Business Context and Reporting Period
The filing is a Form 10-Q for Ambac Financial Group, Inc. and subsidiaries, not Octave Specialty Group Inc. It covers the quarter and six months ended June 30, 2020, with unaudited U.S. GAAP financial statements. Ambac Assurance Corporation and Ambac Assurance UK Limited are financial guarantee insurers in run-off. The company’s strategy focuses on reducing insured exposure, managing investments and liabilities, pursuing recoveries, and evaluating selective new business opportunities.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2020 | Six Months Ended June 30, 2020 |
|---|---|---|
| Total revenues | $75 million | $6 million |
| Net loss attributable to common stockholders | $(35) million | $(315) million |
| Loss per diluted share | $(0.77) | $(6.83) |
| Net cash used in operating activities | Not separately presented | $(112) million |
| Net cash provided by investing activities | Not separately presented | $270 million |
| Net cash used in financing activities | Not separately presented | $(205) million |
- Net premiums earned were $11 million in the quarter and $21 million for the six months, reflecting runoff of the insured portfolio.
- Net investment income was $52 million in the quarter and $31 million for the six months, compared with $86 million and $141 million, respectively, in the prior-year periods.
- Net realized investment gains were $10 million in the quarter and $18 million for the six months.
- Net derivative results were a $2 million gain in the quarter but a $68 million loss for the six months, primarily reflecting interest-rate and counterparty-credit effects.
- Losses and loss expenses were $16 million in the quarter and $132 million for the six months, compared with benefits of $133 million and $121 million in the prior-year periods.
- Insurance intangible amortization was $14 million in the quarter and $27 million for the six months, substantially below the prior-year amounts of $226 million and $263 million.
- Total assets were $12.761 billion and total liabilities were $11.632 billion at June 30, 2020. Total stockholders’ equity was $1.129 billion, down from $1.536 billion at December 31, 2019.
- Cash, cash equivalents and restricted cash totaled $34 million at June 30, 2020, compared with $46 million at June 30, 2019.
- Long-term debt was $2.749 billion, including $785 million of surplus notes, $1.659 billion of the Ambac Note, $292 million of Tier 2 notes and $13 million of Ambac UK debt.
- AFG reported net assets of $481 million, including $328 million of cash and short-term investments, at June 30, 2020.
Material Changes Versus Prior Comparable Period
- Second-quarter net loss improved to $35 million from $128 million, mainly because of sharply lower insurance intangible amortization, a positive derivative result, and lower operating, interest and tax expenses. These improvements were partly offset by higher loss expenses and lower investment income.
- Six-month net loss increased to $315 million from $172 million. The deterioration was driven by lower investment income and realized gains, larger derivative losses, lower premium income, higher insurance losses and lower VIE income.
- Total insured net par outstanding declined 7% to $35.276 billion from $38.018 billion at December 31, 2019, primarily due to de-risking transactions, maturities, amortization, refundings, calls and foreign-exchange effects.
- Adversely classified exposure increased 16% to $8.756 billion, while watch-list exposure declined 22% to $5.238 billion. COVID-19-related additions included approximately $1.002 billion transferred from the watch list to adverse classification.
- Below-investment-grade exposure increased to $7.650 billion from $7.484 billion. COVID-19-related downgrades were a primary driver.
- Loss reserves increased, with gross loss and loss expense reserves rising to $1.814 billion from $1.548 billion. The net reserve position after subrogation recoverables and other adjustments was $(401) million compared with $(482) million at year-end.
- Cash flow improved from $(37) million in the first six months of 2019 to $(47) million in the first six months of 2020, although financing cash use increased to $(205) million, including a $103 million Ambac Note paydown.
Guidance, Outlook, Risks and Unusual Items
- Management did not provide conventional quantitative earnings guidance. Its base-case outlook assumed a deep recession in the first half of 2020, a modest recovery in the second half, continued uncertainty in 2021 and recovery to 2019 economic output levels no earlier than 2022.
- COVID-19 increased credit risk across public finance, project finance, mortgage-backed securities, student loans and other asset-backed exposures. Management increased reserves and warned that further increases may be required.
- Public finance exposures most vulnerable to prolonged disruption included hotels and convention centers, stadiums, airports, dedicated-tax credits, higher education, mass transit and toll roads. These sectors represented $2.474 billion of net insured exposure and $271.8 million of debt service due over the following twelve months.
- Ambac had $1.105 billion of net par exposure to Puerto Rico. Management identified an approximately $1.2 billion possible increase in public-finance loss reserves under stress or adverse conditions, which would reduce stockholders’ equity from $1.129 billion to approximately $(71) million. Losses could exceed this estimate.
- The amended Puerto Rico Plan of Adjustment contemplated an estimated recovery of only 3.9% on certain PRHTA, PRIFA and PRCCDA claims. Its final form, confirmation and impact on Ambac remained uncertain.
- Representation-and-warranty subrogation recoveries totaled $1.757 billion gross, or $1.731 billion net of reinsurance. These estimates depend on litigation, counterparty collectability, timing and regulatory approvals and may not be realized.
- OCI declined Ambac Assurance’s request to pay surplus-note principal and accrued interest scheduled for June 7, 2020. Payments require OCI approval, and accrued interest on third-party surplus and junior surplus notes totaled $323 million and $159 million, respectively, at June 30, 2020.
- Ambac UK had a Solvency II eligible-capital deficiency of £76 million at June 30, 2020, compared with £30 million at December 31, 2019. Discussions with regulators were ongoing.
- Derivative collateral requirements remained material. AFS had posted net collateral of $165 million at June 30, 2020, and all ratings-based contingent features had been triggered.
- The company adopted CECL on January 1, 2020. The opening retained-earnings impact was not material.
- Management stated that disclosure controls and procedures were effective and that remote work had not materially affected internal controls.
Most Important Facts for Investors to Verify
- Confirm the issuer identity: the supplied filing is for Ambac Financial Group, Inc., not Octave Specialty Group Inc.
- Assess the adequacy of reserves for Puerto Rico, COVID-19-affected public-finance credits, student loans and other structured-finance exposures.
- Evaluate whether the $1.731 billion net representation-and-warranty recovery estimate is collectible and on what timetable.
- Review Ambac Assurance’s ability to meet claims, debt obligations and collateral requirements, including the effect of OCI restrictions.
- Monitor Ambac UK’s regulatory capital deficiency and any remediation required by UK regulators.
- Reconcile GAAP equity of $1.129 billion with adjusted book value of $965 million and understand the assumptions underlying the non-GAAP measure.
- Track the Puerto Rico restructuring, related litigation and any changes to the anticipated recovery rates.