Ambac Financial Group, Inc. — 2019 First-Quarter Form 10-Q
Filing identity: The supplied filing is for Ambac Financial Group, Inc. (NASDAQ: AMBC), not Octave Specialty Group Inc. It covers the three months ended March 31, 2019, and was filed May 9, 2019. The interim financial statements are unaudited.
Business Context and Reporting Period
Ambac is a financial-services holding company whose principal subsidiaries provide financial guarantee insurance through Ambac Assurance Corporation and Ambac Assurance UK Limited. The insurance portfolio is in runoff, with management focused on commutations, restructurings, reinsurance, loss recovery, liability management, and maximizing investment returns. Ambac also evaluates adjacent opportunities in credit, insurance, asset management, and other financial services.
Key Financial Metrics
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Total revenues | $100.4 million | $174.1 million |
| Net premiums earned | $27.8 million | $30.9 million |
| Net investment income | $54.8 million | $110.2 million |
| Net realized investment gains | $17.2 million | $4.9 million |
| Net gains/(losses) on derivatives | $(16.2) million | $25.2 million |
| Losses and loss expenses | $12.4 million expense | $247.4 million benefit |
| Operating expenses | $24.9 million | $36.4 million |
| Interest expense | $68.0 million | $48.1 million |
| Net income/(loss) attributable to common stockholders | $(43.2) million | $305.7 million |
| Diluted EPS | $(0.94) | $6.70 |
| Net cash used in operating activities | $95.1 million | $1.19 billion |
At March 31, 2019, total assets were $15.0 billion, total liabilities were $13.4 billion, and total stockholders’ equity was $1.67 billion. Consolidated investments were $4.04 billion, cash and cash equivalents were $21.8 million, and cash, cash equivalents, and restricted cash totaled $25.1 million. Long-term debt was $2.93 billion excluding $5.74 billion of consolidated variable-interest-entity debt.
Ambac Financial Group reported $469 million of cash, investments, and receivables on a standalone basis. Management stated that dividend payments from Ambac Assurance are highly unlikely in the foreseeable future; near-term parent liquidity is expected to rely principally on existing assets, expense-sharing payments, and potential tax-tolling payments.
Material Changes Versus the Prior Comparable Period
- Net income declined to a $43.2 million loss from $305.7 million of income, primarily because Q1 2018 included a $288.2 million benefit from the Rehabilitation Exit Transactions.
- Net investment income fell by $55.4 million, mainly because the 2018 rehabilitation transactions and subsequent sales reduced holdings of Ambac-insured RMBS and other insured securities.
- Derivative results shifted from a $25.2 million gain to a $16.2 million loss, reflecting lower forward interest rates in Q1 2019 versus rising rates in Q1 2018.
- Losses and loss expenses changed from a $247.4 million benefit to a $12.4 million expense. Q1 2019 included $69.3 million of domestic public-finance losses, primarily related to Puerto Rico, partly offset by favorable RMBS and Ambac UK development.
- Operating expenses decreased by $11.5 million, primarily from lower compensation and lower legal, consulting, and advisory costs following completion of the rehabilitation exit.
- Interest expense increased by $19.9 million, reflecting debt issued in connection with the rehabilitation exit transactions, including the Ambac Note and Tier 2 Notes.
- Total net par insured exposure declined 5% to $44.5 billion from $46.9 billion at year-end 2018. Adversely classified credits declined 12% to $9.5 billion, while watch-list credits increased 2% to $9.2 billion.
- A new variable-interest entity was consolidated effective February 12, 2019, generating a $14.9 million gain and increasing consolidated assets and liabilities by approximately $292 million and $364 million, respectively.
Cash Flow, Debt, and Capital
Operating cash outflow was $95.1 million, while investing activities provided $112.2 million, primarily from bond sales and maturities. Financing activities used $75.6 million, including a $13.1 million Ambac Note paydown and $63.0 million of consolidated VIE liability payments. Net cash declined by $58.4 million during the quarter.
Long-term debt consisted of approximately $744 million of surplus notes, $1.93 billion of Ambac Note obligations, and $258 million of Tier 2 Notes. Accrued and unpaid interest on surplus notes and junior surplus notes was $271 million and $127 million, respectively. Payments on surplus notes require approval from the Wisconsin Office of the Commissioner of Insurance.
Ambac Assurance’s statutory policyholder surplus declined to $1.08 billion from $1.15 billion at December 31, 2018. Qualified statutory capital declined to $1.60 billion from $1.65 billion. Ambac UK reported £101 million of available Solvency II capital, including £95 million eligible to meet requirements, versus regulatory capital requirements of £358 million; the resulting £263 million deficiency remained subject to discussions with regulators.
Guidance, Outlook, Risks, and Unusual Items
- No formal earnings or revenue guidance is provided. Management emphasizes active runoff, risk reduction, recoveries, liquidity preservation, and disciplined evaluation of new business opportunities.
- The COFINA Plan of Adjustment became effective February 12, 2019. Related commutations and distributions reduced Ambac’s COFINA net par exposure to approximately $185 million and reduced total Puerto Rico net par exposure to approximately $1.3 billion.
- Puerto Rico remains the principal risk concentration. Ambac incurred $69.3 million of domestic public-finance losses in Q1 2019 and estimated that adverse stress scenarios could increase public-finance loss reserves by approximately $950 million. Such an increase would reduce total stockholders’ equity from $1.67 billion to approximately $716 million, although losses could exceed that amount.
- Recorded representation-and-warranty subrogation recoveries were approximately $1.77 billion gross, or approximately $1.74 billion net of reinsurance. Management cautions that litigation, counterparty collectability, regulatory intervention, and timing could cause actual recoveries to be materially lower.
- The March 2019 First Circuit decision concerning special revenues in Puerto Rico Title III proceedings increased uncertainty for revenue-bond creditors and could reduce recoveries or increase loss reserves.
- Ambac UK entered a proposed Ballantyne Re restructuring in April 2019. If implemented, the transaction is expected to eliminate Ambac UK’s Ballantyne exposure and reduce future loss reserves; completion was not assured.
- Brexit created risks for six Ambac UK policies written under EU passporting rights, with aggregate par exposure of approximately $2.3 billion, $59 million of premium receivables, and $257 million of loss and loss expense reserves.
- The company’s securities remain speculative. Regulatory approvals, liquidity constraints, debt covenants, rehabilitation-related restrictions, litigation outcomes, reserve changes, market movements, and the ability to realize recoveries may materially affect value.
- Ambac adopted the new lease standard on January 1, 2019, recognizing approximately $15 million of right-of-use assets and lease liabilities at transition; management said the adoption did not materially affect the financial statements.
Investor Verification Checklist
- Confirm the filing issuer and ticker: the supplied document is Ambac Financial Group, Inc., AMBC, rather than Octave Specialty Group Inc.
- Reconcile the $43.2 million net loss and $28.1 million comprehensive income, including the large unrealized investment gains recorded in other comprehensive income.
- Assess the adequacy and sensitivity of loss reserves, especially the $950 million public-finance stress amount and the approximately $1.74 billion net RMBS representation-and-warranty recovery estimate.
- Review Ambac Assurance’s statutory surplus, required regulatory approvals for debt payments, and the likelihood and timing of parent-level liquidity transfers.
- Monitor Puerto Rico restructurings, litigation, fiscal plans, special-revenue legal developments, and their effects on insured exposure and recoveries.
- Evaluate Ambac UK’s £263 million Solvency II capital deficiency and the outcome of the proposed Ballantyne Re restructuring.
- Consider the effect of derivative collateral requirements, triggered termination rights, interest-rate movements, and the company’s substantial debt burden on liquidity.