<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 1-10777
AMBAC INC.
(Exact name of Registrant as specified in its charter)
Delaware 13-3621676
(State of incorporation) (I.R.S. employer identification no.)
One State Street Plaza
New York, New York 10004
(Address of principal executive offices) (Zip code)
(212) 668-0340
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
As of September 30, 1996, 34,952,571 shares of Common Stock, par value
$0.01 per share, (net of 387,621 treasury shares) and -0- shares of Class A
Common Stock, par value $0.01 per share, of the Registrant were outstanding.
<PAGE>
AMBAC Inc. and Subsidiaries
INDEX
-----
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - September 30, 1996
and December 31, 1995.................................... 3
Consolidated Statements of Operations - three months and nine
months ended September 30, 1996 and September 30, 1995... 4
Consolidated Statements of Cash Flows - nine months
ended September 30, 1996 and September 30, 1995.......... 5
Notes to Consolidated Financial Statements............... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................... 9
PART II OTHER INFORMATION
Item 5. Other Information........................................... 22
Item 6. Exhibits.................................................... 22
SIGNATURES............................................................... 23
INDEX TO EXHIBITS........................................................ 24
</TABLE>
<PAGE>
PART 1 - FINANCIAL INFORMATION
Item 1 - Financial Statements of AMBAC Inc. and Subsidiaries
AMBAC Inc. and Subsidiaries
Consolidated Balance Sheets
September 30, 1996 and December 31, 1995
(Dollars in Thousands)
<TABLE>
<CAPTION>
September 30, 1996 December 31, 1995
------------------ -----------------
(unaudited)
Assets
- ------
<S> <C> <C>
Investments:
Bonds, at fair value
(amortized cost of $4,846,229 in 1996 and $4,082,791 in 1995) $4,909,604 $4,264,904
Short-term investments, at cost (approximates fair value) 179,252 176,689
------------------ -----------------
Total investments 5,088,856 4,441,593
Cash 13,307 12,167
Securities purchased under agreements to resell 217,055 240,280
Receivable for municipal investment contracts - 204,797
Receivable for securities 23,049 14,523
Investment income due and accrued 62,880 56,370
Investment in affiliate - 45,019
Deferred acquisition costs 90,022 82,620
Prepaid reinsurance 166,588 153,372
Other assets 65,050 58,538
------------------ -----------------
Total assets $5,726,807 $5,309,279
================== =================
Liabilities and Stockholders' Equity
- ------------------------------------
Liabilities:
Unearned premiums $961,413 $903,026
Losses and loss adjustment expenses 60,170 65,996
Ceded reinsurance balances payable 11,280 14,654
Obligations under municipal investment contracts 2,389,271 2,185,746
Obligations under municipal investment repurchase contracts 288,014 241,112
Deferred income taxes 54,785 103,697
Current income taxes 31,013 5,125
Debentures 223,782 223,732
Accrued interest payable 40,346 25,494
Accounts payable and other liabilities 50,262 44,578
Payable for securities 80,736 92,131
------------------ -----------------
Total liabilities 4,191,072 3,905,291
------------------ -----------------
Stockholders' equity:
Preferred stock
Common stock, Class A
Common stock 353 353
Additional paid-in capital 493,917 492,495
Unrealized gains on investments, net of tax 33,013 102,470
Retained earnings 1,027,317 819,479
Common stock held in treasury at cost (18,865) (10,809)
------------------ -----------------
Total stockholders' equity 1,535,735 1,403,988
------------------ -----------------
Total liabilities and stockholders' equity $5,726,807 $5,309,279
================== =================
</TABLE>
See accompanying Notes to Consolidated Financial Statements
3
<PAGE>
AMBAC Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
For the Periods Ended September 30, 1996 and 1995
(Dollars in Thousands Except Common Share Data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
1996 1995 1996 1995
------------------------ -----------------------
<S> <C> <C> <C> <C>
Financial guarantee insurance operations:
Gross premiums written $ 67,613 $ 43,531 $ 176,015 $ 120,129
Ceded premiums written (9,813) (7,369) (29,261) (4,314)
------------ ------------ ------------ ------------
Net premiums written 57,800 36,162 146,754 115,815
Increase in unearned premiums (24,055) (9,929) (45,171) (37,518)
------------ ------------ ------------ ------------
Net premiums earned 33,745 26,233 101,583 78,297
Net investment income 36,887 33,192 107,212 97,239
Net realized losses (5,381) (2,455) (25,125) (9,331)
Other income 1,305 1,498 4,933 4,687
------------ ------------ ------------ ------------
Total financial guarantee revenues 66,556 58,468 188,603 170,892
------------ ------------ ------------ ------------
Losses and loss adjustment expenses 1,301 841 3,811 2,210
Underwriting and operating expenses 8,646 8,208 27,745 25,383
------------ ------------ ------------ ------------
Total financial guarantee expenses 9,947 9,049 31,556 27,593
------------ ------------ ------------ ------------
Financial guarantee insurance operating income 56,609 49,419 157,047 143,299
Financial services operating income 1,133 935 8,745 1,710
Equity in income of affiliate - 868 627 2,961
Interest expense (5,248) (5,417) (15,673) (15,625)
Other income (deductions), net 2,191 545 3,110 109
Other net realized gains - 19,103 155,613 19,103
------------ ------------ ------------ ------------
Income before income taxes 54,685 65,453 309,469 151,557
------------ ------------ ------------ ------------
Income tax expense:
Current taxes 9,994 13,355 89,907 24,585
Deferred taxes 863 2,613 (4,766) 7,201
------------ ------------ ------------ ------------
Total income taxes 10,857 15,968 85,141 31,786
------------ ------------ ------------ ------------
Net income $ 43,828 $ 49,485 $ 224,328 $ 119,771
============ ============ ============ ============
Per share amounts -
Net income per common share $ 1.26 $ 1.41 $ 6.42 $ 3.41
============ ============ ============ ============
Weighted average number of
common shares outstanding 34,905,558 35,130,021 34,958,306 35,108,662
============ ============ ============ ============
</TABLE>
See accompanying Notes to Consolidated Financial Statements
4
<PAGE>
AMBAC Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
For The Periods Ended September 30, 1996 and 1995
(Dollars in Thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
---------------------------
1996 1995
----------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 224,328 $ 119,771
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,696 4,343
Amortization of bond premium and discount (980) 344
Current income taxes payable 25,888 12,031
Deferred income taxes payable (5,154) 7,048
Deferred acquisition costs (7,402) (11,398)
Unearned premiums, net 45,171 37,518
Losses and loss adjustment expenses (5,826) 218
Ceded reinsurance balances payable (3,374) 2,089
Accrued interest payable 14,852 5,270
Gain on sale of investments (130,473) (9,630)
Other, net (13,600) (18,824)
---------- ----------
Net cash provided by operating activities 145,126 148,780
---------- ----------
Cash flows from investing activities:
Proceeds from sales of bonds 1,324,619 1,894,500
Proceeds from matured bonds 713,445 459,066
Purchases of bonds (2,840,183) (2,514,006)
Change in short-term investments (2,563) (10,109)
Securities purchased under agreements to resell 23,225 (79,772)
Proceeds from sale of affiliate 202,609 28,502
Other, net 3,424 (5,746)
---------- ----------
Net cash used in investing activities (575,424) (227,565)
---------- ----------
Cash flows from financing activities:
Dividends paid (15,730) (14,212)
Proceeds from issuance of municipal investment contracts 1,268,896 1,052,668
Payments for municipal investment contract draws (813,672) (966,073)
Proceeds from sale of treasury stock 12,835 5,829
Purchases of treasury stock (20,891) (1,739)
---------- ----------
Net cash provided by financing activities 431,438 76,473
---------- ----------
Net cash flow 1,140 (2,312)
Cash at beginning of year 12,167 4,441
---------- ----------
Cash at September 30 $ 13,307 $ 2,129
========== ==========
Supplemental disclosure of cash flow information
Cash paid during the year for:
Income taxes $ 59,401 $ 8,250
========== ==========
Interest expense on debt $ 18,375 $ 17,988
========== ==========
Interest expense on municipal investment contracts $ 96,540 $ 86,912
========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
5
<PAGE>
AMBAC Inc. and Subsidiaries
Notes to Consolidated Unaudited Financial Statements
(1) Basis of Presentation
AMBAC Inc. (the "Company") is a holding company that provides through
its affiliates financial guarantee insurance and financial services to clients
in both the public and private sectors. The Company's principal operating
subsidiary, AMBAC Indemnity Corporation ("AMBAC Indemnity"), a leading insurer
of municipal and structured finance obligations, has been assigned triple-A
claims-paying ability ratings, the highest ratings available from Moody's
Investors Service, Inc., Standard & Poor's Ratings Group, Fitch Investors
Service, L.P. and Nippon Investors Services, Inc. AMBAC Inc.'s Financial
Services Division provides investment contracts, interest rate swaps and
investment management principally to states, municipalities and municipal
authorities.
The Company's consolidated unaudited interim financial statements have been
prepared on the basis of generally accepted accounting principles ("GAAP") and,
in the opinion of management, reflect all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the Company's
financial condition, results of operations and cash flows for the periods
presented. The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported revenues
and expenses during the reporting period. Actual results could differ from those
estimates. The results of operations for the three months and nine months ended
September 30, 1996, may not be indicative of the results that may be expected
for the full year ending December 31, 1996. These consolidated financial
statements and notes should be read in conjunction with (i) the financial
statements and notes included in the audited consolidated financial statements
of AMBAC Inc. and its subsidiaries contained in the Company's Annual Report on
Form 10-K for the year ended December 31, 1995, which was filed with the
Securities and Exchange Commission (the "Commission") on April 1, 1996, (ii) the
Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31,
1996, which was filed with the Commission on May 15, 1996, (iii) the Company's
Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996,
which was filed with the Commission on August 14, 1996, and (iv) the Company's
Current Report on Form 8-K dated January 31, 1996, which was filed with the
Commission on February 28, 1996.
The consolidated financial statements include the accounts of the Company
and each of its subsidiaries. All significant intercompany balances have been
eliminated.
6
<PAGE>
Notes to Consolidated Unaudited Financial Statements (Continued)
(2) Income Taxes
The effect of temporary differences giving rise to significant portions
of the deferred tax liabilities and deferred tax assets as of September 30, 1996
and December 31, 1995, are presented below:
<TABLE>
<CAPTION>
(Dollars in Thousands) September 30, 1996 December 31, 1995
------------------ -----------------
<S> <C> <C>
Deferred tax liabilities:
Net unrealized gains on bonds............................... $14,500 $58,258
Deferred acquisition costs.................................. 31,508 28,917
Unearned premiums........................................... 26,788 22,167
Unrealized gain on investment in affiliate.................. - 7,730
Investments................................................. 1,867 3,638
Other....................................................... 1,816 2,566
------------------ -----------------
Total deferred tax liabilities....................... 76,479 123,276
------------------ -----------------
Deferred tax assets:
Loss reserves............................................... 12,924 9,631
Insurance in force.......................................... 2,618 2,870
Compensation................................................ 2,569 2,672
Other....................................................... 3,583 4,406
------------------ -----------------
Total deferred tax assets............................ 21,694 19,579
Valuation allowance......................................... - -
------------------ -----------------
Net deferred tax assets............................. 21,694 19,579
------------------ -----------------
Total net deferred tax liabilities................. $54,785 $103,697
=======================================
</TABLE>
The valuation allowance for deferred tax assets did not change during
the nine months ended September 30, 1996. The Company believes that no valuation
allowance is necessary in connection with the deferred tax assets.
The tax provisions in the accompanying consolidated financial
statements reflect effective tax rates differing from the prevailing federal
corporate income tax rates. A reconciliation of these differences is as follows:
<TABLE>
<CAPTION>
Three Months Ended September 30,
------------------------------------------------------
(Dollars in Thousands) 1996 % 1995 %
------------ ------------ ------------ ----------
<S> <C> <C> <C> <C>
Computed expected tax expense
at statutory rate.................................. $19,140 35.0% $22,909 35.0%
Increases (reductions) in expected
tax resulting from:
Tax-exempt interest......................... (7,920) (14.5) (7,266) (11.1)
Other, net.................................. (363) (0.6) 325 0.5
------------ ------------ ------------ ----------
$10,857 19.9% $15,968 24.4%
============ ============ ============ ==========
</TABLE>
7
<PAGE>
Notes to Consolidated Unaudited Financial Statements (Continued)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
------------------------------------------------------
(Dollars in Thousands) 1996 % 1995 %
------------ ------------ ------------ ----------
<S> <C> <C> <C> <C>
Computed expected tax expense
at statutory rate.................................. $108,314 35.0% $53,045 35.0%
Increases (reductions) in expected
tax resulting from:
Tax-exempt interest......................... (22,345) (7.2) (21,448) (14.1)
Other, net.................................. (828) (0.3) 189 0.1
------------ ------------ ------------ ----------
$85,141 27.5% $31,786 21.0%
============ ============ ============ ==========
</TABLE>
8
<PAGE>
Item 2: Management's Discussion and Analysis of
Financial Condition and Results of Operations
The following paragraphs describe the consolidated results of
operations of AMBAC Inc. and its subsidiaries (sometimes collectively referred
to as the "Company") for the three and nine month periods ended September 30,
1996 and 1995, and its financial condition as of September 30, 1996 and December
31, 1995. These results are presented for the Company's two business segments:
Financial Guarantee Insurance and Financial Services.
Results of Operations
Three Months Ended September 30, 1996 Versus Three Months Ended
September 30, 1995
Consolidated Net Income
The Company's net income for the three months ended September 30, 1996
was $43.8 million or $1.26 per common share, a decrease of 12% from $49.5
million or $1.41 per common share in the three months ended September 30, 1995.
The decrease in net income was the result of a realized gain of $19.1 million
(which had a net income per common share effect of $0.34) recognized in the
third quarter of 1995 from the sale of 1.1 million shares of HCIA Inc. ("HCIA"),
a former affiliate of the Company. Excluding the realized gain in the third
quarter of 1995, third quarter 1996 net income increased 16% over the
corresponding period of 1995. This increase was attributable to increased
premiums earned for the period and higher net investment income, partially
offset by higher net realized losses on sales of securities and higher expenses.
Financial Guarantee Insurance
Operating Income. The Company provides financial guarantee insurance
----------------
through its principal operating subsidiary, AMBAC Indemnity Corporation ("AMBAC
Indemnity"), which is a leading insurer of municipal and structured finance
transactions. Financial guarantee insurance operating income for the three
months ended September 30, 1996 was $56.6 million, an increase of 15% from $49.4
million in the three months ended September 30, 1995. The increase was primarily
the result of increased premiums earned and increased net investment income
partially offset by increased net realized losses on sales of investments and
higher expenses.
Gross Par Value Written. AMBAC Indemnity insured $8.3 billion in par
-----------------------
value bonds during the three months ended September 30, 1996, an increase of 41%
from $5.9 billion in the three months ended September 30, 1995. Par value
written for the third quarter of 1996 comprised $6.8 billion from municipal bond
insurance and $1.5 billion from structured finance insurance, versus $5.2
billion and $0.7 billion, respectively, in the third quarter of 1995. The
increase in the amount of structured finance gross par value written reflects
the gradual change in mix of the Company's insured portfolio. It also reflects
the Company's expanding international efforts.
9
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
According to estimates based on industry sources, the total volume of
new issues of municipal bonds decreased 3% to $35.5 billion during the three
months ended September 30, 1996 from $36.7 billion in the three months ended
September 30, 1995. During the three months ended September 30, 1996, the
insured portion of the new issue municipal bond market increased to
approximately 52% from approximately 46% for the three months ended September
30, 1995, reflecting increased demand for insured bonds. During the three months
ended September 30, 1996, AMBAC Indemnity's share of the long-term insured new
issue municipal bond market, based on gross par amount of insurance written and
stated as a percentage of total insured new issue municipal bonds, was
approximately 37%, as compared to approximately 29% during the three months
ended September 30, 1995. (Market size amounts, insured percentage and market
share percentage figures used in this paragraph were determined on a sale date
basis, in conformity with industry practices; all other amounts and percentage
figures in this discussion were determined on a closing date basis.)
Gross Premiums Written. Gross premiums written for the three months
----------------------
ended September 30, 1996 were $67.6 million, an increase of 55% from $43.5
million in the three months ended September 30, 1995. The following table sets
forth the amounts of gross premiums written by type and percent of total:
<TABLE>
<CAPTION>
Three Months Ended September30,
-------------------------------------------
(Dollars in Millions) 1996 % 1995 %
--------- -------- ---------- --------
<S> <C> <C> <C> <C>
Municipal premiums written:
Up-front policies:
New issue............................................ $49.1 73% $32.5 75%
Secondary market..................................... 10.2 15 6.5 15
--------- -------- ---------- --------
Sub-total up-front................................ 59.3 88 39.0 90
--------- -------- ---------- --------
Installment policies:
Annual policies...................................... 2.3 4 1.9 4
Portfolio products................................... 0.9 1 1.3 3
--------- -------- ---------- --------
Sub-total installment............................. 3.2 5 3.2 7
--------- -------- ---------- --------
Total municipal premiums written................ 62.5 93 42.2 97
--------- -------- ---------- --------
Structured finance premiums written:
Up-front............................................. 1.7 2 0.5 1
Installment.......................................... 3.4 5 0.8 2
--------- -------- ---------- --------
Total structured finance premiums written......... 5.1 7 1.3 3
--------- -------- ---------- --------
Total gross premiums written............................... $67.6 100% $43.5 100%
========= ======== ========== ========
</TABLE>
Adjusted Gross Premiums. While most of AMBAC Indemnity's premiums
-----------------------
written are collected up-front at policy issuance, a growing portion of premiums
are collected on an installment basis. The present value of estimated future
installment premiums written in the third quarter of 1996 was $16.7 million, an
increase of 132% from $7.2 million in the third quarter of 1995. The net
aggregate present value of estimated future installment premiums was $137.2
million and $110.0 million as of September 30, 1996 and December 31, 1995,
respectively. Adjusted gross premiums, which are defined as up-front premiums
written plus the present value of estimated future installment premiums written
in the period, were $77.7 million in the third quarter of 1996, up 66% from
$46.7 million in the third quarter of 1995.
10
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Ceded Premiums Written. Ceded premiums written for the third quarter of
----------------------
1996 were $9.8 million, versus $7.4 million in the third quarter of 1995. The
increase is reflective of the higher gross premiums written in the third quarter
of 1996. Ceded premiums written were 14.5% and 16.9% of gross premiums written
for the three month periods ended September 30, 1996 and 1995, respectively.
Net Premiums Earned. Net premiums earned during the three months ended
-------------------
September 30, 1996 were $33.7 million, an increase of 29% from $26.2 million in
the three months ended September 30, 1995. The increase was the result of
increased premiums earned from refundings and calls in the third quarter of 1996
and growth in premiums earned from the underlying book of business during the
period. Net premiums earned for the three months ended September 30, 1996
included $7.1 million from refundings, calls and other accelerations of
previously insured issues (which had a net income per common share effect of
$0.12). Net premiums earned in the three months ended September 30, 1995
included $3.2 million from refundings, calls and other accelerations (which had
a net income per common share effect of $0.05). Refunding levels vary depending
upon a number of conditions, primarily the relationship between current interest
rates and interest rates on outstanding debt. Excluding the effect of
accelerated earnings from refundings, calls and other accelerations, net
premiums earned for the three months ended September 30, 1996 were $26.7
million, an increase of 16% from $23.0 million in the three months ended
September 30, 1995.
Net Investment Income. Net investment income for the three months ended
---------------------
September 30, 1996 was $36.9 million, an increase of 11% from $33.2 million in
the three months ended September 30, 1995. The increase was primarily
attributable to the growth of the investment portfolio partially offset by a
lower investment yield in the third quarter of 1996. AMBAC Indemnity's
investments in tax-exempt securities amounted to 76% of the total market value
of its portfolio as of September 30, 1996, versus 75% at September 30, 1995. The
average pre-tax yield-to-maturity on the financial guarantee insurance
investment portfolio was 6.47% and 6.57% as of September 30, 1996 and 1995,
respectively.
Losses and Loss Adjustment Expenses. Losses and loss adjustment
-----------------------------------
expenses for the three months ended September 30, 1996 were $1.3 million, versus
$0.8 million in the three months ended September 30, 1995. Losses and loss
adjustment expenses are generally based upon estimates of the ultimate aggregate
losses inherent in the obligations insured in each period.
11
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Underwriting and Operating Expenses. Underwriting and operating
-----------------------------------
expenses for the third quarter of 1996 were $8.6 million, an increase of 5% from
$8.2 million in the third quarter of 1995, primarily due to higher gross
underwriting expenses and higher amortization of previously deferred acquisition
costs. Underwriting and operating expenses consist of gross underwriting and
operating expenses, less the deferral to future periods of expenses and
reinsurance commissions related to the acquisition of new insurance contracts,
plus the amortization of previously deferred expenses and reinsurance
commissions. During the three month period ended September 30, 1996, AMBAC
Indemnity's gross underwriting and operating expenses were $12.8 million, an
increase of 7% from $12.0 million in the three months ended September 30, 1995,
primarily due to increased compensation expenses. Underwriting and operating
expenses deferred were $7.3 million and $6.6 million for the three months ended
September 30, 1996 and 1995, respectively. The amortization of previously
deferred expenses and reinsurance commissions was $3.2 million and $2.5 million
for the three months ended September 30, 1996 and 1995, respectively.
Financial Services
Operating Income. Through its financial services subsidiaries, the
----------------
Company provides investment contracts, interest rate swaps and investment
management principally to states, municipalities and municipal authorities.
Financial services operating income for the three months ended September 30,
1996 was $1.1 million, versus $0.9 million in the three months ended September
30, 1995. Financial services revenues for the third quarter of 1996 were $3.9
million, versus $2.6 million in the third quarter of 1995. The increase was
primarily due to revenues on interest rate swaps during the third quarter of
1996. Financial services expenses for the third quarter of 1996 were $2.8
million versus $1.7 million in the third quarter of 1995. The increased expenses
were primarily due to costs associated with the new investment management
business, as well as increased operating expenses at the other financial
services subsidiaries.
Corporate Items
Interest Expense and Other Income. Interest expense for the three
---------------------------------
months ended September 30, 1996 was $5.2 million, versus $5.4 million in the
third quarter of 1995. Other income (deductions), net, includes investment
income and operating expenses of the holding company, AMBAC Inc. Other income
(deductions) increased to $2.2 million in the third quarter of 1996 from $0.5
million in the comparable period of 1995, due to additional investment income
generated by the holding company from the proceeds of the sale of HCIA in the
second quarter of 1996.
Income Taxes. Income taxes for the three months ended September 30,
------------
1996 were at an effective rate of 19.9%, versus 24.4% in the three months ended
September 30, 1995. The Company's effective income tax rate was higher in the
third quarter of 1995 primarily due to the $19.1 million realized gain on the
sale of HCIA holdings during that quarter.
12
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Supplemental Analytical Financial Data
Core Earnings. Core earnings for the three months ended September 30,
--------------
1996, were $43.3 million, an increase of 16% from $37.3 million for the three
months ended September 30, 1995. The increase in core earnings was primarily due
to the continued growth in net premiums earned and net investment income from
financial guarantee insurance operations, as well as increased operating income
from its financial services division. Core earnings, which the Company reports
as analytical data, exclude the effect on consolidated net income from net
realized gains and losses, net insurance premiums earned from refundings and
calls and certain non-recurring items. Core earnings is not a substitute for net
income computed in accordance with Generally Accepted Accounting Principles
("GAAP"), but is an important measure used by management, equity analysts and
investors to measure the financial results of the Company. The definition of
core earnings used by the Company may differ from definitions of core earnings
used by other public financial guarantors and should be considered in such
context.
Operating Earnings. Operating earnings for the third quarter of 1996
-------------------
were $47.3 million, an increase of 21% from $39.2 million in the third quarter
of 1995. The Company defines operating earnings as net income, less the effect
of net realized gains and losses and certain non-recurring items. Similar to
core earnings, operating earnings is used by management, equity analysts and
investors to measure the financial results of the Company, but is not a
substitute for net income computed in accordance with GAAP.
The following table reconciles net income computed in accordance with
GAAP to operating earnings and core earnings for the three months ended
September 30, 1996 and 1995:
<TABLE>
<CAPTION>
(Dollars in Millions) /(1)/ 1996 1995
------------ ------------
<S> <C> <C>
Net Income....................................................... $43.8 $49.5
Net realized (gains)/losses, after tax........................... 3.5 (10.3)
------------ ------------
Operating earnings...................................... 47.3 39.2
Premiums earned from refundings,
calls and other accelerations, after tax................... (4.0) (1.9)
------------ ------------
Core earnings........................................... $43.3 $37.3
============ ============
</TABLE>
/(1)/ Numbers may not add due to rounding.
The weighted average number of shares outstanding during the third
quarter of 1996 and 1995 was 34.9 million and 35.1 million, respectively.
13
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Results of Operations
Nine Months Ended September 30, 1996 Versus Nine Months Ended September 30, 1995
Consolidated Net Income
The Company's net income for the nine months ended September 30, 1996
was $224.3 million or $6.42 per common share, an increase of 87% from $119.8
million or $3.41 per common share in the nine months ended September 30, 1995.
The increase in net income in 1996 was largely due to the second quarter net
realized gain of $155.6 million from the sale of the Company's remaining
holdings of HCIA, (which had a net income per common share effect of $2.88).
Excluding the effects of the respective gains from the sales of HCIA stock in
the second quarter of 1996 and the third quarter of 1995 (discussed in the
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Three Months Ended September 30, 1996 Versus Three Months Ended
September 30, 1995), net income for the first nine months of 1996 increased 15%
over the corresponding period of 1995. This increase in year-to-date net income
is primarily the result of higher premiums earned and net investment income as
well as higher financial services operating income, partially offset by higher
net realized losses on sales of securities and higher expenses.
Financial Guarantee Insurance
Operating Income. Financial guarantee insurance operating income for
-----------------
the nine months ended September 30, 1996 was $157.0 million, an increase of 10%
from $143.3 million in the nine months ended September 30, 1995. The increase
was primarily the result of increased premiums earned and increased investment
income, partially offset by higher net realized losses on sales of securities
and higher expenses during the period.
Gross Par Value Written. AMBAC Indemnity insured $23.8 billion in par
------------------------
value bonds during the nine months ended September 30, 1996, an increase of 51%
from $15.8 billion in the nine months ended September 30, 1995. Par value
written for the nine months ended September 30, 1996 comprised $18.5 billion
from municipal bond insurance and $5.3 billion from structured finance
insurance, versus $13.2 billion and $2.6 billion, respectively, in the
comparable period in 1995.
According to estimates based on industry sources, the total volume of
new issues of municipal bonds increased 19% to $126.8 billion during the nine
months ended September 30, 1996 from $106.7 billion in the nine months ended
September 30, 1995. During the nine months ended September 30, 1996, the insured
portion of the new issue municipal bond market increased to approximately 49%
from approximately 41% for the nine months ended September 30, 1995, reflecting
increased demand for insured bonds. During the nine months ended September 30,
1996, AMBAC Indemnity's share of the long-term insured new issue municipal bond
market, based on gross par amount of insurance written and stated as a
percentage of total insured new issue municipal bonds, was approximately 30%, as
compared to approximately 26% during the nine months ended September 30, 1995.
(Market size amounts, insured percentage and market share percentage figures
used in this paragraph were determined on a sale date basis, in conformity with
industry practices; all other amounts and percentage figures in this discussion
were determined on a closing date basis.)
14
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Gross Premiums Written. Gross premiums written for the nine months
-----------------------
ended September 30, 1996 were $176.0 million, an increase of 47% from $120.1
million in the nine months ended September 30, 1995. The following table sets
forth the amounts of gross premiums written by type and percent of total:
<TABLE>
<CAPTION>
Nine Months Ended September 30,
----------------------------------------------
(Dollars in Millions) 1996 % 1995 %
---------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Municipal premiums written:
Up-front policies:
New issue............................................ $125.3 71% $78.0 65%
Secondary market..................................... 17.5 10 22.9 19
---------- -------- ---------- ---------
Sub-total up-front................................. 142.8 81 100.9 84
---------- -------- ---------- ---------
Installment policies:
Annual policies...................................... 6.2 3 5.4 5
Portfolio products................................... 3.0 2 4.2 3
---------- -------- ---------- ---------
Sub-total installment............................ 9.2 5 9.6 8
---------- -------- ---------- ---------
Total municipal premiums written............... 152.0 86 110.5 92
---------- -------- ---------- ---------
Structured finance premiums written:
Up-front............................................. 16.7 10 7.5 6
Installment.......................................... 7.3 4 2.1 2
---------- -------- ---------- ---------
Total structured finance premiums written......... 24.0 14 9.6 8
---------- -------- ---------- ---------
Total gross premiums written............................... $176.0 100% $120.1 100%
========== ======== ========== =========
</TABLE>
Adjusted Gross Premiums. While most of AMBAC Indemnity's premiums
------------------------
written are collected up-front at policy issuance, a growing portion of premiums
are collected on an installment basis. The present value of estimated future
installment premiums written in the nine month period ended September 30, 1996
was $46.3 million, an increase of 109% from $22.1 million in the same period of
1995. Adjusted gross premiums, which represent up-front premiums written plus
the present value of estimated future installment premiums written in the
period, in the first nine months of 1996 were $205.8 million, up 58% from $130.5
million in the comparable period of 1995.
Ceded Premiums Written. Ceded premiums written for the first nine
-----------------------
months of 1996 were $29.3 million, versus $4.3 million in the comparable period
of 1995. Ceded premiums written in the nine months ended September 30, 1995,
were reduced by $18.1 million in return premiums from the cancellation of
reinsurance contracts in the second quarter of 1995. Excluding the 1995 return
premiums, ceded premiums written for the first nine months of 1996 increased 31%
from the corresponding period of 1995 primarily due to increased gross premiums
written. Ceded premiums written were 16.6% of gross premiums written for the
first nine months of 1996. Excluding the return premiums, ceded premiums written
were 18.7% of gross premiums written for the corresponding period of 1995.
15
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Net Premiums Earned. Net premiums earned during the nine months ended
--------------------
September 30, 1996 were $101.6 million, an increase of 30% from $78.3 million in
the nine months ended September 30, 1995. The increase was primarily the result
of higher premiums earned from refundings and calls and the growth in premiums
earned from the underlying book of business in the nine months ended September
30, 1996. Net premiums earned for the nine months ended September 30, 1996
included $25.2 million from refundings, calls and other accelerations of
previously insured issues (which had a net income per common share effect of
$0.41). Net premiums earned in the nine months ended September 30, 1995 included
$12.1 million from refundings, calls and other accelerations (which had a net
income per common share effect of $0.19). Excluding the effect of accelerated
earnings from refundings, calls and other accelerations, net premiums earned for
the nine months ended September 30, 1996 were $76.4 million, an increase of 15%
from $66.2 million in the nine months ended September 30, 1995.
Net Investment Income. Net investment income for the nine months ended
----------------------
September 30, 1996 was $107.2 million, an increase of 10% from $97.2 million in
the nine months ended September 30, 1995. The increase was primarily
attributable to the growth of the investment portfolio partially offset by a
lower investment yield in the first nine months of 1996.
Net Realized Losses. AMBAC Indemnity's net realized losses for the nine
--------------------
months ended September 30, 1996 were ($25.1) million, versus ($9.3) million in
the nine months ended September 30, 1995. The net realized losses in 1996 were
generated mostly during the second quarter to partially offset the realized gain
from the sale of HCIA.
Losses and Loss Adjustment Expenses. Losses and loss adjustment
------------------------------------
expenses for the nine months ended September 30, 1996 were $3.8 million, versus
$2.2 million in the nine months ended September 30, 1995. Losses and loss
adjustment expenses, exclusive of salvage recognized, were $3.9 million and $2.7
million for the nine months ended September 30, 1996 and 1995, respectively.
Salvage recognized amounted to $0.1 million and $0.5 for the nine month periods
ended September 30, 1996 and 1995, respectively.
Underwriting and Operating Expenses. Underwriting and operating
------------------------------------
expenses for the first nine months of 1996 were $27.7 million, an increase of 9%
from $25.4 million in the comparable period of 1995, primarily due to higher
amortization of previously deferred acquisition costs during the period. During
the nine month period ended September 30, 1996, AMBAC Indemnity's gross
underwriting and operating expenses were $40.6 million, an increase of 10% from
$36.9 million in the nine months ended September 30, 1995, primarily due to
higher compensation expenses and increased premium taxes related to the
increased level of premium writings. Underwriting and operating expenses
deferred were $22.9 million and $19.7 million for the nine months ended
September 30, 1996 and 1995, respectively. The amortization of previously
deferred expenses and reinsurance commissions was $9.5 million and $7.3 million
for the nine months ended September 30, 1996 and 1995, respectively.
16
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Financial Services
Operating Income. Financial services operating income for the nine
-----------------
months ended September 30, 1996 was $8.7 million, versus $1.7 million in the
nine months ended September 30, 1995. Financial services revenues for the nine
months ended September 30, 1996, were $16.0 million, versus $7.2 million in the
comparable period of 1995. The increase was primarily due to revenues on
interest rate swaps during the first nine months 1996. Financial services
expenses for the nine months ended September 30, 1996, were $7.3 million versus
$5.5 million in the nine months ended September 30, 1995. The increased expenses
were primarily due to expenses associated with the new investment management
business.
Corporate Items
Interest Expense and Other Income. Interest expense for the nine months
----------------------------------
ended September 30, 1996 was $15.7 million, nearly unchanged from the $15.6
million incurred in the nine months ended September 30, 1995. Other income
(deductions), net, which includes the investment income and operating expenses
of the holding company, AMBAC Inc., increased to $3.1 million in the first nine
months of 1996 from $0.1 million in the comparable period of 1995 due to
additional investment income generated by AMBAC Inc. from the proceeds of the
HCIA sale in the second quarter of 1996.
Income Taxes. Income taxes for the nine months ended September 30, 1996
-------------
were at an effective rate of 27.5%, versus 21.0% in the nine months ended
September 30, 1995. The increase is primarily the result of the realized gain
from the sale of HCIA in the second quarter of 1996.
Supplemental Analytical Financial Data
Core Earnings. For the nine months ended September 30, 1996, core
--------------
earnings were $125.7 million, an increase of 17% from $107.4 million for the
nine months ended September 30, 1995. The increase in core earnings was
primarily due to the continued growth in net premiums earned and net investment
income from financial guarantee insurance operations, as well as increased
operating revenues from its financial services division, partially offset by
increased expenses at both divisions.
Operating Earnings. Operating earnings for the first nine months
-------------------
of 1996 were $140.0 million, an increase of 23% from $114.1 million in the
comparable period of 1995.
The following table reconciles net income computed in accordance with
GAAP to operating earnings and core earnings for the nine months ended September
30, 1996 and 1995:
<TABLE>
<CAPTION>
(Dollars in Millions)/(1)/ 1996 1995
------------ -------------
<S> <C> <C>
Net Income...................................................... $224.3 $119.8
Net realized (gains)/losses, after tax.......................... (84.3) (5.7)
------------ -------------
Operating earnings..................................... 140.0 114.1
Premiums earned from refundings,
calls and other accelerations, after tax.................. (14.3) (6.8)
------------ -------------
Core earnings.......................................... $125.7 $107.4
============ =============
</TABLE>
(1) Numbers may not add due to rounding.
17
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
The weighted average number of shares outstanding during the nine month
periods ended September 30, 1996 and 1995 were 35.0 million and 35.1 million,
respectively.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Three Months Ended September 30, 1996 Versus Three
Months Ended September 30, 1995," for definitions of "core earnings" and
"operating earnings" and other explanatory information.
Liquidity and Capital Resources
The Company's liquidity, both on a short-term basis (for the next
twelve months) and a long-term basis (beyond the next twelve months), is largely
dependent upon AMBAC Indemnity's ability to pay dividends or make payments to
the Company and external financings.
Pursuant to Wisconsin insurance laws, AMBAC Indemnity may declare
dividends, provided that, after giving effect to the distribution, it would not
violate certain statutory equity, solvency and asset tests. As of December 31,
1995, the maximum amount available during 1996 under Wisconsin's insurance laws
and regulations for payment of dividends to the Company by AMBAC Indemnity
without prior approval of regulatory authorities was approximately $86 million.
However, on April 30, 1996, AMBAC Indemnity, with the approval of the Office of
the Commissioner of Insurance of the State of Wisconsin (the "Wisconsin
Commissioner"), transferred its 2,378,672 shares of HCIA to the Company in the
form of an extraordinary dividend, at fair value. The Company subsequently sold
all 4,159,505 of its shares on May 6, 1996. As a result of such dividend, any
dividends paid by AMBAC Indemnity to the Company for the twelve months following
April 30, 1996, require pre-approval from the Wisconsin Commissioner. However,
the Wisconsin Commissioner has stated to AMBAC Indemnity management that, based
on AMBAC Indemnity's financial position as of the date of the Wisconsin
Commissioner's approval of the extraordinary dividend, it anticipates that
quarterly dividend payments for the balance of 1996 similar to those made during
1995 will not be disapproved. During the nine months ended September 30, 1996,
AMBAC Indemnity paid dividends to the Company totaling $30 million.
The holding company's principal uses of liquidity are for the payment
of its operating expenses, interest on its debt, dividends on its shares of
Common Stock and capital investments in its subsidiaries. Based on the amount of
dividends that AMBAC Indemnity expects to pay during 1996 with the anticipated
prior approval of regulatory authorities along with the proceeds from its sale
of HCIA common stock, the Company believes it will have sufficient liquidity to
satisfy its liquidity needs over the next twelve months, including the payment
of dividends on the Common Stock in accordance with its dividend policy. Beyond
the next twelve months, AMBAC Indemnity's ability to declare and pay dividends
to the Company may be influenced by a variety of factors, including adverse
market changes, insurance regulatory changes and changes in general economic
conditions. Consequently, although the Company believes that it will continue to
have sufficient liquidity to meet its debt service and other obligations over
the long term, no assurance can be given that AMBAC Indemnity will be permitted
to dividend amounts sufficient to pay all of the Company's operating expenses,
debt service obligations and dividends on its Common Stock.
18
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
The principal uses of AMBAC Indemnity's liquidity are the payment of
operating expenses, reinsurance premiums, income taxes and dividends to the
Company. The Company believes that AMBAC Indemnity's operating liquidity needs
can be funded exclusively from its operating cash flow. The principal sources of
AMBAC Indemnity's liquidity are gross premiums written, scheduled investment
maturities and net investment income. Premiums for AMBAC Indemnity's financial
guarantee insurance policies are, in most cases, payable in full at the outset
of the term of the policy even though premiums are earned over the life of such
policies for financial accounting purposes.
The principal uses of liquidity by the Company's financial services
subsidiaries are the payment of investment contract obligations pursuant to
defined terms, obligations under interest rate swaps, operating expenses and
income taxes. The Company believes that its financial services operating
liquidity needs can be funded primarily from its operating cash flow and the
maturity of its invested assets. The principal sources of financial services
liquidity are proceeds from issuance of investment contracts, net investment
income, maturities of securities from its investment portfolio which are
invested with the objective of matching the duration of its obligations under
the investment contracts, and receipts from interest rate swaps. The Company's
investment objective with respect to investment contracts is to achieve the
highest after-tax total return, subject to a minimum average quality rating of
Aa/AA on invested assets and maintaining cash flow matching of invested assets
to funded liabilities to minimize interest rate and liquidity exposure. The
Company maintains a portion of its financial services assets in short-term
investments and repurchase agreements in order to meet unexpected liquidity
needs.
As of September 30, 1996, the Company and AMBAC Indemnity had a
three-year revolving credit facility with two major international banks, as
co-agents, for $100 million, which expires in July 1998. This facility is
available for general corporate purposes, including the payment of claims. As of
September 30, 1996 and 1995, no amounts were outstanding under this credit
facility.
AMBAC Indemnity has an agreement with another major international bank,
as agent, for a $300 million credit facility, expiring in 2002. This facility is
a seven-year stand-by irrevocable limited recourse line-of-credit, which will
provide liquidity to AMBAC Indemnity in the event claims from municipal
obligations exceed specified levels. Repayment of any amounts drawn under the
line will be limited primarily to the amount of any recoveries of losses related
to policy obligations. As of September 30, 1996 and 1995, no amounts were
outstanding under this line.
During the nine months ended September 30, 1996, the Company acquired
430,000 treasury shares in the open market under its existing stock repurchase
program. Since the inception of the program the Company has acquired 895,000
shares and, as of September 30, 1996, has remaining authorization to acquire
2,105,000 additional shares.
19
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Adjusted Book Value ("ABV") per common share increased 6% to $60.05 at
September 30, 1996 from $56.47 at December 31, 1995. ABV, which is not
promulgated under Generally Accepted Accounting Principles ("GAAP"), is used by
management, equity analysts and investors as a measure of the company's
intrinsic value, with no benefit given for ongoing business activity. Management
derives ABV by beginning with stockholders' equity (book value) and adding or
subtracting the after-tax effect of: (i) balance sheet items where revenue has
been collected and deferred or an expense has been incurred and deferred, which
will be recognized in income with the passage of time; (ii) material off-balance
sheet assets and liabilities; and (iii) material mark-to-market adjustments to
assets and liabilities recorded on the balance sheet using an accounting policy
which differs materially from market value. The definition of ABV used by the
Company differs from definitions of ABV used by other public financial
guarantors, and should be considered in such context. The adjustments described
above will not be realized until future periods and may materially differ from
the amounts used in determining ABV.
The following table reconciles Book Value Per Share to Adjusted Book
Value Per Share as of September 30, 1996 and December 31, 1995:
<TABLE>
<CAPTION>
September 30, December 31,
1996/(1)/ 1995/(1)/
---------------------- ----------------------
<S> <C> <C>
Book value per share............................................ $43.94 $40.04
After-tax value of:
Net unearned premium reserve.................................. 14.79 13.89
Deferred acquisition costs.................................... (1.69) (1.54)
Present value of installment premiums......................... 2.55 2.05
Unrealized gain on investment in HCIA/(2)/.................... -- 2.77
Unrealized gain (loss) on investment contract liabilities..... 0.46 (0.74)
---------------------- ----------------------
Adjusted book value per share................................... $60.05 $56.47
====================== ======================
(1) Numbers may not add due to rounding.
(2) The Company sold its remaining investment in HCIA on May 6, 1996.
</TABLE>
As of September 30, 1996, the fair value of the Company's consolidated
investment portfolio was $5.09 billion, an increase of 15% from $4.44 billion at
December 31, 1995. The increase was primarily due to the growth of the Company's
financial guarantee insurance and financial services operations and the proceeds
from the sale of HCIA, partially offset by a decline in market value of the
Company's investment portfolio resulting from the increase in interest rates
during the nine months ended September 30, 1996.
Net cash provided by operating activities was $145.1 million and $148.8
million during the nine months ended September 30, 1996 and 1995, respectively.
These cash flows were primarily provided by the financial guarantee insurance
operations.
Net cash provided by financing activities was $431.4 million and $76.5
million during the nine months ended September 30, 1996 and 1995, respectively.
This activity included $455.2 million and $86.6 million, respectively, in
municipal investment contracts issued (net of draws paid).
20
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
The total cash provided by operating and financing activities was
$576.5 million and $225.3 million during the nine months ended September 30,
1996 and 1995, respectively. From these totals, $575.4 million and $227.6
million was used in investing activities during the nine months ended September
30, 1996 and 1995, respectively, principally for purchases of bonds, offset by
proceeds from the sale of HCIA and sales and maturities of bonds.
The Company has made no commitments for material capital expenditures
within the next twelve months. However, management continually evaluates
opportunities to expand the Company's businesses through internal development of
new products as well as acquisitions.
In the normal course of business, the Company uses interest rate
contracts for hedging purposes as part of its overall interest rate risk
management. The Company also manages a variety of other risks-principally
credit, market, liquidity, operational, and legal. These risks are identified,
measured, and monitored through a variety of control mechanisms, which are in
place at different levels throughout the organization. In addition, one of the
Company's financial services subsidiaries, AMBAC Financial Services, Limited
Partnership ("AFS"), is a dealer specializing in providing interest rate swaps
to states, municipalities and municipal authorities. AFS manages its interest
rate swap business with the goal of being market neutral to changes in overall
interest rates, while retaining "basis risk," the relationship between changes
in floating tax-exempt interest rates and floating taxable interest rates. If
actual or projected floating tax-exempt interest rates rise in relation to
floating taxable interest rates, AFS will experience an unrealized
mark-to-market loss. Conversely, if actual or projected floating tax-exempt
interest rates decline in relation to floating taxable interest rates, AFS will
experience an unrealized mark-to-market gain.
21
<PAGE>
PART II-OTHER INFORMATION
Items 1, 2, 3 and 4 are omitted either because they are inapplicable or
because the answer to such question is negative.
Item 5-Other Information
The Company has announced that the Financial Services Division has
signed a definitive agreement to acquire the assets of Lake Ronkonkoma, New
York-based Cadre Financial Services, Inc., an investment adviser and fund
administrator, and Cadre Securities, Inc., its affiliated broker-dealer. The
acquisition is expected to close by December 31, 1996.
Item 6-Exhibits
The following are annexed as exhibits:
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
10.17 Letter Agreement between Gregory & Hoenemeyer, Inc. and AMBAC
Capital Corporation dated August 1, 1996.
11.00 Statement re computation of per share earnings.
27.00 Financial Data Schedule.
99.05 AMBAC Indemnity Corporation and Subsidiaries Consolidated
Unaudited Financial Statements as of September 30, 1996 and
December 31, 1995 and for the periods ended September 30,
1996 and 1995.
</TABLE>
22
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
AMBAC Inc.
(Registrant)
Dated: November 14, 1996 By: /s/ Frank J. Bivona
-------------------------------
Frank J. Bivona
Senior Vice President,
Chief Financial
Officer and Treasurer
(Principal Financial and
Accounting Officer and Duly
Authorized Officer)
23
<PAGE>
<TABLE>
<CAPTION>
INDEX TO EXHIBITS
Exhibit Description
Number
- ------
<S> <C>
10.17 Letter Agreement between Gregory & Hoenemeyer, Inc. and AMBAC
Capital Corporation dated August 1, 1996.
11.00 Statement re computation of per share earnings.
27.00 Financial Data Schedule.
99.05 AMBAC Indemnity Corporation and Subsidiaries Consolidated
Unaudited Financial Statements as of September 30, 1996 and
December 31, 1995 and for the periods ended September 30,
1996 and 1995.
</TABLE>
24
<PAGE>
EXHIBIT 10.17
August 1, 1996
Gregory & Hoenemeyer, Inc.
660 Steamboat Road
Greenwich, Connecticut 06830
Attention: W. Grant Gregory
Chairman
Dear Mr. Gregory:
This letter agreement sets forth the terms of the retention of Gregory
& Hoenemeyer, Inc. ("G & H") by AMBAC Capital Corporation (collectively with its
affiliates, "AMBAC").
1. (a) G & H will assist AMBAC as its financial advisor in connection
with any Transaction (as such term is defined in clause (b) of
this paragraph 1) with or involving Cadre Financial Services,
Inc. and its broker-dealer affiliate Cadre Securities, Inc.
(collectively, together with their respective subsidiaries and
affiliates, including Cadre Consulting Services, Inc., "Cadre").
G & H's services will include advice on valuation and
structuring of any Transaction and assisting AMBAC in
negotiations with Cadre.
(b) As used in this letter agreement, the term "Transaction" means
(i) any merger, consolidation, reorganization, or other business
combination pursuant to which the business of Cadre is acquired
by, or combined with, AMBAC, (ii) the acquisition, directly or
indirectly, by AMBAC in a single transaction or a series of
transactions, of (A) all or substantially all of the assets of
Cadre or (B) more than fifty percent of Cadre's outstanding
capital stock or (iii) the acquisition, directly or
indirectly, by AMBAC of control of Cadre otherwise than through
the acquisition of Cadre's voting capital stock.
2. In connection with G & H's activities on AMBAC's behalf, AMBAC
will cooperate with G & H and will furnish G & H with all
information and data concerning AMBAC, Cadre and any Transaction
that G & H deems appropriate. G & H agrees to (a) keep any such
non-public information
<PAGE>
Gregory & Hoenemeyer, Inc.
August 1, 1996
Page 2
confidential so long as it remains non-public, unless disclosure
is required by law or requested by any governmental or regulatory
agency or body, and (b) not make any use of such confidential
information, except in connection with G & H's services for AMBAC
under this letter agreement.
3. AMBAC agrees to pay the following fees to G & H:
(a) An advisory fee of Thirty Thousand Dollars ($30,000),
payable in cash on the date of this letter agreement.
(b) A transaction fee of Two Hundred Fifteen Thousand Dollars
($215,000), if, during the period G & H is retained by AMBAC, or
within eighteen (18) months after the date of termination of
this letter agreement, (i) a Transaction is consummated with
Cadre, or (ii) AMBAC enters into an agreement with Cadre which
subsequently results in a Transaction. The transaction fee shall
be payable in cash upon the closing of such Transaction.
4. In addition to any fees that may be payable to G & H under this
letter agreement, AMBAC agrees to reimburse G & H for its
reasonable out-of-pocket expenses incurred in connection with its
activities under this letter agreement, including the reasonable
fees and disbursements of its legal counsel.
5. AMBAC agrees to indemnify G & H and its directors, officers,
employees, agents and controlling persons (G & H and each such
person being an "Indemnified Party") from and against any and all
losses, claims, damages and liabilities, joint or several, to
which such Indemnified Party may become subject in connection
with G & H's engagement under this letter agreement, and will
reimburse any Indemnified Party for all legal and other expenses,
except to the extent that any loss, claim, damage or liability is
found in a final judgment by a court of competent jurisdiction
(not subject to further appeal) to have resulted primarily from
G & H's bad faith, gross negligence or willful misconduct.
6. G & H's engagement under this letter agreement may be terminated
by either AMBAC or G & H at any time with or without cause upon
written notice to that effect to the other party, it being
understood that the provisions relating to payment of fees
and reimbursement of reasonable expenses and indemnification
shall survive any such termination.
<PAGE>
Gregory & Hoenemeyer, Inc.
August 1, 1996
Page 3
7. No waiver, amendment or other modification of this letter
agreement shall be effective unless in writing and signed by each
party to be bound thereby. This letter agreement shall be
governed by, and construed in accordance with, the laws of the
State of New York, applicable to contracts executed in and to be
performed in that state.
If the foregoing is in accordance with your understanding, please sign and
return to me the enclosed copy of this letter agreement.
Very truly yours,
AMBAC CAPITAL CORPORATION
By:/s/ W. Dayle Nattress
---------------------------
W. Dayle Nattress
Chairman, President and
Chief Executive Officer
Accepted and agreed to as of the
date first above written:
GREGORY & HOENEMEYER, INC.
By:/s/ W. Grant Gregory
---------------------------
W. Grant Gregory
Chairman
Enclosure
<PAGE>
(Exhibit Number 11.00)
AMBAC Inc. and Subsidiaries
Statement Re Computation of Per Share Earnings
For The Three and Nine Months Ended September 30, 1996
(Dollars in Thousands Except Per Share Amounts)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, 1996 September 30, 1996
------------------ ------------------
<S> <C> <C>
Net income................................................. $ 1.26 $ 6.42
----------- -----------
Fully diluted shares:
Average number of common shares outstanding...... 34,906 34,958
Assumed exercise of dilutive stock options (1) .. 739 739
----------- -----------
35,645 35,697
=========== ===========
Earnings per share assuming full dilution (2) ............. $ 1.23 $ 6.28
=========== ===========
</TABLE>
(1) As of September 30, 1996, approximately 2,311,000 stock options and
restricted stock units had been granted and were outstanding. Based
upon various exercise prices, the total consideration for the options
and restricted stock units will be approximately $87.6 million. The
dilution would be the equivalent of approximately 739,000 shares, using
the treasury stock method, based upon a market value of $55.75 per
share.
(2) In accordance with Accounting Principles Board Opinion No. 15, any
reduction of less than 3% need not be considered as dilution.
Accordingly, the consolidated statements of operations on page 4 of
this report reflect net income per common share of $1.26 and $6.42 for
the three and nine months ended September 30, 1996, respectively.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<DEBT-HELD-FOR-SALE> 4,909,604
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 5,088,856
<CASH> 13,307
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 90,022
<TOTAL-ASSETS> 5,726,807
<POLICY-LOSSES> 60,170
<UNEARNED-PREMIUMS> 961,413
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 223,782
0
0
<COMMON> 353
<OTHER-SE> 1,535,382
<TOTAL-LIABILITY-AND-EQUITY> 5,726,807
101,583
<INVESTMENT-INCOME> 107,212
<INVESTMENT-GAINS> 130,473
<OTHER-INCOME> 4,933
<BENEFITS> 3,811
<UNDERWRITING-AMORTIZATION> 27,745
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 309,469
<INCOME-TAX> 85,141
<INCOME-CONTINUING> 224,328
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 224,328
<EPS-PRIMARY> 6.42
<EPS-DILUTED> 6.42
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
<PAGE>
(Exhibit 99.05)
AMBAC Indemnity Corporation and Subsidiaries
(a wholly-owned subsidiary of AMBAC Inc.)
Consolidated Unaudited Financial Statements
as of September 30, 1996 and December 31, 1995
and for the periods ended September 30, 1996 and 1995
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Balance Sheets
September 30, 1996 and December 31, 1995
(Dollars in Thousands Except Share Data)
<TABLE>
<CAPTION>
September 30, 1996 December 31, 1995
------------------ -----------------
(unaudited)
<S> <C> <C>
Assets
- ------
Investments:
Bonds held in available for sale account, at fair value
(amortized cost of $2,224,021 in 1996 and $2,090,101 in 1995) $2,302,605 $2,224,528
Short-term investments, at cost (approximates fair value) 151,107 163,953
------------------ -----------------
Total investments 2,453,712 2,388,481
Cash 9,138 6,912
Securities purchased under agreements to resell 8,466 4,120
Receivable for securities 23,433 8,136
Investment income due and accrued 39,135 38,319
Investment in affiliate - 25,827
Deferred acquisition costs 90,022 82,620
Current income taxes - 2,171
Prepaid reinsurance 166,588 153,372
Other assets 51,443 48,472
------------------ -----------------
Total assets $2,841,937 $2,758,430
================== =================
Liabilities and Stockholder's Equity
- ------------------------------------
Liabilities:
Unearned premiums $ 965,192 $ 906,136
Losses and loss adjustment expenses 60,170 65,996
Ceded reinsurance balances payable 11,280 14,654
Deferred income taxes 67,253 85,008
Current income taxes 12,963 -
Accounts payable and other liabilities 48,982 43,625
Payable for securities 80,737 86,304
------------------ -----------------
Total liabilities 1,246,577 1,201,723
------------------ -----------------
Stockholder's equity:
Preferred stock, par value $1,000.00 per share; authorized
shares - 285,000; issued and outstanding shares - none - -
Common stock, par value $2.50 per share; authorized shares
- 40,000,000; issued and outstanding shares - 32,800,000
at September 30, 1996 and December 31, 1995 82,000 82,000
Additional paid-in capital 514,809 481,059
Unrealized gains on investments, net of tax 51,079 87,112
Retained earnings 947,472 906,536
------------------ -----------------
Total stockholder's equity 1,595,360 1,556,707
------------------ -----------------
Total liabilities and stockholder's equity $2,841,937 $2,758,430
================== =================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
For The Periods Ended September 30, 1996 and 1995
(Dollars in Thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- -------------------
1996 1995 1996 1995
------- ----- ------ ------
<S> <C> <C> <C> <C>
Revenues:
Gross premiums written $67,875 $43,960 $177,935 $121,425
Ceded premiums written (9,813) (7,369) (29,261) (4,314)
-------- ------- -------- --------
Net premiums written 58,062 36,591 148,674 117,111
Increase in unearned premiums (23,900) (9,919) (45,840) (37,482)
-------- ------- -------- --------
Net premiums earned 34,162 26,672 102,834 79,629
Net investment income 36,977 33,320 107,466 97,613
Net realized gains (losses) (5,381) (2,455) 64,555 (9,331)
Other income 2,377 1,762 13,182 3,747
-------- ------- -------- --------
Total revenues 68,135 59,299 288,037 171,658
-------- ------- -------- --------
Expenses:
Losses and loss adjustment expenses 1,301 841 3,811 2,210
Underwriting and operating expenses 9,713 8,900 31,379 28,146
Interest expense 514 505 1,542 1,142
-------- ------- -------- --------
Total expenses 11,528 10,246 36,732 31,498
-------- ------- -------- --------
Income before income taxes 56,607 49,053 251,305 140,160
-------- ------- -------- --------
Income tax expense:
Current taxes 10,521 5,113 62,834 18,656
Deferred taxes 888 5,123 1,648 8,789
-------- ------- -------- --------
Total income taxes 11,409 10,236 64,482 27,445
-------- ------- -------- --------
Net income 45,198 38,817 186,823 112,715
======== ======= ======== ========
</TABLE>
See accompanying Notes to Consolidated Unaudited Financial Statements
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
For The Periods Ended September 30, 1996 and 1995
(Dollars in Thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------------
1996 1995
------------ -----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 186,823 $ 112,715
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,463 1,240
Amortization of bond premium and discount (1,525) (707)
Current income taxes payable 15,134 4,282
Deferred income taxes payable 1,648 8,789
Deferred acquisition costs (7,402) (11,398)
Unearned premiums 45,840 37,482
Losses and loss adjustment expenses (5,826) 218
Ceded reinsurance balances payable (3,374) 2,089
(Gain) loss on sales of investments (64,555) 9,331
Other, net (2,004) (1,978)
----------- -----------
Net cash provided by operating activities 166,222 162,063
----------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds at amortized cost 1,210,927 1,085,062
Proceeds from maturities of bonds at amortized cost 78,368 121,470
Purchases of bonds at amortized cost (1,462,567) (1,323,132)
Change in short-term investments 12,846 (15,125)
Proceeds from sale of affiliate 115,865
Securities purchased under agreements to resell (4,346) (531)
Other, net (1,724) (959)
----------- -----------
Net cash used in investing activities (50,631) (133,215)
----------- -----------
Cash flows from financing activities:
Dividends paid (145,865) (30,000)
Capital contribution 32,500 -
----------- -----------
Net cash used in financing activities (113,365) (30,000)
----------- -----------
Net cash flow 2,226 (1,152)
Cash at beginning of year 6,912 2,117
----------- -----------
Cash at September 30 $ 9,138 $ 965
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes $ 13,300 $ 13,700
=========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Unaudited Financial Statements
(1) Basis of Presentation
AMBAC Indemnity Corporation ("AMBAC Indemnity") is a leading insurer of
municipal and structured finance obligations. Financial guarantee insurance
underwritten by AMBAC Indemnity guarantees payment when due of the principal of
and interest on the obligation insured. In the case of a default on the insured
obligation, payments under the insurance policy may not be accelerated by the
policyholder without AMBAC Indemnity's consent. As of September 30, 1996, AMBAC
Indemnity's net insurance in force (principal and interest) was $215.4 billion.
AMBAC Indemnity is a wholly-owned subsidiary of AMBAC Inc., which is a holding
company that provides through its affiliates financial guarantee insurance and
financial services to clients in both the public and private sectors.
AMBAC Indemnity has one wholly-owned subsidiary, American Municipal
Bond Holding Company ("AMBH"), which is a holding company for certain real
estate interests.
On May 6, 1996, AMBAC Inc. sold its 4,159,505 shares of common stock of
its affiliate, HCIA Inc. (NASDAQ:HCIA) ("HCIA") in a secondary public offering.
Prior to consummation of the secondary public offering, AMBAC Indemnity
delivered to AMBAC Inc. (in the form of an extraordinary dividend) its 2,378,672
shares of HCIA common stock, at fair value. The fair value of the HCIA shares
was $115.9 million, based on the offering price per share of HCIA common stock
in the secondary public offering. The carrying value of AMBAC Indemnity's HCIA
shares was $26.2 million, and the resulting gain to AMBAC Indemnity from the
disposition of the shares was $89.7 million. As a result of the secondary public
offering, neither AMBAC Indemnity, nor AMBAC Inc. own any shares of HCIA.
AMBAC Indemnity, as the sole limited partner, owns 90% of the total
partnership interests of AMBAC Financial Services, Limited Partnership ("AFS"),
a limited partnership which provides interest rate swaps primarily to states,
municipalities and municipal authorities. The sole general partner of AFS, AMBAC
Financial Services Holdings, Inc., a wholly-owned subsidiary of AMBAC Inc., owns
a general partnership interest representing 10% of the total partnership
interest in AFS.
AMBAC Indemnity's consolidated unaudited interim financial statements
have been prepared on the basis of generally accepted accounting principles
("GAAP") and, in the opinion of management, reflect all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation of the
Company's financial condition, results of operations and cash flows for the
periods presented. The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosures of contingent assets
and liabilities at the date of the financial statements and the reported
revenues and expenses during the reporting period. Actual results could differ
from those estimates. The results of operations for the nine months ended
September 30, 1996 may not be indicative of the results that may be expected for
the full year ending December 31, 1996. These financial statements and notes
should be read in conjunction with the financial statements and notes included
in
<PAGE>
AMBAC Indemnity Corporation and Subsidiaries
Notes to Consolidated Unaudited Financial Statements (Continued)
the audited consolidated financial statements of AMBAC Indemnity Corporation and
its subsidiaries as of December 31, 1995 and 1994, and for each of the years in
the three-year period ended December 31, 1995.
(2) Income Taxes
The tax provisions in the accompanying financial statements reflect
effective tax rates differing from prevailing federal corporate income tax
rates, primarily as a result of tax-exempt interest income.
