Ambac UK also maintains offices in the United Kingdom (London), which consist of approximately 3,500 square feet of office space, under an agreement that expires in October 2020, with an earlier term option at Ambac’s discretion; and in Italy (Milan), under an agreement that expires in December 2013.
Government programs: In May of 2009, the Federal Government initiated the Home Affordable Modification Plan (HAMP) which allows servicers to modify loans. Under HAMP, after determining a borrower’s eligibility, a servicer can take a series of steps to reduce the borrower’s monthly mortgage payment. HAMP is applicable to the Ambac-wrapped transactions serviced by firms that have signed servicer participation agreements to modify loans under the program. Based on the observed activity reflected in data from government published sources, we believe this program is unlikely to have any additional material impact on Ambac-wrapped transactions beyond that already incorporated into our projections. Beginning in the third quarter of 2011 we no longer assumed any additional impact for HAMP on our first-lien portfolio. We have not given credit to any other government programs, most of which are targeted to home mortgages that are bank-owned, included in RMBS securitizations.
In evaluating our student loan portfolio, losses were projected using either a cash flow or statistical expected loss approach. As more fully described in Note 2 to the Consolidated Financial Statements located in Part II, Item 8 of this Form 10-K, the statistical methodology uses probability of default and loss given default (“LGD”) metrics under various scenarios to derive a weighted average loss expectation. The scenarios used under the statistical expected loss approach evaluate each transaction under base case and stress case scenarios. The main drivers in assigning appropriate probabilities to LGDs for each policy includes an analysis of the collateral mix; debt type and interest rates; parity level; enhancement levels and remediation opportunities. We believe the statistical expected loss approach is a more efficient methodology for certain deals in our student loan portfolio, such as (i) deals where collateral loan level data is unavailable (and thus the cash flow model, as more fully discussed below could not be used), and (ii) deals where we do not expect to experience meaningful losses.
Ambac’s investments in fixed income securities (excluding VIE investments) classified as “available-for-sale” are carried at fair value, with the after-tax difference from amortized cost reflected in stockholders’ equity as a component of Accumulated Other Comprehensive Income (“AOCI”). One of the significant estimates related to available-for-sale securities is the evaluation of investments for other-than-temporary impairments. Under GAAP, if management assesses that it either (i) has the intent to sell its investment in a debt security or (ii) more likely than not will be required to sell the debt security before the anticipated recovery of its amortized cost basis less any current period credit loss, then an other-than-temporary impairment charge must be recognized in earnings, with the amortized cost of the security being written-down to fair value. If these conditions are not met, but it is determined that a credit loss exists, the impairment is separated into the amount related to the credit loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in other comprehensive income. To determine whether a credit loss has occurred, management considers certain factors, including the length of time and extent to which the fair value of the security has been less than its amortized cost and downgrades of the security’s credit rating. If such factors indicate that a potential credit loss exists, management will compare the present value of estimated cash flows from the security to the amortized cost basis to assess whether the entire amortized cost basis will be recovered. When it is determined that all or a portion of the amortized cost basis will not be recovered, a credit impairment charge is recorded in earnings in the amount of the difference between the present value of cash flows and the amortized cost at the balance sheet date, with the amortized cost basis of the impaired security written-down to the present value of cash flows. Ambac estimates expected future cash flows from residential mortgage-backed securities using models and assumptions consistent with those used to project losses in the financial guarantee RMBS portfolio described above under “Critical Accounting Policies-Losses and Loss Expenses of Non-derivative Financial Guarantees.” Estimated cash flows are discounted at the effective interest rate implicit in the security at the date of acquisition or, for debt securities that are beneficial interests in securitized financial assets, at a rate equal to the current yield used to accrete the beneficial interest. For floating rate securities, estimated cash flows are projected using the relevant index rate forward curve and the discount rate is adjusted for changes in that curve. For debt securities for which other-than-temporary impairments were recognized in earnings, the difference between the new amortized cost basis and the cash flows expected to be collected are accreted as interest income over the expected remaining life of the security.
Net Investment Income. Net investment income in 2012 was $382.9 million, an 8% increase from $354.8 million in 2011. The following table provides details by segment for the years ended December 31, 2012 and 2011:
Please refer to the “Critical Accounting Estimates-Financial Guarantee Insurance Losses and Loss Expenses” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations and to the Loss Reserves section located in Note 5 of the Consolidated Financial Statements located in Item 8 of this Form 10-K for further background information on loss reserves.
Corporate expenses include the operating expenses of Ambac. The decrease is primarily due to the provisions of the new expense sharing agreement where Ambac Assurance reimburses Ambac for certain operating expenses.
As further described in Note 1 to the Consolidated Financial Statements in Part II, Item 8 of this Form 10-K, no decision has been announced with respect to effectuating or amending the Segregated Account Rehabilitation Plan. Possible modifications to the Plan, with respect to the form and timing of satisfying the remaining balance of unpaid claims, could have a material effect on the measurement of statutory policyholder surplus.
(5) Amount represents future benefit payments on the Ambac Assurance postretirement benefit plan for the next 10 years.
On October 8, 2010, the Rehabilitator filed a plan of rehabilitation for the Segregated Account (the “Segregated Account Rehabilitation Plan”) in the Circuit Court of Dane County, Wisconsin in which the Segregated Account Rehabilitation Proceedings are pending (the “Rehabilitation Court”). The Rehabilitation Court confirmed the Segregated Account Rehabilitation Plan on January 24, 2011. The confirmed Segregated Account Rehabilitation Plan also makes permanent the injunctions issued by the Rehabilitation Court on March 24, 2010.
The Segregated Account Rehabilitation Plan has not been made effective and is subject to modification. The Rehabilitator may seek to effectuate the current Segregated Account Rehabilitation Plan or modify such Plan. Effective as of March 24, 2010 claims payments on policies allocated to the Segregated Account had been enjoined pursuant to an order of the Rehabilitation Court. However, on May 16, 2012, the Rehabilitator filed a motion seeking approval from the Rehabilitation Court to make partial interim policy claim payments to Segregated Account policyholders. A hearing in the Rehabilitation Court relating to such motion was held on June 4, 2012, and on that date the Rehabilitation Court approved the motion. On August 1, 2012, the Rehabilitator promulgated Rules Governing the Submission, Processing and Partial Payment of Policy Claims in Accordance with the June 4, 2012 Interim Cash Payment Order (the “Policy Claim Rules”), and filed such document with the Rehabilitation Court, to inform Segregated Account policyholders as to the process governing the submission and approval of policy claims. In accordance with the Policy Claim Rules, with effect from August 1, 2012, holders of policies allocated to the Segregated Account were, and continue to be, allowed to submit policy claims for review and partial payment equating to 25% of the permitted policy claim amount.
The Reorganization Plan reflects a resolution of certain issues (the “Amended Plan Settlement”) among the Company, the statutory committee of creditors appointed by the United States Trustee on November 17, 2010 (the “Creditors’ Committee”), Ambac Assurance, the Segregated Account and OCI related to (i) the net operating loss carryforwards (“NOLs”) of the consolidated tax group of which the Company is the parent and Ambac Assurance is a member (the “Ambac Consolidated Group”), (ii) certain tax refunds received in respect thereof and (iii) the sharing of expenses between the Company and Ambac Assurance. The terms of the Amended Plan Settlement are memorialized in that certain Mediation Agreement dated September 21, 2011 (the “Mediation Agreement”) among such parties. In accordance with the Amended Plan Settlement, the Company shall retain ownership of Ambac Assurance, and except as otherwise approved by OCI, the Company shall use its best efforts to preserve the use of NOLs as contemplated by the Amended Plan Settlement.
In January 2013, the FASB issued ASU 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. The objective of this ASU was to clarify the scope of the offsetting disclosure requirements of ASU 2011-11 (discussed above) and address any unintended consequences. The amendments clarify that the scope of ASU 2011-11 applies to i) derivatives accounted for in accordance with ASC 815, Derivatives and Hedging, including bifurcated embedded derivatives, ii) repurchase agreements and reverse repurchase agreements, and iii) securities borrowing and securities lending transactions that are either offset in accordance with ASC 210-20-45 or ASC 815-10-45 or subject to an enforceable master netting arrangement or similar agreement. The effective date and application provisions of ASU 2013-01 is the same those of ASU 2011-13. Ambac will adopt ASU 2013-01 on January 1, 2013 and it will not have a material effect on Ambac’s financial statements.
hedging purposes only. Derivative positions were established at the time MTNs were issued to purchase financial assets. The activities of these entities are contractually limited to purchasing assets from Ambac, issuing MTNs to fund such purchase, executing derivative hedges and obtaining financial guarantee policies with respect to indebtedness incurred. As of December 31, 2012 Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative contracts owned and outstanding by the entities.
(2) At December 31, 2012, all asset-backed net par amounts outstanding relate to commercial asset-based transactions.
As discussed in Note 2, Ambac records estimated subrogation recoveries for breaches of representations and warranties by sponsors of certain RMBS transactions utilizing an Adverse and Random Sample approach. Ambac has updated its estimated RMBS subrogation recoveries to $2,523,225 ($2,497,233 net of reinsurance) at December 31, 2012 from $2,720,266 ($2,692,414, net of reinsurance) at December 31, 2011. The balance of RMBS subrogation recoveries and the related claim liabilities, by estimation approach, at December 31, 2012 and December 31, 2011, are as follows:
When broker quotes for reference obligations are not available, reference obligation prices used in the valuation model are estimated internally based on averages of the quoted prices for other transactions of the same bond type and Ambac rating as well as changes in published credit spreads for securities with similar collateral and ratings characteristics. When price quotes of a similar bond type vary significantly or the number of similar transactions is small, management will consider additional factors, such as specific collateral composition and performance and contractual subordination, to identify similar transactions. Reference obligation prices derived internally as described above were used in the determination of CDS fair values related to transactions representing 19% of CDS gross par outstanding and 21% of the CDS derivative liability as of December 31, 2012.
The net notional outstanding of Ambac’s CDS contracts were $11,281,777 and $14,166,612 at December 31, 2012 and December 31, 2011, respectively. Credit derivative liabilities at December 31, 2012 and 2011 had a combined fair value of $213,585 and $190,653, respectively, and related to underlying reference obligations that are classified as either CLOs or Other. Information about the above described model inputs used to determine the fair value of each class of credit derivatives as of December 31, 2012 and 2011 is summarized below:
The following tables summarize the location and fair values of individual derivative instruments reported in the Consolidated Balance Sheets as of December 31, 2012 and 2011. Amounts are presented gross of the effect of offsetting balances even where a legal right of offset exists.
A summary of option activity for the period ending December 31, 2012 is as follows:
Broadbill Partners LP et al. v. Ambac Assurance Corporation (Supreme Court of the State of New York, County of New York, filed November 8, 2012). Plaintiffs, alleged owners of Ambac Assurance preferred stock, commenced litigation against Ambac Assurance asserting claims for breach of contract, unjust enrichment, constructive trust, resulting trust and rescission related to Ambac Assurance’s exercise in or about December 2008 of rights under put option agreements with certain trusts. Plaintiffs allege that as a result of the improper exercise of such rights, Ambac Assurance received approximately $800,000 in trust assets from the trusts in exchange for nearly worthless shares of Ambac Assurance preferred stock, which were thereafter delivered to the holders of the securities issued by the trusts. Plaintiffs seek damages, the
Ambac Assurance Corporation and The Segregated Account of Ambac Assurance Corporation v. First Franklin Financial Corporation, Bank of America, N.A., Merrill Lynch, Pierce, Fenner & Smith Inc., Merrill Lynch Mortgage Lending, Inc., and Merrill Lynch Mortgage Investors, Inc. (Supreme Court of the State of New York, County of New York, filed April 16, 2012). Ambac Assurance alleges breach of contract, fraudulent inducement, indemnification, reimbursement and requested the repurchase of loans that breach representations and warranties as required under the contracts, as well as damages. Defendants filed a motion to dismiss on July 13, 2012, which Ambac opposed on September 21, 2012. The motion was fully briefed on October 26, 2012. The court has not yet decided the motion.
Ambac Assurance Corporation and The Segregated Account of Ambac Assurance Corporation v. Capital One, N.A., as successor by merger to Chevy Chase Bank, F.S.B. (United States District Court for the Southern District of New York, filed on October 24, 2012). Ambac Assurance alleges claims for breach of contract, indemnification, reimbursement and requested the repurchase of loans that breach representations and warranties as required under the contracts, as well as damages. Defendants filed a motion to dismiss on February 6, 2013, which Ambac Assurance opposed in a brief filed on February 20, 2013. The motion was fully briefed and filed on March 5, 2013. The court held oral argument on March 7, 2013 and has not yet decided the motion.