Ambac Financial Group, Inc. 10-Q Summary (Period Ended September 30, 2009)
Business Context and Reporting Period
This is a Quarterly Report (Form 10-Q) for Ambac Financial Group, Inc. for the period ended September 30, 2009. Ambac is a holding company providing financial guarantees and financial services. The company is currently in a severe liquidity crisis, with its principal operating subsidiary, Ambac Assurance Corporation, unable to pay dividends to the parent company without special regulatory approval. Ambac Assurance's financial strength ratings have been downgraded to CC (S&P) and Caa2 (Moody's). The company has ceased writing new financial guarantee business since November 2007 and is focused on loss mitigation and runoff of existing portfolios.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2009 | Nine Months Ended Sep 30, 2009 |
|---|---|---|
| Total Revenues | $2,689.5 million | $3,344.6 million |
| Net Income (Loss) | $2,188.2 million | ($572.7 million) |
| Net Income (Loss) Per Share (Diluted) | $7.58 | ($1.99) |
| Total Assets | $18,099.1 million | N/A |
| Total Liabilities | $20,273.6 million | N/A |
| Stockholders' Deficit | ($2,174.5 million) | N/A |
| Cash and Cash Equivalents | $149.6 million | N/A |
| Net Cash Used in Operating Activities (9mo) | N/A | ($1,335.7 million) |
Note: The significant net income for the three-month period is primarily driven by a $2.1 billion unrealized gain on credit derivatives, largely due to the widening of Ambac's own credit spreads reducing the fair value of liabilities.
Material Changes vs. Prior Period
- Accounting Changes: Adoption of ASC Topic 944 (Financial Services - Insurance) on January 1, 2009, resulted in a cumulative effect adjustment of ($381.7 million) to retained earnings. This standard changed how premiums and loss reserves are recognized, making 2009 results not directly comparable to 2008.
- Credit Derivatives: The "Net change in fair value of credit derivatives" swung from a loss of ($2,705.2 million) in Q3 2008 to a gain of $2,132.9 million in Q3 2009. This reversal is attributed to the widening of Ambac Assurance's credit spreads, which reduces the fair value of the company's liabilities under fair value accounting rules.
- Loss Reserves: Loss and loss expenses for the nine months ended September 30, 2009, were $2,429.9 million, compared to $1,311.2 million in the same period in 2008. This increase is driven by continued deterioration in residential mortgage-backed securities (RMBS) and other structured finance exposures.
- Impairments: Other-than-temporary impairment (OTTI) losses for the nine months ended September 30, 2009, totaled $1,736.5 million, significantly higher than the $456.9 million in the prior year period, due to management's intent to sell certain securities to meet liquidity needs.
Guidance, Outlook, Risks, and Contingencies
- Liquidity Outlook: Management believes Ambac has sufficient liquidity to meet needs through the second quarter of 2011, based on cash, short-term investments, and bonds of $164.7 million. However, there is no guarantee it can pay operating expenses or debt service thereafter, including $143 million of principal maturing in August 2011.
- Dividend Restrictions: Ambac Assurance is unable to pay dividends in 2009 and likely unable to do so in 2010 without special approval from the Office of the Commissioner of Insurance of the State of Wisconsin (OCI). This constrains the parent company's primary liquidity source.
- Bankruptcy Risk: Ambac is developing strategies to address liquidity, which may include a negotiated debt restructuring or a prepackaged bankruptcy proceeding. If strategies fail, the company may seek bankruptcy protection without a pre-negotiated plan.
- Regulatory Risk: The OCI is evaluating Ambac Assurance's ability to pay claims. Initiation of delinquency proceedings could trigger an event of default on $1.64 billion of debt and terminate credit default swap contracts, potentially liquidating $23.1 billion in mark-to-market claims.
- Legal Proceedings: The company faces multiple class-action lawsuits alleging securities law violations regarding disclosures of CDO and MBS exposures. Management cannot estimate the potential loss but notes adverse outcomes could be material.
Key Facts for Investor Verification
- Liquidity Runway: Verify the accuracy of the management projection that liquidity will last through Q2 2011, given the inability to receive dividends from Ambac Assurance.
- Debt Maturities: Confirm the status of the $143 million principal maturing in August 2011 and the potential acceleration of $1.64 billion of debt if delinquency proceedings are initiated.
- Loss Reserve Adequacy: Assess the sufficiency of the $3.88 billion in net loss reserves, particularly regarding RMBS exposures and the reliance on $1.92 billion in estimated subrogation recoveries from loan originators.
- Accounting Volatility: Understand that reported earnings are heavily influenced by fair value accounting on credit derivatives, where the company's own credit deterioration creates accounting gains that do not reflect operational cash flow.
- Regulatory Status: Monitor the status of the OCI's review of Ambac Assurance and any potential initiation of delinquency proceedings.