Ambac Financial Group, Inc. — Form 10-Q Summary
Business context and reporting period
Ambac Financial Group, Inc. is a financial services holding company providing financial guarantee insurance through Ambac Assurance Corporation and Ambac Assurance UK Limited. The insurance businesses are in runoff and have not written new business since 2008. The filing covers the unaudited quarter ended March 31, 2018, compared primarily with the quarter ended March 31, 2017 and December 31, 2017.
On February 12, 2018, Ambac completed the exit of the Segregated Account from rehabilitation. The transaction discharged approximately $3.857 billion of Deferred Amounts and materially changed the company’s reserves, investments and debt structure.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 / Dec. 31, 2017 |
|---|---|---|
| Total revenues | $174.1 million | $126.4 million |
| Net premiums earned | $30.9 million | $47.6 million |
| Net investment income | $110.2 million | $81.6 million |
| Losses and loss expenses | $247.4 million benefit | $135.0 million expense |
| Pre-tax income | $308.3 million | $(105.9) million |
| Net income attributable to common stockholders | $305.7 million | $(125.4) million |
| Diluted earnings per share | $6.70 | $(2.77) |
| Net cash used in operating activities | $1.192 billion | $4.8 million |
| Total assets | $22.848 billion | $23.192 billion at Dec. 31, 2017 |
| Total liabilities | $20.739 billion | $21.547 billion at Dec. 31, 2017 |
| Total stockholders’ equity | $2.109 billion | $1.645 billion at Dec. 31, 2017 |
The reported profit was driven principally by a $288.2 million benefit from the rehabilitation exit settlement, higher investment income, favorable loss development and $25.5 million of gains on interest-rate derivatives. Adjusted earnings, a non-GAAP measure, were $329.8 million, or $7.22 per diluted share.
Cash and cash equivalents were $38.5 million at March 31, 2018, while cash, cash equivalents and restricted cash totaled $39.6 million. Ambac Financial Group reported approximately $274.1 million of cash and liquid investments, including $126.4 million of Ambac LSNI secured notes. The company also expects approximately $30.5 million of tax tolling payments in May 2018 based on 2017 NOL utilization.
Ambac Assurance’s standalone statutory policyholder surplus was $1.307 billion and qualified statutory capital was $1.774 billion at March 31, 2018. Ambac UK had a reported Solvency II capital deficit of approximately £329.3 million based on the latest available December 31, 2017 information.
Material changes versus prior periods
- Net income improved by $431.1 million from the prior-year loss, primarily because of the rehabilitation settlement benefit and favorable loss development.
- Net premiums earned declined $16.7 million because of continued runoff, terminations and lower call-related activity.
- Net investment income increased $28.6 million, but management expects investment income to decline materially beginning in the second quarter because the rehabilitation transactions reduced the investment portfolio and Ambac-insured RMBS holdings.
- Loss and loss expense reserves fell from $4.745 billion at year-end 2017 to $2.139 billion. Subrogation recoverable increased from $631.2 million to $1.895 billion, reflecting the settlement of Segregated Account claims.
- Long-term debt increased from $991.7 million to $2.958 billion due primarily to the $2.148 billion Ambac Note and $233.9 million of Tier 2 Notes issued in connection with the rehabilitation exit.
- Total net insured par outstanding declined 5% to $59.6 billion; adversely classified credits declined 10% to $12.6 billion.
- Operating cash flow was heavily affected by approximately $1.354 billion of cash outflows related to the rehabilitation exit transactions. Investing activities provided $657.0 million, while financing activities used $50.2 million.
Guidance, outlook, risks and unusual items
Management does not provide conventional revenue or earnings guidance. Its strategy is to run off Ambac Assurance through commutations, settlements, restructurings and risk reduction; maximize investment returns; pursue litigation recoveries; rationalize capital and liabilities; and evaluate selected new business opportunities.
- Ambac’s approximately $2.0 billion Puerto Rico exposure remains a major risk. PROMESA proceedings, fiscal stress, hurricane damage, litigation, mediation and uncertain creditor recoveries could produce losses materially exceeding current reserves.
- Management estimated potential additional stress losses of approximately $1.34 billion for public finance credits, approximately $1.9 billion for RMBS if estimated representation-and-warranty recoveries were not realized, approximately $90 million for student loans and approximately $200 million for other credits including Ambac UK. These are stress estimates, not forecasts.
- Recorded representation-and-warranty subrogation recoveries were approximately $1.834 billion gross, or approximately $1.806 billion net of reinsurance. Recovery depends on litigation outcomes, counterparty collectability, timing and regulatory intervention.
- OCI approval is required for principal and interest payments on Ambac Assurance’s surplus notes. Dividend payments to Ambac are considered highly unlikely for the foreseeable future, making holding-company liquidity dependent on cash and liquid investments, expense-sharing arrangements and tolling payments.
- The Ambac Note bears interest at three-month U.S. dollar LIBOR plus 5%, and the Tier 2 Notes bear 8.5% interest, generally payable in kind. Higher interest expense and substantial indebtedness may constrain financial flexibility.
- OCI proposed limiting protections under Section 6.13 of the Second Amended Plan of Rehabilitation. An adverse change could impair Ambac Assurance’s control rights and increase loss exposure.
- Ambac’s controls and procedures were assessed as effective, with no material changes to internal control over financial reporting during the quarter.
Facts investors should verify
- Whether the rehabilitation exit transactions produce the stated reserve reduction and whether the $288.2 million benefit is nonrecurring.
- The timing, collectability and legal outcomes of Puerto Rico, RMBS representation-and-warranty and other recovery claims.
- Ambac Assurance’s ability to meet debt, policyholder and derivative obligations while obtaining required OCI approvals.
- Holding-company liquidity after considering cash, liquid investments, collateral requirements, debt service and the expected $30.5 million tax tolling payment.
- The magnitude and timing of the expected decline in investment income following the reduced investment portfolio.
- Ambac UK’s capital remediation plan and updated Solvency II results when finalized.
- The effect of fair-value assumptions, interest rates, credit spreads, foreign exchange movements and reserve model changes on reported earnings and book value.