Ambac Announces First Quarter 2014 Results Favorable Loss Reserve Development and Execution of Commutation Strategy Drive Results

NEW YORK, NY, May 12, 2014 (GLOBE NEWSWIRE) -- Ambac Financial Group, Inc. (Nasdaq: AMBC) ("Ambac" or the “Company”), a holding company whose subsidiaries, including Ambac Assurance Corporation (“Ambac Assurance”), provide financial guarantees and other financial services to clients in both the public and private sectors globally, today reported results for the three months ended March 31, 2014.

Commenting on today’s announcement, Diana N. Adams, President and Chief Executive Officer said, “We are pleased to report another quarter of solid financial results. Our efforts in the first quarter remained focused on carrying out our value creation initiatives, which included the acquisition of approximately $280 million par of student loan securities in anticipation of commuting the associated expected future losses. This purchase is another step forward in our strategy to pursue opportunities for loss mitigation through proactive management of our insurance and investment portfolios.”

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 financial results of the Company relating to periods beginning May 1, 2013 are referred to as “Successor” and the financial results relating to periods through April 30, 2013 (“Fresh Start Reporting Date”) are referred to as “Predecessor”.

Net income in the first quarter 2014 was $155.9 million, or $3.31 per diluted share, compared with $282.3 million, or $0.93 per diluted share, in the first quarter 2013. During the same periods, operating earnings were $176.6 million, or $3.75 per diluted share compared with $297.4 million, or $0.98 per diluted share.

Net premiums earned include normal net premiums, and accelerated premiums, which result from calls and other policy accelerations recognized during the period. For the first quarter of 2014, net premiums earned were $82.5 million, as compared to $100.3 million in the first quarter of 2013. The decrease in net premiums earned was primarily driven by decreases in public finance and structured finance normal earned premiums resulting from the run-off of the associated insured portfolios. In addition, accelerated premiums earned decreased as a result of lower public finance and structured finance refundings, partially offset by an increase in international accelerated premiums. The following table provides a summary of net premiums earned for the three month periods ended March 31, 2014 and March 31, 2013:

Net investment income for the first quarter of 2014 was $70.8 million, as compared to $84.5 million for the first quarter of 2013. The decrease in net investment income was driven primarily by Fresh Start adjustments that increased the overall amortized cost basis and decreased the effective yield of the portfolio for Successor Ambac.

The decline in investment income was moderated by the ongoing reallocation of the Financial Guarantee investment portfolio away from municipal securities towards more diversified assets and distressed Ambac insured securities purchased as part of the Company’s loss remediation strategy. Financial Services investment income continues to decline, as the investment agreement portfolio runs off and the balance of investment agreement assets declines accordingly.

Net other-than-temporary impairments of invested assets recognized in earnings was $10.4 million for the three months ended March 31, 2014 compared to no impairments for the three months ended March 31, 2013. Net other-than-temporary impairments in the first quarter of 2014 relate to credit losses on certain Ambac insured securities purchased as part of its risk remediation strategy and the Company’s intent to sell certain securities that were in an unrealized loss position as of March 31, 2014 in connection with its portfolio reallocation initiative referenced above. Our ongoing assessment of liquidity, particularly in light of the previously announced proposed amendments to the Plan of Rehabilitation, could result in Ambac being required to sell securities that are in an unrealized loss position, which could result in additional other-than-temporary impairment charges in the future.

Net realized investment gains for the first quarter of 2014 were $16.3 million, as compared to $46.1 million for the first quarter of 2013. The first quarter of 2014 included gains associated with the sale of certain assets pursuant to Ambac’s remediation activities, gains on securities sold in connection with the investment

portfolio reallocation initiative, and foreign exchange losses of $2.1 million. Net gains for the first quarter of 2013 were primarily the result of recoveries from the settlement of litigation associated with investment securities that were previously written-off.

The gain attributable to the change in fair value of credit derivatives for the three months ended March 31, 2014 was $7.4 million as compared to $12.8 million for the three months ended March 31, 2013. The change in fair value of credit derivatives for both periods includes improvement in reference obligation prices, gains associated with the runoff of the portfolio and credit derivative fees earned, net of the impact of the Ambac Assurance credit valuation adjustment (“Ambac CVA”). The reduction in the Ambac CVA resulted in losses within the overall change in fair value of credit derivative liabilities of $9.8 million for the three months ended March 31, 2014, and $69.5 million for the three months ended March 31, 2013.

The derivative products portfolio has been positioned to generate gains in a rising interest rate environment in order to provide an economic hedge against the impact of rising rates on certain exposures within the financial guarantee insurance portfolio. Derivative products revenue for the three months ended March 31, 2014 was a loss of $53.8 million as compared to a loss of $0.6 million for the three months ended March 31, 2013. Derivative products revenue during both periods reflect mark-to-market gains and losses in the portfolio caused by changing interest rates offset by the impact of the Ambac CVA in the valuation of financial services derivatives. The first quarter 2014 loss was driven by falling interest rates partially offset by gains of $5.4 million from the impact of the Ambac CVA. In the first quarter of 2013, interest rate driven gains were more than offset by losses of $30.1 million from the impact of the Ambac CVA.

VIE losses for the three months ended March 31, 2014 were $5.5 million, as compared to a gain of $38.3 million for the three months ended March 31, 2013. Losses on VIEs for the first quarter of 2014 reflect the decreased fair value of net assets related primarily to the lower CVA applied to certain VIE note liabilities that include significant projected financial guarantee claims. Gains in the first quarter 2013 reflect increases to the fair value of net assets arising from longer estimated lives of certain transactions.

Loss and loss expenses (benefit) for the first quarter of 2014 were $(140.0) million, as compared to $(51.1) million for the three months ended March 31, 2013. First quarter 2014 results were driven by lower estimated losses in residential mortgage-backed securities (“RMBS”) and student loan securities, partially offset by higher estimated losses as a result of declines in discount rates during the period. Reductions in RMBS estimated losses were primarily due to historical and projected housing price appreciation and improved performance in underlying transactions. In the first quarter 2014, Ambac acquired approximately $280 million par of student loan securities and is anticipating commuting the expected future losses. With this purchase, the Company’s view of the likelihood of commutations for such securities increased, resulting in lower probability weighted loss reserves. The first quarter 2013 was impacted by lower estimated losses in RMBS and public finance, partially offset by higher estimated losses in student loan securities.

During the first quarter of 2014, loss and loss expenses paid, net of recoveries and reinsurance from all policies, were $9.4 million as compared to $(12.3) million during the first quarter of 2013. The change was primarily the result of lower claims paid and lower subrogation received. Claims paid include 25% of policy claims permitted and paid by the Segregated Account, all claims presented to the General Account, and supplemental and special payments made as required by the Rehabilitator. Subrogation received includes recoveries under and in connection with RMBS transactions.

Although the Rehabilitation Plan for the Segregated Account has not become effective, the Segregated Account is currently paying 25% of permitted policy claims pursuant to a Rehabilitation Court order. As of March 31, 2014, approximately $4.0 billion of such policy claims remained unpaid.

As previously announced, the Rehabilitator is seeking Rehabilitation Court approval to amend the Rehabilitation Plan. Assuming that the amendments to the Rehabilitation Plan are approved and based on a 5.1% annual interest rate being applicable to all unpaid portions of permitted policy claims, accrued interest

on the unpaid portions of permitted policy claims would be approximately $277 million through March 31, 2014. This accrued interest amount is currently not reflected in the Company’s financial results and will be recorded only upon approval of these amendments by the Rehabilitation Court.

Loss reserves (gross of reinsurance and net of subrogation recoveries) were $5.3 billion at March 31, 2014 and $5.5 billion at December 31, 2013. 

The following table provides loss reserves by bond type at March 31, 2014 and December 31, 2013:

Reserves as of March 31, 2014 and December 31, 2013, are net of $2.2 billion of estimated representation and warranty breach remediation recoveries. Ambac Assurance is pursuing remedies and enforcing its rights, through lawsuits and other methods, to seek redress for breaches of representations and warranties and fraud related to various RMBS transactions.

Gross operating expenses for the three months ended March 31, 2014 were $25.9, compared to $28.3 million for the three months ended March 31, 2013. The decrease in expenses was largely driven by lower compensation-related expenses in the first quarter 2014 compared to the same period last year.

The following table provides a summary of interest expense for the three month periods ended March 31, 2014 and March 31, 2013:

If the Rehabilitation Plan is amended in the form proposed by the Rehabilitator, the Rehabilitator intends to redeem certain Segregated Account surplus notes (other than junior surplus notes) at a redemption price that would include an amount equal to accrued interest on such redeemed surplus notes. Any such payment would also trigger similar proportionate redemption payments on Ambac Assurance's surplus notes. Settlement of these liabilities would result in a charge representing the accelerated recognition of the unamortized discount on the redeemed surplus notes. Ambac will record this charge only upon redemption of such notes. As of March 31, 2014, the unamortized discount on the portion of Segregated Account and General Account surplus notes expected to be redeemed was $82.4 million.

The provision for income taxes of $3.2 million for the first quarter 2014, compared to $0.6 million for the same period last year. First quarter 2014 income taxes consist primarily of alternative minimum taxes. Both periods also included income tax expense as a result of pre-tax profits in Ambac UK’s Italian branch, which cannot be offset by losses in other jurisdictions.

At March 31, 2014 the Company had $5.2 billion of U.S. Federal net operating loss carryforwards (“NOLs”), including $1.4 billion at Ambac Financial Group and $3.8 billion at Ambac Assurance.

Total assets at March 31, 2014 were $27.1 billion, unchanged from December 31, 2013. The fair value of the consolidated non-VIE investment portfolio was $6.7 billion and $6.5 billion at March 31, 2014 and at December 31, 2013, respectively.  The fair value of the financial guarantee investment portfolio was $6.3 billion at March 31, 2014, up $0.2 billion from $6.1 billion at December 31, 2013.

Total liabilities at March 31, 2014 were $25.9 billion, a decrease of approximately $0.2 billion from $26.1 billion at December 31, 2013. The decrease was primarily the result of a decrease in VIE liabilities, loss and loss expense reserves and unearned premium reserves, partially offset by increases in payable for securities purchased and derivative liabilities.

In addition to reporting the Company’s financial results in accordance with GAAP, the Company reports two non-GAAP financial measures: Operating Earnings and Adjusted Book Value. A non-GAAP financial measure is a numerical measure of financial performance or financial position that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with 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 and the impact of certain items that the Company believes will reverse from GAAP book value over time through the GAAP statements of comprehensive income. Operating Earnings and Adjusted Book Value are not substitutes for the Company’s GAAP reporting, should not be viewed in isolation and may differ from similar reporting provided by other companies, which may define non-GAAP measures differently.

Operating Earnings were $176.6 million, or $3.75 per diluted share, for the three months ended March 31, 2014 as compared to $297.4 million, or $0.98 per diluted share, for the three months ended March 31, 2013. Insurance intangible amortization was the primary difference between net income and operating earnings in the first quarter of 2014.

The following table reconciles Net Income attributable to common shareholders to the non-GAAP measure, Operating Earnings, for the three month periods ended March 31, 2014 and March 31, 2013:

Adjusted Book Value was ($187.2) million as of March 31, 2014, as compared to ($280.7) million at December 31, 2013.

The following table reconciles Total Ambac Financial Group, Inc. stockholders’ equity (deficit) to the non-GAAP measure Adjusted Book Value as of each date presented:

Operating Earnings. Operating earnings eliminate the impact of certain GAAP accounting requirements and include certain items that the Company has realized or expects to realize in the future, but that are not reported under GAAP. Operating earnings is defined as net income attributable to common shareholders, as reported under GAAP, adjusted on an after-tax basis for the following:

Adjusted Book Value. Adjusted Book Value eliminates the impact of certain GAAP accounting requirements and includes the addition of certain items that the Company has realized or expects to realize in the future, but that are not reported under GAAP. Adjusted Book Value is defined as Total Ambac Financial Group, Inc. stockholders’ equity (deficit) as reported under GAAP, adjusted for after-tax impact of the following:

of the Financial Services—Insurance Topic of the ASC, whether or not they are subject to consolidation accounting rules.

Ambac has a significant NOL that is offset by a full valuation allowance in the GAAP consolidated financial statements. As a result, for purposes of Adjusted Book Value, we utilized a 0% effective tax rate. We maintain a full valuation allowance against our deferred tax asset and recognition of the value of the NOL would be reflected in Adjusted Book Value considering all the facts and circumstances as of the relevant reporting date.

The following significantly affect the comparability of first quarter 2014 results:

financial guarantee insurance and reinsurance contracts will continue to be reported and measured in accordance with existing accounting policies; these line items primarily comprise premiums receivable, reinsurance recoverable on paid and unpaid losses, unearned premiums, deferred ceded premium, subrogation recoverable, losses and loss expense reserve, and ceded premiums payable. Pursuant to the business combinations guidance for insurance entities in Financial Services—Insurance Topic of the ASC, the insurance intangible asset is amortized into expense on a basis consistent with the related financial guarantee insurance or reinsurance contracts.

In this press release, 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 2013 Annual Report on Form 10-K and in Part II, Item 1A of our Quarterly Report on Form 10-Q for the three month period ended March 31, 2014, and under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 2 of the Quarterly Report on Form 10-Q for the three month period ended March 31, 2014.

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) volatility in the price of Ambac’s common stock; (2) uncertainty concerning our ability to achieve value for holders of Ambac securities, whether from Ambac Assurance Corporation (“Ambac Assurance”) or from new business opportunities, including risks associated with the possible dilution of the ownership interests of our stockholders; (3) our inability to achieve the financial results projected during our Chapter 11 proceeding; (4) potential of rehabilitation proceedings against Ambac Assurance; (5) decisions made by the Rehabilitator of the Segregated Account of Ambac Assurance Corporation (the “Segregated Account”) for the benefit of policyholders that may result in material adverse consequences for Ambac’s security holders; (6) our inability to realize the expected recoveries included in our financial statements; (7) intercompany disputes or disputes with the Rehabilitator of the Segregated Account; (8) 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; (9)  decisions of the Rehabilitator concerning payments of deferred claim amounts or payments on surplus notes, the timing or magnitude of which is disadvantageous to Ambac, (10) increased fiscal stress experienced by issuers of public finance obligations or an increased incidence of Chapter 9 filings by municipal issuers; (11) adverse events arising from the rehabilitation proceedings for 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; (12) adverse tax consequences or other costs resulting from the Segregated Account rehabilitation plan or from rules and procedures governing the payment of permitted policy claims; (13) credit risk throughout our business, including but not limited to credit risk related to residential mortgage-backed securities, student loan and other asset securitizations, collateralized loan obligations, public finance obligations and exposures to reinsurers; (14) risks attendant to the change in composition of securities in our investment portfolio; (15) inadequacy of reserves established for losses and loss expenses; (16) 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; (17) changes in prevailing interest rates; (18) factors that may influence the amount of installment premiums paid to Ambac, including the Segregated Account rehabilitation proceedings; (19) default by one or more of Ambac Assurance’s portfolio investments, insured issuers or counterparties; (20) 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; (21) risks relating to determinations of amounts of impairments taken on investments; (22) credit and liquidity risks due to unscheduled and unanticipated withdrawals on investment agreements; (23) 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; (24) system security risks; (25) the effects of U.S. fiscal policies; (26) market spreads and pricing on derivative products insured or issued by Ambac or its subsidiaries; (27) the risk of volatility in income and earnings, including volatility due to the application of fair value accounting; (28) changes in accounting principles or practices that may impact Ambac’s financial results, including those resulting from potential amendments to the Segregated Account Rehabilitation Plan; (29) legislative and regulatory developments; (30) operational risks, including with respect to internal processes, risk models, systems and employees, and failures in services or products provided by third parties; (31) Ambac’s financial position and the Segregated Account rehabilitation proceedings that may prompt departures of key employees and may impact our ability to attract qualified executives and employees; and (32) other risks and uncertainties that have not been identified at this time.