As of December 31, 2009, management conducted an assessment of the effectiveness of Ambac’s internal control over financial reporting based on the framework established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation in relation to the criteria established in Internal Control-Integrated Framework, management concluded that Ambac’s internal control over financial reporting is effective as of December 31, 2009.
Ambac Assurance has not written a meaningful volume of financial guarantee business since November 2007. Further, the Company’s existing investment agreement and derivative product portfolios are in active runoff, which may result in transaction terminations, settlements, restructuring, assignments of and scheduled amortization of contracts. In the course of managing the inherent risks of these portfolios during runoff, the Financial Services segment may enter into new financial instrument transactions for hedging purposes to the extent we are able to do so.
Ambac’s principal business strategy going forward is to increase the residual value of our financial guarantee business by mitigating losses on poorly performing transactions and maximizing the yield on its investment portfolio. Prior to June 2009, Ambac had intended to reactivate Everspan Financial Guarantee Corp. (“Everspan”) for purposes of writing financial guarantee insurance in the U.S. public finance market; however, Ambac Assurance’s financial condition and market conditions hampered the Company’s efforts to raise third party capital. Since Ambac has been unable to raise capital for Everspan, it has postponed indefinitely its efforts to reactivate Everspan for this purpose. Moreover, as a result of the Segregated Account Rehabilitation Proceedings and the Proposed Settlement, it is unlikely that Ambac will be able to relaunch Everspan.
Policy obligations not transferred to the Segregated Account remain in the general account of Ambac Assurance (the “General Account”), and such policies in the General Account are not subject to and, therefore, will not be directly impacted by, the Segregated Account Rehabilitation Plan. Ambac Assurance is not, itself, in rehabilitation proceedings.
Assumed reinsurance obligations of Ambac Assurance (except for reinsurance assumed from Everspan) shall be allocated to the Segregated Account and, pursuant to the Segregated Account Rehabilitation Plan when it is approved shall be treated consistent with the junior priority of such obligations in liquidation.
Transactions otherwise not permitted by the Covenants if approved by OCI and if, after giving effect thereto, Ambac Assurance has a financial strength rating of at least A (and is not on negative watch for downgrade) from at least two nationally recognized rating agencies.
Ambac has updated its estimated discounted subrogation recoveries from $859,529 at December 31, 2008 to $2,026,266 at December 31, 2009. Ambac’s estimate of subrogation recoveries includes two components: (1) estimated dollar amounts of loans with material breaches of representations and warranties based on an extrapolation of the breach rate identified in a random sample of loans taken from the entire population of loans in a securitization (“random sample approach”), and (2) dollar amount of actual loans with identified material breaches of representations and warranties discovered from samples of impaired loans in a securitization
fair value hedge adjustments are discussed further in “Derivative Contracts used for Non-trading and Hedging Purposes” below. Interest expense is computed based upon daily outstanding liability balances at rates and periods specified in the agreements.
Included in net derivative liabilities at December 31, 2009 are liabilities of $2,473,750, representing the gross fair value of credit derivative contracts that are subject to the Proposed Settlement described in Note 1. The Proposed Settlement is not a binding agreement, and there can be no assurance that a definitive agreement will be executed. In addition, the terms of the Proposed Settlement, as negotiated to date, may change, or the transactions contemplated by the Proposed Settlement may not be consummated at all. If the Proposed Settlement is completed within the terms previously described, an additional loss of $415,880 would be recorded in 2010, as that portion of the settlement amount relates to changes in fair value that occurred during 2010.
period of time. The referenced fixed income obligations met Ambac Assurance’s financial guarantee credit underwriting criteria at the time of the transactions. During 2009, all remaining total return swaps were terminated and settled.
Ambac enters into non-trading derivative contracts for the purpose of economically hedging exposures to fair value or cash flow changes caused by fluctuations in interest rates and foreign currency rates. Such contracts include derivatives that do not meet the technical requirements for hedging under ASC Topic 815. Net gains (losses) recognized on such contracts recognized as part of net mark-to-market gains (losses) on non-trading derivative contracts was $13,928 for the year ended December 31, 2009.
During 2008 and 2007, gross losses paid were $638,194 and $30,417, respectively. During 2008 and 2007, other recoveries (under subrogation rights) of losses were $11,719 and $27,875, respectively.
In the ordinary course of their businesses, certain of Ambac’s subsidiaries assert claims in legal proceedings against third parties to recover losses already paid and/or mitigate future losses. The amounts recovered and/or losses avoided which may be result from these proceedings is uncertain, although recoveries and/or losses avoided in any one or more of these proceedings during any quarter or fiscal year could be material to Ambac’s results of operations in that quarter or fiscal year.
The fair values of fixed income investment securities are based primarily on market prices received from dealer quotes or alternative pricing sources with reasonable levels of price transparency. Such quotes generally consider a variety of factors, including recent trades of the same and similar securities. For those fixed income investments where quotes were not available, fair values are based on internal valuation models. Key inputs to the internal valuation models include maturity date, coupon and yield curves for asset-type and credit rating characteristics that closely match those characteristics of the specific investment securities being valued. At
The amount of expected loss on a reference obligation is a function of the probability that the obligation will default and severity of loss in the event of default. Ambac’s CDS transactions were all originally underwritten
As noted above, reference obligation spreads incorporate market perceptions of default probability and loss severity, as well as liquidity risk and other factors. Loss severities are generally correlated to default probabilities