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 June 30, 1999
[ ] 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 June 30, 1999, 69,902,936 shares of Common Stock, par value $0.01 per
share, (net of 777,448 treasury shares) of the Registrant were outstanding.
Ambac Financial Group, Inc. and Subsidiaries
INDEX
PAGE
----
PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - June 30, 1999
and December 31, 1998...................................................... 3
Consolidated Statements of Operations - three months and
six months ended June 30, 1999 and 1998.................................... 4
Consolidated Statements of Stockholders' Equity - six months
ended June 30, 1999 and 1998............................................... 5
Consolidated Statements of Cash Flows - six months ended
June 30, 1999 and 1998..................................................... 6
Notes to Consolidated Financial Statements................................. 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................ 10
Item 3. Quantitative and Qualitative Disclosures About
Market Risk................................................................ 21
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.............................................. 22
SIGNATURES................................................................................. 24
INDEX TO EXHIBITS.......................................................................... 25
PART 1- FINANCIAL INFORMATION
Item 1- Financial Statements of Ambac Financial Group, Inc. and Subsidiaries
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Balance Sheets
June 30, 1999 and December 31, 1998
(Dollars in Thousands)
June 30, 1999 December 31, 1998
-------------------- ------------------------
(unaudited)
Assets
- ------
Investments:
Fixed income securities, at fair value
(amortized cost of $8,784,445 in 1999 and $8,307,046 in 1998) $8,766,846 $8,622,282
Short-term investments, at cost (approximates fair value) 117,438 119,528
Other 6,611 6,567
-------------------- ------------------------
Total investments 8,890,895 8,748,377
Cash 8,309 8,239
Securities purchased under agreements to resell 68,986 252,295
Receivable for investment agreements 181,657 73,142
Receivable for securities sold 31,706 16,233
Investment income due and accrued 111,913 125,929
Reinsurance recoverable 3,668 3,638
Prepaid reinsurance 202,141 199,920
Deferred acquisition costs 130,238 120,619
Loans 681,600 673,930
Receivable from brokers and dealers 600,000 750,000
Other assets 170,686 239,989
-------------------- ------------------------
Total assets $11,081,799 $11,212,311
==================== ========================
Liabilities and Stockholder's Equity
- ------------------------------------
Liabilities:
Unearned premiums $1,339,268 $1,294,214
Losses and loss adjustment expenses 120,483 115,794
Ceded reinsurance balances payable 5,878 6,576
Obligations under investment and payment agreements 4,845,625 4,774,953
Obligations under investment repurchase agreements 1,368,199 1,181,810
Deferred income taxes 43,240 145,782
Current income taxes 14,493 6,949
Debentures 423,962 423,929
Accrued interest payable 79,495 89,615
Other liabilities 166,973 262,423
Payable to brokers and dealers 600,000 750,000
Payable for securities purchased 29,715 64,176
-------------------- ------------------------
Total liabilities 9,037,331 9,116,221
-------------------- ------------------------
Preferred stock - -
Common stock 707 707
Additional paid-in capital 520,466 519,305
Accumulated other comprehensive income (18,437) 159,313
Retained earnings 1,577,902 1,449,832
Common stock held in treasury at cost (36,170) (33,067)
-------------------- ------------------------
Total stockholders' equity 2,044,468 2,096,090
-------------------- ------------------------
Total liabilities and stockholders' equity $11,081,799 $11,212,311
==================== ========================
See accompanying Notes to Consolidated Financial Statements
3
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
For the Periods Ended June 30, 1999 and 1998
(Dollars in Thousands Except Share Data)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------- -----------------------------------
1999 1998 1999 1998
----------------------------------- -----------------------------------
Revenues:
Financial Guarantee:
Gross premiums written $98,708 $88,042 $188,862 $165,529
Ceded premiums written (16,458) (10,048) (21,544) (36,135)
---------------- ---------------- ---------------- ----------------
Net premiums written 82,250 77,994 167,318 129,394
Increase in unearned premiums (18,306) (24,676) (43,077) (22,892)
---------------- ---------------- ---------------- ----------------
Net premiums earned 63,944 53,318 124,241 106,502
Net investment income 51,296 45,872 100,780 90,912
Net realized (losses) gains (5,569) (509) (5,480) 666
Other income 1,077 235 2,584 2,200
Financial Management Services:
Revenue 13,138 12,732 25,850 25,486
Net realized losses (2,987) (6,350) (3,300) (7,248)
Other:
Revenue 2,603 4,047 6,423 5,403
Net realized gains - 910 775 1,517
---------------- ---------------- ---------------- ----------------
Total revenues 123,502 110,255 251,873 225,438
---------------- ---------------- ---------------- ----------------
Expenses:
Financial Guarantee:
Losses and loss adjustment expenses 2,500 1,423 5,000 3,000
Underwriting and operating expenses 11,872 11,190 23,789 23,208
Financial Management Services 6,779 8,603 13,756 16,046
Interest 9,094 8,782 18,177 14,394
Other 1,272 1,744 3,215 4,080
---------------- ---------------- ---------------- ----------------
Total expenses 31,517 31,742 63,937 60,728
---------------- ---------------- ---------------- ----------------
Income before income taxes 91,985 78,513 187,936 164,710
Provision for income taxes 21,016 17,717 43,773 38,256
---------------- ---------------- ---------------- ----------------
Net income $70,969 $60,796 $144,163 $126,454
================ ================ ================ ================
Net income per share $1.02 $0.87 $2.06 $1.81
================ ================ ================ ================
Net income per diluted share $1.00 $0.85 $2.02 $1.77
================ ================ ================ ================
Weighted average number of
shares outstanding 69,877,457 70,015,177 69,898,316 70,027,486
================ ================ ================ ================
Weighted average number of diluted
shares outstanding 71,309,111 71,665,662 71,319,712 71,619,424
================ ================ ================ ================
See accompanying Notes to Consolidated Financial Statements
4
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(Unaudited)
For The Six Months Ended June 30, 1999 and 1998
(Dollars in Thousands)
1999 1998
------------------------------- -------------------------------
Retained Earnings:
Balance at January 1 $1,449,832 $1,262,740
Net income 144,163 $144,163 126,454 $126,454
---------------- ---------------
Dividends declared - common stock (13,983) (12,593)
Exercise of stock options (2,110) (20,644)
--------------- ----------------
Balance at June 30 $1,577,902 $1,355,957
--------------- ----------------
Accumulated Other Comprehensive Income:
Balance at January 1 $159,313 $135,223
Unrealized (losses) gains on securities, ($281,009),
and $28,464, pre-tax in 1999 and 1998, respectively(1) (176,693) 18,120
Foreign currency (loss) gain (1,057) 173
---------------- ---------------
Other comprehensive (loss) income (177,750) (177,750) 18,293 18,293
------------------------------- -------------------------------
Comprehensive (loss) income ($33,587) $144,747
================ ===============
Balance at June 30 ($18,437) $153,516
--------------- ----------------
Preferred Stock:
Balance at January 1 and June 30 $- $-
--------------- ----------------
Common Stock:
Balance at January 1 and June 30 $707 $707
--------------- ----------------
Additional Paid-in Capital:
Balance at January 1 $519,305 $500,107
Exercise of stock options 1,161 11,932
--------------- ----------------
Balance at June 30 $520,466 $512,039
--------------- ----------------
Common Stock Held in Treasury at Cost:
Balance at January 1 ($33,067) ($26,295)
Cost of shares acquired (9,126) (20,856)
Shares issued under equity plans 6,023 14,866
--------------- ----------------
Balance at June 30 ($36,170) ($32,285)
--------------- ----------------
Total Stockholders' Equity at June 30 $2,044,468 $1,989,934
=============== ================
(1) Disclosure of reclassification amount:
Unrealized holding (losses) gains arising during period ($181,896) $19,580
Less: reclassification adjustment for net (losses) gains
included in net income (5,203) 1,460
--------------- ----------------
Net unrealized (losses) gains on securities ($176,693) $18,120
=============== ================
See accompanying Notes to Consolidated Financial Statements.
5
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
For The Periods Ended June 30, 1999 and 1998
(Dollars in Thousands)
Six Months Ended
June 30,
--------------------------------------
1999 1998
---------------- ----------------
Cash flows from operating activities:
Net income $144,163 $126,454
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,407 792
Amortization of bond premium and discount (3,234) (2,416)
Current income taxes 7,544 (6,753)
Deferred income taxes 1,773 (5,094)
Deferred acquisition costs (9,619) (4,977)
Unearned premiums, net 42,833 22,938
Losses and loss adjustment expenses 4,659 9,306
Ceded reinsurance balances payable (698) (1,380)
Investment income due and accrued 14,016 (8,467)
Accrued interest payable (10,120) 8,897
(Losses) gains on sales of investments 8,005 5,065
Interest rate swaps, at market (22,386) 2,800
Other, net (6,219) (13,420)
---------------- ----------------
Net cash provided by operating activities 172,124 133,745
---------------- ----------------
Cash flows from investing activities:
Proceeds from sales of bonds 1,753,245 265,478
Proceeds from matured bonds 693,290 1,157,445
Purchases of bonds (2,935,988) (2,268,960)
Change in short-term investments 2,090 (41,149)
Securities purchased under agreements to resell 183,309 (128,852)
Loans (7,670) (173,720)
Other, net 8,210 (18,138)
---------------- ----------------
Net cash used in investing activities (303,514) (1,207,896)
---------------- ----------------
Cash flows from financing activities:
Dividends paid (13,983) (12,593)
Proceeds from issuance of investment agreements 1,310,852 1,705,983
Payments for investment agreement draws (1,169,976) (961,435)
Proceeds from issuance of debentures - 193,700
Payment agreements 7,670 173,720
Proceeds from sale of treasury stock 6,023 14,866
Purchases of treasury stock (9,126) (20,856)
---------------- ----------------
Net cash provided by financing activities 131,460 1,093,385
---------------- ----------------
Net cash flow 70 19,234
Cash at January 1 8,239 9,256
---------------- ----------------
Cash at June 30 $8,309 $28,490
================ ================
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes $33,500 $41,250
================ ================
Interest expense on debt $18,266 $14,515
================ ================
Interest expense on investment agreements $143,436 $115,551
================ ================
See accompanying Notes to Consolidated Financial Statements
6
Ambac Financial Group, Inc. and Subsidiaries
Notes to Consolidated Unaudited Financial Statements
(Dollars in thousands)
(1) Basis of Presentation
Ambac Financial Group, Inc., (the "Company") headquartered in New York
City, is a holding company whose affiliates provide financial guaranties and
financial management services to clients in both the public and private sectors
around the world. The Company's principal operating subsidiary, Ambac Assurance
Corporation ("Ambac Assurance"), a leading insurer of municipal and structured
finance obligations, has earned triple-A ratings, the highest ratings available
from Moody's Investors Service, Inc., Standard & Poor's Ratings Group, Fitch
IBCA, Inc., and Japan Rating and Investment Information, Inc. The Company,
through its subsidiaries, also provides investment agreements, interest rate
swaps and investment advisory and cash management services, primarily to states,
municipalities and municipal authorities.
The Company's consolidated unaudited interim financial statements have been
prepared on the basis of U.S. 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 and six months ended
June 30, 1999 may not be indicative of the results that may be expected for the
full year ending December 31, 1999. 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 (i) the Company's Annual Report on
Form 10-K for the year ended December 31, 1998, which was filed with the
Securities and Exchange Commission (the "Commission") on March 30, 1999, and
(ii) the Company's Quarterly Report on Form 10-Q for the quarterly period ended
March 31, 1999, which was filed with the Commission on May 12, 1999.
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.
(2) Segment Information
The Company has two reportable segments, as follows: (1) Financial
Guarantee, which provides insurance of municipal and structured finance
obligations; and (2) Financial Management Services, which provides investment
agreements, interest rate swaps, and investment advisory and cash management
services. During the fourth quarter of 1998, the Company discontinued its
operations relating to electronic commerce applications for the municipal
marketplace.
The Company's reportable segments are strategic business units that offer
different products and services. They are managed separately because each
business requires different marketing strategies, personnel skill sets and
technology.
7
Notes to Consolidated Unaudited Financial Statements (Continued)
(Dollars in thousands)
Pursuant to insurance and indemnity agreements, Ambac Assurance guarantees
the swap and investment agreement obligations of those financial management
services subsidiaries. Intersegment revenues include the premiums earned under
those agreements but which are eliminated in the consolidated financial
statements. Such premiums are accounted for as if they were premiums to third
parties, that is, at current market prices.
Information provided below for "Corporate and Other" relates to Ambac
Financial Group, Inc. corporate activities. Corporate and other revenue from
unaffiliated customers consists primarily of interest income and realized gains
or losses from investment securities.
The following tables summarize the financial information by reportable
segment as of and for the three and six-month periods ended June 30, 1999 and
1998:
Financial
Financial Management Corporate Intersegment
Three months ended June 30, Guarantee Services and Other Eliminations Consolidated
-------------- --------------- ------------- -------------- ---------------
1999:
Revenues:
Unaffiliated customers ..... $110,748 $10,151 $2,603 $- $123,502
Intersegment ............... 770 (840) 13,143 (13,073) -
-------------- ------------------------------ -------------- ---------------
Total revenues.................. $111,518 $9,311 $15,746 ($13,073) $123,502
-------------- ------------------------------ -------------- ---------------
Income before income taxes:
Unaffiliated customers ..... $96,376 $3,372 ($7,763) $- $91,985
Intersegment ............... 912 (1,057) 13,143 (12,998) -
-------------- --------------- ------------- -------------- ---------------
Total income before income taxes $97,288 $2,315 $5,380 ($12,998) $91,985
-------------- --------------- ------------- -------------- ---------------
Identifiable assets............. $3,955,428 $6,985,291 $141,080 $- $11,081,799
-------------- --------------- ------------- -------------- ---------------
1998:
Revenues:
Unaffiliated customers ..... $98,916 $6,382 $4,957 $- $110,255
Intersegment ............... 644 (1,891) 12,060 (10,813) -
-------------- --------------- ------------- -------------- ---------------
Total revenues.................. $99,560 $4,491 $17,017 ($10,813) $110,255
-------------- --------------- ------------- -------------- ---------------
Income before income taxes:
Unaffiliated customers ..... $86,303 ($2,221) ($5,569) $- $78,513
Intersegment ............... 634 (1,111) 12,060 (11,583) -
-------------- --------------- ------------- -------------- ---------------
Total income before income taxes $86,937 ($3,332) $6,491 ($11,583) $78,513
-------------- --------------- ------------- -------------- ---------------
Identifiable assets............. $3,599,449 $6,351,501 $284,190 $- $10,235,140
-------------- --------------- ------------- -------------- ---------------
8
Notes to Consolidated Unaudited Financial Statements (Continued)
(Dollars in thousands)
Financial
Financial Management Corporate Intersegment
Six months ended June 30, Guarantee Services and Other Eliminations Consolidated
-------------- --------------- ------------- -------------- ---------------
1999:
Revenues:
Unaffiliated customers ..... $222,125 $22,550 $7,198 $- $251,873
Intersegment ............... 1,542 (1,740) 26,343 (26,145) -
-------------- ------------------------------ -------------- ---------------
Total revenues.................. $223,667 $20,810 $33,541 ($26,145) $251,873
-------------- ------------------------------ -------------- ---------------
Income before income taxes:
Unaffiliated customers ..... $193,336 $8,794 ($14,194) $- $187,936
Intersegment ............... 1,684 (1,967) 26,343 (26,060) -
-------------- --------------- ------------- -------------- ---------------
Total income before income taxes $195,020 $6,827 $12,149 ($26,060) $187,936
-------------- --------------- ------------- -------------- ---------------
Identifiable assets $3,955,428 $6,985,291 $141,080 $- $11,081,799
-------------- --------------- ------------- -------------- ---------------
1998:
Revenues:
Unaffiliated customers ..... $200,280 $18,238 $6,920 $- $225,438
Intersegment ............... 1,363 (1,305) 24,153 (24,211) -
-------------- --------------- ------------- -------------- ---------------
Total revenues.................. $201,643 $16,933 $31,073 ($24,211) $225,438
-------------- --------------- ------------- -------------- ---------------
Income before income taxes:
Unaffiliated customers ..... $174,072 $2,192 ($11,554) $- $164,710
Intersegment ............... 1,353 (2,064) 24,153 (23,442) -
-------------- --------------- ------------- -------------- ---------------
Total income before income taxes $175,425 $128 $12,599 ($23,442) $164,710
-------------- --------------- ------------- -------------- ---------------
Identifiable assets $3,599,449 $6,351,501 $284,190 $- $10,235,140
-------------- --------------- ------------- -------------- ---------------
The following table summarizes gross premiums written and net premiums
earned included in the financial guarantee segment by location of risk for the
three and six-month periods ended June 30, 1999 and 1998.
Three Months Six Months
---------------------------------- ----------------------------------
Gross Premiums Net Premiums Gross Premiums Net Premiums
Written Earned Written Earned
----------------- --------------- ------------------ ---------------
1999:
United States ...................... $79,222 $56,876 $157,003 $111,321
United Kingdom ..................... 9,530 747 15,197 1,408
Japan .............................. 1,493 1,490 2,488 2,467
France.............................. 727 183 1,081 431
Australia........................... 165 244 546 665
Italy .............................. - 226 - 458
Internationally diversified (1)..... 3,304 1,957 5,475 3,517
Other international................. 4,267 2,221 7,072 3,974
----------------- --------------- ------------------ ---------------
Total........................... $98,708 $63,944 $188,862 $124,241
----------------- --------------- ------------------ ---------------
1998:
United States ...................... $70,500 $50,298 $132,334 $100,599
United Kingdom ..................... 10,466 356 19,822 720
Japan .............................. 1,510 568 2,499 1,063
France.............................. 544 439 780 913
Australia........................... 3,469 125 7,658 193
Italy .............................. - 248 - 497
Internationally diversified (1)..... 797 724 1,588 1,377
Other international................. 756 560 848 1,140
----------------- --------------- ------------------ ---------------
Total........................... $88,042 $53,318 $165,529 $106,502
----------------- --------------- ------------------ ---------------
(1) Internationally diversified represents insured policies with multiple
locations of risk.
9
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 and six month periods ended June 30,
1999 and 1998, and its financial condition as of June 30, 1999 and December 31,
1998. These results include the Company's two reportable segments: Financial
Guarantee 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, credit, or interest rate environment in the United
States and abroad; (2) the level of activity within the national and worldwide
debt markets; (3) competitive conditions and pricing levels; (4) legislative and
regulatory developments; (5) changes in tax laws; and (6) other risks and
uncertainties that have not been identified at this time. 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
Consolidated Net Income
The Company's net income for the three months ended June 30, 1999 was $71.0
million or $1.00 per diluted share. This represents a 17% increase from the
three months ended June 30, 1998 net income of $60.8 million, and an 18%
increase in net income per diluted share from $0.85 for the prior period. This
increase in net income was largely attributable to higher Financial Guarantee
operating income and lower expenses and lower net realized losses in the
Financial Management Services segment. The Company's net income for the six
months ended June 30, 1999 was $144.2 million or $2.02 per diluted share. This
represents an increase of 14% from the comparable prior period net income of
$126.5 million or $1.77 per diluted share. This increase in net income was
largely attributable to higher Financial Guarantee operating income and lower
expenses and lower net realized losses in the Financial Management Services
segment partially offset by higher interest expense.
Financial Guarantee
Gross Par Written. Ambac Assurance insured $17.4 billion in par value bonds
during the three months ended June 30, 1999 and $36.5 billion in par value bonds
during the six months ended June 30, 1999, an increase of 7% from $16.3 billion
in the three months ended June 30, 1998 and an increase of 18% from $30.9
billion in par value bonds during the six months ended June 30, 1998. Par value
written for the second quarter of 1999 was comprised of $7.9 billion from
municipal bond obligations, $7.2 billion from structured finance obligations and
$2.3 billion from international obligations, compared to $8.6 billion, $6.5
billion and $1.2 billion, respectively, in the second quarter of 1998. Par value
written for the six months ended June 30, 1999 was comprised of $16.6 billion
from municipal bond obligations, $16.4 billion
10
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
from structured finance obligations and $3.5 billion from international
obligations, compared to $17.7 billion, $11.0 billion and $2.2 billion,
respectively, in the six months ended June 30, 1998. Insured municipal
obligations for the three and six-month periods ended June 30, 1999 were
affected by declines of 26% and 22%, respectively, in total issuance. The
decline in issuance in 1999 has been more than offset by an overall increase in
Ambac's municipal market share. The increases in insured structured finance
obligations during the three and six-month periods ended June 30, 1999, were
principally in the mortgage-backed and asset-backed sectors.
Management believes, based on growth experienced in the last few years,
that in the foreseeable future, the structured finance and international markets
may grow more rapidly than the municipal market. These markets may see large
quarterly variances primarily due to general market conditions and the
developmental nature of these markets.
Ambac serves clients in international markets through its wholly-owned
subsidiary Ambac Assurance UK Limited and through its participation in a joint
venture with MBIA Insurance Corporation, MBIA-AMBAC International (the "JV
arrangement").
Gross Premiums Written. Gross premiums written for the three and six-month
periods ended June 30, 1999 were $98.7 million and $188.9 million, respectively,
increases of 12% and 14% from $88.0 million and $165.5 million, in the three and
six-month periods ended June 30, 1998, respectively. Increased business activity
in structured finance transactions, especially mortgage-backed and asset-backed
transactions, has spurred the increase. Additionally, on the municipal side,
improved market premium rates as well as Ambac's increased market share during
the first six months of 1999 has more than offset the overall decline in
municipal market issuance when compared to the first six months of 1998. The
following tables set forth the amounts of gross premiums written and the related
gross par written by type:
Three Months Ended June 30,
----------------------------------------------------
(Dollars in Millions) 1999 1998
------------------------- -------------------------
Gross Gross Gross Gross
Premiums Par Premiums Par
Written Written Written Written
----------- ----------- ------------ -----------
Municipal finance:
Up-front:
New issue......................................... $54.2 $6,417 $49.8 $6,954
Secondary market.................................. 2.7 489 7.8 703
----------- ----------- ------------ -----------
Sub-total up-front ............................. 56.9 6,906 57.6 7,657
Installment: 7.2 949 4.1 986
----------- ----------- ------------ -----------
Total municipal finance...................... 64.1 7,855 61.7 8,643
----------- ----------- ------------ -----------
Structured finance:
Up-front.......................................... 0.5 29 0.7 189
Installment....................................... 14.6 7,174 8.1 6,283
----------- ----------- ------------ -----------
Total structured finance.................... 15.1 7,203 8.8 6,472
----------- ----------- ------------ -----------
International(1):
Up-front....................................... 11.0 130 14.9 393
Installment.................................... 8.5 2,182 2.6 784
----------- ----------- ------------ -----------
Total international...................... 19.5 2,312 17.5 1,177
----------- ----------- ------------ -----------
Total..................................... $98.7 $17,370 $88.0 $16,292
=========== =========== ============ ===========
Total up-front.......................................... $68.4 $7,065 $73.2 $8,239
Total installment....................................... 30.3 10,305 14.8 8,053
----------- ----------- ------------ -----------
Total..................................... $98.7 $17,370 $88.0 $16,292
=========== =========== ============ ===========
11
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Six Months Ended June 30,
----------------------------------------------------
(Dollars in Millions) 1999 1998
------------------------- -------------------------
Gross Gross Gross Gross
Premiums Par Premiums Par
Written Written Written Written
----------- ----------- ------------ -----------
Municipal finance:
Up-front:
New issue......................................... $114.7 $14,102 $99.3 $15,264
Secondary market.................................. 4.0 630 10.7 956
----------- ----------- ------------ -----------
Sub-total up-front ............................. 118.7 14,732 110.0 16,220
Installment: 10.8 1,919 6.8 1,473
----------- ----------- ------------ -----------
Total municipal finance...................... 129.5 16,651 116.8 17,693
----------- ----------- ------------ -----------
Structured finance:
Up-front.......................................... 0.5 36 0.7 297
Installment....................................... 27.0 16,316 14.8 10,646
----------- ----------- ------------ -----------
Total structured finance.................... 27.5 16,352 15.5 10,943
----------- ----------- ------------ -----------
International(1):
Up-front....................................... 18.2 276 28.5 705
Installment.................................... 13.7 3,260 4.7 1,525
----------- ----------- ------------ -----------
Total international...................... 31.9 3,536 33.2 2,230
----------- ----------- ------------ -----------
Total..................................... $188.9 $36,539 $165.5 $30,866
=========== =========== ============ ===========
Total up-front.......................................... $137.4 $15,044 $139.2 $17,222
Total installment....................................... 51.5 21,495 26.3 13,644
----------- ----------- ------------ -----------
Total..................................... $188.9 $36,539 $165.5 $30,866
=========== =========== ============ ===========
(1) Gross par written excludes amounts ceded to MBIA Insurance Corporation under
our international joint venture of $1,345.5 million and $224.0 million for the
three months ended June 30, 1999 and 1998, respectively, and $2,146.4 million
and $1,031.0 million for the six months ended June 30, 1999 and 1998,
respectively.
Ceded Premiums Written. Ceded premiums written for the three and six months
ended June 30, 1999 were $16.5 million and $21.5 million, respectively, an
increase of 65% from $10.0 million in the three months ended June 30, 1998 and a
decrease of 40% from $36.1 million in the six months ended June 30, 1998. The
increase in ceded premiums written for the second quarter of 1999 is primarily
due to increased ceded premiums written on international policies via the JV
arrangement with MBIA. The decrease in ceded premiums written for the six months
ended June 30, 1999 is primarily due to the one-time cede of $11.3 million of
the portfolio purchased through the acquisition of Connie Lee Insurance Company
("Connie Lee") during the first quarter of 1998 as well as the overall decrease
in international premiums ceded under the JV arrangement during the first
quarter of 1999 as compared to the first quarter of 1998. Ceded premiums written
were 16.7% and 11.4% of gross premiums written for the three and six months
ended June 30, 1999, respectively, compared with 11.4% and 15.0% (excluding the
one-time cede of the Connie Lee portfolio in 1998) for the three and six months
ended June 30, 1998, respectively.
Net Premiums Written. Net premiums written for the three and six months
ended June 30, 1999 were $82.3 million and $167.3 million, respectively. The
increase of 6% from $78.0 million in the three months ended June 30, 1998
reflects the higher gross premiums written partially offset by the increased
ceded premiums. The increase of 29% from $129.4 million in the six months ended
June 30, 1998 reflects the higher gross premiums written as well as the
substantial decrease in premiums ceded to reinsurers during first quarter of
1999, compared with the corresponding prior period.
Net Premiums Earned. Net premiums earned during the three and six months
ended June 30, 1999 were $63.9 million and $124.2 million, respectively, an
increase of 20% from $53.3 million in the three months ended June 30, 1998 and
an increase of 17% from $106.5 million in the six months ended June 30, 1998.
These increases were primarily the result of
12
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
increased premiums earned from the underlying book of business, referred to as
normal net premiums earned. Normal net premiums earned increased 37% from $39.5
million in the second quarter of 1998 to $54.0 million in the second quarter of
1999. Normal net premiums earned for the six months ended June 30, 1999 were
$103.9 million, an increase of 36% from $76.3 million in the six months ended
June 30, 1998.
Net premiums earned include accelerated premiums that result from
refundings, calls, and other accelerations of previously insured obligations
(collectively referred to as "refundings"). When an issue insured by Ambac
Assurance has been refunded or called, the remaining unearned premium (net of
refunding credits, if any) is generally earned at that time. Refunding levels
vary depending upon a number of conditions, primarily the relationship between
current interest rates and interest rates on outstanding debt. Net premiums
earned for the three and six months ended June 30, 1999 included $9.9 million
(which had a net income per diluted share effect of $0.08) and $20.3 million
(which had a net income per diluted share effect of $0.16), respectively, from
refundings. Net premiums earned in the three and six months ended June 30, 1998
included $13.9 million (which had a net income per diluted share effect of
$0.11) and $30.2 million (which had a net income per diluted share effect of
$0.24), respectively, from refundings.
Net Investment Income. Net investment income for the three and six months
ended June 30, 1999 were $51.3 million and $100.8 million, respectively, an
increase of 12% from $45.9 million in the three months ended June 30, 1998 and
an increase of 11% from $90.9 million in the six months ended June 30, 1999. The
increases were primarily attributable to the growth of the investment portfolio
from ongoing operations. Additionally, investment income grew in the second
quarter of 1999 compared with the corresponding prior period due to a capital
contribution of $100 million from the parent company to Ambac Assurance in late
April 1999. Ambac Assurance's investments in tax-exempt securities amounted to
74% of the total market value of its portfolio as of June 30, 1999, versus 71%
at June 30, 1998. The average pre-tax yield-to-maturity on the investment
portfolio was 6.09% and 6.39% as of June 30, 1999 and 1998, respectively.
Net Realized Gains (Losses). Net realized losses were $5.6 million for the
three months ended June 30, 1999, compared to $0.5 million in net realized
losses for the comparative prior period in 1998. Net realized losses were $5.5
million for the six months ended June 30, 1999, compared to net realized gains
of $0.7 million for the six months ended June 30, 1998.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses
for the three and six months ended June 30, 1999 were $2.5 million and $5.0
million, respectively, compared to $1.4 million and $3.0 million for the three
and six months ended June 30, 1998, respectively. The increase is due to
increased business written. Losses and loss adjustment expenses are generally
based upon estimates of the ultimate aggregate losses inherent in the insured
portfolio. There has been no salvage received during 1999, compared to $5.5
million and $7.2 million for the three and six months ended June 30, 1998,
respectively.
Underwriting and Operating Expenses. Underwriting and operating expenses
for the three and six months ended June 30, 1999 were $11.9 million and $23.8
million, respectively, an increase of 6% from $11.2 million in the three months
ended June 30, 1998 and an increase of 3% from $23.2 million in the six months
ended June 30, 1998. 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.
13
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
During the three and six-month periods ended June 30, 1999, gross underwriting
and operating expenses were $18.1 million and $35.9 million, respectively, an
increase of 10% from $16.4 million in the three months ended June 30, 1998 and
an increase of 13% from $31.9 million in the six months ended June 30, 1998.
These increases reflect the overall increased business activity during the
period. Underwriting and operating expenses deferred for the three and six
months ended June 30, 1999 were $11.2 million and $21.7 million, respectively,
compared to $9.5 million and $17.7 million for the three and six months ended
June 30, 1998, respectively. The amortization of previously deferred expenses
and reinsurance commissions for the three and six months ended June 30, 1999
were $4.9 million and $9.7 million, respectively, compared to $4.6 million and
$9.4 million for the three and six months ended June 30, 1998, respectively.
Financial Management Services
Through its financial management services subsidiaries, the Company
provides investment agreements, interest rate swaps and investment advisory and
cash management services, principally to states, municipalities and their
authorities, school districts, and hospitals and health organizations. Revenues,
net of realized gains and losses, for the three and six months ended June 30,
1999 were $13.1 million and $25.9 million, respectively, up 3% from $12.7
million for the three months ended June 30, 1998 and up 2% from $25.5 million in
the six months ended June 30, 1998. Continuing the trend from the first quarter
of 1999, higher investment agreement revenue ($6.2 million in the second quarter
of 1999, up 24% from $5.0 million in the second quarter of 1998), was offset by
lower interest rate swap revenue ($4.2 million in the second quarter of 1999,
down 18% from $5.1 million in the second quarter of 1998). Expenses for the
three and six months ended June 30, 1999 were $6.8 million and $13.8 million,
respectively, down 21% from $8.6 million for the three months ended June 30,
1998 and down 14% from $16.0 million for the six months ended June 30, 1998.
These decreases were primarily due to savings related to the fourth quarter 1998
closing of Ambac Connect, Inc., a former electronic commerce subsidiary.
Corporate Items
Interest Expense. Interest expense for the three and six months ended June
30, 1999 were $9.1 million and $18.2 million, respectively, compared to $8.8
million and $14.4 million for the three and six months ended June 30, 1998,
respectively. The increase in interest expense for the six-month period ended
June 30, 1999, compared with the corresponding prior period is due to the $200
million debt issuance in April, 1998.
Income Taxes. Income taxes for the three and six months ended June 30, 1999
were at an effective rate of 22.8% and 23.3%, respectively, versus 22.6% and
23.2% for the three and six months ended June 30, 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.
14
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Core Earnings. Core earnings for the three and six months ended June 30,
1999 were $70.9 million and $137.8 million, respectively, an increase of 25%
from $56.8 million for the three months ended June 30, 1998 and an increase of
22% from $112.5 million for the six months ended June 30, 1998. These increases
in core earnings were primarily the result of higher normal net premiums earned
from the growth in the insurance book of business and higher net investment
income from insurance operations. 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 three and six months ended
June 30, 1999 were $76.5 million and $149.4 million, respectively, an increase
of 18% from $64.7 million in the three months ended June 30, 1998 and an
increase of 15% from $129.7 million in the six months ended June 30, 1998. 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 and six months ended June
30, 1999 and 1998:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -- -----------------------------
(Dollars in Millions) 1999 1998 1999 1998
-------------- ------------- ------------- ------------
Net Income............................................ $71.0 $60.8 $144.2 $126.5
Net realized losses (gains), after tax................ 5.5 3.9 5.2 3.2
-------------- ------------- ------------- ------------
Operating earnings........................... 76.5 64.7 149.4 129.7
Premiums earned from refundings, calls and other
accelerations, after tax.............................. (5.6) (7.9) (11.6) (17.2)
-------------- ------------- ------------- ------------
Core earnings................................ $70.9 $56.8 $137.8 $112.5
============== ============= ============= ============
There were 71.3 million weighted-average diluted shares outstanding during
the three and six months ended June 30, 1999. The weighted-average number of
diluted shares outstanding during the three and six months ended June 30, 1998
were 71.7 million and 71.6 million, respectively.
Adjusted Gross Premiums Written. The Company defines adjusted gross
premiums written as gross up-front premiums written plus the present value of
estimated future installment premiums written on insurance policies and
structured credit derivatives issued in the period. While a majority of premiums
are collected up-front at policy issuance, a growing portion of premiums is
collected on an installment basis. Adjusted gross premiums written for the three
and six months ended June 30, 1999 were $134.8 million and $265.2 million,
respectively, up 18% from $114.4 million in the three months ended June 30, 1998
and up 33% from $199.6 million in the six months ended June 30, 1998. The
increases in the second quarter of 1999, as well as the six-month period ended
June 30, 1999 were primarily due to the increase in installment premiums written
on structured finance transactions, especially on mortgage-backed and
asset-backed securities. The present value of future installment premiums
written for the three and six months ended June 30, 1999 was $71.9 million and
$136.7 million, respectively, an increase of 55% from $46.5 million written in
the second quarter of 1998 and an increase of 91% from $71.6 million written in
the six months ended June 30, 1998. The aggregate net present value of estimated
future installment premiums was $373.8 million and $308.4 million as of June 30,
1999 and December 31, 1998, respectively.
15
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
The following table sets forth the amounts of adjusted gross premiums
written by type and percent of total for the three and six months ended June 30,
1999 and 1998:
Three Months Ended June 30, Six Months Ended June 30,
-------------------------------------- ----------------------------------------
(Dollars in Millions) 1999 % 1998 % 1999 % 1998 %
---------- -------- --------- -------- ---------- ------- --------- --------
Municipal Finance:
Up-front:
New issue........................... $54.3 40% $49.8 43% $114.7 43% $99.3 50%
Secondary market.................... 2.7 2 7.9 7 4.0 2 10.7 5
---------- -------- --------- -------- ---------- ------- --------- --------
Sub-total up-front ............... 57.0 42 57.7 50 118.7 45 110.0 55
Installment........................... 13.8 10 8.8 8 23.6 9 11.9 6
---------- -------- --------- -------- ---------- ------- --------- --------
Total Municipal Finance........ 70.8 52 66.5 58 142.3 54 121.9 61
---------- -------- --------- -------- ---------- ------- --------- --------
Structured Finance:
Up-front............................ 0.5 - 0.7 1 0.4 - 0.7 -
Installment......................... 36.9 28 15.9 14 77.1 29 30.4 15
---------- -------- --------- -------- ---------- ------- --------- --------
Total Structured Finance......... 37.4 28 16.6 15 77.5 29 31.1 15
---------- -------- --------- -------- ---------- ------- --------- --------
International (1):
Up-front......................... 5.5 4 9.5 8 9.4 3 17.3 9
Installment...................... 21.1 16 21.8 19 36.0 14 29.3 15
---------- -------- --------- -------- ---------- ------- --------- --------
Total International............. 26.6 20 31.3 27 45.4 17 46.6 24
---------- -------- --------- -------- ---------- ------- --------- --------
Total adjusted gross premiums............. $134.8 100% $114.4 100% $265.2 100% $199.6 100%
========== ======== ========= ======== ========== ======= ========= ========
Total up-front............................
$62.9 47% $67.9 59% $128.5 48% $128.0 64%
Total installment......................... 71.9 53 46.5 41 136.7 52 71.6 36
---------- -------- --------- -------- ---------- ------- --------- --------
Total adjusted gross premiums............ $134.8 100% $114.4 100% $265.2 100% $199.6 100%
========== ======== ========= ======== ========== ======= ========= ========
(1) Excludes amounts ceded to MBIA Insurance Corporation under our international
joint venture of $13.5 million and $8.2 million for the three months ended June
30, 1999 and 1998, respectively, and $29.8 million and $15.5 million for the six
months ended June 30, 1999 and 1998, respectively.
Adjusted Book Value. Adjusted book value ("ABV") per common share increased
3% to $43.14 at June 30, 1999 compared to $41.98 at December 31, 1998. 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 ABV was
positively affected by the Company's net income for the six-month period ended
June 30, 1999, the increase in the after-tax present value of estimated net
future installment premiums, net unearned premium reserve and the unrealized
gain on investment agreement liabilities during the period, partially offset by
the negative effect of the change in the after-tax unrealized gain/loss in the
investment portfolio (included in book value), which went from a net unrealized
gain of $159.0 million at December 31, 1998, to a net unrealized loss of $17.7
million at June 30, 1999.
The following table reconciles book value per share to ABV per share as of
June 30, 1999 and December 31, 1998:
June 30, December 31,
1999 1998
------------------ ------------------
Book value per share.................................................... $29.25 $29.97
After-tax value of:
Net unearned premium reserve....................................... 10.57 10.17
Deferred acquisition costs......................................... (1.22) (1.12)
Present value of installment premiums.............................. 3.48 2.86
Unrealized gain on investment agreement liabilities................ 1.06 0.10
------------------ ------------------
Adjusted book value per share........................................... $43.14 $41.98
================== ==================
16
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 (i) Ambac Assurance's ability to
pay dividends or make payments to the Company; and (ii) 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 six months ended
June 30, 1999, Ambac Assurance paid dividends of $26.0 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 the next twelve months 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 management believes that it will continue to have sufficient liquidity
to meet its debt service and other obligations over the long term, no guarantee
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.
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 Company
believes that Ambac Assurance will have sufficient liquidity to satisfy any
claims that may occur related to the Y2K problem, as defined below.
Financial Management Services Liquidity. The principal uses of liquidity by
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 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 segment's 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. Additionally, from time to time, liquidity needs are satisfied by
short-term inter-company loans from Ambac Financial Group, Inc. The 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. A portion of
Financial Management Services assets is maintained in short-term investments and
repurchase agreements in order to meet unexpected liquidity needs.
17
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Credit Facilities. The Company and Ambac Assurance have a revolving credit
facility with three major international banks for $150 million, which expires in
August 2000 and provides a two-year term loan provision. The facility is
available for general corporate purposes, including the payment of claims. As of
June 30, 1999 and 1998, no amounts were outstanding under this credit facility.
Ambac Assurance maintains third party capital support in the form of a
seven-year irrevocable limited recourse credit facility from a group of
highly-rated international banks. This credit facility provides liquidity to
Ambac Assurance in the event claims from municipal obligations in its covered
portfolio exceed specified levels. Repayment of amounts drawn under the facility
is limited primarily to the amount of any recoveries of losses related to policy
obligations. On May 3, 1999, total third party capital support was increased
from $555 million to $575 million. The line expires in December 2005. As of June
30, 1999 and 1998, no amounts were outstanding under this facility.
Ambac Credit Products, LLC ("ACP"), a wholly-owned subsidiary of Ambac
Assurance, has a revolving credit facility with one major international bank for
$50 million, which expires in June 2000 and provides a three-year term loan
provision. The facility is available to ACP for general corporate purposes,
including payments in regard to its credit derivatives activities. The credit
facility became effective on July 1, 1999.
Stock Repurchase Program. The Board of Directors of the Company has
authorized the establishment of a stock repurchase program that permits the
repurchase of up to 6,000,000 shares of the Company's Common Stock. During the
six months ended June 30, 1999, the Company acquired approximately 169,000
shares for an aggregate amount of $9.1 million. Since inception of the Stock
Repurchase Program, the Company has acquired approximately 4,417,000 shares for
an aggregate amount of $151.8 million.
Balance Sheet. As of June 30, 1999, the fair value of the Company's
consolidated investment portfolio was $8.89 billion, an increase of 2% from
$8.75 billion at December 31, 1998. This increase was primarily due to the
increased volume in investment and payment agreements and cash flow from
operations largely offset by declines in the market values of the investment
portfolios resulting from higher interest rates during the period.
Cash Flows. Net cash provided by operating activities was $172.1 million
and $133.7 million during the six months ended June 30, 1999 and 1998,
respectively. These cash flows were primarily provided from insurance
operations.
Net cash provided by financing activities was $131.5 million during the six
months ended June 30, 1999, of which $140.9 million was from investment
agreements issued (net of draws paid). For the six months ended June 30, 1998,
$1,093.4 million was provided in financing activities, of which $744.5 million
was from investment agreements issued (net of draws paid).
Net cash used in investing activities was $303.5 million during the six
months ended June 30, 1999, of which $2,936.0 million was used to purchase
bonds, partially offset by proceeds from sales and maturities of bonds of
$2,446.5 million. For the six months ended June 30, 1998, $1,207.9 million was
used in investing activities, of which $2,269.0 million was used to purchase
bonds, partially offset by proceeds from sales and maturities of bonds of
$1,422.9 million.
18
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Material Commitments. The Company has made no commitments for material
capital expenditures within the next twelve months.
Year 2000. The issue commonly known as the Y2K problem ("Y2K") relates to
whether computer programs and embedded computer chips will be able to
distinguish between the year 1900 and the year 2000. In 1998, the Company
commenced an initiative to assess and address any risks posed by the Y2K
problem. This initiative was a high priority undertaking and considered crucial
to the operation of the Company's businesses. Pursuant to this initiative, the
Company assessed the risks to its businesses related to the functionality of its
own computer systems and those of third parties. All phases of the initiative
have been completed and the Company has substantially addressed any problems
brought to light as a result of the initiative.
The Company appointed a Y2K Steering Committee comprised of members of
senior management. The committee was given full responsibility and authority to
establish methodologies and budgets and to allocate necessary resources. The
committee was responsible for the coordination of internal and external
resources with the goal of evaluating and remediating, if necessary, critical
internal and external technology systems. The Company also contracted with an
outside consultant to support its Y2K initiative.
The initiative was comprised of a three-phase process. Phase I was an
inventory analysis and impact assessment. Inventory included: (a) those
information technology systems which were deemed critical to running the
businesses, (b) non-information technology systems such as fire systems,
elevators and the like, (c) material third parties such as electronic data
interchange ("EDI") partners, (d) hardware and software vendors, and (e)
business user spreadsheets. Phase II was the testing phase during which: (a) all
critical systems were tested, (b) transactions were run through critical systems
by applying various permutations and combinations of Y2K sensitive dates, and
(c) results were reviewed independently by each business unit. In Phase III, the
extent of code repair was determined and remediated.
The total cost of identifying, testing and remediating its critical systems
was approximately $1.1 million, $0.4 million of which was incurred during 1999.
The Company's principal Y2K risks were grouped into four categories:
(1) Company's Internal Systems Risk. This is the risk that the Company does
not successfully ready its operations for the next century. The Company,
like other financial institutions, is heavily dependent upon its computer
systems. Y2K problems in the Company's internal systems could result in an
interruption in, or failure of, certain normal business activities or
operations. Such failures could adversely affect the Company's operations.
Although findings indicate that the systems supporting the Company's
internal operations will be compliant, management has nevertheless
developed contingent procedures in the event its critical systems should
fail. These procedures have been approved by the Company's Board of
Directors and are in the process of being tested.
(2) Third Party Risk. This is the risk of disruption of Company operations
due to operational failures of third parties. Computer failure of third
parties may also jeopardize Company operations, but how seriously depends
on the nature and duration of such failures. Such third parties could
include suppliers of telecommunications, electric power suppliers, and
services provided by governmental agencies. Based on the results of its
19
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
inquiries to third parties, the Company does not expect significant
disruptions related to the Y2K failure of its suppliers.
(3) Issuer Risk. This is the risk of failure by an obligor of obligations
insured by Ambac Assurance Corporation and its subsidiaries, including
Connie Lee Insurance Company (collectively, the "insurance companies") to
make scheduled payment of debt service due to the obligor's Y2K-related
systems, thus triggering a claim under the applicable insurance policy. In
the event a claim resulting solely from a Y2K problem occurs, the Company
would utilize its sources of liquidity to pay claims and has in fact
increased liquidity for such purpose. The Company would expect full
recovery of such claims when Y2K problems are resolved. The Company
presently has no specific reserves for claims solely associated with Y2K
events. The Company has incorporated Y2K guidelines into its underwriting
and surveillance process and routinely assesses Y2K risk associated with
issuers of both its insured obligations and potential issuers. The Company
relies on information provided by the issuers of these obligations, does
not independently verify such information and therefore cannot attest to
its accuracy.
(4) Financial Institution Risk. Financial institution risk includes the
risk of Y2K systems-related failures by the trustees or paying agents on
transactions insured by one of the insurance companies. The Company relies
on the operating systems of such trustees to identify the correct interest
payment dates, calculate the correct payments and, through various payment
systems, to move the funds to the bondholders. This risk is mitigated by
the fact that the insurance companies' obligations to pay claims is related
to the creditworthiness of the issuer and not the trustee. However, to
minimize payment disruption and identify potential future problems, the
Company requested compliance statements from certain trustees or paying
agents of its insured transactions, reviewed the appropriate publicly
available disclosures and monitored the activities of the banking
regulatory agencies for Y2K developments. Additionally, financial
institution risk relates to custodians of securities held for its own
account and the accounts of others. The securities settlement and custody
systems deemed critical to the conduct of the Company's operations were
also tested. Based on the results of its reviews and inquiries, the Company
believes that the likelihood of system failure by a third party financial
institution is minimal.
20
Item 3. Quantitative and Qualitative Disclosures About Market Risk
In the ordinary course of business, the Company, through its subsidiaries,
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 that are in place at different levels throughout the
organization.
Market risk represents the potential for losses that may result from
changes in the market value of a financial instrument as a result of changes in
market conditions. 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 market 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 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, that utilize current and historical market information. The
valuation results from these models 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 financial futures) used for hedging
purposes.
The Company, through its subsidiary 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 seeking to profit from retaining some basis risk. If
actual or projected tax-exempt interest rates change in relation to taxable
interest rates, AFSLP will experience a mark-to-market gain or loss. The AFSLP
swap portfolio is considered held for trading purposes. Since late 1995, most
municipal interest rate swaps transacted by AFSLP contain provisions that are
designed to protect the Company against certain forms of tax reform, thus
mitigating its basis risk. An independent market risk management group monitors
trading risk limits and, together with senior management, is involved in the
application of risk measurement methodologies.
21
PART II - OTHER INFORMATION
Items 1, 2, 3, and 5 are omitted either because they are inapplicable or
because the answer to such question is negative.
Item 4 - Submission of Matters to a Vote of Security Holders
The following matters were voted upon at the Annual Meeting of Stockholders
of the Company held on May 12, 1999, and received the votes set forth below:
Proposal 1. The following directors were elected to serve on the Company's
Board of Directors:
Number of Votes Cast
--------------------------------------
For Withheld
--------------------- ----------------
Phillip B. Lassiter 63,502,220 83,469
Michael A. Callen 63,509,605 76,084
Renso L. Caporali 63,508,356 77,333
Richard Dulude 63,509,041 76,648
W. Grant Gregory 63,500,380 85,309
C. Roderick O'Neil 63,509,141 76,548
There were no broker non-votes for this proposal.
Proposal 2. The proposal to approve the amendment to the 1997 Equity Plan
to broaden the definition of "eligible individuals" for awards under the Plan
was adopted, with 61,323,606 votes in favor, 2,210,368 votes against and 51,714
votes abstaining. There were no broker non-votes for this proposal.
Proposal 3. The proposal to ratify the selection of KPMG as independent
auditors of the Company and its subsidiaries for 1999 was adopted, with
63,562,979 votes in favor, 9,579 votes against and 13,132 votes abstaining.
There were no broker non-votes for this proposal.
22
PART II- OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K
(a) The following are annexed as exhibits:
Exhibit
Number Description
---------------- ------------------------------------------------------
10.23 First Amendment, dated August 3, 1999, to the U.S.
$150,000,000 Credit Agreement, dated August 3, 1998,
among the Company and Ambac Assurance Corporation as
the Borrowers, certain commercial lending institutions
as the Lenders, Citibank, N.A. as the Documentation
Agent, First National Bank of Chicago as the Co-Agent,
and the Bank of Nova Scotia acting through its New York
Agency as the Arranger and the Administrative Agent.
10.24 Conformed copy of U.S. $50,000,000 Revolving Credit
Agreement, dated as of July 1, 1999 among Ambac Credit
Products, LLC, the banks, financial institutions and
other institutional lenders (the "Initial Lenders")
listed on the signature pages thereof, and The Bank of
New York, as Agent for the Lenders.
10.25 Amendment, effective as of May 3, 1999, to the Amended
and Restated Credit Agreement dated as of December 2,
1998, among Ambac Assurance Corporation, the Banks
party thereto from time to time and Deutsche Bank AG,
New York Branch, as Agent.
27.00 Financial Data Schedule.
99.03 Ambac Assurance Corporation and Subsidiaries
Consolidated Unaudited Financial Statements as of June
30, 1999 and December 31, 1998 and for the periods
ended June 30, 1999 and 1998.
(b) Reports on Form 8-K:
There was no reports on Form 8-K filed during the second quarter of
1999.
23
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: August 13, 1999 By: /s/ Frank J. Bivona
----------------------------------
Frank J. Bivona
Executive Vice President and Chief
Financial Officer (Principal
Financial and Accounting Officer
and Duly Authorized Officer)
24
INDEX TO EXHIBITS
Exhibit
Number Description
----------------- ---------------------------------------------------
10.23 First Amendment, dated August 3, 1999, to the U.S.
$150,000,000 Credit Agreement, dated August 3,
1998, among the Company and Ambac Assurance
Corporation as the Borrowers, certain commercial
lending institutions as the Lenders, Citibank, N.A.
as the Documentation Agent, First National Bank of
Chicago as the Co-Agent, and the Bank of Nova
Scotia acting through its New York Agency as the
Arranger and the Administrative Agent.
10.24 Conformed copy of U.S. $50,000,000 Revolving Credit
Agreement, dated as of July 1, 1999 among Ambac
Credit Products, LLC, the banks, financial
institutions and other institutional lenders (the
"Initial Lenders") listed on the signature pages
thereof, and The Bank of New York, as Agent for the
Lenders.
10.25 Amendment, effective as of May 3, 1999, to the
Amended and Restated Credit Agreement dated as of
December 2, 1998, among Ambac Assurance
Corporation, the Banks party thereto from time to
time and Deutsche Bank AG, New York Branch, as
Agent.
27.00 Financial Data Schedule.
99.03 Ambac Assurance Corporation and Subsidiaries
Consolidated Unaudited Financial Statements as of
June 30, 1999 and December 31, 1998 and for the
periods ended June 30, 1999 and 1998.
25