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 27, 1996 33-84894
- ------------------------- ----------
Mortgage Loan Asset Backed Pass-Through Certificates Trust 1996-B
---------------------------------------------------------------------
(Name of Trust Fund issuing Mortgage Loan Asset Backed
Pass-Through Certificates, Series 1996-B, Class A)
MLCC Mortgage Investors, Inc.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 59-3247986
- --------------------------------- -------------------
(State or other jurisdiction (IRS employer
of incorporation or organization) identification no.)
4802 Deer Lake Drive East
Jacksonville, Florida 32246-6484
- --------------------------------- ------------------
(Address of principal (Zip code)
executive offices)
Registrant's telephone number, including area code: (904) 928-6000
--------------
Securities registered pursuant to Section 12(b) of the Act: None
----
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 No X
----- -----
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. ( )
Aggregate market value of the voting stock held by non-affiliates of the
Registrant: None.
Number of shares of common stock of the Registrant outstanding as of December
31, 1996: Not applicable.
DOCUMENTS INCORPORATED BY REFERENCE
Documents in Part IV incorporated herein by reference are as follows:
1. Monthly statement sent to Certificateholders with the July 1996
distribution incorporated herein by reference as an exhibit to the
Registrant's Current Report on Form 8-K filed with the Securities and
Exchange Commission on July 19, 1996.
2. Monthly statement sent to Certificateholders with the August 1996
distribution incorporated herein by reference as an exhibit to the
Registrant's Current Report on Form 8-K filed with the Securities and
Exchange Commission on August 15, 1996.
3. Monthly statement sent to Certificateholders with the September 1996
distribution incorporated herein by reference as an exhibit to the
Registrant's Current Report on Form 8-K filed with the Securities and
Exchange Commission on September 17, 1996.
4. Monthly statement sent to Certificateholders with the October 1996
distribution incorporated herein by reference as an exhibit to the
Registrant's Current Report on Form 8-K filed with the Securities and
Exchange Commission on October 15, 1996.
5. Monthly statement sent to Certificateholders with the November 1996
distribution incorporated herein by reference as an exhibit to the
Registrant's Current Report on Form 8-K filed with the Securities and
Exchange Commission on November 15, 1996.
6. Monthly statement sent to Certificateholders with the December 1996
distribution incorporated herein by reference as an exhibit to the
Registrant's Current Report on Form 8-K filed with the Securities and
Exchange Commission on December 17, 1996.
PART I
ITEM 1. BUSINESS
Not applicable.
ITEM 2. PROPERTIES
Not applicable.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings with respect to
Merrill Lynch Credit Corporation (the "Master Servicer") or the
Registrant, or to the best of our knowledge, the Trust Fund or
Bankers Trust Company of California, N.A. (the "Trustee"), with
respect to the Trust Fund, other than ordinary routine litigation,
if any, incidental to the duties of the Trust Fund or of the
Trustee, the Master Servicer or the Registrant under the Pooling
and Servicing Agreement relating to the Certificates.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
(a) There is no established public trading market for the
Certificates representing undivided interests in the pool
established by the Registrant of high balance, adjustable
rate, one- to four-family mortgage loans.
(b) At December 31, 1996, the number of holders of record of the
Certificates were as follows:
Number of
Record Holders
--------------
MLCC Mortgage Investors, Inc.,
Mortgage Loan Asset Backed
Pass-Through Certificates,
Series 1996-B 61
(c) Not applicable.
ITEM 6. SELECTED FINANCIAL DATA
Not applicable.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Not applicable.
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
Not applicable.
ITEM 11. EXECUTIVE COMPENSATION
Not applicable.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(a) Not applicable.
(b) Not applicable.
(c) Not applicable.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
(a) Not applicable.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Not applicable.
(2) Not applicable.
(3) The required exhibits are as follows:
Pooling and Servicing Agreement (Filed on
June 20, 1996 as part of the Registrant's current
report on Form 8-K).
Monthly statement sent to Certificateholders with the
July 1996 distribution incorporated herein by reference
as an exhibit to the Registrant's Current Report on Form
8-K filed with the Securities and Exchange Commission on
July 19, 1996.
Monthly statement sent to Certificateholders with the
August 1996 distribution incorporated herein by reference
as an exhibit to the Registrant's Current Report on Form
8-K filed with the Securities and Exchange Commission on
August 15, 1996.
Monthly statement sent to Certificateholders with the
September 1996 distribution incorporated herein by
reference as an exhibit to the Registrant's Current
Report on Form 8-K filed with the Securities and Exchange
Commission on September 17, 1996.
Monthly statement sent to Certificateholders with the
October 1996 distribution incorporated herein by
reference as an exhibit to the Registrant's Current
Report on Form 8-K filed with the Securities and Exchange
Commission on October 15, 1996.
Monthly statement sent to Certificateholders with the
November 1996 distribution incorporated herein by
reference as an exhibit to the Registrant's Current
Report on Form 8-K filed with the Securities and Exchange
Commission on November 15, 1996.
Monthly statement sent to Certificateholders with the
December 1996 distribution incorporated herein by
reference as an exhibit to the Registrant's Current
Report on Form 8-K filed with the Securities and Exchange
Commission on December 17, 1996.
Independent Accountants' Report on Management's Assertion
About Compliance with Uniform Single Attestation Program
Requirements for the year ended December 27, 1996.
Officer's Certificate regarding Annual Statement as to
Compliance of Merrill Lynch Credit Corporation dated
March 21, 1997.
AMBAC Indemnity Corporation and Subsidiaries' audited
consolidated financial statements as of December 31, 1996
and 1995.
(b) The following reports on Form 8-K were filed during the last
quarter of the period covered by this report:
Date Filed Event Reported
---------- --------------
October 15, 1996. Monthly statement sent to
Certificateholders with the October
1996 distribution.
November 15, 1996. Monthly statement sent to
Certificateholders with the November
1996 distribution.
December 17, 1996. Monthly statement sent to
Certificateholders with the December
1996 distribution.
(c) Exhibits required to be filed by the Registrant pursuant to
Item 601 of Regulation S-K are listed in the Exhibit Index
immediately following the signature page hereof.
(d) Not applicable.
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT
TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED
SECURITIES PURSUANT TO SECTION 12 OF THE ACT
No annual report, proxy statement, form of proxy or other soliciting material
has been sent to Certificateholders.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on March 27,
1997.
MLCC MORTGAGE INVESTORS, INC., as
Registrant and on behalf of the Trust Fund
By: /s/ ROBERT J. SMITH
----------------------------
Robert J. Smith
Senior Vice President and
Director
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 in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ MICHAEL A. JOHNSTON President, Chief Executive March 24, 1997
- -----------------------
Michael A. Johnston Officer and Chairman of the
Board of Directors
/s/ KEVIN O'HANLON Senior Vice President and March 24, 1997
- -----------------------
Kevin O'Hanlon Director
/s/ FRANCIS X. ERVIN, JR. Senior Vice President and March 24, 1997
- -------------------------
Francis X. Ervin, Jr. Treasurer (principal
financial officer and
principal accounting officer)
/s/ JOHN J. DONLON Senior Vice President, March 17, 1997
- -----------------------
John J. Donlon Secretary and Director
Director March , 1997
- ----------------------- --
Thomas O. McConnell
/s/ EARLE C. TRAYNHAM Director March 18, 1997
- -----------------------
Earle C. Traynham
EXHIBIT INDEX
Exhibit No. Page
- ----------- ----
4 Pooling and Servicing Agreement (Filed
on June 20, 1996 as part of the
Registrant's current report on Form 8-K) . . . . . . . *
19.1 Report Furnished to Security-Holders
(Filed on July 19, 1996 as part
of the Registrant's current report on
Form 8-K) . . . . . . . . . . . . . . . . . . . . . . *
19.2 Report Furnished to Security-Holders
(Filed on August 15, 1996 as part
of the Registrant's current report on
Form 8-K) . . . . . . . . . . . . . . . . . . . . . . *
19.3 Report Furnished to Security-Holders
(Filed on September 17, 1996 as part
of the Registrant's current report on
Form 8-K) . . . . . . . . . . . . . . . . . . . . . . *
19.4 Report Furnished to Security-Holders
(Filed on October 15, 1996 as part
of the Registrant's current report on
Form 8-K) . . . . . . . . . . . . . . . . . . . . . . *
19.5 Report Furnished to Security-Holders
(Filed on November 15, 1996 as part
of the Registrant's current report on
Form 8-K) . . . . . . . . . . . . . . . . . . . . . . *
19.6 Report Furnished to Security-Holders
(Filed on December 17, 1996 as part
of the Registrant's current report on
Form 8-K) . . . . . . . . . . . . . . . . . . . . . . *
99.1 Independent Accountants' Report on
Management's Assertion About Compliance
with Uniform Single Attestation
Program Requirements for the year ended
December 27, 1996 . . . . . . . . . . . . . . . . . . 11
99.2 Officer's Certificate regarding Annual
Statement as to Compliance of
Merrill Lynch Credit Corporation
dated March 21, 1997 . . . . . . . . . . . . . . . . . 15
99.3 AMBAC Indemnity Corporation and
Subsidiaries' audited consolidated
financial statements as of
December 31, 1996 and 1995 . . . . . . . . . . . . . . 16
- -----------------------------------------
* Incorporated herein by reference.
Exhibit 99.1
------------
INDEPENDENT ACCOUNTANT'S REPORT ON
MANAGEMENT'S ASSERTION ABOUT COMPLIANCE WITH
UNIFORM SINGLE ATTESTATION PROGRAM REQUIREMENTS
Merrill Lynch Credit Corporation and subsidiaries:
We have examined management's assertion about Merrill Lynch Credit
Corporation's compliance with the minimum servicing standards identified in
the Mortgage Bankers Association of America's Uniform Single
--------------
Attestation Program for Mortgage Bankers (USAP) and maintenance of
- ----------------------------------------
adequate hazard insurance as required by investors as of and for the year
ended December 27, 1996 included in the accompanying management assertion.
Management is responsible for Merrill Lynch Credit Corporation's compliance
with those minimum servicing standards. Our responsibility is to express an
opinion on management's assertion about the entity's compliance based on our
examination.
Our examination was made in accordance with standards established by the
American Institute of Certified Public Accountants and, accordingly, included
examining, on a test basis, evidence about Merrill Lynch Credit Corporation's
compliance with the minimum servicing standards and performing such other
procedures as we considered necessary in the circumstances. We believe that
our examination provides a reasonable basis for our opinion. Our examination
does not provide a legal determination on Merrill Lynch Credit Corporation's
compliance with the minimum servicing standards.
All loans serviced by Merrill Lynch Credit Corporation under pooling and
servicing agreements relating to mortgage pass-through certificates listed in
Exhibit I attached were included in the total population which was subject to
selection for testing in our examination.
In our opinion, management's assertion that Merrill Lynch Credit Corporation
complied with the aforementioned minimum servicing standards and maintenance
of adequate hazard insurance as required by investors as of and for the year
ended December 27, 1996 is fairly stated, in all material respects.
This report is intended for the information and use of the Board of Directors
and management of Merrill Lynch Credit Corporation and subsidiaries and the
Trustees for the mortgage pass-through certificates listed in Exhibit I.
/s/ Deloitte & Touche LLP
February 26, 1997
EXHIBIT I
MERRILL LYNCH CREDIT CORPORATION
DETAIL OF MORTGAGE PASS-THROUGH CERTIFICATES
UNDER POOLING AND SERVICING AGREEMENTS
DECEMBER 27, 1996
- --------------------------------------------------------------------------
MLCC PrimeFirst Adjustable Rate Mortgage Senior/Subordinate
Pass-Through Certificates, Series 1991F, Class A-1 and A-2
ML Home Equity Loan Asset Backed Certificates, Series 1991-2,
Class A-1, A-2 and B
MLCC PrimeFirst Adjustable Rate Mortgage Senior/Subordinate
Pass-Through Certificates, Series 1992A, Class A-1 and A-2
MLCC PrimeFirst Adjustable Rate Mortgage Senior/Subordinate
Pass-Through Certificates, Series 1992A, Class B
MLCC PrimeFirst Adjustable Rate Mortgage Senior/Subordinate
Pass-Through Certificates, Series 1992C, Class A-1 and A-2
MLCC PrimeFirst Adjustable Rate Mortgage Senior/Subordinate
Pass-Through Certificates, Series 1992C, Class B
MLCC PrimeFirst Adjustable Rate Mortgage Senior/Subordinate
Pass-Through Certificates, Series 1992F, Class A-1, A-2 and A-3
MLCC PrimeFirst Adjustable Rate Mortgage Senior/Subordinate
Pass-Through Certificates, Series 1992F, Class B
ML Home Equity Loan Asset Backed Certificates, Series 1992-1,
Class A and B
ML Home Equity Loan Asset Backed Certificates, Series 1993-1,
Class A and B
MLCC PrimeFirst Adjustable Rate Mortgage Senior/Subordinate
Pass-Through Certificates, Series 1993B, Class A-1, A-2 and A-3
MLCC PrimeFirst Adjustable Rate Mortgage Senior/Subordinate
Pass-Through Certificates, Series 1993B, Class B
MLCC PrimeFirst Adjustable Rate Mortgage Senior/Subordinate
Pass-Through Certificates, Series 1993C, Class A-1, A-2, A-3 and A-4
MLCC Senior/Subordinate Mortgage Pass-Through Certificates,
Series 1993E, Class A-1, A-2, A-3, A-4, A-5 and A-6
MLCC Senior/Subordinate Mortgage Pass-Through Certificates,
Series 1993F, Class A-1, A-2, A-3, A-4, A-5 and A-6
MLCC Senior/Subordinate Mortgage Pass-Through Certificates,
Series 1993I, Class A-1, A-2, A-3, A-4, A-5 and A-6
MLCC Subordinate Mortgage Backed Certificates,
Series 1994A, Class A-1 and A-2
MLCC Senior/Subordinate Mortgage Pass-Through Certificates,
Series 1994A, Class A-1, A-2, A-3, A-4 and A-5
MLCC Mortgage Investors, Inc., Senior/Subordinate Mortgage
Pass-Through Certificates, Series 1994A, Class A-1, A-2, A-3
M-1, A-4 and M-2
MLCC Mortgage Investors, Inc., Senior/Subordinate Mortgage
Pass-Through Certificates, Series 1994B, Class A-1, A-2, A-3 and A-4
MLCC Senior/Subordinate Mortgage Pass-Through Certificates,
Series 1994F, Class A-1, A-2, A-3, M, A-4 and A-5
MLCC Senior/Subordinate Mortgage Pass-Through Certificates,
Series 1994H, Class A-1, A-2, A-3, M, A-4 and A-5
ML Home Equity Loan Asset Backed Certificates, Series 1994-1,
Class A-1 and A-2
ML Home Equity Loan Pass-Through Certificates, Series 1994-2, Class A
ML Home Equity Loan Pass-Through Certificates, Series 1995-1,
Class A-1 and A-2
MLCC Mortgage Investors, Inc., Senior/Subordinate Mortgage Pass-Through
Certificates, Series 1995A, Class A-1, A-2, A-3, A-4, A-5 and A-6
ML Home Equity Loan Pass-Through Certificates, Series 1995-2, Class A
MLCC Mortgage Investors, Inc., Mortgage Loan Asset Backed Pass-Through
Certificates, Series 1995B, Class A
MLCC Mortgage Investors, Inc., Subordinate Mortgage Backed Certificates,
Series 1995-S1
MLCC Mortgage Investors, Inc., Mortgage Loan Asset Backed Pass-Through
Certificates, Series 1996A, Class A
MLCC Mortgage Investors, Inc., Mortgage Loan Asset Backed Pass-Through
Certificates, Series 1996B, Class A
MLCC Mortgage Investors, Inc., Mortgage Loan Asset Backed Pass-Through
Certificates, Series 1996C, Class A
MLCC Mortgage Investors, Inc., Mortgage Loan Asset Backed Pass-Through
Certificates, Series 1996D, Class A
MLCC Mortgage Investors, Inc., ML Revolving Home Equity Loan
Asset Backed Certificates, Series 1996-1
MLCC Mortgage Investors, Inc., ML Revolving Home Equity Loan
Asset Backed Certificates, Series 1996-2
Merrill Lynch
Credit Corporation
Private Client Group
4802 Deer Lake Drive East
Jacksonville, Florida 32246-6484
800 452 3881
February 26, 1997
Deloitte & Touche LLP
2801 Independent Drive
Jacksonville, FL 32202
Ladies and Gentlemen:
As of and for the year ended December 27, 1996, Merrill Lynch Credit
Corporation and subsidiaries (the "Company") has complied in all material
respects with the minimum servicing standards set forth in the Mortgage
Bankers Association of America's Uniform Single Attestation Program for
--------------------------------------
Mortgage Bankers and has maintained adequate hazard insurance as required
- ----------------
by investors. As of and for the same period, the Company had in effect
fidelity bond and errors and omissions insurance coverage in the amounts of
$325,000,000 and $105,000,000 respectively.
/s/ Michael A. Johnston
------------------------------
Michael A. Johnston
Chairman/Chief Executive Officer
/s/ Kevin M. O'Hanlon
------------------------------
Kevin M. O'Hanlon
President/Chief Operating Officer
/s/ Francis X. Ervin, Jr.
------------------------------
Francis X. Ervin, Jr.
Senior Vice President/Chief
Financial Officer
/s/ Steven T. Hardy
-------------------------
Steven T. Hardy
Vice President/Controller
Exhibit 99.2
------------
OFFICERS' CERTIFICATE
ANNUAL STATEMENT AS TO COMPLIANCE
Re: MLCC Mortgage Investors, Inc. ("Company"),
Merrill Lynch Credit Corporation ("Master Servicer"),
and Bankers Trust Company of California, N.A. ("Trustee"),
Pooling and Servicing Agreement dated as of June 1, 1996
(the "Agreement"), Mortgage Loan Asset Backed Pass-Through
Certificates, Series 1996-B
Pursuant to the above Agreement, the Master Servicer hereby states:
1. A review of the activities of the Master Servicer during the
1996 calendar year and of its performance under the Agreement has been made
under the supervision of each of the undersigned officers, and
2. To the best of each such officer's knowledge, based on such
review, the Master Servicer has fulfilled all of its obligations under the
Agreement in all material respects throughout such year.
3. There were no Sub-Servicers during said calendar year.
Dated: March 21, 1997
Merrill Lynch Credit Corporation
By: /s/Francis X. Ervin
-------------------------
Francis X. Ervin, Senior
Vice President and Treasurer
/s/John M. Wheeler
------------------------------
John M. Wheeler, Senior Vice
President
Exhibit 99.3
------------
AMBAC INDEMNITY CORPORATION AND SUBSIDIARIES
(a wholly owned subsidiary of AMBAC Inc.)
Consolidated Financial Statements
December 31, 1996 and 1995
INDEPENDENT AUDITORS' REPORT
The Board of Directors
AMBAC Indemnity Corporation
We have audited the accompanying consolidated balance sheets of AMBAC
Indemnity Corporation and subsidiaries (a wholly owned subsidiary of AMBAC
Inc.) as of December 31, 1996 and 1995, 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, 1996. These consolidated
financial statements are the responsibility of AMBAC Indemnity 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
Indemnity Corporation and subsidiaries as of December 31, 1996 and 1995, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1996 in conformity with generally
accepted accounting principles.
/s/ KPMG Peat Marwick LLP
New York, New York
January 30, 1997
AMBAC INDEMNITY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
(DOLLARS IN THOUSANDS EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
ASSETS
Investments:
Bonds held in available for sale account, at fair value
(amortized cost of $2,323,259 in 1996 and $2,090,101 in
1995).................................................. $2,424,524 $2,224,528
Short-term investments, at cost (approximates fair
value)................................................. 91,320 163,953
---------- ----------
Total investments...................................... 2,515,844 2,388,481
Cash..................................................... 5,025 6,912
Securities purchased under agreements to resell.......... 4,369 4,120
Receivable for securities................................ 18,462 8,136
Investment income due and accrued........................ 42,263 38,319
Investment in affiliate.................................. -- 25,827
Deferred acquisition costs............................... 94,212 82,620
Current income taxes..................................... -- 2,171
Prepaid reinsurance...................................... 168,786 153,372
Other assets............................................. 59,544 48,472
---------- ----------
Total assets........................................... $2,908,505 $2,758,430
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities:
Unearned premiums....................................... $ 995,220 $ 906,136
Losses and loss adjustment expenses..................... 60,220 65,996
Ceded reinsurance balances payable...................... 7,438 14,654
Deferred income taxes................................... 84,842 85,008
Current income taxes.................................... 8,974 --
Accounts payable and other liabilities.................. 50,244 43,625
Payable for securities.................................. 46,246 86,304
---------- ----------
Total liabilities...................................... 1,253,184 1,201,723
---------- ----------
Stockholder's equity:
Preferred stock, par value $1,000.00 per share;
authorized shares--285,000;
issued and outstanding shares--none.................... -- --
Common stock, par value $2.50 per share; authorized
shares--40,000,000;
issued and outstanding shares--32,800,000 at December
31, 1996 and December 31, 1995......................... 82,000 82,000
Additional paid-in capital.............................. 515,684 481,059
Unrealized gains on investments, net of tax............. 65,822 87,112
Retained earnings....................................... 991,815 906,536
---------- ----------
Total stockholder's equity............................. 1,655,321 1,556,707
---------- ----------
Total liabilities and stockholder's equity............. $2,908,505 $2,758,430
========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
AMBAC INDEMNITY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Revenues:
Gross premiums written........................... $249,761 $195,033 $192,598
Ceded premiums written........................... (37,793) (28,606) 2,815
-------- -------- --------
Net premiums written............................ 211,968 166,427 195,413
Increase in unearned premiums, net............... (73,671) (52,844) (76,077)
-------- -------- --------
Net premiums earned............................. 138,297 113,583 119,336
Net investment income............................ 145,302 131,496 119,737
Net realized gains (losses)...................... 69,149 177 (13,386)
Other income..................................... 16,418 6,777 6,887
-------- -------- --------
Total revenues.................................. 369,166 252,033 232,574
-------- -------- --------
Expenses:
Losses and loss adjustment expenses.............. 3,778 3,377 2,593
Underwriting and operating expenses.............. 42,459 38,722 35,946
Interest expense................................. 2,073 1,590 1,428
-------- -------- --------
Total expenses.................................. 48,310 43,689 39,967
-------- -------- --------
Income before income taxes...................... 320,856 208,344 192,607
-------- -------- --------
Income tax expense:
Current taxes.................................... 68,322 29,085 26,286
Deferred taxes................................... 11,298 14,461 16,277
-------- -------- --------
Total income taxes.............................. 79,620 43,546 42,563
-------- -------- --------
Net Income...................................... 241,236 164,798 150,044
======== ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
AMBAC INDEMNITY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1996 1995 1994
--------- -------- ---------
<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......................... $ 481,059 $444,258 $ 444,143
Capital contributions........................ 32,500 35,000 --
Other paid-in capital........................ 2,125 1,801 115
--------- -------- ---------
Balance at December 31....................... $ 515,684 $481,059 $ 444,258
========= ======== =========
Unrealized Gains (Losses) on Investments, Net
of Tax
Balance at January 1......................... $ 87,112 $(46,087) $ 68,091
Change in unrealized gain (loss)............. (21,290) 133,199 (114,178)
--------- -------- ---------
Balance at December 31....................... $ 65,822 $ 87,112 $ (46,087)
========= ======== =========
Retained Earnings:
Balance at January 1......................... $ 906,536 $781,571 $ 667,527
Net income................................... 241,236 164,798 150,044
Dividends declared--common stock............. (155,865) (40,000) (36,000)
Other........................................ (92) 167 --
--------- -------- ---------
Balance at December 31....................... $ 991,815 $906,536 $ 781,571
========= ======== =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
AMBAC INDEMNITY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income............................. $ 241,236 $ 164,798 $ 150,044
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation and amortization.......... 1,711 1,605 1,106
Amortization of bond premium and
discount.............................. (1,902) (831) (1,097)
Current income taxes................... 11,145 8,373 (6,069)
Deferred income taxes.................. 11,299 14,462 16,277
Deferred acquisition costs............. (11,592) (10,846) (20,757)
Unearned premiums, net................. 73,671 52,844 76,077
Losses and loss adjustment expenses.... (5,776) 334 1,625
Ceded reinsurance balances payable..... (7,216) 13,746 (2,963)
(Gain) loss on sales of investments and
affiliates............................ (69,149) (177) 13,386
Accounts payable and other
liabilities........................... 6,619 106 20,497
Other, net............................. (17,928) (11,273) 7,179
----------- ----------- -----------
Net cash provided by operating
activities........................... 232,118 233,141 255,305
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds at
amortized cost........................ 1,555,372 1,882,485 1,305,011
Proceeds from maturities of bonds at
amortized cost........................ 86,292 163,031 39,126
Purchases of bonds at amortized cost... (1,938,677) (2,192,824) (1,559,982)
Change in short-term investments....... 72,633 (78,751) 9,005
Securities purchased under agreements
to resell............................. (249) 3,891 (8,011)
Other, net............................. (1,876) (1,178) (3,786)
----------- ----------- -----------
Net cash used in investing
activities........................... (226,505) (223,346) (218,637)
----------- ----------- -----------
Cash flows from financing activities:
Dividends paid......................... (40,000) (40,000) (36,000)
Capital contribution................... 32,500 35,000 --
----------- ----------- -----------
Net cash used in financing
activities........................... (7,500) (5,000) (36,000)
----------- ----------- -----------
Net cash flow......................... (1,887) 4,795 668
Cash at January 1....................... 6,912 2,117 1,449
----------- ----------- -----------
Cash at December 31..................... $ 5,025 $ 6,912 $ 2,117
=========== =========== ===========
Supplemental disclosure of cash flow
information:
Cash paid during the year for:
Income taxes.......................... $ 54,504 $ 19,500 $ 32,153
=========== =========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
AMBAC INDEMNITY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
1 BACKGROUND
AMBAC Indemnity Corporation ("AMBAC Indemnity") is a leading insurer of
municipal and structured finance obligations. Financial guarantee insurance
underwritten by AMBAC Indemnity guarantees payment when due of the principal
of and interest on the obligation insured. In the case of a default on the
insured bond, payments under the insurance policy may not be accelerated by
the policyholder without AMBAC Indemnity's consent. As of December 31, 1996,
AMBAC Indemnity's net insurance in force (principal and interest) was
$227,235,000. AMBAC Indemnity is a wholly owned subsidiary of AMBAC Inc.
(NYSE: ABK), a holding company that provides financial guarantee insurance and
financial services to both public and private clients through its
subsidiaries.
AMBAC Indemnity, as the sole limited partner, owns a limited partnership
interest representing 90% of the total partnership interests of AMBAC
Financial Services, Limited Partnership ("AFS"), a limited partnership which
provides interest rate swaps primarily to states, municipalities and municipal
authorities. The sole general partner of AFS, AMBAC Financial Services
Holdings, Inc., a wholly owned subsidiary of AMBAC Inc., owns a general
partnership interest representing 10% of the total partnership interest in
AFS.
AMBAC Indemnity has one wholly owned subsidiary, American Municipal Bond
Holding Company ("AMBH"), which is a holding company for certain real estate
interests.
As of December 31, 1995, AMBAC Indemnity owned 26.5% and AMBAC 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 Inc. and
AMBAC Indemnity, combined, owned approximately 96% of HCIA. During 1996, in
conjunction with the sale of AMBAC Inc.'s and AMBAC Indemnity's combined
holdings in HCIA common stock, AMBAC Indemnity delivered to AMBAC Inc. (in the
form of an extraordinary dividend) its 2,378,672 shares of HCIA common stock.
As a result, AMBAC Indemnity 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 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 Indemnity and its subsidiaries
(sometimes collectively referred to as the "Company") are as described below:
CONSOLIDATION:
The consolidated financial statements include the accounts of AMBAC
Indemnity 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 debt securities that are considered
available for sale and are carried at fair value. Fair value is based on
quotes obtained by the Company from independent market sources. Short-term
investments are carried at cost, which approximates fair value. Unrealized
gains and losses, net of deferred income taxes, are included as a separate
component of 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.
When an AMBAC Indemnity-insured new or secondary market issue has been
refunded or called, the remaining unearned premium is generally earned at that
time, as the risk to AMBAC Indemnity is considered to have been eliminated.
LOSSES AND LOSS ADJUSTMENT EXPENSES:
The liability for losses and loss adjustment expenses consists of the Active
Credit Reserve ("ACR") and case basis loss and loss adjustment expense
reserves. The development of the ACR is based upon estimates of the ultimate
aggregate losses inherent in the obligations insured and reflects the net
result of contributions related to the portion of earnings required to cover
those losses, less reductions of ACR no longer deemed necessary by management.
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 Indemnity's management believes that the reserves for losses and loss
adjustment expenses are adequate to cover the ultimate net cost of claims, but
the reserves are necessarily based on estimates and there can be no assurance
that the ultimate liability will not exceed such estimates.
DEFERRED ACQUISITION COSTS:
Certain costs incurred which vary with, and are primarily related to, the
production of business have been deferred. These costs include direct and
indirect expenses related to underwriting, marketing and policy issuance,
rating agency fees and premium taxes, net of reinsurance ceding commissions.
The deferred acquisition costs are being amortized over the periods in which
the related premiums are earned, and such amortization amounted to $12,553,
$10,183 and $9,348 for 1996, 1995 and 1994, respectively. Deferred acquisition
costs, net of such amortization, amounted to $11,592, $10,846 and $20,757 for
1996, 1995 and 1994, respectively.
DEPRECIATION AND AMORTIZATION:
Depreciation of furniture and fixtures and electronic data processing
equipment is provided over the estimated useful lives of the respective assets
using the straight-line method. Amortization of leasehold improvements and
intangibles, including certain computer software licenses, is provided over
the estimated useful lives of the respective assets using the straight-line
method.
INTEREST RATE CONTRACTS:
Interest Rate Contracts Held for Purposes Other Than Trading:
The Company uses interest rate contracts for hedging purposes as part of its
overall interest rate risk management. Gains and losses on interest rate
futures and options contracts that qualify as accounting hedges of existing
assets are included in the carrying amounts and amortized over the remaining
lives of the assets as an adjustment to interest income. When the hedged asset
is sold, the unamortized gain or loss on the related hedge is recognized in
income. Gains and losses on interest rate contracts that do not qualify as
accounting hedges are recognized in current period income.
The Company accounts for its interest rate futures contracts in accordance
with the provisions of Statement of Financial Accounting Standards No. 80,
"Accounting for Futures Contracts" ("Statement 80"). Statement 80 permits
hedge accounting for interest rate futures contracts when the item to be
hedged exposes the Company to price or interest rate risk, and the futures
contract effectively reduces that exposure and is designated as a hedge.
Interest rate futures contracts held for purposes other than trading are used
primarily to hedge interest-sensitive assets and liabilities. Interest rate
futures contracts are designated at inception as a hedge to specific assets
and liabilities.
Interest rate swaps that are linked with existing liabilities are accounted
for as a hedge of those liabilities, using the accrual method as an adjustment
to interest expense. Interest rate swaps that are linked with existing assets
classified as available for sale are accounted for as hedges of those assets,
using the accrual method as an adjustment to interest income, with unrealized
gains and losses included in stockholder's equity, net of tax.
Interest Rate Contracts Held for Trading Purposes:
The Company, in connection with its market-making activities as a provider
of interest rate swaps to states, municipalities, municipal authorities and
other entities in connection with their financings, uses interest rate
contracts which are classified as held for trading purposes. Interest rate
contracts are recorded on trade date at fair value. Changes in fair value are
recorded as a component of 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 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 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 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.
Income taxes are accounted for under Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("Statement 109"). In
accordance with Statement 109, 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 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.
3 INVESTMENTS
The amortized cost and estimated fair value of investments in debt
securities at December 31, 1996 and 1995 were as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
1996
Municipal obligations.............. $1,892,875 $ 86,984 $2,223 $1,977,636
Corporate securities............... 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
========== ======== ====== ==========
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
1995
Municipal obligations.............. $1,558,754 $ 98,090 $2,428 $1,654,416
Corporate securities............... 261,492 30,785 3,263 289,014
U.S. Government obligations........ 214,224 8,796 621 222,399
Mortgage- and asset-backed
securities (includes U.S.
Government Agency obligations).... 55,631 3,362 294 58,699
Other.............................. 163,953 -- -- 163,953
---------- -------- ------ ----------
$2,254,054 $141,033 $6,606 $2,388,481
========== ======== ====== ==========
</TABLE>
The amortized cost and estimated fair value of debt securities at December
31, 1996, by contractual maturity, were as follows:
<TABLE>
<CAPTION>
AMORTIZED ESTIMATED
COST FAIR VALUE
---------- ----------
<S> <C> <C>
Due in one year or less.............................. $ 119,731 $ 119,838
Due after one year through five years................ 218,634 227,141
Due after five years through ten years............... 218,389 229,227
Due after ten years.................................. 1,807,680 1,887,785
---------- ----------
2,364,434 2,463,991
Mortgage- and asset-backed securities (includes U.S.
Government Agency obligations)...................... 50,145 51,853
---------- ----------
$2,414,579 $2,515,844
========== ==========
</TABLE>
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties.
Net investment income from financial guarantee insurance operations
comprised the following:
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Bonds.......................................... $139,410 $127,865 $118,685
Short-term investments......................... 8,360 6,116 3,512
-------- -------- --------
Total investment income....................... 147,770 133,981 122,197
Investment expense............................. (2,468) (2,485) (2,460)
-------- -------- --------
Net investment income......................... $145,302 $131,496 $119,737
======== ======== ========
</TABLE>
Financial guarantee insurance operations had gross realized gains of
$108,916, $27,786 and $26,514 for 1996, 1995 and 1994, respectively, and gross
realized losses of $39,767, $27,609 and $39,900 for 1996, 1995 and 1994,
respectively.
As of December 31, 1996, the Company did not have any investment
concentrated in any single repayment source (excluding obligations of the U.S.
Government and its agencies) with a fair value greater than 2.0% of its
stockholder's equity.
As of December 31, 1996 and 1995, the Company held securities subject to
agreements to resell for $4,369 and $4,120, respectively. Such securities were
held as collateral by the Company. The agreements had terms of less than 30
days.
Additionally, as of December 31, 1996 and 1995, investment securities with a
fair value of $0 and $4,583, respectively, were pledged to futures brokers for
required margin.
4 REINSURANCE
In the ordinary course of business, AMBAC Indemnity cedes exposures under
various reinsurance contracts primarily designed to minimize losses from large
risks and to protect capital and surplus. The effect of reinsurance on
premiums written and earned was as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
1996 1995 1994
------------------ ------------------ -----------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Direct.............. $243,097 $157,551 $192,277 $127,322 $188,057 $136,632
Assumed............. 6,664 3,126 2,756 1,349 4,541 1,325
Ceded............... (37,793) (22,380) (28,606) (15,088) 2,815 (18,621)
-------- -------- -------- -------- -------- --------
Net premiums........ $211,968 $138,297 $166,427 $113,583 $195,413 $119,336
======== ======== ======== ======== ======== ========
</TABLE>
The reinsurance of risk does not relieve the ceding insurer of its original
liability to its policyholders. In the event that all or any of the reinsurers
are unable to meet their obligations to AMBAC Indemnity under the existing
reinsurance agreements, AMBAC Indemnity would be liable for such defaulted
amounts. To minimize its exposure to significant losses from reinsurer
insolvencies, AMBAC Indemnity evaluates the financial condition of its
reinsurers and monitors concentrations of credit risk. There were no
reinsurance receivables as of December 31, 1996 and 1995. As of December 31,
1996, prepaid reinsurance of approximately $139,629 was associated with AMBAC
Indemnity's three largest reinsurers. As of December 31, 1996, AMBAC Indemnity
held letters of credit and collateral amounting to approximately $159,129 from
its reinsurers to cover liabilities ceded under the aforementioned reinsurance
contracts.
During 1995 and 1994, AMBAC Indemnity terminated reinsurance contracts,
resulting in return premiums to AMBAC Indemnity of $18,141 and $30,482,
respectively, of which $15,700 and $25,891 were recorded as an increase to the
unearned premium reserve in 1995 and 1994, respectively, with the remainder
recognized as revenue.
5 LOSSES AND LOSS ADJUSTMENT EXPENSES
AMBAC Indemnity's liability for losses and loss adjustment expenses includes
case basis loss and loss adjustment expense reserves and the ACR. Following is
a summary of the activity in the case basis loss and loss adjustment expense
reserve and ACR accounts and the components of the liability for losses and
loss adjustment expenses:
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Case basis loss and loss adjustment expense
reserves:
Balance at January 1........................... $39,249 $38,892 $35,155
------- ------- -------
Incurred related to:
Current year.................................. 1,484 750 8,073
Prior years................................... (9,556) 2,650 (3,368)
------- ------- -------
Total incurred............................... (8,072) 3,400 4,705
------- ------- -------
Paid related to:
Current year.................................. 150 150 275
Prior years................................... 9,404 2,893 693
------- ------- -------
Total paid................................... 9,554 3,043 968
------- ------- -------
Balance at December 31......................... 21,623 39,249 38,892
------- ------- -------
Active credit reserve:
Balance at January 1........................... 26,747 26,770 28,882
Net provision for losses....................... 5,115 4,097 4,422
ACR transfers from (to) Case Reserves.......... 6,735 (4,120) (6,534)
------- ------- -------
Balance at December 31......................... 38,597 26,747 26,770
------- ------- -------
Total........................................ $60,220 $65,996 $65,662
======= ======= =======
</TABLE>
The terms "current year" and "prior years" in the foregoing table refer to
the year in which case basis loss reserves were established.
6 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 2014, contain provisions for scheduled periodic rent
increases and are accounted for as operating leases. An estimate of future net
minimum lease payments in each of the next five years ending December 31, and
the periods thereafter, is as follows:
<TABLE>
<CAPTION>
AMOUNT
-------
<S> <C>
1997............................................................... $ 3,329
1998............................................................... 3,615
1999............................................................... 3,757
2000............................................................... 3,683
2001............................................................... 3,683
All later years.................................................... 50,645
-------
$68,712
=======
</TABLE>
Rent expense for the aforementioned leases amounted to $3,286, $2,924 and
$2,719 for the years ended December 31, 1996, 1995 and 1994, respectively.
7 INSURANCE REGULATORY RESTRICTIONS
AMBAC Indemnity is subject to insurance regulatory requirements of the
States of Wisconsin and New York and the other jurisdictions in which it is
licensed to conduct business.
AMBAC Indemnity's ability to pay dividends is generally restricted by law
and subject to approval by the Office of the Commissioner of Insurance of the
State of Wisconsin (the "Wisconsin Commissioner"). Wisconsin insurance law
restricts the payment of dividends in any 12-month period without regulatory
approval to the lesser of (a) 10% of policyholders' surplus as of the
preceding December 31 and (b) the greater of (i) statutory net income for the
calendar year preceding the date of dividend, minus realized capital gains for
that calendar year and (ii) the aggregate of statutory net income for three
calendar years preceding the date of the dividend, minus realized capital
gains for those calendar years and minus dividends paid or credited within the
first two of the three preceding calendar years.
AMBAC Indemnity paid cash dividends of $40,000, $40,000 and $36,000 on its
common stock in 1996, 1995 and 1994, respectively. In addition, on April 30,
1996, AMBAC Indemnity, in conjunction with the sale of the AMBAC Inc.'s and
AMBAC Indemnity's combined remaining holdings in HCIA common stock, delivered
to AMBAC 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. As a result, any dividends paid, or to be paid, by AMBAC Indemnity
to AMBAC Inc. through June 30, 1997 require pre-approval from the Wisconsin
Commissioner. The Wisconsin Commissioner has stated to AMBAC Indemnity
management that it does not foresee any reason pre-approval of anticipated
common stock dividends paid through June 30, 1997 would not be given.
Anticipated common stock dividends paid thereafter and through year-end 1997
will not require such pre-approval.
The New York Financial Guarantee Insurance Law establishes single risk
limits applicable to all obligations issued by a single entity and backed by a
single revenue source. Under the limit applicable to municipal bonds, the
insured average annual debt service for a single risk, net of reinsurance and
collateral, may not exceed 10% of qualified statutory capital, which is defined
as the sum of the insurer's policyholders' surplus and contingency reserves. In
addition, insured principal of municipal bonds attributable to any single risk,
net of reinsurance and collateral, is limited to 75% of 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.
Statutory capital and surplus was $899,023 and $862,976 at December 31, 1996
and 1995, respectively. Qualified statutory capital was $1,466,560 and
$1,358,769 at December 31, 1996 and 1995, respectively. Statutory net income
was $222,810, $142,541 and $116,238 for 1996, 1995 and 1994, respectively.
Statutory capital and surplus differs from stockholder's 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, 1996 and 1995 was as follows:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Total income taxes charged
to income................ $ 79,620 $ 43,546
-------- --------
Income taxes charged
(credited) to
stockholder's equity:
Unrealized gain (loss) on
bonds................... (11,464) 71,722
Unrealized gain on
investment in
affiliate............... -- 602
Other.................... (2,125) (682)
-------- --------
Total (credited) charged
to stockholder's
equity................. (13,589) 71,642
-------- --------
Total effect of income
taxes.................... $ 66,031 $115,188
======== ========
</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>
1996 % 1995 % 1994 %
-------- ---- -------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Computed expected tax at
statutory rate............. $112,300 35.0% $ 72,920 35.0% $ 67,412 35.0%
Increases (reductions) in
expected tax resulting
from:
Tax-exempt interest....... (30,655) (9.6) (28,274) (13.6) (26,336) (13.7)
Other, net................ (2,025) (0.6) (1,100) (0.5) 1,487 0.8
-------- ---- -------- ----- -------- -----
Income tax expense.......... $ 79,620 24.8% $ 43,546 20.9% $ 42,563 22.1%
======== ==== ======== ===== ======== =====
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax liabilities and deferred tax assets at December
31, 1996 and 1995 are presented below:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Deferred tax liabilities:
Contingency reserve...................................... $ 76,805 $ 76,805
Unrealized gains on bonds................................ 35,443 46,906
Deferred acquisition costs............................... 32,974 28,917
Unearned premiums........................................ 27,971 22,079
Unrealized gain on investment in affiliate............... -- 602
Investments.............................................. -- 2,911
Other.................................................... 1,389 1,334
-------- --------
Total deferred tax liabilities.......................... 174,582 179,554
-------- --------
Deferred tax assets:
Tax and loss bonds....................................... 63,871 63,871
Loss reserves............................................ 13,561 9,631
Alternative minimum tax credit carryforward.............. -- 12,272
Amortization and depreciation............................ 6,791 4,763
Compensation............................................. 2,721 2,418
Investments.............................................. 1,374 --
Other.................................................... 1,422 1,591
-------- --------
Sub-total deferred tax assets........................... 89,740 94,546
Valuation allowance...................................... -- --
-------- --------
Total deferred tax assets............................... 89,740 94,546
-------- --------
Net deferred tax liabilities............................ $ 84,842 $ 85,008
======== ========
</TABLE>
The Company believes that no valuation allowance is necessary in connection
with the deferred tax assets.
9 EMPLOYEE BENEFITS
Pensions:
AMBAC Inc. has a defined benefit pension plan covering substantially all
employees of the Company and its subsidiaries. The benefits are based on years
of service and the employee's compensation during the last five years of
employment. AMBAC 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 AMBAC Inc.
as of December 31, 1996 and 1995.
Actuarial present value of the benefit obligations:
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Accumulated benefit obligation, including vested benefits
of $6,282 and $6,049, respectively...................... $(6,979) $(6,788)
======= =======
Projected benefit obligation for service rendered to
date.................................................... (8,189) (7,800)
Plan assets at fair value, primarily listed stocks,
commingled funds and fixed income securities............ 8,153 7,054
------- -------
Unfunded projected benefit............................... (36) (746)
Unrecognized prior service cost.......................... (1,619) (1,784)
Unrecognized net loss.................................... 885 1,906
Unrecognized net transition asset........................ (9) (12)
------- -------
Pension liability included in other liabilities.......... $ (779) $ (636)
======= =======
</TABLE>
Net pension costs for 1996, 1995 and 1994 included the following components:
<TABLE>
<CAPTION>
1996 1995 1994
----- ------- -----
<S> <C> <C> <C>
Service cost.......................................... $ 674 $ 541 $ 558
Interest cost on expected benefit obligation.......... 539 456 386
Actual return on plan assets.......................... (957) (1,333) 30
Net amortization and deferral......................... 263 760 (547)
----- ------- -----
Net periodic pension cost............................. $ 519 $ 424 $ 427
===== ======= =====
</TABLE>
The weighted average discount rate used in the determination of the
actuarial present value for the projected benefit obligation was 7.50% and
7.25% for 1996 and 1995, respectively. The expected long-term rate of return
on assets was 9.25% for both 1996 and 1995. The rate of increase in future
compensation levels used in determining the actuarial present value of the
projected benefit obligation was 5.0% for both 1996 and 1995.
Substantially all employees of AMBAC 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 covered employee's base
salary, plus a matching company contribution of 50% on contributions up to 6%
of base salary made by eligible employees to the plan. The total cost of the
Savings Incentive Plan to AMBAC Indemnity was $1,494, $1,435 and $1,292 in
1996, 1995 and 1994, respectively.
Annual Incentive Plan:
AMBAC Inc. has an annual incentive plan which provides for awards to key
officers and employees based upon predetermined criteria. The cost of the plan
to AMBAC Indemnity for the years ended December 31, 1996, 1995 and 1994
amounted to $7,641, $7,669 and $8,531, respectively.
Postretirement Health Care and Other Benefits:
AMBAC Indemnity provides certain medical and life insurance benefits for
retired employees and eligible dependents. All plans are contributory. None of
the plans is currently funded.
Postretirement benefits expense was $200, $168 and $176 in 1996, 1995 and
1994, respectively. The unfunded accumulated postretirement benefit obligation
was $1,526 and the accrued postretirement liability was $1,524 as of December
31, 1996.
The assumed weighted average health care cost trend rates range from 8.5% in
1996, decreasing ratably to 5.5% in 2001, and remaining at that level
thereafter. Increasing the assumed health care cost trend rate by one
percentage point in each future year would increase the accumulated
postretirement benefit obligation at December 31, 1996 by $194 and the 1996
benefit expense by $40. The weighted average discount rate used to measure the
accumulated postretirement benefit obligation and 1996 expense was 7.50%.
10 INSURANCE IN FORCE
The par amount of bonds insured by AMBAC Indemnity, net of reinsurance, was
$131,497,000 and $110,997,000 at December 31, 1996 and 1995, respectively. As
of December 31, 1996 and 1995, AMBAC Indemnity's insured portfolio was
diversified by type of insured bond as shown in the following table:
<TABLE>
<CAPTION>
NET PAR AMOUNT OUTSTANDING
---------------------------
1996 1995
------------- -------------
(DOLLARS IN MILLIONS)
<S> <C> <C>
Municipal finance:
General obligation............................. $ 31,863 $ 30,546
Lease and Tax-backed revenue................... 25,366 18,780
Utility revenue................................ 22,780 21,053
Health care revenue............................ 13,521 12,553
Transportation revenue......................... 6,891 6,293
Investor-Owned utilities....................... 5,551 4,497
Higher education............................... 4,745 3,973
Housing revenue................................ 4,497 3,577
Student loans.................................. 3,439 3,769
Other.......................................... 484 483
------------- -------------
Total Municipal Finance...................... 119,137 105,524
------------- -------------
Structured finance:
Domestic:
Mortgage-backed and home equity............... 5,263 1,901
Asset-backed.................................. 1,329 1,213
Other......................................... 1,440 124
------------- -------------
Total Domestic Structured Finance............ 8,032 3,238
------------- -------------
International:
Asset-backed.................................. 2,530 1,382
Other......................................... 1,798 853
------------- -------------
Total International Structured Finance....... 4,328 2,235
------------- -------------
Total Structured finance.................... 12,360 5,473
------------- -------------
$ 131,497 $ 110,997
============= =============
</TABLE>
As of December 31, 1996, California was the state with the highest aggregate
net par amount in force, accounting for 15.6% of the total, and the highest
single insured risk represented 0.6% of aggregate net par amount outstanding.
AMBAC Indemnity's direct insurance in force (principal and interest) was
$268,870,000 and $235,118,000 at December 31, 1996 and 1995, respectively. Net
insurance in force (after giving effect to reinsurance) was $227,235,000 and
$199,078,000 as of December 31, 1996 and 1995, respectively.
11 FINANCIAL INSTRUMENTS HELD FOR PURPOSES OTHER THAN TRADING
Financial instruments with off-balance-sheet risk:
In the normal course of business, the Company becomes a party to various
financial transactions to reduce its exposure to fluctuations in interest
rates. These financial instruments include interest rate swaps, exchange
traded interest rate futures contracts and purchased interest rate options.
The notional amounts of the Company's off-balance-sheet financial instruments
which are held for purposes other than trading were as follows:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------
1996 1995
------------------
<S> <C> <C>
Interest rate futures contracts........................ $ -- $ 44,500
Interest rate swap..................................... -- 20,000
</TABLE>
Notional principal amounts are often used to express the volume of these
transactions and do not reflect the extent to which positions may offset one
another. These amounts do not represent the much smaller amounts potentially
subject to risk.
Fair values of financial instruments held for purposes other than trading:
The following fair value amounts were determined by the Company using
independent market information when available, and appropriate valuation
methodologies when market quotes were not available. In cases where specific
market quotes are unavailable, interpreting market data and estimating market
values require considerable judgment by management. Accordingly, the estimates
presented are not necessarily indicative of the amount the Company could
realize in a current market exchange.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
Investments: The fair values of bonds are based on quoted market prices or
dealer quotes.
Short-term investments and cash: The fair values of short-term investments
and cash are assumed to equal amortized cost.
Securities purchased under agreements to resell: The fair value of
securities purchased under agreements to resell is assumed to approximate
carrying value.
Investment in affiliate: At December 31, 1995, the fair value of the
Company's investment in HCIA was based on the quoted market price of HCIA
common stock.
Interest rate contracts: Fair values of off-balance-sheet interest rate
contracts (futures, swaps and interest rate options) are based on quoted
market and dealer prices, current settlement values, or pricing models.
Liability for net financial guarantees written: The fair value of the
liability for those financial guarantees written related to new issue and
secondary market exposures is based on the estimated cost to reinsure those
exposures at current market rates, which amount consists of the current
unearned premium reserve, less an estimated ceding commission thereon.
Certain other financial guarantee insurance policies have been written on an
installment basis, where the future premiums to be received by the Company are
determined based on the outstanding exposure at the time the premiums are due.
The fair value of AMBAC Indemnity's liability under its installment premium
policies is measured using the present value of estimated future installment
premiums, less an 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 Indemnity's liability under
these policies.
The carrying amount and estimated fair value of these financial instruments
are presented below:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------------------------------
1996 1995
----------------------- -----------------------
CARRYING ESTIMATED FAIR CARRYING ESTIMATED FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------------- -------- --------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
Financial assets:
Investments................... $2,425 $2,425 $2,225 $2,225
Short-term investments........ 91 91 164 164
Cash.......................... 5 5 7 7
Securities purchased under
agreements to resell......... 4 4 4 4
Investment in affiliate....... -- -- 26 111
Unrecognized financial
instruments:
Interest rate futures
contracts.................... -- -- -- --
Interest rate swap............ -- -- -- --
Liability for financial
guarantees written:
Direct....................... -- 719 -- 655
Net of reinsurance........... -- 596 -- 543
Net installment premiums..... -- 114 -- 80
</TABLE>
12 FINANCIAL INSTRUMENTS HELD FOR TRADING PURPOSES
The Company, through its affiliate AFS, is a provider of interest rate swaps
to states, municipalities, municipal authorities and other entities, including
its affiliates, AMBAC Capital Management, Inc. ("ACMI") and AMBAC Investments
Inc. ("AII"), in connection with their financings. The Company manages its
interest rate swap business with the goal of being market neutral to changes
in overall interest rates, while retaining basis risk, the relationship
between changes in floating rate tax-exempt and floating rate taxable interest
rates. If actual or projected floating rate tax-exempt interest rates rise in
relation to floating rate taxable interest rates, the Company will experience
an unrealized mark-to-market loss. Conversely, if actual or projected floating
rate tax-exempt interest rates decline in relation to floating rate taxable
interest rates, the Company will experience an unrealized mark-to-market gain.
In the ordinary course of business, the Company manages a variety of risks,
principally credit, market, liquidity, operational, and legal. These risks are
identified, measured and monitored through a variety of control mechanisms,
which are in place at different levels throughout the organization.
Credit risk relates to the ability of counterparties to perform according to
the terms of their contractual commitments. Credit risk is calculated based on
the current replacement cost or fair value of the Company's financial
instruments. The Company executes these transactions with a diverse base of
counterparties in order to minimize concentrations of credit risk.
Various procedures and controls are in place to monitor the credit risk of
interest rate swaps. These include the initial credit approval process, the
establishment of credit limits, management approvals, and a process that
ensures the continuous monitoring of credit exposure.
Market risk relates to the impact of price changes on future earnings. This
risk is a consequence of the Company's market-making activities in the
municipal interest rate swap market. The principal market risk is basis risk,
the relationship between changes in floating rate tax-exempt and floating rate
taxable interest rates. Since the third quarter of 1995, all municipal
interest rate swaps transacted contain provisions which are designed to
protect the Company against certain forms of tax reform, thus mitigating its
basis risk. An independent risk management group monitors trading risk limits
and, together with senior management, is involved in the application of risk
measurement methodologies.
The estimation of potential losses arising from adverse changes in market
relationships, known as "value-at-risk," is a key element in managing market
risk. The Company has developed a value-at-risk methodology to estimate
potential losses over a specified holding period and based on certain
probabilistic assessments. The Company estimates value at risk utilizing
historical short- and long-term interest rate volatilities and the
relationship between changes in tax-exempt and taxable interest rates
calculated on a consistent daily basis. For the years ended December 31, 1996
and 1995, the Company's value-at-risk, calculated at a ninety-nine percent
confidence level, averaged approximately $1,389 and $1,358, respectively. The
Company's value-at-risk ranged from a high of $2,585 to a low of $1,096 in
1996 and from a high of $2,131 to a low of $687 in 1995. Since no single
measure can capture all dimensions of market risk, the Company bolsters its
value-at-risk methodology by performing daily analyses of parallel and non-
parallel shifts in yield curves and stress test scenarios which measure the
potential impact of market conditions, however improbable, which might cause
abnormal volatility swings or disruptions of market relationships.
Liquidity risk relates to the possible inability to satisfy contractual
obligations when due. This risk is present in swaps and in futures contracts
used to hedge swaps. The Company manages liquidity risk by maintaining cash
and cash equivalents, closely matching the dates swap payments are made and
received, and limiting the amount of risk hedged by futures contracts.
Operational risk relates to the potential for loss caused by a breakdown in
information, communication and settlement systems. The Company mitigates
operational risk by maintaining a comprehensive system of internal controls.
This includes the establishment of systems and procedures to monitor
transactions and positions, documentation and confirmation of transactions,
and ensuring compliance with regulations.
Legal risk relates to the uncertainty of the enforceability, through legal
or judicial processes, of the obligations of the Company's counterparties,
including contractual provisions intended to reduce credit exposure by
providing for the offsetting or netting of mutual obligations. The Company
seeks to remove or minimize such uncertainties through continuous consultation
with internal and external legal advisers to analyze and understand the nature
of legal risk, to improve documentation and to strengthen transaction
structure.
The following table summarizes information about the Company's financial
instruments held for trading purposes as of December 31, 1996 and 1995:
<TABLE>
<CAPTION>
AVERAGE NET FAIR VALUE
NET CARRYING NET ESTIMATED ------------------------- NOTIONAL
AMOUNT FAIR VALUE ASSETS LIABILITIES AMOUNT
------------ ------------- ----------- ------------- ----------
<S> <C> <C> <C> <C> <C>
1996:
Interest rate swaps..... $12,341 $12,341 $ 48,734 $ 41,445 $2,856,600
Interest rate futures
contracts.............. -- -- -- -- 484,500
1995:
Interest rate swaps..... $ 5,207 $ 5,207 $ 17,714 $ 16,667 $2,152,400
Interest rate futures
contracts.............. -- -- -- -- 569,800
</TABLE>
The aggregate amount of net trading income recognized from financial
instruments held for trading purposes was $10,799, $2,602 and $3,051 for 1996,
1995 and 1994, respectively. Average net fair values were calculated based on
average daily net fair values. The gross replacement cost of the Company's
financial instruments held for trading purposes is the positive fair value of
all transactions with a counterparty, excluding the effects of netting or
collateral arrangements and was approximately $47,000 and $62,000 as of
December 31, 1996 and 1995, respectively. Net estimated fair value, after
netting and collateral arrangements, more accurately portrays the credit risk
associated with the Company's financial instruments held for trading purposes.
Notional principal amounts are often used to express the volume of these
transactions and do not reflect the extent to which positions may offset one
another. These amounts do not represent the much smaller amounts potentially
subject to risk.
13 LINES OF CREDIT
AMBAC Inc. and AMBAC Indemnity maintain a three-year revolving credit
facility with two major international banks, as co-agents, for $100,000. As of
December 31, 1996 and 1995, no amounts were outstanding under this credit
facility, which expires in July 1998.
AMBAC Indemnity has an agreement with another major group of AAA/Aaa-rated
international banks for a $350,000 credit facility, expiring in 2003. This
facility is a seven-year stand-by irrevocable limited recourse line of credit,
which was increased from $300,000 to $350,000 and extended for an additional
year in December 1996. The line will provide liquidity to AMBAC Indemnity in
the event claims from municipal obligations exceed specified levels. Repayment
of any amounts drawn under the line will be limited primarily to the amount of
any recoveries of losses related to policy obligations. As of December 31,
1996 and 1995, no amounts were outstanding under this line.
14 RELATED PARTY TRANSACTIONS
During 1996 and 1995, AMBAC Indemnity guaranteed the timely payment of
principal and interest on obligations under municipal investment contracts and
municipal investment repurchase agreements issued by its affiliates. As of
December 31, 1996 and 1995, the aggregate amount of municipal investment
contracts and municipal investment repurchase contracts insured was $2,744,283
and $2,240,959, 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, 1996 and 1995 had a fair value of $2,775,250 and
$2,299,687, respectively, in the aggregate. During 1996 and 1995, AMBAC
Indemnity recorded gross premiums written of $2,553 and $1,707, and net
premiums earned of $1,668 and $1,764, respectively, related to these contracts.
During 1996 and 1995, several interest rate swap transactions were executed
between AFS and its affiliates (other than AMBAC Indemnity). As of December
31, 1996 and 1995, these contracts had an outstanding notional amount of
approximately $515,000 and $359,000, respectively. As of December 31, 1996 and
1995, AFS recorded a positive fair value of $3,503 and $6,539, respectively,
related to these transactions.
