Ambac Financial (AMBC) 10-Q 2002 Q2 Quarterly report

EXHIBIT 99.05

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

(a wholly owned subsidiary of Ambac Financial Group, Inc.)

Consolidated Unaudited Financial Statements

As of June 30, 2002 and December 31, 2001

and for the Periods Ended June 30, 2002 and 2001

Ambac Assurance Corporation and Subsidiaries

Notes to Consolidated Unaudited Financial Statements

(Dollars in Thousands)

(1)    Basis of Presentation

Ambac Assurance Corporation is a leading provider of financial guarantees to clients for both the public and private sectors around the world. Ambac Assurance provides financial guarantees on public finance and structured finance obligations. Ambac Assurance has earned triple-A ratings, the highest ratings available from Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services, Fitch, Inc., and Rating and Investment Information, Inc. Insurance policies insured by Ambac Assurance guarantee payment when due of the principal of and interest on the obligation guaranteed. As of June 30, 2002, Ambac Assurance’s net guarantees in force (principal and interest) were $502,956,334. Ambac Assurance is a wholly owned subsidiary of Ambac Financial Group, Inc., a holding company whose subsidiaries provide financial guarantees and financial services to clients in both the public and private sectors around the world.

Ambac Assurance serves clients in international markets through its wholly-owned subsidiary Ambac Assurance UK Limited.

Ambac Credit Products L.L.C., a wholly owned subsidiary of Ambac Assurance, also provides credit protection in the form of structured credit derivatives. These structured credit derivatives require that Ambac Credit Products make payments upon the occurrence of certain defined credit events relating to an underlying obligation (generally a fixed income obligation). Should a credit event occur, Ambac Credit Products would generally pay an amount equivalent to the difference between the par value and market value of the underlying obligation. Substantially all of Ambac Credit Product’s contracts are partially hedged with various financial institutions or structured with first loss protection.

Ambac Assurance, as the sole limited partner, owns a limited partnership interest representing 90% of the total partnership interests of Ambac Financial Services, L.P., a limited partnership which provides interest rate swaps primarily to states, municipalities and their authorities. The sole general partner of Ambac Financial Services, Ambac Financial Services Holdings, Inc., a wholly owned subsidiary of Ambac Financial Group, owns a general partnership interest representing 10% of the total partnership interest in Ambac Financial Services.

The accompanying consolidated unaudited interim financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America (“GAAP”) and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of Ambac Assurance’s financial condition, results of operations and cash flows for the periods presented. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting period. Actual results could differ from those estimates. The results of operations for the six months ended June 30, 2002 may not be indicative of the results that may be expected for the full year ending December 31, 2002. These consolidated financial statements and notes should be read in conjunction with the financial statements and notes included in the audited

Ambac Assurance Corporation and Subsidiaries

Notes to Consolidated Unaudited Financial Statements (Continued)

consolidated financial statements of Ambac Assurance Corporation and its subsidiaries as of December 31, 2001 and 2000, and for each of the years in the three-year period ended December 31, 2001 which was filed with the Securities and Exchange Commission on March 26, 2002 as Exhibit 99.01 to Ambac Financial Group Inc.’s Form 10-K.

The consolidated financial statements include the accounts of Ambac Assurance and each of its subsidiaries. All significant intercompany balances have been eliminated.

Certain reclassifications have been made to prior period’s amounts to conform to the current period’s presentation.

(2)    Accounting Standards

In July 2001, the FASB issued SFAS Statement 142, “Goodwill and Other Intangible Assets”. SFAS 142 addresses the initial recognition and measurement of intangible assets either singly or within a group of assets, as well as the measurement of goodwill and other intangible assets subsequent to their initial acquisition. SFAS 142 changes the accounting for goodwill and intangible assets that have indefinite useful lives from an amortization approach to an impairment-only approach that requires that those assets be tested at least annually for impairment. Intangible assets that have finite useful lives will continue to be amortized over their useful lives, but without an arbitrary ceiling on their useful lives. Ambac adopted SFAS 142 effective January 1, 2002 and has determined that it has no impact on its consolidated results of operations and financial position.

In August 2001, the FASB issued SFAS Statement 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”.) SFAS 143 requires companies to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and/or normal use of the assets. Companies also record a corresponding asset which is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation is adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. Ambac Assurance is required to adopt SFAS 143 on January 1, 2003. Ambac Assurance does not anticipate that SFAS will have a material impact on the consolidated financial statements.

In October 2001, the FASB issued SFAS Statement 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”.) SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. SFAS Statement 144 requires companies to separately report discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. Assets to be disposed of are reported at the lower of the carrying amount or fair value less cost to sell. Ambac adopted SFAS 144 effective January 1, 2002. This statement did not have an effect on Ambac Assurance’s six months ended June 30, 2002 results.

Ambac Assurance Corporation and Subsidiaries

Consolidated Balance Sheets

June 30, 2002 and December 31, 2001

(Dollars in Thousands Except Share Data)

	June 30, 2002		December 31, 2001
	(unaudited)
ASSETS
Investments:
Fixed income securities, at fair value
(amortized cost of $5,255,816 in 2002 and $4,955,542 in 2001)	$	5,475,979	$	5,083,039
Short-term investments, at cost (approximates fair value)		135,787		185,943
Other		1,929		1,394
Total investments		5,613,695		5,270,376
Cash		20,560		33,678
Cash pledged as collateral		9,418		—
Securities purchased under agreements to resell		14,005		—
Receivable for securities sold		307		281
Investment income due and accrued		74,825		73,456
Reinsurance recoverable		1,894		2,259
Prepaid reinsurance		272,946		267,655
Deferred acquisition costs		170,345		163,477
Other assets		578,067		343,866
Total assets	$	6,756,062	$	6,155,048
LIABILITIES AND STOCKHOLDER’S EQUITY
Liabilities:
Unearned premiums	$	1,879,802	$	1,790,084
Losses and loss adjustment expense reserve		161,497		152,352
Ceded reinsurance balances payable		9,831		10,146
Deferred income taxes		185,629		147,642
Current income taxes		28,922		126,039
Note payable to affiliate		60,900		63,500
Payable for securities purchased		109,482		26,097
Other liabilities		581,506		362,465
Total liabilities		3,017,569		2,678,325
Stockholder’s equity:
Preferred stock, par value $1,000 per share; authorized
shares-285,000; issued and outstanding shares-none		—		—
Common stock, par value $2.50 per share; authorized shares
-  40,000,000; issued and outstanding shares-32,800,000
at June 30, 2002 and December 31, 2001		82,000		82,000
Additional paid-in capital		922,676		928,094
Accumulated other comprehensive income		141,851		80,556
Retained earnings		2,591,966		2,386,073
Total stockholder’s equity		3,738,493		3,476,723
Total liabilities and stockholder’s equity	$	6,756,062	$	6,155,048

See accompanying Notes to Consolidated Unaudited Financial Statements

Ambac Assurance Corporation and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

For The Periods Ended June 30, 2002 and 2001

(Dollars in Thousands)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2002			2001			2002			2001
Revenues:
Gross premiums written	$	196,789		$	238,133		$	348,258		$	348,424
Ceded premiums written		(24,705	)		(23,767	)		(44,254	)		(36,468	)
Net premiums written	$	172,084		$	214,366		$	304,004		$	311,956
Net premiums earned	$	114,956		$	94,384		$	220,168		$	180,472
Other credit enhancement fees		6,576			4,995			12,864			9,648
Net premiums earned and other
credit enhancement fees		121,532			99,379			233,032			190,120
Net investment income		73,942			65,421			146,342			130,385
Net securities (losses) gains		(4,510	)		1,350			(9,081	)		(3,588	)
Other income		1,826			6,000			10,504			13,552
Total revenues		192,790			172,150			380,797			330,469
Expenses:
Losses and loss adjustment expenses		5,900			4,800			11,600			9,400
Underwriting and operating expenses		19,582			18,777			39,876			37,184
Interest expense		949			1,155			1,500			2,309
Total expenses		26,431			24,732			52,976			48,893
Income before income taxes		166,359			147,418			327,821			281,576
Provision for income taxes		42,495			36,390			82,928			69,335
Net income	$	123,864		$	111,028		$	244,893		$	212,241

See accompanying Notes to Consolidated Unaudited Financial Statements

Ambac Assurance Corporation and Subsidiaries

Consolidated Statements of Stockholder’s Equity

(Unaudited)

For The Periods Ended June 30, 2002 and 2001

(Dollars in Thousands)

	2002					2001
Retained Earnings:
Balance at January 1	$	2,386,073				$	2,002,120
Net income		244,893		$	244,893		212,241		$	212,241
Dividends declared—common stock		(39,000	)				(34,000	)
Balance at June 30	$	2,591,966				$	2,180,361
Accumulated Other Comprehensive Income:
Balance at January 1	$	80,556				$	81,616
Unrealized gains (losses) on securities, $92,667
and ($5,210), pre-tax, in 2002 and 2001, respectively(1)					60,233					(3,386	)
Foreign currency translation gain (loss)					1,062					(1,133	)
Other comprehensive income (loss)		61,295			61,295		(4,519	)		(4,519	)
Comprehensive income				$	306,188				$	207,722
Balance at June 30	$	141,851				$	77,097
Preferred Stock:
Balance at January 1 and June 30	$	—				$	—
Common Stock:
Balance at January 1 and June 30	$	82,000				$	82,000
Additional Paid-in Capital:
Balance at January 1	$	928,094				$	760,006
Capital issuance costs		(5,767	)				—
Exercise of stock options		349					—
Balance at June 30	$	922,676				$	760,006
Total Stockholder’s Equity at June 30	$	3,738,493				$	3,099,464
(1) Disclosure of reclassification amount:
Unrealized holding gains (losses) arising during period		60,943					(3,065	)
Less: reclassification adjustment for net securities gains
included in net income		710					321
Net unrealized gains (losses) on securities	$	60,233				$	(3,386	)

See accompanying Notes to Consolidated Unaudited Financial Statements.

Ambac Assurance Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

For The Periods Ended June 30, 2002 and 2001

(Dollars in Thousands)

	Six Months Ended
	June 30,
	2002			2001
Cash flows from operating activities:
Net income	$	244,893		$	212,241
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization		1,424			1,465
Amortization of bond premium and discount		(3,262	)		(3,863	)
Current income taxes		(97,117	)		8,360
Deferred income taxes		5,553			9,935
Deferred acquisition costs		(6,868	)		(11,710	)
Unearned premiums, net		84,427			131,080
Losses and loss adjustment expenses		9,510			8,625
Ceded reinsurance balances payable		(315	)		1,848
Net securities losses		9,081			3,624
Other, net		(16,064	)		(20,043	)
Net cash provided by operating activities		231,262			341,562
Cash flows from investing activities:
Proceeds from sales of bonds		294,283			231,991
Proceeds from maturities of bonds		144,684			86,583
Purchases of bonds		(649,007	)		(648,988	)
Change in short-term investments		52,456			21,332
Securities purchased under agreements to resell		(14,005	)		(4,862	)
Other, net		(13,706	)		(4,296	)
Net cash used in investing activities		(185,295	)		(318,240	)
Cash flows from financing activities:
Dividends paid		(39,000	)		(34,000	)
Capital issuance costs		(5,767	)		—
Note payable to affiliate		(2,600	)		—
Short-term financing		(2,300	)		—
Net cash used in financing activities		(49,667	)		(34,000	)
Net cash flow		(3,700	)		(10,678	)
Cash and cash pledged as collateral at January 1		33,678			36,828
Cash and cash pledged as collateral at June 30	$	29,978		$	26,150
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income taxes	$	144,744		$	51,029

See accompanying Notes to Consolidated Unaudited Financial Statements.