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Ambac Financial Group, Inc. Announces Second Quarter 2010 Results

Business Wire

Ambac Financial Group, Inc. (NYSE: ABK) (Ambac) today announced a second quarter 2010 net loss of $57.6 million, or a net loss of $0.20 per share. This compares to a second quarter 2009 net loss of $2,368.8 million, or a net loss of $8.24 per share. The second quarter 2010 results reflect loss and loss expenses in consumer asset-backed securities, other structured finance exposures and a transportation transaction and a net operating loss in the financial services segment, partially offset by a positive change in fair value of credit derivatives. In 2009, Ambac’s second quarter results reflected significant loss and loss expenses related to the insured residential mortgage-backed securities (“RMBS”) portfolio, other-than-temporary impairment write downs of securities in its investment portfolios and an increase in its deferred tax asset valuation allowance.

Second Quarter 2010 Summary

• Net loss and loss expenses incurred amounted to $323.3 million for the current quarter, down from $1,230.8 million in the second quarter of 2009.
• Net change in fair value of credit derivatives was positive $202.2 million in the current quarter, up from $1.0 million in the second quarter 2009.
• The financial services segment recorded a $69.6 million operating loss primarily related to interest rate movements in the derivative products business.
• Statutory surplus of Ambac Assurance Corporation (“AAC”) increased to approximately $1.5 billion at June 30, 2010 from $160.2 million at March 31, 2010, driven primarily by the CDO of ABS commutation settlement on June 7, 2010.

Financial Results

Implementation of New Accounting Standards

Effective January 1, 2010, Ambac adopted Accounting Standards Update No. (“ASU”) 2009-17, “Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities”. The implementation of ASU 2009-17 on January 1, 2010, required Ambac to consolidate 83 additional VIEs resulting in an increase to shareholders' equity of $705 million. This adoption gain resulted from the initial recognition of all assets and liabilities of the newly consolidated VIEs at fair value in Ambac’s financial statements, while eliminating from our financial statements the related net insurance liabilities which are generally calculated using estimated future cash flows discounted at risk free interest rates. In March 2010, Ambac acquiesced to Office of the Commissioner of Insurance of the State of Wisconsin’s (“OCI’s”) request to establish a segregated account pursuant to Wisconsin statutes (the “Segregated Account”) for purposes of initiation of the rehabilitation of the Segregated Account and AAC allocated certain policies to the Segregated Account. This action resulted in Ambac no longer having the unilateral power to direct the activities of certain VIEs whose insurance policies were allocated to the Segregated Account and therefore those VIEs were de-consolidated in March 2010. The de-consolidation resulted in Ambac reversing the ASU 2009-17 transition effect for those specific transactions with the charge to Ambac’s Consolidated Statement of Operations amounting to $492.7 million in the first quarter of 2010.

As of June 30, 2010, the Company's balance sheet included 24 remaining consolidated VIEs with $18.0 billion of assets and $17.8 billion of liabilities.

Net Premiums Earned

Net premiums earned for the second quarter of 2010 were $167.0 million, down 6% from $177.7 million earned in the second quarter of 2009. Net premiums earned include accelerated premiums, which result from calls, terminations and other accelerations recognized during the quarter. Accelerated premiums were $54.3 million in the second quarter of 2010, up 61% from $33.8 million in the second quarter 2009. Normal net premiums earned, which exclude accelerated premiums, were $112.7 million in the second quarter of 2010, down 22% from $143.9 million in the second quarter of 2009. Normal net premiums earned for the period have been negatively impacted by the lack of new business written and the high level of refundings and terminations over the past two and a half years, as well as non-recognition of premiums earned on VIEs that have been consolidated as a result of implementation of ASU 2009-17, effective January 1, 2010.

Net Investment Income

Net investment income for the second quarter of 2010 was $69.0 million, representing a decrease of 45% from $125.5 million in the second quarter of 2009. The decrease was primarily driven by three factors: (i) a decrease in the asset base as commutation settlements on CDO of ABS transactions (including the $2.8 billion payment in the current quarter) and claim payments on insured RMBS and other transactions over the past 12 months were greater than the cash inflows resulting from collections of financial guarantee premiums, fees, tax refunds and coupon receipts on invested assets over the same period; (ii) the average yield on the portfolio decreased as a result of maintaining a large portion of the portfolio in highly liquid short-term securities awaiting the finalization of the CDO of ABS commutation; and (iii) a reduction in interest income related to AAC-insured RMBS held in the financial guarantee investment portfolio that are subject to the payment moratorium ordered by the OCI in connection with the rehabilitation plan for the Segregated Account of AAC.

Other-Than-Temporary Impairment Losses

Other-than-temporary impairment (“OTTI”) losses in the financial guarantee investment portfolio were $7.5 million in the second quarter of 2010, compared to OTTI losses of $675.4 million in the second quarter of 2009. The second quarter 2010 OTTI loss was driven primarily by impairment write downs on AAC-wrapped RMBS securities within its investment portfolio. The second quarter 2009 OTTI impairment loss was driven by write-downs of certain RMBS securities rated below investment grade and tax exempt securities within the investment portfolio that management intended to sell in connection with its revised investment strategies.

Net Change in Fair Value of Credit Derivatives

The net change in fair value of credit derivatives, which comprises realized gains/(losses) and other settlements from credit derivatives and unrealized gains/(losses) on credit derivatives, was a gain of $202.2 million for the second quarter of 2010, compared to a gain of $1.0 million for the second quarter of 2009.

Realized losses and other settlements from credit derivative contracts represent the normal accretion into income of fees received for transactions executed in credit derivative format, offset by loss and settlement payments on such transactions. Net realized losses and other settlements from credit derivative contracts in the second quarter of 2010 and 2009 amounted to $2,777.3 million and $5.0 million, respectively. The net realized losses in the second quarter 2010 relate primarily to the counterparty settlement of the CDO of ABS portfolio that was announced on June 7, 2010. Ambac paid in the aggregate, cash of $2.6 billion and $2.0 billion of newly issued surplus notes to several counterparties to settle the $16.4 billion of CDO of ABS exposure outstanding at that time. In addition, Ambac settled other exposures for $186.5 million.

Net unrealized gains on credit derivative contracts in the second quarter of 2010 and 2009 amounted to $2,979.5 million and $6.0 million, respectively. The net unrealized gain during the second quarter of 2010 is primarily the result of reclassification of unrealized losses to realized losses resulting from the commutations referenced above. Additionally, the unrealized gains were impacted by the net decrease in mark-to-market liabilities of the remaining credit derivative portfolio due to higher valuation adjustments to reflect Ambac’s own credit risk. Beginning in the second quarter 2010, the Ambac credit valuation adjustment is internally estimated using relevant data points, including the final settlement value of AAC credit default swaps (determined through auction in June 2010) and quoted prices of securities guaranteed by AAC, which indicate the market’s view of the recovery rate on AAC’s insurance obligations.

Financial Guarantee Loss Reserves

Total net loss and loss expenses were $323.3 million in the second quarter of 2010, compared to $1,230.8 million in the second quarter of 2009. Losses and loss expenses in the second quarter of 2010 were primarily related to credit deterioration in certain student loan transactions and the impact of using a lower average risk-free rate to discount losses. Second quarter of 2009 loss and loss expenses were driven by continued deterioration in the RMBS portfolio.

Loss and loss adjustment expenses paid (on policies not allocated to the Segregated Account) during the second quarter 2010, net of recoveries from all policies (allocated and not allocated to the Segregated Account), amounted to a net recovery of $17.1 million. Total insurance claims presented for payment during the quarter but not paid as a result of the moratorium imposed in March 2010 by the OCI on all policies allocated to the Segregated Account amounted to $525.4 million, all related to RMBS policies. Total net claims paid in the second quarter of 2009 were $400.8 million, primarily related to second-lien RMBS transactions.

Loss and loss expense reserves for all RMBS insurance exposures as of June 30, 2010, were $2,689.7 million (including $655.5 million representing claims presented but not paid since March 24, 2010 due to the claims moratorium). RMBS reserves are net of $2,227.2 million of estimated net remediation recoveries. The estimate of net remediation recoveries related to material representation and warranty breaches increased from $2,069.2 million as of March 31, 2010, primarily as a result of breaches identified during the re-underwriting of additional transactions. Ambac has initiated and may continue to initiate lawsuits seeking compliance with the repurchase obligations in the securitization documents with respect to sponsors who disregard their obligations to repurchase. Additionally, Ambac is in the process of re-underwriting additional transactions that have drastically underperformed expectations and the forensic results of those transactions will be available over the next few quarters.

Financial Services

The financial services segment comprises the investment agreement business and the derivative products business. Gross interest income less gross interest expense and operating expenses from investment and payment agreements, plus operating results from the derivative products business was ($69.6) million for the second quarter of 2010, down from ($37.1) million for the second quarter of 2009. The decrease was primarily driven by the impact of declining interest rates on the financial services derivative portfolio during the second quarter of 2010, partially offset by lower termination losses on canceled swaps and valuation adjustments relating to Ambac’s credit risk. Beginning in the second half of 2009, the financial services segment has been positioned to record gains in a rising interest rate environment in order to provide a hedge against certain exposures within the financial guarantee segment. The interest rate swap and investment agreement businesses are in run-off.

Balance Sheet and Liquidity

Total assets decreased by approximately $5.8 billion during the second quarter of 2010, from $35.8 billion at March 31, 2010 to $30.0 billion at June 30, 2010, primarily due to the cash outflow related to the commutation of the CDO of ABS portfolio and other exposures discussed above, and the reduction of VIE assets by approximately $2.6 billion, related primarily to commuted CDOs of ABS that had been consolidated in compliance with ASU 2009-17 in the previous quarter.

The fair value of the consolidated non-VIE investment portfolio decreased from $9.7 billion (amortized cost of $9.6 billion) as of March 31, 2010 to $6.6 billion (amortized cost of $6.3 billion) as of June 30, 2010. The decrease was primarily driven by the cash outflow related to the commutations of the CDO of ABS portfolio and other exposures, discussed above, partially offset by generally increased market values of securities in the financial guarantee investment portfolio.

The financial guarantee non-VIE investment portfolio had a fair value of $5.3 billion (amortized cost of $5.0 billion) as of June 30, 2010. The portfolio consists of high quality municipal bonds, corporate bonds, Treasuries, U.S. Agencies and Agency MBS as well as mortgage and asset-backed securities.

Long-term debt increased during the quarter from $1,633.4 million at March 31, 2010 to $1,815.0 million due to the issuance of $2.0 billion of surplus notes related to the CDO of ABS commutation which have a carrying value of $200.1 million at June 30, 2010. The surplus notes will accrete to face value over the 10-year life of the bonds. This increase was partially offset by decreases in Ambac’s debt resulting from debt for equity exchanges transacted with certain holders of Ambac’s 9⅜% debentures due in August 2011. During the second quarter 2010, Ambac issued an aggregate of 13,638,482 shares of its common stock in exchange for $20.3 million in aggregate principal amount of its 9⅜% debentures and recognized a gain on the extinguishment of those debentures amounting to $10.7 million during the period.

Cash, short-term securities and bonds at the holding company amounted to $76.0 million as of June 30, 2010. Ambac’s annual debt service costs amount to approximately $87.0 million. As a result of the recent actions taken by OCI (as discussed in our press release dated March 25, 2010 and in our 10-K filed with Securities Exchange Commission on April 9, 2010), management believes that it is highly unlikely that AAC will be able to make dividend payments to Ambac for the foreseeable future.

Overview of AAC Statutory Results

As of June 30, 2010, AAC reported statutory capital and surplus of approximately $1.5 billion, up from $160 million as of March 31, 2010. AAC’s statutory financial statements include the results of AAC’s general account, the Segregated Account which was formed on March 24, 2010, Ambac Assurance UK Ltd. and Everspan Financial Guarantee Corporation. Statutory capital and surplus was positively impacted by the various credit derivative commutations during the period, primarily the June 7, 2010 CDO of ABS settlement. Consideration for these settlements included both cash and surplus notes of AAC. As prescribed by OCI, the surplus notes are included in AAC’s statutory surplus at their par value of $2.0 billion. At June 30, 2010 AAC has no remaining statutory impairments on its credit derivative portfolio.

AAC recorded a statutory net loss during the second quarter of 2010. The primary drivers of the statutory net loss were (i) statutory loss and loss expenses related primarily to AAC’s RMBS financial guarantee portfolio for both initial defaults and continued deterioration in previously defaulted credits; (ii) impairment losses related to AAC’s CDO of ABS transactions that were commuted during the quarter; and (iii) impairment losses within AAC’s investment portfolio driven by reduced pricing on certain previously impaired RMBS securities. These negative drivers were partially offset by revenues (primarily premiums earned and investment income) generated during the quarter.

AAC’s consolidated claims-paying resources amount to approximately $8.5 billion as of June 30, 2010, down from $10.8 billion at March 31, 2010, as net cash outflows during the quarter exceeded the ongoing cash inflows from operations.

About Ambac

Ambac Financial Group, Inc., headquartered in New York City, is a holding company whose affiliates provided financial guarantees and financial services to clients in both the public and private sectors around the world. Ambac's principal operating subsidiary, Ambac Assurance Corporation, a guarantor of public finance and structured finance obligations, has a Caa2 rating under review for possible upgrade from Moody's Investors Service, Inc. and an R (regulatory intervention) financial strength rating from Standard & Poor's Ratings Services. Ambac Financial Group, Inc. common stock is listed on the New York Stock Exchange (ticker symbol ABK).

Forward-Looking Statements

This release contains statements that may constitute "forward-looking statements" within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any or all of management’s forward-looking statements here or in other publications may turn out to be incorrect and are based on Ambac 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) ability of Ambac Assurance to realize the remediation recoveries contained in its loss reserves; (2) Ambac has insufficient capital to finance its debt service and operating expense requirements beyond the second quarter of 2011 and may need to seek bankruptcy protection; (3) the unlikely ability of Ambac Assurance to pay dividends to Ambac in the near term; (4) the risk that holders of debt securities or counterparties on credit default swaps or other similar agreements bring claims alleging that the rehabilitation of the Segregated Account (as defined in Part I, Item 1, Recent Developments) constitutes an event of default under the applicable debt indenture or an event of default under the applicable ISDA contract; (5) adverse events arising from the Segregated Account Rehabilitation Proceedings (as defined in Part I, Item 1, Recent Developments), including the injunctions issued by the Wisconsin rehabilitation court to enjoin certain adverse actions related to the Segregated Account being successfully challenged as not enforceable; (6) litigation arising from the Segregated Account Rehabilitation Proceedings; (7) decisions made by the rehabilitator for the benefit of policyholders may result in material adverse consequences for Ambac’s securityholders; (8) potential of rehabilitation proceedings against Ambac Assurance, with resulting adverse impacts; (9) the risk that reinsurers may dispute amounts owed us under our reinsurance agreements; (10) possible delisting of Ambac’s common shares from the NYSE; (11) the risk that market risks impact assets in our investment portfolio or the value of our assets posted as collateral in respect of investment agreements and interest rate swap and currency swap transactions; (12) risks which impact assets in Ambac Assurance’s investment portfolio; (13) risks relating to determination of amount of impairments taken on investments; (14) credit and liquidity risks due to unscheduled and unanticipated withdrawals on investment agreements; (15) market spreads and pricing on insured CDOs and other derivative products insured or issued by Ambac; (16) inadequacy of reserves established for losses and loss expenses, including our inability to realize the remediation recoveries included in our reserves; (17) Ambac’s financial position and the Segregated Account Rehabilitation Proceedings may prompt departures of key employees; (18) 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 our business, operations, financial position, profitability or cash flows; (19) difficult economic conditions, which may not improve in the near future, and adverse changes in the economic, credit, foreign currency or interest rate environment in the United States and abroad; (20) the actions of the U. S. Government, Federal Reserve and other government and regulatory bodies to stabilize the financial markets; (21) likely unavailability of adequate capital support and liquidity; (22) credit risk throughout our business, including credit risk related to residential mortgage-backed securities and collateralized debt obligations (“CDOs”) and large single exposures to reinsurers; (23) default by one or more of Ambac Assurance’s portfolio investments, insured issuers, counterparties or reinsurers; (24) the risk that our risk management policies and practices do not anticipate certain risks and/or the magnitude of potential for loss as a result of unforeseen risks; (25) factors that may influence the amount of installment premiums paid to Ambac, including the imposition of the payment moratorium with respect to claims payments as a result of Segregated Account Rehabilitation Proceedings; (26) changes in prevailing interest rates; (27) the risk of volatility in income and earnings, including volatility due to the application of fair value accounting, required under the relevant derivative accounting guidance, to the portion of our credit enhancement business which is executed in credit derivative form; (28) changes in accounting principles or practices that may impact Ambac’s reported financial results; (29) legislative and regulatory developments; (30) operational risks, including with respect to internal processes, risk models, systems and employees; (31) changes in tax laws and other tax-related risks; (32) other factors described in the Risk Factors section in Part I, Item 1A of the 2009 Annual Report on Form 10-K and Part II, Item 1A of this Form 10-Q and also disclosed from time to time by Ambac in its subsequent reports on Form 10-Q and Form 8-K, which are or will be available on the Ambac website at www.ambac.com and at the SEC’s website, www.sec.gov; and (33) other risks and uncertainties that have not been identified at this time. Readers are cautioned that forward-looking statements speak only as of the date they are made and that Ambac does not undertake to update forward-looking statements to reflect circumstances or events that arise after the date the statements are made. You are therefore advised to consult any further disclosures we make on related subjects in Ambac’s reports to the SEC.