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ABK AT A GLANCE

P/E ► -0.0730   EV/EBITDA ► -23.1   ROA ► -13% LOW ROE ► -274.7% VERY LOW Debt to Equity ► -7.40   Interest Coverage Ratio ► 4.77 AVG

 

 

 

 

 

 

Ambac Financial Group, Inc. (NYSE:ABK) is the second largest bond insurer in the United States, and has two main businesses: financial guarantees and financial services. Its primary business, which operates as a monoline insurer, is known as Ambac Assurance Group. It earns revenues by writing insurance policies on municipal bonds and other asset backed securities, protecting holders of these assets against default. In other words, if a bond or security fails, Ambac will guarantee the interest and the principal. As of April 24, 2008, Ambac insured over $524 billion of debt.^[1]

Ambac has insured large numbers of collateralized debt obligation (CDO) such as mortgage backed securities (MBS). These insurance policies were lucrative and Ambac doubled its revenue in the four years between 2002 and 2006.^[2] Since the onset of the 2007 Credit Crunch and 2008 Financial Crisis however, Ambac was obligated to cover increasingly large numbers of failed mortgage backed securities, leading Ambac to post net income losses of $3.25 billion and $5.61 billion in 2007 and 2008 respectively.^[3]

For the third quarter of 2009, ABK reported a net income of $2.19 billion, a sharp turnaround from its $2.43 billion loss for the same period a year ago.^[4] This is also an impressive rebound from its 2009 second quarter results of a $2.4 billion loss.^[5] Ambac credited a significant portion of this recovery to an unrealized gain on derivatives of $2.87 billion.^[4]

On November 10, 2009, Ambac issued a warning to its shareholders that it might not have enough cash to meet payments during second quarter of 2011.^[6] Ambac announced that it is developing strategies such as restructuring its debt to help meet its liquidity needs, but it also declared that if unsuccessful, it may file for bankruptcy protection. In response to investor fears of bankruptcy, Ambac's shares fell by over 33%. However, on November 18, 2009 Ambac reported that its capital surplus nearly tripled from $305.6 million to $856 million between the second and third quarters of 2009.^[7] While some analysts still expect Ambac to run out of liquidity, this news certainly extends the time horizon beyond what was originally expected.

Company Overview

Headquartered in New York City, Ambac Financial Group provides financial guarantees and financial services to clients worldwide. Its main business is in the bond insurance industry, where it insures the second most bonds behind only MBIA (MBI). Due to Ambac losings its AAA rating, it has had trouble originating new financial guarantee transactions since November 2007.^[8]

Credit ratings are also an important aspect to Ambac, as potential clients use the rating to determine the likelihood that Ambac will remain solvent (be able to meet insurance claims against them). Since January 2008, when Ambac first lost its AAA rating, Ambac's credit rating has been downgraded to Ba3, non-investment or "junk" grade.^[9]

2008 was an unsteady year for markets, caused in large part by the 2007 Credit Crunch and 2008 Financial Crisis. In response to the loss of its AAA rating and recent losses, Ambac began implementing a refocused business strategy. Included in this strategy are the discontinuation of writing new business in its Financial Services segment, stopping quarterly dividend payments, and the reactivation of Everspan as a stand alone legal entity.^[10] Everspan was a financial guarantee Insurance company that was purchased by Ambac in 1997 and placed into runoff.^[8] However, Ambac has faced problems with reactivating Everspan, and has since put on hold the Everspan project.^[11]

Business and Financial Metrics

Total Revenue and Net Income for Ambac has had sharp declines in 2007 and 2008.^[3]

Ambac's situation deteriorated in 2008 relative to 2007 for a number of reasons. According to Ambac, the main reasons were i) a higher provision for loss and loss expense, ii) higher net realized capital losses in the Financial Services portfolio, iii) lower Financial Services investment income, and iv) losses in derivative products revenue.^[12] However, these were partially offset by i) lower losses related to the change in fair value of credit derivative positions, ii) higher net premiums earned, iii) higher Financial Guarantee net investment income, and iv) lower interest on investment and payment agreement expenses.^[12]

For the second quarter of 2009, Ambac had a net loss of $2.4 billion compared to a $823.1 million net income in the year ago period.^[5] Part of the loss was attributed to an $862.1 million charge related to selling part of its investment portfolio at a loss.^[5]

Business Segments

Ambac breaks its business into two operating segments: the Financial Guarantee segment and the Financial Services segment

Financial Guarantee (90.6% of 2008 Revenue (Loss))

Ambac 2008 Revenue.^[15]

Gross premiums written during 2008 were $536.9 million, a 48% drop from its 2007 total of $1,031.4 million.^[16] Of the $536.9 million of premiums written in 2008, approximately $519.6 million of it was underwritten before 2008.^[16] Net premiums earned in 2008 were $1,022.8 million, an increase of 22% from $841.5 million in 2007, mainly due to higher refunding and calls of previously insured obligations.^[17] 19.9% of its 2008 net premiums come from the Public Finance sector, 25.5% from the Structured Finance sector, 17.2% from the International Finance sector, and 37.3% from accelerated earnings.^[17] Net investment income increased 6% in 2008 to $491.1 million compared to its 2007 income of $$465.0 million, attributing this increase to an increase in its investment portfolio.^[18] Ambac's net change in fair value of derivatives was a $4.03 billion loss, compared to a $5.93 billion loss in 2007.^[18] This loss was largely attributed to declining market values of the underlying assets and internal ratings downgrades on Collateralized debt obligation (CDO) of asset backed securities (ABS).^[19] Other revenue for 2008 was a loss of $713.4 million, largely due to rising losses related to their residential mortgage backed securities (RMBS) sector and rising operating expenses and underwriting costs.^[20]

Financial Services (9.4% of 2008 Revenue (Loss))

Through its subsidiaries, Ambac offers a range of financial services including interest rate swaps, currency swaps, and total return swaps. In the first quarter of 2008, Ambac declared that it would no longer write new business in its Financial Services segment. In 2008, Financial Services decreased to a loss of $260 million, a decline from its 2007 revenue of $380.8 million.^[15] While its investment agreement business and swaps will be run off, Ambac has stated it may continue to use swaps as a hedging tool.

Key Trends and Forces

Reactivation of Everspan

One leg of Ambac's refocused business strategy is the reactivation of Everspan during the second quarter of 2009. Everspan was a financial guarantee insurance company purchased by Ambac in 1997 and placed into runoff.^[8] Ambac hopes to bring it back as a municipal bond insurer, and by separating it from its main business, it also hopes to achieve the high credit ratings necessary to compete and generate new business. However, on June 19 2009, Ambac announced that it is delaying the reactivation of Everspan.^[11]

Credit Ratings

Ambac's business model is largely dependent upon its overall credit rating. Credit ratings provide objective judgments about the insurer’s ability to pay insured parties when necessary. Declines in the credit quality of the company will cause its potential customer pool to shrink because of increased cost of capital. It receives an insurance premiums by guaranteeing the coupon and principal of bonds. This premium is almost entirely based on Ambac's financial strength. Since January 2008, when Ambac first lost its AAA rating, Ambac's credit rating has been downgraded to Ba3, non-investment or "junk" grade.^[9] On July 29, 2009 Ambac's credit rating was further into junk grade, as Standard & Poor's Ratings Services dropped it from BBB to CC.^[21]

Credit Spreads

The spread between the interest rates on credit instruments insured by Ambac and the risk-free rate is a major driver affecting the premiums earned by the company. Wider spreads mean larger premiums and generally higher margins, whereas narrow spreads decrease premiums. Spreads on most credit securities and derivatives have generally become wider in 2008^[22], leading to two offsetting trends for Ambac. First, wider spreads indicate that it becomes more likely to incur losses on securities insured when spreads were lower. This can be potentially offset by making future business more attractive due to higher premiums. However, because its low credit ratings, it will be difficult for Ambac to offset losses with new business, as low credit ratings not only decrease consumer confidence, but also raises its cost of underwriting policies.

Competition

The guarantor/financial insurance business is highly competitive. The only barrier to entry that deters smaller financial entities from entering the market is a minimum capital requirement necessary to maintain a strong credit ratings. Largely, companies compete on a mix of price and consumer trust as well as judgment of the insurer’s ability to pay. Ambac also competes with alternative forms of insurance, including derivative contracts such as credit default swaps, which are written by most major bank and financial institutions. This makes the credit insurance business substantially larger and more competitive. Ambac is a financial guarantor insurance giant, and competes directly against large bond insurers, most notably MBIA (MBI).

• MBIA (MBI), headquartered in New York City, is the world's largest bond insurer. Its net income fell in 2007 and 2008, and like Ambac, it has begun implementing a restructuring plan aimed at bringing in new business.^[23] In 2008, it had total revenues of -$857 million and a net loss of $2.67 billion.^[24]

References

1. ↑ Ambac May Raise More Capital After Reporting Loss. Christine Richard. Bloomberg.
2. ↑ ABK 10-K 2008 Item 6 Pg. 35
3. ↑ ^{3.0 3.1 3.2 3.3} ABK 10-K 2008 Item 6 Pg. 53
4. ↑ ^{4.0 4.1} Ambac reports $2.2 bln quarterly profit, shares jump. Alistair Barr. MarketWatch.
5. ↑ ^{5.0 5.1 5.2} John Spence. Bond insurer Ambac swings to loss; shares fall. MarketWatch.
6. ↑ Ambac warns it may file for bankruptcy. Alistair Barr. MarketWatch.
7. ↑ Ambac Reports Its Capital Surplus Almost Triples. Christine Richards. Bloomberg.
8. ↑ ^{8.0 8.1 8.2} ABK 10-K 2008 Item 1 Pg. 3
9. ↑ ^{9.0 9.1} Ambac unit downgraded to junk on loss estimates. John Letzing. MarketWatch.
10. ↑ ABK 10-K 2008 Item 1 Pg. 5
11. ↑ ^{11.0 11.1} Ambac postpones plan for new muni bond insurer. Alistair Barr. MarketWatch.
12. ↑ ^{12.0 12.1} ABK 10-K 2008 Item 7 Pg. 81
13. ↑ ^{13.0 13.1 13.2} ABK 10-K 2006 Item 6 Pg. 35
14. ↑ ABK 10-Q 2009 Item 1 Pg. 4
15. ↑ ^{15.0 15.1} ABK 10-K 2008 Item 7 Pg. 91
16. ↑ ^{16.0 16.1} ABK 10-K 2008 Item 7 Pg 83.
17. ↑ ^{17.0 17.1} ABK 10-K 2008 Item 7 Pg. 85
18. ↑ ^{18.0 18.1} ABK 10-K 2008 Item 7 Pg. 86
19. ↑ ABK 10-K 2008 Item 7 Pg. 87
20. ↑ ABK 10-K 2008 Item 7 Pg. 89
21. ↑ Ambac Ratings Cut Deep Into Junk. Lavonne Kuykendall and Jay Miller. The Wall Street Journal.
22. ↑ Credit Spreads Widen Despite Signs of Recovery. Liz Peek. The New York Sun.
23. ↑ MBI 10-K 2008 Item 1 Pg. 2
24. ↑ ^{24.0 24.1} MBI 10-K 2008 Item 6 Pg. 47