<PAGE>
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): March 13, 2000
AMBAC FINANCIAL GROUP, INC.
(Exact name of Registrant as specified in its charter)
Delaware 1-10777 13-3621676
(State of incorporation) (Commission file number) (I.R.S. employer
identification no.)
One State Street Plaza 10004
New York, New York (Zip code)
(Address of principal executive offices)
(212) 668-0340
(Registrant's telephone number, including area code)
Page 1 of 27 Pages
================================================================================
Index to Exhibits on Page 4
<PAGE>
Item 5. Other Events
On March 13, 2000, financial statements for Ambac Assurance Corporation and
Subsidiaries, the Registrant's wholly-owned subsidiary, for the year ended
December 31, 1999 became available.
Item 7. Financial Statements and Exhibits
(c) Exhibits.
Exhibit Number Item
-------------- ----
99.06 Ambac Assurance Corporation and Subsidiaries
Consolidated Financial Statements (with
independent auditors' report thereon) as of
December 31, 1999 and 1998 and for the three
years ended December 31, 1999.
Page 2 of 27
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Ambac Financial Group, Inc.
(Registrant)
Dated: March 13, 2000 By: /s/ Frank J. Bivona
------------------------------
Frank J. Bivona
Executive Vice President, and
Chief Financial Officer
Page 3 of 27
<PAGE>
INDEX TO EXHIBITS
-----------------
Exhibit
- -------
Number Description of Exhibit
- ------ ----------------------
99.06 Ambac Assurance Corporation and Subsidiaries Consolidated
Financial Statements (with independent auditors' report thereon)
as of December 31, 1999 and 1998 and for the three years ended
December 31, 1999.
Page 4 of 27
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
(a wholly-owned subsidiary of Ambac Financial Group, Inc.)
Consolidated Financial Statements
December 31, 1999 and 1998
<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, 1999 and 1998, 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, 1999. 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, 1999 and 1998, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1999 in conformity with generally accepted
accounting principles.
/s/ KPMG LLP
New York, New York
January 21, 2000
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1999 and 1998
(Dollars in Thousands Except Share Data)
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
ASSETS
Investments:
Fixed income securities, at fair value
(amortized cost of $3,657,146 in 1999 and $3,097,289 in 1998)............. $3,515,969 $3,310,047
Short-term investments, at cost (approximates fair value)..................... 207,121 93,912
---------- ----------
Total investments......................................................... 3,723,090 3,403,959
Cash............................................................................. 6,531 4,895
Securities purchased under agreements to resell.................................. -- 5,449
Receivable for securities sold................................................... 18,011 12,132
Investment income due and accrued................................................ 61,147 54,088
Deferred acquisition costs....................................................... 135,324 120,619
Reinsurance recoverable.......................................................... 500 3,638
Prepaid reinsurance.............................................................. 217,977 199,920
Other assets..................................................................... 219,231 212,475
---------- ----------
Total assets.............................................................. $4,381,811 $4,017,175
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities:
Unearned premiums............................................................. $1,441,679 $1,303,203
Losses and loss adjustment expenses........................................... 121,475 115,794
Ceded reinsurance balances payable............................................ 15,028 6,576
Deferred income taxes......................................................... 27,860 144,565
Current income taxes.......................................................... 33,782 19,984
Accounts payable and other liabilities........................................ 233,127 226,950
Payable for securities purchased.............................................. 93,149 33,758
---------- ----------
Total liabilities......................................................... 1,966,100 1,850,830
---------- ----------
Stockholder's equity:
Preferred stock, par value $1,000 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, 1999 and December 31, 1998................................ 82,000 82,000
Additional paid-in capital.................................................... 751,522 541,021
Accumulated other comprehensive (loss) income................................. (92,049) 138,651
Retained earnings............................................................. 1,674,238 1,404,673
---------- ----------
Total stockholder's equity................................................ 2,415,711 2,166,345
---------- ----------
Total liabilities and stockholder's equity................................ $4,381,811 $4,017,175
========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
(Dollars in Thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Revenues:
Gross premiums written............................................ $449,786 $366,791 $289,383
Ceded premiums written............................................ (61,845) (49,563) (32,452)
---------- ---------- ----------
Net premiums written........................................... $387,941 $317,228 $256,931
========== ========== ==========
Net premiums earned............................................... $267,356 $215,023 $155,668
Net fees earned and other income.................................. 21,907 25,399 16,661
Net investment income............................................. 209,686 186,259 160,088
Net realized (losses) gains....................................... (5,675) (12,346) 18,798
---------- ---------- ----------
Total revenues................................................. 493,274 414,335 351,215
---------- ---------- ----------
Expenses:
Losses and loss adjustment expenses............................... 11,000 6,000 2,854
Underwriting and operating expenses............................... 54,930 51,000 46,769
Interest expense.................................................. 3,055 3,039 2,293
---------- ---------- ----------
Total expenses................................................. 68,985 60,039 51,916
---------- ---------- ----------
Income before income taxes..................................... 424,289 354,296 299,299
---------- ---------- ----------
Income tax expense:
Current taxes..................................................... 95,552 71,395 55,492
Deferred taxes.................................................... 7,172 9,550 11,702
---------- ---------- ----------
Total income taxes............................................. 102,724 80,945 67,194
---------- ---------- ----------
Net income..................................................... $321,565 $273,351 $232,105
========== ========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholder's Equity
(Dollars in Thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------------------------------
1999 1998 1997
---------------------- --------------------- ----------------------
<S> <C> <C> <C> <C> <C> <C>
Retained Earnings:
Balance at January 1 $1,404,673 $1,179,322 $ 991,815
Net income 321,565 $ 321,565 273,351 $273,351 232,105 $232,105
--------- -------- --------
Dividends declared -
common stock (52,000) (48,000) (44,000)
Other -- -- (598)
---------- ---------- ----------
Balance at December 31 $1,674,238 $1,404,673 $1,179,322
---------- ---------- ----------
Accumulated Other
Comprehensive (Loss) Income:
Balance at January 1 $ 138,651 $ 118,119 $ 65,822
Unrealized (losses) gains on
securities, ($353,935),
$31,278, and $80,215,
pre-tax, in 1999, 1998
and 1997, respectively) (1) (230,058) 20,331 52,140
Foreign currency (loss) gain (642) 201 157
--------- -------- --------
Other comprehensive (loss) income (230,700) (230,700) 20,532 20,532 52,297 52,297
---------------------- --------------------- ----------------------
Total comprehensive income $ 90,865 $293,883 $284,402
========= ======== ========
Balance at December 31 ($ 92,049) $ 138,651 $ 118,119
---------- ---------- ----------
Common Stock:
Balance at January 1 and
December 31 $ 82,000 $ 82,000 $ 82,000
---------- ---------- ----------
Additional Paid-in Capital:
Balance at January 1 $ 541,021 $ 521,153 $ 515,684
Capital contribution 209,012 9,000 1,475
Exercise of stock options 1,489 10,868 3,994
---------- ---------- ----------
Balance at December 31 $ 751,522 $ 541,021 $ 521,153
---------- ---------- ----------
Total Stockholder's Equity at
December 31 $2,415,711 $2,166,345 $1,900,594
========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
(1) Disclosure of reclassification amount: 1999 1998 1997
-------------------------------------
<S> <C> <C> <C>
Unrealized holding (losses) gains arising during period ($ 233,747) $22,758 $63,182
Less: reclassification adjustment for net (losses)
gains included in net income (3,689) 2,427 11,042
-------------------------------------
Net unrealized (losses) gains on securities ($ 230,058) $20,331 $52,140
=====================================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
Ambac Assurance Corporation And Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in Thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income...................................................... $ 321,565 $ 273,351 $ 232,105
Adjustments to reconcile net income to net cash
Provided by operating activities:
Depreciation and amortization................................... 2,337 1,877 1,689
Amortization of bond premium and discount....................... (4,552) (1,733) (1,084)
Current income taxes............................................ 13,798 270 18,240
Deferred income taxes........................................... 7,172 11,064 11,702
Deferred acquisition costs...................................... (14,705) (14,623) (11,784)
Unearned premiums, net.......................................... 120,419 102,238 101,257
Losses and loss adjustment expenses............................. 8,819 13,030 408
Ceded reinsurance balances payable.............................. 8,452 (2,682) 1,303
Loss (gain) on sales of investments............................. 5,675 12,346 (18,798)
Other, net...................................................... 7,205 (25,241) 12,315
----------- ----------- -----------
Net cash provided by operating activities.................... 476,185 369,897 347,353
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds.................................... 1,235,605 1,127,196 1,346,231
Proceeds from matured bonds..................................... 177,870 126,822 115,476
Purchases of bonds.............................................. (1,715,372) (1,616,863) (1,623,486)
Change in short-term investments................................ (113,209) 22,993 (25,585)
Securities purchased under agreements to resell................. 5,449 (2,965) 1,885
Purchase of affiliate, net of cash acquired..................... -- -- (120,006)
Other, net...................................................... (5,192) (1,472) (236)
----------- ----------- -----------
Net cash used in investing activities........................ (414,849) (344,289) (305,721)
----------- ----------- -----------
Cash flows from financing activities:
Dividends paid.................................................. (52,000) (48,000) (44,000)
Capital contribution............................................ -- 9,000 --
Short-term financing from affiliates............................ (7,700) 10,283 5,347
----------- ----------- -----------
Net cash used in financing activities........................ (59,700) (28,717) (38,653)
----------- ----------- -----------
Net cash flow................................................ 1,636 (3,109) 2,979
Cash at January 1................................................. 4,895 8,004 5,025
----------- ----------- -----------
Cash at December 31............................................... $ 6,531 $ 4,895 $ 8,004
=========== =========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes................................................. $ 77,456 $ 64,618 $ 42,100
=========== =========== ===========
Interest expense on intercompany line of credit.............. $ 661 $ 783 $ 15
=========== =========== ===========
</TABLE>
Supplemental disclosure of non-cash financing activities:
The Company received capital contributions from its parent company in April
1999 and November 1999, in the form of fixed income securities amounting to
$101,479 and $107,533, respectively.
See accompanying Notes to Consolidated 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 guarantor of
municipal and structured finance obligations. Ambac Assurance has earned
triple-A ratings, the highest ratings available from Moody's Investors Service,
Inc., Standard & Poor's Rating Group, Fitch IBCA, Inc., and Japan Rating and
Investment Information, Inc. Financial guarantees underwritten by Ambac
Assurance guarantee payment when due of the principal of and interest on the
obligation guaranteed. In the case of a monetary default on the guaranteed bond,
payments may not be accelerated by the policyholder without Ambac Assurance's
consent. As of December 31, 1999, Ambac Assurance's net guarantees in force
(principal and interest) were $374,484,000. Ambac Assurance is a wholly owned
subsidiary of Ambac Financial Group, Inc. ("AFGI"), a holding company whose
subsidiaries provide financial guarantees and financial services to clients in
both the public and private sectors around the world.
In December 1997, Ambac Assurance acquired Construction Loan Insurance
Corporation ("CLIC"). CLIC's wholly-owned subsidiary, Connie Lee Insurance
Company ("Connie Lee"), a triple-A rated financial guarantee insurance company
guaranteed bonds primarily for college and hospital infrastructure projects.
Ambac Assurance and Connie Lee have arrangements in place to ensure 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.
Ambac Assurance serves clients in international markets through its wholly-
owned subsidiary Ambac Assurance UK Limited and through its participation in an
unincorporated joint venture with MBIA Insurance Corporation ("MBIA"),
MBIA.AMBAC International (the "JV Arrangement"). 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 international market. Under the
joint venture arrangement, financial guarantees are issued separately by each of
the companies.
Ambac Assurance provides another form of financial guarantee, known as
credit derivatives, through its wholly owned subsidiary, Ambac Credit Products
L.L.C. ("ACP"). These structured credit derivatives require that ACP make a
payment upon the occurrence of certain defined credit events relating to an
underlying obligation. Should a credit event occur, ACP would generally pay an
amount equivalent to the difference between the par value and market value of
the underlying obligation. The majority of ACP's structured credit derivatives
have been structured with certain first loss protection.
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. ("AFSLP"), a limited partnership which provides interest rate
swaps primarily to states, municipalities and their authorities. The sole
general partner of AFSLP, Ambac Financial Services Holdings, Inc., a wholly
owned subsidiary of AFGI, owns a general partnership interest representing 10%
of the total partnership interest in AFSLP.
2 SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements have been prepared on
the basis of U.S. Generally Accepted Accounting Principles ("GAAP"). The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the consolidated financial statements and the reported revenues and expenses
during the reporting period. Actual results could differ from those estimates.
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
The significant accounting policies of Ambac Assurance and its subsidiaries
(sometimes collectively referred to as the "Company") are as described below:
CONSOLIDATION:
The accompanying 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 primarily of investments in fixed income securities that are
considered available-for-sale and are carried at fair value. Fair value is based
primarily 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
component of "Accumulated Other Comprehensive (Loss) Income" in 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 that do
not have call features, such premiums are amortized over the remaining terms of
the securities. Premiums and discounts on mortgage-backed and asset-backed
securities are adjusted for the effects of actual and anticipated prepayments.
Realized gains and losses on sales 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:
Up-front premiums are earned pro-rata over the period of risk. Premiums are
allocated to each bond maturity based on par amount and are earned on a
straight-line basis over the term of each maturity. Installment premiums are
earned over each installment period, generally one year or less. When a new or
secondary market issue insured by Ambac Assurance has been refunded or called,
the remaining unearned premium (net of refunding credits, if any) is generally
earned at that time.
2
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollar Amounts in Thousands)
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 expected
annual levels of debt service defaults resulting from credit failures on
currently insured issues that are not presently or imminently in monetary
default. 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. The case basis loss reserves
are discounted at 7% for both 1999 and 1998. All or part of case basis loss
reserves are allocated from any ACR available. The following table summarizes
the Company's loss reserves split between case basis loss reserves and ACR at
December 31, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
-------------------------------
<S> <C> <C>
Net loss and loss adjustment expense reserves:
Case basis /(*)/ $ 26,204 $ 33,916
ACR 94,771 78,240
-------------------------------
Total $120,975 $112,156
-------------------------------
</TABLE>
(*) After netting reinsurance recoverable amounting to $500 and $3,638
in 1999 and 1998, respectively.
Paid losses, net of salvage received, were $2,181, ($7,030) and $2,474 in
1999, 1998 and 1997, respectively.
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 guarantee
that the ultimate liability will not exceed such estimates.
DEFERRED ACQUISITION COSTS:
Certain costs incurred that 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 $20,843, $18,248
and $14,213 for 1999, 1998 and 1997, respectively. Deferred acquisition costs,
net of such amortization, amounted to $14,705, $14,623 and $11,784 for 1999,
1998 and 1997, 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 three to five 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 three to 10 years, using the straight-line method.
3
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
DERIVATIVE CONTRACTS CLASSIFIED AS HELD FOR TRADING PURPOSES:
The Company, through its affiliate AFSLP, provides interest rate swaps to
states, municipalities and their authorities, and other entities in connection
with their financings. The Company, through its subsidiary ACP, enters into
structured credit derivative transactions with various financial institutions.
Interest rate swaps and structured credit derivatives are classified as held for
trading purposes. These contracts are recorded on trade date at fair value.
Changes in fair value are recorded as a component of net fees earned and other
income on the Consolidated Statements of Operations. The fair value of interest
rate swaps and structured credit derivatives are determined by broker quotes or
valuation models (when broker quotes are not available). Contracts are recorded
on the Consolidated Balance Sheets on a gross basis; assets and liabilities are
netted by customer only when a legal right of set-off exists. Gross asset and
gross liability balances for interest rate swaps and structured credit
derivatives are recorded as other assets or other liabilities on the
Consolidated Balance Sheets.
INCOME TAXES:
Pursuant to a tax sharing agreement, the Company is included in AFGI'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 AFGI'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.
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.
POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS:
AFGI, 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.
STOCK COMPENSATION PLANS:
The Company participates in AFGI's equity plan. Under this plan, awards are
granted to eligible employees of the Company in the form of incentive stock
options or other stock-based awards. Other than the tax benefits derived from
this plan, pursuant to the tax sharing agreement, no other recognition is given
by the Company.
4
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
ACCOUNTING STANDARDS:
In June 1998, the Financial Accounting Standards Board issued FAS Statement
133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133").
FAS 133 establishes accounting and reporting standards for derivative
instruments and hedging activities. The statement requires all derivatives to be
recorded on the balance sheet at fair value and establishes special accounting
for the following three different types of hedges: (1) hedges of changes in the
fair value of assets, liabilities or firm commitments (fair value hedges); (2)
hedges of the variable cash flows of forecasted transactions (cash flow hedges);
and (3) hedges of foreign currency exposures of net investments in foreign
operations. Though the accounting treatment and criteria for each of the three
types of hedges is unique, they all result in recognizing offsetting changes in
value or cash flow of both the hedge and the hedged item in earnings in the same
period. Changes in the fair value of derivatives that do not meet the criteria
of one of these three categories of hedges are included in earnings in the
period of the change with no related offset. FAS 133 is effective for years
beginning after June 15, 2000, but companies may adopt early. The Company will
adopt FAS 133 effective January 1, 2001. The impact of adopting FAS 133 as of
December 31, 1999 would have been insignificant to the Company's consolidated
financial position and results of operations.
RECLASSIFICATIONS:
Certain reclassifications have been made to prior years' amounts to conform
to the current year's presentation.
5
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
3 INVESTMENTS
The amortized cost, gross unrealized gains and losses, and estimated fair
value of investments in fixed income securities and short-term investments at
December 31, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
1999
Municipal obligations.............................. $3,046,162 $ 40,986 $ 163,618 $2,923,530
Corporate obligations.............................. 432,663 8,241 20,403 420,501
U.S. Government obligations........................ 61,620 778 1,481 60,917
Mortgage- and asset-backed securities (includes
U.S. Government Agency Obligations)................ 116,701 546 6,226 111,021
Short-term......................................... 207,121 -- -- 207,121
----------- ---------- ---------- -----------
$3,864,267 $ 50,551 $ 191,728 $3,723,090
=========== ========== ========== ===========
</TABLE>
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
1998
Municipal obligations.............................. $2,592,649 $ 168,481 $ 3,912 $2,757,218
Corporate obligations.............................. 275,416 36,292 289 311,419
U.S. Government obligations........................ 130,383 9,203 -- 139,586
Mortgage- and asset-backed securities (includes
U.S. Government Agency Obligations)................ 98,841 3,000 17 101,824
Short-term......................................... 93,912 -- -- 93,912
----------- ---------- ---------- -----------
$3,191,201 $ 216,976 $ 4,218 $3,403,959
=========== ========== ========== ===========
</TABLE>
The amortized cost and estimated fair value of fixed income securities and
short-term investments at December 31, 1999, by contractual maturity, were as
follows:
<TABLE>
<CAPTION>
Amortized Estimated
Cost Fair Value
----------- ----------
<S> <C> <C>
1999
Due in one year or less.......................................... $ 266,311 $ 266,309
Due after one year through five years............................ 254,231 262,292
Due after five years through ten years........................... 369,020 370,442
Due after ten years.............................................. 2,858,004 2,713,026
----------- ----------
3,747,566 3,612,069
Mortgage- and asset-backed securities (includes U.S.
Government Agency Obligations)................................... 116,701 111,021
----------- ----------
$3,864,267 $3,723,090
=========== ==========
</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.
6
<PAGE>
AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
Securities carried at $5,442 and $6,191 at December 31, 1999 and 1998
respectively, were deposited by the Company with governmental authorities or
designated custodian banks as required by laws affecting insurance companies.
Net investment income of the Company comprised the following:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Fixed income securities.................................. $202,804 $181,437 $155,810
Short-term investments................................... 8,193 8,208 6,885
---------- ---------- ----------
Total investment income............................... 210,997 189,645 162,695
Investment expense....................................... (1,311) (3,386) (2,607)
---------- ---------- ----------
Net investment income................................. $209,686 $186,259 $160,088
========== ========== ==========
</TABLE>
The Company had gross realized gains of $8,050, $17,186 and $26,950 for
1999, 1998 and 1997, respectively, and gross realized losses of $13,725, $29,532
and $8,152 for 1999, 1998 and 1997, respectively. Gross realized gains and
losses in 1998 and 1997 include amounts related to a trading position, which
represented a small portion of the Company's assets, containing high quality
municipal bonds hedged with Treasury futures. These gains were $2,967 and
$1,309 for 1998 and 1997, respectively, and losses of $19,047 and $3,593 for
1998 and 1997, respectively.
As of December 31, 1999 and 1998, the Company held securities subject to
agreements to resell for $0 and $5,449, respectively. Such securities were held
as collateral by the Company. The agreements had terms of less than 30 days.
4 REINSURANCE
In the ordinary course of business, the Company 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,
------------------------------------------------------------------------------------
1999 1998 1997
-------------------------- -------------------------- --------------------------
Written Earned Written Earned Written Earned
----------- ------------ ----------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Direct................ $425,213 $291,983 $339,432 $240,791 $281,034 $177,677
Assumed............... 24,573 19,161 27,359 7,367 8,349 3,614
Ceded................. (61,845) (43,788) (49,563) (33,135) (32,452) (25,623)
----------- ------------ ----------- ------------ ----------- ------------
Net premiums.......... $387,941 $267,356 $317,228 $215,023 $256,931 $155,668
=========== ============ =========== ============ =========== ============
</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 the Company under the existing
reinsurance agreements, the Company would be liable for such defaulted amounts.
To minimize its exposure to significant losses from reinsurer insolvencies, the
Company 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, 1999 and 1998. As of December 31, 1999, prepaid
reinsurance of approximately $158,597 was associated with the Company's three
largest
7
<PAGE>
AMBAC ASSURRANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
reinsurers. As of December 31, 1999, the Company held letters of credit and
collateral amounting to approximately $214,896 from its reinsurers to cover
liabilities ceded under the aforementioned reinsurance contracts.
Premiums assumed from MBIA under the JV Arrangement were $24,503, $18,715
and $8,009 in 1999, 1998 and 1997, respectively. Premiums ceded to MBIA were
$27,418, $15,505 and $8,874 in 1999, 1998 and 1997, respectively.
5 COMMITMENTS AND CONTINGENCIES
The Company is responsible for leases on the rental of office space,
principally 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>
2000............................................ $ 6,355
2001............................................ 5,520
2002............................................ 5,437
2003............................................ 5,443
2004............................................ 5,448
All later years................................. 82,933
----------
$111,136
==========
</TABLE>
Rent expense for the aforementioned leases amounted to $5,298, $5,097 and
$4,210 for the years ended December 31, 1999, 1998 and 1997, respectively.
Total rentals to be received under future sublease agreements are estimated at
$978.
6 INSURANCE REGULATORY RESTRICTIONS
Ambac Assurance is subject to the 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. Based upon these restrictions, at December 31,
1999, the maximum amount that will be available during 2000 for payment of
dividends by Ambac Assurance is approximately $150,000.
Ambac Assurance paid cash dividends of $52,000, $48,000 and $44,000 on its
common stock in 1999, 1998 and 1997, respectively.
8
<PAGE>
AMBAC ASSURRANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
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 differs from stockholder's equity determined
under GAAP principally due to statutory accounting rules that treat loss
reserves, premiums earned, policy acquisition costs, deferred income taxes and
investment carrying values differently.
The following is a reconciliation of consolidated stockholder's equity
presented on a GAAP basis for the Company and its consolidated subsidiaries to
statutory capital and surplus for Ambac Assurance Corporation:
<TABLE>
<CAPTION>
For the Years Ended December 31,
-------------------------------------
1999 1998
---------- ----------
<S> <C> <C>
Ambac Assurance Corporation GAAP stockholder's equity............... $2,415,711 $2,166,345
Mandatory contingency reserve.................................. (917,152) (773,464)
GAAP loss reserves............................................. 94,771 78,240
Unearned premium reserve....................................... (267,233) (234,441)
Deferred acquisition costs..................................... (135,105) (121,665)
Income taxes................................................... 27,860 144,565
Tax and loss bonds............................................. 120,971 88,471
Unrealized gains (losses) on investments....................... 138,396 (216,663)
Statutory goodwill, net of amortization........................ 32,850 36,956
Other.......................................................... (7,766) (5,705)
---------- ----------
Statutory capital and surplus....................................... $1,503,303 $1,162,639
========== ==========
</TABLE>
Statutory net income was $262,756, $271,808 and $198,615 for 1999, 1998 and
1997, respectively.
7 INCOME TAXES
The total effect of income taxes on income and stockholder's equity for the
years ended December 31, 1999 and 1998 was as follows:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Total income taxes charged to income................................ $ 102,724 $ 80,945
---------- ----------
Income taxes charged to stockholder's equity:
Unrealized (losses) gains on bonds................................ (123,877) 10,947
Exercise of stock options......................................... (1,489) (10,868)
---------- ----------
Total (credited) charged to stockholder's equity............... (125,366) 79
---------- ----------
Total effect of income taxes........................................ ($22,642) $ 81,024
========== ==========
</TABLE>
9
<PAGE>
AMBAC ASSURRANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
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>
1999 % 1998 % 1997 %
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Computed expected tax at
statutory rate............ $148,501 35.0% $124,004 35.0% $104,755 35.0%
Reductions in expected
tax resulting from:
Tax-exempt interest....... (43,136) (10.2) (38,821) (10.9) (35,458) (11.8)
Other, net................ (2,641) (0.6) (4,238) (1.2) (2,103) (0.7)
------------ ------------ ------------ ------------ ------------ ------------
Income tax expense........ $102,724 24.2% $ 80,945 22.9% $ 67,194 22.5%
============ ============ ============ ============ ============ ============
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax liabilities and deferred tax assets at December 31,
1999 and 1998 are presented below:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Deferred tax liabilities:
Contingency reserve.......................................... $153,613 $119,150
Unrealized gains on bonds.................................... -- 74,465
Deferred acquisition costs................................... 47,287 42,583
Unearned premiums............................................ 43,319 36,572
Other........................................................ 5,714 1,248
------------ ------------
Total deferred tax liabilities............................. 249,933 274,018
------------ ------------
Deferred tax assets:
Tax and loss bonds........................................... 120,971 88,471
Unrealized losses on bonds................................... 49,412 --
Loss reserves................................................ 33,339 27,918
Alternative minimum tax credit carryforward.................. 9,896 1,838
Amortization and depreciation................................ 1,139 2,778
Compensation................................................. 3,818 4,066
Other........................................................ 3,498 4,382
------------ ------------
Sub-total deferred tax assets.............................. 222,073 129,453
Valuation allowance.......................................... -- --
------------ ------------
Total deferred tax assets.................................. 222,073 129,453
------------ ------------
Net deferred tax liabilities............................... $ 27,860 $144,565
============ ============
</TABLE>
The Company believes that no valuation allowance is necessary in connection
with the deferred tax assets.
10
<PAGE>
AMBAC ASSURRANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
8 EMPLOYEE BENEFITS
Pensions:
AFGI has a defined benefit pension plan covering substantially all
employees of the Company. The benefits are based on years of service and the
employee's highest salary during five consecutive years of employment within the
last ten years of employment. AFGI'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 table below sets forth a reconciliation of AFGI's beginning and ending
projected benefit obligation, beginning and ending balances of the fair value of
plan assets, and the funded status of AFGI's plan as of December 31, 1999 and
1998:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Change in Projected Benefit Obligation:
Projected benefit obligation at beginning of year..................... $ 12,433 $ 9,374
Service cost.......................................................... 979 691
Interest cost......................................................... 783 684
Amendments............................................................ 0 116
Actuarial (gain) loss................................................. (2,702) 1,843
Benefits paid......................................................... (292) (275)
------------ ------------
Projected benefit obligation at end of year........................... $ 11,201 $ 12,433
------------ ------------
Change in Plan Assets:
Fair value of plan assets at beginning of year........................ $ 10,934 $ 9,644
Actual return on plan assets.......................................... 1,679 1,595
AFGI contributions.................................................... 520 0
Benefits paid......................................................... (292) (275)
Expenses paid......................................................... 0 (30)
------------ ------------
Fair value of plan assets at end of year.............................. $ 12,841 $ 10,934
------------ ------------
Funded status......................................................... $ 1,640 ($ 1,499)
Unrecognized net (gain) loss.......................................... (2,615) 1,118
Unrecognized prior service cost....................................... (931) (1,289)
Unrecognized net transition asset..................................... (1) (4)
------------ ------------
Pension liability included in other liabilities....................... ($ 1,907) ($ 1,674)
============ ============
</TABLE>
AFGI's net pension costs for the years ended December 31, 1999, 1998 and
1997 included the following components:
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Service cost...................................... $ 979 $ 807 $ 723
Interest cost on expected benefit obligation...... 783 684 601
Expected return on plan assets.................... (893) (793) (701)
Amortization of unrecognized transition asset..... (3) (3) (3)
Amortization of prior service cost................ (151) (165) (165)
Recognized net actuarial loss..................... 39 15 33
------------ ------------ ------------
Net periodic pension cost......................... $ 754 $ 545 $ 488
============ ============ ============
</TABLE>
11
<PAGE>
AMBAC ASSURRANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
Pension expense is allocated to each of AFGI's subsidiaries based on
percentage of payroll. Pension expense recorded by the Company amounted to $718,
$526 and $431 in 1999, 1998 and 1997, respectively.
The discount rate used in the determination of the actuarial present value
for the projected benefit obligation was 7.50% and 6.50% for 1999 and 1998,
respectively. The expected long-term rate of return on assets was 9.25% for both
1999 and 1998. The rate of increase in future compensation levels used in
determining the actuarial present value of the projected benefit obligation was
5.0% for both 1999 and 1998.
Substantially all employees of AFGI 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
eligible base salary, plus a matching company contribution of 50% on
contributions up to 6% of base salary made by eligible employees to the Savings
Incentive Plan. The total cost of the Savings Incentive Plan to Ambac Assurance
was $1,695, $1,299 and $1,417 in 1999, 1998 and 1997, respectively.
Annual Incentive Program:
AFGI has an annual incentive program that provides for awards to key
officers and employees based upon predetermined criteria. The Company's cost of
the program for the years ended December 31, 1999, 1998 and 1997 amounted to
$16,106, $13,877 and $10,392, 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.
The Company's postretirement benefits expense was $456, $275 and $242 in
1999, 1998 and 1997, respectively. AFGI's unfunded accumulated postretirement
benefit obligation was $2,897, and the accrued postretirement liability was
$2,315 as of December 31, 1999.
The assumed health care cost trend rates range from 8.0% in 1999,
decreasing ratably to 5.5% in 2003, and remaining at that level thereafter.
Increasing the assumed health care cost trend rate by one percentage point in
each future year would increase AFGI's accumulated postretirement benefit
obligation at December 31, 1999 by $415 and AFGI's 1999 benefit expense by $78.
The weighted average discount rate used to measure the accumulated
postretirement benefit obligation and 1999 expense was 7.50%.
9 GUARANTEES IN FORCE
The par amount of bonds guaranteed, for non-affiliates, was $273,080,000
and $227,198,000 at December 31, 1999 and 1998, respectively. The par amount of
bonds guaranteed, for non-affiliates, net of reinsurance, was $240,307,000 and
$198,274,000 at December 31, 1999 and 1998, respectively. As of December 31,
1999 and 1998, the guarantee portfolio was diversified by type of insured bond
as shown in the following table:
12
<PAGE>
AMBAC ASSURRANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
<TABLE>
<CAPTION>
Net Par Amount Outstanding
-------------------------------------
(Dollars in Millions) 1999 1998
------------ ------------
<S> <C> <C>
Municipal finance:
Lease and tax-backed revenue..................................... $ 40,874 $ 36,929
General obligation............................................... 39,777 37,502
Utility revenue.................................................. 28,867 27,014
Health care revenue.............................................. 18,628 20,071
Transportation revenue........................................... 10,247 7,831
Investor-owned utilities......................................... 9,393 8,013
Higher education................................................. 9,172 7,720
Housing revenue.................................................. 7,033 6,445
Student loans.................................................... 5,474 4,528
Other............................................................ 3,550 873
------------ ------------
Total municipal finance....................................... 173,015 156,926
------------ ------------
Structured finance:
Mortgage-backed and home equity.................................. 33,294 19,478
Asset-backed and conduits........................................ 16,398 12,147
Other............................................................ 3,270 1,238
------------ ------------
Total structured finance...................................... 52,962 32,863
------------ ------------
International finance:
Asset-backed and conduits........................................ 6,023 3,180
Structured credit derivatives.................................... 2,110 0
Utilities........................................................ 1,188 1,073
Mortgage-backed and home equity.................................. 1,172 607
Sovereign/sub-sovereign.......................................... 1,097 1,027
Other............................................................ 2,740 2,598
------------ ------------
Total international finance................................... 14,330 8,485
------------ ------------
$240,307 $198,274
============ ============
</TABLE>
As of December 31, 1999 and 1998, the international guarantee portfolio is
shown in the following table by location of risk:
<TABLE>
<CAPTION>
Net Par Amount Outstanding
-------------------------------------
(Dollars in Millions) 1999 1998
------------ ------------
<S> <C> <C>
United Kingdom........................................ $ 2,416 $2,289
Japan................................................. 1,485 675
France................................................ 738 692
Australia............................................. 722 779
Mexico................................................ 569 375
Internationally diversified........................... 5,686 1,621
Other international................................... 2,714 2,054
------------ ------------
$14,330 $8,485
============ ============
</TABLE>
Internationally diversified includes structured credit derivatives and
other guarantees with multiple locations of risk. International business
includes all transactions conducted through the JV Arrangement. Joint venture
transactions may include components of domestic exposure.
Gross financial guarantees in force (principal and interest) were
$430,536,000 and $367,801,000 at December 31, 1999 and 1998, respectively. Net
financial guarantees in force (after giving effect to reinsurance) were
$374,484,000 and $317,668,000 as of December 31, 1999 and 1998, respectively.
13
<PAGE>
AMBAC ASSURRANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
In the United States, California was the state with the highest aggregate
net par amount in force, accounting for 10.5% of the total at December 31, 1999,
and no other state accounted for more than ten percent. The highest single
insured risk represented less than 1% of aggregate net par amount insured.
10 FINANCIAL INSTRUMENTS HELD FOR PURPOSES OTHER THAN TRADING
Fair value amounts were determined by 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
primarily on quoted market prices received from a nationally recognized pricing
service 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.
Liability for net financial guarantees written: The fair value of the
liability for those financial guarantees written where premiums are collected
upfront, 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.
14
<PAGE>
AMBAC ASSURRANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
The carrying amount and estimated fair value of financial instruments are
presented below:
<TABLE>
<CAPTION>
As of December 31,
--------------------------------------------------------------------------
1999 1998
------------------------------------- -------------------------------
(Dollars in Millions) Carrying Estimated Fair Carrying Estimated Fair
Amount Value Amount Value
----------- ------------------ ---------- ----------------
<S> <C> <C> <C> <C>
Financial assets:
Fixed income securities............... $3,516 $3,516 $3,310 $3,310
Short-term investments................ 207 207 94 94
Cash.................................. 7 7 5 5
Securities purchased under agreements
to resell............................ -- -- 5 5
Liability for financial guarantees
written:
Gross (up-front).................... 1,442 1,009 1,303 912
Net (up-front)..................... 1,224 857 1,103 772
Gross installment premiums.......... -- 454 -- 248
Net installment premiums............ -- 369 -- 216
</TABLE>
11 FINANCIAL INSTRUMENTS CLASSIFIED AS HELD FOR TRADING PURPOSES
The Company, through its affiliate AFSLP, is a provider of interest rate
swaps to states, municipalities and their authorities and other entities in
connection with their financings. AFSLP is subject to basis risk (the
relationship between tax-exempt and taxable interest rates). If actual or
projected tax-exempt interest rates change in relation to taxable rates, the
Company will experience an unrealized mark-to-market gain or loss. The AFSLP
swap portfolio is classified as held for trading purposes.
ACP enters into structured credit derivative transactions. These
structured credit derivatives require ACP to make payments upon the occurrence
of certain defined credit events relating to an underlying obligation (generally
a fixed income security). If credit spreads of the underlying obligations
change, the market value of the related structured credit derivative could
change. As such, ACP could experience an unrealized mark-to-market gain or
loss. Market liquidity could also impact valuations. Changes in credit spreads
are generally caused by changes in the market's perception of the credit quality
of the underlying obligations. The majority of ACP's contracts are partially
hedged with various financial institutions or structured with first loss
protection provided by the counterparty. Such structuring mitigates ACP's risk
of loss and the price volatility of these financial instruments. The ACP credit
derivative portfolio is classified as held for trading purposes.
15
<PAGE>
AMBAC ASSURRANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
The following table summarizes information about the Company's financial
instruments held for trading purposes as of December 31, 1999 and 1998:
<TABLE>
<CAPTION>
Net Estimated Fair Value Average Net Fair Value
------------------------------ -------------------------------
Notional
Assets Liabilities Assets Liabilities Amount
------------ --------------- ------------- --------------- -------------
<S> <C> <C> <C> <C> <C>
1999:
Derivative financial
instruments:
Interest rate swaps............ $177,369 $129,695 $136,008 $ 96,509 $6,321,400
Structured credit derivatives 27,704 27,438 13,572 13,069 6,315,954
Futures contracts.............. -- -- -- -- 751,700
Other financial instruments..... -- -- -- -- --
1998:
Derivative financial
instruments:
Interest rate swaps............ $203,021 $163,140 $134,394 $103,739 $5,857,170
Structured credit derivatives -- -- -- -- --
Futures contracts.............. -- -- -- -- 706,700
Other financial instruments..... -- -- 183,682 181,698 --
</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 $20,301, $825 and
$8,560 for 1999, 1998 and 1997, respectively. Other financial instruments held
for trading purposes consist of fixed income securities held in 1997 and sold
during 1998. The aggregate amount of net trading income recognized from other
financial instruments was $2,967 and $1,309 in 1998 and 1997, respectively.
Average net fair values were calculated based on average monthly 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.
12 LINES OF CREDIT
AFGI and Ambac Assurance have a revolving credit facility with three major
international banks for $150,000, which expires in August 2000 and provides a
two-year term loan provision. The facility is available for general corporate
purposes, including the payment of claims. As of December 31, 1999 and 1998, no
amounts were outstanding under this credit facility.
Ambac Assurance maintains third-party capital support in the form of a
seven-year irrevocable limited recourse credit facility from a group of highly-
rated banks. This credit facility provides liquidity to Ambac Assurance in the
event claims from municipal obligations in its insured portfolio exceed
specified levels. Repayments of amounts drawn under the credit facility are
limited primarily to the amount of any recoveries of losses related to municipal
policy obligations. During 1999, such third-party capital support was increased
from $555,000 to $750,000 and its expiration reset to December 2006. As of
December 31, 1999 and 1998, no amounts were outstanding under this credit
facility.
ACP has a revolving credit facility with one major international bank for
$50,000, which expires in June 2000, and provides for three-year term loans. The
facility is available to ACP for general corporate
16
<PAGE>
AMBAC ASSURRANCE CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(Dollar Amounts in Thousands)
purposes, including the settlement of transactions related to credit derivative
instruments. The credit facility became effective on July 1, 1999. As of
December 31, 1999, no amounts were outstanding under this credit facility.
13 RELATED PARTY TRANSACTIONS
During 1999 and 1998, 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, 1999 and
1998, the aggregate amount of investment agreements and investment repurchase
agreements insured was $5,503,818 and $5,331,820, respectively, including
accrued interest. These guarantees are collateralized by investment securities,
accrued interest receivable, securities purchased under agreements to resell and
cash and cash equivalents, which as of December 31, 1999 and 1998, had a fair
value of $5,358,300 and $5,387,493, respectively, in the aggregate. During 1999
and 1998, Ambac Assurance recorded gross premiums written of $4,463 and $5,598,
and net premiums earned of $2,850 and $2,156, respectively, related to these
agreements.
During 1998, several interest rate swap transactions were executed between
AFSLP and its affiliates (other than Ambac Assurance), while during 1999 there
were none. As of December 31, 1999 and 1998, these contracts had an outstanding
notional amount of approximately $60,660 and $499,720, respectively. As of
December 31, 1999 and 1998, AFSLP recorded a positive fair value of $888 and
$4,571, respectively, related to these transactions.
AFSLP has a $25 million line of credit with AFGI. The line is available
through August 1, 2000. The purpose of this line is to fund short-term
liquidity needs of AFSLP's operations. Interest on borrowings is payable at
rates which vary according to the terms. Outstanding borrowings under the line
were $7,930 and $15,630 as of December 31, 1999 and 1998, respectively.
14 YEAR 2000
To date the Company has had no disruptions with its internal computer
systems as a result of what is commonly known as the Y2K problem. Although the
Company had been running tests on its critical systems throughout 1999, a final
live test occurred on January 1, 2000. The results of that test indicated that
the Company's internal computer systems, and the normal business activities and
operations that depend on them have not been adversely impacted by Y2K sensitive
dates.
Although the Company does not expect issuers of Ambac-guaranteed
obligations to experience significant disruptions due to Y2K, it may take a
considerable amount of time before a full assessment can be made of how each
issuer fared.
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