Following this summary is a discussion addressing the consolidated results of operations and financial condition ofAmbac Financial Group, Inc. ("AFG") for the periods indicated. References to "Ambac ," the "Company," "we," "our," and "us" are to AFG and its subsidiaries, as the context requires. This discussion should be read in conjunction withAmbac's Annual Report on Form 10-K for the year endedDecember 31, 2019 , 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 ("MD&A") contains certain financial measures, in particular the presentation of Adjusted Earnings and Adjusted Book Value, which are not presented in accordance withU.S. generally accepted accounting principles ("GAAP"). We are presenting these non-GAAP financial measures because they provide greater transparency and enhanced visibility into the underlying drivers of our business. We do not intend for these non-GAAP financial measures to be a substitute for any GAAP financial measures and they 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. Adjusted 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 provide reconciliations to the most directly comparable GAAP measures; Adjusted Earnings to Net income attributable to common stockholders and Adjusted Book Value toTotal Ambac Financial Group, Inc. stockholders' equity. CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 Management has included in Parts I and II of this Quarterly Report on Form 10-Q, including this MD&A, 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 2019 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
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performance ofAmbac's securities. Among events, risks, uncertainties or factors that could cause actual results to differ materially are: (1) the highly speculative nature of AFG's common stock and volatility in the price of AFG's common stock; (2) uncertainty concerning the Company's ability to achieve value for holders of its securities, whether fromAmbac Assurance Corporation ("Ambac Assurance") and its subsidiaries or from transactions or opportunities apart fromAmbac Assurance and its subsidiaries, including new business initiatives; (3) changes inAmbac's estimated representation and warranty recoveries or loss reserves over time; (4) failure to recover claims paid onPuerto Rico exposures or incurrence of losses in amounts higher than expected; (5) adverse effects on AFG's share price resulting from future offerings of debt or equity securities that rank senior to AFG's common stock; (6) potential of rehabilitation proceedings againstAmbac Assurance ; (7) dilution of current shareholder value or adverse effects on AFG's share price resulting from the issuance of additional shares of common stock; (8) inadequacy of reserves established for losses and loss expenses and possibility that changes in loss reserves may result in further volatility of earnings or financial results; (9) increased fiscal stress experienced by issuers of public finance obligations or an increased incidence of Chapter 9 filings or other restructuring proceedings by public finance issuers, including an increased risk of loss on revenue bonds of distressed public finance issuers due to recent judicial decisions adverse to revenue bond holders; (10)Ambac's inability to realize the expected recoveries included in its financial statements; (11) insufficiency or unavailability of collateral to pay secured obligations; (12) credit risk throughoutAmbac's business, including but not limited to credit risk related to residential mortgage-backed securities, student loan and other asset securitizations, public finance obligations (including obligations of theCommonwealth of Puerto Rico and its instrumentalities and agencies) and exposures to reinsurers; (13) credit risks related to large single risks, risk concentrations and correlated risks; (14) the risk that theAmbac's risk management policies and practices do not anticipate certain risks and/or the magnitude of potential for loss; (15) risks associated with adverse selection asAmbac's insured portfolio runs off; (16) adverse effects on operating results or the Company's financial position resulting from measures taken to reduce risks in its insured portfolio; (17) disagreements or disputes withAmbac's insurance regulators; (18) our inability to mitigate or remediate losses, commute or reduce insured exposures or achieve recoveries or investment objectives, or the failure of any transaction intended to accomplish one or more of these objectives to deliver anticipated results; (19)Ambac's substantial indebtedness could adversely affect its financial condition and operating flexibility; (20)Ambac may not be able to obtain financing or raise capital on acceptable terms or at all due to its substantial indebtedness and financial condition; (21)Ambac may not be able to generate the significant amount of cash needed to service its debt and financial obligations, and may not be able to refinance its indebtedness; (22) restrictive covenants in agreements and instruments may impairAmbac's ability to pursue or achieve its business strategies; (23) loss of control rights in transactions for which we provide insurance due to a finding thatAmbac has defaulted; (24) the impact of catastrophic environmental or natural events, including catastrophic public health events like the COVID-19 pandemic, on significant portions of our insured and investment portfolios; (25) adverse tax consequences or other costs resulting from the characterization ofAmbac Assurance's surplus notes or other obligations as equity; (26) risks attendant to the change in composition of securities inAmbac's investment portfolio; (27) changes in prevailing interest rates; (28) the expected discontinuance of the London Inter-Bank Offered Rate; (29) factors that may influence the amount of installment premiums paid toAmbac ; (30) default by one or more ofAmbac 's portfolio investments, insured issuers or counterparties; (31) market risks impacting assets in theAmbac's investment portfolio or the value of our assets posted as collateral in respect of interest rate swap transactions; (32) risks relating to determinations of amounts of impairments taken on investments; (33) 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 onAmbac's business, operations, financial position, profitability or cash flows; (34) actions of stakeholders whose interests are not aligned with broader interests ofAmbac's stockholders; (35) system security risks, data protection breaches and cyber attacks; (36) changes in accounting principles or practices that may impactAmbac's reported financial results; (37) the economic and regulatory impact of "Brexit"; (38) operational risks, including with respect to internal processes, risk and investment models, systems and employees, and failures in services or products provided by third parties; (39)Ambac's financial position that may prompt departures of key employees and may impact the its ability to attract qualified executives and employees; (40) fluctuations in foreign currency exchange rates could adversely impact the insured portfolio in the event of loss reserves or claim payments denominated in a currency other than US dollars and the value of non-US dollar denominated securities in our investment portfolio; and (41) other risks and uncertainties that have not been identified at this time. EXECUTIVE SUMMARY Company Overview: See Note 1. Background and Business Description to the Unaudited Consolidated Financial Statements, included in Part I, Item 1 in this Form 10-Q and Note 1. Background and Business Description in the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , for a description of the Company and our key strategic priorities to achieve our primary goal to maximize stockholder value.Ambac Assurance and Subsidiaries: A key strategy forAmbac is to increase the value of its investment inAmbac Assurance by actively managing its assets and liabilities. Asset management primarily entails maximizing the risk adjusted return on non-VIE invested assets and managing liquidity to help ensure resources are available to meet operational and strategic cash needs. These strategic cash needs include activities associated withAmbac's liability management and loss mitigation programs. Asset Management: Investment portfolios are subject to internal investment guidelines, as well as limits on types and quality of investments imposed by applicable insurance laws and regulations. As part of its investment strategy, and in accordance with the aforementioned guidelines,Ambac Assurance and AmbacUK , a subsidiary ofAmbac Assurance , purchase distressedAmbac -insured securities based on their relative risk/reward characteristics. The investment portfolios ofAmbac Assurance and AmbacUK also hold fixed income securities and various pooled investment funds. Refer to
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Note 8. Investments to the Unaudited Consolidated Financial Statements, included in Part I, Item 1 in this Form 10-Q for further details of fixed income investments by asset category and pooled investment funds by investment type. AtMarch 31, 2020 ,Ambac and its subsidiaries owned$402 million of distressedAmbac -insured bonds, including$164 million ofPuerto Rico bonds and excludingAmbac's holdings of secured notes issued by Ambac LSNI in connection with the Rehabilitation Exit Transactions. Subject to applicable internal and regulatory guidelines, market conditions and other constraints,Ambac will continue to opportunistically purchaseAmbac -insured securities. Liability and Insured Exposure Management:Ambac Assurance's Risk Management Group focuses on the analysis, implementation and execution of commutations, risk reduction or defeasance, and loss recovery strategies. Analysts evaluate the estimated timing and severity of projected policy claims as well as the potential impact of loss mitigation or remediation strategies in order to target and prioritize policies, or portions thereof, for commutation, reinsurance, refinancing, restructuring or other risk reduction strategies. For targeted policies, analysts will engage with issuers, bondholders and other economic stakeholders to negotiate, structure and execute such strategies. During 2020, successful risk reduction transactions included: • A commutation inJanuary 2020 , via a refunding, of a watch list public
finance transaction with net par outstanding of
2019; and
• A refinancing in
leasing transaction with net par outstanding of
2019.
The following table provides a comparison of total, adversely classified credits ("ACC") and watch list credits net par outstanding in the insured portfolio atMarch 31, 2020 andDecember 31, 2019 . Net par exposure within theU.S. public finance market includes capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bonds. March 31, December 31, ($ in millions) 2020 2019 Variance Total$ 36,186 $ 38,018 $ (1,832 ) (5 )% ACC 8,376 7,535 841 11 % Watch list 5,442 6,752 (1,310 ) (19 )% The overall reduction in ACC andWatch List total net par outstanding resulted from active de-risking initiatives atAmbac Assurance and AmbacUK , including the transactions noted above, as well as scheduled maturities, amortizations, refundings and calls. Additionally, total net par outstanding reduced as a result of the weakening of British Pounds as compared to US Dollars. The increase in ACC exposures is primarily due to the addition of credits impacted by COVID-19 (including$970 million of net par outstanding from the watch list category), such as hotel tax, convention center and public house insured transactions, partially offset by active de-risking and paydowns or calls by issuers. In addition, as a result of the economic impacts from the COVID-19 pandemic,$2,635 million of net par outstanding in sectors such as mass transit, toll roads, and private higher education, among others, have been added to the Survey List. The Survey List is a categorization for enhanced monitoring of currently performing credits. We continue to experience stress in our exposure toPuerto Rico that consists of several different issuing entities (all below investment grade). Each issuing entity has its own credit risk profile attributable to discreet revenue sources, direct general obligation pledges and general obligation guarantees. Refer to Part 1, Item 1 in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , for additional information regarding the different issuing entities that encompassAmbac's exposures toPuerto Rico . COVID-19 InMarch 2020 , the outbreak of COVID-19, caused by a novel strain of the coronavirus, was recognized as a pandemic by theWorld Health Organization , and the outbreak is now widespread globally, including in the markets in which we operate. The COVID-19 outbreak has had a notable impact on general economic conditions, including but not limited to a sharp spike in unemployment; a broad based and significant decrease in asset valuations; closure or severe curtailment of the operations of many businesses and enterprises to which we are directly or indirectly exposed, such as hotels, restaurants, sports and entertainment facilities, airports and other transportation facilities, and retail establishments, mostly due to shelter-in-place orders, social distancing guidelines, travel bans and restrictions, and business shutdowns. In addition, inMarch 2020 a disagreement betweenRussia andSaudi Arabia over oil production quotas led to a sudden and sharp decline in oil prices which have subsequently fallen to historic lows. Accordingly, we are now in a global recession with most large economies experiencing negative growth. In theU.S. , monetary policy and fiscal stimulus, particularly the Coronavirus Aid, Relief and Economic Security ("CARES") Act, have helped moderate the economic impact of COVID-19, along with stimulus and other actions taken by governments outside theU.S. ; however, credit risk remains a concern given the uncertainty over the severity and duration of the COVID-19 related disruption. COVID-19 has impactedAmbac's operating environment.Ambac has implemented a COVID-19 response plan designed to ensure the safety of our staff and business continuity. Our employees have transitioned to working remotely while maintaining full operational capabilities. We have not experienced and do not anticipate incurring material incremental operating expenditures to maintain the current remote operating environment. In addition to our own staff,Ambac's critical third-party service providers are operating remotely and therefore we have conducted a review of these service providers and have not presently identified or experienced any limitations or operational constraints with respect to services provided in the current environment.Ambac does not believe that our current operating environment has resulted in a significant change to our disclosure controls or internal controls over financial reporting. COVID-19 has adversely impactedAmbac's financial position and results of operations as credit risk in the insured and investment portfolios has increased. Municipal, project finance, mortgage-backed and student loan sectors, and other asset securitizations, in particular, could be materially adversely impacted, and as a result
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we have increased loss reserves across each of these and other sectors during the three months endedMarch 31, 2020 . We are continuously evaluating and updating our view of the macro economic environment as well as our specific credit view of each of our insured exposures considering the significant uncertainties brought upon us by the COVID-19 pandemic. The overall financial impact from COVID-19 has been and will be a function of (i) the ability of issuers of insured obligations and other counterparties to pay their obligations when due, whether due to operational or financial reasons; (ii) the impact of changes to interest rates on policy and derivative payments and (iii) the performance of the investment portfolio. •Ambac's insurance policies will be drawn in the event that the issuers of
insured obligations do not make payments on their obligations when due. As a
result of the COVID-19 related economic disruption on markets where
provides financial guarantees, including lower tax, project, and business
revenues and increases in forbearances or delinquencies on mortgage and
student loan payments, we have increased our loss reserves and may further
increase them in the future depending on the duration and severity of the
crisis.
any significant delay or increase in credit impairments with respect to
insurance premiums, but that is subject to change.
•
claim payments.
outstanding to four reinsurance counterparties. Each of these reinsurance
counterparties is experienced in the business of reinsuring and/or writing
financial guaranty insurance. All have ratings of A+ (by S&P) or better and
have sufficient collateralization or replacement triggers upon downgrade.
believes they have the ability to perform under their respective reinsurance
policies, but that is subject to change.
•
under our RMBS litigations and derivative counterparties) may default in their financial obligations, whether as the result of insolvency, lack of
liquidity, operational failure, fraud or other reasons. At present,
no concerns about the ability of our contractual counterparties, which
include certain regulated exchanges in the case of interest rate swaps and
futures, to perform under their contracts, but that is also subject to
change.
• Asset prices have declined substantially during the quarter, particularly in
directly affected industries such as tourism, airlines, hospitality,
commercial real estate and manufacturing. While
significant investments in these asset classes, we did experience a negative
total return for the investment portfolio of approximately (4.4)% during the
three month period ending
credit impairments on the investment portfolio as of such date. However, in
early
investments in certain assets classes; including corporate securities rated
below the 'A 'rated category, all directly owned CMBS (other than Military
Housing bonds and mostly 'AAA' rated), and approximately
50% of all CLOs (all rated investment grade). While these positions were sold at a net gain, future investment losses and impairments may be possible. Given the economic uncertainties associated with the COVID-19 pandemic it is impossible to fully predict all of its consequences and, as a result, it is possible that our future operating results and financial condition may be materially adversely affected. Refer to "Financial Guarantees In Force", "Results of Operations" and "Balance Sheet Commentary" for further financial details on the current impact from COVID-19. With regard toAmbac's new business strategic objective, we continue to evaluate opportunities in a disciplined manner. Our evaluation process has been revised to incorporate consideration of the impact of COVID-19 on new business prospects as well asAmbac's existing business and operations. While we continue to pursue new business opportunities, we believe that the COVID-19 pandemic has caused a general slow down in activity as potential targets evaluate the financial and strategic impact of the pandemic on their businesses and due to the practical constraints of shelter-in-place orders, social distancing guidelines, travel bans and restrictions, and business shutdowns. AFG: As ofMarch 31, 2020 the net assets of AFG were$482 million . ($ in millions) Cash and short-term investments$ 317 Other investments (1) 157 Other net assets (2) 8 Total$ 482
(1) Includes surplus notes (fair value of
that are eliminated in consolidation.
(2) Includes accruals for tolling payments from
with the Amended Tax Sharing Agreement of
Income Taxes for discussion over the timing of collection.
Financial Statement Impact of Foreign Currency: The impact of foreign currency as reported inAmbac's Unaudited Consolidated Statement of Total Comprehensive Income for the three months endedMarch 31, 2020 , included the following: ($ in millions) Net income (1) $ 1 Gain (loss) on foreign currency translation
(46 ) Unrealized gains (losses) on non-functional currency available-for-sale securities
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Impact on total comprehensive income (loss) $
(34 )
(1) A portion of Ambac
liabilities are denominated in currencies other than its functional currency
and accordingly, we recognized net foreign currency transaction
gains/(losses) as a result of changes to foreign currency rates through our
Unaudited Consolidated Statement of Total Comprehensive Income (Loss). Refer
to Note 2. Basis of Presentation and Significant Accounting Policies to the
Unaudited Consolidated Financial Statements included in Part I, Item 1 in
this Form 10-Q for further details on transaction gains and losses.
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Future changes to currency rates may adversely affect our financial results. Refer to Part II, Item 7A in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 for further information on the impact of future currency rate changes onAmbac's financial instruments. CRITICAL ACCOUNTING POLICIES AND ESTIMATESAmbac's Unaudited Consolidated Financial Statements have been prepared in accordance withU.S. generally accepted accounting principles ("GAAP"), which require the use of material estimates and assumptions. For a discussion ofAmbac'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 inAmbac's Annual Report on Form 10-K for the year endedDecember 31, 2019 . FINANCIAL GUARANTEES IN FORCE Financial guarantee products were sold in three principal markets:U.S. public finance,U.S. structured finance and international finance. The following table provides a breakdown of guaranteed net par outstanding by market atMarch 31, 2020 andDecember 31, 2019 . Net par exposures within theU.S. public finance market include capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bonds. Guaranteed net par outstanding includes the exposures of policies insuring 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 and excludes exposure of the policy that insures the notes issued by Ambac LSNI as defined in Note 1. Background and Business Description in the Notes to the Consolidated Financial Statements included in Part II, Item 8 in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 :March 31 ,December 31 ,
($ in millions) 2020 2019 Public Finance (1) (2)$ 17,093 $ 17,653 Structured Finance 7,139 7,508 International Finance 11,954 12,857 Total net par outstanding$ 36,186 $ 38,018
(1) Includes
(2) Includes
2020 and
outstanding include capital appreciation bonds which are reported at the par
amount at the time of issuance of the related insurance policy as opposed to
the current accreted value of the bonds.
The table below showsAmbac's ten largest insured exposures, by repayment source, as a percentage of total financial guarantee net par outstanding atMarch 31, 2020 : % of Total Ambac Net Par Net Par ($ in millions) Risk Name Country-Bond Type Ratings (1) Outstanding (2) Outstanding IF AUK Mitchells & Butlers Finance UK-Asset BBB $ 957 2.6 % plc-UK Pub Securitisation Securitizations IF AUK Capital Hospitals plc (3) UK-Infrastructure A- 830 2.3 % IF AUK Aspire Defence Finance plc UK-Infrastructure A- 802 2.2 % New Jersey Transportation Trust US-Lease and PF AAC Fund Authority - Transportation Tax-backed Revenue BBB- 778 2.2 % System IF AUK Anglian Water UK-Utility A- 772 2.1 % IF AUK National Grid Gas UK-Utility A- 713 2.0 % IF AUK Posillipo Finance II S.r.l Italy-Sub-Sovereign BIG 698 1.9 % IF AUK Ostregion Investmentgesellschaft Austria-Infrastructure BIG 662 1.8 % NR 1 SA (3) PF AAC Mets Queens Baseball Stadium US-Stadium Financing BBB- 540 1.5 % Project, NY, Lease Revenue IF AUK RMPA Services plc UK-Infrastructure BBB+ 531 1.5 % Total $ 7,283 20.1 %
PF = Public Finance, SF = Structured Finance, IF = International Finance
AAC =
(1) Internal credit ratings are provided solely to indicate the underlying credit
quality of guaranteed obligations based on the view of
ratings, or more than one obligation of an issuer with varying internal
ratings, a weighted average rating is used.
to revision at any time and do not constitute investment advice. BIG denotes
credits deemed below investment grade.
(2)
amount at the time of issuance of the insurance policy as opposed to the
current accreted value of the bonds.
(3) A portion of this transaction is insured by an insurance policy issued by
that will only pay in the event that Ambac
insurance policies ("second to pay policies").
Net par related to the top ten exposures reduced$357 million fromDecember 31, 2019 . Exposures are impacted by changes in foreign exchange rates, certain indexation rates and scheduled and unscheduled paydowns. The decrease from 2019 was primarily related to foreign exchange
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and scheduled paydowns. The concentration of net par amongst the top ten (as a percentage of net par outstanding) remains at 20% atMarch 31, 2020 , andDecember 31, 2019 , however certain credits within the top ten have hadAmbac rating downgrades sinceDecember 31, 2019 , primarily related to the impact of COVID-19, includingMitchells & Butlers Finance plc ,New Jersey Transportation Trust Fund Authority andMets Queens Baseball Stadium Project .Aspire Defence Finance plc's rating atMarch 31, 2020 , improved sinceDecember 31, 2019 . The remaining insured portfolio of financial guarantees has an average net par outstanding of$31 million per single risk, with insured exposures ranging up to$493 million and a median net par outstanding of$5 million . Given thatAmbac has not written any new insurance policies since 2008, the risk exists that the insured portfolio becomes increasingly concentrated to large and/or below investment grade exposures. COVID-19 COVID-19 and the public health responses by the US federal and state governments have shut down significant portions of the US economy, including areas thatAmbac's insured obligors rely upon to generate the revenues and cash flows necessary to service debts we insure. Governments outside the US, in markets in whichAmbac operates, have implemented similar measures to the US.Ambac has undertaken a detailed analysis of the potential impact of the closure of certain portions of the US economy as well as certain other economies, including theUK ,Italy , andAustralia , to assess the impact of the current global recession on its insured financial guarantee portfolio. The duration and depth of the recession; actions such as monetary policy and fiscal stimulus, including the CARES Act in the US that was signed into law onMarch 27, 2020 , and future fiscal stimulus programs; and our insured obligors' financial flexibility and ability to mitigate the operational and economic impact of the recession will determine the ultimate impact toAmbac's insured portfolio. CARES Act and Other Relief Measures: The$2.2 trillion Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") provides relief and stimulus funds for American consumers, businesses and industries impacted by COVID-19. The CARES Act has several measures that impacted US municipalities and other borrowers, including consumers, such as mortgage and student loan borrowers, represented in our insured portfolio, including: •$500 billion for direct lending, loans, loan guarantees and investments to
eligible businesses, states and municipalities, including
dedicated to passenger airlines and
•
amended by the Paycheck Protection Program and Health Care Enhancement Act
("PPP & HCE Act"));
•
reimburse them for the costs of dealing with COVID-19;
•
of grants to healthcare providers and hospitals (as amended by the PPP & HCE
Act);
•
•
• direct payments to households and for unemployment insurance, estimated to
cost$560 billion . Despite the above provisions, which are designed to help mitigate the economic impact of the COVID-19 pandemic generally, the CARES Act contains certain provisions that may adversely affectAmbac . The CARES Act temporarily suspended payments on all student loans held by theDepartment of Education throughSeptember 30, 2020 . Although it is unclear what impact this CARES Act provision will have on the private student loans owned by special purpose entities that have their securitized obligations guaranteed byAmbac Assurance , we have incorporated into our loss reserves analysis assumptions related to increased delinquencies for borrowers with private student loans who often also have federal student loans and may elect not to pay altogether. Despite the assumed increase in delinquencies and losses related to this potential phenomena as well as the general deterioration in consumer credit related to the economic downturn,Ambac Assurance does not anticipate making substantial claim payments on insured student loan transactions for several years due to the structures governing the insured bonds. Additionally, the federal government has provided temporary relief measures to which servicers of mortgage loans must adhere. TheFederal Housing Administration ("FHA") of theUS Department of Housing and Urban Development and theFederal Housing Finance Agency ("FHFA") are providing temporary relief measures that require mortgage loan servicers to offer relief to borrowers who suffer hardship as a result of COVID-19. The relief measures announced include a 60-day moratorium on foreclosures and evictions and the expansion of forbearance and repayment options. Such servicers are generally applying these guidelines to non-FHFA loans, including those loans owned by special purpose entities that have their securitized obligations guaranteed byAmbac Assurance . Moreover, several State agencies have issued similar guidance to mortgage loan servicers concerning loan forbearances and other relief for borrowers. Depending on the severity and length of the economic downturn, there may be increasing pressure to extend the duration of forbearances and subsequently to offer generous repayment plans. While the impact of these and other forbearance measures onAmbac Assurance's insured RMBS obligations are unclear, we have assumed that such measures, as well as the economic impact of the global recession, will have an adverse impact on delinquencies and home price appreciation for the mortgages that underlie our insured RMBS transactions. Consequently, we have anticipated that we will experience an increase in claim payments for certain of our insured RMBS obligations. However, we also anticipate that the significant decline in interest rates experienced during the first quarter of 2020 will likely generate additional excess spread recoveries on insured RMBS obligations that will likely more than compensate for such adverse effects.
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In addition to, as well as in connection with the CARES Act, theFederal Reserve has implemented a number of programs to improve liquidity and the functioning of the financial markets in an effort to help mitigate the impact of the COVID-19 pandemic on financial markets and the macro economy as well as certain displaced sectors of the economy, including those in whichAmbac operates, including, but not limited to: •$500 billion for the Municipal Liquidity Facility;
•
Market Corporate Credit Facility; and
• The Money Market Mutual Fund Liquidity Facility.
In theUK , onMarch 20, 2020 , the government announced the closure of all non-essential leisure, food and retail operations, including public houses. This closure remains in place with the date at which such operations may be permitted to reopen being uncertain. TheUK Government also announced a number of measures to mitigate the impact of these enforced closures including rebating employers 80% of staff salaries (up to a £2,500 per month per employee cap), tax deferrals, business loan schemes and property tax relief. WhileAmbac expects the foregoing measures to help mitigate economic damage and aid the functioning of the capital markets,Ambac's exposure to credit risk as a result of the economic fallout from the COIVD-19 pandemic remains elevated, and we could experience material losses that would adversely impact our future results of operations and financial condition. Insured Portfolio:Ambac established a set of base case assumptions that includes a deep recession during the first half of 2020 with a modest recovery in the second half of 2020, including the loosening of business and travel restrictions. We expect that US states and municipalities will face significant budget deficits as a result of COVID-19 related costs and lower (and delayed) income, sales and other taxes. We expect that monetary policy and federal stimulus through the CARES Act and other programs will help moderate the depth of the recession and therefore the impact onAmbac's insured portfolio. As part of the detailed analysis of the insured portfolio, we have identified certain Public Finance sectors that are most susceptible to potential claims or impairments as a result of a prolonged recession caused by COVID-19. Our near-term concerns are concentrated on exposures substantially reliant on narrow, economically sensitive revenue streams. The ability of issuers of these obligations to pay is expected to be impaired although several issuers expressed a willingness to use their balance sheets to support their obligations and avoid defaults in the near-term.Ambac's insured par outstanding, net of reinsurance ("NPO"), to these Public Finance sectors are as follows: ($ in millions) Market / Sector Total NPO Total Debt Service Due Next Twelve Months Hotels / Convention Centers$ 258 $ 36.7 Stadiums 635 41.7 Airports 124 22.4 Dedicated Tax 622 290.1 Higher Education Auxiliary 252 27.0 Rail / Mass Transit 329 30.2 Toll Roads / Bridges 502 37.6 Total Public Finance$ 2,722 $ 485.7 The RMBS and student loan insured portfolios are expected to be adversely impacted by the previously mentioned forbearances and the general economic downturn. Offsetting such impact for RMBS exposures is the benefit to excess spread within the securitization structures as a result of the significant reduction in interest rates, which will result in higher recoveries.Ambac insured exposure includes a number of international policies where the revenue of the issuer is demand dependent. Such transactions have been impacted by the reduction of revenue due to the COVID-19 pandemic.Ambac and its advisors are working closely with impacted issuers to review their plans and liquidity facilities in light of these events.Ambac's NPO with respect to these demand dependent policies are as follows: ($ in millions) Market / Sector Total NPO Total Debt Service Due for Twelve Months Stadiums$ 204 $ 23.7 Higher Education 162 8.7 Airports 171 5.4 Asset Securitizations 957 78.5 Toll Roads / Bridges 717 56.2 Total$ 2,211 $ 172.5 At this time, there are significant uncertainties surrounding the ultimate number of claims and scope of damage resulting from this pandemic. Actual losses from these events may vary materially fromAmbac's loss and loss expense reserves due to several factors, including the inherent uncertainties in making such determinations and the evolving nature of this pandemic. Potential losses from the economic consequences of the COVID-19 pandemic could be material and therefore may have a material adverse effect on our results of operations and financial condition. Puerto RicoAmbac has exposure to theCommonwealth of Puerto Rico (the "Commonwealth") and its instrumentalities across several different issuing entities with total net par exposure of$1,105 million as ofMarch 31, 2020 . Each has its own credit risk profile attributable to, as applicable, discrete revenue sources, direct general obligation pledges and/or general obligation guarantees.
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Fiscal Plans OnMay 9, 2019 , the Oversight Board certified its own version of a new Commonwealth Fiscal Plan. In this current Commonwealth Fiscal Plan, the annual Commonwealth budget surpluses are lower in the short term but larger in the long term than the previous plan because of a longer than previously expected roll-out of federal disaster spending. The surplus through fiscal 2024 is just under$14 billion , whereas the previous plan was almost$18 billion . The current plan projects a 30-year surplus of$19.7 billion , but$5.4 billion of that money may not be available to the Commonwealth because it is being generated by public corporations. OnMay 3, 2020 , the Government ofPuerto Rico submitted a draft revised Commonwealth Fiscal Plan to the Oversight Board. The Government's draft revised Commonwealth Fiscal Plan purports to incorporate the impact of COVID-19 on the Commonwealth economy, and projects diminished growth, surplus, and debt capacity as compared to previous Fiscal Plans. The draft revised Commonwealth Fiscal Plan also states that the Oversight Board's current Plan of Adjustment is likely not feasible given the impact of the COVID-19 pandemic. The Oversight Board has not certified the Government ofPuerto Rico's draft revised Fiscal Plan, and may modify the draft revised Commonwealth Fiscal Plan significantly before certifying a revised fiscal plan. The Oversight Board has stated that it hopes to certify a revised Commonwealth Fiscal Plan by the end ofMay 2020 . The Oversight Board's certified Fiscal Plan could be significantly different than either the current Commonwealth Fiscal Plan or the Government ofPuerto Rico's draft revised Commonwealth Fiscal Plan. OnJune 5, 2019 , the Oversight Board certified its own version of the Fiscal Plan for thePuerto Rico Highways and Transportation Authority ("PRHTA"). Without considering PRHTA Fiscal Plan measures, the PRHTA's total financial surplus over the six-year plan period is projected to be$31 million . However, after taking into account the measures set forth in the PRHTA Fiscal Plan, the Oversight Board states that the cumulative surplus over that six-year period would grow to$493 million . It is unknown if and when a PRHTA Plan of Adjustment will be filed by the Oversight Board or confirmed by the court overseeing the Title III proceedings of PRHTA. It is also unknown if and when otherPuerto Rico instrumentalities, which have debt outstanding insured byAmbac Assurance , will be filed under Title III and what effect their fiscal plans and/or plans of adjustment may have onAmbac's financial position. The Oversight Board will determine, in its sole discretion, when to certify the updated fiscal plans given the uncertainty of the current situation. Moreover, the schedule for development and certification of other instrumentalities' fiscal plans could be adjusted as well. No assurances can be given thatAmbac's financial condition will not suffer a materially negative impact as an ultimate result of the Commonwealth Fiscal Plan, the Commonwealth Plan of Adjustment, or any future changes or revisions to Commonwealth fiscal plans or future fiscal plans and/or plans of adjustment for PRHTA or otherPuerto Rico instrumentalities. Commonwealth Plan of Adjustment OnFebruary 9, 2020 , the Oversight Board announced it reached an agreement in principle ("Plan Support Agreement") with certain creditors supporting the restructuring of the Commonwealth's General Obligation and PBA debt, and intended to file an amended plan of adjustment ("Amended POA") reflecting the terms of this agreement. OnFebruary 28, 2020 , the Oversight Board filed an amended disclosure statement and Amended POA to restructure$35 billion of debt and other claims against theCommonwealth of Puerto Rico , PBA, and ERS, as well as more than$50 billion in pension liabilities. The Amended POA would reduce Commonwealth debt and other claims from$35 billion to less than$11 billion , a 70% cut. The Amended POA would reduce the Commonwealth's annual debt service by 56%. Treatment for pension claims is the same as contained in the Initial POA, which is a reduction in pension payments by as much as 8.5% for retirees who currently receive at least$1,200 a month, such that 60% of retirees would not face any cuts, and the establishment of a pension reserve fund to help support retirement payments in future years. OnMarch 21, 2020 , the Oversight Board announced that in light of the developing COVID-19 crisis it was shifting its efforts to assisting the government ofPuerto Rico in preparing to face the crisis. As part of this shift, the Oversight Board presented a motion in court to adjourn consideration of the Amended POA's disclosure hearing, originally scheduled forJune 2020 , until further notice. OnMay 1, 2020 , the Oversight Board filed a status report before the court indicating that it was not yet prepared to propose a revised timeline for hearings related to the Amended POA or the disclosure statement related thereto. The Oversight Board is scheduled to file a status report onJuly 15, 2020 , at which time the Oversight Board has indicated it will propose a timeline for such hearings. In a radio interview onMarch 24, 2020 , Oversight Board ChairmanJose Carrion stated that the COVID-19 pandemic has had a material impact on Commonwealth finances and that the Oversight Board is reviewing the Commonwealth Plan of Adjustment, including the size of the proposed reduction in Commonwealth debt and proposed cuts to pensions. Carrion went on to say he does not see the Commonwealth Plan of Adjustment moving forward as currently structured. It is unclear at this time how much timelines for the POA process may shift as a result of the COVID-19 crisis. The Amended POA, as is, disproportionately disadvantages claims against the Commonwealth related to certain revenue bonds issued byPuerto Rico instrumentalities, including those insured byAmbac Assurance . The Amended POA provides for estimated recovery of 3.9% on claims against the Commonwealth related to PRHTA bonds,Puerto Rico Infrastructure Financing Authority (PRIFA) Special Tax Revenue (Rum Tax) bonds, andPuerto Rico Convention Center District Authority (PRCCDA) bonds. It is unknown if and how the Amended POA may be modified or what the final adjustments will be to the revenues available to thePuerto Rico instrumentalities addressed in the Amended POA or the recoveries on claims against the Commonwealth by creditors of those instrumentalities, includingAmbac andAmbac -insured bondholders. However, if the Amended POA were confirmed in its current form,Ambac's financial condition would suffer a material negative impact. Refer to Note 6.Financial Guarantee Insurance Contracts to the Unaudited Consolidated Financial
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Statements included in Part I, Item 1 in this Form 10-Q for the possible increase in loss reserves under stress or other adverse conditions, including the impact of the Amended POA. There can be no assurance that losses may not exceed such estimates. Mediation The status, timing and subject of any subsequent or future mediation discussion has not yet been publicly disclosed. No assurances can be given that negotiations will be successfully concluded, that Commonwealth, Oversight Board and creditor parties will reach definitive agreements on debt restructurings, that any additional negotiated transaction, debt restructuring, definitive agreement or Plan of Adjustment will be approved by the court and completed, or that any transaction or Plan of Adjustment will not have an adverse impact onAmbac's financial conditions or results. Federal Aid TheCommonwealth of Puerto Rico is projected to benefit from over$48 billion of federal disaster aid for infrastructure improvement initiatives or recovery efforts, as a result of the damage cause by hurricanes Irma and Maria as well as the earthquakes that began in lateDecember 2019 . To date, only about$15 billion has been disbursed. More than$20 billion of Community Development Block Grants (CDBG) was appropriated byCongress forPuerto Rico for reconstruction following Hurricane Maria, but very little has yet been drawn down.The Department of Housing and Urban Development (HUD), which administers the CDBG program, has approved release of a second tranche of CDBG funds totaling$8.2 billion , which brings the total amount available for drawdown to nearly$10 billion (an additional roughly$10 billion has not yet been approved by HUD for release). In order to ensure federal taxpayer dollars are spent effectively and efficiently, HUD has conditioned release of the$8.2 billion on various requirements thatPuerto Rico must meet. GovernorWanda Vasquez has agreed to these requirements, which includes a prohibition on any of the funds from being used to rebuild the electric grid until (and unless) HUD publishes additional requirements on such spending; overturns an executive order establishing a$15 minimum wage for government construction projects using CDBG; requires greaterPuerto Rico to provide greater transparency and implement enhanced financial controls; and requires CDFBG spending plans to be submitted to theOversight Board for determination that they are in accordance with its certified budgets and fiscal plans. Consequently, it is anticipated that drawdown of funds will begin soon. HUD has also appointed a federal monitor to oversee use of CDBG funds. The Oversight Board states, on their COVID-19 webpage, thatPuerto Rico residents, businesses, and government appear to be eligible for approximately$10 billion in federal aid under the CARES Act. OnApril 22, 2020 , the Government ofPuerto Rico announced that they had received$2.2 billion in direct aid provided by the CARES Act for the territories, for necessary COVID-19 related expenditures and costs not previously budgeted for. In addition, allU.S. citizens and residents (including inPuerto Rico ) will receive one-time cash payments of$1,200 for single taxpayers,$2,400 for married filers and$500 for each child, with payments gradually phasing out for individuals who earn between$75,000 and$99,000 per year (or$150,000 and$198,000 for married filers). The Government ofPuerto Rico's initial estimate is that eligible residents ofPuerto Rico will receive a total aggregate amount of$1.5 billion . Separately, Commonwealth small businesses have received an estimated$757 million in loans under the first portion of thePayroll Protection Fund (PPP) under the CARES Act. Puerto Ricans who are unemployed will also benefit from federal funding in the CARES Act that increases unemployment insurance benefits significantly for several months. The full extent of federal government support toPuerto Rico is still uncertain as existing federal stimulus has not been fully implemented and additional measures are likely to be enacted. While the previously allocated federal disaster relief funds, Medicaid money, and the more recent COVID-19 crisis related funds are all expected to support economic recovery and growth and inPuerto Rico , there can be no assurances as to the certainty, timing, usage, efficacy or magnitude of benefits to creditor outcomes related to disaster aid and ensuing economic growth, if any. SummaryAmbac has considered these developments and other factors in evaluating itsPuerto Rico loss reserves. During the quarter endedMarch 31, 2020 ,Ambac had incurred losses associated with its Domestic Public Finance insured portfolio of$178 million , which was impacted by lower discount rates as well as the continued uncertainty and volatility of the situation inPuerto Rico , including the potential impact of the COVID-19 crisis on the Commonwealth and the developing potential impact of the COVID-19 crisis on other sectors in the Domestic Public Finance insured portfolio. While management believes its reserves are adequate to cover losses in its Public Finance insured portfolio, there can be no assurance thatAmbac may not incur additional losses in the future, particularly given the developing economic, political, and legal circumstances inPuerto Rico and the overall uncertain impact of the COVID-19 crisis on the Commonwealth and the Domestic Public Finance Insured Portfolio in general. Such additional losses may have a material adverse effect onAmbac's results of operations and financial condition. Exposure Currency The table below shows the distribution by currency ofAmbac Assurance's insured exposure as ofMarch 31, 2020 : Net Par Amount Net Par Amount Currency Outstanding in Outstanding in (Amounts in millions) Base Currency U.S. Dollars U.S. Dollars $ 24,621$ 24,621 British Pounds £ 7,6659,530 Euros € 1,5431,700 Australian Dollars A$ 545 335 Total$ 36,186
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Ratings Distribution The following charts provide a rating distribution of net par outstanding based upon internalAmbac credit ratings(1) and a distribution by bond type ofAmbac's below investment grade ("BIG") net par exposures atMarch 31, 2020 andDecember 31, 2019 . BIG is defined as those exposures with anAmbac internal credit rating below BBB-: [[Image Removed: chart-839372e76f7d5a4393b.jpg]][[Image Removed: chart-6029d955762f5948b2c.jpg]] Note:AAA is less than 1% in both periods. (1) Internal credit ratings are provided solely to indicate the underlying credit
quality of guaranteed obligations based on the view of
ratings, or more than one obligation of an issuer with varying internal
ratings, a weighted average rating is used.
to revision at any time and do not constitute investment advice. Net Par Outstanding
Summary of
2019 Public Finance: Lease and tax-backed (1)$ 1,236 $ 1,109 General obligation (1) 354 525 Housing (2) 310 311 Transportation 27 27 Other 42 42 Total Public Finance 1,969 2,014 Structured Finance: RMBS 3,204 3,362 Student loans 592 620 Other 21 33 Total Structured Finance 3,817 4,015 International Finance: Other 1,477 1,455 Total International Finance 1,477 1,455 Total$ 7,263 $ 7,484
(1) Lease and tax-backed revenue includes
at
includes
31, 2019, respectively. Components of
includes capital appreciation bonds which are reported at the par amount at
the time of issuance of the related insurance policy as opposed to the
current accreted value of the bonds.
(2) Relates to military housing net par.
The decrease in below investment grade exposures is primarily due to the commutation of certain general obligation exposures and the impact of foreign exchange rates resulting from the strengthening of the US Dollar, partially offset by the addition of certain lease and tax-baked exposures and an international structured finance exposure driven by the COVID-19 pandemic. Despite the decrease in below investment grade exposures, such exposures could increase as a relative proportion of the guarantee portfolio given that stressed borrowers generally have less ability to prepay or refinance their debt. Accordingly, due to these and other factors, it is not unreasonable to expect the proportion of below investment grade exposure in the guarantee portfolio to increase in the future. RESULTS OF OPERATIONS Net loss attributable to common stockholders for the three months endedMarch 31, 2020 , was$280 million compared to a net loss attributable to common stockholders of$43 million for the three months endedMarch 31, 2019 . The decrease was primarily driven by: (i) net losses on investments, (ii) larger net losses on derivative contracts, (iii) lower net premiums earned, (iv) lower income on variable interest entities and (v) higher loss and loss expenses, partially offset by lower insurance intangible amortization.
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A summary of our financial results is shown below:
Three Months Ended March 31, ($ in millions) 2020 2019 Revenues: Net premiums earned $ 10 $ 28 Net investment income (loss) (21 ) 55 Net realized investment gains (losses) 8 17 Net gains (losses) on derivative contracts (70 ) (16 ) Income (loss) on variable interest entities 3 16
Expenses:
Losses and loss expenses (benefit) 117 12 Insurance intangible amortization 13 36 Operating expenses 24 25 Interest expense 63 68 Provision for income taxes (7 ) 2
Net income (loss) attributable to common stockholders $ (280 )
$ (43 )Ambac's results of operations and financial position have been adversely impacted by the COVID-19 pandemic's effect on the global economy and financial markets. Significant interest rate declines during the first quarter of 2020 drove a net increase to loss reserves and losses on interest rate derivative contracts. Credit driven losses were recognized in both loss incurred (primarily from public finance insurance policies) and losses in counterparty credit adjustments on derivative asset valuations. Financial market disruptions are reflected through lower valuations of certain fixed income securities (recorded through other comprehensive income) and the majority of other investments (recorded through net investment income (loss)). The scope, duration and magnitude of the direct and indirect effects of COVID-19 are evolving rapidly and in ways that are difficult or impossible to anticipate. As a result, it is possible thatAmbac's results of operations and financial condition may be further adversely affected by the evolving affects of the COVID-19 pandemic. For additional information on the risks posed by COVID-19, refer to "Part II, Item 1A-Risk Factors" in this Quarterly Report on Form 10-Q. During 2019,Ambac executed on a number of restructuring / commutation transactions that had significant impacts to the consolidated results of operations. As described further below, the completion of the these transactions, including the related changes to invested assets, loss reserves and debt of the Company, had a significant impact on the comparability of the results of operation for the three months endedMarch 31, 2020 and 2019. The most significant transactions, which are more fully discussed in "Financial Guarantees in Force" in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" included inAmbac's Annual Report on Form 10-K for the year endedDecember 31, 2019 were: Puerto Rico COFINA Plan of Adjustment ("POA"). OnFebruary 12, 2019 , the POA, including certain related commutation transactions, and subsequent distributions, became effective, resulting in a significant reduction ofAmbac Assurance's insured net par exposure to COFINA. Pursuant to the COFINA POA, approximately 75% of holders ofAmbac Assurance -insured senior COFINA bonds (includingAmbac ) elected to commute their insurance policy.Ballantyne Re plc ("Ballantyne") Restructuring. OnApril 25, 2019 , Ballantyne commenced, under Irish law, a restructuring transaction ("Restructuring") in respect of its obligations, including obligations that were guaranteed byAmbac UK . The arrangement was approved onJune 17, 2019 . With the successful implementation of the Restructuring, AmbacUK has ceased to have any exposure with respect to the obligations of Ballantyne. The following paragraphs describe the consolidated results of operations ofAmbac and its subsidiaries for the three months endedMarch 31, 2020 and 2019, respectively. Net Premiums Earned. Net premiums earned primarily represent the amortization into income of insurance premiums. We present accelerated premiums, which result from calls and other accelerations of insured obligations separate from normal net premiums earned. When an insured bond has been retired, any remaining unearned premium revenue ("UPR") is recognized at that time to the extent the financial guarantee contract is legally extinguished, causing accelerated premium revenue. For installment premium paying transactions, we offset the recognition of any remaining UPR by the reduction of the related premium receivable to zero (as it will not be collected as a result of the retirement), which may cause negative accelerated premium revenue. Net premiums earned decreased$18 million for the three months endedMarch 31, 2020 , compared to the same period in the prior year. Normal net premiums earned and accelerated premiums are reconciled to total net premiums earned in the table below. The following table provides a breakdown of normal premiums earned by market: Three Months Ended March 31, ($ in millions) 2020 2019 Normal premiums earned Public finance $ 5$ 8 Structured finance 1 3 International finance 4 5 Total normal premiums earned 10 16 Accelerated earnings - 12 Total net premiums earned $ 10$ 28 The decrease in normal premiums earned in the three months endedMarch 31, 2020 , is primarily attributable to (i) the continued runoff of the insured portfolio in all markets and (ii) changes to allowance for credit losses on premiums receivables.Ambac adopted ASU 2016-13, Measurement of Credit Losses on Financial Instruments ("CECL"), onJanuary 1, 2020 , and will assess the allowance for credit losses on premium receivables on a quarterly basis. Prior to adoption of ASU 2016-13,Ambac assessed collectability of premium receivables in accordance with ASC 944 and recorded an allowance for uncollectible premiums. The three months endedMarch 31, 2020 , includes an increase in the allowance for credit losses since adoption of CECL of$2 million as compared to an increase of less than$1 million for the three months endedMarch 31, 2019 . Terminations and accelerations, including those which occurred in prior periods, result in lower normal premiums earned in current and future periods. First quarter 2020 Public Finance
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normal earned premiums were also impacted by large reinsurance cessions in the second half of 2019. The decrease in accelerated earnings in the three months endedMarch 31, 2020 , as compared to the three months endedMarch 31, 2019 , is primarily related to the COFINA restructuring that occurred inFebruary 2019 . Net Investment Income (Loss). Net investment income (loss) primarily consists of interest and net discount accretion on fixed income securities classified as available-for-sale and net gains (losses) on pooled investment funds which include changes in fair value of the funds' net assets. Fixed income securities include investments inAmbac -insured securities that are made opportunistically based on their risk/reward and asset-liability management characteristics. As described further below, investment income from holdings ofAmbac -insured securities (including Secured Notes issued byAmbac LSNI, LLC ) for the periods presented have primarily been affected by restructuring transactions involvingPuerto Rico and Ballantyne bonds. Investments in pooled investment funds and certain other investments are either classified as trading securities with changes in fair value recognized in earnings or are reported under the equity method. These funds and other investments are reported in Other investments on the Unaudited Consolidated Balance Sheets and consist primarily of pooled fund investments in diversified asset classes. For further information about investment funds held, refer to Note 8. Investments to the Unaudited Consolidated Financial Statements, included in Part I, Item 1 in this Form 10-Q. Net investment income (loss) fromAmbac -insured securities; available-for-sale and short-term securities, other thanAmbac -insured; and Other investments is summarized in the table below: Three Months EndedMarch 31 , ($ in millions) 2020
2019
Securities available-for-sale:Ambac -insured (including Secured Notes) $ 16 $ 29 Securities available-for-sale and short-term other than Ambac-insured 15 18 Other investments (includes trading securities) (52 ) 8 Net investment (loss) income $ (21 ) $ 55 Net investment (loss) income was$(21) million for the three months endedMarch 31, 2020 , a decrease of$76 million compared to the three months endedMarch 31, 2019 . The decrease was primarily driven by unrealized losses on fund investments resulting from the impact of the COVID-19 pandemic on financial markets, a smaller allocation to higher yieldingAmbac -insured securities and a lower overall invested asset base. Losses on Other investments reported for the three months endedMarch 31, 2020 , were in hedge and other fund investments focusing on asset-backed securities, equities, high-yield, leveraged loans and private credit. These losses were primarily driven by adverse changes in fair values, as opposed to realized losses, stemming from an increase in risk premiums (including credit spreads) as a consequence of the economic and financial market impact of the COVID-19 pandemic. These investment funds have begun to recover in value during the second quarter of 2020.Ambac currently views these unrealized losses as temporary subject to any subsequent decisions to monetize certain investments in connection with changes in investment strategy, market conditions, and/or other circumstances. Other investment income for the three months endedMarch 31, 2019 , was driven by gains on equity, high-yield and loan funds, partially offset by losses on an insurance-linked security fund. Income fromAmbac -insured securities was lower due to the effects of 2019 de-risking transactions and ongoing redemptions of Secured Notes issued byAmbac LSNI, LLC .Ambac's holdings of insured COFINA and Ballantyne bonds were settled in connection with theFebruary 2019 COFINA commutation andJune 2019 Ballantyne Restructuring, respectively, accounting for the majority of the decrease in income fromAmbac -insured securities. Additionally, income from Secured Notes is down as a result of early redemptions as well as lower LIBOR indexed coupon rates effective for the three months endedMarch 31, 2020 as compared to the three months endedMarch 31, 2019 . Net investment income (loss) from available-for-sales securities other thanAmbac -insured securities decreased primarily as a result of the favorable impact on income for the three months endedMarch 31, 2019 , of high yielding uninsured COFINA bonds received under the POA. All of these uninsured COFINA bonds were sold fromAmbac's non-VIE investment portfolio byDecember 31, 2019 . Additionally, income from available-for-sale securities for the three months endedMarch 31, 2020 , was down due to a smaller asset base and generally declining reinvestment rates since first quarter 2019. Net Realized Investment Gains (Losses). The following table provides a breakdown of net realized gains (losses) for the periods presented: Three Months Ended March 31, ($ in millions) 2020
2019
Net gains (losses) on securities sold or called $ 6 $ 20 Net foreign exchange gains (losses) 2 (3 ) Credit impairments - - Intent / requirement to sell impairments - - Total net realized gains (losses) $ 8
$ 17
Net realized gains on securities sold or called for the three months endedMarch 31, 2020 , are primarily from sales in connection with routine portfolio management. Net realized gains on securities sold or called for the three months endedMarch 31, 2019 , included$19 million of net gains related to the impact of the COFINA Plan of Adjustment and sales ofAmbac -insured Puerto Rico COFINA bonds and new uninsured COFINA bonds received in the commutation. Impairments are reported through earnings if management intends to sell securities or it is more likely than not that the Company will be required to sell before recovery of amortized cost. Credit impairments are recorded in earnings only to the extent management does not intend to sell, and it is not more likely than not that the Company will be required to sell the securities, before recovery of their amortized cost. When credit impairments are recorded, any non-credit related impairment amounts on the securities are recorded in other comprehensive income.
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Intent / requirement to sell impairments for the three month periods endedMarch 31, 2020 , and 2019, related solely to management's intent to sell securities.Net Gains (Losses) on Derivative Contracts. Net gains (losses) on derivative contracts include results from the Company's interest rate derivatives portfolio and its runoff credit derivatives portfolio. The interest rate derivatives portfolio is positioned to benefit from rising rates as a partial economic hedge against interest rate exposure in the financial guarantee and investment portfolios. As forward rates and interest rate exposures elsewhere in the company have declined over the course of 2019 into the first quarter 2020, the economic hedge position has been reduced. Net gains (losses) on interest rate derivatives generally reflect mark-to-market gains (losses) in the portfolio caused by increases (declines) in forward interest rates during the periods, the carrying cost of the portfolio, and the impact of counterparty credit adjustments as discussed below. Results from credit derivatives were not significant to the periods presented. Net gains (losses) on interest rate derivatives for the three months endedMarch 31, 2020 , were($68) million , compared to($17) million for the three months endedMarch 31, 2019 . The net loss for the three months endedMarch 31, 2020 , reflects significant declines in forward interest rates, triggered by the COVID-19 pandemic, and losses from the application of counterparty credit adjustments, described further below. The net losses for three months endedMarch 31, 2019 , were driven by the impact of declines in forward interest rates during the period. Net carrying costs were not significant to the periods presented. Counterparty credit adjustments are generally applicable for uncollateralized derivative assets that may not be offset by derivative liabilities under a master netting agreement. Inclusion of counterparty credit adjustments in the valuation of interest rate derivatives resulted in (losses) within Net gains (losses) on derivative contracts of$(30) million for the three months endedMarch 31, 2020 , and$(1) million for the three months endedMarch 31, 2019 . The loss for the three months endedMarch 31, 2020 , was driven by wider credit spreads, including the effect of a credit rating downgrade of a derivative counterparty byAmbac during the quarter, simultaneous with an increase in the underlying asset value as interest rates declined. Income (loss) on Variable Interest Entities. Included within Income (loss) on variable interest entities are income statement amounts relating to VIEs, consolidated under the Consolidation Topic of the ASC as a result ofAmbac's variable interest arising from financial guarantees written byAmbac's subsidiaries, including gains or losses attributable to consolidating or deconsolidating VIEs during the periods reported. Generally, the Company's consolidated VIEs are entities for whichAmbac has provided financial guarantees on all of or a portion of its assets or liabilities. In consolidation, assets and liabilities of the VIEs are initially reported at fair value and the related insurance assets and liabilities are eliminated. However, the amount of VIE net assets (liabilities) that remain in consolidation generally result from the net positive (negative) projected cash flows from (to) the VIEs which are attributable toAmbac's insurance subsidiaries in the form of financial guarantee insurance premiums, fees and losses. In the case of VIEs with net negative projected cash flows, the net liability is generally to be funded byAmbac's insurance subsidiaries through insurance claim payments. Differences between the net carrying value of the insurance accounts under the Financial Services-Insurance Topic of the ASC and the carrying value of the consolidated VIE's net assets or liabilities are recorded through income at the time of consolidation or deconsolidation. Additionally, terminations or other changes toAmbac's financial guarantee insurance policies that impact projected cash flows between a consolidated VIE andAmbac could result in gains or losses, even if such policy changes do not result in deconsolidation of the VIE. Income (loss) on variable interest entities was$3 million for the three months endedMarch 31, 2020 , compared to income of$16 million for the three months endedMarch 31, 2019 . Results for the three months endedMarch 31, 2020 , were due primarily to realized gains of$8 million on sales of assets from theCOFINA Trust partially offset by the lower valuation of net assets on another VIE driven by the economic uncertainty caused by COVID-19. Results for the three months endedMarch 31, 2019 , were driven by the$15 million gain on consolidation of theCOFINA Trust . Refer to Note 3. Variable Interest Entities to the Unaudited Consolidated Financial Statements, included in Part I, Item 1 in this Form 10-Q for further information on the accounting for VIEs. Losses and Loss Expenses. Losses and loss expenses are based upon estimates of the aggregate losses inherent in the non-derivative financial guarantee portfolio for insurance policies issued to beneficiaries, including unconsolidated VIEs.Ambac records as a component of its loss reserve estimate subrogation recoveries related to securitized loans in RMBS transactions with respect to whichAmbac Assurance is pursuing claims for breaches of representations and warranties.Ambac does not include potential recoveries attributed solely to fraudulent inducement claims in our litigations in our estimate of subrogation recoveries. Generally, the sponsor of an RMBS transaction provided representations and warranties with respect to the securitized loans, including representations with respect to the loan characteristics, the absence of borrower fraud in the underlying loan pools or other misconduct in the origination process and attesting to the compliance of loans with the prevailing underwriting policies.Ambac has recorded representation and warranty subrogation recoveries, net of reinsurance, of approximately$1,738 and$1,702 atMarch 31, 2020 , andDecember 31, 2019 , respectively. The increase in these recoveries was primarily driven by lower discount rates used to discount estimated cash flows. Refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , for more information regarding the estimation process for R&W subrogation recoveries.
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The following provides details, by bond type, for losses and loss expenses (benefit) incurred for the periods presented:
Three Months Ended March 31, ($ in millions) 2020 2019 RMBS$ (83 ) $ (39 ) Domestic Public Finance 178 69 Student Loans 14 (4 ) Ambac UK and Other Credits 7 (15 ) Totals (1)$ 117 $ 12
(1) Includes loss expenses incurred (benefit) of
ended
Losses and loss expenses (benefit) for the three months endedMarch 31, 2020 , were driven by the following: • Higher projected losses in domestic public finance driven mostly by lower discount rates (primarily relating toPuerto Rico ) and incurred losses related to transactions directly impacted by the economic impact from COVID-19; and
• An increase in student loan losses as a result of lower discount rates and
the impact from COVID-19; partially offset by
• Favorable RMBS development as a result of the positive impact of lower
interest rates on excess spread, reduced by the negative impact of lower
discount rates and expected losses from COVID-19 related
delinquencies/defaults.
Losses and loss expenses (benefit) for the three months endedMarch 31, 2019 , were driven by the following: • Higher projected losses in domestic public finance largely driven by
additions to
• Favorable RMBS development as a result of credit improvement and the impact
on excess spread from declines in interest rates reduced by an increase in
loss expenses;
• Favorable development within Ambac
certain Ambac
• A portion of Ambac
than their functional currency of British Pounds resulting in incurred losses
(gains) when the British Pound depreciates (appreciates).
million in foreign exchange gain for the three months ended
Insurance Intangible Amortization. Insurance intangible amortization for the three months endedMarch 31, 2020 , was$13 million , a decrease of$23 million over the three months endedMarch 31, 2019 , primarily due to accelerated amortization related to the COFINA restructuring that occurred inFebruary 2019 . Operating Expenses. Operating expenses consist of gross operating expenses plus reinsurance commissions. The following table provides a summary of operating expenses for the periods presented: Three Months Ended March 31, ($ in millions) 2020 2019 Compensation $ 14$ 14 Non-compensation 9 10 Gross operating expenses 24 25 Reinsurance commissions, net - - Total operating expenses $ 24$ 25 Gross operating expense for the three months endedMarch 31, 2020 , were$24 million , a decrease of$1 million from the three months endedMarch 31, 2019 . Operating expenses incurred relating to COVID-19 have been minimal for the three months endedMarch 31, 2020 . The decrease in operating expenses was due to the following: • Lower compensation costs primarily due to lower salaries resulting from
continued right sizing of staffing levels during 2019, partially offset by
higher incentive compensation costs related to final performance metrics
impacting settlement of 2019 annual bonuses, and
• Lower non-compensation costs primarily due to a
(VAT) refund recognized in the three months ended
Legal and consulting services provided for the benefit of OCI amounted to$0.5 million and$0.5 million during the three months endedMarch 31, 2020 and 2019, respectively. Interest Expense. Interest expense includes accrued interest on the Ambac Note, Tier 2 Notes, surplus notes and other debt obligations. Additionally, interest expense includes discount accretion when the debt instrument carrying value is at a discount to par. The following table provides details by type of obligation for the periods presented: Three Months Ended March 31, ($ in millions) 2020 2019 Surplus notes (1) $ 26$ 24 Ambac note 31 38 Tier 2 notes 7 6 Other - - Total interest expense $ 63$ 68
(1) Includes junior surplus notes.
The decrease in interest expense for the three months ended
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level yield method on surplus notes and Tier 2 Notes as the discount to the face value of the long-term debt accretes over time. Surplus note principal and interest payments require the approval of OCI. Since the issuance of the surplus notes in 2010, OCI has declined to approve regular payments of interest on surplus notes, although the OCI has permitted exceptional payments in connection with (a) increasing the percentage of deferred policy payments of the Segregated Account ofAmbac Assurance from 25% to 45% in 2014 and (b) a one-time payment of approximately six months of interest on the surplus notes (other than junior surplus notes) outstanding immediately after consummation of the Rehabilitation Exit Transactions in 2018.Ambac Assurance has not requested to pay interest on any junior surplus notes since their issuance. InApril 2020 , OCI declined the request ofAmbac Assurance to pay the principal amount of the surplus notes, plus all accrued and unpaid interest thereon, on the scheduled maturity date ofJune 7, 2020 . As a result, the scheduled payment date for interest, and the scheduled maturity date for payment of principal of the surplus notes, shall be extended until OCI grants approval to make the payment. Interest will accrue, compounded on each anniversary of the original scheduled payment date or scheduled maturity date, on any unpaid principal or interest through the actual date of payment, at 5.1% per annum. Holders of surplus notes will have no rights to enforce the payment of the principal of, or interest on, surplus notes in the absence of OCI approval to pay such amount. The interest on the outstanding surplus notes and junior surplus notes were accrued for andAmbac Assurance is accruing interest on the interest amounts following each scheduled payment date. Total accrued and unpaid interest for surplus notes and junior surplus notes outstanding to third parties were$312 million and$152 million , respectively, atMarch 31, 2020 . Provision for Income Taxes. The provision for income taxes for the three months endedMarch 31, 2020 , was$(7) million , a decrease of$9 million compared to the provision for income taxes reported for three months endedMarch 31, 2019 . The change for the three months endedMarch 31, 2020 , compared to the prior year was primarily attributable AmbacUK , which had a taxable loss, related to investment losses on pooled funds, in 2020 as compared to taxable income in 2019. LIQUIDITY AND CAPITAL RESOURCESAmbac Financial Group, Inc. ("AFG") Liquidity. AFG's liquidity is primarily dependent on its cash, investments, and net receivables totaling$482 million as ofMarch 31, 2020 , and secondarily on its expense sharing and other arrangements withAmbac Assurance . • Pursuant to the amended and restated tax sharing agreement among AFG,Ambac
Assurance and certain affiliates (the "Amended TSA"),
required to make payments ("tolling payments") to AFG with respect to the
utilization of net operating loss carry-forwards ("NOLs"). AFG has accrued
2017. In
agreement pursuant to which
to make this payment by
payment for the use of
net operating losses byAmbac Assurance in 2017 until such time as OCI consents to the payment. • Under an inter-company cost allocation agreement, AFG is reimbursed byAmbac
Assurance for a portion of certain operating costs and expenses and, if
approved by OCI, entitled to an additional payment of up to
year to cover expenses not otherwise reimbursed. OCI approved this
reimbursement for 2019 expenses, which was paid in
AFG's investments include securities directly and indirectly issued by and/or insured byAmbac Assurance , some of which are eliminated in consolidation. Securities issued or insured byAmbac Assurance are generally less liquid than investment grade and other traded investments. It is highly unlikely thatAmbac Assurance will be able to make dividend payments to AFG for the foreseeable future and therefore cash and investments, payments under the intercompany cost allocation agreement and future tolling payments, if any, will be AFG's principal source of liquidity in the near term. Refer to Part I, Item 1, "Insurance Regulatory Matters - Dividend Restrictions, Including Contractual Restrictions" in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , and Note 8. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8, in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , for more information on dividend payment restrictions. The principal uses of liquidity are the payment of operating expenses, including costs to explore opportunities to grow and diversifyAmbac ; and the making of investments, including securities issued or insured byAmbac Assurance . Future uses of liquidity may include the acquisition or capitalization of new businesses. Contingencies could cause material liquidity strains. Ambac Assurance Liquidity.Ambac Assurance's liquidity is dependent on the balance of liquid investments and, over time, the net impact of sources and uses of funds. The principal sources ofAmbac Assurance's liquidity are gross installment premiums on insurance policies; principal and interest payments from investments; sales of investments; proceeds from repayment of affiliate loans; and recoveries on claim payments, including from litigation and reinsurance recoveries. Termination of installment premium policies on an accelerated basis may adversely impactAmbac Assurance's liquidity. The principal uses ofAmbac Assurance's liquidity are the payment of operating and loss adjustment expenses, claims, commutation and related expense payments on insurance policies, ceded reinsurance premiums, principal and interest payments on the Ambac Note, surplus note principal and interest payments, Tier 2 Note payments, additional loans to affiliates, tolling payments due to AFG under the Amended TSA, and purchases of securities and other investments that may not be immediately converted into cash. • The COVID-19 pandemic had a negative impact onAmbac's available liquidity as
a consequence of the adverse reaction of the capital markets, which led to a
reduction in the value and marketability of our invested assets; derivative
losses, which required additional collateral posting; and higher credit risk
within the insured portfolio, as further described below.
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Nevertheless,
as issuers, particularly those with revenues that will be interrupted by
social distancing, other restrictions and the increase in unemployment, may
not have sufficient cash inflows to pay debt service on
Refer to "Financial Guarantees in Force" in this Management's Discussion and
Analysis for further discussion of the potential impact of the COVID-19
pandemic on claim payments.
• Interest and principal payments on surplus notes are subject to the approval
of OCI, which has full discretion over payments regardless of the liquidity
position of
either payment or collateralization of a portion of the Tier 2 Notes under
the terms of the Tier 2 Note indenture. See Note 13. Long-term Debt in the
Notes to Consolidated Financial Statements, included in Part II, Item 8, in
the Company's Annual Report on Form 10-K for the year ended
for further discussion of the payment terms and conditions of the Tier 2
Notes. As discussed more fully in "Results of Operations" above in this
Management's Discussion and Analysis OCI declined
to pay the principal amount of the surplus notes, plus all accrued and unpaid
interest thereon, on
Ambac Assurance's intercompany loans are withAmbac Financial Services ("AFS"). AFS uses interest rate derivatives (primarily interest rated swaps andUS Treasury futures) as an economic hedge against the effects of rising interest rates elsewhere in the Company, including onAmbac Assurance's financial guarantee exposures. AFS's derivatives include interest rate swaps previously provided to asset-backed issuers and other entities in connection with their financings.Ambac Assurance loans cash and securities to AFS as needed to fund payments under these derivative contracts, collateral posting requirements and operating expenses. Intercompany loans are governed by an established lending agreement with defined borrowing limits that has received non-disapproval from OCI.Ambac Assurance manages its liquidity risk by maintaining comprehensive analyses of projected cash flows and maintaining specified levels of cash and short-term investments at all times.Ambac Assurance is limited in its ability to pay dividends pursuant to the terms of its Auction Market Preferred Shares ("AMPS"), which state that dividends may not be paid on the common stock ofAmbac Assurance unless all accrued and unpaid dividends on the AMPS for the then current dividend period have been paid, provided that dividends on the common stock may be made at all times for the purpose of, and only in such amounts as are necessary for enabling AFG (i) to service its indebtedness for borrowed money as such payments become due or (ii) to pay its operating expenses. If dividends are paid on the common stock for such purposes, dividends on the AMPS become cumulative until the date that all accumulated and unpaid dividends have been paid on the AMPS.Ambac Assurance has not paid dividends on the AMPS since 2010.Ambac Assurance is also subject to additional restrictions on the payment of dividends pursuant to certain contractual and regulatory restrictions. Refer to Part I, Item 1, "Insurance Regulatory Matters - Dividend Restrictions, Including Contractual Restrictions" in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , and Note 8. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8, in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , for more information on dividend payment restrictions. Our ability to realize RMBS representation and warranty ("R&W") subrogation recoveries is subject to significant uncertainty, including risks inherent in litigation; collectability of such amounts from counterparties (and/or their respective parents and affiliates); timing of receipt of any such recoveries, including uncertainty due to delays in court proceedings as a result of the COVID-19 pandemic; intervention by the OCI, which could impede our ability to take actions required to realize such recoveries; and uncertainty inherent in the assumptions used in estimating the amount of such recoveries. The amount of these subrogation recoveries is significant and if we are unable to recover any amounts or recover materially less than our estimated recoveries, our future available liquidity to pay claims, debt service and meet our other obligations would be reduced materially. See Part I, Item 1A. Risk Factors in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 for more information about risks relating to our RMBS R&W subrogation recoveries. Cash Flow Statement Discussion. The following table summarizes the net cash flows for the periods presented. Three Months Ended March 31, ($ in million) 2020 2019 Cash provided by (used in): Operating activities $ (87 ) $ (95 ) Investing activities 244 112 Financing activities (146 ) (76 ) Foreign exchange impact on cash and cash equivalents - - Net cash flow $ 10 $ (58 ) Operating activities The following represents the significant cash activities during the three months endedMarch 31, 2020 and 2019: • Cash used in operating activities relating to long-term debt on theAmbac
Note were
2020 and 2019, respectively.
• Cash used in operating activities related to interest rate derivatives were
2019, respectively.
• Cash provided by operating activities relating to the investment portfolio
were
and 2019, respectively.
• Net loss and loss expenses paid, including commutation payments, during the
three months endedMarch 31, 2020 and 2019 are detailed below:
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Three Months Ended March
31,
($ in million) 2020 2019 Net loss and loss expenses paid (recovered): Net losses paid (1)$ 44 $ 123 Net subrogation received (2) (25 ) (68 ) Net loss expenses paid 20 10 Net cash flow$ 39 $ 64
(1) Net losses paid include commutation payments of
months ended
(2) For the three months ended
related to the COFINA Plan of Adjustment.
Future operating cash flows will primarily be impacted by the level of premium collections, investment coupon receipts and claim and expense payments. Financing Activities Financing activities for the three months endedMarch 31, 2020 , include paydowns of the Ambac Note of$77 million and paydowns / maturities of VIE debt obligations of$66 million . Financing activities for the three months endedMarch 31, 2019 , include proceeds$3 million fromAmbac's issuance of 201 shares of AMPS, paydowns of theAmbac Note of$13 million and paydowns / maturities of VIE debt obligations of$63 million . Collateral AFS hedges a portion of the interest rate risk in the financial guarantee and investment portfolio, along with legacy customer interest rate swaps, with standardized derivative contracts, including financial futures contracts, which contain collateral or margin requirements. Under these hedge agreements, AFS is required to post collateral or margin to its counterparties and futures commission merchants to cover unrealized losses. In addition, AFS is required to post collateral or margin in excess of the amounts needed to cover unrealized losses. All AFS derivative contracts containing ratings-based downgrade triggers that could result in collateral or margin posting or a termination have been triggered. If terminations were to occur, AFS would be required to make termination payments but would also receive a return of collateral or margin in the form of cash orU.S. Treasury obligations with market values equal to or in excess of market values of the swaps and futures contracts. AFS may look to re-establish hedge positions that are terminated early, resulting in additional collateral or margin obligations. The amount of additional collateral or margin posted on derivatives contracts will depend on several variables including the degree to which counterparties exercise their termination rights (or agreements terminate automatically) and the terms on which hedges can be replaced. All collateral and margin obligations are currently met. Collateral and margin posted by AFS totaled a net amount of$165 million (cash and securities collateral of$80 million and$85 million , respectively), including independent amounts, under these contracts atMarch 31, 2020 . Ambac Credit Products ("ACP") is not required to post collateral under any of its outstanding credit derivative contracts. BALANCE SHEET Total assets decreased by approximately$542 million fromDecember 31, 2019 , to$12,777 million atMarch 31, 2020 , primarily due to the negative total return for the non-VIE investment portfolio caused by the economic effects of the COVID-19 pandemic and lower consolidated VIE assets as a result of currency changes (strengthening of the US Dollar). Other significant changes during the three months endedMarch 31, 2020 , were higher subrogation recoverables primarily related to increases in excess spread on RMBS as a result of lower interest rates, higher collateral receivable from derivative counterparties (within Other assets) and lower intangible assets from the continued runoff of the financial guarantee insurance portfolio. Total liabilities decreased by approximately$68 million fromDecember 31, 2019 , to$11,716 million as ofMarch 31, 2020 , primarily due to lower consolidated VIE liabilities as a result of currency changes, as noted above, and lower long-term debt plus accrued interest payable due to partial redemption of the Ambac Note, partially offset by higher loss reserves and increases in interest rate derivative obligations as a result of reductions in forward interest rates. As ofMarch 31, 2020 , total stockholders' equity was$1,062 million , compared with total stockholders' equity of$1,536 million atDecember 31, 2019 . This decrease was primarily due to a Total Comprehensive Loss during 2020. The Comprehensive Loss was primarily driven by the net loss attributable to common stockholders for the three months endedMarch 31, 2020 , of$280 million , unrealized losses on investment securities of$146 million and translation losses on the consolidation of AFG's foreign subsidiaries of$46 million . Investment Portfolio.Ambac Assurance's investment objective is to achieve the highest risk-adjusted after-tax return on a diversified portfolio of primarily fixed income investments and pooled investment funds while employing asset/liability management practices to satisfy operating and strategic liquidity needs.Ambac Assurance's investment portfolio is subject to internal investment guidelines and is subject to limits on types and quality of investments imposed by the insurance laws and regulations of the jurisdictions in which it is licensed, primarily the States ofWisconsin andNew York . Such guidelines set forth minimum credit rating requirements and credit risk concentration limits. Within these guidelines, which in certain instances may be exceeded with the approval of the applicable regulatory authority,Ambac Assurance opportunistically purchasesAmbac Assurance insured securities given their relative risk/reward characteristics.Ambac Assurance's investment policies are subject to oversight by OCI pursuant to the Settlement Agreement, the Stipulation and Order and the indenture for the Tier 2 Notes. The Board of Directors ofAmbac Assurance approves any changes toAmbac Assurance's investment policy. AmbacUK's investment policy is designed with the primary objective of ensuring that AmbacUK is able to meet its financial obligations as they fall due, in particular with respect to policyholder claims. AmbacUK's investment portfolio is primarily fixed income investments and diversified holdings of pooled investment funds. The portfolio is subject to internal investment guidelines and may be subject to limits on types and quality of investments imposed by the PRA as regulator ofAmbac
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UK . AmbacUK's investment policy sets forth minimum credit rating requirements and concentration limits, among other restrictions. The Board of Directors of AmbacUK approves any changes or exceptions to AmbacUK's investment policy. AFG's investment portfolio's primary objective is to preserve capital and liquidity for strategic uses while maximizing income. Refer to Note 8. Investments to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q for information aboutAmbac's consolidated investment portfolio.Ambac's investment policies and objectives do not apply to the assets of VIEs consolidated as a result of financial guarantees written by its insurance subsidiaries. The following table summarizes the composition ofAmbac's investment portfolio, excluding VIE investments, at carrying value atMarch 31, 2020 andDecember 31, 2019 : March 31, December 31, ($ in millions) 2020 2019 Fixed income securities$ 2,367 $ 2,577 Short-term 586 653 Other investments 363 478 Fixed income securities pledged as collateral 85 85 Total investments (1)$ 3,400 $ 3,792
(1) Includes investments denominated in non-US dollar currencies with a fair
value of £238 (
and €2 (
Ambac invests in various asset classes in its fixed income securities portfolio, including securities covered by guarantees issued byAmbac Assurance andAmbac UK and other financial guarantors ("insured securities"). Other investments include diversified interests in pooled funds. Refer to Note 8. Investments to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q for information about insured securities and fixed income and pooled funds by asset class. The following table represents the fair value of other asset-backed securities, included in fixed income securities above, atMarch 31, 2020 andDecember 31, 2019 by classification: March 31, December 31, ($ in millions) 2020 2019 Other asset-backed securities Military Housing 224 237 Student Loans 27 32 Credit Cards 24 18 Auto 8 -
Total other asset-backed securities
The following charts provide the ratings (1) distribution of the fixed income investment portfolio based on fair value atMarch 31, 2020 andDecember 31, 2019 : [[Image Removed: chart-b7ce91b0f3ad5fa598a.jpg]][[Image Removed: chart-8a8e7afba5e85273a17.jpg]] (1) Ratings are based on the lower of Moody's or S&P ratings. If ratings are unavailable from Moody's or S&P, Fitch ratings are used. If guaranteed, rating represents the higher of the underlying or guarantor's financial strength rating.
(2) Below investment grade and not rated bonds insured by
33% of the 2020 and 2019 combined fixed income portfolio, respectively.
Premium Receivables.Ambac's premium receivables decreased to$403 million atMarch 31, 2020 , from$416 million atDecember 31, 2019 . As further discussed in Note 6. Financial Guarantee Insurance Contracts, the decrease is due to premium receipts, changes to the allowance for credit losses and changes in foreign currencies, partially offset by changes in expected and contractual cash flows and accretion of premium receivable discount.
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Premium receivables by payment currency were as follows: Currency
Premium Receivable in Premium Receivable in (Amounts in millions) Payment Currency U.S. Dollars U.S. Dollars $ 250 $250 British Pounds £ 103128 Euros € 22 24 Total $ 403 Reinsurance Recoverable on Paid and Unpaid Losses.Ambac Assurance has reinsurance in place pursuant to surplus share treaty and facultative agreements. To minimize its exposure to losses from reinsurers,Ambac Assurance (i) monitors the financial condition of its reinsurers; (ii) is entitled to receive collateral from its reinsurance counterparties under certain reinsurance contracts; and (iii) has certain cancellation rights that can be exercised byAmbac Assurance in the event of rating agency downgrades of a reinsurer (among other events and circumstances).Ambac Assurance benefited from letters of credit and collateral amounting to approximately$124 million from its reinsurers atMarch 31, 2020 . As ofMarch 31, 2020 andDecember 31, 2019 , reinsurance recoverable on paid and unpaid losses were$36 million and$26 million , respectively. The increase was primarily a result of adverse development in public finance and student loan insured exposures. Insurance Intangible Asset. At the Fresh Start Reporting Date, an insurance intangible asset was recorded which represented the difference between the fair value and aggregate carrying value of the financial guarantee insurance and reinsurance assets and liabilities. As ofMarch 31, 2020 andDecember 31, 2019 , the net insurance intangible asset was$406 million and$427 million , respectively. Other than through amortization, variance in the insurance intangible asset is solely from translation gains (losses) from the consolidation ofAmbac's foreign subsidiary (AmbacUK ). Derivative Assets and Liabilities. The interest rate derivative portfolio is positioned to benefit from rising rates as a partial economic hedge against interest rate exposure in the financial guarantee and investment portfolios. Derivative assets increased from$75 million atDecember 31, 2019 , to$88 million as ofMarch 31, 2020 . Derivative liabilities increased from$90 million atDecember 31, 2019 , to$137 million as ofMarch 31, 2020 . The net increases resulted primarily from lower interest rates during the three months endedMarch 31, 2019 , with the effect on assets partially offset by higher counterparty credit adjustments. Loss and Loss Expense Reserves and Subrogation Recoverable. Loss and loss expense reserves are based upon estimates of the ultimate aggregate losses inherent in the non-derivative portfolio for insurance policies issued to beneficiaries, including unconsolidated VIEs. The evaluation process for determining the level of reserves is subject to certain estimates and judgments. Refer to the "Critical Accounting Policies and Estimates" and "Results of Operations" sections of Management's Discussion and Analysis of Financial Condition and Results of Operations, in addition to Basis of Presentation and Significant Accounting Policies and Loss Reserves sections included in Note 2. Basis of Presentation and Significant Accounting Policies and Note 6. Financial Guarantee Insurance Contracts, respectively, of the Consolidated Financial Statements included in Part II, Item 8 in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 for further information on loss and loss expenses. The loss and loss expense reserves, net of subrogation recoverables and before reinsurance as ofMarch 31, 2020 andDecember 31, 2019 , were$(395) million and$(482) million , respectively.
Loss and loss expense reserves are included in the Unaudited Consolidated Balance Sheets as follows:
Present Value of Expected Net Cash Flows Gross Loss Claims and Unearned and Loss ($ in millions) Loss Premium Expense Balance Sheet Line Item Expenses Recoveries (1) Revenue ReservesMarch 31, 2020 : Loss and loss expense reserves$ 2,112 $ (245 )$ (70 ) $ 1,797 Subrogation recoverable 135 (2,327 ) - (2,192 ) Totals$ 2,247 $ (2,572
)
December 31, 2019 : Loss and loss expense reserves$ 1,835 $ (233 )$ (54 ) $ 1,548 Subrogation recoverable 131 (2,160 ) - (2,029 ) Totals$ 1,966 $ (2,394 ) $ (54 ) $ (482 )
(1) Present value of future recoveries includes R&W subrogation recoveries of
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Ambac has exposure to various bond types issued in the debt capital markets. Our experience has shown that, for the majority of bond types, we have not experienced significant claims. The bond types that have experienced significant claims, including through commutations, are residential mortgage-backed securities ("RMBS"), student loan securities and public finance securities. These bond types represent 94% of our ever-to-date insurance claims recorded, with RMBS comprising 76%. The table below indicates gross par outstanding and the components of gross loss and loss expense reserves related to policies inAmbac's gross loss and loss expense reserves atMarch 31, 2020 andDecember 31, 2019 : Present Value of Expected Net Cash Flows Gross Loss Gross Claims and Unearned and Loss Par Loss Premium Expense ($ in millions) Outstanding (1)(2) Expenses Recoveries Revenue Reserves (1)(3)March 31, 2020 : RMBS $ 2,871$ 728 $ (2,183 ) $ (13 ) $ (1,468 ) Domestic Public Finance 2,848 1,176 (353 ) (41 ) 783 Student Loans 458 268 (37 ) (4 ) 227 Ambac UK and Other Credits 869 20 - (12 ) 8 Loss expenses - 55 - - 55 Totals $ 7,046$ 2,247 $ (2,572 ) $ (70 ) $ (395 ) December 31, 2019: RMBS$ 3,027 $ 634 $ (2,013 ) $ (13 ) $ (1,392 ) Domestic Public Finance 2,398 1,007 (344 ) (36 )
627
Student Loans 472 248 (36 ) (4 )
208
Ambac UK and Other Credits 271 4 - (1 ) 3 Loss expenses - 73 - - 73 Totals$ 6,168 $ 1,966 $ (2,394 ) $ (54 ) $ (482 )
(1) Ceded par outstanding on policies with loss reserves and ceded loss and loss
expense reserves are
and
reserves are included in Reinsurance recoverable on paid and unpaid losses.
(2) Gross Par Outstanding includes capital appreciation bonds, which are reported
at the par amount at the time of issuance of the insurance policy as opposed
to the current accreted value of the bond.
(3) Loss reserves are included in the balance sheet as Loss and loss expense
reserves or Subrogation recoverable dependent on if a policy is in a net
liability or net recoverable position.
Variability of Expected Losses and RecoveriesAmbac's management believes that the estimated future loss component of loss reserves (present value of expected net cash flows) are adequate to cover future claims presented, but there can be no assurance that the ultimate liability will not be higher than such estimates. It is possible that our estimated future losses for insurance policies discussed above could be understated or that our estimated future recoveries could be overstated. We have attempted to identify possible cash flows related to losses and recoveries using more stressful assumptions than the probability-weighted outcome recorded. The possible net cash flows consider the highest stress scenario that was utilized in the development of our probability-weighted expected loss atMarch 31, 2020 , and assumes an inability to execute any commutation transactions with issuers and/or investors. Such stress scenarios are developed based on management's view about all possible outcomes relating to losses and recoveries. In arriving at such view, management makes considerable judgments about the possibility of various future events. Although we do not believe it is possible to have stressed outcomes in all cases, it is possible that we could have stress case outcomes in some or even many cases. See "Risk Factors" in Part I, Item 1A as well as the descriptions of "RMBS Variability," "Public Finance Variability," "Student Loan Variability," and "Other Credits, including AmbacUK , Variability," in Part II, Item 7 of the Company's 2019 Annual Report on Form 10-K for further discussion of the risks relating to future losses and recoveries that could result in more highly stressed outcomes, and "Risk Factors" in Part II, Item 1A of this Quarterly Report on Form 10-Q as well as the descriptions of "RMBS Variability," "Public Finance Variability," "Student Loan Variability," and "Other Credits, including AmbacUK , Variability" appearing below. The occurrence of these stressed outcomes individually or collectively would have a material adverse effect on our results of operations and financial condition and may result in materially adverse consequence for the Company, including (without limitation) impairing the ability ofAmbac Assurance to honor its financial obligations; the initiation of rehabilitation proceedings againstAmbac Assurance ; decreased likelihood ofAmbac Assurance delivering value to AFG, through dividends or otherwise; and a significant drop in the value of securities issued or insured by AFG orAmbac Assurance .
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RMBS Variability:Ambac has exposure to theU.S. mortgage market primarily through direct financial guarantees of RMBS, including transactions collateralized by first and second liens. Changes to assumptions that could make our reserves under-estimated include an increase in interest rates, deterioration in housing prices, poor servicing, the effect of a weakened economy characterized by growing unemployment and wage pressures. We utilize a model to project losses in our RMBS exposures and changes to reserves, either upward or downward, are not unlikely if we used a different model or methodology to project losses. We established a representation and warranty subrogation recovery as further discussed in Note 6. Financial Guarantee Insurance Contracts to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q. Our ability to realize RMBS representation and warranty recoveries is subject to significant uncertainty, including risks inherent in litigation; collectability of such amounts from counterparties (and/or their respective parents and affiliates); delays in realizing such recoveries, including as a result of trial delays due to court closures related to COVID-19 or other events; intervention by the OCI, which could impede our ability to take actions required to realize such recoveries; and uncertainty inherent in the assumptions used in estimating such recoveries. Additionally, our R&W actual subrogation recoveries could be significantly lower than our estimate of$1,738 million , net of reinsurance, as ofMarch 31, 2020 , if the sponsors of these transactions: (i) fail to honor their obligations to repurchase the mortgage loans, (ii) successfully dispute our breach findings or claims for damages, (iii) no longer have the financial means to fully satisfy their obligations under the transaction documents, or (iv) our pursuit of recoveries is otherwise unsuccessful. Failure to realize R&W subrogation recoveries for any reason or the realization of R&W subrogation recoveries materially below the amount recorded onAmbac's consolidated balance sheet would have a material adverse effect on our results of operations and financial condition. In the case of both first and second-lien exposures, the possible stress case assumes a lower housing price appreciation projection, which in turn drives higher defaults and severities. Using this approach, the possible increase in loss reserves for RMBS credits for which we have an estimate of expected loss atMarch 31, 2020 could be approximately$25 million . Combined with the absence of any R&W subrogation recoveries, a possible increase in loss reserves for RMBS could be approximately$1,763 million . Additionally, loss payments are sensitive to changes in interest rates, increasing as interest rates rise. For example an increase in interest rates of 0.50% could increase our estimate of expected losses by approximately$40 million . Additionally, the RMBS portfolio is sensitive to the COVID-19 related forbearances and delinquencies caused by the general economic downturn. Due to the uncertainties related to the economic effects of the COVID-19 pandemic and other risks inherent associated with RMBS, there can be no assurance that losses may not exceed our stress case estimates. Public Finance Variability:Ambac's U.S. public finance portfolio consists predominantly of municipal bonds such as general and revenue obligations and lease and tax-backed obligations of state and local government entities; however, the portfolio also includes a wide array of non-municipal types of bonds, including financings for not-for-profit entities and transactions with public and private elements, which generally finance infrastructure, housing and other public purpose facilities and interests. The increase in public finance gross loss reserves atMarch 31, 2020 , as compared toDecember 31, 2019 , was primarily related to declines in discount rates and the adverse impact on loss reserves from the global and issuer-specific economic impact of the COVID-19 pandemic. Total public finance gross loss reserves and related gross par outstanding onAmbac insured obligations by bond type were as follows: March 31, 2020 December 31, 2019 Issuer Type Gross Par Gross Loss Gross Par Gross Loss ($ in millions) Outstanding (1) Reserves Outstanding (1) Reserves Lease and tax-backed $ 1,380$ 694 $ 1,075 $ 561 General obligation 636 (17 ) 681 (16 ) Housing 456 33 457 29 Transportation revenue 232 47 88 42 Other 144 26 97 11 Total $ 2,848$ 783 $ 2,398 $ 627
(1) Gross Par Outstanding includes capital appreciation bonds, which are reported
at the par amount at the time of issuance of the insurance policy as opposed
to the current accreted value of the bond.
It is possible our loss reserves for public finance credits may be under-estimated if issuers are faced with prolonged exposure to adverse political, judicial, economic, fiscal or socioeconomic events or trends. Additionally, our loss reserves may be under-estimated as a result of the ultimate scope, duration and magnitude of the effects of COVID-19. The COVID-19 related economic downturn has put a strain on municipal issuers dependent upon narrow sources of revenues or dedicated taxes to support debt services, such as hotel occupancy taxes, sales taxes, parking revenues, tolls, licensing fees, etc. A prolonged recovery from the COVID-19 related economic downturn could put additional stresses on these issuers as well as other types of municipal finance issuers and result in increased defaults and potential additional losses forAmbac . Our experience with the city ofDetroit in 2013 in its bankruptcy proceeding was not favorable and renders future outcomes with other public finance issuers even more difficult to predict and may
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increase the risk that we may suffer losses that could be sizable. We agreed to settlements regarding our insuredDetroit general obligation bonds that provide better treatment of our exposures than the city planned to include in its plan of adjustment, but nevertheless required us to incur a loss for a significant portion of our exposure. An additional troubling precedent in theDetroit case, as well as other municipal bankruptcies, is the preferential treatment of certain creditor classes, especially the public pensions. The cost of pensions and the need to address frequently sizable unfunded or underfunded pensions is often a key driver of stress for many municipalities and their related authorities, including entities to whom we have significant exposure, such asChicago's school district, theState of New Jersey and many others. Less severe treatment of pension obligations in bankruptcy may lead to worse outcomes for traditional debt creditors. Variability of outcomes applies to even what is generally considered more secure municipal financings, such as dedicated sales tax revenue bonds that capture sales tax revenues for debt service ahead of any amounts being deposited into the general fund of an issuer. In the case of the Puerto Rico COFINA sales tax bonds that were part of theCommonwealth of Puerto Rico's Title III proceedings,Ambac Assurance and other creditors agreed to settle at a recovery rate equal to about 93% of pre-petition amounts owed on theAmbac insured senior COFINA bonds. In the COFINA case, the senior bonds still received a reduction or "haircut" despite the existence of junior COFINA bonds, which received a recovery rate equal to about 56% of pre-petition amounts owed. In addition, municipal entities may be more inclined to use bankruptcy to resolve their financial stresses if they believe preferred outcomes for various creditor groups can be achieved. We expect municipal bankruptcies and defaults to continue to be challenging to project given the unique political, economic, fiscal, legal, governance and public policy differences among municipalities as well as the complexity, long duration and relative infrequency of the cases themselves in forums with a scarcity of legal precedent. Another potentially adverse development that could cause the loss reserves on our public finance credits to be underestimated is deterioration in the municipal bond market, resulting from reduced or limited access to alternative forms of credit (such as bank loans) or other exogenous factors, such as the Tax Cuts and Jobs Act that was signed into law onDecember 22, 2017 , which could reduce certain municipal investors' appetite for tax-exempt municipal bonds and over the longer term could potentially put additional pressure on issuers in states with high state and local taxes. These factors as well as more recent volatility in the municipal markets as a result of the COVID-19 related economic downturn and the building budgetary pressures at the state and local level related to the cost of fighting the virus could deprive issuers access to funding at a level necessary to avoid defaulting on their obligations. In addition, a judicial decision in connection with the PRHTA Title III proceedings could cause the loss reserves on our public finance credits to be underestimated. OnJanuary 13, 2020 , theU.S. Supreme Court denied a petition for certiorari arising out of an appeal to theMarch 26, 2019 ruling by theU.S. Court of Appeals for the First Circuit . In the ruling, the First Circuit affirmed the decision by theU.S. District Court overseeing the PROMESA Title III proceedings for the PRHTA, which found that under Sections 928(a) and 922(d) of theU.S. Bankruptcy Code, municipal issuers of revenue bonds secured by special revenues are permitted, but not required, to apply special revenues to pay debt service on such revenue bonds during the pendency of bankruptcy proceedings for such municipal issuers. The First Circuit's decision challenges what had been a commonly understood notion in the municipal finance marketplace that municipal revenues bondholders secured by special revenues (as defined in Chapter 9 of theU.S. Bankruptcy Code) would continue to receive payment during a bankruptcy of the municipal issuer. This decision introduces uncertainty into the public finance market and it may make it more difficult for municipal instrumentalities to procure revenue bond financings in the future and increases the credit risk to bondholders of existing special revenue bonds, particularly those from weaker issuers. While our loss reserves consider our judgment regarding issuers' financial flexibility to adapt to adverse markets, they may not adequately capture sudden, unexpected or protracted uncertainty that adversely affects market conditions, such as the developing COVID-19 related economic downturn. Our exposures to theCommonwealth of Puerto Rico are under stress arising from the Commonwealth's poor financial condition, weak economy, loss of capital markets access and the severe damage caused by hurricanes Irma and Maria. These factors, taken together with the payment moratorium on debt payments of the Commonwealth and its instrumentalities, ongoing PROMESA Title III proceedings, and certain other provisions under PROMESA, the potential for restructurings of debt insured byAmbac Assurance , either with or without its consent, and the possibility of protracted litigation as a result of which its rights may be materially impaired, may cause losses to exceed current reserves in a material manner. See "Financial Guarantees in Force" section of Management's Discussion and Analysis of Financial Condition and Results of Operations included in Part II, Item 7 in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 for further details on the legal, economic and fiscal developments that have impacted or may impactAmbac Assurance's insuredPuerto Rico bonds. In this Form 10-Q, refer to "Financial Guarantees in Force" in Part I, Item 2 in Management's Discussion and Analysis of Financial Condition and Results of Operation and Note 11. Commitments and Contingencies to the Unaudited Consolidated Financial Statements for further updates related toPuerto Rico . Material additional losses on our public finance credits caused by the aforementioned factors and including the possibility of a protracted recovery related to the COVID-19 crisis would have a material adverse effect on our results of operations and financial condition. For the public finance credits, includingPuerto Rico , for which we have an estimate of expected loss atMarch 31, 2020 , the possible increase in loss reserves could be approximately$1,220 million . However, there can be no assurance that losses may not exceed such amount. Among other things, this estimate includes the possibility that the amended Commonwealth plan of adjustment (as discussed above in the Financial Guarantees in Force section of this Management Discussion and Analysis) were to become effective. Student Loan Variability: Changes to assumptions that could make our reserves under-estimated include, but are not limited to, increases in interest rates, default rates and loss severities on the collateral due to economic
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or other factors, including the COVID-19 related economic downturn. Such factors may include lower recoveries on defaulted loans or additional losses on collateral or trust assets, including as a result of any enforcement actions by theConsumer Finance Protection Bureau . For student loan credits for which we have an estimate of expected loss atMarch 31, 2020 , the possible increase in loss reserves could be approximately$35 million . Additionally, an increase in interest rates of 0.50% could increase our estimate of expected losses by approximately$20 million . Additionally, the student loan portfolio is sensitive to COVID-19 related payment moratoriums and delinquencies caused by the general economic downturn. There can be no assurance that losses may not exceed our stress case estimates. Other Credits, including AmbacUK , Variability: It is possible our loss reserves on other types of credits, including those insured by AmbacUK , may be under-estimated because of various risks that vary widely, including the risk that we may not be able to recover or mitigate losses through our remediation processes. For all other credits, including AmbacUK , for which we have an estimate of expected loss, the sum of all the highest stress case loss scenarios is approximately$400 million greater than the loss reserves atMarch 31, 2020 . Additionally, our loss reserves may be under-estimated as a result of the ultimate scope, duration and magnitude of the effects of COVID-19. There can be no assurance that losses may not exceed our stress case estimates. Long-term Debt: Long-term debt consists of senior and junior surplus notes issued byAmbac Assurance , the Ambac Note and Tier 2 Notes issued in connection with the Rehabilitation Exit Transactions, and AmbacUK debt issued in connection with the 2019 Ballantyne commutation. The carrying value of each of these as ofMarch 31, 2020 andDecember 31, 2019 is below: March 31, ($ in millions) 2020 December 31, 2019 Surplus notes (1)$ 778 $ 769 Ambac note 1,685 1,763 Tier 2 notes 284 278 Ambac UK debt 13 13 Total Long-term Debt$ 2,760 $ 2,822
(1) Includes junior surplus notes.
The decrease in long-term debt from
VARIABLE INTEREST ENTITIES Please refer to Note 3. Variable Interest Entities to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q and Note 2. Basis of Presentation and Significant Accounting Policies and Note 3. Variable Interest Entities to the Consolidated Financial Statements, included in Part II, Item 8 in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , for information regarding variable interest entities. ACCOUNTING STANDARDS The following accounting standards have been issued but have not yet been adopted. We do not expect these standards to have a consequential impact onAmbac's financial statements. Defined Benefit and Other Postretirement Plans Disclosures InAugust 2018 , the FASB issued ASU 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20) - Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans. The ASU modifies various disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. Relevant disclosures that will be removed are: i) amounts in accumulated other comprehensive income expected to be recognized as net periodic benefit cost over the next fiscal year and ii) the effects of a one percentage point change in assumed health care cost trend rates on the (a) aggregate of the service and interest cost components of the net periodic pension cost and (b) benefit obligation for postretirement healthcare benefits. Relevant disclosures that will be added are an explanation of the reasons for significant gains and losses related to changes in the benefit obligations for the period. The ASU is effective for fiscal years ending afterDecember 15, 2020 , with early adoption permitted. The modified disclosures must be applied on a retrospective basis for all periods presented.Ambac will adopt this ASU onDecember 31, 2020 Simplifying Income Tax Accounting InDecember 2019 , the FASB issued ASU 2019-12, Income Taxes (Topic 740) - Simplifying the Accounting for Income Taxes. The FASB issued this ASU as part of its initiative to reduce complexity in accounting standards. The ASU removes certain exceptions in the guidance related to investments, intraperiod allocations and interim period allocations. It further adds new guidance related to the allocation of consolidated income taxes and evaluating a step-up in the tax basis of goodwill. The ASU is effective for fiscal years beginning afterDecember 15, 2020 , with early adoption permitted. The modified disclosures must be applied on a retrospective basis for all periods presented.Ambac will adopt this ASU onJanuary 1, 2021 . Please refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements, included in Part II, Item 8 in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , for a discussion of the impact of other recent accounting pronouncements onAmbac's financial condition and results of operations. AMBAC ASSURANCE STATUTORY BASIS FINANCIAL RESULTSAmbac Assurance statutory financial statements are prepared on the basis of accounting practices prescribed or permitted by the OCI. OCI recognizes only statutory accounting practices prescribed or permitted by theState of Wisconsin ("SAP") for determining and reporting the financial condition and results of operations of an insurance company for determining its solvency underWisconsin Insurance Law. TheNational Association of Insurance Commissioners ("NAIC") Accounting Practices and Procedures manual ("NAIC SAP") has been adopted as a component of prescribed practices by theState of Wisconsin . For further information, see "Ambac Assurance Statutory Basis
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Financial Results," in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Note 8. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 .Ambac Assurance's statutory policyholder surplus and qualified statutory capital (defined as the sum of policyholders surplus and mandatory contingency reserves) were$930 million and$1,465 million atMarch 31, 2020 , respectively, as compared to$1,088 million and$1,618 million atDecember 31, 2019 , respectively. As ofMarch 31, 2020 , statutory policyholder surplus and qualified statutory capital included$574 million principal balance of surplus notes outstanding,$365 million principal balance of junior surplus notes outstanding and$138 million liquidation preference of preferred stock outstanding. These surplus and junior surplus notes (including related accrued interest of$489 million that is not recorded under statutory basis accounting principles), preferred stock issued byAmbac Assurance and all other liabilities (including insurance claims and debt issued byAmbac Assurance ) are obligations that have claims on the resources ofAmbac Assurance that are senior to AFG's equity and therefore impact AFG's ability to realize residual value or receive dividends fromAmbac Assurance . The drivers to the net decrease in policyholder surplus are primarily due to a (i) statutory net loss of$93 million for the three months endedMarch 31, 2020 ; (ii) decrease of$35 million from declines in the fair value of investment securities that are recorded at the lower of amortized cost or fair value; (iii) decrease of$21 million from net losses on pooled fund investments; and (iv) contributions to contingency reserves of$5 million .Ambac Assurance statutory surplus is sensitive to multiple factors, including: (i) loss reserve development, (ii) approval by OCI of payments on surplus notes and junior surplus notes, (iii) ongoing interest costs associated with theAmbac Note and Tier 2 Notes, including changes to interest rates as the Ambac Note is a floating rate obligation, (iv) deterioration in the financial position ofAmbac Assurance subsidiaries that have their obligations guaranteed byAmbac Assurance , (v) first time payment defaults of insured obligations, which increase statutory loss reserves, (vi) commutations of insurance policies or credit derivative contracts at amounts that differ from the amount of liabilities recorded, (vii) reinsurance contract terminations at amounts that differ from net assets recorded, (viii) changes to the fair value of investments carried at fair value and investment impairments, (ix) settlements of representation and warranty breach claims at amounts that differ from amounts recorded, including failures to collect such amounts or receive recoveries sufficient to pay or redeem the Ambac Note and Tier 2 Notes, (x) realized gains and losses, including losses arising from other than temporary impairments of investment securities, and (xi) future changes to prescribed practices by the OCI. AMBACUK FINANCIAL RESULTS UNDERUK ACCOUNTING PRINCIPLES
Ambac
£387 million atDecember 31, 2019 . AtMarch 31, 2020 , the carrying value of cash and investments was £464 million, a decrease from £470 million atDecember 31, 2019 . The decrease in shareholders' funds and cash & investments was primarily due to losses in the period within AmbacUK's investment portfolio, offset by foreign exchange gains and the continued receipt of premiums. AmbacUK is also required to prepare financial information in accordance with the Solvency II Directive. The basis of preparation of this information is significantly different from both US GAAP andUK GAAP. Available capital resources under Solvency II were a surplus of £163 million atMarch 31, 2020 , of which £149 million were eligible to meet solvency capital requirements. This is a reduction fromDecember 31, 2019 , when available capital resources were a surplus of £188 million of which £178 million were eligible to meet solvency capital requirements. The eligible capital resources atMarch 31, 2020 , andDecember 31, 2019 , were in comparison to regulatory capital requirements of £243 million and £208 million respectively. AmbacUK is therefore deficient in terms of compliance with applicable regulatory capital requirements by £94 million and £30 million atMarch 31, 2020 , andDecember 31, 2019 , respectively. The deficit increased as atMarch 31, 2020 due to an increase in regulatory capital requirements for non-life insurers in the credit and surety line of business and due to a reduction eligible assets mainly caused by the fall over the period in long term discount rates. The regulators are aware of the deficiency in capital resources as compared to capital requirements and dialogue between AmbacUK management and its regulators remains ongoing with respect to options for addressing the shortcoming, although such options remain few. NON-GAAP FINANCIAL MEASURES In addition to reporting the Company's quarterly financial results in accordance with GAAP, the Company currently reports two non-GAAP financial measures: Adjusted Earnings and Adjusted Book Value. The most directly comparable GAAP measures are net income attributable to common stockholders forAdjusted Earnings and Total Ambac Financial Group, Inc. stockholders' equity for 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 drivers of our business. Adjusted 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.Ambac has a significantU.S. tax net operating loss ("NOL") that is offset by a full valuation allowance in the GAAP consolidated financial statements. As a result of this and other considerations, we utilized a 0% effective tax rate for non-GAAP adjustments; which is subject to change. The following paragraphs define each non-GAAP financial measure and describe why it is useful. A reconciliation of the non-
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GAAP financial measure and the most directly comparable GAAP financial measure is also presented below. Adjusted Earnings (Loss). Adjusted Earnings (Loss) is defined as net income (loss) attributable to common stockholders, as reported under GAAP, adjusted on an after-tax basis for the following: • Non-credit impairment fair value (gain) loss on credit derivatives:
Elimination of the non-credit impairment fair value gains (losses) on credit
derivatives, which is the amount in excess of the present value of the
expected estimated credit losses. Such fair value adjustments are affected
by, and in part fluctuate with changes in market factors such as interest
rates and credit spreads, including the market's perception of
risk ("Ambac CVA"), and are not expected to result in an economic gain or
loss. These adjustments allow for all financial guarantee contracts to be
accounted for consistent with the Financial Services - Insurance Topic of
ASC, whether or not they are subject to derivative accounting rules.
• Insurance intangible amortization: Elimination of the amortization of the
financial guarantee insurance intangible asset that arose as a result of
reporting. This adjustment ensures that all financial guarantee contracts are
accounted for consistent with the provisions of the Financial Services - Insurance Topic of the ASC.
• Foreign exchange (gains) losses: Elimination of the foreign exchange gains
(losses) on the re-measurement of assets, liabilities and transactions in
non-functional currencies. This adjustment eliminates the foreign exchange
gains (losses) on all assets, liabilities and transactions in non-functional
currencies, which enables users of our financial statements to better view
the results without the impact of fluctuations in foreign currency exchange
rates and facilitates period-to-period comparisons of
performance.
The following table reconciles net income attributable to common stockholders to the non-GAAP measure, Adjusted Earnings on a dollar amount and per diluted share basis, for all periods presented: Three Months
Ended
2020 2019
($ in millions, except share data) $ Amount Per Diluted Share
$ Amount Per Diluted Share Net income (loss) attributable to common stockholders$ (280 ) $ (6.07 )$ (43 ) $ (0.94 )
Adjustments:
Non-credit impairment fair value (gain) loss on credit derivatives 2 0.03 - (0.01 ) Insurance intangible amortization 13 0.29 36 0.79 Foreign exchange (gains) losses - - (2 ) (0.04 ) Adjusted earnings (loss)$ (265 ) $ (5.75 )$ (9 ) $ (0.20 ) Adjusted Book Value. Adjusted Book Value is defined asTotal Ambac Financial Group, Inc. stockholders' equity as reported under GAAP, adjusted for after-tax impact of the following: • Non-credit impairment fair value losses on credit derivatives: Elimination of
the non-credit impairment fair value loss on credit derivatives, which is the
amount in excess of the present value of the expected estimated economic
credit loss. GAAP fair values are affected by, and in part fluctuate with,
changes in market factors such as interest rates, credit spreads, including
These adjustments allow for all financial guarantee contracts to be accounted
for within Adjusted Book Value consistent with the provisions of the Financial Services-Insurance Topic of the ASC, whether or not they are subject to derivative accounting rules.
• Insurance intangible asset: Elimination of the financial guarantee insurance
intangible asset that arose as a result of
and the implementation of Fresh Start reporting. This adjustment ensures that
all financial guarantee contracts are accounted for within Adjusted Book
Value consistent with the provisions of the
Topic of the ASC.
• Net unearned premiums and fees in excess of expected losses: Addition of the
value of the unearned premium revenue ("UPR") on financial guarantee
contracts, in excess of expected losses, net of reinsurance. This non-GAAP
adjustment presents the economics of UPR and expected losses for financial
guarantee contracts on a consistent basis. In accordance with GAAP,
stockholders' equity reflects a reduction for expected losses only to the
extent they exceed UPR. However, when expected losses are less than UPR for a
financial guarantee contract, neither expected losses nor UPR have an impact
on stockholders' equity. This non-GAAP adjustment adds UPR in excess of
expected losses, net of reinsurance, to stockholders' equity for financial
guarantee contracts where expected losses are less than UPR.
• Net unrealized investment (gains) losses in Accumulated Other Comprehensive
Income: Elimination of the unrealized gains and losses on the Company's
investments that are recorded as a component of accumulated other
comprehensive income ("AOCI"). The AOCI component of the fair value
adjustment on the investment portfolio may differ from realized gains and
losses ultimately recognized by the Company based on the Company's investment
strategy. This adjustment only allows for such gains and losses in Adjusted
Book Value when realized.
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