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AMBC > SEC Filings for AMBC > Form 10-Q on 14-Aug-2013All Recent SEC Filings

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Form 10-Q for AMBAC FINANCIAL GROUP INC


14-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Following this summary is a discussion addressing the consolidated results of operations and financial condition of Ambac Financial Group, Inc. "("Ambac" or "the Company") for the periods indicated. This discussion should be read in conjunction with Ambac's Annual Report on Form 10-K for the year ended December 31, 2012, the CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995 below and Risk Factors set forth in Part II, Item 1A of this Form 10-Q.

This Management's Discussion and Analysis of Financial Condition and Results of Operations contains certain financial measures, in particular the presentation of Operating Earnings and Adjusted Book Value, which are not presented in accordance with accounting principles generally accepted in the United States ("GAAP"). We are presenting these non-GAAP financial measures because they provide greater transparency and enhanced visibility into the underlying profitability drivers of our business. We do not intend for these non-GAAP financial measures to be a substitute for any GAAP financial measures and may differ from similar reporting provided by other companies. Readers of this Form 10-Q should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures. Operating Earnings and Adjusted Book Value are non-GAAP financial measures that adjust for the impact of certain non-recurring or non-economic GAAP accounting requirements and include the addition of certain items that the Company has or expects to realize in the future, but that are not reported under GAAP. We also provide reconciliations to the most directly comparable GAAP measure; Operating earnings to Net income
(loss) attributable to common stockholders and Adjusted Book Value to Total Ambac Financial Group, Inc. stockholders' equity (deficit).

CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF In this Quarterly Report, we have included statements that may constitute "forward-looking statements" within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Words such as "estimate," "project," "plan," "believe," "anticipate," "intend," "planned," "potential" and similar expressions, or future or conditional verbs such as "will," "should," "would," "could," and "may," or the negative of those expressions or verbs, identify forward-looking statements. We caution readers that these statements are not guarantees of future performance. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, which, may by their nature be inherently uncertain and some of which may be outside our control. These statements may relate to plans and objectives with respect to the future, among other things which may change. We are alerting you to the possibility that our actual results may differ, possibly materially, from the expected objectives or anticipated results that may be suggested, expressed or implied by these forward-looking statements. Important factors that could cause our results to differ, possibly materially, from those indicated in the forward-looking statements include, among others, those discussed under "Risk Factors" in Part I, Item 1A of the 2012 Annual Report on Form 10-K and in Part II, Item 1A of this Quarterly Report on Form 10-Q.

Any or all of management's forward-looking statements here or in other publications may turn out to be incorrect and are based on management's current belief or opinions. Ambac's actual results may vary materially, and there are no guarantees about the performance of Ambac's securities. Among events, risks, uncertainties or factors that could cause actual results to differ materially are: (1) adverse events arising from the rehabilitation proceedings for the Segregated Account of Ambac Assurance Corporation (the "Segregated Account"), including the failure of the injunctions issued by the Wisconsin rehabilitation court to protect the Segregated Account and Ambac Assurance from certain adverse actions; (2) litigation arising from the Segregated Account rehabilitation proceedings; (3) decisions made by the rehabilitator of the Segregated Account for the benefit of policyholders may result in material adverse consequences for Ambac's security holders; (4) intercompany disputes or disputes with the rehabilitator of the Segregated Account; (5) uncertainty concerning our ability to achieve value for holders of Ambac securities; (6) potential of a full rehabilitation proceeding against Ambac Assurance; (7) material changes to the Segregated Account rehabilitation plan or to current rules and procedures governing the payment of permitted policy claims, with resulting adverse impacts; (8) inadequacy of reserves established for losses and loss expenses, including our inability to realize the recoveries or future commutations included in our reserves; (9) market risks impacting assets in our investment portfolio or the value of our assets posted as collateral in respect of investment agreements and interest rate swap transactions; (10) risks relating to determinations of amounts of impairments taken on investments; (11) credit and liquidity risks due to unscheduled and unanticipated withdrawals on investment agreements; (12) market spreads and pricing on insured CLOs and other derivative products insured or issued by Ambac or its subsidiaries; (13) Ambac's financial position and the Segregated Account rehabilitation proceedings may prompt departures of key employees and may impact our ability to attract qualified executives and employees; (14) the risk of litigation and regulatory inquiries or investigations, and the risk of adverse outcomes in connection therewith, which could have a material adverse effect on our business, operations, financial position, profitability or cash flows; (15) credit risk throughout our business, including but not limited to credit risk related to residential mortgage-backed securities, student loan and other asset securitizations, CLOs, public finance obligations and exposures to reinsurers;
(16) default by one or more of Ambac Assurance's portfolio investments, insured issuers or counterparties; (17) the risk that our risk management policies and practices do not anticipate certain risks and/or the magnitude of potential for loss as a result of unforeseen risks; (18) factors that may influence the amount of installment premiums paid to Ambac, including the Segregated Account


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rehabilitation proceedings; (19) changes in prevailing interest rates; (20) the risk of volatility in income and earnings, including volatility due to the application of fair value accounting, required under the relevant derivative accounting guidance; (21) changes in accounting principles or practices that may impact Ambac's reported financial results; (22) legislative and regulatory developments; (23) operational risks, including with respect to internal processes, risk models, systems and employees; (24) changes in tax laws, tax disputes and other tax-related risks; and (25) other risks and uncertainties that have not been identified at this time.

COMPANY OVERVIEW

Ambac Financial Group, Inc. ("Ambac" or the "Company"), headquartered in New York City, is a holding company incorporated in the state of Delaware. On November 8, 2010, Ambac filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York ("Bankruptcy Court"). The Company, as debtor and debtor-in-possession, filed a Fifth Amended Plan of Reorganization on March 12, 2012, which was confirmed by order of the Bankruptcy Court on March 14, 2012 and modified in accordance with orders entered by the Bankruptcy Court on April 29, 2013 (such Fifth Amended Plan of Reorganization, as so modified, the "Reorganization Plan"). On April 30, 2013, Ambac executed a closing agreement with the United States Internal Revenue Service (the "IRS") to conclude the settlement of a dispute with the IRS, and concurrently paid $1.9 million, while the Segregated Account (as defined below) paid $100 million, to the United States in connection with such settlement. On May 1, 2013, the Reorganization Plan became effective and Ambac emerged from bankruptcy. Refer to Note 1 to the Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q for further discussion of Ambac's emergence from bankruptcy.

Ambac's primary goal is to maximize shareholder value through executing the following key strategies:

Increasing the value of its investment in Ambac Assurance Corporation ("Ambac Assurance") by actively managing its assets and liabilities with a focus on maximizing investment portfolio returns and mitigating or remediating losses on poorly performing transactions, including through executing policy commutations, repurchasing liabilities at a discount, pursuing recoveries of losses through litigation and the exercise of contractual and legal rights, and restructuring transactions; and

Pursuing new financial services businesses, apart from Ambac Assurance and Everspan Financial Guarantee Corp. These new businesses may include advisory, asset servicing, asset management and/or insurance.

Although we are exploring new business opportunities for Ambac, it is not possible at this time to predict the operating results or prospects of any future business. Our efforts to pursue new business opportunities may be unsuccessful or require significant financial or other resources. No assurance can be given that we will be able to identify or execute the acquisition or development of any new business. Due to these factors, as well as uncertainties relating to the ability of Ambac Assurance to deliver value to Ambac, the value of our securities is speculative. For additional risks and uncertainties concerning Ambac, please refer to Part I, Item 1A of Ambac's 2012 Form 10-K and

Part II, Item 1A of this Form 10-Q.

Ambac has two reportable business segments: Financial Guarantee and Financial Services.

Ambac's financial guarantee business was executed through its primary operating subsidiary, Ambac Assurance. Ambac Assurance provided financial guarantees and financial services to clients in both the public and private sectors globally. The deterioration of Ambac Assurance's financial condition resulting from losses in its insured portfolio caused downgrades and ultimately rating withdrawals of Ambac Assurance's financial strength ratings from the independent rating agencies. These losses have prevented Ambac Assurance from being able to write new business. Ambac Assurance is unable to pay dividends, and as a result Ambac's liquidity has been restricted.

In March 2010, Ambac Assurance established a segregated account pursuant to Wisc. Stat. 611.24(2) (the "Segregated Account") to segregate certain segments of Ambac Assurance's liabilities. As of June 30, 2013, insurance liabilities for policies allocated to the Segregated Account were $6,150.2 million. These insurance liabilities include loss reserves and loss expense reserves, gross of remediation and reinsurance recoveries. In March 2010, the Office of the Commissioner of Insurance for the State of Wisconsin ("OCI" (which term shall be understood to refer to such office as regulator of Ambac Assurance and to the Commissioner of Insurance for the State of Wisconsin as rehabilitator of the Segregated Account (the "Rehabilitator"), as the context requires)) commenced rehabilitation proceedings with respect to the Segregated Account (the "Segregated Account Rehabilitation Proceedings") in order to permit the OCI to facilitate an orderly run-off and/or settlement of the liabilities allocated to the Segregated Account pursuant to the provisions of the Wisconsin Insurers Rehabilitation and Liquidation Act. The Rehabilitator is Theodore Nickel, the Commissioner of Insurance of the State of Wisconsin. Refer to Note 1 to the Consolidated Financial Statements in Part II, Item 8 of Ambac's 2012 Form 10-K and to Note 1 to the Consolidated Financial Statements in Part I, Item I of this Form 10-Q for further discussion of the creation and rehabilitation of the Segregated Account.

Ambac's existing financial services segment is operated by subsidiaries of Ambac Assurance. This segment provided financial and investment products, including investment agreements, funding conduits, and interest rate swaps, principally to the clients of its


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financial guarantee business. Ambac Assurance insured all of the obligations of its financial services subsidiaries. The financial services businesses are in active runoff, which is being effectuated by means of transaction terminations, settlements, assignments and scheduled amortization of contracts.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Ambac's Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP"), which require the use of estimates and assumptions. For a discussion of Ambac's critical accounting policies and estimates, see "Critical Accounting Policies and Estimates" in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Ambac's Annual Report on Form 10-K for the year ended December 31, 2012. In conjunction with Ambac's emergence from bankruptcy, Ambac is required to implement fresh start reporting as further described in Note 2 of the Consolidated Financial Statements. In connection with the implementation of fresh start reporting, we have adopted an additional critical accounting policy related to goodwill as discussed below.

Goodwill:

At the Fresh Start Reporting Date, we revalued our assets and liabilities to current estimated fair value. The excess reorganization value which could not be attributed to the fair value of specific identified tangible and intangible assets was recorded as goodwill. Goodwill is not amortized but is subject to annual impairment testing and more frequent interim testing, if indicators of impairment exist for each reporting unit. The Company has an option to first assess qualitative factors, in their totality, to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform a goodwill impairment test as described below. If, the Company determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the Company is required to perform the goodwill impairment test.

Goodwill impairment is determined using a two-step approach. In the first step of the goodwill impairment test, the fair value of a reporting unit is compared with its carrying amount, including goodwill. In performing the first step, management determined the fair value of the reporting unit considering the market capitalization of Ambac. Determining the allocation of the market capitalization of Ambac to the reporting unit requires the exercise of significant judgment. If the fair value is in excess of the carrying amount, including goodwill, the reporting unit's goodwill is considered not to be impaired. If the carrying amount, including goodwill, of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. In the second step, the implied fair value of a reporting unit's goodwill is compared with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination and is defined as the excess of the fair value of a reporting unit over the fair value of the net assets of a reporting unit. If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized for the excess. If the carrying amount of goodwill is less than its implied fair value, no goodwill impairment is recognized.

We have identified two reporting units of Ambac: (1) Financial Guarantee, which provided financial guarantees (including credit derivatives) for public finance, structured finance and other obligations; and (2) Financial Services, which provided investment agreements, funding conduits, interest rate and currency swaps, principally to clients of the financial guarantee business. These reporting units are also the sole operating segments which make up the Financial Guarantee and Financial Services reportable segments, respectively, that are disclosed in Note 13 to the Unaudited Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q of the Consolidated Financial Statements. In evaluating which reporting units should be assigned goodwill, we considered the sources of Ambac's estimated enterprise value at the Fresh Start Reporting Date as further described in Note 2 to the Unaudited Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q. Based on that analysis, we have assigned all goodwill recorded at the Fresh Start Reporting Date to the Financial Guarantee reporting unit which we believe represents the only identified reporting unit that can be ascribed any enterprise value.

We will perform our annual impairment test as of October 1st of each year. Furthermore, we will perform interim impairment tests if we determine events or circumstances changed since the last impairment test that would more likely than not reduce the fair value of the Financial Guarantee reporting unit below its carrying amount. Factors we consider for determining whether an interim impairment test are necessary may include: i) macroeconomic conditions, ii) industry conditions, iii) operating cost factors, iv) company financial performance, v) changes in management, key personnel or strategy, vi) events affecting the composition or carrying amounts of net assets, and vii) a sustained decrease in Ambac's share price. After making this assessment as of June 30, 2013, we do not believe an interim impairment test is necessary and as a result, no goodwill impairment was recognized.


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FINANCIAL GUARANTEES IN FORCE

Financial guarantee products were sold in three principal markets: the U.S. public finance market, the U.S. structured finance and asset-backed market and the international finance market. The following table provides a breakdown of guaranteed net par outstanding by market sector at June 30, 2013 and December 31, 2012. Guaranteed net par outstanding includes the exposures of policies that insure variable interest entities ("VIEs") consolidated in accordance with the Consolidation Topic of the ASC, Consolidation. Guaranteed net par outstanding excludes the exposures of policies that insure bonds which have been refunded or pre-refunded:

                                  Successor Ambac  -           Predecessor Ambac -
     ($ in millions)                June 30, 2013               December 31, 2012
     Public Finance              $            128,450         $             143,018
     Structured Finance                        35,387                        42,359
     International Finance                     32,604                        38,256

     Total net par outstanding   $            196,441         $             223,633

Included in the above net par exposures at June 30, 2013 and December 31, 2012 are $5,861 and $11,282, respectively, of exposures that were executed in credit derivatives form.

As part of its efforts to increase the residual value of its financial guarantee business, Ambac Assurance pursues various loss mitigation strategies, including seeking recovery of paid claims, commencing litigation to recover losses or to mitigate future losses, entering into commutations of policies at discounts to their expected losses, other policy or exposure terminations, and purchasing Ambac-insured securities (collectively "de-risking"). Ambac Assurance considers the cash payment, if any, as well as the potential for lost future premium receipts in its review of the economic impact of such de-risking transactions. The change in guaranteed net par outstanding includes commutations, terminations, and settlements of $344 million relating to student loan exposure.

Ratings Distribution

The following tables provide a rating distribution of guaranteed total net par outstanding based upon internal Ambac Assurance credit ratings at June 30, 2013 and December 31, 2012 and a distribution by bond type of Ambac Assurance's below investment grade net par exposures at June 30, 2013 and December 31, 2012. Below investment grade is defined as those exposures with a credit rating below BBB-:

Percentage of Guaranteed Portfolio



                               Successor Ambac  -            Predecessor Ambac -
     Ambac Rating (1)            June 30, 2013                December 31, 2012
     AAA                                        <1 %                            1 %
     AA                                         21                             22
     A                                          44                             44
     BBB                                        20                             18
     Below investment grade                     15                             15

     Total                                     100 %                          100 %

(1) Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance, and for Ambac UK related transactions, based on the view of Ambac UK. In cases where Ambac Assurance or Ambac UK has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used. Ambac Assurance and Ambac UK credit ratings are subject to revision at any time and do not constitute investment advice.


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                   Summary of Below Investment Grade Exposure



                                                     Successor Ambac  -           Predecessor Ambac -
Bond Type                                              June 30, 2013               December 31, 2012
($ in millions)
Public Finance:
Housing (1)                                         $                761         $                 775
Tax-backed                                                           729                           741
Transportation                                                       519                           533
General obligation                                                   362                           392
Health care                                                           32                            11
Other                                                              1,298                         1,436

Total Public Finance                                               3,701                         3,888

Structured Finance:
Residential mortgage-backed and home equity-first
lien                                                               8,750                         9,592
Residential mortgage-backed and home
equity-second lien                                                 6,958                         7,533
Student loans                                                      4,693                         5,331
Structured Insurance                                               1,657                         1,657
Residential mortgage-backed and home equity-other                    374                           403
Other                                                                545                           554

Total Structured Finance                                          22,977                        25,070

International Finance:
Airports                                                              -                          1,504
Other                                                              3,258                         3,452

Total International Finance                                        3,258                         4,956

Total                                               $             29,936         $              33,914

(1) Includes $488 of military housing net par at June 30, 2013 and December 31, 2012.

The decrease in below investment grade exposures are primarily due to
(i) reductions to residential mortgage-backed securities during the year as a result of both voluntary prepayments by issuers and claims presented to Ambac Assurance; (ii) maturity of a portion of an international airport exposure resulting in an overall improvement in the credit quality of the remaining exposures; and (iii) principal payments on student loans (including commutation payments by Ambac).


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RESULTS OF OPERATIONS

We follow the accounting prescribed by the Reorganizations Topic of the ASC from the period starting with Ambac's bankruptcy filing through to our emergence from bankruptcy. Following the Company's emergence from bankruptcy on May 1, 2013, the consolidated financial statements reflect the application of fresh start reporting ("Fresh Start"), incorporating, among other things, the discharge of debt obligations, issuance of new common stock, and fair value adjustments. The effects of the reorganization and Fresh Start adjustments are recorded in Predecessor Ambac's Consolidated Statement of Total Comprehensive Income for the period ended April 30, 2013. The financial results of the Company for the periods from May 1, 2013 are referred to as "Successor" and the financial results for the periods through April 30, 2013 ("Fresh Start Reporting Date") are referred to as "Predecessor". The 2013 Successor Period and the 2013 Predecessor Period are distinct reporting periods. The effects of emergence and Fresh Start had a material impact on the comparability of our results of operations between these periods, as discussed below. However, certain references to 2013 results of operations combine the two periods when amounts are comparable to 2012 in order to enhance the comparability of such information. The significant Fresh Start items impacting comparability of both quarterly and year-to-date amounts are as follows:

Investment Income: As required under Fresh Start, the amortized cost basis of Ambac's fixed income securities were adjusted to fair value as of the Fresh Start Reporting Date. This resulted in an overall increase in the amortized cost of fixed income securities and offsetting decrease in Accumulated Other Comprehensive Income of $826.6 million. Premiums and discounts are amortized or accreted over the remaining term of the securities using the effective interest method. As a result of Fresh Start, the net unamortized discount in the portfolio decreased on the Fresh Start Reporting Date by the amount of the increase to amortized cost described above, which will impact the amount of premium amortization and discount accretion reflected in net investment income of Successor Ambac.

Interest Expenses: As required under Fresh Start, surplus notes issued by Ambac Assurance and the Segregated Account and the related accrued interest on such . . .

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