SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 1-10777
AMBAC FINANCIAL GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-3621676
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
ONE STATE STREET PLAZA
NEW YORK, NEW YORK 10004
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(212) 668-0340
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
As of March 31, 1998, 70,081,749 shares of Common Stock, par value $0.01
per share, (net of 598,635 treasury shares) of the Registrant were outstanding.
Ambac Financial Group, Inc. and Subsidiaries
INDEX
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PAGE
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PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - March 31, 1998
and December 31, 1997................................................. 3
Consolidated Statements of Operations - three months ended
March 31, 1998 and March 31, 1997..................................... 4
Consolidated Statements of Stockholders' Equity - three months
ended March 31, 1998 and March 31, 1997............................... 5
Consolidated Statements of Cash Flows - three months
ended March 31, 1998 and March 31, 1997............................... 6
Notes to Consolidated Financial Statements............................ 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................... 8
Item 3. Quantitative and Qualitative Disclosures About
Market Risk........................................................... 16
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K........................................ 18
SIGNATURES......................................................................... 19
INDEX TO EXHIBITS.................................................................. 20
PART 1 - FINANCIAL INFORMATION
Item 1 - Financial Statements of Ambac Financial Group, Inc. and Subsidiaries
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Balance Sheets
March 31, 1998 and December 31, 1997
(Dollars in Thousands)
March 31, 1998 December 31, 1997
-------------- -----------------
(unaudited)
Assets
Investments:
Fixed income securities, at fair value
(amortized cost of $7,177,908 in 1998 and $6,525,650 in 1997) $7,416,641 $6,773,844
Short-term investments, at cost (approximates fair value) 145,263 136,278
Preferred stock 5,000 5,000
------------------- -------------------
Total investments 7,566,904 6,915,122
Cash 10,570 9,256
Securities purchased under agreements to resell 227,732 85,466
Receivable for investment agreements 83,322 -
Receivable for securities sold 11,287 106,246
Investment income due and accrued 80,625 78,690
Reinsurance recoverable 4,128 4,219
Prepaid reinsurance 200,930 183,492
Deferred acquisition costs 107,037 105,996
Loans 503,723 503,192
Receivable from brokers and dealers 182,318 183,041
Other assets 134,639 116,985
------------------- -------------------
Total assets $9,113,215 $8,291,705
=================== ===================
Liabilities and Stockholders' Equity
Liabilities:
Unearned premiums $1,194,701 $1,178,990
Losses and loss adjustment expenses 105,962 103,345
Ceded reinsurance balances payable 14,352 9,258
Obligations under investment and payment agreements 3,548,341 3,230,052
Obligations under investment repurchase agreements 1,475,636 1,090,912
Deferred income taxes 133,368 135,228
Current income taxes 14,736 9,016
Debentures 223,880 223,864
Accrued interest payable 51,412 46,017
Accounts payable and other liabilities 139,615 117,153
Payable for securities purchased 297,008 275,388
------------------- -------------------
Total liabilities 7,199,011 6,419,223
------------------- -------------------
Stockholders' equity:
Preferred stock - -
Common stock 707 707
Additional paid-in capital 503,797 500,107
Accumulated other comprehensive income 129,571 135,223
Retained earnings 1,306,180 1,262,740
Common stock held in treasury at cost (26,051) (26,295)
------------------- -------------------
Total stockholders' equity 1,914,204 1,872,482
------------------- -------------------
Total liabilities and stockholders' equity $9,113,215 $8,291,705
=================== ===================
See accompanying Notes to Consolidated Financial Statements
3
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
For the Periods Ended March 31, 1998 and 1997
(Dollars in Thousands Except Share Data)
Three Months Ended
March 31,
------------------------------
1998 1997
------------------------------
Revenues:
Financial Guarantee Insurance:
Gross premiums written $77,487 $51,792
Ceded premiums written (26,087) (5,432)
------------- -------------
Net premiums written 51,400 46,360
Decrease (increase) in unearned premiums 1,784 (9,327)
------------- -------------
Net premiums earned 53,184 37,033
Net investment income 45,040 38,447
Net realized gains 1,175 812
Other income 1,965 1,103
Financial Management Services:
Income 12,754 7,222
Net realized losses (898) -
Other:
Income 1,356 1,861
Net realized gains 607 788
------------- -------------
Total revenues 115,183 87,266
------------- -------------
Expenses:
Financial Guarantee Insurance:
Losses and loss adjustment expenses 1,577 728
Underwriting and operating expenses 12,018 9,092
Financial Management Services 7,443 8,980
Interest 5,612 5,241
Other 2,336 829
------------- -------------
Total expenses 28,986 24,870
------------- -------------
Income before income taxes 86,197 62,396
Provision for income taxes 20,539 12,658
------------- -------------
Net income $65,658 $49,738
============= =============
Net income per share $0.94 $0.71
============= =============
Net income per diluted share $0.92 $0.70
============= =============
Weighted average number of
shares outstanding 70,039,795 69,887,336
============= =============
Weighted average number of diluted
shares outstanding 71,632,026 71,028,502
============= =============
See accompanying Notes to Consolidated Financial Statements
4
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(Unaudited)
For the Periods Ended March 31, 1998 and 1997
(Dollars in Thousands)
1998 1997
--------------------------- --------------------------
Retained Earnings:
Balance at January 1 $1,262,740 $1,072,418
Net income 65,658 $65,658 49,738 $49,738
------------- -------------
Dividends declared - common stock (6,300) (5,797)
Exercise of stock options (15,918) (952)
-------------- -------------
Balance at March 31 $1,306,180 $1,115,407
-------------- -------------
Accumulated Other Comprehensive Income:
Balance at January 1 $135,223 $58,911
Unrealized losses on securities, (($10,300) pre-tax
and ($89,636) pre-tax in 1998 and 1997, respectively)(/1/) (5,996) (56,034)
Foreign currency 344 81
------------- -------------
Other comprehensive loss (5,652) (5,652) (55,953) (55,953)
--------------------------- --------------------------
Comprehensive income (loss) $60,006 ($6,215)
============= =============
Balance at March 31 $129,571 $2,958
-------------- -------------
Preferred Stock:
Balance at January 1 and March 31 $- $-
-------------- -------------
Common Stock:
Balance at January 1 and March 31 $707 $353
-------------- -------------
Additional Paid-in Capital:
Balance at January 1 $500,107 $498,401
Issuance of stock - (3,547)
Exercise of stock options 3,690 2,322
-------------- -------------
Balance at March 31 $503,797 $497,176
-------------- -------------
Common Stock Held in Treasury at Cost:
Balance at January 1 ($26,295) ($15,067)
Cost of shares acquired (9,274) (29,428)
Shares issued under equity plans 9,518 13,684
-------------- -------------
Balance at March 31 ($26,051) ($30,811)
-------------- -------------
Total Stockholders' Equity at March 31 $1,914,204 $1,585,083
============== =============
(/1/) Disclosure of reclassification amount:
Unrealized holding losses arising during period ($4,814) ($54,994)
Less: reclassification adjustment for gains
included in net income 1,182 1,040
-------------- -------------
Net unrealized losses on securities ($5,996) ($56,034)
============== =============
See accompanying Notes to Consolidated Financial Statements.
5
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
For The Periods Ended March 31, 1998 and 1997
(Dollars in Thousands)
Three Months Ended
March 31,
-------------------------------
1998 1997
------------- -------------
Cash flows from operating activities:
Net income $65,658 $49,738
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 377 438
Amortization of bond premium and discount (1,005) (736)
Current income taxes 5,720 8,212
Deferred income taxes 2,443 2,010
Deferred acquisition costs (1,041) (3,175)
Unearned premiums, net (1,727) 9,327
Losses and loss adjustment expenses 2,617 290
Ceded reinsurance balances payable 5,094 (3,274)
Investment income due and accrued (1,935) 1,111
Accrued interest payable 5,395 12,447
Gain on sales of investments (884) (1,600)
Accounts payable and other liabilities 22,462 (14,359)
Other, net (29,585) (5,615)
------------- -------------
Net cash provided by operating activities 73,589 54,814
------------- -------------
Cash flows from investing activities:
Proceeds from sales of bonds 187,234 325,530
Proceeds from matured bonds 351,223 254,857
Purchases of bonds (1,070,748) (652,347)
Change in short-term investments (8,985) 6,995
Securities purchased under agreements to resell (142,266) 68,013
Loans (531) -
Other, net (1,837) 9,030
------------- -------------
Net cash (used in) provided by investing activities (685,910) 12,078
------------- -------------
Cash flows from financing activities:
Dividends paid (6,300) (5,797)
Proceeds from issuance of investment agreements 1,043,675 239,105
Payments for investment agreement draws (424,515) (283,715)
Payment agreements 531 -
Proceeds from sale of treasury stock 9,518 13,684
Purchases of treasury stock (9,274) (29,428)
------------- -------------
Net cash provided by (used in) financing activities 613,635 (66,151)
------------- -------------
Net cash flow 1,314 741
Cash at January 1 9,256 7,734
------------- -------------
Cash at March 31 $10,570 $8,475
============= =============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes $8,700 $249
============= =============
Interest expense on debt $7,761 $7,557
============= =============
Interest expense on investment agreements $52,029 $24,715
============= =============
See accompanying Notes to Consolidated Financial Statements
6
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
(1) Basis of Presentation
Ambac Financial Group, Inc., (the "Company") headquartered in New York
City, is a holding company whose affiliates provide financial guarantee
insurance and financial management services to clients in both the public and
private sectors in the U.S. and abroad. The Company's principal operating
subsidiary, Ambac Assurance Corporation ("Ambac Assurance"), a leading insurer
of municipal and structured finance obligations, has earned triple-A claims-
paying ability ratings, the highest ratings available from Moody's Investors
Service, Inc., Fitch IBCA, Inc., and Japan Rating and Investment Information,
Inc., and a financial strength rating of triple-A from Standard & Poor's Ratings
Group. Ambac Financial Group, Inc.'s Financial Management Services segment
provides investment agreements, interest rate swaps, investment advisory and
cash management services, and electronic commerce solutions, principally to
states, municipalities and their authorities, school districts, and hospitals
and health organizations.
The Company's consolidated unaudited interim financial statements have been
prepared on the basis of generally accepted accounting principles ("GAAP") and,
in the opinion of management, reflect all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the Company'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 three months ended March 31, 1998
may not be indicative of the results that may be expected for the full year
ending December 31, 1998. These consolidated financial statements and notes
should be read in conjunction with the financial statements and notes included
in the audited consolidated financial statements of Ambac Financial Group, Inc.
and its subsidiaries contained in the Company's Annual Report on Form 10-K for
the year ended December 31, 1997, which was filed with the Securities and
Exchange Commission (the "Commission") on March 31, 1998.
The consolidated financial statements include the accounts of the Company
and each of its subsidiaries. All significant intercompany balances have been
eliminated.
Certain reclassifications have been made to prior periods' amounts to
conform to the current period's presentation.
All common stock data has been retroactively adjusted to reflect the two-
for-one stock split effective September 10, 1997.
(2) NEW ACCOUNTING STANDARD
As of January 1, 1998, the Company adopted Financial Accounting Standard
("FAS") No. 130, Reporting Comprehensive Income. This statement establishes
standards for the reporting and presentation of comprehensive income and its
components in a full set of financial statements. Comprehensive income
encompasses all changes in stockholders' equity (except those arising
7
NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS (CONTINUED)
from transactions with stockholders) and includes net income, net unrealized
capital gains or losses on available-for-sale securities and foreign currency
translation adjustments. As this new standard only requires additional
information in the financial statements, it does not affect the Company's
financial position or results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following paragraphs describe the consolidated results of operations of
Ambac Financial Group, Inc. and its subsidiaries (sometimes collectively
referred to as the "Company") for the three month periods ended March 31, 1998
and 1997, and its financial condition as of March 31, 1998 and December 31,
1997. These results include the Company's two business segments: Financial
Guarantee Insurance and Financial Management Services.
In this Form 10-Q, we make statements about our future results that are
considered "forward-looking statements" under the Private Securities Litigation
Reform Act of 1995. These statements are based on our current expectations and
the current economic environment. We caution you that these statements are not
guarantees of future performance. They involve a number of risks and
uncertainties that are difficult to predict. Our actual results could differ
materially from those expressed or implied in the forward-looking statements.
Among the factors that could cause actual results to differ materially are (1)
changes in the economic or interest rate environment in the U.S. and abroad, (2)
the level of national and worldwide fixed income markets, (3) competitive
conditions and pricing levels, (4) legislative and regulatory developments, (5)
changes in tax laws and (6) other risks and uncertainties that we identify from
time to time in our public filings with the Securities and Exchange Commission.
We undertake no obligation to publicly correct or update any forward-looking
statement if we later become aware that it is not likely to be achieved.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998 VERSUS
THREE MONTHS ENDED MARCH 31, 1997
CONSOLIDATED NET INCOME
The Company's net income for the three months ended March 31, 1998 was
$65.7 million or $0.92 per diluted share. This represents a 32% increase from
the three months ended March 31, 1997 net income of $49.7 million, and a 31%
increase in net income per diluted share from $0.70 for the prior period. This
increase in net income was attributable to higher operating income in both
business segments.
FINANCIAL GUARANTEE INSURANCE
Gross Par Written. Ambac Assurance insured $15.4 billion in par value
-----------------
bonds during the three months ended March 31, 1998, an increase of 95% from $7.9
billion in the three months ended March 31, 1997. Par value written for the
first quarter of 1998 was comprised of $9.0
8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
billion from domestic municipal bond obligations, $4.5 billion from domestic
structured finance obligations and $1.9 billion from international obligations,
compared to $5.2 billion, $2.5 billion and $0.2 billion, respectively, in the
first quarter of 1997. The first quarter of 1998 increase in insured domestic
municipal bond obligations resulted primarily from an 86% increase in market
issuance and a higher market share. The first quarter 1998 increase in insured
domestic structured finance obligations was principally in the mortgage-
backed/home equity loan and asset-backed sectors. The first quarter 1998
increase in insured international obligations resulted from greater acceptance
of financial guarantee insurance, primarily in Europe and Japan.
Management believes that in the foreseeable future, domestic structured
finance and international markets will grow more rapidly than the domestic
municipal market. Domestic structured finance and international insured par may
see large quarterly variances, primarily due to the developmental nature of
these markets.
Ambac serves clients in international markets through its wholly-owned
subsidiary Ambac Insurance UK Limited and through its participation in a joint
venture with MBIA Insurance Corporation, MBIA-AMBAC International.
Gross Premiums Written. Gross premiums written for the three months ended
----------------------
March 31, 1998 were $77.5 million, an increase of 50% from $51.8 million in the
three months ended March 31, 1997. During the first quarter of 1998, there
emerged an upward pricing trend for bond insurance in certain municipal sectors.
The following table sets forth the amounts of gross premiums written by type and
percent of total:
Three Months Ended March 31,
-------------------------------------------------------------
(Dollars in Millions) 1998 % 1997 %
------------ ---------- ------------- -----------
Domestic:
Municipal finance policies:
Up-front policies:
New issue...................................... $49.6 64% $31.9 61%
Secondary market............................... 2.8 4 4.6 9
---------- -------- ----------- ---------
Sub-total up-front............................ 52.4 68 36.5 70
---------- -------- ----------- ---------
Installment policies:
Annual policies................................ 2.1 2 1.8 3
Portfolio products............................. 0.6 1 0.8 2
---------- -------- ----------- ---------
Sub-total installment...................... 2.7 3 2.6 5
---------- -------- ----------- ---------
Total municipal finance policies............ 55.1 71 39.1 75
---------- -------- ----------- ---------
Structured finance policies:
Up-front....................................... - - 7.2 14
Installment.................................... 6.7 9 3.7 7
---------- -------- ----------- ---------
Total structured finance policies......... 6.7 9 10.9 21
---------- -------- ----------- ---------
Total domestic written................. 61.8 80 50.0 96
---------- -------- ----------- ---------
International:
Up-front................................. 13.6 17 0.8 2
Installment.............................. 2.1 3 1.0 2
---------- -------- ----------- ---------
Total international written............ 15.7 20 1.8 4
---------- -------- ----------- ---------
Total up-front written............................ 66.0 85 44.5 86
Total installment written......................... 11.5 15 7.3 14
---------- -------- ----------- ---------
Total gross premiums written..................... $77.5 100% $51.8 100%
========== ======== =========== =========
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Ceded Premiums Written. Ceded premiums written for the first quarter of
----------------------
1998 were $26.1 million, compared to $5.4 million in the first quarter of 1997.
The 383% increase in ceded premiums written is primarily due to the following
factors: (i) the reinsurance of $11.3 million of the portfolio purchased through
the acquisition of Connie Lee Insurance Company ("Connie Lee"); (ii) an increase
of $6.2 million ceded on international policies; and (iii) an increase of $3.2
million ceded on municipal finance policies. Ceded premiums written were 34% and
10% of gross premiums written for the three months ended March 31, 1998 and
1997, respectively.
Net Premiums Written. Net premiums written for the three months ended
--------------------
March 31, 1998 were $51.4 million, an increase of 11% from the $46.4 million in
the three months ended March 31, 1997. This increase reflects higher gross
premiums written, partially offset by higher premiums ceded to reinsurers in the
three months ended March 31, 1998 compared with the corresponding prior period.
Net Premiums Earned. Net premiums earned during the three months ended
-------------------
March 31, 1998 were $53.2 million, an increase of 44% from $37.0 million in the
three months ended March 31, 1997. The increase was primarily the result of
increased premiums earned from refundings, calls, and other accelerations and an
increase in premiums earned from the underlying book of business during the
three months ended March 31, 1998. Net premiums earned for the three months
ended March 31, 1998 included $16.3 million (which had a net income per diluted
share effect of $0.13) from refundings, calls and other accelerations of
previously insured issues. Net premiums earned in the three months ended March
31, 1997 included $7.6 million (which had a net income per diluted share effect
of $0.06) from refundings, calls and other accelerations. Refunding levels vary
depending upon a number of conditions, primarily the relationship between
current interest rates and interest rates on outstanding debt. Excluding the
effect of accelerated earnings from refundings, calls and other accelerations,
net premiums earned for the three months ended March 31, 1998 were $36.9
million, an increase of 26% from $29.4 million in the three months ended March
31, 1997.
Net Investment Income. Net investment income for the three months ended
---------------------
March 31, 1998 was $45.0 million, an increase of 17% from $38.4 million in the
three months ended March 31, 1997. The increase was primarily attributable to
the growth of the investment portfolio from ongoing operations and the net
increase in the investment portfolio from the acquisition of Connie Lee. Ambac
Assurance's investments in tax-exempt securities amounted to 73% of the total
market value of its portfolio as of March 31, 1998, versus 79% at March 31,
1997. The average pre-tax yield-to-maturity on the investment portfolio was
6.41% and 6.46% as of March 31, 1998 and 1997, respectively.
Net Realized Gains. Net realized gains were $1.2 million for the three
------------------
months ended March 31, 1998, compared to $0.8 million in net realized gains for
the comparative prior period in 1997.
Other Income. Other income was $2.0 million for the three months ended
-------------
March 31, 1998, compared to $1.1 million for the three months ended March 31,
1997. This increase was primarily due to an increase in fees received.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses
-----------------------------------
for the three months ended March 31, 1998 were $1.6 million, versus $0.7 million
in the three months ended March 31, 1997. Losses and loss adjustment expenses
are generally based upon estimates of the ultimate aggregate losses inherent in
the obligations insured. No salvage was recognized for the three month periods
ended March 31, 1998 and 1997, respectively.
Underwriting and Operating Expenses. Underwriting and operating expenses
-----------------------------------
for the first quarter of 1998 were $12.0 million, an increase of 32% from $9.1
million in the first quarter of 1997, primarily as a result of higher gross
underwriting expenses. Underwriting and operating expenses consist of gross
underwriting and operating expenses, less the deferral to future periods of
expenses and reinsurance commissions related to the acquisition of new insurance
contracts, plus the amortization of previously deferred expenses and reinsurance
commissions. During the three month period ended March 31, 1998, gross
underwriting and operating expenses were $15.5 million, an increase of 14% from
$13.6 million in the three months ended March 31, 1997. This increase reflects
the overall increased business activity during the period. Underwriting and
operating expenses deferred were $8.2 million and $7.9 million for the three
months ended March 31, 1998 and 1997, respectively. The amortization of
previously deferred expenses and reinsurance commissions was $4.7 million and
$3.4 million for the three months ended March 31, 1998 and 1997, respectively.
FINANCIAL MANAGEMENT SERVICES
Through its financial management services subsidiaries, the Company
provides investment agreements, interest rate swaps, investment advisory and
cash management services, and electronic commerce solutions, principally to
states, municipalities and their authorities, school districts, and hospitals
and health organizations. Revenues for the three months ended March 31, 1998
were $11.9 million (includes $0.9 million in net realized losses), up 65% from
$7.2 million for the three months ended March 31, 1997. This increase is
primarily due to (i) higher revenues on interest rate swaps of $5.4 million in
the first quarter of 1998, up 184% from $1.9 million in the first quarter of
1997, and (ii) higher investment agreement net investment income of $4.7 million
in the first quarter of 1998, up 62% on increased volume, from $2.9 million in
the first quarter of 1997; (iii) partially offset by net realized losses of $0.9
million in the first quarter of 1998. Expenses for the first quarter of 1998
were $7.4 million, down from $9.0 million in the first quarter of 1997. Included
in the first quarter of 1997 expenses was a $3.5 million restructuring charge.
Excluding this one-time charge, expenses increased 36% in the first three months
of 1998 versus the comparative prior period. This increase was primarily due to
start up expenses relating to the Company's electronic commerce business and
increased expenses relating to its investment agreement business. The increased
expenses in the investment agreement business relate to the overall increase in
volume for that business.
CORPORATE ITEMS
Interest Expense. Interest expense for the three months ended March 31,
----------------
1998 was $5.6 million, up 8% from $5.2 million for the three months ended March
31, 1997, primarily due to higher fees associated with the Company's credit
facilities and lower net payments received under an interest rate swap related
to the Company's debentures. The Company terminated its interest rate swap in
the first quarter of 1998.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Income Taxes. Income taxes for the three months ended March 31, 1998 were
------------
at an effective rate of 23.8%, versus 20.3% in the three months ended March 31,
1997. This increase was primarily due to the higher level of pre-tax income in
the three months ended March 31, 1998.
SUPPLEMENTAL ANALYTICAL FINANCIAL DATA
Management, equity analysts and investors consider the following four
measures important in analyzing the financial results, and measuring the
intrinsic value of the Company: core earnings; operating earnings; adjusted
gross premiums written; and adjusted book value. However, none of these measures
are promulgated in accordance with GAAP and should not be considered as
substitutes for net income, gross premiums written and book value. The
definitions of core earnings, operating earnings, adjusted gross premiums
written and adjusted book value described below may differ from the definitions
used by other public holding companies of financial guarantee insurers.
Core Earnings. Core earnings for the three months ended March 31, 1998 were
-------------
$55.8 million , an increase of 20% from $46.5 million for the three months ended
March 31, 1997. The increase in core earnings was primarily the result of
continued higher premiums earned from the growth in the insurance book of
business, higher net investment income from insurance operations, as well as
higher revenues from the investment agreement and swap businesses from the
financial management services segment. The Company defines core earnings as
consolidated net income, less the effect of net realized gains and losses, net
insurance premiums earned from refundings and calls and certain non-recurring
items.
Operating Earnings. Operating earnings for the first quarter of 1998 were
------------------
$65.1 million, an increase of 28% from $50.8 million in the first quarter of
1997. The Company defines operating earnings as consolidated net income, less
the effect of net realized gains and losses and certain non-recurring items.
The following table reconciles net income computed in accordance with GAAP
to operating earnings and core earnings for the three months ended March 31,
1998 and 1997:
(Dollars in Millions) 1998(/1/) 1997(/1/)
------------ -----------
Net Income............................................. $65.7 $49.7
Net realized gains, after tax.......................... (0.6) (1.0)
Non-recurring item, after tax.......................... - 2.1
--------- -------
Operating earnings.................................. 65.1 50.8
Premiums earned from refundings,
calls and other accelerations, after tax............ (9.3) (4.3)
--------- -------
Core earnings....................................... $55.8 $46.5
========= =======
(/1/) Numbers may not add due to rounding.
The weighted average number of diluted shares outstanding during the first
quarter of 1998 and 1997 was 71.6 million and 71.0 million, respectively.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Adjusted Gross Premiums Written. Adjusted gross premiums written were $92.6
-------------------------------
million in the first quarter of 1998, up 34% from $69.3 million in the first
quarter of 1997. The Company defines adjusted gross premiums written as up-front
premiums written plus the present value of estimated future installment premiums
written in the period. While most premiums are collected up-front at policy
issuance, a growing portion of premiums are collected on an installment basis.
The net present value of estimated future installment premiums written in the
first quarter of 1998 was $26.6 million, an increase of 7% from $24.9 million
written in the first quarter of 1997. The aggregate net present value of
estimated future installment premiums was $222.4 million and $210.8 million as
of March 31, 1998 and December 31, 1997, respectively.
The following table reconciles total up-front premiums written to adjusted
gross premiums written for the three months ended March 31, 1998 and 1997:
(Dollars in Millions) 1998(/1/) 1997(/1/)
------------ ------------
Adjusted Gross Premium Analysis:
Total Up-front premiums written................. $66.0 $44.5
PV of estimated future installment premiums..... 26.6 24.9
----------- ----------
Adjusted gross premiums written............. $92.6 $69.3
=========== ==========
(/1/) Numbers may not add due to rounding.
Adjusted Book Value. Adjusted book value ("ABV") per common share increased
--------------------
2% to $37.50 at March 31, 1998 compared to $36.59 at December 31, 1997. The
Company derives ABV by beginning with stockholders' equity (book value) and
adding or subtracting the after-tax value of: the net unearned premium reserve;
deferred acquisition costs; the present value of estimated net future
installment premiums; and the unrealized gain or loss on investment agreement
liabilities. These adjustments will not be realized until future periods and may
differ materially from the amounts used in determining ABV.
The following table reconciles book value per share to ABV per share as of
March 31, 1998 and December 31, 1997:
March 31, December 31,
1998(/1/) 1997(/1/)
------------------ ------------------
Book value per share...................................... $27.31 $26.77
After-tax value of:
Net unearned premium reserve............................ 9.22 9.25
Deferred acquisition costs.............................. (1.00) (0.99)
Present value of installment premiums................... 2.07 1.96
Unrealized gain on investment agreement liabilities..... (0.10) (0.40)
------------------ ------------------
Adjusted book value per share............................. $37.50 $36.59
================== ==================
(/1/) Numbers may not add due to rounding.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Liquidity and Capital Resources
Ambac Financial Group, Inc. Liquidity. The Company's liquidity, both on a
--------------------------------------
short-term basis (for the next twelve months) and a long-term basis (beyond the
next twelve months), is largely dependent upon Ambac Assurance's ability to pay
dividends or make payments to the Company and external financings.
Pursuant to Wisconsin insurance laws, Ambac Assurance may declare
dividends, provided that, after giving effect to the distribution, it would not
violate certain statutory equity, solvency and asset tests. During the three
months ended March 31, 1998, Ambac Assurance paid dividends of $12.0 million on
its common stock to the Company.
The Company's principal uses of liquidity are for the payment of its
operating expenses, interest on its debt, dividends on its shares of common
stock and capital investments in its subsidiaries. Based on the amount of
dividends that Ambac Assurance expects to pay during 1998 and the income it
expects to receive from its investment portfolio, the Company believes it will
have sufficient liquidity to satisfy its liquidity needs over the next twelve
months, including the payment of dividends on the Common Stock in accordance
with its dividend policy. Beyond the next twelve months, Ambac Assurance's
ability to declare and pay dividends to the Company may be influenced by a
variety of factors, including adverse market changes, insurance regulatory
changes and changes in general economic conditions. Consequently, although the
Company believes that it will continue to have sufficient liquidity to meet its
debt service and other obligations over the long term, no assurance can be given
that Ambac Assurance will be permitted to dividend amounts sufficient to pay all
of the Company's operating expenses, debt service obligations and cash dividends
on its Common Stock.
On April 1, 1998, the Company issued $200.0 million in principal amount of
its 7.08% debentures due on March 31, 2098. The Company may not redeem the
debentures prior to March 31, 2003. On or after March 31, 2003, the Company may
redeem the debentures at 100% of their principal amount, plus accrued interest
to the date of redemption. Use of the net proceeds received from the sale of the
debentures will be for general corporate purposes, which include additions to
working capital of subsidiaries, acquisitions and repurchases of common stock.
These debentures are listed on the New York Stock Exchange.
Ambac Assurance Liquidity. The principal uses of Ambac Assurance's
--------------------------
liquidity are the payment of operating expenses, reinsurance premiums, income
taxes and dividends to the Company. The Company believes that Ambac Assurance's
operating liquidity needs can be funded exclusively from its operating cash
flow. The principal sources of Ambac Assurance's liquidity are gross premiums
written, scheduled investment maturities and net investment income. The majority
of premiums for Ambac Assurance's financial guarantee insurance policies are
payable in full at the outset of the term of the policy, even though premiums
are earned over the life of such policies for financial accounting purposes.
Financial Management Services Liquidity. The principal uses of liquidity by
----------------------------------------
the Company's financial management services subsidiaries are the payment of
investment agreement obligations pursuant to defined terms, net obligations
under interest rate swaps and related hedges, operating expenses and income
taxes. The Company believes that its financial
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
management services liquidity needs can be funded primarily from its operating
cash flow and the maturity of its invested assets. The principal sources of this
segments liquidity are proceeds from issuance of investment agreements, net
investment income, maturities of securities from its investment portfolio which
are invested with the objective of matching the duration of its obligations
under the investment agreements, net receipts from interest rate swaps and
related hedges and fees for investment management services. The Company's
investment objectives with respect to investment agreements are to achieve the
highest after-tax total return, subject to a minimum average quality rating of
Aa/AA on invested assets, and to maintain cash flow matching of invested assets
to funded liabilities to minimize interest rate and liquidity exposure. The
Company maintains a portion of its financial management services assets in
short-term investments and repurchase agreements in order to meet unexpected
liquidity needs.
Credit Facilities. As of March 31, 1998, the Company and Ambac Assurance
------------------
had a revolving credit facility with two major international banks, as co-
agents, for $100.0 million, which expires in July 1998. This facility is
available for general corporate purposes, including the payment of claims. As of
March 31, 1998 and 1997, no amounts were outstanding under this credit facility.
Ambac Assurance has an agreement with a group of AAA/Aaa-rated
international banks for a $450.0 million credit facility, expiring December 2,
2004. This facility is a seven-year stand-by irrevocable limited recourse line-
of-credit, which will provide liquidity to Ambac Assurance in the event that
claims from municipal obligations exceed specified levels. Repayment of any
amounts drawn under the line will be limited primarily to the amount of any
recoveries of losses related to policy obligations. As of March 31, 1998 and
1997, no amounts were outstanding under this line.
Connie Lee has an agreement with commercial banks for a $50.0 million
standby credit facility, expiring in 2003. The line will provide a source of
additional claims-paying resources for insured transactions. The obligation to
repay is a limited recourse obligation payable solely from, and collateralized
by, a pledge of recoveries realized on defaulted insured obligations including
installment premiums and other collateral. As of March 31, 1998, no amounts were
outstanding under this line.
Stock Repurchase Program. The Board of Directors of the Company has
-------------------------
authorized the establishment of a stock repurchase program which permits the
repurchase of up to 6,000,000 shares of the Company's Common Stock. During the
three months ended March 31, 1998, the Company acquired approximately 237,000
shares for an aggregate amount of $13.0 million. Since inception of the Stock
Repurchase Program, the Company has acquired approximately 3,509,000 shares for
an aggregate amount of $103.0 million.
Balance Sheet. As of March 31, 1998, the fair value of the Company's
--------------
consolidated investment portfolio was $7.57 billion, an increase of 9% from
$6.92 billion at December 31, 1997. This increase was primarily due to the
increased volume in investment and payment agreements and cash flow from
operations.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Cash Flows. Net cash provided by operating activities was $73.6 million and
-----------
$54.8 million during the three months ended March 31, 1998 and 1997,
respectively. These cash flows were primarily provided from insurance
operations.
Net cash provided by financing activities was $613.6 million during the
three months ended March 31, 1998, of which $619.2 million was from investment
agreements issued (net of draws paid). For the three months ended March 31,
1997, $66.1 million was used in financing activities, which includes $44.6
million in investment agreement draws (net of amounts received).
Net cash used in investing activities was $685.9 million during the three
months ended March 31, 1998, of which $1,213.0 million was used to purchase
bonds and securities purchased under agreements to resell, partially offset by
proceeds from bonds of $538.5 million. For the three months ended March 31,
1997, $12.1 million was provided by investing activities, which includes $648.4
million from proceeds from bonds and securities purchased under agreements to
resell, partially offset by purchases of bonds of $652.3 million.
Material Commitments. The Company has made no commitments for material
---------------------
capital expenditures within the next twelve months. However, management
continually evaluates opportunities to expand the Company's businesses through
internal development of new products as well as acquisitions.
Year 2000. The Company recognizes the worldwide challenge for all systems
----------
to recognize the date change for the year 2000 and, is assessing its computer
applications and business processes to provide for their continued
functionality. The process of identifying and analyzing the Company's internally
developed systems is complete. The process of testing these systems and making
any modifications, if necessary, have begun. The Company will also be
communicating with software vendors, municipalities and other issuers and their
paying agents, financial institutions and others with which it conducts business
to help them identify and resolve the year 2000 issue. However, there can be no
guarantee that the systems of such other entities on which the Company's systems
rely will be timely converted, or that of failure to convert by such entities,
would not have a material impact on the operations of the Company. The Company
expects to incur internal staff costs, as well as consulting expenses related
to this process. The Company does not anticipate that the related overall costs
will be material.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the ordinary course of business, the Company, through its affiliates,
manages a variety of risks, principally market, credit, liquidity, operational,
and legal. These risks are identified, measured and monitored through a variety
of control mechanisms, which are in place at different levels throughout the
organization.
Market risk generally represents the risk of loss that may result from the
potential change in the fair value of a financial instrument as a result of
changes in prices and interest rates. The Company has financial instruments
held for purposes other than trading and for trading purposes. The principal
market risk for the Company's financial instruments held for purposes other than
trading is interest rate risk. An independent risk management group is involved
in setting and monitoring risk limits and the application of risk measurement
methodologies. The estimation of potential losses arising from adverse changes
in market conditions is a key element in managing market risk. The
Company utilizes various models and stress test
16
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
scenarios to monitor and manage interest rate risk. This process includes
frequent analyses of both parallel and non-parallel shifts in the yield curve.
These models include estimates made by management and the valuation results
could differ materially from amounts that would actually be realized in the
market. Financial instruments held for purposes other than trading which may be
adversely affected by changes in interest rates, consist primarily of investment
securities, investment agreement liabilities, debentures, and related derivative
contracts (primarily interest rate swaps and futures) used for hedging purposes.
The Company through its affiliate Ambac Financial Services, L.P. ("AFSLP"),
is a provider of interest rate swaps to states, municipalities and their
authorities and other entities in connection with their financings. AFSLP
manages its business with the goal of being market neutral to changes in overall
interest rates, while retaining basis risk, the relationship between floating
tax-exempt and floating taxable interest rates. If actual or projected floating
tax-exempt interest rates change in relation to floating taxable interest rates,
AFSLP will experience an unrealized mark-to-market gain or loss. The AFSLP swap
portfolio is considered held for trading purposes. Market risk for financial
instruments held for trading purposes relates to the impact of pricing changes
on future earnings. The principal market risk is basis risk. Since late 1995,
most municipal interest rate swaps transacted contain provisions which are
designed to protect the Company against certain forms of tax reform, thus
mitigating its basis risk. An independent risk management group monitors
trading risk limits and, together with senior management, is involved in the
application of risk measurement methodologies.
17
PART II - OTHER INFORMATION
Items 1, 2, 3, 4, and 5 are omitted either because they are inapplicable
or because the answer to such question is negative.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) THE FOLLOWING ARE ANNEXED AS EXHIBITS:
EXHIBIT
Number DESCRIPTION
------ -----------
10.05* Ambac Financial Group, Inc. 1997 Non-Employee Directors Equity Plan
(Filed as Exhibit 4.2 to the Company's Registration Statement on
Form S-8 (Reg. No. 333-52449) and incorporated herein by reference.)
27.00 Financial Data Schedule.
99.02 Ambac Assurance Corporation and Subsidiaries Consolidated Unaudited
Financial Statements as of March 31, 1998 and December 31, 1997 and
for the periods ended March 31, 1998 and 1997.
(b) REPORTS ON FORM 8-K:
On February 6, 1998, the Company filed a Current Report on Form 8-K with
--------
its January 29, 1998 press release containing unaudited financial information
and accompanying discussion for the three months ended December 31, 1997 and the
year ended December 31, 1997. On March 27, 1998, the Company filed a current
report on Form 8-K containing consolidated financial statements (with
--------
independent auditor's report thereon) of Ambac Assurance Corporation and
Subsidiaries as of December 31, 1997 and 1996. The filing of these Current
Reports on Form 8-K were previously noted in the Company's Annual Report on Form
-------- ----
10-K for the fiscal year ended December 31, 1997, which was filed on March 31,
- ----
1998.
- -------------------------
* Management contract or compensatory plan, contract or arrangement required to
be filed as an exhibit pursuant to Item 6(a) of Form 10-Q.
----------
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
Ambac Financial Group, Inc.
(Registrant)
Dated: May 15, 1998 By: /s/ Frank J. Bivona
-------------------
Frank J. Bivona
Executive Vice President, Chief
Financial Officer and Treasurer
(Principal Financial and Accounting
Officer and Duly Authorized Officer)
19
INDEX TO EXHIBITS
EXHIBIT
Number Description
- ------ -----------
27.00 Financial Data Schedule.
99.02 Ambac Assurance Corporation and Subsidiaries Consolidated Unaudited
Financial Statements as of March 31, 1998 and December 31, 1997 and
for the periods ended March 31, 1998 and 1997.
20