(Source: Business Wire)
Ambac Financial Group, Inc. (NYSE: ABK) (Ambac) today announced a first quarter 2009 net loss of $392.2 million, or a net loss of $1.36 per share. This compares to the first quarter 2008 net loss of $1,660.3 million, or a net loss of $11.69 on a per share basis. The first quarter 2009 results reflect pre-tax net income amounting to $279.7 million resulting primarily from a positive net change in fair value of credit derivatives. The unrealized gain in credit derivatives was partially offset by loss and loss expenses primarily related to the residential mortgage-backed securities (RMBS) portfolio and other-than-temporary impairment write downs of RMBS securities in the investment portfolio. During the quarter Ambac increased its deferred tax asset valuation allowance by approximately $600 million, causing the after-tax net loss. The first quarter 2008 results reflected a net change in fair value of credit derivatives amounting to ($1,708.2) million as a result of deterioration in certain insured CDO of ABS transactions and loss and loss expenses amounting to $1,042.8 million related to RMBS securities.
Quarter Summary
Net positive change in fair value of credit derivatives amounted to $1,545.9 million, driven primarily by Ambac Assurance Corporation (AAC) credit spread widening during the period. Estimated impairment losses in this portfolio did not change significantly during the quarter.
Net loss provisioning amounted to $739.8 million for the quarter primarily relating to the RMBS insurance portfolio.
AAC and the investment agreement business recorded $744.7 million and $85.5 million, respectively, of other-than-temporary impairment write-downs related to Alt-A RMBS securities held in their respective investment portfolios.
The deferred tax asset valuation allowance increased by approximately $600 million during the quarter. For the purposes of estimating future taxable income available to utilize net operating losses, management revised its estimate of potential future investment income and increases in loss reserves to conservatively reflect the potential impact that further deterioration in Ambac's insured portfolio would have on future taxable income. The revised estimate was primarily driven by continuing deterioration in AAC's insured RMBS transactions and the impact of the low interest rate environment on projected investment income.
FAS 163 was implemented on January 1, 2009. Due to changes in calculations of certain income statement items such as net premiums earned and loss and loss expenses, 2009 and 2008 amounts are not comparable, as described in further detail below.
On April 13, 2009, Moody's downgraded Ambac Assurance Corp. and Ambac Assurance UK Limited to Ba3 from Baa1. The rating downgrade had no material impact on corporate-wide liquidity or collateral requirements.
Ambac's President and Chief Executive Officer, David Wallis, commented, "The credit environment remains adverse, although perhaps the rate of degradation is slowing. We remain focused upon our key strategic initiatives of: (i) aggressively managing our existing book of business; (ii) identifying strategic opportunities that take advantage of our core competencies and assets; and (iii) sensibly accessing outside capital to enable the launch of our public finance-only financial guarantee subsidiary, Everspan." Mr. Wallis continued, "Looking forward, I believe that the resilience of our business model combined with the efforts of our entire staff positions us well in relation to the ultimate goal of restoring value for our key stakeholders."
Financial Results
Implementation of FAS 163
Effective January 1, 2009, Ambac adopted SFAS No. 163, "Accounting for Financial Guarantee Insurance Contracts, an interpretation of SFAS 60, Accounting and Reporting by Insurance Enterprises" (FAS 163). The new standard clarifies how SFAS No. 60, "Accounting and Reporting by Insurance Enterprises," applies to financial guarantee insurance contracts issued by insurance enterprises, including the recognition and measurement of premium revenue and claim liabilities. Accordingly, results for premium revenue and losses incurred are not comparable from 2008 to 2009. Under FAS 163:
Ambac is required to record unearned premiums for upfront and installment paying transactions. Installment unearned premiums are established in an amount equal to: (i) the present value of future contractual premiums due or, (ii) if the underlying insured obligation is a homogenous pool of assets which are contractually pre-payable (primarily RMBS securities), the present value of premiums expected to be collected over the life of the transaction. Prior to implementation of FAS 163, Ambac recorded unearned premiums only for premiums received in advance.
Ambac is required to recognize premium revenue for both up-front and installment paying policies by recognizing a fixed percentage of premium to the amount of exposure outstanding at each reporting date (referred to as the level-yield approach), rather than being recognized over the term of each maturity for up-front paying policies. For installment paying policies, FAS 163 also requires that the accretion discount, equating to the difference between the undiscounted installment premiums and the present value of installment premiums, be recognized through the income statement.
Ambac is required to recognize a loss reserve for the excess of: (a) the present value of expected net cash outflows to be paid under the insurance contract (expected loss), over (b) the unearned premium revenue for that contract. To the extent (a) is less than (b), no loss reserve will be recorded. Changes to the loss reserve estimate in subsequent periods will be recorded as a loss expense in the income statement.
Net Loss Per Share
Net loss per share is computed in conformity with U.S. generally accepted accounting principles (GAAP). However, many research analysts and investors do not limit their analysis of our earnings to a strictly GAAP basis. In order to assist investors in their understanding of quarterly results, Ambac provides additional information.
Earnings measures reported by research analysts exclude the net impact of net gains and losses from sales of investment securities and mark-to-market gains and losses on credit, total return and non-trading derivative contracts that are not impaired (collectively "net security gains and losses") and certain other items. Certain research analysts and investors further exclude the net income impact of accelerated premiums earned on guaranteed obligations that have been refunded and other accelerated earnings ("accelerated earnings"). Table I, below, provides first quarter comparisons of loss for 2009 and 2008.
Table I Earnings Per Share First Quarter 2009 2008 Net loss per share ($1.36 ) ($11.69 ) Effect of net security losses (gains) ($1.86 ) $4.76 Operating loss (a)(b) ($3.22 ) ($6.93 ) Effect of accelerated earnings ($0.09 ) ($0.15 ) Core loss ((b)) ($3.31 ) ($7.08 ) -------------------------------------------------------------------------------
(a) Consensus earnings that are reported by earnings estimate services, such as First Call, are on this basis. (b) Operating and core loss are non-GAAP measures. See footnote 1, below. -------------------------------------------------------------------------------
Net Premiums Earned
Net premiums earned for the first quarter of 2009 were $196.8 million, up 5% from $186.9 million earned in the first quarter of 2008. Normal earned premiums amounted to $155.8 million and $172.9 million in the first quarter 2009 and 2008, respectively. With the implementation of FAS 163, as discussed above, normal earned premium amounts reported in 2009 are not comparable to amounts that were reported in 2008.
Net premiums earned include accelerated premiums, which result from refundings, calls and other accelerations recognized during the quarter. Accelerated premiums were $41.0 million in the first quarter of 2009, up from $14.0 million in the first quarter 2008. During the first quarter of 2009 and 2008, approximately 87% and 66%, respectively, of the accelerated premiums related to U.S. public finance transactions.
A breakout of net premiums earned by market sectorfor 2009 and 2008 are included in Table II. Normal net premiums earned exclude accelerated premiums that result from refundings, calls and other accelerations.
Table II Net Premiums Earned $-millions 2009 2008 Public Finance $ 49.6 $ 55.8 Structured Finance 58.8 70.4 International 47.4 46.7 Total Normal Premiums 155.8 172.9 Accelerated Premiums 41.0 14.0 Total $ 196.8 $ 186.9 -------------------------------------------------------------------------------
Net Realized (Losses)/Gains
Net realized (losses)/gains in the AAC investment portfolio amounted to a net loss of ($742.9) million in the first quarter of 2009, down from a gain of $22.2 million in the first quarter 2008. The first quarter 2009 net loss was driven by other-than-temporary impairment write-downs of certain Alt-A RMBS securities amounting to ($744.7) million in the quarter. The Alt-A RMBS securities had been purchased from the Financial Services investment agreement business in the fourth quarter 2008 and the first quarter 2009, as approved by the Wisconsin Office of the Commissioner of Insurance (OCI) to provide the investment agreement business with liquidity required for collateral and terminating its agreements.
Net Investment Income
Net investment income excluding variable interest entities for the first quarter of 2009 was $97.5 million, representing a decrease of 19% from $120.0 million in the comparable period of 2008. The decrease was primarily due to lower invested assets driven by reductions in the portfolio to pay commutations on CDO of ABS transactions and RMBS claim payments, partially offset by $1.3 billion in funds received via the capital raise in March 2008, $800 million from the issuance of AAC preferred stock in December 2008 and January 2009, and cash flow from the collection of financial guarantee premiums, tax refunds and fees and coupon receipts on invested assets. Net investment income was also negatively impacted by the re-balancing of the portfolio to a greater proportion of short-term securities, and lower yields on invested assets compared to the first quarter 2008.
Net Change in Fair Value of Credit Derivatives
The net change in fair value of credit derivatives was $1,545.9 million for the first quarter of 2009, compared to ($1,708.2) million in the comparable period of 2008.
Realized gain/(losses) and other settlements from credit derivative contracts represents the normal accretion into income of premiums received for transactions executed in credit derivative format, offset by loss and settlement payments on such transactions. Net realized gains/(losses) and other settlements from credit derivative contracts in the first quarter of 2009 amounted to $6.6 million, representing $13.2 million of net premiums received partially offset by paid losses of $6.6 million. In the first quarter 2008, premiums received amounted to $17.0 million while no loss payments were made.
Net unrealized gains/(losses) on credit derivative contracts were $1,539.2 million in the three months ended March 31, 2009, compared to ($1,725.2) million in the three months ended March 31, 2008. The net gain during the first quarter of 2009 is primarily the result of: (i) the effect of incorporating widening AAC credit default swap spreads into the measurement of fair value of credit derivative liabilities; and (ii) longer estimates of the weighted average lives of certain CDO of ABS transactions at March 31, 2009 compared to December 31, 2008. The positive effects were partially offset by: (i) the adverse effect of higher default probabilities in our fair value model caused by internal ratings downgrades; and (ii) declining market values on underlying reference obligations. The consideration of Ambac's own credit risk in measuring the change in fair value of credit derivatives as required under FAS 157 resulted in positive adjustments of $4,489 million and $1,616 million to the reported change in fair value during the three months ended March 31, 2009 and 2008, respectively.
Ambac reports credit impairments on CDO of ABS transactions where we believe we may have to pay claims in the future. Ambac's estimate of credit impairment did not change significantly from December 31, 2008 to March 31, 2009.
Financial Guarantee Loss Reserves
Total net loss and loss expenses were $739.8 million in the first quarter 2009, down 29% from $1,042.8 million in the first quarter of 2008. Losses and loss expenses in the first quarter 2009 were heavily concentrated in the RMBS insurance portfolio. Continued deterioration in the performance of the underlying RMBS loans was observed, most prominently in the Alt-A affordability product (negative amortization and interest-only loans).
Under the provisions of FAS 163, Ambac changed the discount rate it uses to estimate the present value of future loss payments from 4.5% in 2008 to the weighted average estimated risk-free rate of approximately 1.5%. Additionally, Ambac will no longer characterize loss reserves as active credit reserves and case reserves as FAS 163 does not distinguish between reserves for transactions that have defaulted and those established for probable and estimable losses due to credit deterioration on insured transactions that have not yet defaulted.
A roll forward of loss reserves from December 31, 2008 to March 31, 2009 is shown in Table III.
