(Source: Business Wire)
Ambac Financial Group, Inc. (NYSE: ABK) (Ambac) today announced a second quarter 2009 net loss of $2,396.6 million, or a net loss of $8.33 per share. This compares to a second quarter 2008 net income of $823.1 million, or income of $2.80 on a fully-diluted per share basis. The second quarter 2009 results reflect higher loss and loss expenses primarily related to the residential mortgage-backed securities (RMBS) insured portfolio and other-than-temporary impairment losses in its investment portfolios related to RMBS and tax-exempt municipal securities that it is prepared to sell. Additionally, during the quarter Ambac increased its deferred tax asset valuation allowance. In 2008, Ambac's second quarter results reflected a positive change in fair value of credit derivatives amounting to $961.6 million, primarily related to its own credit spreads widening; and a reduction of loss reserves amounting to $339.3 million, primarily related to the insured second lien residential mortgage-backed securities portfolio.
Quarter Summary
Net loss and loss expenses incurred amounted to $1,230.8 million for the quarter, primarily relating to second-lien and Alt-A RMBS transactions.
AAC and the investment agreement business recorded other-than-temporary impairment losses amounting to $675.4 million and $186.7 million, respectively, related to the decision during the second quarter 2009 to sell certain investment portfolio securities.
The deferred tax asset valuation allowance currently represents substantially all of the gross deferred tax asset at June 30, 2009. The increased estimate in the valuation allowance was primarily driven by continued weakening in Ambac Assurance Corporation's (AAC's) insured RMBS transactions and the resultant decreased ability to reliably project future taxable income.
During July 2009, Ambac reduced a significant portion of its exposure under a collateralized debt obligation of asset-backed securities (CDO of ABS) transaction via a settlement, and commuted all of its exposure under another CDO of ABS transaction. The two transactions, with an aggregate of approximately $2.8 billion net notional outstanding at June 30, 2009, were settled with counterparties for a total cash payment of approximately $746 million.
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 detail in our Operating Supplement.
Estimated statutory impairment losses within the credit derivatives portfolio amounted to $1,568.7 million during the quarter, driven by rising forward LIBOR rates, which increase estimated future cash outflows, and further deterioration of the underlying collateral within CDO of ABS transactions.
Statutory loss and loss expenses incurred amounted to $751.0 million for the quarter ended June 30, 2009.
Statutory capital and surplus of AAC amounts to $305.6 million at June 30, 2009. The Office of the Commissioner of Insurance of the State of Wisconsin (OCI) permitted AAC to release approximately $1.8 billion of contingency reserves, thereby increasing its capital and surplus by that amount.
On July 15, 2009, Ambac completed its acquisition of the asset management and advisory business of NSM Capital Management LLC.
Ambac's President and Chief Executive Officer, David Wallis, commented, "The quarter's financial results are obviously very disappointing, as continued poor performance of the mortgage-related portfolios and rising forward interest rates have escalated projections of future claims." Mr. Wallis continued, "While overshadowed by our results, we continue to work hard and make progress in our expanding risk management activity."
Financial Results
Net Premiums Earned
Net premiums earned for the second quarter of 2009 were $177.7 million, down 45% from $325.5 million earned in the second quarter of 2008. Normal earned premiums amounted to $143.9 million and $166.2 million in the second quarter 2009 and 2008, respectively. As a result of 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 $33.8 million in the second quarter of 2009, down significantly from $159.2 million in the second quarter 2008. During the second quarter 2008, a lack of liquidity in the auction rate and variable rate bond markets had resulted in significant refinancing activity in the municipal sector.
Net Investment Income
Net investment income excluding variable interest entities for the second quarter of 2009 was $120.4 million, representing a decrease of 5% from $127.3 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 $800 million proceeds 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.
Other-Than-Temporary Impairment Losses
Other-than-temporary losses in the AAC investment portfolio amounted to ($675.4) million in the second quarter of 2009, compared to a net loss of ($2.4) million in the second quarter 2008. In connection with the Company's revised investment strategies, during the second quarter 2009, management determined its intent to sell certain investment securities (primarily Alt-A RMBS securities rated below investment grade by Moody's or S&P and tax-exempt municipal securities) held in the insurance company investment portfolio.As a result of this decision, other-than-temporary impairment charges were recorded through earnings on such securities that were in an unrealized loss position. These amounts represent the entire difference between the amortized cost and estimated fair value of the impacted securities as of June 30, 2009. Prior to management's decision to sell these securities, unrealized losses were recorded in stockholders' equity.
Net Change in Fair Value of Credit Derivatives
The net change in fair value of credit derivatives, which comprises realized gains/(losses) and other settlements from credit derivatives and unrealized gains/(losses) on credit derivatives, was a gain of $1.0 million for the second quarter of 2009, compared to a gain of $976.6 million in the comparable period of 2008.
Realized gains/(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 second quarter of 2009 and 2008 amounted to ($5.0) million and $15.0 million, respectively. Second quarter 2009 premiums received of $12.2 million were offset by paid losses of $17.2 million while second quarter 2008 premiums received of $16.7 million were offset by $1.7 million of losses paid.
Net unrealized gains/(losses) on credit derivative contracts were $6.0 million in the three months ended June 30, 2009, compared to $961.6 million in the three months ended June 30, 2008. The net gain during the second quarter of 2009 is primarily the result of: (i) improvement in the average pricing level of CLO reference obligations; and (ii) amortization of notional outstanding in the CDO of ABS portfolio. The positive effects were largely offset by: (i) the adverse effect of higher default probabilities in our fair value model caused by internal ratings downgrades; and (ii) the net increase in mark-to-market liabilities due to the effect of movements in AAC's credit spreads (FAS 157 adjustment). The second quarter 2008 gain was driven by significant increases in AAC's credit spreads, partially offset by negative adjustments for internal ratings downgrades and lower quoted values on the reference obligations.
During July 2009, Ambac reduced a significant portion of its exposure under a CDO of ABS transaction via a settlement, and commuted all of its exposure under another CDO of ABS transaction. The two transactions, with an aggregate of approximately $2.8 billion net notional outstanding at June 30, 2009, were settled with counterparties for cash payments totaling approximately $746 million.
Financial Guarantee Loss Reserves
Total net loss and loss expenses were $1,230.8 million in the second quarter 2009, compared to a net reduction in loss reserves amounting to ($339.3) million recorded in the second quarter of 2008. Losses and loss expenses in the second quarter 2009 were primarily related to second-lien and Alt-A RMBS insured securities as continued deterioration beyond that which had been expected at March 31, 2009, continues to be observed.
In accordance with 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 2.2%.
Total net claims paid of $400.8 million, exclusive of amounts received under reinsurance commutations during the quarter, were primarily related to RMBS transactions and highly concentrated in the second-lien portfolio.
Loss and loss expense reserves for all RMBS insurance exposures at June 30, 2009 total $3,216.1 million. RMBS reserves are net of $1,162.1 million of estimated remediation recoveries. The remediation benefit increased $280.1 million from $882.0 million at June 30, 2009, directly as a result of continued identification of representation and warranty breaches observed during a continuing intense loan re-underwriting initiative during the second quarter.
Financial Services
The financial services segment comprises the investment agreement business and the derivative products business. Gross interest income less gross interest expense from investment and payment agreements plus results from the derivative products business, excluding net realized investment gains and losses and unrealized gains and losses on total return swaps and non-trading derivative contracts, was ($33.5) million in the second quarter of 2009, down from ($16.7) million in the second quarter of 2008. Derivative products results declined by $28.7 million, primarilydue to losses realized on transactions professional derivative counterparties terminated as a result of the downgrades of AAC as guarantor of the swaps. The majority of our professional derivative counterparties retain the right to terminate contracts and, accordingly, we may have similar losses in the future. The negative effect of swap termination costs was partially offset by the reduction of high rate resets associated with cost of funds swaps, which resets have been limited through mitigation strategies and less volatility in market rates. Net investment income from the investment agreement business improved by $11.5 million primarily as a result of favorable variable interest rate reset adjustments as compared to the second quarter of 2008 and the effects of intercompany loans from AAC.
Other-than-temporary losses in the investment agreement investment portfolio amounted to ($186.7) million in the second quarter of 2009. Similar to the insurance company strategy discussed above, during the second quarter 2009 management determined its intent to sell certain investment securities (primarily Alt-A RMBS securities rated below investment grade by Moody's or S&P) held in the investment agreement investment portfolio.
The interest rate swap and investment agreement businesses are in run-off. The investment and payment agreement portfolio has been reduced by approximately $1.1 billion during the first six months of 2009 to approximately $1.5 billion at June 30, 2009, through negotiated terminations, terminations contractually triggered by rating downgrades of AAC, and scheduled amortization.
Taxes
Due to continued deterioration in Ambac's exposures to mortgage-related securities and the resultant decreased ability to reliably project future taxable income, the tax benefit generated during the quarter was fully offset by a valuation reserve. Additionally, during the quarter Ambac recorded a $573.9 million valuation allowance against the balance of the unreserved deferred tax asset from the prior quarter.
