Ambac records the impact of estimated recoveries related to securitized loans in RMBS transactions that breached certain representations and warranties within losses and loss expenses (benefit). The expense (benefit) associated with changes to our estimated recoveries for the years ended December 31, 2017, 2016, 2015 and 2014, the eight months ended December 31, 2013 and the four months ended April 30, 2013 were $72.0 million, $(71.4) million, $(303.6) million, $(481.7) million, $199.4 million, and $(61.6) million, respectively.
Ambac records as a component of its loss reserves and subrogation recoverable, estimated recoveries related to securitized loans in RMBS transactions that breached certain representations and warranties. Ambac has recorded gross estimated recoveries of $1,834.4 million, $1,907.0 million, $2,829.6 million, $2,523.5 million and $2,206.6 million at December 31, 2017, 2016, 2015, 2014 and 2013, respectively.
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 with accounting principles generally accepted in the United States (“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-K 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 certain items that the Company has or expects to realize in the future, but that are not reported under GAAP. We also provide reconciliations to the most directly comparable GAAP measures; Adjusted Earnings to Net income attributable to common stockholders and Adjusted Book Value to Total Ambac Financial Group, Inc. stockholders’ equity.
A key strategy for Ambac is to increase the value of its investment in Ambac 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 with Ambac's liability management and loss mitigation programs. Management evaluates the potential impact of loss mitigation and
avoidance strategies in order to target and prioritize policies, or portions thereof, for commutation, refinancing, restructuring or other risk reduction or defeasance strategies.
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 Ambac Assurance UK Limited ("Ambac UK"), purchase distressed Ambac-insured securities based on their relative risk/reward characteristics. The investment portfolios of Ambac Assurance and Ambac UK also hold fixed income securities and funds that include a variety of other assets including, but not limited to, corporate bonds, asset backed and mortgage backed securities, municipal bonds, high yield bonds, leveraged loans, equities, real estate, insurance-linked securities and hedge
funds. Refer to Note 10. Investments to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for further details of fixed income investments by asset class.
On June 27, 2017, Ambac Assurance entered into a termination agreement with various parties, including a special purpose entity Augusta Funding Limited IV ("Augusta"), in connection with the commutation of an interest rate swap between Augusta and Ambac Assurance's wholly-owned subsidiary, Ambac Financial Services ("AFS"). During the second quarter, AFS made net settlement payments of approximately $103.6 million, including $94.4 million under the termination agreement. At March 31, 2017, Ambac had recorded a mark-to-market liability under this swap transaction of $147.0 million (net of an Ambac Assurance CVA of $42.9 million), resulting in a gain of
approximately $43.4 million during 2017. In July 2017, Augusta redeemed its outstanding Ambac Assurance-insured debt and Ambac recognized approximately $2.6 million in accelerated premiums in 2017 relating to this redemption. The Ambac-insured Augusta net par outstanding was $185 million at the time of redemption and was adversely classified.
Ambac worked closely with servicers and owners of Master Servicing Rights to exercise clean-up calls on 20 RMBS transactions, resulting in a benefit in losses and loss expenses of $21.8 million and reducing adversely classified net par exposure by $422.5 million;
During 2017, Ambac Assurance purchased the remaining $4.0 million of unpaid accrued interest related to certain surplus notes that were previously repurchased under call options. Ambac recognized a realized gain on these purchases of $1.1 million in the Consolidated Statements of Total Comprehensive Income (Loss).
On February 12, 2018, the Second Amended Plan of Rehabilitation of the Segregated Account became effective and Ambac and Ambac Assurance consummated a series of transactions that generally involved (i) the exchange of certain surplus notes held by holders of surplus notes that elected to participate in a voluntary exchange transaction and (ii) the satisfaction and discharge of all Deferred Amounts of the Segregated Account, in each case for an effective consideration package comprised of cash, new Secured Notes and certain existing surplus notes and (iii) the exit from rehabilitation of the Segregated Account (the “Rehabilitation Exit Transactions”). See Note 1. Background and Business Description to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for details regarding the Rehabilitation Exit Transactions.
The overall reduction in total net par outstanding resulted from scheduled maturities, amortizations, commutations, refundings, refinancings and calls, including reductions as a result of the activities of Ambac and its subsidiaries as noted above.
In 2017, Ambac established a new non-adversely classified credit category of watch list. Watch list credits are currently fully performing but demonstrate the potential for future material adverse development due to such factors as long-term uncertainty about a particular sector, a certain structural element related to the issuer or transaction, or overall financial and economic sustainability. Total net par exposures of watch list credits are $11.1 billion at December 31, 2017.
As of December 31, 2017 total cash and investments of Ambac were $368.2 million, which include the following:
As a result of positive taxable income at Ambac Assurance in 2016, Ambac received $28.7 million in tax tolling payments in May 2017. As a result of filing its 2016 tax return, Ambac received an additional $0.6 million of tolling payments in December 2017. For the year ended December 31, 2017, $30.5 million of tolling payments were accrued which are expected to be paid to Ambac no later than forty-five days after April 15, 2018. There are no assurances that Ambac Assurance will be able to generate taxable income and therefore make tolling payments to Ambac in the future, which may ultimately constrain Ambac's access to capital and liquidity to support it operations and strategic initiatives.
Future changes to currency rates may adversely affect our financial results. Refer to Part II,
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2017 and 2016, the related consolidated statements of total comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes and financial statement schedules (collectively, the consolidated financial statements), and our report dated February 28, 2018 expressed an unqualified opinion on those consolidated financial statements.
We have audited the accompanying consolidated balance sheets of Ambac Financial Group, Inc. and subsidiaries (the Company) as of December 31, 2017 and 2016, the related consolidated statements of total comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes and financial statement schedules (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
As of the Reorganization Effective Date, the Company was generally discharged and released from all pre-Reorganization Effective Date debts, liabilities, claims, causes of action and interests in accordance with the provisions of the Reorganization Plan. Holders of claims and equity interests are also generally barred from commencing or continuing any action or proceeding relating to such claims, causes of action or interests. The Reorganization Plan also provides for broad exculpation and releases of the Company, Ambac Assurance, the Segregated Account (as defined below), OCI, the Rehabilitator, the board of directors and board committees of the Company and Ambac Assurance, all individual directors, officers and employees of the Company and Ambac Assurance, the Creditors’ Committee and the individual members thereof, and each of the respective representatives of such parties, for actions or omissions that occurred on or prior to the Reorganization Effective Date.
Ambac also provides other financial products through subsidiaries of Ambac Assurance. These products consist of interest rate swaps, funding conduits and investment agreements (until the first quarter of 2017) that were provided principally to clients that were also provided financial guarantee policies. These financial products have been in active runoff since 2007.
Prior to the second quarter of 2017, Ambac had two reportable business segments: i) the financial guarantee segment, which consisted of financial guarantee insurance policies and credit derivative contracts and ii) the financial services segment which consisted of the other financial products discussed above. With respect to the financial services segment, there were significant swap commutations in June 2017. The remaining interest rate swaps, along with other interest rate derivatives, are managed to economically hedge interest rate risk in the financial guarantee and investment portfolios. The last remaining investment agreement matured in March 2017 and the remaining conduit transactions are not material. The significant wind-down of these financial products, along with the appointment of a new Chief Executive Officer effective January 1, 2017, has resulted in a change in how the Company manages its business. Management now reviews financial information, allocates resources and measures financial performance on a consolidated basis. As a result, beginning with the second quarter of 2017, the Company has a single reportable segment. All prior period amounts and disclosures have been adjusted to reflect the reportable segment change.
Ongoing rationalization of Ambac's and its subsidiaries' capital and liability structures;
Ongoing review of organizational effectiveness and efficiency of the operating platform; and
With respect to our new business strategy, we have identified certain business sectors adjacent to Ambac's core business in which future opportunities will be evaluated. The evaluation will be conducted through a measured and disciplined approach to identify opportunities that are synergistic to Ambac, match Ambac's core competencies, are rapidly scalable or available through mergers and acquisitions and that may allow for the utilization of Ambac's net operating loss carry-forwards. Although we are exploring new business opportunities, no assurance can be given that we will be able to execute, or obtain the financial and other resources that may be required to finance, the acquisition or development of any new businesses or assets. Furthermore, the execution of Ambac’s strategy to increase the value of its investment in Ambac Assurance is subject to the rights of OCI under the Stipulation and Order, which requires OCI to approve certain actions taken by or in respect of Ambac Assurance. Opportunities for remediating losses on poorly performing insured transactions also depend on market conditions, including the perception of Ambac Assurance’s creditworthiness, the structure of the underlying risk and associated policy as well as other counterparty specific factors. Decisions by OCI could impair Ambac’s ability to execute certain of its strategies. Ambac Assurance's ability to commute policies or purchase certain investments may also be limited by available liquidity. Due to these factors, as well as uncertainties relating to the ability of Ambac Assurance to deliver value to Ambac, the value of our securities remains speculative.
In March 2010, Ambac Assurance established a Segregated Account pursuant to Wisc. Stat. §611.24 (2) (the “Segregated Account”) to segregate certain segments of Ambac Assurance’s liabilities, and OCI commenced rehabilitation proceedings in the Dane County, Wisconsin Circuit Court (the “Rehabilitation Court”) with respect to the Segregated Account (the “Segregated Account Rehabilitation Proceedings”) in order to permit OCI to facilitate an orderly run-off and/or settlement of the liabilities allocated to the Segregated Account pursuant to the provisions
of the Wisconsin Insurers Rehabilitation and Liquidation Act. On October 8, 2010, OCI filed a plan of rehabilitation for the Segregated Account (the “Segregated Account Rehabilitation Plan”) in the Rehabilitation Court. The Rehabilitation Court confirmed the Segregated Account Rehabilitation Plan on January 24, 2011. On June 11, 2014, the Rehabilitation Court approved amendments to the Segregated Account Rehabilitation Plan and the Segregated Account Rehabilitation Plan, as amended, became effective on June 12, 2014. Net par exposure as of December 31, 2017 for policies allocated to the Segregated Account was $9,246,357. Policy obligations not allocated to the Segregated Account remained in the General Account of Ambac Assurance, and such policies in the General Account were not subject to and, therefore, were not directly impacted by the Segregated Account Rehabilitation Plan.
On July 19, 2017, Ambac Assurance and Ambac entered into an agreement (as amended as of September 21, 2017, the “Rehabilitation Exit Support Agreement”) with holders or beneficial owners (the “Supporting Holders”) of surplus notes issued by Ambac Assurance and beneficial interests in Deferred Amounts (as defined in the Segregated Account Rehabilitation Plan) of the Segregated Account with respect to a transaction which, subject to the conditions precedent set forth in the Rehabilitation Exit Support Agreement, and if consummated, would generally involve (i) the exchange of certain surplus notes held by holders of surplus notes that elect to participate in a voluntary exchange transaction and (ii) the satisfaction and discharge of all Deferred Amounts, in each case for an effective consideration package comprised of cash and new Secured Notes (as defined below) and certain existing surplus notes and (iii) the exit from rehabilitation of the Segregated Account and the merger of the Segregated Account with and into Ambac Assurance (the “Rehabilitation Exit Transactions”).
In accordance with the Rehabilitation Exit Support Agreement, the Rehabilitation Exit Transactions also involved a series of interrelated transactions involving the exchange of certain surplus notes (collectively, the “Exchange Offers”), pursuant to which, for each $1.00 of principal amount outstanding and accrued and unpaid interest thereon, holders effectively (i) received $0.40 in cash, (ii) received $0.41 in principal amount of Secured Notes, (iii) retained $0.125 in principal amount and accrued and unpaid interest thereon of surplus notes and (iv) provided a discount of $0.065 in principal amount and accrued and unpaid interest thereon. Ambac did not participate in the Exchange Offers. An aggregate of 99.6% of the surplus notes held by the Supporting Holders and parties other than Ambac and Ambac Assurance participated both in the Rehabilitation Exit Transactions and in the Exchange Offers.
title and interest in up to the first $1,400,000 of proceeds (net of reinsurance) from certain litigations in which Ambac Assurance seeks redress for breaches of representations and warranties and/or fraud related to residential mortgage-backed securitizations (the “RMBS Litigations”). In addition, the Ambac Note is secured by securities having a market value of approximately $350,000. Ambac Assurance also pledged for the benefit of the holders of Secured Notes (other than Ambac Assurance) the proceeds of the Secured Notes held by Ambac Assurance from time to time, and issued a financial guaranty insurance policy to a trustee for the benefit of holders of Secured Notes irrevocably guarantying all principal and interest payments in respect of the Secured Notes as and when such payments become due and owing.
Until the earlier of (i) June 8, 2020 and (ii) the date on which at least 25% of the principal amount of surplus notes (other than junior surplus notes) are no longer outstanding, Ambac has agreed to hold and not sell surplus notes (other than junior surplus notes) which, as of June 30, 2017, have an aggregate of $60,000 of principal amount and accrued and unpaid interest outstanding.
In connection with the Rehabilitation Exit Transactions, certain documents and instruments relating to the operation of the Segregated Account or the rights of the Segregated Account and the Rehabilitator were terminated, including the Plan of Operation for the Segregated Account; the Secured Note issued by Ambac Assurance to the Segregated Account; the Aggregate Excess of Loss Reinsurance Agreement between Ambac Assurance, as reinsurer, and the Segregated Account; the Management Services Agreement between Ambac Assurance and the Segregated Account; the Cooperation Agreement among Ambac Assurance, Ambac, the Segregated Account and the Rehabilitator; and the Mediation Agreement dated September 21, 2011 among Ambac, Ambac Assurance, the Segregated Account, the Rehabilitator, OCI and the official committee of unsecured creditors of Ambac.
In connection with the consummation of the Rehabilitation Exit Transactions, Ambac Assurance received the approval of the OCI to make a one-time current interest payment of $13,501 on the surplus notes (other than junior surplus notes) outstanding immediately following the Effective Date. On February 12, Ambac Assurance notified the fiscal agent for the surplus notes that the record date for such interest payment would be February 28, 2018 and the payment date would be March 1, 2018.
On the Effective Date, Ambac Assurance issued $240,000 of senior notes (the “Tier 2 Notes”) secured by Ambac Assurance’s rights, title and interest in the cash and non-cash proceeds (net of reinsurance) above $1,600,000 received in connection with the RMBS Litigations.
Following the consummation of the Rehabilitation Exit Transactions, Ambac Assurance will seek to further improve its financial condition by continuing to pursue asset monetizations; loss recoveries; restructurings, purchases, modifications or exchanges of certain outstanding obligations; extinguishment or modification of certain contractual restrictions; and/or commuting or reducing insured exposures. Separately from or in connection with the actions described above, we may seek to further optimize our capital and corporate structure to unlock shareholder value.
A Stipulation and Order, the terms of which were agreed between OCI, Ambac and Ambac Assurance, became effective upon the Effective Date (the "Stipulation and Order") and provides as follows:
Statutory surplus may not reflect the benefit of any reserve discounting, except to the extent approved by the Commissioner.
Ambac Assurance may not enter any transactions with affiliates, including the payment of a dividend or other distribution, without the approval of the Commissioner, subject to limited exceptions.
Ambac Assurance must provide OCI with a monthly report of financial information, the scope of which is to be determined.
Ambac Assurance shall disclose, and Ambac shall disclose, to the Commissioner any instance of fraud or any significant change to the internal control environment incurred by Ambac Assurance, any of its subsidiaries, or Ambac.
Ambac shall use its best efforts to preserve use of net operating loss carry-forwards for the benefit of Ambac Assurance and its subsidiaries, including but not limited to, refraining from taking any action that would result in, and taking such affirmative steps as are appropriate to avoid, any deconsolidation event.
The Commissioner reserves the right to modify or terminate the Stipulation and Order in a manner consistent with the interests of policyholders, creditors and the public generally, and recognizes that Ambac Assurance may request the Commissioner to do so periodically as conditions warrant.
Ambac’s consolidated financial statements have been prepared on the basis of U.S. generally accepted accounting principles (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and disclosures of contingent assets and liabilities. Such estimates that are particularly susceptible to change are used in connection with certain fair value measurements, the evaluation of other than temporary impairments on investments, loss reserves for non-derivative insurance policies or valuation allowance on the deferred tax asset, any of which individually could be material.
The consolidated financial statements include the accounts of Ambac and all other entities in which Ambac (directly or through its subsidiaries) has a controlling financial interest, including variable interest entities (“VIEs”) for which Ambac or an Ambac subsidiary is deemed the primary beneficiary in accordance with the Consolidation Topic of the Accounting Standards Codification ("ASC"). All significant intercompany balances have been eliminated. The usual condition for a controlling financial interest is ownership of a majority of the voting interests of an entity. However, a controlling financial interest may also exist in entities, such as VIEs, through arrangements that do not involve controlling voting interests. A VIE is an entity: a) that lacks enough equity investment at risk to permit the entity to finance its activities without additional subordinated financial support from other parties; or b) where the group of equity holders does not have: (1) the power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entity’s economic performance; (2) the obligation to absorb the entity’s expected losses; or (3) the right to receive the entity’s expected residual returns. The determination of whether a variable interest holder is the primary beneficiary involves performing a qualitative analysis of the VIE that includes, among other factors, its capital structure, contractual terms including the rights of each variable interest holder, the activities of the VIE, whether the variable interest holder has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, whether the variable interest holder has the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE, related party relationships and the design of the VIE. An entity that is deemed the primary beneficiary of a VIE is required to consolidate the VIE. Refer to Note 3. Special Purpose Entities, Including Variable Interest Entities, for a
Ambac’s non-VIE investment portfolio also includes equity interests in pooled investment funds. Such equity interests in the form of common stock or in-substance common stock are classified as trading securities. Equity interests in pooled funds organized as limited liability companies are recorded under the fair value option in accordance with the Financial Instruments Topic of the ASC. Investments classified either as trading or fair value option securities are reported as Other investments on the Consolidated Balance Sheet at fair value with changes in fair value reported through Net investment income on the Statement of Comprehensive Income. Investments in pooled funds have been classified as trading or fair value option securities so that any undistributed earnings of the funds may be reflected in Net investment income as they occur.
VIE investments in fixed income securities are carried at fair value under the fair value option. For additional information about VIE investments, including fair value by asset-type, see Note 3. Special Purpose Entities, Including Variable Interest Entities.
The evaluation of securities for impairment is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether, and to what extent, declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer’s or guarantor’s financial condition and/or future prospects, the impact of regulatory actions on the investment portfolio, the performance of the underlying collateral, the effects of changes in interest rates or credit spreads and the expected recovery period. With respect to Ambac insured securities owned, future cash flows used to measure credit impairment represents the sum of (i) the bond’s intrinsic cash flows and (ii) the estimated Ambac Assurance claim payments. For Ambac-insured securities owned and guaranteed under policies that were allocated to the Segregated Account, the estimate of Ambac Assurance claim payments included interest on Deferred Amounts, which were discharged on February 12, 2018. Ambac estimated the timing of claim payment
Gross premiums are received either upfront or in installments. For premiums received upfront, an unearned premium revenue (“UPR”) liability is established, which is initially recorded as the cash amount received. For installment premium transactions, a premium receivable asset and offsetting UPR liability is initially established in an amount equal to: (i) the present value of future contractual premiums due (the “contractual” method) or (ii) if the underlying insured obligation is a homogenous pool of assets which are contractually prepayable, the present value of premiums to be collected over the expected life of the transaction (the “expected” method). An appropriate risk-free rate corresponding to the weighted average life of each policy and currency is used to discount the future premiums contractually due or expected to be collected. For example, U.S. dollar exposures are discounted using U.S. Treasury rates while exposures denominated in a foreign currency are discounted using the appropriate risk-free rate for the respective currency. The weighted average risk-free rate at December 31, 2017 and 2016, was 2.5%. and 2.6%, respectively, and the weighted average period of future premiums used to estimate the premium receivable at December 31, 2017 and 2016, was 9.8 years and 9.0 years, respectively.
The Company has entered into derivative contracts both for trading purposes and to hedge certain economic risks inherent in its financial asset and liability portfolios. None of Ambac’s derivative contracts are designated as hedges under the Derivatives and Hedging Topic of the ASC. Ambac's derivatives consist primarily of credit derivatives, interest rate swaps and futures contracts. Ambac’s credit derivative contracts are accounted for at fair value since they do not qualify for the financial guarantee scope exception under the Derivatives and Hedging Topic of the ASC. Changes in fair value of credit derivatives are recorded in Net change in fair value of credit derivatives on the Consolidated Statements of Total Comprehensive Income. Ambac maintains a derivatives portfolio consisting primarily of interest rate swaps and futures contracts to economically hedge interest rate risk in the financial guarantee and investment portfolios. This portfolio also includes legacy interest rate swaps with asset-backed securitization issuers, states, municipalities and their authorities which were written in connection with their financings. Changes in fair value of all interest rate derivatives are recorded in net gains (losses) on interest rate derivatives on the Consolidated Statements of Total Comprehensive Income. VIEs consolidated under the Consolidation Topic of the ASC entered into derivative contracts to meet specified purposes within their securitization structure. Changes in fair value of consolidated VIE derivatives are included within Income (loss) on variable interest entities on the Consolidated Statements of Total Comprehensive Income.
All derivatives are recorded on the Consolidated Balance Sheets at fair value on a gross basis; assets and liabilities are netted by counterparty only when a legal right of offset exists. Ambac has determined that the amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral may not be used to offset amounts due under the derivative instruments in the normal course of settlement. Therefore, such amounts are not offset against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement. Effective January 3, 2017, as a result of rule changes by the central clearing party ("CCP"), variation payments are considered settlements of the associated derivative balance and are reflected as a reduction to derivative liabilities on the Consolidated Balance Sheet at December 31, 2017. For periods presented prior to this rule change, variation payments were included in "Other assets" on the Consolidated Balance Sheet. Refer to Note 11. Derivative Instruments for further discussion of the Company’s use of derivative instruments and their impact of the consolidated financial statements, including details of the CCP rule change. Refer to Note 9. Fair Value Measurements for further description of the methodologies used to determine the fair value of derivative contracts, including model inputs and assumptions where applicable.
We tested goodwill for impairment as of October 1st of each year. Goodwill is also tested more frequently if indicators of impairment exist for each reporting unit. During the third quarter of 2015, Ambac determined sufficient indicators of potential impairment existed to perform an interim goodwill impairment evaluation for the reporting unit to which goodwill was assigned. Those indicators included the trading values of Ambac stock and changes in Ambac credit spreads. In conducting the goodwill impairment analysis, we performed step one of the goodwill impairment test where we estimated the fair value of the reporting unit using a market approach, which was derived using: i) Ambac’s common stock and warrant market capitalization, ii) fair value estimates of Ambac Assurance preferred shares (reported as noncontrolling interests on Ambac's balance sheet) and iii) an estimated control premium. Step one of the impairment test indicated the reporting unit's carrying value exceeded its fair value.
As a result, the Company recorded a full non-cash, non-tax deductible goodwill impairment charge of $514,511 in 2015.
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. The carrying values of our financial guarantee insurance and reinsurance contracts continue to be reported and measured in accordance with existing accounting policies. Pursuant to the Financial Services-Insurance Topic of the ASC, the insurance intangible is to be measured on a basis consistent with the related financial guarantee insurance and reinsurance contracts. The insurance intangible asset is amortized using a level yield method based on par exposure of the related financial guarantee insurance or reinsurance contracts and is applied to groups of contracts with similar characteristics.
The PV of expected net cash flows represents the PV of expected cash outflows less the PV of expected cash inflows. The PV of expected net cash flows are impacted by: (i) expected future claims to be paid under an insurance contract, including the impact of potential settlement outcomes upon future installment premiums, (ii) expected recoveries from contractual breaches of RMBS representations and warranties by transaction sponsors, which is discussed further in the “RMBS Representation and Warranty Subrogation Recoveries” section below, (iii) excess spread within the underlying transaction's cash flow structure, and (iv) other subrogation recoveries, including expected receipts from third parties within the underlying transaction's cash flow structure. Ambac’s approach to resolving disputes involving contractual breaches by transaction sponsors or other third parties has included negotiations and/or pursuing litigation. Ambac does not include potential recoveries attributed solely to fraudulent inducement claims in our estimate of subrogation recoveries, since any remedies under such claims would be non-contractual.
CLASS I - “Fully Performing - Meets Ambac Criteria with Remote Probability of Claim” - Credits that demonstrate adequate security and structural protection with a strong capacity to pay interest, repay principal and perform as underwritten. Factors supporting debt service payment and performance are considered unlikely to change and any such change would not have a negative impact upon the fundamental credit quality. Through ongoing surveillance, Ambac may also designate Class I credits into one or more of the following categories:
CLASS V - “Fully Reserved” - The credit has defaulted and payments have occurred. The claim payments are scheduled and known, reserves have been established to fully cover such claims, and no claim volatility is expected.
Ambac records as a component of its loss reserve estimate, subrogation recoveries related to securitized loans in RMBS transactions that breached certain representations and warranties described herein. Generally, the sponsor of a RMBS transaction provided representations and warranties with respect to the securitized loans, including representations and warranties with respect to loan characteristics, the absence of borrower fraud in the underlying loan pools and other misconduct in the origination process and attesting to the compliance of loans with the prevailing underwriting policies. In such cases, the sponsor of the transaction is contractually obligated to repurchase, cure or substitute collateral for any loan that breaches the representations or warranties. Ambac or its counsel have engaged consultants with significant mortgage underwriting experience to review the underwriting documentation for mortgage loans underlying certain insured RMBS transactions which exhibited exceptionally poor performance. Factors which Ambac believes to be indicative of poor performance include (i) increased levels of early payment defaults, (ii) significant numbers of loan liquidations or charge-offs and resulting high levels of losses, and (iii) rapid elimination of credit protections inherent in the transactions’ structures. With respect to item (ii), “loan liquidations” refers to loans for which the servicer has liquidated the related collateral and the securitization has realized losses on the loan; “charge-offs” refers to loans which have been written off as uncollectible by the servicer, generating no recoveries to the securitization, and may also refer to the unrecovered balance of liquidated loans. In either case, the servicer has taken actions to recover against the collateral, and the securitization has incurred losses to the extent such actions did not result in full repayment of the borrower’s obligations.
While the obligation by sponsors to repurchase loans with material breaches is clear, generally the sponsors have not yet honored those obligations without actual or threatened litigation. Ambac has utilized the results of the above described loan file examinations to make demands for loan repurchases from sponsors or their successors and, in certain instances, as a part of the basis for litigation. Ambac’s approach to resolving these disputes has included negotiating with individual sponsors at the transaction level and in some cases at the individual loan level and has resulted in the repurchase of some loans. Ambac has initiated and will continue to pursue lawsuits seeking compliance with the repurchase obligations in the securitization documents.
Obligations under investment agreements are reported as liabilities on the Consolidated Balance Sheets at their principal value less unamortized discount. The carrying value of these obligations is adjusted for principal paid and interest credited to the account. Interest expense is computed based upon daily outstanding liability balances at rates and periods specified in the agreements adjusted for accretion of discount, and is included in Interest expense on the Consolidated Statements of Total Comprehensive Income.
At December 31, 2016 and 2017, Ambac Assurance had 26,411 shares of issued and outstanding auction rate preferred shares with a liquidation preference of $660,300 (reported as noncontrolling interest of $264,110 on Ambac's balance sheet). The auction occurs every 28 days. Due to the dislocation in the auction rate markets and the Company’s financial condition, the dividend rate on the auction market preferred has continuously been reset at the maximum rate of one-month LIBOR plus 200 basis points.
Incentive compensation is a key component of our compensation strategy. Our incentive compensation awards generally have two components: short term incentive compensation (consisting of an annual cash bonus and deferred stock units for certain officers) and long term incentive plan awards (consisting of cash awards and performance stock units). Annual decisions with regard to incentive compensation are generally made in the first quarter of each year and are based on Company performance and individual and business unit performance of the prior year.
Prior to the adoption of ASU 2016-09 (as noted below), Ambac recognized compensation costs for all equity classified awards granted at fair value with an estimation of forfeitures for all unvested shares. As a result of the adoption of ASU 2016-09 in 2017, Ambac recognizes compensation costs for all equity classified awards granted at fair value and records forfeitures for unvested shares only when they occur.
Restricted stock units granted only require future service and accordingly the respective fair value is amortized into compensation expense over the relevant service period.
Remeasurement of loss reserves, classified in Loss and loss expenses, in the amount of $28,939, $(77,578) and $(24,838) for the years ended December 31, 2017, 2016 and 2015, respectively;
Remeasurement of premium receivables, classified in Other income, in the amount of $(1,904), $8,003 and $(2,555) for the years ended December 31, 2017, 2016 and 2015, respectively; and
In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting. The objective of this ASU is to improve and simplify the accounting for employee share-based payment accounting. The amendments are as follows: (i) recognizing excess tax benefits and tax deficiencies as income tax expense, (ii) recognizing excess tax benefits regardless of whether it reduces taxes payable in the current period, (iii) classifying excess tax benefits related to share-based payments along with other income tax cash flows as an operating activity on the statement of cash flows, (iv) for purposes of accruing compensation costs, allowing companies to make an accounting policy election to either: a) estimate forfeitures or b) account for forfeitures as they occur, which Ambac elected to do upon adoption, (v) to qualify for equity classification treatment, permitting tax withholding by employees up to the maximum statutory tax rate and (vi) classifying cash paid by an employer to a taxing authority when directly withholding shares as a financing activity on the statement of cash flows. Adoption of this ASU did not have a material impact on Ambac's financial statements.
In March 2016, the FASB issued ASU 2016-07, Investments-Equity Method and Joint Ventures (Topic 323) - Simplifying the Transition to the Equity Method of Accounting. This ASU eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively as if the equity method had been in effect during all previous periods that the investment had been owned. The ASU will now require that at the date an available-for-sale equity security becomes qualified for the equity method of accounting, the reporting entity will recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income. Adoption of this ASU did not have an impact on Ambac's financial statements.
In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260) and Derivatives and Hedging (Topic 815) - Accounting for Certain Financial Instruments with Down Round Features. Equity-linked instruments, such as warrants and convertible instruments may contain down round features that result in the strike price being reduced on the basis of the pricing of future equity offerings. Under the ASU,
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740) - Intra-Entity Transfers of Assets Other Than Inventory. Current GAAP prohibits the recognition of current and deferred income taxes for intercompany transfers of assets until the asset has been sold to an outside party. The ASU will require companies to recognize the income tax effects of intercompany sales and transfers of assets other than inventory, as income tax expense (or benefit) in the period in which the transfer occurs. ASU 2016-16 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. Early adoption is permitted as of the beginning of an annual reporting period for which financial statements (interim or annual) have not been issued. Ambac will adopt this ASU on January 1, 2018 and we are evaluating its impact on Ambac's financial statements.
ASU 2016-15 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. Early adoption is permitted, including adoptions within an interim period. Ambac will adopt this ASU on January 1, 2018. Adoption of this ASU is not expected to have a consequential impact on Ambac's financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The main difference between current U.S. GAAP and this ASU is the recognition of lease assets and lease liabilities for those leases classified as operating leases. For operating leases, a lessee is required to: 1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the balance sheet, 2) recognize a single lease cost, calculated so that the cost is allocated over the lease term generally on a straight-line basis and 3) classify all cash payment within operating activities in the statement of cash flows. The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The transition guidance requires lessees to recognize and measure leases at the beginning of the
Ambac sponsors special purpose entities that issued notes to fund the purchase of certain financial assets.
As of December 31, 2017 consolidated FG VIE assets and liabilities relating to 11 consolidated entities were $14,500,507 and $14,366,434, respectively. As of December 31, 2016, consolidated FG VIE assets and liabilities relating to 12 consolidated entities were $13,367,834 and $13,235,425, respectively. As of December 31, 2017, eight and three consolidated FG VIEs related to transaction insured by Ambac UK and Ambac Assurance and eight and four as of December 31, 2016. As of December 31, 2017 FG VIE assets and liabilities of $14,160,152 and $14,026,704 and as of December 31, 2016, FG VIE assets and liabilities of $12,950,009 and $12,833,466 related to transactions guaranteed by Ambac UK. The remaining balance of consolidated FG VIE assets and liabilities are related to transactions guaranteed by Ambac Assurance. Ambac is not primarily liable for, and generally does not guarantee all of the debt obligations issued by the VIEs. Ambac would only be required to make payments on the VIE debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest due and such obligation is guaranteed by Ambac. Additionally, Ambac’s general creditors, other than those specific policy holders which own the VIE debt obligations, do not have rights with regard to the assets of the VIEs. Ambac evaluates the net income effects and earnings per share effects to determine attributions between Ambac and non-controlling interests as a result of consolidating a VIE. Ambac has determined that the net income and earnings per share effect of these consolidated FG VIEs are attributable to Ambac’s interests through financial guarantee premium and loss payments with the VIE.
The table below provides the fair value of fixed income securities, by asset-type, held by consolidated VIEs as of December 31, 2017 and 2016:
Total principal amount of debt outstanding was $420,600 and $388,950 at December 31, 2017 and 2016, respectively. In each case, Ambac sold assets to this entity. The assets are composed of utility obligations with a weighted average rating of BBB+ at December 31, 2017 and weighted average life of 3.1 years. The purchase by this entity of financial assets was financed through the issuance of MTNs, which are cross-collateralized by the purchased assets. The MTNs have the same expected weighted average life as the purchased assets. Derivative contracts (interest rate swaps) are used within the entity for economic hedging purposes only. Derivative positions were established at the time MTNs were issued to purchase financial assets. As of December 31, 2017, all fixed-income securities owned, MTNs outstanding and payments due under derivative contracts were guaranteed under financial guarantee insurance policies issued by Ambac Assurance or Ambac UK.
In July 2015, Ambac Assurance entered into a secured borrowing transaction whereby it sold 17 Ambac insured residential mortgage-backed securities (the "Securities") and all rights associated therewith as of May 31, 2015, to a Delaware statutory trust (the "Trust") in exchange for an equity certificate in the Trust, all financial guarantee claim payments associated with the Securities and cash of $146,000 (prior to expenses associated with the transaction). Although the Securities were legally sold to the Trust, the Securities will remain in fixed income securities on the Consolidated Balance Sheets. The Securities had par and fair value of $293,409 and $346,212 as of December 31, 2017, respectively. Refer to Note 10. Investments for further discussion of the restrictions on the invested assets. At the same time, a second Delaware statutory trust (the "Issuer"), issued $146,000 of debt securities and used the proceeds, together with an equity certificate of the Issuer, to purchase from the Trust a certificate secured by and entitling the Issuer to all principal and interest payments (other than financial guarantee claim payments) on the Securities. Interest on the debt securities is payable monthly at an annual rate of one month LIBOR + 2.8%. Both the Trust and the Issuer are consolidated VIEs because Ambac Assurance was involved in their design and holds a significant amount of the beneficial interests issued by the VIEs or guaranteed the assets held by the VIEs. VIE debt outstanding to third parties under this secured borrowing transaction had a carrying value of $73,993 and $102,403 as of December 31, 2017 and 2016, respectively, and is reported in Long-Term Debt on the Consolidated Balance Sheets.
On August 28, 2014, Ambac monetized its ownership of the junior surplus note issued to it by the Segregated Account by depositing the junior surplus note into a newly formed VIE trust in exchange for cash and an owner trust certificate, which represents Ambac's right to residual cash flows from the junior surplus notes. Ambac does not consolidate the VIE. Ambac reports its interest in the VIE as an equity investment within Other investments on the Consolidated Balance Sheets with associated results from operations included within Net investment income: Other investments on the Consolidated Statements of Total Comprehensive Income (Loss). The equity investment had a carrying value of $34,941 and $30,003 as of December 31, 2017 and 2016, respectively. Additionally, at December 31, 2017 Ambac held $35,000 of the debt issued by this VIE.
On May 1, 2013, pursuant to the Second Modified Fifth Amended Plan of Reorganization of Ambac (the "Reorganization Plan"), 45,000,000 shares of new common stock at par value of $0.01 per share and 5,047,138 warrants were issued. Warrants entitled such holders to acquire up to 5,047,138 shares of new common stock at an exercise price of $16.67 per share at any time on or prior to April 30, 2023. For the years ended December 31, 2017, 2016 and 2015, 0, 136, and 740, warrants, respectively, were exercised, resulting in an issuance of 0, 136 and 236 shares of common stock.
On June 30, 2015, the Board of Directors of Ambac authorized the establishment of a warrant repurchase program that permits the repurchase of up to $10,000 of warrants. On November 3, 2016, the Board of Directors of Ambac authorized a $10,000 increase to the warrant repurchase program. For the year ended December 31, 2017, Ambac repurchased 0 warrants at a cost of $0. As of December 31, 2017, Ambac had repurchased 985,331 warrants at a cost of $8,092, (average cost of $8.21 per warrant), leaving 4,053,670 warrants outstanding. The remaining aggregate authorization at December 31, 2017 is $11,939.
The following table provides a reconciliation of the common shares used for basic net income per share to the diluted shares used for diluted net income per share:
Performance stock units are reflected herein at their target issuance amounts. Vesting of these units is contingent upon meeting certain performance metrics. Although a portion of these performance metrics have been achieved as of the respective period end, it is possible that awards may no longer meet the metric at the end of the performance period.
Financial guarantees outstanding includes the exposures of policies that insure variable interest entities (“VIEs”) consolidated in accordance with ASC Topic 810, Consolidation. Financial guarantees outstanding includes the exposure of policies that insure 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. Financial guarantees outstanding exclude the exposures of policies that insure bonds which have been called, pre-refunded or refunded. The gross par amount of financial guarantees outstanding was $67,140,000 and $86,373,000 at December 31, 2017 and 2016, respectively. The par amount of financial guarantees outstanding, net of reinsurance, was $62,716,000 and $79,346,000 at December 31, 2017 and 2016, respectively.
As of December 31, 2017 and 2016, the guarantee portfolio was diversified by type of guaranteed bond as shown in the following table:
At December 31, 2017 and 2016, all asset-backed net par amounts outstanding relate to commercial asset-based transactions.
As of December 31, 2017 and 2016, the International Finance guaranteed portfolio by location of risk was as outlined in the table below:
Amounts presented in this Note relate only to Ambac’s non-derivative insurance business for insurance policies issued to beneficiaries, including VIEs, for which we do not consolidate the VIE.
The following table summarizes net premiums earned by location of risk:
The table below summarizes the future gross undiscounted premiums to be collected and future premiums earned, net of reinsurance at December 31, 2017:
While our reserving scenarios reflect a wide range of possible outcomes reflecting the significant uncertainty regarding future developments and outcomes, given our exposure to Puerto Rico and the economic, fiscal, legal and political uncertainties associated
The tables below summarize information related to policies currently included in Ambac’s loss and loss expense reserves or subrogation recoverable at December 31, 2017 and 2016. Gross par exposures 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 bond. The weighted average risk-free rate used to discount loss reserves at December 31, 2017 and 2016 was 2.5% and 2.7%, respectively.
Ambac records estimated subrogation recoveries for breaches of R&Ws by sponsors of certain RMBS transactions. For a discussion of the approach utilized to estimate R&W subrogation recoveries, see Note 2. Basis of Presentation and Significant Accounting Policies. R&W subrogation may include estimates of potential sponsor settlements, but have not been subject to a sampling approach. However, such estimates are not material to Ambac’s financial results and therefore are included in the below table.
Ambac has recorded R&W subrogation recoveries of $1,834,387, ($1,806,736 net of reinsurance) and $1,907,035, ($1,878,740 net of reinsurance) at December 31, 2017 and 2016, respectively. The balance of R&W subrogation recoveries and the related loss reserves at December 31, 2017 and 2016, are as follows:
Amount represents gross loss reserves for policies that have established a representation and warranty subrogation recovery. Includes unpaid RMBS claims, including accrued interest on Deferred Amounts, on policies allocated to the Segregated Account.
The amount of recorded subrogation recoveries related to each securitization is limited to ever-to-date paid and unpaid losses plus the present value of expected future cash flows for each policy. To the extent losses have been paid but not yet fully recovered, the recorded amount of R&W subrogation recoveries may exceed the sum of the unpaid claims and the present value of expected cash flows for a given policy. The net cash inflow for these policies is recorded as a “Subrogation recoverable” asset. For those transactions where the subrogation recovery is less than the sum of unpaid claims and the present value of expected cash flows, the net cash outflow for these policies is recorded as a “Loss and loss expense reserves” liability.
The sponsor’s repurchase obligation may differ depending on the terms of the particular transaction and the status of the specific loan, such as whether it is performing or has been liquidated or charged off.
Below is the rollforward of R&W subrogation for the affected periods:
Represents reinsurance recoverables on paid and unpaid losses and deferred ceded premiums, net of ceded premium payables due to reinsurers, letters of credit, and collateral posted for the benefit of Ambac Assurance.
The insurance intangible amortization expense is included in insurance intangible amortization on the Consolidated Statements of Total Comprehensive Income (Loss). For the years ended December 31, 2017, 2016 and 2015, the insurance intangible amortization expense was $150,854, $174,608 and $169,557, respectively. As of December 31, 2017 and 2016, the gross carrying value of the insurance intangible asset was $1,581,156 and $1,534,419, respectively. Accumulated amortization of the insurance intangible asset was $734,183 and $572,339, as of December 31, 2017 and 2016, respectively, resulting in a net insurance intangible asset of $846,973 and $962,080, respectively.
The estimated future amortization expense for the net insurance intangible asset is as follows:
Ambac Assurance and Everspan are domiciled in the State of Wisconsin and, as such, are subject to the insurance laws and regulations of the State of Wisconsin (the “Wisconsin Insurance Laws”) and are regulated by the OCI. In addition, Ambac Assurance and Everspan are subject to the insurance laws and regulations of the other jurisdictions in which they are licensed.
As the principal, or domiciliary, regulator of Ambac Assurance and Everspan, OCI has primary regulatory authority, including with respect to the initiation and administration of rehabilitation or liquidation proceedings. Additionally, the accounts and operations of Ambac Assurance and Everspan are subject to periodic comprehensive examinations by the OCI. Wisconsin Insurance Laws require regulated insurance companies to maintain minimum standards of business conduct, maintain minimum surplus to policyholders, meet certain financial tests, and file certain reports, including information concerning their capital structure, ownership, financial condition and enterprise risk. Ambac Assurance and Everspan are not subject to risk-based capital requirements, since they are financial guarantee insurers. Ambac Assurance and Everspan are in compliance with minimum surplus levels. Wisconsin Insurance Laws also require prior approval by OCI of certain transactions between Ambac Assurance or Everspan and their respective affiliates.
In addition, pursuant to the terms of the Settlement Agreement and the Stipulation and Order, Ambac Assurance must seek prior approval by OCI of certain corporate actions. The Settlement Agreement and Stipulation and Order include covenants which restrict the operations of Ambac Assurance. The Settlement Agreement will remain in force until the surplus notes that were issued pursuant to the Settlement Agreement have been redeemed, repurchased or repaid in full. The Stipulation and Order will remain in force for so long as OCI determines it to be necessary. Certain of the restrictions in the Settlement Agreement may be waived with the approval of the OCI and/or the requisite percentage of holders of surplus notes issued in connection with the Settlement Agreement.
The OCI has prescribed or permitted accounting practices for Ambac Assurance. As a result of the prescribed and permitted practices discussed below, Ambac Assurance’s statutory surplus at December 31, 2017 and 2016 was lower by $104,097 and higher by $17,290, respectively, than if Ambac Assurance had reported such amounts in accordance with NAIC SAP.
practice is no longer applicable. Ambac Assurance received a new prescribed practice from OCI with regard to the carrying value of investments in Ambac Assurance insured securities with policies that were allocated to the Segregated Account. The new prescribed practice, effective beginning June 11, 2014, exempts Ambac Assurance from evaluating such investments for other than temporary impairments and requires all such investments be reported at amortized cost regardless of its NAIC risk designation. This accounting determination is intended to recognize that Ambac Assurance continues to maintain statutory loss reserves without adjustment for the economic effects of its ownership of the insured investment securities, improve transparency to the users of the statutory financial statements and to minimize operational risks. As a result of the exit of the Segregated Account from rehabilitation on February 12, 2018, this prescribed practice will no longer be applicable.
The Prudential Regulatory Authority (“PRA”) and Financial Conduct Authority (“FCA”) (and their predecessor regulator the Financial Services Authority (“FSA”)) are the dual statutory regulator responsible for regulating the financial services industry in the United Kingdom, with the purpose of maintaining confidence in the U.K. financial system, providing public understanding of the system, securing the proper degree of protection for consumers and helping to reduce financial crime. In addition, the regulatory regime in the United Kingdom must comply with certain EU legislation binding on all EU member states.
Pursuant to the Settlement Agreement Ambac Assurance may not make any “Restricted Payment” (which includes dividends from Ambac Assurance to Ambac) in excess of $5,000 in the aggregate per annum, other than Restricted Payments from Ambac Assurance to Ambac in an amount up to $7,500 per annum solely to pay operating expenses of Ambac. Concurrent with making any such Restricted Payment, a pro rata amount of Ambac Assurance's surplus notes would also need to be redeemed at par.
Excluded from the fair value measurement categories in the table above are investment funds of $310,441 and $336,513 as of December 31, 2017 and 2016, respectively, which are measured using NAV per share as a practical expedient.
When available, Ambac uses quoted active market prices specific to the financial instrument to determine fair value, and classifies such items within Level 1. The determination of fair value for financial instruments categorized in Level 2 or 3 involves significant judgment due to the complexity of factors contributing to the valuation. Third-party sources from which we obtain independent market quotes also use assumptions, judgments and estimates in determining financial instrument values and different third parties may use different methodologies or provide different values for financial instruments. In addition, the use of internal valuation models may require assumptions about hypothetical or inactive markets. As a result of these factors, the actual trade value of a financial instrument in the market, or exit value of a financial instrument position by Ambac, may be significantly different from its recorded fair value.
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. Because many fixed income securities do not trade on a daily basis, pricing sources apply available market information through processes such as matrix pricing to calculate fair value. Such prices generally consider a variety of factors, including recent trades of the same and similar securities. In those cases, the items are classified within Level 2. For those fixed income investments where quotes were not available or cannot be reasonably corroborated, fair values are based on internal valuation models. Key inputs to the internal valuation models generally 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. Items valued using valuation models are classified according to the lowest level input or value driver that is significant to the valuation. Thus, an item may be classified in Level 3 even though there may be significant inputs that are readily observable. Longer (shorter) expected maturities or higher (lower) yields used in the valuation model will, in isolation, result in decreases (increases) in fair value. Generally, lower credit ratings or longer expected maturities will be accompanied by higher yields used to value a security. At December 31, 2017, approximately 6%, 79%, and 15% of the investment portfolio (excluding variable interest entity investments) was valued using dealer quotes, alternative pricing sources with reasonable levels of price transparency and internal valuation models, respectively. At December 31, 2016, approximately 5%, 82%, and 13% of the fixed income investment portfolio (excluding variable interest entity investments) was valued using dealer quotes, alternative pricing sources with reasonable levels of price transparency and internal valuation models, respectively. Among the investments valued using internal valuation models are Ambac insured securities for which projected cash flows consist solely of Deferred Amounts and interest thereon. These securities are internally valued based upon the valuation of Ambac Assurance's surplus notes and comprise 13% and 12% of the portfolio at December 31, 2017 and 2016, respectively.
The remaining portion of Level 3 residential mortgage-backed securities are an Ambac-insured re-REMIC containing distressed mortgage-backed securities as collateral, the fair value of which was $26,067 at December 31, 2017. There were $0 such securities classified as Level 3 as of December 31, 2016. Fair value was calculated using a discounted cash flow approach with expected future cash flows discounted using a yield consistent with the security type and rating. Significant inputs for the valuation at December 31, 2017 were as follows:
Other asset-backed securities: These securities are a subordinated tranche of a resecuritization collateralized by Ambac-insured military housing bonds. The fair value of such securities classified as Level 3 was $72,540 and $65,990 at December 31, 2017 and 2016, respectively. Fair value was calculated using a discounted cash flow approach with expected future cash flows discounted using a yield consistent with the security type and rating. Significant inputs for the valuation at December 31, 2017 and 2016 include the following weighted averages:
Information about the above described model inputs used to determine the fair value of credit derivatives, including the CVA as a percentage of the gross mark-to-market liability before considering Ambac credit risk (“CVA percentage”), as of December 31, 2017 and 2016 is summarized below:
Changes in fair value are recorded in “Net change in fair value of credit derivatives” on the Consolidated Statements of Total Comprehensive Income (Loss). Although CDS contracts are accounted for at fair value, they are surveilled similar to non-derivative financial guarantee contracts. As with financial guarantee insurance policies, Ambac’s Risk Management group tracks credit migration of CDS contracts’ reference obligations from period to period. Credits are assigned risk classifications by the Risk Management group. As of December 31, 2017, there
The fair value estimate of financial guarantees is computed by utilizing cash flows calculated at the policy level. For direct and assumed contracts, net cash flows for each policy includes future: (i) installment premium receipts, (ii) gross claim payments, (iii) subrogation receipts, and (iv) unpaid claims on claims presented and not yet paid for policies allocated to the Segregated Account, including Deferred Amounts and interest thereon. The timing of future claim payments of the Segregated Account was at the sole discretion of the Rehabilitator until the Segregated Account rehabilitation was concluded on February 12, 2018. For ceded reinsurance contracts, net cash flows for each policy includes future: (i) installment ceded premium payments, (ii) ceding commission receipts, (iii) ceded claim receipts, and (iv) ceded subrogation payments. For each assumed,or ceded reinsurance contract, the respective undiscounted cash flow components are aggregated to determine if we are in a net asset or net liability position. U.S. GAAP requires that the nonperformance risk of a financial liability be included in the estimation of fair value, which includes considering Ambac Assurance’s own credit risk. Accordingly, for each contract in a net liability position, we estimate the fair value using internally developed discount rates and market pricing that incorporate Ambac’s own credit risk and subsequently apply a profit margin. This profit margin represents what another market participant would require to assume the financial guarantee contracts. A profit margin was developed based on discussions with the third-party institutions with valuation expertise, discussions with industry participants and yields on Ambac Assurance surplus notes. The discount rates used for contracts in a net liability position are derived from the rates implicit in the fair value of surplus notes and guaranteed securities with future cash flows that are highly dependent upon Ambac financial guarantee payments. For each contract in a net asset position, we estimate the fair value using a discount rate that is commensurate with a hypothetical buyer’s cost of capital.
The financial assets and liabilities of VIEs consolidated under the Consolidation Topic of the ASC consist primarily of fixed income securities, loans, derivative and debt instruments and are generally carried at fair value. These consolidated VIEs are securitization entities which have liabilities and/or assets guaranteed by Ambac Assurance. The fair values of VIE debt instruments are determined using the same methodologies used to value Ambac’s fixed income securities in its investment portfolio as described above. VIE debt fair value is based on market prices received from dealer quotes or alternative pricing sources with reasonable levels of price transparency. Such quotes are considered Level 2 and generally consider a variety of factors, including recent trades of the same and similar securities. For those VIE debt instruments where
quotes were not available, the debt instrument fair values are considered Level 3 and are based on internal discounted cash flow models. Comparable to the sensitivities of investments in fixed income securities described above, longer (shorter) expected maturities or higher (lower) yields used in the valuation model will, in isolation, result in decreases (increases) in fair value liability measurement for VIE debt. VIE debt instruments considered Level 3 include fixed rate, floating rate and zero coupon notes secured by various asset types, primarily European ABS. Information about the valuation inputs for the various VIE debt categories classified as Level 3 is as follows:
Significant inputs for the valuation at December 31, 2016, include the following weighted averages:
Additional Fair Value Information for Financial Assets and Liabilities Accounted for at Fair Value:
The following tables present the changes in the Level 3 fair value category for the periods presented in 2017, 2016 and 2015. Ambac classifies financial instruments in Level 3 of the fair value hierarchy when there is reliance on at least one significant unobservable input to the valuation model. In addition to these unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Thus, the gains and losses presented below include changes in the fair value related to both observable and unobservable inputs.
The amortized cost and estimated fair value of available-for-sale investments, excluding VIE investments, at December 31, 2017 and 2016 were as follows:
The following table shows gross unrealized losses and fair values of Ambac’s available-for-sale investments, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2017 and 2016:
The gross unrealized losses on corporate obligations as of December 31, 2016 and to a lesser extent at December 31, 2017 resulted from an increase in interest rates since purchase (or the Fresh Start Reporting Date of April 30, 2013 if owned as of that date). These securities are primarily fixed-rate securities with an investment grade credit rating. Management believes that the timely receipt of all principal and interest on these positions is probable.
Of the $30,482 of unrealized losses on residential mortgage-backed securities, $30,482 is attributable to Ambac insured securities. The unrealized loss on these securities is primarily the result of discount accretion, which has exceeded the increase in fair value since either the purchase date or Fresh Start Reporting Date of April 30, 2013 for securities owned prior to such date. As part of the quarterly impairment review process, management estimates expected future cash flows from residential mortgage-backed securities. This approach includes the utilization of market accepted software models in conjunction with detailed data of the historical performance of the collateral pools, which assists in the determination of assumptions such as defaults, severity and voluntary prepayment rates that are largely driven by home price forecasts as well as other macro-economic factors. Additionally, for Ambac insured securities that were allocated to the Segregated Account, expected future cash flows included assumptions about the timing and amount of Ambac Assurance claim payments, including interest on Deferred Amounts, although the actual timing of such payments were at the sole discretion of the Rehabilitator. These assumptions are used to project future cash flows for each security and at December 31, 2017 incorporate the 6.5% discount on the settlement of Deferred Amounts as part of the Rehabilitation Exit Transactions described in Note 1. Management considered this analysis in making our determination that a credit loss has not occurred at December 31, 2017 on these transactions.
Ambac routinely pledges and receives collateral related to certain transactions. Ambac pledges cash and securities it holds in its investment portfolio to investment agreement (prior to repayment in March 2017) and derivative counterparties, as collateral. Securities pledged to investment agreement counterparties were not to be re-pledged to another entity. Ambac’s counterparties under derivative agreements have the right to pledge or rehypothecate the securities and as such, these pledged securities are separately classified on the Consolidated Balance Sheets as “Fixed income securities pledged as collateral, at fair value”.
The following table presents collateral owned by Ambac that was pledged to investment agreement and derivative counterparties at December 31, 2017 and 2016:
Ambac’s fixed income portfolio includes securities covered by guarantees issued by Ambac Assurance and other financial guarantors (“insured securities”). The published rating agency ratings on these securities reflect the higher of the financial strength rating of the financial guarantor or the rating of the underlying issuer. Rating agencies do not always publish separate underlying ratings (those ratings excluding the insurance by the financial guarantor). In the event these underlying ratings are not available from the rating agencies, Ambac will assign an internal rating. The following table represents the fair value, including the value of the financial guarantee, and weighted-average underlying rating, excluding the financial guarantee, of the insured securities at December 31, 2017 and 2016, respectively:
Includes corporate obligations and asset-backed securities with a fair value of $170,280 and $118,813 at December 31, 2017 and 2016, respectively, insured by Ambac UK.
Investments consist of UK property to generate income and capital growth.
Investments seek diversified exposure to hedge fund core strategies to produce high risk-adjusted returns, with low long-term correlation to traditional markets and with targeted volatility levels. Funds may have the right to defer redemptions under certain circumstances.
This class seeks to obtain high long-term total return through investments with low liquidity and defined term, resulting in expected capital distributions to subscribers between 2020 and 2023. Redemptions cannot occur prior to the expiration of the investment lock-up period in May 2018.
This class aims to provide returns from the insurance and reinsurance markets through investments in catastrophe bonds, life insurance and other insurance linked investments. Redemption periods are quarterly, subject to 90-day notice for January/July redemption dates and 120-day notice for April/October redemption dates with redemptions greater than 3.5% during the first five years following share issuance subject to redemption fees.
Ambac also holds interests in an unconsolidated trust created in connection with the 2014 sale of Segregated Account junior surplus notes. The investment in debt securities is accounted for as trading and the equity interest is accounted for under the equity method and included in Other Investments on the Consolidated Balance Sheets.
Effective January 3, 2017, the central clearing party ("CCP") for certain of Ambac's derivative contracts changed its rules governing the character of variation payments. Under the new CCP rules, variation payments are considered settlements of the associated derivative balance. Prior to the rule change such variation payments were considered to be margin and were not offset against the fair value of the derivatives, but were recognized as collateral receivable or payable. The amount of variation margin included within "Other assets" on the Consolidated Balance Sheet as of December 31, 2016, and was applied as a reduction to derivative liabilities effective January 3, 2017 under the new CCP rules is $71,023. Amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral are not offset against fair value amounts recognized for derivative instruments on the Consolidated Balance Sheets. The amounts representing the right to reclaim cash collateral and posted margin, recorded in “Other assets” were $20,926 and $137,701 as of December 31, 2017 and 2016, respectively. There were no amounts held representing an obligation to return cash collateral as of December 31, 2017 and 2016.
The portfolio of our credit derivatives were written on a “pay-as-you-go” basis. Similar to an insurance policy execution, pay-as-you-go provides that Ambac pays interest shortfalls on the referenced transaction as they are incurred on each scheduled payment date, but only pays principal shortfalls upon the earlier of (i) the date on which the assets designated to fund the referenced obligation have been disposed of and (ii) the legal final maturity date of the referenced obligation.
Below investment grade internal ratings reflect bonds which are of speculative grade credit quality with the adequacy of future margin levels for payment of interest and repayment of principal potentially adversely affected by major ongoing uncertainties or exposure to adverse conditions.
Certain VIEs consolidated under the Consolidation Topic of the ASC entered into derivative contracts to meet specified purposes within the securitization structure. The notional for VIE derivatives outstanding as of December 31, 2017 and 2016 are as follows:
As of December 31, 2017 and 2016, the net liability fair value of derivative instruments with contingent features linked to Ambac’s own credit risk was $79,912 and $82,944, respectively, related to which Ambac had posted cash and securities as collateral with a fair value of $111,391 and $128,754, respectively. All such ratings-based contingent features have been triggered as requiring maximum collateral levels to be posted by Ambac while preserving counterparties’ rights to terminate the contracts. Assuming all such contracts terminated on December 31, 2017, settlement of collateral balances and net derivative liabilities would result in a net receipt of cash and/or securities by Ambac. If counterparties elect to exercise their right to terminate, the actual termination payment amounts will be determined in accordance with derivative contract terms, which may result in amounts that differ from market values as reported in Ambac’s financial statements.
Loans by consolidated VIEs are generally carried at fair value on the Consolidated Balance Sheets. See Note 3. Special Purpose Entities, Including Variable Interest Entities for further information about VIEs for which the assets and liabilities are carried at fair value.
Other loans had an outstanding principal balance of $20,184 and $4,873 at December 31, 2017 and 2016, respectively. The interest rate on these loans ranged from 0.00% to 4.58% at December 31, 2017 and were 4.53% December 31, 2016. The maturity date of these loans ranged from June 2026 to December 2046 as of December 31, 2017 and were June 2026 as of December 31, 2016. Collectability of these loans is evaluated on an ongoing basis; no loan has been considered impaired and as such no loan impairments have been recorded as of December 31, 2017 and 2016.
The Segregated Account surplus notes, with a par amount of $0 and $39,102 at December 31, 2017 and 2016, respectively, are reported in long-term debt on the Consolidated Balance Sheets and have a scheduled maturity of June 7, 2020. In 2017, Ambac purchased $39,102 par amount of these surplus notes. The gains on these repurchases were $212 and recognized in Net realized gains (losses) on extinguishment of debt of the Consolidated Statements of Total Comprehensive Income. These surplus notes were recorded at their fair value at the date of issuance. The discount on these notes was being accreted into income using the effective interest method at an imputed interest rate of 10.5%. All payments of principal and interest on the these surplus notes are subject to the prior approval of the OCI. If the OCI does not approve the payment of interest on these surplus notes, such interest will accrue and compound annually until paid. OCI disapproved of the requests of the Rehabilitator of the Segregated Account, acting for and on behalf of the Segregated Account, to pay interest on the outstanding Segregated Account surplus notes on their respective scheduled interest payment dates since their issuance. Pursuant to the Second Amended Plan of Rehabilitation, Ambac Assurance became the obligor under the Segregated Account surplus notes as of February 12, 2018.
The Segregated Account junior surplus notes, with a par value of $370,237 and $374,036 at December 31, 2017 and 2016, respectively, are reported in long-term debt on the Consolidated Balance Sheets and have a scheduled maturity of June 7, 2020, subject to the following restrictions. Pursuant to the Second Amended Plan of Rehabilitation, Ambac Assurance became the obligor under the junior surplus notes as of February 12, 2018. Principal and interest payments on these junior surplus notes cannot be made until all Ambac Assurance surplus notes (other than junior surplus notes) are paid in full and after all of Ambac Assurance's future and existing senior indebtedness, policy and other priority claims have been paid in full. All payments of principal and interest on these junior surplus notes are subject to the prior approval of the OCI. If the OCI does not approve the payment of interest on the junior surplus notes, such interest will accrue and compound annually until paid. No such approval has been sought or obtained to pay interest on junior surplus notes since their issuance.
The secured borrowing, with a par value of $73,993 and $102,986 at December 31, 2017 and 2016, respectively, is reported in long-term debt on the Consolidated Balance Sheets and has a legal maturity of July 25, 2047. Interest on the secured borrowing is payable monthly at an annual rate of one month LIBOR + 2.8%. Refer to Note 3. Special Purpose Entities, Including Variable Interest Entities for further discussion on the secured borrowing transaction.
The variable interest entity notes were issued by consolidated VIEs. Ambac is the primary beneficiary of the VIEs as a result of providing financial guarantees on certain of the the variable interest obligations. Consequently, Ambac has consolidated these variable interest entity notes and all other assets and liabilities of the VIEs. Ambac is not primarily liable for the debt obligations of these entities. Ambac would only be required to make payments on these debt obligations in the event that the issuer defaults on any principal or interest due and to the extent
such obligations are guaranteed by Ambac. The total unpaid principal amount of outstanding long-term debt associated with VIEs consolidated as a result of the financial guarantee provided by Ambac was $9,387,884 and $8,854,530 as of December 31, 2017 and 2016, respectively. The range of final maturity dates of the outstanding long-term debt associated with these VIEs is November 2018 to December 2047 as of December 31, 2017 and 2016. As of December 31, 2017 and 2016, the interest rates on these VIEs’ long-term debt ranged from 0.96% to 8.35% and from 0.82% to 13.00%, respectively. Final maturities of VIE long-term debt for each of the five years following December 31, 2017 are as follows: 2018-$141,327; 2019-$307,915; 2020-$44,100; 2021-$94,024; 2022-$0.
On December 22, 2017, H.R. 1. (commonly referred to as the Tax Cut and Jobs Act or "TCJA") was enacted and significantly changed the tax code effective January 1, 2018. We incorporated the effects of the TCJA in our current and deferred tax evaluation for the year ended December 31, 2017. Given the complexity of the TCJA and the limited time between its enactment and the filing of year-end financial statements, the SEC issued guidance (SAB 118), which provides a one-year measurement period for companies to finalize the accounting for the impact of the TCJA. Ambac has recorded the income tax effect of those aspects of the TCJA for which the accounting is completed and recorded provisional amounts for those aspects for which the accounting is incomplete.
In connection with our preliminary analysis of the TCJA, Ambac recorded an estimated discrete current benefit of $29,581 (net of an estimated 6.6% Congressional budget sequestration haircut) related to the repeal of the Alternative Minimum Tax ("AMT") and deferred taxes of $31,418 attributable to Ambac UK, including the effect of the TCJA changes relating to unrealized gains on investments, resulting in an estimated net cost of $1,886. The AMT credit will be refunded in installments through 2021 or sooner based upon taxable income.
Ambac has not completed its accounting analysis of the TCJA's impact on moving to a new quasi-territorial worldwide tax system, the primary effect of which is a mandatory repatriation of Ambac UK's historical earnings. Accordingly, the provisions related to these international tax changes have been recorded as estimates. Ambac has also not completed the accounting analysis on provisions related to executive compensation and, therefore, recorded these amounts as estimates.
As of December 31, 2017 Ambac had U.S. federal net operating loss tax carryforwards of approximately $3,694,844, which, if not utilized, will begin expiring in 2029, and will fully expire in 2032.
In accordance with the Income Tax Topic of the ASC, a valuation allowance is recognized if, based on the weight of available evidence, it is more-likely-than-not that some, or all, of the deferred tax asset will not be realized. With respect to Ambac's domestic subsidiaries subject to U.S. tax, as a result of the risks and uncertainties associated with future operating results, management believes it is more likely than not that the Company will not generate sufficient taxable income to recover the deferred tax operating asset and therefore maintains a full valuation allowance. The remaining net deferred tax liability of $33,659 is attributable to Ambac U.K.
The total effect of income taxes on net income and stockholders’ equity for the years ended December 31, 2017, 2016 and 2015 is as follows:
A reconciliation of the beginning and ending amount of unrecognized tax benefits for 2017, 2016 and 2015 is as follows:
Included in these balances at December 31, 2017, 2016 and 2015 are $0, $0 and $0, respectively, of unrecognized tax benefits that, if recognized, would affect the effective tax rate. During the years ended December 31, 2017, 2016 and 2015, Ambac recognized interest of approximately $0, $0 and $0, respectively. Ambac had approximately $0, $0 and $0, for the payment of interest accrued at December 31, 2017, 2016 and 2015, respectively.
Pursuant to the amended and restated tax sharing agreement among Ambac, Ambac Assurance and certain affiliates (the “Amended TSA"), to the extent Ambac Assurance generates taxable income after September 30, 2011, which is offset with "Allocated NOLs" of $3,650,000, it is obligated to make payments (“Tolling Payments”), subject to certain credits, to Ambac in accordance with the following NOL usage table, where the “Applicable Percentage” is applied to the aggregate amount of federal income tax liability that would have been paid if the Allocated NOLs were not available. Pursuant to the Closing Agreement between Ambac and the Internal Revenue Service ("IRS"), the IRS will receive 12.5% of Tier C and 17.5% of Tier D payments, if made.
Beginning on the fifth anniversary date subsequent to Ambac's May 1, 2013, emergence from bankruptcy, and subject to Ambac's consent, not to be unreasonably withheld, to the extent Ambac Assurance generates post-determination date income in excess of the $3,650,000, Allocated NOLs, Ambac Assurance may utilize the remaining NOLs, previously reserved for usage by Ambac, in exchange for a payment of 25% of the federal income tax liability that Ambac Assurance would have been paid had Ambac's NOLs not been available.
As of December 31, 2017, the remaining balance of the $3,650,000 NOL allocated to Ambac Assurance was $2,282,205. As of December 31, 2017 Ambac's NOL was $1,412,639.
Incentive compensation is a key component of our compensation strategy. Our incentive compensation awards generally have two components: short term incentive compensation or annual bonuses and long term incentive plan awards. Annual decisions with regard to incentive compensation are generally made in the first quarter of each year and are based on Company performance and individual and business unit performance of the previous year. For all employees, an allocation of incentive compensation is made between annual bonuses and LTIP awards. Beginning for the 2016 performance year, the annual bonus was settled via cash and vested restricted stock units for certain employees.
Employees, directors and consultants of Ambac are eligible to participate in Ambac’s 2013 Incentive Compensation Plan (“2013 Plan”) subject to the discretion of the compensation committee of Ambac’s Board of Directors. The 2013 Plan provides for incentives and rewards that are valued or determined by reference to Ambac common stock as traded on the NASDAQ exchange. There are 4,000,000 shares of Ambac’s common stock authorized for awards under the 2013 Plan of which 2,793,323 shares are available for future grant as of December 31, 2017.
In 2015, Ambac UK 's Board of Directors adopted a long term incentive plan which provides cash based performance awards to Ambac UK employees. Cash based compensation expense related to performance awards granted to Ambac UK employees was $2,159, $283 and $253 for the years ended December 31, 2017, 2016 and 2015, respectively.
A performance award issued to Ambac's former Chief Executive Officer in the form of performance stock units has yet to be expensed given the performance conditions have not been met.
Stock options were awarded to the former Chief Executive Officer in 2015 (vested January 1, 2016), with an expiry term of seven years from the grant date, subject to earlier expiration upon the recipient's departure from the Company. The Company intends to use Treasury shares first and then, if necessary, issue new shares to satisfy stock option exercises. No stock options were awarded in 2016 or 2017.
In 2016, RSU awards were granted to certain Executive Officers. The awards vest in three equal installments on February 21, 2017, 2018 and 2019 ("Time-Based RSUs"). The vesting of the Time-Based RSUs are expressly conditioned upon the respective Executive's continued service with Ambac through the applicable vesting date.
In 2017, RSU awards were granted to certain employees as consideration for a portion of their annual bonus. These awards vest upon grant, but settlement, other than for employment tax withholdings, occurs in two equal installments on March 2, 2018 and 2019, or upon termination if earlier.
As of December 31, 2017, 221,803 RSUs remained outstanding, of which (i) 68,654 units required future service as a condition to the delivery of the underlying shares of common stock and (ii) 153,149 units did not require future service and are deferred for future settlement. As of December 31, 2016, 264,230 RSUs remained outstanding, of which (i) 102,794 units required future service as a condition to the delivery of the underlying shares of common stock, (ii) 103,486 units vested on December 31, 2016 but were not settled until January 3, 2017 and (ii) 57,950 units did not require future service and are deferred for future settlement.
When restricted stock unit awards issued by Ambac become taxable compensation to employees, shares may be withheld to cover the employee’s withholding taxes. For the year ended December 31, 2017, Ambac purchased 56,410 of shares from employees that settled restricted stock units to meet the required tax withholdings.
Performance awards granted vest in 3 years and actual awards will be based on performance at both Ambac and Ambac Assurance. Actual awards can payout 0% to 200% of the number of units granted.
In 2015, a performance award was granted to the former Chief Executive Officer. This award will vest on February 12, 2018 upon the emergence of the Segregated Account from rehabilitation.
Reflects the number of performance shares attributable to the performance goals attained over the completed performance period and for which service conditions have been met.
Represents the increase (decrease) in shares issued for awards granted in 2014 based upon the attainment of performance metrics at the end of the performance period.
As of December 31, 2017 there was $3,523 of total unrecognized compensation costs related to the PSU portion of unvested performance awards, which are expected to be recognized over a weighted average period of 1.6 years.
Ambac is responsible for leases on the rental of office space. The executive office of Ambac is located in New York City under a lease agreement that was modified and extended in 2015 to allow Ambac to remain in the same office space through September 2019 and on one floor through the end of 2029, with an option to continue to occupy other currently leased floors through the end of 2029. Rent payments under this lease made through September 2019 will result in the periodic reduction of junior surplus notes that were previously issued to the landlord, beginning in January 2016. Ambac leases additional space for its data center, disaster recovery site and for its international location under lease agreements that expire periodically through October 2020. An estimate of future net minimum lease payments in each of the next five years ending December 31, and the periods thereafter, is as follows:
Ambac rent expense for the aforementioned leases amounted to $2,717, $3,008 and $5,746 for the years ended December 31, 2017, 2016 and 2015, respectively. Beginning in 2016, rent expense is reduced by the reduction in junior surplus notes discussed above.
confirming the Second Amended Plan of Rehabilitation (the "Confirmation Order"), which became effective on February 12, 2018. Pursuant to the Confirmation Order, the Rehabilitation Court also ruled that, contrary to allegations made by certain parties to certain military housing litigations (the "MHPI Projects"), the Rehabilitation Court did not previously enter any order that could form the predicate for a claim of “Ambac Default” and confirmed Section 6.13 of the Second Amended Plan of Rehabilitation which, among other things, provided that any such default is deemed not to have existed or to be cured.
Ambac Assurance is defending several lawsuits in which borrowers have brought declaratory judgment actions claiming, among other things, that Ambac Assurance’s claims for specific performance related to the construction and development of housing at various military bases to replace or cash-fund a debt-service-reserve surety bond, as required under the applicable loan documents (see Litigation Filed By Ambac), are time-barred or are barred by the doctrine of laches, that Ambac lacks standing on the basis that there has been an “Ambac Default,” and that Ambac is not entitled to specific performance pursuant to the terms of the loan documents. Specifically, Ambac Assurance is a defendant in the following actions:
The Company believes that it has substantial defenses to the claims raised in these lawsuits and intends to defend itself vigorously; however, the Company is not able to predict the outcome of these actions.
Monterey Bay Military Housing, LLC, et al. v. Ambac Assurance Corporation, et al. (United States District Court, Northern District of California, San Jose Division, Case No. 17-cv-04992-BLF, filed August 28, 2017). Plaintiffs-the corporate developers of various military housing projects-filed an amended complaint on October 27, 2017 asserting claims for (i) violation of 18 U.S.C §§ 1962(c) and 1962(d) (civil Racketeer Influenced and Corrupt Organizations Act (“RICO”) and conspiracy to commit civil RICO), (ii) breach of fiduciary duty, (iii) aiding and abetting breach of fiduciary duty, (iv) fraudulent misrepresentation, (v) fraudulent concealment and (vi) conspiracy to commit fraud. Ambac Assurance and a former employee of Ambac Assurance are included in the named defendants. The claims relate to bonds and debt certificates (insured by Ambac Assurance) that were issued to finance the renovation and construction of housing at certain military bases. Plaintiffs allege that defendants secretly conspired to overcharge plaintiffs for the financing of the projects and directed the excess profits to themselves. Plaintiffs allege defendants generated these excess profits by supposedly charging inflated interest rates, manipulating “shadow ratings,” charging unnecessary fees, rigging the Guaranteed Investment Contract (“GIC”) bidding process, and hiding evidence of their alleged wrongdoing. Plaintiffs seek, among other things, compensatory damages, disgorgement of profits and fees, punitive damages, trebled damages and attorneys’ fees. On September 21, 2017, Ambac Assurance filed a motion to transfer venue to the United States District Court for the Southern District of New York, which motion plaintiffs opposed on October 5, 2017. The Court heard oral argument on November 30, 2017 and requested additional briefing from both parties. After the submission of the additional briefing, the Court denied Ambac’s motion to transfer on January 2, 2018. Ambac and the other defendants filed motions to dismiss the amended complaint on November 13, 2017, which Plaintiffs opposed on December 15, 2017. The motions are fully briefed and a hearing is scheduled on the motions for April 12, 2018. Ambac believes the lawsuit is without merit.
Erste Europäische Pfandbriefund Kommunalkreditbank AG In Luxemburg and Ambac Assurance Corporation v. City of San Bernardino, California (United States Bankruptcy Court, Central District of California, Riverside Division, Docket No. 15-1185, filed on January 7, 2015). Plaintiffs commenced this adversary proceeding, which relates to the Debtor’s obligations under the Public Employees Retirement Law, California Government Code Section 20000 et seq. (the “Retirement Law”), in connection with the City of San Bernardino’s bankruptcy proceeding. In the complaint, plaintiffs seek a declaratory judgment that the Debtor is obligated to make equivalent payments to both the holders of certain pension obligation bonds (the “Bonds”), a portion of which are insured by Ambac, and the California Public Employees Retirement Systems (“CalPERS”) to fund pension and other retirement benefits. It is the plaintiffs’ position that they are entitled to declaratory judgment because (i) when the City issue the Bonds, the City argued and a California court found, that the obligations under the Bonds were
Lex Claims, LLC et al. v. Alejandro Garcia Padilla et al. (United States District Court, District of Puerto Rico, No. 16-2374, filed July 20, 2016). On October 7, 2016, certain General Obligation bondholder Plaintiffs in an action to which Ambac Assurance was not then a party filed a motion for leave to amend their complaint and for partial relief from the PROMESA stay. Plaintiffs’ proposed second amended complaint added the Puerto Rico Sales Tax Financing Corporation (COFINA), COFINA’s executive director, and the trustee for the COFINA bonds as Defendants, and asserted numerous claims that challenge the legal validity of the COFINA structure and seek injunctive relief requiring the sales and use tax proceeds securing COFINA’s bonds to be transferred to the Puerto Rico Treasury. Plaintiffs contended that many of the claims
challenging COFINA are not subject to PROMESA’s litigation stay provisions. On October 24, 2016, Defendants filed an opposition to the motion for leave to amend, arguing that the entire action is subject to the PROMESA stay. On October 26, 2016, Ambac Assurance filed a motion for leave to intervene and in support of the PROMESA stay. Ambac Assurance seeks to intervene principally to argue that the claims challenging COFINA are stayed by PROMESA, but also reserves the right to move to dismiss or otherwise defend against those claims should the court determine they are not stayed. On November 4, 2016, the Court granted Plaintiffs’ motion for leave to amend. Plaintiffs filed their second amended complaint that same day. On November 7, 2016, government Defendants sought to stay the case. On February 17, 2017, the court granted the motions to intervene of Ambac Assurance and certain other parties. The court also denied Defendants’ motion to stay, rejecting the arguments in support of the stay filed by Defendants and the intervenors, including Ambac Assurance. On March 20, 2017, Ambac Assurance filed in the district court an answer to the second amended complaint and a motion to dismiss Plaintiffs’ claim against COFINA, to strike certain portions of the second amended complaint, or, in the alternative, to certify the question of COFINA’s constitutionality to the Supreme Court of Puerto Rico. Certain other intervenors also filed answers and various motions in the district court. On April 4, 2017, the U.S. Court of Appeals for the First Circuit reversed the district court’s decision concerning the application of the PROMESA stay, which had the effect of reinstating the stay. PROMESA’s litigation stay expired on May 2, 2017. On May 3, 2017, a petition under Title III of PROMESA was filed on behalf of the Commonwealth of Puerto Rico. On May 16, 2017, Defendants filed a statement requesting that the court take notice of the stay resulting from the Commonwealth’s Title III filing. On May 17, 2017, the court issued an order staying this case until further order of the court.
Ambac Assurance Corporation v. Puerto Rico, et al. (United States District Court, District of Puerto Rico, No. 17-1567, filed May 2, 2017). On May 2, 2017, Ambac Assurance filed a complaint seeking a declaration that the Commonwealth’s Fiscal and Economic Growth Plan (the FEGP) and a recently enacted statute called the “Fiscal Plan Compliance Law” are unconstitutional and unlawful because they violate the Contracts, Takings, and Due Process Clauses of the U.S. Constitution, are preempted by PROMESA, and are unlawful transfers of property from COFINA to the Commonwealth in violation of PROMESA. The complaint further seeks an injunction against the filing of any Title III petitions, an injunction against the enactment or enforcement of any future legislation, rules, budgets, or restructuring plans premised on the FEGP, and a declaration that the Commonwealth is liable for any funds unlawfully transferred to it from COFINA. The complaint also seeks a declaration that the FEGP and Fiscal Plan Compliance Law violate covenants made by the Commonwealth and COFINA in the COFINA Resolution, which constitute Events of Default under the COFINA Resolution. On May 3, 2017, a petition under Title III of PROMESA was filed on behalf of the Commonwealth of Puerto Rico, and on May 5, 2017, a petition under Title III of PROMESA was filed on behalf of COFINA. On May 15, 2017, the Oversight Board filed a statement requesting that the court take notice of the stays resulting from these Title III filings. On May 17, 2017, the court issued an order staying this case until further order of the court.
Ambac Assurance Corporation v. U.S. Department of Treasury et al. (United States District Court, District of Columbia, No. 17-809, filed May 2, 2017). On May 2, 2017, Ambac Assurance filed a complaint against the U.S. Department of Treasury and Steven Mnuchin, in his official capacity as Secretary of the Treasury, alleging that Puerto Rico’s ongoing diversion of rum taxes from PRIFA violates the Contracts, Takings, and Due Process Clauses of the U.S. Constitution, and seeking an equitable lien on all rum taxes possessed by the U.S. Treasury, and an injunction preventing their transfer to the Commonwealth, in order to prevent further dissipation of those funds by the Commonwealth. On May 24, 2017, the Oversight Board filed a statement requesting that the court take notice of the stay resulting from the Commonwealth’s Title III filing. On May 25, 2017, the court issued an order staying this case pending the final disposition of the Title III proceedings.
Ambac Assurance Corporation v. Puerto Rico, et al. (United States District Court, District of Puerto Rico, No. 1:17-ap-00159, filed June 8, 2017). On June 8, 2017, Ambac Assurance filed an adversary complaint in the Commonwealth’s Title III case against the Commonwealth, PRHTA, the Oversight Board, AAFAF, and other Commonwealth government officers. The complaint seeks declarations that (i) various moratorium laws ("Moratorium Legislation") enacted by the Commonwealth and executive orders ("Moratorium Orders") issued by the Governor to claw back funds from the PRIFA, PRHTA, and PRCCDA bonds and (ii) the FEGP and Fiscal Plan Compliance Act violate the Contracts, Takings, and Due Process Clauses of the U.S. Constitution, are preempted by PROMESA, and unlawfully transfer PRHTA, PRCCDA, and PRIFA property to the Commonwealth. The complaint further seeks a declaration that revenues pledged to the PRHTA bonds are “special revenues” under Sections 922 and 928 of the Bankruptcy Code, and an injunction compelling Defendants to remit the pledged special revenues to PRHTA for payment of the PRHTA bonds. On July 7, 2017, Ambac Assurance filed an amended complaint that added an additional claim for relief: a declaration that the funds held in the PRHTA reserve accounts are property of the PRHTA bondholders. On August 3, 2017, the court entered an order, to which all parties stipulated, providing that BNYM, as fiscal agent for PRHTA bondholders, shall continue to hold the funds in the reserve accounts established under PRHTA’s governing bond documents until further order of the court. On October 27, 2017, the court ordered that the Creditors’ Committee is entitled to “limited intervention,” in the proceeding. On July 28, 2017, Defendants moved to dismiss Ambac Assurance’s complaint; briefing on the motion to dismiss concluded on October 31, 2017, and oral argument on the motion was held on November 21, 2017. On February 27, 2018, the court granted Defendants’ motion to dismiss. As to certain of the claims, the court found that it lacks subject matter jurisdiction (i) to the extent the claims seek to invalidate the certification of the FEGP and prohibit certain actions under PROMESA due to alleged non-compliance with PROMESA requirements that are predicates to certification of the FEGP, or (ii) to the extent Ambac Assurance sought a determination of its lien rights over the PRHTA reserve accounts. As to other claims, the court found that Ambac Assurance had failed to state a claim upon which the court could grant relief, including that (i) as to constitutional issues, Ambac Assurance had failed to plead facts sufficient to allow the court to draw a reasonable inference that the Moratorium Legislation, Moratorium Orders, and Fiscal Plan Compliance Act were “unreasonable or unnecessary to effectuate an important government purpose” and had failed to allege plausibly that the FEGP is an exercise of Commonwealth legislative power, (ii) Ambac Assurance had failed to plead facts sufficient to show that the Moratorium Legislation and Moratorium Orders prohibited the payment of principal and interest or purported to bind creditors to any reduction of the outstanding obligations and therefore would have been preempted by PROMESA under PROMESA Section 303(1), and Ambac Assurance failed to plead plausible, ripe claims that the Moratorium Orders are unlawful under PROMESA section
303(3), (iii) the automatic stay is currently in effect and renders unavailable any cause of action pursuant to Section 407 of PROMESA, including claims by PRHTA bondholders that PRHTA should be compensated for any pledged special revenues transferred away from it in violation of applicable law, (iv) the court is not required or empowered under PROMESA or the Bankruptcy Code to order the payment of pledged special revenues to the PRHTA bondholders, and (v) Ambac Assurance had failed to plead facts sufficient to show that the PRHTA reserve accounts are the property of the bondholders. Finally, the court held that PROMESA section 305 prevented it from ordering any relief on Ambac’s claim that the PRHTA reserve accounts are held in trust for bondholders.
Official Committee of Unsecured Creditors v. Whyte (United States District Court, District of Puerto Rico, No. 1:17-ap-00257, filed September 8, 2017). On August 10, 2017, the court approved a stipulation between the Oversight Board, the Commonwealth, COFINA, and certain creditor parties, including Ambac Assurance, to resolve the Commonwealth-COFINA dispute regarding entitlement to sales and use taxes. The stipulation contemplates separate agents for each of COFINA and the Commonwealth, which agents will litigate the dispute, while preserving the ability of interested parties, including Ambac Assurance, to participate in the litigation. The court order names Ms. Bettina Whyte as the agent for COFINA, and names the Creditors’ Committee as the agent for the Commonwealth. On September 8, 2017, pursuant to a stipulation and scheduling order entered by the court, the Creditors’ Committee, as Commonwealth Agent, filed an adversary proceeding against Bettina Whyte, as COFINA Agent. The thirteen-count complaint for declaratory relief alleges (a) that COFINA’s enabling legislation did not, and could not, transfer present ownership of the future Sales and Use Tax revenues to COFINA, (b) that this purported transfer is governed by Article 9 of the Uniform Commercial Code and is not enforceable, was never perfected, and is avoidable and (c) that the COFINA structure is unconstitutional because the COFINA enabling legislation was designed to evade the constitutional debt limit, the constitutional priority of payment granted to Puerto Rico’s public debtholders, and the balanced budget provision. The Creditors’ Committee filed a revised complaint on October 25, 2017, making technical corrections to the original complaint; the COFINA Agent filed an answer to this amended complaint on October 30, 2017. On November 6, 2017, Ambac Assurance filed a notice of intervention, together with an answer and counterclaims; other interested parties named in the stipulation governing the Commonwealth-COFINA dispute similarly filed answers and counterclaims. On November 13, 2017, Ambac Assurance and certain other interested parties filed motions seeking to enforce the stipulated scope of the Commonwealth-COFINA dispute. Ambac Assurance moved to strike the Commonwealth Agent’s fourth through thirteenth causes of action as beyond the stipulated scope of the dispute, which is narrowly focused on whether the Pledged Sales Taxes are the property of COFINA. On December 21, 2017, the District Court dismissed all but the first and second causes of action in the Commonwealth Agent’s complaint as outside the scope of the Commonwealth-COFINA dispute, ruling that the stipulation governing such dispute contemplates a narrow focus on the ownership of the Pledged Sales Taxes. On January 4, 2018, the Commonwealth Agent filed a motion to clarify the District Court’s December 21 scope order, seeking reconsideration of the dismissal of the Commonwealth’s Agent’s constitutional claims or leave to amend its complaint such that its constitutional claims might fall within the permitted scope. Ambac Assurance objected to this motion on January 8, 2018. On January 10, 2018, the District Court denied the Commonwealth Agent’s motion to reconsider, but permitted the Commonwealth Agent to move to amend its complaint in a manner consistent with the December 21 scope order. The Commonwealth Agent moved to file an amended complaint on January 11, 2018, which motion Ambac Assurance opposed on January 12, 2018; the District Court granted the Commonwealth Agent’s motion on January 13, 2018, and the Commonwealth Agent filed its amended complaint on January 16, 2018; the COFINA Agent, Ambac Assurance, and other parties filed answers and counterclaims to the amended complaint on January 30, 2018. The Commonwealth and other parties filed answers to these counterclaims on February 13 and 14, 2018. Motions for summary judgment were filed on February 21, 2018, with a hearing on those motions scheduled for April 10, 2018.
Ambac Assurance has filed various lawsuits seeking specific performance of obligations of borrowers on loans related to the construction and development of housing at various military bases to replace or cash-fund a debt-service-reserve surety bond provided by Ambac Assurance, as required under the applicable loan documents. Defendants have asserted, among other things, that Ambac Assurance's claims are barred by the doctrine of laches, that Ambac Assurance lacks standing on the basis that there has been an “Ambac Default” or "Credit Enhancer Default" and that Ambac Assurance is not entitled to specific performance pursuant to the terms of the loan documents. Specifically, Ambac Assurance has instituted the following actions:
Ambac Assurance Corporation v. Fort Leavenworth Frontier Heritage Communities, II, LLC (U.S. District Court, District of Kansas, Index No. 15-CV-9596). Ambac Assurance filed this action on November 19, 2015. On January 4, 2016, defendant moved to dismiss for failure to join an indispensable party, which Ambac Assurance opposed on January 25, 2016. On June 29, 2016, the court denied defendant’s motion to dismiss and granted Ambac Assurance leave to file an amended complaint, which was filed on July 13, 2016. On August 1, 2016, Defendant filed a motion to dismiss the amended complaint for lack of subject matter jurisdiction. Ambac Assurance opposed the motion. On March 17, 2017, the court granted Fort Leavenworth's motion to dismiss for lack of subject matter jurisdiction. On March 28, 2017, Ambac re-filed the case in state court in Shawnee County, Kansas. The re-filed case is styled Ambac Assurance Corporation v. Fort Leavenworth Frontier Heritage Communities II, LLC (District Court, Shawnee County, Kansas, No. 2017-cv-000216).
Ambac Assurance Corporation v. Fort Bliss/White Sands Missile Range Housing LP (District Court, El Paso County, Texas, Cause No. 2016DCV0094). Ambac Assurance filed this action on January 8, 2016. Defendant served its answer on February 11, 2016. Defendant filed a motion for summary judgment on November 16, 2017 on two of its affirmative defenses, including statute of limitations and "Credit Enhancer Default" by virtue of certain orders of the Rehabilitation Court. Ambac Assurance filed a consolidated (i) opposition to Fort Bliss/White Sands’ motion for summary judgment and (ii) counter-motion for partial summary judgment on December 13, 2017. Defendant filed its opposition on January 22, 2018. Ambac Assurance filed its reply brief on January 30, 2018 arguing, among other things, that the Rehabilitation Court’s January 22 Order constituted further grounds for entering summary judgment for Ambac Assurance on the "Credit Enhancer Default" argument. Oral argument on the summary judgment motions has been scheduled for April 27, 2018. On February 7, 2018, the Rehabilitation Court entered a further order enjoining Bliss (among others) from continuing to argue that an Ambac Default occurred by virtue of the Rehabilitation Court's prior orders and requiring Bliss to file that order with the Texas Court. On February 8, 2018, Bliss filed the Rehabilitation Court's January 22 and February 7 orders with the Texas court.
The Segregated Account of Ambac Assurance Corporation and Ambac Assurance Corporation v. Countrywide Home Loans, Inc. (Wisconsin Circuit Court for Dane County, Case No 14 CV 3511, filed on December 30, 2014). Ambac Assurance alleges a claim for fraudulent inducement in connection with Ambac Assurance’s issuance of insurance policies relating to five residential mortgage-backed securitizations that are not the subject of Ambac Assurance’s previously filed lawsuit against the same defendant. Defendant filed a motion
to dismiss the complaint on February 20, 2015, which Ambac Assurance opposed. The court heard oral argument on two of Countrywide’s grounds for dismissal on June 23, 2015, and indicated that it would dismiss the Wisconsin Action without prejudice for lack of personal jurisdiction. The court issued an order to that effect on July 2, 2015. Ambac Assurance appealed the July 2, 2015 order. On June 23, 2016, the Wisconsin Court of Appeals reversed the trial court’s dismissal of the complaint, and on October 11, 2016, the Wisconsin Supreme Court granted Countrywide’s petition for review of the June 23 decision by the Wisconsin Court of Appeals. The Wisconsin Supreme Court appeal was argued on February 28, 2017. On June 30, 2017, the Wisconsin Supreme Court reversed the decision of the Wisconsin Court of Appeals and remanded the case to the Wisconsin Court of Appeals for further proceedings. On December 14, 2017, the Wisconsin Court of Appeals affirmed the trial court’s July 2, 2015 decision dismissing the case for lack of personal jurisdiction. On January 16, 2018, Ambac Assurance filed a petition with the Supreme Court of Wisconsin for review of the December 14, 2017 decision. On January 30, 2018, Countrywide opposed the petition. On June 30, 2015, plaintiffs filed a Summons with Notice in the Supreme Court of the State of New York, County of New York, No. 652321/15 (the “2015 New York Action”), alleging claims identical to the Wisconsin Action. On July 21, 2015, plaintiffs filed a complaint in the 2015 New York Action and a motion to stay the 2015 New York Action pending appeal and litigation of the Wisconsin Action. On August 5, 2015, Countrywide filed its opposition to plaintiffs’ motion to stay and on August 10, 2015, Countrywide filed a motion to dismiss the complaint, which Ambac opposed. The court held oral argument in November 2015 and on September 20, 2016 granted Ambac Assurance’s motion to stay. Countrywide’s motion to dismiss the complaint is held in abeyance pending resolution of the Wisconsin Action.
Ambac Assurance Corporation and The Segregated Account of Ambac Assurance Corporation v. U.S. Bank National Association (United States District Court, Southern District of New York, Docket No. 17-cv-00446 (SHS), filed January 20, 2017). Ambac Assurance commenced this action to enjoin the defendant from accepting a proposed settlement in a separate litigation that the defendant is prosecuting, as trustee, in connection with a residential mortgage-backed securitization for which Ambac Assurance issued an insurance policy. Ambac Assurance alleges claims for declaratory judgment, breach of contract, breach of fiduciary duty, and violation of the Streit Act. On February 14, 2017, plaintiffs filed an amended complaint asserting additional claims for declaratory judgment and breach of contract related to the defendant’s treatment of trust recoveries. On February 23, 2017, plaintiffs filed a second amended complaint to reflect a revised settlement offer, and also filed a motion for a preliminary injunction, which U.S. Bank opposed. On March 9, 2017, U.S. Bank filed a motion to dismiss the second amended complaint, which plaintiffs opposed. The court heard oral argument on plaintiffs’ motion for a preliminary injunction and U.S. Bank’s motion to dismiss on April 24, 2017. On June 1, 2017, the court denied U.S. Bank’s motion to dismiss and denied plaintiffs’ motion for a preliminary injunction. U.S. Bank filed a motion for reconsideration of the court’s denial of its motion to dismiss, which plaintiffs opposed. On December 6, 2017, the court granted the motion for reconsideration and granted U.S. Bank’s motion to dismiss, and on January 18, 2018, the court issued an opinion memorializing the reasons for its decision. On March 6, 2017, U.S. Bank filed a trust instruction proceeding in Minnesota state court concerning the proposed settlement, which is captioned, In the matter of HarborView Mortgage Loan Trust 2005-10, No. 27-TR-CV-17-32 (the “Minnesota Action”). On April 5, 2017, Ambac Assurance filed a motion to dismiss the Minnesota Action. On June 12, 2017, U.S. Bank filed an amended petition in the Minnesota Action and on July 7, 2017, Ambac Assurance renewed its motion to dismiss, which U.S Bank opposed. On November 13, 2017, the court denied the motion to dismiss the proceeding. On February 7, 2018, Ambac Assurance appealed this dismissal. Additionally, certain certificate holders have objected or otherwise responded to the petition filed by U.S. Bank.
Ambac Assurance Corporation and The Segregated Account of Ambac Assurance Corporation v. U.S. Bank National Association (United States District Court, Southern District of New York, Docket No. 17-cv-02614, filed April 11, 2017). Ambac Assurance alleges claims for breach of contract, breach of fiduciary duty, declaratory judgment, and violation of the Streit Act in connection with defendant’s failure to enforce rights and remedies and defendant’s treatment of trust recoveries, as trustee of five residential mortgage-backed securitizations for which Ambac Assurance issued insurance policies. On September 15, 2017, U.S. Bank filed a motion to dismiss, which Ambac Assurance opposed on October 13, 2017. Oral argument on that motion was held on November 17, 2017. The motion remains pending.
U.S. Securities and Exchange Commission (the “SEC”) v. Citigroup Global Markets Inc. (“Citigroup”) (United States District Court Southern District of New York, Docket No. 11-CV-7387, filed in October 2011). This suit related to a collateralized debt obligation transaction arranged by Citigroup where Ambac Credit Products, LLC (insured by Ambac Assurance) provided credit protection through a credit default swap to a bank counterparty that was exposed to the transaction. The SEC and Citigroup reached a settlement of this action for $285,000. The presiding judge approved the settlement in August of 2014. A fair fund has been established to distribute the $285,000 (plus $2,550 received from a related proceeding). RCB Fund Services (the “Distribution Agent”) has been appointed as distribution agent for the fund and has invited
investor participants in the CDO transaction to provide information regarding their investments in the CDO transaction. Ambac Assurance filed a submission with the requested information on February 28, 2018. The Distribution Agent, in consultation with the SEC, will then develop a distribution plan for the fair fund, which will be filed with the Court and will be subject to a comment period. While there can be no assurance as what the Distribution Plan will provide, or the timing or substance of what the Court will decide, Ambac Assurance expects to receive a significant portion of the settlement funds. Ambac has not recorded any receivable for its estimated portion of these settlement funds
As more fully discussed in Note 1. Background and Business Description, on February 12, 2018:
the Second Amended Plan of Rehabilitation became effective and a series of transactions were consummated which provided holders of beneficial interests in Deferred Amounts (other than Ambac, but including Ambac Assurance) a total effective consideration package, in full satisfaction and discharge of each $1.00 of Deferred Amounts (including accretion), of (i) $0.40 in cash, (ii) $0.41 in principal amount of new Secured Notes and (iii) from certain holders of surplus notes, $0.125 currently outstanding surplus notes. Such consideration package provided a discount of $0.065 (set first against accretion of Deferred Amounts). Ambac received $0.91 in principal amount of Secured Notes for each $1.00 of Deferred Amounts (including accretion) that it held, and provided a $0.09 discount in full satisfaction and discharge of its Deferred Amount claims. This transaction is being accounted for as an extinguishment of Deferred Amounts and the discount of approximately $288,000 from the settlement will be reflected as a benefit to loss and loss expenses in the Consolidated Statements of Comprehensive Income (Loss) in the quarter ended March 31, 2018.
the Exchange Offers were consummated, pursuant to which holders of surplus notes received the same effective package as holders of beneficial interests in Deferred Amounts, including the discount of $0.065 in principal amount and accrued and unpaid interest on the surplus notes tendered; resulting in Ambac Assurance's cancellation of $809,520 of principal and accrued and unpaid interest of general account surplus notes. The Exchange Offers will be accounted for as a debt modification since the creditors before and after the discount remain the same and the change in the terms is not considered substantial. A substantial change is considered to be a change in cash flows of equal to or greater than 10% as a result of the modification of terms. As the change in cash flows is less than 10%, debt modification accounting is appropriate. Under debt modification accounting, no gain or loss is recorded, and a new effective interest rate is established based on the cash flows of the Ambac Note, which secures the Secured Notes issued as part of the Exchange Offers. Additionally, any consideration paid that is directly related to the issuance of the Ambac Note is capitalized and amortized as part of the effective yield calculation.
in connection with the Rehabilitation Exit Transactions, Ambac Assurance is making a one-time current interest payment on remaining surplus notes (other than junior surplus notes) of $13,501, of which $2,618 will be received by Ambac.
In order to execute these transactions, Ambac established a special purpose entity, Ambac LSNI, LLC, for the sole purpose of the issuance of Secured Notes. Ambac Assurance will not consolidate Ambac LSNI, LLC and will receive $768,464 par amount of the Secured Notes, which will be held in Ambac's investment portfolio.
Ambac's invested assets and cash will be reduced by the total cash outflow of approximately $1,353,560 and Ambac will experience reductions in the value of Ambac-insured RMBS securities held in the investment portfolio.
The Ambac Note (and Secured Notes) will accrue interest at a per annum rate of 3-month U.S. Dollar LIBOR plus 5.00%, subject to a 1.00% LIBOR floor. Accrued and unpaid interest will be paid in cash on each payment date (quarterly on the last day of each quarter beginning with June 30, 2018) until the maturity date. The maturity date for the Secured Notes and the Ambac Note will be the earlier of (x) February 12, 2023, and (y) if the Secured Notes are then outstanding, the date that is five business days prior to the date for which OCI has approved the repayment of the outstanding principal amount of the surplus notes (other than junior surplus notes) issued by Ambac Assurance. Promptly, and in any event within four business days after the receipt (whether directly or indirectly) of any representation and warranty subrogation recoveries, Ambac Assurance shall (i) apply an amount (the “Mandatory Redemption Amount”) equal to the lesser of (a) the amount of such RMBS proceeds and (b) all outstanding principal and accrued and unpaid interest on the Ambac Note to redeem the Ambac Note, in whole or in part, as applicable; provided, that any non-cash RMBS proceeds shall be deemed to be received upon the receipt of the applicable appraisal. Redemptions or prepayments of the Ambac Note will result in corresponding redemptions or prepayments of the Secured Notes.
The Tier 2 Notes will mature in 2055 and shall bear interest at a rate of 8.50% per annum, calculated on a 30/360 basis. Interest payments will not be made in cash on interest payment dates and shall be paid-in-kind and compounded on the last day of each calendar quarter, unless (i) funds are available to make such payments in cash as a result of receiving recoveries in respect of the representation and warranty subrogation recoveries in excess of $1,600,000 or (ii) interest is paid in cash on surplus notes (other than in connection with the Exchange Offers and Second Amended Plan of Rehabilitation). The Tier 2 Notes may not be redeemed or repaid prior to December 17, 2020, unless Ambac Assurance pays a make-whole premium. Thereafter, the Tier 2 Notes may be redeemed, in whole or in part, at the option of Ambac Assurance, at a price equal to 100% of the aggregate principal amount redeemed, plus accrued and unpaid interest, if any.