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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED COMMISSION FILE NUMBER
DECEMBER 31, 1996 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)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Title of each class Name of each exchange on which registered
COMMON STOCK, $0.01 PER SHARE AND
PREFERRED STOCK PURCHASE RIGHTS NEW YORK STOCK EXCHANGE, INC.
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
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
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of voting stock held by non-affiliates of the
Registrant as of March 1, 1997 was $2,317,739,691 (based upon the closing price
of the Registrant's shares of the New York Stock Exchange on March 1, 1997,
which was $66.75). For purposes of this information, the outstanding shares of
Common Stock which were owned by all directors and executive officers of the
Registrant were deemed to be shares of Common Stock held by affiliates.
As of March 1, 1997, 34,840,291 shares of Common Stock, par value $0.01 per
share, (net of 499,901 TREASURY SHARES) AND 0 SHARES OF CLASS A COMMON STOCK,
PAR VALUE $0.01 PER SHARE, WERE OUTSTANDING.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Annual Report to Stockholders for the year
ended December 31, 1996 are incorporated by reference into Parts II and IV
hereof. Portions of the Registrant's Proxy Statement dated March 31, 1997 in
connection with the Annual Meeting of Stockholders to be held on May 14, 1997
are incorporated by reference into Part III hereof.
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TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business................................... 1
Item 2. Properties................................. 31
Item 3. Legal Proceedings.......................... 31
Item 4. Submission of Matters to a
Vote of Security Holders................... 31
PART II
Item 5. Market for Registrant's Common
Equity and Related Stockholder Matters..... 32
Item 6. Selected Financial Data.................... 32
Item 7. Management's Discussion and
Analysis of Financial Condition
and Results of Operations.................. 32
Item 8. Financial Statements and Supplementary Data 33
Item 9. Changes in and Disagreements With
Accountants on Accounting and
Financial Disclosure....................... 33
PART III
Item 10. Directors and Executive Officers
of the Registrant.......................... 33
Item 11. Executive Compensation..................... 33
Item 12. Security Ownership of Certain
Beneficial Owners and Management........... 33
Item 13. Certain Relationships and
Related Transactions....................... 33
PART IV
Item 14. Exhibits, Financial Statement
Schedules, and Reports on Form 8-K......... 34
SIGNATURES............................................... 40
APPENDIX A Types and Ratings of Bonds................. A-1
FINANCIAL STATEMENT SCHEDULES............................ S-1
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PART I
ITEM 1. BUSINESS.
GENERAL
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"), is a leading
insurer of municipal and structured finance obligations. The Company's Financial
Services Division provides investment contracts, interest rate swaps and
investment management and advisory services principally to states,
municipalities, municipal authorities and hospitals and health organizations.
During 1995 the Company sold its controlling position in its publicly
traded health care information content subsidiary, HCIA Inc. ("HCIA"). In May
1996, the Company sold its remaining holdings in HCIA.
During 1996 the Company acquired substantially all of the assets and the
name of Cadre Financial Services, Inc. ("Cadre"). Cadre is a provider of cash
management and investment advisory services to local school districts, hospitals
and health organizations and municipalities. Also during 1996 the Company
acquired a controlling interest in AMBAC Connect Inc. ("ACI"), the successor to
Advanced Procurement Systems, Inc. ACI develops and markets software for
governmental procurement applications.
AMBAC Indemnity is primarily engaged in insuring municipal and structured
finance obligations and is the successor of the oldest municipal bond insurance
company, which wrote the first municipal bond insurance policy in 1971.
Financial guarantee insurance written by AMBAC Indemnity in both the primary and
secondary markets 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. AMBAC Indemnity seeks to maintain a
diversified insurance portfolio which spreads its risk across a number of
criteria, including issue size, type of bond, geographic area and issuer. As of
December 31, 1996, AMBAC Indemnity's net insurance in force (after giving effect
for reinsurance) was $227.2 billion. See "Insurance in Force" below.
AMBAC Indemnity has been assigned triple-A claims-paying ability ratings,
the highest ratings of Moody's Investors Service, Inc. ("Moody's"), Standard &
Poor's Ratings Group ("S&P"), Fitch Investors Service, L.P. ("Fitch") and Nippon
Investors Service, Inc. ("Nippon"). These ratings are an essential part of AMBAC
Indemnity's ability to provide credit enhancement. See "Rating Agencies" below.
The Company's municipal investment contract business ("MIC business")
provides triple-A investment contracts primarily to states, municipalities and
municipal authorities. The investment contracts are rated triple-A by virtue of
AMBAC Indemnity's insurance policies which guarantee the MIC business'
performance. Investment contracts are used by municipal bond issuers to invest
bond proceeds until the proceeds can be used for their intended
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purpose, such as financing construction. The municipal investment contract
provides for the guaranteed return of principal invested, and for the payment of
interest thereon at a guaranteed rate. See "Municipal Investment Contract
Business" below.
The Company provides interest rate swaps through its subsidiary AMBAC
Financial Services, Limited Partnership ("AFS") to states, municipalities,
municipal authorities and other entities in connection with their financings.
The interest rate swaps provided by AFS are insured by triple-A rated AMBAC
Indemnity and provide a financing alternative that can reduce a municipal
issuer's overall borrowing costs. See "AMBAC Financial Services, Limited
Partnership" below.
As a holding company, AMBAC Inc. depends primarily on dividends from AMBAC
Indemnity, its principal operating subsidiary, to pay dividends on its capital
stock, to pay principal and interest on its indebtedness and to pay its
operating expenses. Such dividends from AMBAC Indemnity are subject to certain
insurance regulatory restrictions. See "Insurance Regulatory Matters --
Wisconsin Dividend Restrictions" below and "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Liquidity and Capital
Resources" in the Company's 1996 Annual Report to Stockholders.
BUSINESS SEGMENTS
The following paragraphs describe the business operations of AMBAC Inc.,
its subsidiaries and affiliates (sometimes collectively referred to as "the
Company") for the Company's two business segments: Financial Guarantee Insurance
and Financial Services.
FINANCIAL GUARANTEE INSURANCE
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Financial guarantee insurance of the type written by AMBAC Indemnity
guarantees to the holder of the underlying obligation the timely payment of
principal of and interest on such obligation in accordance with its original
payment schedule. Accordingly, in the case of an issuer default on the insured
obligation, payments under the insurance policy may not be accelerated by the
policyholder without AMBAC Indemnity's consent.
Financial guarantee insurance provides a form of credit enhancement which
benefits both the issuer and the investor. Issuers benefit because their
securities are sold with a higher credit rating than securities of the issuer
sold on an uninsured basis, resulting in interest cost savings and greater
marketability. In addition, for complex financings and obligations of issuers
that are not well known by investors, insured obligations receive greater market
acceptance than uninsured obligations. Investors benefit from greater
marketability and a reduction in the risk of loss associated with an issuer's
default.
The Company derives financial guarantee insurance revenues from (i)
premiums earned over the life of the obligations insured, (ii) net investment
income, (iii) realized gains and losses and (iv) fees. Excluding transactions
with affiliates, total financial guarantee insurance revenues were $266.3
million, $248.6 million and $225.0 million in 1996, 1995 and 1994, respectively.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Note 17 of Notes to Consolidated Financial Statements in the
Company's 1996 Annual Report to Stockholders.
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Financial guarantee insurance is sold in two primary markets: the United
States municipal market and the structured finance and asset-backed market.
UNITED STATES MUNICIPAL MARKET
Until 1993, AMBAC Indemnity was almost exclusively focused on the
municipal market in the United States. The municipal market includes taxable and
tax-exempt bonds, notes and other evidences of indebtedness issued by states,
political subdivisions (e.g., cities, counties, towns and villages), water,
sewer and other utility districts, higher educational institutions, hospitals,
transportation and housing authorities and other similar authorities and
agencies. Municipal obligations are supported by either the taxing authority of
the issuer or the issuer's or underlying obligor's ability to collect fees or
assessments for certain projects or public services. The following table sets
forth the volume of new issues of long-term (longer than 12 months) municipal
bonds and the volume of new issues of insured long-term municipal bonds over the
period from 1987 through 1996 in the United States.
NEW ISSUES OF U.S. LONG-TERM MUNICIPAL BONDS
INSURED
BONDS AS
PERCENTAGE
TOTAL INSURED OF TOTAL
VOLUME VOLUME VOLUME
($ in Billions) ------- ------- --------
1987...................... $105.0 $ 19.1 18.2
1988...................... 117.3 27.1 23.1
1989...................... 125.0 31.1 24.9
1990...................... 127.8 33.5 26.2
1991...................... 172.4 51.9 30.1
1992...................... 234.6 80.8 34.4
1993...................... 291.9 108.0 37.0
1994...................... 164.6 61.4 37.3
1995...................... 159.4 68.5 43.0
1996...................... 180.8 85.8 47.5
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Source: Amounts in the total volume column (except for 1996) are based upon
estimated data reported by The Bond Buyer's 1996 Yearbook. The 1996 volume
amounts are AMBAC Indemnity estimates, compiled from industry sources
including Securities Data Company, Inc. and The Bond Buyer. Statistics in
the Insured Volume column include only the insured portion of an issue and
are based upon industry sources including Securities Data Company, Inc. and
The Bond Buyer. Amounts in the Total Volume and Insured Volume columns
represent gross par amounts issued or insured, respectively, during such
year.
The foregoing table illustrates the changes in the total volume and
insured volume of new issues of municipal bonds over the past ten years. The
increase in volume of municipal bond issuance during 1991, 1992 and 1993 was
primarily due to increased refunding activity related to a lower interest rate
environment. The decrease in municipal bond issuance during 1994 and 1995 was
primarily due to decreased refunding activity related to a higher interest rate
environment.
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Although there have been certain monetary defaults in bond issues of
substantial amounts, incidents of monetary default on municipal bonds have been
infrequent in recent years. With the exception of the default by the Washington
Public Power Supply System, most monetary defaults since 1981 have been related
to industrial revenue bonds, nursing home bonds, housing bonds and other non-
general obligation bonds. Furthermore, based upon data reported by the
Association of Financial Guaranty Insurers, the percentage of insured municipal
bonds experiencing monetary defaults in recent years is relatively low compared
to the entire municipal market. The relatively low incidence of municipal bond
defaults may be partially the result of safeguards developed over the years
since the Depression of the 1930's, when a great number of municipal defaults
occurred. Such safeguards include the imposition of issuer debt limits, greater
supervision by state governments of local debt administration, and more thorough
credit reviews by investment firms, rating agencies and institutional investors.
While these safeguards address many of the causes of earlier defaults, they may
be inadequate to prevent an increased level of defaults in the future caused by
presently unforeseen economic and other factors. For example, 1994 and 1995 were
notable years in the municipal finance industry in that certain municipal
issuers realized losses in their investment portfolios as a result of the use of
derivative instruments. These investment losses, however, did not result in a
higher level of ultimate payment defaults by municipal issuers. See "Losses and
Reserves" below.
STRUCTURED FINANCE AND ASSET-BACKED MARKET
Insurance on securities in the structured finance and asset-backed market
is typically issued in connection with structured financings or securitizations
in which the securities being issued are secured by or payable from a specific
pool of assets having an ascertainable cash flow or market value and held by a
special purpose issuing entity. Such obligations include, but are not limited
to: mortgage-backed securities and pools of home equity loans, credit card
receivables, trade receivables or other assets. While most structured finance
and asset-backed obligations are secured by or represent interest in pools of
assets, monoline financial guarantors have also insured structured finance
obligations secured by one or a few assets.
In general, structured finance and asset-backed obligations are payable
only from cash flow generated by a pool of assets and take the form of either
"pass-through" obligations, which represent interests in the related assets, or
"pay-through" obligations, which generally are debt obligations which are
collateralized by the related assets. Both types of obligations also generally
have the benefit of over-collateralization or one or more forms of credit
enhancement to cover credit risks associated with the related assets.
Structured finance and asset-backed obligations generally entail two
forms of risks: asset risk, which relates to the amount and quality of asset
coverage; and structural risk, which relates to the extent to which the
transaction structure protects the interests of the investors, and therefore the
insurer.
In general, the amount and quality of asset coverage required is
determined by the historical performance of the assets. The future performance
of the underlying pool of assets will generally determine whether the amount of
over-collateralization or other credit enhancement ultimately is sufficient to
protect investors, and therefore the insurer, against
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adverse asset performance. The ability of the servicer of the assets to properly
service and collect the underlying assets often is a factor in determining
future asset performance.
Structural risks addressed by asset-backed transactions include
bankruptcy and tax risks. Structured and asset-backed securities are usually
designed to protect the investors, and therefore the insurer, from the
bankruptcy or insolvency of the entity that originated the underlying assets as
well as from the bankruptcy or insolvency of the servicer of those assets. (The
servicer of the assets is typically responsible for collecting cash payments on
the underlying assets and forwarding such payments, net of servicing fees, to
the special purpose issuing entity). Related issues that often arise concern
whether the sale of the assets by the originator to the issuer of the asset-
backed obligations would be respected in the event of the bankruptcy or
insolvency of the originator and whether the servicer of the assets may be
permitted or required to delay the remittance to investors of any cash
collections held by it at or received by it after the time it becomes subject to
bankruptcy or insolvency proceedings. AMBAC Indemnity addresses these risks
through its credit underwriting guidelines, standards and procedures.
The structured finance and asset-backed market in which AMBAC Indemnity
provides financial guarantee insurance is broad and disparate, comprising
domestic (U.S.) and international transactions, and public issues and private
placements. The varied classes of assets securitized or guaranteed, and the
recent rapid development of the market make estimating the size of the aggregate
structured finance and asset-backed markets difficult. One of the most well
developed sectors of this market is the U.S. public asset-backed market. The
volume in this market in recent years is summarized in the following table.
NEW ISSUES OF U.S. PUBLIC ASSET-BACKED SECURITIES
TOTAL
VOLUME
($ in Billions)
------------
1993................................................. $ 57.7
1994................................................. 75.5
1995................................................. 108.0
1996................................................. 150.5
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Source: Amounts are based upon estimated data reported by Asset Sales
Report.
Just as the U.S. public asset-backed market has grown significantly in
recent years, AMBAC Indemnity management believes the international markets for
insured structured finance and asset-backed securities have also expanded. A
number of important trends in international markets have contributed to this
expansion. In the United Kingdom, Australia and elsewhere, ongoing privatization
efforts have shifted the burden of funding from the government to public and
private capital markets, where investors may seek the security of financial
guarantee insurance. In Europe, there is growing interest in asset-backed
securitization, especially through commercial paper conduits.
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While the principles of securitization have been increasingly applied in
overseas markets, development in particular countries has varied due to the
sophistication of the local capital markets and the impact of financial
regulatory requirements, accounting standards and legal systems. It is
anticipated that securitization will continue to expand internationally, albeit
at varying rates in each country. AMBAC Indemnity insures both asset-backed and
structured transactions, as well as sovereign ad sub-sovereign debt issues, in
selected international markets.
AMBAC INDEMNITY CORPORATION
AMBAC Indemnity is organized into two business divisions, the Public
Finance Division and the Specialized Finance Division.
PUBLIC FINANCE DIVISION
The Public Finance Division is responsible for underwriting insurance and
maintaining client relationships for the following types of municipal bonds:
general obligation, tax-backed, transportation, leases, utilities, higher
education and airports. During 1996 and 1995, the Public Finance Division was
responsible for insured gross par written of $19.0 billion and $13.7 billion,
respectively. As of December 31, 1996, net par outstanding related to the Public
Finance Division was $86.3 billion.
During 1995, the Public Finance Division was reorganized along regional
lines, with a team of underwriters assigned to each of three regions of the
United States; North, South and West. Prior to the reorganization, underwriters
were assigned to an underwriting group based on the type of obligation insured.
Management believes the change to a regional focus promotes closer ties to
issuers, financial advisors and bankers who now deal with the same team of
professionals in each region, regardless of the type of obligation being
insured.
Within the Public Finance Division, the management of credit decisions
and criteria is centralized in the Credit Management Group. This group, in
conjunction with the Public Finance Senior Credit Committee, seeks to assure
that credit criteria are maintained, are appropriate and are systematically and
consistently applied across the regions.
The Public Finance Portfolio Risk Management Group reviews the division's
insured portfolio for concentration of risk, whether in specific bond types,
geographically or by size of issue. This group is also responsible for portfolio
surveillance within the Public Finance Division. Analysts and others responsible
for portfolio surveillance, schedule and execute regular and ad hoc reviews of
credits in the book of business. Risk adjusted surveillance strategies have been
developed for each bond type. Review periods and scope of review vary by bond
type based upon the risk inherent in the nature of the credits. The focus of the
surveillance review is to determine credit trends and recommend appropriate
classification and review periods. Generally, the surveillance reviews are
performed by analysts having the same experience and authority as those
reviewing issues for initial underwriting. Compliance with this process is
monitored by the head of Public Finance Portfolio Risk Management.
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AMBAC Indemnity assigns internal ratings to individual exposures as part
of the new issue underwriting process and at surveillance reviews. These
internal ratings, which represent AMBAC Indemnity's independent judgments, are
based upon underlying credit parameters similar to those used by nationally
recognized rating agencies.
SPECIALIZED FINANCE DIVISION
The Specialized Finance Division is responsible for underwriting
insurance and maintaining client relationships for the following types of
financings: structured transactions; receivable securitizations; asset-backed
commercial paper conduits; home equity and mortgage-backed securities; bonds of
state housing and student loan agencies, health care institutions and investor-
owned utilities. Underwriters in the Specialized Finance Division are organized
into teams of experienced professionals with expertise in a specific type of
security. During 1996 and 1995, the Specialized Finance Division was responsible
for insured gross par written of $17.8 billion and $12.4 billion, respectively.
As of December 31, 1996, net par outstanding related to the Specialized Finance
Division was $45.2 billion.
The Specialized Finance Division is also responsible for underwriting all
transactions with international exposure, primarily in Europe. During 1996 and
1995, AMBAC Indemnity insured gross par written in international transactions of
$3.7 billion and $1.2 billion, respectively. As of December 31, 1996, net par
outstanding related to international risks was $4.3 billion. Geographically, the
countries receiving AMBAC Indemnity's primary international focus have been
France and the United Kingdom. The types of international obligations insured
primarily have been asset-backed securities, sovereign and sub-sovereign
obligations, and special revenue and infrastructure obligations. Management has
developed underwriting standards for international risks which are consistent
with those applied to risks in the United States. In addition management
believes that the international risks insured to date are largely similar in
risk type to those insured in the United States.
In September 1995, AMBAC Indemnity and MBIA Insurance Corporation
("MBIA") formed an unincorporated joint venture, MBIA/AMBAC International, to
market financial guarantee insurance in Europe. The joint venture was formed
with the goal of bringing the combined capital and human resources of the two
companies together to more efficiently serve the European markets. Since the
inception of the joint venture, the two companies have insured a combined total
par amount of approximately $7.0 billion related to international risks under
the joint venture. Under the joint venture, financial guarantee policies are
issued separately by each of the companies. While retaining the right to act
individually, each company has the opportunity to reinsure up to 50 percent of
the financial guarantee business written by the other company in Europe as part
of the joint venture. Customer preference, licensing and market considerations
determine which company insures a transaction.
In January 1997, AMBAC Indemnity capitalized a new subsidiary in the
United Kingdom, AMBAC Insurance UK Limited ("AMBAC UK"), which was authorized on
February 4, 1997 to carry on certain classes of general insurance business in
the United Kingdom. Beginning in 1997, AMBAC UK will be the primary vehicle for
directly issuing financial guarantee policies in the United Kingdom and Europe.
AMBAC Indemnity and AMBAC UK have entered into a net worth maintenance agreement
and reinsurance agreements.
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As is the case with the Public Finance Division, the management of credit
decisions and criteria in the Specialized Finance Division is centralized in the
Risk Management Group. This group, in conjunction with the Specialized Finance
Senior Credit Committee, seeks to assure that credit criteria are appropriate
and systematically applied across the division. The Risk Management Group is
responsible for overseeing the surveillance process, setting and monitoring
standards for quality, timing and documentation of credit reviews. Analysts
responsible for portfolio surveillance schedule and execute regular and ad hoc
reviews of credits in the book of business. Risk adjusted surveillance
strategies have been developed for each bond type. Review periods and scope of
review vary by bond type based upon the risk inherent in the nature of the
credits. In certain cases, portfolio surveillance may be the responsibility of
the underwriting departments that originate the transactions. The focus of the
surveillance review is to determine credit trends, recommend appropriate
classification and set the next review date. Compliance with this process is
monitored by the head of Specialized Finance Risk Management.
INSURANCE WRITTEN
AMBAC Indemnity provides financial guarantee insurance for municipal
bonds, including taxable municipal bonds and structured finance obligations.
AMBAC Indemnity's financial guarantee insurance is delivered in two markets: the
new issue market and the secondary market. New issue insurance includes
municipal bond insurance, insurance of structured finance obligations, insurance
of debt service reserve funds, assumed reinsurance and insurance of other
financial obligations. The secondary market includes insurance of municipal
bonds, structured finance obligations, bonds in mutual funds and unit investment
trusts ("UITs").
The following table indicates the gross par amount written for each of
the years, 1996, 1995 and 1994 with respect to each market:
1996 1995 1994
-------- --------- ----------
($ In Millions)
New issue market.. . . . . . . . . . . $35,384 $23,630 $19,692
Secondary market.. . . . . . . . . . . 1,434 2,339 2,394
------- ------- -------
$36,818 $25,969 $22,086
======= ======= =======
NEW ISSUE MARKET - MUNICIPAL
AMBAC Indemnity sells the majority of its insurance in the new issue
municipal bond market. Of the $35.4 billion, $23.6 billion and $19.7 billion of
new issue par exposure written in 1996, 1995 and 1994, respectively, $25.3
billion, $18.0 billion and $17.9 billion, respectively, was new issue municipal
bond exposure. In the new issue municipal bond market, an issuer typically pays
a single premium to AMBAC Indemnity at the time the policy is issued. Premiums
are based on the total amount of principal and interest that will become
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due during the life of the bonds and on AMBAC Indemnity's evaluation of the
inherent strength and credit quality of the issuer. Insurance premium rates take
into account the risk assumed by the insurer. Critical factors in assessing risk
include the credit quality of the issuer, type of issue, the repayment source,
the type of security pledged, the presence of restrictive covenants and the
length of maturity. Each bond issue is evaluated in accordance with, and the
final premium rate is a function of, the particular factors as they relate to
such issue. Charges for new issue insurance also take into account the benefits
to be obtained by the issuer, as well as the cost and the projected return to
AMBAC Indemnity.
Proposed new municipal bond issues are submitted to AMBAC Indemnity to
determine their insurability by issuers or by their investment bankers or
financial advisors. Municipal bond issues are sold on either a competitive or a
negotiated basis. With respect to competitive issues, an issuer will publish a
notice of sale soliciting bids for the purchase of a proposed issue of municipal
bonds. Various syndicates are then formed by potential bidders on the bonds.
These syndicates then solicit a determination from some or all of the financial
guarantee insurers whether an issue is insurable and at what premium rate and on
what terms. The syndicate then determines whether to bid on the issue with
insurance (and if so, with which insurer) or without insurance. The issuer then
generally selects the syndicate with the lowest bid. In a negotiated offering,
an individual investment banker or team of investment bankers has already been
selected by the issuer and that banker or team then typically solicits premium
quotes and terms from the insurers.
The new issue market includes insurance policies designed to satisfy debt
service reserve fund requirements of municipal bond issuers. These policies
insure the availability of an amount not to exceed the debt service reserve fund
requirement for the issues, which in most cases is the lesser of one year's
maximum principal and interest payments or approximately 10% of the original
principal amount of a bond issue. Any amounts drawn under the debt service
reserve fund policy must be reimbursed by the issuer within a specified time
period and at a specified interest rate.
NEW ISSUE MARKET - STRUCTURED FINANCE
Of the $35.4 billion, $23.6 billion and $19.7 billion of new issue par
exposure written in 1996, 1995 and 1994, respectively, $10.1 billion, $5.6
billion and $1.8 billion was new issue structured finance bond exposure.
Premiums for structured finance policies are based on a percentage of either
principal or principal and interest insured. The timing of the collection of
structured finance premiums varies among individual transactions; some being
collected in a single payment at policy inception date, and others being
collected periodically (i.e., monthly, quarterly or annually). As of December
31, 1996 and 1995, net outstanding par exposure related to structured finance
transactions was $12.4 billion and $5.5 billion, respectively.
SECONDARY MARKET
Insurance on bonds outstanding in the secondary market is typically
purchased by an institution to facilitate the sale of municipal bonds in its
portfolio or inventory. The insurance generally increases the sale price of
bonds (typically by an amount greater than the cost of the policy) and affords a
wider secondary market and therefore greater marketability
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to a given issue of previously-issued bonds. As is the case with new issues, the
premium is generally payable in full at the time of policy issuance. AMBAC
Indemnity employs the same underwriting standards on secondary market issues
that it does on new municipal bond issues. However, AMBAC Indemnity is more
selective in the types of bonds it will insure in the secondary market.
Secondary market insurance can be riskier for a more complex legal structure
since the insurer does not have the ability to influence restrictive covenants
at the time of issuance. Consequently, AMBAC Indemnity concentrates its
secondary market insurance efforts on insurance of general obligation and
utility revenue bonds, in addition to issues where AMBAC Indemnity has existing
exposure.
Sponsors of UITs contact AMBAC Indemnity for insurance on individual
bonds in a specific trust. Insurance policies on individual bonds in insured
UITs are effective only as long as such bonds remain in the UIT unless an
additional premium is paid to extend their effective date to the stated maturity
of the bonds.
AMBAC Indemnity insures individual bonds in insured mutual funds.
Insurance policies on individual bonds in insured mutual funds are effective
only as long as the individual bonds remain in the fund. Premiums on bonds
included in mutual funds are collected monthly.
INSURANCE IN FORCE
AMBAC Indemnity underwrites and prices financial guarantee insurance on
the assumption that the insurance will remain in force until maturity of the
insured bonds. AMBAC Indemnity estimates that the average life (as opposed to
the stated maturity) of its insurance policies on new issue par in force at
December 31, 1996 was 12.5 years. The 12.5 year average life is determined by
applying a weighted average calculation, using the remaining years to maturity
of each insured bond, and weighting them on the basis of the remaining par
insured. No assumptions are made for any prepayment of insured bonds or for any
future refundings of insured issues. Municipal bonds generally have provisions
that allow the issuer to prepay all or a portion of the outstanding amount prior
to maturity.
AMBAC Indemnity seeks to maintain a diversified insurance portfolio
designed to spread its risk based on a variety of criteria, including (i) issue
size, (ii) type of bond, (iii) geographic area and (iv) issuer.
As of December 31, 1996, the total net par amount of insured bonds
outstanding was $131.5 billion. This amount excludes (a) AMBAC Indemnity's
guarantees for the timely payment of principal and interest on obligations under
municipal investment contracts issued by the MIC business and (b) AMBAC
Indemnity's policies which guarantee the obligations of AFS and its
counterparties under AFS's interest rate swaps. As of December 31, 1996, the
aggregate amount of municipal investment contracts insured was $2.74 billion,
including accrued interest. The insurance policies covering the MIC business are
collateralized by the MIC business' investment securities, accrued interest,
securities purchased under agreements to resell and cash and cash equivalents,
which as of December 31, 1996, had a fair value of $2.78 billion in the
aggregate. As of December 31, 1996, the total amount of guarantees covering AFS
and its swap counterparties was not material. See "Financial Services" below.
10
<PAGE>
ISSUE SIZE
AMBAC Indemnity seeks a broad coverage of the market by insuring small
and large issues alike. AMBAC Indemnity's insured exposure as of December 31,
1996 reflects the emphasis on issues insured with an original par amount of less
than $25 million, which reduces AMBAC Indemnity's average per-issue exposure to
losses. The following table sets forth the distribution of AMBAC Indemnity's
insured portfolio as of December 31, 1996 with respect to the original size of
each insured issue:
ORIGINAL PAR AMOUNT PER ISSUE
AS OF DECEMBER 31, 1996
<TABLE>
<CAPTION>
% OF TOTAL NET PAR % OF TOTAL NET
NUMBER OF AMOUNT PAR AMOUNT
ORIGINAL PAR AMOUNT NUMBER OF ISSUES ISSUES OUTSTANDING OUTSTANDING
- ---------------------------- ---------------- -------- ------------ ------------
($ In Millions)
<S> <C> <C> <C> <C>
Less than $10 million...... 7,959 73% $ 23,544 18%
$10-25 million............. 1,579 14 20,994 16
$25-50 million............. 757 7 22,623 17
Greater than $50 million... 683 6 64,336 49
------ --- -------- ---
10,978 100% $131,497 100%
====== === ======== ===
</TABLE>
11
<PAGE>
TYPES OF BONDS
The table below shows the distribution by bond type of AMBAC Indemnity's
insured portfolio as of December 31, 1996. As the table illustrates,
approximately 42% of AMBAC Indemnity's net par amount outstanding at December
31, 1996, consisted of general obligation bonds and utility revenue bonds, which
generally present less credit risk than other types of municipal bonds. AMBAC
Indemnity tries to avoid insuring bond issues which entail excessive single
project risk, over-capacity or customer contract disputes. For a more detailed
discussion of the various types of obligations in AMBAC Indemnity's insured
portfolio, see "Types and Ratings of Bonds" attached as Appendix A hereto.
INSURED PORTFOLIO BY BOND TYPE
AS OF DECEMBER 31, 1996
<TABLE>
<CAPTION>
% OF TOTAL NET
NET PAR AMOUNT PAR AMOUNT
BOND TYPE OUTSTANDING OUTSTANDING
- ---------------------------------------- ------------------- ------------------
($ In Millions)
MUNICIPAL FINANCE:
<S> <C> <C>
General obligation.................... $ 31,863 24 %
Lease and tax-backed revenue.......... 25,366 19
Utility revenue....................... 22,780 18
Health care revenue................... 13,521 10
Transportation revenue................ 6,891 5
Investor-owned utilities.............. 5,551 4
Higher education...................... 4,745 4
Housing revenue....................... 4,497 3
Student loans......................... 3,439 3
Other................................. 484 1
------------------- ------------------
Total municipal finance............ 119,137 91
------------------- ------------------
STRUCTURED FINANCE:
Domestic:.............................
Mortgage-backed and home equity..... 5,263 4
Asset-backed........................ 1,329 1
Other............................... 1,440 1
------------------- ------------------
Total domestic structured finance.. 8,032 6
------------------- ------------------
International:........................
Asset-backed........................ 2,530 2
Other............................... 1,798 1
------------------- ------------------
Total international structured 4,328 3
finance........................... ------------------- ------------------
Total structured finance......... 12,360 9
------------------- ------------------
Total.......................... $131,497 100%
=================== ==================
</TABLE>
12
<PAGE>
The table below shows the percentage, by bond type, of new business
insured by AMBAC Indemnity during each of the last five years. During this
period, AMBAC Indemnity has consistently emphasized insurance of general
obligation bonds, utility revenue bonds and tax-backed revenue bonds and has
maintained a decreasing but substantial proportion of its insured volume in such
bond types.
NEW BUSINESS INSURED BY BOND TYPE (1)
<TABLE>
<CAPTION>
BOND TYPE 1992 1993 1994 1995 1996
- --------------------------------------- --------- ------ -------- ------- -------
MUNICIPAL FINANCE:
<S> <C> <C> <C> <C> <C>
General obligation..................... 36% 29% 29% 23% 16%
Utilities (2).......................... 27 26 21 16 15
Lease and tax-backed revenue........... 13 21 16 16 23
Health care revenue.................... 8 13 8 8 7
Housing revenue........................ 2 2 5 5 3
Transportation revenue................. 8 3 5 5 3
Student loans.......................... 2 1 4 5 3
Higher education....................... 3 3 4 3 3
Other.................................. 1 0 1 0 0
--------- ------ -------- ------- -------
Total municipal finance.............. 100 98 93 81 73
--------- ------ -------- ------- -------
STRUCTURED FINANCE:
Domestic:
Mortgage-backed and home
equity............................... 0 0 1 8 12
Asset-backed.......................... 0 0 0 5 4
Other................................. 0 2 1 1 3
--------- ------ -------- ------- -------
Total domestic structured
finance............................. 0 2 2 14 19
--------- ------ -------- ------- -------
International:
Asset-backed.......................... 0 0 1 2 6
Other................................. 0 0 4 3 2
--------- ------ -------- ------- -------
Total international
structured finance.................. 0 0 5 5 8
--------- ------ -------- ------- -------
Total structured finance............. 0 2 7 19 27
--------- ------ -------- ------- -------
Total.............................. 100% 100% 100% 100% 100%
========= ====== ======== ====== =======
</TABLE>
(1) Stated as a percentage of total net par amount insured during such year.
(2) Includes investor-owned utilities.
GEOGRAPHIC AREA
AMBAC Indemnity is licensed to write business in all 50 states, the
District of Columbia, the Commonwealth of Puerto Rico and Guam. As of December
31, 1996, the six largest states, as measured by net par amount outstanding,
accounted for approximately 51% of AMBAC indemnity's total net par amount
outstanding. The following table sets forth those states and geographic areas in
which AMBAC indemnity's aggregate insured exposure equaled 2% or more of its
total net par amount outstanding as of December 31, 1996.
13
<PAGE>
INSURED PORTFOLIO BY STATE AS OF DECEMBER 31, 1996
<TABLE>
<CAPTION>
NET PAR % OF TOTAL NET
NUMBER OF AMOUNT PAR AMOUNT
STATE/GEOGRAPHIC AREA ISSUES OUTSTANDING OUTSTANDING
- ----------------------- ----------- --------------- --------------
($ In Millions)
<S> <C> <C> <C>
California............. 825 $ 20,536 16%
New York............... 965 10,832 8
Florida................ 564 10,169 8
Pennsylvania........... 911 9,559 7
Texas.................. 1,208 8,513 6
Illinois............... 542 7,235 5
Ohio................... 484 5,186 4
New Jersey............. 401 4,633 4
Michigan............... 505 4,624 4
Massachusetts.......... 293 4,147 3
Indiana................ 194 2,799 2
Washington............. 379 2,635 2
Other States........... 3,644 36,301 28
----------- --------------- --------------
Total domestic.... 10,915 127,169 97
International.......... 63 4,328 3
----------- --------------- --------------
10,978 $131,497 100%
=========== =============== ===============
</TABLE>
ISSUERS
AMBAC Indemnity has adopted underwriting and exposure management policies
designed to limit the net insurance in force for any one credit. In addition,
AMBAC Indemnity uses reinsurance to limit net exposure to any one credit. As of
December 31, 1996, AMBAC Indemnity's net par amount outstanding for its 20
largest credits, totaling $9.5 billion, was approximately 7% of AMBAC
Indemnity's total net par amount outstanding with no one credit representing
more than 1% of AMBAC Indemnity's total net par amount outstanding. AMBAC
Indemnity is also subject to certain regulatory limits and rating agency
guidelines on exposure to a single credit. See "Insurance Regulatory Matters"
and "Rating Agencies" below.
UNDERWRITING GUIDELINES, POLICIES AND PROCEDURES
Underwriting guidelines, policies and procedures have been developed by
AMBAC Indemnity's management with the intent that AMBAC Indemnity insure only
those obligations which, in the opinion of AMBAC Indemnity analysts, are of
investment grade quality. There are instances where one of the major rating
agencies will differ with AMBAC Indemnity's assessment of the investment grade
nature of a particular obligation or where the underlying rating of an issuer is
subsequently downgraded to below investment grade. As of December 31, 1996,
AMBAC Indemnity's aggregate outstanding net par insured of below investment
grade issues was $860.2 million (or 0.7% of AMBAC Indemnity's total net par
amount outstanding of obligations insured).
14
<PAGE>
The underwriting process involves review of structural, legal and credit
issues, including compliance with current AMBAC Indemnity underwriting
standards. These standards are reviewed periodically by management. The rating
agencies also monitor the credits underlying AMBAC Indemnity's insurance in
force and, in most cases, advise AMBAC Indemnity of the credit rating each issue
would receive if it were not insured by AMBAC Indemnity.
The following table sets forth AMBAC Indemnity's insured portfolio by
rating as of December 31, 1996:
INSURED PORTFOLIO BY RATING (1)
AS OF DECEMBER 31, 1996
<TABLE>
<CAPTION>
NET PAR % OF TOTAL NET
NUMBER OF AMOUNT PAR AMOUNT
RATING ISSUES OUTSTANDING OUTSTANDING
- ------------------ --------- ----------- ---------------
($ In millions)
<S> <C> <C> <C>
AAA.............. 63 $ 756 1%
AA............... 831 9,564 7
A................ 6,093 88,858 67
BBB.............. 3,891 31,459 24
BIG (2).......... 100 860 1
------ -------- ---
10,978 $131,497 100%
====== ======== ===
</TABLE>
(1) Ratings represent AMBAC Indemnity internal ratings.
(2) Represents those bonds which have been categorized as "below investment
grade" by AMBAC Indemnity.
AMBAC Indemnity's policy is to reduce default risk associated with the
obligations insured by it to the extent practicable. The decision to insure an
issue is based upon the issuer's ability to repay the bonds, security features
and structure, rather than upon an actuarial or statistical prediction of the
likelihood that the issuer will default on the underlying debt obligation. AMBAC
Indemnity insures only those bonds on which it expects not to incur a loss.
However, AMBAC Indemnity's policy is to provide for loss reserves that are
adequate to cover potential losses. See "Losses and Reserves" below.
Underwriting criteria vary by bond type, reflecting the differences, for
example, in economic and social factors, debt management, public purpose
essentiality, financial management, legal and administrative factors, revenue
sources and security features.
All requests for insurance are reviewed by AMBAC Indemnity's underwriting
staff, which is divided into two major underwriting divisions. The underwriting
process is designed to screen each issue carefully and begins with a thorough
credit analysis and written report prepared by the primary analyst assigned to
the issue. The report is then reviewed within the primary analyst's underwriting
group and division. The primary analyst's recommendation to qualify or reject an
issue must be approved by a concurring analyst and an underwriting officer. The
number of additional approvals required and the extent of an attorney's
involvement in a particular credit depends on the aggregate amount of AMBAC
Indemnity's existing or potential exposure to the credit. On large credits,
where the aggregate exposure exceeds a certain pre-determined amount, the
insurance decision must be approved by a credit committee comprised of senior
underwriting officers and an attorney in addition to the analysts and
underwriting officer mentioned above.
15
<PAGE>
AMBAC Indemnity determines premium rates on the basis of the bond type
and credit strength of the bond issue, the maturity and structure of the issue,
and other credit and market factors, including, but not limited to, security
features, the presence or absence of a debt service reserve fund or additional
credit enhancement features and the interest rate spread between insured and
uninsured obligations with characteristics similar to those of the proposed bond
issue. Premium rates are based upon established premium ranges, extensive
consultation with the analysts responsible for the issue, and market
intelligence developed from daily contact with syndicate managers and traders at
investment banking firms to help form the most accurate view of the value of
AMBAC Indemnity's insurance on each issue.
REMEDIAL MANAGEMENT
Those issues which are either in default or have developed problems that,
with the passage of time, may lead to a claim or loss are tracked closely by the
appropriate surveillance team. The documents underlying any problem credit are
reviewed by internal or outside counsel and an analysis is prepared outlining
AMBAC Indemnity's rights and potential remedies, the duties of all parties
involved and recommendations for corrective actions. This analysis, along with
the schedule of corrective actions, is reviewed in the monthly remedial credit
meetings. AMBAC Indemnity also meets with issuers to reach agreement upon the
nature and the scope of the problem and to discuss the issuers' operating plans.
In many instances, AMBAC Indemnity, under the terms of the documents
governing the underlying obligation, has the ability, among other things, to
direct that audits be performed with respect to servicer and trustee contractual
responsibilities and to meet with the appropriate officials to outline AMBAC
Indemnity's concerns and rights. When the underlying economics so indicate,
AMBAC Indemnity may aid in a restructuring to improve the debt service coverage.
LOSSES AND RESERVES
AMBAC Indemnity's policy is to provide for loss and loss adjustment
expense reserves that are adequate to cover potential losses as well as losses
that may arise from insured obligations which are currently or imminently in
default. The Active Credit Reserve ("ACR") is that portion of the reserves that
is based on AMBAC Indemnity's estimate of ultimate aggregate losses inherent in
the obligations insured. As of December 31, 1996, AMBAC Indemnity's ACR was
$38.6 million. When a default occurs or is imminent with respect to a particular
insured obligation, a reserve ("Case Basis Reserve") is established in an amount
that is sufficient to cover the present value of the anticipated defaulted debt
service payments over the expected period of default and the estimated expenses
associated with settling the claims, less estimated recoveries under salvage or
subrogation rights. In estimating the losses on defaults, AMBAC Indemnity makes
its assessment based on the full term of the insured obligation. All or part of
the Case Basis Reserve is allocated from any ACR available for such insured
obligation. AMBAC Indemnity's Case Basis Reserves totaled $21.6 million at
December 31, 1996.
16
<PAGE>
AMBAC Indemnity's reserve for losses and loss adjustment expenses
consists of the ACR and Case Basis Reserves. The most recent three-year history
of AMBAC Indemnity's loss reserves, and losses and loss adjustment expenses
incurred and paid, is described in the table below:
RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES (1)
YEARS ENDED DECEMBER 31,
--------------------------------
1996 1995 1994
---------- ---------- -----------
($ In Thousands)
Reserve for losses and loss adjustment
expenses at January 1,................. $65,996 $65,662 $64,037
Losses and loss adjustment expenses 3,778 3,377 2,593
incurred...............................
Losses and loss adjustment expenses
paid................................... (9,554) (3,043) (968)
------- ------- -------
Reserve for losses and loss adjustment
expenses at December 31,............... $60,220 $65,996 $65,662
======= ======= =======
(1) All information is net of salvage.
Management of AMBAC Indemnity believes that the reserves for losses and
loss adjustment expenses are adequate to cover the ultimate net costs of claims,
but the reserves are necessarily based on estimates and there can be no
assurance that the ultimate liability will not exceed such estimates. See Notes
2 and 5 of Notes to Consolidated Financial Statements in the Company's 1996
Annual Report to Stockholders.
COMPETITION
The financial guarantee insurance business is highly competitive. AMBAC
Indemnity's principal competitors in the market for municipal bond insurance are
three other monoline insurance companies, Financial Guaranty Insurance Company
("FGIC"), Municipal Bond Investors Assurance Corporation ("MBIA") and Financial
Security Assurance Inc. ("FSA"). According to AMBAC Indemnity estimates based on
industry sources, AMBAC Indemnity, FGIC, MBIA and FSA, in the aggregate, insured
approximately 99% of all new issue municipal bonds insured during 1996, with
MBIA insuring approximately 40% of such bonds, AMBAC Indemnity insuring
approximately 29% of such bonds, FGIC insuring approximately 18% of such bonds
and FSA insuring approximately 12% of such bonds. In the structured finance and
asset-backed markets, AMBAC Indemnity's principal competitors, in addition to
FGIC, MBIA and FSA, is one other monoline insurance company, Capital Markets
Assurance Corporation. The principal competitive factors among financial
guarantee insurers are (i) premium rates, (ii) conditions precedent to the
issuance of a policy related to the structure and security features of a
proposed bond issue, (iii) the financial strength of an insurer and (iv) the
quality of service provided to issuers, investors and other clients of the
issuer. With respect to each of these competitive factors, AMBAC Indemnity
believes it is on equal footing with each of its principal competitors in the
municipal bond, structured finance and asset-backed markets.
Financial guarantee insurance also competes domestically and
internationally with other forms of credit enhancement, including letters of
credit and guarantees (for example, mortgage guarantees where pools of mortgages
secure debt service payments) provided by banks and other financial
institutions, some of which are governmental agencies. Letters of credit are
most often issued for periods of less than 10 years, although there is no legal
restriction on the issuance of letters of credit having longer terms. Thus,
financial institutions and banks issuing letters of credit compete directly with
AMBAC Indemnity to guarantee short-term notes and bonds with a maturity of less
than 10 years. To the extent that banks providing credit enhancement may begin
to issue letters of credit with commitments of longer than 10 years, the
competitive position of financial guarantee insurers, such as AMBAC Indemnity,
could be adversely affected. Letters of credit also are frequently used to
assure the liquidity of a short-term put option for a long-term bond issue. This
assurance of liquidity effectively confers on such issues, for the short-term,
the credit standing of the financial institution providing the facility, thereby
competing with AMBAC Indemnity and other financial guarantee insurers in
providing interest cost savings on such issues. Financial guarantee insurance
and other forms of credit enhancement also compete in nearly all instances with
the issuer's alternative of foregoing credit enhancement and paying a higher
interest rate. If the interest savings from insurance or another form of credit
enhancement do not exceed the cost of such credit enhancement, the issuer will
generally choose to issue bonds without enhancement.
17
<PAGE>
Multiline insurance companies are not significant direct participants in
the financial guarantee industry. Also, under a law enacted in 1989 in New York,
multiline insurers are prohibited from writing financial guarantee insurance in
New York State, except during a transitional period which, subject to certain
specific conditions, will expire in May 1997. Although a significant minimum
amount of capital is required of a financial guarantee insurer by the rating
agencies in order to obtain triple-A claims-paying ability ratings (at least
$100 million), there can be no assurance that major multiline insurers or other
financial institutions will not participate in financial guarantee insurance in
the future, either directly or through subsidiaries. Under the New York law, a
financial guarantee insurance company must have at least $75 million of paid-in
capital and surplus and maintain thereafter at least $65 million of
policyholders' surplus. A similar law in California imposes a $100 million
minimum capital and surplus requirement, with a maintenance requirement
thereafter of $75 million.
REINSURANCE
State insurance laws and regulations (as well as the rating agencies)
impose minimum capital requirements on financial guarantee insurance companies,
limiting the aggregate amount of insurance which may be written and the maximum
size of any single risk exposure which may be assumed. Such companies can use
reinsurance to diversify risk, increase underwriting capacity, reduce additional
capital needs, stabilize shareholder returns and strengthen financial ratios.
See "Insurance Regulatory Matters" below.
During 1996 and in prior years, AMBAC Indemnity entered into pro rata
reinsurance agreements with certain reinsurers which provided for a combination
reinsurance program. Each agreement was divided into a quota share program and a
surplus share program. Under each agreement, which was renewed on an annual
basis, the reinsurer shared the interests and liabilities of AMBAC Indemnity
under all municipal bond business (as defined below) written during the term of
the agreement. Municipal bond business was defined as all new issue and
secondary market insurance policies written by AMBAC Indemnity which were
classified by AMBAC Indemnity as municipal bond insurance and which insured
bonds satisfying the definition of municipal bonds contained in the applicable
laws and regulations in the States of Wisconsin and New York. Any policy written
during the term of the agreement was reinsured for the full term of the policy,
even if the reinsurer did not renew its participation in AMBAC Indemnity's
reinsurance program for subsequent years.
Under the 1996 quota share program, AMBAC Indemnity ceded a percentage of
each insured policy. The surplus share program provided a surplus layer of
reinsurance in excess of the quota share percentage which increased AMBAC
Indemnity's insurance capacity. A ceding commission was withheld to defray AMBAC
Indemnity's underwriting expenses under both the quota share program and surplus
share program.
AMBAC Indemnity has also entered into facultative reinsurance agreements
with certain of the same reinsurers that are party to the agreements described
above, which allow AMBAC Indemnity to reduce its large risks, to manage its
portfolio of insurance by bond type and geographic distribution, and to provide
additional capacity for frequent bond issuers. Under these agreements, portions
of AMBAC Indemnity's interests and liabilities
18
<PAGE>
are ceded on an issue-by-issue basis. A ceding commission is withheld to defray
AMBAC Indemnity's underwriting expenses. In addition, AMBAC Indemnity and MBIA,
in conjunction with the MBIA/AMBAC joint venture described above, have entered
into facultative reinsurance agreements whereupon each company may reinsure the
other on risks insured in conjunction with the joint venture.
Effective January 1, 1997, AMBAC Indemnity has discontinued the quota
share and surplus share reinsurance programs as described above, and will only
use facultative reinsurance agreements to reduce its risks and manage its
insurance portfolio in the future.
As of December 31, 1996, AMBAC Indemnity had retained approximately 85%
of its gross insurance in force of $268.9 billion and had ceded approximately
15% to its treaty and facultative reinsurers. See Note 4 of Notes to
Consolidated Financial Statements in the Company's 1996 Annual Report to
Stockholders.
As a primary insurer, AMBAC Indemnity is required to honor its
obligations to its policyholders whether or not its reinsurers perform their
obligations under the various reinsurance agreements with AMBAC Indemnity. To
minimize its exposure to significant losses from reinsurer insolvencies, AMBAC
Indemnity evaluates the financial condition of its reinsurers, prepares annual
written reviews of such reinsurers and monitors for concentrations of credit
risk. AMBAC Indemnity's current reinsurers are Aachener Ruckversicherungs, AXA
Re Finance, Capital Markets Assurance Corporation, Capital Reinsurance Company,
Enhance Reinsurance Company, MBIA and Royal Reinsurance Company, Ltd.. The
majority of these reinsurers have long-standing relationships with AMBAC
Indemnity. In addition, Aachener Ruckversicherungs, AXA Re Finance and Royal
Reinsurance Company, Ltd., are multiline insurance companies which are
diversified by the lines of insurance they underwrite.
RATING AGENCIES
Moody's, S&P, Fitch and Nippon periodically review the business and
financial condition of AMBAC Indemnity and other companies providing financial
guarantee insurance. These rating agencies' reviews focus on the insurer's
underwriting policies and procedures and the quality of the obligations insured.
The rating agencies frequently perform assessments of the credits insured by
AMBAC Indemnity to confirm that AMBAC Indemnity continues to meet the capital
allocation criteria considered necessary by the particular rating agency to
maintain AMBAC Indemnity's triple-A claims-paying ability ratings. A rating by
Moody's, S&P, Fitch or Nippon, however, is not a "market rating" or a
recommendation to buy, hold or sell any security. See "Underwriting Guidelines,
Policies and Procedures" above. AMBAC Indemnity's ability to attract new
business or to compete with other triple-A rated financial guarantors, and its
results of operations and financial condition, would be materially adversely
affected by any reduction in its ratings.
19
<PAGE>
INSURANCE REGULATORY MATTERS
GENERAL LAW
AMBAC Indemnity is licensed to do business as an insurance company in all
50 states, the District of Columbia, the Commonwealth of Puerto Rico and Guam.
It is subject to the insurance laws and regulations of the State of Wisconsin
(the "Wisconsin Insurance Laws"), its state of incorporation, and the insurance
laws and regulations of other states in which it is licensed to transact
business. These laws and regulations, as well as the level of supervisory
authority that may be exercised by the various state insurance departments, vary
by jurisdiction, but generally require insurance companies to maintain minimum
standards of business conduct and solvency, meet certain financial tests, file
certain reports with regulatory authorities, including information concerning
their capital structure, ownership and financial condition, and require prior
approval of certain changes in control of domestic insurance companies and their
direct and indirect parents and the payment of certain dividends and
distributions. In addition, these laws and regulations require approval of
certain inter-corporate transfers of assets and certain transactions between
insurance companies and their direct and indirect parents and affiliates, and
generally require that all such transactions have terms no less favorable than
terms that would result from transactions between parties negotiating at arm's
length. AMBAC Indemnity is required to file quarterly and annual statutory
financial statements in each jurisdiction in which it is licensed, and is
subject to single and aggregate risk limits and other statutory restrictions
concerning the types and quality of investments and the filing and use of policy
forms and premium rates. Additionally, AMBAC Indemnity's accounts and operations
are subject to periodic examination by the Office of the Commissioner of
Insurance of the State of Wisconsin (the "Wisconsin Commissioner") (the last
such examination having been conducted in 1992 for the period ended December 31,
1991) and other state insurance regulatory authorities. See Note 8 of Notes to
Consolidated Financial Statements in the Company's 1996 Annual Report to
Stockholders.
The Company believes that AMBAC Indemnity is in material compliance with
all applicable insurance laws and regulations.
INSURANCE HOLDING COMPANY LAWS
Under the Wisconsin insurance holding company laws, any acquisition of
control of the Company and thereby indirect control of AMBAC Indemnity requires
the prior approval of the Wisconsin Commissioner. "Control" is defined as the
direct or indirect power to direct or cause the direction of the management and
policies of a person. Any purchaser of 10% or more of the outstanding voting
stock of a corporation is presumed to have acquired control of that corporation
and its subsidiaries unless the Wisconsin Commissioner, upon application,
determines otherwise. For purposes of this 10% test, the Company believes that a
holder of common stock having the right to cast 10% of the votes which may be
cast by the holders of all shares of common stock of the Company would be deemed
to have control of AMBAC Indemnity within the meaning of the Wisconsin Insurance
Laws.
20
<PAGE>
Pursuant to these laws, both J.P. Morgan & Co. Incorporated and Harris
Associates, L.P. each obtained approval from the Wisconsin Insurance
Commissioner to acquire greater than 10% of the Company's outstanding stock. As
of December 31, 1996 their respective percentages of ownership were
approximately 12.9% and 11.4%. In their respective requests for approval from
the Wisconsin Commissioner, each entity disclaimed any present intention to
exercise control over the Company or AMBAC Indemnity or to control or attempt to
control the management or operations of the Company or AMBAC Indemnity.
The Wisconsin insurance holding company laws also require prior approval
by the Wisconsin Commissioner of certain transactions between AMBAC Indemnity
and companies affiliated with AMBAC Indemnity.
WISCONSIN DIVIDEND RESTRICTIONS
Pursuant to the Wisconsin Insurance Laws, AMBAC Indemnity may declare
dividends, subject to any restriction in its articles of incorporation, provided
that, after giving effect to the distribution, it would not violate certain
statutory equity, solvency, income and asset tests. Distributions to
shareholders (other than stock dividends) must be reported to the Wisconsin
Commissioner. Extraordinary dividends must be reported prior to payment and are
subject to disapproval by the Wisconsin Commissioner. An extraordinary dividend
is defined as a dividend or distribution, the fair market value of which,
together with all dividends from the preceding 12 months, exceeds the lesser of
(a) 10% of policyholders' surplus as of the preceding December 31 or (b) the
greater of (i) statutory net income for the calendar year preceding the date of
the dividend or distribution, minus realized capital gains for that calendar
year or (ii) the aggregate of statutory net income for the three calendar years
preceding the date of the dividend or distribution, minus realized capital gains
for those calendar years and minus dividends paid or credited and distributions
made within the first two of the preceding three calendar years.
On April 30, 1996, AMBAC Indemnity, in conjunction with the sale of the
Company's remaining holdings of HCIA common stock, delivered to the Company (in
the form of an extraordinary dividend) its 2,378,672 shares of HCIA common
stock, at fair value. The Wisconsin Commissioner approved such dividend. As a
result, any dividends paid by AMBAC Indemnity to the Company through June 30,
1997 require pre-approval from the Wisconsin Commissioner. The Wisconsin
Commissioner has stated to AMBAC Indemnity management that it does not foresee
any reason pre-approval of anticipated dividends on the common stock of AMBAC
Indemnity to be paid through June 30, 1997 would not be given. Anticipated AMBAC
Indemnity common stock dividends paid thereafter and through year-end 1997, will
not require such pre-approval. During 1996, AMBAC Indemnity paid to the Company
cash dividends on its common stock totaling $40.0 million. See Note 8 of Notes
to Consolidated Financial Statements in the Company's 1996 Annual Report to
Stockholders.
NEW YORK FINANCIAL GUARANTEE INSURANCE LAW
New York's comprehensive financial guarantee insurance law governs the
conduct of business of all financial guarantee insurers licensed to do business
in New York,
21
<PAGE>
including AMBAC Indemnity. This law requires a financial guarantee insurer to
contribute to a contingency reserve an amount equal to 50% of premiums as they
are earned on a statutory basis on policies written prior to July 1, 1989, and,
with respect to policies written on and after July 1, 1989, it must make
contributions over a period of 20 years for municipal bonds and 15 years for all
other obligations until the contingency reserve for such insured obligations
equals the greater of 50% of premiums written for the relevant category of
insurance or a percentage of the principal guaranteed, varying from 0.55% to
2.50%, depending upon the type of obligation guaranteed. This reserve must be
maintained for the periods specified above, except that withdrawals by the
insurer may be permitted under specified circumstances in the event that actual
loss experience exceeds certain thresholds or if the reserve accumulated is
deemed excessive in relation to the insurer's outstanding insured obligations.
Financial guarantee insurers are also required to maintain case basis loss and
loss adjustment expense reserves and unearned premium reserves on bases
established by the regulations.
The New York financial guarantee insurance law establishes single risk
limits applicable to all obligations issued by a single entity and backed by a
single revenue source. Under the limit applicable to municipal bonds, the
insured average annual debt service for a single risk, net of reinsurance and
collateral, may not exceed 10% of the sum of the insurer's policyholders'
surplus and contingency reserves. In addition, insured principal of municipal
bonds attributable to any single risk, net of reinsurance and collateral, is
limited to 75% of the insurer's policyholders' surplus and contingency reserves.
Additional single risk limits, which generally are more restrictive than the
municipal bond single risk limit, are also specified for several other
categories of insured obligations, including structured finance obligations.
Aggregate risk limits are also established on the basis of aggregate net
liability and policyholders' surplus requirements. "Aggregate net liability" is
defined as outstanding principal and interest of guaranteed obligations insured,
net of reinsurance and collateral. Under these limits, policyholders' surplus
and contingency reserves must at least equal a percentage of aggregate net
liability that is equal to the sum of various percentages of aggregate net
liability for various categories of specified obligations. The percentage varies
from 0.33% for municipal bonds to 4.00% for certain non-investment grade
obligations.
FINANCIAL GUARANTEE INSURANCE REGULATION IN OTHER STATES
The Wisconsin Insurance Laws have regulations of municipal bond insurers
similar in structure to those in effect in New York. Under the Wisconsin
regulations, AMBAC Indemnity must establish a contingency reserve in an amount
equal to 50% of net statutory earned premium on municipal bond insurance
policies. This reserve must be maintained for 20 years. However, the regulations
provide that compliance with contingency reserve provisions under statutes in
other jurisdictions which result in greater contributions than under the
Wisconsin regulations is deemed to constitute compliance with the Wisconsin
regulations. The Wisconsin regulations also include certain single and aggregate
risk limitations. The average annual debt service for any single issue of
municipal bonds may not exceed 10% of AMBAC Indemnity's policyholders' surplus.
In addition, AMBAC Indemnity's cumulative net liability, defined as one-third of
one percent of the insured unpaid principal and interest covered by current
municipal bond insurance policies,
22
<PAGE>
may not exceed its qualified statutory capital, which is defined as the sum of
its capital and surplus and contingency reserve.
California has a financial guarantee insurance law similar in structure
and effect to the New York statute. None of the risk limits established in
California's legislation with respect to business transacted by AMBAC Indemnity
are more stringent in any material respect than the corresponding provisions in
the New York financial guarantee insurance statute. California law requires a
financial guarantee insurer to contribute to a contingency reserve an amount
equal to 50% of premiums as they are earned on a statutory basis on policies
written prior to July 1, 1989, and, with respect to policies written on and
after July 1, 1989, it must make contributions over a period of 20 years for
municipal bonds and 15 years for all other obligations until the contingency
reserve for such insured obligations equals a percentage of principal
outstanding, varying from 0.80% to 3.00%, depending upon the type of obligation
guaranteed. This reserve must be maintained for the periods specified above,
except that withdrawals by the insurer may be permitted under specified
circumstances in the event that actual loss experience exceeds certain
thresholds or if the reserve accumulated is deemed excessive in relation to the
insurer's outstanding insured obligations. AMBAC Indemnity's reported
contingency reserve is equal to the greater of the required reserve as
calculated under New York and California law.
In addition to the laws and regulations of New York, Wisconsin and
California, AMBAC Indemnity is subject to laws and regulations of other states
concerning the transaction of financial guarantee insurance, none of which is
more stringent in any material respect than the New York financial guarantee
insurance statute.
FINANCIAL SERVICES
------------------
The Company's Financial Services Division provides investment contracts,
municipal interest rate swaps and investment management and advisory services
principally to states, municipalities, municipal authorities and hospitals and
health organizations.
Financial services revenues are derived from (i) net investment income,
(ii) net swap trading revenues, (iii) fund management and advisory revenues, and
(iv) realized gains and losses. Excluding transactions with affiliates, total
revenues were $22.2 million, $13.0 million and $16.7 million in 1996, 1995 and
1994, respectively. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Note 17 of Notes to Consolidated
Financial Statements in the Company's 1996 Annual Report to Stockholders.
The principal competitive factors among providers of municipal investment
contracts are (i) contract rates, (ii) conditions precedent to the issuance of a
policy related to the structure and security features of a proposed investment
contract, (iii) the financial strength of the financial services provider, and
(iv) the quality of service provided to issuers, investors and other clients of
the issuer. The Company believes that the MIC business competes favorably with
respect to each of these factors.
The principal competitive factors among providers of municipal interest
rate swap contracts are (i) pricing of contracts, (ii) the financial strength of
the financial services
23
<PAGE>
provider, (iii) the ability to structure a complete financial package, and (iv)
the quality of service provided to issuers, investors and other clients of the
issuer. The Company believes that AFS competes favorably with respect to each of
these competitive factors.
The principal competitive factors among providers of investment
management and advisory service are (i) pricing of services, (ii) investment
returns, (iii) the ability to provide services tailored to customers needs, and
(iv) the quality of service provided to customers. The Company believes that
Cadre competes favorably with respect to each of these competitive factors.
MUNICIPAL INVESTMENT CONTRACT BUSINESS
In 1992, the Company formed its MIC business, with the principal
purpose of providing municipal investment contracts and municipal investment
repurchase contracts primarily to states, municipalities and municipal
authorities. Investment contracts are used by municipal bond issuers to invest
bond proceeds until such proceeds can be used for their intended purpose, such
as financing construction. The municipal investment contract provides for the
guaranteed return of principal invested, as well as the payment of interest
thereon at a guaranteed rate and is rated triple-A by virtue of AMBAC
Indemnity's insurance policy which guarantees the MIC business' performance.
The MIC business manages its balance sheet to protect against a number
of risks inherent in its business including liquidity, market (principally
interest rate) and credit risk. The MIC business' asset-liability guidelines
stipulate that the effective duration of the invested assets, including hedges,
must be matched to the effective duration of the municipal investment contract
liabilities. The MIC business maintains expected cash flow matching of invested
assets (including hedges) to funded liabilities in order to minimize market and
liquidity risk.
A source of liquidity risk is the ability of some counterparties to
withdraw moneys on dates other than those specified in the draw down schedule.
Liquidity risk is somewhat mitigated by provisions in certain of the municipal
investment contracts that limit an issuer's ability to draw on the funds and by
risk management procedures that require the regular reevaluation and
reprojection of draw down schedules. Investments are restricted to fixed income
securities with a minimum average credit quality of Aa/AA. Based upon
management's projections, the MIC business maintains funds invested in cash and
cash equivalents to meet short term liquidity needs.
The MIC business uses interest rate contracts in the normal course of
business for hedging purposes as part of its overall interest rate risk
management. Several of its interest rate contracts have been entered into with
its affiliate, AFS. Interest rate contracts used by the MIC business include
financial instruments with off-balance sheet risk such as interest rate futures
contracts, interest rate swap agreements and a purchased interest rate option
contract. These instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amounts recognized in the financial
statements. For further discussion, see Notes 2 and 12 of Notes to Consolidated
Financial Statements in the Company's 1996 Annual Report to Stockholders.
24
<PAGE>
Interest rate futures contracts are commitments to either purchase or
sell designated financial instruments at a future date for a specified price and
are settled in cash. Initial margin requirements are met in cash or other
financial instruments, and changes in the contract values are settled daily.
Futures contracts have little credit risk since futures exchanges are the
counterparties.
Interest rate swap contracts are agreements where the MIC business agrees
with other parties to exchange, at specified intervals, the difference between
fixed-rate and floating-rate interest amounts or the difference between
different interest rate indices calculated by reference to an agreed upon
notional amount. The MIC business is exposed to credit risk in the event
counterparties fail to perform according to the terms of the contractual
commitments. The MIC business deals only with counterparties of high credit
quality and as such, does not expect any counterparties to fail to meet their
obligations.
Credit risk is also likely to be a factor on longer term investment
contracts where credit deterioration or the default of an issuer would increase
the likelihood of early withdrawal of funds. The MIC business and AMBAC
Indemnity have various procedures and controls in place to monitor the credit
risk of these contracts, including the initial credit approval process and the
continuous monitoring of credit exposure.
The following table sets forth the net payments due under the MIC
business' municipal investment contracts in each of the next five years ending
December 31, and the period thereafter, based on expected call dates:
OBLIGATIONS UNDER MUNICIPAL INVESTMENT CONTRACTS
PRINCIPAL AMOUNT (1)
- ----------------------------------------------------------------------------
($ In Thousands)
1997..................................................... $ 945,960
1998..................................................... 677,213
1999..................................................... 443,880
2000..................................................... 43,234
2001..................................................... 82,174
All later years.......................................... 528,830
----------
$2,721,291
==========
(1) As of December 31, 1996, the interest rates on these agreements ranged from
4.23% TO 8.14%.
AMBAC FINANCIAL SERVICES, LIMITED PARTNERSHIP
In 1994, the Company formed AFS with the purpose of providing interest
rate swaps primarily to states, municipalities, municipal authorities and other
entities in connection with their financings. In addition, AFS also provides
interest rate swaps to the MIC business, an affiliate. AFS commenced operations
in September 1994 and manages its business with the goal of being market neutral
to changes in overall interest rates, while retaining "basis risk," the
relationship between changes in floating rate tax-exempt and floating rate
taxable interest rates. The interest rate swaps provided by AFS are insured by
AMBAC Indemnity through policies which guarantee the obligations of AFS and its
counterparties.
25
<PAGE>
AFS is a limited partnership. AMBAC Indemnity, the sole limited
partner, owns a limited partnership interest representing 90% of the total
partnership interests of AFS. AMBAC Financial Services Holdings, Inc. ("AFS
Holdings"), a wholly-owned subsidiary of the Company, the sole general partner,
owns a general partnership interest representing 10% of the total partnership
interest in AFS.
Interest rate swaps are agreements to exchange with a counterparty, a
stream of periodic payments calculated by reference to agreed upon interest
rates, indices and notional amounts.
In the ordinary course of business, AFS manages a variety of risks
principally (i) credit, (ii) market, (iii) liquidity, (iv) operational, and (v)
legal. These risks are identified, measured, and monitored through a variety of
control mechanisms, which are in place at different levels throughout the
organization. Below is a discussion of these risks:
(i) Credit risk relates to the ability of counterparties to perform
according to the terms of their contractual commitments. Various procedures and
controls are in place to monitor the credit risk of interest rate swaps. These
include the initial credit approval process, the establishment of credit limits,
management approvals and a process that ensures the continuous monitoring of
credit exposure.
(ii) Market risk relates to the impact of price changes on future
earnings. This risk is a consequence of AFS's market-making activities in the
municipal interest rate swap market. The principal market risk is basis risk,
the relationship between changes in floating rate tax-exempt and floating rate
taxable interest rates. Since the third quarter of 1995, all municipal interest
rate swaps transacted contain provisions which are designed to protect AFS
against certain forms of tax reform, thus mitigating its basis risk. An
independent risk management group monitors trading risk limits and, together
with senior management, is involved in the application of risk measurement
methodologies.
The estimation of potential losses arising from adverse changes in market
relationships, known as "value-at-risk," is a key element in managing market
risk. AFS has developed a value-at-risk methodology to estimate potential losses
over a specified holding period and based on certain probabilistic assessments.
AFS estimates value at risk utilizing historical short-term and long-term
interest rate volatilities and the relationship between changes in tax-exempt
and taxable interest rates calculated on a consistent daily basis. AFS's value-
at-risk, calculated at a 99% confidence level, averaged approximately $1.4
million in both 1996 and 1995. AFS's value-at-risk ranged from a high of $2.6
million to a low of $1.1 million for 1996 and from a high of $2.1 million to a
low of $0.7 million for 1995. Since no single measure can capture all dimensions
of market risk, AFS bolsters its value at risk methodology by performing daily
analyses of parallel and non-parallel shifts in yield curves and stress test
scenarios which measure the potential impact of market conditions, however
improbable, which might cause abnormal volatility swings or disruptions of
market relationships.
(iii) Liquidity risk relates to the possible inability to satisfy
contractual obligations when due. This risk is present in swaps and in futures
contracts used to hedge swaps. AFS
26
<PAGE>
manages liquidity risk by maintaining cash and cash equivalents, closely
matching the dates swap payments are made and received, and limiting the amount
of risk hedged by futures contracts.
(iv) Operational risk relates to the potential for loss caused by a
breakdown in information, communication, and settlement systems. AFS mitigates
operational risk by maintaining a comprehensive system of internal controls.
This includes the establishment of systems and procedures to monitor
transactions and positions, documentation and confirmation of transactions,
ensuring compliance with regulations.
(v) Legal risk relates to the uncertainty of the enforceability, through
legal or judicial processes, of the obligations of AFS's counterparties,
including contractual provisions intended to reduce credit exposure by providing
for the offsetting or netting of mutual obligations. AFS seeks to remove or
minimize such uncertainties through continuous consultation with internal and
external legal advisers, to analyze and understand the nature of legal risk, to
improve documentation, and to strengthen transaction structure.
For further discussion, see Notes 2 and 13 of Notes to Consolidated
Financial Statements in the Company's 1996 Annual Report to Stockholders.
CADRE FINANCIAL SERVICES, INC.
Effective December 31, 1996, the Company completed its acquisition of
certain assets including the name and assumption of certain liabilities of Cadre
Financial Services, Inc. ("Cadre"). Cadre is registered as an investment
adviser with the Securities and Exchange Commission and with certain states that
currently require such registration. As a registered adviser, Cadre is subject
to regulation in certain aspects of its business, particularly with respect to
advisory activities on behalf of investment companies.
Cadre provides administrative services to money market funds which were
established to enable qualified participants, primarily school districts and
municipalities, to pool available moneys for investment. At December 31, 1996,
Cadre was providing investment administration services for approximately 2,600
clients with approximately $5.9 billion in assets. Marketing and investment
advisory services are also provided to the participants of these and other
registered funds. Included in the assets under administration at December 31,
1996, were approximately $1.9 billion of assets for which Cadre provides direct
investment advisory services. Other investment services are provided to fund
participants including placing certificates of deposit with qualified financial
institutions and purchasing commercial paper, bankers' acceptances and U.S.
government securities through dealers.
Fees from the money market funds for which Cadre performs services are
based on percentages of the average daily net assets of such funds. Fees for
placement of certificates of deposit and other fixed-rate investments on behalf
of participants in funds are based on the value and time to maturity of the
related investment. Fixed-rate investment fees are recorded upon placement of
the instrument since, at that time, substantially all of Cadre's obligations
have been fulfilled.
27
<PAGE>
INVESTMENTS AND INVESTMENT POLICY
As of December 31, 1996, the consolidated investments of the Company had
an aggregate fair value of $5.2 billion and an aggregate amortized cost of $5.1
billion. These investments are managed internally by officers of the Company and
its subsidiaries, who are experienced investment managers. In the normal course
of business, the Company uses interest rate contracts for hedging purposes as
part of its overall interest rate risk management. These interest rate contracts
include interest rate futures contracts, interest rate swap agreements and
purchased interest rate option contracts. All investments, including interest
rate contracts, are effected in accordance with the general objectives and
guidelines for investments established by each subsidiary's Board of Directors,
including guidelines relating to quality, risk concentration and holding period.
These guidelines are periodically reviewed and revised as appropriate.
Pursuant to Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities 115," the
Company has designated all investments as "available-for-sale" and reports them
at fair value. Unrealized gains and losses are excluded from earnings and
reported as a separate component of stockholders' equity, net of tax.
As of December 31, 1996, AMBAC Indemnity's investment portfolio had an
aggregate fair value of $2.5 billion and an aggregate amortized cost of $2.4
billion. The investment policy established by the Board of Directors of AMBAC
Indemnity for its investments is designed to achieve diversification of the
portfolio and generally to preclude investments in obligations insured by AMBAC
Indemnity. AMBAC Indemnity's current investment policy only permits investment
in investment grade fixed-income securities, consistent with its goal to achieve
the highest after-tax, long-term return. This policy takes into consideration
AMBAC Indemnity's desire for both current income and long-term capital growth.
AMBAC Indemnity is subject to limits on types and quality of investments imposed
by the insurance laws and regulations of the States of Wisconsin and New York.
In compliance with these laws, AMBAC Indemnity's Board of Directors approves
each specific investment transaction of AMBAC Indemnity. See "Insurance
Regulatory Matters -- General Law" above.
As of December 31, 1996, the MIC business' investment portfolio had an
aggregate fair value of $2.6 billion and an aggregate amortized cost of $2.6
billion. The investment policy established by the Board of Directors of the MIC
business for its investments is designed to achieve the highest after-tax return
on equity, subject to minimum average quality ratings. The MIC business also
uses interest rate contracts for hedging purposes as part of its overall
interest rate risk management. For further discussion, see "Municipal Investment
Contract Business."
28
<PAGE>
The following tables set forth certain information concerning the
investments of the Company:
INVESTMENTS BY RATING (1)
AS OF DECEMBER 31, 1996
% OF INVESTMENT
RATING PORTFOLIO
- ---------------------------------------------- ----------------
AAA (2)....................................... 62%
AA............................................ 17
A............................................. 20
BBB........................................... 1
Not Rated.. -
-------
100%
=======
(1) Ratings represent S&P categories.
(2) Includes U.S. Treasury and agency obligations, which comprised
approximately 33% of the total investment portfolio.
SUMMARY OF INVESTMENTS
AS OF DECEMBER 31,
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------
1996 1995 1994
----------------------------- ------------------------------ ---------------------------
WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
INVESTMENT CATEGORY VALUE YIELD (1)(2) VALUE YIELD (1)(2) VALUE YIELD(1)(2)
- -------------------------- ---------- -------------- --------- --------------- --------- ------------
($ In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Long-term investments:
Taxable bonds............. $3,105,120 6.69% $2,605,001 6.91% $2,174,075 6.47%
Tax-exempt bonds.......... 1,982,911 6.21 1,659,903 6.17 1,452,104 6.35
----------- ---------- ----------
Total long-term
investments............ 5,088,031 6.52 4,264,904 6.59 3,626,179 6.42
Short-term investments (3). 112,511 5.24 176,689 5.72 137,975 5.49
---------- ---------- ----------
Total investments....... $5,200,542 6.46% $4,441,593 6.56% $3,764,154 6.39%
========== ========== ==========
</TABLE>
(1) Yields presented include assets held in the MIC business portfolio. Interest
expense on related municipal investment contracts was $154.5 million, $127.6
million and $92.4 million in 1996, 1995 and 1994, respectively.
(2) Yields are stated on a pre-tax basis, based on average amortized cost.
Yields on tax-exempt bonds represent taxable equivalent yields.
(3) Includes taxable and tax-exempt investments.
29
<PAGE>
INVESTMENTS BY SECURITY TYPE
AS OF DECEMBER 31,
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------
1996 1995 1994
--------------------------------- ---------------------------------- ---------------------------------
WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
INVESTMENT CATEGORY VALUE YIELD (1) (2) VALUE YIELD (1) (2) VALUE YIELD (1)(2)
- -------------------------- --------------- -------------- -------------- ------------- ------------ --------------
($ In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Municipal obligations...... $1,982,911 6.21% $1,659,903 6.17% $1,452,104 6.35%
Corporate securities....... 963,890 7.56 828,060 7.67 525,444 7.82
U.S. government obligations 102,430 6.09 227,425 6.51 109,709 6.75
Mortgage- and asset-backed
securities (includes U.S.
Government Agency
obligations) (3).......... 2,035,115 6.35 1,549,516 6.48 1,538,922 5.96
Other...................... 3,685 3.50 -- -- -- --
-------------- --------------- -----------
Total long-term
investments............ 5,088,031 6.52 4,264,904 6.59 3,626,179 6.42
Short-term investments (4). 112,511 5.24 176,689 5.72 137,975 5.49
-------------- --------------- ----------------
Total investments....... $5,200,542 6.46% $4,441,593 6.56% $3,764,154 6.39%
============== =============== ===============
</TABLE>
(1) Yields presented include assets held in the MIC business portfolio. Interest
expense on related municipal investment contracts was $154.5 million, $127.6
million and $92.4 million in 1996, 1995 and 1994, respectively.
(2) Yields are stated on a pre-tax basis, based on average amortized cost.
Yields on tax-exempt bonds represent taxable equivalent yields.
(3) The actual maturity dates of mortgage-backed securities are uncertain
because the underlying mortgages may be paid prior to the stated maturity of
such securities. This possibility of pre-payment creates the risk that the
Company will be unable to replace such investments with securities of
comparable yield.
(4) Includes taxable and tax-exempt investments.
DISTRIBUTION OF INVESTMENTS BY MATURITY
AS OF DECEMBER 31, 1996
AMORTIZED ESTIMATED
MATURITY COST FAIR VALUE
- ---------------------------------------- ----------- -----------
($ In Thousands)
Due in one year or less (1)............. $ 140,921 $ 141,028
Due after one year through five years... 344,615 354,696
Due after five years through ten years.. 279,108 290,987
Due after ten years..................... 2,291,165 2,378,716
---------- ----------
3,055,809 3,165,427
Mortgage- and asset-backed securities
(2).................................... 2,035,719 2,035,115
---------- ----------
Total investments....................... $5,091,528 $5,200,542
========== ==========
(1) Includes long-term investments in the amount of $28.4 million maturing
within one year.
(2) The actual maturity dates of mortgage- and asset-backed securities are
uncertain because the underlying mortgages may be paid prior to the stated
maturity of such securities. This possibility of pre-payment creates the
risk that the Company will be unable to replace such investments with
securities of comparable yield.
30
<PAGE>
For further discussion, see Note 3 of Notes to Consolidated Financial
Statements in the Company's 1996 Annual Report to Stockholders.
EMPLOYEES
As of December 31, 1996, the Company and its subsidiaries had 225
employees. None of the employees is covered by collective bargaining agreements.
The Company considers its employee relations to be satisfactory.
ITEM 2. PROPERTIES.
The principal executive offices of the Company are located at One State
Street Plaza, New York, New York 10004. The telephone number is (212) 668-0340.
AMBAC Indemnity maintains its principal executive offices at One State
Street Plaza, New York, New York 10004, which consists of approximately 97,000
square feet of office space, under an agreement which expires on September 30,
2014. AMBAC Indemnity also maintains offices in London, England and Westport,
Connecticut.
The MIC business and AFS maintain their principal executive offices at 300
Nyala Farms Road, Westport, Connecticut 06880. This office space consists of
approximately 21,000 square feet under a lease agreement which expires on March
31, 2005. The lease contains one option to renew for an additional period of
five years.
Cadre maintains its principal executive office at 905 Marconi Avenue,
Ronkonkoma, New York 11779. The office building was acquired by the Company as
part of the acquisition of Cadre. It consists of approximately 15,000 square
feet of office space and storage.
In addition, the Company owns certain interests in real estate acquired in
connection with the defeasance of AMBAC Indemnity's policy obligations with
respect to certain industrial revenue bonds.
ITEM 3. LEGAL PROCEEDINGS.
There are no material lawsuits pending, or to the knowledge of the Company
threatened, to which the Company or any of its majority-owned subsidiaries is a
party.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
There were no matters submitted to a vote of security holders during the
fourth quarter of 1996.
31
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Information relating to the principal market on which the Company's Common
Stock is tradable, the high and low sales prices per share for each full
quarterly period within the two most recent fiscal years, and the frequency and
amount of any cash dividends declared for the two most recent fiscal years is
set forth on page 52 of the Company's 1996 Annual Report to Stockholders and
such information is incorporated herein by reference. Information concerning
restrictions on the payment of dividends is set forth in Item 1 above under the
caption "Insurance Regulatory Matters - Wisconsin Dividend Restrictions." As of
March 21, 1997, there were 101 stockholders of record of the Company's Common
Stock, which is listed on the New York Stock Exchange.
On December 31, 1996, the Company issued 214,192 shares of its Common
Stock ("Private Shares") to Cadre Financial Services, Inc. ("Cadre") in exchange
for substantially all of its assets and its name. The aggregate amount of assets
acquired for the Private Shares plus cash totaled approximately $20.0 million,
including goodwill. The Private Shares were issued in a private placement exempt
from registration under Section 4(2) of the Securities Act of 1933, as amended.
Cadre represented to the Company that it acquired the Private Shares for its own
account and not with a view to, or for resale in connection with, a distribution
except to its shareholders. Cadre and each shareholder represented to the
Company that its knowledge and experience in financial and business matters was
such that Cadre and each shareholder was capable of evaluating the merits and
risks of the investment. Each Cadre shareholder agreed that it will not
transfer, sell or otherwise dispose of the Private Shares, except as permitted
under the Securities Act of 1933, as amended.
ITEM 6. SELECTED FINANCIAL DATA.
Selected financial data for the Company and its subsidiaries for each of
the last five fiscal years is set forth under the caption "Financial Highlights"
on page 3 of the Company's 1996 Annual Report to Stockholders. Such information
is incorporated herein by reference and should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto contained on pages 30 to
49 of such Annual Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Management's Discussion and Analysis of Financial Condition and Results of
Operations is set forth under the same caption on pages 21 through 28 of the
Company's 1996 Annual Report to Stockholders. Such information is incorporated
herein by reference and should be read in conjunction with the Consolidated
Financial Statements and the Notes thereto contained on pages 30 to 49 of such
Annual Report.
32
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The 1996 Consolidated Financial Statements, together with the Notes
thereto and the Independent Auditors' Report thereon, are set forth on pages 29
through 49 of the Company's 1996 Annual Report to Stockholders. Such information
is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information relating to the Company's directors and executive officers
is set forth on pages 7, 8, 10, 11 and 23 to 24 of the Company's 1996 Proxy
Statement and such information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION.
Information relating to compensation of the Company's directors and
executive officers is set forth on pages 9 and 10 and on pages 12 to 18 of the
Company's 1997 Proxy Statement and such information is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information relating to security ownership of certain beneficial owners
and management is set forth on pages 5 to 7 of the Company's 1997 Proxy
Statement and such information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information relating to certain relationships and related transactions
is set forth on page 10 of the Company's 1997 Proxy Statement and such
information is incorporated herein by reference.
33
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(A) DOCUMENTS FILED AS A PART OF THIS REPORT:
1. Financial Statements
--------------------
The following consolidated financial statements included in the 1996
Annual Report to Stockholders are incorporated herein by reference
under Part II, Item 8:
PAGE NUMBER
IN ANNUAL
REPORT
-------------
Independent Auditors' Report................................. 29
Consolidated Balance Sheets as of
December 31, 1996 and 1995................................... 30
Consolidated Statements of
Operations for each of the years
ended December 31, 1996, 1995 and
1994......................................................... 31
Consolidated Statements of
Stockholders' Equity for each of
the years ended December 31, 1996,
1995 and 1994................................................ 32
Consolidated Statements of Cash
Flows for each of the years ended
December 31, 1996, 1995 and 1994............................. 33
Notes to Consolidated Financial
Statements................................................... 34-49
2. Financial Statement Schedules
-----------------------------
The financial statement schedules filed herein, which are the only
schedules required to be filed, are as follows:
Independent Auditors' Report (Page S-1)
Schedule I -- Summary of
Investments Other
Than Investments
in Related Parties (Page S-2)
Schedule II -- Condensed
Financial
Information of
Registrant (Parent (Pages S-3
Company Only) to S-5)
Schedule IV -- Reinsurance (Page S-6)
34
<PAGE>
3. Exhibits
-----------
The following items are annexed as exhibits:
Exhibit Number Description
--------------- -----------
3.01 Conformed Restated Certificate of Incorporation of the
Company filed with the Secretary of State of the State
of Delaware on June 7, 1991. (Filed as Exhibit 3.01 to
the Company's Registration Statement on Form S-1 (Reg.
No. 33-40306) and incorporated herein by reference.)
3.02 Amendment to the Restated Certificate of Incorporation
of the Company filed with the Secretary of State of the
State of Delaware on June 22, 1992. (Filed as Exhibit
3.02 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1992 and incorporated
herein by reference.)
3.03 By-laws of the Company, as amended on January
29, 1997.
4.01 Definitive Engraved Stock Certificate representing
shares of Common Stock. (Filed as Exhibit 4.01 to the
Company's Registration Statement on Form S-1 (Reg. No.
33-45201) and incorporated herein by reference.)
4.02 Definitive Engraved Stock Certificate representing
shares of Common Stock, as amended. (Filed as Exhibit
10.16 to the Company's Quarterly Report on Form 10-Q
for the period ended March 31, 1996 and incorporated
herein by reference.)
4.03 Indenture, dated as of August 1, 1991, between the
Company and The Chase Manhattan Bank (National
Association), Trustee. (Filed as Exhibit 4.01 to the
Company's Registration Statement on Form S-3 (Reg. No.
33-59290) and incorporated herein by reference.)
4.04 Rights Agreement, dated as of January 31, 1996, between
AMBAC Inc. and Citibank N.A., as Rights Agent,
including all exhibits thereto. (Filed as Exhibit 1 to
the Company's Registration Statement on Form 8-A dated
February 27, 1996 and incorporated herein by
reference.)
35
<PAGE>
10.01(a)* Amendment and Restated Employment Agreement dated as of
December 31, 1994, between the Company and Phillip B.
Lassiter. (Filed as Exhibit 10.12 to the Company's
Quarterly Report on Form 10-Q for the period ended
March 31, 1995, and incorporated herein by reference.)
10.01(b)* Amendment to Amended and Restated Employment Agreement
dated as of January 29, 1997 between the Company and
Phillip B. Lassiter.
10.02* AMBAC Inc. 1991 Stock Incentive Plan (as amended
through January 29, 1997).
10.03* AMBAC Inc. 1991 Non-Employee Directors Stock Plan.
(Filed as Exhibit 10.09 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1992 and
incorporated herein by reference.)
10.04* Amended and Restated Form of Award and Cancellation
Agreement, dated as of June 5, 1992. (Filed as Exhibit
10.10 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1992 and incorporated
herein by reference.)
10.05* AMBAC Inc. Deferred Compensation Plan for Outside
Directors and Eligible Senior Officers, effective as of
December 1, 1993 and amended as of December 30, 1994.
(Filed as Exhibit 10.14 to the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31,
1995 and incorporated herein by reference.)
10.06(a)* Form of Management Retention Agreement dated as of
December 30, 1994. (Filed as Exhibit 10.13 to the
Company's Quarterly Report on Form 10-Q for the period
ended March 31, 1995, and incorporated herein by
reference.)
10.06(b)* Form of Amendment to Management Retention Agreement
dated as of January 29, 1997.
10.07* The AMBAC Inc. Non-Qualified Savings Incentive Plan
(effective as of January 1, 1995). (Filed as Exhibit
10.16 to the Company's Quarterly Report on Form 10-Q
for the period ended September 30, 1995, and
incorporated herein by reference.)
- -------------------------
* Management contract or compensatory plan, contract or arrangement required to
be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
----------
36
<PAGE>
10.08* AMBAC Inc. Excess Benefits Pension Plan (Amended and
Restated as of January 1, 1994) (As amended through
October 25, 1995). (Filed as Exhibit 10.17 to the
Company's Quarterly Report on Form 10-Q for the period
ended September 30, 1995, and incorporated herein by
reference.)
10.09* AMBAC Inc. Supplemental Pension Plan (Amended and
Restated as of January 1, 1995) (As amended through
October 25, 1995). (Filed as Exhibit 10.18 to the
Company's Quarterly Report on Form 10-Q for the period
ended September 30, 1995, and incorporated herein by
reference.)
10.10 Lease Agreement, dated as of January 1, 1992 between
South Ferry Building Company and AMBAC Indemnity
Corporation. (Filed as Exhibit 10.36 to the Company's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1992 and incorporated herein by
reference.)
10.11 Tax Settlement Agreement, dated as of March 30, 1993,
among Citicorp, Citibank, N.A., Citicorp Financial
Guaranty Holdings, Inc., AMBAC Inc., AMBAC Indemnity
Corporation, American Municipal Bond Holding Company
and Health Care Investment Analysts, Inc. (Filed as
Exhibit 10.02 to the Company's Registration Statement
on Form S-3 (Registration No. 33-59290) and
incorporated herein by reference.)
10.12 Second Amended and Restated U.S. $100,000,000 Credit
Agreement, dated as of July 21, 1995 (the "BNS Credit
Agreement") among the Company and AMBAC Indemnity
Corporation as the Borrowers, Certain Commercial
Lending Institutions as the Lenders, The Bank of Nova
Scotia, acting through its New York Agency, and
Citibank, N.A., as the Co-Agents for the Lenders, and
The Bank of Nova Scotia, acting through its New York
Agency, as the Administrative Agent. (Filed as Exhibit
10.15 to the Company's Quarterly Report on Form 10-Q
for the period ended September 30, 1995 and
incorporated herein by reference.)
10.13 Credit Agreement, dated December 2, 1993 (the "Deutsche
Bank Credit Agreement") between AMBAC Indemnity
Corporation and Deutsche Bank AG (New York Branch),
Individually and as Agent. (Filed as Exhibit 10.09 to
the Company's Report on Form 10-K for the year ended
December 31, 1993 and incorporated herein by
reference.)
- ----------------------------------------
*Management contractt or compensatory plan, contract or arrangement required to
be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
37
<PAGE>
10.14 Amendment No. 1 to the Deutsche Bank Credit Agreement,
dated as of December 2, 1994 between AMBAC Indemnity
Corporation and Deutsche Bank AG, New York Branch,
Individually and as Agent. (Filed as Exhibit 10.11 to
the Company's Report on Form 10-K for the year ended
December 31, 1994, and incorporated herein by
reference.)
10.15 Amendment No. 2 to the Deutsche Bank Credit Agreement,
dated as of December 1, 1995, between AMBAC Indemnity
Corporation and Deutsche Bank AG, New York Branch,
Individually and as Agent. (Filed as Exhibit 10.15 to
the Company's Report on Form 10-K for the year ended
December 31, 1995, and incorporated herein by
reference.)
10.16 Amendment No. 3 to the Deutsche Bank Credit Agreement,
dated as of December 2, 1996, between AMBAC Indemnity
Corporation and Deutsche Bank AG, New York Branch,
Individually and as Agent.
10.17 Amendment No. 4 to the Deutsche Bank Credit Agreement,
dated as of February 14, 1997, between AMBAC Indemnity
Corporation and Deutsche Bank AG, New York Branch,
Individually and as Agent.
10.18 Letter Agreement, dated as of August 1, 1996 between
Gregory & Hoenemeyer, Inc. and AMBAC Capital
Corporation. (Filed as Exhibit 10.17 to the Company's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996 and incorporated herein by
reference.)
11.00 Statement re computation of per share earnings.
13.01 Annual Report to Stockholders for the fiscal year ended
December 31, 1996. (Furnished for the information of
the Securities and Exchange Commission and not deemed
"filed" as part of this Form 10-K except for those
portions which are expressly incorporated by
reference.)
21.01 List of Subsidiaries of AMBAC Inc.
24.01 Power of Attorney from Phillip B. Lassiter.
24.02 Power of Attorney from Michael A. Callen.
24.03 Power of Attorney from Renso L. Caporali.
24.04 Power of Attorney from Richard Dulude.
24.05 Power of Attorney from W. Grant Gregory.
38
<PAGE>
24.06 Power of Attorney from C. Roderick O'Neil.
27.00 Financial Data Schedule.
(b) REPORTS ON FORM 8-K:
There were no reports on Form 8-K filed during the fourth quarter of 1996.
--------
However, on February 14, 1997, the Company filed a Current Report on Form 8-K
--------
with its January 30, 1997 press release containing unaudited financial
information and accompanying discussion for the three months ended December 31,
1996 and the year ended December 31, 1996. On March 12, 1997, the Company filed
a Current Report on Form 8-K containing the consolidated financial statements
--------
(with independent auditors' report thereon) of AMBAC Indemnity Corporation and
Subsidiaries as of December 31, 1996 and 1995.
39
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
AMBAC INC.
(Registrant)
Dated: March 31, 1997 By: /s/ Frank J. Bivona
-----------------------------
Name: Frank J. Bivona
Title: Senior Vice President,
Chief Financial Officer and
Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
- --------- -------- -------
Phillip B. Lassiter* Chairman, President March 31, 1997
- --------------------------- and Chief Executive Officer
Phillip B. Lassiter and Director (Principal Executive
Officer)
/s/ Frank J. Bivona Senior Vice President, March 31, 1997
- --------------------------- Chief Financial Officer and
Frank J. Bivona Treasurer (Principal Financial
and Accounting Officer)
Michael A. Callen* Director March 31, 1997
- ---------------------------
Michael A. Callen
Renso L. Caporali* Director March 31, 1997
- ---------------------------
Renso L. Caporali
Richard Dulude* Director March 31, 1997
- ---------------------------
Richard Dulude
W. Grant Gregory* Director March 31, 1997
- ---------------------------
W. Grant Gregory
C. Roderick O'Neil* Director March 31, 1997
- ---------------------------
C. Roderick O'Neil
- ---------------------
* Frank J. Bivona, by signing his name hereto, does hereby sign this Annual
Report on Form 10-K on behalf of each of the directors and officers of the
Registrant after whose typed names asterisks appear pursuant to powers of
attorney duly executed by such directors and officers and filed with the
Securities and Exchange Commission as exhibits to this report.
By: /s/ Frank J. Bivona
----------------------
Frank J. Bivona
Attorney-in-fact
40
<PAGE>
APPENDIX A
TYPES AND RATINGS OF BONDS
TYPES OF BONDS INSURED - MUNICIPAL
General Obligation Bonds. These bonds are supported by the general
------------------------
obligation of the issuer to pay from available funds and by a pledge of the
issuer to levy property taxes sufficient in amount to provide for the full
payment of the bonds.
Utility Revenue Bonds. This category includes primarily revenue bonds
---------------------
supported by a pledge of revenues from municipal utility systems that supply
basic services to the community. In most cases the utility systems are subject
to little competition, if any. These issuers typically have control over their
utility rates and are required by their bond indentures to raise rates as
necessary to meet certain debt service coverage requirements. This category also
includes bonds secured by revenues of major power generation or regional water
or sewer facilities which serve many local utilities.
Tax-Backed Revenue Bonds. This category includes a wide range of issues
------------------------
secured by various municipal taxes (including sales and excise taxes),
assessments and fees. Bond proceeds are typically used for local municipal
purposes such as the construction of roads and municipal buildings.
Health Care Revenue Bonds. This category includes both long-term issues
-------------------------
for capital construction of hospitals and medium-term pool issues for hospital
equipment purchase purposes.
Transportation Revenue Bonds. This category includes a range of revenue
----------------------------
bonds, including revenue bonds for airports, toll roads, bridges, tunnels and
parking facilities.
Investor-Owned Utilities. This category includes bonds that are sold by
------------------------
electric, gas and water utilities, generally secured by a first mortgage lien on
the utility's assets and are payable from the utility revenues derived from the
sale of an essential service.
Higher Education Bonds. This category includes both public and private
----------------------
college and university bonds issued to finance general university improvements
or specific projects the payment of which is secured by the general credit of
the institution, tuition or unrestricted revenues, student fees or auxiliary
enterprise fees.
Student Loan Bonds. These bonds include issues to finance the origination
------------------
of student loans or the purchase of student loans from eligible lenders in the
state and are often insured by state guarantee agencies and reinsured by the
federal government through the Department of Education.
A-1
<PAGE>
Housing Revenue Bonds. This category includes both multi-family and
---------------------
single-family housing bonds which exhibit multi-tiered security structures based
on the underlying mortgages, reserve funds, and various combinations of features
which might include FHA or private mortgage insurance, bank letters of credit,
the general obligation of the issuing housing agency and, in some cases, a
state's "moral obligation" (that is, not a legally binding commitment) to make
up deficiencies.
TYPES OF BONDS INSURED - STRUCTURED FINANCE AND ASSET-BACKED
Asset-Backed Obligations. These obligations are typically issued in
------------------------
connection with transactions in which the securities being issued are secured by
or payable from a specific pool of assets, such as residential mortgages and
high quality corporate trade receivables and securities, having an ascertainable
cash flow or market value and held by a special purpose issuing entity. While
most asset-backed obligations are secured by or represent interest in pools of
assets, some of these asset-backed obligations can be secured by one or a few
assets.
Home Equity Security. A financial instrument whose collateral and source
--------------------
of repayment consist of a pool of individual home equity loans. Such loans may
have a first or second lien position, or be unsecured.
Mortgage Backed Security. A financial instrument whose collateral and
------------------------
source of repayment consist of a pool of individual residential first mortgage
loans.
Sovereign Obligation. The financial obligation, such as a bond or note, of
--------------------
a national government.
Special Revenue Bond. A bond whose sole source of repayment is the
--------------------
revenues derived from a specific project, such as a toll road or a mass transit
system, financed with such bonds. Such bonds typically have no recourse to any
other entity, government or taxing authority.
Subsovereign Obligation. The financial obligation, such as a bond or note,
-----------------------
of the government of a political subdivision of a country, such as a state or
department.
TYPES OF PROGRAMS
New issue insurance. The insurance of bonds at the time of issuance by the
-------------------
issuer of the bonds.
Unit investment trust insurance. The insurance of individual bonds
-------------------------------
deposited into a unit investment trust while such bonds remain in the unit
investment trust, unless an additional premium is paid to extend the insurance
coverage to the stated maturity of the bonds.
Secondary market insurance. The insurance of individual bonds outstanding
--------------------------
in the secondary market.
A-2
<PAGE>
Mutual fund insurance. The insurance of individual bonds in insured mutual
---------------------
funds. Insurance policies on individual bonds in insured mutual funds are
effective only as long as the individual bonds remain in the fund.
Debt service reserve fund insurance. Insurance, by means of a debt service
-----------------------------------
reserve fund surety policy, designed to satisfy debt service reserve fund
requirements of municipal bond issuers. The surety policy insures the
availability of an amount not to exceed the debt service reserve fund
requirement for the issues, which in most cases is the lesser of (a) one year's
maximum principal and interest payments and (b) approximately 10% of the
original principal amount of a bond issue.
Structured finance insurance. The insurance of various types of asset-
----------------------------
backed and mortgage-backed financings.
A-3
<PAGE>
RATINGS OF BONDS
The following descriptions of credit ratings applicable to bonds are taken
from more extensive explanations provided by Standard & Poor's Ratings Group,
Moody's Investors Service, Inc., Fitch Investors Service, L.P. and Nippon
Investors Service, Inc. All bonds given a rating of BBB or Baa or better are
considered by S&P, Moody's, Fitch, and Nippon to be investment grade.
STANDARD & POOR'S RATINGS GROUP
DEBT RATINGS
AAA: Debt rated "AAA" has the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is extremely strong.
AA: Debt rated "AA" has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in a small degree.
A: Debt rated "A" has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
BBB: Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
BB, B, CCC, CC: Debt rated "BB", "B", "CCC" and "CC" is regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. "BB"
indicates the lowest degree of speculation and "CC" the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
A-4
<PAGE>
MOODY'S INVESTORS SERVICE, INC.
DEBT RATINGS
Aaa: Bonds which are rated "Aaa" are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be anticipated are
most unlikely to impair the fundamentally strong position of such issues.
Aa: Bonds which are rated "Aa" are judged to be of high quality by all
standards. Together with the "Aaa" group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation in protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risk appear somewhat larger than in Aaa securities.
A: Bonds which are rated "A" possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa: Bonds which are rated "Baa" are considered to be medium grade
obligations: that is, they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba: Bonds which are rated "Ba" are judged to have speculative elements:
their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
A-5
<PAGE>
FITCH INVESTORS SERVICE, L.P.
DEBT RATINGS
AAA: Debt rated "AAA" are bonds considered to be investment grade and of
the highest credit quality. The obligor has an exceptionally strong ability to
pay interest and repay principal, which is unlikely to be affected by reasonable
foreseeable events.
AA: Debt rated "AA" are bonds considered to be investment grade and of
very high credit quality. The obligor's ability to pay interest and repay
principal is very strong, although not quite as strong as bonds rated "AAA."
A: Debt rated "A" are bonds considered to be investment grade and of high
credit quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
BBB: Debt rated "BBB" are bonds considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have an adverse impact on these
bonds and, therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
BB, B, CCC, CC: Debt rated "BB", "B", "CCC" and "CC" is regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. "BB"
indicates the lowest degree of speculation and "CC" the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
Plus (+) or Minus (-) signs are used with a rating symbol to indicate the
relative position of a credit within the rating category. Plus and minus signs,
however, are not used in the "AAA" category.
A-6
<PAGE>
NIPPON INVESTORS SERVICE, INC.
DEBT RATINGS
AAA: Debt rated "AAA" are bonds with the highest degree of certainty
regarding the discharge of debt, even under adverse circumstances.
AA: Debt rated "AA" are bonds with an extremely strong degree of certainty
regarding the discharge of debt, even under adverse circumstances.
A: Debt rated "A" are bonds with a strong degree of certainty regarding
the discharge of debt, even under adverse circumstances.
BBB: Debt rated "BBB" are bonds with an adequate degree of certainty
regarding the discharge of debt. However, it can be affected by major adverse
changes in circumstances.
BB, B, CCC, CC, C: Debt rated "BB", "B", "CCC", "CC" or "C" are bonds with
varying degrees of uncertainty regarding the discharge of debt. "BB" indicates
the lowest degree of uncertainty and therefore the lowest probability of
default, "C" the highest degree of uncertainty, and therefore the highest
probability of default.
Plus (+) or Minus (-) signs may be added to ratings from "AA" through "B"
to indicate the relative standing within each of these categories.
A-7
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
AMBAC Inc.:
Under the date of January 30, 1997, we reported on the consolidated balance
sheets of AMBAC Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 1996, as
contained in the 1996 Annual Report to Stockholders. These consolidated
financial statements and our report thereon are incorporated by reference in the
annual report on Form 10-K for the year 1996. In connection with our audits of
the aforementioned consolidated financial statements, we also audited the
related consolidated financial statement schedules. These financial statement
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statement schedules based on our
audits.
In our opinion, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
KPMG Peat Marwick LLP
New York, New York
January 30, 1997
S-1
<PAGE>
AMBAC INC. AND SUBSIDIARIES
SCHEDULE I - SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1996
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
AMOUNT AT
WHICH SHOWN
AMORTIZED ESTIMATED IN THE BALANCE
TYPE OF INVESTMENT COST FAIR VALUE SHEET
- -------------------------------------- ---------- ----------- --------------
<S> <C> <C> <C>
U.S. Government obligations............. $ 102,774 $ 102,430 $ 102,430
Municipal obligations................... 1,897,518 1,982,911 1,982,911
Mortgage- and asset-backed securities
(includes U.S. Government Agency
obligations)........................... 2,035,719 2,035,115 2,035,115
Corporate securities.................... 939,312 963,890 963,890
Other fixed maturities.................. 116,205 116,196 116,196
---------- ---------- ----------
Total investments.................. $5,091,528 $5,200,542 $5,200,542
========== ========== ==========
</TABLE>
S-2
<PAGE>
AMBAC INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1996 1995
------------- ------------
ASSETS
Assets:
<S> <C> <C>
Cash................................... $ 9 $ 28
Investments in subsidiaries............ 1,716,328 1,631,886
Bonds, at fair value
(amortized cost of $104,925 in 1996
and $0 in 1995)...................... 107,338 --
Short-term investments, at cost
(approximates fair value)............. 15,722 11,137
Current income taxes receivable........ 3,066 --
Other assets........................... 5,106 3,751
---------- ----------
Total assets.......................... $1,847,569 $1,646,802
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Current income taxes payable........... $ -- $ 7,377
Debentures............................. 223,798 223,732
Accrued interest payable............... 6,797 6,825
Accounts payable and other liabilities. 1,958 4,880
---------- ----------
Total liabilities..................... 232,553 242,814
---------- ----------
Stockholders' equity:
Preferred stock, par value $0.01 per
share; authorized shares - 4,000,000;
issued and outstanding shares - none... -- --
Common Stock, Class A shares, par value
$0.01 per share; authorized shares -
20,000,000; issued and outstanding
shares - none.......................... -- --
Common Stock, par value $0.01 per
share; authorized shares - 50,000,000;
issued shares - 35,340,192 at December
31, 1996 and at December 31, 1995...... 353 353
Additional paid-in capital.............. 498,401 492,495
Unrealized gains on investments, net of
tax.................................... 58,911 102,470
Retained earnings....................... 1,072,418 819,479
Common Stock held in treasury at cost,
249,807 shares at December 31, 1996
and 276,619 at December 31, 1995....... (15,067) (10,809)
---------- ----------
Total stockholders' equity.......... 1,615,016 1,403,988
---------- ----------
Total liabilities and stockholders'
equity............................ $1,847,569 $1,646,802
========== ==========
</TABLE>
S-3
<PAGE>
AMBAC INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
THREE YEARS ENDED DECEMBER 31,
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
------------ ----------- ----------
Revenues:
<S> <C> <C> <C>
Dividend income....................... $ 44,000 $ 40,000 $ 36,000
Extraordinary dividend (1)............ 115,865 -- --
Interest and other income............. 7,589 389 1,841
Net realized gains (losses)........... 66,633 19,103 (2,632)
---------- -------- -------
Total revenues....................... 234,087 59,492 35,209
---------- -------- -------
Expenses:
Interest expense...................... 18,852 19,467 17,469
Operating expenses.................... 3,477 1,531 2,041
---------- -------- -------
Total expenses....................... 22,329 20,998 19,510
---------- -------- -------
Income before income taxes and equity
in undistributed net income of
subsidiaries........................... 211,758 38,494 15,699
Federal income tax expense (benefit).... 18,203 155 (7,890)
---------- -------- -------
Income before equity in undistributed
net income of subsidiaries............. 193,555 38,339 23,589
Equity in undistributed net income of
subsidiaries........................... 82,762 129,256 117,516
---------- -------- -------
Net income.............................. 276,317 167,595 141,105
Common dividends........................ (21,500) (19,484) (17,429)
Other................................... (1,878) (1,761) (328)
Retained earnings at beginning of period 819,479 673,129 549,781
---------- -------- -------
Retained earnings at end of period...... $1,072,418 $819,479 $673,129
========== ======== ========
</TABLE>
(1) Represents fair value of 2,378,672 shares of HCIA common stock received from
AMBAC Indemnity in the form of an extraordinary dividend on April 30, 1996.
S-4
<PAGE>
AMBAC INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS
THREE YEARS ENDED DECEMBER 31,
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income............................ $ 276,317 $ 167,595 $ 141,105
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Equity in undistributed net income of
subsidiaries......................... (82,762) (129,256) (117,516)
Extraordinary dividend(1)............. (115,865) -- --
(Decrease) increase in accrued
interest payable..................... (28) 28 --
(Gain) loss on sale of investments.... (66,633) (19,103) 2,632
(Decrease) increase in current income
taxes payable........................ (10,443) 6,176 (1,552)
Other, net............................ (8,292) (941) 3,117
--------- --------- ---------
Net cash (used in) provided by
operating activities................. (7,706) 24,499 27,786
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sales of bonds.......... 17,396 -- 17,205
Purchases of bonds.................... (121,734) -- --
Proceeds from sale of affiliate....... 202,609 28,502 --
Change in short-term investments...... (4,585) 2,108 1,591
Other, net............................ 13,842 -- --
--------- --------- ---------
Net cash provided by investing
activities.......................... 107,528 30,610 18,796
--------- --------- ---------
Cash flows from financing activities:
Dividends paid........................ (21,500) (19,484) (17,429)
Proceeds from issuance of common stock -- -- 164
Purchases of treasury stock........... (31,751) (5,913) (11,907)
Proceeds from sale of treasury stock.. 17,211 6,302 709
Contribution to subsidiaries.......... (63,801) (36,001) (18,105)
--------- --------- ---------
Net cash used in financing activities (99,841) (55,096) (46,568)
--------- --------- ---------
Net cash flow........................... (19) 13 14
Cash at January 1..................... 28 15 1
--------- --------- ---------
Cash at December 31................... $ 9 $ 28 $ 15
========= ========= =========
Supplemental disclosure of cash flow
information:
Cash paid during the year for:
Income taxes......................... $ 90,197 $ 24,800 $ 30,536
========= ========= =========
Interest expense..................... $ 19,687 $ 19,687 $ 19,687
========= ========= =========
Cash received during the year for:
Income taxes......................... $ -- $ 8,749 $ 1,167
========= ========= =========
</TABLE>
(1) Represents fair value of 2,378,672 shares of HCIA common stock received from
AMBAC Indemnity in the form of an extraordinary dividend on April 30, 1996.
S-5
<PAGE>
AMBAC INC. AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PERCENTAGES)
<TABLE>
<CAPTION>
ASSUMED PERCENTAGE OF
CEDED TO FROM AMOUNT
GROSS OTHER OTHER NET AMOUNT ASSUMED TO
INSURANCE PREMIUMS WRITTEN AMOUNT COMPANIES COMPANIES NET
- --------------------------- ------------ -------------- ----------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Year ended December 31,
1994...................... $185,365 $(2,815) $4,541 $192,721 2.36%
Year ended December 31,
1995...................... $190,570 $28,606 $2,756 $164,720 1.67%
Year ended December 31,
1996...................... $240,544 $37,793 $6,664 $209,415 3.18%
</TABLE>
S-6
<PAGE>
INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
3.03 By-laws of the Company, as amended on January 29, 1997.
10.01(b)* Amendment to Amended and Restated Employment
Agreement dated as of January 29, 1997 between
the Company and Phillip B. Lassiter.
10.02* AMBAC Inc. 1991 Stock Incentive Plan (as
amended through January 29, 1997).
10.06(b)* Form of Amendment to Management Retention Agreement dated as
of January 29, 1997.
10.16 Amendment No. 3 to the Deutsche Bank Credit Agreement, dated
as of December 2, 1996, between AMBAC Indemnity Corporation
and Deutsche Bank AG, New York Branch, Individually and as
Agent.
10.17 Amendment No. 4 to the Deutsche Bank Credit Agreement, dated
as of February 14, 1997, between AMBAC Indemnity Corporation
and Deutsche Bank AG, New York Branch, Individually and as
Agent.
11.00 Statement re computation of per share earnings.
13.01 Annual Report to Stockholders for the fiscal year ended
December 31, 1996. (Furnished for the information of the
Securities and Exchange Commission and not deemed "filed" as
part of this Form 10-K except for those portions which are
expressly incorporated by reference.)
21.01 List of Subsidiaries of AMBAC Inc.
24.01 Power of Attorney from Phillip B. Lassiter.
24.02 Power of Attorney from Michael A. Callen.
24.03 Power of Attorney from Renso L. Caporali.
24.04 Power of Attorney from Richard Dulude.
24.05 Power of Attorney from W. Grant Gregory.
24.06 Power of Attorney from C.Roderick O'Neil.
27.00 Financial Data Schedule.
* Management contract or compensatory plan, contract or arrangement required to
be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
----------
l-1
<PAGE>
EXHIBIT 3.03
BY-LAWS
OF
AMBAC INC.
Amended as of
January 29, 1997
<PAGE>
<TABLE>
<CAPTION>
ARTICLE I
OFFICES
<S> <C>
SECTION 1.01 Registered Office ........................................... 1
SECTION 1.02 Other Offices ............................................... 1
ARTICLE II
MEETINGS OF STOCKHOLDERS
SECTION 2.01 Annual Meetings ............................................. 1
SECTION 2.02 Special Meetings ............................................ 1
SECTION 2.03 Notice of Meetings .......................................... 1
SECTION 2.04 Waiver of Notice ............................................ 2
SECTION 2.05 Adjournments ................................................ 2
SECTION 2.06 Quorum ...................................................... 3
SECTION 2.07 Voting ...................................................... 3
SECTION 2.08 Proxies ..................................................... 3
SECTION 2.09 Chairman and Secretary at Meetings .......................... 3
SECTION 2.10 Judges ...................................................... 3
SECTION 2.11 List of Stockholders ........................................ 4
SECTION 2.12 Notice of Stockholder Business .............................. 4
SECTION 2.13 Notice of Stockholder Nominees .............................. 5
SECTION 2.14 Stockholders' Consent in Lieu of Meeting .................... 6
ARTICLE III
BOARD OF DIRECTORS
SECTION 3.01 General Powers .............................................. 7
SECTION 3.02 Number and Term of Office ................................... 7
SECTION 3.03 Resignation ................................................. 7
SECTION 3.04 Removal ..................................................... 7
SECTION 3.05 Vacancies ................................................... 7
SECTION 3.06 Meetings .................................................... 8
SECTION 3.07 Committees of the Board ..................................... 9
SECTION 3.08 Directors' Consent in Lieu of Meeting ....................... 10
SECTION 3.09 Action by Means of Telephone or Similar
Communications Equipment .................................... 10
SECTION 3.10 Compensation ................................................ 10
</TABLE>
i
<PAGE>
<TABLE>
<CAPTION>
ARTICLE IV
OFFICERS
Page
----
<S> <C>
SECTION 4.01 Officers .................................................... 11
SECTION 4.02 Authority and Duties ........................................ 11
SECTION 4.03 Term of Office, Resignation and Removal ..................... 11
SECTION 4.04 Vacancies ................................................... 11
SECTION 4.05 The Chairman ................................................ 12
SECTION 4.06 The President ............................................... 12
SECTION 4.07 Vice Presidents ............................................. 12
SECTION 4.08 The Secretary ............................................... 12
SECTION 4.09 Assistant Secretaries ....................................... 13
SECTION 4.10 The Treasurer ............................................... 13
SECTION 4.11 Assistant Treasurers ........................................ 13
ARTICLE V
CHECKS, DRAFTS, NOTES AND PROXIES
SECTION 5.01 Checks, Drafts and Notes .................................... 14
SECTION 5.02 Execution of Proxies ........................................ 14
ARTICLE VI
SHARES AND TRANSFERS OF SHARES
SECTION 6.01 Certificates Evidencing Shares .............................. 14
SECTION 6.02 Stock Ledger ................................................ 14
SECTION 6.03 Transfers of Shares ......................................... 15
SECTION 6.04 Addresses of Stockholders ................................... 15
SECTION 6.05 Lost, Destroyed and Mutilated Certificates .................. 15
SECTION 6.06 Regulations ................................................. 16
SECTION 6.07 Fixing Date for Determination of Stockholders of
Record ...................................................... 16
ARTICLE VII
SEAL
SECTION 7.01 Seal ........................................................ 16
</TABLE>
ii
<PAGE>
<TABLE>
<CAPTION>
Page
----
ARTICLE VIII
FISCAL YEAR
<S> <C>
SECTION 8.01 Fiscal Year ................................................. 16
ARTICLE IX
INDEMNIFICATION AND INSURANCE
SECTION 9.01 Indemnification ............................................. 17
SECTION 9.02 Insurance for Indemnification ............................... 19
ARTICLE X
AMENDMENTS
SECTION 10.01 Amendments ................................................. 20
</TABLE>
iii
<PAGE>
BY-LAWS
OF
AMBAC INC.
ARTICLE I
OFFICES
SECTION 1.01 Registered Office. The registered office of AMBAC Inc. (the
"Corporation") in the State of Delaware shall be at the principal office of The
Corporation Trust Company in the City of Wilmington, County of New Castle, and
the registered agent in charge thereof shall be The Corporation Trust Company.
SECTION 1.02 Other Offices. The Corporation may also have an office or
offices at any other place or places within or without the State of Delaware as
the Board of Directors of the Corporation (the "Board") may from time to time
determine or the business of the Corporation may from time to time require.
ARTICLE II
MEETINGS OF STOCKHOLDERS
SECTION 2.01 Annual Meetings. The annual meeting of Stockholders (as
defined in Section 2.03) of the Corporation for the election of directors of the
Corporation ("Directors"), and for the transaction of such other business as may
properly come before such meeting, shall be held at such place, date and time as
shall be fixed by the Board and designated in the notice or waiver of notice of
such annual meeting.
SECTION 2.02 Special Meetings. Special meetings of Stockholders for any
purpose or purposes may be called by the Board or the Chairman of the Board of
the Corporation (the "Chairman"), the President of the Corporation (the
"President") or the Secretary of the Corporation (the "Secretary"), to be held
at such place, date and time as shall be designated in the notice or waiver of
notice thereof.
SECTION 2.03 Notice of Meetings. (a) Except as otherwise provided by law,
written notice of each annual or special meeting of Stockholders stating the
place, date and time of such meeting and, in the case of a special meeting, the
purpose or purposes for which such meeting is to be held, shall be given
personally or by first-class mail (airmail in the case of international
communications) to each
<PAGE>
By-laws of AMBAC Inc.
Amended as of 1/29/97
Page 2
recordholder of shares of common stock of the Corporation issued and outstanding
("Shares") entitled to vote thereat, not less than 10 nor more than 90 days
before the date of such meeting. If mailed, such notice shall be deemed to be
given when deposited in the United States mail, postage prepaid, directed to the
recordholder of Shares (a "Stockholder") at such Stockholder's address as it
appears on the records of the Corporation. If, prior to the time of mailing, the
Secretary shall have received from any Stockholder a written request that
notices intended for such Stockholder are to be mailed to some address other
than the address that appears on the records of the Corporation, notices
intended for such Stockholder shall be mailed to the address designated in such
request.
(b) Notice of a special meeting of Stockholders may be given by the person
or persons calling the meeting, or, upon the written request of such person or
persons, such notice shall be given by the Secretary on behalf of such person or
persons. If the person or persons calling a special meeting of Stockholders give
notice thereof, such person or persons shall deliver a copy of such notice to
the Secretary. Each request to the Secretary for the giving of notice of a
special meeting of Stockholders shall state the purpose or purposes of such
meeting.
SECTION 2.04 Waiver of Notice. Notice of any annual or special meeting of
Stockholders need not be given to any Stockholder who files a written waiver of
notice with the Secretary, signed by the person entitled to notice, whether
before or after such meeting. Neither the business to be transacted at, nor the
purpose of, any meeting of Stockholders need be specified in any written waiver
of notice thereof. Attendance of a Stockholder at a meeting, in person or by
proxy, shall constitute a waiver of notice of such meeting, except when such
Stockholder attends a meeting for the express purpose of objecting, at the
beginning of the meeting, to the transaction of any business on the grounds that
the notice of such meeting was inadequate or improperly given.
SECTION 2.05 Adjournments. Whenever a meeting of Stockholders,
annual or special, is adjourned to another date, time or place, notice need not
be given of the adjourned meeting if the date, time and place thereof are
announced at the meeting at which the adjournment is taken. If the adjournment
is for more than 30 days, or if after the adjournment a new record date is fixed
for the adjourned meeting, a notice of the adjourned meeting shall be given to
each Stockholder entitled to vote thereat. At the adjourned meeting, any
business may be transacted which might have been transacted at the original
meeting. Any previously scheduled meeting of the Stockholders may be postponed,
and (unless the Certificate of Incorporation of the Corporation (the
"Certificate of Incorpo-
<PAGE>
By-laws of AMBAC Inc.
Amended as of 1/29/97
Page 3
ration") otherwise provides) any special meeting of the Stockholders may be
cancelled, by resolution of the Board upon public notice given prior to the date
previously scheduled for such meeting of Stockholders.
SECTION 2.06 Quorum. Except as otherwise provided by law or the Certificate
of Incorporation, the recordholders of a majority of the Shares entitled to vote
thereat, present in person or by proxy, shall constitute a quorum for the
transaction of business at all meetings of Stockholders, whether annual or
special. If, however, such quorum shall not be present in person or by proxy at
any meeting of Stockholders, the presiding officer at the meeting of the
Stockholders entitled to vote thereat may adjourn the meeting from time to time
in accordance with Section 2.05 hereof until a quorum shall be present in person
or by proxy.
SECTION 2.07 Voting. Each Stockholder shall be entitled to one vote for
each Share held of record by such Stockholder. Except as otherwise provided by
law or the Certificate of Incorporation, when a quorum is present at any meeting
of Stockholders, the vote of the recordholders of a majority of the Shares
constituting such quorum shall decide any question brought before such meeting.
SECTION 2.08 Proxies. Each Stockholder entitled to vote at a meeting of
Stockholders or to express, in writing, consent to or dissent from any action of
Stockholders without a meeting may authorize another person or persons to act
for such Stockholder by proxy. Such proxy shall be filed with the Secretary
before such meeting of Stockholders or such action of Stockholders without a
meeting, at such time as the Board may require. No proxy shall be voted or acted
upon more than three years from its date, unless the proxy provides for a longer
period.
SECTION 2.09 Chairman and Secretary at Meetings. At any meeting of
Stockholders, the Chairman, or in his absence, the President, or if neither such
person is available, then a person designated by the Board, shall preside at and
act as chairman of the meeting. The Secretary, or in his absence a person
designated by the chairman of the meeting, shall act as secretary of the
meeting.
SECTION 2.10 Judges. The votes at each meeting of Stockholders shall be
supervised by not less than two judges who shall decide all questions respecting
the qualification of voters, the validity of the proxies and the acceptance or
rejection of votes. The judges shall be appointed by the Board but if, for any
reason, there are less than two judges present and acting at any meeting, the
<PAGE>
By-laws of AMBAC Inc.
Amended as of 1/29/97
Page 4
chairman of the meeting shall appoint an additional judge or judges so that
there shall always be at least two judges to act at the meeting.
SECTION 2.11 List of Stockholders. A complete list of the Stockholders
entitled to vote at each meeting of Stockholders, arranged in alphabetical
order, and showing the address and number of shares registered in the name of
each Stockholder, shall be prepared and made available for examination during
regular business hours by any Stockholder for any purpose germane to the
meeting. The list shall be available for such examination for a period of not
less than ten days prior to the meeting and during the whole time of the meeting
either at a place within the city where the meeting is to be held, which place
shall be specified in the notice of meeting or, if not so specified, at the
place where the meeting is to be held.
SECTION 2.12 Notice of Stockholder Business. At an annual meeting of the
Stockholders, only such business shall be conducted as shall have been brought
before the meeting (a) by or at the direction of the Board or (b) by any
Stockholder who complies with the notice procedures set forth in this Section
2.12. For business to be properly brought before an annual meeting by a
Stockholder, the Stockholder must have given timely notice thereof in writing to
the Secretary of the Corporation. To be timely, a Stockholder's notice must be
delivered to or mailed and received at the principal executive offices of the
Corporation, not less than sixty days nor more than ninety days prior to the
meeting; provided, however, that in the event that less than seventy days'
notice or prior public disclosure of the date of the meeting is given or made to
the Stockholders, notice by the Stockholder to be timely must be received not
later than the close of business on the 10th day following the day on which such
notice of the date of the annual meeting was mailed or such public disclosure
was made. A Stockholder's notice to the Secretary shall set forth as to each
matter the Stockholder proposes to bring before the annual meeting (a) a brief
description of the business desired to be brought before the annual meeting and
the reasons for conducting such business at the annual meeting; (b) the name and
address, as they appear on the Corporation's books, of the Stockholder proposing
such business; (c) the class and number of shares of the Corporation which are
beneficially owned by the Stockholder; and (d) any material interest of the
Stockholder in such business. Notwithstanding anything in these By-laws to the
contrary, no business shall be conducted at an annual meeting except in
accordance with the procedures set forth in this Section 2.12. The chairman of
an annual meeting shall, if the facts warrant, determine and declare to the
meeting that business was not properly brought before the meeting and in
accordance with the provisions of this
<PAGE>
By-laws of AMBAC Inc.
Amended as of 1/29/97
Page 5
Section 2.12, and if he should so determine, he shall so declare to the meeting
and any such business not properly brought before the meeting shall not be
transacted. Notwithstanding the foregoing provisions of this Section 2.12, a
Stockholder seeking to have a proposal included in the Corporation's proxy
statement shall comply with the requirements of Regulation 14A under the
Securities Exchange Act of 1934, as amended (including, but not limited to, Rule
14a-8 or its successor provision).
SECTION 2.13 Notice of Stockholder Nominees. Only persons who are nominated
in accordance with the procedures set forth in these By-laws shall be eligible
for election as Directors. Nominations of persons for election to the Board may
be made at a meeting of Stockholders (a) by or at the direction of the Board or
(b) by any Stockholder entitled to vote for the election of Directors at the
meeting who complies with the notice procedures set forth in this Section 2.13.
Nominations by Stockholders shall be made pursuant to timely notice in writing
to the Secretary of the Corporation. To be timely, a Stockholder's notice shall
be delivered to or mailed and received at the principal executive offices of the
Corporation not less than sixty days nor more than ninety days prior to the
meeting; provided, however, that in the event that less than seventy days'
notice or prior public disclosure of the date of the meeting is given or made to
Stockholders, notice by the Stockholder to be timely must be so received not
later than the close of business on the 10th day following the day on which such
notice of the date of the meeting was mailed or such public disclosure was made.
Such Stockholder's notice shall set forth (a) as to each person whom the
Stockholder proposes to nominate for election or re-election as a Director, all
information relating to such person that is required to be disclosed in
solicitations of proxies for election of directors, or is otherwise required, in
each case pursuant to Regulation 14A under the Securities Exchange Act of 1934,
as amended (including such person's written consent to being named in the proxy
statement as a nominee and to serving as a Director if elected); and (b) as to
the Stockholder giving the notice (i) the name and address, as they appear on
the Corporation's books, of such Stockholder and (ii) the class and number of
shares of the Corporation which are beneficially owned by such Stockholder. At
the request of the Board any person nominated by the Board for election as a
Director shall furnish to the Secretary that information required to be set
forth in a Stockholder's notice of nomination which pertains to the nominee. No
person shall be eligible for election as a Director unless nominated in
accordance with the procedures set forth in these By-laws. The chairman of the
meeting shall, if the facts warrant, determine and declare to the meeting that a
nomination was not made in accordance with the
<PAGE>
By-laws of AMBAC Inc.
Amended as of 1/29/97
Page 6
procedures prescribed by these By-laws, and if he should so determine, he shall
so declare to the meeting and the defective nomination shall be disregarded.
SECTION 2.14 Stockholders' Consent in Lieu of Meeting.
(a) Consents to Corporate Action. Any action which is required to be or may
be taken at any annual or special meeting of Stockholders, subject to the
provisions of Subsections (b) and (c) of this Section 2.14, may be taken without
a meeting, without prior notice and without a vote if consents in writing,
setting forth the action so taken, shall have been signed by the holders of the
outstanding Shares having not less than the minimum number of votes that would
be necessary to authorize or to take such action at a meeting at which all
Shares entitled to vote thereon were present and voted; provided, however, that
prompt notice of the taking of the corporate action without a meeting and by
less than unanimous written consent shall be given to those Stockholders who
have not consented in writing.
(b) Determination of Record Date of Action by Written Consent. The record
date for determining Stockholders entitled to express consent to corporate
action in writing without a meeting shall be fixed by the Board. Any Stockholder
of record seeking to have the Stockholders authorize or take corporate action by
written consent without a meeting shall, by written notice to the Secretary,
request the Board to fix a record date. Upon receipt of such a request, the
Secretary shall place such request before the Board at its next regularly
scheduled meeting, provided, however, that if the Stockholder represents in such
request that he intends, and is prepared, to commence a consent solicitation as
soon as is permitted by the Securities Exchange Act of 1934, as amended, and the
regulations thereunder and other applicable law, the Secretary shall, as
promptly as practicable, call a special meeting of the Board, which meeting
shall be held as promptly as practicable. At such regular or special meeting,
the Board shall fix a record date as provided in Section 213(a) (or its
successor provision) of the General Corporation Law of the State of Delaware
(the "General Corporation Law"). Should the Board fail to fix a record date as
provided for in this Subsection (b), then the record date shall be the day on
which the first written consent is expressed.
(c) Procedures for Written Consent. In the event of the delivery to the
Corporation of a written consent or consents purporting to represent the
requisite voting power to authorize or take corporate action and/or related
revocations, the Secretary shall provide for the safekeeping of such consents
and
<PAGE>
By-laws of AMBAC Inc.
Amended as of 1/29/97
Page 7
revocations and shall, as promptly as practicable, engage nationally
recognized independent judges of election for the purpose of promptly performing
a ministerial review of the validity of the consents and revocations. No action
by written consent and without a meeting shall be effective until such judges
have completed their review, determined that the requisite number of valid and
unrevoked consents has been obtained to authorize or take the action specified
in the consents, and certified such determination for entry in the records of
the Corporation kept for the purpose of recording the proceedings of meetings of
Stockholders.
ARTICLE III
BOARD OF DIRECTORS
SECTION 3.01 General Powers. The business and affairs of the Corporation
shall be managed by the Board, which may exercise all such powers of the
Corporation and do all such lawful acts and things as are not by law, the
Certificate of Incorporation or these By-laws directed or required to be
exercised or done by Stockholders.
SECTION 3.02 Number and Term of Office. The number of Directors shall be
three or such greater number as shall be fixed from time to time by the Board.
Directors need not be Stockholders. Directors shall be elected at the annual
meeting of Stockholders, and each Director shall hold office until his successor
is elected and qualified, or until his earlier death or resignation or removal
in the manner hereinafter provided.
SECTION 3.03 Resignation. Any Director may resign at any time by giving
written notice to the Board, the Chairman or the Secretary. Such resignation
shall take effect at the time specified in such notice or, if the time be not
specified, upon receipt thereof by the Board, the Chairman or the Secretary, as
the case may be. Unless otherwise specified therein, acceptance of such
resignation shall not be necessary to make it effective.
SECTION 3.04 Removal. Any or all of the Directors may be removed, with or
without cause, at any time by vote of the recordholders of a majority of the
Shares then entitled to vote at an election of Directors, or by written consent
of the recordholders of Shares pursuant to Section 2.14 hereof.
SECTION 3.05 Vacancies. Vacancies occurring on the Board as a result of the
removal of Directors without cause may be filled only by vote of the
<PAGE>
By-laws of AMBAC Inc.
Amended as of 1/29/97
Page 8
recordholders of a majority of the Shares then entitled to vote at an election
of Directors, or by written consent of such recordholders pursuant to Section
2.14 hereof. Vacancies occurring on the Board for any other reason, including,
without limitation, vacancies occurring as a result of the creation of new
directorships that increase the number of Directors, may be filled by such vote
or written consent or by vote of the Board or by written consent of the
Directors pursuant to Section 3.08 hereof. If the number of Directors then in
office is less than a quorum, such other vacancies may be filled by vote of a
majority of the Directors then in office or by written consent of all such
Directors pursuant to Section 3.08 hereof. Unless earlier removed pursuant to
Section 3.04 hereof, each Director chosen in accordance with this Section 3.05
shall hold office until the next annual election of Directors by the
Stockholders and until his successor shall be elected and qualified.
SECTION 3.06 Meetings. (a) Annual Meetings. As soon as practicable after
each annual election of Directors by the Stockholders, the Board shall meet for
the purpose of organization and the transaction of other business, unless it
shall have transacted all such business by written consent pursuant to Section
3.08 hereof.
(b) Stated Meetings. The Board may provide for stated meetings of the
Board.
(c) Other Meetings. Other meetings of the Board shall be held at such times
as the Chairman, the President, the Secretary or a majority of the Board shall
from time to time determine.
(d) Notice of Meetings. No notice need be given of any organization or
stated meeting of the Board for which the date, hour and place have been fixed
by the Board. The Secretary shall give written notice to each Director of each
other organization and stated meeting and of all special meetings of the Board,
which notice shall state the place, date, time and purpose of such meeting.
Notice of each such meeting shall be given to each Director, if by mail,
addressed to him at his residence or usual place of business, at least two days
before the day on which such meeting is to be held, or shall be sent to him at
such place by telecopy, telegraph, cable, or other form of recorded
communication, or be delivered personally or by telephone not later than the day
before the day on which such meeting is to be held. A written waiver of notice,
signed by the Director entitled to notice, whether before or after the time of
the meeting referred to in such waiver, shall be deemed equivalent to notice.
Neither the business to be transacted at, nor the purpose any meeting of the
Board need be specified in any written waiver of
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notice thereof. Attendance of a Director at a meeting of the Board shall
constitute a waiver of notice of such meeting, except as provided by law.
(e) Place of Meetings. The Board may hold its meetings at such place or
places within or without the State of Delaware as the Board or the Chairman may
from time to time determine, or as shall be designated in the respective notices
or waivers of notice of such meetings.
(f) Quorum and Manner of Acting. One-third of the total number of Directors
then in office (but in no event less than three Directors) shall be present in
person at any meeting of the Board in order to constitute a quorum for the
transaction of business at such meeting, and the vote of a majority of those
Directors present at any such meeting at which a quorum is present shall be
necessary for the passage of any resolution or act of the Board, except as
otherwise expressly required by law, the Certificate of Incorporation or these
By-laws. In the absence of a quorum for any such meeting, a majority of the
Directors present thereat may adjourn such meeting from time to time until a
quorum shall be present.
(g) Organization. At each meeting of the Board, one of the following shall
act as chairman of the meeting and preside, in the following order of
precedence:
(i) the Chairman;
(ii) the President;
(iii) any Director chosen by a majority of the Directors present.
The Secretary or, in the case of his absence, any person (who shall be an
Assistant Secretary, if an Assistant Secretary is present) whom the chairman of
the meeting shall appoint shall act as secretary of such meeting and keep the
minutes thereof.
SECTION 3.07 Committees of the Board. The Board may designate one or more
committees, each committee to consist of one or more Directors. The Board may
designate one or more Directors as alternate members of any committee, who may
replace any absent or disqualified member at any meeting of such committee. In
the absence or disqualification of a member of a committee, the member or
members thereof present at any meeting and not disqualified from voting, whether
or not he or they constitute a quorum, may unanimously appoint
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another Director to act at the meeting in the place of any such absent or
disqualified member. A majority of the members of any committee of the Board
shall be present in person at any meeting of the committee in order to
constitute a quorum for the transaction of business at such meeting, and the act
of a majority of the members present at any such meeting at which a quorum is
present shall be the act of the committee. In the absence of a quorum for any
such meeting, a majority of the members present thereat may adjourn such meeting
from time to time until a quorum shall be present. Any committee of the Board,
to the extent provided in the resolution of the Board designating such
committee, shall have and may exercise all the powers and authority of the Board
in the management of the business and affairs of the Corporation, and may
authorize the seal of the Corporation to be affixed to all papers which may
require it; provided, however, that no such committee shall have such power or
authority in reference to the following matters: (i) approving or adopting, or
recommending to the stockholders, any action or matter expressly required by the
General Corporation Law to be submitted to stockholders for approval or (ii)
adopting, amending or repealing these By-laws. In addition, each committee of
the Board so appointed may appoint a sub-committee of the Board in furtherance
of the duties delegated to it by the Board. Each committee of the Board shall
keep regular minutes of its proceedings and report the same to the Board when so
requested by the Board.
SECTION 3.08 Directors' Consent in Lieu of Meeting. Any action required or
permitted to be taken at any meeting of the Board or of any committee thereof
may be taken without a meeting, without prior notice and without a vote, if a
consent in writing, setting forth the action so taken, shall be signed by all
the members of the Board or such committee and such consent is filed with the
minutes of the proceedings of the Board or such committee.
SECTION 3.09 Action by Means of Telephone or Similar Communications
Equipment. Any one or more members of the Board, or of any committee thereof,
may participate in a meeting of the Board or such committee by means of
conference telephone or similar communications equipment by means of which all
persons participating in the meeting can hear each other, and participation in a
meeting by such means shall constitute presence in person at such meeting.
SECTION 3.10 Compensation. Unless otherwise restricted by the Certificate
of Incorporation, the Board may determine the compensation of Directors. In
addition, as determined by the Board, Directors may be reimbursed by the
Corporation for their expenses, if any, in the performance of their duties as
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Directors. No such compensation or reimbursement shall preclude any Director
from serving the Corporation in any other capacity and receiving compensation
therefor.
ARTICLE IV
OFFICERS
SECTION 4.01 Officers. The officers of the Corporation shall be the
Chairman, the President, the Secretary and a Treasurer and may include one or
more Vice Presidents and one or more Assistant Secretaries and one or more
Assistant Treasurers. Any two or more offices may be held by the same person
provided that the office of President and Secretary shall not be held by the
same person.
SECTION 4.02 Authority and Duties. All officers shall have such authority
and perform such duties in the management of the Corporation as may be provided
in these By-laws or, to the extent not so provided, by resolution of the Board.
SECTION 4.03 Term of Office, Resignation and Removal. (a) Each officer
shall be appointed by the Board and shall hold office for such term as may be
determined by the Board. Each officer shall hold office until his successor has
been appointed and qualified or his earlier death or resignation or removal in
the manner hereinafter provided. The Board may require any officer to give
security for the faithful performance of his duties.
(b) Any officer may resign at any time by giving written notice to the
Board, the Chairman, the President or the Secretary. Such resignation shall take
effect at the time specified in such notice or, if the time be not specified,
upon receipt thereof by the Board, the Chairman, the President or the Secretary,
as the case may be. Unless otherwise specified therein, acceptance of such
resignation shall not be necessary to make it effective.
(c) All officers and agents appointed by the Board shall be subject to
removal, with or without cause, at any time by the Board or by the action of the
recordholders of a majority of the Shares entitled to vote thereon.
SECTION 4.04 Vacancies. Any vacancy occurring in any office of the
Corporation, for any reason, shall be filled by action of the Board. Unless
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earlier removed pursuant to Section 4.03 hereof, any officer appointed by the
Board to fill any such vacancy shall serve only until such time as the unexpired
term of his predecessor expires unless reappointed by the Board.
SECTION 4.05 The Chairman. The Chairman shall be the chief executive
officer of the Corporation and shall have general and active management and
control of the business and affairs of the Corporation, subject to the control
of the Board, and shall see that all orders and resolutions of the Board are
carried into effect. The Chairman shall have the power to call special meetings
of Stockholders, to call special meetings of the Board and, if present, to
preside at all meetings of Stockholders and all meetings of the Board. The
Chairman shall perform all duties incident to the office of Chairman of the
Board and all such other duties as may from time to time be assigned to him by
the Board or these By-laws.
SECTION 4.06 The President. The President shall be the chief operating
officer of the Corporation and shall have general and active management and
control the operations of the Corporation, subject to the control of the Board,
and shall see that all orders and resolutions of the Board are carried into
effect. The President shall perform all duties incident to the office of
President and all such other duties as may from time to time be assigned to him
by the Board or these By-laws.
SECTION 4.07 Vice Presidents. Vice Presidents, if any, in order of their
seniority or in any other order determined by the Board, shall generally assist
the President and perform such other duties as the Board or the President shall
prescribe, and in the absence or disability of the President, shall perform the
duties and exercise the powers of the President.
SECTION 4.08 The Secretary. The Secretary shall, to the extent practicable,
attend all meetings of the Board and all meetings of Stockholders and shall
record all votes and the minutes of all proceedings in a book to be kept for
that purpose, and shall perform the same duties for any committee of the Board
when so requested by such committee. He shall give or cause to be given notice
of all meetings of Stockholders and of the Board, shall perform such other
duties as may be prescribed by the Board, the Chairman or the President and
shall act under the supervision of the Chairman. He shall keep in safe custody
the seal of the Corporation and affix the same to any instrument that requires
that the seal be affixed to it and which shall have been duly authorized for
signature in the name of the Corporation and, when so affixed, the seal shall be
attested by his signature or by the signature of the Treasurer of the
Corporation (the "Treasurer") or an
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Assistant Secretary or Assistant Treasurer of the Corporation. He shall keep in
safe custody the certificate books and stockholder records and such other books
and records of the Corporation as the Board, the Chairman or the President may
direct and shall perform all other duties incident to the office of Secretary
and such other duties as from time to time may be assigned to him by the Board,
the Chairman or the President.
SECTION 4.09 Assistant Secretaries. Assistant Secretaries of the
Corporation ("Assistant Secretaries"), if any, in order of their seniority or in
any other order determined by the Board, shall generally assist the Secretary
and perform such other duties as the Board or the Secretary shall prescribe,
and, in the absence or disability of the Secretary, shall perform the duties and
exercise the powers of the Secretary.
SECTION 4.10 The Treasurer. The Treasurer shall have the care and custody
of all the funds of the Corporation and shall deposit such funds in such banks
or other depositories as the Board, or any officer or officers, or any officer
and agent jointly, duly authorized by the Board, shall, from time to time,
direct or approve. He shall disburse the funds of the Corporation under the
direction of the Board and the President. He shall keep a full and accurate
account of all moneys received and paid on account of the Corporation and shall
render a statement of his accounts whenever the Board, the Chairman or the
President shall so request. He shall perform all other necessary actions and
duties in connection with the administration of the financial affairs of the
Corporation and shall generally perform all the duties usually appertaining to
the office of treasurer of a corporation. When required by the Board, he shall
give bonds for the faithful discharge of his duties in such sums and with such
sureties as the Board shall approve.
SECTION 4.11 Assistant Treasurers. Assistant Treasurers of the Corporation
("Assistant Treasurers"), if any, in order of their seniority or in any other
order determined by the Board, shall generally assist the Treasurer and perform
such other duties as the Board or the Treasurer shall prescribe, and, in the
absence or disability of the Treasurer, shall perform the duties and exercise
the powers of the Treasurer.
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ARTICLE V
CHECKS, DRAFTS, NOTES AND PROXIES
SECTION 5.01 Checks, Drafts and Notes. All checks, drafts and other orders
for the payment of money, notes and other evidences of indebtedness issued in
the name of the Corporation shall be signed by such officer or officers, agent
or agents of the Corporation and in such manner as shall be determined, from
time to time, by resolution of the Board.
SECTION 5.02 Execution of Proxies. The Chairman or the President, or, in
the absence or disability of both of them, any Vice President, may authorize,
from time to time, the execution and issuance of proxies to vote shares of stock
or other securities of other corporations held of record by the Corporation and
the execution of consents to action taken or to be taken by any such
corporation. All such proxies and consents, unless otherwise authorized by the
Board, shall be signed in the name of the Corporation by the Chairman, the
President or any Vice President.
ARTICLE VI
SHARES AND TRANSFERS OF SHARES
SECTION 6.01 Certificates Evidencing Shares. Shares shall be evidenced by
certificates in such form or forms as shall be approved by the Board.
Certificates shall be issued in consecutive order and shall be numbered in the
order of their issue, and shall be signed by the Chairman, the President or any
Vice President and by the Secretary, any Assistant Secretary, the Treasurer or
any Assistant Treasurer; provided that if such a certificate is manually signed
by one such officer, any other signature on the certificate may be a facsimile
and, if such a certificate is countersigned by a transfer agent or registrar
other than the Corporation or its employee, any other signature on the
certificate may be a facsimile. In the event any such officer who has signed or
whose facsimile signature has been placed upon a certificate shall have ceased
to hold such office or to be employed by the Corporation before such certificate
is issued, such certificate may be issued by the Corporation with the same
effect as if such officer had held such office on the date of issue.
SECTION 6.02 Stock Ledger. A stock ledger in one or more counterparts shall
be kept by the Corporation, in which shall be recorded the name and address of
each person, firm or corporation owning the Shares evidenced by
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each certificate evidencing Shares issued by the Corporation, the number of
Shares evidenced by each such certificate, the date of issuance thereof and, in
the case of cancellation, the date of cancellation. Except as otherwise
expressly required by law, the person in whose name Shares stand on the stock
ledger of the Corporation shall be deemed the owner and recordholder thereof for
all purposes. The Board may from time to time appoint such transfer agents or
registrars as it may deem advisable and may define their powers and duties. Any
such transfer agent or registrar need not be an employee of the Corporation.
SECTION 6.03 Transfers of Shares. Registration of transfers of Shares shall
be made only in the stock ledger of the Corporation upon request of the
registered holder of such shares, or of his attorney thereunto authorized by
power of attorney duly executed and filed with the Corporation, and upon the
surrender of the certificate or certificates evidencing such Shares properly
endorsed or accompanied by a stock power duly executed, together with such proof
of the authenticity of signatures as the Corporation may reasonably require.
SECTION 6.04 Addresses of Stockholders. Each Stockholder shall designate to
the Corporation an address at which notices of meetings and all other corporate
notices may be served or mailed to such Stockholder, and, if any Stockholder
shall fail to so designate such an address, corporate notices may be served upon
such Stockholder by mail directed to the mailing address, if any, as the same
appears in the stock ledger of the Corporation or at the last known mailing
address of such Stockholder.
SECTION 6.05 Lost, Destroyed and Mutilated Certificates. Each recordholder
of Shares shall promptly notify the Corporation of any loss, destruction or
mutilation of any certificate or certificates evidencing any Share or Shares of
which he is the recordholder. The Board, in its discretion, or any transfer
agent thereunto duly authorized by the Board, may authorize the issue of a new
certificate in place of any certificate theretofore issued and alleged to have
been mutilated, lost, stolen or destroyed, upon the surrender of the mutilated
certificate or, in the case of loss, theft or destruction of the certificate,
upon satisfactory proof of such loss, theft or destruction, and the Board may,
in its discretion, require, and its transfer agents and registrars may so
require, the recordholder of the Shares evidenced by the lost, stolen or
destroyed certificate or his legal representative to give the Corporation a bond
sufficient to indemnify the Corporation against any claim made against it on
account of the alleged loss, theft or destruction of any such certificate or the
issuance of such new certificate.
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SECTION 6.06 Regulations. The Board may make such other rules and
regulations as it may deem expedient, not inconsistent with these By-laws,
concerning the issue, transfer and registration of certificates evidencing
Shares.
SECTION 6.07 Fixing Date for Determination of Stockholders of Record. In
order that the Corporation may determine the Stockholders entitled to notice of
or to vote at any meeting of Stockholders or any adjournment thereof, or to
express consent to, or to dissent from, corporate action in writing without a
meeting, or entitled to receive payment of any dividend or other distribution or
allotment of any rights, or entitled to exercise any rights in respect of any
change, conversion or exchange of stock, or for the purpose of any other lawful
action, the Board may fix, in advance, a record date, which shall not be more
than 60 nor less than 10 days before the date of such meeting, nor more than 60
days prior to any other such action. A determination of the Stockholders
entitled to notice of or to vote at a meeting of Stockholders shall apply to any
adjournment of such meeting; provided, however, that the Board may fix a new
record date for the adjourned meeting.
ARTICLE VII
SEAL
SECTION 7.01 Seal. The Board may approve and adopt a corporate seal, which
shall be in the form of a circle and shall bear the full name of the
Corporation, the year of its incorporation and the words "Corporate Seal
Delaware".
ARTICLE VIII
FISCAL YEAR
SECTION 8.01 Fiscal Year. The fiscal year of the Corporation shall end on
the thirty-first day of December of each year unless changed by resolution of
the Board.
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ARTICLE IX
INDEMNIFICATION AND INSURANCE
SECTION 9.01 Indemnification. (a) The Corporation shall indemnify any
person who was or is a party or is threatened to be made a party to any
threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative (other than an action by or in the
right of the Corporation) by reason of the fact that he is or was a director,
officer, employee or agent of the Corporation, or is or was serving at the
request of the Corporation as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust or other enterprise, against
expenses (including attorneys' fees), judgments, fines and amounts paid in
settlement actually and reasonably incurred by him in connection with such
action, suit or proceeding if he acted in good faith and in a manner he
reasonably believed to be in, or not opposed to, the best interests of the
Corporation, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful. The termination of any
action, suit or proceeding by judgment, order, settlement, conviction, or upon a
plea of nolo contendere or its equivalent, shall not, of itself, create a
presumption that the person did not act in good faith and in a manner which he
reasonably believed to be in or not opposed to the best interests of the
Corporation, and, with respect to any criminal action or proceeding, had
reasonable cause to believe that his conduct was unlawful.
(b) The Corporation shall indemnify any person who was or is a party or is
threatened to be made a party to any threatened, pending or completed action or
suit by or in the right of the Corporation to procure a judgment in its favor by
reason of the fact that he is or was a director, officer, employee or agent of
the Corporation, or is or was serving at the request of the Corporation as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise against expenses (including attorneys' fees)
actually and reasonably incurred by him in connection with the defense or
settlement of such action or suit if he acted in good faith and in a manner he
reasonably believed to be in or not opposed to the best interests of the
Corporation and except that no indemnification shall be made in respect of any
claim, issue or matter as to which such person shall have been adjudged to be
liable to the Corporation unless and only to the extent that the Court of
Chancery of the State of Delaware or the court in which such action or suit was
brought shall determine upon application that, despite the adjudication of
liability but in view of all the circumstances of the case, such person is
fairly and reasonably entitled to indemnity for such expenses which the Court of
Chancery or such other court shall deem proper.
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(c) To the extent that a director, officer, employee or agent of the
Corporation has been successful on the merits or otherwise in defense of any
action, suit or proceeding referred to in Section 9.01(a) and (b) of these
By-laws, or in defense of any claim, issue or matter therein, he shall be
indemnified against expenses (including attorneys' fees) actually and reasonably
incurred by him in connection therewith.
(d) Any indemnification under Section 9.01(a) and (b) of these By-laws
(unless ordered by a court) shall be made by the Corporation only as authorized
in the specific case upon a determination that indemnification of the director,
officer, employee or agent is proper in the circumstances because he has met the
applicable standard of conduct set forth in Section 9.01(a) and (b) of these
By-laws. Such determination shall be made (i) by the Board by a majority vote of
a quorum consisting of directors who were not parties to such action, suit or
proceeding, or (ii) if such a quorum is not obtainable, or, even if obtainable,
a quorum of disinterested directors so directs, by independent legal counsel in
a written opinion, or (iii) by the stockholders of the Corporation.
(e) Expenses (including attorneys' fees) incurred by an officer or director
in defending any civil, criminal, administrative or investigative action, suit
or proceeding may be paid by the Corporation in advance of the final disposition
of such action, suit or proceeding upon receipt of an undertaking by or on
behalf of such director or officer to repay such amount if it shall ultimately
be determined that he is not entitled to be indemnified by the Corporation
pursuant to this Article IX. Such expenses (including attorneys' fees) incurred
by other employees and agents may be so paid upon such terms and conditions, if
any, as the Board deems appropriate.
(f) The indemnification and advancement of expenses provided by, or granted
pursuant to, other Sections of this Article IX shall not be deemed exclusive of
any other rights to which those seeking indemnification or advancement of
expenses may be entitled under any law, by-law, agreement, vote of stockholders
or disinterested directors or otherwise, both as to action in an official
capacity and as to action in another capacity while holding such office.
(g) For purposes of this Article IX, references to "the Corporation" shall
include, in addition to the resulting corporation, any constituent corporation
(including any constituent of a constituent) absorbed in a consolidation or
merger which, if its separate existence had continued, would have had power and
authority to indemnify its directors, officers, employees or agents so that any
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person who is or was a director, officer, employee or agent of such constituent
corporation, or is or was serving at the request of such constituent corporation
as a director, officer, employee or agent of another corporation, partnership,
joint venture, trust or other enterprise, shall stand in the same position under
the provisions of this Article IX with respect to the resulting or surviving
corporation as he would have with respect to such constituent corporation if its
separate existence had continued.
(h) For purposes of this Article IX, references to "other enterprises"
shall include employee benefit plans; references to "fines" shall include any
excise taxes assessed on a person with respect to an employee benefit plan; and
references to "serving at the request of the Corporation" shall include any
service as a director, officer, employee or agent of the Corporation which
imposes duties on, or involves service by, such director, officer, employee or
agent with respect to any employee benefit plan, its participants, or
beneficiaries; and a person who acted in good faith and in a manner he
reasonably believed to be in the interest of the participants and beneficiaries
of an employee benefit plan shall be deemed to have acted in a manner "not
opposed to the best interests of the Corporation" as referred to in this Article
IX.
(i) The indemnification and advancement of expenses provided by, or granted
pursuant to, this Article IX shall, unless otherwise provided when authorized or
ratified, continue as to a person who has ceased to be a director, officer,
employee or agent and shall inure to the benefit of the heirs, executors and
administrators of such a person.
SECTION 9.02 Insurance for Indemnification. The Corporation may purchase
and maintain insurance on behalf of any person who is or was a director,
officer, employee or agent of the Corporation, or is or was serving at the
request of the Corporation as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust or other enterprise, against any
liability asserted against him and incurred by him in any such capacity, or
arising out of his status as such, whether or not the Corporation would have the
power to indemnify him against such liability under the provisions of Section
145 of the General Corporation Law.
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ARTICLE X
AMENDMENTS
SECTION 10.01 Amendments. Any By-law (including these By-laws) may be
adopted, amended or repealed by the vote of the recordholders of a majority of
the Shares then entitled to vote at an election of Directors or by written
consent of Stockholders pursuant to Section 2.09 hereof, or by vote of the Board
or by a written consent of Directors pursuant to Section 3.08 hereof.
<PAGE>
EXHIBIT 10.01(b)
AMENDMENT TO
EMPLOYMENT AGREEMENT
AMENDMENT, DATED AS OF JANUARY 29, 1997, TO THE EMPLOYMENT AGREEMENT, DATED
AS OF JULY 18, 1991, AND AS AMENDED AND RESTATED IN FULL AS OF DECEMBER 30, 1994
(AS SO AMENDED AND RESTATED, THE "AGREEMENT"), BY AND BETWEEN AMBAC INC., A
DELAWARE CORPORATION (THE "COMPANY"), AND PHILLIP B. LASSITER (THE "EXECUTIVE").
WHEREAS, the Company and the Executive entered into the original version of
the Agreement as of July 18, 1991, in order to provide for the Executive to be
employed by the Company as its Chairman and Chief Executive Officer upon the
terms and conditions set forth in such original version, the Executive's
responsibilities subsequently having been enlarged to include President of the
Company; and
WHEREAS, the Company and the Executive agreed to certain amendments to the
original version of the Agreement and entered into the amended and restated
version of the Agreement as of December 30, 1994; and
WHEREAS, the Company and the Executive now wish to amend the Agreement in
the manner set forth herein, such amendments having been approved by the
Compensation and Organization Committee of the Company's Board of Directors;
NOW, THEREFORE, in consideration of the foregoing premises and of the
covenants and agreements herein contained, the parties hereto agree as follows
(all capitalized terms used herein without definition having the meanings
ascribed thereto in the Agreement):
1. DEFINITION OF CHANGE IN CONTROL. SECTION 10(C) OF THE AGREEMENT IS
AMENDED IN ITS ENTIRETY TO READ AS FOLLOWS:
"For purposes of this Agreement, a "Change in Control" shall be deemed
to occur on the date on which one of the following events occurs:
(i) the acquisition by any Person of beneficial ownership (within the
meaning of Rule 13d-3 promulgated under the Securities Exchange Act of
1934, as amended) of 20% or more of the common stock of the Company, par
value $0.01 per share (the "COMMON STOCK"), THEN OUTSTANDING, BUT SHALL NOT
INCLUDE ANY SUCH ACQUISITION BY:
(A) the Company;
(B) any Subsidiary of the Company;
(C) any employee benefit plan of the Company or of any
Subsidiary of the Company;
(D) any Person or entity organized, appointed or established by
the Company for or pursuant to the terms of any such plan;
(E) any Person who as of January 31, 1996 was the beneficial
owner of 15% or more of the shares of Common Stock
outstanding on such date unless and until such Person,
together with all affiliates and associates of such Person,
becomes the beneficial owner of 25% or more of the shares
of Common Stock then outstanding whereupon a Change in
Control shall be deemed to have occurred; or
<PAGE>
(F) any Person who becomes the Beneficial Owner of 20% or more,
or, with respect to a Person described in clause (E) above,
25% or more, of the shares of Common Stock then outstanding
as a result of a reduction in the number of shares of
Common Stock outstanding due to the repurchase of shares of
Common Stock by the Company unless and until such Person,
after becoming aware that such Person has become the
beneficial owner of 20% or more, or 25% or more, as the
case may be, of the then outstanding shares of Common
Stock, acquires beneficial ownership of additional shares
of Common Stock representing 1% or more of the shares of
Common Stock then outstanding, whereupon a Change in
Control shall be deemed to have occurred; or
(ii) individuals who, as of January 29, 1997, constitute the
Board, and subsequently elected members of the Board whose election is
approved or recommended by at least a majority of such current members or
their successors whose election was so approved or recommended (other than
any subsequently elected members whose initial assumption of office occurs
as a result of an actual or threatened election contest with respect to the
election or removal of directors or other actual or threatened solicitation
of proxies or consents by or on behalf of a person other than the Board),
cease for any reason to constitute at least a majority of such Board. As
used herein, "Person" means any individual, firm, corporation, partnership
or other entity, and "Subsidiary" means (i) a corporation or other entity
with respect to which the Company, directly or indirectly, has the power,
whether through the ownership of voting securities, by contract or
otherwise, to elect at least a majority of the members of such
corporation's board of directors or analogous governing body, or (ii) any
other corporation or other entity in which the Company, directly or
indirectly, has an equity or similar interest and which the Committee
designates as a Subsidiary for purposes of this Agreement."
2. AGREEMENT REMAINS IN FORCE. Except as modified by this Amendment,
the Agreement remains in full force and effect in accordance with the terms
thereof.
IN WITNESS WHEREOF the parties hereto have executed this Amendment as
of the day and year first written above.
AMBAC INC.
By:/s/ Richard B. Gross
--------------------
Richard B. Gross
Senior Vice President, General Counsel
and Secretary
/s/ Phillip B. Lassiter
-----------------------
Phillip B. Lassiter
16 Sutton Place - 12A
New York, NY 10022
<PAGE>
EXHIBIT 10.02
AMBAC INC. 1991 STOCK INCENTIVE PLAN
AS AMENDED THROUGH JANUARY 29, 1997
1. DEFINITIONS
(a) "Agreement" means an agreement between the Company and a Participant
setting forth the terms and conditions of an Award.
(b) "Award" means a stock option (including an incentive stock option under
Section 422 of the Code), stock appreciation right, performance unit award,
restricted stock award or other stock or stock-based award, or any combination
of them, as described in and granted under the Plan.
(c) "Board" means the Board of Directors of the Company.
(d) "Change in Control" means
(i) the acquisition by any Person of beneficial ownership
(within the meaning of Rule 13d-3 promulgated under the Exchange Act)
of 20% or more of the Common Stock then outstanding, but shall not
include any such acquisition by:
(A) the Company;
(B) any Subsidiary of the Company;
(C) any employee benefit plan of the Company or of any Subsidiary
of the Company;
(D) any Person or entity organized, appointed or established by
the Company for or pursuant to the terms of any such plan;
(E) any Person who as of January 31, 1996 was the beneficial owner
of 15% or more of the shares of Common Stock outstanding on such date
unless and until such Person, together with all affiliates and
associates of such Person, becomes the beneficial owner of 25% or more
of the shares of Common Stock then outstanding whereupon a Change in
Control shall be deemed to have occurred; or
(F) any Person who becomes the Beneficial Owner of 20% or more,
or, with respect to a Person described in clause (E) above, 25% or
more, of the shares of Common Stock then outstanding as a result of a
reduction in the number of shares of Common Stock outstanding due to
the repurchase of shares of Common Stock by the Company unless and
until such Person, after becoming aware that such
1
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2
Person has become the beneficial owner of 20% or more, or 25% or more,
as the case may be, of the then outstanding shares of Common Stock,
acquires beneficial ownership of additional shares of Common Stock
representing 1% or more of the shares of Common Stock then outstanding,
whereupon a Change in Control shall be deemed to have occurred; or
(ii) individuals who, as of January 29, 1997, constitute the
Board, and subsequently elected members of the Board whose election is
approved or recommended by at least a majority of such current members or
their successors whose election was so approved or recommended (other than
any subsequently elected members whose initial assumption of office occurs
as a result of an actual or threatened election contest with respect to the
election or removal of directors or other actual or threatened solicitation
of proxies or consents by or on behalf of a person other than the Board),
cease for any reason to constitute at least a majority of such Board.
(e) "Code" means the Internal Revenue Code of 1986, as amended.
(f) "Committee" means the committee referred to in Section 3(a) of the Plan.
(g) "Common Stock" means the Common Stock of the Company, par value $.01 per
share, or such other class or kind of share or other securities as may be
applicable under Section 12.
(h) "Company" means AMBAC Inc., a Delaware corporation, or any successor
to substantially all its business.
(i) "Employee" means an officer or other employee of the Company or a
Related Company.
(j) "ERISA" means the Employee Retirement Income Security Act of 1974, as
amended, and the rules and regulations thereunder.
(k) "Exchange Act" means the Securities and Exchange Act of 1934, as
amended, and the rules and regulations thereunder.
(l) "Fair Market Value" means the average of the highest and the lowest
quoted selling price of a share of Common Stock as reported on the composite
tape for securities listed on the New York Stock Exchange, or such other
national securities exchange as may be designated by the Committee, or, in the
event that the Common Stock is not listed for trading on a national securities
exchange but is quoted on an automated quotation system, on such automated
quotation system, in any such case on the valuation date (or, if there were no
sales on the valuation date, the average of
<PAGE>
3
the highest and the lowest quoted selling prices as reported on said composite
tape or automated quotation system for the most recent day during which a sale
occurred).
(m) "Incentive Stock Option" means a stock option that is intended to comply
with the requirements of Section 422 of the Code or any successor provision
thereto.
(n) "Participant" means an Employee who has been granted an Award under the
Plan.
(o) "Person" means any individual, firm, corporation, partnership or other
entity.
(p) "Plan" means the 1991 Stock Incentive Plan of the Company as described
herein.
(q) "Related Company" means any corporation or other entity in which the
Company has or obtains a proprietary interest by reason of stock ownership or
otherwise.
(r) "Subsidiary" means (i) a corporation or other entity with respect to
which the Company, directly or indirectly, has the power, whether through the
ownership of voting securities, by contract or otherwise, to elect at least a
majority of the members of such corporation's board of directors or analogous
governing body, or (ii) any other corporation or other entity in which the
Company, directly or indirectly, has an equity or similar interest and which the
Committee designates as a Subsidiary for purposes of the Plan.
2. PURPOSE
The Plan is intended to provide an incentive to selected Employees of the
Company and of its Related Companies to remain in the employ of the Company and
its Related Companies and to increase their interest in the success of the
Company by providing them with opportunities to increase their proprietary
interest in the Company and to receive compensation based upon the Company's
success.
3. ADMINISTRATION
(a) A committee (the "COMMITTEE") appointed by the Board shall be
responsible for administering the Plan. The Committee shall be comprised of two
or more members of the Board who qualify as "disinterested persons" as
contemplated by Rule 16b-3 promulgated under the Exchange Act, or any successor
provision thereto.
(b) The Committee shall have authority to adopt such rules as it may deem
appropriate to carry out the purposes of the Plan, and shall have authority to
interpret and construe the provisions of the Plan and any agreements under the
Plan and to make determinations pursuant to any Plan provision or agreement.
Each interpretation, determination or other action made or taken
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4
by the Committee pursuant to the Plan shall be final and binding on all persons.
No member of the Committee shall be liable for any action or determination made
in good faith, and the members of the Committee shall be entitled to
indemnification and reimbursement in the manner provided in the Company's
Certificate of Incorporation as it may be amended from time to time.
(c) The Committee may designate persons other than its members to carry out
its responsibilities under such conditions or limitations as it may set, except
that the Committee may not delegate (i) its authority with regard to Awards
(including decisions concerning the timing, pricing and amount of Awards)
granted to Employees who are officers or directors for purposes of Section 16(b)
of the Exchange Act or (ii) its authority pursuant to Section 10 to amend the
Plan.
4. ELIGIBILITY
Awards may be granted only to Employees. The Committee shall have the
authority to select the Participants to whom Awards may be granted and to
determine the number and form of Awards to be granted to each Participant.
5. STOCK SUBJECT TO THE PROVISIONS OF THE PLAN
(a) Subject to adjustment in accordance with the provisions of Section
12, and subject to Sections 5(c) and 5(d) below, the total number of shares of
Common Stock available for Awards under the Plan shall be:
(i) 1,500,000, plus
(ii) for each calendar year, starting with 1993, during any part of
which the Plan is in effect, a number of shares (hereinafter referred to as
the "Annual Limit" for such year) equal to 1.3% of the total number of
shares of Common Stock outstanding on a fully diluted basis as of the
immediately preceding December 31,
provided, however, that at no time may any Award be made that would cause the
cumulative number of shares of Common Stock subject to Award made under the Plan
since its inception to exceed 10% of the number of shares of Common Stock
outstanding on a fully diluted basis as of the last day of the most recently
completed fiscal quarter of the Company. Any unused portion of the Annual Limit
for any calendar year shall be carried forward and shall be available for Awards
in future years. Any shares issued under the Plan may consist, in whole or in
part, of authorized but unissued Common Stock or of treasury stock.
(b) For purposes of computing the number of shares Common Stock remaining
available for Awards at any time, there shall be debited against the total
number of shares determined to be available pursuant to Section 5(a) and 5(c)
(i) the number of shares of Common
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5
Stock issuable upon exercise of stock options granted pursuant to Section 6,
(ii) the number of shares of restricted stock awarded pursuant to Section 6 and
(iii) the maximum number of shares of Common Stock that may be issued under
performance unit Awards or other stock or stock-based Awards granted pursuant to
Section 6. In the case of a stock option granted in tandem with a stock
appreciation right, the exercise of the option or stock appreciation right will
reduce proportionately the number of shares subject to the tandem stock
appreciation right or option, as the case may be. Any shares ceasing to be
subject to the tandem option or right because of such reduction shall not be
available for future Awards granted under the Plan.
(c) Any shares represented by Awards which are forfeited, terminated, paid
in cash or expire unexercised, any shares which have been exchanged by a
Participant or withheld by the Company as full or partial payment to the Company
in connection with any Award (including in connection with the payment of any
taxes related to such Award), and the excess amount of variable Awards which
become fixed at less than their maximum limitations (including as such any
Awards denominated in a specified number of shares of Common Stock that are
settled by issuance of a lesser number of shares), shall again be available for
grants and issuance under the Plan, provided, however, that the Committee may
limit the application of this Section 5(c) in any manner that it considers
necessary or appropriate to ensure that the Plan complies with the requirements
of Rule 16b-3 under the Exchange Act or any successor provision.
(d) At no time may any Award be made that would cause the cumulative number
of shares of Common Stock (and of units denominated in Common Stock) granted to
Participants under the Plan for no consideration other than the provision of
services, or sold for consideration in cash, other property or a combination of
cash and other property the aggregate value of which (as determined by the
Committee) is less than the Fair Market Value of such shares, since the
inception of the Plan to exceed 4% of the total number of shares of Common Stock
outstanding on a fully diluted basis as of the last day of the most recently
completed fiscal quarter of the Company, provided, however, that any such shares
or units that are granted in lieu of cash compensation that otherwise would be
paid to a Participant, or that are granted in satisfaction of any other
obligation owed by the Company or a Related Company (including without
limitation obligations under the former AMBAC Indemnity Corporation Long-Term
Incentive Plan) to a Participant (other than an obligation to a newly hired
employee), shall not be counted against such limitation.
<PAGE>
6
6. AWARDS UNDER THE PLAN
(a) Restricted Stock
(i) General. Subject to Section 5(d), shares of Common Stock may be
granted to a Participant for no consideration other than the provision of
services or may be offered for sale to a Participant at a purchase price
determined by the Committee. Such shares of Common Stock shall be subject to
such restrictions on transfer or other incidents of ownership for such
periods of time, and shall be subject to such conditions of vesting, as the
Committee may determine and as shall be set forth in the Agreement relating
to such stock. (Shares subject to such restrictions are referred to herein
as "Restricted Shares.") If shares of Common Stock are offered for sale
under the Plan, the purchase price shall be payable in cash, or, in the sole
discretion of the Committee and to the extent provided in any applicable
Agreement, in shares of Common Stock already owned by the Participant, for
other consideration acceptable to the Committee or in any combination of
cash, shares of Common Stock or such other consideration.
(ii) Share Certificates; Rights and Privileges. At the time
Restricted Shares are granted or sold to a Participant, share certificates
representing the appropriate number of Restricted Shares shall be registered
in the name of the Participant but shall be held by the Company in custody
for the account of such person. The certificates shall bear a legend
restricting their transferability as provided herein. Except for such
restrictions on transfer or other incidents of ownership as may be
determined by the Committee and set forth in the Agreement relating to an
award or sale of Restricted Shares, a Participant shall have the rights of a
stockholder as to such Restricted Shares, including the right to receive
dividends and the right to vote in accordance with the Company's Restated
Certificate of Incorporation.
(iii) Distributions. Any shares of Common Stock or other securities of
the Company received by a Participant to whom Restricted Shares have been
granted or sold as a result of a stock distribution to holders of Common
Stock or as a stock dividend on Common Stock shall be subject to the same
terms, conditions and restrictions as such Restricted Shares.
<PAGE>
7
(b) Stock Options
(i) General. A stock option shall entitle the Participant to whom
the option is granted to purchase a specified number of shares of Common
Stock during a specified time at an exercise price that is fixed at the time
of grant or for which the method of determining the exercise price is
specified at the time of grant, all as the Committee may determine. With
respect to any stock option granted on or after March 3, 1993, the per share
exercise price of any stock options whose price is fixed at the time of
grant shall not be less than the Fair Market Value of a share of Common
Stock as of the date of grant, and the per share exercise price of any stock
option whose price is not fixed at the time of grant but for which the
method of determining the exercise price is specified at the time of grant
shall be not less than the Fair Market Value of a share of Common Stock as
of the date on which such exercise price is so determined. Payment of the
exercise price shall be made in cash, or, to the extent provided in the
Agreement relating to the option, in shares of Common Stock (including
shares already owned by the Participant or to be issued to the Participant
upon exercise of the option) or in any combination of cash and shares of
Common Stock. The Agreement relating to a stock option shall set forth the
applicable vesting schedule. A stock option shall be effective for such term
as shall be determined by the Committee and set forth in the Agreement
relating to such option.
(ii) Incentive Stock Options. Each stock option granted pursuant to
the Plan shall be designated at the time of grant as either an Incentive
Stock Option (or shall otherwise be designated as an option entitled to
favorable treatment under the Code) or as a "nonqualified stock option." The
aggregate fair market value (within the meaning of the Code and determined
at the time of grant of the Award) of the stock with respect to which
Incentive Stock Options are exercisable for the first time by a Participant
during a calendar year shall not exceed $100,000, or such other limit as may
from time to time be established under the Code. No Incentive Stock Option
may be issued pursuant to the Plan to any individual who, at the time the
option is granted, owns stock possessing more than 10% of the total combined
voting power of all classes of stock of the Company or any of its
subsidiaries, unless (A) the exercise price determined as of the date of
grant is at least 110% of the Fair Market Value on the date of grant of the
shares of Common Stock subject to such option, and (B) the Incentive Stock
Option is not exercisable more than five years from the date of grant
thereof.
(c) Stock Appreciation Rights
(i) General. A stock appreciation right shall entitle a Participant
to receive, upon exercise, (x) an amount in cash equal to the excess, if
any, of the Fair Market Value on the exercise date of the number of shares
of Common Stock for which the stock appreciation right is exercised, over
the Fair Market Value of such number of shares on the
<PAGE>
8
date of grant (or, in the case of a stock appreciation right granted in
tandem with a stock option, the aggregate exercise price which the
Participant would otherwise have been required to pay under the terms of the
stock option in order to purchase such shares), or (y) a number of shares of
Common Stock having an aggregate Fair Market Value, as of the date of
exercise, equal to the amount determined as in the preceding clause (x), or
(z) a combination of cash and shares having an aggregate value equal to the
amount determined as in the preceding clause (x).
(ii) Exercisability. The Committee shall determine whether payments
in respect of a stock appreciation right shall be in cash, shares of Common
Stock or a combination thereof. A stock appreciation right shall be
exercisable at the time or times established by the Committee at the time of
grant. If a stock appreciation right is granted in tandem with a stock
option, the stock appreciation right shall not be exercisable prior to or
later than the time the related stock option could be exercised.
(d) Performance Units. Performance units may be granted as fixed or
variable share-or dollar-denominated units subject to such conditions of vesting
and time of payment as the Committee may determine and as shall be set forth in
the Agreement relating to such performance units. Performance units may be paid
in Common Stock, cash or a combination of Common Stock and cash, as the
Committee may determine.
(e) Other Stock or Stock-Based Awards. An Award other than as described in
subsections (a) through (d) above may be granted pursuant to which Common Stock
is or in the future may be acquired, or which is valued or determined in whole
or part by reference to, or otherwise based upon, Common Stock.
(f) General Terms. The following terms and conditions shall be applicable
to Awards:
(i) Dividend Equivalents. The Committee may provide Participants
with the right to receive payments equivalent to dividends or interest with
respect to an outstanding Award, which payments can either be paid currently
or deemed to have been reinvested in shares of Common Stock. Payment of such
amounts can be made in Common Stock, cash or a combination of Common Stock
and cash, as the Committee shall determine.
(ii) Transfers. Unless the Committee determines otherwise, no Award
shall be transferable other than by will or by the laws of descent and
distribution or pursuant to a domestic relations order; provided, however,
that the Committee may, in its discretion and subject to such terms and
conditions as it shall specify, permit the transfer of an Award for no
consideration to a Participant's family members or to one or more trusts or
partnerships established in whole or in part for the benefit of one or more
of such family members (collectively, "PERMITTED TRANSFEREES"). Any Award
transferred to a Permitted Transferee
<PAGE>
9
shall be further transferable only by will or the laws of descent and
distribution or, for no consideration, to another Permitted Transferee of
the Participant. The Committee may in its discretion permit transfers of
Awards other than those contemplated by this Section.
(iii) Award Exercisable Only by Participant and Permitted Transferees.
During the lifetime of a Participant, a stock option, stock appreciation
right or other Award providing for exercise shall be exercisable only by the
Participant or by a Permitted Transferee to whom such stock option, stock
appreciation right or other Award has been transferred in accordance with
Section 6(f)(ii). The grant of an Award shall impose no obligation on a
Participant to exercise the Award.
(iv) Rights of a Stockholder. A Participant shall have no rights as a
stockholder with respect to shares covered by an Award until the date the
Participant or his nominee becomes the holder of record of such shares. No
adjustment will be made for dividends or other rights for which the record
date is prior to such date, except as provided in Section 12.
(v) Limitation on Exercise. An Award may not be exercised, and no
shares of Common Stock may be issued in connection with an Award, unless the
issuance of such shares has been registered under the Securities Act of
1933, as amended, and qualified under applicable state "blue sky" laws, or
the Company has determined that an exemption from registration and from
qualification under such state "blue sky" laws is available.
(vi) Single or Tandem Grants. Any Award described in subsections (a)
through (e) above may be granted singly or in combination or tandem with any
other Award, as the Committee may determine. Awards may be made in
combination with, in replacement of or as alternatives to grants or rights
under any other employee or compensation plan of the Company, including the
plan of any acquired entity.
7. AGREEMENTS
The terms and conditions of each Award shall be embodied in an Agreement in
a form approved by the Committee, which shall contain terms and conditions not
inconsistent with the Plan and which shall incorporate the Plan by reference.
<PAGE>
10
8. TERMINATION OF EMPLOYMENT
The Agreement relating to an Award will set forth provisions governing the
disposition of an Award in the event of the retirement, disability, death or
other termination of a Participant's employment.
9. TAX WITHHOLDING
The Company or a subsidiary thereof, as appropriate, may require any
individual entitled to receive a payment in respect of an Award to remit to the
Company, prior to such payment, an amount sufficient to satisfy any Federal,
state or local tax withholding requirements. The Company or a subsidiary
thereof, as appropriate, shall also have the right to deduct from all cash
payments made pursuant to or in connection with any Award any Federal, state or
local taxes required to be withheld with respect to such payments. In addition,
the Company may permit any individual to whom an Award has been made to satisfy,
in whole or in part, such obligation to remit taxes, by directing the Company to
withhold shares of Common Stock that would otherwise be received by such
individual upon settlement or exercise of such Award, pursuant to such rules as
the Committee may establish from time to time.
10. AMENDMENTS
The Committee may at any time and from time to time alter, amend, suspend or
terminate the Plan in whole or in part, provided, however, that any amendment
which under the requirements of applicable law must be approved by the
stockholders of the Company shall not be effective unless and until such
stockholder approval has been obtained in compliance with such law, and
provided, further, that any amendment that must be approved by the stockholders
of the Company in order to maintain the continued qualification of the Plan
under Rule 16b-3 under the Exchange Act, or any successor provision, shall not
be effective unless and until such stockholder approval has been obtained in
compliance with such rule. No termination or amendment of the Plan may, without
the consent of the Participant to whom an Award has been granted, adversely
affect the rights of such Participant under such Award.
11. APPLICATION OF FUNDS
The proceeds received by the Company from the sale of Common Stock or other
securities pursuant to Awards will be used for general corporate purposes.
<PAGE>
11
12. ADJUSTMENT OF AND CHANGES IN SHARES
In the event of any merger, consolidation, recapitalization,
reclassification, stock dividend, distribution of property, special cash
dividend, or other change in corporate structure affecting the shares, the
Committee shall make such adjustments, if any, as it deems appropriate in the
number and class of shares subject to, and the exercise price of, outstanding
options granted under the Plan, and in the value of, or number or class of
shares subject to, other Awards granted or available to be granted under the
Plan. The foregoing adjustments shall be determined by the Committee in its sole
discretion.
13. NO RIGHT TO EMPLOYMENT
No person shall have any claim or right to receive grants of Awards under
the Plan. Neither the Plan, the grant of Awards under the Plan, nor any action
taken or omitted to be taken under the Plan shall be deemed to create or confer
on any employee any right to be retained in the employ of the Company or any
subsidiary or other affiliate thereof, or to interfere with or to limit in any
way the right of the Company or any subsidiary or other affiliate thereof to
terminate the employment of such employee at any time.
14. CHANGE IN CONTROL
In order to maintain the Participants' rights in the event of a Change in
Control, the Committee, in its sole discretion, may, either at the time an Award
is made hereunder or at any time prior to, or coincident with or after the time
of a Change in Control:
(i) provide for the acceleration of any time periods relating to the
exercise or realization of such Awards so that such Awards may be exercised
or realized in full on or before a date fixed by the Committee;
(ii) provide for the purchase of such Awards, upon the Participant's
request, for an amount of cash equal to the amount which could have been
obtained upon the exercise or realization of such rights had such Awards
been currently exercisable or payable;
(iii) make such adjustments to the Awards then outstanding as the
Committee deems appropriate to reflect such Change in Control; or
(iv) cause the Awards then outstanding to be assumed, or new rights
substituted therefor, by the surviving corporation in such Change in
Control.
<PAGE>
12
The Committee may, in its discretion, include such further provisions and
limitations in any agreement documenting such Awards as it may deem equitable
and in the best interests of the Company in the event of a Change in Control,
except that in no event may the Committee take actions that would cause the Plan
to lose qualification under Rule 16b-3 under the Exchange Act, or take actions
that will enable any Participant to incur liability under Section 16(b) of the
Exchange Act.
15. GOVERNING LAW
The Plan and all agreements entered into under the Plan shall be construed
in accordance with and governed by the laws of the state of Delaware.
16. EFFECTIVE DATE
The effective date of this Plan shall be the date of the consummation of the
"Equity Offerings", as such term is defined in the Company's Registration
Statement No. 33-40306 on Form S-1.
17. TERM OF THE PLAN
Unless earlier terminated pursuant to Section 10, the Plan shall terminate
on the tenth anniversary of the effective date provided for in Section 16,
except with respect to Awards then outstanding.
18. NO RESTRICTION ON RIGHT OF COMPANY TO EFFECT CORPORATE CHANGES
The Plan shall not affect in any way the right or power of the Company or
its stockholders to make or authorize any or all adjustments, recapitalization,
reorganizations or other changes in the Company's capital structure or its
business, or any merger or consolidation of the Company, or any issue of stock
or of options, warrants or rights to purchase stock or of bonds, debentures,
preferred or prior preference stocks whose rights are superior to or affect the
Common Stock or the rights thereof or which are convertible into or exchangeable
for Common Stock, or the dissolution or liquidation of the Company, or any sale
or transfer of all or any part of its assets or business, or any other corporate
act or proceeding, whether of a similar character or otherwise.
<PAGE>
13
19. EXCHANGE ACT
Notwithstanding anything contained in the Plan or any agreement under the
Plan to the contrary, if the consummation of any transaction under the Plan, or
the taking of any action by the Committee in connection with a Change in
Control, would result in the possible imposition of liability on a Participant
pursuant to Section 16(b) of the Exchange Act, the Committee shall have the
right, in its sole discretion, but shall not be obligated, to defer such
transaction or the effectiveness of such action to the extent necessary to avoid
such liability, but in no event for a period longer than 180 days.
<PAGE>
EXHIBIT 10.06(b)
FORM OF AMENDMENT NO. 1
TO MANAGEMENT RETENTION AGREEMENT
AMENDMENT NO. 1, DATED AS OF JANUARY 29, 1997, TO THE MANAGEMENT RETENTION
AGREEMENT, MADE AS OF DECEMBER 30, 1994 (THE "AGREEMENT"), BY AND BETWEEN AMBAC
INC., A DELAWARE CORPORATION (THE "COMPANY"), AND THE OFFICER NAMED ON THE
SIGNATURE PAGE OF THIS AMENDMENT NO. 1 (THE "EXECUTIVE").
WHEREAS, the Company and the Executive entered into the Agreement in order
to further the Company's policy of fostering the continuous employment of key
management personnel, such as the Executive, in the event of any actual or
threatened change in control by providing for the payment of severance and other
benefits in the event of the Executive's termination of employment following a
change in control; and
WHEREAS, the Company and the Executive have agreed to amend the Agreement
in the manner set forth herein, such amendments having been approved by the
Compensation and Organization Committee of the Company's Board of Directors;
NOW, THEREFORE, in consideration of the foregoing premises and of the
covenants and agreements herein contained, the parties hereto agree as follows
(all capitalized terms used herein without definition having the meanings
ascribed thereto in the Agreement):
1. DEFINITION OF CHANGE IN CONTROL.
(a) Addition of Cross-Reference. The first sentence of Section 2 of the
Agreement is amended by adding the expression "(as defined in Section 7(i) of
this Agreement)" immediately following the words "on the date of any Change in
Control" occurring in such sentence.
(b) Elimination of Old Definition. The third sentence of Section 2 of the
Agreement, which sets forth the definition of "Change in Control" currently
applicable to the Agreement, is eliminated in its entirety.
(b) Addition of New Definition. A new Section 7(i) is added to the
Agreement as follows:
"(i) CHANGE IN CONTROL. For purposes of this Agreement, a "Change in
Control" shall be deemed to occur on the date on which one of the following
events occurs:
(i) the acquisition by any Person of beneficial ownership (within
the meaning of Rule 13d-3 promulgated under the Securities Exchange Act of
1934, as amended) of 20% or more of the common stock of the Company, par
value $0.01 per share (the "COMMON STOCK"), then outstanding, but shall not
include any such acquisition by:
(A) the Company;
(B) any Subsidiary of the Company;
(C) any employee benefit plan of the Company or of any
Subsidiary of the Company;
(D) any Person or entity organized, appointed or established by
the Company for or pursuant to the terms of any such plan;
<PAGE>
(E) any Person who as of January 31, 1996 was the beneficial
owner of 15% or more of the shares of Common Stock outstanding on such
date unless and until such Person, together with all Affiliates and
associates of such Person, becomes the beneficial owner of 25% or more
of the shares of Common Stock then outstanding whereupon a Change in
Control shall be deemed to have occurred; or
(F) any Person who becomes the Beneficial Owner of 20% or more,
or, with respect to a Person described in clause (E) above, 25% or
more, of the shares of Common Stock then outstanding as a result of a
reduction in the number of shares of Common Stock outstanding due to
the repurchase of shares of Common Stock by the Company unless and
until such Person, after becoming aware that such Person has become
the beneficial owner of 20% or more, or 25% or more, as the case may
be, of the then outstanding shares of Common Stock, acquires
beneficial ownership of additional shares of Common Stock representing
1% or more of the shares of Common Stock then outstanding, whereupon a
Change in Control shall be deemed to have occurred; or
(ii) individuals who, as of January 29, 1997, constitute the Board,
and subsequently elected members of the Board whose election is approved
or recommended by at least a majority of such current members or their
successors whose election was so approved or recommended (other than any
subsequently elected members whose initial assumption of office occurs
as a result of an actual or threatened election contest with respect to
the election or removal of directors or other actual or threatened
solicitation of proxies or consents by or on behalf of a person other
than the Board), cease for any reason to constitute at least a majority
of such Board.
As used herein, "Person" means any individual, firm, corporation,
partnership or other entity, and "Subsidiary" means (i) a corporation or
other entity with respect to which the Company, directly or indirectly,
has the power, whether through the ownership of voting securities, by
contract or otherwise, to elect at least a majority of the members of
such corporation's board of directors or analogous governing body, or
(ii) any other corporation or other entity in which the Company,
directly or indirectly, has an equity or similar interest and which the
Committee designates as a Subsidiary for purposes of this Agreement."
2. AGREEMENT REMAINS IN FORCE. Except as modified by this
Amendment no. 1, the Agreement remains in full force and effect in accordance
with the original terms thereof.
IN WITNESS WHEREOF the parties hereto have executed this
Amendment No. 1 as of the day and year first written above.
AMBAC INC.
By:
---------------------------- -----------------------------------
Name: Name:
Title: Address:
<PAGE>
EXHIBIT 10.16
AMENDMENT NO. 3 TO CREDIT AGREEMENT
-----------------------------------
AMENDMENT NO. 3 TO CREDIT AGREEMENT (this "Amendment") dated as of December
2, 1996 among AMBAC Indemnity Corporation (the "Borrower"), Deutsche Bank AG,
New York Branch ("Deutsche Bank"), Landesbank Hessen-Thuringen Girozentrale,
("Helaba"), Bayerische Landesbank Girozentrale, ("BLG"), Cooperatieve Centrale
Raiffeisen-Boerenleenbank B.A., "Rabobank Nederland", New York Branch
("Rabobank" and, together with Helaba and BLG, the "New Banks"), and Deutsche
Bank AG, New York Branch, as Agent (the "Agent").
W I T N E S S E T H :
- - - - - - - - - -
WHEREAS, the Borrower, Deutsche Bank and the Agent have entered into a
Credit Agreement, dated as of December 2, 1993 (as amended to date, the
"Agreement"); and
WHEREAS, each of the New Banks desire to become, and the Borrower, Deutsche
Bank and the Agent desire that the New Banks become, Banks pursuant to and for
purposes of the Agreement; and
WHEREAS, the parties hereto desire to amend the Agreement as herein
provided; and
WHEREAS, pursuant to Section 12.12 of the Agreement, the Agreement may be
amended by the written agreement of the Borrower, the Banks and the Agent;
NOW, THEREFORE, in consideration of the premises and the mutual covenants
herein contained, the parties hereto hereby agree as follows:
1. Defined Terms. Capitalized terms used herein and not
-------------
otherwise defined herein shall have the meanings assigned to such terms in the
Agreement.
2. Amendments. (a) The "December 2, 2002" date set forth in
----------
the first sentence of Section 3.04 is hereby amended to "December 2, 2003".
<PAGE>
(b) Schedule I is hereby deleted in its entirety and replaced with Exhibit
A attached hereto.
3. No Default. The Borrower hereby represents and warrants to
----------
the Banks and the Agent that, both before and after giving effect to this
Amendment, no Default or Event of Default exists.
4. Representations and Warranties. The Borrower hereby
------------------------------
represents and warrants to the Banks and the Agent that, both before and after
giving effect to this Amendment, the representations and warranties contained in
Section 7 of the Agreement are true and correct in all material respects on and
as of the date hereof.
5. Counterparts. This Amendment may be executed simultaneously
------------
in two or more counterparts, each of which shall be deemed to be an original,
and it shall not be necessary in making proof of this Amendment to produce or
account for more than one such counterpart.
6. Agreement Not Otherwise Amended. Terms and provisions of
-------------------------------
the Agreement not amended hereby shall continue to remain in full force and
effect. From and after the date hereof, all references in the Agreement and
each of the Credit Documents to the Agreement shall be deemed references to the
Agreement as amended by this Amendment.
7. GOVERNING LAW. THIS AMENDMENT AND THE RIGHTS AND
-------------
OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE CONSTRUED IN ACCORDANCE WITH AND
GOVERNED BY THE LAWS OF THE STATE OF NEW YORK.
IN WITNESS WHEREOF, each of the parties hereto has caused this Amendment to
be executed and delivered on its behalf, all on the date first above written.
AMBAC INDEMNITY CORPORATION
By /s/ Frank Bivona
------------------------------
Title: SVP, CFO & Treas.
-2-
<PAGE>
DEUTSCHE BANK AG, NEW
YORK BRANCH, Individually
and as Agent
By /s/ Eckhard Osenberg
------------------------------
Title: AVP
By /s/ Louis Caltavuturo
------------------------------
Title: AVP
Address:
LANDESBANK HESSEN-THURINGEN
420 Fifth Avenue GIROZENTRALE
24th Floor
New York, New York 10018
Attention: Mr. Richard Skierra By /s/ Lisa S. Pent
----------------
Title: SVP, Manager
By /s/ Richard E. Skiera
---------------------
Title: AVP
BAYERISCHE LANDESBANK
560 Lexington Avenue GIROZENTRALE
22nd Floor
New York, New York 10022
Attention: Mr. Scott Allison By /s/ Peter Obermann
------------------
Title: SVP
By /s/ Wilfried Freudenberger
--------------------------
Title: EVP
COOPERATIEVE CENTRALE
245 Park Avenue RAIFFEISEN-BOERENLEENBANK
New York, New York 10167 B.A.,"RABOBANK NEDERLAND",
Attention: Corporate Services NEW YORK BRANCH
Department
By /s/ Ian Reece
-------------
Title: VP & Manager
By /s/ Angela R. Reilly
--------------------
Title: VP
-3-
<PAGE>
EXHIBIT A
---------
SCHEDULE I
----------
COMMITMENTS
-----------
BANK COMMITMENT AMOUNT
---- -----------------
DEUTSCHE BANK AG, NEW YORK BRANCH $213,000,000
LANDESBANK HESSEN-THURINGEN GIROZENTRALE 35,000,000
BAYERISCHE LANDESBANK GIROZENTRALE 30,000,000
COOPERATIEVE CENTRALE RAIFFEISEN- 72,000,000
BOERENLEENBANK B.A., "RABOBANK
NEDERLAND", NEW YORK BRANCH
---------------
TOTAL $350,000,000
============
<PAGE>
EXHIBIT 10.17
AMENDMENT NO. 4 TO CREDIT AGREEMENT
-----------------------------------
AMENDMENT NO. 4 TO CREDIT AGREEMENT (this "Amendment") dated as of February
14, 1997 among AMBAC Indemnity Corporation (the "Borrower"), Deutsche Bank AG,
New York Branch ("Deutsche Bank"), Landesbank Hessen-Thuringen Girozentrale,
("Helaba"), Bayerische Landesbank Girozentrale, ("BLG"), Cooperatieve Centrale
Raiffeisen-Boerenleenbank B.A., "Rabobank Nederland", New York Branch
("Rabobank" and, together with Deutsche Bank, Helaba and BLG, the "Banks"), and
Deutsche Bank AG, New York Branch, as Agent (the "Agent").
W I T N E S S E T H :
- - - - - - - - - -
WHEREAS, the Borrower, the Banks and the Agent have entered into a Credit
Agreement, dated as of December 2, 1993 (as amended to date, the "Agreement");
and
WHEREAS, Deutsche Bank desires to be removed as a Bank, and transfer all of
its interest in the Agreement to the Helaba, BLG and Rabobank; and
WHEREAS, Helaba, BLG and Rabobank are willing to accept a transfer of
Deutsche Bank's interest in the Agreement by amendment to the Agreement as
herein provided; and
WHEREAS, pursuant to Section 12.12 of the Agreement, the Agreement may be
amended by the written agreement of the Borrower, the Banks and the Agent;
NOW, THEREFORE, in consideration of the premises and the mutual covenants
herein contained, the parties hereto hereby agree as follows:
1. Defined Terms. Capitalized terms used herein and not
-------------
otherwise defined herein shall have the meanings assigned to such terms in the
Agreement.
2. Amendment. Schedule I is hereby deleted in its entirety and
---------
replaced with Exhibit A attached hereto.
<PAGE>
3. No Default. The Borrower hereby represents and warrants to
----------
the Banks and the Agent that, both before and after giving effect to this
Amendment, no Default or Event of Default exists.
4. Representations and Warranties. The Borrower hereby
------------------------------
represents and warrants to the Banks and the Agent that, both before and after
giving effect to this Amendment, the representations and warranties contained in
Section 7 of the Agreement are true and correct in all material respects on and
as of the date hereof.
5. Counterparts. This Amendment may be executed simultaneously
------------
in two or more counterparts, each of which shall be deemed to be an original,
and it shall not be necessary in making proof of this Amendment to produce or
account for more than one such counterpart.
6. Agreement Not Otherwise Amended. Terms and provisions of
-------------------------------
the Agreement not amended hereby shall continue to remain in full force and
effect. From and after the date hereof, all references in the Agreement and
each of the Credit Documents to the Agreement shall be deemed references to the
Agreement as amended by this Amendment.
7. GOVERNING LAW. THIS AMENDMENT AND THE RIGHTS AND
-------------
OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE CONSTRUED IN ACCORDANCE WITH AND
GOVERNED BY THE LAWS OF THE STATE OF NEW YORK.
IN WITNESS WHEREOF, each of the parties hereto has caused this Amendment to
be executed and delivered on its behalf, all on the date first above written.
AMBAC INDEMNITY CORPORATION
By /s/ Phillip Lassiter
--------------------------------
Title: Chairman, Pres. &
CEO
-2-
<PAGE>
DEUTSCHE BANK AG, NEW
YORK BRANCH, Individually
and as Agent
By /s/ Eckhard Osenberg
--------------------------------
Title: AVP
By /s/ Louis Caltavuturo
--------------------------------
Title: AVP
LANDESBANK HESSEN-THURINGEN
GIROZENTRALE
By /s/ Lisa S. Pent
-------------------
Title: SVP & Manager
By /s/ Richard E. Skiera
------------------------
Title: AVP
BAYERISCHE LANDESBANK
GIROZENTRALE
By /s/Wilfried Freudenberger
----------------------------
Title: EVP & Gen. Manager
By /s/ Peter Obermann
---------------------
Title:SVP, Man. Lend. Div.
COOPERATIEVE CENTRALE
RAIFFEISEN-BOERENLEENBANK
B.A.,"RABOBANK NEDERLAND",
NEW YORK BRANCH
By /s/ Ian Reece
----------------
Title: VP & Manager
By /s/ Angela R. Reilly
-----------------------
Title: VP
-3-
<PAGE>
EXHIBIT A
---------
SCHEDULE I
----------
COMMITMENTS
-----------
BANK COMMITMENT AMOUNT
---- -----------------
LANDESBANK HESSEN-THURINGEN GIROZENTRALE $ 82,000,000
BAYERISCHE LANDESBANK GIROZENTRALE 81,000,000
COOPERATIEVE CENTRALE RAIFFEISEN- 187,000,000
BOERENLEENBANK B.A., "RABOBANK
NEDERLAND", NEW YORK BRANCH
-----------------
TOTAL $350,000,000
============
<PAGE>
EXHIBIT 11
AMBAC INC. AND SUBSIDIARIES
STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1996 1995 1994
---------- --------- ----------
<S> <C> <C> <C>
Net income.............................. $276,317 $167,595 $141,105
-------- -------- --------
Fully diluted shares:
Average number of common shares
outstanding.......................... 34,965 35,101 35,207
Assumed exercise of dilutive stock
options (1).......................... 935 540 416
-------- -------- --------
35,900 35,641 35,623
-------- -------- --------
Earnings per share assuming full
dilution (2)........................... $ 7.70 $ 4.70 $ 3.96
======== ======== ========
</TABLE>
(1) As of December 31, 1996, approximately 2,175,000 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 $82.3 million. The dilution
would be the equivalent of approximately 935,000 shares, using the Treasury
Stock Method, based upon a market value of $66.38 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 31 of the 1996 Annual
Report to Stockholders reflect net income per common share of $7.90 for the
year ended December 31, 1996.
E-1
<PAGE>
EXHIBIT 13.01
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS HIGHLIGHTS
(Dollars in Millions Except Per Share Amounts)
Years ended December 31 1996 1995 1994 1993 1992
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Gross premiums written $ 247.2 $ 193.3 $ 189.9 $ 318.3 $ 255.1
Net premiums earned 136.6 111.8 117.5 152.0 103.4
Net investment income 144.9 131.0 117.1 104.6 99.7
Losses and loss adjustment expenses 3.8 3.4 2.6 (1.8) 4.3
Underwriting and operating expenses 37.2 34.5 32.8 34.5 27.8
Financial guarantee operating income 225.3 210.8 189.6 255.6 188.0
Financial services operating income (loss) 10.9 5.2 10.6 7.5 (0.3)
Equity in income (loss) of affiliate 0.6 (0.2) 1.5 0.5 (1.0)
Interest expense 20.9 20.9 18.8 15.8 14.2
Net income 276.3 167.6 141.1 179.3 130.2
Net income per common share 7.90 4.78 4.01 5.08 3.71
BALANCE SHEET HIGHLIGHTS
(Dollars in Millions) As of December 31
- -----------------------------------------------------------------------------------------------------------------------------------
Total investments $ 5,200.5 $ 4,441.6 $ 3,764.2 $ 3,132.7 $ 1,769.3
Prepaid reinsurance 168.8 153.4 139.9 161.3 154.3
Total assets 5,876.0 5,309.3 4,287.0 3,807.2 2,228.8
Unearned premiums 991.2 903.0 836.6 782.8 645.3
Losses and loss adjustment expenses 60.2 66.0 65.7 64.0 64.8
Obligations under municipal investment
contracts and municipal investment
repurchase contracts 2,754.6 2,426.9 2,025.3 1,477.7 382.0
Debentures 223.8 223.7 223.7 223.6 149.2
Total stockholders' equity 1,615.0 1,404.0 1,033.5 1,099.7 861.3
Dividends declared - common stock 21.5 19.5 17.4 15.9 14.4
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
NET INCOME ($ MILLIONS)
[THE FOLLOWING WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL}
See Statement of Operations Highlights above
RETURN ON EQUITY
[THE FOLLOWING WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL}
1992, 16.2%; 1993, 18.3%; 1994, 13.2%; 1995, 13.8%; 1996, 18.3%; 5 yr. avg.,
16.0%
NET INCOME PER COMMON SHARE
[THE FOLLOWING WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL}
See Statement of Operations Highlights above
CAPITAL RATIO/FINANCIAL RESOURCES RATIO(1)
[THE FOLLOWING WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL}
1992, 138:1/79:1; 1993, 133:1/70:1; 1994, 141:1/72:1; 1995, 147:1/73:1; 1996,
155:1/76:1
(1) Capital ratio is net insurance in force divided by qualified statutory
capital. Qualified statutory capital is the aggregate of policyholders'
surplus and contingency reserves, calculated in accordance with statutory
accounting principles.
Financial resources ratio is net insurance in force divided by the
aggregate of policyholders' reserves, third party capital support and net
present value of installment premiums. Policyholders' reserves is the
aggregate of unearned premium reserves, loss reserves (including
contingency reserves) and policyholders' surplus, calculated in accordance
with statutory accounting principles.
3 AMBAC 1996 ANNUAL REPORT
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
AMBAC Inc. (the "Company") is a holding company that provides through its
affiliates financial guarantee insurance and financial services in both the
public and private sectors.
The following paragraphs describe the consolidated results of operations of
AMBAC Inc. and its subsidiaries (sometimes collectively referred to as the
"Company") for 1996, 1995 and 1994, and its financial condition as of December
31, 1996 and 1995. These results are presented for the Company's two business
segments: Financial Guarantee Insurance and Financial Services.
RESULTS OF OPERATIONS
Year Ended December 31, 1996 Versus Year Ended December 31, 1995
Consolidated Net Income
The Company's net income in 1996 was $276.3 million or $7.90 per common share,
an increase of 65% from $167.6 million or $4.78 per common share in 1995. This
increase was due to a number of factors, primarily a net realized gain of $155.6
million (which had a net income per common share effect of $2.88) from the
Company's sale of its affiliate, HCIA Inc. ("HCIA") in May 1996. In 1995, the
Company recognized a realized gain of $19.1 million (which had a net income per
common share effect of $0.34) from the sale of approximately 1.1 million shares
of HCIA. Excluding the effects of the respective gains from the sales of HCIA
stock in both 1996 and 1995, net income in 1996 increased 13% over 1995 due to
higher operating income in both the financial guarantee insurance and financial
services business segments.
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 obligations.
Total financial guarantee insurance operating income in 1996 was $225.3 million,
an increase of 7% from $210.8 million in 1995. The increase was primarily the
result of higher earned premiums and net investment income, partially offset by
net realized losses on sales of investments and higher operating expenses.
Gross Par Written. AMBAC Indemnity insured $36.8 billion of par value bonds
during 1996, an increase of 42% from $26.0 billion in 1995. Par written in 1996
comprised $26.7 billion from municipal bond insurance and $10.1 billion from
structured finance insurance, versus $20.3 billion and $5.7 billion,
respectively, in 1995. According to estimates based on industry sources, the
total volume of new issues of municipal bonds increased 13% to $180.8 billion in
1996 from $160.6 billion in 1995. During 1996, the insured portion of the new
issue municipal bond market increased to 47% from 42% in 1995, reflecting
increased demand for insured bonds. During 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 29%, as compared to approximately 25% during
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 in 1996 were $247.2 million, an
increase of 28% from $193.3 million in 1995. This increase was primarily due to
higher new issue municipal finance premiums written. The following table sets
forth the amounts of gross premiums written by type and percent of total:
<TABLE>
<CAPTION>
(Dollars in Millions) 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Municipal finance policies:
Up-front policies:
New issue ........................... $182.9 74% $ 125.2 65%
Secondary market .................... 20.4 8 27.3 14
-------------------------------------
Sub-total up-front ................. 203.3 82 152.5 79
-------------------------------------
Installment policies:
Annual policies ...................... 9.2 4 7.8 4
Portfolio products ................... 3.8 1 5.4 3
-------------------------------------
Sub-total installment ............... 13.0 5 13.2 7
-------------------------------------
Total municipal finance policies ... 216.3 87 165.7 86
-------------------------------------
Structured finance policies:
Up-front ............................. 19.1 8 24.2 12
Installment .......................... 11.8 5 3.4 2
-------------------------------------
Total structured finance policies ... 30.9 13 27.6 14
-------------------------------------
Total gross premiums written ........ $247.2 100% $ 193.3 100%
- --------------------------------------------------------------------------------
</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. Adjusted gross
21 AMBAC 1996 ANNUAL REPORT
<PAGE>
premiums, which are defined as up-front premiums written plus the present value
of estimated future installment premiums written in the period, were $296.4
million in 1996, up 34% from $221.3 million in 1995. The present value of
estimated future installment premiums written in 1996 was $74.0 million, an
increase of 66% from $44.6 million in 1995. The aggregate net present value of
estimated future installment premiums was $157.7 million and $110.0 million as
of December 31, 1996 and 1995, respectively.
Ceded Premiums Written. Ceded premiums written in 1996 were $37.8 million,
versus $28.6 million in 1995. Ceded premiums written in 1995 were reduced by
$18.1 million in return premiums from the cancellation of reinsurance contracts.
A portion of the return premiums, $15.7 million, was deferred in unearned
premiums, with the remainder included in accelerated premiums earned in 1995.
Excluding the return premiums in 1995, ceded premiums written in 1996 decreased
by 19% compared to 1995. The decrease reflects lower premiums ceded under
facultative reinsurance agreements in 1996. Ceded premiums written, exclusive of
return premiums, were 15.3% and 24.2% of gross premiums written in 1996 and
1995, respectively.
Net Premiums Written. Net premiums written in 1996 were $209.4 million, an
increase of 27% from $164.7 million in 1995. The increase reflects higher gross
premiums written in 1996, partially offset by higher premiums ceded to
reinsurers (after the effect of the 1995 return premium).
Net Premiums Earned. Net premiums earned during 1996 were $136.6 million, an
increase of 22% from $111.8 million in 1995. This increase was primarily the
result of the growth in premiums earned from the underlying book of business
during the year as well as higher premiums earned from refundings, calls and
other accelerations in 1996. Net premiums earned in 1996 included $31.3 million
(net income per common share effect of $0.51) from refundings, calls and other
accelerations of previously insured issues. Net premiums earned in 1995 included
$22.6 million (net income per common share effect of $0.36) from refundings,
calls and other accelerations. 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, net premiums earned in 1996 were $105.3 million, an increase of 18%
from $89.2 million in 1995.
Net Investment Income. Net investment income in 1996 was $144.9 million, an
increase of 11% from $131.0 million in 1995. This increase was primarily
attributable to the growth of the investment portfolio. AMBAC Indemnity's
investments in tax-exempt securities amounted to 79% of the total market value
of the portfolio as of December 31, 1996, versus 69% as of December 31, 1995.
The average pre-tax yield-to-maturity on the financial guarantee insurance
investment portfolio was 6.47% as of December 31, 1996, unchanged from December
31, 1995.
Net Realized (Losses) Gains. Financial guarantee related net realized (losses)
gains in 1996 were ($20.5) million, versus $0.2 million in 1995. The net
realized losses were generated for tax planning purposes to partially offset the
realized gain from the sale of HCIA.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses in
1996 were $3.8 million, versus $3.4 million in 1995. Losses and loss adjustment
expenses are generally based upon estimates of the ultimate aggregate losses
inherent in the obligations insured. Losses and loss adjustment expenses,
exclusive of salvage recognized, were $5.1 million and $4.1 million in 1996 and
1995, respectively. Salvage recognized was $1.3 million in 1996, compared to
$0.7 million in 1995.
Underwriting and Operating Expenses. Underwriting and operating expenses were
$37.2 million in 1996, an increase of 8% from $34.5 million in 1995.
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
1996, AMBAC Indemnity's gross underwriting and operating expenses were $56.4
million, an increase of 11% from $50.9 million in 1995, primarily due to
increased compensation costs and premium taxes. Underwriting and operating
expenses deferred were $32.3 million and $27.8 million in 1996 and 1995,
respectively. Reinsurance commissions which related to the current period were
($0.6) million and ($1.2) million in 1996 and 1995, respectively. The
amortization of previously deferred expenses and reinsurance commissions was
$12.5 million and $10.2 million in 1996 and 1995, respectively.
22 AMBAC 1996 ANNUAL REPORT
<PAGE>
Financial Services
Through its financial services subsidiaries, the Company provides investment
contracts, interest rate swaps and investment management and advisory services
principally to states, municipalities, municipal authorities and hospitals and
health organizations. Financial services operating income in 1996 was $10.9
million, versus $5.2 million in 1995. The increase was primarily due to
recoveries in 1996 of net unrealized mark-to-market losses in the portfolio of
municipal interest rate swaps which were recognized in 1995. The Company manages
the municipal interest rate swap portfolio to be market neutral to overall
interest rates. However, the Company does retain certain "basis risk," defined
as the relationship between changes in floating rate tax-exempt and floating
rate taxable interest rates. Since the third quarter of 1995, all municipal
interest rate swaps transacted contain provisions designed to protect the
Company against certain forms of tax reform, thus mitigating basis risk. Also
contributing to the increased operating income was higher net interest income
from municipal investment contracts due to higher volume, partially offset by
higher operating expenses related to starting up an investment advisory
business. Total financial services revenues in 1996 were $22.1 million, versus
$13.0 million in 1995. Financial services expenses in 1996 were $11.2 million,
versus $7.8 million in 1995.
Corporate Items
Equity in Income (Loss) of Affiliate. In May 1996, the Company sold its
remaining interest in HCIA common stock. The Company's share of HCIA's income in
1994, 1995 and for the first four months of 1996 is reported as "Equity in
income (loss) of affiliate." Equity in income (loss) of affiliate was $0.6
million in 1996, as compared to ($0.2) million in 1995.
Interest Expense. Interest expense in 1996 was $20.9 million, unchanged from
1995.
Other Income (Deductions), Net. Other income (deductions), net, includes
investment income and operating expenses of the holding company, AMBAC Inc. Also
included in this line is the Company's 61% equity interest in the operating
earnings of AMBAC Connect Inc., a developer of procurement software, which the
Company acquired in August 1996. Other income (deductions), net, increased to
$3.2 million in 1996 from $0.2 million in 1995, primarily due to additional
investment income generated by the holding company from the proceeds of the sale
of HCIA.
Other Net Realized Gains (Losses). The net realized gain in 1996 resulted
primarily from the sale of its remaining holdings in HCIA in a secondary public
offering yielding net proceeds to the Company of $202.6 million. The sale
resulted in a net realized gain of $155.6 million pre-tax, $100.6 million after-
tax (net income per common share effect of $2.88). During 1995, the Company sold
approximately 1.1 million shares of its HCIA stock in a public offering
resulting in a realized gain of $19.1 million (which had a net income per common
share effect of $0.34).
Income Taxes. Income taxes for 1996 were at an effective rate of 26.4%, compared
to 21.7% in 1995. The increase in the effective rate is primarily due to the
realized gain on the sale of HCIA in 1996 taxed at the statutory rate of 35%.
Supplemental Analytical Financial Data
Core Earnings.(1) In 1996, core earnings were $170.5 million, an increase of
17% from $145.5 million in 1995. The increase in core earnings was primarily the
result of continued growth in premiums earned from the underlying book of
business and net investment income from financial guarantee insurance
operations, as well as increased operating income from the 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, calls and other accelerations and
certain non-recurring items.
Operating Earnings.(1) Operating earnings in 1996 were $188.3 million, an
increase of 19% from $158.2 million in 1995. The Company defines operating
earnings as net income, less the effect of net realized gains and losses and
certain non-recurring items.
Following is a table reconciling net income computed in accordance with
Generally Accepted Accounting Principles ("GAAP") to operating earnings and core
earnings for the years ended December 31, 1996 and 1995:
<TABLE>
<CAPTION>
(Dollars in Millions) 1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C>
Net income ......................................... $276.3 $167.6
Net realized gains, after tax ...................... (88.0) (11.9)
Non-recurring item, after tax(a) ................... -- 2.5
-----------------------
Operating earnings ................................. 188.3 158.2
Premiums earned from refundings,
calls and other accelerations, after tax .......... (17.8) (12.7)
-----------------------
Core earnings ...................................... $170.5 $145.5
-----------------------
</TABLE>
(a) Non-recurring item in 1995 was an HCIA charge related to an acquisition.
23 AMBAC 1996 ANNUAL REPORT
<PAGE>
RESULTS OF OPERATIONS
Year Ended December 31, 1995 Versus Year Ended December 31, 1994
Consolidated Net Income
The Company's net income in 1995 was $167.6 million or $4.78 per common share,
an increase of 19% from $141.1 million or $4.01 per common share in 1994. The
increase was due to a number of factors, primarily a realized gain of $19.1
million (which had a net income per common share effect of $0.34) from the
August 1995 sale of approximately 1.1 million shares of HCIA in a secondary
public offering. Additionally, the increase in net income in 1995 versus 1994
was due to higher financial guarantee insurance operating income, partially
offset by lower financial services operating income.
Financial Guarantee Insurance
Operating Income. Total financial guarantee insurance operating income in 1995
was $210.8 million, an increase of 11% from $189.6 million in 1994. The increase
was primarily due to the growth of investment income, higher premiums earned
from the underlying book of business and realized gains on sales of investments,
partially offset by lower accelerated premiums earned from refundings, calls and
other accelerations.
Gross Par Written. AMBAC Indemnity insured $26.0 billion in par value bonds
during 1995, an increase of 18% from $22.1 billion in 1994. Par written in 1995
comprised $20.3 billion from municipal bond insurance and $5.7 billion from
structured finance insurance, versus $20.3 billion and $1.8 billion,
respectively, in 1994. According to estimates based on industry sources, the
total volume of new issues of municipal bonds decreased 3% to $160.6 billion
during 1995 from $164.9 billion in 1994. During 1995, the insured portion of the
new issue municipal bond market increased to 42% from 38% in 1994, reflecting
increased demand for insured bonds. During 1995, 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 25%, as compared to approximately 28% during
1994. (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 in 1995 were $193.3 million, an
increase of 2% from $189.9 million in 1994. This increase was primarily due to
higher structured finance premiums written, partially offset by lower new issue
municipal premium rates. The following table sets forth the amounts of gross
premiums written by type and percent of total:
<TABLE>
<CAPTION>
(Dollars in Millions) 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Municipal finance policies:
Up-front policies:
New issue ........................... $125.2 65% $ 136.7 72%
Secondary market .................... 27.3 14 23.7 12
-----------------------------------
Sub-total up-front ................. 152.5 79 160.4 84
-----------------------------------
Installment policies:
Annual policies ...................... 7.8 4 4.9 3
Portfolio products ................... 5.4 3 7.9 4
-----------------------------------
Sub-total installment ............... 13.2 7 12.8 7
-----------------------------------
Total municipal finance policies ... 165.7 86 173.2 91
-----------------------------------
Structured finance policies:
Up-front ............................. 24.2 12 15.2 8
Installment .......................... 3.4 2 1.5 1
-----------------------------------
Total structured finance policies ... 27.6 14 16.7 9
-----------------------------------
Total gross premiums written ........ $193.3 100% $ 189.9 100%
- --------------------------------------------------------------------------------
</TABLE>
Adjusted Gross Premiums. 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 $221.3 million in 1995, up 12% from $197.1 million
in 1994. The present value of estimated future installment premiums written in
the year 1995 was $44.6 million, more than double the $21.5 million in 1994. The
aggregate net present value of estimated future installment premiums written was
$110.0 million and $71.0 million as of December 31, 1995 and 1994, respectively.
Ceded Premiums Written. Ceded premiums written in 1995 were $28.6 million,
versus ($2.8) million in 1994. Ceded premiums written in 1995 and 1994 include
$18.1 million and $30.5 million, respectively, in return premiums from the
cancellation of reinsurance contracts. A portion of these return premiums, $15.7
million and $25.9 million, was deferred in unearned premiums in 1995 and 1994,
respectively, with the remainder included in accelerated premiums earned in 1995
and 1994. Excluding these return premiums, ceded premiums written in 1995
increased by 69% compared to 1994. The increase was due to higher premiums ceded
under facultative reinsurance agreements primarily related to structured finance
transactions, as well as increased premiums ceded under surplus share
reinsurance agreements in 1995, partially offset by a decrease in premiums ceded
under quota share reinsurance agreements
24 AMBAC 1996 ANNUAL REPORT
<PAGE>
during 1995. Ceded premiums written, exclusive of return premiums, were 24.2%
and 14.6% of gross premiums written in 1995 and 1994, respectively.
Net Premiums Written. Net premiums written in 1995 were $164.7 million, a
decrease of 15% from $192.7 million in 1994. The decrease reflects higher
premiums ceded to reinsurers in 1995 and higher return premiums from
cancellation of reinsurance contracts in 1994.
Net Premiums Earned. Net premiums earned during 1995 were $111.8 million, a
decrease of 5% from $117.5 million in 1994. This decrease was primarily due to
the lower volume of refundings, calls and other accelerations of AMBAC-insured
municipal bonds in 1995, partially offset by the growth in premiums earned from
the underlying book of business during the year. Net premiums earned in 1995
included $22.6 million (net income per common share effect of $0.36) from
refundings, calls and other accelerations of previously insured issues. Net
premiums earned in 1994 included $35.9 million (net income per common share
effect of $0.58) from refundings, calls and other accelerations. Excluding the
effect of accelerated earnings from refundings, calls and other accelerations,
net premiums earned in 1995 were $89.2 million, an increase of 9% from $81.6
million in 1994.
Net Investment Income. Net investment income in 1995 was $131.0 million, an
increase of 12% from $117.1 million in 1994. The increase was primarily
attributable to the growth of the investment portfolio. AMBAC Indemnity's
investments in tax-exempt securities amounted to 69% of the total market value
of the portfolio as of December 31, 1995, versus 78% at December 31, 1994. The
average pre-tax yield-to-maturity on the financial guarantee investment
portfolio was 6.47% and 6.61% as of December 31, 1995 and 1994, respectively.
Net Realized (Losses) Gains. Financial guarantee related net
realized (losses) gains in 1995 were $0.2 million, versus ($13.4) million in
1994. The net realized losses in 1994 were generated primarily to recover taxes
paid on prior years' realized gains, for which the carry-back limitation was
otherwise due to expire.
Other Income. Other income in 1995 was $5.6 million, versus $3.8 million in
1994. The increase was primarily due to higher income related to certain real
estate interests.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses in 1995
were $3.4 million, versus $2.6 million in 1994. The increase in losses and loss
adjustment expenses was primarily due to lower salvage recognized in 1995.
Losses and loss adjustment expenses, exclusive of salvage recognized, were $4.1
million and $7.4 million in 1995 and 1994, respectively. Salvage recognized was
$0.7 million in 1995, compared to $4.8 million in 1994.
Underwriting and Operating Expenses. Underwriting and operating expenses were
$34.5 million in 1995, an increase of 5% from $32.8 million in 1994. During
1995, AMBAC Indemnity's gross underwriting and operating expenses were $50.9
million, a decrease of 3% from $52.6 million in 1994. Underwriting and operating
expenses deferred were $27.8 million and $28.5 million in 1995 and 1994,
respectively. Reinsurance commissions which related to the current period were
($1.2) million and $0.6 million in 1995 and 1994, respectively. The amortization
of previously deferred expenses and reinsurance commissions was $10.2 million
and $9.3 million in 1995 and 1994, respectively.
Financial Services
Financial services operating income in 1995 was $5.2 million, versus $10.6
million in 1994. The decrease was primarily due to the recognition of net
unrealized mark-to-market losses in the portfolio of municipal interest rate
swaps due to the threat of tax reform in 1995 which caused projected floating
rate tax-exempt interest rates to increase in relation to floating rate taxable
interest rates. As discussed above under "Results of Operations - Year Ended
December 31, 1996 Versus Year Ended December 31, 1995, Financial Services," the
Company manages its municipal interest rate swaps portfolio to be market neutral
to overall interest rates, but does retain certain basis risk. Also,
contributing to the financial services operating income decline in 1995 as
compared to 1994 was lower net interest income from municipal investment
contracts and higher financial services operating expenses. Total financial
services revenues in 1995 were $13.0 million, versus $16.7 million in 1994.
Financial services expenses in 1995 were $7.8 million, versus $6.1 million in
1994.
Corporate Items
Equity in Income (Loss) of Affiliate. During 1995, the Company reduced its
equity holdings in HCIA to less than 50% and started reporting its share of
HCIA's
25 AMBAC 1996 ANNUAL REPORT
<PAGE>
income as "Equity in income (loss) of affiliate." Equity in income (loss) of
affiliate was ($0.2) million in 1995, versus $1.5 million in 1994. The loss in
1995 was primarily due to HCIA's recording of a non-recurring charge related to
a 1995 acquisition. Excluding this charge, equity in income of affiliate would
have been $3.5 million.
Interest Expense. Interest expense in 1995 was $20.9 million, an increase of 11%
from $18.8 million in 1994, primarily due to lower net payments received under
an interest rate swap related to the Company's debentures.
Income Taxes. Income taxes in 1995 were at an effective rate of 21.7%,
relatively unchanged from the prior year's effective rate of 21.6%.
Supplemental Analytical Financial Data
Core Earnings.(1) In 1995, the Company's core earnings were $145.5 million, an
increase of 11% from $131.2 million in 1994. The increase in core earnings was
primarily the result of the continued growth in net premiums earned from the
underlying book of business and net investment income from financial guarantee
insurance operations, partially offset by lower financial services operating
income.
Operating Earnings.(1) Operating earnings in 1995 were $158.2 million, an
increase of 4% from $151.5 million in 1994.
Following is a table reconciling net income computed in accordance with
GAAP to operating earnings and core earnings for the years ended December 31,
1995 and 1994:
<TABLE>
<CAPTION>
(Dollars in Millions) 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C>
Net income ......................................... $167.6 $141.1
Net realized (gains)/losses, after tax ............. (11.9) 10.4
Non-recurring item, after tax (a) ................. 2.5 --
------------------------
Operating earnings ................................. 158.2 151.5
Premiums earned from refundings,
calls and other accelerations, after tax .......... (12.7) (20.3)
------------------------
Core earnings ...................................... $145.5 $131.2
- --------------------------------------------------------------------------------
</TABLE>
(a) Non-recurring item in 1995 was an HCIA charge related to an acquisition.
ACQUISITIONS
Cadre Financial Services, Inc. ("Cadre"). On December 31, 1996, the Company
acquired substantially all of the assets of Cadre for approximately $20.0
million in Company stock and cash. Cadre, based in Ronkonkoma, New York, is a
provider of cash management and investment advisory services to local school
districts, hospitals and health care organizations and municipalities. At
December 31, 1996, Cadre was providing investment administration services for
approximately 2,600 clients with approximately $5.9 billion in assets. Included
in the assets under administration at December 31, 1996, were approximately $1.9
billion of assets for which Cadre provides direct investment advisory services.
AMBAC Connect Inc. ("ACI"). In August 1996, the Company acquired a controlling
equity interest in ACI, the successor to Advanced Procurement Systems, Inc. ACI,
based in Austin, Texas, develops and markets software for governmental
procurement applications.
LIQUIDITY AND CAPITAL RESOURCES
AMBAC Inc. Liquidity. 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. However, on April 30, 1996, AMBAC Indemnity, in conjunction with
the sale of the Company's remaining holdings in HCIA common stock, delivered to
the Company (in the form of an extraordinary dividend) its 2,378,672 shares of
HCIA common stock, at fair value. The Wisconsin Commissioner approved such
dividend. As a result, any dividends paid by AMBAC Indemnity to the Company
through June 30, 1997, require pre-approval from the Wisconsin Commissioner. The
Wisconsin Commissioner has stated to AMBAC Indemnity management that it does not
foresee any reason pre-approval of anticipated common stock dividends paid
through June 30, 1997 would not be given. Anticipated common stock dividends
paid thereafter and through year-end 1997, will not require such pre-approval.
During 1996, AMBAC Indemnity paid dividends of $40.0 million on its common stock
to the Company. For further discussion, see Note 8 of Notes to Consolidated
Financial Statements.
The Company's principal uses of liquidity are for the payment of its
operating expenses, interest
26 AMBAC 1996 ANNUAL REPORT
<PAGE>
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 1997 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.
AMBAC Indemnity Liquidity. 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. The majority of
premiums for AMBAC Indemnity's financial guarantee insurance policies are
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.
Financial Services Liquidity. The principal uses of liquidity by the Company's
financial services subsidiaries are the payment of investment contract
obligations pursuant to defined terms, net 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 net receipts from interest rate
swaps and related hedges. The Company's investment objectives with respect to
investment contracts are to achieve the highest after-tax total return, subject
to a minimum average quality rating of Aa/AA on invested assets, and to maintain
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.
Credit Facilities. As of December 31, 1996, the Company and AMBAC Indemnity had
a revolving credit facility with two major international banks, as co-agents,
for $100.0 million, which expires in July 1998. This facility is available for
general corporate purposes, including the payment of claims. As of December 31,
1996 and 1995, no amounts were outstanding under this credit facility.
AMBAC Indemnity has an agreement with a group of Aaa/AAA-rated international
banks for a $350.0 million credit facility, expiring in 2003. The terms of this
facility were renegotiated in December 1996, to increase the facility from
$300.0 million to $350.0 million; and to extend the expiration date from
December 2, 2002 to December 2, 2003. 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
December 31, 1996 and 1995, no amounts were outstanding under this line.
Treasury Stock Repurchase Program. During 1996, the Company acquired
approximately 597,000 treasury shares for an aggregate amount of $31.8 million.
Since inception of the Stock Repurchase Program, the Company has acquired
approximately 1,061,000 shares for an aggregate amount of $49.6 million.
27 AMBAC 1996 ANNUAL REPORT
<PAGE>
Adjusted Book Value. (2) Adjusted Book Value ("ABV")
per common share increased 11% to $62.50 at December 31, 1996 from $56.47 at
December 31, 1995.
The following table reconciles Book Value Per Share to Adjusted Book Value
Per Share as of December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996(a) 1995(a)
- --------------------------------------------------------------------------------
<S> <C> <C>
Book value per share ............................... $46.02 $40.04
After-tax value of:
Net unearned premium reserve ...................... 15.25 13.89
Deferred acquisition costs ........................ (1.74) (1.54)
Present value of installment premiums ............. 2.91 2.05
Unrealized gain on investment in HCIA(b) .......... -- 2.77
Unrealized gain (loss) on investment
contract liabilities .............................. 0.06 (0.74)
----------------------
Adjusted book value per share ...................... $62.50 $56.47
- --------------------------------------------------------------------------------
</TABLE>
(a) Numbers may not add due to rounding.
(b) The Company sold its remaining investment in HCIA on May 6, 1996.
Balance Sheet. As of December 31, 1996, the fair value of the Company's
consolidated investment portfolio was $5.20 billion, an increase of 17% 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
during 1996, partially offset by a decline in the market value of investments
resulting from the increase in interest rates during 1996.
Cash Flows. Net cash provided by operating activities was $190.6 million, $231.3
million and $265.6 million during 1996, 1995 and 1994, respectively. These cash
flows were primarily provided by the financial guarantee insurance operations.
Net cash provided by financing activities was $463.2 million, $177.7 million and
$534.2 million during 1996, 1995 and 1994, respectively. This activity included
$499.2 million, $196.8 million and $562.7 million in municipal investment
contracts issued (net of draws paid) in 1996, 1995 and 1994, respectively. The
total cash provided by operating and financing activities was $653.8 million,
$409.0 million and $799.8 million during 1996, 1995 and 1994, respectively. From
these totals, $658.2 million, $401.3 million and $799.5 million was used in
investing activities, principally purchases of investment securities during
1996, 1995 and 1994, respectively.
Off-Balance-Sheet Risk. In the normal course of business, the Company uses
interest rate contracts for hedging purposes as part of its overall interest
rate risk management. In addition, the Company's financial services subsidiaries
include a dealer of interest rate swaps primarily to states, municipalities and
municipal authorities. This subsidiary manages its interest rate swap business
with the goal of being market neutral to changes in taxable interest rates. In
the ordinary course of business, it manages a variety of 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. For additional
information, see Notes 12 and 13 in Notes to Consolidated Financial Statements.
Material Commitments. 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.
FOOTNOTES
(1) Core earnings and operating earnings are not substitutes for net income
computed in accordance with GAAP, but are important measures used by management,
equity analysts and investors to measure the financial results of the Company.
(2) Adjusted book value ("ABV"), which is not promulgated under GAAP, is used by
management, equity analysts and investors as a measurement of the Company's
intrinsic value with no benefit given for ongoing business activity. Management
derives adjusted book value by beginning with stockholders' equity (book value)
and adding or subtracting the after-tax value of: the net unearned premium
reserve, deferred acquisition costs, the present value of estimated net future
installment premiums, the unrealized gain on the investment in HCIA (prior to
sale on May 6, 1996), and the unrealized gain or loss on investment contract
liabilities. The definition of ABV used by the Company may differ from
definitions of ABV used by other public holding companies of financial guarantee
insurers. The adjustments described above will not be realized until future
periods and may differ materially from the amounts used in determining ABV.
28 AMBAC 1996 ANNUAL REPORT
<PAGE>
REPORT ON MANAGEMENT'S RESPONSIBILITIES
The management of AMBAC is responsible for the integrity and objectivity of the
financial statements and all other financial information presented in this
Annual Report and for assuring that such information fairly presents the
consolidated financial position and operating results of AMBAC. The accompanying
consolidated financial statements have been prepared in conformity with
generally accepted accounting principles using management's best estimates and
judgment. The financial information presented elsewhere in this Annual Report is
consistent with that in the consolidated financial statements.
AMBAC maintains a system of internal accounting controls designed to
provide reasonable assurance that assets are safeguarded against loss or
unauthorized use and that the financial records are reliable for use in
preparing financial statements and maintaining accountability of assets.
Qualified and professional financial personnel maintain and monitor these
internal controls on a continuous basis. The concept of reasonable assurance is
based on the recognition that the cost of a system of internal control should
not exceed the related benefits.
AMBAC's consolidated financial statements have been audited by KPMG Peat
Marwick LLP, independent auditors, whose audits were made in accordance with
generally accepted auditing standards and included a review of internal
accounting controls to the extent necessary to express an opinion on the
fairness of the consolidated financial statements.
The Audit Committee of the Board of Directors, comprised solely of outside
directors, meets regularly with financial management, the independent auditors
and the internal auditors to review the work and procedures of each. The
independent auditors and the internal auditors have free access to the Audit
Committee, without the presence of management, to discuss the results of their
work and their considerations of AMBAC and its subsidiaries and the quality of
AMBAC's financial reporting. The Board of Directors, upon recommendation of the
Audit Committee, appoints the independent auditors, subject to stockholder
approval.
/s/ Phillip B. Lassiter
Phillip B. Lassiter
Chairman, President and Chief Executive Officer
/s/ Frank J. Bivona
Frank J. Bivona
Senior Vice President, Chief Financial Officer and Treasurer
January 30, 1997
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders AMBAC Inc.
We have audited the accompanying consolidated balance sheets of AMBAC Inc. and
subsidiaries as of December 31, 1996 and 1995, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
years in the three-year period ended December 31, 1996. These consolidated
financial statements are the responsibility of AMBAC Inc.'s management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of AMBAC Inc.
and subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1996 in conformity with generally accepted accounting
principles.
/s/ KPMG Peat Marwick LLP
KPMG Peat Marwick LLP
New York, New York
January 30, 1997
29 AMBAC 1996 ANNUAL REPORT
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AMBAC INC. AND SUBSIDIARIES
(Dollars in Thousands Except Per Share Amounts) December 31, 1996 1995
- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Investments:
Bonds, at fair value
(amortized cost of $4,979,017 in 1996 and $4,082,791 in 1995) ........ $ 5,088,031 $ 4,264,904
Short-term investments, at cost (approximates fair value) .............. 112,511 176,689
--------------------------
Total investments ................................................... 5,200,542 4,441,593
Cash ...................................................................... 7,734 12,167
Securities purchased under agreements to resell ........................... 201,169 240,280
Receivable for municipal investment contracts ............................. 33,299 204,797
Receivable for securities sold ............................................ 18,467 14,523
Investment income due and accrued ......................................... 65,920 56,370
Investment in affiliate ................................................... -- 45,019
Prepaid reinsurance ....................................................... 168,786 153,372
Deferred acquisition costs ................................................ 94,212 82,620
Other assets .............................................................. 85,836 58,538
--------------------------
Total assets ........................................................ $ 5,875,965 $ 5,309,279
--------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities:
Unearned premiums ...................................................... $ 991,224 $ 903,026
Losses and loss adjustment expenses .................................... 60,220 65,996
Ceded reinsurance balances payable ..................................... 7,438 14,654
Obligations under municipal investment contracts ....................... 2,417,817 2,185,746
Obligations under municipal investment repurchase contracts ............ 336,773 241,112
Deferred income taxes .................................................. 80,086 103,697
Current income taxes ................................................... 6,538 5,125
Debentures ............................................................. 223,798 223,732
Accrued interest payable ............................................... 29,958 25,494
Accounts payable and other liabilities ................................. 57,689 44,578
Payable for securities purchased ....................................... 49,408 92,131
--------------------------
Total liabilities ................................................... 4,260,949 3,905,291
Stockholders' equity:
Preferred stock, par value $0.01 per share; authorized shares -
4,000,000; issued and outstanding shares - none ...................... -- --
Common stock, Class A, par value $0.01 per share; authorized
shares - 20,000,000; issued and outstanding shares - none ............ -- --
Common stock, par value $0.01 per share; authorized shares - 50,000,000;
issued shares - 35,340,192 at December 31, 1996
and December 31, 1995 ................................................ 353 353
Additional paid-in capital ............................................. 498,401 492,495
Unrealized gains on investments, net of tax ............................ 58,911 102,470
Retained earnings ...................................................... 1,072,418 819,479
Common stock held in treasury at cost, 249,807 shares at
December 31, 1996 and 276,619 at December 31, 1995 ................... (15,067) (10,809)
--------------------------
Total stockholders' equity .......................................... 1,615,016 1,403,988
------------------------
Total liabilities and stockholders' equity .......................... $5,875,965 $ 5,309,279
- ---------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
30 AMBAC 1996 ANNUAL REPORT
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
AMBAC INC. AND SUBSIDIARIES
(Dollars in Thousands Except Per Share Amounts)
Years Ended December 31, 1996 1995 1994
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Financial guarantee insurance operations:
Gross premiums written .................... $ 247,208 $ 193,326 $ 189,906
Ceded premiums written .................... (37,793) (28,606) 2,815
--------------------------------------------
Net premiums written ................... 209,415 164,720 192,721
Increase in unearned premiums ............. (72,786) (52,900) (75,257)
--------------------------------------------
Net premiums earned ..................... 136,629 111,820 117,464
Net investment income ..................... 144,941 131,049 117,112
Net realized (losses) gains ............... (20,531) 177 (13,386)
Other income .............................. 5,261 5,580 3,836
--------------------------------------------
266,300 248,626 225,026
--------------------------------------------
Losses and loss adjustment expenses ....... 3,778 3,377 2,593
Underwriting and operating expenses ....... 37,182 34,450 32,849
--------------------------------------------
40,960 37,827 35,442
--------------------------------------------
Financial guarantee insurance operating
income .................................... 225,340 210,799 189,584
Financial services operating income .......... 10,943 5,216 10,571
Equity in income (loss) of affiliate ......... 627 (185) 1,492
Interest expense ............................. (20,925) (20,934) (18,786)
Other income (deductions), net ............... 3,208 175 (310)
Other net realized gains (losses) ............ 156,313 19,103 (2,632)
--------------------------------------------
Income before income taxes ................ 375,506 214,174 179,919
Provision for income taxes ................... 99,189 46,579 38,814
--------------------------------------------
Net income ................................ $ 276,317 $ 167,595 $ 141,105
--------------------------------------------
Net income per common share ............... $ 7.90 $ 4.78 $ 4.01
--------------------------------------------
Weighted average number of
common shares outstanding .................. 34,964,814 35,100,881 35,207,364
- ---------------------------------------------------------------------------------------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
31 AMBAC 1996 ANNUAL REPORT
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
AMBAC INC. AND SUBSIDIARIES
(Dollars in Thousands) Years Ended December 31, 1996 1995 1994
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
PREFERRED STOCK:
Balance at January 1 and December 31 ............. $ -- $ -- $ --
-------------------------------------
COMMON STOCK, CLASS A:
Balance at January 1 and December 31 ............. $ -- $ -- $ --
-------------------------------------
COMMON STOCK:
Balance at January 1 and December 31 ............. $ 353 $ 353 $ 353
-------------------------------------
ADDITIONAL PAID-IN CAPITAL:
Balance at January 1 ............................. $ 492,495 $ 477,467 $ 476,419
Issuance of stock ................................ 3,624 (5) 585
Sale of affiliate, net of tax .................... -- 14,356 --
Other ............................................ 2,282 677 463
-------------------------------------
Balance at December 31 ........................... $ 498,401 $ 492,495 $ 477,467
-------------------------------------
UNREALIZED GAINS (LOSSES) ON INVESTMENTS, NET OF TAX:
Balance at January 1 ............................. 102,470 ($106,264) $ 73,174
Change in unrealized gains (losses) .............. (43,559) 208,734 (179,438)
-------------------------------------
Balance at December 31 ........................... $ 58,911 $ 102,470 ($106,264)
-------------------------------------
RETAINED EARNINGS:
Balance at January 1 ............................. $ 819,479 $ 673,129 $ 549,781
Net income ....................................... 276,317 167,595 141,105
Dividends declared-common stock .................. (21,500) (19,484) (17,429)
Other ............................................ (1,878) (1,761) (328)
-------------------------------------
Balance at December 31 ........................... $ 1,072,418 $ 819,479 $ 673,129
-------------------------------------
COMMON STOCK HELD IN TREASURY AT COST:
Balance at January 1 ............................. ($ 10,809) ($ 11,198) $ --
Cost of shares acquired during year .............. (31,751) (5,913) (11,907)
Issued under stock incentive plan ................ 17,211 6,302 709
Issued to acquire subsidiary ..................... 10,282 -- --
-------------------------------------
Balance at December 31 ........................... ($ 15,067) ($ 10,809) ($ 11,198)
- ----------------------------------------------------------------------------------------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
32 AMBAC 1996 ANNUAL REPORT
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
AMBAC INC. AND SUBSIDIARIES
(Dollars in Thousands) Years Ended December 31, 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 276,317 $ 167,595 $ 141,105
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ......................... 1,986 4,765 6,079
Amortization of bond premium and discount ............. (1,603) 324 3,384
Current income taxes .................................. 1,413 15,713 (7,855)
Deferred income taxes ................................. 4,497 13,727 15,584
Deferred acquisition costs ............................ (11,592) (10,846) (20,757)
Unearned premiums, net ................................ 72,786 52,900 75,257
Losses and loss adjustment expenses ................... (5,776) 334 1,625
Ceded reinsurance balances payable .................... (7,216) 13,746 (2,963)
Investment income due and accrued ..................... (9,550) (6,465) (9,911)
Accrued interest payable .............................. 4,464 1,668 6,084
(Gain) loss on sales of investments and affiliates .... (136,175) (19,222) 15,695
Accounts payable and other liabilities ................ 13,111 (6,240) 20,110
Other, net ............................................ (12,032) 3,340 22,120
------------------------------------------
Net cash provided by operating activities .......... 190,630 231,339 265,557
------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of bonds ............................. 1,911,909 2,955,475 2,024,880
Proceeds from matured bonds .............................. 959,527 660,181 352,791
Purchases of bonds ....................................... (3,825,803) (3,820,086) (3,332,696)
Change in short-term investments ......................... 64,178 (38,714) (28,933)
Securities purchased under agreements to resell .......... 39,111 (152,269) 193,716
Proceeds from sale of affiliate .......................... 202,609 28,502 --
Other, net ............................................... (9,783) (34,380) (9,304)
------------------------------------------
Net cash used in investing activities ................. (658,252) (401,291) (799,546)
------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid ........................................... (21,500) (19,484) (17,429)
Proceeds from issuance of municipal
investment contracts ..................................... 1,696,813 1,374,856 1,685,809
Payments for municipal investment contract draws ......... (1,197,584) (1,178,083) (1,123,096)
Purchases of treasury stock .............................. (31,751) (5,913) (11,907)
Proceeds from sale of treasury stock ..................... 17,211 6,302 709
Other, net ............................................... -- -- 164
------------------------------------------
Net cash provided by financing activities ............. 463,189 177,678 534,250
------------------------------------------
Net Cash Flow ............................................ (4,433) 7,726 261
Cash at January 1 ..................................... 12,167 4,441 4,180
------------------------------------------
Cash at December 31................................... $ 7,734 $ 12,167 $ 4,441
------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Income taxes.......................................... $ 90,649 $ 25,731 $ 31,846
------------------------------------------
Interest expense on debt.............................. $ 21,675 $ 21,170 $ 20,926
------------------------------------------
Interest expense on municipal investment contracts.... $ 148,526 $ 124,797 $ 85,540
------------------------------------------
Cash received during the year for:
Income taxes.......................................... $ -- $ 8,843 $ 1,167
- --------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
33 AMBAC 1996 ANNUAL REPORT
<PAGE>
================================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
(Dollars in Thousands, Except Per Share Amounts)
NOTE 1 Background
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 Service, Inc. AMBAC Inc.'s Financial
Services Division provides investment contracts, interest rate swaps and
investment management and advisory services principally to states,
municipalities, municipal authorities and hospitals and health organizations.
Prior to 1995, the Company and AMBAC Indemnity combined owned approximately
96% of HCIA Inc. ("HCIA"), a leading health care information content company. As
such, HCIA's results of operations were reported as a separate industry segment.
During 1995, the Company reduced its ownership equity in HCIA to approximately
46%, and consequently stopped consolidating its investment in HCIA and reporting
HCIA's results as a separate industry segment. In May 1996, the Company sold its
remaining holdings in HCIA.
On December 31, 1996, the Company acquired substantially all of the assets
of Cadre Financial Services, Inc. ("Cadre") for approximately $20,000 in Company
stock and cash. Cadre is a provider of cash management and investment advisory
services to local school districts, hospitals and health organizations and
municipalities. At December 31, 1996, Cadre was providing investment
administration services for approximately 2,600 clients with approximately
$5,900,000 in assets. Included in the assets under administration at December
31, 1996, were approximately $1,900,000 of assets for which Cadre provides
direct investment advisory services. As the transaction was consummated at the
end of business on December 31, 1996, no results of operations from the
acquisition are reflected in the Consolidated Statements of Operations. The
acquisition of Cadre resulted in goodwill of $20,010, included in Other Assets,
which is being amortized over 15 years on a straight-line basis.
On August 8, 1996, the Company acquired a controlling equity interest in
AMBAC Connect Inc. ("ACI"), the successor to Advanced Procurement Systems, Inc.,
for $2,400 in cash. The Company also invested $5,000 in cumulative preferred
stock of ACI. ACI develops and markets software for governmental procurement
applications. The acquisition of ACI resulted in goodwill of approximately
$2,400, included in Other Assets, which is being amortized over 10 years on a
straight-line basis.
Both transactions were accounted for using the purchase method. The pro
forma results of operations for the years ended December 31, 1996 and 1995,
assuming Cadre and ACI had been acquired as of January 1, 1995, would not have
been significantly different from those presented in the Consolidated Statements
of Operations.
NOTE 2 Significant Accounting Policies
The accompanying consolidated financial statements have been prepared on the
basis of 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 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
significant accounting policies of AMBAC Inc. and its subsidiaries (sometimes
collectively referred to as the "Company") are as described below:
Consolidation: The consolidated financial statements include the accounts of
AMBAC Inc. and its subsidiaries. All significant intercompany balances have been
eliminated.
34 AMBAC 1996 ANNUAL REPORT
<PAGE>
Net Income Per Common Share: Net income per common share is based on the
weighted average number of shares outstanding during the year. The effects of
common stock equivalents on net income per share calculations are not
significant.
Investments: The Company's investment portfolio is accounted for on a trade-date
basis and consists entirely of investments in debt securities that are
considered available-for-sale and are carried at fair value. Fair value is based
on quotes obtained by the Company from independent market sources. Short-term
investments are carried at cost, which approximates fair value. Unrealized gains
and losses, net of deferred income taxes, are included as a separate component
of stockholders' equity and are computed using amortized cost as the basis. For
purposes of computing amortized cost, premiums and discounts are accounted for
using the interest method. For bonds purchased at a price below par value,
discounts are accreted over the remaining term of the securities. For bonds
purchased at a price above par value which have call features, premiums are
amortized to the most likely call dates as determined by management. For premium
bonds which do not have call features, such premiums are amortized over the
remaining terms of the securities. Premiums and discounts on mortgage- and
asset-backed securities are adjusted for the effects of actual and anticipated
prepayments. Realized gains and losses on the sale of investments are determined
on the basis of specific identification.
Securities Purchased Under Agreements to Resell: Securities purchased under
agreements to resell are collateralized financing transactions, and are recorded
at their contracted resale amounts, plus accrued interest. The Company takes
possession of the collateral underlying those agreements and monitors its market
value on a daily basis and, when necessary, requires prompt transfer of
additional collateral to reflect current market value.
Obligations Under Municipal Investment Contracts: Obligations under municipal
investment contracts and municipal investment repurchase contracts are recorded
as liabilities on the consolidated balance sheet at the face value of the
contract, adjusted for draws paid and interest credited to the account.
Unsettled contracts are accrued on a trade-date basis on the consolidated
balance sheet at the time of commitment. Interest expense is computed based upon
daily outstanding settled liability balances at rates and periods specified in
the contracts and is included as a component of financial services operating
income.
Premium Revenue Recognition: Premiums for municipal new issue and secondary
market policies are: (i) generally computed as a percentage of principal and
interest insured; (ii) typically collected in a single payment at policy
inception date; and (iii) are earned pro rata over the period of risk. Premiums
for structured finance policies can be computed as a percentage of either
principal or principal and interest insured. The timing of the collection of
structured finance premiums varies among individual transactions. For policies
where premiums are collected in a single payment at policy inception date,
premiums are earned pro rata over the period of risk. For policies with premiums
that are collected periodically (i.e., monthly, quarterly or annually), premiums
are reflected in income pro rata over the period covered by the premium payment.
When an AMBAC Indemnity-insured new or secondary market issue has been
refunded or called, the remaining unearned premium is generally earned at that
time, as the risk to AMBAC Indemnity is considered to have been eliminated.
Losses and Loss Adjustment Expenses: The liability for losses and loss
adjustment expenses consists of the Active Credit Reserve ("ACR") and case basis
loss and loss adjustment expense reserves. The development of the ACR is based
upon estimates of the ultimate aggregate losses inherent in the obligations
insured. When losses occur (actual monetary defaults or defaults which are
imminent on insured obligations), case basis loss reserves are established in an
amount that is sufficient to cover the present value of the anticipated
defaulted debt service payments over the expected period of default and
estimated expenses associated with settling the claims, less estimated
recoveries under salvage or subrogation rights. All or part of case basis loss
reserves are allocated from any ACR available for such insured obligation.
35 AMBAC 1996 ANNUAL REPORT
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Dollars in Thousands,Except Per Share Amounts)
AMBAC Indemnity's management believes that the reserves for losses and loss
adjustment expenses are adequate to cover the ultimate net cost of claims, but
the reserves are necessarily based on estimates and there can be no assurance
that the ultimate liability will not exceed such estimates.
Deferred Acquisition Costs: Certain costs incurred which vary with, and are
primarily related to, the production of business have been deferred. These costs
include direct and indirect expenses related to underwriting, marketing and
policy issuance, rating agency fees and premium taxes, net of reinsurance ceding
commissions. The deferred acquisition costs are being amortized over the periods
in which the related premiums are earned, and such amortization amounted to
$12,553, $10,183 and $9,348 for 1996, 1995 and 1994, respectively. Deferred
acquisition costs, net of such amortization, amounted to $11,592, $10,845 and
$20,757 for 1996, 1995 and 1994, respectively.
Depreciation and Amortization: Depreciation of furniture and fixtures and
electronic data processing equipment is provided over the estimated useful lives
of the respective assets using the straight-line method. Amortization of
leasehold improvements and intangibles, including certain computer software
licenses, is provided over the estimated useful lives of the respective assets
using the straight-line method.
Interest Rate Contracts:
Interest Rate Contracts Held for Purposes Other Than Trading:The Company uses
interest rate contracts for hedging purposes as part of its overall interest
rate risk management. Gains and losses on interest rate futures and options
contracts that qualify as accounting hedges of existing assets or liabilities
are included in the carrying amounts and amortized over the remaining lives of
the assets and liabilities as an adjustment to interest income or expense. When
the hedged asset is sold or the hedged liability is settled, the unamortized
gain or loss on the related hedge is recognized in income. Gains and losses on
interest rate contracts that do not qualify as accounting hedges are recognized
in current period income.
The Company accounts for its interest rate futures contracts in accordance
with the provisions of Statement of Financial Accounting Standards No. 80,
"Accounting for Futures Contracts" ("Statement 80"). Statement 80 permits hedge
accounting for interest rate futures contracts when the item to be hedged
exposes the Company to price or interest rate risk, and the futures contract
effectively reduces that exposure and is designated as a hedge. Interest rate
futures contracts held for purposes other than trading are used primarily to
hedge interest-sensitive assets and liabilities. Interest rate futures contracts
are designated at inception as a hedge to specific assets and liabilities.
Interest rate swaps that are linked with existing liabilities are accounted
for as a hedge of those liabilities, using the accrual method as an adjustment
to interest expense. Interest rate swaps that are linked with existing assets
classified as available for sale are accounted for as hedges of those assets,
using the accrual method as an adjustment to interest income, with unrealized
gains and losses included in stockholders' equity, net of tax. Interest rate
risk is managed through the linkage of the interest rate swaps, which
synthetically changes the nature of the underlying asset or liability (for
example, from a fixed to floating interest rate obligation).
Interest Rate Contracts Held for Trading Purposes: The Company, in connection
with its market-making activities as a provider of interest rate swaps to
states, municipalities, municipal authorities and other entities in connection
with their financings, uses interest rate contracts which are classified as held
for trading purposes. Interest rate contracts are recorded on trade date at fair
value. Changes in fair value are recorded as a component of financial services
operating income. The fair value of interest rate swaps is determined through
the use of valuation models. The portion of the interest rate swap's initial
fair value that reflects credit considerations, ongoing servicing, and
transaction hedging costs is recognized over the life of the interest rate swap,
as an adjustment to financial services operating income. Interest rate swaps are
recorded on a gross basis; assets and liabilities are netted by customer only
when a legal right of set-off exists.
36 AMBAC 1996 ANNUAL REPORT
<PAGE>
Income Taxes: The Company, as common parent, files a consolidated Federal income
tax return with its subsidiaries. In accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes," deferred tax assets
and liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the period that includes the enactment
date.
The Internal Revenue Code permits municipal bond insurance companies to
deduct from taxable income, subject to certain limitations, the amounts added to
the statutory mandatory contingency reserve during the year. The deduction taken
is allowed only to the extent that U.S. Treasury noninterest-bearing tax and
loss bonds are purchased at their par value prior to the original due date of
the Company's consolidated Federal tax return and held in an amount equal to the
tax benefit attributable to such deductions. The amounts deducted must be
included in taxable income when the contingency reserve is released, at which
time the Company may redeem the tax and loss bonds to satisfy the additional tax
liability. The purchases of tax and loss bonds are recorded as payments of
Federal income taxes and are not reflected in the Company's current tax
provision.
Postretirement and Postemployment Benefits: The Company provides various
postretirement and postemployment benefits, including pension, and health and
life benefits covering substantially all employees who meet certain age and
service requirements. The Company accounts for these benefits under the accrual
method of accounting. Amounts related to the defined benefit pension plan and
postretirement health benefits are charged based on actuarial determinations.
Stock Compensation Plans: In 1991, the Company adopted the AMBAC Inc. 1991 Stock
Incentive Plan. Under this plan, awards are granted to eligible employees of the
Company and its subsidiaries in the form of incentive stock options or other
stock-based awards. Effective in 1996, the Company adopted Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("Statement 123"). Statement 123 applies to all stock-based
employee compensation plans (except employee stock ownership plans) in which an
employer grants shares of its stock or other equity instruments to employees.
Statement 123 permits a company to choose either the fair value based method of
accounting as defined in the Statement or the intrinsic value based method of
accounting as prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"), for its stock-based compensation plans. Companies
electing the accounting requirements under APB 25 must also make pro forma
disclosures of net income and earnings per share as if the fair value based
method of accounting had been applied. The Company has elected to account for
its plans under APB 25. The adoption of Statement 123 had no effect on the
Company's results of operations.
Reclassifications: Certain reclassifications have been made to prior years'
amounts to conform to the current year's presentation.
NOTE 3 Investments
The amortized cost and estimated fair value of investments in debt securities at
December 31, 1996 and 1995 were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
1996 Cost Gains Losses Value
-----------------------------------------------
<S> <C> <C> <C> <C>
Municipal obligations .......... $1,897,518 $ 87,616 $ 2,223 $1,982,911
Corporate securities ........... 939,312 33,943 9,365 963,890
U.S. Government obligations .... 102,774 1,363 1,707 102,430
Mortgage- and asset-backed
securities (includes U.S. ....
Government Agency obligations) 2,035,719 8,882 9,486 2,035,115
Other .......................... 116,205 -- 9 116,196
-----------------------------------------------
$5,091,528 $131,804 $ 22,790 $5,200,542
- ----------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
1995 Cost Gains Losses Value
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Municipal obligations .......... $1,563,389 $ 98,942 $ 2,428 $1,659,903
Corporate securities ........... 764,179 67,618 3,737 828,060
U.S. Government obligations .... 219,250 8,796 621 227,425
Mortgage- and asset-backed
securities (includes U.S. ....
Government Agency obligations) 1,535,973 18,058 4,515 1,549,516
Other .......................... 176,689 -- -- 176,689
-----------------------------------------------
$4,259,480 $193,414 $ 11,301 $4,441,593
- ----------------------------------------------------------------------------------
</TABLE>
37 AMBAC 1996 ANNUAL REPORT
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Dollars in Thousands,Except Per Share Amounts)
The amortized cost and estimated fair value of debt securities at December 31,
1996, by contractual maturity, were as follows:
<TABLE>
<CAPTION>
Amortized Estimated
1996 Cost Fair Value
- --------------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less ........................ $ 140,921 $ 141,028
Due after one year through five years .......... 344,615 354,696
Due after five years through ten years ......... 279,108 290,987
Due after ten years ............................ 2,291,165 2,378,716
--------------------------
3,055,809 3,165,427
Mortgage- and asset-backed securities .......... 2,035,719 2,035,115
--------------------------
$5,091,528 $5,200,542
- --------------------------------------------------------------------------------
</TABLE>
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
Net investment income from financial guarantee insurance operations
comprised the following:
<TABLE>
<CAPTION>
1996 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Bonds .......................... $ 139,410 $ 127,864 $ 116,272
Short-term investments ......... 7,999 5,670 3,300
-----------------------------------------
Total investment income ...... 147,409 133,534 119,572
Investment expense ............. (2,468) (2,485) (2,460)
-----------------------------------------
Net investment income ........ $ 144,941 $ 131,049 $ 117,112
- -------------------------------------------------------------------------------
</TABLE>
Financial guarantee insurance operations had gross realized gains of $19,236,
$27,786 and $26,514 for 1996, 1995 and 1994, respectively, and gross realized
losses of $39,767, $27,609 and $39,900 for 1996, 1995 and 1994, respectively.
Net investment income related to municipal investment contracts comprises
gross investment income less related interest expense, and is a component of
financial services operating income. For 1996, 1995 and 1994, gross investment
income from municipal investment contracts was $165,196, $137,382 and $105,958,
respectively, and the related interest expense was $154,484, $127,666 and
$92,403, respectively.
As of December 31, 1996, the Company did not have any investment
concentrated in any single repayment source (excluding obligations of the U.S.
Government and its agencies) with a fair value greater than 2.0% of its
stockholders' equity.
As of December 31, 1996 and 1995, the Company held securities subject to
agreements to resell for $201,169 and $240,280, respectively. Such securities
were held as collateral by the Company. The agreements had terms of less than 30
days.
As of December 31, 1996 and 1995, the Company had pledged (or sold under
agreements to repurchase) securities purchased under agreements to resell and
investment securities to certain municipalities, with a fair value of $1,642,964
and $1,176,251, respectively, in connection with certain municipal investment
contracts (including contracts structured as municipal investment repurchase
contracts). Additionally, as of December 31, 1996 and 1995, investment
securities with a fair value of $896 and $5,755, respectively, were pledged to
futures brokers for required margin.
NOTE 4 Reinsurance
In the ordinary course of business, AMBAC Indemnity cedes exposures under
various reinsurance contracts primarily designed to minimize losses from large
risks and to protect capital and surplus. The effect of reinsurance on premiums
written and earned was as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
- -----------------------------------------------------------------------------------------
1996 1995 1994
- -----------------------------------------------------------------------------------------
Written Earned Written Earned Written Earned
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Direct ...... $240,544 $155,883 $190,570 $125,559 $185,365 $134,760
Assumed ..... 6,664 3,126 2,756 1,349 4,541 1,325
Ceded ....... (37,793) (22,380) (28,606) (15,088) 2,815 (18,621)
------------------------------------------------------------------------
Net premiums $209,415 $136,629 $164,720 $111,820 $192,721 $117,464
- -----------------------------------------------------------------------------------------
</TABLE>
The reinsurance of risk does not relieve the ceding insurer of its original
liability to its policyholders. In the event that all or any of the reinsurers
are unable to meet their obligations to AMBAC Indemnity under the existing
reinsurance agreements, AMBAC Indemnity would be liable for such defaulted
amounts. To minimize its exposure to significant losses from reinsurer
insolvencies, AMBAC Indemnity evaluates the financial condition of its
reinsurers and monitors concentrations of credit risk. There were no reinsurance
receivables as of December 31, 1996 and 1995. As of December 31, 1996, prepaid
reinsurance of approximately $139,629 was associated with AMBAC Indemnity's
three largest reinsurers. As of December 31, 1996, AMBAC Indemnity held letters
of credit and collateral amounting to approximately $159,129 from its reinsurers
to cover liabilities ceded under the aforementioned reinsurance contracts.
During 1995 and 1994, AMBAC Indemnity terminated reinsurance contracts,
resulting in return premiums to AMBAC Indemnity of $18,141 and $30,482,
respectively, of which $15,700 and $25,891 were recorded as an increase to the
unearned premium reserve in 1995 and 1994, respectively, with the remainder
recognized as revenue.
38 AMBAC 1996 ANNUAL REPORT
<PAGE>
NOTE 5 Losses and Loss Adjustment Expenses
AMBAC Indemnity's liability for losses and loss adjustment expenses includes
case basis loss and loss adjustment expense reserves and the ACR. Following is a
summary of the activity in the case basis loss and ACR accounts and the
components of the liability for losses and loss adjustment expenses:
<TABLE>
<CAPTION>
1996 1995 1994
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Case basis loss and loss adjustment
expense reserves:
Balance at January 1 ................................ $39,249 $38,892 $35,155
----------------------------------
Incurred related to:
Current year ...................................... 1,484 750 8,073
Prior years ....................................... (9,556) 2,650 (3,368)
----------------------------------
Total incurred ................................... (8,072) 3,400 4,705
----------------------------------
Paid related to:
Current year ...................................... 150 150 275
Prior years ....................................... 9,404 2,893 693
----------------------------------
Total paid ....................................... 9,554 3,043 968
----------------------------------
Balance at December 31 .............................. 21,623 39,249 38,892
----------------------------------
Active credit reserve:
Balance at January 1 .............................. 26,747 26,770 28,882
Net provision for losses .......................... 5,115 4,097 4,422
ACR transfers from (to) Case Reserves ............. 6,735 (4,120) (6,534)
----------------------------------
Balance at December 31 .............................. 38,597 26,747 26,770
----------------------------------
Total ............................................. $60,220 $65,996 $65,662
- -----------------------------------------------------------------------------------------
</TABLE>
The terms "current year" and "prior years" in the foregoing table refer to the
year in which case basis loss reserves were established.
NOTE 6 Stockholders' Equity
The Company is authorized to issue 50,000,000 shares of Common Stock, par value
$0.01 per share, of which 35,340,192 were issued as of December 31, 1996. The
Company is also authorized to issue 20,000,000 shares of Class A Common Stock,
par value $0.01 per share, none of which was issued and outstanding as of
December 31, 1996, and 4,000,000 shares of preferred stock, $0.01 par value per
share, none of which was issued and outstanding as of December 31, 1996.
Dividends declared per common share amounted to $0.615, $0.555 and $0.495
in 1996, 1995 and 1994, respectively.
The Board of Directors of the Company (the "Board") has authorized the
establishment of a stock repurchase program which permits the repurchase of up
to 3,000,000 shares of the Company's Common Stock. As of December 31, 1996,
approximately 1,061,000 shares had been repurchased under this program for an
aggregate amount of $49,571.
Stockholder Rights Plan: In January 1996, the Company adopted a Stockholder
Rights Plan under which stockholders received one Right for each share of Common
Stock owned. Each Right entitles the registered holder to purchase from the
Company one one-hundredth of a share of Series A Junior Participating Preferred
Stock, par value $0.01 per share, at a purchase price of $190 per share. The
Rights generally detach and become exercisable when any person or group acquires
20% or more (or announces a tender offer for 20% or more) of the Company's
Common Stock, at which time each Right (other than those held by the acquiring
company) will entitle the holder to receive that number of shares of Common
Stock of the Company with a value of two times the exercise price of the Right.
If the Company is acquired in a merger or other business combination transaction
in which the Company is not the surviving corporation or 50% or more of the
Company's assets, cash flow or earning power is sold or transferred, each Right
will entitle the holder to receive that number of shares of stock of the
acquiring company having a value equal to two times the exercise price of the
Right. The Rights, which expire on January 31, 2006, are redeemable in whole,
but not in part, by action of the Board of Directors at a price of $.01 per
Right at any time prior to their becoming exercisable.
NOTE 7 Commitments and Contingencies
The Company is responsible for leases on the rental of office space, principally
in New York City and Westport, CT. The lease agreements, which expire
periodically through September 2014, contain provisions for scheduled periodic
rent increases and are accounted for as operating leases. 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:
<TABLE>
<CAPTION>
Amount
- --------------------------------------------------------------------------------
<S> <C>
1997 .................................................... $4,027
1998 .................................................... 4,311
1999 .................................................... 4,502
2000 .................................................... 4,399
2001 .................................................... 4,338
All later years ......................................... 52,837
-------
$74,414
</TABLE>
Rent expense for the aforementioned leases amounted to $3,862, $3,461 and $2,859
for the years ended December 31, 1996, 1995 and 1994, respectively.
39 AMBAC 1996 ANNUAL REPORT
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Dollars in Thousands,Except Per Share Amounts)
NOTE 8 Insurance Regulatory Restrictions
AMBAC Indemnity is subject to insurance regulatory requirements of the States of
Wisconsin and New York and the other jurisdictions in which it is licensed to
conduct business.
AMBAC Indemnity's ability to pay dividends is generally restricted by law
and subject to approval by the Office of the Commissioner of Insurance of the
State of Wisconsin (the "Wisconsin Commissioner"). Wisconsin insurance law
restricts the payment of dividends in any 12-month period without regulatory
approval to the lesser of (a) 10% of policyholders' surplus as of the preceding
December 31 and (b) the greater of (i) statutory net income for the calendar
year preceding the date of dividend, minus realized capital gains for that
calendar year and (ii) the aggregate of statutory net income for three calendar
years preceding the date of the dividend, minus realized capital gains for those
calendar years and minus dividends paid or credited within the first two of the
three preceding calendar years. AMBAC Indemnity paid cash dividends of $40,000,
$40,000 and $36,000 on its common stock in 1996, 1995 and 1994, respectively. In
addition, on April 30, 1996, AMBAC Indemnity, in conjunction with the sale of
the Company's remaining holdings in HCIA common stock, delivered to the Company
(in the form of an extraordinary dividend) its 2,378,672 shares of HCIA common
stock, at fair value. The Wisconsin Commissioner approved such dividend. As a
result, any dividends paid by AMBAC Indemnity to the Company through June 30,
1997, require pre-approval from the Wisconsin Commissioner. The Wisconsin
Commissioner has stated to AMBAC Indemnity management that it does not foresee
any reason pre-approval of anticipated common stock dividends paid through June
30, 1997, would not be given. Anticipated common stock dividends paid thereafter
and through year-end 1997, will not require such pre-approval.
The New York Financial Guarantee Insurance Law establishes single risk
limits applicable to all obligations issued by a single entity and backed by a
single revenue source. Under the limit applicable to municipal bonds, the
insured average annual debt service for a single risk, net of reinsurance and
collateral, may not exceed 10% of qualified statutory capital, which is defined
as the sum of the insurer's policyholders' surplus and contingency reserves. In
addition, insured principal of municipal bonds attributable to any single risk,
net of reinsurance and collateral, is limited to 75% of AMBAC Indemnity's
qualified statutory capital. Additional single risk limits, which generally are
more restrictive than the municipal bond single risk limit, are also specified
for several other categories of insured obligations.
Statutory capital and surplus was $899,023 and $862,976 at December 31,
1996 and 1995, respectively. Qualified statutory capital was $1,466,560 and
$1,358,769 at December 31, 1996 and 1995, respectively. Statutory net income was
$222,810, $142,541 and $116,238 for 1996, 1995 and 1994, respectively. Statutory
capital and surplus differs from stockholders' equity determined under GAAP
principally due to statutory accounting rules that treat loss reserves, premiums
earned, policy acquisition costs and deferred income taxes differently.
NOTE 9 Income Taxes
The Company's provision for income taxes is comprised of the following:
<TABLE>
<CAPTION>
1996 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Current taxes .................. $94,392 $33,286 $22,960
Deferred taxes ................. 4,797 13,293 15,854
---------------------------------------
$99,189 $46,579 $38,814
- --------------------------------------------------------------------------------
</TABLE>
The total effect of income taxes on income and stockholders' equity for the
years ended December 31, 1996 and 1995 was as follows:
<TABLE>
<CAPTION>
1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
Total income taxes charged to income ................... $99,189 $46,579
---------------------
Income taxes charged (credited) to stockholders' equity:
Unrealized (losses) gains on bonds ................... (28,108) 127,038
Unrealized gain on investment in affiliate ........... -- 7,730
Other ................................................ (2,282) (677)
---------------------
Total (credited) charged to stockholders' equity .... (30,390) 134,091
---------------------
Total effect of income taxes ........................... $68,799 $180,670
- --------------------------------------------------------------------------------
</TABLE>
The tax provisions in the accompanying consolidated statements of operations
reflect effective tax rates differing from prevailing Federal corporate income
tax rates. The following is a reconciliation of these differences:
40 AMBAC 1996 ANNUAL REPORT
<PAGE>
<TABLE>
<CAPTION>
1996 1995 1994
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Computed expected
tax at statutory rate $131,427 35.0% $74,961 35.0% $62,972 35.0%
Increases (reductions)
in expected tax
resulting from:
Tax-exempt interest ... (30,760) (8.2) (28,379) (13.3) (26,441) (14.6)
Other, net .......... (1,478) (0.4) (3) -- 2,283 1.2
---------------------------------------------------------------
Income tax expense .... $99,189 26.4% $46,579 21.7% $38,814 21.6%
- -------------------------------------------------------------------------------------------
</TABLE>
The tax effects of temporary differences that give rise to significant portions
of the deferred tax liabilities and deferred tax assets at December 31, 1996 and
1995 are presented below:
<TABLE>
<CAPTION>
1996 1995
- --------------------------------------------------------------------
<S> <C> <C>
Deferred tax liabilities:
Contingency reserve ....................... $ 76,805 $ 76,805
Unrealized gains on bonds ................. 30,150 58,258
Deferred acquisition costs ................ 32,974 28,917
Unearned premiums ......................... 28,060 22,167
Unrealized gain on investment in affiliate -- 7,730
Investments ............................... 60 3,638
Other ..................................... 1,250 1,904
------------------
Total deferred tax liabilities ........... 169,299 199,419
------------------
Deferred tax assets:
Tax and loss bonds ........................ 63,871 63,871
Loss reserves ............................. 13,512 9,631
Alternative minimum tax credit carryforward -- 12,272
Amortization and Depreciation ............. 4,836 2,870
Compensation .............................. 2,884 2,672
Other ..................................... 4,110 4,406
------------------
Sub-total deferred tax assets ............ 89,213 95,722
Valuation allowance ....................... -- --
------------------
Total deferred tax assets ................ 89,213 95,722
------------------
Net deferred tax liabilities ............. $ 80,086 $103,697
- -------------------------------------------------------------------
</TABLE>
The Company believes that no valuation allowance is necessary in connection with
the deferred tax assets.
NOTE 10 Employee Benefits
Pensions: The Company has a defined benefit pension plan covering substantially
all employees of the Company and its subsidiaries. The benefits are based on
years of service and the employee's compensation during the last five years of
employment. The Company's funding policy is to contribute annually the maximum
amount that can be deducted for Federal income tax purposes. Contributions are
intended to provide not only for benefits attributed to service-to-date but also
for those expected to be earned in the future.
The actuarial present value of the benefit obligations shown in the
following table sets forth the plan's funded status and amounts recognized by
the Company as of December 31, 1996 and 1995.
<TABLE>
<CAPTION>
1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C>
Accumulated benefit obligation, including vested
benefits of $6,282 and $6,049, respectively ........... ($6,979) ($6,788)
---------------------
Projected benefit obligation for service rendered to date (8,189) (7,800)
Plan assets at fair value, primarily listed stocks,
commingled funds and fixed income securities .......... 8,153 7,054
---------------------
Unfunded projected benefit .............................. (36) (746)
Unrecognized prior service cost ......................... (1,619) (1,784)
Unrecognized net loss ................................... 885 1,906
Unrecognized net transition asset ....................... (9) (12)
---------------------
Pension liability included in other liabilities ......... ($ 779) ($ 636)
- --------------------------------------------------------------------------------
</TABLE>
Net pension costs for 1996, 1995 and 1994 included the following components:
<TABLE>
<CAPTION>
1996 1995 1994
- ------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost ............................... $ 674 $ 541 $ 558
Interest cost on expected benefit obligation 539 456 386
Actual return on plan assets ............... (957) (1,333) 30
Net amortization and deferral .............. 263 760 (547)
-------------------------
Net periodic pension cost .................. $ 519 $ 424 $ 427
- ------------------------------------------------------------------------
</TABLE>
The weighted-average discount rate used in the determination of the actuarial
present value for the projected benefit obligation was 7.50% and 7.25% for 1996
and 1995, respectively. The expected long-term rate of return on assets was
9.25% for both 1996 and 1995. The rate of increase in future compensation levels
used in determining the actuarial present value of the projected benefit
obligation was 5.0% for both 1996 and 1995.
Substantially all employees of the Company and its subsidiaries are covered
by a defined contribution plan (the "Savings Incentive Plan"), for which
contributions and costs are determined as 6% of each covered employee's base
salary, plus a matching company contribution of 50% on contributions up to 6% of
base salary made by eligible employees to the plan. The total cost of the
Savings Incentive Plan was $1,680, $1,555 and $1,292 in 1996, 1995 and 1994,
respectively.
Annual Incentive Plan: The Company has an annual incentive plan which provides
for awards to key officers and employees based upon predetermined criteria. The
cost of the plan for the years ended December 31, 1996, 1995 and 1994 amounted
to $10,822, $8,860 and $9,880, respectively.
Postretirement Health Care and Other Benefits: AMBAC Indemnity provides certain
medical and life insurance benefits for retired employees and eligible
dependents. All plans are contributory. None of the plans is currently funded.
41 AMBAC 1996 ANNUAL REPORT
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Dollars in Thousands,Except Per Share Amounts)
Postretirement benefits expense was $220, $168 and $176 in 1996, 1995 and
1994, respectively. The unfunded accumulated postretirement benefit obligation
was $1,526 and the accrued postretirement liability was $1,524 as of December
31, 1996.
The assumed weighted average health care cost trend rates range from 8.5%
in 1996, decreasing ratably to 5.5% in 2001, and remaining at that level
thereafter. Increasing the assumed health care cost trend rate by one percentage
point in each future year would increase the accumulated postretirement benefit
obligation at December 31, 1996 by $194 and the 1996 benefit expense by $40. The
weighted average discount rate used to measure the accumulated postretirement
benefit obligation and 1996 expense was 7.50%.
NOTE 11 Insurance in Force
The par amount of bonds insured by AMBAC Indemnity, net of reinsurance, was
$131,497,000 and $110,997,000 at December 31, 1996 and 1995, respectively. As of
December 31, 1996 and 1995, AMBAC Indemnity's insured portfolio was diversified
by type of insured bond as shown in the following table:
<TABLE>
<CAPTION>
Net Par Amount Outstanding
--------------------------
(Dollars in Millions) 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
Municipal finance:
General obligation ............................... $ 31,863 $ 30,546
Lease and tax-backed revenue ..................... 25,366 18,780
Utility revenue .................................. 22,780 21,053
Health care revenue .............................. 13,521 12,553
Transportation revenue ........................... 6,891 6,293
Investor-owned utilities ......................... 5,551 4,497
Higher education ................................. 4,745 3,973
Housing revenue .................................. 4,497 3,577
Student loans .................................... 3,439 3,769
Other ............................................ 484 483
--------------------------
Total municipal finance ......................... 119,137 105,524
--------------------------
Structured finance:
Domestic:
Mortgage-backed and home equity ................. 5,263 1,901
Asset-backed .................................... 1,329 1,213
Other ........................................... 1,440 124
--------------------------
Total domestic structured finance ............. 8,032 3,238
--------------------------
International:
Asset-backed .................................... 2,530 1,382
Other ........................................... 1,798 853
--------------------------
Total international structured finance ........ 4,328 2,235
--------------------------
Total structured finance ...................... 12,360 5,473
--------------------------
$131,497 $110,997
- --------------------------------------------------------------------------------
</TABLE>
As of December 31, 1996, California was the state with the highest aggregate net
par amount in force, accounting for 15.6% of the total, and the highest single
insured risk represented 1.0% of aggregate net par amount insured. AMBAC
Indemnity's direct insurance in force (principal and interest) was $268,870,000
and $235,118,000 at December 31, 1996 and 1995, respectively. Net insurance in
force (after giving effect to reinsurance) was $227,235,000 and $199,078,000 as
of December 31, 1996 and 1995, respectively.
NOTE 12 Financial Instruments Held For
Purposes Other Than Trading
Financial instruments with off-balance-sheet risk: In the normal course of
business, the Company becomes a party to various financial transactions to
reduce its exposure to fluctuations in interest rates. These financial
instruments include interest rate swaps, exchange traded interest rate futures
contracts and purchased interest rate options. The notional amounts of the
Company's off-balance-sheet financial instruments which are held for purposes
other than trading were as follows:
<TABLE>
<CAPTION>
As of December 31, 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
Interest rate futures contracts .............. $1,569,800 $1,171,600
Interest rate swaps .......................... 689,023 240,000
Purchased interest rate options .............. 32,200 15,000
- --------------------------------------------------------------------------------
</TABLE>
Notional principal amounts are often used to express the volume of these
transactions and do not reflect the extent to which positions may offset one
another. These amounts do not represent the much smaller amounts potentially
subject to risk.
In the ordinary course of business, the Company, through its affiliates,
manages a variety of 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.
Credit risk relates to the ability of counterparties to perform according
to the terms of their contractual commitments. Credit risk is calculated based
on the current replacement cost or fair value of the Company's financial
instruments. The gross replacement cost of these financial instruments is the
positive fair value of all transactions with a counterparty, excluding the
effects of netting or collateral arrangements, and was approximately $2,000 and
$5,000 as of December 31, 1996 and 1995, respectively. The Company executes
these transactions with a diverse base of counterparties in order to minimize
concentrations of credit risk.
Various procedures and controls are in place to monitor the credit risk
associated with municipal investment contracts and interest rate swaps. These
include the initial credit approval process, minimum
42 AMBAC 1996 ANNUAL REPORT
<PAGE>
credit rating requirements and the continuous monitoring of credit exposure. The
Company also has credit risk associated with its investment portfolio. These
risks are controlled through strict compliance with written investment policy
guidelines. These investment policy guidelines include a pre-established set of
criteria including minimum credit ratings, restrictions on the nature of
investments and single credit concentration limits.
Market risk relates to the impact of value changes of the Company's assets
and hedges on equity. The principal market risk is interest rate risk. An
independent risk management group is involved in setting and monitoring risk
limits and in the application of risk measurement methodologies. The estimation
of potential losses arising from adverse changes in market conditions is a key
element in managing market risk. The Company utilizes various models and stress
testing to manage interest rate risk. This process includes frequent analyses of
both parallel and non-parallel shifts in yield curve risk.
Liquidity risk relates to the possible inability to satisfy contractual
obligations when due. This risk is present in municipal investment contracts and
interest rate swaps and futures contracts. The Company manages liquidity risk by
matching the effective duration of its invested assets, including hedges, with
the effective duration of its municipal investment contract liabilities.
Additionally, the Company's policy is to maintain a minimum level of cash and
short-term liquid assets equivalent to a specified percentage of its municipal
investment contract liabilities outstanding.
Operational risk relates to the potential for loss caused by a breakdown in
information, communication and settlement systems. The Company mitigates
operational risk by maintaining a comprehensive system of internal controls.
This includes the establishment of systems and procedures to monitor
transactions and positions, documentation and confirmation of transactions and
ensuring compliance with regulations.
Legal risk relates to the uncertainty of the enforceability, through legal
or judicial processes, of the obligations of the Company's counterparties,
including contractual provisions intended to reduce credit exposure by providing
for the offsetting or netting of mutual obligations. The Company seeks to remove
or minimize such uncertainties through continuous consultation with internal and
external legal advisers to analyze and understand the nature of legal risk, to
improve documentation and to strengthen transaction structure.
As discussed in Note 2, interest rate futures contracts held for purposes
other than trading are used primarily to hedge price or interest rate risk
inherent in the portfolio of interest-sensitive assets and liabilities. Interest
rate swaps held for purposes other than trading are used to manage interest rate
risk by synthetically changing the nature of specific assets or liabilities.
Interest rate futures contracts are purchased to hedge interest rate risk
inherent in fixed rate liabilities. Interest rate futures contracts are sold to
hedge interest rate risk inherent in fixed rate investment securities. At
December 31, 1996 and 1995, interest rate futures contracts with an outstanding
notional amount of $1,091,900 and $1,006,500, respectively, were designated as
hedges of fixed rate liabilities. Additionally, at December 31, 1996 and 1995,
interest rate futures contracts with an outstanding notional amount of $477,900
and $165,100, respectively, were designated as hedges of fixed rate investment
securities.
Interest rate swaps which require the Company to pay the fixed rate are
used primarily to hedge fixed rate investment securities. Interest rate swaps
which require the Company to receive the fixed rate are used primarily to hedge
fixed rate liabilities. The table below summarizes, for each major type of swap,
the weighted-average fixed rate paid or received on the respective notional
amounts outstanding. Notional amounts are used to calculate the contractual
payments to be exchanged under these contracts.
<TABLE>
<CAPTION>
Maturing after December 31,
- ---------------------------------------------------------------------------------------------------------------------------
1997 1998 1999 2000 2001 Thereafter
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Pay fixed swaps:
Notional amount .................. $ 192,046 $ 226,528 $ 299,775 $ 202,368 $ 161,145 $ 61,191
Weighted-average fixed rate ...... 6.00% 6.05% 6.98% 7.02% 6.93% 7.04%
Receive fixed swaps:
Notional amount .................. $ 169,776 $ 138,556 $ 137,922 $ 137,271 $ 136,602 $ 146,352
Weighted-average fixed rate ...... 6.25% 6.45% 6.45% 6.45% 6.45% 6.54%
Range of implied floating
interest rates ................. 5.90% 5.99% 6.52% 6.60% 6.84%
to 6.09% to 6.48% to 6.69% to 6.88% to 6.90%
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
43 AMBAC 1996 ANNUAL REPORT
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Dollars in Thousands,Except Per Share Amounts)
The floating rate side of the Company's interest rate swaps is based on several
indices, primarily one-month, three-month and six-month LIBOR. The floating
rates shown above reflect the range of the implied forward LIBOR yield curve for
those indices, as of December 31, 1996.
Fair values of financial instruments held for purposes other than trading: The
following fair value amounts were determined by the Company using independent
market information when available, and appropriate valuation methodologies when
market quotes were not available. In cases where specific market quotes are
unavailable, interpreting market data and estimating market values require
considerable judgment by management. Accordingly, the estimates presented are
not necessarily indicative of the amount the Company could realize in a current
market exchange.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
Investments: The fair values of bonds are based on quoted market prices or
dealer quotes.
Short-term investments and cash: The fair values of short-term investments and
cash are assumed to equal amortized cost.
Securities purchased under agreements to resell: The fair value of securities
purchased under agreements to resell is assumed to approximate carrying value.
Investment in affiliate: At December 31, 1995, the fair value of the Company's
investment in HCIA was based on the quoted market price of HCIA common stock.
Debentures: The fair value of the debentures is based on the quoted market
prices and dealer quotes.
Municipal investment contracts and municipal investment repurchase contracts:
The fair value of the liability for municipal investment contracts and
repurchase agreements (including accrued interest) is estimated based upon
valuation models using rates currently offered for contracts of similar
remaining maturities.
Interest rate contracts: Fair values of off-balance-sheet interest rate
contracts (futures, swaps and interest rate options) are based on quoted market
and dealer prices, current settlement values, or pricing models.
Liability for net financial guarantees written: The fair value of the liability
for those financial guarantees written related to new issue and secondary market
exposures is based on the estimated cost to reinsure those exposures at current
market rates, which amount consists of the current unearned premium reserve,
less an estimated ceding commission thereon.
Certain other financial guarantee insurance policies have been written on
an installment basis, where the future premiums to be received by the Company
are determined based on the outstanding exposure at the time the premiums are
due. The fair value of AMBAC Indemnity's liability under its installment premium
policies is measured using the present value of estimated future installment
premiums, less an estimated ceding commission. The estimate of the amounts and
timing of the future installment premiums is based on contractual premium rates,
debt service schedules and expected run-off scenarios. This measure is used as
an estimate of the cost to reinsure AMBAC Indemnity's liability under these
policies.
The carrying amount and estimated fair value of these financial instruments
are presented below:
<TABLE>
<CAPTION>
As of December 31, 1996 1995
- -----------------------------------------------------------------------------------
Estimated Estimated
Carrying Fair Carrying Fair
(Dollars in Millions) Amount Value Amount Value
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Investments ............................... $5,088 $ 5,088 $4,265 $4,265
Short-term investments .................... 113 113 177 177
Cash ...................................... 8 8 12 12
Securities purchased under
agreements to resell .................... 201 201 240 240
Investment in affiliate ................... -- -- 45 194
Financial liabilities:
Debentures ................................ 224 259 224 271
Municipal investment contracts
and municipal investment
repurchase contracts (including
accrued interest) ....................... 2,778 2,775 2,446 2,486
Unrecognized financial instruments:
Interest rate futures contracts ........... -- -- -- --
Interest rate swaps ....................... -- (1) -- 2
Purchased interest rate option ............ -- -- -- --
Liability for financial guarantees written:
Direct .................................... -- 719 -- 655
Net of reinsurance ........................ -- 596 -- 543
Net installment premiums .................. -- 114 -- 80
- -----------------------------------------------------------------------------------
</TABLE>
NOTE 13 Financial Instruments Held
For Trading Purposes
The Company, through its affiliate AMBAC Financial Services, Limited
Partnership, is a provider of interest rate swaps to states, municipalities,
municipal authorities and other entities in connection with their financings.
The Company manages its business
44 AMBAC 1996 ANNUAL REPORT
<PAGE>
with the goal of being market neutral to changes in overall interest rates,
while retaining basis risk, the relationship between changes in floating rate
tax-exempt and floating rate taxable interest rates. If actual or projected
floating rate tax-exempt interest rates rise in relation to floating rate
taxable interest rates, the Company will experience an unrealized mark-to-market
loss. Conversely, if actual or projected floating rate tax-exempt interest rates
decline in relation to floating rate taxable interest rates, the Company will
experience an unrealized mark-to-market gain.
In the ordinary course of business, the Company manages a variety of 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. Operational
and legal risks related to financial instruments held for trading purposes are
similar to those risks as described in Note 12.
Credit risk relates to the ability of counterparties to perform according
to the terms of their contractual commitments. Credit risk is calculated based
on the current replacement cost or fair value of the Company's financial
instruments. The Company executes these transactions with a diverse base of
counterparties in order to minimize concentrations of credit risk.
Various procedures and controls are in place to monitor the credit risk of
interest rate swaps. These include the initial credit approval process, the
establishment of credit limits, management approvals, and a process that ensures
the continuous monitoring of credit exposure.
Market risk relates to the impact of price changes on future earnings. This
risk is a consequence of the Company's market-making activities in the municipal
interest rate swap market. The principal market risk is basis risk, the
relationship between changes in floating rate tax-exempt and floating rate
taxable interest rates. Since the third quarter of 1995, all municipal interest
rate swaps transacted contain provisions which are designed to protect the
Company against certain forms of tax reform, thus mitigating its basis risk. An
independent risk management group monitors trading risk limits and, together
with senior management, is involved in the application of risk measurement
methodologies.
The estimation of potential losses arising from adverse changes in market
relationships, known as "value-at-risk," is a key element in managing market
risk. The Company has developed a value-at-risk methodology to estimate
potential losses over a specified holding period and based on certain
probabilistic assessments. The Company estimates value-at-risk utilizing
historical short- and long-term interest rate volatilities and the relationship
between changes in tax-exempt and taxable interest rates calculated on a
consistent daily basis. For the years ended December 31, 1996 and 1995, the
Company's value-at-risk, calculated at a ninety-nine percent confidence level,
averaged approximately $1,389 and $1,358, respectively. The Company's
value-at-risk ranged from a high of $2,585 to a low of $1,096 in 1996 and from a
high of $2,131 to a low of $687 in 1995. Since no single measure can capture all
dimensions of market risk, the Company bolsters its value-at-risk methodology by
performing daily analyses of parallel and non-parallel shifts in yield curves
and stress test scenarios which measure the potential impact of market
conditions, however improbable, which might cause abnormal volatility swings or
disruptions of market relationships.
Liquidity risk relates to the possible inability to satisfy contractual
obligations when due. This risk is present in swaps and in futures contracts
used to hedge swaps. The Company manages liquidity risk by maintaining cash and
cash equivalents, closely matching the dates swap payments are made and
received, and limiting the amount of risk hedged by futures contracts.
The following table summarizes information about the Company's financial
instruments held for trading purposes as of December 31, 1996 and 1995:
<TABLE>
<CAPTION>
Average
Net Net Net Fair Value
Carrying Estimated ------------------------- Notional
Amount Fair Value Assets Liabilities Amount
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1996:
Interest rate swaps ........................ $12,133 $12,133 $44,241 $37,451 $2,341,660
Interest rate futures
contracts ................................ -- -- -- -- 484,500
1995:
Interest rate swaps ........................ $ 6,066 $ 6,066 $14,639 $13,663 $1,793,400
Interest rate futures
contracts ................................ -- -- -- -- 569,800
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The aggregate amount of net trading income recognized from financial instruments
held for trading purposes was $10,579, $2,871 and $2,101 for 1996,
45 AMBAC 1996 ANNUAL REPORT
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Dollars in Thousands,Except Per Share Amounts)
1995 and 1994, respectively. Average net fair values were calculated based on
average daily net fair values. The gross replacement cost of the Company's
financial instruments held for trading purposes is the positive fair value of
all transactions with a counterparty, excluding the effects of netting or
collateral arrangements, and was approximately $42,000 and $52,000 as of
December 31, 1996 and 1995, respectively. Net estimated fair value, after
netting and collateral arrangements more accurately portrays the credit risk
associated with the Company's financial instruments held for trading purposes.
Notional principal amounts are often used to express the volume of these
transactions and do not reflect the extent to which positions may offset one
another. These amounts do not represent the much smaller amounts potentially
subject to risk.
NOTE 14 Long-Term Debt and
Lines of Credit
The carrying value of long-term debt was as follows:
<TABLE>
<CAPTION>
December 31, 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
9-3/8% Debentures, due 2011 .................. $149,344 $149,299
7-1/2% Debentures, due 2023 .................. 74,454 74,433
-------------------------
$223,798 $223,732
- --------------------------------------------------------------------------------
</TABLE>
The Debentures due on February 1, 2011 were issued on August 8, 1991 in the
principal amount of $150,000 and bear interest of 9-3/8%, payable on February 1
and August 1 of each year. The Debentures are noncallable and were sold at 99.4%
of their principal amount at an effective yield of 9.44%.
The Debentures due on November 1, 2023 were issued on May 11, 1993 in the
principal amount of $75,000 and bear interest of 7-1/2%, payable on May 1 and
November 1 of each year. The Debentures are noncallable and were sold at 99.171%
of their principal amount at an effective yield of 7.57%.
The Company uses an interest rate swap based on a notional value of
$125,000 to synthetically manage a portion of its interest rate risk relative to
its long-term debt.
The Company and AMBAC Indemnity maintain a three-year revolving credit
facility with two major international banks, as co-agents, for $100,000. As of
December 31, 1996 and 1995, no amounts were outstanding under this credit
facility, which expires in July 1998.
AMBAC Indemnity has an agreement with a group of Aaa/AAA-rated
international banks for a $350,000 credit facility, expiring in 2003. This
facility is a seven-year stand-by irrevocable limited recourse line of credit,
which was increased from $300,000 to $350,000 and extended for an additional
year in December 1996. The line 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 December 31, 1996 and
1995, no amounts were outstanding under this line.
NOTE 15 Obligations Under Municipal
Investment Contracts
Obligations under municipal investment contracts, including those structured in
the form of repurchase contracts, are recorded on a trade-date basis. Certain
obligations may be called at various times prior to maturity at the option of
the counterparty. As of December 31, 1996 and 1995, the interest rates on these
agreements ranged from 4.23% to 8.14% and 3.65% to 8.14%, respectively. As of
December 31, 1996 and 1995, obligations under municipal investment contracts and
municipal investment repurchase contracts were as follows:
<TABLE>
<CAPTION>
1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
Settled .......................... $2,721,291 $2,222,061
Unsettled ........................ 33,299 204,797
---------------------------------
$2,754,590 $2,426,858
- --------------------------------------------------------------------------------
</TABLE>
Net payments due under settled investment contracts in each of the next five
years ending December 31, and the periods thereafter, based on expected call
dates, were as follows:
<TABLE>
<CAPTION>
Principal
Amount
- --------------------------------------------------------------------------------
<S> <C>
1997 ................................................. $ 945,960
1998 ................................................. 677,213
1999 ................................................. 443,880
2000 ................................................. 43,234
2001 ................................................. 82,174
All later years ...................................... 528,830
----------
$2,721,291
- --------------------------------------------------------------------------------
</TABLE>
46 AMBAC 1996 ANNUAL REPORT
<PAGE>
NOTE 16 Common Stock Incentives
The Company's stock incentive plan, the AMBAC Inc. 1991 Stock Incentive Plan
(the "Plan"), provides for the granting of incentive stock options, nonqualified
stock options, stock appreciation rights, restricted stock units, performance
unit awards, stock purchase rights, or other stock or stock-based awards that
are valued or determined by reference to the Common Stock. Options are
exercisable and expire as specified at the time of grant. The cumulative number
of shares subject to award is limited to a maximum of 10% of the number of
shares outstanding on a fully diluted basis as of the immediately preceding
fiscal quarter. The Plan also limits the number of shares available for grant in
each year (as determined by formula). Based on the provisions of the Plan, there
are approximately 650,000 shares available for grant in 1997. As of December 31,
1996, the maximum number of shares subject to award under the Plan was
approximately 3,727,000 of which approximately 3,076,000 (net of cancellations)
had previously been awarded. A summary of option activity is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
- ------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
- --------------------------- ------------- --------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding
at beginning
of year .... 2,070,412 $ 36.34 1,700,120 $ 34.60 1,266,852 $ 31.70
Granted ...... 482,075 $ 48.49 511,645 $ 39.57 517,620 $ 41.56
Exercised .... (360,862) $ 37.06 (121,248) $ 24.79 (19,580) $ 21.24
Forfeited .... (67,304) $ 43.74 (20,105) $ 41.59 (64,772) $ 33.53
---------- ---------- ----------
Outstanding
at end
of year .... 2,124,321 $ 38.74 2,070,412 $ 36.34 1,700,120 $ 34.60
- ------------------------------------------------------------------------------------------------------
Exercisable .. 1,203,919 1,141,245 855,806
- ------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- --------------------------------------------------------------------------------
Number Weighted Weighted Number Weighted
Range of Outstanding Average Average Exercisable Average
Exercise at December Remaining Exercise at December Exercise
Prices 31, 1996 Contract Life Price 31, 1996 Price
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$20 to 32 450,155 5.3 $20.35 450,155 $20.35
$34 to 44 932,221 7.4 $40.25 488,444 $40.19
$45 to 62 741,945 6.5 $47.99 265,320 $47.09
----------- ---------
2,124,321 1,203,919
- --------------------------------------------------------------------------------
</TABLE>
The Company applies APB 25 and related Interpretations in accounting for its
plans. Accordingly, since the fair value of the options at grant date equals the
exercise price, no compensation cost has been recognized for its fixed stock
option plan. Had compensation cost for the Company's stock-based compensation
plan been determined consistent with Statement 123, the Company's net income and
earnings per share for the years ended December 31, 1996 and 1995, would have
been reduced to the pro forma amounts below:
<TABLE>
<CAPTION>
1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C>
Net Income:
As reported ........................ $ 276,317 $ 167,595
Pro forma .......................... $ 273,528 $ 166,080
Earnings per share:
As reported ........................ $ 7.90 $ 4.78
Pro forma .......................... $ 7.82 $ 4.73
- --------------------------------------------------------------------------------
</TABLE>
The weighted-average fair value of options granted in 1996 and 1995 was $12.38
per share and $12.80 per share, respectively. The fair value of each option
grant issued was estimated as of the date of the grant using the Black-Scholes
option-pricing model, with the following weighted-average assumptions used for
grants in 1996 and 1995, respectively: dividend yield of 1.24% and 1.18%;
expected volatility of 16.5% and 20.0%; risk-free interest rates of 6.2% and
7.2%; and expected lives of 5 years and 6 years. The pro forma amounts disclosed
above are not likely to be representative of reported pro forma net income and
earnings per share for future years because options vest over several years and
additional awards are granted each year.
NOTE 17 Segment Information
As of December 31, 1996, the Company's products are reported in two industry
segments, as follows:
Financial guarantee insurance includes insurance of municipal and
structured finance obligations.
Financial services includes investment management and advisory services,
the issuance of investment contracts, investment repurchase contracts and
interest rate swaps principally to states, municipalities and municipal
authorities.
Prior to the sale of the Company's controlling portion in its health care
information content subsidiary in August 1995, the Company reported a third
industry segment called information services. Information services included
information products and analytical services on the financial and operating
performance of hospitals, nursing homes, retirement facilities and health
maintenance organizations through on-line computer services and publications
primarily to the hospital, health insurance and health care supplier markets.
47 AMBAC 1996 ANNUAL REPORT
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED)
(Dollars in Thousands, Except per Share amount)
The following table is a summary of the operations by operating segment for
the years ended December 31, 1996, 1995 and 1994:
<TABLE>
<CAPTION>
Financial Adjustments
Guarantee Financial Information Corporate and
Insurance Services Services and Other Eliminations Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1996:
Revenues:
Unaffiliated customers .............. $ 266,300 $ 22,156 $ -- $ 164,587 $ -- $ 453,043
Intersegment ........................ 1,728 (810) -- 159,883 (160,801) --
------------------------------------------------------------------------------------
Total revenues ......................... $ 268,028 $ 21,346 $ -- $ 324,470 ($160,801) $ 453,043
------------------------------------------------------------------------------------
Operating income:
Unaffiliated customers .............. $ 225,340 $ 10,943 $ -- $ 139,223 $ -- $ 375,506
Intersegment ........................ 1,728 (980) -- 159,883 (160,631) --
------------------------------------------------------------------------------------
Total operating income ................. $ 227,068 $ 9,963 $ -- $ 299,106 ($160,631) $ 375,506
------------------------------------------------------------------------------------
Identifiable assets .................... $2,886,264 $ 2,854,744 $ -- $ 134,957 $ -- $5,875,965
------------------------------------------------------------------------------------
1995:
Revenues:
Unaffiliated customers .............. $ 248,626 $ 13,009 $ -- $ 42,698 $ -- $ 304,333
Intersegment ........................ 1,798 (2,187) -- 40,292 (39,903) --
------------------------------------------------------------------------------------
Total revenues ......................... $ 250,424 $ 10,822 $ -- $ 82,990 ($ 39,903) $ 304,333
------------------------------------------------------------------------------------
Operating income:
Unaffiliated customers .............. $ 210,799 $ 5,216 $ -- ($ 1,841) $ -- $ 214,174
Intersegment ........................ 1,549 (2,610) -- 40,268 (39,207) --
------------------------------------------------------------------------------------
Total operating income ................. $ 212,348 $ 2,606 $ -- $ 38,427 ($ 39,207) $ 214,174
------------------------------------------------------------------------------------
Identifiable assets .................... $2,741,426 $ 2,533,743 $ -- $ 34,110 $ -- $5,309,279
------------------------------------------------------------------------------------
1994:
Revenues:
Unaffiliated customers .............. $ 225,026 $ 16,676 $30,423 ($ 901) $ -- $ 271,224
Intersegment ........................ 4,285 (871) 288 36,110 (39,812) --
------------------------------------------------------------------------------------
Total revenues ......................... $ 229,311 $ 15,805 $30,711 $ 35,209 ($ 39,812) $ 271,224
------------------------------------------------------------------------------------
Operating income:
Unaffiliated customers .............. $ 189,584 $ 10,571 $ 1,492 ($ 21,728) $ -- $ 179,919
Intersegment ........................ 3,997 (871) 288 36,000 (39,414) --
------------------------------------------------------------------------------------
Total operating income ................. $ 193,581 $ 9,700 $ 1,780 $ 14,272 ($ 39,414) $ 179,919
------------------------------------------------------------------------------------
Identifiable assets .................... $2,200,607 $ 2,031,039 $39,132 $ 16,221 $ -- $4,286,999
------------------------------------------------------------------------------------
</TABLE>
48 AMBAC 1996 ANNUAL REPORT
<PAGE>
NOTE 18 Quarterly Financial Information (unaudited)
<TABLE>
<CAPTION>
First Second Third Fourth Full Year
- ------------------------------------------------------------------------------------------------------------------------------------
1996
<S> <C> <C> <C> <C> <C>
Gross premiums written ............................... $50,287 $ 58,115 $67,613 $ 71,193 $ 247,208
Net premiums written ................................. 40,675 48,279 57,800 62,661 209,415
Net premiums earned .................................. 28,193 39,645 33,745 35,046 136,629
Net investment income ................................ 34,827 35,498 36,887 37,729 144,941
Losses and loss adjustment expenses .................. 810 1,700 1,301 (33) 3,778
Financial guarantee operating income ................. 57,210 43,228 56,609 68,293 225,340
Financial services operating income .................. 4,875 2,737 1,133 2,198 10,943
Equity in income of affiliate ........................ 627 -- -- -- 627
Other net realized gains ............................. -- 155,613 -- 700 156,313
Income before income taxes ........................... 57,007 197,777 54,685 66,037 375,506
Net income ........................................... 44,553 135,947 43,828 51,989 276,317
Net income per common share .......................... $ 1.27 $ 3.89 $ 1.26 $ 1.49 $ 7.90
-------------------------------------------------------------------------
1995
Gross premiums written ............................... $40,196 $ 36,402 $43,531 $ 73,197 $ 193,326
Net premiums written ................................. 36,737 42,916 36,162 48,905 164,720
Net premiums earned .................................. 24,217 27,847 26,233 33,523 111,820
Net investment income ................................ 31,755 32,292 33,192 33,810 131,049
Losses and loss adjustment expenses .................. 1,028 341 841 1,167 3,377
Financial guarantee operating income ................. 43,786 50,094 49,419 67,500 210,799
Financial services operating income (loss) ........... 1,527 (752) 935 3,506 5,216
Equity in income (loss) of affiliate ................. 226 1,867 868 (3,146) (185)
Other net realized gains ............................. -- -- 19,103 -- 19,103
Income before income taxes ........................... 40,325 45,779 65,453 62,617 214,174
Net income ........................................... 33,301 36,985 49,485 47,824 167,595
Net income per common share .......................... $ 0.95 $ 1.05 $ 1.41 $ 1.36 $ 4.78
-------------------------------------------------------------------------
</TABLE>
Due to changes in the number of shares outstanding, quarterly per share amounts
may not add to the totals for the year.
49 AMBAC 1996 ANNUAL REPORT
<PAGE>
CORPORATE HEADQUARTERS
AMBAC Inc.
One State Street Plaza
New York, New York 10004
212-668-0340
fax 212-509-9190
ANNUAL MEETING OF STOCKHOLDERS
The Annual Meeting of Stockholders of AMBAC Inc. will be held on Wednesday, May
14, 1997, at 11:30 a.m. in New York City. Detailed information about the meeting
is contained in the Notice of Annual Meeting and Proxy Statement to be sent to
each stockholder of record as of March 21, 1997. The Company estimates that it
has approximately 18,500 stockholders.
FORM 10-K
A copy of the Company's 1996 Annual Report on Form 10-K for the year ended
December 31, 1996, as filed with the Securities and Exchange Commission, may be
obtained without charge by writing to AMBAC Inc., Attn: Investor Relations, One
State Street Plaza, New York, New York 10004.
TRANSFER AGENT, REGISTRAR AND DIVIDEND PAYING AGENT
Citibank, N.A.
111 Wall Street, 5th Floor
New York, New York 10005
212-412-6209
STOCK LISTING
AMBAC Inc. common stock is listed on the New York Stock Exchange (ticker symbol
ABK). The Company is listed in the daily stock tables under "Ambac."
COMMON STOCK DATA
<TABLE>
<CAPTION>
1996 1995
--------------------------------------------------------------------------------
Market Price Market Price
----------------------------- ------------------------------
Dividends Dividends
Three Months Ended High Low Close Per Share High Low Close Per Share
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
March 31 $49 1/2 $45 1/2 $48 1/8 $0.150 $41 1/8 $36 1/2 $40 5/8 $0.135
June 30 55 1/4 47 1/4 52 1/8 0.150 41 1/2 39 1/4 40 1/8 0.135
September 30 58 3/8 47 55 3/4 0.150 45 39 1/2 44 0.135
December 31 69 1/2 55 3/4 66 3/8 0.165 47 7/8 42 46 7/8 0.150
- -----------------------------------------------------------------------------------------------------------
$0.615 $0.555
- -----------------------------------------------------------------------------------------------------------
</TABLE>
INVESTOR RELATIONS
1-800-221-1854
INTERNET: [email protected]
Frank J. Bivona
Senior Vice President
Chief Financial Officer and Treasurer
212-208-3236
John M. Cathey
Vice President
212-208-3490
INDEPENDENT AUDITORS
KPMG Peat Marwick LLP
New York, New York
[LOGO] ABK
Listed
NYSE
The New York Stock Exchange
52 AMBAC 1996 ANNUAL REPORT
<PAGE>
EXHIBIT 21.01
LIST OF SUBSIDIARIES OF AMBAC INC.
---------------------------------
The following list of significant and other subsidiaries of AMBAC Inc.
omits certain subsidiaries which, considered in the aggregate as a single
subsidiary, would not constitute a significant subsidiary. The jurisdiction of
incorporation of each subsidiary is included in parentheses after its name.
AMBAC INDEMNITY CORPORATION (Wisconsin)
AMBAC CAPITAL CORPORATION (Delaware)
AMBAC CAPITAL MANAGEMENT, INC. (Delaware)
AMBAC FINANCIAL SERVICES HOLDINGS, INC. (Delaware)
AMBAC FINANCIAL SERVICES, LIMITED PARTNERSHIP (Delaware)
<PAGE>
EXHIBIT 24.01
AMBAC INC.
POWER OF ATTORNEY
-----------------
KNOW ALL MEN BY THESE PRESENTS that the undersigned director and officer
of AMBAC Inc., a Delaware corporation, hereby constitutes and appoints each of
FRANK J. BIVONA and RICHARD B. GROSS, as his true and lawful attorney-in-fact
and agent, with full power of substitution, for him and in his name, place and
stead, in any and all capacities, to sign the ANNUAL REPORT ON FORM 10-K FOR THE
YEAR ENDED DECEMBER 31, 1996, to be filed with the Securities and Exchange
Commission and the New York Stock Exchange, and any and all amendments thereto,
and any and all instruments and documents filed as a part of or in connection
with the said Form 10-K or amendments thereto, and does hereby grant unto each
said attorney-in-fact and agent full power and authority to do and perform each
and every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he or she might or could do in
person, hereby ratifying and confirming all that each said attorney-in-fact and
agent shall do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has subscribed these presents as of
this 18 day of March, 1997.
/s/ Phillip B. Lassiter
-------------------------------
Phillip B. Lassiter
<PAGE>
EXHIBIT 24.02
AMBAC INC.
POWER OF ATTORNEY
-----------------
KNOW ALL MEN BY THESE PRESENTS that the undersigned director of AMBAC
Inc., a Delaware corporation, hereby constitutes and appoints each of FRANK J.
BIVONA and RICHARD B. GROSS, as his true and lawful attorney-in-fact and agent,
with full power of substitution, for him and in his name, place and stead, in
any and all capacities, to sign the ANNUAL REPORT ON FORM 10-K FOR THE YEAR
ENDED DECEMBER 31, 1996, to be filed with the Securities and Exchange Commission
and the New York Stock Exchange, and any and all amendments thereto, and any and
all instruments and documents filed as a part of or in connection with the said
FORM 10-K or amendments thereto, and does hereby grant unto each said attorney-
in-fact and agent full power and authority to do and perform each and every act
and thing requisite and necessary to be done in and about the premises, as fully
to all intents and purposes as he or she might or could do in person, hereby
ratifying and confirming all that each said attorney-in-fact and agent shall do
or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has subscribed these presents as of
this 17 day of February, 1997.
/s/ Michael A. Callen
------------------------------
Michael A. Callen
<PAGE>
EXHIBIT 24.03
AMBAC INC.
POWER OF ATTORNEY
-----------------
KNOW ALL MEN BY THESE PRESENTS that the undersigned director of AMBAC
Inc., a Delaware corporation, hereby constitutes and appoints each of FRANK J.
BIVONA and RICHARD B. GROSS, as his true and lawful attorney-in-fact and agent,
with full power of substitution, for him and in his name, place and stead, in
any and all capacities, to sign the ANNUAL REPORT ON FORM 10-K FOR THE YEAR
ENDED DECEMBER 31, 1996, to be filed with the Securities and Exchange Commission
and the New York Stock Exchange, and any and all amendments thereto, and any and
all instruments and documents filed as a part of or in connection with the said
FORM 10-K or amendments thereto, and does hereby grant unto each said attorney-
in-fact and agent full power and authority to do and perform each and every act
and thing requisite and necessary to be done in and about the premises, as fully
to all intents and purposes as he or she might or could do in person, hereby
ratifying and confirming all that each said attorney-in-fact and agent shall do
or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has subscribed these presents as of
this 18 day of February, 1997.
/s/ Renso L. Caporali
------------------------------
Renso L. Caporali
<PAGE>
EXHIBIT 24.04
AMBAC INC.
POWER OF ATTORNEY
-----------------
KNOW ALL MEN BY THESE PRESENTS that the undersigned director of AMBAC
Inc., a Delaware corporation, hereby constitutes and appoints each of FRANK J.
BIVONA and RICHARD B. GROSS, as his true and lawful attorney-in-fact and agent,
with full power of substitution and resubstitution, for him and in his name,
place and stead, in any and all capacities, to sign the ANNUAL REPORT ON FORM
10-K FOR THE YEAR ENDED DECEMBER 31, 1996, to be filed with the Securities and
Exchange Commission and the New York Stock Exchange, and any and all amendments
thereto, and any and all instruments and documents filed as a part of or in
connection with the said FORM 10-K or amendments thereto, and does hereby grant
unto each said attorney-in-fact and agent full power and authority to do and
perform each and every act and thing requisite and necessary to be done in and
about the premises, as fully to all intents and purposes as he or she might or
could do in person, hereby ratifying and confirming all that each said attorney-
in-fact and agent shall do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has subscribed these presents as of
this 16 day of February, 1997.
/s/ Richard Dulude
------------------------------
Richard Dulude
<PAGE>
EXHIBIT 24.05
AMBAC INC.
POWER OF ATTORNEY
-----------------
KNOW ALL MEN BY THESE PRESENTS that the undersigned director of AMBAC
Inc., a Delaware corporation, hereby constitutes and appoints each of FRANK J.
BIVONA and RICHARD B. GROSS, as his true and lawful attorney-in-fact and agent,
with full power of substitution, for him and in his name, place and stead, in
any and all capacities, to sign the ANNUAL REPORT ON FORM 10-K FOR THE YEAR
ENDED DECEMBER 31, 1996, to be filed with the Securities and Exchange Commission
and the New York Stock Exchange, and any and all amendments thereto, and any and
all instruments and documents filed as a part of or in connection with the said
FORM 10-K or amendments thereto, and does hereby grant unto each said attorney-
in-fact and agent full power and authority to do and perform each and every act
and thing requisite and necessary to be done in and about the premises, as fully
to all intents and purposes as he or she might or could do in person, hereby
ratifying and confirming all that each said attorney-in-fact and agent shall do
or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has subscribed these presents as of
this 18 day of February, 1997.
/s/ W. Grant Gregory
------------------------------
W. Grant Gregory
<PAGE>
EXHIBIT 24.06
AMBAC INC.
POWER OF ATTORNEY
-----------------
KNOW ALL MEN BY THESE PRESENTS that the undersigned director of AMBAC
Inc., a Delaware corporation, hereby constitutes and appoints each of FRANK J.
BIVONA and RICHARD B. GROSS, as his true and lawful attorney-in-fact and agent,
with full power of substitution, for him and in his name, place and stead, in
any and all capacities, to sign the ANNUAL REPORT ON FORM 10-K FOR THE YEAR
ENDED DECEMBER 31, 1996, to be filed with the Securities and Exchange Commission
and the New York Stock Exchange, and any and all amendments thereto, and any and
all instruments and documents filed as a part of or in connection with the said
FORM 10-K or amendments thereto, and does hereby grant unto each said attorney-
in-fact and agent full power and authority to do and perform each and every act
and thing requisite and necessary to be done in and about the premises, as fully
to all intents and purposes as he or she might or could do in person, hereby
ratifying and confirming all that each said attorney-in-fact and agent shall do
or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has subscribed these presents as of
this 19 day of February, 1997.
/s/ C. Roderick O'Neil
------------------------------
C. Roderick O'Neil
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<DEBT-HELD-FOR-SALE> 5,088,031
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 0
<MORTGAGE> 0
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0
0
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136,629
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</TABLE>
