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, 2001
[_] 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 August 2, 2001, 105,865,558 shares of Common Stock, par value $0.01
per share, (net of 154,979 treasury shares) of the Registrant were outstanding.
Ambac Financial Group, Inc. and Subsidiaries
INDEX
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PAGE
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PART I FINANCIAL INFORMATION
Item 1. Consolidated Unaudited Financial Statements
Consolidated Balance Sheets - June 30, 2001
And December 31, 2000............................................................ 3
Consolidated Statements of Operations - three months and six months
Ended June 30, 2001 and 2000..................................................... 4
Consolidated Statements of Stockholders' Equity - six months
ended June 30, 2001 and 2000..................................................... 5
Consolidated Statements of Cash Flows - six months ended
June 30, 2001 and 2000........................................................... 6
Notes to Consolidated Unaudited Financial Statements............................. 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................................. 11
Item 3. Quantitative and Qualitative Disclosures About
Market Risk...................................................................... 22
PART II OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.............................. 24
Item 6. Exhibits and Reports on Form 8-K................................................. 24
SIGNATURES................................................................................. 26
INDEX TO EXHIBITS.......................................................................... 27
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, 2001 and December 31, 2000
(Dollars in Thousands)
June 30, 2001 December 31, 2000
------------- -----------------
(unaudited)
Assets
- ------
Investments:
Fixed income securities, at fair value
(amortized cost of $7,457,931 in 2001 and $6,743,450 in 2000) $ 7,543,512 $ 6,825,152
Fixed income securities pledged as collateral, at fair value
(amortized cost of $1,338,850 in 2001 and $1,238,401 in 2000) 1,340,798 1,239,349
Short-term investments, at cost (approximates fair value) 217,090 253,519
Other 2,340 5,852
----------- -----------
Total investments 9,103,740 8,323,872
Cash 35,217 20,493
Cash pledged as collateral - 24,935
Securities purchased under agreements to resell 134,448 255,786
Receivable for investment agreements 65,212 6,663
Receivable for securities sold 551 1,926
Investment income due and accrued 114,910 130,692
Reinsurance recoverable 1,919 1,091
Prepaid reinsurance 246,538 242,604
Deferred acquisition costs 165,134 153,424
Loans 691,261 695,251
Other assets 250,086 263,563
----------- -----------
Total assets $10,809,016 $10,120,300
=========== ===========
Liabilities and Stockholders' Equity
- ------------------------------------
Liabilities:
Unearned premiums $ 1,681,159 $ 1,546,290
Losses and loss adjustment expense reserve 141,898 132,445
Ceded reinsurance balances payable 12,740 10,892
Obligations under investment and payment agreements 3,510,236 3,509,049
Obligations under investment repurchase agreements 1,580,433 1,383,882
Deferred income taxes 119,530 106,035
Current income taxes 25,339 25,628
Debentures 424,094 424,061
Accrued interest payable 71,584 90,575
Other liabilities 272,252 291,394
Payable for securities purchased 179,987 3,935
----------- -----------
Total liabilities 8,019,252 7,524,186
----------- -----------
Stockholders' equity:
Preferred stock - -
Common stock 1,060 1,060
Additional paid-in capital 540,026 533,558
Accumulated other comprehensive income 44,222 45,154
Retained earnings 2,212,762 2,035,209
Common stock held in treasury at cost (8,306) (18,867)
----------- -----------
Total stockholders' equity 2,789,764 2,596,114
----------- -----------
Total liabilities and stockholders' equity $10,809,016 $10,120,300
=========== ===========
See accompanying Notes to Consolidated Unaudited Financial Statements
3
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
For the Periods Ended June 30, 2001 and 2000
(Dollars in Thousands Except Share Data)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- --------------------------------
2001 2000 2001 2000
--------------------------------- --------------------------------
Revenues:
Financial Guarantee:
Gross premiums written $ 236,668 $ 121,669 $ 346,335 $ 191,007
Ceded premiums written (23,767) (26,247) (36,468) (42,374)
------------- ------------- ------------- -------------
Net premiums written $ 212,901 $ 95,422 $ 309,867 $ 148,633
============= ============= ============= =============
Net premiums earned $ 93,412 $ 80,921 $ 178,528 $ 152,079
Net fees and other premiums earned 7,971 2,301 13,100 5,048
Net investment income 65,058 58,902 129,534 116,533
Net realized gains (losses) 658 922 (3,624) 432
Financial Services:
Revenue 11,767 21,127 26,226 35,569
Net realized gains (losses) - (7,090) 1,065 (7,271)
Other:
Revenue 678 438 2,307 1,005
------------- ------------- ------------- -------------
Total revenues 179,544 157,521 347,136 303,395
------------- ------------- ------------- -------------
Expenses:
Financial Guarantee:
Losses and loss adjustment expenses 4,800 3,600 9,400 6,849
Underwriting and operating expenses 17,426 13,876 34,069 27,354
Financial Services 5,973 6,276 11,604 12,755
Interest 9,485 9,380 18,968 18,759
Other 1,714 2,219 3,451 3,414
------------- ------------- ------------- -------------
Total expenses
39,398 35,351 77,492 69,131
------------- ------------- ------------- -------------
Income before income taxes 140,146 122,170 269,644 234,264
Provision for income taxes 32,509 29,530 64,084 55,986
------------- ------------- ------------- -------------
Income before accounting change 107,637 92,640 205,560 178,278
Cumulative effect of accounting change
(net of income taxes of $219) - - (408) -
------------- ------------- ------------- -------------
Net income $ 107,637 $ 92,640 $ 205,152 $ 178,278
============= ============= ============= =============
Net income per share:
Basic $ 1.02 $ 0.88 $ 1.94 $ 1.70
============= ============= ============= =============
Diluted $ 0.99 $ 0.87 $ 1.88 $ 1.67
============= ============= ============= =============
Weighted average number of common shares outstanding:
Basic 105,816,151 104,743,016 105,739,608 104,768,535
============= ============= ============= =============
Diluted 109,051,506 106,889,822 108,954,037 106,825,926
============= ============= ============= =============
See accompanying Notes to Consolidated Unaudited Financial Statements
4
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(Unaudited)
For The Periods Ended June 30, 2001 and 2000
(Dollars in Thousands)
2001 2000
------------------------ -----------------------
Retained Earnings:
Balance at January 1 $2,035,209 $1,713,446
Net income 205,152 $205,152 178,278 $178,278
-------- --------
Dividends declared - common stock (16,911) (15,375)
Exercise of stock options (10,688) (4,750)
---------- ----------
Balance at June 30 $2,212,762 $1,871,599
---------- ----------
Accumulated Other Comprehensive Income (Loss):
Balance at January 1 $ 45,154 ($187,540)
Unrealized gains (losses) on securities, $2,351 and
$93,717, pre-tax in 2001 and 2000, respectively /(1)/ 1,138 56,573
Cumulative effect of accounting change (880) -
Loss on derivative transactions (57) -
Foreign currency translation loss (1,133) (1,449)
-------- --------
Other comprehensive income (loss) (932) (932) 55,124 55,124
---------- -------- ---------- --------
Comprehensive income (loss) $204,220 $233,402
======== ========
Balance at June 30 $ 44,222 ($132,416)
---------- ----------
Preferred Stock:
Balance at January 1 and June 30 $ - $ -
---------- ----------
Common Stock:
Balance at January 1 and June 30 $ 1,060 $ 707
---------- ----------
Additional Paid-in Capital:
Balance at January 1 $ 533,558 $ 525,012
Exercise of stock options 6,468 1,756
---------- ----------
Balance at June 30 $ 540,026 $ 526,768
---------- ----------
Common Stock Held in Treasury at Cost:
Balance at January 1 ($18,867) ($33,175)
Cost of shares acquired (8,362) (12,560)
Shares issued under equity plans 18,923 9,131
---------- ----------
Balance at June 30 ($8,306) ($36,604)
---------- ----------
Total Stockholders' Equity at June 30 $2,789,764 $2,230,054
========== ==========
/(1)/ Disclosure of reclassification amount:
Unrealized holding gains arising during period $ 2,151 $ 53,458
Less: reclassification adjustment for net gains
included in net income
1,013 (3,115)
---------- ----------
Net unrealized gains on securities $ 1,138 $ 56,573
========== ==========
See accompanying Notes to Consolidated Unaudited Financial Statements.
5
Ambac Financial Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
For The Periods Ended June 30, 2001 and 2000
(Dollars in Thousands)
Six Months Ended
June 30,
-----------------------------------
2001 2000
------------- ----------------
Cash flows from operating activities:
Net income $ 205,152 $ 178,278
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,761 1,758
Amortization of bond premium and discount (9,934) (5,367)
Current income taxes (289) (3,592)
Deferred income taxes 12,906 9,643
Deferred acquisition costs (11,710) (6,756)
Unearned premiums, net 130,935 (3,876)
Losses and loss adjustment expenses 8,625 5,657
Ceded reinsurance balances payable 1,848 (6,868)
Investment income due and accrued 15,782 15,203
Accrued interest payable (18,991) (13,873)
Net realized losses 2,559 6,839
Other, net (12,650) (1,519)
----------- -----------
Net cash provided by operating activities 325,994 175,527
----------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds 583,003 703,116
Proceeds from matured bonds 1,241,798 860,364
Purchases of bonds (2,450,137) (1,014,330)
Change in short-term investments 36,429 92,340
Securities purchased under agreements to resell 121,338 (43,003)
Loans 3,990 (5,743)
Other, net (5,465) (3,658)
----------- -----------
Net cash (used in) provided by investing activities (469,044) 589,086
----------- -----------
Cash flows from financing activities:
Dividends paid (16,911) (15,375)
Proceeds from issuance of investment agreements 1,435,243 810,643
Payments for investment agreement draws (1,292,064) (1,563,812)
Payment agreements (3,990) 5,743
Proceeds from sale of treasury stock 18,923 9,131
Purchases of treasury stock (8,362) (12,560)
----------- -----------
Net cash provided by (used in) financing activities 132,839 (766,230)
----------- -----------
Net cash flow (10,211) (1,617)
Cash and cash pledged as collateral at January 1 45,428 13,588
----------- -----------
Cash and cash pledged as collateral at June 30 $ 35,217 $ 11,971
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes $ 45,000 $ 48,200
=========== ===========
Interest expense on debt $ 18,874 $ 18,920
=========== ===========
Interest expense on investment agreements $ 113,091 $ 149,540
=========== ===========
See accompanying Notes to Consolidated Unaudited 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., headquartered in New York City, is a holding
company whose affiliates provide financial guarantees and financial services to
clients in both the public and private sectors around the world. Ambac's
principal operating subsidiary, Ambac Assurance Corporation, a 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 Services, Fitch, Inc., and Rating and
Investment Information, Inc. Ambac's Financial Services segment provides
financial and investment products including investment agreements, interest rate
swaps, funding conduits, investment advisory and cash management services,
principally to its financial guarantee clients which include municipalities and
their authorities, school districts, healthcare organizations and asset-backed
issuers.
Ambac's consolidated unaudited interim financial statements have been
prepared on the basis of accounting principles generally accepted in the United
States of America ("GAAP") and, in the opinion of management, reflect all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of Ambac'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 and
six months ended June 30, 2001 may not be indicative of the results that may be
expected for the full year ending December 31, 2001. 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) Ambac's
Annual Report on Form 10-K for the year ended December 31, 2000, which was filed
with the Securities and Exchange Commission on March 28, 2001, and (ii) Ambac's
Quarterly report on Form 10-Q for the quarterly period ended March 31, 2001,
which was filed with the SEC on May 15, 2001.
The consolidated financial statements include the accounts of Ambac and
each of its subsidiaries. All significant intercompany balances have been
eliminated.
Certain reclassifications have been made to prior period's amounts to
conform to the current period's presentation.
(2) Segment Information
Ambac has two reportable segments, as follows: (1) financial guarantee,
which provides financial guarantees (including structured credit derivatives)
for municipal and structured finance obligations; and (2) financial services,
which provides investment agreements, interest rate swaps, funding conduits, and
investment advisory and cash management services.
7
Notes to Consolidated Unaudited Financial Statements (Continued)
(Dollars in thousands)
Ambac'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 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. Intersegment revenues consist of dividends
received.
The following tables summarize the financial information by reportable
segment as of and for the three and six-month periods ended June 30, 2001 and
2000:
Financial Financial Corporate Intersegment
Three months ended June 30, Guarantee Services And Other Eliminations Consolidated
------------- ----------- ------------ ------------- --------------
2001:
Revenues:
Unaffiliated customers........... $ 167,099 $ 11,767 $ 678 $ - $ 179,544
Intersegment..................... 1,862 (972) 17,000 (17,890) -
---------- ---------- --------- --------- -----------
Total revenues..................... $ 168,961 $ 10,795 $ 17,678 ($17,890) $ 179,544
---------- ---------- --------- --------- -----------
Income before income taxes:
Unaffiliated customers........... $ 144,873 $ 5,794 ($10,521) $ - $ 140,146
Intersegment..................... 1,559 (936) 16,653 (17,276) -
---------- ---------- --------- --------- -----------
Total income before income taxes... $ 146,432 $ 4,858 $ 6,132 ($17,276) $ 140,146
---------- ---------- --------- --------- -----------
Identifiable assets................ $5,310,145 $5,427,417 $ 71,454 $ - $10,809,016
---------- ---------- --------- --------- -----------
2000:
Revenues:
Unaffiliated customers........... $ 143,046 $ 14,037 $ 438 $ - $ 157,521
Intersegment..................... 947 (810) 15,957 (16,094) -
---------- ---------- --------- --------- -----------
Total revenues..................... $ 143,993 $ 13,227 $ 16,395 ($16,094) $ 157,521
---------- ---------- --------- --------- -----------
Income before income taxes:
Unaffiliated customers........... $ 125,570 $ 7,761 ($11,161) $ - $ 122,170
Intersegment..................... 947 (550) 15,957 (16,354) -
---------- ---------- --------- --------- -----------
Total income before income taxes... $ 126,517 $ 7,211 $ 4,796 ($16,354) $ 122,170
---------- ---------- --------- --------- -----------
Identifiable assets................ $4,353,446 $6,397,803 $ 46,984 $ - $10,798,233
---------- ---------- --------- --------- -----------
8
Notes to Consolidated Unaudited Financial Statements (Continued)
(Dollars in thousands)
Financial Financial Corporate Intersegment
Six months ended June 30, Guarantee Services And Other Eliminations Consolidated
----------------- ----------------- ---------------- ------------------- ----------------
2001:
Revenues:
Unaffiliated customers............. $ 317,538 $ 27,291 $ 2,307 $ - $ 347,136
Intersegment....................... 2,391 (1,944) 35,000 (35,447) -
---------- ---------- --------- --------- -----------
Total revenues....................... $ 319,929 $ 25,347 $ 37,307 ($35,447) $ 347,136
---------- ---------- --------- --------- -----------
Income before income taxes:
Unaffiliated customers............. $ 274,069 $ 15,687 ($20,112) $ - $ 269,644
Intersegment....................... 2,655 (1,817) 34,306 (35,144) -
---------- ---------- --------- --------- -----------
Total income before income taxes..... $ 276,724 $ 13,870 $ 14,194 ($35,144) $ 269,644
---------- ---------- --------- --------- -----------
Identifiable assets.................. $5,310,145 $5,427,417 $ 71,454 $ - $10,809,016
---------- ---------- --------- --------- -----------
2000:
Revenues:
Unaffiliated customers............. $ 274,092 $ 28,298 $ 1,005 $ - $ 303,395
Intersegment....................... 1,770 (1,648) 31,928 (32,050) -
---------- ---------- --------- --------- -----------
Total revenues....................... $ 275,862 $ 26,650 $ 32,933 ($32,050) $ 303,395
---------- ---------- --------- --------- -----------
Income before income taxes:
Unaffiliated customers............. $ 239,889 $ 15,543 ($21,168) $ - $ 234,264
Intersegment....................... 1,770 (1,603) 31,928 (32,095) -
---------- ---------- --------- --------- -----------
Total income before income taxes..... $ 241,659 $ 13,940 $ 10,760 ($32,095) $ 234,264
---------- ---------- --------- --------- -----------
Identifiable assets.................. $4,353,446 $6,397,803 $ 46,984 $ - $10,798,233
---------- ---------- --------- --------- -----------
The following table summarizes unaffiliated 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, 2001 and 2000.
Three Months Six Months
------------------------------------------- ----------------------------------------
Gross Premiums Net Premiums Gross Premiums Net Premiums
2001: Written Earned Written Earned
--------------------- ------------------- --------------------- ----------------
United States.............................. $176,078 $79,140 $254,453 $150,662
Australia.................................. 4,537 951 5,051 1,793
Mexico..................................... 3,988 1,847 8,026 3,683
Japan...................................... 2,716 2,177 5,510 4,154
France..................................... 287 309 436 548
United Kingdom............................. 12,595 2,043 27,425 4,036
Internationally diversified /(1)/.......... 16,928 3,429 20,746 7,320
Other international........................ 19,539 3,516 24,688 6,332
-------- ------- -------- --------
Total.................................. $236,668 $93,412 $346,335 $178,528
-------- ------- -------- --------
2000:
United States.............................. $ 78,294 $69,751 $132,803 $131,137
Australia.................................. 13,035 926 17,426 1,444
Mexico..................................... 4,185 1,955 8,146 3,613
Japan...................................... 1,751 1,563 3,471 3,206
France..................................... 277 321 521 593
United Kingdom............................. 13,484 1,170 13,499 2,424
Internationally diversified /(1)/.......... 3,719 2,717 5,947 5,428
Other international........................ 6,924 2,518 9,194 4,234
-------- ------- -------- --------
Total.................................. $121,669 $80,921 $191,007 $152,079
-------- ------- -------- --------
1) Internationally diversified includes guarantees with multiple locations of
risk and includes components of domestic exposure.
9
Notes to Consolidated Unaudited Financial Statements (Continued)
(Dollars in thousands)
(3) Cumulative Effect of Accounting Change
In June 1998, the Financial Accounting Standards Board issued FAS Statement
133, "Accounting for Derivative Instruments and Hedging Activities". FAS 133, as
amended by FAS 138 and related guidance, established accounting and reporting
standards for derivative instruments and hedging activities. Ambac adopted FAS
133 and its related guidance on January 1, 2001, that resulted in a transition
adjustment loss of $0.4 million (net of related income tax) in net income.
(4) Goodwill and Other Intangible Assets
In July 2001, the FASB issued FAS Statement 142, "Goodwill and Other
Intangible Assets". FAS 142 addresses the initial recognition and measurement of
intangible assets either singly or within a group of assets, as well as the
measurement of goodwill and other intangible assets subsequent to their initial
acquisition. FAS 142 changes the accounting for goodwill and intangible assets
that have indefinite useful lives from an amortization approach to an
impairment-only approach that requires that those assets be tested at least
annually for impairment. Intangible assets that have finite useful lives will
continue to be amortized over their useful lives, but without an arbitrary
ceiling on their useful lives. FAS 142 is required to be applied starting with
fiscal years beginning after December 15, 2001 and is required to be applied at
the beginning of an entity's fiscal year. The statement is to be applied to all
goodwill and other intangible assets recognized in an entity's financial
statements at that date. Impairment losses for goodwill and indefinite lived
intangible assets that arise due to the initial application of FAS 142
(resulting from an impairment test) are to be reported as a change in accounting
principle. Retroactive application is not permitted. Ambac has not yet
determined the impact that FAS 142 will have on its consolidated financial
statements.
10
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 and its subsidiaries for the three and six-month periods ended June 30,
2001 and 2000, and its financial condition as of June 30, 2001 and December 31,
2000. These results are presented for Ambac's two reportable segments: Financial
Guarantee and Financial 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 Ambac's
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 and
relate to future operating or financial performance.
Any or all of Ambac's forward-looking statements here or in other
publications may turn out to be wrong and are based on current expectations and
the current economic environment. Ambac's actual results may vary materially,
and there are no guarantees about the performance of our securities. 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 is not obligated
to publicly correct or update any forward-looking statement if we later become
aware that it is not likely to be achieved, except as required by law. You are
advised, however, to consult any further disclosures we make on related subjects
in Ambac's reports to the SEC.
Results of Operations
Consolidated Net Income
Ambac's net income for the three months ended June 30, 2001 was $107.6
million or $0.99 per diluted share. This represents a 16% increase from the
three months ended June 30, 2000 net income of $92.6 million and a 14% increase
in net income per diluted share from $0.87 in the three months ended June 30,
2000. The increase in net income was primarily attributable to higher Financial
Guarantee operating earnings driven by a $24.1 million, or 17%, increase in
revenues, partially offset by lower financial services revenues. Ambac's net
income for the six months ended June 30, 2001 was $205.2 million, or $1.88 per
diluted share. This represents an increase of 15% from the comparable prior
period net income of $178.3 million, and a 13% increase in net income per
diluted share from $1.67 per diluted share in the six months ended June 30,
2000.
Financial Guarantee
Ambac provides financial guarantees for municipal and structured finance
obligations through its principal operating subsidiary, Ambac Assurance. Ambac
Assurance serves clients in international markets through its wholly owned
subsidiary, Ambac Assurance UK Limited.
Ambac Credit Products, L.L.C., a wholly owned subsidiary of Ambac
Assurance, also provides credit protection in the global markets in the form of
structured credit derivatives.
11
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Gross Par Written. Ambac Assurance guaranteed $27.7 billion in par value
------------------
bonds during the three months ended June 30, 2001, a 26% increase from $22.0
billion in par during the comparable prior year period. Par value written for
the second quarter of 2001 was comprised of $11.5 billion from municipal bond
obligations, $9.7 billion from structured finance obligations and $6.5 billion
from international obligations, compared to $4.1 billion, $8.5 billion and $9.4
billion, respectively, in the second quarter of 2000. During the six months
ended June 30, 2001, Ambac Assurance guaranteed $44.6 billion in par value
bonds, a 22% increase from $36.6 billion in par during the first six months of
2000. Par value written for the six months ended June 30, 2001 was comprised of
$17.5 billion from municipal bond obligations, $15.7 billion from structured
finance obligations and $11.4 billion from international obligations, compared
to $6.6 billion, $16.4 billion, and $13.6 billion, respectively, in the six
months ended June 30, 2000. Municipal obligations issued for the three and six
month periods ended June 30, 2001 saw increases of 53% and 51% respectively,
versus comparable prior year periods. The increase in total issuance was largely
the result of the lower interest rate environment. Additionally, increases in
insured market penetration and Ambac Assurance's municipal market share,
contributed to the increase in Ambac's insured municipal obligations during the
periods. Declines in Structured Finance guarantees resulted from lower mortgage-
backed guarantees offset by greater penetration into new asset classes (auto
rental, credit card and lease securitizations). International guarantees of
structured credit derivatives were $4.2 billion and $7.5 billion in par for the
three and six months ended June 30, 2001, respectively. This resulted in a
decrease of 31% from $6.1 billion in par in the three months ended June 30, 2000
and a decrease of 19% from $9.3 billion in par during the six months ended June
30, 2000.
Gross Premiums Written. Gross premiums written for the three and six-
-----------------------
month periods ended June 30, 2001 were $236.7 million and $346.3 million,
respectively, an increase of 94% over $121.7 million in the three-month period
ended June 30, 2000 and an increase of 81% from $191.0 million in the six months
ended June 30, 2000. Installment premiums written for the three and six months
ended June 30, 2001 were $59.8 million and $114.1 million, respectively, an
increase of 29% from $46.2 million in the three months ended June 30, 2000 and
an increase of 35% over $84.4 million in the six months ended June 30, 2000. The
growth in installment premiums is due to the growing book of business, primarily
in domestic and international mortgage-backed and asset-backed segments.
International premiums collected up-front increased due to continued penetration
in the utility and infrastructure finance sectors. On the municipal side, Ambac
saw an increase in writings for the three and six months ended June 30, 2001. As
mentioned above under "Gross Par Written", increases in municipal market volume,
Ambac's market share growth and increased pricing were the primary drivers of
this increase. The following tables set forth the amounts of gross premiums
written and the related gross par written by type:
12
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Three Months Ended June 30,
------------------------------------------------------------------
(Dollars in Millions) 2001 2000
------------------------------ -------------------------------
Gross Gross Gross Gross
Premiums Par Premiums Par
Written Written Written Written
------------ ------------ ------------- ------------
Municipal finance:
Up-front:
New issue...................................... $ 117.1 $ 9,828 $ 25.5 $ 3,164
Secondary market............................... 11.0 677 3.1 333
------------ ------------ ------------- ------------
Sub-total up-front........................... 128.1 10,505 28.6 3,497
Installment...................................... 7.9 967 5.7 660
------------ ------------ ------------- ------------
Total municipal finance..................... 136.0 11,472 34.3 4,157
------------ ------------ ------------- ------------
Structured finance:
Up-front....................................... 6.2 650 18.5 1,859
Installment.................................... 33.8 9,058 25.5 6,597
------------ ------------ ------------- ------------
Total structured finance.................... 40.0 9,708 44.0 8,456
------------ ------------ ------------- ------------
International/(1)/:
Up-front....................................... 42.6 1,330 28.4 1,453
Installment.................................... 18.1 5,161 15.0 7,967
------------ ------------ ------------- ------------
Total international......................... 60.7 6,491 43.4 9,420
------------ ------------ ------------- ------------
Total....................................... $ 236.7 $ 27,671 $ 121.7 $ 22,033
------------ ------------ ------------- ------------
Total up-front.................................... $ 176.9 $ 12,485 $ 75.5 $ 6,809
Total installment................................. 59.8 15,186 46.2 15,224
------------ ------------ ------------- ------------
Total....................................... $ 236.7 $ 27,671 $ 121.7 $ 22,033
============ ============ ============= ============
Six Months Ended June 30,
---------------------------------------------------------------------
(Dollars in Millions) 2001 2000
-------------------------------- ---------------------------------
Gross Gross Gross Gross
Premiums Par Premiums Par
Written Written Written Written
-------------- -------------- --------------- --------------
Municipal finance:
Up-front:
New issue....................................... $ 152.2 $ 14,366 $ 49.0 $ 5,179
Secondary market................................ 15.5 1,224 6.4 596
-------------- -------------- --------------- --------------
Sub-total up-front............................ 167.7 15,590 55.4 5,775
Installment....................................... 13.9 1,871 10.3 815
------------ ------------ ------------- ------------
Total municipal finance................... 181.6 17,461 65.7 6,590
-------------- -------------- --------------- --------------
Structured finance:
Up-front........................................ 6.8 734 18.6 1,859
Installment..................................... 66.0 14,997 48.5 14,589
------------ ------------ ------------- ------------
Total structured finance.................. 72.8 15,731 67.1 16,448
-------------- -------------- --------------- --------------
International/(1)/:
Up-front........................................ 57.7 1,792 32.6 1,740
Installment..................................... 34.2 9,640 25.6 11,853
------------ ------------ ------------- ------------
Total international...................... 91.9 11,432 58.2 13,593
------------ ------------ ------------- ------------
Total..................................... $ 346.3 $ 44,624 $ 191.0 $ 36,631
------------ ------------ ------------- ------------
Total up-front...................................... $ 232.2 $ 18,116 $ 106.6 $ 9,374
Total installment................................... 114.1 26,508 84.4 27,257
-------------- -------------- --------------- --------------
Total..................................... $ 346.3 $ 44,624 $ 191.0 $ 36,631
============== ============== =============== ==============
(1) International par written includes structured credit derivatives of $4,215
million and $6,072 million for the three months ended June 30, 2001 and 2000,
respectively, and $7,511 million and $9,329 million for the six months ended
June 30, 2001 and 2000, respectively. Previously, gross par written was net of
par related to international deals that were ceded to MBIA Insurance Corporation
pursuant to a joint venture agreement that ceased during 2000. Prior period
amounts have been restated.
Ceded Premiums Written. Ceded premiums written for the three and six months
-----------------------
ended June 30, 2001 were $23.8 million and $36.5 million, respectively, a
decrease of 9% from $26.2
13
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
million in the three months ended June 30, 2000 and a decrease of 14% from $42.4
million in the six months ended June 30, 2000. Ceded premiums written were 10.0%
and 10.5% of gross premiums written for the three and six months ended June 30,
2001, respectively, compared with 21.6% and 22.2% for the three and six months
ended June 30, 2000, respectively. The decline in ceded premiums written for the
second quarter of 2001 was largely due to lower cessions on international
policies, partially offset by higher municipal cessions. The decrease in ceded
premiums written for the six months ended June 30, 2001 was primarily from a
one-time cede of municipal health care exposure during the first quarter of 2000
and lower cessions on international policies. During the second quarter of 2001,
Ambac Assurance began ceding under a new surplus share treaty that covers
certain large new issue policies that are underwritten directly by Ambac
Assurance.
Net Premiums Written. Net premiums written for the three and six months
---------------------
ended June 30, 2001 were $212.9 million and $309.9 million, respectively.
Increases of 123% and 109% from $95.4 million for the three months ended June
30, 2000 and $148.6 million for the six months ended June 30, 2000,
respectively, reflects the higher level of gross premiums written as well as
lower ceded premiums during their respective 2001 periods.
Net Premiums Earned. Net premiums earned during the three and six months
--------------------
ended June 30, 2001 were $93.4 million and $178.5 million, respectively, an
increase of 15% from $80.9 million in the three months ended June 30, 2000, and
an increase of 17% from $152.1 million in the six months ended June 30, 2000.
These increases were primarily the result of the larger financial guarantee book
of business during the periods. 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") increased 17% from $70.5 million in the second quarter of 2000 to
$82.8 million in the second quarter of 2001. Normal net premiums earned for the
six months ended June 30, 2001 were $161.8 million, an increase of 18% from
$137.1 million in the six months ended June 30, 2000. The increases in normal
net premiums earned resulted primarily from strong business written from prior
periods in all areas, particularly structured and international finance.
Net premiums earned include accelerated premiums that result from
refundings. When a guaranteed issue is called by the issuer or is in substance
paid in advance through a refunding, the remaining unearned premium is
recognized 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, 2001 included $10.6 million (which had a net income per
diluted share effect of $0.06) and $16.7 million (which had a net income per
diluted share effect of $0.09) from refundings. Net premiums earned for the
three and six months ended June 30, 2000 included $10.4 million (which had a net
income per diluted share effect of $0.06) and $15.0 million (which had a net
income per diluted share effect of $0.08) from refundings. During the second
quarter of 2000, Ambac performed a detailed review of its insured book of
business. This review resulted in the reporting of refunded issues totaling
approximately $7.5 million (net income per diluted share effect of $0.04) during
the second quarter of 2000.
Net Investment Income. Net investment income for the three and six months
----------------------
ended June 30, 2001 was $65.1 million and $129.5 million, respectively, an
increase of 11% from $58.9 million in the three months ended June 30, 2000 and
an increase of 11% from $116.5 million in the six months ended June 30, 2000.
The increases were primarily attributable to the growth of the investment
portfolio from ongoing operations, partially offset by a lower
14
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
reinvestment rate due to the current interest rate environment. Ambac
Assurance's investments in tax-exempt securities amounted to 70% of the total
fair value of its portfolio as of June 30, 2001, versus 76% at June 30, 2000.
The average pre-tax yield-to-maturity on the investment portfolio was 5.92% and
6.12% as of June 30, 2001 and 2000, respectively.
Net Realized Gains (Losses). Net realized gains for the three months ended
----------------------------
June 30, 2001 were $0.7 million. Net realized losses for the six months ended
June 30, 2001 were $3.6 million. This compares to net realized gains of $0.9
million and $0.4 million for the three and six months ended June 30, 2000.
Included in net realized gains (losses) for the three and six months ended June
30, 2001 are gains of $0.2 million and losses of $4.1 million, respectively, of
changes in foreign exchange related to Ambac Assurance's foreign denominated
short-term investments. Foreign exchange losses related to Ambac Assurance's
foreign denominated short-term investments for the three and six months ended
June 30, 2000 were $1.1 million and $2.0 million, respectively.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses
------------------------------------
for the three and six months ended June 30, 2001 were $4.8 million and $9.4
million, respectively, compared to $3.6 million and $6.8 million for the three
and six months ended June 30, 2000, respectively. Losses and loss adjustment
expenses are based upon estimates of the ultimate aggregate losses inherent in
the financial guarantee portfolio. The liability for losses and loss adjustment
expenses consists of the active credit reserve, which represents an estimate of
the expected annual levels of debt service defaults resulting from credit
failures on currently guaranteed issues that are not presently or imminently in
default, and case basis loss reserves for obligations in monetary default, or,
in the judgement of management, for which default is imminent. The following
table summarizes Ambac's loss reserves split between case basis loss reserves
and active credit reserves at June 30, 2001 and December 31, 2000.
(Dollars in millions) June 30, December 31,
2001 2000
--------------------- -----------------------
Net loss and loss adjustment expense reserves:
Case basis reserves * $ 36.9 $ 31.0
Active credit reserves 103.1 100.3
----------------------- -----------------------
Total $140.0 $131.3
----------------------- -----------------------
(*) After netting reinsurance recoverable amounting to $1.9 million and
$1.1 million at June 30, 2001 and December 31, 2000, respectively.
Management continually reviews and monitors the guaranteed book of business
for potential problem credits. Net additions were made to the case reserves of
$5.9 million and $4.5 million for the six months ended June 30, 2001 and 2000,
respectively. Losses paid and recoveries of previously paid losses were $1.6
million and $0.8 million for the six months ended June 30, 2001, respectively,
and $1.2 million and zero for the six months ended June 30, 2000, respectively.
The entire case reserves, losses paid and recoveries relate to the municipal
finance book of business for all periods presented.
Underwriting and Operating Expenses. Underwriting and operating expenses
------------------------------------
for the three and six months ended June 30, 2001 were $17.4 million and $34.1
million, respectively, an increase of 25% from $13.9 million in the three months
ended June 30, 2000 and an increase of 24% from $27.4 million in the six months
ended June 30, 2000. 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
15
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
commissions. During the three and six month periods ended June 30, 2001, gross
underwriting and operating expenses were $26.3 million and $51.3 million,
respectively, an increase of 28% from $20.6 million in the three months ended
June 30, 2000 and an increase of 25% from $41.0 million in the six months ended
June 30, 2000. The increase reflects the overall increased business activity
during the periods and are primarily due to increased compensation related to
new hires and increased premium tax expense. Underwriting and operating expenses
deferred for the three and six months ended June 30, 2001 were $16.0 million and
$31.3 million, respectively, and $12.6 million and $25.0 million for the three
and six months ended June 30, 2001, respectively. The amortization of previously
deferred expenses and reinsurance commissions for the three and six months ended
June 30, 2001 were $7.1 million and $14.1 million, respectively, and $5.9
million and $11.3 million for the three and six months ended June 30, 2000,
respectively.
Financial Services
Through its financial services subsidiaries, Ambac provides financial and
investment products including investment agreements, interest rate swaps,
funding conduits, investment advisory and cash management services, principally
to its financial guarantee clients which include municipalities and their
authorities, school districts, health care organizations and asset-backed
issuers.
Revenues. Revenues, excluding realized gains and losses, for the three and
---------
six months ended June 30, 2001 were $11.8 million and $26.2 million,
respectively, a decrease of 44% from $21.1 million in revenues for the second
quarter of 2000 and a decrease of 26% from $35.6 million for the six months
ended June 30, 2000. A decrease in municipal swap revenues of 54%, to $6.0
million in the second quarter of 2001 from $13.0 million in the second quarter
of 2001, was due to lower inception revenue during the second quarter of 2001.
Investment agreements declined 54%, from $5.2 million in revenues in the second
quarter of 2000 to $2.4 million in the second quarter of 2001, is due to lower
interest rate spreads. Investment advisory and cash management revenues
increased 13% to $3.4 million in the second quarter of 2001 compared to $3.0
million in the second quarter of 2000. Interest rate swap revenues for the six
months ended June 30, 2001 were $13.1 million, down 30% from $18.8 million in
the six months ended June 30, 2000. Investment agreement revenues for the six
months ended June 30, 2001 were $6.4 million, down 41% from $10.8 million in the
six months ended June 30, 2000. Investment advisory and cash management revenues
for the six months ended June 30, 2001 were $6.7 million, up 14% from $5.9
million in the six months ended June 30, 2000.
Expenses. Expenses for the three and six months ended June 30, 2001 were
---------
$6.0 million and $11.6 million, respectively, down 5% from $6.3 million in the
three months ended June 30, 2000 and down 9% from $12.8 million in the six
months ended June 30, 2000.
Corporate Items
Income Taxes. Income taxes for the three and six months ended June 30, 2001
-------------
were at an effective rate of 23.2% and 23.8%, respectively, versus 24.2% and
23.9% for the three and six months ended June 30, 2000. The decreased effective
tax rate in the second quarter of 2001 is primarily the result of a favorable
settlement of a state income tax audit. The increase
16
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
in the effective rate for the six months ended 2001 as compared to the prior
period is due to increased underwriting profits, partially offset by the
favorable settlement of a state income tax audit.
Supplemental Analytical Financial Data
Management, equity analysts and investors consider the following three
measures important in analyzing the financial results of Ambac: core earnings;
operating earnings; and adjusted gross premiums written. However, none of these
measures are promulgated in accordance with GAAP and should not be considered as
substitutes for net income and gross premiums written. The definitions of core
earnings, operating earnings, and adjusted gross premiums written described
below may differ from the definitions used by other public holding companies of
financial guarantee insurers.
Core Earnings. Ambac 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. Core earnings for the
three and six months ended June 30, 2001 were $101.2 million and $197.7 million,
respectively, an increase of 12% from $90.7 million for the three months ended
June 30, 2000 and an increase of 13% from $174.2 million for the six months
ended June 30, 2000. These increases were primarily the result of: higher normal
net premiums earned from the growth in the financial guarantee book of business
and higher net investment income from financial guarantee operations. These
increases were partially offset by higher expenses in the financial guarantee
segment and lower revenues from both the interest rate swap and investment
agreement businesses in the financial services segment.
Operating Earnings. Ambac defines operating earnings as consolidated net
-------------------
income, less the effect of net realized gains and losses and certain non-
recurring items. Operating earnings for the three and six months ended June 30,
2001 were $107.2 million and $207.2 million, respectively, an increase of 11%
from $96.6 million in the three months ended June 30, 2000 and an increase of
13% from $182.7 million for the six months ended June 30, 2000.
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, 2001 and 2000:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------
(Dollars in Millions) 2001 2000 2001 2000
------- ------- ------- -------
Net Income......................................... $ 107.6 $ 92.6 $ 205.2 $ 178.3
Net realized (gains) losses, after tax............. (0.4) 4.0 1.6 4.4
Non-recurring item, after tax...................... - - 0.4 -
------- ------ ------- -------
Operating earnings.............................. 107.2 96.6 207.2 182.7
Premiums earned from refundings, calls and other
accelerations, after tax.......................... (6.0) (5.9) (9.5) (8.5)
------- ------ ------- -------
Core earnings................................... $ 101.2 $ 90.7 $ 197.7 $ 174.2
======= ====== ======= =======
17
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Adjusted Gross Premiums Written. Ambac defines adjusted gross premiums written
- --------------------------------
as gross (direct and assumed) up-front premiums written plus the present value
of estimated installment premiums written on insurance policies and structured
credit derivatives issued in the period. Previously, adjusted gross premiums was
net of premiums related to international deals that were ceded to MBIA Insurance
Corporation pursuant to a joint venture that ceased during 2000. Prior period
amounts have been restated. Adjusted gross premiums for the three and six months
ended June 30, 2001 were $307.8 million and $465.5 million, respectively, up 44%
from $214.2 million in the three months ended June 30, 2000 and up 39% from
$334.7 million in the six months ended June 30, 2000. The increases in 2001 were
primarily due to increased activity in municipal and structured finance,
partially offset by a decline in international. On the municipal side, Ambac
benefited from increased municipal volume resulting from the lower interest rate
environment. Included in the overall mix of insured municipal issues were
several large transportation deals and several high-quality health care issues.
The structured business was dominated by consumer asset-backed transactions,
including the traditional mortgage-backed market and auto rental
securitizations. Adjusted gross premiums for the five largest structured
transactions increased from $37.1 million (one greater than $10 million) in the
second quarter of 2000 to $48.7 million (two greater than $10 million) in the
second quarter of 2001. Though international premiums written declined, the
comparison in part reflects the fact that the second quarter of 2000 included an
unusually large securitization issue in the United Kingdom. International
premiums in the second quarter of 2001 included a number of utilities and a
Private Finance Initiative transaction in the United Kingdom. The present value
of future installment premiums written for the three and six months ended June
30, 2001 was $130.9 million and $233.2 million, respectively, a decrease of 6%
from $138.7 million written in the second quarter of 2000 and an increase of 2%
from $228.1 million in the six months ended June 30, 2000.
The following table sets forth the amounts of adjusted gross premiums by
type and percent of total for the three and six months ended June 30, 2001 and
2000:
Three Months Ended June 30, Six Months Ended June 30,
------------------------------------- -------------------------------------
(Dollars in Millions) 2001 % 2000 % 2001 % 2000 %
------- ------- -------- ------ ------- ------ -------- --------
Municipal Finance:
Up-front:
New issue............................. $117.1 38% $ 25.5 12% $152.2 33% $ 49.0 14%
Secondary market...................... 11.0 4 3.1 1 15.5 3 6.4 2
------- ------- -------- ------ ------- ------ -------- --------
Sub-total up-front................. 128.1 42 28.6 13 167.7 36 55.4 16
Installment.............................. 17.0 5 10.6 5 25.7 5 13.9 4
------- ------- -------- ------ ------- ------ -------- --------
Total Municipal Finance........ 145.1 47 39.2 18 193.4 41 69.3 20
------- ------- -------- ------ ------- ------ -------- --------
Structured Finance:
Up-front.............................. 6.2 2 18.5 9 6.9 2 18.6 6
Installment........................... 73.3 24 47.4 22 126.4 27 104.1 31
------- ------- -------- ------ ------- ------ -------- --------
Total Structured Finance......... 79.5 26 65.9 31 133.3 29 122.7 37
------- ------- -------- ------ ------- ------ -------- --------
International /(1)/:
Up-front.............................. 42.6 14 28.4 13 57.7 12 32.6 10
Installment........................... 40.6 13 80.7 38 81.1 18 110.1 33
------- ------- -------- ------ ------- ------ -------- --------
Total International............. 83.2 27 109.1 51 138.8 30 142.7 43
------- ------- -------- ------ ------- ------ -------- --------
Total adjusted gross premiums................ $307.8 100% $ 214.2 100% $465.5 100% $334.7 100%
======= ======= ======== ====== ======= ====== ======== ========
Total up-front............................... $176.9 57% $ 75.5 35% $232.3 50% $106.6 32%
Total installment............................ 130.9 43 138.7 65 233.2 50 228.1 68
------- ------- -------- ------ ------- ------ -------- --------
Total adjusted gross premiums............... $307.8 100% $ 214.2 100% $465.5 100% $334.7 100%
======= ======= ======== ====== ======= ====== ======== ========
(1) Adjusted gross premiums written include reinsurance assumed of $27.1 million
and $41.6 million in the second quarter and six months of 2001. Adjusted gross
premiums written also include structured credit derivatives of $10.4 million and
$14.7 million for the three and six months ended June 30,2001, respectively, and
$14.2 million and $26.0 million for the three and six months ended June 30,
2000, respectively.
18
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Liquidity and Capital Resources
Ambac Financial Group, Inc. Liquidity. Ambac'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 and other
subsidiaries' ability to pay dividends or make payments to Ambac; 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, 2001, Ambac Assurance paid dividends of $34.0 million
on its common stock to Ambac. Also during the six months ended June 30, 2001,
Ambac Capital Corporation, a financial services wholly-owned subsidiary paid
dividends of $1.0 million on its common stock to Ambac.
Ambac's principal uses of liquidity are for the payment of its operating
expenses, interest on its debt, dividends on its shares of common stock,
purchases of its common stock in the open market and capital investments in its
subsidiaries. Based on the amount of dividends that it expects to receive from
Ambac Assurance and other subsidiaries during the next twelve months and the
income it expects to receive from its investment portfolio, management believes
that Ambac will have sufficient liquidity to satisfy its liquidity needs over
the next twelve months, including the ability to pay dividends on its common
stock in accordance with its dividend policy. Beyond the next twelve months,
Ambac Assurance's ability to declare and pay dividends to Ambac 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 Ambac 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 Ambac's operating expenses, debt service
obligations and 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, dividends to Ambac and capital investments in its subsidiaries.
Management 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, net investment income and receipts from structured credit
derivatives.
Financial Services Liquidity. The principal uses of liquidity by financial
-----------------------------
services subsidiaries are payment of investment agreement obligations pursuant
to defined terms, net obligations under interest rate swaps and related hedges,
operating expenses, income taxes and dividends to Ambac. Management believes
that its financial 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 maturity
schedule 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 of the financial
services subsidiaries are satisfied by short-term inter-company loans from
Ambac. The investment objectives with respect to investment agreements are to
achieve the highest after-tax total return, subject to a minimum average credit
quality rating of Aa/AA on invested
19
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
assets, and to maintain cash flow matching of invested assets to funded
liabilities to minimize interest rate and liquidity exposure. Financial services
maintain a portion of their assets in short-term investments and repurchase
agreements in order to meet unexpected liquidity needs.
Credit Facilities. Ambac and Ambac Assurance have a revolving credit
------------------
facility with four major international banks for $200 million, which expires in
August 2002 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, 2001 and December 31, 2000, no amounts were outstanding under this
credit facility.
Ambac Assurance maintains third party capital support in the form of seven-
year irrevocable limited recourse credit facilities from a group of highly rated
banks for $800 million. These credit facilities provide liquidity to Ambac
Assurance in the event claims from municipal or certain structured obligations
in its covered portfolios exceed specified levels. Repayments of amounts drawn
under the credit facilities are limited primarily to the amount of any
recoveries of losses related to policy obligations in the covered portfolios.
The line expires in December 2007. As of June 30, 2001 and December 31, 2000, no
amounts were outstanding under these facilities.
Ambac Credit Products, L.L.C. has a revolving credit facility with one
major international bank for $50 million that expires in June 2002 and provides
a three-year term loan provision. The facility is available to Ambac Credit
Products for general corporate purposes, including payments in regard to its
structured credit derivative activities. As of June 30, 2001 and December 31,
2000, no amounts were outstanding under this facility.
Stock Repurchase Program. The Board of Directors of Ambac has authorized
-------------------------
the establishment of a stock repurchase program that permits the repurchase of
up to 9,000,000 shares of Ambac's Common Stock. During the six months ended June
30, 2001, Ambac acquired approximately 150,000 shares for an aggregate amount of
$8.4 million. Since inception of the Stock Repurchase Program, Ambac has
acquired approximately 7,641,000 shares for an aggregate amount of $192.3
million.
Balance Sheet. Total assets as of June 30, 2001 were $10.81 billion, an
--------------
increase of 7% from $10.12 billion at December 31, 2000. This increase was
primarily due to an increase in the fair value of Ambac's investment portfolio.
This increase was provided by cash flows from financial guarantee operations. As
of June 30, 2001, stockholders' equity was $2.79 billion, a 7% increase from
year-end 2000 stockholders' equity of $2.60 billion. The increase stemmed
primarily from net income during the period.
Cash Flows. Net cash provided by operating activities was $326.0 million
-----------
and $175.5 million during the six months ended June 30, 2001 and 2000,
respectively. These cash flows were primarily provided by financial guarantee
operations.
Net cash provided by financing activities was $132.8 million during the six
months ended June 30, 2001, of which $143.2 million was provided by investment
agreements issued (net of draws paid). For the six months ended June 30, 2000,
$766.2 million was used in financing activities, of which $753.2 million was
used by investment agreements draws paid (net of investment agreements issued).
20
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Net cash used in investing activities was $469.0 million during the six
months ended June 30, 2001, of which $2,450.1 million was used to purchase
bonds, partially offset by the proceeds from sales and maturities of bonds of
$1,824.8 million. For the six months ended June 30, 2000, $589.1 million was
provided by investing activities, of which $1,563.5 million was provided by
sales and maturities of bonds, partially offset by purchases of bonds totaling
$1,014.3 million.
Material Commitments. Ambac has made no commitments for material capital
---------------------
expenditures within the next twelve months.
21
Item 3. Quantitative and Qualitative Disclosures About Market Risk
In the ordinary course of business, Ambac, through its affiliates, manages
a variety of risks, principally market, credit, liquidity, operational, and
legal. These risks are identified, measured and monitored through a variety of
control mechanisms that are in place at different levels throughout the
organization.
Market risk represents the potential for losses that may result from
changes in the value of a financial instrument as a result of changes in market
conditions. The primary market risks that would impact the value of Ambac's
financial instruments are interest rate risk, basis risk (taxable interest rates
relative to tax-exempt interest rates, discussed below) and credit spread risk.
Senior managers in Ambac's Risk Management Group are responsible for monitoring
risk limits and applying risk measurement methodologies. The estimation of
potential losses arising from adverse changes in market conditions is a key
element in managing market risk. Ambac utilizes various systems, models and
stress test scenarios to monitor and manage market risk. This process includes
frequent analyses of parallel and non-parallel shifts in the yield curve,
"Value-at-Risk" and changes in credit spreads. These models include estimates,
made by management, which 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 that may be adversely affected by changes in interest
rates consist primarily of investment securities, investment agreement
liabilities, debentures, certain derivative contracts (primarily interest rate
swaps) used for hedging purposes.
Financial instruments that may be adversely affected by changes in basis
include Ambac's municipal interest rate swap portfolio. Ambac, through its
affiliate Ambac Financial Services, L.P., is a provider of interest rate swaps
to states, municipalities and their authorities and other entities in connection
with their financings. Ambac Financial Services 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, Ambac will
experience a mark-to-market gain or loss. Since late 1995, most municipal
interest rate swaps transacted by Ambac Financial Services contain provisions
that are designed to protect Ambac against certain forms of tax reform, thus
mitigating its basis risk. The estimation of potential losses arising from
adverse changes in market relationships, known as VaR, is a key element in
management's monitoring of basis risk for the municipal interest rate swap
portfolio. Ambac has developed a VaR methodology to estimate potential losses
over a specified holding period and based on certain probabilistic assessments.
Ambac's methodology estimates VaR using a 300-day historical "look back" period.
This means that changes in market values are simulated using market inputs from
the past 300 days. Since no single measure can capture all dimensions of market
risk, Ambac supplements its VaR methodology by performing analyses of parallel
and non-parallel shifts in yield curves and stress test scenarios which measure
the potential impact of normal market conditions, which might cause abnormal
volatility swings or disruptions of market relationships.
Financial instruments that may be adversely affected by changes in credit
spreads include Ambac's outstanding structured credit derivative contracts.
Ambac, through its affiliate, Ambac Credit Products, enters into structured
credit derivative contracts. These contracts require Ambac Credit Products to
make payments upon the occurrence of certain defined credit events relating to
underlying obligations (generally fixed income obligations). If credit spreads
of the underlying obligations change, the market value of the related structured
credit derivative changes. As such, Ambac Credit Products could experience mark-
to-market gains or
22
Item 3. Quantitative and Qualitative Disclosures About Market Risk (Continued)
losses. Market liquidity could also impact valuations. Changes in credit spreads
are generally caused by changes in the market's perception of the credit quality
of the underlying obligations. The majority of Ambac Credit Product's contracts
are partially hedged with various financial institutions or structured with
first loss protection. Such structuring mitigates Ambac Credit Product's risk of
loss and reduces the price volatility of these financial instruments. Personnel
in Ambac's credit surveillance group monitor credit spread risk. Additionally,
management models the potential impact of credit spread changes on the value of
its contracts.
23
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 1, 2001, 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 94,289,393 76,231
Michael A. Callen 94,289,353 76,271
Renso L. Caporali 94,287,453 78,171
Jill M. Considine 94,289,591 76,033
Richard Dulude 94,287,091 78,533
Robert J. Genader 94,289,475 76,149
W. Grant Gregory 94,288,138 77,486
There were no broker non-votes for this proposal.
Proposal 2. The proposal to ratify the selection of KPMG LLP as independent
----------
auditors of the Company and its subsidiaries for 2001 was adopted, with
93,801,811 votes in favor, 313,196 votes against and 250,617 votes abstaining.
There were no broker non-votes for this proposal.
Item 6 - Exhibits and Reports on Form 8-K
(a) The following are annexed as exhibits:
Exhibit
Number Description
- ---------- -------------------------------------------------------
10.26 Second Extension of U.S. $50,000,000 Revolving
Credit Agreement, dated June 28 2001 among Ambac
Credit Products, LLC, the banks, financial
institutions and other institutional lenders (the
"Lenders"), and the Bank of New York, as Agent for
the Lenders.
10.27 Third Amendment to the BNS Agreement dated as of
August 3, 2001 among Ambac and Ambac Assurance as
the Borrowers, Citibank, N.A. as the Document
Agent and as Lender, The Bank of New York and Caja
Madrid, each as co-agent and as Lender, and The
Bank of Nova Scotia, as Administrative Agent for
the Lenders and, as Lender.
24
PART II - OTHER INFORMATION (Continued)
Exhibit
Number Description
99.04 Ambac Assurance Corporation and Subsidiaries
Consolidated Unaudited Financial Statements as of
June 30, 2001 and December 31, 2000 and for the
periods ended June 30, 2001 and 2000.
(b) Reports on Form 8-K:
On July 23, 2001, Ambac filed a Current Report on Form 8-K with its July
--------
18, 2001 press release containing unaudited interim financial information and
accompanying discussion for the three and six months ended June 30, 2001.
25
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 10, 2001 By: /s/ Frank J. Bivona
--------------------------
Frank J. Bivona
Vice Chairman and Chief
Financial Officer (Principal
Financial and Accounting Officer
and Duly Authorized Officer)
26
INDEX TO EXHIBITS
Exhibit
Number Description
- ---------- ------------------------------------------------------
10.26 Second Extension of U.S. $50,000,000 Revolving
Credit Agreement, dated June 28 2001 among Ambac
Credit Products, LLC, the banks, financial
institutions and other institutional lenders (the
"Lenders"), and the Bank of New York, as Agent for
the Lenders.
10.27 Third Amendment to the BNS Agreement dated as of
August 3, 2001 among Ambac and Ambac Assurance as
the Borrowers, Citibank, N.A. as the Document
Agent and as Lender, The Bank of New York and Caja
Madrid, each as co-agent and as Lender, and The
Bank of Nova Scotia, as Administrative Agent for
the Lenders and, as Lender.
99.04 Ambac Assurance Corporation and Subsidiaries
Consolidated Unaudited Financial Statements as of
June 30, 2001 and December 31, 2000 and for the
periods ended June 30, 2001 and 2000.
27