Ambac Financial Group (ABK)

TOP CONTRIBUTORS

Thomas Shyr

Michael Francis

Mark Deluzio

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. In 2010, Ambac incurred a net loss of $735 million, while earning $434 million in total revenues.^[1]

Ambac's profits and revenues are susceptible to changes in the regulatory environment, its ability to accurately estimate the risk in bonds, as well as the demand for bond insurance. In 2010, Ambac earned a total of $434 million in total revenues, and a net loss of $735 million.^[2]

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). In the past, Ambac also insured large numbers of collateralized debt obligation (CDO) such as mortgage backed securities (MBS). However, with the onset of the 2007 Credit Crunch and 2008 Financial Crisis leading to many mortgages defaulting, Ambac was obligated to cover increasingly large numbers of failed mortgage backed securities, leading Ambac to lose its top credit ratings.

These credit ratings play a vital aspect to Ambac's business, as potential clients use the rating to determine the likelihood that Ambac will remain solvent (be able to meet insurance claims against them). Since its credit rating downgrade, Ambac has had difficulty obtaining new financial guarantee transactions.^[3]

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.^[4] Everspan was a financial guarantee Insurance company that was purchased by Ambac in 1997 and placed into runoff.^[3] However, Ambac has faced problems with reactivating Everspan, and has since put on hold the Everspan project.^[5]

Just cause it's smiple doesn't mean it's not super helpful.

Cool! That's a clever way of lokonig at it!

Key Trends and Forces

Ambac has declared bankruptcy

Ambac has filed and declared for Chapter 11 bankruptcy in New York. It declared total liabilities of $1.68 billion, and also announced that it was unable to reach an agreement for a prepackaged bankruptcy, which would have allowed for a faster restructuring.^[6]

The Wisconsin Circuit Court approved a rehabilitation plan by Ambac's regulating group, which essentially is a plan to help bring Ambac profitable and eventually out of bankruptcy.^[7] The rehabilitation plan put some of the most troubled bond guarantees into a separate account, thereby leaving the remaining portion of the company in better financial shape. However, the United States Justice Department filed a federal suit with regards to the restructuring of Ambac, claiming that the state courts did not have the power to essentially stop the federal government from collecting up to $700 million in taxes.^[8] The Federal Government wants to ensure that the rehabilitation plan does not interfere with its ability to collect the taxes, and has temporarily stopped the plan from continuing.

Reactivation of Everspan

One leg of Ambac's refocused business strategy is the reactivation of Everspan. Everspan was a financial guarantee insurance company purchased by Ambac in 1997 and placed into runoff.^[3] 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, Ambac has since announced that it is delaying the reactivation of Everspan.^[5]

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 Ambac first lost its AAA rating, Ambac's credit rating has been downgraded to Ba3, non-investment or "junk" grade. Ambac's credit rating was further into junk grade, as Standard & Poor's Ratings Services dropped it from BBB to CC.^[9] Furthermore, as a result of these credit rating downgrades, many of Ambac's clients exercised options in their contractual agreements which allowed them to either cancel their contract or to demand additional collateral in the event of credit rating downgrades.^[10]

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. Higher credit spreads generally leads 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. Like Ambac, MBIA has begun implementing a restructuring plan aimed at bringing in new business.^[11] However, MBIA's new restructuring plan has met resistance from its counterparties and is facing lawsuits.

References

1. ↑
2. ↑ ABK 10-K 2010 Item 6 Pg. 43
3. ↑ ^{3.0 3.1 3.2} ABK 10-K 2008 Item 1 Pg. 3
4. ↑ ABK 10-K 2008 Item 1 Pg. 5
5. ↑ ^{5.0 5.1} Ambac postpones plan for new muni bond insurer. Alistair Barr. MarketWatch.
6. ↑ Bond insurer Ambac files for bankruptcy. Tom Hals. Reuters
7. ↑ Ambac rehabilitation plan approved. Alistair Barr. MarketWatch.
8. ↑ U.S. sues to block Ambac rehabilitation plan: filing. Caroline Humer. Reuters.
9. ↑ Ambac Ratings Cut Deep Into Junk. Lavonne Kuykendall and Jay Miller. The Wall Street Journal.
10. ↑
11. ↑ MBI 10-K 2008 Item 1 Pg. 2