equity (Deficit)
$
6.38
$
15.62
$
31.09
$
37.41
$
37.94
$
30.52
$
Adjustments:
Non-credit impairment unrealized fair value losses on credit derivatives
Insurance intangible asset
Goodwill
Ambac CVA on derivative product liabilities (excluding credit derivatives)
Net unearned premiums and fees in excess of expected losses
Net unrealized investment (gains) losses in Accumulated Other
Comprehensive Income
Adjusted book value (2)
4.19
(36.03)
(11.43)
(1.44)
40.08
1.62
(35.51)
(11.43)
(1.08)
38.17
1.24
(31.35)
(11.43)
(1.43)
31.57
0.42
(26.91)
—
(1.75)
20.11
0.25
(21.30)
—
(0.99)
16.21
0.01
(18.71)
—
—
13.20
10.19
2.02
0.93
(4.68)
(1.13)
(2.63)
(0.68)
(1.89)
$
3.77
$
8.32
$
15.01
$
28.15
$
29.48
$
24.34
$
27.58
(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.
2018
186
1
107
7
—
301
2018
35.12
0.03
(15.87)
—
—
[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 Monday, June 3, 2019,
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 2018
Annual Report on Form 10-K.
1
AMBAC FINANCIAL GROUP, INC.
One State Street Plaza
New York, NY 10004
www.ambac.com