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 September 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 September 30, 1999, 69,920,289 shares of Common Stock, par value
$0.01 per share, (net of 760,095 treasury shares) of the Registrant were
outstanding.
Ambac Financial Group, Inc. and Subsidiaries
INDEX
-----
PART I FINANCIAL INFORMATION
PAGE
----
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - September 30, 1999
and December 31, 1998............................................. 3
Consolidated Statements of Operations - three months and
nine months ended September 30, 1999 and 1998..................... 4
Consolidated Statements of Stockholders' Equity - nine months
ended September 30, 1999 and 1998................................. 5
Consolidated Statements of Cash Flows - nine months ended
September 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....................................................... 22
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K..................................... 23
SIGNATURES.................................................................... 24
INDEX TO EXHIBITS............................................................. 25
PART I - FINANCIAL INFORMATION
ITEM I - Financial Statements of Ambac Financial Group, Inc. and Subsidiaries
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Balance Sheets
September 30, 1999 and December 31, 1998
(Dollars in Thousands)
September 30, 1999 December 31, 1998
------------------ -----------------
(unaudited)
Assets
Investments:
Fixed income securities, at fair value
(amortized cost of $9,034,012 in 1999 and $8,307,046 in 1998) $8,885,127 $8,622,282
Short-term investments, at cost (approximates fair value) 190,415 119,528
Other 2,592 6,567
------------------------ -----------------------
Total investments 9,078,134 8,748,377
Cash 11,714 8,239
Securities purchased under agreements to resell 119,293 252,295
Receivable for investment agreements 93,767 73,142
Receivable for securities sold 33,575 16,233
Investment income due and accrued 116,583 125,929
Reinsurance recoverable 3,688 3,638
Prepaid reinsurance 201,579 199,920
Deferred acquisition costs 133,079 120,619
Deferred income taxes 4,872 -
Loans 686,924 673,930
Receivable from brokers and dealers 650,000 750,000
Other assets 192,455 239,989
------------------------ -----------------------
Total assets $11,325,663 $11,212,311
========================= =======================
Liabilities and Stockholders' Equity
Liabilities:
Unearned premiums $1,365,545 $1,294,214
Losses and loss adjustment expenses 123,027 115,794
Ceded reinsurance balances payable 4,082 6,576
Obligations under investment and payment agreements 4,432,908 4,774,953
Obligations under investment repurchase agreements 1,913,073 1,181,810
Deferred income taxes - 145,782
Current income taxes 26,370 6,949
Debentures 423,979 423,929
Accrued interest payable 83,019 89,615
Other liabilities 206,335 262,423
Payable to brokers and dealers 650,000 750,000
Payable for securities purchased 70,128 64,176
------------------------ -----------------------
Total liabilities 9,298,466 9,116,221
------------------------ -----------------------
Stockholders' equity:
Preferred stock - -
Common stock 707 707
Additional paid-in capital 522,334 519,305
Accumulated other comprehensive income (98,964) 159,313
Retained earnings 1,638,325 1,449,832
Common stock held in treasury at cost (35,205) (33,067)
------------------------ -----------------------
Total stockholders' equity 2,027,197 2,096,090
------------------------ -----------------------
Total liabilities and stockholders' equity $11,325,663 $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 September 30, 1999 and 1998
(Dollars in Thousands Except Share Data)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------- ----------------------------------
1999 1998 1999 1998
----------------------------------- ----------------------------------
Revenues:
Financial Guarantee:
Gross premiums written $106,841 $88,731 $295,703 $254,260
Ceded premiums written (11,896) (4,764) (33,440) (40,899)
---------------- ---------------- ---------------- ---------------
Net premiums written $94,945 $83,967 $262,263 $213,361
================ ================ ================ ===============
Net premiums earned $68,325 $50,143 $192,566 $156,645
Net fees earned and other income 1,720 385 4,304 2,585
Net investment income 52,946 47,436 153,726 138,348
Net realized (losses) gains (62) 537 (5,542) 1,203
Financial Management Services:
Revenue 12,097 13,541 37,947 39,027
Net realized gains (losses) 8 156 (3,292) (7,092)
Other:
Revenue 2,164 4,450 8,587 9,853
Net realized gains - 709 775 2,226
---------------- ---------------- ---------------- ---------------
Total revenues 137,198 117,357 389,071 342,795
---------------- ---------------- ---------------- ---------------
Expenses:
Financial Guarantee:
Losses and loss adjustment expenses 3,000 1,500 8,000 4,500
Underwriting and operating expenses 11,976 11,844 35,765 35,052
Financial Management Services 6,174 8,237 19,930 24,283
Interest 9,145 9,254 27,322 23,648
Other 1,520 1,323 4,735 5,403
---------------- ---------------- ---------------- ---------------
Total expenses 31,815 32,158 95,752 92,886
---------------- ---------------- ---------------- ---------------
Income before income taxes 105,383 85,199 293,319 249,909
Provision for income taxes 25,581 19,817 69,354 58,073
---------------- ---------------- ---------------- ---------------
Net income $79,802 $65,382 $223,965 $191,836
================ ================ ================ ===============
Net income per share $1.14 $0.94 $3.20 $2.74
================ ================ ================ ===============
Net income per diluted share $1.12 $0.92 $3.14 $2.68
================ ================ ================ ===============
Weighted average number of
shares outstanding 69,911,638 69,823,032 69,902,757 69,959,334
================ ================ ================ ===============
Weighted average number of diluted
shares outstanding 71,337,017 71,389,724 71,367,987 71,509,315
================ ================ ================ ===============
See accompanying Notes to Consolidated Financial Statements
4
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(Unaudited)
For The Nine Months Ended September 30, 1999 and 1998
(Dollars in Thousands)
1999 1998
-------------------------------- --------------------------
Retained Earnings:
Balance at January 1 $1,449,832 $1,262,740
Net income 223,965 $223,965 191,836 $191,836
---------------- ------------
Dividends declared - common stock (21,672) (19,594)
Exercise of stock options (13,800) (24,798)
---------------- ----------
Balance at September 30 $1,638,325 $1,410,184
---------------- ----------
Accumulated Other Comprehensive Income:
Balance at January 1 $159,313 $135,223
Unrealized (losses) gains on securities, ($412,240),
and $109,563, pre-tax in 1999 and 1998, respectively(1) (258,072) 70,067
Foreign currency (loss) gain (205) 673
---------------- -----------
Other comprehensive (loss) income (258,277) (258,277) 70,740 70,740
-------------------------------- ----------------------
Comprehensive (loss) income ($34,312) $262,576
================ ===========
Balance at September 30 ($98,964) $205,963
---------------- ----------
Preferred Stock:
Balance at January 1 and September 30 $- $-
---------------- ------------
Common Stock:
Balance at January 1 and September 30 $707 $707
---------------- ------------
Additional Paid-in Capital:
Balance at January 1 $519,305 $500,107
Exercise of stock options 3,029 13,115
---------------- ------------
Balance at September 30 $522,334 $513,222
---------------- ------------
Common Stock Held in Treasury at Cost:
Balance at January 1 ($33,067) ($26,295)
Cost of shares acquired (16,643) (45,649)
Shares issued under equity plans 14,505 26,251
---------------- ------------
Balance at September 30 ($35,205) ($45,693)
---------------- ------------
Total Stockholders' Equity at September 30 $2,027,197 $2,084,383
================ ============
(1) Disclosure of reclassification amount:
Unrealized holding (losses) gains arising during period ($263,310) $78,711
Less: reclassification adjustment for net (losses) gains
included in net income (5,238) 8,644
---------------- ----------
Net unrealized (losses) gains on securities ($258,072) $70,067
================ ==========
See accompanying Notes to Consolidated Financial Statements.
5
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
For The Periods Ended September 30, 1999 and 1998
(Dollars in Thousands)
Nine Months Ended
September 30,
--------------------------------------
1999 1998
---------------- ----------------
Cash flows from operating activities:
Net income $223,965 $191,836
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,167 1,785
Amortization of bond premium and discount (3,809) (3,948)
Current income taxes 19,421 939
Deferred income taxes 3,515 (6,181)
Deferred acquisition costs (12,460) (10,634)
Unearned premiums, net 69,672 56,857
Losses and loss adjustment expenses 7,183 14,150
Ceded reinsurance balances payable (2,494) (5,482)
Investment income due and accrued 9,346 (21,452)
Accrued interest payable (6,596) 18,545
Losses on sales of investments 8,059 3,663
Interest rate swaps, at market (22,448) 13,589
Other, net 3,383 2,159
---------------- ----------------
Net cash provided by operating activities 298,904 255,826
---------------- ----------------
Cash flows from investing activities:
Proceeds from sales of bonds 1,930,672 1,347,504
Proceeds from matured bonds 1,020,893 887,467
Purchases of bonds (3,650,767) (3,423,562)
Change in short-term investments (70,887) (33,708)
Securities purchased under agreements to resell 133,002 (251,335)
Loans (12,994) (175,948)
Other, net 9,868 (38,884)
---------------- ----------------
Net cash used in investing activities (640,213) (1,688,466)
---------------- ----------------
Cash flows from financing activities:
Dividends paid (21,672) (19,594)
Proceeds from issuance of investment agreements 2,268,867 2,670,496
Payments for investment agreement draws (1,913,267) (1,568,146)
Proceeds from issuance of debentures - 193,700
Payment agreements 12,994 175,948
Proceeds from sale of treasury stock 14,505 26,251
Purchases of treasury stock (16,643) (45,649)
---------------- ----------------
Net cash provided by financing activities 344,784 1,433,006
---------------- ----------------
Net cash flow 3,475 366
Cash at January 1 8,239 9,256
---------------- ----------------
Cash at September 30 $11,714 $9,622
================ ================
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes $43,599 $53,338
================ ================
Interest expense on debt $29,569 $25,934
================ ================
Interest expense on investment agreements $220,929 $179,610
================ ================
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 guarantees 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 provider of financial guarantees for
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 nine
months ended September 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, (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, and (iii) the Company's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1999, which was filed with the Commission on
August 13, 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 guarantees 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.
7
Notes to Consolidated Unaudited Financial Statements (Continued)
(Dollars in thousands)
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.
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 nine-month periods ended September 30, 1999
and 1998:
Financial
Financial Management Corporate Intersegment
Three months ended September 30, Guarantee Services And Other Eliminations Consolidated
----------------- --------------- ---------------- ----------------- -------------
1999:
Revenues:
Unaffiliated customers.......... $ 122,929 $ 12,105 $ 2,164 $ - $ 137,198
Intersegment.................... 758 (846) 13,148 (13,060) -
------------- ----------------------------------- ------------------- ------------------
Total revenues................... $ 123,687 $ 11,259 $ 15,312 ($13,060) $ 137,198
------------- ----------------------------------- ------------------- ------------------
Income before income taxes:
Unaffiliated customers.......... $ 107,953 $ 5,931 ($8,501) $ - $ 105,383
Intersegment.................... 1,164 (1,023) 13,148 (13,289) -
------------- ----------------- -------------- ------------------- ------------------
Total income before income taxes. $ 109,117 $ 4,908 $ 4,647 ($13,289) $ 105,383
------------- ----------------- -------------- ------------------- ------------------
Identifiable assets.............. $3,952,407 $7,217,599 $155,657 $ - $11,325,663
------------- ----------------- -------------- ------------------- ------------------
1998:
Revenues:
Unaffiliated customers.......... $ 98,501 $ 13,697 $ 5,159 $ - $ 117,357
Intersegment.................... 650 (691) 12,162 (12,121) -
------------- ---------------- -------------- ------------------- ------------------
Total revenues.................... $ 99,151 $ 13,006 $ 17,321 ($12,121) $ 117,357
------------- ---------------- -------------- ------------------- ------------------
Income before income taxes:
Unaffiliated customers.......... $ 85,157 $ 5,460 ($5,418) $ - $ 85,199
Intersegment.................... 660 (976) 12,162 (11,846) -
------------- --------------- -------------- ------------------- ------------------
Total income before income taxes.. $ 85,817 $ 4,484 $ 6,744 ($11,846) $ 85,199
------------- --------------- -------------- ------------------- ------------------
Identifiable assets............... $3,812,399 $7,010,293 $269,014 $ - $11,091,706
------------- --------------- -------------- ------------------- ------------------
8
Notes to Consolidated Unaudited Financial Statements (Continued)
(Dollars in thousands)
Financial
Financial Management Corporate Intersegment
Nine months ended September 30, Guarantee Services And Other Eliminations Consolidated
----------------- ----------------- ---------------- ----------------- -------------
1999:
Revenues:
Unaffiliated customers......... $ 345,054 $ 34,655 $ 9,362 $ - $ 389,071
Intersegment................... 2,300 (2,586) 39,491 (39,205) -
--------------- -------------------------------------- ------------ ------------
Total revenues................... $ 347,354 $ 32,069 $ 48,853 ($39,205) $ 389,071
--------------- -------------------------------------- ------------ ------------
Income before income taxes:
Unaffiliated customers......... $ 301,289 $ 14,725 ($22,695) $ - $ 293,319
Intersegment................... 2,848 (2,990) 39,491 (39,349) -
--------------- ----------------- ---------------- ------------- ------------
Total income before income taxes. $ 304,137 $ 11,735 $ 16,796 ($39,349) $ 293,319
--------------- ----------------- ---------------- ------------- ------------
Identifiable assets $3,952,407 $7,217,599 $ 155,657 $ - $11,325,663
--------------- ----------------- ---------------- ------------- ------------
1998:
Revenues:
Unaffiliated customers......... $ 298,781 $ 31,935 $ 12,079 $ - $ 342,795
Intersegment................... 2,013 (1,996) 36,315 (36,332) -
--------------- ----------------- ---------------- ----------------- -----------
Total revenues................... $ 300,794 $ 29,939 $ 48,394 ($36,332) $ 342,795
--------------- ----------------- ---------------- ----------------- -----------
Income before income taxes:
Unaffiliated customers......... $ 259,229 $ 7,652 ($16,972) $ - $ 249,909
Intersegment................... 2,013 (3,040) 36,315 (35,288) -
--------------- ----------------- ---------------- ----------------- -----------
Total income before income taxes. $ 261,242 $ 4,612 $ 19,343 ($35,288) $ 249,909
--------------- ----------------- ---------------- ----------------- -----------
Identifiable assets $3,812,399 $7,010,293 $ 269,014 $ - $11,091,706
--------------- ----------------- ---------------- ----------------- -----------
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 nine-month periods ended September 30, 1999 and 1998.
Three Months Nine Months
------------------------------------------- --------------------------------------
Gross Premiums Net Premiums Gross Premiums Net Premiums
Written Earned Written Earned
--------------------- ------------------- ------------------ ---------------
1999:
United States.............................. $ 97,228 $60,468 $254,231 $171,789
United Kingdom............................. 388 851 15,585 2,259
Japan...................................... 1,235 1,037 3,723 3,504
France..................................... 833 341 1,914 772
Australia.................................. 183 419 729 1,085
Mexico..................................... 3,533 1,431 7,469 3,263
Internationally diversified (1)............ 2,363 2,051 7,838 5,568
Other international........................ 1,078 1,727 4,214 4,326
--------------------- ------------------- --------------------- --------------
Total.................................. $106,841 $68,325 $295,703 $192,566
--------------------- ------------------- --------------------- --------------
1998:
United States.............................. $ 81,767 $46,598 $214,101 $147,197
United Kingdom............................. 19 442 19,842 1,162
Japan...................................... 987 528 3,387 1,632
France..................................... 185 427 954 1,339
Australia.................................. 4,259 161 11,916 354
Mexico..................................... 190 190 190 190
Internationally diversified (1)............ 1,180 868 2,768 2,245
Other international........................ 144 929 1,102 2,526
--------------------- ------------------- --------------------- --------------
Total.................................. $ 88,731 $50,143 $254,260 $156,645
--------------------- ------------------- --------------------- --------------
(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 nine month periods ended
September 30, 1999 and 1998, and its financial condition as of September 30,
1999 and December 31, 1998. These results include the Company's two reportable
segments: Financial Guarantee and Financial Management Services.
Materials in this Form 10-Q may contain information that includes or
is based upon forward-looking statements within the meaning of the Securities
Litigation Reform Act of 1995. Forward-looking statements give our expectations
or forecasts of future events. You can identify these statements by the fact
that they do not relate strictly to historical or current facts. They use words
such as "anticipate," "estimate," "expect," "project," "intend," "plan,"
"believe," and other words and terms of similar meaning in connection with a
discussion of future operating or financial performance. In particular, these
include statements relating to future actions, prospective services or products,
future performance or results of current and anticipated services or products,
sales efforts, expenses, the outcome of contingencies such as legal proceedings,
and financial results.
Any or all of our forward-looking statements here or in other publications
may turn out to be wrong. They can be affected by inaccurate assumptions or by
known or unknown risks and uncertainties. Many such factors will be important in
determining our actual future results. Our actual results may vary materially,
and there are no guarantees about the performance of the Company's stock. These
statements are based on current expectations and the current economic
environment. They involve a number of risks and uncertainties that are difficult
to predict. These statements are not guarantees of future performance. Actual
results could differ materially from those expressed or implied in the forward-
looking statements. Among 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. Ambac
undertakes no obligation to publicly correct or update any forward-looking
statement if we later become aware that it is not likely to be achieved. You are
advised, however, to consult any further disclosures we make on related subjects
in our reports to the SEC.
Results of Operations
Consolidated Net Income
The Company's net income for the three months ended September 30, 1999 was
$79.8 million or $1.12 per diluted share. This represents a 22% increase from
the three months ended September 30, 1998 net income of $65.4 million or $0.92
per diluted share. This increase in net income was largely attributable to
higher Financial Guarantee operating income driven by a $24.4 million, or 25%,
increase in revenues. The Company's net income for the nine months ended
September 30, 1999 was $224.0 million or $3.14 per diluted share. This
represents an increase of 17% from the comparable prior period net income of
$191.8 million or $2.68 per diluted share. This increase in net income was
largely attributable to higher Financial Guarantee operating income driven by a
$46.3 million, or 15%, increase in revenues.
10
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Financial Guarantee
The Company provides financial guarantees through its principal operating
subsidiary, Ambac Assurance Corporation ("Ambac Assurance"). Ambac Assurance
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").
Ambac Assurance, through its wholly owned subsidiary, Ambac Credit Products
("ACP"), also issues structured credit derivatives.
Gross Par Written. Ambac Assurance insured $19.7 billion in par value
------------------
bonds during the three months ended September 30, 1999 and $56.3 billion in par
value bonds during the nine months ended September 30, 1999, an increase of 37%
from $14.4 billion in the three months ended September 30, 1998 and an increase
of 24% from $45.3 billion in par value bonds during the nine months ended
September 30, 1998. Par value written for the third quarter of 1999 was
comprised of $7.8 billion from municipal bond obligations, $10.4 billion from
structured finance obligations and $1.6 billion from international obligations,
compared to $8.5 billion, $5.1 billion and $0.8 billion, respectively, in the
third quarter of 1998. Par value written for the nine months ended September 30,
1999 was comprised of $24.4 billion from municipal bond obligations, $26.7
billion from structured finance obligations and $5.1 billion from international
obligations, compared to $26.2 billion, $16.1 billion and $3.0 billion,
respectively, in the nine months ended September 30, 1998. Insured municipal
obligations for the three and nine-month periods ended September 30, 1999 were
affected by declines of 18% and 21%, respectively, in total issuance. The
decline in issuance in 1999 has been partially offset by an overall increase in
Ambac's municipal market share. The increases in insured structured finance
obligations during the three and nine-month periods ended September 30, 1999,
were principally in the mortgage-backed and asset-backed sectors.
Management anticipates, 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. Management believes that these
markets may see large quarterly variances primarily due to general market
conditions and the developmental nature of these markets.
Gross Premiums Written. Gross premiums written for the three and nine-
-----------------------
month periods ended September 30, 1999 were $106.8 million and $295.7 million,
respectively, increases of 20% and 16% from $88.7 million and $254.3 million, in
the three and nine-month periods ended September 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 nine months of 1999 has more
than offset the overall decline in municipal market issuance when compared to
the first nine months of 1998. The following tables set forth the amounts of
gross premiums written and the related gross par written by type:
11
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Three Months Ended September 30,
------------------------------------------------------------------
(Dollars in Millions) 1999 1998
------------------------------- -------------------------------
Gross Gross Gross Gross
Premiums Par Premiums Par
Written Written Written Written
------------- -------------- --------------- ------------
Municipal finance:
Up-front:
New issue................................................... $ 69.0 $ 6,725 $66.4 $7,717
Secondary market............................................ 4.0 303 1.6 196
------------- -------------- --------------- ------------
Sub-total up-front......................................... 73.0 7,028 68.0 7,913
Installment:............................................... 4.2 746 4.0 577
------------- -------------- --------------- ------------
Total municipal finance.................................. 77.2 7,774 72.0 8,490
------------- -------------- --------------- ------------
Structured finance:
Up-front.................................................... - - 0.2 1,526
Installment................................................. 20.0 10,396 9.5 3,601
------------- -------------- --------------- ------------
Total structured finance............................... 20.0 10,396 9.7 5,127
------------- -------------- --------------- ------------
International(1):
Up-front.............................................. 0.7 73 4.3 228
Installment........................................... 8.9 1,489 2.7 575
------------- -------------- --------------- ------------
Total international................................. 9.6 1,562 7.0 803
------------- -------------- --------------- ------------
Total................................................. $106.8 $19,732 $88.7 $14,420
============= ============== =============== ============
Total up-front................................................. $ 73.7 $ 7,101 $72.5 $ 9,667
Total installment.............................................. 33.1 12,631 16.2 4,753
------------- -------------- --------------- ------------
Total................................................. $106.8 $19,732 $88.7 $14,420
============= ============== =============== ============
Nine Months Ended September 30,
-------------------------------------------------------------------
(Dollars in Millions) 1999 1998
-------------------------------- -------------------------------
Gross Gross Gross Gross
Premiums Par Premiums Par
Written Written Written Written
-------------- -------------- --------------- ------------
Municipal finance:
Up-front:
New issue................................................... $183.7 $20,826 $165.7 $22,980
Secondary market............................................ 7.9 933 12.3 1,152
-------------- -------------- --------------- ------------
Sub-total up-front......................................... 191.6 21,759 178.0 24,132
Installment:............................................... 15.1 2,666 10.8 2,050
-------------- -------------- --------------- ------------
Total municipal finance.................................. 206.7 24,425 188.8 26,182
-------------- -------------- --------------- ------------
Structured finance:
Up-front.................................................... 0.5 36 1.0 1,823
Installment................................................. 47.0 26,712 24.3 14,247
-------------- -------------- --------------- ------------
Total structured finance............................... 47.5 26,748 25.3 16,070
-------------- -------------- --------------- ------------
International(1):
Up-front.............................................. 18.9 349 32.7 934
Installment........................................... 22.6 4,749 7.5 2,100
-------------- -------------- --------------- ------------
Total international................................. 41.5 5,098 40.2 3,034
-------------- -------------- --------------- ------------
Total................................................. $295.7 $56,271 $254.3 $45,286
============== ============== =============== =============
Total up-front................................................. $211.0 $22,144 $211.7 $26,889
Total installment.............................................. 84.7 34,127 42.6 18,397
-------------- -------------- --------------- ------------
Total................................................. $295.7 $56,271 $254.3 $45,286
============== ============== =============== ============
(1) Gross par written excludes amounts ceded to MBIA Insurance Corporation under
our international joint venture of $538.9 million and $80.0 million for the
three months ended September 30, 1999 and 1998, respectively, and $2,685.3
million and $1,111.1 million for the nine months ended September 30, 1999 and
1998, respectively.
12
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Ceded Premiums Written. Ceded premiums written for the three and nine
-----------------------
months ended September 30, 1999 were $11.9 million and $33.4 million,
respectively, an increase of 148% from $4.8 million in the three months ended
September 30, 1998 and a decrease of 18% from $40.9 million in the nine months
ended September 30, 1998. The increase in ceded premiums written for the third
quarter of 1999 is primarily due to increased ceded premiums written on
international policies via the JV arrangement with MBIA as well as a higher
quarterly cede of municipal business written. The decrease in ceded premiums
written for the nine months ended September 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 11.1% and 11.3% of gross
premiums written for the three and nine months ended September 30, 1999,
respectively, compared with 5.4% and 11.6% (excluding the one-time cede of the
Connie Lee portfolio in 1998) for the three and nine months ended September 30,
1998, respectively.
Net Premiums Written. Net premiums written for the three and nine months
---------------------
ended September 30, 1999 were $94.9 million and $262.3 million, respectively.
The increase of 13% from $84.0 million in the three months ended September 30,
1998 reflects the higher gross premiums written partially offset by the
increased ceded premiums. The increase of 23% from $213.4 million in the nine
months ended September 30, 1998 reflects the higher gross premiums written as
well as the substantial decrease in premiums ceded to reinsurers during the
first quarter of 1999, compared with the corresponding prior period.
Net Premiums Earned. Net premiums earned during the three and nine months
--------------------
ended September 30, 1999 were $68.3 million and $192.6 million, respectively, an
increase of 36% from $50.1 million in the three months ended September 30, 1998,
and an increase of 23% from $156.6 million in the nine months ended September
30, 1998. These increases were primarily the result of increased normal net
premiums earned (defined as net premiums earned excluding the effects of
refundings, calls and other accelerations of previously insured obligations,
collectively referred to as "refundings") during the periods. Normal net
premiums earned increased 41% from $43.2 million in the third quarter of 1998 to
$60.9 million in the third quarter of 1999. Normal net premiums earned for the
nine months ended September 30, 1999 were $164.8 million, an increase of 38%
from $119.5 million in the nine months ended September 30, 1998. The increases
in normal net premiums earned resulted from strong business written in all
areas, particularly structured and international finance.
Net premiums earned include accelerated premiums that result from
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 nine
months ended September 30, 1999 included $7.4 million (which had a net income
per diluted share effect of $0.06) and $27.7 million (which had a net income per
diluted share effect of $0.22), respectively, from refundings. Net premiums
earned in the three and nine months ended September 30, 1998 included $6.9
million (which had a net income per diluted share effect of $0.06) and $37.1
million (which had a net income per diluted share effect of $0.30),
respectively, from refundings.
13
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Net Investment Income. Net investment income for the three and nine months
----------------------
ended September 30, 1999 were $52.9 million and $153.7 million, respectively, an
increase of 12% from $47.4 million in the three months ended September 30, 1998
and an increase of 11% from $138.3 million in the nine months ended September
30, 1998. The increases were primarily attributable to the growth of the
investment portfolio from ongoing operations. Additionally, investment income
grew in the third 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 April 1999. Ambac Assurance's investments in tax-exempt securities
amounted to 73% of the total market value of its portfolio as of September 30,
1999, versus 72% at September 30, 1998. The average pre-tax yield-to-maturity on
the investment portfolio was 6.05% and 6.33% as of September 30, 1999 and 1998,
respectively.
Net Realized Gains (Losses). Net realized losses were $0.1 million for the
----------------------------
three months ended September 30, 1999, compared to $0.5 million in net realized
gains for the comparative prior period in 1998. Net realized losses were $5.5
million for the nine months ended September 30, 1999, compared to net realized
gains of $1.2 million for the nine months ended September 30, 1998.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses
------------------------------------
for the three and nine months ended September 30, 1999 were $3.0 million and
$8.0 million, respectively, compared to $1.5 million and $4.5 million for the
three and nine months ended September 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
$3.7 million and $10.9 million for the three and nine months ended September 30,
1998, respectively.
Underwriting and Operating Expenses. Underwriting and operating expenses
------------------------------------
for the three and nine months ended September 30, 1999 were $12.0 million and
$35.8 million, respectively, representing increases of 2% from $11.8 million and
$35.1 million in the three and nine months ended September 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. During
the three and nine-month periods ended September 30, 1999, gross underwriting
and operating expenses were $18.5 million and $54.3 million, respectively, an
increase of 2% from $18.2 million in the three months ended September 30, 1998
and an increase of 8% from $50.1 million in the nine months ended September 30,
1998. These increases reflect the overall increased business activity during the
period. Underwriting and operating expenses deferred for the three and nine
months ended September 30, 1999 were $11.6 million and $33.3 million,
respectively, compared to $10.4 million and $28.1 million for the three and nine
months ended September 30, 1998, respectively. The amortization of previously
deferred expenses and reinsurance commissions for the three and nine months
ended September 30, 1999 were $5.6 million and $15.3 million, respectively,
compared to $4.2 million and $13.6 million for the three and nine months ended
September 30, 1998, respectively.
14
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
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. Revenues, net of realized gains and losses, for the three and
---------
nine months ended September 30, 1999 were $12.1 million and $37.9 million,
respectively, down 10% from $13.5 million for the three months ended September
30, 1998 and 3% from $39.0 million in the nine months ended September 30, 1998.
Continuing the trend from the first two quarters of 1999, higher investment
agreement revenue ($6.2 million in the third quarter of 1999, up 35% from $4.6
million in the third quarter of 1998), was offset by lower interest rate swap
revenue ($2.9 million in the third quarter of 1999, down 50% from $5.8 million
in the third quarter of 1998).
Expenses. Expenses for the three and nine months ended September 30, 1999
---------
were $6.2 million and $19.9 million, respectively, down 24% from $8.2 million
for the three months ended September 30, 1998 and down 18% from $24.3 million
for the nine months ended September 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 nine months ended
-----------------
September 30, 1999 were $9.1 million and $27.3 million, respectively, compared
to $9.3 million and $23.6 million for the three and nine months ended September
30, 1998, respectively. The increase in interest expense for the nine-month
period ended September 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 nine months ended September
-------------
30, 1999 were at an effective rate of 24.3% and 23.6%, respectively, versus
23.3% and 23.2% for the three and nine months ended September 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.
Core Earnings. Core earnings for the three and nine months ended September
--------------
30, 1999 were $75.6 million and $213.4 million, respectively, an increase of 25%
from $60.5 million for the three months ended September 30, 1998 and an increase
of 23% from $173.1 million for the nine months ended September 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
15
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
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 nine months ended
-------------------
September 30, 1999 were $79.8 million and $229.2 million, respectively, an
increase of 24% from $64.5 million in the three months ended September 30, 1998
and an increase of 18% from $194.2 million in the nine months ended September
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 nine months ended
September 30, 1999 and 1998:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------------
(Dollars in Millions) 1999 1998 1999 1998
--------------------------------------------
Net Income................................................ $79.8 $65.4 $224.0 $191.8
Net realized losses (gains), after tax.................... - (0.9) 5.2 2.4
--------------------------------------------
Operating earnings..................................... 79.8 64.5 229.2 194.2
Premiums earned from refundings, calls and other
accelerations, after tax................................. (4.2) (4.0) (15.8) (21.1)
--------------------------------------------
Core earnings.......................................... $75.6 $60.5 $213.4 $173.1
============================================
There were 71.3 million and 71.4 million weighted-average diluted shares
outstanding during the three and nine months ended September 30, 1999,
respectively. The weighted-average number of diluted shares outstanding during
the three and nine months ended September 30, 1998 were 71.4 million and 71.5
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 nine months ended September 30, 1999 were $164.6 million and $429.8 million,
respectively, up 46% from $113.0 million in the three months ended September 30,
1998 and up 37% from $312.7 million in the nine months ended September 30, 1998.
The increases in the third quarter of 1999, as well as the nine-month period
ended September 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 nine months ended September 30, 1999 was
$90.9 million and $227.6 million, respectively, an increase of 123% from $40.8
million written in the third quarter of 1998 and an increase of 102% from $112.4
million written in the nine months ended September 30, 1998. The aggregate net
present value of estimated future installment premiums was $497.1 million and
$308.4 million as of September 30, 1999 and December 31, 1998, respectively. At
September 30, 1999, the rate used to discount future installment premiums was
changed from 9% to 7%. The prior period's estimate of present value of future
installment premiums has not been restated.
16
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 nine months ended
September 30, 1999 and 1998:
Three Months Ended September 30, Nine Months Ended September 30,
----------------------------------------- -----------------------------------
(Dollars in Millions) 1999 % 1998 % 1999 % 1998 %
------------ ----- --------- ----- ----- -- ------- ----
Municipal Finance:
Up-front:
New issue........................... $ 69.0 42% $ 66.4 59% $183.7 43% $165.7 53%
Secondary market.................... 4.0 2 1.6 1 8.0 2 12.3 4
-------- ----- ------ ----- ------- ---- ------ ----
Sub-total up-front................. 73.0 44 68.0 60 191.7 45 178.0 57
Installment........................ 9.7 6 4.0 4 33.3 7 15.8 5
-------- ----- ------ ----- ------- ---- ------- ----
Total Municipal Finance.......... 82.7 50 72.0 64 225.0 52 193.8 62
-------- ----- ------ ----- ------- ---- ------- ----
Structured Finance:
Up-front............................ - - 0.2 - 0.5 - 1.0 -
Installment......................... 46.0 28 17.8 16 123.1 29 48.2 16
-------- ----- ------ ----- ------- ---- ------- ----
Total Structured Finance.......... 46.0 28 18.0 16 123.6 29 49.2 16
-------- ----- ------ ----- ------- ---- ------- ----
International (1):
Up-front...................... 0.7 1 4.0 4 10.0 2 21.3 7
Installment................... 35.2 21 19.0 16 71.2 17 48.4 15
-------- ----- ------ ----- ------- ---- ------- ----
Total International.............. 35.9 22 23.0 20 81.2 19 69.7 22
-------- ----- ------ ----- ------- ---- ------- ----
Total adjusted gross premiums.......... $164.6 100% $113.0 100% $429.8 100% $312.7 100%
-------- ----- ------ ----- ------- ---- ------ ----
Total up-front......................... $ 73.7 45% $ 72.2 64% $202.2 47% $200.3 64%
Total installment...................... 90.9 55 40.8 36 227.6 53 112.4 36
-------- ----- ------ ----- ------ ---- ------ ----
Total adjusted gross premiums......... $164.6 100% $113.0 100% $429.8 100% $312.7 100%
-------- ----- ------ ----- ------ ---- ------ ----
(1) Excludes amounts ceded to MBIA Insurance Corporation under our international
joint venture of $13.4 million and $1.9 million for the three months ended
September 30, 1999 and 1998, respectively, and $43.2 million and $17.4 million
for the nine months ended September 30, 1999 and 1998, respectively.
Adjusted Book Value. Adjusted book value ("ABV") per common share increased
--------------------
5% to $44.22 at September 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. At September 30,
1999, the rate used to discount future installment premiums was changed from 9%
to 7%. The prior period's estimate of present value of future installment
premiums has not been restated. The ABV was positively affected by the Company's
net income for the nine-month period ended September 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 $99.1 million at
September 30, 1999.
17
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
The following table reconciles book value per share to ABV per share as of
September 30, 1999 and December 31, 1998:
September 30, December 31,
1999 1998
------------------- -------------------
Book value per share.................................................. $28.99 $29.97
After-tax value of:
Net unearned premium reserve........................................ 10.82 10.17
Deferred acquisition costs.......................................... (1.23) (1.12)
Present value of installment premiums............................... 4.62 2.86
Unrealized gain on investment agreement liabilities................. 1.02 0.10
------------------- -------------------
Adjusted book value per share......................................... $44.22 $41.98
=================== ===================
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 nine months ended
September 30, 1999, Ambac Assurance paid dividends of $39.0 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
18
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
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.
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
September 30, 1999 and December 31, 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 high
quality 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
September 30, 1999 and December 31, 1998, no amounts were outstanding under this
facility.
ACP 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. As of September 30, 1999, no amounts
were outstanding under this facility.
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
nine months ended September 30, 1999, the Company acquired approximately 307,000
shares for an aggregate amount of $16.6 million. Since inception of the Stock
Repurchase Program, the Company has acquired approximately 4,555,000 shares for
an aggregate amount of $159.3 million.
Balance Sheet. As of September 30, 1999, the fair value of the Company's
--------------
consolidated investment portfolio was $9.08 billion, an increase of 4% 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
financial guarantee 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 $298.9 million
-----------
and $255.8 million during the nine months ended September 30, 1999 and 1998,
respectively. These cash flows were primarily provided from financial guarantee
operations.
19
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Net cash provided by financing activities was $344.8 million during the
nine months ended September 30, 1999, $355.6 million was from investment
agreements issued (net of draws paid). For the nine months ended September 30,
1998, $1,433.0 million was provided in financing activities, of which $1,102.4
million was from investment agreements issued (net of draws paid).
Net cash used in investing activities was $640.2 million during the nine
months ended September 30, 1999, $3,650.8 million was used to purchase bonds,
partially offset by proceeds from sales and maturities of bonds of $2,951.6
million. For the nine months ended September 30, 1998, $1,688.5 million was used
in investing activities, $3,423.6 million was used to purchase bonds, partially
offset by proceeds from sales and maturities of bonds of $2,235.0 million.
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 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
20
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
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 are being
tested and are expected to be satisfactory.
(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
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' obligation 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 have
been 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.
21
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 within
the Company monitors trading risk limits and, together with senior management,
is involved in the application of risk measurement methodologies.
22
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
----------- ---------------------------------------------
10.26 Ambac Financial Group, Inc. Deferred Compensation Plan for
Outside Directors, effective as of December 1, 1993 and
amended and restated as of October 26, 1999.
10.27 Ambac Financial Group, Inc. 1997 Equity Plan Senior Officer
Deferred Compensation Sub-Plan of the 1997 Equity Plan
effective as of October 26, 1999.
27.00 Financial Data Schedule.
99.04 Ambac Assurance Corporation and Subsidiaries Consolidated
Unaudited Financial Statements as of September 30, 1999 and
December 31, 1998 and for the periods ended September 30,
1999 and 1998.
(b) Reports on Form 8-K:
There was no reports on Form 8-K filed during the third 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: November 12, 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
- ----------------- -----------------------------------------------------
10.26 Ambac Financial Group, Inc. Deferred Compensation Plan
for Outside Directors, effective as of December 1,
1993 and amended and restated as of October 26, 1999.
10.27 Ambac Financial Group, Inc. 1997 Equity Plan Senior
Officer Deferred Compensation Sub-Plan of the 1997
Equity Plan effective as of October 26, 1999.
27.00 Financial Data Schedule.
99.04 Ambac Assurance Corporation and Subsidiaries
Consolidated Unaudited Financial Statements as of
September 30, 1999 and December 31, 1998 and for the
periods ended September 30, 1999 and 1998.
25