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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, 1997 1-10777
Ambac Financial Group, 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 15, 1998 was $3,956,113,609 (based upon the closing price
of the Registrant's shares of the New York Stock Exchange on March 15, 1998,
which was $56.625). 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 15, 1998, 70,110,811 shares of Common Stock, par value $0.01 per
share, (net of 569,573 treasury shares) were outstanding.
Documents Incorporated By Reference
Portions of the Registrant's Annual Report to Stockholders for the year
ended December 31, 1997 are incorporated by reference into Parts II and IV
hereof. Portions of the Registrant's Proxy Statement dated March 31, 1998 in
connection with the Annual Meeting of Stockholders to be held on May 13, 1998
are incorporated by reference into Part III hereof.
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TABLE OF CONTENTS
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Page
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PART I
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Item 1. Business................................................................ 1
Item 2. Properties.............................................................. 29
Item 3. Legal Proceedings....................................................... 29
Item 4. Submission of Matters to a
Vote of Security Holders................................................ 29
PART II
Item 5. Market for Registrant's Common
Equity and Related Stockholder Matters.................................. 29
Item 6. Selected Financial Data................................................. 29
Item 7. Management's Discussion and
Analysis of Financial Condition
and Results of Operations............................................... 30
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.............. 30
Item 8. Financial Statements and Supplementary Data............................. 30
Item 9. Changes in and Disagreements With
Accountants on Accounting and
Financial Disclosure.................................................... 30
PART III
Item 10. Directors and Executive Officers
of the Registrant....................................................... 30
Item 11. Executive Compensation.................................................. 30
Item 12. Security Ownership of Certain
Beneficial Owners and Management........................................ 30
Item 13. Certain Relationships and
Related Transactions.................................................... 31
PART IV
Item 14. Exhibits, Financial Statement
Schedules, and Reports on Form 8-K...................................... 31
SIGNATURES 36
APPENDIX A Types and Ratings of Bonds.............................................. A-1
FINANCIAL STATEMENT SCHEDULES S-1
</TABLE>
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Part I
ITEM 1. BUSINESS.
GENERAL
Ambac Financial Group, Inc. (the "Company") headquartered in New York
City, is a holding company whose affiliates provide financial guarantee
insurance and financial management services to clients in both the public and
private sectors in the U.S. and abroad. The Company was incorporated on April
29, 1991. The Company's principal operating subsidiary, Ambac Assurance
Corporation ("Ambac Assurance"), is a leading insurer of municipal and
structured finance obligations. Through its financial management services
subsidiaries, the Company provides investment agreements, interest rate swaps,
investment management advisory, cash management, fund administration and
broker/dealer services, and electronic commerce and information management
solutions, principally to states, municipalities and their authorities, school
districts, and hospitals and health organizations.
During the first quarter of 1997, Ambac Assurance established a new
subsidiary in the United Kingdom, Ambac Insurance UK Limited ("Ambac UK"), which
is authorized to conduct certain classes of general insurance business in the
United Kingdom. Ambac UK is the Company's primary vehicle for the issuance of
financial guarantee insurance policies in the United Kingdom and Europe.
On December 18, 1997, Ambac Assurance acquired Construction Loan Insurance
Corporation ("CLIC"). Ambac Assurance paid $106.0 million in cash and retired
$18.4 million of CLIC debt. CLIC (renamed Connie Lee Holdings, Inc.) and its
triple-A rated financial guarantee insurance subsidiary Connie Lee Insurance
Company ("Connie Lee"), are now wholly owned subsidiaries of Ambac Assurance.
Connie Lee, which guaranteed bonds primarily for college and hospital
infrastructure projects, is not expected to write any new business. Ambac
Assurance and Connie Lee have arrangements in place to assure that Connie Lee
maintains a level of capital sufficient to support Connie Lee's outstanding
obligations and for Connie Lee insured bonds to retain their triple-A rating. As
previously reported, management expects the acquisition to have a positive
impact on earnings in 1998, depending upon several factors, including interest
rates and economic conditions.
Ambac Assurance 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 Assurance 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 Assurance's consent. Ambac Assurance seeks to minimize the risk
inherent in its insurance portfolio by maintaining a diverse portfolio which
spreads its risk across a number of criteria, including issue size, type of
bond, geographic area and obligor. As of December 31, 1997, Ambac Assurance's
net insurance in force (after giving effect for reinsurance) was $275.9 billion.
See "Insurance in Force" below.
Ambac Assurance 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 IBCA, Inc., ("Fitch") and Nippon Investors
Service, Inc. ("Nippon"). These ratings are an essential part of Ambac
Assurance's ability to provide credit enhancement. See "Rating Agencies" below.
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The Company's investment agreement business ("IA Business") provides
triple-A investment agreements primarily to states, municipalities and their
authorities. The investment agreements are rated triple-A by virtue of Ambac
Assurance's insurance policies which guarantee the IA Business' performance.
Investment agreements are used by municipal bond issuers to invest bond proceeds
until the proceeds can be used for their intended purpose, such as financing
construction. The investment agreement provides for the guaranteed return of
principal invested, and for the payment of interest thereon at a guaranteed
rate. See "Investment Agreement Business" below.
The Company provides interest rate swaps through its subsidiary Ambac
Financial Services, L.P. ("AFS") to states, municipalities and their
authorities, and other entities in connection with their financings. The
interest rate swaps provided by AFS are insured by triple-A rated Ambac
Assurance and provide a financing alternative that can reduce a municipal
issuer's overall borrowing costs. See "Ambac Financial Services, L.P. below.
The Company provides investment advisory, cash management and fund
administration services through its Cadre Financial Services, Inc. ("Cadre")
subsidiary and broker/dealer services through its Cadre Securities, Inc. ("Cadre
Securities") subsidiary, to school districts, hospitals and health
organizations, and municipalities. The Company also provides electronic commerce
solutions through its 61% owned subsidiary, Ambac Connect, Inc. ("ACI") to
states, municipalities and their authorities.
As a holding company, Ambac Financial Group, Inc. is largely dependent on
dividends from Ambac Assurance, its principal operating subsidiary, to pay
dividends on its capital stock, to pay principal and interest on its
indebtedness, to pay its operating expenses, and to make capital investments in
its subsidiaries. Such dividends from Ambac Assurance 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 1997 Annual Report to Stockholders.
BUSINESS SEGMENTS
The following paragraphs describe the business operations of Ambac
Financial Group, Inc., its subsidiaries and affiliates (sometimes collectively
referred to as "the Company") for the Company's two business segments: Financial
Guarantee Insurance and Financial Management Services.
FINANCIAL GUARANTEE INSURANCE
Financial guarantee insurance of the type written by Ambac Assurance
guarantees to the holder of the underlying obligation the timely payment of
principal 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 Assurance'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
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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) net realized gains and losses and (iv) fees. Excluding
transactions with affiliates, total financial guarantee insurance revenues were
$339.2 million, $266.3 million and $248.6 million in 1997, 1996 and 1995,
respectively. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and Note 18 of Notes to Consolidated Financial
Statements in the Company's 1997 Annual Report to Stockholders.
Financial guarantee insurance is sold in three principal markets: the
United States municipal market, the United States structured finance and asset-
backed market, and the international market.
UNITED STATES MUNICIPAL MARKET
Until 1993, Ambac Assurance was almost exclusively focused on the
municipal market in the United States. The municipal market includes taxable and
tax-exempt bonds, notes and other evidences of indebtedness issued by states,
political subdivisions (e.g., cities, counties, towns and villages), water,
sewer and other utility districts, higher educational institutions, hospitals,
transportation and housing authorities and other similar authorities and
agencies. Municipal obligations are supported by either the taxing authority of
the issuer or the issuer's or underlying obligor's ability to collect fees or
assessments for certain projects or public services. The following table sets
forth the volume of new issues of long-term (longer than 12 months) municipal
bonds and the volume of new issues of insured long-term municipal bonds over the
period from 1988 through 1997 in the United States.
NEW ISSUES OF U.S. LONG-TERM MUNICIPAL BONDS
<TABLE>
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INSURED
BONDS AS
PERCENTAGE
TOTAL INSURED OF TOTAL
Volume Volume Volume
($ in Billions)
<S> <C> <C> <C>
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........................................................ 234.7 80.8 34.4
1993........................................................ 292.2 107.8 36.9
1994........................................................ 164.8 61.4 37.3
1995........................................................ 160.3 68.5 42.7
1996........................................................ 183.5 85.5 46.6
1997........................................................ 215.1 104.8 48.7
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<S> <C>
Source: Amounts in the total volume column (except for 1997) are based upon estimated data reported by The
Bond Buyer's 1997 Yearbook. The 1997 volume amounts are Ambac Assurance 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.
</TABLE>
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
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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. During 1996
and 1997, municipal bond issuance began to rise again as interest rates began to
decrease.
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 financial instruments. These investment losses, however, did not
result in a higher level of ultimate payment defaults by municipal issuers. See
"Losses and Reserves" below.
UNITED STATES 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 and
asset-backed 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
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enhancement ultimately is sufficient to protect investors, and therefore the
insurer, against 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 or received by it after the time it becomes subject to
bankruptcy or insolvency proceedings. Ambac Assurance addresses these risks
through its credit underwriting guidelines, standards and procedures.
The U.S. structured finance and asset-backed market in which Ambac
Assurance provides financial guarantee insurance is broad and disparate,
comprising 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 U.S. 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
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TOTAL
Volume
($ in Billions)
<S> <C>
1993................................................................................. $ 57.7
1994................................................................................. 75.5
1995................................................................................. 108.0
1996................................................................................. 151.5
1997................................................................................. 176.0
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<TABLE>
<CAPTION>
Source: Amounts are based upon estimated data reported by Asset Sales Report.
<S> <C>
INTERNATIONAL MARKET
</TABLE>
Outside of the United States, sovereign and sub-sovereign, structured and
asset-backed, utilities and other issuers are increasingly using financial
guarantee insurance, particularly in markets throughout Western Europe. 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.
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,
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albeit at varying rates in each country. Ambac Assurance insures both asset-
backed and structured transactions, sovereign and sub-sovereign debt issues,
utilities, and other obligations in selected international markets.
Ambac Assurance believes that the risk profile of the international
business it insures is generally the same as in the U.S. However, there are
some unique risks inherent in the international business, including legal and
political environments, capital market dynamics, exposures to foreign exchange
and transfer risk, and the degree of governmental support. Ambac Assurance
monitors these risks carefully, and addresses them through its credit
underwriting guidelines, standards and procedures.
FINANCIAL GUARANTEE INSURANCE
PUBLIC FINANCE - ORGANIZATION
Public Finance 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 1997 and 1996, Public Finance was responsible for insured gross
par written of $22.5 billion and $19.0 billion, respectively. As of December 31,
1997, net par outstanding related to Public Finance was $101.5 billion.
Public Finance is organized along regional lines, with a team of
underwriters assigned to each of three regions of the United States; North,
South and West. Management believes 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 Public Finance, 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.
Ambac Assurance assigns internal ratings to individual exposures as part
of the new issue underwriting process and at surveillance reviews. These
internal ratings, which represent Ambac Assurance's independent judgments, are
based upon underlying credit parameters similar to those used by nationally
recognized rating agencies.
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SPECIALIZED FINANCE - ORGANIZATION
Specialized Finance 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 Specialized Finance are organized into teams of
experienced professionals with expertise in a specific type of security. During
1997 and 1996, Specialized Finance was responsible for insured gross par written
of $23.8 billion and $17.8 billion, respectively. As of December 31, 1997, net
par outstanding related to Specialized Finance was $64.1 billion.
Specialized Finance is also responsible for underwriting all transactions
with international exposure, primarily in Europe. During 1997 and 1996, Ambac
Assurance insured gross par written in international transactions of $4.0
billion and $3.7 billion, respectively. As of December 31, 1997, net par
outstanding related to international risks was $5.6 billion. Geographically, the
countries receiving Ambac Assurance's primary international focus have been
France, Japan 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.
Ambac Assurance and MBIA Insurance Corporation ("MBIA") formed an
unincorporated joint venture, MBIA/AMBAC International, to market financial
guarantee insurance in Europe in September 1995. 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 $12.0 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 non-U.S. financial guarantee business written by the other company as part
of the joint venture. Customer preference, licensing and market considerations
determine which company insures a transaction.
In January 1997, Ambac Assurance capitalized a new subsidiary in the
United Kingdom, Ambac UK, which is authorized to conduct certain classes of
general insurance business in the United Kingdom. Ambac UK is the Company's
primary vehicle for directly issuing financial guarantee insurance policies in
the United Kingdom and Europe. Ambac Assurance and Ambac UK have entered into a
net worth maintenance agreement and reinsurance agreements.
As is the case with Public Finance, the management of credit decisions
and criteria in Specialized Finance 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.
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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 Assurance provides financial guarantee insurance for U.S. municipal
bonds, U.S. structured finance and asset-backed obligations and international
obligations. Financial guarantee insurance is delivered in two markets: the new
issue market and the secondary market. The new issue market includes municipal
bond insurance, insurance of structured finance and asset-backed obligations,
insurance of debt service reserve funds, insurance of international obligations,
assumed reinsurance, and insurance of other financial obligations. The secondary
market includes insurance of municipal bonds, structured finance and asset-
backed obligations, bonds in mutual funds, and unit investment trusts ("UITs").
The following table indicates the gross par amount written for each of
the years, 1997, 1996 and 1995 with respect to each market:
<TABLE>
<CAPTION>
1997 1996 1995
--------------------- --------------------- ---------------------
($ In Millions)
<S> <C> <C> <C>
New issue market....................................... $44,726 $35,384 $23,630
Secondary market....................................... 1,571 1,434 2,339
--------------------- --------------------- ---------------------
$46,297 $36,818 $25,969
===================== ===================== =====================
</TABLE>
New Issue Market - U. S. Municipal
Ambac Assurance sells the majority of its insurance in the new issue
municipal bond market. Of the $44.7 billion, $35.4 billion and $23.6 billion of
new issue par exposure written in 1997, 1996 and 1995, respectively, $27.9
billion, $25.3 billion and $18.0 billion, respectively, was new issue U.S.
municipal bond exposure. In the new issue U.S. municipal bond market, an issuer
typically pays a single premium to Ambac Assurance at the time the policy is
issued. Premiums are based on the total amount of principal and interest that
will become due during the life of the bonds and on Ambac Assurance'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 Assurance.
Proposed new municipal bond issues are submitted to Ambac Assurance 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,
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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 U.S. 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 - U.S. Structured Finance and Asset-Backed
Of the $44.7 billion, $35.4 billion and $23.6 billion of new issue par
exposure written in 1997, 1996 and 1995, respectively, $12.8 billion, $6.5
billion and $3.7 billion was new issue U.S. structured finance bond exposure.
Premiums for U.S. structured finance and asset-backed policies are based on a
percentage of either principal or principal and interest insured. The timing of
the collection of structured finance and asset-backed 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, 1997 and 1996, net outstanding par
exposure related to U. S. structured finance and asset-backed transactions was
$18.6 billion and $8.1 billion, respectively.
NEW ISSUE MARKET - INTERNATIONAL
Of the $44.7 billion, $35.4 billion and $23.6 billion of new issue par
exposure written in 1997, 1996 and 1995, respectively, $4.0 billion, $3.6
billion and $1.9 billion was new issue international structured finance and
asset-backed bond exposure. Premiums for international policies are based on a
percentage of either principal or principal and interest insured. The timing of
the collection of structured finance and asset-backed 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, 1997 and 1996, net outstanding par
exposure related to international transactions was $5.6 billion and $4.3
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 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 Assurance
employs the same underwriting standards on secondary market issues that it does
on new municipal bond issues. However, Ambac Assurance 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 Assurance concentrates its secondary market
insurance efforts on insurance of general obligation and utility revenue bonds,
in addition to issues where Ambac Assurance has existing exposure.
9
<PAGE>
Sponsors of UITs contact Ambac Assurance 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 Assurance 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 Assurance underwrites and prices financial guarantee insurance on
the assumption that the insurance will remain in force until maturity of the
insured bonds. Ambac Assurance estimates that the average life (as opposed to
the stated maturity) of its insurance policies on new issue par in force at
December 31, 1997 was 12.8 years. The 12.8 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 Assurance 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, 1997, the total net par amount of insured bonds
outstanding was $165.6 billion. This amount excludes Ambac Assurance's
guarantees for the timely payment of principal and interest on obligations under
investment agreements issued by the IA Business. As of December 31, 1997, the
aggregate amount of investment agreements insured was $3.86 billion, including
accrued interest. The insurance policies covering the IA Business are
collateralized by the IA Business' investment securities, accrued interest,
securities purchased under agreements to resell and cash and cash equivalents,
which as of December 31, 1997, had a fair value of $3.94 billion in the
aggregate. See "Financial Management Services" below.
ISSUE SIZE
Ambac Assurance seeks a broad coverage of the market by insuring small
and large issues alike. Ambac Assurance's insured exposure as of December 31,
1997 reflects the emphasis on issues insured with an original par amount of less
than $25 million, which reduces Ambac Assurance's average per-issue exposure to
losses. The following table sets forth the distribution of Ambac Assurance's
insured portfolio as of December 31, 1997 with respect to the original size of
each insured issue:
10
<PAGE>
ORIGINAL PAR AMOUNT PER ISSUE
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
% OF TOTAL NET PAR
% OF TOTAL NUMBER NET PAR AMOUNT AMOUNT OUTSTANDING
ORIGINAL PAR AMOUNT NUMBER OF ISSUES OF ISSUES OUTSTANDING
- ------------------------------------- -------------------- -------------------- -------------------- --------------------
($ In Millions)
<S> <C> <C> <C> <C>
Less than $10 million................ 9,215 64% $ 23,698 14%
$10-25 million....................... 2,004 14 24,249 15
$25-50 million....................... 911 6 24,292 15
Greater than $50 million............. 2,369 16 93,362 56
-------------------- ------------------- ------------------- --------------------
14,499 100% $165,601 100%
==================== ==================== ==================== ====================
</TABLE>
TYPES OF BONDS
The table below shows the distribution by bond type of Ambac Assurance's
insured portfolio as of December 31, 1997. As the table illustrates,
approximately 37% of Ambac Assurance's net par amount outstanding at December
31, 1997, consisted of general obligation bonds and utility revenue bonds, which
generally present less credit risk than other types of municipal bonds. Ambac
Assurance tries to avoid insuring bond issues which entail excessive single
project risk, over-capacity or customer contract disputes. For a more detailed
discussion of the various types of obligations in Ambac Assurance's insured
portfolio, see "Types and Ratings of Bonds" attached as Appendix A hereto.
INSURED PORTFOLIO BY BOND TYPE
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
% of Total Net Par
NET PAR AMOUNT Amount Outstanding
BOND TYPE OUTSTANDING
- -------------------------------------------------------------------------- ---------------------- ---------------------
($ In Millions)
U.S. MUNICIPAL MARKET:
<S> <C> <C>
General obligation...................................................... $ 36,324 22 %
Lease and tax-backed revenue............................................ 30,980 19
Utility revenue......................................................... 24,913 15
Health care revenue..................................................... 18,545 11
Transportation revenue.................................................. 7,370 4
Higher education........................................................ 6,852 4
Investor-owned utilities................................................ 6,255 4
Housing revenue......................................................... 6,064 4
Student loans........................................................... 3,516 2
Other................................................................... 597 1
---------------------- ---------------
Total U.S. Municipal Market.......................................... 141,416 86
---------------------- --------------
U.S. STRUCTURED FINANCE AND ASSET-BACKED MARKET:
Mortgage-backed and home equity........................................ 11,620 7
Commercial asset-backed................................................ 4,538 3
Other consumer asset-backed............................................ 1,514 1
Banks/financial institutions........................................... 524 -
Other.................................................................. 439 -
Total U.S. Structured Finance and Asset-Backed Market................ 18,635 11
---------------------- ---------------
Total U.S............................................................ 160,051 97
---------------------- ---------------
INTERNATIONAL MARKET:.....................................................
Commercial asset-backed............................................... 2,600 2
Sovereign/sub-sovereign............................................... 981 1
Mortgage-backed and home equity....................................... 496 -
Utilities............................................................. 456 -
Banks/financial institutions.......................................... 283 -
Other................................................................. 734 -
---------------------- --------------
Total International Market........................................... 5,550 3
N ---------------------- --------------
Total............................................................ $165,601 100%
====================== ==============
</TABLE>
11
<PAGE>
The table below shows the percentage, by bond type, of new business
insured by Ambac Assurance during each of the last five years. During this
period, Ambac Assurance 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 1993 1994 1995 1996 1997
- -----------------------------------------------------------------------------------------
U.S. Municipal Market:
<S> <C> <C> <C> <C> <C>
General obligation..................... 29% 29% 23% 16% 18%
Utilities (2).......................... 26 21 16 15 12
Lease and tax-backed revenue........... 21 16 16 23 17
Health care revenue.................... 13 8 8 7 8
Housing revenue........................ 2 5 5 3 3
Transportation revenue................. 3 5 5 3 2
Student loans.......................... 1 4 5 3 1
Higher education....................... 3 4 3 3 3
Other.................................. 0 1 0 0 1
------------------------------------------------
Total Municipal Market............... 98 93 81 73 65
-------------------------------------------------
U.S. STRUCTURED FINANCE AND
ASSET-BACKED MARKET:
Mortgage-backed and home..............
equity............................. 0 1 8 12 18
Commercial asset-backed............... 0 0 5 4 8
Other consumer asset-backed..........
0 0 0 0 1
Banks/financial institutions.......... 0 0 0 0 2
Other................................. 2 1 1 3 1
------------------------------------------------
Total U.S. Structured
Finance and Asset-Backed
Market............................... 2 2 14 19 30
-------------------------------------------------
INTERNATIONAL MARKET:
Commercial asset-backed............... 0 1 2 6 1
Sovereign/sub-sovereign............... 0 0 0 0 1
Mortgage-backed and home..............
equity............................. 0 0 0 0 1
Utilities............................. 0 0 0 0 1
Banks/financial institutions.......... 0 0 0 0 0
Other................................. 0 4 3 2 1
Total International Market...........-------------------------------------------------
0 5 5 8 5
-------------------------------------------------
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 Assurance is licensed to write business in all 50 states, the
District of Columbia, the Commonwealth of Puerto Rico and Guam. As of December
31, 1997, the eight largest states, as measured by net par amount outstanding,
accounted for approximately 51% of Ambac Assurance's total net par amount
outstanding. The following table sets forth those states and geographic areas in
which Ambac Assurance's aggregate insured exposure equaled 2% or more of its
total net par amount outstanding as of December 31, 1997.
12
<PAGE>
INSURED PORTFOLIO BY STATE AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
Net Par Amount % of Total Net Par
Outstanding Amount Outstanding
STATE/GEOGRAPHIC AREA
- ------------------------------------------------------------ --------------------- ---------------------
($ In Millions)
<S> <C> <C>
California.................................................. $ 19,593 12%
New York.................................................... 13,219 8
Pennsylvania................................................ 11,988 7
Florida..................................................... 11,803 7
Texas....................................................... 8,607 5
Illinois.................................................... 7,510 5
Ohio........................................................ 6,210 4
Michigan.................................................... 5,535 3
New Jersey.................................................. 5,432 3
Massachusetts............................................... 5,142 3
Washington.................................................. 3,255 2
Indiana..................................................... 3,075 2
Other States................................................ 58,682 36
--------------------- ---------------------
Total domestic......................................... 160,051 97
International............................................... 5,550 3
--------------------- ---------------------
$165,601 100%
===================== =====================
</TABLE>
Issuers
Ambac Assurance has adopted underwriting and exposure management policies
designed to limit the net insurance in force for any one credit. In addition,
Ambac Assurance uses reinsurance to limit net exposure to any one credit. As of
December 31, 1997, Ambac Assurance's net par amount outstanding for its 20
largest credits, totaling $12.1 billion, was approximately 7% of Ambac
Assurance's total net par amount outstanding with no one credit representing
more than 1% of Ambac Assurance's total net par amount outstanding. Ambac
Assurance 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 Assurance's management with the intent that Ambac Assurance insure only
those obligations which, in the opinion of Ambac Assurance analysts, are of
investment grade quality. There are instances where one of the major rating
agencies will differ with Ambac Assurance'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, 1997,
Ambac Assurance's aggregate outstanding net par insured of below investment
grade issues was $1,428.4 million (or 0.9% of Ambac Assurance's total net par
amount outstanding of obligations insured).
The underwriting process involves review of structural, legal and credit
issues, including compliance with current Ambac Assurance underwriting
standards. These standards are reviewed periodically by management. The rating
agencies also monitor the credits underlying Ambac Assurance's insurance in
force and, in most cases, advise Ambac Assurance of the credit rating each issue
would receive if it were not insured by Ambac Assurance.
13
<PAGE>
The following table sets forth Ambac Assurance's insured portfolio by
rating as of December 31, 1997:
INSURED PORTFOLIO BY RATING (1)
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
Net Par Amount % of Total Net Par
Outstanding Amount Outstanding
RATING
- ------------------------------------------------------------ --------------------- ---------------------
($ In millions)
<S> <C> <C>
AAA......................................................... $ 287 -%
AA.......................................................... 14,720 9
A........................................................... 102,667 62
BBB......................................................... 46,499 28
BIG (2)..................................................... 1,428 1
-------------------- ----------------------
$165,601 100%
===================== =====================
</TABLE>
(1) Ratings represent Ambac Assurance internal ratings.
(2) Represents those bonds which have been categorized as "below investment
grade" by Ambac Assurance.
Ambac Assurance'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
Assurance insures only those bonds on which it expects not to incur a loss.
However, Ambac Assurance'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 Assurance'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
Assurance'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.
Ambac Assurance 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 Assurance's insurance on each issue.
14
<PAGE>
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 Assurance'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 Assurance 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 Assurance, 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
Assurance's concerns and rights. When the underlying economics so indicate,
Ambac Assurance may aid in a restructuring to improve the debt service coverage.
LOSSES AND RESERVES
Ambac Assurance'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 Assurance's estimate of ultimate aggregate losses inherent in
the obligations insured. As of December 31, 1997, Ambac Assurance's ACR was
$48.2 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 Assurance 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 Assurance's case basis reserves totaled $55.1 million at
December 31, 1997.
Ambac Assurance's reserve for losses and loss adjustment expenses
consists of the ACR and Case Basis Reserves. The most recent three-year history
of Ambac Assurance's loss reserves, and losses and loss adjustment expenses
incurred and paid, is described in the table below:
15
<PAGE>
RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES (1)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------
1997 1996 1995
------------------ --------------------- ---------------------
<S> <C> <C> <C>
($ In Thousands)
Reserve for losses and loss adjustment expenses at
January 1,.............................................. $ 60,613 $66,637 $66,112
Less: reinsurance recoverables.............................. 393 641 450
------------------ --------------------- --------------------
Net reserve for losses and loss adjustment expenses
at January 1,........................................... 60,220 65,996 65,662
Losses and loss adjustment expenses incurred................ 2,854 3,778 3,377
Losses and loss adjustment expenses paid.................... (2,474) (9,554) (3,043)
Net balance for Connie Lee, at acquisition.................. 38,526 - -
------------------ --------------------- --------------------
Net reserve for losses and loss adjustment expenses
at December 31,......................................... 99,126 60,220 65,996
Plus: reinsurance recoverables.............................. 4,219 393 641
------------------ --------------------- --------------------
Reserve for losses and loss adjustment expenses at
December 31,............................................... $103,345 $60,613 $66,637
================== ===================== ====================
</TABLE>
(1) All information is net of salvage.
Management of Ambac Assurance 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 6 of Notes to Consolidated Financial Statements in the Company's 1997
Annual Report to Stockholders.
COMPETITION
The financial guarantee insurance business is highly competitive. Ambac
Assurance's principal competitors in the market for municipal bond insurance are
three other monoline insurance companies, Financial Guaranty Insurance Company
("FGIC"), MBIA and Financial Security Assurance Inc. ("FSA"). According to Ambac
Assurance estimates based on industry sources, Ambac Assurance, FGIC, MBIA and
FSA, in the aggregate, insured approximately 100% of all new issue municipal
bonds insured during 1997, with MBIA insuring approximately 43% of such bonds,
Ambac Assurance insuring approximately 24% of such bonds, FGIC insuring
approximately 19% of such bonds and FSA insuring approximately 14% of such
bonds. In the structured finance and asset-backed markets, Ambac Assurance's
principal competitors are FGIC, MBIA and FSA. 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
Assurance 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 Assurance to guarantee short-term notes and bonds with a maturity of less
than 10 years. To the extent
16
<PAGE>
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 Assurance, 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
Assurance 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.
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, expired 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 Assurance 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 Assurance
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 Assurance which were
classified by Ambac Assurance 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 Assurance's
reinsurance program for subsequent years.
Under the 1996 quota share program, Ambac Assurance ceded a percentage of
each insured policy. The surplus share program provided a surplus layer of
reinsurance in
17
<PAGE>
excess of the quota share percentage which increased Ambac Assurance's insurance
capacity. A ceding commission was withheld to defray Ambac Assurance's
underwriting expenses under both the quota share program and surplus share
program.
Ambac Assurance has also entered into facultative reinsurance agreements
with certain of the same reinsurers that are party to the agreements described
above, which allow Ambac Assurance 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 Assurance's interests and liabilities are ceded on an issue-by-issue
basis. A ceding commission is withheld to defray Ambac Assurance's underwriting
expenses. In addition, Ambac Assurance 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 Assurance discontinued the quota share
and surplus share reinsurance programs as described above, and has only used
facultative reinsurance agreements to reduce its risks and manage its insurance
portfolio.
As of December 31, 1997, Ambac Assurance had retained approximately 84%
of its gross insurance in force of $321.1 billion and had ceded approximately
16% to its treaty and facultative reinsurers. See Note 5 of Notes to
Consolidated Financial Statements in the Company's 1997 Annual Report to
Stockholders.
As a primary insurer, Ambac Assurance is required to honor its
obligations to its policyholders whether or not its reinsurers perform their
obligations under the various reinsurance agreements with Ambac Assurance. To
minimize its exposure to significant losses from reinsurer insolvencies, Ambac
Assurance evaluates the financial condition of its reinsurers, prepares annual
written reviews of such reinsurers and monitors for concentrations of credit
risk. Ambac Assurance's current reinsurers are Aachener Ruckversicherungs, AXA
Re Finance, Capital Markets Assurance Corporation (acquired by MBIA in 1998),
Capital Reinsurance Company, Enhance Reinsurance Company, MBIA and Royal
Reinsurance Company, Ltd.. The majority of these reinsurers have long-standing
relationships with Ambac Assurance. 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 Assurance 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 Assurance to confirm that Ambac Assurance continues to meet the capital
allocation criteria considered necessary by the particular rating agency to
maintain Ambac Assurance'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 Assurance'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.
18
<PAGE>
INSURANCE REGULATORY MATTERS
GENERAL LAW
Ambac Assurance 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 Assurance 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 Assurance'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 1997 for the period ended December 31,
1996) and other state insurance regulatory authorities. See Note 9 of Notes to
Consolidated Financial Statements in the Company's 1997 Annual Report to
Stockholders.
The Company believes that Ambac Assurance 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 Assurance 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 Assurance within the meaning of the Wisconsin Insurance
Laws. As of December 31, 1997, no one had percentages of 10% or more of the
outstanding common stock of the Company.
The Wisconsin insurance holding company laws also require prior approval
by the Wisconsin Commissioner of certain transactions between Ambac Assurance
and companies affiliated with Ambac Assurance.
19
<PAGE>
Wisconsin Dividend Restrictions
Pursuant to the Wisconsin Insurance Laws, Ambac Assurance 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 the
shareholder (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.
During 1997, Ambac Assurance paid to the Company cash dividends on its
common stock totaling $44.0 million. See Note 9 of Notes to Consolidated
Financial Statements in the Company's 1997 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, including Ambac Assurance. 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.
20
<PAGE>
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 Assurance 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 Assurance's policyholders' surplus.
In addition, Ambac Assurance'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, 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 Assurance
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 Assurance'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 Assurance 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 Management Services
-----------------------------
The Company's Financial Management Services Division provides investment
agreements, interest rate swaps, investment advisory and fund administration
services, and
21
<PAGE>
electronic commerce and information management solutions, principally to states,
municipalities and their authorities, school districts, and hospitals and health
organizations.
Financial management services revenues are derived from (i) net
investment income, (ii) net swap trading revenues, (iii) fund management and
advisory revenues, and (iv) net realized gains and losses. Excluding
transactions with affiliates, total revenues were $34.6 million, $22.4 million
and $13.0 million in 1997, 1996 and 1995, respectively. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Note 18 of Notes to Consolidated Financial Statements in the Company's 1997
Annual Report to Stockholders.
The principal competitive factors among providers of investment
agreements 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 IA Business competes favorably with
respect to each of these factors.
The principal competitive factors among providers of interest rate swap
contracts are (i) pricing of contracts, (ii) the financial strength of the
financial services 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 advisory
and fund administration services 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.
INVESTMENT AGREEMENT BUSINESS
The principal purpose of the IA Business is providing investment
agreements and investment repurchase agreements primarily to states,
municipalities and their authorities. Investment agreements 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 investment
agreement 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 Assurance's insurance policy which guarantees the IA Business'
performance.
The IA 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 IA Business' asset-liability guidelines
stipulate that the effective duration of the invested assets, including hedges,
must be matched to the effective duration of the investment agreement
liabilities. The IA 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
22
<PAGE>
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 IA Business maintains funds
invested in cash and cash equivalents to meet short term liquidity needs.
The IA Business uses derivative rate contracts in the normal course of
business for hedging purposes as part of its overall interest rate risk
management. Several of its derivative contracts have been entered into with its
affiliate, AFS. Derivative contracts used by the IA Business include financial
instruments with off-balance sheet risk such as interest rate futures contracts,
interest rate swap agreements and purchased interest rate option contracts.
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 13 of Notes to Consolidated Financial
Statements in the Company's 1997 Annual Report to Stockholders.
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 IA 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 IA Business is exposed to credit risk in the event
counterparties fail to perform according to the terms of the contractual
commitments. The IA 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
agreements where credit deterioration or the default of an issuer would increase
the likelihood of early withdrawal of funds. The IA Business and Ambac Assurance
have various procedures and controls in place to monitor the credit risk of
these agreements, including the initial credit approval process and the
continuous monitoring of credit exposure.
The following table sets forth the net payments due under the IA
Business' investment agreements in each of the next five years ending December
31, and the period thereafter, based on expected call dates:
OBLIGATIONS UNDER INVESTMENT AGREEMENTS
<TABLE>
<CAPTION>
Principal Amount (1)
- --------------------------------------------------------------------------------------------------------------------------------
($ In Thousands)
<S> <C>
1998............................................................................................... $1,463,194
1999............................................................................................... 1,120,315
2000............................................................................................... 410,454
2001............................................................................................... 202,237
2002............................................................................................... 33,677
All later years.................................................................................... 587,895
-----------------------------
$3,817,772
=============================
</TABLE>
(1) As of December 31, 1997, the interest rates on these agreements ranged from
4.23% to 8.14%.
23
<PAGE>
AMBAC FINANCIAL SERVICES, L.P.
AFS provides interest rate swaps primarily to states, municipalities and
their authorities, and other entities in connection with their financings. In
addition, AFS also provides interest rate swaps to the IA 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 Assurance through policies which guarantee
the obligations of AFS and its counterparties.
AFS is a limited partnership. Ambac Assurance, 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, most 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 $1.6
million and $1.4 million in 1997 and 1996, respectively. AFS's value-at-risk
ranged from a high of $2.6 million to a low of $0.9 million for 1997 and from a
high of $2.6 million to a low of $1.1 million for 1996. Since no single measure
can capture all dimensions of market risk, AFS supplements its value at risk
methodology by performing daily analyses of parallel
24
<PAGE>
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 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 14 of Notes to Consolidated
Financial Statements in the Company's 1997 Annual Report to Stockholders.
CADRE FINANCIAL SERVICES, INC. AND CADRE SECURITIES, INC.
Effective December 31, 1996, the Company completed its acquisition of
certain assets, including the name, and the 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.
On June 19, 1997, Ambac Securities Inc., a wholly-owned subsidiary of the
Company, completed its acquisition of certain assets, including the name, and
the assumption of certain liabilities of Cadre Securities, Inc. ("Cadre
Securities"). Cadre Securities is a distributor and marketing agent for various
registered and unregistered money market funds and offers its clients U.S.
government securities and money market instruments. Cadre Securities is
registered as a broker-dealer with the Securities and Exchange Commission and
with certain states that require such registration, and it is a member of the
National Association of Securities Dealers, Inc. As a registered broker-dealer,
Cadre Securities is subject to the net capital requirements of Rule 15c3-1 of
the Securities Exchange Act of 1934, as amended, which is designed to measure
the general financial condition and liquidity of a broker-dealer. In accordance
with this rule, the ratio of aggregate indebtedness to net capital shall not
exceed 8 to 1 for the first year of operations and 15 to 1 thereafter. At
December 31, 1997, Cadre Securities had net capital of $160,790, which was
$60,790 in excess of its required net capital of $100,000. The net capital ratio
was 1.19 to 1.
25
<PAGE>
Cadre provides administrative and investment advisory 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, 1997, Cadre was providing investment administration services for
approximately 3,000 clients with approximately $6.0 billion in assets. Marketing
services are also provided through Cadre Securities to the participants of these
and other registered funds. Included in the assets under administration at
December 31, 1997, were approximately $2.6 billion of assets for which Cadre
Securities provides marketing services. Also included in the assets under
administration at December 31, 1997, were approximately $2.0 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 and Cadre Securities
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
Securities obligations have been fulfilled.
INVESTMENTS AND INVESTMENT POLICY
As of December 31, 1997, the consolidated investments of the Company had
an aggregate fair value of $6.9 billion and an aggregate amortized cost of $6.7
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 derivative contracts for hedging purposes as part
of its overall interest rate risk management. These derivative contracts include
interest rate futures contracts, interest rate swap agreements and purchased
interest rate option contracts. All investments, including derivative 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 credit 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," 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, 1997, Ambac Assurance's investment portfolio had an
aggregate fair value of $3.0 billion and an aggregate amortized cost of $2.8
billion. The investment policy established by the Board of Directors of Ambac
Assurance for its investments is designed to achieve diversification of the
portfolio and generally to preclude investments in obligations insured by Ambac
Assurance. Ambac Assurance'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 Assurance's desire for both current income and long-term capital growth.
Ambac Assurance 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
26
<PAGE>
compliance with these laws, Ambac Assurance's Board of Directors approves
each specific investment transaction of Ambac Assurance. See "Insurance
Regulatory Matters - General Law" above.
As of December 31, 1997, the IA Business' investment portfolio had an
aggregate fair value of $3.8 billion and an aggregate amortized cost of $3.8
billion. The investment policy established by the Board of Directors of the IA
Business for its investments is designed to achieve the highest after-tax return
on equity, subject to minimum average quality ratings. The IA Business also uses
derivative contracts for hedging purposes as part of its overall interest rate
risk management. For further discussion, see "Investment Agreement Business."
The following tables set forth certain information concerning the
investments of the Company:
INVESTMENTS BY RATING (1)
as of December 31, 1997
<TABLE>
<CAPTION>
% OF INVESTMENT
RATING PORTFOLIO
- -------------------------------------------------------------------------------------------------------- ----------------------
<S> <C>
AAA (2)................................................................................................. 70%
AA...................................................................................................... 13
A....................................................................................................... 16
BBB..................................................................................................... 1
Not Rated............................................................................................... -
----------------------
100%
======================
</TABLE>
(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>
----------------------------------------------------------------------------------------------------
1997 1996 1995
----------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
CARRYING VALUE AVERAGE YIELD CARRYING VALUE AVERAGE YIELD CARRYING VALUE AVERAGE YIELD
INVESTMENT CATEGORY (1) (2) (1) (2) (1) (2)
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
($ In Thousands)
Long-term investments:
Taxable bonds................ $4,545,177 6.75% $3,116,373 6.69 $2,610,164 6.91%
Tax-exempt bonds............. 2,228,667 6.20 1,971,658 6.21 1,654,740 6.17
------------------ ----------------
Total long-term investments
6,773,844 6.55 5,088,031 6.52 4,264,904 6.59
Short-term investments (3).... 136,278 5.43 112,511 5.24 176,689 5.72
------------------ ---------------- ---------------
Total investments.......... $6,910,122 6.52% $5,200,542 6.46 $4,441,593 6.56%
================== ================ ===============
</TABLE>
(1) Yields presented include assets held in the IA Business portfolio. Interest
expense on related investment agreements was $186.7 million, $154.5 million
and $127.6 million in 1997, 1996 and 1995, respectively.
(2) Yields are stated on a pre-tax basis, based on average amortized cost.
(3) Includes taxable and tax-exempt investments.
27
<PAGE>
INVESTMENTS BY SECURITY TYPE
AS OF DECEMBER 31,
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------
1997 1996 1995
----------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
CARRYING VALUE AVERAGE YIELD CARRYING VALUE AVERAGE YIELD CARRYING VALUE AVERAGE YIELD
INVESTMENT CATEGORY (1) (2) (1) (2) (1) (2)
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
($ In Thousands)
Municipal obligations......... $2,298,996 6.20 % $1,982,911 6.21 % $1,659,903 6.17 %
Corporate securities.......... 1,093,587 7.61 963,890 7.56 828,060 7.67
U.S. government obligations...
139,598 6.25 102,430 6.09 227,425 6.51
Mortgage- and asset-backed
securities (includes U.S.
Government Agency............
obligations) (3)............. 3,222,756 6.46 2,035,115 6.35 1,549,516 6.48
Other......................... 18,907 3.72 3,685 3.50 -- --
------------------ --------------- -------------------
Total long-term investments
6,773,844 6.55 5,088,031 6.52 4,264,904 6.59
Short-term investments (4).... 136,278 5.43 112,511 5.24 176,689 5.72
------------------ --------------- -------------------
Total investments.......... $6,910,122 6.52 % $5,200,542 6.46 % $4,441,593 6.56 %
================== =============== ===================
</TABLE>
(1) Yields presented include assets held in the IA Business portfolio. Interest
expense on related investment agreements was $186.7 million, $154.5 million
and $127.6 million in 1997, 1996 and 1995, respectively.
(2) Yields are stated on a pre-tax basis, based on average amortized cost.
(3) The actual maturity dates of mortgage-backed securities are uncertain
because the underlying mortgages may be paid prior to the stated maturity of
such securities. This possibility of pre-payment creates the risk that the
Company will be unable to replace such investments with securities of
comparable yield.
(4) Includes taxable and tax-exempt investments.
DISTRIBUTION OF INVESTMENTS BY MATURITY
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
Amortized Estimated
MATURITY COST FAIR VALUE
- ---------------------------------------------------------------------------- ------------------- --------------------
($ In Thousands)
<S> <C> <C>
Due in one year or less (1)................................................. $ 171,955 $ 172,067
Due after one year through five years....................................... 309,796 316,696
Due after five years through ten years...................................... 433,363 452,362
Due after ten years......................................................... 2,546,552 2,746,241
-------------- ------------------
3,461,666 3,687,366
Mortgage- and asset-backed securities (2)................................... 3,200,262 3,222,756
-------------- ------------------
Total investments........................................................... $6,661,928 $6,910,122
============== ==================
</TABLE>
(1) Includes long-term investments in the amount of $35.8 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.
For further discussion, see Note 3 of Notes to Consolidated Financial
Statements in the Company's 1997 Annual Report to Stockholders.
28
<PAGE>
EMPLOYEES
As of December 31, 1997, the Company and its subsidiaries had 340
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 Assurance maintains its principal executive offices at One State
Street Plaza, New York, New York 10004, which consists of approximately 121,000
square feet of office space, under an agreement which expires on September 30,
2019. Ambac UK maintains offices in London, England.
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 Assurance'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 1997.
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 54 of the Company's 1997 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 23, 1998, there were 94 stockholders of record of the Company's Common
Stock, which is listed on the New York Stock Exchange.
29
<PAGE>
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 1 of the Company's 1997 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 31 to
51 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 23 through 29 of the
Company's 1997 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 31 to 51 of such
Annual Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Quantitative and Qualitative Disclosures About Market Risk is set forth
under the caption Risk Management on pages 28 and 29 of the Company's 1997
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 31 to 51 of such Annual
Report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The 1997 Consolidated Financial Statements, together with the Notes
thereto and the Independent Auditors' Report thereon, are set forth on pages 30
through 51 of the Company's 1997 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, 11 to 12, and 27 to 28 of the Company's 1998 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 13 to 21 of the
Company's 1998 Proxy Statement and such information is incorporated herein by
reference.
30
<PAGE>
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 1998 Proxy
Statement and such information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
None.
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 1997
Annual Report to Stockholders are incorporated herein by reference
under Part II, Item 8:
<TABLE>
<CAPTION>
PAGE NUMBER
IN ANNUAL REPORT
--------------------
<S> <C> <C>
Independent Auditors' Report.................................. 30
Consolidated Balance Sheets as of December 31, 1997 and 1996..
31
Consolidated Statements of Operations for each of the years
ended December 31, 1997, 1996 and 1995........................ 32
Consolidated Statements of Stockholders' Equity for each of
the years ended December 31, 1997, 1996 and 1995.............. 33
Consolidated Statements of Cash Flows for each of the years
ended December 31, 1997, 1996 and 1995........................ 34
Notes to Consolidated Financial Statements.................... 35-51
</TABLE>
<TABLE>
<S> <C>
2. Financial Statement Schedules
------------------------------------------------------------------------------------------------------------------
The financial statement schedules filed herein, which are the only schedules required to be filed, are as follows:
</TABLE>
<TABLE>
<CAPTION>
Independent Auditors' Report (Page S-1)
<S> <C> <C>
Schedule I -- Summary of Investments Other Than (Page S-2)
Investments in Related Parties
Schedule II -- Condensed Financial Information of (Pages S-3
Registrant (Parent Company Only) to S-5)
Schedule IV -- Reinsurance (Page S-6)
</TABLE>
31
<PAGE>
3. Exhibits
--------
The following items are annexed as exhibits:
<TABLE>
<CAPTION>
Exhibit Number Description
---------------- -----------
<S> <C>
3.01 Conformed Amended and Restated Certificate of Incorporation of the Company
filed with the Secretary of State of the State of Delaware on July 11, 1997.
(Filed as Exhibit 4.05 to the Company's Quarterly Report for the quarter ended
September 30, 1997 and incorporated herein by reference.)
3.02 By-laws of the Company, as amended through January 28, 1998.
4.01 Definitive Engraved Stock Certificate representing shares of Common Stock.
4.02 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.)
4.03 Rights Agreement, dated as of January 31, 1996, between Ambac Financial Group,
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.)
10.01 Second Amended and Restated Employment Agreement dated as of December 2, 1997,
between the Company and Phillip B. Lassiter.
10.02 Ambac Financial Group, Inc. 1991 Stock Incentive Plan, as amended as of
December 2, 1997 (Filed as Exhibit 10.02 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1996 and incorporated herein by
reference.)
10.03* Ambac Financial Group, Inc. 1997 Equity Plan, amended as of October 28 1997.
10.04* Ambac Financial Group, 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.)
10.05* Ambac Financial Group, Inc. 1997 Non-Employee Directors Equity Plan. (Filed as
Exhibit 10.23 to the Company's Quarterly Report on Form 10-Q for the period
ended June 30, 1997 and incorporated herein by reference.)
10.06* Ambac Financial Group, Inc. 1997 Executive Incentive Plan. (Filed as Exhibit
10.24 to the Company's Quarterly Report on Form 10-Q for the period ended June
30, 1997 and incorporated herein by reference.)
</TABLE>
* Management contract or compensatory plan, contract or arrangement required to
be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
---------
*
32
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
10.07* Ambac Financial Group, 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.)
10.08* Form of Amended and Restated Management Retention Agreement dated as of
December 2, 1997.
10.09* The Ambac Financial Group, 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.)
10.10* Amendment Number 1 to the Ambac Financial Group, Inc. Non-Qualified Savings
Incentive Plan effective as of April 30, 1997.
10.11* Ambac Financial Group, 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.)
10.12* Amendment Number 1 to the Ambac Financial Group, Inc. Excess Benefits Pension
Plan effective as of April 30, 1997.
10.13* Employment letter between David L. Boyle and the Company. (Filed as Exhibit
10.19 to the Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1997, and incorporated herein by reference.)
10.14* Agreement and General Release between W. Dayle Nattress, the Company and AMBAC
Indemnity Corporation dated April 10, 1997. (Filed as Exhibit 10.20 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997,
and incorporated herein by reference.)
10.15 Supplemental Pension Agreement between the Company and Philip B. Lassiter
dated April 30, 1997. (Filed as Exhibit 10.24 in the Company's Quarterly
Report Form 10-Q for the quarter ended June 30, 1997, and incorporated herein
by reference.)
10.16 Supplemental Pension Agreement between the Company and David L. Boyle dated
April 30, 1997. (Filed as Exhibit 10.25 in the Company's Quarterly Report Form
10-Q for the quarter ended June 30, 1997, and incorporated herein by reference.)
10.17 Ambac Financial Group, 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.)
10.18 Amendment Number 1 to the Ambac Financial Group, Inc. Supplemental Pension
Plan effective as of April 30, 1997.
</TABLE>
* Management contract or compensatory plan, contract or arrangement required to
be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
---------
33
<PAGE>
<TABLE>
<C> <S> <C>
10.19 Lease Agreement, dated as of January 1, 1992 between South Ferry Building
Company and Ambac Assurance 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.)
10.20 Amendment to Lease Agreement dated August 1, 1997 between South Ferry Building
Company and Ambac Assurance Corporation.
10.21 Tax Settlement Agreement, dated as of March 30, 1993, among Citicorp,
Citibank, N.A., Citicorp Financial Guaranty Holdings, Inc., Ambac Financial
Group, Inc., Ambac Assurance 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.)
10.22 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
Assurance 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.)
10.23 Credit Agreement, dated December 2, 1993 (the "Deutsche Bank Credit
Agreement") between Ambac Assurance 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.)
10.24 Amendment No. 1 to the Deutsche Bank Credit Agreement, dated as of December 2,
1994 between Ambac Assurance 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.)
10.25 Amendment No. 2 to the Deutsche Bank Credit Agreement, dated as of December 1,
1995, between Ambac Assurance 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.)
10.26 Amendment No. 3 to the Deutsche Bank Credit Agreement, dated as of December 2,
1996, between Ambac Assurance Corporation and Deutsche Bank AG, New York
Branch, Individually and as Agent. (Filed as Exhibit 10.16 to the Company's
Report on Form 10-K for the year ended December 31, 1996, and incorporated
herein by reference.)
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
10.27 Amendment No. 4 to the Deutsche Bank Credit Agreement, dated as of February
14, 1997, between Ambac Assurance Corporation and Deutsche Bank AG, New York
Branch, Individually and as Agent. (Filed as Exhibit 10.17 to the Company's
Report on Form 10-K for the year ended December 31, 1996, and incorporated
herein by reference.)
10.28 Amendment No. 5 to the Deutsche Bank Credit Agreement, dated as of December 2,
1997, between Ambac Assurance Corporation and Deutsche Bank AG, New York
Branch, Individually and as Agent.
10.29 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.)
12.01 Statement re computation of ratios.
13.01 Annual Report to Stockholders for the fiscal year ended December 31, 1997.
(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 Financial Group, Inc.
24.01 Power of Attorney from Phillip B. Lassiter.
24.02 Power of Attorney from Frank J. Bivona.
24.03 Power of Attorney from Michael A. Callen.
24.04 Power of Attorney from Renso L. Caporali.
24.05 Power of Attorney from Richard Dulude.
24.06 Power of Attorney from W. Grant Gregory.
24.07 Power of Attorney from C. Roderick O'Neil.
27.00 Financial Data Schedule.
99.01 Ambac Assurance Corporation and Subsidiaries Consolidated Financial Statements
(with independent auditors' report thereon) as of December 31, 1997 and 1996.
</TABLE>
(B) REPORTS ON FORM 8-K:
There were no reports on Form 8-K filed during the fourth quarter of 1997.
--------
However, on February 6, 1998, the Company filed a Current Report on Form 8-K
--------
with its January 29, 1998 press release containing unaudited financial
information and accompanying discussion for the three months ended December 31,
1997 and the year ended December 31, 1997. On March 27, 1998, the Company filed
a Current Report on Form 8-K containing the consolidated financial statements
(with independent auditors' report thereon) of Ambac Assurance Corporation and
Subsidiaries as of December 31, 1997 and 1996. On March 27, 1998, the Company
filed a Current Report on Form 8-K containing the consolidated financial
statements (with independent auditors' report thereon) of Ambac Assurance
Corporation and Subsidiaries as of December 31, 1997 and 1996.
35
<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 FINANCIAL GROUP, INC.
(Registrant)
Dated: March 31, 1998 By: /s/ Frank J. Bivona
Name: Frank J. Bivona
Title: Executive 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.
<TABLE>
<CAPTION>
Signature Title Date
- ------------------------------------------ ------------------------------------ -----------------------
<S> <C> <C>
Phillip B. Lassiter* Chairman, President March 31, 1998
- ------------------------------------------ and Chief Executive Officer
Phillip B. Lassiter and Director (Principal Executive
Officer)
/s/ Frank J. Bivona Executive Vice President, March 31, 1998
- ------------------------------------------ Chief Financial Officer and
Frank J. Bivona Treasurer (Principal Financial
and Accounting Officer)
Michael A. Callen* Director March 31, 1998
- ------------------------------------------
Michael A. Callen
Renso L. Caporali* Director March 31, 1998
- ------------------------------------------
Renso L. Caporali
Richard Dulude* Director March 31, 1998
- ------------------------------------------
Richard Dulude
W. Grant Gregory* Director March 31, 1998
- ------------------------------------------
W. Grant Gregory
C. Roderick O'Neil* Director March 31, 1998
- ------------------------------------------
C. Roderick O'Neil
</TABLE>
- ---------------------
* 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
36
<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.
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.
A-1
<PAGE>
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.
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-2
<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 IBCA, Inc., 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.
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
A-3
<PAGE>
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.
FITCH IBCA, INC.
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-4
<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-5
<PAGE>
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Ambac Financial Group, Inc.:
The audits referred to in our report dated January 29, 1998, included the
related financial statement schedules as of December 31, 1997 and 1996 and for
each of the years in the three-year period ended December 31, 1997, included in
this Form 10-K. 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 audit. In our opinion, such
financial statement schedules, when considered in relation to the basic
financial statement taken as a whole, present fairly in all material respects
the information set forth therein.
We consent to the use of our reports incorporated by reference in the
registration statement (No. 333-43695) on Form S-3, and the registration
statements (Nos. 33-47970, 33-63134, 33-47971 and 33-44913) on Form S-8 of Ambac
Financial Group, Inc.
New York, New York
March 30, 1998
S-1
<PAGE>
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE I - SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1997
(Dollar Amounts in Thousands)
<TABLE>
<CAPTION>
Amount at which
shown in the
AMORTIZED ESTIMATED balance sheet
TYPE OF INVESTMENT COST FAIR VALUE
- ------------------------------------------------------------ ------------------------------------------ ------------------
<S> <C> <C> <C>
U.S. Government obligations................................. $ 136,771 $ 139,598 $ 139,598
Municipal obligations....................................... 2,146,137 2,298,996 2,298,996
Mortgage- and asset-backed securities (includes U.S.
Government Agency obligations)............................. 3,200,262 3,222,756 3,222,756
Corporate obligations....................................... 1,022,995 1,093,587 1,093,587
Other....................................................... 155,763 155,185 155,185
------------------------ ------------- ----------------
Total investments...................................... $6,661,928 $6,910,122 $6,910,122
======================== ============= ================
</TABLE>
S-2
<PAGE>
AMBAC FINANCIAL GROUP, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION
OF REGISTRANT (PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(Dollar Amounts in Thousands Except Per Share Data)
<TABLE>
<CAPTION>
1997 1996
------------------------- ------------------
ASSETS
Assets:
<S> <C> <C>
Cash....................................................................... $ 8 $ 9
Investments in subsidiaries................................................ 2,002,653 1,716,328
Fixed income securities, at fair value
(amortized cost of $65,772 in 1997 and $104,925 in 1996).................. 70,380 107,338
Short-term investments, at cost (approximates fair value).................. 13,592 15,722
Current income taxes receivable............................................ 4,576 3,066
Deferred income taxes receivable........................................... 2,207 --
Other assets............................................................... 9,876 5,106
--------------- -------------------------
Total assets.............................................................. $2,103,292 $1,847,569
=============== =========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Debentures................................................................. 223,864 223,798
Accrued interest payable................................................... 6,797 6,797
Accounts payable and other liabilities..................................... 149 1,958
--------------- -------------------------
Total liabilities......................................................... 230,810 232,553
--------------- -------------------------
Stockholders' equity:
Preferred stock, par value $0.01 per share; authorized shares - 4,000,000;
issued and outstanding shares - none....................................... -- --
Common Stock, par value $0.01 per share; authorized shares - 100,000,000;
issued shares - 70,680,384 at December 31, 1997 and 35,340,192 at December
31, 1996................................................................... 707 353
Additional paid-in capital.................................................. 500,107 498,401
Unrealized gains on investments, net of tax................................. 135,066 58,911
Retained earnings........................................................... 1,262,740 1,072,418
Cumulative translation adjustment........................................... 157 --
Common Stock held in treasury at cost, 732,947 shares at December 31, 1997
and 249,807 at December 31, 1996 (26,295) (15,067)
---------------- --------------------------
Total stockholders' equity................................................ 1,872,482 1,615,016
--------------- -------------------------
Total liabilities and stockholders' equity................................ $2,103,292 $1,847,569
=============== =========================
</TABLE>
S-3
<PAGE>
AMBAC FINANCIAL GROUP, 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>
1997 1996 1995
---------------- --------------------- --------------
Revenues:
<S> <C> <C> <C>
Dividend income........................................... $ 44,000 $ 44,000 $ 40,000
Extraordinary dividend (1)................................ -- 115,865 --
Interest and other income................................. 7,047 7,589 389
Net realized gains........................................ 748 66,633 19,103
---------------- --------------------- ---------------
Total revenues........................................... 51,795 234,087 59,492
---------------- --------------------- ---------------
Expenses:
Interest expense.......................................... 19,053 18,852 19,467
Operating expenses........................................ 2,826 3,477 1,531
--------------- --------------------- ---------------
Total expenses........................................... 21,879 22,329 20,998
---------------- --------------------- ---------------
Income before income taxes and equity in undistributed
net income of subsidiaries................................. 29,916 211,758 38,494
Federal income tax (benefit) expense........................ (5,433) 18,203 155
---------------- --------------------- ---------------
Income before equity in undistributed net income of
subsidiaries............................................... 35,349 193,555 38,339
Equity in undistributed net income of subsidiaries.......... 187,681 82,762 129,256
---------------- --------------------- ---------------
Net income.................................................. 223,030 276,317 167,595
Common dividends............................................ (24,165) (21,500) (19,484)
Other....................................................... (8,543) (1,878) (1,761)
Retained earnings at beginning of period................... 1,072,418 819,479 673,129
---------------------- --------------------- ---------------
Retained earnings at end of period.......................... $1,262,740 $1,072,418 $819,479
===================== ===================== ===============
</TABLE>
(1) Represents fair value of 2,378,672 shares of HCIA common stock received from
Ambac Assurance in the form of an extraordinary dividend on April 30, 1996.
S-4
<PAGE>
AMBAC FINANCIAL GROUP, 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>
1997 1996 1995
---------------- --------------------- ---------------------
Cash flows from operating activities:
<S> <C> <C>
Net income................................................ $ 223,030 $ 276,317 $ 167,595
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Equity in undistributed net income of
subsidiaries............................................. (187,681) (82,762) (129,256)
Extraordinary dividend(1)................................. -- (115,865) --
(Decrease) increase in accrued interest payable........... -- (28) 28
(Gain) loss on sale of investments........................ (748) (66,633) (19,103)
(Decrease) increase in current income
taxes payable............................................ (1,510) (10,443) 6,176
Other, net................................................ (20,715) (8,292) (941)
---------------- --------------------- ---------------------
Net cash provided by (used in) operating................
activities 12,376 (7,706) 24,499
---------------- --------------------- ---------------------
Cash flows from investing activities:
Proceeds from sales of bonds.............................. 39,728 17,396 --
Purchases of bonds........................................ -- (121,734) --
Proceeds from sale of affiliate........................... -- 202,609 28,502
Change in short-term investments.......................... 2,130 (4,585) 2,108
Other, net -- 13,842 --
---------------- --------------------- ---------------------
Net cash provided by investing activities................ 41,858 107,528 30,610
---------------- --------------------- ---------------------
Cash flows from financing activities:
Dividends paid............................................ (24,165) (21,500) (19,484)
Purchases of treasury stock............................... (40,397) (31,751) (5,913)
Proceeds from sale of treasury stock...................... 29,169 17,211 6,302
Contribution to subsidiaries.............................. (18,842) (63,801) (36,001)
---------------- --------------------- ---------------------
Net cash used in financing activities.................... (54,235) (99,841) (55,096)
---------------- --------------------- ---------------------
Net cash flow............................................... (1) (19) 13
Cash at January 1......................................... 9 28 15
---------------- --------------------- ---------------------
Cash at December 31....................................... $ 8 $ 9 $ 28
================ ===================== =====================
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes............................................. $ 12,861 $ 90,197 $ 24,800
===================== ===================== =====================
Interest expense......................................... $ 19,687 $ 19,687 $ 19,687
===================== ===================== =====================
Cash received during the year for:
Income taxes............................................. $ -- $ -- $ 8,749
===================== ===================== =============
</TABLE>
(1) Represents fair value of 2,378,672 shares of HCIA common stock received from
Ambac Assurance in the form of an extraordinary dividend on April 30, 1996.
S-5
<PAGE>
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
(Dollar Amounts in Thousands Except Percentages)
<TABLE>
<CAPTION>
ASSUMED PERCENTAGE OF
CEDED TO FROM AMOUNT
OTHER OTHER NET AMOUNT ASSUMED TO
GROSS AMOUNT COMPANIES COMPANIES NET
INSURANCE PREMIUMS WRITTEN
<S> <C> <C> <C> <C> <C>
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 %
Year ended December 31, 1997............ $277,814 $32,452 $8,349 $253,711 3.29 %
</TABLE>
S-6
<PAGE>
(EXHIBIT 3.02)
_________________________________
BY-LAWS
OF
AMBAC FINANCIAL GROUP, INC.
_________________________________
Amended through
January 28, 1998
<PAGE>
TABLE OF CONTENTS
Page
----
ARTICLE I
OFFICES
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........................................ 3
SECTION 2.12 Notice of Stockholder Business.............................. 4
SECTION 2.13 Notice of Stockholder Nominees.............................. 4
SECTION 2.14 Stockholders' Consent in Lieu of Meeting.................... 5
ARTICLE III
BOARD OF DIRECTORS
SECTION 3.01 General Powers.............................................. 6
SECTION 3.02 Number and Term of Office................................... 6
SECTION 3.03 Resignation................................................. 7
SECTION 3.04 Removal..................................................... 7
SECTION 3.05 Vacancies................................................... 7
SECTION 3.06 Meetings.................................................... 7
SECTION 3.07 Committees of the Board..................................... 8
SECTION 3.08 Directors' Consent in Lieu of Meeting....................... 9
SECTION 3.09 Action by Means of Telephone or Similar Communications
Equipment................................................... 9
SECTION 3.10 Compensation................................................ 9
-i-
<PAGE>
Page
----
ARTICLE IV
OFFICERS
SECTION 4.01 Officers..................................................... 10
SECTION 4.02 Authority and Duties......................................... 10
SECTION 4.03 Term of Office, Resignation and Removal...................... 10
SECTION 4.04 Vacancies.................................................... 10
SECTION 4.05 The Chairman................................................. 10
SECTION 4.06 The President................................................ 11
SECTION 4.07 Vice Chairmen, Vice Presidents and Managing Directors........ 11
SECTION 4.08 The Secretary................................................ 11
SECTION 4.09 Assistant Secretaries........................................ 11
SECTION 4.10 The Treasurer................................................ 12
SECTION 4.11 Assistant Treasurers......................................... 12
ARTICLE V
CHECKS, DRAFTS, NOTES AND PROXIES
SECTION 5.01 Checks, Drafts and Notes..................................... 12
SECTION 5.02 Execution of Proxies......................................... 12
ARTICLE VI
SHARES AND TRANSFERS OF SHARES
SECTION 6.01 Certificates Evidencing Shares............................... 13
SECTION 6.02 Stock Ledger................................................. 13
SECTION 6.03 Transfers of Shares.......................................... 13
SECTION 6.04 Addresses of Stockholders.................................... 13
SECTION 6.05 Lost, Destroyed and Mutilated Certificates................... 14
SECTION 6.06 Regulations.................................................. 14
SECTION 6.07 Fixing Date for Determination of Stockholders of Record...... 14
ARTICLE VII
SEAL
SECTION 7.01 Seal......................................................... 14
ARTICLE VIII
FISCAL YEAR
SECTION 8.01 Fiscal Year.................................................. 15
-ii-
<PAGE>
Page
----
ARTICLE IX
INDEMNIFICATION AND INSURANCE
SECTION 9.01 Indemnification.............................................. 15
SECTION 9.02 Insurance for Indemnification................................ 17
ARTICLE X
AMENDMENTS
SECTION 10.01 Amendments.................................................. 17
-iii-
<PAGE>
By-laws of Ambac Financial Group, Inc.
Amended through January 28, 1998
BY-LAWS
OF
AMBAC FINANCIAL GROUP, INC.
(Amended through January 28, 1998)
ARTICLE I
OFFICES
SECTION 1.01 REGISTERED OFFICE. The registered office of Ambac
-----------------
Financial Group, 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
-1-
<PAGE>
By-laws of Ambac Financial Group, Inc.
Amended through January 28, 1998
mail (airmail in the case of international communications) to each 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 to 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 INCORPORATION") otherwise provides) any special meeting of the
Stockholders may be canceled, by resolution of the Board upon public notice
given prior to the date previously scheduled for such meeting of Stockholders.
-2-
<PAGE>
By-laws of Ambac Financial Group, Inc.
Amended through January 28, 1998
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 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
-3-
<PAGE>
By-laws of Ambac Financial Group, Inc.
Amended through January 28, 1998
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 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
-4-
<PAGE>
By-laws of Ambac Financial Group, Inc.
Amended through January 28, 1998
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 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
-5-
<PAGE>
By-laws of Ambac Financial Group, Inc.
Amended through January 28, 1998
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 safekeeping of such consents and
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 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.
-6-
<PAGE>
By-laws of Ambac Financial Group, Inc.
Amended through January 28, 1998
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
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 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
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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 of any meeting
of the Board need be specified in any written waiver of 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 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
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By-laws of Ambac Financial Group, Inc.
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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 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 of the following: Vice Chairmen, Vice Presidents, Managing Directors,
Assistant Secretaries
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By-laws of Ambac Financial Group, Inc.
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and 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
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 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
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By-laws of Ambac Financial Group, Inc.
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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 CHAIRMEN, VICE PRESIDENTS AND MANAGING DIRECTORS.
-----------------------------------------------------
Vice Chairmen, Vice Presidents and Managing Directors, 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. A Vice President may be
designated as an Executive Vice President, a Senior Vice President, a First Vice
President, a Vice President or an Assistant Vice 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 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
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By-laws of Ambac Financial Group, Inc.
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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.
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 Chairman, Vice
President or Managing Director, 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 Chairman, Vice
President or Managing Director.
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By-laws of Ambac Financial Group, Inc.
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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 Chairman, Vice President or Managing Director 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 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.
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By-laws of Ambac Financial Group, Inc.
Amended through January 28, 1998
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.
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".
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By-laws of Ambac Financial Group, Inc.
Amended through January 28, 1998
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.
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 attorney's 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
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By-laws of Ambac Financial Group, Inc.
Amended through January 28, 1998
fairly and reasonably entitled to indemnity for such expenses which the Court of
Chancery or such other court shall deem proper.
(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 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
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Amended through January 28, 1998
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.
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 2.14 hereof, or by vote of the Board
or by a written consent of Directors pursuant to Section 3.08 hereof.
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SUEM 8-1-97
NUMBER
A
AMBAC
SEAL
American Bank Note Company
(EXHIBIT 4.01)
SM ETHER 1 H-51928
SHARES
COMMON STOCK
AMBAC FINANCIAL GROUP, INC.
INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE
SEE REVERSE FOR LEGEND
AND CERTAIN DEFINITIONS
CUSIP 023139 10 8
THIS IS TO CERTIFY THAT
IS THE OWNER OF
FULLY PAID AND NON-ASSESSABLE SHARES OF THE COMMON STOCK OF
AMBAC FINANCIAL GROUP, INC., transferable in person or by duly authorized
attorney upon surrender of this Certificate properly endorsed. This Certificate
is not valid until countersigned and registered by the Transfer Agent and
Registrar.
Witness the facsimile seal of the Corporation and the facsimile
signatures of its duly authorized officers.
Dated
Countersigned and Registered:
CITIBANK, N.A.
Transfer Agent and Registrar
By /s/Richard B. Gross /s/P. Lassiter
Senior vice President Chairman of the Board and
Authorized Signatory and Secretary Chief Executive Officer
Richard B. Gross P. Lassiter
<PAGE>
AMBAC FINANCIAL GROUP, INC.
This Certificate also evidences and entitles the holder hereof to certain
Rights as set forth in the Rights Agreement between the Corporation and the
Rights Agent thereunder (the "Rights Agreement"), the terms of which are hereby
incorporated herein by reference and a copy of which is on file at the principal
offices of the Corporation. Under certain circumstances, as set forth in the
Rights Agreement, such Rights will be evidenced by separate Certificates and
will no longer be evidenced by this Certificate. The Corporation will mail to
the holder of this Certificate a copy of the Rights Agreement, as in effect on
the date of mailing, without charge, promptly after receipt of a written request
therefor. Under certain circumstances set forth in the Rights Agreement, Rights
issued to, or held by, any Person who is, was or becomes an Acquiring Person or
any Affiliate or Associate thereof (as such terms are defined in the Rights
Agreement), whether currently held by or on behalf of such Person or by any
subsequent holder, may become null and void.
The Corporation will furnish without charge to any stockholder who so requests
the designations, preferences and relative, participating, optional or other
special rights of each class and series of stock which the Corporation is
authorized to issue and the qualifications, limitations or restrictions of such
preferences and/or rights. Such request may be made to the Secretary of the
Corporation or to the Transfer Agent named on the face hereof.
The following abbreviations, when used in the inscription on the face of this
Certificate, shall be construed as though they were written out in full
according to applicable laws or regulations:
TEN COM -as tenants in common UNIF GIFT MIN ACT-______Custodian_______
(Cust) (Minor)
TEN ENT -as tenants by the entireties
JT TEN -as joint tenants with right
of survivorship and not as tenants under Uniform Gifts to Minors
in common Act_____________________
(State)
Additional abbreviations may also be used though not in the above list.
For value received,___________hereby sell, assign and transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
[____________________________________]
_____________________________________________________________________________
(PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE)
_____________________________________________________________________________
_____________________________________________________________________________
_______________________________________________________________________shares
of the capital stock represented by the within Certificate, and do hereby
irrevocably constitute and appoint
_____________________________________________________________________Attorney
to transfer the said stock on the books of the within named Corporation with
full power of substitution in the premises.
Dated______________________
_____________________________________________
NOTICE: THE SIGNATURE TO THIS ASSIGNMENT MUST
CORRESPOND WITH THE NAME AS WRITTEN UPON THE
FACE OF THE CERTIFICATE IN EVERY PARTICULAR
WITHOUT ALTERATION OR ENLARGEMENT OR ANY
CHANGE WHATEVER.
Signature(s) Guaranteed:
____________________________________________________
THE SIGNATURE(S) SHOULD BE GUARANTEED BY AN ELIGIBLE
GUARANTOR INSTITUTION (BANKS, STOCKBROKERS, SAVINGS
AND LOAN ASSOCIATIONS AND CREDIT UNIONS WITH MEM-
BERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION
PROGRAM), PURSUANT TO S.E.C. RULE 17Ad-15.
<PAGE>
(EXHIBIT 10.01)
SECOND AMENDED AND RESTATED
EMPLOYMENT AGREEMENT
SECOND AMENDED AND RESTATED EMPLOYMENT AGREEMENT dated as of July 18,
1991, as initially amended and restated in full as of December 30, 1994 and
subsequently further amended and restated in full as of December 2, 1997, by and
between AMBAC FINANCIAL GROUP, INC., a Delaware corporation (the "COMPANY"), and
PHILLIP B. LASSITER (the "EXECUTIVE").
WHEREAS, the Company and the Executive originally entered into this
Agreement as of July 18, 1991 providing 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 agreement, the Executive's positions
having subsequently been enlarged to include President of the Company; and
WHEREAS, the Company and the Executive amended and restated this
Agreement in its entirety as of December 30, 1994 in order to reflect certain
amendments to the terms thereof; and
WHEREAS, the Company and the Executive have agreed to amend this
Agreement further, principally to conform to certain terms set forth in Amended
and Restated Management Retention Agreements between the Company and certain of
its senior officers, and to restate this Agreement in its entirety;
NOW, THEREFORE, in consideration of the premises and the mutual
covenants herein contained, the parties hereto hereby agree as follows
(capitalized terms used herein without definition shall have the meanings
ascribed to such terms in Section 12 below):
1. EMPLOYMENT AND DUTIES.
(a) EFFECTIVE DATE. The effective date of this Agreement (the
"EFFECTIVE DATE") was July 18, 1991, such date being the date of the
consummation of the "Equity Offerings," as such term is defined in Registration
Statement No. 33-40306 on Form S-1 of the Company.
(b) GENERAL. The Company hereby continues the employment of the
Executive, and the Executive agrees upon the terms and conditions herein set
forth to continue to serve, as the Chairman, President and Chief Executive
Officer of the Company. In addition, the Executive shall continue to serve as
the Chairman, President and Chief Executive
<PAGE>
Second Amended and Restated
Employment Agreement
Page 2 of 23
Officer of Ambac Assurance Corporation, a Wisconsin corporation that is a
wholly-owned subsidiary of the Company ("AMBAC ASSURANCE"). The Executive shall
devote his full-time working hours and best efforts to his duties hereunder. The
Company agrees to nominate the Executive for election to its Board of Directors
(the "BOARD") as a member of the management slate at each annual meeting of
stockholders (or if the members of the Board are divided into classes pursuant
to Section 141(d) of the Delaware General Corporation Law, at each annual
meeting of stockholders at which the Executive's director class comes up for
election) during his employment hereunder. The Executive agrees to serve on the
Board if elected. In addition, the Executive agrees to serve, if requested by
the Board, as an officer or director of any subsidiary or affiliate of the
Company at no additional compensation.
2. TERM OF EMPLOYMENT. The term of the Executive's employment under
this Agreement (the "TERM") commenced on the Effective Date and initially
continued until the second anniversary of the Effective Date. Starting with the
day following the Effective Date the Term has been extended, and, continuing
until the date the Executive's employment is terminated in accordance with the
terms of this Agreement, the Term shall continue to be so extended, on a daily
basis to continue until the second anniversary of the date of such extension,
provided, however, that (i) the Company or the Executive may give the other
notice that it does not wish to extend the Term beyond two years from the date
of such notice, and (ii) unless the Company shall specify in writing to the
contrary, the Term shall not extend past the Executive's sixty-fifth birthday.
Notwithstanding the preceding sentence, upon the occurrence of a Change in
Control, the Term shall be extended and shall at any time be considered to
continue until the later of (x) the third anniversary of the Change in Control
and (y) the date determined in accordance with the preceding sentence. Nothing
in this Section 2 shall limit the right of the Company to terminate the
Executive's employment hereunder on the terms and conditions set forth in
Section 4.
3. COMPENSATION AND OTHER BENEFITS. Subject to the provisions of
this Agreement, the Company shall pay and provide the following compensation and
other benefits to the Executive during the Term as compensation for services
rendered hereunder:
(a) SALARY. The Executive's rate of salary (the "SALARY") was
initially $410,000 and has subsequently been increased to $530,000. The Salary
is payable in substantially equal installments at such intervals (not less
frequently than monthly) as may be determined by the Company in accordance with
its payroll practices as established from time to time. The Compensation and
Organization Committee of the Board (or any successor thereto) (the "COMMITTEE")
shall periodically review and may increase, but not decrease, the Executive's
Salary as in effect at the time of such review.
<PAGE>
Second Amended and Restated
Employment Agreement
Page 3 of 23
(b) BONUS. The Executive shall participate for each calendar year in
a bonus arrangement pursuant to which he shall be eligible to earn an annual
bonus, based on the Company's achieving certain performance goals which the
Committee shall establish. For each such year, the bonus arrangement will
provide that, in the event that target performance goals are achieved, the bonus
for such year shall be no less than 70% of the Executive's Salary for such year
(the "TARGET BONUS") and may provide for a bonus greater or less than the Target
Bonus in the event the target performance goals for such year are exceeded or
are not met in full. The form of payment of the Executive's bonus (whether in
cash, in awards under the Company's 1997 Equity Plan, as the same may be amended
from time to time, or any successor thereto (the "EQUITY PLAN"), in a
combination of cash and such awards or in some other form), and the value to be
attributed to any non-cash component of the bonus, will be determined by the
Committee in its discretion.
(c) LONG-TERM INCENTIVE COMPENSATION. The Executive's long-term
incentive compensation awards, whether under the Equity Plan or any other plan
or program of the Company, shall be determined by the Committee in its
discretion.
(d) EXPENSES. The Company shall reimburse the Executive for
reasonable travel and other business related expenses incurred by him in
performance of the business of the Company. In addition, the Company shall
reimburse the Executive for the annual membership fees of one golf club and one
luncheon club.
(e) PENSION, WELFARE AND FRINGE BENEFITS.
(i) GENERAL. The Executive shall participate in each pension,
welfare, life insurance, health, disability and other fringe benefit plan
or program maintained by the Company for its executive officers in
accordance with the terms thereof.
(ii) PARTICIPATION IN RETIREMENT PLAN. The Executive participates,
and shall continue to participate, in the Company's Pension Plan (the
"RETIREMENT PLAN") or any successor plan thereto and has received service
credit under the Retirement Plan, in accordance with the terms thereof, for
periods of service with Citibank, N.A. and its affiliates for which he
received credit under The Retirement Plan of Citibank, N.A. and its
affiliates (the "CITIBANK PLAN"), it being understood that under the terms
of such plans amounts paid under the Citibank Plan shall reduce the amounts
payable from the Retirement Plan.
(iii) SUPPLEMENTAL RETIREMENT BENEFITS. Provided that the Executive
remains in the employ of the Company or its affiliates until at least the
age at which he becomes
<PAGE>
Second Amended and Restated
Employment Agreement
Page 4 of 23
eligible for early retirement under the terms of the Retirement Plan (or,
if earlier, until termination of his employment by reason of death or
Disability, the Company will pay the Executive, commencing at the time
payment of benefits under the Retirement Plan commences (or, if earlier,
commencing as of the first month following termination of the executive's
employment by reason of death or Disability), an annual supplemental
retirement benefit (the "ASRB") determined by the formula "ASRB = X - (Y +
Z)", where "X", "Y" and "Z" are defined as follows:
"X" equals the annual amount that would be payable under the
Retirement Plan to the Executive commencing at his retirement (or
earlier termination of employment due to death or Disability)
determined as though (A) the provisions of the Retirement Plan in
effect on December 31, 1991 had remained in effect through such
retirement or earlier termination, (B) the Executive's bonus
compensation (including cash bonus and any restricted stock or stock
units awarded in lieu of cash (any such stock and units to be
considered to have the value attributed thereto by the Committee as
provided in Section 3(b)), but excluding the value of any stock
options) were taken into account in computing the benefit payable
thereunder, and (C) such benefit were calculated without giving effect
to the limitations provided for in Sections 401(a)(17) and 415 of the
Internal Revenue Code of 1986, as amended (the "CODE"), or any
successor provisions thereto.
"Y" equals the aggregate annual benefits payable to the Executive
under any qualified or nonqualified defined benefit retirement plan or
arrangement maintained by the Company or any of its subsidiaries or
affiliates.
"Z" equals an annual amount that is the actuarial equivalent of the
excess, if any of:
(A) the aggregate amount of employer contributions that would
have been contributed to the Executive's account under the
Company's Savings Incentive Plan or any successor plan thereto
(the "SIP") through the date of the Executive's retirement (or
earlier termination of employment due to death or Disability),
determined pursuant to the terms of the SIP and any such other
plans or arrangements as in effect from time to time, over
(B) the amount of employer contributions that would have been so
contributed to the Executive's account under the SIP determined
<PAGE>
Second Amended and Restated
Employment Agreement
Page 5 of 23
pursuant to the terms of the SIP in effect on December 31, 1991,
in each such case calculated on the assumptions:
(a) that Section 401(a)(17), 402(g) and 415 of the Code did not
apply and that the Executive's annual contributions would not be
limited by operation of the actual deferral percentage or actual
contribution percentage tests under Sections 401(k) and (m),
respectively, of the Code, and
(b) that the Executive had deferred 6% of his salary under the
SIP,
all such amounts to be credited with interest from December 31 of the
year in respect of which any such contribution would have been made to
the date of the Executive's retirement or other termination of
employment at a rate equal to the applicable long-term federal rate
compounded semiannually, such rate to be adjusted annually on the
first day of each calendar year to reflect the rate then in effect.
For this purpose, actuarial equivalence shall be determined using the
actuarial assumptions used in the valuation of the required minimum
contribution to the Retirement Plan under Section 412 of the Code for
the plan year in which the Executive retires or otherwise terminates
employment.
The ASRB shall be determined and paid on the basis of the same payment
alternative that the Executive shall have elected under the Retirement
Plan.
4. TERMINATION OF EMPLOYMENT.
This Section 4 sets forth the provisions that will apply generally
upon a termination of the Executive's employment with the Company. Special
provisions that will apply in the event of a Change in Control are set forth at
Section 5 below.
(a) TERMINATION FOR CAUSE; RESIGNATION WITHOUT GOOD REASON.
(i) RIGHTS ON TERMINATION. If, prior to the expiration of the Term,
the Executive's employment is terminated by the Company for Cause, or the
Executive resigns from his employment hereunder other than for Good Reason, the
Executive shall be entitled to payment of his Salary accrued through the date of
such termination or resignation, plus any other accrued but unpaid benefits or
compensation (including any accrued but unpaid bonus compensation in respect of
a year prior to the year in which such termination or resignation
<PAGE>
Second Amended and Restated
Employment Agreement
Page 6 of 23
occurs), provided, however, that the Executive shall not be entitled to any
bonus compensation pursuant to Section 3(b) in respect of the year in which such
termination or resignation occurs. Except as may be provided under the terms of
any applicable grants to the Executive under the Stock Plan or any amended or
successor plan thereto, the Executive shall have no right under this Agreement
or otherwise to receive any other compensation, or to participate in any other
plan, arrangement or benefit, with respect to future periods after such
termination or resignation of Employment.
(ii) NOTICE OF TERMINATION OR RESIGNATION. Termination of the
Executive's employment for Cause shall be communicated by delivery to the
Executive of a copy of a resolution duly adopted by the affirmative vote of not
less than a majority (or, following a Change in Control, not less than three-
fourths) of the entire membership of the Board at a meeting of the Board called
and held for such purpose (after reasonable notice to the Executive and
reasonable opportunity for the Executive, together with the Executive's counsel,
to be heard before the Board prior to such vote), finding that in the good faith
opinion of the Board an event constituting Cause for termination in accordance
with Section 10(a) has occurred and specifying the particulars thereof (a
"NOTICE OF TERMINATION"). If the event constituting Cause for termination is of
a type specified in clause (i) or clause (iii) of the definition of Cause set
forth in Section 12, the Executive shall have 20 business days from the date of
receipt of such Notice of Termination to effect a cure of the event described
therein and, upon cure thereof by the Executive to the reasonable satisfaction
of the Company, such event shall no longer constitute Cause for purposes of this
Agreement.
(b) TERMINATION WITHOUT CAUSE; RESIGNATION FOR GOOD REASON.
(i) SEVERANCE AMOUNT. If, prior to the expiration of the Term, the
Executive's employment is terminated by the Company without Cause, or the
Executive resigns from his employment hereunder for Good Reason, the Company
shall pay to the Executive his Salary accrued up to and including the date of
such termination or resignation, plus a pro rata portion (based on the number of
days elapsed prior to such termination or resignation) of the Target Bonus for
the year in which such termination or resignation occurs, plus any other accrued
but unpaid benefits or compensation. In addition, the Company shall pay to the
Executive the Severance Amount (as hereinafter defined) over a two-year period
commencing with the date of such termination or resignation (the "SEVERANCE
PERIOD"). As used herein, the "SEVERANCE AMOUNT" shall mean the product of "A"
times "B" where "A" equals the number of years (including any fraction thereof,
based on 365 days per year) remaining in the Term as of the date of such
termination or resignation, and "B" equals the sum of the Salary as in effect on
the date of such termination or resignation and the Executive's Target Bonus for
the year in which such termination or resignation occurs (or if
<PAGE>
Second Amended and Restated
Employment Agreement
Page 7 of 23
the Executive's Target Bonus has not yet been determined for such year, his
Target Bonus for the immediately preceding year) (such sum, which shall be not
less than 170% of such Salary, is referred to as the "REFERENCE AMOUNT"). The
Severance Amount shall be payable in equal monthly installments over the
Severance Period and each such installment shall be subject to regular payroll
deductions.
(ii) BENEFITS UNDER THE STOCK PLAN. In the event of the Executive's
termination or resignation as provided in this Section 4(b), the Executive shall
be fully vested in all stock options, restricted stock, restricted stock units
and any other awards theretofore awarded to him under the Company's 1991 Stock
Incentive Plan, as amended, the Equity Plan, or any successor thereto.
(iii) OTHER BENEFITS. In the event of the Executive's termination or
resignation as provided in this Section 4(b), the Executive shall also be
entitled to the following benefits:
(A) For purposes of calculating the Executive's benefit under the
Retirement Plan, the Executive shall receive an additional two years of
credited service. In addition, for all purposes under the Retirement Plan,
including for purposes of benefit calculations, the Executive shall be
treated as having retired from service with the Company, rather than as a
"terminated vested" employee.
(B) Within five business days following the Termination Date, the
Company shall make a lump sum payment to the Executive equal to the amount
that the Company would have contributed for the Executive's account under
the SIP in respect of the two years following the Termination Date, based
on (A) the formula for determining employer contributions in effect on the
Termination Date and (B) the Salary (and, if such formula takes account of
bonus compensation, the Target Bonus) used for purposes of determining the
Reference Amount, and calculated without giving effect to the limitations
provided for in Sections 401(a)(17) and 415 of the Code, or any successor
provisions thereto.
(C) Within five business days following the Termination Date the
Executive shall receive a lump sum payment of his account balance as of the
Termination Date under any nonqualified plan maintained by the Company or
any of its Affiliates to provide benefits in excess of those permitted
under the Code to be provided by the SIP. (It is understood that no such
plan exists as of the date of this Agreement.). The Company shall remain
obligated to pay to the Executive or his beneficiaries any benefits to
which he or they may be entitled under any nonqualified plan maintained by
<PAGE>
Second Amended and Restated
Employment Agreement
Page 8 of 23
the Company or any of its Affiliates to provide benefits in excess of those
permitted under the Code to be provided by the Retirement Plan (including
without limitation benefits under the Company's Excess Benefit Plan and
Supplemental Retirement Plan or any successors to such plans, and the ASRB
provided for in Section 3(e) of this Agreement); such payments shall be
made in accordance with the terms of such plans, and benefits thereunder
shall take account of the two years of additional credited service provided
for in clause (ii) above.
(D) During the Severance Period, the Executive and his
dependents, if any, shall continue to participate (at no greater expense to
them than was the case for such coverage prior to his termination) in the
employee benefit arrangements described in Section 3(e)(i) above, provided,
however, that such benefits shall cease to the extent the Executive begins
coverage under plans of a subsequent employer.
(E) At the end of the Severance Period, the Executive and his
family shall be entitled for the remainder of his life to retiree medical
and dental benefits under the applicable plans and programs of the Company
as if he retired on the last day of the Severance Period, with such
benefits to commence immediately at the end of the Severance Period and
with the amount of contribution by the Executive to be no greater than that
of any other employee of the Company who had retired on the last day of the
Severance Period (it being understood and agreed that contribution rates
may be changed, and the terms of such benefits may be modified, to the
extent permitted under the relevant plans, from those in effect on the date
hereof).
(F) During the Severance Period, the Company shall provide the
Executive with appropriate individual outplacement services and financial
planning at the Company's expense.
(G) The Executive shall receive all amounts due to him under
any compensatory plan or arrangement of the Company and not specifically
addressed above, in accordance with the terms of the relevant plan or
arrangement.
Anything herein to the contrary notwithstanding, the Company shall have no
obligation to continue to maintain during the Severance Period any plan or
program solely as a result of the provisions of this Agreement. If, during the
Severance Period, the Executive is precluded from participating in a plan or
program by its terms or applicable law or if the Company for any reason ceases
to maintain such plan or program, the Company shall provide the Executive with
compensation or benefits the aggregate value of which is no less than the
aggregate value of the compensation or benefits that the Executive would have
received under such plan or
<PAGE>
Second Amended and Restated
Employment Agreement
Page 9 of 23
program had he been eligible to participate therein or had such plan or program
continued to be maintained by the Company.
(iv) OFFSET PROVISIONS. In the event of any termination of the
Executive's employment, the Executive shall be under no obligation to seek other
employment or otherwise to mitigate damages resulting from his termination of
employment. Nevertheless, subject to Section 5 below, amounts owed to the
Executive under Section 4(b)(i) shall be offset by the amount of cash
compensation to which the Executive becomes entitled, or which is voluntarily
deferred at his request, during the Severance Period, from a Third Party
Employer. Promptly upon becoming engaged by a Third Party Employer, the
Executive shall provide the Company with written notice of such engagement and
shall set forth the terms of his compensation, including any amount of
guaranteed or target bonus; within five business days of the receipt of such
notice, the Company shall make a lump-sum payment to the Executive equal to the
amount that remains due to the Executive under Section 4(b)(i) reduced by the
amount of cash compensation to which the Executive is expected to become
entitled during the Severance Period from the Third Party Employer (including
any amounts which are to be voluntarily deferred at his request) based on the
compensation information set forth in his notice to the Company, including
therein a pro rata portion (based on the number of days remaining in the
Severance Period) of any guaranteed or target bonus. The Company and the
Executive shall use their good faith efforts to agree upon the offset amount,
but in the event they are unable to agree, the amount proposed by the Executive,
and certified by an independent certified public account selected by the
Executive, shall control.
(v) DEATH DURING SEVERANCE PERIOD. In the event of the Executive's
death during the Severance Period, the balance of the Severance Amount will be
paid to his Beneficiary in a lump sum. "BENEFICIARY" shall mean the person or
persons designated by the Executive in writing to the Company to receive payment
under this Agreement or, if no such person or persons are designated, the
Executive's estate.
(c) TERMINATION DUE TO DEATH OR DISABILITY. In the event of the
Executive's Disability, the Company shall be entitled to terminate his
employment. Notwithstanding anything contained in this Agreement to the
contrary, if the Executive employment terminates due to death or Disability, any
Salary earned by the Executive up to the date of such termination, plus a pro
rata portion (based on the number of days elapsed prior to such termination or
resignation) of the Target Bonus for the year in which such termination occurs,
shall be paid to the Executive or his estate, as the case may be, within 30 days
of such termination. All stock options, restricted stock, restricted stock
units or other awards awarded to the Executive under the Stock Plan shall be
fully vested as of the date of death or termination of employment due to
Disability. As used in this Section 4(c), the term
<PAGE>
Second Amended and Restated
Employment Agreement
Page 10 of 23
"DISABILITY" shall be defined in the same manner as such term or a similar term
is defined in any long-term disability policy maintained by the Company which
covers the Executive and is in effect on the date of the Executive's termination
of employment with the Company, provided, however, that the Executive shall not
be "disabled" for purposes of this Section 4(c) unless he has a physical or
mental incapacity that substantially prevents him from performing his duties
hereunder, that has continued at least 180 days and that can reasonably be
expected to continue indefinitely. Any dispute as to whether or not the
Executive is disabled within the meaning of the preceding sentence shall be
resolved by a physician reasonably satisfactory to the Executive and the Board,
and the determination of such physician shall be final and binding upon both the
Executive and the Company.
5. CHANGE IN CONTROL PROVISIONS.
Notwithstanding anything in to the contrary in this Agreement, the
provisions of this Section 5 shall apply in the event there is a Change in
Control.
(a) EQUITY AWARDS. Upon the occurrence of a Change in Control, the
Executive shall be fully vested in all stock options, restricted stock,
restricted stock units and any other awards theretofore awarded to him under the
Equity Plan, or any successor thereto, on or after January 1, 1998 provided,
however, that if any Person commences a tender offer for shares of the Company's
common stock, par value $0.01 per share (the "COMMON STOCK"), which, if
successfully completed, would result in a Change in Control, then the Executive
shall be fully vested in all such stock options, restricted stock units and any
other such awards, and any such awards that by their terms are to be paid or
settled by the delivery of shares of Common Stock without the payment of any
additional consideration by the Executive shall be so paid or settled,
immediately prior to the scheduled expiration of such tender offer, and the
Company shall have instituted procedures to enable the Executive, if he so
desires, to tender the shares issued upon the exercise of such stock options or
delivered in payment or settlement of such restricted stock units or other
awards into such offer.
(b) PAYMENT OF SEVERANCE AMOUNT. If the Executive's employment with
the Company is terminated by the Executive for Good Reason or by the Company
without Cause, in either case at any time during the period beginning with a
Change in Control and ending on the third anniversary thereof, then:
(i) the Reference Amount shall equal the sum of (X) the Salary in
effect on the Termination Date and (Y) the higher of the Target Bonus for
the year in which the Termination Date occurs (or if the Executive's Target
Bonus has not yet been determined for such year, his Target Bonus for the
immediately preceding year) and the
<PAGE>
Second Amended and Restated
Employment Agreement
Page 11 of 23
highest Bonus percentage paid or payable to the Executive at any time prior
to his Termination Date times the Salary in effect on the Termination Date;
and
(ii) the Severance Amount shall equal two times the Reference Amount
and shall be paid to the Executive by the Company in a lump sum within five
business days of the Termination Date.
(c) NO OBLIGATION TO MITIGATE AND NO OFFSET. As provided above in
Section 4, upon termination of the Executive's employment, the Executive shall
be under no obligation to seek other employment or otherwise to mitigate damages
resulting from his termination of employment. In addition, notwithstanding
Section 4(b)(iv) above, if such termination occurs at any time during the period
beginning with a Change in Control and ending on the third anniversary thereof,
there shall be no offset against amounts due to the Executive under any
provision of this Agreement on account of any remuneration to which the
Executive becomes entitled from any Third Party Employer or any other Person for
whom the Executive subsequently provides services (as an officer, director,
employee, independent contractor or otherwise), other than as provided in
Section 4(b)(iii)(D) relating to continuation of benefits coverage.
(d) NO REDUCTION IN RIGHTS UNDER SECTION 4. Except as otherwise
provided in this Section 5, the rights and entitlements of the Executive upon
termination of employment incident to or following a Change in Control shall be
as provided in Section 4. In particular, nothing in this Section 5 is intended,
or shall be construed, to reduce any of the rights and entitlements of the
Executive set forth in Section 4.
6. CERTAIN ADDITIONAL PAYMENTS BY THE COMPANY.
(a) Anything in this Agreement to the contrary notwithstanding, in the
event it shall be determined that any payment or distribution by the Company to
or for the benefit of the Executive (whether paid or payable or distributed or
distributable pursuant to the terms of this Agreement or otherwise, but
determined without regard to any additional payments required under this Section
6) (a "PAYMENT") would be subject to the excise tax imposed by the Code or any
interest or penalties are incurred by the Executive with respect to such excise
tax (such excise tax, together with any such interest and penalties, are
hereinafter collectively referred to as the "EXCISE TAX"), then the Executive
shall be entitled to receive an additional payment (a "GROSS-UP PAYMENT") in an
amount such that after payment by the Executive of all taxes (including any
interest or penalties imposed with respect to such taxes), including, without
limitation, any income taxes (and any interest and penalties imposed with
respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive
retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon
the Payments.
<PAGE>
Second Amended and Restated
Employment Agreement
Page 12 of 23
(b) Subject to the provisions of Section 6(c), all determinations
required to be made under this Section 6, including whether and when a Gross-Up
Payment is required and the amount of such Gross-Up Payment and the assumptions
to be utilized in arriving at such determination, shall be made by KPMG Peat
Marwick LLP or such other certified public accounting firm as may be jointly
designated by the Executive and the Company (the "ACCOUNTING FIRM"), which shall
provide detailed supporting calculations both to the Company and the Executive
within 15 business days of the receipt of notice from the Executive that there
has been a Payment, or such earlier time as is requested by the Company. All
fees and expenses of the Accounting Firm shall be borne solely by the Company.
Any Gross-Up Payment, as determined pursuant to this Section 6, shall be paid by
the Company to the Executive within five days of the receipt of the Accounting
Firm's determination. Any determination by the Accounting Firm shall be binding
upon the Company and the Executive. As a result of the uncertainty in the
application of Section 4999 of the Code at the time of the initial determination
by the Accounting Firm hereunder, it is possible that Gross-Up Payments which
will not have been made by the Company should have been made ("UNDERPAYMENT"),
consistent with the calculations required to be made hereunder. In the event
that the Company exhausts its remedies pursuant to Section 6(c) and the
Executive thereafter is required to make a payment of any Excise Tax, the
Accounting Firm shall determine the amount of the Underpayment that has occurred
and any such Underpayment shall be promptly paid by the Company to or for the
benefit of the Executive.
(c) The Executive shall notify the Company in writing of any claim by
the Internal Revenue Service that, if successful, would require the payment by
the Company of the Gross-Up Payment. Such notification shall be given as soon
as practicable but no later than ten business days after the Executive is
informed in writing of such claim and shall apprize the Company of the nature of
such claim and the date on which such claim is requested to be paid. The
Executive shall not pay such claim prior to the expiration of the 30-day period
following the date on which it gives such notice to the Company (or such shorter
period ending on the date that any payment of taxes with respect to such claim
is due). If the Company notifies the Executive in writing prior to the
expiration of such period that it desires to contest such claim, the Executive
shall:
(i) give the Company any information reasonably requested by the
Company relating to such claim,
(ii) take such action in connection with contesting such claim as the
Company shall reasonably request in writing from time to time, including,
without limitation, accepting legal representation with respect to such
claim by an attorney
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Second Amended and Restated
Employment Agreement
Page 13 of 23
reasonably selected by the Company,
(iii) cooperate with the Company in good faith in order effectively
to contest such claim, and
(iv) permit the Company to participate in any proceedings relating to
such claim;
provided, however, that the Company shall bear and pay directly all costs and
expenses (including additional interest and penalties) incurred in connection
with such contest and shall indemnify and hold the Executive harmless, on an
after-tax basis, for any Excise Tax or income tax (including interest and
penalties with respect thereto) imposed as a result of such representation and
payment of costs and expenses. Without limitation on the foregoing provisions
of this Section 6(c), the Company shall control all proceedings taken in
connection with such contest and, at its sole option, may pursue or forgo any
and all administrative appeals, proceedings, hearings and conferences with the
taxing authority in respect of such claim and may, at its sole option, either
direct the Executive to pay the tax claimed and sue for a refund or contest the
claim in any permissible manner, and the Executive agrees to prosecute such
contest to a determination before any administrative tribunal, in a court of
initial jurisdiction and in one or more appellate courts, as the Company shall
determine; provided, however, that if the Company directs the Executive to pay
such claim and sue for a refund, the Company shall advance the amount of such
payment to the Executive, on an interest-free basis and shall indemnify and hold
the Executive harmless, on an after-tax basis, from any Excise Tax or income tax
(including interest or penalties with respect thereto) imposed with respect to
such advance or with respect to any imputed income with respect to such advance;
and further provided that any extension of the statute of limitations relating
to payment of taxes for the taxable year of the Executive with respect to which
such contested amount is claimed to be due is limited solely to such contested
amount. Furthermore, the Company's control of the contest shall be limited to
issues with respect to which a Gross-Up Payment would be payable hereunder and
the Executive shall be entitled to settle or contest, as the case may be, any
other issue raised by the Internal Revenue Service or any other taxing
authority.
(d) If, after the receipt by the Executive of an amount advanced by
the Company pursuant to Section 6(c), the Executive becomes entitled to receive
any refund with respect to such claim, the Executive shall (subject to the
Company's complying with the requirements of Section 6(c)) promptly pay to the
Company the amount of such refund (together with any interest paid or credited
thereon after taxes applicable thereto). If, after the receipt by the Executive
of an amount advanced by the Company pursuant to Section 6(c), a determination
is made that the Executive shall not be entitled to any refund with respect to
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Second Amended and Restated
Employment Agreement
Page 14 of 23
such claim and the Company does not notify the Executive in writing of its
intent to contest such denial of refund prior to the expiration of 30 days after
such determination, then such advance shall be forgiven and shall not be
required to be repaid and the amount of such advance shall offset, to the extent
thereof, the amount of Gross-Up Payment required to be paid.
7. PROTECTION OF THE COMPANY'S INTERESTS.
(a) CONFIDENTIAL INFORMATION. Except for actions taken in the course
of his employment hereunder or as required by law, at no time shall the
Executive divulge, furnish or make accessible to any person any information of a
confidential or proprietary nature obtained by him while in the employ of the
Company. Upon termination of his employment with the Company, the Executive
shall return to the Company all such information which exists in written or
other physical form and all copies thereof in his possession or under his
control.
(b) EXCLUSIVE SERVICES. During the Term, the Executive shall not
directly or indirectly engage in competition with, or own any interest in any
business which competes with, any business of the Company or any of its
subsidiaries, provided, however, that the provisions of this Section 7 shall not
prohibit the Executive's ownership of not more than 5% of the voting stock of
any publicly held corporation, and provided, further, that the Executive's
covenant under this Section 7(b) shall not apply following termination of his
employment following a Change in Control.
8. REMEDIES. The Executive acknowledges that a breach of any of the
covenants contained in Section 7 may result in material irreparable injury to
the Company or its Affiliates for which there is no adequate remedy at law, that
it will not be possible to measure damages for such injuries precisely and that,
in the event of such breach or threat thereof, the Company shall be entitled, in
addition to any other rights or remedies it may have, to obtain a temporary
restraining order and/or a preliminary or permanent injunction enjoining or
restraining the Executive from engaging in activities prohibited by Section 7.
In no event, however, shall an asserted violation of the provisions of Section 7
constitute a basis for deferring or withholding any amounts otherwise payable to
the Executive under this Agreement, unless the Company shall have first obtained
a final decision, in an arbitration conducted in accordance with Section 11 of
this Agreement, finding that the Executive has materially breached the
provisions of Section 7.
9. INDEMNIFICATION. The Company will indemnify the Executive to the
fullest extent permitted (including payment of expenses in advance of final
disposition of a
<PAGE>
Second Amended and Restated
Employment Agreement
Page 15 of 23
proceeding) by the laws of the State of Delaware, as in effect
at the time of the subject act or omission, or by the Certificate of
Incorporation and By-Laws of the Company, as in effect at such time or on the
Effective Date of this Agreement, whichever affords or afforded greatest
protection to the Executive, and the Executive shall be entitled to the
protection of any insurance policies the Company may elect to maintain generally
for the benefit of its directors and officers (and to the extent the Company
maintains such an insurance policy or policies, the Executive shall be covered
by such policy or policies, in accordance with its or their terms, to the
maximum extent of the coverage provided for any Company officer or director),
against all costs, charges and expenses whatsoever incurred or sustained by him
or his legal representatives at the time such costs, charges and expenses are
incurred or sustained, in connection with any action, suit or proceeding to
which he may be made a party by reason of his being or having been a director,
officer or employee of the Company or any subsidiary thereof, or his serving or
having served any other enterprise as a director, officer or employee at the
request of the Company.
10. LIMITATION OF LIABILITY. The Company hereby represents that, as
of the Effective Date, its Certificate of Incorporation and By-Laws provide the
Executive with the maximum limitation on his liability permitted by the laws of
the State of Delaware and the Company agrees that during the Term it will amend
its Certificate of Incorporation and By-Laws, to the extent necessary, to
provide the Executive the maximum limitation on his liability permitted by such
laws.
11. ARBITRATION.
(a) Any dispute or controversy arising under or in connection with
this Agreement shall be settled exclusively by arbitration in New York, New York
in accordance with the rules of the American Arbitration Association then in
effect. Judgment may be entered on the arbitrator's award in any court having
jurisdiction; provided, however, that the Executive shall be entitled to seek
specific performance of the Executive's right to be paid until the Termination
Date during the pendency of any dispute or controversy arising under or in
connection with this Agreement.
(b) The Company shall promptly reimburse the Executive for all legal
fees and expenses incurred by the Executive in connection any claim to enforce
his rights under this Agreement, except for any claim which shall have been
determined, in an arbitration conducted in accordance with subsection (a) above,
to have been brought by the Executive in bad faith.
(c) In addition to the reimbursement provided for in subsection (b)
above,
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Second Amended and Restated
Employment Agreement
Page 16 of 23
the Company shall reimburse the Executive for up to $15,000 in legal,
accounting and financial expenses incurred after a Change in Control in
connection with this Agreement (whether or not the Executive's employment is
terminated), including without limitation in connection with financial planning
and the investigation of the Executive's rights hereunder.
12. DEFINITIONS. For purposes of this Agreement, the following
definitions shall apply.
"AFFILIATE" includes any company or other entity or person
controlling, controlled by or under common control with the Company.
"CAUSE" means any of the following:
(i) the willful commission by the Executive of acts that are
dishonest and demonstrably and materially injurious to the Company or
any of its Affiliates, monetarily or otherwise;
(ii) the conviction of the Executive for a felonious act
resulting in material harm to the financial condition or business
reputation of the Company or any of its Affiliates; or
(iii) a material breach of any of the covenants set forth in
Section 5 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 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;
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Second Amended and Restated
Employment Agreement
Page 17 of 23
(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 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; or
(iii) approval by the stockholders of the Company of (A) a merger
or consolidation of the Company with any other corporation, (B) the
issuance of voting securities of the Company in connection with a
merger or consolidation of the Company (or any Subsidiary) pursuant to
applicable stock exchange requirements, or (C) sale or other
disposition of all or substantially all of the assets of the Company
or the acquisition of assets of another corporation (each, a "BUSINESS
COMBINATION"), unless, in each case, immediately following such
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Second Amended and Restated
Employment Agreement
Page 18 of 23
Business Combination, all or substantially all of the individuals and
entities who were the beneficial owners of the Common Stock
outstanding immediately prior to such Business Combination
beneficially own, directly or indirectly, more than 70% of the then
outstanding shares of common stock and 70% of the combined voting
power of the then outstanding voting securities entitled to vote
generally in the election of directors, as the case may be, of the
corporation resulting from such Business Combination (including,
without limitation, a corporation which as a result of such
transaction owns the Company or all or substantially all of the
Company's assets either directly or through one or more subsidiaries)
in substantially the same proportions as their ownership, immediately
prior to such Business Combination, of the Common Stock.
"GOOD REASON" means, without the Executive's express written consent,
any of the following:
(i) a substantial adverse alteration in the nature or status of
the Executive's duties or responsibilities or in the Executive's
title, including the Executive's ceasing to report directly to the
Board, except that the appointment by the Company and/or Ambac
Assurance of an individual other than the Executive as its President
shall not constitute Good Reason hereunder, so long as the Executive
retains the titles and responsibilities of Chairman and Chief
Executive Officer;
(ii) a reduction in the Salary as then in effect or failure of
the Company to pay any amount owing to the Executive hereunder when
due;
(iii) the Company's requiring the Executive to be based at any
office or location more than 25 miles outside of the city limits of
New York City;
(iv) the failure to obtain a satisfactory agreement from any
successor of the Company to assume and agree to perform this
Agreement, as contemplated in Section 9(d) hereof;
(v) following a Change in Control, the failure by the Company to
continue in effect any compensation plan in which the Executive
participates as of the date of such Change in Control, or any
substitute plans adopted after the date thereof, unless an equitable
arrangement (embodied in an ongoing substitute or alternative plan)
has been made with respect to such plan, or the failure by the Company
to continue the Executive's participation therein on at
<PAGE>
Second Amended and Restated
Employment Agreement
Page 19 of 23
least as favorable a basis as that enjoyed by other similarly situated
executives of the Company and its Affiliates;
(vi) following a Change in Control, the failure by the Company
to continue to provide the Executive with benefits at least as
favorable to those enjoyed by other similarly situated executives of
the Company and its Affiliates under any of the Company's pension,
life insurance, medical, dental, health and accident, disability,
deferred compensation or savings plans, or the taking of any action by
the Company which would directly or indirectly materially reduce any
of such benefits or deprive the Executive of any material fringe
benefit enjoyed by the Executive.
provided, however, that unless the Executive provides written notification
of his intention to resign within 10 business days after the Executive has
actual knowledge of the occurrence of any such event constituting Good
Reason, the Executive shall be deemed to have consented thereto and such
event shall no longer constitute Good Reason for purposes of this
Agreement. If the Executive provides such written notice to the Company,
the Company shall have 20 business days from the date of receipt of such
notice to effect a cure of the event described therein and, upon cure
thereof by the Company to the reasonable satisfaction of the Executive,
such event shall no longer constitute Good Reason for purposes of this
Agreement.
Anything in this Agreement to the contrary notwithstanding, a
termination by the Executive for any reason during the 30-day period
immediately following the first anniversary of the occurrence of a Change
in Control shall be deemed to be a termination for Good Reason for all
purposes of this Agreement.
"PERSON" means any individual, firm, corporation, partnership or other
entity.
"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.
"TERMINATION DATE" means:
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Second Amended and Restated
Employment Agreement
Page 20 of 23
(i) in the case of a termination of the Executive's employment
by the Company for Cause, the effective date of such termination
specified in the Notice of Termination, which, if the event
constituting Cause for termination is of a type specified in clause
(i) or clause (iii) of the definition of Cause, shall be not less than
21 business days from receipt of the Notice of Termination by the
Executive;
(ii) in the case of a termination of the Executive's employment
by the Company without Cause, the date specified in a written notice
of termination to the Executive, such written notice to provide at
least 90 days' advance written notice of termination;
(iii) in the case of the Executive's resignation from
employment without Good Reason, the date specified in a written notice
of resignation from the Executive to the Company, such written notice
provide at least 90 days' advance written notice of resignation;
(iv) in the case of the Executive's resignation from employment
for Good Reason, the date specified in a written notice of resignation
from the Executive to the Company, provided, however, that no such
written notice shall be effective unless the cure period specified in
the definition of Good Reason has expired without the Company having
corrected, to the reasonable satisfaction of the Executive, the event
or events subject to cure;
(v) in the case of termination of employment due to the
Executive's death, the date of death; and
(vi) in the case of termination of employment due to the
Executive's Disability, the effective date of termination specified in
a written notice of termination from the Company to the Executive,
which effective date shall be not earlier than the last day of the 180
day period provided for in Section 4(c) above.
13. GENERAL PROVISIONS.
(a) NO OTHER SEVERANCE BENEFITS. Except as specifically set forth in
this Agreement, the Executive covenants and agrees that he shall not be entitled
to any other form of severance benefits from the Company, including, without
limitation, benefits otherwise payable under any of the Company's regular
severance policies, in the event his employment
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Second Amended and Restated
Employment Agreement
Page 21 of 23
hereunder ends for any reason and, except with respect to obligations of the
Company expressly provided for herein, the Executive unconditionally releases
the Company and its subsidiaries and affiliates, and their respective directors,
officers, employees and stockholders, or any of them, form any and all claims,
liabilities or obligations under this Agreement or under any severance or
termination arrangements of the Company or any of its subsidiaries or affiliates
for compensation or benefits in connection with his employment or the
termination thereof.
(b) NOTICES. Any notice hereunder by either party to the other
(including, without limitation, any notice of intention to arbitrate pursuant to
Section 14) shall be given in writing by personal delivery, telex, telecopy or
certified mail, return receipt requested, to the applicable address set forth
below:
(i) To the Company: Ambac Financial Group, Inc.
One State Street Plaza
New York, NY 10004
Attention: General Counsel
(ii) To the Executive: Phillip B. Lassiter
16 Sutton Place
Apartment 12A
New York, New York 10022
or to such other person or other address as either party may specify to the
other in writing.
(c) LIMITED WAIVER. The waiver by the Company or the Executive of a
violation of any of the provisions of this Agreement, whether express or
implied, shall not operate or be construed as a waiver of any subsequent
violation of any such provision.
(d) ASSIGNMENT. No right, benefit or interest hereunder shall be
subject to assignment, encumbrance, charge, pledge, hypothecation or set off by
the Executive in respect of any claim, debt, obligation or similar process. The
Company will require any successor (whether direct or indirect, by purchase,
merger, consolidation or otherwise) to all or substantially all of the business
or assets or the Company to assume expressly and to agree to perform this
Agreement in the same manner and to the same extent that the Company would be
required to perform it if no such succession had taken place.
(e) AMENDMENT. This Agreement may not be amended, modified or
canceled except by written agreement of the Executive and the Company.
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Second Amended and Restated
Employment Agreement
Page 22 of 23
(f) SEVERABILITY. If any term or provision hereof is determined to be
invalid or unenforceable in a final court or arbitration proceeding, (i) the
remaining terms and provisions hereof shall be unimpaired and (ii) the invalid
or unenforceable term or provision shall be deemed replaced by a term or
provision that is valid and enforceable and that comes closest to expressing the
intention of the invalid or unenforceable term or provision.
(g) UNSECURED PROMISE. No benefit or promise hereunder shall be
secured by any specific assets of the Company. Unless otherwise stated herein,
the Executive shall have only the rights of an unsecured general creditor of the
Company in seeking satisfaction of such benefits or promises.
(h) GOVERNING LAW. This Agreement has been made in and shall be
governed by and construed in accordance with the laws of the State of Delaware.
(i) ENTIRE AGREEMENT. This Agreement sets forth the entire agreement
and understanding of the parties hereto with respect to the matters covered
hereby.
(j) HEADINGS. The headings and captions of the Sections of this
Agreement are included solely for convenience of reference and shall not control
the meaning or interpretation of any provisions of this Agreement.
(k) COUNTERPARTS. This Agreement may be executed by the parties
hereto in counterparts, each of which shall be deemed an original, but all such
counterparts shall together constitute one and the same document.
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Second Amended and Restated
Employment Agreement
Page 23 of 23
IN WITNESS WHEREOF, the parties have executed this Agreement effective
as of the day and year first written above.
AMBAC FINANCIAL GROUP, INC.
By /s/ Richard B. Gross
---------------------------------
Name: Richard B. Gross
Title: Sen. Vice President, General
Counsel and Secretary
EXECUTIVE
/s/ Phillip B. Lassiter
------------------------------------
Phillip B. Lassiter
<PAGE>
(EXHIBIT 10.03)
AMBAC 1997 EQUITY PLAN
(AMENDED OCTOBER 28, 1997)
1. PURPOSES
The purposes of the Ambac 1997 Equity Plan (the "PLAN") are to attract,
retain and motivate key employees of the Company, to compensate them for their
contributions to the growth and profits of the Company and to encourage
ownership by them of Common Stock.
2. DEFINITIONS
For purposes of the Plan, the following terms shall be defined as follows:
"ADMINISTRATOR" means the individual or individuals to whom the Committee
delegates authority under the Plan in accordance with Section 3(d).
"AMBAC" means Ambac Financial Group, Inc., a Delaware corporation.
"AWARD" means an award made pursuant to the terms of the Plan to an Eligible
Individual in the form of Stock Options, Stock Appreciation Rights, Stock
Awards, Restricted Stock Units, Performance Units or Other Awards.
"AWARD AGREEMENT" means a written document approved in accordance with Section 3
which sets forth the terms and conditions of the Award to the Participant. An
Award Agreement may be in the form of (i) an agreement between Ambac or one of
its Subsidiaries which is executed by an officer on behalf of Ambac or such
Subsidiary and is signed by the Participant or (ii) a certificate issued by
Ambac or one of its Subsidiaries which is executed by an officer on behalf of
Ambac or such Subsidiary but does not require the signature of the Participant.
"BOARD" means the Board of Directors of the Company.
"CODE" means the Internal Revenue Code of 1986, as amended, and the applicable
rulings and regulations (including any proposed regulations) thereunder.
"COMMITTEE" means the Compensation and Organization Committee of the Board, any
successor committee thereto or any other committee appointed from time to time
by the Board to administer the Plan. The Committee shall consist of at least two
individuals and shall serve at the pleasure of the Board.
"COMMON STOCK" means the Common Stock, par value $.01 per share, of the Company.
"COMPANY" means Ambac and its Subsidiaries.
"ELIGIBLE INDIVIDUALS" means the individuals described in Section 6 who are
eligible for Awards under the Plan.
"EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended, and the
applicable rulings and regulations thereunder.
"FAIR MARKET VALUE" means, with respect to a share of Common Stock, the fair
market value thereof as of the relevant date of determination, as determined in
accordance with a valuation methodology approved by the Committee. In the
absence of any alternative valuation methodology approved by the Committee, the
Fair Market Value of a share of Common Stock shall equal the average of the
highest and the lowest quoted selling price of a share of Common Stock as
reported on the composite tape for
1
<PAGE>
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 system, on such automated system, in any such case on
the valuation date (or, if there were no sales on the valuation date, the
average of the highest and the lowest quoted selling prices as reported on said
composite tape or automated system for the most recent day during which a sale
occurred).
"INCENTIVE STOCK OPTION" means a Stock Option which is an "incentive stock
option" within the meaning of Section 422 of the Code and designated by the
Committee as an Incentive Stock Option in an Award Agreement.
"NONQUALIFIED STOCK OPTION" means a Stock Option which is not an Incentive
Stock Option.
"OTHER AWARD" means any other form of award authorized under Section 13 of
the Plan.
"PARTICIPANT" means an Eligible Individual to whom an Award has been granted
under the Plan.
"PERFORMANCE UNIT" means a performance unit granted to an Eligible
Individual pursuant to Section 12 hereof.
"PREDECESSOR PLAN" means the AMBAC Inc. 1991 Stock Incentive Plan, as
amended.
"RESTORATION OPTION" means a Stock Option that is awarded upon the exercise
of a Stock Option earlier awarded under the Plan or the Predecessor Plan (an
"UNDERLYING OPTION") for which the exercise price is paid in whole or in party
by tendering shares of Common Stock previously owned by the Participant, where
such Restoration Option (i) covers a number of shares of Common Stock no greater
than the number of previously owned shares tendered in payment of the exercise
price of the Underlying Option plus the number of shares withheld to pay taxes
arising upon such exercise, (ii) the expiration date of the Restoration Option
is no later than the expiration date of the Underlying Option and (iii) the
exercise price per share of the Restoration Option is no less than the Fair
Market Value per share of Common Stock on the date of exercise of the Underlying
Option.
"RESTRICTED STOCK UNIT" means a restricted stock unit granted to an Eligible
Individual pursuant to Section 11 hereof.
"STOCK APPRECIATION RIGHT" means a right to receive all or some portion of the
appreciation on shares of Common Stock granted to an Eligible Individual
pursuant to Section 9 hereof.
"STOCK AWARD" means a share of Common Stock granted to an Eligible Individual
for no consideration other than the provision of services or offer for sale to
an Eligible Employee at a purchase price determined by the Committee, in either
case pursuant to Section 10 hereof.
"STOCK OPTION" means an Award to purchase shares of Common Stock granted to an
Eligible Individual pursuant to Section 8 hereof, which Award may be either an
Incentive Stock Option or a Nonqualified Stock Option.
"SUBSIDIARY" means (i) a corporation or other entity with respect to which
Ambac, 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 Ambac, directly or
indirectly, has an equity or similar interest and which the Committee designates
as a Subsidiary for purposes of the Plan.
2
<PAGE>
"SUBSTITUTE AWARD" means an Award granted upon assumption of, or in
substitution for, outstanding awards previously granted by a company or other
entity in connection with a corporate transaction, such as a merger,
combination, consolidation or acquisition of property or stock.
3. ADMINISTRATION OF THE PLAN
(a) POWER AND AUTHORITY OF THE COMMITTEE. The Plan shall be administered
by the committee, which shall have full power and authority, subject to the
express provisions hereof:
(i) to select Participants from the Eligible Individuals;
(ii) to make Awards in accordance with the Plan;
(iii) to determine the number of shares of Common Stock subject to each
Award or the cash amount payable in connection with an Award;
(iv) to determine the terms and conditions of each Award, including,
without limitation, those related to vesting, forfeiture, payment and
exercisability, and the effect, if any, of a Participant's termination of
employment with the Company, and including the authority to amend the terms
and conditions of an Award after the granting thereof to a Participant in a
manner that is not, without the consent of the Participant, prejudicial to the
rights of such Participant in such Award;
(v) to specify and approve the provisions of the Award Agreements
delivered to Participants in connection with their Awards;
(vi) to construe and interpret any Award Agreement delivered under the
Plan;
(vii) to prescribe, amend and rescind rules and procedures relating to
the Plan;
(viii) to vary the terms of Awards to take account of tax, securities
law and other regulatory requirements of foreign jurisdictions;
(ix) subject to the provisions of the Plan and subject to such
additional limitations and restrictions as the Committee may impose, to
delegate to one or more officers of the Company some or all of its authority
under the Plan;
(x) to employ such legal counsel, independent auditors and consultants
as it deems desirable for the administration of the Plan and to rely upon any
opinion or computation received therefrom; and
(xi) to make all other determinations and to formulate such procedures
as may be necessary or advisable for the administration of the Plan.
(b) PLAN CONSTRUCTION AND INTERPRETATION. The Committee shall have full
power and authority, subject to the express provisions hereof, to construe and
interpret the Plan.
(c) DETERMINATIONS OF COMMITTEE FINAL AND BINDING. All determinations by the
Committee in carrying out and administering the Plan and in construing and
interpreting the Plan shall be final, binding and conclusive for all purposes
and upon all persons interested herein.
(d) DELEGATION OF AUTHORITY. The Committee may, but need not, from time to
tiMe delegate some or all of its authority under the Plan to an Administrator
consisting of one or more members of the Committee or of one or more officers of
the Company; provided, however, that the Committee may not delegate its
authority (i) to make Awards to Eligible Individuals who are officers of the
Company who are
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delegated authority by the Committee hereunder, or (ii) under Sections 3(b) and
16 of the Plan. Any delegation hereunder shall be subject to the restrictions
and limits that the Committee specifies at the time of such delegation or
thereafter. Nothing in the Plan shall be construed as obligating the Committee
to delegate authority to an Administrator, and the Committee may at any time
rescind the authority delegated to an Administrator appointed hereunder or
appoint a new Administrator. At all times, the Administrator appointed under
this Section 3(d) shall serve in such capacity at the pleasure of the Committee.
Any action undertaken by the Administrator in accordance with the Committee's
delegation of authority shall have the same force and effect as if undertaken
directly by the Committee, and any reference in the Plan to the Committee shall,
to the extent consistent with the terms and limitations of such delegation, be
deemed to include a reference to the Administrator.
(e) LIABILITY OF COMMITTEE. No member of the Committee shall be liable for
any action nor determination made in good faith, and the members of the
Committee shall be entitled to indemnification and reimbursement in the manner
provided in Ambac's Certificate of Incorporation as it may be amended from time
to time. In the performance of its responsibilities with respect to the Plan,
the Committee shall be entitled to rely upon information and advice furnished by
the Company's officers, the Company's accountants, the Company's counsel and any
other party the Committee deems necessary, and no member of the Committee shall
be liable for any action taken or not taken in reliance upon any such advice.
(f) ACTION BY THE BOARD. Anything in the Plan to the contrary
notwithstanding, any authority or responsibility which, under the terms of the
Plan, may be exercised by the Committee may alternatively be exercised by the
Board.
4. EFFECTIVE DATE AND TERM
The Plan shall become effective upon its adoption by the Board subject to its
approval by the stockholders of Ambac. Prior to such stockholder approval, the
Committee may grant Awards conditioned on stockholder approval. If such
stockholder approval is not obtained at or before the first annual meeting of
stockholders to occur after the adoption of the Plan by the Board (including any
adjournment or adjournments thereof), the Plan and any Awards made thereunder
shall terminate ab initio and be of no further force and effect. In no event
shall any Awards be made under the Plan after the seventh anniversary of the
date of stockholder approval.
5. SHARES OF COMMON STOCK SUBJECT TO THE PLAN
(a) GENERAL. Subject to adjustment as provided in Section 15(b) hereof, the
number of shares of Common Stock that may be issued pursuant to Awards under the
Plan (the "SECTION 5 LIMIT") shall not exceed, in the aggregate:
(I) 5,500,000 shares; plus
(II) the number of shares of Common Stock that remain available for
issuance under the Predecessor Plan as of the date this Plan is approved by the
stockholders of the Company (increased by any shares of Common Stock subject to
any award (or portion thereof) outstanding under the Predecessor Plan on such
date which lapses, expires or is otherwise terminated without the issuance of
such shares or is settled by the delivery of consideration other than shares).
Shares issued under this Plan may be either authorized but unissued shares,
treasury shares or any combination thereof.
(b) RULES APPLICABLE TO DETERMINING SHARES AVAILABLE FOR ISSUANCE. For
purPoses of determining the number of shares of Common Stock that remain
available for issuance, the following shares shall be added back to the Section
5 Limit and again be available for Awards:
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(x) The number of shares tendered to pay the exercise price of a Stock
Option or other Award; and
(y) The number of shares withheld from any Award to satisfy a Participant's
tax withholding obligations or, if applicable, to pay the exercise price of a
Stock Option or other Award.
In addition, any shares underlying Substitute Awards shall not be counted
against the Section 5 Limit and shall not be subject to Section 5(c) below.
(c) SPECIAL LIMITS. Anything to the contrary in Section 5(a) above
notwithstanding, but subject to Section 15(b) below, the following special
limits shall apply to shares of Common Stock available for Awards under the
Plan:
(i) The maximum number of shares that may be issued in the form of Stock
Awards, or issued upon settlement of Restricted Stock Units or Other Awards,
shall equal 1,600,000 shares, of which no more than a number of shares equal
to 10% of the Section 5 Limit shall be in the form of Other Awards, provided,
however, that any such Stock Awards, Restricted Stock Units or Other Awards
that are issued in lieu of cash compensation that otherwise would be paid to a
Participant, or in satisfaction of any other obligation owed by the Company to
a Participant, shall not be counted against such limitation; and
(ii) The maximum number of shares of Common Stock that may be subject to
Stock Options or Stock Appreciation Rights granted to any Eligible Individual
in any fiscal year of the Company shall equal 400,000 shares plus any shares
which were available under this Section 5(c) (ii) for Awards of Stock Options
or Stock Appreciation Rights to such Eligible individual in any prior fiscal
year but which were not covered by such Awards.
(d) NO FURTHER AWARDS UNDER PREDECESSOR PLAN. From and after the date this
Plan is approved by the stockholders of the Company, no further awards shall be
made under the Predecessor Plan.
6. ELIGIBLE INDIVIDUALS
Awards may be granted by the Committee to individuals ("ELIGIBLE
INDIVIDUALS") who are officers or other key employees of the Company. Members of
the Committee will not be eligible to receive Awards under the Plan. An
individual's status as an Administrator will not affect his or her eligibility
to participate in the Plan.
7. AWARDS IN GENERAL
(a) TYPES OF AWARD AND AWARD AGREEMENT. Awards under the Plan may consist of
Stock Options, Stock Appreciation Rights, Stock Awards, Restricted Stock Units,
Performance Units or Other Awards. Any Award described in Sections 8 through 13
of the Plan 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 of rights under any other
employee compensation plan of the Company, including the plan of any acquired
entity, or may be granted in satisfaction of the Company's obligations under any
such plan.
(b) TERMS SET FORTH IN AWARD AGREEMENT. The terms and provisions of an Award
shall be set forth in a written Award Agreement approved by the Committee and
delivered or made available to the Participant as soon as practicable following
the date of the award. The vesting, exercisability, payment and other
restrictions applicable to an Award (which may include, without limitation,
restrictions on transferability or provision for mandatory resale to the
Company) shall be determined by the Committee and set forth in the applicable
Award Agreement. Notwithstanding the foregoing, the Committee may
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accelerate (i) the vesting or payment of any Award, (ii) the lapse of
restrictions on any Award or (iii) the date on which any Stock Option, Stock
Appreciation Right or other Award first becomes exercisable.
(c) TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL. The Committee shall
also have full authority to determine and specify in the applicable Award
Agreement the effect, if any, that a Participant's termination of employment for
any reason will have on the vesting, exercisability, payment or lapse of
restrictions applicable to an Award. The date of a Participant's termination of
employment for any reason shall be determined in the sole discretion of the
Committee. Similarly, the Committee shall have full authority to determine the
effect, if any, of a change in control of Ambac on the vesting, exercisability,
payment or lapse of restrictions applicable to an Award, which effect may be
specified in the applicable Award Agreement or determined at a subsequent time.
(d) DIVIDENDS AND DIVIDEND EQUIVALENTS. The Committee may provide
Participants with the right to receive dividends or payments equivalent to
dividends or interest with respect to an outstanding Awards, which payments can
either be paid currently or deemed to have been reinvested in shares of Common
Stock, and can be made in Common Stock, cash or a combination thereof, as the
Committee shall determine.
8. STOCK OPTIONS
(a) TERMS OF STOCK OPTIONS GENERALLY. A Stock Option shall entitle the
Participant to whom the Stock Option was granted to purchase a specified number
of shares of Common Stock during a specified period at a price that is
determined in accordance with Section 8(b) below. Stock Options may be either
Nonqualified Stock Options or Incentive Stock Options. The Committee will fix
the vesting and exercisability conditions applicable to a Stock Option, provided
that no Stock Option shall vest sooner than one year from the date of grant
(subject to early vesting, if so provided by the Committee, upon death,
disability, termination of employment or a change in control of the Company),
but provided, further, that such minimum vesting period shall not apply to any
Restoration Option.
(b) EXERCISE PRICE. The exercise price per share of Common Stock
purchasable under a Stock Option shall be fixed by the Committee at the time of
grant or, alternatively, shall be determined by a method specified by the
Committee at the time of grant; provided, however, that the exercise price per
share shall be no less than 100% of the Fair Market Value per share on the date
of grant (or it the exercise price is not fixed on the date of grant, then on
such date as the exercise price is fixed); and provided further, that, except as
provided in Section 15(b) below, the exercise price per share of Common Stock
applicable to a Stock Option may not be adjusted or amended, including by means
of amendment, cancellation or the replacement of such Stock Option with a
subsequently awarded Stock Option. Notwithstanding the foregoing, the exercise
price per share of a Stock Option that is a Substitute Award may be less than
the Fair Market Value per share on the date of award, provided that the excess
of:
(i) the aggregate Fair Market Value (as of the date such Substitute Award
is granted) of the shares of Common Stock subject to the Substitute Award,
over
(ii) the aggregate exercise price thereof,
does not exceed the excess of:
(iii) the aggregate fair market value (as of the time immediately preceding
the transaction giving rise to the Substitute Award, such fair market value to
be determined by the Committee) of the shares of the predecessor entity that
were subject to the award assumed or substituted for by the Company, over
(iv) the aggregate exercise price of such shares.
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(c) OPTION TERM. The term of each Stock Option shall be fixed by the
Committee and shall not exceed ten years from the date of grant.
(d) METHOD OF EXERCISE. Subject to the provisions of the applicable Award
Agreement, the exercise price of a Stock Option may be paid in cash or
previously owned shares or a combination thereof and, if the applicable Award
Agreement so provides, in whole or in part through the withholding of shares
subject to the Stock Option with a value equal to the exercise price. In
accordance with the rules and procedures established by the Committee for this
purpose, the Stock Option may also be exercised through a "cashless exercise"
procedure approved by the Committee involving a broker or dealer approved by the
Committee, that affords Participants the opportunity to sell immediately some or
all of the shares underlying the exercised portion of the Stock Option in order
to generate sufficient cash to pay the Stock Option exercise price and/or to
satisfy withholding tax obligations related to the Stock Option.
9. STOCK APPRECIATION RIGHTS
(a) GENERAL. A Stock Appreciation Right shall entitle a Participant to
receive, upon satisfaction of the conditions to the payment specified in the
applicable Award Agreement, an amount 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 exercise price for
such Stock Appreciation Right specified in the applicable Award Agreement. The
exercise price per share of Common Stock covered by a Stock Appreciation Right
shall be fixed by the Committee at the time of grant or, alternatively, shall be
determined by a method specified by the Committee at the time of grant;
provided, however, that, except as provided in Section 9(b) below, the exercise
price per share shall be no less than 100% of the Fair Market Value per share on
the date of grant (or if the exercise price is not fixed on the date of grant,
then on such date as the exercise price is fixed); and provided further, that,
except as provided in Section 15(b) below, the exercise price per share of
Common Stock subject to a Stock Appreciation Right may not be adjusted or
amended, including by means of amendment, cancellation or the replacement of
such Stock Appreciation Right with a subsequently awarded Stock Appreciation
Right. Notwithstanding the foregoing, the exercise price per share of a Stock
Appreciation Right that is a Substitute Award may be less than the Fair Market
Value per share on the date of award, provided, that such exercise price is not
less than the minimum exercise price that would be permitted for an equivalent
Stock Option as determined in accordance with Section 8(b) above. At the sole
discretion of the Committee, payments to a Participant upon exercise of a Stock
Appreciation Right may be made in cash, in shares of Common Stock having an
aggregate Fair Market Value as of the date of exercise equal to such amount, or
in a combination of cash and shares having an aggregate value as of the date of
exercise equal to such amount.
(b) STOCK APPRECIATION RIGHTS IN TANDEM WITH STOCK OPTIONS. A Stock
Appreciation Right may be granted alone or in addition to other Awards, or in
tandem with a Stock Option. A Stock Appreciation Right granted in tandem with a
Stock Option may be granted either at the same time as such Stock Option or
subsequent thereto. If granted in tandem with a Stock Option, a Stock
Appreciation Right shall cover the same number of shares of Common Stock as
covered by the Stock Option (or such lesser number of shares as the Committee
may determine) and shall be exercisable only at such time or times and to the
extent the related Stock Option shall be exercisable, and shall have the same
term and exercise price as the related Stock Option (which, in the case of a
Stock Appreciation Right granted after the grant of the related Stock Option,
may be less than the Fair Market Value per share on the date of grant of the
tandem Stock Appreciation Right). Upon exercise of a Stock Appreciation Right
granted in tandem with a Stock Option, the related Stock Option shall be
canceled automatically to the extent of the number of shares covered by such
exercise; conversely, if the related Stock Option is exercised as to some or all
of the shares covered by the tandem grant, the tandem Stock Appreciation Right
shall be canceled automatically to the extent of the number of shares covered by
the Stock Option exercise.
10. STOCK AWARDS
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(a) GENERAL. A Stock Award shall consist of one or more shares of Common
Stock granted to a Participant for no consideration other than the provision of
services (or, if required by applicable law in the reasonable judgment of the
Company, for payment of the par value of such shares). Stock Awards shall be
subject to such restrictions (if any) 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
applicable Award Agreement.
(b) DISTRIBUTIONS. Any shares of Common Stock or other securities of the
Company received by a Participant to whom a Stock Award has been granted 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 Stock Award.
11. RESTRICTED STOCK UNITS
An Award of Restricted Stock Units shall consist of a grant of units, each
of which represents the right of the Participant to receive one share of Common
Stock, subject to the terms and conditions established by the Committee in
connection with the Award and set forth in the applicable Award Agreement. Upon
satisfaction of the conditions to vesting and payment specified in the
applicable Award Agreement, Restricted Stock Units will be payable, at the
discretion of the Committee, in Common Stock, in cash equal to the Fair Market
Value of the shares subject to such Restricted Stock Units, or in a combination
of Common Stock and cash. Restricted Stock Units that are granted in respect to
individual or corporate performance shall vest no sooner than one year from the
date of grant, and Restricted Stock Units that are granted in connection with
hiring or retention arrangements between the Company and a Participant shall
vest no sooner than three years from the date of grant (subject, in either case,
to early vesting, if so provided by the Committee, upon death, disability,
termination of employment or a change in control of the Company).
12. 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 applicable Award
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.
13. OTHER AWARDS
The Committee shall have the authority to specify the terms and provisions
of other forms of equity-based or equity-related Awards not described above
which the Committee determines to be consistent with the purpose of the Plan and
the interests of the Company, which Awards may provide for cash payments based
in whole or in part on the value or future value of Common Stock, for the
acquisition or future acquisition of Common Stock, or any combination thereof.
Other Awards shall also include cash payments (including the cash payment of
dividend equivalents) under the Plan which may be based on one or more criteria
determined by the Committee which are unrelated to the value of Common Stock and
which may be granted in tandem with, or independent of, other Awards under the
Plan.
14. CERTAIN RESTRICTIONS
(a) 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 shall
be further transferable only by will or the laws of descent and distribution or,
for no consideration, to
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another Permitted Transferee of the Participant. The Committee may in its
discretion permit transfers of Awards other than those contemplated by this
Section.
(b) EXERCISE. During the lifetime of the Participant, a Stock Option, Stock
Appreciation Right or similar-type Other Award 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 14(a).
15. RECAPITALIZATION OR REORGANIZATION
(a) AUTHORITY OF THE COMPANY AND STOCKHOLDERS. The existence of the Plan,
the Award Agreements and the Awards granted hereunder shall not affect or
restrict in any way the right or power of the Company or the stockholders of the
Company to make or authorize any adjustment, recapitalization, reorganization or
other change in the Company's capital structure or its business, any merger or
consolidation of the Company, 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.
(b) CHANGE IN CAPITALIZATION. Notwithstanding any provision of the Plan or
any Award Agreement, the number and kind of shares authorized for issuance under
Section 5(a) above, including the maximum number of shares available under the
special limits provided for in Section 5(c) above, may be equitably adjusted in
the sole discretion of the Committee in the event of a stock split, stock
dividend, recapitalization, reorganization, merger, consolidation, extraordinary
dividend, split-up, spin-off, combination, exchange of shares, warrants or
rights offering to purchase Common Stock at a price substantially below Fair
Market Value or other similar corporate event affecting the Common Stock in
order to preserve, but not increase, the benefits or potential benefits intended
to be made available under the Plan. In addition, upon the occurrence of any of
the foregoing events, the number of outstanding Awards and the number and kind
of shares subject to any outstanding Award and the purchase price per share, if
any, under any outstanding Award may be equitably adjusted (including by payment
of cash to a Participant) in the sole discretion of the Committee in order to
preserve the benefits or potential benefits intended to be made available to
Participants granted Awards. Such adjustments shall be made by the Committee,
whose determination as to what adjustments shall be made, and the extent
thereof, shall be final. Unless otherwise determined by the Committee, such
adjusted Awards shall be subject to the same vesting schedule and restrictions
to which the underlying Award is subject.
16. AMENDMENTS
The Board or Committee may at any time and from time to time alter, amend,
suspend or amend the Plan in whole or in part; provided, however, that any
amendment which under the requirements of any applicable law or stock exchange
rule 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 or rule; and provided further, that, except as contemplated by Section
15(b) above, the Board or Committee may not, without the approval of the
Company's stockholders, increase the maximum number of shares issuable under the
Plan or reduce the exercise price of a Stock Option or Stock Appreciation Right.
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. Notwithstanding any provision herein to the
contrary, the Board or Committee shall have broad authority to amend the Plan or
any Award under the Plan to take into account changes in applicable tax laws,
securities laws, accounting rules and other applicable state and federal laws.
17. MISCELLANEOUS
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(a) TAX WITHHOLDING. The Company 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 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
the case of an Award payable in shares of Common Stock, the Company may permit
such individual 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, pursuant to such rules as the Committee may
establish from time to time.
(b) NO RIGHT TO GRANTS OR EMPLOYMENT. No Eligible Individual or Participant
shall have any claim or right to receive grants of Awards under the Plan.
Nothing in the Plan or in any Award or Award Agreement shall confer upon any
employee of the Company any right to continued employment with the Company or
interfere in any way with the right of the Company to terminate the employment
of any of its employees at any time, with or without cause.
(c) OTHER COMPENSATION. Nothing in this Plan shall preclude or limit the
ability of the Company to pay any compensation to a Participant under the
Company's other compensation and benefit plans and programs.
(d) OTHER EMPLOYEE BENEFIT PLANS. Payments received by a Participant under
any Award made pursuant to the Plan shall not be included in, nor have any
effect on, the determination of benefits under any other employee benefit plan
or similar arrangement provided by the Company, unless otherwise specifically
provided for under the terms of such plan or arrangement or by the Committee.
(e) UNFUNDED PLAN. The Plan is intended to constitute an unfunded plan for
incentive compensation. Prior to the payment or settlement of any Award, nothing
contained herein shall give any Participant any rights that are greater than
those of a general creditor of the Company. In its sole discretion, the
Committee may authorize the creation of trusts or other arrangements to meet the
obligations created under the Plan to deliver Common Stock or payments in lieu
thereof with respect to awards hereunder.
(f) SECURITIES LAW RESTRICTIONS. The Committee may require each Eligible
Individual purchasing or acquiring shares of Common Stock pursuant to a Stock
Option or other Award under the Plan to represent to and agree with the Company
in writing that such Eligible Individual is acquiring the shares for investment
and not with a view to the distribution thereof. All certificates for shares of
Common Stock delivered under the Plan shall be subject to such stock-transfer
orders and other restrictions as the Committee may deem advisable under the
rules, regulations, and other requirements of the Securities and Exchange
Commission, any exchange upon which the Common Stock is then listed, and any
applicable federal or state securities law, and the Committee may cause a legend
or legends to be put on any such certificates to make appropriate reference to
such restrictions. No shares of Common Stock shall be issued hereunder unless
the Company shall have determined that such issuance is in compliance with, or
pursuant to an exemption from, all applicable federal and state securities laws.
(g) COMPLIANCE WITH RULE 16B-3. Notwithstanding anything contained in the
Plan or in any Award Agreement to the contrary, if the consummation of any
transaction under the Plan 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 six
months.
(h) AWARD AGREEMENT. In the event of any conflict or inconsistency between
the Plan and any Award Agreement, the Plan shall govern, and the Award Agreement
shall be interpreted to minimize or eliminate any such conflict or
inconsistency.
(i) EXPENSES. The costs and expenses of administering the Plan shall be
borne by the Company.
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(j) APPLICATION OF FUNDS. The proceeds received from the Company from the
sale of Common Stock or other securities pursuant to Awards will be used for
general corporate purposes.
(k) APPLICABLE LAW. Except as to matters of federal law, the Plan and all
actions taken thereunder shall be governed by and construed in accordance with
the laws of the State of Delaware without giving effect to conflicts of law
principles.
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(EXHIBIT 10.08)
FORM OF
AMENDED AND RESTATED MANAGEMENT RETENTION
AGREEMENT
AMENDED AND RESTATED MANAGEMENT RETENTION AGREEMENT (this
"AGREEMENT"), made as of December 30, 1994, as amended and restated as of
December 2, 1997, by and between AMBAC FINANCIAL GROUP, INC., a Delaware
corporation (the "COMPANY"), and the executive officer named on the signature
page of this Agreement (the "EXECUTIVE").
W I T N E S S E T H:
WHEREAS, the Executive is currently a valued key executive of the
Company or one of its Affiliates (as defined below); and
WHEREAS, the Compensation and Organization Committee (the "COMMITTEE")
of the Board of Directors of the Company (the "BOARD"), recognizes that in the
event of a future change in control of the Company, or any threatened change in
control, uncertainty and questions could rise among management and could result
in the departure or distraction of management personnel to the detriment of the
Company and its stockholders; and
WHEREAS, the Company considers it essential to the best interests of
its stockholders to foster 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;
NOW, THEREFORE, in consideration of the covenants and agreements
herein contained, the parties hereto agree as follows:
1. EMPLOYMENT AND DUTIES
The Company hereby agrees to employ the Executive in the capacity
indicated on the signature page of this Agreement (or such other, superior
position to which the Executive may be promoted by the Company in its
discretion), and the Executive hereby accepts such employment. During the Term,
as defined in Section 2 below, the Executive shall have such duties as may be
assigned to the Executive from time to time by the Board or the Board's designee
which are commensurate with the duties of the Executive in the capacity
indicated on the signature page of this Agreement (or such other, superior
position to which the Executive may be promoted by the Company in its
discretion). The Executive shall devote
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2
substantially all his business time, attention, skill and efforts during the
Term to the faithful performance of his duties hereunder and shall not accept
employment elsewhere during the Term.
2. TERM
The term of the Executive's employment under this Agreement (the
"TERM") shall commence on the date of any Change in Control (as defined in
Section 8(i) of this Agreement) occurring after the date hereof and shall
continue in effect through the third anniversary thereof. Anything in this
Agreement to the contrary notwithstanding, if a Change in Control occurs and if
the Executive's employment with the Company is terminated prior to the date on
which the Change in Control occurs, and if it is reasonably demonstrated by the
Executive that such termination of employment (i) was at the request of a third
party who has taken steps reasonably calculated to effect a Change in Control or
(ii) otherwise arose in connection with or anticipation of a Change in Control,
then for all purposes of this Agreement the Term shall be considered to have
commenced on the date immediately prior to the date of the Executive's
termination of employment, rather than on the date of such Change in Control.
The provisions of this Agreement shall continue in effect beyond the Term to the
extent necessary to carry out the intentions of the parties hereto.
3. COMPENSATION
During the Term the Executive shall be entitled to the following
compensation for his services to the Company:
(a) BASE SALARY. The Company shall pay, and the Executive shall
accept, a base salary (the "BASE SALARY") at a rate no less than the Executive's
base salary in effect immediately prior to the Change in Control, subject to
increase in accordance with the immediately succeeding sentence. The Base
Salary shall be reviewed at least annually by the Committee and may be
increased, but not decreased, to reflect the Executive's performance and shall
be increased to provide the Executive with such other increases as shall be
consistent with increases in base salary awarded in the ordinary course of
business to other key executives of the Company or of any Affiliate.
(b) CASH BONUS. In addition to the Base Salary, the Executive shall
be paid for each full or partial fiscal year of the Company during the Term, an
annual cash bonus (the "BONUS") pursuant to the current bonus and incentive
plans of the Company, as may be amended or supplemented by the Company during
the Term; provided, however, that such annual Bonus shall in no event be less
than 70% of the Base Salary payable to the Executive for the relevant fiscal
year. Bonuses shall be paid in cash to the Executive no later than 30 days
following the close of each fiscal year during and immediately following the
Term.
<PAGE>
3
(c) EQUITY AWARDS. Upon the occurrence of a Change in Control, the
Executive shall be fully vested in all stock options, restricted stock,
restricted stock units and any other awards theretofore awarded to him under the
Company's 1997 Equity Plan, as amended, or any successor thereto, on or after
January 1, 1998 provided, however, that if any Person (as defined in Section 8
hereof) commences a tender offer for shares of the Company's common stock, par
value $0.01 per share (the "COMMON STOCK"), which, if successfully completed,
would result in a Change in Control, then the Executive shall be fully vested in
all such stock options, restricted stock units and any other such awards, and
any such awards that by their terms are to be paid or settled by the delivery of
shares of Common Stock without the payment of any additional consideration by
the Executive shall be so paid or settled, immediately prior to the scheduled
expiration of such tender offer, and the Company shall have instituted
procedures to enable the Executive, if he so desires, to tender the shares
issued upon the exercise of such stock options or delivered in payment or
settlement of such restricted stock units or other awards into such offer.
(d) INCENTIVE, SAVINGS AND RETIREMENT PLANS. In addition to the
Base Salary and Bonuses payable pursuant to this Agreement, the Executive shall
be entitled to participate in incentive, savings and retirement plans and
programs, whether qualified or non-qualified, of the Company and its Affiliates
applicable to other key executives (including, without limitation, the following
plans of the Company and its Affiliates: the 1991 Stock Incentive Plan, the 1997
Equity Plan, the Savings Incentive Plan, the Retirement Plan, the Excess
Benefits Plan, the Supplemental Retirement Plan, and the Deferred Compensation
Plan for Outside Directors and Eligible Senior Officers, the Non-Qualified
Savings Incentive Plan or substantially equivalent successor or substitute
plans), providing an aggregate level of compensation (including target payouts,
where applicable) and benefits no less favorable than in effect prior to a
Change in Control.
(e) WELFARE BENEFIT PLANS. The Executive and/or the Executive's
family, as the case may be, shall be eligible for participation in and shall
receive all benefits under each welfare benefit plan of the Company applicable
to other key executives, including, without limitation, all medical, dental,
disability, group life, accidental death and travel accident insurance plans and
programs of the Company and its Affiliates, upon terms, and at a level of
participation, no less favorable than applicable to other similarly situated
executives of the Company and its Affiliates.
(f) EXPENSES. The Executive shall be entitled to receive prompt
reimbursement for all reasonable expenses incurred by him in the performance of
his duties for the Company which shall be paid to him in accordance with the
policies and procedures of the Company as in effect at any time thereafter with
respect to other key executives.
(g) FRINGE BENEFITS. The Executive shall be entitled to fringe
benefits no less favorable than in effect prior to a Change in Control.
<PAGE>
4
(h) OFFICE AND SUPPORT STAFF. The Executive shall be entitled to an
office or offices of a size and with furnishings and other amenities, and to
secretarial and other assistance, at least equal to those currently used by the
Executive.
(i) VACATION. The Executive shall be entitled to four weeks of paid
vacation per year, or such longer period as the Company shall institute for
senior executives, and paid holidays in accordance with the policies of the
Company as in effect at any time.
(j) APPLICATION OF SEVERANCE POLICIES AFTER THE TERM. Upon the
expiration of the Term, the Executive shall become a participant in the most
favorable severance policy applicable to similarly situated executives of the
Company and its Affiliates (other than as agreed to as part of individual
employment agreements), with all years of service with the Company and any
Affiliate counted for purposes of the calculation of such severance benefits.
4. TERMINATION OF EMPLOYMENT
(a) TERMINATION FOR CAUSE; RESIGNATION WITHOUT GOOD REASON. The
Company may terminate the Executive's employment hereunder for Cause (as defined
in Section 8(a) of this Agreement). If the Executive's employment is terminated
by the Company for Cause, or by the Executive for reasons other than Good Reason
(as defined in Section 8(b) of this Agreement) prior to the expiration of the
Term, the Company shall be obligated to make payment of any Compensation (as
defined in Section 8(h) of this Agreement) earned prior to the Date of
Termination (as defined in Section 8(d) of this Agreement) but not yet paid to
the Executive and any payment from any employee benefit plan described in
Section 3 of this Agreement which shall be paid in accordance with such plan and
the continuation of coverage under any insurance program as required under any
such benefit plan or which may be required by law. The Executive shall also be
entitled to the payment of any Bonus earned but not yet paid, including, without
limitation, any deferred Bonus, and the pro rata amount of the guaranteed
--------
minimum Bonus under Section 3(b) of this Agreement if the Date of Termination
occurs before the end of any fiscal year. Except as provided above, the Company
shall not be obligated to make any additional payments of Compensation or
benefits specified in Section 3 of this Agreement for any periods after the Date
of Termination.
(b) RESIGNATION FOR GOOD REASON; TERMINATION WITHOUT CAUSE. If the
Executive's employment is terminated by the Executive for Good Reason or by the
Company without Cause, in either case at any time prior to the expiration of the
Term, the Executive shall be entitled to the following benefits:
(i) In addition to the payment of all Base Salary and any Bonus
earned but not paid, or a pro rata portion of the guaranteed minimum Bonus
--------
under Section 3(b) of
<PAGE>
5
this Agreement if the Date of Termination occurs prior to the end of any
fiscal year, within five business days of the Termination Date the Company
shall make a lump sum payment to the Executive equal to two times the sum
of:
(x) his highest Base Salary, plus
(y) the highest Bonus percentage paid or payable to the
Executive at any time prior to his Date of Termination times his
highest Base Salary
(the sum of the amounts described in the foregoing clauses (x) and (y)
being referred to as the "REFERENCE AMOUNT"). For purposes of calculating
the Reference Amount, "BONUS" shall include cash bonus and the value on the
grant date, as determined by the Committee, of any restricted stock or
restricted stock units or other awards granted in lieu of cash, but
excluding the value of any stock options.
(ii) For purposes of calculating the Executive's benefit under the
AMBAC Inc. Retirement Plan (or any successor plan) (the "RETIREMENT PLAN"),
the Executive shall receive an additional two years of credited service.
In addition, for all purposes under the Retirement Plan, including for
purposes of benefit calculations, the Executive shall be treated as having
retired from service with the Company and its Affiliates, rather than as a
"terminated vested" employee.
(iii) Within five business days following the Termination Date, the
Company shall make a lump sum payment to the Executive equal to the amount
that the Company would have contributed for the Executive's account under
the AMBAC Inc. Savings Incentive Plan (or any successor plan) (the "SIP")
in respect of the two years following the Termination Date, based on (A)
the formula for determining employer contributions in effect on the
Termination Date and (B) the Base Salary (and, if such formula takes
account of bonus compensation, the Bonus) used for purposes of determining
the Reference Amount, and calculated without giving effect to the
limitations provided for in Sections 401(a)(17) and 415 of the Internal
Revenue Code of 1986, as amended (the "CODE"), or any successor provisions
thereto.
(iv) Within five business days following the Termination Date the
Executive shall receive a lump sum payment of his account balance as of the
Date of Termination under any nonqualified plan maintained by the Company
or any of its Affiliates to provide benefits in excess of those permitted
under the Code to be provided by the SIP. The Company shall remain
obligated to pay to the Executive or his beneficiaries any benefits to
which he or they may be entitled under any nonqualified plan maintained by
the Company or any of its Affiliates to provide benefits in excess of those
permitted under the Code to be provided by the Retirement Plan (including
without limitation benefits under the AMBAC Excess Benefit Plan and the
AMBAC Supplemental
<PAGE>
6
Retirement Plan, or any successors to such plans); such payments shall be
made in accordance with the terms of such plans, and benefits thereunder
shall take account of the two years of additional credited service provided
for in clause (ii) above.
(v) For a period of two years following the Date of Termination (the
"CONTINUATION PERIOD"), the Executive and his dependents, if any, shall
continue to participate (at no greater expense to them than was the case
for such coverage prior to his termination) in the employee benefit
arrangements described in Section 3(e) and 3(g) above, provided, however,
that the benefits described in Section 3(e) shall cease to the extent the
Executive begins coverage under plans of a subsequent employer.
(vi) At the end of the Continuation Period, the Executive and his
family shall be entitled for the remainder of his life to retiree medical
and dental benefits under the applicable plans and programs of the Company
as if he retired on the last day of the Continuation Period, with such
benefits to commence immediately at the end of the Continuation Period and
with the amount of contribution by the Executive to be no greater than that
of any other employee of the Company who had retired on the last day of the
Continuation Period (it being understood and agreed that contribution rates
may be changed, and the terms of such benefits may be modified, to the
extent permitted under the relevant plans, from those in effect on the date
hereof).
(vii) During the Continuation Period, the Company shall provide the
Executive with appropriate individual outplacement services and financial
planning at the Company's expense.
(viii) To the extent not previously vested pursuant to Section 3(c)
above, the Executive shall be fully vested in all stock options, restricted
stock, restricted stock units and any other awards theretofore awarded to
him under the Company's 1991 Stock Incentive Plan, as amended, or the
Company's 1997 Equity Plan, as amended, or any successor thereto.
(viii) The Executive shall receive all amounts due to him under any
compensatory plan or arrangement of the Company and not specifically
addressed above, in accordance with the terms of the relevant plan or
arrangement.
(c) DEATH BEFORE END OF TERM. If the Executive dies prior to the
expiration of the Term, the Company shall be under no obligation to make
additional payments of the Compensation and benefits described in Section 3 of
the Agreement to the Executive's estate after the Date of Termination except,
however, for any Compensation earned prior to the Date of Termination but not
yet paid, including, without limitation, any deferred Bonus and the pro rata
amount of the guaranteed minimum Bonus under Section 3(b) of this Agreement if
the Date of Termination occurs before the end of a fiscal year, and all benefits
<PAGE>
7
payable under the various plans described in Section 3 of this Agreement, which
shall be paid in accordance with the terms of all such applicable plans. The
Company shall also continue to provide any benefits to the Executive's survivors
as required by law.
(d) DISABILITY. In the event of the Executive's Permanent
Disability (as defined in Section 8(e) of this Agreement) prior to the
expiration of the Term, the Executive's employment shall terminate. In that
event, the Executive shall be entitled to continue to receive payment of the
Compensation and benefits described in Section 3 of the Agreement through the
end of the Term, less the amount of any payment to the Executive on account of
disability from any employer sponsored disability insurance plan. In addition,
the Executive shall receive all benefits payable under the various plans
described in Section 3 of this Agreement, which shall be paid in accordance with
the terms of all such applicable plans.
(e) RETIREMENT. The Executive may terminate his employment on
account of Retirement (as defined in Section 8(f) of this Agreement). The
Executive shall not be entitled to any further payments of Compensation or other
benefits provided under Section 3 of this Agreement after the Date of
Termination, other than any retirement benefit payments from any employer
sponsored plan, any Compensation earned prior to the date of Retirement but not
yet paid, including, without limitation, any deferred Bonus and the pro rata
amount of the guaranteed minimum Bonus under Section 3(b) of this Agreement if
the Date of Termination occurs before the end of a fiscal year, and all benefits
payable under the various plans described in Section 3 of this Agreement, which
shall be paid in accordance with the terms of all such applicable plans.
(f) NOTICE OF TERMINATION REQUIRED. No termination of employment by
the Executive or by the Company pursuant to this Section 4 shall be effective
unless the terminating party shall have delivered a Notice of Termination (as
defined in Section 8(c) of this Agreement) to the other party.
(g) NATURE OF PAYMENTS. Any amounts due under this Section 4 are in
the nature of severance payments, liquidated damages, or both, and are not in
the nature of a penalty.
5. NO OBLIGATION TO MITIGATE
Following termination of the Executive's employment, the Executive
shall be under no obligation to seek other employment or otherwise to mitigate
damages resulting from his termination of employment. In addition, there shall
be no offset against amounts due to the Executive under any provision of this
Agreement, on account of any remuneration to which the Executive becomes
entitled from any Person for whom the Executive subsequently provides services
(as an officer, director, employee, independent contractor or otherwise), other
than as provided in Section 4(b)(v) relating to continuation of benefits
coverage.
<PAGE>
8
6. CERTAIN ADDITIONAL PAYMENTS BY THE COMPANY.
(a) Anything in this Agreement to the contrary notwithstanding, in the
event it shall be determined that any payment or distribution by the Company to
or for the benefit of the Executive (whether paid or payable or distributed or
distributable pursuant to the terms of this Agreement or otherwise, but
determined without regard to any additional payments required under this Section
6) (a "PAYMENT") would be subject to the excise tax imposed by the Code or any
interest or penalties are incurred by the Executive with respect to such excise
tax (such excise tax, together with any such interest and penalties, are
hereinafter collectively referred to as the "EXCISE TAX"), then the Executive
shall be entitled to receive an additional payment (a "GROSS-UP PAYMENT") in an
amount such that after payment by the Executive of all taxes (including any
interest or penalties imposed with respect to such taxes), including, without
limitation, any income taxes (and any interest and penalties imposed with
respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive
retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon
the Payments.
(b) Subject to the provisions of Section 6(c), all determinations
required to be made under this Section 6, including whether and when a Gross-Up
Payment is required and the amount of such Gross-Up Payment and the assumptions
to be utilized in arriving at such determination, shall be made by KPMG Peat
Marwick LLP or such other certified public accounting firm as may be jointly
designated by the Executive and the Company (the "ACCOUNTING FIRM"), which shall
provide detailed supporting calculations both to the Company and the Executive
within 15 business days of the receipt of notice from the Executive that there
has been a Payment, or such earlier time as is requested by the Company. All
fees and expenses of the Accounting Firm shall be borne solely by the Company.
Any Gross-Up Payment, as determined pursuant to this Section 6, shall be paid by
the Company to the Executive within five days of the receipt of the Accounting
Firm's determination. Any determination by the Accounting Firm shall be binding
upon the Company and the Executive. As a result of the uncertainty in the
application of Section 4999 of the Code at the time of the initial determination
by the Accounting Firm hereunder, it is possible that Gross-Up Payments which
will not have been made by the Company should have been made ("UNDERPAYMENT"),
consistent with the calculations required to be made hereunder. In the event
that the Company exhausts its remedies pursuant to Section 6(c) and the
Executive thereafter is required to make a payment of any Excise Tax, the
Accounting Firm shall determine the amount of the Underpayment that has occurred
and any such Underpayment shall be promptly paid by the Company to or for the
benefit of the Executive.
(c) The Executive shall notify the Company in writing of any claim by
the Internal Revenue Service that, if successful, would require the payment by
the Company of the Gross-Up Payment. Such notification shall be given as soon
as practicable but no later than ten business days after the Executive is
informed in writing of such claim and shall apprize the
<PAGE>
9
Company of the nature of such claim and the date on which such claim is
requested to be paid. The Executive shall not pay such claim prior to the
expiration of the 30-day period following the date on which it gives such notice
to the Company (or such shorter period ending on the date that any payment of
taxes with respect to such claim is due). If the Company notifies the Executive
in writing prior to the expiration of such period that it desires to contest
such claim, the Executive shall:
(i) give the Company any information reasonably requested by the
Company relating to such claim,
(ii) take such action in connection with contesting such claim as the
Company shall reasonably request in writing from time to time, including,
without limitation, accepting legal representation with respect to such
claim by an attorney reasonably selected by the Company,
(iii) cooperate with the Company in good faith in order effectively
to contest such claim, and
(iv) permit the Company to participate in any proceedings relating to
such claim;
provided, however, that the Company shall bear and pay directly all costs and
expenses (including additional interest and penalties) incurred in connection
with such contest and shall indemnify and hold the Executive harmless, on an
after-tax basis, for any Excise Tax or income tax (including interest and
penalties with respect thereto) imposed as a result of such representation and
payment of costs and expenses. Without limitation on the foregoing provisions
of this Section 6(c), the Company shall control all proceedings taken in
connection with such contest and, at its sole option, may pursue or forgo any
and all administrative appeals, proceedings, hearings and conferences with the
taxing authority in respect of such claim and may, at its sole option, either
direct the Executive to pay the tax claimed and sue for a refund or contest the
claim in any permissible manner, and the Executive agrees to prosecute such
contest to a determination before any administrative tribunal, in a court of
initial jurisdiction and in one or more appellate courts, as the Company shall
determine; provided, however, that if the Company directs the Executive to pay
such claim and sue for a refund, the Company shall advance the amount of such
payment to the Executive, on an interest-free basis and shall indemnify and hold
the Executive harmless, on an after-tax basis, from any Excise Tax or income tax
(including interest or penalties with respect thereto) imposed with respect to
such advance or with respect to any imputed income with respect to such advance;
and further provided that any extension of the statute of limitations relating
to payment of taxes for the taxable year of the Executive with respect to which
such contested amount is claimed to be due is limited solely to such contested
amount. Furthermore, the Company's control of the contest shall be limited to
issues with respect to which a Gross-Up Payment would be payable
<PAGE>
10
hereunder and the Executive shall be entitled to settle or contest, as the case
may be, any other issue raised by the Internal Revenue Service or any other
taxing authority.
(d) If, after the receipt by the Executive of an amount advanced by
the Company pursuant to Section 6(c), the Executive becomes entitled to receive
any refund with respect to such claim, the Executive shall (subject to the
Company's complying with the requirements of Section 6(c)) promptly pay to the
Company the amount of such refund (together with any interest paid or credited
thereon after taxes applicable thereto). If, after the receipt by the Executive
of an amount advanced by the Company pursuant to Section 6(c), a determination
is made that the Executive shall not be entitled to any refund with respect to
such claim and the Company does not notify the Executive in writing of its
intent to contest such denial of refund prior to the expiration of 30 days after
such determination, then such advance shall be forgiven and shall not be
required to be repaid and the amount of such advance shall offset, to the extent
thereof, the amount of Gross-Up Payment required to be paid.
7. PROTECTION OF THE COMPANY'S INTERESTS
(a) CONFIDENTIAL INFORMATION. Except for actions taken in the course
of his employment hereunder or as required by law, at no time shall the
Executive divulge, furnish or make accessible to any person any information of a
confidential or proprietary nature obtained by him while in the employ of the
Company. Upon termination of his employment with the Company, the Executive
shall return to the Company all such information which exists in written or
other physical form and all copies thereof in his possession or under his
control.
(b) REMEDIES. The Executive acknowledges that a breach of any of the
covenants contained in this Section 7 may result in material irreparable injury
to the Company or its Affiliates for which there is no adequate remedy at law,
that it will not be possible to measure damages for such injuries precisely and
that, in the event of such breach or threat thereof, the Company shall be
entitled, in addition to any other rights or remedies it may have, to obtain a
temporary restraining order and/or a preliminary or permanent injunction
enjoining or restraining the Executive from engaging in activities prohibited by
this Section 7. In no event, however, shall an asserted violation of the
provisions of this Section 7 constitute a basis for deferring or withholding any
amounts otherwise payable to the Executive under this Agreement, unless the
Company shall have first obtained a final decision, in an arbitration conducted
in accordance with Section 17 of this Agreement, finding that the Executive has
materially breached the provisions of this Section 7.
8. DEFINITIONS
As used in this Agreement, the following terms shall have the
following
<PAGE>
11
meanings:
(a) CAUSE. Each of the following shall constitute "CAUSE":
(i) the willful commission by the Executive of acts that are
dishonest and demonstrably and materially injurious to the Company or any
of its Affiliates, monetarily or otherwise;
(ii) the conviction of the Executive for a felonious act resulting
in material harm to the financial condition or business reputation of the
Company or any of its Affiliates; or
(iii) a material breach of any of the covenants set forth in
Section 7 of this Agreement.
Notwithstanding the foregoing, the Executive shall not be deemed to have been
terminated for Cause unless there shall have been delivered to him, together
with a Notice of Termination, a copy of a resolution duly adopted by the
affirmative vote of not less than three-fourths (3/4ths) of the entire
membership of the Board at a meeting of the Board called and held for such
purpose (after reasonable notice to the Executive and an opportunity for the
Executive, together with his counsel, to be heard before the Board), finding
that in the good faith opinion of the Board the Executive was guilty of conduct
set forth above in clause (i), (ii) or (iii) above and specifying the
particulars thereof in detail.
(b) GOOD REASON. For purposes of this Agreement, "GOOD REASON"
shall mean, without the Executive's express written consent, any of the
following:
(i) a substantial adverse alteration in the nature or status of the
Executive's duties or responsibilities or in the Executive's title;
(ii) the failure of the Company to pay when due the Executive any
Compensation or provide other benefits as specified in this Agreement or a
reduction by the Company in the Executive's Compensation or benefits or a
failure by the Company to increase the Executive's Compensation as required
in Section 3 of this Agreement;
(iii) the relocation of the office of the Executive to a location
more than 25 miles from the location where the Executive is employed
immediately prior to the Change in Control;
(iv) the failure by the Company to continue in effect any
compensation plan in which the Executive participates, including but not
limited to all plans described in
<PAGE>
12
Section 3 of this Agreement, or any substitute plans adopted after the date
hereof, unless an equitable arrangement (embodied in an ongoing substitute
or alternative plan) has been made with respect to such plan, or the
failure by the Company to continue the Executive's participation therein on
at least as favorable a basis as that enjoyed by other similarly situated
executives of the Company and its Affiliates;
(v) the failure by the Company to continue to provide the Executive
with benefits at least as favorable to those enjoyed by other similarly
situated executives of the Company and its Affiliates under any of the
Company's pension, life insurance, medical, dental, health and accident,
disability, deferred compensation or savings plans, or the taking of any
action by the Company which would directly or indirectly materially reduce
any of such benefits or deprive the Executive of any material fringe
benefit enjoyed by the Executive; or
(vi) the failure to obtain a satisfactory agreement from any
successor of the Company to assume and agree to perform this Agreement, as
contemplated in Section 9 hereof or, if the business of the Company for
which the Executive's services are principally performed is sold, the
purchaser of such business shall fail to agree to provide the Executive
with the same or a comparable position, duties, salary and benefits as
provided to the Executive by the Company hereunder.
Anything in this Agreement to the contrary notwithstanding, a termination by the
Executive for any reason during the 30-day period immediately following the
first anniversary of the Effective Date shall be deemed to be a termination for
Good Reason for all purposes of this Agreement.
(c) NOTICE OF TERMINATION. For purposes of this Agreement, a
"NOTICE OF TERMINATION" shall mean a written notice which shall indicate the
specific termination provision in this Agreement relied upon and, in the case of
a termination of the Executive's employment by the Company for Cause or by the
Executive for Good Reason, shall set forth in reasonable detail the facts and
circumstances claimed to provide a basis for termination of the Executive's
employment under the provision so indicated.
(d) DATE OF TERMINATION. "DATE OF TERMINATION" shall mean:
(i) in the case of Retirement or death, the date of such event;
(ii) if the Executive's employment is terminated for Permanent
Disability, thirty (30) days after a Notice of Termination is given
(provided that the Executive shall not have returned to the full-time
performance of the Executive's duties during such thirty (30) day period);
and
<PAGE>
13
(iii) if the Executive's employment is terminated for any other
reason, the date specified in the Notice of Termination (which, in the case
of a termination by the Company (whether with or without Cause) shall not
be less than thirty (30) days, and in the case of a resignation by the
Executive (whether with or without Good Reason) shall not be less than
thirty (30) nor more than sixty (60) days, from the date such Notice of
Termination is given).
(e) PERMANENT DISABILITY. "PERMANENT DISABILITY" shall mean a
disability within the meaning of the long-term disability plan of the Company
which covers the Executive immediately prior to the Change in Control.
(f) RETIREMENT. "RETIREMENT" shall mean the voluntary termination
of the Executive's employment by the Executive in accordance with the Retirement
Plan or any other plan or the retirement policy of the Company.
(g) AFFILIATE. The term "AFFILIATE" includes any company or other
entity or person controlling, controlled by or under common control with the
Company.
(h) COMPENSATION. The term "COMPENSATION" shall mean all amounts paid
or payable to the Executive pursuant to Sections 3(a), 3(b) and 3(c) of this
Agreement.
(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 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,
<PAGE>
14
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; or
. (iii) approval by the stockholders of the Company of (A) a merger or
consolidation of the Company with any other corporation, (B) the issuance
of voting securities of the Company in connection with a merger or
consolidation of the Company (or any Subsidiary) pursuant to applicable
stock exchange requirements, or (C) sale or other disposition of all or
substantially all of the assets of the Company or the acquisition of assets
of another corporation (each, a "BUSINESS COMBINATION"), unless, in each
case, immediately following such Business Combination, all or substantially
all of the individuals and entities who were the beneficial owners of the
Common Stock outstanding immediately prior to such Business Combination
beneficially own, directly or indirectly, more than 70% of the then
outstanding shares of common stock and 70% of the combined voting power of
the then outstanding voting securities entitled to vote generally in the
election of directors, as the case may be, of the corporation resulting
from such Business Combination (including, without limitation, a
corporation which as a result of such transaction owns the Company or all
or substantially all of the Company's assets either directly or through one
or more subsidiaries) in substantially the same proportions as their
ownership, immediately prior to such Business Combination, of the Common
Stock.
<PAGE>
15
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.
9. SUCCESSORS; BINDING AGREEMENT
(a) The Company will require any successor (whether direct or
indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business and/or assets of the Company to expressly
assume and agree to perform this Agreement in the same manner and to the same
extent that the Company would be required to perform it if no such succession
had taken place. Failure of the Company to obtain such assumption and agreement
prior to the effectiveness of any such succession shall be a breach of this
Agreement and shall entitle the Executive to compensation from the Company in
the same amount and on the same terms as the Executive would be entitled
hereunder if the Executive had terminated his employment for Good Reason, except
that for purposes of implementing the foregoing, the date on which any such
succession becomes effective shall be deemed the Date of Termination.
(b) This Agreement shall inure to the benefit of and be enforceable
by the Executive's personal or legal representatives, executors, administrators,
successors, heirs, distributees, devisees and legatees. If the Executive should
die while any amount would still be payable hereunder if the Executive had
continued to live, all such amounts, unless otherwise provided herein, shall be
paid in accordance with the terms of this Agreement to the Executive's devisee,
legatee or other designee or, if there is no such designee, to the Executive's
estate.
10. INDEMNIFICATION
The Company will indemnify the Executive to the fullest extent
permitted (including payment of expenses in advance of final disposition of a
proceeding) by the laws of the State of Delaware, as in effect at the time of
the subject act or omission, or by the Certificate of Incorporation and By-Laws
of the Company, as in effect at such time or on the date of this Agreement,
whichever affords or afforded greatest protection to the Executive, and the
Executive shall be entitled to the protection of any insurance policies the
Company may elect to maintain generally for the benefit of its directors and
officers (and to the extent the Company maintains such an insurance policy or
policies, the Executive shall be covered by such policy or policies, in
accordance with its or their terms, to the maximum extent of the coverage
provided for any Company officer or director), against all costs, charges and
<PAGE>
16
expenses whatsoever incurred or sustained by him or his legal representatives at
the time such costs, charges and expenses are incurred or sustained, in
connection with any action, suit or proceeding to which he may be made a party
by reason of his being or having been a director, officer or employee of the
Company or any subsidiary thereof, or his serving or having served any other
enterprise as a director, officer or employee at the request of the Company.
11. NOTICES
Any notice hereunder by either party to the other shall be given in
writing by personal delivery, telex, telecopy or certified mail, return receipt
requested, to the address first set forth below in the case of the Company, and
to the address set forth on the signature page hereof in the case of the
Executive (or, in either case, to such other address as may from time to time be
designated by notice by any party hereto for such purpose):
Ambac Financial Group, Inc.
One State Street Plaza
New York, New York 10004
Attn: Chief Executive Officer
Notice shall be deemed given, if by personal delivery, on the date of such
delivery or, if by telex or telecopy, on the business day following receipt of
answer back or telecopy confirmation or, if by certified mail, on the date shown
on the applicable return receipt.
12. AMENDMENT AND WAIVER
No provision of this Agreement may be amended, modified, waived or
discharged unless such amendment, modification, waiver or discharge is agreed to
in writing and signed by the Executive and such officer as may be specifically
designated by the Board. No waiver by either party hereto at any time of any
breach by the other party hereto of, or compliance with, any condition or
provision of this Agreement to be performed by such other party shall be deemed
a waiver of similar or dissimilar provisions or conditions at the same or at any
prior or subsequent time.
13. MERGER OF PRIOR NEGOTIATIONS
(a) This Agreement sets forth all of the promises, agreements,
conditions and understandings between the parties hereto respecting the subject
matter hereof and supersedes all prior negotiations, conversations, discussions,
correspondence, memoranda and agreements between the parties concerning such
subject matter.
(b) The Executive and the Company acknowledge that, except as may
otherwise be provided under any other written agreement between the Executive
and the
<PAGE>
17
Company, the employment of the Executive by the Company is "at will" and that,
subject to the provisions of Section 2 above, if the Executive's employment is
terminated by either the Executive or the Company at any time prior to the
beginning of the Term, the Executive shall have no further rights under this
Agreement. From and after the commencement of the Term, this Agreement shall
supersede any other agreement between the parties with respect to the subject
matter hereof.
14. PARTIAL INVALIDITY
If the final determination of a court of competent jurisdiction or
arbitrator declares, after the expiration of the time within which judicial
review (if permitted) of such determination may be perfected, that any term or
provision hereof is invalid or unenforceable, (a) the remaining term and
provisions hereof shall be unimpaired and (b) the invalid or unenforceable term
or provision shall be deemed replaced by a term or provision that is valid and
enforceable and that comes closest to expressing the intention of the invalid or
unenforceable term or provision.
<PAGE>
18
15. GOVERNING LAW
This Agreement is to be governed by and interpreted in accordance with
the laws of the State of New York.
16. COUNTERPARTS
This Agreement may be executed in two or more counterparts, each of
which shall be deemed to be an original but all of which together will
constitute one and the same instrument.
17. ARBITRATION; LEGAL FEES
(a) Any dispute or controversy arising under or in connection with
this Agreement shall be settled exclusively by arbitration in New York, New York
in accordance with the rules of the American Arbitration Association then in
effect. Judgment may be entered on the arbitrator's award in any court having
jurisdiction; provided, however, that the Executive shall be entitled to seek
specific performance of the Executive's right to be paid until the Date of
Termination during the pendency of any dispute or controversy arising under or
in connection with this Agreement.
(b) The Company shall promptly reimburse the Executive for all legal
fees and expenses incurred by the Executive in connection any claim to enforce
his rights under this Agreement, except for any claim which shall have been
determined, in an arbitration conducted in accordance with subsection (a) above,
to have been brought by the Executive in bad faith.
(c) In addition to the reimbursement provided for in subsection (b)
above, the Company shall reimburse the Executive for up to $15,000 in legal,
accounting and financial expenses incurred after a Change in Control in
connection with this Agreement (whether or not the Executive's employment is
terminated), including without limitation in connection with financial planning
and the investigation of the Executive's rights hereunder.
<PAGE>
19
IN WITNESS WHEREOF, the parties hereto, having entered into this
Agreement as of December 30, 1994, have executed this Amended and Restated
Management Retention Agreement as of December 2, 1997.
AMBAC FINANCIAL GROUP, INC.
By:
---------------------------------------
Phillip B. Lassiter
Chairman, President and Chief Executive
Officer
EXECUTIVE
------------------------------------------
Name:
Title:
Address:
<PAGE>
(EXHIBIT 10.10)
AMENDMENT NUMBER 1 TO THE
AMBAC INC. NONQUALIFIED SAVINGS INCENTIVE PLAN
WHEREAS, Section 12 of the AMBAC Inc. Nonqualified Savings Incentive
Plan (the "PLAN") provides that the Board of Directors (the "BOARD") of AMBAC
Inc. (the "COMPANY") may amend the Plan; and
WHEREAS, the Board has approved an amendment to the Plan in the manner
set forth below;
NOW, THEREFORE, effective as of April 30, 1997, the Plan is hereby
amended as follows:
1. Section 2 of the Plan is hereby amended to add after the
definition of "ERISA" the following:
""Excluded Individual" means (i) any individual who is designated
by the Company at the time of hire as not eligible to participate in
the Plan or (ii) any individual who is treated or designated by the
Company as an independent contractor, leased employee or consultant
(regardless of whether such treatment or designation is subsequently
upheld by a court, judicial or arbitral authority or any other
governmental agency). Excluded Individuals are not eligible to
participate in or receive benefits under the Plan."
2. The definition of "Participant" in Section 2 of the Plan is
hereby deleted and replaced by the following:
""Participant" means an individual, other than an Excluded
Individual, who has satisfied the qualification requirements of
Section 3(a)."
3. The second paragraph of Section 3 is hereby amended by adding at
the end thereof the following:
"Furthermore, no Excluded Individual may qualify as a
Participant."
4. Section 14(a) is hereby deleted and replaced by the following:
"(a) The Plan shall be administered and operated by the
Committee, which shall be responsible for the interpretation of the
Plan and the establishment of the rules and regulations governing the
administration thereof. The Committee shall have complete authority,
in its sole and absolute discretion, to construe the terms of the Plan
(and any related or underlying documents or policies), and to
determine the eligibility for, and amount of benefits due under, the
Plan to Participants. All such interpretations and determinations of
the Committee shall be final and binding upon all parties and persons
affected thereby."
<PAGE>
5. Except as otherwise amended above, the Plan shall remain in full
force and effect.
AMBAC Inc.
By: /s/ Janice Reals Ellig
-------------------------
Title: Senior Vice President
<PAGE>
(EXHIBIT 10.12)
AMENDMENT NUMBER 1 TO THE
AMBAC INC. EXCESS BENEFITS PENSION PLAN
WHEREAS, Section 12.1 of the AMBAC Inc. Excess Benefits Pension Plan
(the "PLAN") provides that the Board of Directors (the "BOARD") of AMBAC Inc.
(the "COMPANY") may amend the Plan; and
WHEREAS, the Board has approved an amendment to the Plan in the manner
set forth below;
NOW, THEREFORE, effective as of April 30, 1997, the Plan is hereby
amended as follows:
1. The text of Section 3.1 of the Plan is hereby deleted and is
replaced by the following:
"Eligibility. Any Employee who is not an Excluded Individual and
-----------
who is a participant in the Pension Plan and whose retirement benefits
under the Pension Plan are limited by the benefit limitation set forth
in Code Section 415 shall be eligible to participate in this Excess
Plan. "Excluded Individual" shall mean (i) any Employee who is
-------- ----------
designated by the Company at the time of hire as not eligible to
participate in the Excess Plan, (ii) any employee of AMBAC Connect
Inc., a Delaware corporation, or its predecessors, (iii) any employee
of Cadre Financial Services, Inc., a Delaware corporation, or its
predecessors, (iv) any employee of AMBAC Securities Inc., a Delaware
corporation, or its predecessors, or (v) any individual who is treated
or designated by the Company as an independent contractor, leased
employee or consultant (regardless of whether such treatment or
designation is subsequently upheld by a court, judicial or arbitral
authority or any other governmental agency). Excluded Individuals are
not eligible to participate in or receive benefits under the Excess
Plan."
2. The text of Section 7.2 of the Plan is hereby deleted and is
replaced by the following:
"Interpretation of the Excess Plan; Finality of Determination.
------------------------------------------------------------
The Plan Administrator has complete authority, in its sole and
absolute discretion, to construe the terms of the Excess Plan (and any
related or underlying documents or policies), and to determine the
eligibility for, and amount of benefits due under, the Excess Plan to
Participants. All such interpretations and determinations of the Plan
Administrator shall be final and binding upon all parties and persons
affected thereby."
3. Except as otherwise amended above, the Plan shall remain in full
force and effect.
AMBAC Inc.
By: /s/ Janice Reals Ellig
-------------------------
Title: Senior Vice President
<PAGE>
(EXHIBIT 10.18)
AMENDMENT NUMBER 1 TO THE
AMBAC INC. SUPPLEMENTAL PENSION PLAN
WHEREAS, Section 12.1 of the AMBAC Inc. Supplemental Pension Plan (the
"PLAN") provides that the Board of Directors (the "BOARD") of AMBAC Inc. (the
"COMPANY") may amend the Plan; and
WHEREAS, the Board has approved an amendment to the Plan in the manner
set forth below;
NOW, THEREFORE, effective as of April 30, 1997, the Plan is hereby
amended as follows:
1. The text of Section 3.1 of the Plan is hereby deleted and is
replaced by the following:
"Eligibility. Any Employee who is not an Excluded Individual and
-----------
who is a participant in the Pension Plan and whose retirement
benefits under the Pension Plan are limited by the benefit limitation
set forth in Code Section 401(a)(17) shall be eligible to participate
in this Supplemental Plan. "Excluded Individual" shall mean (i) any
-------- ----------
Employee who is designated by the Company at the time of hire as not
eligible to participate in the Supplemental Plan, (ii) any employee of
AMBAC Connect Inc., a Delaware corporation, or its predecessors, (iii)
any employee of Cadre Financial Services, Inc., a Delaware
corporation, or its predecessors, (iv) any employee of AMBAC
Securities Inc., a Delaware corporation, or its predecessors, or (v)
any individual who is treated or designated by the Company as an
independent contractor, leased employee or consultant (regardless of
whether such treatment or designation is subsequently upheld by a
court, judicial or arbitral authority or any other governmental
agency). Excluded Individuals are not eligible to participate in or
receive benefits under the Supplemental Plan."
2. The text of Section 7.2 of the Plan is hereby deleted and is
replaced by the following:
"Interpretation of the Supplemental Plan; Finality of
----------------------------------------------------
Determination. The Plan Administrator has complete authority, in its
-------------
sole and absolute discretion, to construe the terms of the
Supplemental Plan (and any related or underlying documents or
policies), and to determine the eligibility for, and amount of
benefits due under, the Supplemental Plan to Participants. All such
interpretations and determinations of the Plan Administrator shall be
final and binding upon all parties and persons affected thereby."
3. Except as otherwise amended above, the Plan shall remain in full
force and effect.
AMBAC Inc.
By: /s/ Janice Reals Ellig
-------------------------
Title: Senior Vice President
<PAGE>
(EXHIBIT 10.20)
August 1, 1997
Ambac Assurance Corporation
One State Street Plaza
New York, NY 10004
Attention: Mr. Bill Mitchell
Dear Sirs:
Reference is made to the Lease between South Ferry Building Company, Landlord,
and Ambac Assurance Corporation (formerly known as AMBAC Indemnity Corporation),
Tenant, dated January 1, 1992 (as amended from time to time, the "Lease").
Capitalized terms not defined herein shall have their respective meanings as set
forth in the Lease.
Landlord and Tenant hereby agree that the Lease be amended as follows:
1. The "Expiration Date" of the Lease as defined in Section 1.03 of the Lease
is hereby changed to September 30, 2019 for the entire Premises (i.e., the
existing premises and the additional premises added pursuant to this
Amendment).
2. Landlord hereby leases to Tenant, and Tenant hereby hires from Landlord and
adds to the Premises under the Lease, the entire nineteenth (19/th/) floor,
substantially as shown cross-hatched on Exhibit A annexed hereto (the
"19/th/ Floor Space") for the period commencing on May 1, 1997 and ending on
the Expiration Date (or sooner termination of the Lease), pursuant to the
terms, covenants, conditions and provisions of the Lease, subject to the
following:
(a) As of the date hereof, with respect to the 19/th/ Floor Space:
(i) "Tenant's Proportionate Share" under Section 3.02(c) of the
Lease shall be increased by 3.4058%;
(ii) The "Operating Payment" multiplier under clause (ii) of the
first sentence of the second paragraph of Section 3.01(c) of the
Lease shall be increased by 24,254;
(iii) For purposes of calculating Tenant's Operating Payments
allocable to the 19/th/ Floor Space, the Base Wage Rate shall be
the Wage Rate in effect on January 1, 1997; and
<PAGE>
Ambac Assurance Corporation
August 1, 1997
page 2
(iv) For purposes of calculating Tenant's Tax Payments allocable to
the 19/th/ Floor Space, the Basic Tax shall be the Taxes for the
real estate tax fiscal year commencing July 1, 1997 and ending
June 30, 1998, as finally determined.
(v) Nothing contained in this paragraph 2(a) shall affect Tenant's
Operating Payments or Tenant's Tax Payments for the existing
Premises other than the 19/th/ Floor Space.
(b) Landlord shall perform (i) demolition of all portions of the 19/th/
Floor Space other than the core bathrooms and other core areas on the
floor and cart away all debris caused thereby, (ii) asbestos removal
in compliance with all laws and requirements of any public authority
having jurisdiction with respect to the same as is required for the
issuance of an ACP-5 Certificate for the 19/th/ floor of the Building
and (iii) fireproof the 19/th/ floor of the Building as required by
laws or requirements of public authorities (all of such work to
constitute, the "Landlord's 19/th/ Floor Work"). Such work shall be
completed on or prior to September 15, 1997 (the "Work Completion
Date"). If Landlord's 19/th/ Floor Work is not substantially complete
on or before the Work Completion Date, then Landlord and Tenant agree
that the failure to substantially complete Landlord's 19/th/ Floor Work
on or before the Work Completion Date shall in no way affect the
validity of this Agreement or the inclusion of the 19/th/ Floor Space
in the Premises or the obligations of the Landlord or Tenant hereunder;
provided, however, in the event Landlord shall fail to substantially
complete Landlord's 19/th/ Floor Work on or before the Work Completion
Date, then for each one day after the Work Completion Date that
Landlord's 19/th/ Floor Work is not substantially complete, Tenant
shall receive a credit equal to $1927.03 per day which credit shall be
applied to Fixed Rent commencing on April 1, 1999, provided that no
more than $57,810.90 of such credit shall be applied against the Fixed
Rent in any month, and any excess shall be carried over to the
following month. Tenant has examined the 19/th/ Floor Space and, with
the exception of the Landlord's 19/th/ Floor Work, agrees to take the
same "as is" and Landlord shall not be obligated to perform any other
work or incur any other expense to prepare the 19/th/ Floor Space for
Tenant's use and the provisions of Landlord's Work in Article 38 of the
Lease shall not apply to the 19/th/ Floor Space.
(c) To the extent required by applicable law, Landlord shall, in
conjunction with the Tenant's initial buildout of its space, perform
any work required to bring the core areas of the 19/th/ floor of the
Building in compliance with the American with Disabilities Act of 1990,
as amended to date.
<PAGE>
Ambac Assurance Corporation
August 1, 1997
page 3
(d) Landlord shall deliver to Tenant an ACP-5 Certificate applicable to the
area in which Landlord shall perform asbestos removal pursuant to
paragraph 2(b) herein. Landlord shall deliver to Tenant such ACP-5
Certificate promptly after Tenant delivers to Landlord construction
plans for the 19/th/ Floor Space which are sufficient to obtain such
ACP-5 Certificate.
(e) The provisions of Article 14 of the Lease which are applicable to
Tenant's use and consumption of electricity in the 15/th/, 16/th/ and
17/th/ floors of the Building shall apply to Tenant's use and
consumption of electricity in the 19/th/ Floor Space; provided (i) the
$2.80 per rentable square foot "interim rate" described in Section
14.01 of the Lease shall commence on the date that Tenant commences its
buildout of the 19/th/ Floor Space and (ii) Landlord shall install the
meters described in Section 14.01 of the Lease with respect to the
19/th/ Floor Space within six (6) months after the completion of
Landlord's 19/th/ Floor Work and in the event that Landlord fails to
install such meters within such six (6) month period then the remedies
available to Tenant under Section 37.03 of the Lease with respect to
the installation of meters in the 18/th/ floor of the Building shall be
available to Tenant with respect to the installation of meters in the
19/th/ Floor Space.
3. Sections 1.04(a) of the Lease is hereby deleted in its entirety and the
following is inserted in its place:
"(a) fixed rent (herein called "Fixed Rent") at the following rates during
the following periods:
(i) For the period commencing on the Commencement Date and ending
March 14, 1994, Zero and 00/100 ($0.00) DOLLARS per annum;
(ii) For the period commencing March 15, 1994 (hereinafter called the
"Rent Commencement Date") and ending June 30, 1995, ONE MILLION
NINE HUNDRED SIXTY-FOUR THOUSAND FIVE HUNDRED SEVENTY-FOUR and
00/100 ($1,964,574.00) DOLLARS per annum;
(iii) For the period commencing on the July 1, 1995 (hereinafter called
the "18/th/ Floor Rent Commencement Date") and ending December
31, 1995, TWO MILLION SIX HUNDRED NINETEEN THOUSAND FOUR HUNDRED
THIRTY-TWO and 00/100 ($2,619,432.00) DOLLARS per annum;
<PAGE>
Ambac Assurance Corporation
August 1, 1997
page 4
(iv) For the period commencing January 1, 1996 and ending December
31, 1996, TWO MILLION SEVEN HUNDRED SIXTY-FOUR THOUSAND NINE
HUNDRED FIFTY-SIX and 00/100 ($2,764,956.00) DOLLARS per annum;
(v) For the period commencing January 1, 1997 and ending December
31, 1997, TWO MILLION EIGHT HUNDRED THIRTEEN THOUSAND FOUR
HUNDRED SIXTY-FOUR and 00/100 ($2,813,464.00) DOLLARS per
annum;
(vi) For the period commencing January 1, 1998 and ending December
31, 1998, THREE MILLION NINETY-NINE THOUSAND SIX HUNDRED SIXTY-
ONE and 20/100 ($3,099,661.20) DOLLARS per annum;
(vii) For the period commencing January 1, 1999 and ending March 31,
1999, THREE MILLION THREE HUNDRED NINETY THOUSAND SEVEN HUNDRED
NINE and 20/100 ($3,390,709.20) DOLLARS per annum;
(viii) For the period commencing April 1, 1999 and ending December 31,
2001, FOUR MILLION TWO HUNDRED THIRTY-EIGHT THOUSAND THREE
HUNDRED EIGHTY-SIX and 50/100 ($4,238,386.50) DOLLARS per
annum;
(ix) For period commencing January 1, 2002 and ending December 31,
2008, FOUR MILLION THREE HUNDRED FIFTY-NINE THOUSAND SIX
HUNDRED FIFTY-SIX DOLLARS and 50/100 ($4,359,656.50) DOLLARS
per annum;
(x) For the period commencing January 1, 2009 and ending on
December 31, 2009, FOUR MILLION FIVE HUNDRED FORTY-ONE THOUSAND
FIVE HUNDRED SIXTY-ONE DOLLARS and 50/100 ($4,541,561.50)
DOLLARS per annum;
(xi) For the period commencing January 1, 2010 and ending on
September 30, 2014, FOUR MILLION NINE HUNDRED SIXTY-SIX
THOUSAND SIX and 50/100 ($4,966,006.50) DOLLARS per annum;
(xii) For the period commencing on October 1, 2014 and ending on the
Expiration Date, FIVE MILLION THREE HUNDRED NINETY THOUSAND
FOUR HUNDRED FIFTY-ONE and 50/100 ($5,390,451.50) DOLLARS per
annum.
<PAGE>
Ambac Assurance Corporation
August 1, 1997
page 5
Such Fixed Rent shall be payable commencing on the Rent Commencement Date
and thereafter in equal monthly installments in advance on the first day of
each and every calendar month during the term of the Lease, and"
4. Article 41 of the Lease is hereby deleted in its entirety.
5. (a) As of July 31, 1997 and thereafter throughout the term of the Lease,
Landlord shall furnish, in addition to the 100 tons of condenser water
to be provided pursuant to Article 15 of the Lease, 40 tons of
additional condenser water from the Building tower for Tenant's use,
and Tenant shall pay, as additional rent, at the same time together
with the payments of the monthly rent under the Lease, the amounts set
forth in this paragraph (hereinafter referred to as the "Additional
Condenser Water Charges") for such 40 tons. The Additional Condenser
Water Charges are twenty-five cents ($0.25) per ton per hour of the
maximum permitted use (whether or not Tenant shall use such maximum)
per year, which rate shall be increased on each anniversary of the July
31, 1997 to an amount equal to 105% of the Additional Condenser Water
Charges payable during the immediately preceding year (without regard
to any abatement or setoff which may have been in effect). Tenant shall
obtain and maintain, at Tenant's sole cost and expense, all permits
necessary for the operation of any air conditioning units installed in
the Premises, other than those relating to the supply of condenser
water by Landlord.
(b) As of the date hereof, Tenant shall be entitled to an additional 6
Blocs (as such term is defined in Section 15.04(a) of the Lease) during
each calendar year to occur during the term of the Lease (prorated with
respect to any partial calendar year to occur during the term of the
Lease).
6. (a) For the period (the "Additional Basement Term") from April 29, 1997
(the "Basement Effective Date") until October 31, 1997 (the "Basement
Termination Date") Tenant shall have the right to use and occupy the
portion of the basement area of the Building known as Subconcourse
level no. 2 substantially as shown hatched on the floor plan annexed
hereto as Exhibit B (hereinafter referred to as the "Additional
Basement Space"); accordingly, effective as of the Basement Effective
Date throughout the Additional Basement Term the Basement Space (as
such term is used in the Lease) shall include the Additional Basement
Space, and except as hereinafter expressly otherwise provided in this
Amendment, all of the terms, covenants, conditions and provisions of
Article 42 of the Lease shall be applicable to the Additional Basement
Space from and after the Basement Effective Date, and all references in
the Lease to the Basement Space shall be deemed to include the
Additional Basement Space.
<PAGE>
Ambac Assurance Corporation
August 1, 1997
page 6
(b) In the event Landlord's 19/th/ Floor Work is not substantially complete
on or prior to the Work Completion Date then for each one day after the
Work Completion Date that Landlord's 19/th/ Floor Work is not
substantially complete, the Basement Termination Date as defined herein
shall occur one calendar day later.
(c) Effective as of the Basement Effective Date, the Fixed Rent payable
pursuant to Section 42.01 of the Lease shall be increased (in addition
to the amounts set forth in Section 42.01 of the Lease) with respect to
the Additional Basement Space as follows:
For the period commencing on the Basement Effective Date and
ending on the Basement Termination Date, at the rate of TWENTY
THOUSAND FOUR HUNDRED THIRTY and 00/100 ($20,430.00) DOLLARS per
annum ($1,702.50 per month).
(d) Tenant agrees that it shall vacate the Additional Basement Space no
later than the Basement Termination Date. In addition, all other terms
of the Lease relating to the termination of the Basement Space Term
shall apply to the termination of the Additional Basement Term with
respect to the Additional Basement Space.
(e) The Basement Space Term with respect to the existing Basement Space
without regard to the Additional Basement Space) shall
terminate 30 days after the date that Tenant first uses the 19/th/
Floor Space for the purpose of conducting business operations or at
such earlier time as Tenant gives five (5) business days notice to
Landlord of its intent to vacate such Basement Space.
7. Tenant represents that it has not dealt with any brokers other than
Insignia/Edward S. Gordon Company, Inc. in connection with this Amendment,
and agrees to indemnify and hold harmless Landlord from and against any and
all claims for brokerage commission and all costs, expenses and liabilities
(including, without limitation, reasonable attorneys fees) by any person
other than Insignia/Edward S. Gordon Company, Inc. in connection with this
agreement. Landlord represents that it has not dealt with any brokers other
than Edward S. Gordon in connection with this Amendment.
8. Landlord shall cooperate with Tenant, at Tenant's cost and expense, in
connection with any application made, or proposed to be made, by Tenant
seeking a refund, abatement, reduction, rebate, or incentive pursuant to
Title 4 of Article 4 of the New York Real Property Tax Law, commonly referred
to as the lower Manhattan tax incentive plan (the "Lower Manhattan Tax
Incentive Plan") with respect to the 19/th/ Floor Space. Landlord shall not
be required hereunder to take any action, other than to cooperate with Tenant
as aforesaid (including the execution of application materials prepared by
Tenant), in order to make any such refund, abatement, reduction, rebate
<PAGE>
Ambac Assurance Corporation
August 1, 1997
page 7
or incentive available to Tenant. Tenant shall indemnify and hold Landlord
harmless from and against all loss, damage, liability, reasonable cost or
reasonable expense of any nature (including without limitation reasonable
attorney's fees and disbursements) resulting from Landlord's cooperation with
Tenant as aforesaid. Nothing contained in this paragraph, however, shall be
deemed or construed to constitute any representation or warranty by Landlord
that Tenant will be entitled to any refund, abatement, reduction, rebate, or
incentive pursuant to the Lower Manhattan Tax Incentive Plan.
9. Notwithstanding any other provision to the contrary, in the event that
Landlord receives any refund or abatement of Taxes pursuant to the Lower
Manhattan Tax Incentive Plan, or any other similar tax reduction, rebate or
incentive which is attributable to and passed though to a particular
tenant(s) in the Building (whether related to the Premises under the Lease or
otherwise and whether related to the Tenant or another tenant in the
Building), (i) Tenant shall not be entitled to any payment or credit under
the Lease in connection with such refund or abatement (except to the extent
such abatement is for the benefit of, and required by law to be paid to,
Tenant) and (ii) for purposes of computing Taxes for any Tax Year pursuant to
Section 3.02 of the Lease, there shall not be deducted from Taxes all or any
portion of such refund or abatement.
<PAGE>
Ambac Assurance Corporation
August 1, 1997
page 8
Please confirm your agreement to this letter by executing and returning a copy
of this letter to the undersigned.
Sincerely,
SOUTH FERRY BUILDING COMPANY, Landlord
By: /s/ Zev Wolfson
---------------
Name: Zev Wolfson
-----------
Title: General Partner
---------------
ACCEPTED AND AGREED TO:
AMBAC ASSURANCE CORPORATION (formerly known as AMBAC Indemnity Corporation),
Tenant
By: /s/ Frank. Bivona
-----------------
Name: Frank J. Bivona
---------------
Title: Chief Financial Officer
-----------------------
MM: adf
Enclosure
<PAGE>
EXHIBIT 10.28
AMENDMENT NO. 5 TO CREDIT AGREEMENT
-----------------------------------
AMENDMENT NO. 5 TO CREDIT AGREEMENT (this "Amendment") dated as of
December 2, 1997 among Ambac Assurance Corporation (formerly, AMBAC Indemnity
Corporation) (the "Borrower"), 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 "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, 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) All references in the Agreement (including
----------
in any Schedule or Exhibit thereto) to "AMBAC Indemnity Corporation" are hereby
amended to "Ambac Assurance Corporation".
(b) The definition of "Parent" in Section 1.01 is hereby amended in its
entirety and replaced with the following: "Parent" shall mean Ambac Financial
Group, Inc., a Delaware corporation.
(c) The "December 2, 2003" date set forth in the first sentence of Section
3.04 is hereby amended to "December 2, 2004".
<PAGE>
(d) 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, WITHOUT REGARD TO THE CONFLICT OF LAW PROVISIONS
THEREOF.
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 ASSURANCE CORPORATION
By /s/ Frank Bivona
-------------------------
Title: Senior Vice President,
CFO and Treasurer
LANDESBANK HESSEN-THURINGEN
GIROZENTRALE
-2-
<PAGE>
By /s/ Lisa S. Pent
-----------------------------
Title: Senior Vice President,
Manager
By /s/ Peter Icreccaio III
-----------------------------
Title: Assistant Vice President
BAYERISCHE LANDESBANK
GIROZENTRALE
By /s/ Peter Obermann
-----------------------------
Title: Senior Vice President
By /s/ Scott Allison
-----------------------------
Title: First Vice President
COOPERATIEVE CENTRALE
RAIFFEISEN-BOERENLEENBANK
B.A.,"RABOBANK NEDERLAND",
NEW YORK BRANCH
By /s/ Michael de Konkoly Thege
-----------------------------
Title: Managing Director
By /s/ Angela R. Reilly
-----------------------------
Title: Vice President
DEUTSCHE BANK AG, NEW YORK
BRANCH, as Agent
By /s/ Louis Caltavuturo
-----------------------------
Title: Vice President
By /s/ Alan Krour
-----------------------------
Title: Associate
-3-
<PAGE>
EXHIBIT A
---------
SCHEDULE I
----------
COMMITMENTS
-----------
BANK COMMITMENT AMOUNT
---- -----------------
COOPERATIEVE CENTRALE RAIFFEISEN- $180,000,000
BOERENLEENBANK B.A., "RABOBANK
NEDERLAND", NEW YORK BRANCH
BAYERISCHE LANDESBANK GIROZENTRALE 165,000,000
LANDESBANK HESSEN-THURINGEN GIROZENTRALE 105,000,000
-----------
TOTAL $450,000,000
===========
<PAGE>
(EXHIBIT 12.01)
Ambac Financial Group, Inc.
Ratio of Earnings to Fixed Charges
The following table contains our ratio of earnings to fixed charges for
each of the periods indicated:
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------------
1997 1996 1995 1994 1993
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Ratio of earnings to fixed charges 13.41x 17.91x 10.77x 10.14x 15.78x
- --------------------------
</TABLE>
We computed the ratio of earnings to fixed charges by dividing earnings
before income taxes and extraordinary items plus fixed charges by the fixed
charges. For the purpose of this ratio, fixed charges consist of interest
expense incurred, capitalized interest, amortization of debt expense and
one-third of rental payments under operating leases (an amount deemed
representative of the appropriate interest factor).
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES Years Ended December 31
- ------------------------------------------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS HIGHLIGHTS 1997 1996 1995 1994 1993
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Gross premiums written ...................................... $ 286.2 $ 247.2 $ 193.3 $ 189.9 $ 318.3
Net premiums earned ......................................... 154.0 136.6 111.8 117.5 152.0
Net investment income ....................................... 159.7 144.9 131.0 117.1 104.6
Financial management services income ........................ 35.2 22.0 13.1 15.9 8.7
Total revenues .............................................. 381.8 452.9 282.3 242.3 299.3
Losses and loss adjustment expenses ......................... 2.9 3.8 3.4 2.6 (1.8)
Financial guarantee insurance underwriting
and operating expenses ................................... 40.7 37.2 34.5 32.8 34.5
Financial management services expenses ...................... 28.0 12.0 7.8 6.1 2.0
Interest expense ............................................ 21.3 20.9 20.9 18.8 15.8
Net income .................................................. 223.0 276.3 167.6 141.1 179.3
Net income per share ........................................ 3.19 3.95 2.39 2.00 2.54
Net income per diluted share ................................ 3.13 3.91 2.37 1.99 2.52
- ------------------------------------------------------------------------------------------------------------------------------------
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES As of December 31
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET HIGHLIGHTS 1997 1996 1995 1994 1993
(DOLLARS IN MILLIONS)
Total investments ........................................... $ 6,915.1 $ 5,200.5 $ 4,441.6 $ 3,764.2 $ 3,132.7
Prepaid reinsurance ......................................... 183.5 168.8 153.4 139.9 161.3
Total assets ................................................ 8,249.7 5,876.4 5,309.3 4,287.0 3,807.2
Unearned premiums ........................................... 1,179.0 991.2 903.0 836.6 782.8
Losses and loss adjustment expenses ......................... 103.3 60.6 66.0 65.7 64.0
Obligations under investment agreements, investment
repurchase agreements and payment agreements ............. 4,321.0 2,754.6 2,426.9 2,025.3 1,477.7
Debentures .................................................. 223.9 223.8 223.7 223.7 223.6
Total stockholders' equity .................................. 1,872.5 1,615.0 1,404.0 1,033.5 1,099.7
</TABLE>
<PAGE>
FIVE YEAR HIGHLIGHTS
[THE FOLLOWING TABLE WAS REPRESENTED AS A BAR CHART IN THE PRINTED MATERIAL.]
<TABLE>
<CAPTION>
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
TOTAL REVENUES ($ MILLIONS) $299.3 $242.3 $282.3 $452.9 $381.8
NET INCOME ($ MILLIONS) $179.3 $141.1 $167.6 $276.3 $223.0
NET INCOME PER DILUTED SHARE $ 2.52 $ 1.99 $ 2.37 $ 3.91 $ 3.13
RETURN ON EQUITY 18.3% 13.2% 13.8% 18.3% 12.8%
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF
OPERATIONS
- --------------------------------------------------------------------------------
GENERAL
Ambac Financial Group, Inc. (the "Company") headquartered in New York City, is a
holding company that provides through its affiliates financial guarantee
insurance and financial management services to clients in both the public and
private sectors in the U.S. and abroad.
The following paragraphs describe the consolidated results of operations of
Ambac Financial Group, Inc. and its subsidiaries (sometimes collectively
referred to as the "Company") for 1997, 1996 and 1995, and its financial
condition as of December 31, 1997 and 1996. These results are presented for the
Company's two business segments: Financial Guarantee Insurance and Financial
Management Services.
RESULTS OF OPERATIONS
CONSOLIDATED NET INCOME
The Company's net income in 1997 was $223.0 million or $3.13 per diluted share,
a decrease of 19% from $276.3 million or $3.91 per diluted share in 1996. This
decrease was primarily the result of a net realized gain in 1996 of $155.6
million (which had a net income per diluted share effect of $1.42) from the
Company's sale of its former affiliate, HCIA Inc. ("HCIA"). Excluding the effect
of this one-time gain, 1997 net income increased 27% over 1996 due to higher net
income in the financial guarantee insurance segment, partially offset by lower
net income in the financial management services segment. The Company's net
income in 1996 increased 65% from $167.6 million or $2.37 per diluted share in
1995. This increase was due to a number of factors, primarily the $155.6 million
net realized gain from the Company's sale of HCIA. In 1995, the Company had
recognized a realized gain of $19.1 million (which had a net income per diluted
share effect of $0.17) from a partial sale of its investment in 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 net income in
both the financial guarantee insurance and financial management services
business segments.
FINANCIAL GUARANTEE INSURANCE
The Company provides financial guarantee insurance through its principal
operating subsidiary, Ambac Assurance Corporation ("Ambac Assurance"), which is
a leading insurer of municipal and structured finance obligations both in the
U.S. and abroad.
Gross Par Value Written. Ambac Assurance insured $46.3 billion of par value
bonds during 1997, an increase of 26% from $36.8 billion in 1996. Par value
written in 1996 represented an increase of 42% from $26.0 billion in 1995. Par
value written in 1997 comprised $29.4 billion from the insurance of domestic
municipal bond obligations, $12.9 billion from domestic structured finance
obligations and $4.0 billion from international obligations, versus $26.7
billion, $6.4 billion and $3.7 billion, respectively, in 1996 and $20.3 billion,
$4.0 billion and $1.7 billion, respectively, in 1995. The 1997 increase in
insured domestic municipal bond obligations resulted primarily from a 19%
increase in market issuance, partially offset by lower market share. The 1997
increase in insured domestic structured finance obligations was attributable to
higher market share, mostly in the home equity loan and mortgage-backed sectors.
The 1997 increase in insured international obligations resulted from greater
acceptance of financial guarantee insurance, primarily in Europe and Japan.
Gross Premiums Written. Gross premiums written in 1997 were $286.2 million, an
increase of 16% from $247.2 million in 1996. This increase was primarily due to
higher structured finance and international premiums written, partially offset
by lower municipal finance premiums. Gross premiums written in 1996 increased
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:
[PHOTOS]
From left to right: Ambac Connect: John Harrison, Martha Rochelle; Human
Resources: Gregg Bienstock; Cadre Financial Services: Will Sullivan and Tim
Sullivan; Finance: Graham Nelson, Yiping Guo
23
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF
OPERATIONS (continued)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN MILLIONS) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Municipal finance policies:
Up-front policies:
New issue ......................................... $178.9 62% $182.9 74% $125.2 65%
Secondary market .................................. 19.6 7 20.4 8 27.3 14
------------------------------------------------------------------
Sub-total up-front ............................. 198.5 69 203.3 82 152.5 79
------------------------------------------------------------------
Installment policies:
Annual policies ................................... 10.5 4 9.2 4 7.8 4
Portfolio products ................................ 3.0 1 3.8 1 5.4 3
------------------------------------------------------------------
Sub-total installment .......................... 13.5 5 13.0 5 13.2 7
------------------------------------------------------------------
Total municipal finance policies ............ 212.0 74 216.3 87 165.7 86
------------------------------------------------------------------
Structured finance policies:
Up-front ............................................. 11.1 4 1.2 -- 0.5 --
Installment .......................................... 19.6 7 8.8 4 2.8 1
------------------------------------------------------------------
Total structured finance policies .............. 30.7 11 10.0 4 3.3 1
------------------------------------------------------------------
Total domestic written ...................... 242.7 85 226.3 91 169.0 87
International:
Up-front ............................................. 37.6 13 18.0 8 23.7 12
Installment .......................................... 5.9 2 2.9 1 0.6 1
------------------------------------------------------------------
Total international written ................. 43.5 15 20.9 9 24.3 13
------------------------------------------------------------------
Total gross premiums written ................ $286.2 100% $247.2 100% $193.3 100%
------------------------------------------------------------------
Total up-front written .................................. $247.2 86% $222.5 90% $176.7 91%
Total installment written ............................... 39.0 14 24.7 10 16.6 9
------------------------------------------------------------------
Total gross premiums written ................ $286.2 100% $247.2 100% $193.3 100%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Adjusted Gross Premiums.(1) While the majority of Ambac Assurance's premiums
written are collected up front at policy issuance, a growing portion of premiums
are collected on an installment basis. Adjusted gross premiums written, which
are defined as up-front premiums written plus the present value of estimated
future installment premiums written in the period, were $339.6 million in 1997,
up 15% from $296.4 million in 1996. The increase in 1997 was primarily due to
increased structured finance and international business. Adjusted gross premiums
written in 1996 increased 34% from $221.3 million in 1995. The present value of
estimated future installment premiums written in 1997 was $92.4 million, an
increase of 25% from $74.0 million in 1996. The present value of estimated
future installment premiums written in 1996 increased 66% from $44.6 million in
1995. The aggregate net present value of estimated future installment premiums
was $210.8 million, $157.7 million, and $110.0 million as of December 31, 1997,
1996, and 1995 respectively.
Ceded Premiums Written. Ceded premiums written in 1997 were $32.5 million,
versus $37.8 million in 1996. The 14% decrease in ceded premiums written is
primarily due to the non-renewal of automatic treaty reinsurance, partially
offset by higher ceded premiums for international business. In 1997, Ambac
Assurance began using only facultative reinsurance to reduce its risk and manage
its insurance portfolio. Ceded premiums written in 1995 were $28.6 million.
Ceded premiums written in 1995 include $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 agreements in 1996. Ceded
premiums written, exclusive of return premiums, were 11%, 15%, and 24% of gross
premiums written in 1997, 1996, and 1995 respectively.
Net Premiums Written. Net premiums written in 1997 were $253.7 million, an
increase of 21% from $209.4 million in 1996. The increase reflects higher gross
premiums written and lower premiums ceded to reinsurers in 1997 compared with
1996. Net premiums written in 1996 increased 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).
24
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF
OPERATIONS (continued)
- --------------------------------------------------------------------------------
Net Premiums Earned. Net premiums earned during 1997 were $154.0 million, an
increase of 13% from $136.6 million in 1996. This increase was primarily the
result of higher premiums earned from the growth of the book of business during
the year, partially offset by a decline in premiums earned from refundings,
calls and other accelerations in 1997. Net premiums earned in 1997 included
$28.0 million (net income per diluted share effect of $0.22) from refundings,
calls and other accelerations of previously insured issues. Net premiums earned
in 1996 included $31.3 million (net income per diluted share effect of $0.25)
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 1997 were $126.0 million, an
increase of 20% from $105.3 million in 1996. Net premiums earned during 1996
increased 22% from $111.8 million in 1995. This increase was primarily the
result of higher premiums earned from the growth of the book of business during
the year, as well as higher premiums earned from refundings, calls and other
accelerations in 1996. Net premiums earned in 1995 included $22.6 million (net
income per diluted share effect of $0.18) from refundings, calls and other
accelerations. Excluding the effect of accelerated earnings, net premiums earned
in 1996 increased 18% from $89.2 million in 1995.
Net Investment Income. Net investment income in 1997 was $159.7 million, an
increase of 10% from $144.9 million in 1996. This increase was primarily
attributable to the growth of the investment portfolio, partially offset by
lower yields. Investments in tax-exempt securities amounted to 75% of the total
market value of the portfolio as of December 31, 1997, versus 79% and 69% as of
December 31, 1996 and 1995 respectively. The average pre-tax yield-to-maturity
on the investment portfolio was 6.40% as of December 31, 1997 and 6.47% for both
December 31, 1996 and December 31, 1995. Net investment income in 1996 increased
11% from $131.0 million in 1995. This increase was primarily attributable to the
growth of the investment portfolio.
Net Realized Gains (Losses). Net realized gains in 1997 were $21.1 million,
compared to $20.5 million in net realized losses in 1996. The 1997 net realized
gains were generated as a result of the ongoing management of the investment
portfolio. The net realized losses in 1996 were realized 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 1997
were $2.9 million, versus $3.8 million in 1996 and $3.4 million in 1995. Losses
and loss adjustment expenses are generally based upon estimates of the ultimate
aggregate losses inherent in the insured portfolio. Losses and loss adjustment
expenses, exclusive of salvage recognized, were $3.0 million, $5.1 million, and
$4.1 million in 1997, 1996, and 1995 respectively.
Underwriting and Operating Expenses. Underwriting and operating expenses were
$40.7 million in 1997, an increase of 9% from $37.2 million in 1996.
Underwriting and operating expenses in 1996, increased 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 1997, Ambac Assurance's gross underwriting and operating
expenses were $59.2 million, an increase of 5% from $56.4 million in 1996.
During 1996, Ambac Assurance's gross underwriting and operating expenses
increased 11% from $50.9 million in 1995. The increase in gross underwriting and
operating expenses in both 1997 and 1996 reflects the overall increased business
activity in those years. Underwriting and operating expenses deferred were $32.8
million, $32.3 million, and $27.8 million in 1997, 1996, and 1995 respectively.
Reinsurance commissions which related to the current period (net of deferred)
were $0, $(0.6) million, and $(1.2) million in 1997, 1996, and 1995
respectively. The amortization of previously deferred expenses and reinsurance
commissions was $14.2 million, $12.5 million, and $10.2 million in 1997, 1996,
and 1995 respectively.
FINANCIAL MANAGEMENT SERVICES
Through its financial management services subsidiaries, the Company provides
investment agreements, interest rate swaps, investment advisory and cash
management services, and electronic commerce solutions, principally to states,
municipalities and their authorities, school districts, and hospitals and health
organizations. Revenues in 1997 were $34.6 million (includes $0.6 million in net
realized losses), versus $22.4 million (includes $0.4 million in net realized
gains) in 1996. This increase is primarily due to revenues of Cadre Financial
Services, Inc. ("Cadre"), acquired at the end of 1996, and higher revenues from
investment agreements, due to higher volume. Expenses in 1997 were $28.0
million, versus $12.0 million in 1996. This increase reflects expenses for
Cadre, and start-up expenses for Ambac Connect, a new electronic commerce
initiative. Additionally, 1997 expenses include a $3.5 million restructuring
charge ($0.03 per diluted share) to consolidate certain operations in New York.
Revenues in 1996 reflected a 72% increase from $13.0 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
had been
25
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF
OPERATIONS (continued)
- --------------------------------------------------------------------------------
recognized in 1995. Also contributing to the increased revenues in 1996, was
higher net interest income from investment agreements due to higher volume.
Expenses in 1996 increased 54% from $7.8 million in 1995. This increase related
primarily to the start up of an investment advisory business.
CORPORATE ITEMS
Interest Expense. Interest expense in 1997 was $21.3 million, an increase of 2%
from $20.9 million in 1996. Interest expense in 1995 was $20.9 million.
Other Income. Other income includes investment income of the holding company,
Ambac Financial Group, Inc., and the equity in income of HCIA for 1995 and the
first four months of 1996. Other income decreased to $7.2 million in 1997 from
$7.9 million in 1996, primarily due to the inclusion of equity in income from
HCIA in 1996. The increase in 1996 from $1.5 million in 1995 was primarily due
to additional investment income generated by the proceeds from the sale of HCIA.
Other Net Realized Gains. 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 diluted share effect of $1.42). During 1995 the Company sold a
portion of its HCIA stock in a public offering resulting in a realized gain of
$19.1 million (net income per diluted share effect of $0.17).
Other Expenses. Other expenses includes the operating expenses of Ambac
Financial Group, Inc. Other expenses were $2.9 million in 1997, $3.5 million in
1996, and $1.5 million in 1995.
Income Taxes. Income taxes for 1997 were at an effective rate of 22.0%, compared
to 26.4% in 1996. The decrease in the effective rate is primarily due to the
realized gain on the sale of HCIA in 1996 taxed at the statutory federal rate of
35%. Income taxes for 1995 were at an effective rate of 21.7%.
SUPPLEMENTAL ANALYTICAL FINANCIAL DATA
Core Earnings.(2) In 1997 core earnings were $195.8 million, an increase of 15%
from $170.5 million in 1996. The increase was primarily the result of continued
higher premiums earned from the growth in the insurance book of business and net
investment income. In 1996 core earnings increased 17% from $145.5 million in
1995. This increase was primarily the result of continued higher premiums earned
from the growth in the insurance book of business and net investment income, as
well as increased net income from the financial management services segment.
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.(2) Operating earnings in 1997 were $211.8 million, an
increase of 12% from $188.3 million in 1996. Operating earnings in 1996
increased 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, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
(DOLLARS IN MILLIONS) 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income .............................. $223.0 $276.3 $167.6
Net realized gains, after tax ........... (13.3) (88.0) (11.9)
Non-recurring items, after tax .......... 2.1 -- 2.5
--------------------------------
Operating earnings ...................... 211.8 188.3 158.2
Premiums earned from refundings,
calls and other accelerations,
after tax ............................. (16.0) (17.8) (12.7)
--------------------------------
Core earnings ........................ $195.8 $170.5 $145.5
- --------------------------------------------------------------------------------
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Ambac Financial Group, 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 Assurance's ability to pay
dividends or make payments to the Company and external financings. Pursuant to
Wisconsin insurance laws, Ambac Assurance may declare dividends, provided that,
after giving effect to the distribution, it would not violate certain statutory
equity, solvency and asset tests. During 1997, Ambac Assurance paid dividends of
$44.0 million on its common stock to the Company. For further discussion, see
Note 9 of Notes to Consolidated Financial Statements.
The Company's principal uses of liquidity are for the payment of its
operating expenses, interest on its debt, dividends on its shares of common
stock, and capital investments in its subsidiaries. Based on the amount of
dividends that Ambac Assurance expects to pay during 1998 and the income it
expects to receive from its investment portfolio, 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 Assurance'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
26
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF
OPERATIONS (continued)
- --------------------------------------------------------------------------------
can be given that Ambac Assurance 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.
The Company has an effective shelf registration covering the issuance of up
to $250 million of debt securities.
Ambac Assurance Liquidity. The principal uses of Ambac Assurance's liquidity are
the payment of operating expenses, reinsurance premiums, income taxes, and
dividends to the Company. The Company believes that Ambac Assurance's operating
liquidity needs can be funded exclusively from its operating cash flow. The
principal sources of Ambac Assurance's liquidity are gross premiums written,
scheduled investment maturities and net investment income. The majority of
premiums for Ambac Assurance'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 Management Services Liquidity. The principal uses of liquidity by the
Company's financial management services subsidiaries are the payment of
investment agreement obligations pursuant to defined terms, net obligations
under interest rate swaps and related hedges, operating expenses, and income
taxes. The Company believes that its financial management services liquidity
needs can be funded primarily from its operating cash flow and the maturity of
its invested assets. The principal sources of this segment's liquidity are
proceeds from issuance of investment agreements, 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
agreements, net receipts from interest rate swaps and related hedges, and fees
for investment management services. The Company's investment objectives with
respect to investment agreements 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 management services assets in short-term investments and
repurchase agreements in order to meet unexpected liquidity needs.
Credit Facilities. As of December 31, 1997, the Company and Ambac Assurance 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,
1997 and 1996, no amounts were outstanding under this credit facility.
Ambac Assurance has an agreement with a group of AAA/Aaa-rated
international banks for a $450.0 million credit facility, expiring in 2004. The
terms of this facility were renegotiated in December 1997, to increase the
facility from $350.0 million to $450.0 million; and to extend the expiration
date from December 2, 2003 to December 2, 2004. This facility is a seven-year
stand-by irrevocable limited recourse line-of-credit which will provide
liquidity to Ambac Assurance 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, 1997 and 1996, no amounts were outstanding under
this line.
Connie Lee Insurance Company, which the Company acquired in 1997 and is a
subsidiary of Ambac Assurance (see "Other Matters" section) has an agreement
with commercial banks for a $50.0 million standby credit facility, expiring in
2003. The line will provide a source of additional claims-paying resources for
insured transactions. The obligation to repay is a limited recourse obligation
payable solely from, and collateralized by, a pledge of recoveries realized on
defaulted insured obligations including installment premiums and other
collateral. As of December 31, 1997, no amounts were outstanding under this
line.
Stock Repurchase Program. During 1997, the Company acquired approximately
1,149,000 treasury shares for an aggregate amount of $40.4 million. Since
inception of the Stock Repurchase Program the Company has acquired approximately
3,272,000 shares for an aggregate amount of $90.0 million.
Adjusted Book Value.(3) Adjusted Book Value ("ABV") per share increased 17% to
$36.59 at December 31, 1997 from $31.25 at December 31, 1996.
The following table reconciles book value per share to ABV per share as of
December 31, 1997 and 1996:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
1997 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
Book value per share ............................. $26.77 $23.01
After-tax value of:
Net unearned premium reserve .................. 9.25 7.63
Deferred acquisition costs .................... (0.99) (0.87)
Present value of installment premiums ......... 1.96 1.45
Unrealized (loss) gain on
investment agreements ...................... (0.40) 0.03
---------------------
Adjusted book value per share .................... $36.59 $31.25
- -------------------------------------------------------------------------------
</TABLE>
Balance Sheet. Total assets as of December 31, 1997 were $8.25 billion, an
increase of 40% over $5.88 billion at December 31, 1996. The increase was
primarily due to the increased volume in investment and payment agreements, cash
flow from operations and the acquisition of Connie Lee Insurance Company.
Stockholders' equity as of December 31, 1997 was $1.87 billion, an increase of
16% from $1.62 billion at year-end 1996. This increase was primarily due to net
income for the year and a change in unrealized gains on investments, net of tax,
of $76.2 million, partially offset by dividends to shareholders.
27
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF
OPERATIONS (continued)
- --------------------------------------------------------------------------------
Cash Flows. Net cash provided by operating activities was $324.5 million, $190.6
million and $231.3 million during 1997, 1996 and 1995, respectively. These cash
flows were primarily provided by the financial guarantee insurance operations.
Net cash provided by financing activities was $1,564.3 million, $463.2 million
and $177.7 million during 1997, 1996 and 1995, respectively. This activity
included $1,096.5 million, $499.2 million and $196.8 million in investment
agreements issued (net of draws paid) in 1997, 1996 and 1995, respectively. The
total cash provided by operating and financing activities was $1,888.8 million,
$653.8 million and $409.0 million during 1997, 1996 and 1995, respectively. From
these totals, $1,887.3 million, $658.2 million and $401.3 million was used in
investing activities, principally purchases of investment securities during
1997, 1996 and 1995, respectively.
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.
RISK MANAGEMENT
In the ordinary course of business, the Company, through its affiliates, manages
a variety of risks, principally market, credit, 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.
Market risk generally represents the risk of loss that may result from the
potential change in the fair value of a financial instrument as a result of
changes in prices and interest rates. The Company has financial instruments held
for purposes other than trading and for trading purposes. The principal market
risk for the Company's financial instruments held for purposes other than
trading is interest rate risk. An independent risk management group is involved
in setting and monitoring risk limits and 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 test scenarios to monitor and manage interest
rate risk. This process includes frequent analyses of both parallel and
nonparallel shifts in the yield curve. These models include estimates made by
management and the valuation results could differ materially from amounts that
would actually be realized in the market. Financial instruments held for
purposes other than trading which may be adversely affected by changes in
interest rates, consist primarily of investment securities, investment agreement
liabilities, debentures, and related derivative contracts (primarily interest
rate swaps and futures) used for hedging purposes.
The following summarizes the estimated change in fair value (based
primarily on the valuation models discussed above) on the net balance of these
financial instruments assuming immediate changes in interest rates at specified
levels at December 31, 1997:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
ESTIMATED FAIR ESTIMATED
CHANGE IN VALUE OF CHANGE
INTEREST RATES NET FINANCIAL IN FAIR
(DOLLARS IN MILLIONS) INSTRUMENTS VALUE
- -------------------------------------------------------------------------------
<S> <C> <C>
300 basis point rise ........................ $2,071 $(560)
200 basis point rise ........................ 2,264 (367)
100 basis point rise ........................ 2,489 (142)
Base scenario ............................... 2,631 --
100 basis point decline ..................... 2,801 170
200 basis point decline ..................... 2,965 334
300 basis point decline ..................... 3,136 505
- -------------------------------------------------------------------------------
</TABLE>
The Company through its affiliate Ambac Financial Services, L.P. ("AFSLP"),
is a provider of interest rate swaps to states, municipalities and their
authorities and other entities in connection with their financings. AFSLP
manages its business with the goal of being market neutral to changes in overall
interest rates, while retaining basis risk, the relationship between floating
tax-exempt and floating taxable interest rates. If actual or projected floating
tax-exempt interest rates change in relation to floating taxable interest rates,
AFSLP will experience an unrealized mark-to-market gain or loss. The AFSLP swap
portfolio is considered held for trading purposes. Market risk for financial
instruments held for trading purposes relates to the impact of pricing changes
on future earnings. The principal market risk is basis risk. Since late 1995,
most 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 for financial instruments held for trading purposes. AFSLP has developed a
value-at-risk methodology to estimate potential losses over a specified holding
period and based on certain probabilistic assessments. AFSLP 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, 1997 and 1996, AFSLP's value-at-risk, for financial instruments
considered held for trading purposes, calculated at a ninety-nine percent
confidence level, averaged approximately $1.6 million and $1.4 million,
respectively. AFSLP's value-at-risk ranged from a high of $2.6 million to a low
of $0.9 million in 1997, and from a high of $2.6 million to a low of $1.1
million in 1996. Since no single measure can
28
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF
OPERATIONS (continued)
- --------------------------------------------------------------------------------
capture all dimensions of market risk, AFSLP supplements 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.
Credit risk arises from the potential inability of counterparties to
perform on an obligation in accordance with the terms of the contract. The
Company is exposed to credit risk in various capacities including as an issuer
of a financial guarantee policy, as counterparty to financial contracts and as a
holder of investment securities. The Company has established various procedures
and controls to monitor and manage credit risk. These include the initial credit
review and approval process, minimum credit rating requirements, single credit
concentration limits, and the continuous monitoring of credit exposures.
Liquidity risk relates to the possible inability to satisfy contractual
obligations when due. This risk is present in financial guarantee insurance,
investment agreements, interest rate swaps and futures contracts. Ambac
Assurance manages its liquidity risk by maintaining a comprehensive daily
analysis of projected cash flows. Additionally, Ambac Assurance maintains a
minimum level of cash and short-term investments at all times. See additional
discussion in "Liquidity and Capital Resources" section. The investment
agreement business manages liquidity risk by matching the effective duration of
its invested assets, including hedges, with the effective duration of its
investment agreement liabilities. Additionally, the Company's policy is to
maintain a minimum level of cash and short-term assets equivalent to a specified
percentage of its investment agreement liabilities outstanding. AFSLP maintains
cash and cash equivalents, closely matching the dates swap payments are made and
received, and limiting the amount of risk hedged with futures contracts.
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 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.
OTHER MATTERS
Acquisitions. On December 18, 1997 Ambac Assurance acquired Construction Loan
Insurance Corporation ("CLIC"). Ambac Assurance paid $106 million in cash and
retired $18.4 million of CLIC debt. CLIC (renamed Connie Lee Holdings, Inc.) and
its triple-A rated financial guarantee insurance subsidiary Connie Lee Insurance
Company ("Connie Lee"), are now wholly owned subsidiaries of Ambac Assurance
Corporation. Connie Lee, which guaranteed bonds issued primarily for college and
hospital infrastructure projects, is not expected to write any new business.
Ambac Assurance and Connie Lee have arrangements in place to assure that Connie
Lee maintains a level of capital sufficient to support Connie Lee's outstanding
obligations and for Connie Lee insured bonds to retain their triple-A rating.
Year 2000. The Company recognizes the worldwide challenge for all systems to
recognize the date change for the year 2000 and, is assessing its computer
applications and business processes to provide for their continued
functionality. A process of inventory, scoping and analysis, modification,
testing, certification and implementation is under way. The Company expects to
incur internal staff costs, as well as consulting expense related to this
process. The Company does not anticipate that the related overall costs will be
material.
FOOTNOTES
(1) Adjusted gross premiums written, which is not promulgated under GAAP, is
used by management, equity analysts and investors to measure the financial
results of the Company. Adjusted gross premiums written, which the Company
reports as analytical data, is defined as gross up-front premiums written plus
the present value of estimated future installment premiums written in the
period. The definition of adjusted gross premiums written used by the Company
may differ from definitions of adjusted gross premiums written used by other
public holding companies of financial guarantee insurers.
(2) 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.
The definition of core earnings and operating earnings used by the Company may
differ from definitions of core earnings and operating earnings used by other
public holding companies of financial guarantee insurers.
(3) 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, and the unrealized gain or loss on investment agreement
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 to book value described above will not be realized
until future periods and may differ materially from the amounts used in
determining ABV.
29
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
REPORT ON
MANAGEMENT'S
RESPONSIBILITIES
- --------------------------------------------------------------------------------
The management of Ambac Financial Group, Inc. 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.
The Company 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.
The Company'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/ P. Lassiter
Phillip B. Lassiter
Chairman, President and Chief Executive Officer
/s/ Frank Bivona
Frank J. Bivona
Executive Vice President, Chief Financial Officer and Treasurer
January 29, 1998
- --------------------------------------------------------------------------------
INDEPENDENT
AUDITORS' REPORT
- --------------------------------------------------------------------------------
To the Board of Directors and Stockholders
Ambac Financial Group, Inc.
We have audited the accompanying consolidated balance sheets of Ambac Financial
Group, Inc. and subsidiaries as of December 31, 1997 and 1996, 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, 1997. These
consolidated financial statements are the responsibility of Ambac Financial
Group, 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
Financial Group, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997 in conformity with generally accepted
accounting principles.
/s/ KPMG Peat Marwick LLP
KPMG Peat Marwick LLP
New York, New York
January 29, 1998
30
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
CONSOLIDATED
BALANCE SHEETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES December 31,
- --------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1997 1996
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Investments:
Fixed income securities, at fair value
(amortized cost of $6,525,650 in 1997 and $4,979,017 in 1996) ............. $6,773,844 $5,088,031
Short-term investments, at cost (approximates fair value) .................... 136,278 112,511
Preferred stock, at cost ..................................................... 5,000 --
-------------------------
Total investments ......................................................... 6,915,122 5,200,542
Cash ............................................................................ 9,256 7,734
Securities purchased under agreements to resell ................................. 85,466 201,169
Receivable for investment agreements ............................................ -- 33,299
Receivable for securities sold .................................................. 106,246 18,467
Investment income due and accrued ............................................... 78,690 65,920
Reinsurance recoverable ......................................................... 4,219 393
Prepaid reinsurance ............................................................. 183,492 168,786
Deferred acquisition costs ...................................................... 105,996 94,212
Loans ........................................................................... 503,192 --
Receivable from brokers and dealers ............................................. 183,041 --
Other assets .................................................................... 75,002 85,836
-------------------------
Total assets .............................................................. $8,249,722 $5,876,358
-------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities:
Unearned premiums ............................................................ $1,178,990 $991,224
Losses and loss adjustment expenses .......................................... 103,345 60,613
Ceded reinsurance balances payable ........................................... 9,258 7,438
Obligations under investment and payment agreements .......................... 3,230,052 2,417,817
Obligations under investment repurchase agreements ........................... 1,090,912 336,773
Deferred income taxes ........................................................ 135,228 80,086
Current income taxes ......................................................... 9,016 6,538
Debentures ................................................................... 223,864 223,798
Accrued interest payable ..................................................... 46,017 29,958
Accounts payable and other liabilities ....................................... 75,170 57,689
Payable for securities purchased ............................................. 275,388 49,408
-------------------------
Total liabilities ......................................................... 6,377,240 4,261,342
-------------------------
Stockholders' equity:
Preferred stock, par value $0.01 per share; authorized shares - 4,000,000;
issued and outstanding shares - none ...................................... -- --
Common stock, par value $0.01 per share; authorized shares - 100,000,000;
issued shares - 70,680,384 at December 31, 1997 and 35,340,192
at December 31, 1996 ...................................................... 707 353
Additional paid-in capital ................................................... 500,107 498,401
Unrealized gains on investments, net of tax .................................. 135,066 58,911
Retained earnings ............................................................ 1,262,740 1,072,418
Cumulative translation adjustment ............................................ 157 --
Common stock held in treasury at cost, 732,947 shares at December 31, 1997 and
249,807 at December 31, 1996 .............................................. (26,295) (15,067)
-------------------------
Total stockholders' equity ................................................ 1,872,482 1,615,016
-------------------------
Total liabilities and stockholders' equity ................................ $8,249,722 $5,876,358
-------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
31
- --------------------------------------------------------------------------------
<PAGE>
---------------------------------------
CONSOLIDATED STATEMENTS
OF OPERATIONS
---------------------------------------
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES Years Ended December 31,
- ----------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1997 1996 1995
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUES:
Financial Guarantee Insurance:
Gross premiums written ........................... $286,163 $247,208 $193,326
Ceded premiums written ........................... (32,452) (37,793) (28,606)
------------------------------------------
Net premiums written .......................... 253,711 209,415 164,720
Increase in unearned premiums .................... (99,711) (72,786) (52,900)
------------------------------------------
Net premiums earned ........................... 154,000 136,629 111,820
Net investment income ............................ 159,709 144,941 131,049
Net realized gains (losses) ...................... 21,084 (20,531) 177
Other income ..................................... 4,402 5,261 5,580
Financial Management Services: Income ........................................... 35,249 21,973 13,126
Net realized (losses) gains ...................... (637) 393 (117)
Other:
Income ........................................... 7,207 7,929 1,521
Net realized gains ............................... 748 156,313 19,103
------------------------------------------
Total revenues ................................ 381,762 452,908 282,259
------------------------------------------
EXPENSES:
Financial Guarantee Insurance: Losses and loss adjustment expenses .............. 2,854 3,778 3,377
Underwriting and operating expenses .............. 40,672 37,182 34,450
Financial Management Services ....................... 27,993 12,040 7,793
Interest ............................................ 21,346 20,925 20,934
Other ............................................... 2,901 3,477 1,531
------------------------------------------
Total expenses ................................ 95,766 77,402 68,085
------------------------------------------
Income before income taxes .......................... 285,996 375,506 214,174
Provision for income taxes .......................... 62,966 99,189 46,579
------------------------------------------
Net income .................................... $223,030 $276,317 $167,595
------------------------------------------
Net income per share ............................. $3.19 $3.95 $2.39
------------------------------------------
Net income per diluted share ..................... $3.13 $3.91 $2.37
------------------------------------------
Weighted average number of shares outstanding ....... 69,988,497 69,929,628 70,201,762
------------------------------------------
Weighted average number of diluted shares outstanding 71,227,347 70,748,470 70,847,441
------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
32
- --------------------------------------------------------------------------------
<PAGE>
- ----------------------------------------------
CONSOLIDATED STATEMENTS
OF STOCKHOLDERS' EQUITY
- ----------------------------------------------
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES Years Ended December 31,
- -------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
PREFERRED STOCK:
Balance at January 1 and December 31 ............. $ -- $ -- $ --
-----------------------------------------
COMMON STOCK:
Balance at January 1 ............................. $ 353 $ 353 $ 353
Stock split effected as dividend ................. 354 -- --
-----------------------------------------
Balance at December 31 ........................... $ 707 $ 353 $ 353
-----------------------------------------
ADDITIONAL PAID-IN CAPITAL:
Balance at January 1 ............................. $ 498,401 $ 492,495 $ 477,467
Issuance of stock ................................ (3,506) 3,624 (5)
Sale of affiliate, net of tax .................... -- -- 14,356
Stock split effected as dividend ................. (354) -- --
Other ............................................ 5,566 2,282 677
-----------------------------------------
Balance at December 31 ........................... $ 500,107 $ 498,401 $ 492,495
-----------------------------------------
UNREALIZED GAINS (LOSSES) ON INVESTMENTS, NET OF TAX:
Balance at January 1 ............................. $ 58,911 $ 102,470 $ (106,264)
Change in unrealized gains (losses), net of tax .. 76,155 (43,559) 208,734
-----------------------------------------
Balance at December 31 ........................... $ 135,066 $ 58,911 $ 102,470
-----------------------------------------
RETAINED EARNINGS:
Balance at January 1 ............................. $ 1,072,418 $ 819,479 $ 673,129
Net income ....................................... 223,030 276,317 167,595
Dividends declared - common stock ................ (24,165) (21,500) (19,484)
Other ............................................ (8,543) (1,878) (1,761)
-----------------------------------------
Balance at December 31 ........................... $ 1,262,740 $ 1,072,418 $ 819,479
-----------------------------------------
CUMULATIVE TRANSLATION ADJUSTMENT:
Balance at January 1 ............................. $ -- $ -- $ --
Changes during year .............................. 157 -- --
-----------------------------------------
Balance at December 31 ........................... $ 157 $ -- $ --
-----------------------------------------
COMMON STOCK HELD IN TREASURY AT COST:
Balance at January 1 ............................. $ (15,067) $ (10,809) $ (11,198)
Cost of shares acquired during year .............. (40,397) (31,751) (5,913)
Issued under equity plans ........................ 29,169 17,211 6,302
Issued to acquire subsidiary ..................... -- 10,282 --
-----------------------------------------
Balance at December 31 ........................... $ (26,295) $ (15,067) $ (10,809)
-----------------------------------------
TOTAL STOCKHOLDERS' EQUITY AT DECEMBER 31 ........... $ 1,872,482 $ 1,615,016 $ 1,403,988
-----------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
33
- --------------------------------------------------------------------------------
<PAGE>
------------------------------
CONSOLIDATED STATEMENTS
OF CASH FLOWS
------------------------------
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES Years Ended December 31,
- ---------------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ...................................................................... $ 223,030 $ 276,317 $ 167,595
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization ................................................ 1,925 1,986 4,765
Amortization of bond premium and discount .................................... (3,257) (1,603) 324
Current income taxes ......................................................... 9,978 1,413 15,713
Deferred income taxes ........................................................ 12,015 4,497 13,727
Deferred acquisition costs ................................................... (11,784) (11,592) (10,846)
Unearned premiums, net ....................................................... 99,706 72,786 52,900
Losses and loss adjustment expenses .......................................... 408 (5,776) 334
Ceded reinsurance balances payable ........................................... 1,303 (7,216) 13,746
Investment income due and accrued ............................................ (9,415) (9,550) (6,465)
Accrued interest payable ..................................................... 16,059 4,464 1,668
Gains on sales of investments and affiliates ................................. (21,195) (136,175) (19,222)
Accounts payable and other liabilities ....................................... 4,754 13,111 (6,240)
Other, net ................................................................... 990 (12,032) 3,340
-----------------------------------------
Net cash provided by operating activities ................................. 324,517 190,630 231,339
-----------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of bonds .................................................... 1,718,174 1,911,909 2,955,475
Proceeds from matured bonds ..................................................... 1,080,338 959,527 660,181
Purchases of bonds .............................................................. (4,135,404) (3,825,803) (3,820,086)
Purchases of preferred stock .................................................... (5,000) -- --
Change in short-term investments ................................................ (23,767) 64,178 (38,714)
Securities purchased under agreements to resell ................................. 115,703 39,111 (152,269)
Loans ........................................................................... (503,192) -- --
Purchase of affiliate, net of cash acquired ..................................... (120,006) -- --
Proceeds from sale of affiliate ................................................. -- 202,609 28,502
Other, net ...................................................................... (14,121) (9,783) (34,380)
-----------------------------------------
Net cash used in investing activities ..................................... (1,887,275) (658,252) (401,291)
-----------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid .................................................................. (24,165) (21,500) (19,484)
Proceeds from issuance of investment agreements ................................. 2,805,256 1,696,813 1,374,856
Payments for investment agreement draws ......................................... (1,708,775) (1,197,584) (1,178,083)
Payment agreements .............................................................. 503,192 -- --
Purchases of treasury stock ..................................................... (40,397) (31,751) (5,913)
Proceeds from sale of treasury stock ............................................ 29,169 17,211 6,302
-----------------------------------------
Net cash provided by financing activities ................................. 1,564,280 463,189 177,678
-----------------------------------------
Net cash flow ................................................................... 1,522 (4,433) 7,726
Cash at January 1 ............................................................... 7,734 12,167 4,441
-----------------------------------------
Cash at December 31 ............................................................. $ 9,256 $ 7,734 $ 12,167
-----------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Income taxes ................................................................. $ 34,163 $ 90,649 $ 25,731
-----------------------------------------
Interest expense on debt ..................................................... $ 21,799 $ 21,675 $ 21,170
-----------------------------------------
Interest expense on investment agreements .................................... $ 169,875 $ 148,526 $ 124,797
-----------------------------------------
Cash received during the year for:
Income taxes ................................................................. $ -- $ -- $ 8,843
-----------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
34
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
1 BACKGROUND
Ambac Financial Group, Inc. (the "Company") is a holding company whose
affiliates provide financial guarantee insurance and financial management
services to clients in both the public and private sectors in the U.S. and
abroad. The Company's principal operating subsidiary, Ambac Assurance
Corporation ("Ambac Assurance"), a leading insurer of municipal and structured
finance obligations, has earned triple-A claims-paying ability ratings, the
highest ratings available from Moody's Investors Service, Inc., Standard &
Poor's Ratings Group, Fitch IBCA, Inc., and Nippon Investors Services, Inc.
Ambac Financial Group, Inc.'s Financial Management Services segment provides
investment agreements, interest rate swaps, investment advisory and cash
management services, and electronic commerce solutions, principally to states,
municipalities and their authorities, school districts, and hospitals and health
organizations.
During the first quarter of 1997, Ambac Assurance established a new
subsidiary in the United Kingdom, Ambac Insurance UK Limited ("Ambac UK"), which
is authorized to conduct certain classes of general insurance business in the
United Kingdom. Ambac UK is the Company's primary vehicle for the issuance of
financial guarantee insurance policies in the United Kingdom and Europe.
On December 18, 1997, Ambac Assurance acquired Construction Loan Insurance
Corporation ("CLIC") for $106,000 in cash and retired $18,400 of CLIC debt.
CLIC's wholly owned subsidiary, Connie Lee Insurance Company ("Connie Lee"), a
triple-A rated financial guarantee insurance company which guaranteed bonds
primarily for college and hospital infrastructure projects, is not expected to
write any new business. Ambac Assurance and Connie Lee have arrangements in
place to assure that Connie Lee maintains a level of capital sufficient to
support Connie Lee's outstanding obligations and for Connie Lee insured bonds to
retain their triple-A rating. The acquisition of CLIC was accounted for using
the purchase method. CLIC's results of operations subsequent to December 18,
1997 are included in the accompanying Consolidated Statements of Operations. The
pro forma results of operations for the years ended December 31, 1997 and 1996,
assuming CLIChad been acquired as of January 1, 1996, are as follows: 1997:
revenues of $406,400; pre-tax income of $260,500; net income of $205,800; and
earnings per diluted share of $2.89; 1996: revenues of $477,300; pre-tax income
of $390,500; net income of $287,300; and earnings per diluted share of $4.08.
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 the Company are as described below:
CONSOLIDATION:
The consolidated financial statements include the accounts of Ambac Financial
Group, Inc. and its subsidiaries. All significant intercompany balances have
been eliminated.
NET INCOME PER SHARE AND NET INCOME PER DILUTED SHARE:
Net income per share is based on the weighted average number of shares
outstanding during the year, retroactively adjusted to reflect a two-for-one
stock split in 1997. Net income per diluted share reflects the potential
dilution that would occur if securities, such as employee stock options, were
exercised.
INVESTMENTS:
The Company's investment portfolio is accounted for on a trade-date basis and
consists primarily of investments in fixed income 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.
35
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
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.
LOANS:
Loans are reported at their outstanding unpaid principal balances, net of any
deferred fees. Interest income is accrued on the unpaid principal balance.
Deferred fees are amortized to interest income over the contractual life of the
loan using the interest method or the straight line method if not materially
different. Interest and amortization income are included in financial guarantee
revenue.
OBLIGATIONS UNDER INVESTMENT AND PAYMENT AGREEMENTS:
Obligations under investment and payment agreements and investment repurchase
agreements are recorded as liabilities on the consolidated balance sheet at the
face value of the agreement, adjusted for draws paid and interest credited to
the account. Unsettled agreements 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 agreements. Net interest income relating to investment
agreements and investment repurchase agreements is included as a component of
financial management services revenue.
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 Assurance 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 Assurance 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.
Ambac Assurance'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 $14,213, $12,553
and $10,183 for 1997, 1996 and 1995, respectively. Deferred acquisition costs,
net of such amortization, amounted to $11,784, $11,592 and $10,846 for 1997,
1996 and 1995, 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, ranging
from 3 to 5 years, 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, ranging from
3 to 5 years, using the straight-line method.
DERIVATIVE CONTRACTS:
Derivative Contracts Held for Purposes Other Than Trading:
The Company uses derivative contracts (primarily interest rate swaps and futures
contracts) for hedging purposes as part of its overall interest rate risk
management.
36
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
The Company accounts for its 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 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. Futures contracts held for purposes other than
trading are used primarily to hedge interest sensitive assets and liabilities.
Futures contracts are designated at inception as a hedge to specific assets and
liabilities. Gains and losses on 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.
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).
Gains and losses on futures contracts, purchased options or interest rate
swaps that do not qualify as accounting hedges are recognized in current period
income immediately.
Derivative Contracts Held for Trading Purposes:
The Company, through its affiliate Ambac Financial Services, L.P. ("AFSLP"), a
provider of interest rate swaps to states, municipalities and their authorities,
and other entities in connection with their financings, uses derivative
contracts which are classified as held for trading purposes. Derivative
contracts are recorded on trade date at fair value. Changes in fair value are
recorded as a component of financial management 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 management 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.
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 1997, the Company adopted the Ambac 1997 Equity 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. The Company
accounts for its incentive stock options and stock-based awards under Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("Statement 123"). 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
37
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
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.
ACCOUNTING STANDARDS:
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
("Statement 128"), which the Company implemented in 1997. Statement 128 replaces
the presentation of primary and fully diluted earnings per share with "basic
earnings per share" and "diluted earnings per share," respectively. All prior
periods presented have been restated to reflect the new requirement.
In June 1997, the FASB issued Statement 130, "Reporting Comprehensive
Income," which requires enterprises to disclose comprehensive income and its
components in a prominent position on the face of the financial statements. The
Company will implement this statement in 1998. This statement relates to
presentation of information and will have no impact on results of operations or
financial condition.
In June 1997, the FASB issued Statement 131, "Disclosures about Segments of
an Enterprise and Related Information," which will be effective for the Company
beginning January 1, 1998. Statement 131 redefines how operating segments are
determined and requires disclosure of certain financial and descriptive
information about a company's operating segments. This statement relates to
presentation of information and will have no impact on results of operations or
financial condition.
RECLASSIFICATIONS:
Certain reclassifications have been made to prior years' amounts to conform to
the current year's presentation.
3 INVESTMENTS
The amortized cost and estimated fair value of investments in fixed income
securities at December 31, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
1997 COST GAINS LOSSES VALUE
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Municipal obligations ...... $2,146,137 $ 152,971 $ 112 $2,298,996
Corporate obligations ...... 1,022,995 71,520 928 1,093,587
U.S. Government obligations 136,771 2,855 28 139,598
Mortgage- and asset-backed
securities (includes U.S.
Government Agency
obligations) ............. 3,200,262 25,511 3,017 3,222,756
Other ...................... 155,763 91 669 155,185
-------------------------------------------------
$6,661,928 $ 252,948 $ 4,754 $6,910,122
- --------------------------------------------------------------------------------
</TABLE>
<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 obligations ...... 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>
The amortized cost and estimated fair value of fixed income securities at
December 31, 1997, by contractual maturity, were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
ESTIMATED
AMORTIZED FAIR
1997 COST VALUE
- --------------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less .................. $ 171,955 $ 172,067
Due after one year
through five years ..................... 309,796 316,696
Due after five years
through ten years ...................... 433,363 452,362
Due after ten years ...................... 2,546,552 2,746,241
- --------------------------------------------------------------------------------
3,461,666 3,687,366
Mortgage- and asset-
backed securities ...................... 3,200,262 3,222,756
- --------------------------------------------------------------------------------
$6,661,928 $6,910,122
- --------------------------------------------------------------------------------
</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.
Securities carried at $8,415 and $2,422 at December 31, 1997 and 1996
respectively, were deposited by the Company with governmental authorities or
designated custodian banks as required by laws affecting insurance companies.
38
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
Net investment income from financial guarantee insurance operations
comprised the following:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
1997 1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Fixed income securities ........ $ 155,810 $ 139,410 $ 127,864
Short-term investments ......... 6,506 7,999 5,670
-----------------------------------------
Total investment income ...... 162,316 147,409 133,534
Investment expense ............. (2,607) (2,468) (2,485)
-----------------------------------------
Net investment income ........ $ 159,709 $ 144,941 $ 131,049
- -------------------------------------------------------------------------------
</TABLE>
Financial guarantee insurance operations had gross realized gains of
$25,641, $19,236 and $27,786 for 1997, 1996 and 1995, respectively, and gross
realized losses of $4,557, $39,767 and $27,609 for 1997, 1996 and 1995,
respectively.
Net investment income related to investment agreements comprises gross
investment income less related interest expense, and is a component of financial
management services revenue. For 1997, 1996 and 1995, gross investment income
from investment agreements was $200,337, $165,196 and $137,382, respectively,
and the related interest expense was $186,678, $154,484 and $127,666,
respectively.
As of December 31, 1997 and 1996, the Company held securities subject to
agreements to resell for $85,466 and $201,169, respectively. Such securities
were held as collateral by the Company. The agreements had terms of less than 30
days.
As of December 31, 1997 and 1996, 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 $2,714,719
and $1,642,964, respectively, in connection with certain investment agreements
(including agreements structured as investment repurchase agreements).
Additionally, as of December 31, 1997 and 1996, investment securities with a
fair value of $63 and $896, respectively, were pledged to futures brokers for
required margin.
4 LOANS
In the normal course of business, the Company has extended loans to customers
participating in certain structured municipal transactions. The loans are
collateralized with cash that the customers have deposited with a payment
custodian in amounts adequate to repay the loan balance and interest thereon.
Equipment and other assets underlying the transactions serve as additional
collateral for the loans. The Company may act as the payment custodian and hold
the funds posted as collateral. As of December 31, 1997, the interest rates on
these loans ranged from 6.25% to 8.42%.
5 REINSURANCE
In the ordinary course of business, Ambac Assurance 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,
- ----------------------------------------------------------------------------------------
1997 1996 1995
- ----------------------------------------------------------------------------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Direct ..... $277,814 $176,009 $240,544 $155,883 $190,570 $125,559
Assumed .... 8,349 3,614 6,664 3,126 2,756 1,349
Ceded ...... (32,452) (25,623) (37,793) (22,380) (28,606) (15,088)
------------------------------------------------------------------------
Net premiums $253,711 $154,000 $209,415 $136,629 $164,720 $111,820
- ----------------------------------------------------------------------------------------
</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 Assurance under the existing
reinsurance agreements, Ambac Assurance would be liable for such defaulted
amounts. To minimize its exposure to significant losses from reinsurer
insolvencies, Ambac Assurance evaluates the financial condition of its
reinsurers and monitors concentrations of credit risk. There were no reinsurance
recoverables on paid losses as of December 31, 1997 and 1996. As of December 31,
1997, prepaid reinsurance of approximately $152,283 was associated with Ambac
Assurance's three largest reinsurers. As of December 31, 1997, Ambac Assurance
held letters of credit and collateral amounting to approximately $154,387 from
its reinsurers to cover liabilities ceded under the aforementioned reinsurance
contracts.
During 1995, Ambac Assurance terminated reinsurance contracts, resulting in
return premiums to Ambac Assurance of $18,141, of which $15,700 was recorded as
an increase to the unearned premium reserve, with the remainder recognized as
revenue.
6 LOSSES AND LOSS ADJUSTMENT EXPENSES
Ambac Assurance'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
39
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
case basis loss and ACR accounts and the components of the liability for losses
and loss adjustment expenses:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------
1997 1996 1995
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Case basis loss and loss adjustment expense reserves:
Balance at January 1 ................................ $22,016 $39,890 $39,342
Less reinsurance recoverables ..................... 393 641 450
----------------------------------
Net balance at January 1 ............................ 21,623 39,249 38,892
----------------------------------
Incurred related to:
Current year ...................................... 212 1,484 750
Prior years ....................................... 1,973 (9,556) 2,650
----------------------------------
Total incurred ................................... 2,185 (8,072) 3,400
----------------------------------
Paid related to:
Current year ...................................... 200 150 150
Prior years ....................................... 2,274 9,404 2,893
----------------------------------
Total paid ....................................... 2,474 9,554 3,043
----------------------------------
Net balance for Connie Lee, at acquisition .......... 29,526 -- --
----------------------------------
Net balance at December 31 .......................... 50,860 21,623 39,249
Plus reinsurance recoverables ..................... 4,219 393 641
----------------------------------
Balance at December 31 .............................. 55,079 22,016 39,890
----------------------------------
Active credit reserve:
Balance at January 1 ................................ 38,597 26,747 26,770
Net provision for losses ............................ 3,000 5,115 4,097
ACR transfers (to) from case reserves ............... (2,331) 6,735 (4,120)
Balance for Connie Lee, at acquisition .............. 9,000 -- --
----------------------------------
Balance at December 31 .............................. 48,266 38,597 26,747
----------------------------------
Total ............................................ $103,345 $60,613 $66,637
- -------------------------------------------------------------------------------------------
</TABLE>
The terms "current year" and "prior years" in the foregoing table refer to
the year in which case basis loss reserves were established.
7 STOCKHOLDERS' EQUITY
The Company is authorized to issue 100,000,000 shares of Common Stock, par value
$0.01 per share, of which 70,680,384 were issued as of December 31, 1997. The
Company is also authorized to issue 4,000,000 shares of preferred stock, $0.01
par value per share, none of which was issued and outstanding as of December 31,
1997.
Dividends declared per share amounted to $0.3450, $0.3075 and $0.2775 in
1997, 1996 and 1995, 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 6,000,000 shares of the Company's Common Stock. As of December 31, 1997,
approximately 3,272,000 shares had been repurchased under this program for an
aggregate amount of $89,968.
The difference between weighted average number of shares outstanding and
weighted average number of diluted shares outstanding is from employee stock
options.
STOCKHOLDER RIGHTS PLAN:
In January 1996, the Company adopted a Stockholder Rights Plan under which
stockholders received (after giving effect to a stock split since adoption of
the Plan) one Right for each two shares 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 $0.01 per Right at any time prior to their
becoming exercisable.
8 COMMITMENTS AND CONTINGENCIES
The Company is responsible for leases on the rental of office space. In 1997,
the Company executed an agreement for additional office space and a lease term
extension at its corporate headquarters in New York City. The lease agreements,
which expire periodically through September 2019, 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>
1998 ............................................................... $ 5,474
1999 ............................................................... 6,469
2000 ............................................................... 6,648
2001 ............................................................... 5,772
2002 ............................................................... 5,714
All later years .................................................... 91,418
--------
$121,495
- --------------------------------------------------------------------------------
</TABLE>
Rent expense for the aforementioned leases amounted to $5,048, $3,862 and
$3,461 for the years ended December 31, 1997, 1996 and 1995, respectively.
40
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
9 INSURANCE REGULATORY RESTRICTIONS
Ambac Assurance 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 Assurance'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 Assurance paid cash dividends of $44,000,
$40,000 and $40,000 on its common stock in 1997, 1996 and 1995, respectively. In
addition, on April 30, 1996, Ambac Assurance, 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. Based
upon these restrictions, at December 31, 1997, the maximum amount that will be
available during 1998 for payment of dividends by Ambac Assurance is
approximately $100,700.
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 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 Assurance'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 $1,006,829 and $899,023 at December 31,
1997 and 1996, respectively. Qualified statutory capital was $1,655,554 and
$1,466,560 at December 31, 1997 and 1996, respectively. Statutory net income was
$198,615, $222,810 and $142,541 for 1997, 1996 and 1995, 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.
10 INCOME TAXES
The Company's provision for income taxes is comprised of the following:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Current taxes .................. $51,036 $94,392 $33,286
Deferred taxes ................. 11,930 4,797 13,293
---------------------------------------
$62,966 $99,189 $46,579
- --------------------------------------------------------------------------------
</TABLE>
The total effect of income taxes on income and stockholders' equity for the
years ended December 31, 1997 and 1996 was as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------
1997 1996
<S> <C> <C>
Total income taxes charged to income .................. $62,966 $99,189
----------------------
Income taxes charged (credited) to stockholders' equity:
Unrealized gains (losses) on bonds ................... 45,192 (28,108)
Other ................................................ (5,566) (2,282)
----------------------
Total charged (credited) to stockholders' equity .... 39,626 (30,390)
----------------------
Total effect of income taxes ........................... $102,592 $68,799
- ---------------------------------------------------------------------------------
</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:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
1997 % 1996 % 1995 %
<S> <C> <C> <C> <C> <C> <C>
Computed expected
tax at statutory rate .................. $100,099 35.0% $131,427 35.0% $74,961 35.0%
Reductions in expected tax resulting from:
Tax-exempt interest ...................... (35,682) (12.5) (30,760) (8.2) (28,379) (13.3)
Other, net ............................... (1,451) (0.5) (1,478) (0.4) (3) --
------------------------------------------------------------
Income tax expense ....................... $62,966 22.0% $99,189 26.4% $46,579 21.7%
- ----------------------------------------------------------------------------------------------------------
</TABLE>
41
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to significant
portions of the deferred tax liabilities and deferred tax assets at December 31,
1997 and 1996 are presented below:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax liabilities:
Contingency reserve ............................ $115,360 $76,805
Unrealized gains on bonds ...................... 75,342 30,150
Deferred acquisition costs ..................... 38,030 32,974
Unearned premiums .............................. 35,679 28,060
Investments .................................... 1,491 60
Other .......................................... 2,026 1,250
-----------------------
Total deferred tax liabilities ................ 267,928 169,299
-----------------------
Deferred tax assets:
Tax and loss bonds ............................. 87,951 63,871
Loss reserves .................................. 17,182 13,512
Alternative minimum tax carryforward ........... 14,049 --
Amortization and depreciation .................. 6,032 4,836
Compensation ................................... 4,030 2,884
Other .......................................... 3,456 4,110
-----------------------
Sub-total deferred tax assets ................. 132,700 89,213
Valuation allowance ............................ -- --
-----------------------
Total deferred tax assets ..................... 132,700 89,213
-----------------------
Net deferred tax liabilities .................. $135,228 $80,086
- --------------------------------------------------------------------------------
</TABLE>
The Company believes that no valuation allowance is necessary in connection
with the deferred tax assets.
11 EMPLOYEE BENEFITS
PENSIONS:
The Company has a defined benefit pension plan covering substantially all
employees of the Company and most of 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 table
below sets forth the plan's funded status and amounts recognized by the Company
as of December 31, 1997 and 1996.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
1997 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
Accumulated benefit obligation,
including vested benefits of
$7,192 and $6,282, respectively .................... $(7,956) $(6,979)
---------------------
Projected benefit obligation for
service rendered to date ........................... (9,374) (8,189)
Plan assets at fair value, primarily
listed stocks, commingled funds
and fixed income securities ........................ 9,644 8,153
---------------------
Funded/unfunded projected benefit .................... 270 (36)
Unrecognized prior service cost ...................... (1,454) (1,619)
Unrecognized net loss ................................ 62 885
Unrecognized net transition asset .................... (7) (9)
---------------------
Pension liability included in other liabilities ...... $(1,129) $(779)
- -------------------------------------------------------------------------------
</TABLE>
Net pension costs for 1997, 1996 and 1995 included the following
components:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
1997 1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost ......................... $723 $674 $541
Interest cost on expected
benefit obligation ................. 601 539 456
Actual return on plan assets ......... (1,606) (957) (1,333)
Net amortization and deferral ........ 770 263 760
----------------------------------
Net periodic pension cost ............ $488 $519 $424
- -------------------------------------------------------------------------------
</TABLE>
The weighted average discount rate used in the determination of the
actuarial present value for the projected benefit obligation was 7.25% and 7.50%
for 1997 and 1996, respectively. The expected long-term rate of return on assets
was 9.25% for both 1997 and 1996. The rate of increase in future compensation
levels used in determining the actuarial present value of the projected benefit
obligation was 4.8 % and 5.0% for 1997 and 1996, respectively.
Upon the acquisition of CLIC, the Company assumed the liability for its two
terminated pension plans. Those plans had unfunded projected benefit obligations
of approximately $800, which is included in other liabilities at December 31,
1997.
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 eligible employee's base
salary, plus a matching company contribution of 50% on contributions up to 6% of
base salary, subject to Internal Revenue Code limitations, made by eligible
employees to the plan. The total cost of the Savings Incentive Plan was $1,806,
$1,680 and $1,555 in 1997, 1996 and 1995, respectively.
42
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
ANNUAL INCENTIVE PROGRAM:
The Company has an annual incentive program which provides for awards to key
officers and employees based upon predetermined criteria. The cost of the
program for the years ended December 31, 1997, 1996 and 1995 amounted to
$12,038, $10,822 and $8,860, respectively.
POSTRETIREMENT HEALTH CARE AND OTHER BENEFITS:
Ambac Assurance provides certain medical and life insurance benefits for retired
employees and eligible dependents. All plans are contributory. None of the plans
are currently funded.
Postretirement benefits expense was $262, $220 and $168 in 1997, 1996 and
1995, respectively. The unfunded accumulated postretirement benefit obligation
was $2,064 and the accrued postretirement liability was $1,719 as of December
31, 1997.
The assumed weighted average health care cost trend rates range from 9.0%
in 1997, decreasing ratably to 6.0% in 2002, 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, 1997 by $172 and the 1997 benefit expense by $48. The
weighted average discount rate used to measure the accumulated postretirement
benefit obligation and 1997 expense was 7.25%.
12 INSURANCE IN FORCE
The par amount of bonds insured, net of reinsurance, was $165,601,000 and
$131,497,000 at December 31, 1997 and 1996, respectively. As of December 31,
1997 and 1996, the insured portfolio was diversified by type of insured bond as
shown in the following table:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
NET PAR AMOUNT OUTSTANDING
- --------------------------------------------------------------------------------
(DOLLARS IN MILLIONS) 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Municipal finance:
General obligation ............................. $36,324 $31,863
Lease and tax-backed revenue ................... 30,980 25,366
Utility revenue ................................ 24,913 22,780
Health care revenue ............................ 18,545 13,521
Transportation revenue ......................... 7,370 6,891
Higher education ............................... 6,852 4,745
Investor-owned utilities ....................... 6,255 5,492
Housing revenue ................................ 6,064 4,497
Student loans .................................. 3,516 3,439
Other .......................................... 597 484
----------------------
Total municipal finance ....................... 141,416 119,078
----------------------
Domestic structured finance:
Mortgage-backed and home equity ................ 11,620 5,263
Commercial asset-backed ........................ 4,538 1,329
Other consumer asset-backed .................... 1,514 1,126
Banks/financial institutions ................... 524 214
Other .......................................... 439 159
----------------------
Total domestic structured finance ............. 18,635 8,091
----------------------
Total domestic ................................ 160,051 127,169
----------------------
International finance:
Commercial asset-backed ........................ 2,600 2,530
Sovereign/sub-sovereign ........................ 981 631
Mortgage-backed and home equity ................ 496 265
Utilities ...................................... 456 131
Banks/financial institutions ................... 283 346
Other .......................................... 734 425
----------------------
Total international finance ................... 5,550 4,328
----------------------
$165,601 $131,497
- --------------------------------------------------------------------------------
</TABLE>
As of December 31, 1997 and 1996, the international insured portfolio by
geographic area is shown in the following table:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
NET PAR AMOUNT OUTSTANDING
- --------------------------------------------------------------------------------
(DOLLARS IN MILLIONS) 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
International:
France ....................................... $1,032 $1,025
Japan ........................................ 879 645
United Kingdom ............................... 865 569
Italy ........................................ 555 423
Spain ........................................ 380 130
Internationally diversified .................... 899 985
Other international ............................ 940 551
----------------------
$5,550 $4,328
- --------------------------------------------------------------------------------
</TABLE>
43
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
As of December 31, 1997, California was the state with the highest
aggregate net par amount in force, accounting for 11.8% of the total. The
highest single insured risk represented less than 1% of aggregate net par amount
insured. Direct insurance in force (principal and interest) was $321,104,000 and
$268,870,000 at December 31, 1997 and 1996, respectively. Net insurance in force
(after giving effect to reinsurance) was $275,931,000 and $227,235,000 as of
December 31, 1997 and 1996, respectively.
13 FINANCIAL INSTRUMENTS HELD FOR PURPOSES OTHER THAN TRADING
DERIVATIVE FINANCIAL INSTRUMENTS:
In the normal course of business, the Company becomes a party to various
financial instruments to reduce its exposure to fluctuations in interest rates.
These financial instruments include interest rate swaps, exchange traded futures
contracts and purchased interest rate options. The notional amounts of these
financial instruments were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AS OF DECEMBER 31, 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Derivative financial instruments
with off balance sheet risk:
Interest rate futures contracts ............ $3,689,100 $1,569,800
Interest rate swaps ........................ 712,206 689,023
Other:
Purchased interest rate options ............ 85,500 32,200
- --------------------------------------------------------------------------------
</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.
RISK MANAGEMENT:
In the ordinary course of business, the Company, through its affiliates, manages
a variety of risks, principally market, credit, 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.
Market risk generally represents the risk of loss that may result from the
potential change in the fair value of a financial instrument as a result of
changes in prices or interest rates. The principal market risk for financial
instruments held for purposes other than trading 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 nonparallel shifts in the yield curve. These models include
estimates made by management and the valuation results could differ materially
from amounts that would actually be realized in the market.
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 $3,000 and
$2,000 as of December 31, 1997 and 1996, 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 investment agreements and interest rate
swaps. These include the initial credit approval process, minimum 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.
Liquidity risk relates to the possible inability to satisfy contractual
obligations when due. This risk is present in investment agreements, interest
rate swaps and futures contracts. The investment agreement business manages
liquidity risk by matching the effective duration of its invested assets,
including hedges, with the effective duration of its investment agreement
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
investment agreement 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
44
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
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 and purchased option
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.
Futures contracts are purchased to hedge interest rate risk inherent in
fixed rate liabilities. Futures contracts are sold to hedge interest rate risk
inherent in fixed rate investment securities. Interest rate option contracts are
purchased to hedge interest rate risk inherent in fixed rate assets and
liabilities. At December 31, 1997 and 1996, futures and purchased option
contracts with an outstanding notional of $627,000 and $1,109,100, respectively,
were designated as hedges of fixed rate liabilities. Additionally, at December
31, 1997 and 1996, futures and purchased option contracts with an outstanding
notional of $3,147,600 and $492,900, respectively, were designated as hedges of
fixed rate investment securities.
Interest rate swaps which require the Company to pay a fixed rate are used
primarily to hedge fixed rate investment securities. Interest rate swaps which
require the Company to receive a 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,
- -------------------------------------------------------------------------------------------------------------
THERE-
1998 1999 2000 2001 2002 AFTER
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Pay fixed swaps:
Notional amount .. $226,528 $299,775 $202,368 $161,145 $173,144 $58,217
Weighted-average
fixed rate ...... 6.05% 6.98% 7.02% 6.93% 6.93% 7.06%
Receive fixed swaps:
Notional amount .. $138,556 $137,922 $137,271 $136,602 $135,913 $20,756
Weighted-average
fixed rate ...... 6.45% 6.45% 6.45% 6.45% 6.45% 7.06%
Range of
implied floating
interest rates.... 5.86% to 5.94% to 5.95% to 6.04% to 6.13% to
6.01% 6.11% 6.16% 6.22% 6.22%
- -------------------------------------------------------------------------------------------------------------
</TABLE>
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, 1997.
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 fixed income investments 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.
Preferred stock: The fair value of preferred stock is based on an evaluation of
the underlying company and recent transactions in such preferred stock.
Securities purchased under agreements to resell: The fair value of securities
purchased under agreements to resell is assumed to approximate carrying value.
Debentures: The fair value of the debentures is based on quoted market prices
and dealer quotes.
Obligations under investment, repurchase and payment agreements (including
accrued interest): The fair value of the liability for investment agreements and
repurchase agreements (including accrued interest) is estimated based upon
valuation models using rates currently offered for contracts of similar
maturities.
Derivative contracts: Fair values of derivative contracts (futures, swaps and
interest rate options) are based on quoted market prices and dealer quotes,
current settlement values, or pricing models.
45
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
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 Assurance's liability under its installment premium
policies is measured using the present value of estimated future installment
premiums, less an assumed 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 Assurance's liability under these
policies.
The carrying amount and estimated fair value of financial instruments held
for purposes other then trading are presented below:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
AS OF DECEMBER 31, 1997 1996
- --------------------------------------------------------------------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
(DOLLARS IN MILLIONS) AMOUNT VALUE AMOUNT VALUE
<S> <C> <C> <C> <C>
Financial assets:
Fixed income securities ................... $6,774 $6,774 $5,088 $5,088
Short-term investments .................... 136 136 113 113
Preferred stock ........................... 5 5 -- --
Cash ...................................... 9 9 8 8
Securities purchased under
agreements to resell .................... 85 85 201 201
Financial liabilities:
Debentures ................................ 224 269 224 259
Obligations under investment,
repurchase and
payment agreements
(including accrued interest) ............ 4,367 4,405 2,778 2,775
Derivative financial instruments:
Interest rate futures contracts ........... (2) -- -- --
Interest rate swaps ....................... (9) (7) -- (1)
Purchased interest rate
option contracts ........................ -- -- -- --
Liability for financial guarantees written:
Gross ................................... 1,179 855 991 719
Net of reinsurance ...................... 995 722 822 596
Net installment premiums ................ -- 153 -- 114
- -------------------------------------------------------------------------------------
</TABLE>
14 FINANCIAL INSTRUMENTS HELD FOR
TRADING PURPOSES
AFSLP is a provider of interest rate swaps to states, municipalities and their
authorities and other entities in connection with their financings. AFSLP
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 tax-exempt and floating taxable interest rates. If actual or projected
floating tax-exempt interest rates change in relation to floating taxable rates,
the Company will experience an unrealized mark-to-market gain or loss. The AFSLP
swap portfolio is considered held for trading purposes.
In the ordinary course of business, AFSLP manages a variety of risks,
principally market, credit, 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. Qualitative
factors relating to credit, operational and legal risks for financial
instruments held for trading purposes are similar to those risks as described in
Note 13.
Market risk relates to the impact of price changes on future earnings. This
risk is a consequence of AFSLP's market-making activities in the interest rate
swap market. The principal market risk is basis risk, the relationship between
changes in floating tax-exempt and floating taxable interest rates. Since late
1995, most interest rate swaps transacted contain provisions which are designed
to protect AFSLP 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.
As discussed in Note 13, credit risk is calculated based on the current
replacement cost or fair value of the Company's financial instruments. The gross
replacement 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 $66,000 and
$42,000 as of December 31, 1997 and 1996, respectively.
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.
46
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
The following table summarizes information about the Company's financial
instruments held for trading purposes as of December 31, 1997 and 1996:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------
NET ESTIMATED AVERAGE NET
FAIR VALUE FAIR VALUE NOTIONAL
ASSETS LIABILITIES ASSETS LIABILITIES AMOUNT
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997:
Derivative financial instruments:
Interest rate swaps ........... $67,743 $49,265 $43,748 $33,954 $3,347,190
Futures contracts ............. -- -- -- -- 514,900
Other financial instruments ..... 183,041 181,732 160,251 159,213 --
1996:
Derivative financial instruments:
Interest rate swaps ........... $42,030 $29,897 $44,241 $37,451 $2,341,660
Futures contracts ............. -- -- -- -- 484,500
Other financial instruments ..... -- -- -- -- --
- --------------------------------------------------------------------------------------------------
</TABLE>
Financial instruments held for trading purposes are carried at estimated
fair value. The aggregate amount of net trading income recognized from
derivative financial instruments held for trading purposes was $7,454, $10,579
and $2,871 for 1997, 1996 and 1995, respectively. Other financial instruments
held for trading purposes consist of fixed income securities. The aggregate
amount of net trading income recognized from other financial instruments was
$1,309 for 1997. Average net fair values were calculated based on average daily
net fair values. 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.
15 LONG-TERM DEBT AND LINES OF CREDIT
The carrying value of long-term debt was as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AS OF DECEMBER 31, 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
9 3/8% Debentures, due 2011 ................... $149,389 $149,344
7 1/2% Debentures, due 2023 ................... 74,475 74,454
-------------------------
$223,864 $223,798
- --------------------------------------------------------------------------------
</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 and Ambac Assurance maintain a three-year revolving credit
facility with two major international banks, as co-agents, for $100,000. As of
December 31, 1997 and 1996, no amounts were outstanding under this credit
facility, which expires in July 1998.
Ambac Assurance has an agreement with a group of AAA/Aaa-rated
international banks for a $450,000 credit facility, expiring in 2004. This
facility is a seven-year stand-by irrevocable limited recourse line of credit,
which was increased from $350,000 to $450,000 and extended for an additional
year in December 1997. The line will provide liquidity to Ambac Assurance 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, 1997 and
1996, no amounts were outstanding under this line.
Connie Lee has an agreement with commercial banks for a $50,000 stand-by
credit facility, expiring in 2003. The line will provide a source of additional
claims-paying resources for insured transactions. The obligation to repay is a
limited recourse obligation payable solely from, and collateralized by, a pledge
of recoveries realized on defaulted insured obligations including installment
premiums and other collateral. As of December 31, 1997 and 1996, no amounts were
outstanding under this line.
47
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
16 OBLIGATIONS UNDER INVESTMENT AGREEMENTS
AND PAYMENT AGREEMENTS
Obligations under investment agreements, 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, 1997 and 1996, the interest rates on these
agreements ranged from 4.23% to 8.14% for each year. The average yield on these
agreements for the years ended December 31, 1997 and 1996, were 5.85% and 5.87%,
respectively. As of December 31, 1997 and 1996, obligations under investment
agreements and investment repurchase agreements were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AS OF DECEMBER 31, 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Settled .............................. $3,817,772 $2,721,291
Unsettled ............................ -- 33,299
-------------------------------
$3,817,772 $2,754,590
- --------------------------------------------------------------------------------
</TABLE>
Net payments due under settled investment agreements 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>
1998 .............................................................. $1,463,194
1999 .............................................................. 1,120,315
2000 .............................................................. 410,454
2001 .............................................................. 202,237
2002 .............................................................. 33,677
All later years ................................................... 587,895
----------
$3,817,772
- --------------------------------------------------------------------------------
</TABLE>
Obligations under payment agreements represent funds received by the
Company from certain municipal customers. These funds serve as collateral for
loans extended by the Company in connection with certain structured municipal
transactions. In connection with these transactions, the Company is obligated to
make periodic agreed upon payments. As of December 31, 1997, the interest rates
on these obligations ranged from 6.25% to 8.42%. Net payments due under payment
agreements in each of the next five years ending December 31, and the periods
thereafter, based on contractual payment dates, are as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
PRINCIPAL
AMOUNT
- --------------------------------------------------------------------------------
<S> <C>
1998 ................................................................ $ 8,219
1999 ................................................................ 10,157
2000 ................................................................ 10,169
2001 ................................................................ 13,323
2002 ................................................................ 11,220
All later years ..................................................... 450,104
--------
$503,192
- --------------------------------------------------------------------------------
</TABLE>
17 COMMON STOCK INCENTIVES
The Company's stock incentive plan for officers and other key employees, the
Ambac 1997 Equity Plan (the "1997 Plan"), provides for the granting of stock
options, stock appreciation rights, restricted stock units, performance units
and other awards that are valued or determined by reference to the Common Stock.
The 1997 Plan was approved by the stockholders of the Company in 1997 and
replaces the 1991 Stock Incentive Plan, under which no further awards will be
made. Stock options awarded to employees are exercisable and expire as specified
at the time of grant and generally may not have a per share exercise price less
than the fair market value of a share of Common Stock on the date of grant or a
term in excess of ten years from the date of the grant. The Company also
maintains the Ambac 1997 Non-Employee Directors Equity Plan ("The Directors
Plan"), which provides awards of stock options and restricted stock units to
non-employee members of the Company's Board of Directors. The number of options
and their exercise price, and the number of restricted stock units, awarded to
each non-employee director under the Directors Plan is determined by formula. As
of December 31, 1997, approximately 6,500,000 shares were available for future
grant under the 1997 Plan and the Directors Plan.
A summary of option activity is as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
1997 1996 1995
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 4,248,642 $19.37 4,140,824 $18.17 3,400,240 $17.30
Granted ........... 859,800 $33.59 964,150 $24.25 1,023,290 $19.79
Exercised ......... (898,942) $19.05 (721,724) $18.53 (242,496) $12.39
Forfeited ......... (291,807) $24.99 (134,608) $21.87 (40,210) $20.79
--------- --------- ---------
Outstanding at
end of year ..... 3,917,693 $22.15 4,248,642 $19.37 4,140,824 $18.17
--------- --------- ---------
Exercisable ....... 2,392,853 2,407,838 2,282,490
- -------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
WEIGHTED WEIGHTED WEIGHTED
RANGE OF NUMBER AVERAGE AVERAGE NUMBER AVERAGE
EXERCISE OUTSTANDING AT REMAINING EXERCISE EXERCISABLE AT EXERCISE
PRICES DECEMBER 31, 1997 CONTRACT LIFE PRICE DECEMBER 31, 1997 PRICE
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$10 to 20 1,481,674 5.2 $15.02 1,265,183 $14.20
$21 to 25 1,647,479 5.4 $23.07 1,124,337 $22.54
$30 to 42 788,540 6.1 $33.60 3,333 $30.88
3,917,693 2,392,853
- ---------------------------------------------------------------------------------------
</TABLE>
48
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
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,
earnings per share and earnings per diluted share for the years ended December
31, 1997, 1996 and 1995, would have been reduced to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Income:
As reported ..................... $223,030 $276,317 $167,595
Pro forma ....................... $218,852 $273,528 $166,080
Earnings per share:
As reported ..................... $3.19 $3.95 $2.39
Pro forma ....................... $3.13 $3.91 $2.37
Earnings per diluted share:
As reported ..................... $3.13 $3.91 $2.37
Pro forma ....................... $3.07 $3.87 $2.34
- --------------------------------------------------------------------------------
</TABLE>
The weighted-average fair value (determined as of the date of the grants)
of options granted in 1997, 1996 and 1995 was $9.85 per share, $6.19 per share,
and $6.40 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 1997,
1996 and 1995, respectively: dividend yield of 1.08%, 1.24% and 1.18%; expected
volatility of 19.4%, 16.5% and 20.0%; risk-free interest rates of 6.4%, 6.2% and
7.2%; and expected lives of 6 years, 5 years and 6 years. The pro forma amounts
disclosed above are not likely to be representative of the effects of reported
pro forma net income for future years because options vest over several years
and additional awards are granted each year.
18 SEGMENT INFORMATION
As of December 31, 1997, the Company's products are reported in two industry
segments, as follows:
Financial guarantee insurance includes insurance of municipal and
structured finance obligations.
Financial management services includes the issuance of investment
agreements, interest rate swaps, investment advisory and management services,
and electronic commerce solutions, principally to states, municipalities and
their authorities, school districts, and hospitals and health organizations.
The following table is a summary of the operations by operating segment for
the years ended December 31, 1997, 1996 and 1995:
49
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
FINANCIAL FINANCIAL ADJUSTMENTS
GUARANTEE MANAGEMENT CORPORATE AND
INSURANCE SERVICES AND OTHER ELIMINATIONS CONSOLIDATED
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997:
Revenues:
Unaffiliated customers .................. $ 339,195 $ 34,612 $ 7,955 $ -- $ 381,762
Intersegment ............................ 1,857 (194) 44,068 (45,731) --
----------------------------------------------------------------------------------
Total revenues ............................. $ 341,052 $ 34,418 $ 52,023 $ (45,731) $ 381,762
----------------------------------------------------------------------------------
Income before income taxes:
Unaffiliated customers .................. $ 295,669 $ 6,619 $ (16,292) $ -- $ 285,996
Intersegment ............................ 1,736 (1,031) 44,068 (44,773) --
----------------------------------------------------------------------------------
Total income before income taxes ........... $ 297,405 $ 5,588 $ 27,776 $ (44,773) $ 285,996
----------------------------------------------------------------------------------
Identifiable assets ........................ $ 3,392,333 $ 4,763,534 $ 93,855 $ -- $ 8,249,722
----------------------------------------------------------------------------------
1996:
Revenues:
Unaffiliated customers .................. $ 266,300 $ 22,366 $ 164,242 $ -- $ 452,908
Intersegment ............................ 1,728 (810) 159,883 (160,801) --
----------------------------------------------------------------------------------
Total revenues ............................. $ 268,028 $ 21,556 $ 324,125 $ (160,801) $ 452,908
----------------------------------------------------------------------------------
Income before income taxes:
Unaffiliated customers .................. $ 225,340 $ 10,326 $ 139,840 $ -- $ 375,506
Intersegment ............................ 1,728 (980) 159,883 (160,631) --
----------------------------------------------------------------------------------
Total income before income taxes ........... $ 227,068 $ 9,346 $ 299,723 $ (160,631) $ 375,506
----------------------------------------------------------------------------------
Identifiable assets ........................ $ 2,886,657 $ 2,861,527 $ 128,174 $ -- $ 5,876,358
----------------------------------------------------------------------------------
1995:
Revenues:
Unaffiliated customers .................. $ 248,626 $ 13,009 $ 20,624 $ -- $ 282,259
Intersegment ............................ 1,798 (2,187) 40,292 (39,903) --
----------------------------------------------------------------------------------
Total revenues ............................. $ 250,424 $ 10,822 $ 60,916 $ (39,903) $ 282,259
----------------------------------------------------------------------------------
Income before income taxes:
Unaffiliated customers .................. $ 210,799 $ 5,216 $ (1,841) $ -- $ 214,174
Intersegment ............................ 1,549 (2,610) 40,268 (39,207) --
----------------------------------------------------------------------------------
Total income before income taxes ........... $ 212,348 $ 2,606 $ 38,427 $ (39,207) $ 214,174
----------------------------------------------------------------------------------
Identifiable assets ........................ $ 2,741,426 $ 2,533,743 $ 34,110 $ -- $ 5,309,279
----------------------------------------------------------------------------------
</TABLE>
50
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
19 QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
FIRST SECOND THIRD FOURTH FULL YEAR
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997
Gross premiums written ......................... $51,792 $73,740 $52,371 $108,260 $286,163
Net premiums written ........................... 46,360 66,545 45,876 94,930 253,711
Net premiums earned ............................ 37,033 36,386 35,672 44,909 154,000
Net investment income .......................... 38,447 39,258 40,109 41,895 159,709
Financial management services income ........... 7,222 6,150 9,062 12,815 35,249
Losses and loss adjustment expenses ............ 728 664 730 732 2,854
Financial guarantee underwriting and
operating expenses .......................... 9,092 9,732 10,173 11,675 40,672
Financial management services expenses ......... 8,980 5,474 5,751 7,788 27,993
Income before income taxes ..................... 62,396 67,836 79,637 76,127 285,996
Net income ..................................... 49,738 53,613 60,795 58,884 223,030
Net income per share(1) ........................ 0.71 0.77 0.87 0.84 3.19
Net income per diluted share ................... $0.70 $0.75 $0.85 $0.83 $3.13
------------------------------------------------------------------------
1996
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
Financial management services income ........... 7,011 5,114 4,034 5,814 21,973
Other net realized gains ....................... -- 155,613 -- 700 156,313
Losses and loss adjustment expenses ............ 810 1,700 1,301 (33) 3,778
Financial guarantee underwriting and
operating expenses .......................... 8,748 10,351 8,646 9,437 37,182
Financial management services expenses ......... 2,136 2,358 3,073 4,473 12,040
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 share(1) ........................ 0.64 1.95 0.63 0.74 3.95
Net income per diluted share ................... $0.63 $1.92 $0.62 $0.73 $3.91
------------------------------------------------------------------------
</TABLE>
(1) Net income per share has been retroactively adjusted to reflect the
two-for-one stock split which occurred in September 1997.
51
- --------------------------------------------------------------------------------
<PAGE>
-------------------------------
STOCKHOLDER INFORMATION
-------------------------------
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CORPORATE OTHER LOCATIONS: ANNUAL MEETING OF TRANSFER AGENT,
HEADQUARTERS AUSTRALIA: STOCKHOLDERS REGISTRAR AND DIVIDEND
PAYING AGENT
Ambac Financial Group, Inc. Level 29, The Chifley Tower The Annual Meeting of
One State Street Plaza 2 Chiefly Square, Sydney Stockholders of Ambac Financial Citibank, N.A.
New York, New York 10004 NSW 2000, Australia Group, Inc. will be held on 111 Wall Street, 5th Floor
212-668-0340 61 2 9375 2117 Wednesday, May 13, 1998, at 11:30 New York, New York 10043
fax 212-509-9190 a.m. in New York City. Detailed 212-657-5997
www.ambac.com FRANCE: information about the meeting is
contained in the Notice of Annual INDEPENDENT AUDITORS
CADRE FINANCIAL Citicenter Meeting and Proxy Statement to be
SERVICES, INC. 19, le Parvis sent to each stockholder of KPMG Peat Marwick LLP
92073 Paris la Defense record as of March 23, 1998. The New York, New York
905 Marconi Avenue Cedex 37, France Company estimates that it has
Ronkonkoma, New York 11779 330146939364 approximately 15,000 STOCK LISTING
516-467-0200 stockholders.
SPAIN: Ambac Financial Group, Inc. common
AMBAC CONNECT, INC. FORM 10-K stock is listed on the New York
Serrano, 20-2 Dcha Stock Exchange (ticker symbol
9130 Jollyville Road, Suite 355 28001 Madrid, Spain A copy of the Company's 1997 ABK). The Company is listed in
Austin, Texas 78759 3414316881 Annual Report on Form 10-K for the daily stock tables under
512-338-0091 the year ended December 31, 1997, "Ambac."
UK: as filed with the Securities and
MBIA-AMBAC Exchange Commission, may be INVESTOR RELATIONS
INTERNATIONAL St. Helen's, One Undershaft obtained without charge by
JOINT VENTURE OFFICES: London EC3A 8JL, England writing to: Ambac Financial 1-800-221-1854
44 171-444-7200 Group, Inc., Attn: Investor E-mail: [email protected]
One State Street Plaza Relations One State Street Plaza Frank J. Bivona
New York, New York 10004 New York, New York 10004 Executive Vice President,
212-668-0304 Chief Financial Officer
and Treasurer
113 King Street 212-208-3236
Armonk, New York 10504
914-273-4545 Brian S. Moore
Managing Director
212-208-3333
</TABLE>
COMMON STOCK DATA
The table below shows the high and low price per share for each quarter of 1997
and 1996, as adjusted for the two-for-one common stock split, which occurred in
September 1997.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
1997 Market Price 1996 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 .............. $37 $31 5/8 $32 1/4 $0.0825 $24 3/4 $22 3/4 $24 1/16 $0.0750
June 30 ............... 42 1/4 31 38 3/16 0.0825 27 5/8 23 5/8 26 1/16 0.0750
September 30 .......... 42 15/16 38 1/4 40 11/16 0.0900 29 3/16 23 1/2 27 7/8 0.0750
December 31 ........... 47 9/16 40 46 0.0900 34 3/4 27 7/8 33 3/16 0.0825
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------
</TABLE>
52
- --------------------------------------------------------------------------------
<PAGE>
List of Subsidiaries of Ambac Financial Group,Inc.
--------------------------------------------------
The following is a list of significant and other subsidiaries of Ambac
Financial Group, Inc. The state of incorporation of each subsidiary is included
in parentheses after its name.
AMBAC ASSURANCE CORPORATION (Wisconsin)
AMBAC CAPITAL CORPORATION (Delaware)
AMBAC CAPITAL MANAGEMENT, INC. (Delaware)
AMBAC INVESTMENTS, INC. (Delaware)
AMBAC FINANCIAL SERVICES HOLDINGS, INC. (Delaware)
AMBAC FINANCIAL SERVICES, L.P. (Delaware)
<PAGE>
(EXHIBIT 24.01)
AMBAC FINANCIAL GROUP, INC.
Power of Attorney
-----------------
KNOW ALL MEN BY THESE PRESENTS that the undersigned director and
officer of Ambac Financial Group, 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, 1997, 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 9th day of March, 1998.
/s/ Phillip B. Lassiter
--------------------------
Phillip B. Lassiter
<PAGE>
(EXHIBIT 24.02)
AMBAC FINANCIAL GROUP, INC.
Power of Attorney
-----------------
KNOW ALL MEN BY THESE PRESENTS that the undersigned officer of Ambac
Financial Group, Inc., a Delaware corporation, hereby constitutes and appoints
each of RICHARD B. GROSS and ANNE G. GILL, 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, 1997, 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 9th day of March, 1998.
/s/ Frank J. Bivona
--------------------
Frank J. Bivona
<PAGE>
(EXHIBIT 24.03)
AMBAC FINANCIAL GROUP, INC.
Power of Attorney
-----------------
KNOW ALL MEN BY THESE PRESENTS that the undersigned director of
Ambac Financial Group, 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, 1997, 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 12th day of March, 1998.
/s/ Michael A. Callen
----------------------
Michael A. Callen
<PAGE>
(EXHIBIT 24.04)
AMBAC FINANCIAL GROUP, INC.
Power of Attorney
-----------------
KNOW ALL MEN BY THESE PRESENTS that the undersigned director of
Ambac Financial Group, 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, 1997, 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 5th day of March, 1998.
/s/ Renso L. Caporali
----------------------
Renso L. Caporali
<PAGE>
(EXHIBIT 24.05)
AMBAC FINANCIAL GROUP, INC.
Power of Attorney
-----------------
KNOW ALL MEN BY THESE PRESENTS that the undersigned director of
Ambac Financial Group, 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, 1997, 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 9th day of March, 1998.
/s/ Richard Dulude
-------------------
Richard Dulude
<PAGE>
(EXHIBIT 24.06)
AMBAC FINANCIAL GROUP, INC.
Power of Attorney
-----------------
KNOW ALL MEN BY THESE PRESENTS that the undersigned director of
Ambac Financial Group, 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, 1997, 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 10th day of March, 1998.
/s/ W. Grant Gregory
---------------------
W. Grant Gregory
<PAGE>
(EXHIBIT 24.07)
AMBAC FINANCIAL GROUP, INC.
Power of Attorney
-----------------
KNOW ALL MEN BY THESE PRESENTS that the undersigned director of
Ambac Financial Group, 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, 1997, 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 8th day of March, 1998.
/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-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 6,773,844
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 5,000
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 6,915,122
<CASH> 9,256
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 105,996
<TOTAL-ASSETS> 8,249,722
<POLICY-LOSSES> 103,345
<UNEARNED-PREMIUMS> 1,178,990
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 223,864
0
0
<COMMON> 707
<OTHER-SE> 1,871,775
<TOTAL-LIABILITY-AND-EQUITY> 8,249,722
154,000
<INVESTMENT-INCOME> 159,709
<INVESTMENT-GAINS> 21,195
<OTHER-INCOME> 4,402
<BENEFITS> 2,854
<UNDERWRITING-AMORTIZATION> 40,672
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 285,996
<INCOME-TAX> 62,966
<INCOME-CONTINUING> 223,030
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 223,030
<EPS-PRIMARY> 3.19
<EPS-DILUTED> 3.13
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1995
<PERIOD-START> JAN-01-1996 JAN-01-1995
<PERIOD-END> DEC-31-1996 DEC-31-1995
<DEBT-HELD-FOR-SALE> 5,088,031 4,264,904
<DEBT-CARRYING-VALUE> 0 0
<DEBT-MARKET-VALUE> 0 0
<EQUITIES> 0 0
<MORTGAGE> 0 0
<REAL-ESTATE> 0 0
<TOTAL-INVEST> 5,200,542 4,441,593
<CASH> 7,734 12,167
<RECOVER-REINSURE> 0 0
<DEFERRED-ACQUISITION> 94,212 82,620
<TOTAL-ASSETS> 5,876,358 5,309,279
<POLICY-LOSSES> 60,613 65,996
<UNEARNED-PREMIUMS> 991,224 903,026
<POLICY-OTHER> 0 0
<POLICY-HOLDER-FUNDS> 0 0
<NOTES-PAYABLE> 223,798 223,732
0 0
0 0
<COMMON> 353 353
<OTHER-SE> 1,614,663 1,403,635
<TOTAL-LIABILITY-AND-EQUITY> 5,876,358 5,309,279
136,629 111,820
<INVESTMENT-INCOME> 144,941 131,049
<INVESTMENT-GAINS> 136,175 19,163
<OTHER-INCOME> 5,261 5,580
<BENEFITS> 3,778 3,377
<UNDERWRITING-AMORTIZATION> 37,182 34,450
<UNDERWRITING-OTHER> 0 0
<INCOME-PRETAX> 375,506 214,174
<INCOME-TAX> 99,189 46,579
<INCOME-CONTINUING> 276,317 167,595
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 276,317 167,595
<EPS-PRIMARY> 3.95 2.39
<EPS-DILUTED> 3.91 2.37
<RESERVE-OPEN> 0 0
<PROVISION-CURRENT> 0 0
<PROVISION-PRIOR> 0 0
<PAYMENTS-CURRENT> 0 0
<PAYMENTS-PRIOR> 0 0
<RESERVE-CLOSE> 0 0
<CUMULATIVE-DEFICIENCY> 0 0
</TABLE>
<PAGE>
Exhibit 99.01
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF AMBAC FINANCIAL GROUP, INC.)
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
<PAGE>
Independent Auditors' Report
The Board of Directors
Ambac Assurance Corporation
We have audited the accompanying consolidated balance sheets of Ambac
Assurance Corporation and subsidiaries (a wholly owned subsidiary of Ambac
Financial Group, Inc.) as of December 31, 1997 and 1996, and the related
consolidated statements of operations, stockholder's equity and cash flows for
each of the years in the three-year period ended December 31, 1997. These
consolidated financial statements are the responsibility of Ambac Assurance
Corporation'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
Assurance Corporation and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997 in conformity with generally accepted
accounting principles.
New York, New York
January 29, 1998
<PAGE>
Ambac Assurance Corporation and Subsidiaries
Consolidated Balance Sheets
December 31, 1997 and 1996
(Dollars in Thousands Except Share Data)
<TABLE>
<CAPTION>
1997 1996
------------------ -------------------
<S> <C> <C>
ASSETS
------
Investments:
Fixed income securities, at fair value
(amortized cost of $2,696,603 in 1997 and $2,323,259 in 1996) $2,878,083 $2,424,524
Short-term investments, at cost (approximates fair value) 116,905 91,320
------------------ -------------------
Total investments 2,994,988 2,515,844
Cash 8,004 5,025
Securities purchased under agreements to resell 2,484 4,369
Receivable for securities sold 24,018 18,462
Investment income due and accrued 49,987 42,263
Deferred acquisition costs 105,996 94,212
Receivable from brokers and dealers 183,041 -
Reinsurance recoverable 4,219 393
Prepaid reinsurance 183,492 168,786
Other assets 48,802 59,544
------------------ -------------------
Total assets $3,605,031 $2,908,898
================== ===================
LIABILITIES AND STOCKHOLDER'S EQUITY
------------------------------------
Liabilities:
Unearned premiums $1,184,537 $995,220
Losses and loss adjustment expenses 103,345 60,613
Ceded reinsurance balances payable 9,258 7,438
Deferred income taxes 122,554 84,842
Current income taxes 19,714 8,974
Accounts payable and other liabilities 69,641 50,244
Payable for securities purchased 195,388 46,246
------------------ -------------------
Total liabilities 1,704,437 1,253,577
------------------ -------------------
Stockholder's equity:
Preferred stock, par value $1,000.00 per share; authorized
shares - 285,000; issued and outstanding shares - none - -
Common stock, par value $2.50 per share; authorized shares
- 40,000,000; issued and outstanding shares - 32,800,000
at December 31, 1997 and December 31, 1996 82,000 82,000
Additional paid-in capital 521,153 515,684
Unrealized gains on investments, net of tax 117,962 65,822
Cumulative translation adjustment 157 -
Retained earnings 1,179,322 991,815
------------------ -------------------
Total stockholder's equity 1,900,594 1,655,321
------------------ -------------------
Total liabilities and stockholder's equity $3,605,031 $2,908,898
================== ===================
</TABLE>
See accompanying Notes to Consolidated Unaudited Financial Statements.
<PAGE>
Ambac Assurance Corporation and Subsidiaries
Consolidated Statements of Operations
(Dollars in Thousands)
<TABLE>
<CAPTION>
Years Ended December 31
-------------------------------------------------
1997 1996 1995
------------ ------------ ------------
Revenues:
<S> <C> <C> <C>
Gross premiums written $289,383 $249,761 $195,033
Ceded premiums written (32,452) (37,793) (28,606)
------------ ------------ ------------
Net premiums written 256,931 211,968 166,427
Increase in unearned premiums, net (101,263) (73,671) (52,844)
------------ ------------ ------------
Net premiums earned 155,668 138,297 113,583
Net investment income 160,088 145,302 131,496
Net realized gains 18,798 69,149 177
Other income 16,661 16,418 6,777
------------ ------------ ------------
Total revenues 351,215 369,166 252,033
------------ ------------ ------------
Expenses:
Losses and loss adjustment expenses 2,854 3,778 3,377
Underwriting and operating expenses 46,769 42,459 38,722
Interest expense 2,293 2,073 1,590
------------ ------------ ------------
Total expenses 51,916 48,310 43,689
------------ ------------ ------------
Income before income taxes 299,299 320,856 208,344
------------ ------------ ------------
Income tax expense:
Current taxes 55,492 68,322 29,085
Deferred taxes 11,702 11,298 14,461
------------ ------------ ------------
Total income taxes 67,194 79,620 43,546
------------ ------------ ------------
Net Income $232,105 $241,236 $164,798
============ ============ ============
</TABLE>
See accompanying Notes to Consolidated Unaudited Financial Statements.
<PAGE>
Ambac Assurance Corporation and Subsidiaries
Consolidated Statements of Stockholder's Equity
(Dollars In Thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Preferred Stock:
Balance at January 1 and December 31 $ - $ - $ -
============ ============ ============
Common Stock:
Balance at January 1 and December 31 $82,000 $82,000 $82,000
============ ============ ============
Additional Paid-in Capital:
Balance at January 1 $515,684 $481,059 $444,258
Capital contributions 1,475 32,500 35,000
Other 3,994 2,125 1,801
------------ ------------ ------------
Balance at December 31 $521,153 $515,684 $481,059
============ ============ ============
Unrealized Gains (Losses) on Investments, Net of Tax:
Balance at January 1 $65,822 $87,112 ($46,087)
Change in unrealized gain (loss) 52,140 (21,290) 133,199
------------ ------------ ------------
Balance at December 31 $117,962 $65,822 $87,112
============ ============ ============
Cumulative Currency Adjustment:
Balance at January 1 $ - $ - $ -
Changes during the year 157 - -
------------ ------------ ------------
Balance at December 31 $157 $ - $ -
============ ============ ============
Retained Earnings:
Balance at January 1 $991,815 $906,536 $781,571
Net income 232,105 241,236 164,798
Dividends declared-common stock (44,000) (155,865) (40,000)
Other (598) (92) 167
------------ ------------ ------------
Balance at December 31 $1,179,322 $991,815 $906,536
============ ============ ============
Total Stockholder's Equity at December 31 $1,900,594 $1,655,321 $1,556,707
============ ============ ============
</TABLE>
See accompanying Notes to Consolidated Unaudited Financial Statements.
<PAGE>
Ambac Assurance Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in Thousands)
<TABLE>
<CAPTION>
Years Ended
December 31,
-------------------------------------------
1997 1996 1995
------------ ------------- ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $232,105 $241,236 $164,798
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,689 1,711 1,605
Amortization of bond premium and discount (1,084) (1,902) (831)
Current income taxes 18,240 11,145 8,373
Deferred income taxes 11,702 11,299 14,462
Deferred acquisition costs (11,784) (11,592) (10,846)
Unearned premiums 101,257 73,671 52,844
Losses and loss adjustment expenses 408 (5,776) 334
Ceded reinsurance balances payable 1,303 (7,216) 13,746
Gain on sales of investments (18,798) (69,149) (177)
Accounts payable and other liabilities 6,670 6,619 106
Other, net 10,992 (17,928) (11,273)
------------ ------------- ------------
Net cash provided by operating activities 352,700 232,118 233,141
------------ ------------- ------------
Cash flows from investing activities:
Proceeds from sales of bonds at amortized cost 1,346,231 1,555,372 1,882,485
Proceeds from maturities of bonds at amortized cost 115,476 86,292 163,031
Purchases of bonds at amortized cost (1,623,486) (1,938,677) (2,192,824)
Change in short-term investments (25,585) 72,633 (78,751)
Securities purchased under agreements to resell 1,885 (249) 3,891
Purchase of affiliate (120,006) - -
Other, net (236) (1,876) (1,178)
------------ ------------- ------------
Net cash used in investing activities (305,721) (226,505) (223,346)
------------ ------------- ------------
Cash flows from financing activities:
Dividends paid (44,000) (40,000) (40,000)
Capital contribution - 32,500 35,000
------------ ------------- ------------
Net cash used in financing activities (44,000) (7,500) (5,000)
------------ ------------- ------------
Net cash flow 2,979 (1,887) 4,795
Cash at January 1 5,025 6,912 2,117
------------ ------------- ------------
Cash at December 31 $8,004 $5,025 $6,912
============ ============= ============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes $42,100 $54,504 $19,500
============ ============= ============
</TABLE>
See accompanying Notes to Consolidated Unaudited Financial Statements.
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
1 BACKGROUND
Ambac Assurance Corporation ("Ambac Assurance") is a leading insurer of
municipal and structured finance obligations. Financial guarantee insurance
underwritten by Ambac Assurance guarantees payment when due of the principal of
and interest on the obligation insured. In the case of a default on the insured
bond, payments under the insurance policy may not be accelerated by the
policyholder without Ambac Assurance's consent. As of December 31, 1997, Ambac
Assurance's net insurance in force (principal and interest) was $275,931,000.
Ambac Assurance is a wholly owned subsidiary of Ambac Financial Group, Inc.
(NYSE: ABK), a holding company that provides financial guarantee insurance and
financial management services to clients in the public and private sectors in
the U.S. and abroad through its subsidiaries.
Ambac Assurance, as the sole limited partner, owns a limited partnership
interest representing 90% of the total partnership interests of Ambac Financial
Services, L.P. ("AFS"), a limited partnership which provides interest rate swaps
primarily to states, municipalities and their authorities. The sole general
partner of AFS, Ambac Financial Services Holdings, Inc., a wholly owned
subsidiary of Ambac Financial Group, Inc., owns a general partnership interest
representing 10% of the total partnership interest in AFS.
On December 18, 1997, Ambac Assurance acquired Construction Loan Insurance
Corporation ("CLIC") for $106,000 in cash and retired $18,400 of CLIC debt.
CLIC's wholly owned subsidiary, Connie Lee Insurance Company ("Connie Lee"), a
triple-A rated financial guarantee insurance company which guaranteed bonds
primarily for college and hospital infrastructure projects, is not expected to
write any new business. Ambac Assurance and Connie Lee have arrangements in
place to assure that Connie Lee maintains a level of capital sufficient to
support Connie Lee's outstanding obligations and for Connie Lee insured bonds to
retain their triple-A rating. The acquisition of CLIC was accounted for using
the purchase method. CLIC's results of operations subsequent to December 18,
1997 are included in the accompanying Consolidated Statements of Operations. The
pro forma results of operations for the years ended December 31, 1997 and 1996,
assuming CLIC had been acquired as of January 1, 1996, are as follows; 1997:
revenues of $375,839; pre-tax income of $273,806 and net income of $214,894;
1996: revenues of $393,577; pre-tax income of $335,826; net income of $252,181.
During the first quarter of 1997, Ambac Assurance established a new
subsidiary in the United Kingdom, Ambac Insurance UK Limited ("Ambac UK"), which
is authorized to conduct certain classes of general insurance business in the
United Kingdom. Ambac UK is the Company's primary vehicle for the issuance of
financial guarantee insurance policies in the United Kingdom and Europe.
As of December 31, 1995, Ambac Assurance owned 26.5% and Ambac Financial
Group, Inc. owned 19.9% of the outstanding common stock of an affiliate, HCIA
Inc. ("HCIA"), a leading health care information content company. Prior to 1995,
Ambac Financial Group, Inc. and Ambac Assurance, combined, owned approximately
96% of HCIA. During 1996, in conjunction with the sale of Ambac Financial Group,
Inc.'s and Ambac Assurance's combined holdings in HCIA common stock, Ambac
Assurance delivered to Ambac Financial Group, Inc. (in the form of an
extraordinary dividend) its 2,378,672 shares of HCIA common stock. As a result,
Ambac Assurance recognized a realized gain of $89,680.
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
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
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 Assurance and
its subsidiaries (sometimes collectively referred to as the "Company") are as
described below:
CONSOLIDATION:
The consolidated financial statements include the accounts of Ambac
Assurance and its subsidiaries. All significant intercompany balances have been
eliminated.
INVESTMENTS:
The Company's investment portfolio is accounted for on a trade-date basis
and consists entirely of investments in fixed income 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 stockholder's 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.
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.
2
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
When an Ambac Assurance 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 Assurance 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.
Ambac Assurance'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 $14,213, $12,553
and $10,183 for 1997, 1996 and 1995, respectively. Deferred acquisition costs,
net of such amortization, amounted to $11,784, $11,592 and $10,846 for 1997,
1996 and 1995, 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,
ranging from 3 to 5 years, 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,
ranging from 3 to 5 years, using the straight-line method.
DERIVATIVE CONTRACTS:
DERIVATIVE CONTRACTS HELD FOR TRADING PURPOSES:
The Company, through its affiliate AFS, a provider of interest rate swaps
to states, municipalities and their authorities, and other entities in
connection with their financings, uses derivative contracts which are classified
as held for trading purposes. Derivative contracts are recorded on trade date at
fair value. Changes in fair value are recorded as a component of other 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
3
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
that reflects credit considerations, ongoing servicing, and transaction hedging
costs is recognized over the life of the interest rate swap, as an adjustment to
other 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.
INCOME TAXES:
Pursuant to a tax-sharing agreement, the Company is included in Ambac
Financial Group, Inc.'s consolidated Federal income tax return. The tax-sharing
agreement provides for the determination of tax expense or benefit based on the
contribution of the Company to Ambac Financial Group, Inc.'s consolidated
Federal income tax liability, computed substantially as if the Company filed a
separate Federal income tax return. The tax liability due is settled quarterly,
with a final settlement taking place after the filing of the consolidated
Federal income tax return. The Company files its own state income tax returns.
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 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 will redeem the
tax and loss bonds to satisfy the additional tax liability. 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:
Ambac Financial Group, Inc., through its subsidiaries, 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.
ACCOUNTING STANDARDS:
In June 1997, the FASB issued Statement 130, "Reporting Comprehensive Income,"
which requires enterprises to disclose comprehensive income and its components
in a prominent position on the face of the financial statements. The Company
will implement this statement in 1998. This statement relates to presentation
of information and will have no impact on results of operations or financial
condition.
4
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
In June 1997, the FASB issued Statement 131, "Disclosures about Segments of an
Enterprise and Related Information," which will be effective for the Company
beginning January 1, 1998. Statement 131 redefines how operating segments are
determined and requires disclosure of certain financial and descriptive
information about a company's operating segments. This statement relates to
presentation of information and will have no impact on results of operations or
financial condition.
RECLASSIFICATIONS:
Certain reclassifications have been made to prior years' amounts to conform to
the current year's presentation.
3 INVESTMENTS
The amortized cost and estimated fair value of investments in fixed income
securities at December 31, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------- ----------------- ----------------- -----------------
1997
<S> <C> <C> <C> <C>
Municipal obligations................................. $2,126,136 $149,807 $ 112 $2,275,831
Corporate obligations................................. 315,492 27,384 36 342,840
U.S. Government obligations........................... 136,771 2,854 27 139,598
Mortgage- and asset-backed securities (includes U.S.
Government Agency Obligations) 98,719 2,190 2 100,907
Other................................................. 136,390 91 669 135,812
-------------- --------------- ----------------- ---------------
$2,813,508 $182,326 $ 846 $2,994,988
============== =============== ================= ===============
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------------- --------------- ----------------- ---------------
1996
Municipal obligations................................. $1,892,875 $ 86,984 $ 2,223 $1,977,636
Corporate obligations................................. 273,770 17,336 2,187 288,919
U.S. Government obligations........................... 102,774 1,363 1,707 102,430
Mortgage- and asset-backed securities (includes U.S.
Government Agency Obligations) 50,145 2,081 373 51,853
Other................................................. 95,015 - 9 95,006
-------------- -------------- ---------------- ---------------
$2,414,579 $107,764 $6,499 $2,515,844
============== ============== ================ ===============
</TABLE>
5
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
The amortized cost and estimated fair value of fixed income securities at
December 31, 1997, by contractual maturity, were as follows:
<TABLE>
<CAPTION>
Amortized Estimated
Cost Fair Value
----------------------- -----------------------
1997
<S> <C> <C>
Due in one year or less................................................. $ 152,582 $ 152,695
Due after one year through five years................................... 180,417 185,672
Due after five years through ten years.................................. 360,248 375,831
Due after ten years..................................................... 2,070,321 2,228,662
----------------------- -----------------------
2,763,568 2,942,860
Mortgage- and asset-backed securities (includes U.S. Government Agency
Obligations)........................................................... 49,940 52,128
----------------------- -----------------------
$2,813,508 $2,994,988
======================= =======================
</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.
Securities carried at $8,415 and $2,422 at December 31, 1997 and 1996
respectively, were deposited by the Company with governmental authorities or
designated custodian banks as required by laws affecting insurance companies.
Net investment income from the Company comprised the following:
<TABLE>
<CAPTION>
1997 1996 1995
----------- -------------- --------------
<S> <C> <C> <C>
Fixed income securities................................... $155,810 $139,410 $127,865
Short-term investments.................................... 6,885 8,360 6,116
----------- ------------- -------------
Total investment income................................ 162,695 147,770 133,981
Investment expense........................................ (2,607) (2,468) (2,485)
----------- ------------- -------------
Net investment income.................................. $160,088 $145,302 $131,496
=========== ============= =============
</TABLE>
The Company had gross realized gains of $25,641, $108,916 and $27,786 for
1997, 1996 and 1995, respectively, and gross realized losses of $6,843, $39,767
and $27,609 for 1997, 1996 and 1995, respectively.
As of December 31, 1997 and 1996, the Company held securities subject to
agreements to resell for $2,484 and $4,369, respectively. Such securities were
held as collateral by the Company. The agreements had terms of less than 30
days.
6
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
4 REINSURANCE
In the ordinary course of business, Ambac Assurance 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>
Year Ended December 31,
------------------------------------------------------------------------------------------------------------------
1997 1996 995
------------------------------------ ------------------------------------ ----------------------------------
Written Earned Written Earned Written Earned
--------------- --------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Direct............ $281,034 $177,677 $243,097 $157,551 $192,277 $ 127,322
Assumed........... 8,349 3,614 6,664 3,126 2,756 1,349
Ceded............. (32,452) (25,623) (37,793) (22,380) (28,606) (15,088)
--------------- --------------- --------------- --------------- --------------- ---------------
Net premiums...... $256,931 $155,668 $211,968 $138,297 $166,427 $ 113,583
=============== =============== =============== =============== =============== ===============
</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 Assurance under the existing
reinsurance agreements, Ambac Assurance would be liable for such defaulted
amounts. To minimize its exposure to significant losses from reinsurer
insolvencies, Ambac Assurance evaluates the financial condition of its
reinsurers and monitors concentrations of credit risk. There were no reinsurance
recoverables on paid losses as of December 31, 1997 and 1996. As of December 31,
1997, prepaid reinsurance of approximately $152,283 was associated with Ambac
Assurance's three largest reinsurers. As of December 31, 1997, Ambac Assurance
held letters of credit and collateral amounting to approximately $154,387 from
its reinsurers to cover liabilities ceded under the aforementioned reinsurance
contracts.
During 1995, Ambac Assurance terminated reinsurance contracts, resulting in
return premiums to Ambac Assurance of $18,141, of which $15,700 was recorded as
an increase to the unearned premium reserve, with the remainder recognized as
revenue.
7
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
5 LOSSES AND LOSS ADJUSTMENT EXPENSES
Ambac Assurance'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 loss
adjustment expense reserve and ACR accounts and the components of the liability
for losses and loss adjustment expenses:
<TABLE>
<CAPTION>
1997 1996 1995
--------------- ---------------- ---------------
<S> <C> <C> C>
Case basis loss and loss adjustment expense reserves:
Balance at January 1................................. $ 22,016 $39,890 $ 39,342
Less reinsurance recoverables...................... 393 641 450
--------------- ---------------- ---------------
Net balance at January 1............................. 21,623 39,249 38,892
--------------- ---------------- ---------------
Incurred related to:
Current year....................................... 212 1,484 750
Prior years........................................ 1,973 (9,556) 2,650
--------------- ---------------- ---------------
Total incurred................................... 2,185 (8,072) 3,400
--------------- ---------------- ---------------
Paid related to:
Current year....................................... 200 150 150
Prior years........................................ 2,274 9,404 2,893
Total paid....................................... 2,474 9,554 3,043
--------------- ---------------- ----------------
Net balance for Connie Lee, at acquisition........... 29,526 - -
--------------- ---------------- ----------------
Net balance at December 31........................... 50,860 21,623 39,249
Plus reinsurance recoverables...................... 4,219 393 641
Balance at December 31............................... 55,079 22,016 39,890
--------------- ---------------- ----------------
Active credit reserve:
Balance at January 1................................. 38,597 26,747 26,770
Net provision for losses............................. 3,000 5,115 4,097
ACR transfers (to) from case reserves................ (2,331) 6,735 (4,120)
Balance for Connie Lee, at acquisition............... 9,000 - -
--------------- ---------------- ------------------
Balance at December 31............................... 48,266 38,597 26,747
--------------- ---------------- ------------------
Total............................................ $103,345 $60,613 $ 66,637
=============== ================ ==================
</TABLE>
The terms "current year" and "prior years" in the foregoing table refer to
the year in which case basis loss reserves were established.
8
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
6 COMMITMENTS AND CONTINGENCIES
The Company is responsible for leases on the rental of office space,
principally in New York City. In 1997, the Company executed an agreement for
additional office space and a lease term extension at its corporate headquarters
in New York City. The lease agreements, which expire periodically through
September 2019, 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>
1998.......................... $ 4,621
1999.......................... 5,634
2000.......................... 5,861
2001.......................... 5,087
2002.......................... 5,010
All later years............... 89,902
----------------
$116,115
================
</TABLE>
Rent expense for the aforementioned leases amounted to $4,210, $3,286 and
$2,924 for the years ended December 31, 1997, 1996 and 1995, respectively.
7 INSURANCE REGULATORY RESTRICTIONS
Ambac Assurance 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 Assurance'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 Assurance paid cash dividends of $44,000, $40,000 and $40,000 on its
common stock in 1997, 1996 and 1995, respectively. In addition, on April 30,
1996, Ambac Assurance, in conjunction with the sale of the Ambac Financial
Group, Inc.'s remaining holdings in HCIA common stock, delivered to Ambac
Financial Group, Inc. (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. Based upon these restrictions, at December 31, 1997, the maximum
amount that will be available during 1998 for payment of dividends by Ambac
Assurance is approximately $100,700.
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 insurer's policyholders'
9
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
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 Assurance'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 $1,006,829 and $899,023 at December 31,
1997 and 1996, respectively. Qualified statutory capital was $1,655,554 and
$1,466,560 at December 31, 1997 and 1996, respectively. Statutory net income was
$198,615, $222,810 and $142,541 for 1997, 1996 and 1995, 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.
8 INCOME TAXES
The total effect of income taxes on income and stockholder's equity for the
years ended December 31, 1997 and 1996 was as follows:
<TABLE>
<CAPTION>
1997 1996
---------- ---------
<S> <C> <C>
Total income taxes charged to income...................... $67,194 $ 79,620
----------- ---------
Income taxes charged (credited) to stockholder's equity:
Unrealized gain (loss) on bonds......................... 28,043 (11,464)
Other................................................... (3,995) (2,125)
Total charged (credited) to stockholder's equity..... 24,048 (13,589)
----------- ---------
Total effect of income taxes.............................. $91,242 $ 66,031
=========== =========
</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:
<TABLE>
<CAPTION>
1997 % 1996 % 1995 %
--------- -------- ------------ --------- --------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Computed expected tax at
statutory rate.............. $104,755 35.0% $112,300 35.0% $ 72,920 35.0%
Increases (reductions) in
expected tax resulting from:
Tax-exempt interest.......... (35,458) (11.8) (30,655) (9.6) (28,274) (13.6)
Other, net................... (2,103) (0.7) (2,025) (0.6) (1,100) (0.5)
--------- --------- ---------- -------- ---------- -----------
Income tax expense $ 67,194 22.5% $ 79,620 24.8% $ 43,546 20.9%
========== ======== ========= ======== ======== ============
</TABLE>
10
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax liabilities and deferred tax assets at December 31,
1997 and 1996 are presented below:
<TABLE>
<CAPTION>
1997 1996
------------- --------------
<S> <C> <C>
Deferred tax liabilities:
Contingency reserve................................ $111,160 $ 76,805
Unrealized gains on bonds.......................... 63,518 35,443
Deferred acquisition costs......................... 38,030 32,974
Unearned premiums.................................. 35,591 27,971
Other.............................................. 2,225 1,389
---------- -----------
Total deferred tax liabilities..................... 250,524 174,582
---------- -----------
Deferred tax assets:
Tax and loss bonds................................. 87,951 63,871
Loss reserves...................................... 17,231 13,561
Alternative minimum tax credit carryforward........ 10,049 --
Amortization and depreciation...................... 6,556 6,791
Compensation....................................... 3,924 2,721
Investments........................................ -- 1,374
Other.............................................. 2,259 1,422
---------- --------------
Sub-total deferred tax assets...................... 127,970 89,740
Valuation allowance................................ -- --
---------- --------------
Total deferred tax assets.......................... 127,970 89,740
---------- --------------
Net deferred tax liabilities....................... $122,554 $ 84,842
========== ==============
</TABLE>
The Company believes that no valuation allowance is necessary in connection
with the deferred tax assets.
9 EMPLOYEE BENEFITS
PENSIONS:
Ambac Financial Group, Inc. has a defined benefit pension plan covering
substantially all employees of the Company and most of its subsidiaries. The
benefits are based on years of service and the employee's compensation during
the last five years of employment. Ambac Financial Group, Inc.'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 table
below sets forth the plan's funded status and amounts recognized by the Ambac
Financial Group, Inc. as of December 31, 1997 and 1996.
11
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
--------------- ------------
<S> <C> <C>
Accumulated benefit obligation, including vested
benefits of $7,192 and $6,282, respectively................... ($7,956) ($6,979)
================ ==========
Projected benefit obligation for service rendered to date..... (9,374) (8,189)
Plan assets at fair value, primarily listed stocks,
commingled funds and fixed income securities.................. 9,644 8,153
---------------- ----------
Funded/unfunded projected benefit............................. 270 (36)
Unrecognized prior service cost............................... (1,454) (1,619)
Unrecognized net loss......................................... 62 885
Unrecognized net transition asset............................. (7) (9)
---------------- ----------
Pension liability included in other liabilities............... ($1,129) ($779)
================ ==========
</TABLE>
Net pension costs for 1997, 1996 and 1995 included the following
components:
<TABLE>
<CAPTION>
1997 1996 1995
------------- ----------- ------------
<S> <C> <C> <C>
Service cost................................................... $ 723 $ 674 $ 541
Interest cost on expected benefit obligation................... 601 539 456
Actual return on plan assets................................... (1,606) (957) (1,333)
Net amortization and deferral.................................. 770 263 760
------------- ----------- ------------
Net periodic pension cost...................................... $ 488 $ 519 $ 424
============= =========== ============
</TABLE>
The weighted average discount rate used in the determination of the
actuarial present value for the projected benefit obligation was 7.25% and 7.50%
for 1997 and 1996, respectively. The expected long-term rate of return on assets
was 9.25% for both 1997 and 1996. The rate of increase in future compensation
levels used in determining the actuarial present value of the projected benefit
obligation was 4.8 % and 5.0% for 1997 and 1996, respectively.
Upon the acquisition of CLIC, Ambac Financial Group, Inc. assumed the
liability for its two terminated pension plans. Those plans had an unfunded
projected obligation of approximately $800, which is included in other
liabilities at December 31, 1997.
Substantially all employees of Ambac Financial Group, Inc. 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 eligible
employee's base salary, plus a matching company contribution of 50% on
contributions up to 6% of base salary, subject to Internal Revenue Code
limitations, made by eligible employees to the plan. The total cost of the
Savings Incentive Plan to Ambac Assurance was $1,417, $1,494 and $1,435 in 1997,
1996 and 1995, respectively.
ANNUAL INCENTIVE PROGRAM:
Ambac Financial Group, Inc. has an annual incentive program which provides
for awards to key officers and employees based upon predetermined criteria. The
cost of the program for the years ended December 31, 1997, 1996 and 1995
amounted to $9,429, $7,641 and $7,669, respectively.
POSTRETIREMENT HEALTH CARE AND OTHER BENEFITS:
Ambac Assurance provides certain medical and life insurance benefits for
retired employees and eligible dependents. All plans are contributory. None of
the plans are currently funded.
12
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
Postretirement benefits expense was $230, $220 and $168 in 1997, 1996 and
1995, respectively. The unfunded accumulated postretirement benefit obligation
was $2,064 and the accrued postretirement liability was $1,719 as of December
31, 1997.
The assumed weighted average health care cost trend rates range from 9.0%
in 1997, decreasing ratably to 6.0% in 2002, 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, 1997 by $172 and the 1997 benefit expense by $48. The
weighted average discount rate used to measure the accumulated postretirement
benefit obligation and 1997 expense was 7.25%.
10 INSURANCE IN FORCE
The par amount of bonds insured, for non-affiliates, net of reinsurance,
was $165,601,000 and $131,497,000 at December 31, 1997 and 1996, respectively.
As of December 31, 1997 and 1996, the insured portfolio was diversified by type
of insured bond as shown in the following table:
<TABLE>
<CAPTION>
Net Par Amount Outstanding
------------------------------
(Dollars in Millions) 1997 1996
------------------------------
<S> <C> <C>
Municipal finance:
General obligation.......................... $ 36,324 $ 31,863
Lease and tax-backed revenue................ 30,980 25,366
Utility revenue............................. 24,913 22,780
Health care revenue......................... 18,545 13,521
Transportation revenue...................... 7,370 6,891
Higher education............................ 6,852 4,745
Investor-owned utilities.................... 6,255 5,492
Housing revenue............................. 6,064 4,497
Student loans............................... 3,516 3,439
Other....................................... 597 484
------------------------------
Total municipal finance.................. 141,416 119,078
------------------------------
Domestic structured finance:
Mortgage-backed and home equity.......... 11,620 5,263
Commercial asset-backed.................. 4,538 1,329
Other consumer asset-backed.............. 1,514 1,126
Banks/financial institutions............. 524 214
Other.................................... 439 159
------------------------------
Total domestic structured finance........ 18,635 8,091
------------------------------
Total domestic........................... 160,051 127,169
------------------------------
International finance:
Commercial asset-backed.................. 2,600 2,530
Sovereign/sub-sovereign.................. 981 631
Mortgage-backed and home equity.......... 496 265
Utilities................................ 456 131
Banks/financial institutions............. 283 346
Other.................................... 734 425
------------------------------
Total international finance.............. 5,550 4,328
------------------------------
$165,601 $131,497
==============================
</TABLE>
13
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
As of December 31, 1997 and 1996, the international insured portfolio by
geographic area is shown in the following table:
<TABLE>
<CAPTION>
Net Par Amount Outstanding
-----------------------------------
(Dollars in Millions) 1997 1996
---------------- ---------------
International:
<S> <C> <C>
France.............................. $1,032 $1,025
Japan............................... 879 645
United Kingdom...................... 865 569
Italy............................... 555 423
Spain............................... 380 130
Internationally diversified............ 899 985
Other international.................... 940 551
---------------- ---------------
$5,550 $4,328
================ ===============
</TABLE>
As of December 31, 1997, California was the state with the highest
aggregate net par amount in force, accounting for 11.8% of the total. The
highest single insured risk represented less than 1% of aggregate net par amount
insured. Direct insurance in force (principal and interest) was $321,104,000 and
$268,870,000 at December 31, 1997 and 1996, respectively. Net insurance in force
(after giving effect to reinsurance) was $275,931,000 and $227,235,000 as of
December 31, 1997 and 1996, respectively.
11 FINANCIAL INSTRUMENTS HELD FOR PURPOSES OTHER THAN TRADING
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 fixed income investments 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.
Derivative contracts: Fair values of derivative contracts (futures, swaps
and interest rate options) are based on quoted market prices and dealer quotes,
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
14
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
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 Assurance's liability under its installment premium
policies is measured using the present value of estimated future installment
premiums, less an assumed 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 Assurance'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,
-----------------------------------------------------------------------------------
1997 1996
----------------------------------------- -------------------------------------
(Dollars in Millions) Carrying Estimated Fair Carrying Amount Estimated Fair
Amount Value Value
---------------- ------------------- ------------------- --------------
Financial assets:
<S> <C> <C> <C> <C>
Investments................................ $2,878 $2,878 $2,425 $2,425
Short-term investments..................... 117 117 91 91
Cash....................................... 8 8 5 5
Securities purchased under agreements to
resell.................................... 2 2 4 4
Liability for financial guarantees written:
Gross.................................... 1,185 855 995 719
Net of reinsurance....................... 1,002 722 826 596
Net installment premiums................. -- 153 -- 114
</TABLE>
12 FINANCIAL INSTRUMENTS HELD FOR TRADING PURPOSES
The Company, through its affiliate AFS is a provider of interest rate swaps
to states, municipalities and their authorities and other entities in connection
with their financings. AFS 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 tax-exempt and floating taxable
interest rates. If actual or projected floating tax-exempt interest rates change
in relation to floating taxable rates, the Company will experience an unrealized
mark-to-market gain or loss. The AFS swap portfolio is considered held for
trading purposes.
In the ordinary course of business, AFS manages a variety of risks,
principally market, credit, 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.
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 interest rate
swap market. The principal market risk is basis risk, the
15
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
relationship between changes in floating tax-exempt and floating taxable
interest rates. Since late 1995, most 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.
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 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 $72,000 and $47,000 as of December 31, 1997 and 1996,
respectively.
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, 1997 and 1996, the
Company's value-at-risk, for financial instruments considered held for trading
purposes, calculated at a ninety-nine percent confidence level, averaged
approximately $1,600 and $1,400, respectively. The Company's value-at-risk
ranged from a high of $2,600 to a low of $900 in 1997, and from a high of $2,600
to a low of $1,100 in 1996. Since no single measure can capture all dimensions
of market risk, the Company supplements 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, 1997 and 1996:
<TABLE>
<CAPTION>
Net Estimated Fair Value Average Net Fair Value
---------------------------- ---------------------------
Notional
Assets Liabilities Assets Liabilities Amount
---------------------------- ----------------------------------------------
<S> <C> <C> <C> <C> <C>
1997:
Derivative financial instruments:
Interest rate swaps............... $ 71,505 $ 49,772 $ 47,276 $ 34,768 $4,174,160
Futures contracts................. -- -- -- -- 514,900
Other financial instruments........... 183,041 181,732 160,251 159,213 --
1996:
Derivative financial instruments:
Interest rate swaps............... $ 45,990 $ 33,650 $ 48,734 $ 41,445 $2,856,600
Futures contracts................. -- -- -- -- 484,500
Other financial instruments........... -- -- -- -- --
</TABLE>
16
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS)
Financial instruments held for trading purposes are carried at estimated
fair value. The aggregate amount of net trading income recognized from
derivative financial instruments held for trading purposes was $8,560, $10,799
and $2,602 for 1997, 1996 and 1995, respectively. Other financial instruments
held for trading purposes consist of fixed income securities. The aggregate
amount of net trading income recognized from other financial instruments was
$1,309 for 1997. Average net fair values were calculated based on average daily
net fair values. 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.
13 LINES OF CREDIT
Ambac Financial Group, Inc. and Ambac Assurance maintain a three-year
revolving credit facility with two major international banks, as co-agents, for
$100,000. As of December 31, 1997 and 1996, no amounts were outstanding under
this credit facility, which expires in July 1998.
Ambac Assurance has an agreement with a group of AAA/Aaa-rated
international banks for a $450,000 credit facility, expiring in 2004. This
facility is a seven-year stand-by irrevocable limited recourse line of credit,
which was increased from $350,000 to $450,000 and extended for an additional
year in December 1997. The line will provide liquidity to Ambac Assurance 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, 1997 and
1996, no amounts were outstanding under this line.
Connie Lee has an agreement with commercial banks for a $50,000 stand-by
credit facility, expiring in 2003. The line will provide a source of additional
claims-paying resources for insured transactions. The obligation to repay is a
limited recourse obligation payable solely from, and collateralized by, a pledge
of recoveries realized on defaulted insured obligations including installment
premiums and other collateral. As of December 31, 1997 and 1996, no amounts were
outstanding under this line.
14 RELATED PARTY TRANSACTIONS
During 1997 and 1996, Ambac Assurance guaranteed the timely payment of
principal and interest on obligations under investment agreements and investment
repurchase agreements issued by its affiliates. As of December 31, 1997 and
1996, the aggregate amount of investment agreements and investment repurchase
agreements insured was $3,856,786 and $2,744,283, respectively, including
accrued interest. These insurance policies are collateralized by investment
securities, accrued interest, securities purchased under agreements to resell
and cash and cash equivalents, which as of December 31, 1997 and 1996 had a fair
value of $3,936,718 and $2,775,250, respectively, in the aggregate. During 1997
and 1996, Ambac Assurance recorded gross premiums written of $3,220 and $2,553,
and net premiums earned of $1,668 and $1,668, respectively, related to these
agreements.
During 1997 and 1996, several interest rate swap transactions were executed
between AFS and its affiliates (other than Ambac Assurance). As of December 31,
1997 and 1996, these contracts had an outstanding notional amount of
approximately $827,000 and $515,000, respectively. As of December 31, 1997 and
1996, AFS recorded a positive fair value of $3,762 and $3,503, respectively,
related to these transactions.
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