AMBAC FINANCIAL GROUP, INC. The objectives of our Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") are to provide users of our consolidated financial statements with the following:
•A narrative explanation from the perspective of management of our financial condition, results of operations, cash flows, liquidity and certain other factors that may affect future results;
•Context to the consolidated financial statements; and
•Information that allows assessment of the likelihood that past performance is indicative of future performance.
The following discussion should be read in conjunction with our consolidated financial statements in Item 8 of this Report and the matters described under Item 1A. Risk Factors in our Annual Report on Form 10-K for the year endedDecember 31, 2021 . Refer to Item 1. Business and Note 1. Background and Business Description for a description of our business and our key strategies to achieve our primary goal to maximize shareholder value.
MD&A includes the following sections:
Page
Executive Summary 29
Critical Accounting Estimates 32
Financial Guarantees in Force 34
Results of Operations 42
Liquidity and Capital Resources 46
Balance Sheet 48
Accounting Standards 54
Ambac Assurance Statutory Basis Financial Results 54
Ambac UK Financial Results under UK Accounting Principles 56
Non-GAAP Financial Measu res 57
EXECUTIVE SUMMARY ($ in millions)
AFG
During 2021, AFG progressed the development of its specialty property and casualty program insurance business. Developments included the following:
•AFG contributed
•Everspan received an 'A-' Financial Strength Rating from AM Best in
•Everspan launched its specialty insurance program business in
•To support expansion of the admitted insurance component of its business, during 2021 Everspan entered into stock purchase agreements to acquire four insurance shell companies. Such acquisitions will enhance Everspan's capabilities to launch new admitted programs, develop innovative products and provide enhanced flexibility to foster strategic relationships with prospective program partners. OnOctober 1, 2021 , Everspan completed the acquisition ofProvidence Washington Insurance Company ("PWIC") from a subsidiary of Enstar Group Limited. PWIC holds certificates of authority in forty-seven states and territories. PWIC's legacy liabilities were fully ceded to reinsurers and Everspan also benefits from an unlimited, uncapped indemnity fromEnstar Holdings (US) to mitigate any residual risk to these reinsurers. OnJanuary 3, 2022 , Everspan completed the acquisition of the 21st Century Companies (three carriers) from a national insurance group that has a Financial Strength Rating of "A" (Excellent) from AM Best. The 21st Century Companies collectively possess certificates of authority in thirty-nine states. All legacy liabilities remain with affiliates of the sellers through reinsurance and contractual indemnities. The 21st Century Companies will be re-named during 2022.
•During 2021, AFG made minority investments in certain insurance related
businesses, including insurtech platforms, that we believe will be synergistic
to our specialty property & casualty program insurance or
•See below AAC and Subsidiaries for the various 2021 activities relating to the financial guarantee business
In addition to its focus on Xchange, AFG is actively seeking to expand the MGA/U business though additional acquisitions and development of new MGA/U companies.
Net Assets
As of
($ in millions) Cash and short-term investments$ 125 Other investments (1) 130 Other net assets 14 Total$ 269
(1)Includes surplus notes (fair value of
AAC and Subsidiaries A key strategy forAmbac is to increase the value of its investment in AAC by actively managing its assets and liabilities. Asset management primarily entails maximizing the risk-adjusted return on non-VIE invested assets and managing liquidity to help ensure resources are available to meet operational and strategic cash needs. These strategic cash needs include activities associated withAmbac's liability management and loss mitigation programs.
Asset Management
Investment portfolios are subject to internal investment guidelines, as well as limits on types and quality of investments
|Ambac Financial Group, Inc. 29 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents imposed by insurance laws and regulations. The investment portfolios of AAC and AmbacUK hold fixed maturity securities and various pooled investment funds. Refer to Note 4. Investments to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for further details of fixed maturity investments by asset category and pooled investment funds by investment type.
At
Subject to internal and regulatory guidelines, market conditions and other constraints,Ambac may continue to opportunistically purchase or sellAmbac -insured securities, surplus notes and/or otherAmbac issued securities, and may consider opportunities to exchange securities issued by it from time to time for other securities issued by it.
Liability and Insured Exposure Management
AAC's Risk Management Group focuses on the implementation and execution of risk reduction, defeasance and loss recovery strategies. Analysts evaluate the estimated timing and severity of projected policy claims as well as the potential impact of loss mitigation or remediation strategies in order to target and prioritize policies, or portions thereof, for commutation, reinsurance, refinancing, restructuring or other risk reduction strategies. For targeted policies, analysts will engage with issuers, bondholders and other economic stakeholders to negotiate, structure and execute such strategies. During 2021,Ambac completed risk reduction transactions consisting of quota share reinsurance, refinancings, and commutations of$2,695 , of which, quota share reinsurance represented$1,695 . The following table provides a comparison of total, adversely classified ("ACC") and watch list credit net par outstanding in the insured portfolio atDecember 31, 2021 and 2020. Net par exposure within theU.S. public finance market includes capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bonds. ($ in billions) December 31, 2021 2020 Variance Total$ 28,020 $ 33,888 $ (5,868) (17) % ACC$ 6,361 $ 8,458 $ (2,097) (25) % Watch List$ 3,824 $ 4,720 $ (896) (19) %
The decrease in total, ACC and watch list credit net par outstanding resulted from active de-risking initiatives, as noted above, as well as scheduled maturities, amortizations, refundings and calls.
We have been paying claims for several years on most of our exposure toPuerto Rico , which consists of several different issuing entities (all below investment grade). These issuing entities, which have been part of the PROMESA restructuring process that began in 2016, each have their own credit risk profile attributable to discrete revenue sources, direct general obligation pledges, and/or general obligation guarantees.
On
Amended Plan of Adjustment for theCommonwealth of Puerto Rico ("Eighth Amended POA"). OnJanuary 20, 2022 ,Judge Swain approved the Qualifying Modifications for PRIFA and CCDA ("PRIFA QM" and "CCDA QM", respectively). Although the Eighth Amended POA, the PRIFA QM and CCDA QM remain subject to appeal (see Risk Factors- "Insured Portfolio Losses"), the Eighth Amended POA, PRIFA QM, and CCDA QM are expected to become effective on or beforeMarch 15, 2022 . Consummation of the plan of adjustment and qualifying modifications will resolve the PROMESA restructuring process for the GO, PBA, PRIFA and CCDA issuing entities that have portions of their bonds insured by AAC. On the effective date of the Eighth Amended POA, PRIFA QM, and CCDA QM, and pursuant to bondholder elections, (i) all of the remaining outstanding AAC-insured GO and PBA bonds will be satisfied and eliminated via commutation or acceleration, and (ii) about 39% and 19% of the par of AAC's outstanding AAC-insured PRIFA and CCDA bonds, respectively, will be reduced via commutation, with the remainder of those bonds (belonging to bondholders who elected not to commute their AAC Insurance Policies) being deposited into trusts together with such policies and the bondholders' respective shares of distributed Eighth Amended POA, PRIFA QM, or CCDA QM consideration. Those bondholders participating in the trusts are expected to receive scheduled payments from the applicable trust, unlessAmbac elects, in its sole discretion, to pay all or a portion of the outstanding par amounts of the AAC-insured bonds in such trust.
AAC-insured bonds of PRHTA are subject to the PRHTA POA, a separate plan of
adjustment that is expected to be filed prior to
Refer to Part II, Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, Financial Guarantees in Force, in this
Annual Report on Form 10-K for additional information regarding the different
issuing entities that encompass
COVID-19
The COVID-19 pandemic had, and to a lesser degree, continues to have, an impact on general economic conditions; including, but not limited to, higher unemployment; volatility in the capital markets; closure or severe curtailment of the operations and, hence, revenues, of many businesses and public and private enterprises to which we are directly or indirectly exposed. COVID-19 and the public health responses by the US federal and state governments at the onset of the pandemic resulted in a shut down for several months of significant portions of the US economy, including areas thatAmbac's insured obligors rely upon to generate the revenues and cash flows necessary to service debts we insure. In theU.S. andEurope , where most ofAmbac's financial guaranty exposure is located, significant fiscal stimulus measures, monetary policy actions and other relief measures helped to moderate the negative economic impacts of COVID-19 and supported the economic recovery which began in the second half of 2020 and continues into 2022. As ofDecember 31, 2021 , there have been no defaults ofAmbac -insured obligations as a result of the COVID-19 pandemic. |Ambac Financial Group, Inc. 30 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents Despite the significant overall benefit of the above relief measures, which were designed to help mitigate the economic impact of the COVID-19 pandemic generally, certain of these measures may still adversely affectAmbac's insured portfolio. In particular, this includes theU.S. government's temporary relief measures that required mortgage loan servicers to offer relief to borrowers who suffer hardship as a result of COVID-19. These relief measures included moratoriums on foreclosures and evictions as well as the expansion of forbearance and subsequent repayment options. While these relief measures have largely since expired, the resulting delays in starting mortgage foreclosure processes and the impact of potential post-forbearance related mortgage loan modifications may have an adverse impact on our insured RMBS transactions. Consequently, we have anticipated that we will experience an increase in claim payments for certain of our insured RMBS obligations following the resumption of foreclosure activity and the implementation of post-forbearance mortgage loan modifications. However, since the onset of the COVID-19 pandemic, much of the potential increase in claim experience has been offset by the benefit to excess spread within the securitization structures as a result of the reduction in interest rates, which is expected to result in higher excess spread recoveries toAmbac . The impact from the COVID-19 pandemic onAmbac also includes the ability of our counterparties to pay their obligations when due, most notably AAC's reinsurers for their portion of future financial guaranty claim payments.Ambac has reinsured approximately 17.9% of its gross par outstanding to five reinsurance counterparties. Each of these reinsurance counterparties (i) is experienced in the business of reinsuring and/or writing financial guaranty insurance and (ii) have current ratings of A+ (by S&P) or better and have collateralization or replacement triggers upon downgrade withinAmbac's reinsurance agreements.Ambac actively monitors each of these reinsurance entities and currently believes they have the ability to perform under their respective reinsurance policies, but this is subject to change. Given the economic uncertainties associated with the duration and effects of the COVID-19 pandemic, it is impossible to fully predict all of its consequences and, as a result, it is possible that our future operating results and financial condition may be materially adversely affected. Refer to "Financial Guarantees In Force," "Results of Operations" and "Balance Sheet Commentary" for further financial details on the current impact from COVID-19. With regard toAmbac's new business strategic objective, we continue to evaluate opportunities in a disciplined manner. Our evaluation process incorporates the perceived impact of COVID-19 on historical and prospective business results.
Financial Statement Impact of Foreign Currency
The impact of foreign currency as reported inAmbac's Consolidated Statement of Total Comprehensive Income (Loss) for the year endedDecember 31, 2021 included the following: ($ in millions) Net income (1) $ (7) Gain (losses) on foreign currency translation (net of tax) (8)
Unrealized gains (losses) on non-functional currency available-for-sale securities (net of tax)
3
Impact on total comprehensive income (loss) $ (12)
(1) A portion of AmbacUK's , and to a lesser extent AAC's, assets and liabilities are denominated in currencies other than its functional currency and accordingly, we recognized net foreign currency transaction gains/(losses) as a result of changes to foreign currency rates through our Consolidated Statement of Total Comprehensive Income (Loss). Refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report in Form 10-K for further details on transaction gains and losses. Future changes to currency rates, may adversely affect our financial results. Refer to Part II, Item 7A "Quantitative and Qualitative Disclosures about Market Risk" for further information on the impact of future currency rate changes onAmbac's financial instruments.
LIBOR Sunset
InJuly 2017 , theFinancial Conduct Authority , the authority that regulates LIBOR, announced its intention to stop compelling banks to submit rates for the calculation of LIBOR after 2021. The Alternative Reference Rates Committee ('ARRC'), a group of private-market participants convened by theFederal Reserve Board and theFederal Reserve Bank of New York to help ensure a successful transition fromU.S. dollar LIBOR ('USD-LIBOR') to a more robust reference rate, proposed that the Secured Overnight Financing Rate ('SOFR') represents the best alternative to USD-LIBOR for use in derivatives and other financial contracts that are currently indexed to USD-LIBOR. ARRC has proposed a transition plan with specific steps and timelines designed to encourage the adoption of SOFR and guide the transition to SOFR from USD-LIBOR.The Financial Conduct Authority in theUnited Kingdom and other regulatory bodies have issued statements encouraging cessation of new transactions referencing USD LIBOR afterDecember 31, 2021 , while supporting extension of the publication of major USD-LIBOR tenors to mid-2023 to allow additional legacy contracts to mature on their existing terms. Organizations are currently working on industry-wide and company-specific transition plans related to derivatives and cash markets exposed to USD-LIBOR. AfterDecember 31, 2021 , banks ceased publishing most GBP-LIBOR rates. In response, inOctober 2021 , noteholders of obligations linked to GBP-LIBOR and insured by AmbacUK consented to the replacement of GBP-LIBOR references with compounded Sterling Overnight Index Average ("SONIA") plus a credit adjustment spread effective on the first interest payment date in 2022.Ambac therefore no longer insures any obligations linked to Non-USD LIBOR. As ofDecember 31, 2021 , the Company has exposure to LIBOR in the following areas: (i) the financial guarantee insured portfolio, (ii) the Sitka AAC Note (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K) included in long-term debt, (iii) certain invested assets and interest rate derivatives. |Ambac Financial Group, Inc. 31 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of ContentsAmbac has reviewed its financial guarantee portfolio to identify insured transactions that it believes may be impacted by the transition from LIBOR. The review focused on insured issues that were scheduled or projected to have an outstanding principal balance as ofDecember 31, 2021 . The Company reviewed the governing documents' provisions for the setting of interest rates in the event LIBOR is unavailable ("fallback language"). The Company has initiated a dialogue with relevant trustees, calculation agents, auction agents, servicers and other parties responsible for implementing the rate change in these transactions. Most have not yet committed to specific courses of action, but the passage of legislation inNew York State and the expectation that similar federal legislation will be enacted should facilitate greater clarity for those transactions that do not have clear fallback language. The Sitka AAC Note is referenced to 3-month USD-LIBOR and has a final maturity ofJuly 6, 2026 . The Sitka AAC Note includes specific fallback language that addresses both the calculation of interest using a replacement reference rate to 3-month USD-LIBOR and the circumstances that would trigger use of the replacement rate.Ambac's investment and derivative portfolios have been evaluated to assess the risk of LIBOR unavailability based on the respective instruments' fallback language and parties responsible for implementing the alternative rates. Investments that areAmbac -insured securities are being addressed through efforts on the financial guarantee portfolio described above. For other investments, we are working with our investment managers to ensure LIBOR indexed positions in our portfolio contain unambiguous fallback language or will be governed by relevant legislation.Ambac's centrally cleared interest rate swaps are expected to follow LIBOR transition steps outlined by theInternational Swaps and Derivatives Association, Inc. ("ISDA"). Our non-cleared interest rate swaps are all governed byNew York law and either have offsetting LIBOR exposure with a single counterparty that serves as calculation agent responsible for rate changes or haveAmbac as the calculation agent. Given the uncertainty of the ultimate timing of the LIBOR sunset, as well as the lack of clarity on decisions that parties responsible for calculating interest rates will make and the reaction of impacted parties as well as the unknown level of interest rates when the change occurs, the Company cannot at this time predict the impact of the discontinuance of LIBOR, if it occurs, on every obligation the Company guarantees or on its other LIBOR indexed financial instruments. For more information, see the the risk factor "Uncertainties regarding the expected discontinuance of the London Inter-Bank Offered Rate or any other interest rate benchmark could have adverse consequences" found in Part I, Item 1A of this Form 10-K. CRITICAL ACCOUNTING POLICIES AND ESTIMATESAmbac's Consolidated Financial Statements have been prepared in accordance with GAAP. This section highlights accounting estimates management views as critical because they are most important to the portrayal of the Company's financial condition; and require management to make difficult and subjective judgments regarding matters that are inherently uncertain and subject to change. These estimates are evaluated on an on-going basis considering historical developments, political events, market conditions, industry trends and other information. There can be no assurance that actual results will conform to estimates and that reported results of operations will not be materially adversely affected by the need to make future accounting adjustments to reflect changes in these estimates from time to time. Management has identified the following critical accounting policies and estimates: (i) valuation of financial guarantee loss and loss expense reserves, (ii) valuation of certain financial instruments and (iii) valuation of deferred tax assets. Management has discussed each of these critical accounting policies and estimates with the Audit Committee, including the reasons why they are considered critical and how current and anticipated future events impact those determinations. Additional information about these policies can be found in Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K.
Valuation of Financial Guarantee Losses and Loss Expense Reserves (including Subrogation Recoverables)
The loss and loss expense reserves and subrogation recoverable assets (collectively defined as "loss reserves") discussed in this section relate only toAmbac's non-derivative financial guarantee insurance policies issued to beneficiaries, including unconsolidated VIEs. A loss reserve is recorded on the balance sheet on a policy-by-policy basis at the present value ("PV") of expected net claim cash outflows or expected net recovery cash inflows, discounted at risk-free rates. The estimate for future net cash flows consider the likelihood of all possible outcomes that may occur from missed principal and/or interest payments on the insured obligation. This estimate also considers future recoveries related to breaches of contractual representations and warranties by RMBS transaction sponsors, remediation strategies, excess spread and other contractual or subrogation-related cash flows.Ambac's approach to resolving disputes involving contractual breaches by transaction sponsors or other third parties has included negotiations and/or pursuing litigation.Ambac does not estimate recoveries for litigations where its sole claim is for fraudulent inducement, since any remedies under such claims would be non-contractual. Nor doesAmbac include potential recoveries attributable to pre-judgment interest in the estimate of subrogation recoveries. The evaluation process for expected future net cash flows is subject to certain estimates and judgments regarding the probability of default by the issuer of the insured security, probability of negotiation or settlement outcomes (which may include commutation, litigation and other settlements, and/or a refinancing), probability of a restructuring outcome (which may include payment moratoriums, debt haircuts and/or subsequent recoveries) and the expected loss severity of credits for each insurance contract.
As the probability of default for an individual credit increases and/or the severity of loss given a default increases, our loss reserve for that insured obligation will also increase. Political,
|Ambac Financial Group, Inc. 32 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents economic, credit or other unforeseen events could have an adverse impact on default probabilities and loss severities. The loss reserves for many transactions are derived from the issuer's creditworthiness. For public finance issuers, loss reserves will consider not only creditworthiness but also political dynamics and economic status and prospects. The loss reserves for transactions which have no direct issuer support, such as most structured finance exposures, including RMBS and student loan exposures, are derived from the default activity and the estimated loss given default of the underlying collateral supporting the transactions. In addition, many transactions have a combination of issuer/entity and collateral support. Loss reserves reflect our assessment of the transaction's overall structure, support and expected performance. Loss reserve volatility will be a direct result of the credit performance of our insured portfolio, including the number, size, bond types and quality of credits included in our loss reserves; our ability to execute workout strategies and commutations; economic and market conditions; and management's judgments with regards to the current performance and future developments within the insured portfolio. The number and severity of credits included in our loss reserves depend to a large extent on transaction specific attributes, but will generally increase during periods of economic stress and decline during periods of economic prosperity. Reinsurance contracts mitigate our loss reserves but sinceAmbac currently has minimal exposure ceded to reinsurers on credits with loss reserves, the existing reinsurance contracts are unlikely to have a significant effect on loss reserve volatility. Loss reserve volatility will also be materially impacted by changes in interest rates from period to period.
The table below indicates the gross par outstanding and gross loss reserves
(including loss expenses) related to policies in
Gross Par Gross Loss and Loss Expense
Outstanding Reserves
(1) (2) (1) (3) (4)
December 31, 2021
Structured Finance 2,371 (1,178)
Domestic Public Finance 2,742 562
Other 1,189 17
Loss expenses - 45
Totals 6,302 (554)
December 31, 2020
Structured Finance 2,945 (1,212)
Domestic Public Finance 3,016 724
Other 1,612 23
Loss expenses - 68
Totals 7,573 (397)
(1) Ceded par outstanding on policies with loss reserves and ceded loss and
loss expense reserves are $784 and $24 respectively, at December 31, 2021 , and
$739 and $33 , respectively at December 31, 2020 . Ceded loss and loss expense
reserves are included in Reinsurance recoverable on paid and unpaid losses.
(2) Gross Par Outstanding includes capital appreciation bonds, which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bond.
(3) Loss and Loss Expense reserves atDecember 31, 2021 , of$(554) are included in the balance sheet in the following line items: Loss and loss expense reserves:$1,538 and Subrogation recoverable: (2,092). Loss and Loss Expense reserves atDecember 31, 2020 , of$(397) are included in the balance sheet in the following line items: Loss and loss expense reserves:$1,759 and Subrogation recoverable:$2,156 .
(4)
See Note 2. Basis of Presentation and Significant Accounting Policies to the
Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K
for a description of the cash flow and statistical methodologies used to develop
loss reserves. The majority of our large loss reserves utilize the cash flow
method of reserving. Various cash flow scenarios are developed to represent the
range of possible outcomes and resultant future claim payments and timing.
Scenarios and probabilities of each are adjusted regularly to reflect changes in
status, outlook and our analysis and views. Significant judgment is used to
develop the cash flow assumptions and related probabilities, and there can be no
certainty that the scenarios or probabilities will not deviate materially from
ultimate outcomes.
•In some cases, such as RMBS and student loans, cash flow projections include
the modeling of an issuer or transaction's future revenues and expenses to
determine the resources available to pay debt service on our insured
obligations. Key assumptions impacting RMBS cash flow models include projected
home price appreciation and interest rates A component of our RMBS loss reserve
estimate includes subrogation recoveries related to securitized loans in such
transactions that breached certain representations and warranties ("R&W"). Key
assumptions impacting student loan cash flow models include projected loan
defaults, recoveries and interest rates.
•In other cases, such as many public finance exposures, we consider the issuer's
overall ability and willingness to pay as it relates to the existing fiscal,
economic, legal, restructuring and/or political framework relevant to a
particular exposure or group of exposures. We then develop multiple scenarios
where issuer debt service is paid, missed and/or haircut with claims paid then
modeled for any recovery amount (and potential variability of the recovery
amount) and timing. There is no certainty our assumptions as to scenarios or
probabilities will not be subject to material changes as developments occur.
•In estimating loss reserves, we also incorporate scenarios which represent the
potential outcome of remediation strategies. Remediation scenarios may include
(i) a potential refinancing of the transaction by the issuer; (ii) the issuer's
ability to redeem outstanding securities at a discount, thereby increasing the
structure's ability to absorb future losses; and (iii) our ability to terminate,
restructure or commute the policy in whole or in part. The remediation scenarios
and the related probabilities of occurrence vary by policy depending on ongoing
and expected discussions and negotiations with issuers and/or investors. In
addition to commutation negotiations that are underway with various
counterparties in various forms, our reserve
| Ambac Financial Group, Inc. 33 2021 FORM 10-K |
--------------------------------------------------------------------------------Table of Contents estimates may also include scenarios which incorporate our ability and/or expectation to commute additional exposure with other counterparties.
Valuation of Certain Financial Instruments
The Fair Value Measurement Topic of the ASC requires financial instruments to be classified within a three-level fair value hierarchy. The fair value hierarchy, the financial instruments classified within each level, our valuation methods, inputs, assumptions and the review and validation procedures over quoted and modeled pricing are further detailed in Note 5. Fair Value Measurements to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. The level of judgment in estimating fair value is largely dependent on the amount of observable market information available to fair value a financial instrument, which is also determinative of where the financial instrument is classified in the fair value hierarchy. Level 3 instruments are valued using models which use one or more significant inputs or value drivers that are unobservable and therefore require significant judgment. Level 3 financial instruments which are material include certain invested assets, uncollateralized interest rate swaps and investments and loan receivables of consolidated VIEs. Model-derived valuations of Level 3 financial instruments incorporate estimates of the effects ofAmbac's own credit risk and/or counterparty credit risk, which can be complex and judgmental. Furthermore, Level 3 investments and loan receivables of consolidated VIEs incorporate estimates ofAmbac's financial guarantee cash flows, including future premiums and losses. Such cash flow estimates require judgments regarding prepayments of VIE debt, loss probabilities and loss severities, all of which are inherently uncertain. All models and related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based on improvements in information and modeling techniques. The re-evaluation process includes a quarterly meeting of senior Finance personnel to review and approve changes to models and key assumptions. As a result of the significant judgment for the above-described instruments, the actual trade value of the financial instrument in the market, or exit value of the financial instrument owned byAmbac , may be significantly different from its recorded fair value.
Valuation of Deferred Tax Assets
Our provision for taxes is based on our income, statutory tax rates and tax
planning opportunities available to us in the jurisdictions in which we operate.
Tax laws are complex and subject to different interpretations by the taxpayer
and respective governmental taxing authorities. Significant judgment is required
in determining our tax expense and in evaluating our tax positions. We review
our tax positions quarterly and adjust the balances as new information becomes
available. Deferred tax assets arise because of temporary differences between
the financial reporting and tax bases of assets and liabilities, as well as from
net operating loss ("NOL"). More specifically, deferred tax assets represent a
future tax benefit that results from losses recorded under GAAP in a current
period which are only
deductible for tax purposes in future periods and NOL carry forwards.
Valuation allowances are established to reduce deferred tax assets to an amount that "more likely than not" will be realized. On a quarterly basis, management identifies and considers all available evidence, both positive and negative, in making the determination with significant weight given to evidence that can be objectively verified. Positive evidence includes removal of the going concern independent auditor opinion in 2018, the Segregated Account'sFebruary 12, 2018 exit from rehabilitation, Everspan's receipt of an 'A-'' Financial Strength Rating from AM Best, the launch of a specialty program property and casualty insurance business, and AFG's acquisition of a majority interest in an MGA/U business. Negative evidence includes the potential for unrecognized future insurance tax losses; cumulative pre-tax losses in recent years; uncertainty regarding timing and magnitude of RMBS R&W litigation recoveries; and no new financial guarantee business. The level of deferred tax asset recognition is influenced by management's assessment of future expected taxable income, which depends on the existence of sufficient taxable income within the carry forward periods available under the tax law. As a result of the above-described risks and uncertainties associated with future operating results, management believes it is more likely than not that the Company will not generate sufficient taxable income to recover theU.S. federal deferred tax asset and therefore has a full valuation allowance. To the extent such risks and uncertainties are resolved,Ambac may have the ability to establish a history of making reliable estimates of future income which could ultimately result in a reduction to the deferred tax asset valuation allowance. See Note 16. Income Taxes to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for additional information on the Company's deferred income taxes. FINANCIAL GUARANTEES IN FORCE ($ in millions) Financial guarantee products were sold in three principal markets:U.S. public finance,U.S. structured finance and international finance. The following table provides a breakdown of guaranteed net par outstanding by market atDecember 31, 2021 and 2020. Net par exposures within theU.S. public finance market include capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bonds. Guaranteed net par outstanding includes the exposures of policies insuring variable interest entities ("VIEs") consolidated in accordance with the Consolidation Topic of the ASC. Guaranteed net par outstanding excludes the exposures of policies that insure bonds which have been refunded or pre-refunded and excludes exposure of the policies insuring the Sitka Senior Secured Notes and LSNI Secured Notes as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. |Ambac Financial Group, Inc. 34 2021 FORM 10-K | --------------------------------------------------------------------------------
Table of Contents December 31, 2021 2020 Public Finance (1) (2)$ 12,360 $ 15,497 Structured Finance 4,904 6,337 International Finance 10,756 12,054 Total net par outstanding$ 28,020 $ 33,888
(1) Includes
(2) Includes
Below we will discuss the significant exposures in our insured portfolio relating to each of the three markets. See Note 6. Financial Guarantees in Force to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for exposures by bond type.
Ambac's portfolio ofU.S. public finance exposures is$12,360 in net par outstanding, representing 44% ofAmbac's net par outstanding as ofDecember 31, 2021 , and a 20% reduction from the amount outstanding atDecember 31, 2020 . This reduction in exposure was due to additional reinsurance acquired, restructuring transactions, scheduled paydowns, and early terminations (calls, refundings and pre-refundings). WhileAmbac's U.S. public finance portfolio consists predominantly of municipal bonds such as general obligation, revenue, and lease and tax-backed obligations of state and local government entities, the portfolio also includes several non-municipal types of bonds, such as financings for not-for-profit entities and transactions with public and private elements, which generally finance infrastructure, housing and other public interests. Municipal bonds are generally supported directly or indirectly by the issuer's taxing authority or by public sector fees and assessments which may or may not be specifically pledged. Risk factors in these transactions derive from the municipal issuer, including its fiscal management, politics, and economic position, as well as its ability and willingness to continue to pay its debt service. Municipal bankruptcies and similar proceedings, while still relatively uncommon, have occurred, exposingAmbac to the risk of liquidity claims and ultimate losses if issuers cannot successfully adjust their liabilities without impairing creditors. Public/private transactions are generally structured to achieve their targeted public interest objective without direct support from the public sector. Some examples of this type of financing include affordable housing, private education, privatized military housing and student housing. Protections within these financings provided toAmbac usually include the strength of the financed asset's essentiality and public purpose and may include financial covenants, collateral and control rights. Risk factors include financial underperformance, event risk and a shift in the asset's mission or essentiality. One example of this type of financing isU.S. military housing. •Ambac insures approximately$5,490 net par of privatized military housing debt. The debt was issued to finance the construction and/or renovation of housing units for military personnel and their families on domesticU.S. military bases. Debt service is not directly paid or guaranteed by theU.S. Government . Rather, the bonds are serviced from the cash flow generated in most cases by rental payments deposited by the military directly into lockbox accounts as part of each service personnel's Basic Allowance for Housing (BAH). In typically small percentages, rental payments can also come from civilians, including retired service personnel andUS Department of Defense contractors living on a particular base. Collateral for these transactions includes the BAH payments as well as an interest in the ground lease. Risk factors affecting these transactions include ongoing base essentiality, military deployments, theU.S. government's commitment to fund the BAH, marketability/attractiveness of the on-base housing units versus off-base housing, construction completion, environmental remediation, utility and other operating costs and housing management.Ambac's exposure to privatized military housing debt is a growing concentration given the long-dated maturity profile of the exposure relative to faster run-off of other parts ofAmbac's insured portfolio. As ofDecember 31, 2021 , privatized military housing represented approximately 20% of net par outstanding.
Ambac's portfolio ofU.S. structured finance exposures is$4,904 in net par outstanding, representing 18% ofAmbac's net par outstanding as ofDecember 31, 2021 , and a 23% reduction from the amount outstanding atDecember 31, 2020 . This reduction in exposure was primarily related to (i) residential mortgage-backed securities ("RMBS") policies, which continued to prepay as well as incur claims and (ii) quota share reinsurance of a structured insurance credit. Current insured exposures primarily include securitizations of mortgage loans, home equity loans and student loans, in each case where the majority of the underlying collateral risk is situated inthe United States . AtDecember 31, 2021 , RMBS represented approximately 10% of net par outstanding. Structured finance securitization exposures generally entail three forms of risk: (i) asset risk, which relates to the amount and quality of the underlying assets; (ii) structural risk, which relates to the extent to which the transaction's legal structure and credit support provide protection from loss; and (iii) servicer risk, which is the risk that poor performance at the servicer or manager level contributes to a decline in cash flow available to the transaction. AAC seeks to mitigate and manage these risks through its risk management practices.
International Finance Insured Portfolio
Ambac's portfolio of international finance insured exposures is$10,756 in net par outstanding, representing 38% ofAmbac's net par outstanding as ofDecember 31, 2021 , and a 11% reduction from the amount outstanding atDecember 31, 2020 . This reduction in exposure was primarily the result of scheduled maturities within investor-owned utilities, commutations and a strengthening of the US dollar versus the British pound and the Euro.Ambac's international finance insured exposures include a wide array of obligations in the international markets, including infrastructure financings, utility obligations, whole business securitizations (e.g., securitizations of substantially all of the operating assets of a corporation) and sub-sovereign credits. AtDecember 31, 2021 , sub-sovereign and investor-owned and |Ambac Financial Group, Inc. 35 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents public utilities represented approximately 18% and 12% of net par outstanding, respectively.Ambac has no insured exposure related to emerging markets. When underwriting transactions in the international markets,Ambac considered the specific risks related to the particular country and region that could impact the credit of the issuer. These risks include the legal and political environment, capital markets dynamics, foreign exchange issues and the degree of governmental support.Ambac continues to assess these risks through its ongoing risk management.
Ambac
portfolio of insured exposures underwritten by AmbacUK is financially supported exclusively by the assets of AmbacUK and no capital support arrangements are in place with any otherAmbac affiliate.Ambac's international net par exposures are principally in theUnited Kingdom ($9,255 ); however, we also have exposures with credit risk based in various EU member states, includingAustria ,France ,Germany andItaly ($1,284 ).Italy , with net par exposure of$718 in particular has experienced economic, fiscal and political strains since the 2008 global financial crisis such that the likelihood of default on an insured sub-sovereign obligation in that country is higher than when the policy was underwritten.Ambac does not guarantee any sovereign bonds of the above EU countries.
Largest Insured Exposures:
The table below showsAmbac's ten largest exposures, by repayment source, as a percentage of total financial guarantee net par outstanding atDecember 31, 2021 (in millions): % of Total Ambac Net Par Net Par Risk Name Country-Bond Type Ratings (1) Ultimate Maturity Year Outstanding Outstanding IF AUK Capital Hospitals plc (2) UK-Infrastructure A- 2046 925 3.3 % IF AUK Anglian Water UK-Utility A- 2035 905 3.2 % IF AUK Mitchells & Butlers Finance plc-UK UK-Asset Securitizations BBB 2033$ 892 3.2 % Pub Securitisation IF AUK Aspire Defence Finance plc UK-Infrastructure A- 2040 836 3.0 % IF AUK National Grid Gas UK-Utility BBB+ 2037 835 3.0 % IF AUK Posillipo Finance II S.r.l Italy-Sub-Sovereign BIG 2035 661 2.4 % New Jersey Transportation Trust PF AAC Fund Authority - Transportation US-Lease and Tax-backed Revenue BBB- 2036 623 2.2 % System IF AUK National Grid Electricity UK-Utility BBB+ 2036 557 2.0 % Transmission IF AUK RMPA Services plc UK-Infrastructure BBB+ 2038 550 2.0 % IF AUK Catalyst Healthcare (Manchester) UK-Infrastructure BBB- 2040 541 1.9 % Financing plc (2) Total$ 7,325 26.2 %
PF = Public Finance, SF = Structured Finance, IF = International Finance
AAC =
(1)Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view ofAmbac . In cases whereAmbac has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used.Ambac credit ratings are subject to revision at any time and do not constitute investment advice. BIG denotes credits deemed below investment grade. (2)A portion of this transaction is insured by an insurance policy issued by AAC. AAC has issued a policy for this transaction that will only pay in the event that AmbacUK does not pay under its insurance policies ("second to pay policy") Net par related to the top ten exposures reduced$394 fromDecember 31, 2020 . Exposures are impacted by changes in foreign exchange rates, certain indexation rates, scheduled and unscheduled paydowns and the purchase of quota share reinsurance. As a result of recent increases in inflation, such indexation exposures have increased at a faster pace than they have historically. The concentration of net par amongst the top ten (as a percentage of net par outstanding) increased slightly to 26.2% atDecember 31, 2021 from 22.9% atDecember 31, 2020 .National Grid Gas had anAmbac rating downgrade sinceDecember 31, 2020 , Excluding the top ten exposures, the remaining insured portfolio of financial guarantees has an average net par outstanding of$32 per single risk, with insured
exposures ranging up to
Given thatAmbac has not written any new insurance policies since 2008, the risk exists that the insured portfolio becomes increasingly concentrated to large and/or below investment grade exposures.
We continue to experience stress in our exposure toPuerto Rico (the "Commonwealth") that consists of several different issuing entities (all below investment grade) with total net par exposure of$1,054 as ofDecember 31, 2021 . Each issuing entity has its own credit risk profile attributable to, as applicable, discrete revenue sources, direct general obligation pledges and/or general |Ambac Financial Group, Inc. 36 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents obligation guarantees. Refer to Part I, Item 1 in this Annual Report on Form 10-K for additional information regarding the different issuing entities that encompassAmbac's exposures toPuerto Rico .
Commonwealth Plan of Adjustment (Title III Case)
OnNovember 3, 2021 , the Financial Oversight andManagement Board for Puerto Rico ("Oversight Board"), as representative of theCommonwealth of Puerto Rico , thePuerto Rico Public Buildings Authority , and the Employees Retirement System of the Government of theCommonwealth of Puerto Rico , filed the Eighth Amended Title III Joint Plan of Adjustment of theCommonwealth of Puerto Rico , et al. ("Eighth Amended POA"). The Eighth Amended POA proposed to restructure approximately$33,000 of debt across various Commonwealth instrumentalities, including obligations insured by AAC, and approximately$50,000 in pension obligations. The Eighth Amended POA, among other things, incorporated the settlement reflected in the PRIFA Related Plan Support Agreement ("PRIFA PSA") that was signed onJuly 27, 2021 , by the Oversight Board, as representative of theCommonwealth of Puerto Rico , AAC, FGIC, and other holders of bonds issued by PRIFA. The Eighth Amended POA also incorporated the settlements reflected in the PRHTA/CCDA Related Plan Support Agreement ("PRHTA/CCDA PSA") datedMay 5, 2021 , and the Amended and Restated Plan Support Agreement with the Oversight Board, as representative of theCommonwealth of Puerto Rico , PBA, and the Employee Retirement System of the Government of theCommonwealth of Puerto Rico ("Amended and Restated GO / PBA PSA") dated as ofJuly 12, 2021 . The plan consideration to be made available to creditors under these plan support agreements is described below. A hearing to confirm the Commonwealth's plan of adjustment was held over several days betweenNovember 8, 2021 . OnJanuary 10, 2022 , JudgeLaura Taylor Swain ,U.S. District Court for the District of Puerto Rico , entered an order requesting certain changes to the Eighth Amended POA and related materials. None of the requested changes would substantively impact the contemplated recovery toAmbac and holders of AAC-insured bonds under the Eighth Amended POA. The Oversight Board filed a revised version of the plan and corresponding materials shortly thereafter. OnJanuary 18, 2022 ,Judge Swain confirmed the Eighth Amended POA. The Eighth Amended POA, together with the qualifying modifications for PRIFA and CCDA discussed below, are expected to have an effective date on beforeMarch 15, 2022 . Certain parties have appealed from the order confirming the Eighth Amended POA and have sought a stay pending this appeal; if the stay is granted, the effective date may be delayed.
The successful consummation of the Eighth Amended POA and qualifying
modifications for PRIFA and CCDA on the effective date will represent a
significant step towards resolution of AAC's remaining
PRIFA/CCDA Qualifying Modifications (Title VI Cases)
The PRIFA PSA and PRHTA/CCDA PSA contain provisions requiring the parties thereto to support the terms of Title VI
Qualifying Modifications for PRIFA and CCDA. OnOctober 8, 2021 , the Oversight Board commenced Title VI proceedings and filed applications for approval of the proposed PRIFA Qualifying Modification ("PRIFA QM") and CCDA Qualifying Modification ("CCDA QM"). The PRIFA QM and CCDA QM proposed to restructure about$1,900 and$384 of debt, respectively, including obligations insured by AAC. The hearing to consider approval of the PRIFA QM and the CCDA QM was held contemporaneously with the confirmation hearing in the Commonwealth's Title III proceedings inNovember 2021 . OnJanuary 20, 2022 ,Judge Swain approved the PRIFA QM and CCDA QM. The PRIFA QM and CCDA QM will share the same effective date as the Eighth Amended POA, which is expected to occur on or prior toMarch 15, 2022 . As discussed above, this date may be delayed if a stay is granted pending the appeal of the Eighth Amended POA.
PRHTA Plan of Adjustment (Title III Case)
The Oversight Board, as Title III representative of the
Bondholder Elections: GO, PBA, PRIFA, and CCDA
As outlined in the Election Notice for Ambac Bond Holders with Claims in Class 19 (the "GO Election Notice") and the Election Notice for Ambac Bond Holders with Claims in Classes 4 and 26 (the "PBA Election Notice"), GO and PBA bondholders were each permitted to choose between two different treatment options for the satisfaction of their claims. The first option allows the bondholders to elect commutation of their insurance policies (the "Ambac Insurance Policies"). Under this option, bondholders will receive: 1) their respective shares of certain consideration available under the Commonwealth Plan, and 2) cash fromAmbac .Ambac's obligations to the bondholders under the Ambac Insurance Policies who elected this option will be deemed fully satisfied. Under the second option, bondholders who failed to elect commutation will receive payment, in cash, of the outstanding principal amount of the bondholders' insured bonds plus the accrued and unpaid interest thereon as of the effective date (the "Ambac Acceleration Price."), as adjusted for any payments already made byAmbac on account of the applicableAmbac Insurance Policies. Pursuant to this option, bondholders will receive theAmbac Acceleration Price in full and final discharge ofAmbac's obligations under the Ambac Insurance Policies. As outlined in the Election Notice for Holders of Ambac Insured PRIFA Bond Claims in Connection with Certain Capital Appreciation Bonds (the "PRIFA CABs Election Notice"), the Election Notice for Holders of Ambac Insured PRIFA Bond Claims in Connection with Certain Current Interest Bonds (the "PRIFA CIBs Election Notice"), and the Election Notice for Holders of Ambac Insured CCDA Bond Claims (the "CCDA Election Notice"), PRIFA and CCDA bondholders were each permitted to choose between two different treatment options for the satisfaction of their claims. The first option allows the bondholders to elect commutation of their Ambac Insurance Policies. Under the first option, bondholders will receive: 1) their respective shares of certain consideration available under |Ambac Financial Group, Inc. 37 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents the Commonwealth Plan and the PRIFA QM, or CCDA QM, as applicable and 2) cash fromAmbac . Bondholders who elected this option will receive this consideration in full and final discharge ofAmbac's obligations under theAmbac Insurance Policies. Under the second option, the bondholders' respective shares of consideration available under the Commonwealth Plan and the PRIFA QM, or CCDA QM, as applicable, will be deposited into a trust. Those bondholders are expected to receive scheduled payments from this trust, unlessAmbac elects, in its sole discretion, to pay all or a portion of the outstanding par amounts of theAmbac -insured bonds in such trust. The accelerated payments will satisfyAmbac's obligations under the applicable Ambac Insurance Policies. On the plan effective date, about 39% and 19% of the outstanding par of theAmbac -insured PRIFA and CCDA bonds, respectively, will be commuted with the remainder deposited into the trusts. Plan Support Agreements PRIFA PSA The PRIFA PSA reflects aJuly 14, 2021 , agreement between the Oversight Board, AAC and FGIC to resolve claims related to bonds issued by PRIFA. Under the PRIFA PSA, PRIFA creditors will receive, on account of approximately$1,900 of allowed claims arising from PRIFA bonds, consideration in the form of (i)$193.5 cash and (ii) a contingent value instrument ("CVI") premised on outperformance of general fund rum tax collections relative to the certified 2021 Commonwealth Fiscal Plan's projections (the "Rum Tax CVI"). The Rum Tax CVI is subject to a lifetime nominal cap of about$1,300 , and is also subject to various permitted rum tax waterfall deductions and caps on distributions, including the lesser of (a) 40% of cumulative outperformance (net of waterfall deductions), starting onJuly 1, 2021 , less Rum Tax CVI payments made to PRIFA creditors in previous years, (b) 50% of annual rum tax outperformance (net of waterfall deductions), and (c)$30 annually. The Rum Tax CVI will be deposited into a master trust (the "CVI Master Trust ") and into a sub trust (the "PRIFA CVI Sub Trust ") within theCVI Master Trust for the benefit of PRIFA bondholders (the "PRIFA Trust "); thePRIFA CVI Sub Trust will also be funded with a share (approximately 27%) of the Clawback CVI, described below. The lifetime sum of the Rum Tax CVI and the Clawback CVI cannot exceed the$1,300 lifetime nominal cap (75% of allowed PRIFA claim) under the Eighth Amended POA. Further, under the PRIFA PSA, AAC and other creditors may also receive fees in connection with negotiating the PRIFA PSA and supporting the restructuring agreement reflected therein. The value of thePRIFA CVI Sub Trust is highly uncertain given the contingent, outperformance-driven structure of the CVIs coupled with the likely back-ended nature of most of the potential cash flows. Changes in our assumed values of thePRIFA CVI Sub Trust or the actual performance of the CVIs could cause an adverse change in our reserves which could be material. As a result, a decrease in our assumed values of thePRIFA CVI Sub Trust could have a material adverse impact on our results of operations and financial condition.
PRHTA/CCDA PSA
AAC signed a joinder to the PRHTA/CCDA PSA on
issued by certain Commonwealth instrumentalities, PRHTA, and CCDA on account of
their claims against the Commonwealth arising from such bonds ("Clawback"
claims). This consideration consists of a contingent value instrument tied to
the outperformance of the Commonwealth's sales and use tax ("SUT") relative to
the certified 2020 Commonwealth Fiscal Plan's projections (the "Clawback CVI").
For years one through 30, a portion of the Clawback CVI consideration reflects a
40% share of cumulative outperformance, starting July 1, 2021 , subject to a
combined 95% outperformance limit with the subsequently described amounts
subject to a waterfall. The other portion of the Clawback CVI receives, on an
annual basis, the lesser of (i) 50% of cumulative outperformance, less payments
previously made, and (ii) 75% of annual outperformance, and is subject to a
waterfall. The waterfall provides that, in years one through 22, (a) holders of
general obligation ("GO") bonds will receive the first $100 of outperformance;
(b) the Clawback creditors will receive the next $11.1 ; and (c) any amounts
received thereafter will be split 90%/10% between GO creditors and Clawback
creditors. In years 23 through 30, subject to the limits in (i) and (ii) above,
100% of the outperformance goes to the Clawback creditors. Overall, Clawback CVI
recoveries are subject to a lifetime cap of 75% of allowed claim amounts under
the Eighth Amended POA. PRHTA creditors will receive an approximately 69% share
of the Clawback CVI, subject to a lifetime nominal cap of about $3,700 , and
subject to a PRHTA-specific waterfall: holders of PRHTA '68 bonds will receive
the first dollars of Clawback CVI, followed by holders of PRHTA '98 bonds. CCDA
bondholders will receive a 4% share of the Clawback CVI, subject to a lifetime
nominal cap of about $217 . The value of the Clawback CVI is highly uncertain,
given the contingent, outperformance-driven structure of the instrument coupled
with the likelihood that cash flows in later years (years 23 through 30) will
significantly exceed those in earlier years. Changes in our assumed values of
the Clawback CVI or in the actual performance of the Clawback CVI could cause an
adverse change in our reserves which could be material. As a result, a
significant decrease in our assumed values of the Clawback CVI could have a
material adverse impact on our results of operations and financial condition.
For example, a 1% change in the estimated value of the Clawback CVI plan
consideration related to the AAC-insured PRIFA, CCDA and PRHTA bonds would have
an impact of about $2 on reserves.
Under the PRHTA/CCDA PSA, PRHTA bondholders will also receive new PRHTA bonds
with a face amount of $1,245 , maturities of up to 40 years and an average
interest rate of 5.0%. Of the $1,245 in new bonds, approximately $646.4 will be
allocated to holders of PRHTA '68 bonds and approximately $598.6 will be
allocated to holders of PRHTA '98 bonds. PRHTA creditors will also share $389 of
cash proceeds, including a $264 interim distribution, payable at the effective
date of the Eighth Amended POA. In addition, certain restriction fees and
consummation costs are payable at the effective date of the PRHTA POA. AAC will
receive directly the pro rata share of the CW/PRHTA clawback recovery and
interim PRHTA distributions allocable to its owned or insured PRHTA bonds. Of
the $264 interim cash distribution, $184.8 would be allocated to holders of
PRHTA '68 bonds and $79.2 would be allocated to holders of PRHTA '98 bonds.
Claim recovery expectations for PRHTA creditors under the PRHTA/CCDA PSA are
uncertain and subject to interpretation due to the aforementioned
| Ambac Financial Group, Inc. 38 2021 FORM 10-K |
--------------------------------------------------------------------------------Table of Contents uncertainty related to the value of and/or the actual performance of the Clawback CVI.
Under the PRHTA/CCDA PSA, CCDA creditors will receive
Amended and Restated GO / PBA PSA
OnJuly 27, 2021 ,Ambac joined theJuly 12, 2021 , Amended and Restated Plan Support Agreement with the Oversight Board, as representative of theCommonwealth of Puerto Rico , PBA, and the Employee Retirement System of the Government of theCommonwealth of Puerto Rico ("Amended and Restated GO / PBA PSA"). In general, this PSA follows the Second Amended GO/PBA PSA, originally signed onFebruary 23, 2021 . Under the Amended GO/PBA PSA, creditors will receive up to$7,024 of cash, of which up to$350 was contingent upon FY2021 revenue outperformance exceeding$350 on a dollar-for-dollar basis,$6,683 of new GO current interest bonds,$443 of new GO 5.375% capital appreciation bonds,$288 of new GO 5.00% capital appreciation bonds, and GO Bond CVI, subject to a lifetime cap of about$3,500 . The GO Bond CVI is intended to provide creditors with additional returns tied to outperformance of the SUT against the certified 2020 Commonwealth Fiscal Plan's projections. The value of the GO Bond CVI is highly uncertain, given the contingent, outperformance-driven structure of the instrument Recovery derived from fixed consideration (i.e., excluding GO Bond CVI) is estimated to vary between approximately 67% and 77% (as of the petition date) for GO creditors, and between approximately 75% and 80% (as of the petition date) for PBA creditors.
Under the Amended and Restated GO/PBA PSA, in exchange for executing the agreement and agreeing to its terms and conditions, creditors that were authorized to vote their claim will receive a PSA restriction fee of 1.32% of their claim amount at the effective date of the Eighth Amended POA.
The Amended and Restated GO/PBA PSA was further amended to allow for additional
time to consummate the Eighth Amended POA (i.e., relevant deadlines therein
extended from
Plan of Adjustment and Qualifying Modification Considerations
The Eighth Amended POA has been confirmed, and the PRIFA QM and the CCDA QM have been approved. All are expected to become effective on or beforeMarch 15, 2022 . However, uncertainty remains as to (i) whether the effective date will be stayed pending the appeal of the order confirming Eighth Amended POA; (ii) the result of the pending First Circuit appeal of the order confirming the Eighth Amended POA; (iii) the value or perceived value of the consideration provided by or on behalf of the debtors under the Eighth Amended POA, PRIFA QM, and CCDA QM; (iv) the extent to which exposure management strategies, such as commutation and acceleration, will be executed; (v) the tax treatment of the consideration provided by or on behalf of the debtors under the Eighth Amended POA, PRIFA QM, and CCDA QM; (vi) whether and when the PRHTA POA will be confirmed; and (vii) other factors, including market conditions such as interest rate movements, credit spread changes on the new GO and CVI instruments, and liquidity for the new GO and CVI instruments.Ambac's loss reserves may prove to be understated or overstated, possibly materially, due to favorable or unfavorable developments or results with respect to these factors. Refer to Management's Discussion and Analysis of Financial Condition and Results of Operations - Balance Sheet to the Unaudited Consolidated Financial Statements included in Part I, Item 2 in this Form 10-Q for the possible increase in loss reserves under stress or other adverse conditions. There can be no assurance that losses may not exceed such estimates.
Ambac Title III Litigation Update
AAC is party to a number of litigations related to itsPuerto Rico exposures, and actively participates in the Commonwealth's Title III proceedings before theUnited States District Court for the District of Puerto Rico . In connection with theJuly 27, 2021 PRIFA PSA,Ambac filed an urgent motion to stay various pending matters related to outstanding litigation in connection with the Commonwealth's Title III proceedings. OnAugust 3, 2021 , the Court entered an order staying the requested matters. While confirmation of the Eighth Amended POA and approval of the PRIFA QM and CCDA QM resolve many of the issues raised in the pending matters, the Court's order confirming the Eighth Amended POA are now subject to appeal.
AAC continues to actively participate in PRHTA's Title III proceedings.
Refer to Note 19. Commitments and Contingencies to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information aboutAmbac's litigation relating toPuerto Rico .
Summary
Ambac has considered these developments and other factors in evaluating itsPuerto Rico loss reserves. While management believes its reserves are adequate to cover losses in its Public Finance insured portfolio, there can be no assurance thatAmbac may not incur additional losses in the future, particularly given the developing economic, political, and legal circumstances inPuerto Rico . Such additional losses may have a material adverse effect onAmbac's results of operations and financial condition. Due to uncertainty regarding numerous factors, described above, that will ultimately determine the extent ofAmbac's losses, it is also possible that favorable developments and results with respect to such factors may cause losses to be lower than current reserves, possibly materially. | Ambac Financial Group, Inc. 39 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents The following table outlinesAmbac's insured exposure to eachCommonwealth of Puerto Rico issuer. Net Par and Interest Ever-to-Date Range of Ambac Net Par Outstanding Net Claims ($ in millions) Maturity Ratings (1) Outstanding (2)(4) Paid (3)PR Infrastructure Financing Authority (Special Tax Revenue) 2023-2044 BIG$ 403 $ 872 $ 202 PR Highways and Transportation Authority (1998 Resolution - Senior Lien Transportation Revenue) 2022-2042 BIG 394 620 164PR Convention Center District Authority (Hotel Occupancy Tax) 2028-2031 BIG 86 123 72PR Public Buildings Authority - Guaranteed by the Commonwealth of Puerto Rico 2022-2035 BIG 83 139 96PR Sales Tax Financing Corporation - Senior Sales Tax Revenue (COFINA) 2047-2054 BIG 73 648 37Commonwealth of Puerto Rico - General Obligation Bonds 2022-2023 BIG 11 12 56 PR Highways and Transportation Authority (1968 Resolution - Highway Revenue) 2022-2027 BIG 4 9 25 Total Net Exposure to The Commonwealth ofPuerto Rico and Related Entities
(1) Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view ofAmbac . In cases whereAmbac has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used.Ambac credit ratings are subject to revision at any time and do not constitute investment advice. BIG denotes credits deemed below investment grade. . (2)Net Par and Interest Outstanding ("P&I") represent the total insured future debt service remaining over the lifetime of the bonds. P&I for capital appreciation bonds does not represent the accreted amount but rather the amount due at respective maturity dates.
(3) In addition to ever-to-date net claims paid,
(4)Net Par and Interest Outstanding excludes the effects of a 10% current interest rate on$60 net par ofPR Public Buildings Authority ("PBA") bonds with a maturity date ofJuly 1, 2035 , resulting from the absence of a remarketing. Should a remarketing not occur before the maturity of the bonds, the Net Par and Interest Outstanding for PBA exposure would increase by$37 .
Additional Insured Portfolio Information
Average Life of Insured Portfolio
Ambac estimates that the average life of its guarantees on par in force atDecember 31, 2021 is approximately 10 years. The average life is determined by applying a weighted average calculation, using the remaining years to expected maturity of each guaranteed bond, and weighting them on the basis of the remaining net par guaranteed. Except for RMBS policies, no assumptions are made for non-contractual reductions, refundings or terminations of insured issues. RMBS policies incorporate assumptions on expected prepayments over the remaining life of the insured obligation.
The following table depicts amortization of existing guaranteed net par outstanding:
Net Par Outstanding Amortization (1) Estimated Net ($ in millions) Amortization 2022$ 2,395 2023 1,584 2024 1,814 2025 1,468 2026 1,385 2022-2026$ 8,646 2027-2031 6,131 2032-2036 6,817 2037-2041 3,544 After 2041 2,882 Total$ 28,020 (1) Depicts amortization of existing guaranteed portfolio, assuming no advance refundings, as ofDecember 31, 2021 . Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay guaranteed obligations. | Ambac Financial Group, Inc. 40 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents Exposure Currency
The table below shows the distribution by currency of
Net Par Net Par
Amount Amount Percentage
Outstanding Outstanding of Net Par
Currency in Base in U.S. Amount
($ in millions) Currency Dollars Outstanding
U.S. Dollars $ 17,497 $ 17,497 62 %
British Pounds £ 6,690 9,054 32 %
Euros € 1,113 1,267 5 %
Australian Dollars A$ 279 202 1 %
Total $ 28,020 100 %
See Note 6. Financial Guarantees in Force to the Consolidated Financial
Statements, included in Part II, Item 8 included in this Form 10-K, for
geographic detail by location of risk as of
Ratings Distribution
The following charts provide a rating distribution of existing net par outstanding based upon internalAmbac credit ratings atDecember 31, 2021 and 2020 and a distribution ofAmbac's below investment grade ("BIG") net par exposures atDecember 31, 2021 and 2020. BIG is defined as those exposures with an internal credit rating below BBB-: [[Image Removed: ambc-20211231_g3.jpg]] [[Image Removed: ambc-20211231_g4.jpg]] Note:AAA is less than 1% in both periods. (1) Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view ofAmbac . In cases whereAmbac has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used.Ambac credit ratings are subject to revision at any time and do not constitute investment advice.
Summary of Below Investment Grade Exposure:
Bond Type ($ in millions) Net Par Outstanding December 31, 2021 2020 Public Finance: Puerto Rico$ 1,054 $ 1,070 Military Housing 370 308 Other 317 1,057 Total Public Finance 1,741 2,435 Structured Finance: RMBS 2,170 2,800 Student loans 302 512 Total Structured Finance 2,472 3,312 International Finance: Sovereign/sub-sovereign 774 742 Transportation 389 760 Other 62 72 Total International Finance 1,225 1,574 Total$ 5,438 $ 7,321
The net decline in below investment grade exposures is primarily due to de-risking activities.
Below investment grade exposures could increase as a relative proportion of the guarantee portfolio given that stressed borrowers generally have less ability to prepay or refinance their debt. Accordingly, due to these and other factors, it is not unreasonable to expect the proportion of below investment grade exposure in the guarantee portfolio to continue to increase in the future.
Ceded Reinsurance
AAC has reinsurance in place pursuant to surplus share treaties and facultative agreements. As a primary financial guarantor, AAC is required to honor its obligations to its policyholders whether or not its reinsurers perform their obligations under these reinsurance agreements. As ofDecember 31, 2021 , the aggregate amount of insured par ceded by AAC to reinsurers under reinsurance agreements was$6,102 , with the largest reinsurer accounting for$2,695 or 7.9% of gross par outstanding atDecember 31, 2021 . |Ambac Financial Group, Inc. 41 2021 FORM 10-K | --------------------------------------------------------------------------------
Table of Contents
The following table shows the distribution, by bond type, of AAC's ceded
guaranteed portfolio at
Bond Type Ceded Par Amount ($ in millions) Outstanding December 31, 2021 2020 Public Finance: Lease and tax-backed revenue$ 1,618 $ 1,156 General obligation 1,458 1,327 Housing revenue 922 934 Transportation revenue 749 586 Other 612 509 Total Public Finance 5,359 4,512 Structured Finance: Structured insurance 313 115 Investor-owned utilities 222 224 Other 185 280 Total Structured Finance 720 619 Total Domestic 6,079 5,131 International Finance: Total International Finance 23 51 Total$ 6,102 $ 5,182 Percentage of Gross Par Ceded 18 % 13 %
RESULTS OF OPERATIONS ($ in millions)
The following discussion should be read along with the financial statements
included in this Form 10-K, as well as Part II, "Item 7, Management's Discussion
and Analysis's of Financial Condition and Results of Operations" of our Form
10-K for the year ended December 31, 2020 , which provides additional information
on comparisons of years 2020 and 2019.
Net loss attributable to common stockholders for the year ended December 31,
2021 , was $17 compared to a net loss attributable to common stockholders of $437
for the year ended December 31, 2020 . The decrease in losses was primarily
driven by: (i) lower loss and loss expenses, (ii) net gains on derivative
contracts, (iii) a $33 net gain on extinguishment of debt in 2021, (iv) higher
investment income and (v) lower interest expense, partially offset by higher
operating and tax expenses.
A summary of our financial results is shown below:
($ in millions) Year Ended December 31, 2021 2020 2019 Revenues: Net premiums earned$ 47 $ 54 $ 66 Net investment income 139 122 227
Net investment gains (losses), including impairments 7 22
81
Net gains (losses) on derivative contracts 22 (50)
(50)
Net realized gains (losses) on extinguishment of debt 33 -
-
Other income (expense) (1) 27 3
134
Income (loss) on variable interest entities 7 5
38
Expenses:
Losses and loss expenses (benefit) (88) 225 13 Intangible amortization 55 57 295 Operating expenses 126 92 103 Interest expense 187 222 269 Provision (benefit) for income taxes 18 (3)
32
Net income (loss) (16) (437)
(216)
Net income (loss) attributable to common stockholders
(1)2019 includes proceeds received in connection with an
Ambac's 2020 results of operations and financial position were adversely impacted by the COVID-19 pandemic's effect on the global economy and financial markets. Significant interest rate declines during the first quarter of 2020 contributed materially to a net increase in loss reserves and losses on interest rate derivative contracts for the year endedDecember 31, 2020 . Financial market disruptions were reflected through lower valuations of certain fixed maturity securities (recorded through other comprehensive income) and the majority of other investments (recorded through net investment income). During the second half of 2020 and into 2021, valuations recovered (favorably impacting counterparty credit adjustments on derivative assets and valuations of investment securities). The scope, duration and magnitude of the direct and indirect effects of COVID-19 are evolving in ways that are difficult or impossible to anticipate. As a result, it is possible thatAmbac's results of operations and financial condition may be further adversely affected by the evolving effects of the COVID-19 pandemic. For additional information on the risks posed by COVID-19, refer to "Part I, Item 1A-Risk Factors" in this Form 10-K. |Ambac Financial Group, Inc. 42 2021 FORM 10-K | --------------------------------------------------------------------------------
Table of Contents
The following paragraphs describe the consolidated results of operations of
Net Premiums Earned. Net premiums earned for the year endedDecember 31, 2021 , decreased by$7 or 13% as compared to net premiums earned for the year endedDecember 31, 2020 . The decline was driven by reductions in FG premiums earned partially offset by$1 of specialty property and casualty net premiums earned. Net premiums earned for FG were impacted by the runoff of the financial guarantee insured portfolio, including through transaction terminations, calls and scheduled maturities, which reduce current and future net premiums earned and were also impacted by the following: •Changes to the allowance for credit losses on the premium receivable asset. The impact on net premiums earned related to credit losses amounted to$6 and$(5) for the for the years endedDecember 31, 2021 and 2020. •Accelerated financial guarantee premium earnings as a result of calls and other accelerations on insured obligations largely due to de-risking activity of$1 and$12 for the for the years endedDecember 31, 2021 and 2020.
•New financial guarantee ceded reinsurance which reduces normal net premiums earned over the remaining period of the related ceded policies.
•The strengthening or weakening of the
Net Investment Income. Net investment income primarily consists of interest and net discount accretion on fixed maturity securities classified as available-for-sale, and net gains (losses) on pooled investment funds which include changes in fair value of the funds' net assets. Fixed maturity securities include investments inAmbac -insured securities that are made opportunistically based on their risk/reward and asset-liability management characteristics. Investments in pooled investment funds and certain other investments are either classified as trading securities with changes in fair value recognized in earnings or are reported under the equity method. These funds and other investments are reported in Other investments on the Consolidated Balance Sheets. For further information about investment funds held, refer to Note 4. Investments to the Consolidated Financial Statements, included in this Annual Report on Form 10-K.
Net investment income from
($ in millions) Year Ended December 31, 2021 2020 2019 Securities available-for-sale:Ambac -insured (including LSNI and Sitka Senior Secured Notes) $ 45 $ 62$ 121 Securities available-for-sale and short-term other than Ambac-insured 29 41 75 Other investments (includes trading securities) 66 19 32 Net investment income$ 139 $ 122 $ 227 Net investment income increased$18 for the year endedDecember 31, 2021 , compared to 2020. As described further below, the variance was primarily driven by 2020 pricing volatility within fund investments resulting from the impact of the COVID-19 pandemic on financial markets and the impact of the LSNI Secured Note redemption inJuly 2021 . •Investment income fromAmbac -insured securities decreased$17 in 2021, compared to 2020, due to lower income on LSNI Secured Notes. As described in Note 1. Background and Business Description, to the Consolidated Financial Statements, included in this Annual Report on Form 10-K, onJuly 6, 2021 , the LSNI Secured Notes were fully redeemed, including those held inAmbac's investment portfolio. Investment income from otherAmbac -insured securities, primarily consisting of RMBS andPuerto Rico bonds, was flat compared to 2020. •Net investment income from available-for-sales securities other thanAmbac -insured securities decreased$12 in 2021, compared to the prior year, reflecting a smaller asset base and lower average yields. Portfolio repositioning during 2021 and 2020, resulted in a higher allocation of pooled funds andAmbac -insuredPuerto Rico bonds, while reinvestment in non-insured available-for-sale securities were generally at lower yields. Short term rates also remained low throughout 2021, adversely impacting investment income. Additionally, the use of cash for early debt redemptions and operating cash needs contributed to the smaller asset base. •Other investments income increased$47 in 2021, compared to the prior year. The increase resulted from overall positive performance in 2021 and additional investments, particularly in hedge and equity funds. Relatively low returns in 2020 were driven by adverse changes in fair values as a consequence of the initial economic and financial market impact of the COVID-19 pandemic in the first quarter, offset by a generally strong market recovery in subsequent quarters of 2020. | Ambac Financial Group, Inc. 43 2021 FORM 10-K | --------------------------------------------------------------------------------
Table of Contents Net Investment Gains (Losses), including Impairments. The following table provides a breakdown of net investment gains, for the periods presented:
($ in millions) Year Ended December 31, 2021 2020
2019
Net realized gains on securities sold or called
(5) (4) 22
Credit impairment - - - Intent / requirement to sell impairments - - -
Total net investment gains, including impairments
Net investment gains on securities sold or called during the year endedDecember 31, 2021 , included a gain of$4 realized on the sale of AFG's equity interest in theCorolla Trust in connection with the Corolla Exchange Transaction. Other net realized gains on securities sold or called in 2021 and 2020 are primarily from sales in connection with routine portfolio management. Impairments are reported through earnings if management intends to sell securities or it is more likely than not that the Company will be required to sell before recovery of amortized cost. Credit impairments are recorded in earnings only to the extent management does not intend to sell, and it is not more likely than not that the Company will be required to sell the securities, before recovery of their amortized cost. When credit impairments are recorded, any non-credit related impairment amounts on the securities are recorded in other comprehensive income.Net Gains (Losses) on Derivative Contracts. Net gains (losses) on derivative contracts includes result from the Company's interest rate derivatives portfolio and its runoff credit derivative portfolio. The interest rate derivatives portfolio is positioned to benefit from rising rates as a partial economic hedge against interest rate exposure in the financial guarantee and investment portfolios. Net gain (loss) on interest rate derivatives generally reflect mark-to-market gains (losses) in the portfolio caused by increases (declines) in forward interest rates during the periods, the carrying cost of the portfolio, and the impact of counterparty credit adjustments as discussed below. Results from credit derivatives were not significant to the periods presented. •Net gains on interest rate derivatives for the year endedDecember 31, 2021 , were$22 , compared to a net losses of$50 for the year endedDecember 31, 2020 . The net gain for the year endedDecember 31, 2021 , resulted from the impact of rising interest rates and gains related to counterparty credit adjustments partially offset by the carrying cost of maintaining the economic hedge position. The net loss for the year endedDecember 31, 2020 , reflects significant declines in forward interest rates, triggered by the COVID-19 pandemic, and losses from the application of counterparty credit adjustments, described further below.
•Counterparty credit adjustments are generally applicable for uncollateralized derivative assets that may not be offset by derivative liabilities under a master netting agreement. Inclusion of counterparty credit adjustments in the
valuation of interest rate derivatives resulted in gains (losses) within Net gains (losses) on derivative contracts of$5 and$(6) for the years endedDecember 31, 2021 and 2020, respectively. The gain for the year endedDecember 31, 2021 , resulted from the decrease in underlying net asset values as interest rates increased. The loss in 2020 was driven by wider credit spreads reflecting the credit rating downgrade of a derivative counterparty byAmbac during the first quarter, simultaneous with an increase in the underlying asset values as interest rates declined. Other Income (Expense). Other income (expense) includes commission revenues of Xchange, ceding fees from the specialty property and casualty business, various financial guarantee fees and foreign exchange gains / (losses) unrelated to investments or loss reserves. For the year endedDecember 31, 2021 , other income includes Xchange revenues of$26 . Xchange pays commissions to sub-producers which are included in operating expenses. Net Realized Gains on Extinguishment of Debt. Net realized gains on extinguishment of debt was$33 for the year endedDecember 31, 2021 , resulting from the first quarter 2021 exchanges of junior surplus notes below their carrying values. Refer to Note 1. Background and Business Description to the Consolidated Financial Statements, included in this Annual Report on Form 10-K, for further discussion of the 2021 Surplus Notes Exchanges. Income (Loss) on Variable Interest Entities. Included within Income (loss) on variable interest entities are income statement amounts relating to VIEs consolidated under the Consolidation Topic of the ASC as a result ofAmbac's variable interest arising from financial guarantees written byAmbac's subsidiaries, including gains or losses attributable to consolidating or deconsolidating VIEs during the periods reported. Generally, the Company's consolidated VIEs are entities for whichAmbac has provided financial guarantees on all of or a portion of its assets or liabilities. In consolidation, assets and liabilities of the VIEs are initially reported at fair value and the related insurance assets and liabilities are eliminated. However, the amount of VIE net assets (liabilities) that remain in consolidation generally result from the net positive (negative) projected cash flows from (to) the VIEs which are attributable toAmbac's insurance subsidiaries in the form of financial guarantee insurance premiums, fees and losses. In the case of VIEs with net negative projected cash flows, the net liability is generally to be funded byAmbac's insurance subsidiaries through insurance claim payments. Differences between the net carrying value of the insurance accounts under the Financial Services-Insurance Topic of the ASC and the carrying value of the consolidated VIE's net assets or liabilities are recorded through income at the time of consolidation. Additionally, terminations or other changes toAmbac's financial guarantee insurance policies that impact projected cash flows between a consolidated VIE andAmbac could result in gains or losses, even if such policy changes do not result in deconsolidation of the VIE.
Income (loss) on variable interest entities was
|Ambac Financial Group, Inc. 44 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents higher valuation of net assets on VIEs, together with realized gains of$2 on sales of assets from theCOFINA Trust . Results for the year endedDecember 31, 2020 , were due to realized gains of$8 on sales of assets from theCOFINA Trust partially offset by the lower valuation of net assets on a VIE impacted by COVID-19.
Refer to Note 11. Variable Interest Entities to the Consolidated Financial Statements included in this Annual Report on Form 10-K for further information on the accounting for VIEs.
Losses and Loss Expenses (Benefit). Losses and loss expenses include the financial guarantee and specialty property and casualty businesses.
Ambac records as a component of its loss reserve estimate subrogation recoveries related to securitized loans in RMBS transactions with respect to which AAC is pursuing claims for breaches of representations and warranties.Ambac does not include potential recoveries attributed solely to fraudulent inducement claims in our litigations in our estimate of subrogation recoveries. Nor doesAmbac include potential recoveries attributable to pre-judgment interest in the estimate of subrogation recoveries. Generally, the sponsor of an RMBS transaction provided representations and warranties with respect to the securitized loans, including representations with respect to the loan characteristics, the absence of borrower misrepresentations in the underlying loan pools or other misconduct in the origination process and attesting to the compliance of loans with the applicable underwriting guidelines.Ambac has recorded R&W subrogation recoveries, net of reinsurance, of$1,704 and$1,725 atDecember 31, 2021 and 2020, respectively. The decrease in these recoveries was primarily driven by lower projected losses. Refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report on Form 10-K for more information regarding the estimation process for R&W subrogation recoveries.
The following table provides details, by bond type, for losses and loss expenses (benefit) incurred for the periods presented:
($ in millions) Year Ended December 31, 2021 2020 2019 Structured Finance (1)$ (20) $ (52) $ (111) Domestic Public Finance (73) 256 250 Other (2) 4 21 (127) Totals (3)$ (88) $ 225 $ 13 (1) The loss and loss expense (benefit) associated with changes in estimated representation and warranties for the year endedDecember 31, 2021 , 2020 and 2019 was$20 , ($23 ) and$42 , respectively.
(2) Includes specialty property and casualty loss and loss expenses incurred
of less than
(3) Includes loss expenses incurred of
Losses and loss expenses for 2021 were largely driven by favorable loss
development in domestic public finance, primarily related to
the negative impact of discount rates, and loss expenses incurred.
Losses and loss expenses for 2020 were driven by higher projected losses in domestic public finance, largelyPuerto Rico ; partially offset by improved Structured Finance losses as a result of the positive impact of lower interest rates on excess spread, reduced by lower discount rates and expected losses from COVID-19 related delinquencies. Intangible Amortization. Insurance intangible amortization was$52 and$57 for the years endedDecember 31, 2021 and 2020, respectively. The decrease in amortization for the year endedDecember 31, 2021 , compared to 2020, is primarily due to run-off of the insured portfolio and de-risking activity. Other intangible amortization for the year endedDecember 31, 2021 was$3 . Operating Expenses. Operating expenses consist of gross operating expenses plus reinsurance commissions. The following table provides a summary of operating expenses for the periods presented: ($ in millions) Year Ended December 31, 2021 2020 2019 Compensation$ 62 $ 51 $ 58 Non-compensation 64 41 44 Gross operating expenses 126 92 103 Reinsurance commissions, net - - - Total operating expenses$ 126 $ 92 $ 103
Gross operating expenses for the year ended
•Higher compensation costs primarily due to: (i) hiring in connection with the launch of Everspan offset by continued right sizing of staff levels, (ii) inclusion of Xchange costs of$4 and (iii) the impact of performance factors on incentive compensation. •Higher non-compensation costs primarily due to: (i) inclusion of Xchange costs of$16 , mainly from producer commissions of$15 , (ii) launch of Everspan, and (iii) increased legal fees.
Legal and consulting services provided for the benefit of OCI were flat at
Interest Expense. Interest expense includes accrued interest on the LSNI Ambac Note (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K), Sitka AAC Note, Tier 2 Notes, Surplus Notes and other debt obligations. Additionally, interest expense includes discount accretion when the debt instrument carrying value is at a discount to par. The following table provides details by type of obligation for the periods presented: |Ambac Financial Group, Inc. 45 2021 FORM 10-K | --------------------------------------------------------------------------------
Table of Contents ($ in millions) Year Ended December 31, 2021 2020 2019 Surplus Notes (1)$ 77 $ 85 $ 99 LSNI Ambac Note 50 107 143 Sitka AAC Note 32 - - Tier 2 Notes 27 28 26 Other 1 1 - Total interest expense$ 187 $ 222 $ 269
(1)Includes interest on Junior Surplus Notes that were acquired and retired in 2021.
The decrease in interest expense for the year endedDecember 31, 2021 , compared to the year endedDecember 31, 2020 , reflects the impacts of the Secured Note Refinancing and 2021 Surplus Note Exchanges, described further in Note 1. Background and Business Description to the Consolidated Financial Statements, included in this Annual Report on Form 10-K. These transactions resulted in lower debt outstanding and a lower coupon interest rate on the Sitka AAC Note relative to the LSNI Ambac Note. Interest expense for 2021 also declined as a result of the Tier 2 Note fully accreting through interest expense byDecember 31, 2020 . These benefits were partially offset by the effects of interest compounding on surplus notes and the Tier 2 Notes. Surplus Note principal and interest payments require the approval of OCI. InMay 2021 , OCI declined the request of AAC to pay the principal amount of the Surplus Notes, plus all accrued and unpaid interest thereon, on the scheduled payment date ofJune 7, 2021 . As a result, the scheduled payment date for interest, and the scheduled maturity date for payment of principal of the Surplus Notes, was extended and shall continue to be extended until OCI grants approval to make the payment. Interest will accrue, compounded on each anniversary of the original scheduled payment date or scheduled maturity date, on any unpaid principal or interest through the actual date of payment, at 5.1% per annum. Holders of Surplus Notes will have no rights to enforce the payment of the principal of, or interest on, Surplus Notes in the absence of OCI approval to pay such amount. The interest on the outstanding Surplus Notes were accrued for and AAC is accruing interest on the interest amounts following each scheduled payment date. Total accrued and unpaid interest for Surplus Notes outstanding to third parties were$576 atDecember 31, 2021 . Since the issuance of the Surplus Notes in 2010, OCI has declined to approve regular payments of interest on Surplus Notes, although the OCI has permitted two exceptional payments.Ambac can provide no assurance as to when Surplus Note principal and interest payments will be made, if ever. If OCI does not approve regular payments on Surplus Notes within the next several years, the total amount due for Surplus Notes may exceed AAC's financial resources and holders of Surplus Notes may not ever be paid in full. Provision for Income Taxes. The provision for income taxes for the year endedDecember 31, 2021 and 2020, was a expense of$18 and a benefit of$3 , respectively. Income taxes for the year endedDecember 31, 2021 and 2020, includes provisions for income tax due in respect of AmbacUK of$16 and$(3) , respectively. AtDecember 31, 2021 , the Company had approximately$3,744 ofU.S. Federal net ordinary operating loss carryforwards, including approximately$1,596 at AFG and$2,148 at AAC. LIQUIDITY AND CAPITAL RESOURCES ($ in millions) Liquidity is a measure of a company's ability to generate sufficient cash to meet the cash requirements of its business operations and to satisfy general corporate obligations.
Holding Company Liquidity
AFG is organized as a legal entity separate and distinct from its operating subsidiaries. AFG is a holding company with no outstanding debt. AFG's liquidity is primarily dependent on its net assets, excluding its equity investments in subsidiaries, totaling$269 as ofDecember 31, 2021 , of which$142 is considered highly liquid, and secondarily on distributions and expense sharing payments from its subsidiaries. AFG's investments include securities directly and indirectly issued and/or insured by AAC, some of which are eliminated in consolidation. Securities issued or insured by AAC and certain other of AFG's investments are generally less liquid than investment grade and highly traded investments.
•During 2021, AFG received distributions from Xchange of
•Under an inter-company cost allocation agreement, AFG is reimbursed by AAC for a portion of certain operating costs and expenses and, if approved by OCI, entitled to an additional payment of up to$4 per year to cover expenses not otherwise reimbursed. The$4 reimbursement for 2020 expenses was approved (by OCI) and paid (by AAC) inApril 2021 . It is highly unlikely that AAC will be able to make dividend payments to AFG for the foreseeable future or that Everspan will be able to make dividend payments to AFG for several years, and therefore cash and investments, payments under the intercompany cost allocation agreement and distributions from Xchange will be AFG's principal sources of liquidity in the near term. Refer to Part I, Item 1, "Insurance Regulatory Matters - Dividend Restrictions, Including Contractual Restrictions" in this Annual Report on Form 10-K, and Note 8. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8, in this Annual Report on Form 10-K, for more information on dividend payment restrictions. The principal uses of liquidity are the payment of operating expenses, including costs to explore opportunities to grow and diversifyAmbac ; the making of strategic investments, which may include illiquid investments; and capital investments to acquire, grow and/or capitalize new and/or existing businesses. AFG may also provide short-term financial support, primarily in the form of loans, to its operating subsidiaries to support their operating requirements. Contingencies could cause material liquidity strains.
•AFG supported the development of the Specialty P&C business, and its acquisitions, by contributing capital to
|Ambac Financial Group, Inc. 46 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents Everspan Indemnity of approximately$92 and$6 in 2021 and the first quarter of 2022, respectively. In the opinion of the Company's management the net assets of AFG are sufficient to meet AFG's current liquidity requirements. However, events or circumstances could arise that may cause AFG to seek additional capital.
Operating Companies' Liquidity
Insurance:
The liquidity requirements of the Company's insurance subsidiaries are met primarily by funds generated from premiums; recoveries on claim payments, including RMBS representation and warranty subrogation recoveries (AAC only); reinsurance recoveries; fees; investment income and maturities and sales of investments.
•Our ability to realize RMBS representation and warranty subrogation recoveries is subject to significant uncertainty, including risks inherent in litigation, such as adverse rulings or decisions in our cases or in litigations to which AAC is not a party that set precedents or resolve questions of law that impact our own claims; collectability of such amounts from counterparties (and/or their respective parents and affiliates); timing of receipt of any such recoveries, including uncertainty due to delays in court proceedings; intervention by the OCI, which could impede our ability to take actions required to realize such recoveries; and uncertainty inherent in the assumptions used in estimating the amount of such recoveries. The amount of these subrogation recoveries is significant and if AAC is unable to recover any amounts or recovers materially less than estimated recoveries, its future available liquidity to pay claims, debt service and meet other obligations would be materially adversely impacted. See Part I, Item 1A. Risk Factors in this Annual Report on Form 10-K for more information about risks relating to RMBS R&W subrogation recoveries. •See Note 7. Insurance Contracts to the Consolidated Financial Statements included in Part II, Item 8, in this Annual Report on Form 10-K for a summary of future gross financial guarantee premiums to be collected by AAC and AmbacUK . Termination of financial guarantee policies on an accelerated basis may adversely impact AAC's liquidity.
Cash provided from these sources is used primarily for claim payments and commutations, loss expenses and acquisition costs, debt service on outstanding debt (AAC only), operating expenses, reinsurance payments and purchases of securities and other investments that may not be immediately converted into cash.
•Although AAC has not yet experienced incremental claim payments as a result of the impact of COVID-19, such claims may occur in the future as issuers, particularly those with revenues that have been interrupted by the effects of the pandemic, may not have sufficient resources to pay debt service on insured debt. Refer to "Executive Summary" in this Management's Discussion and Analysis for further discussion of the potential impact of the COVID-19 pandemic. See below within this Management Discussion
and Analysis in the section titled "Balance Sheet" for the expected future financial guarantee claim payments, gross of expected recoveries.
•Interest and principal payments on surplus notes are subject to the approval of OCI, which has full discretion over payments regardless of the liquidity position of AAC. Any such payment on surplus notes would require either payment or collateralization of a portion of the Tier 2 Notes under the terms of the Tier 2 Note indenture. As discussed more fully in "Results of Operations" above in this Management's Discussion and Analysis, OCI declined AAC's request to pay the principal amount of the surplus notes, plus all accrued and unpaid interest thereon, onJune 7, 2021 . See Note 12. Long-term Debt to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for further discussion of the payment terms and conditions of the Tier 2 Notes as well as the aggregate annual maturities of all debt outstanding. In addition to principal amounts of$2,334 as ofDecember 31, 2021 with various maturities as described in Note 12. Long-term Debt to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K, AAC's future interest obligations include$62 annually on the Sitka AAC Note through maturity onJuly 6, 2026 ,$605 of accrued and unpaid interest that would be payable on surplus notes if approved by OCI on the next scheduled payment date ofJune 7, 2022 , and Tier 2 Note interest that may be paid-in-kind until maturity onFebruary 12, 2055 at which time$5,060 would be due. •Ambac is the lessee in operating leases for corporate offices, a data center and various equipment. See Note 18. Leases to the Consolidated Financial Statements included in Part II, Item 8, in this Annual Report on Form 10-K, for a scheduled future undiscounted lease payments, gross of sublease receipts. •AAC lends its wholly-owned subsidiary,Ambac Financial Services ("AFS") cash to support its operations. AFS uses interest rate derivatives (primarily interest rate swaps andUS Treasury futures) as a partial economic hedge against the effects of rising interest rates elsewhere in the Company, including on AAC's financial guarantee exposures. AFS's derivatives also include interest rate swaps previously provided to asset-backed issuers and other entities in connection with their financings. AAC loans cash and securities to AFS as needed to fund payments under these derivative contracts, collateral posting requirements and operating expenses. Intercompany loans are governed by an established lending agreement with defined borrowing limits that has received non-disapproval from OCI. Insurance subsidiaries manage their liquidity risk by maintaining comprehensive analyses of projected cash flows and maintaining specified levels of cash and short-term investments at all times. It is the opinion of the Company's management that the insurance subsidiaries' near term liquidity needs will be adequately met from the sources described above.
Managing
The liquidity requirements of the MGA/U subsidiary are met primarily by funds generated from commission receipts (both
|Ambac Financial Group, Inc. 47 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents base and profit commissions) from insurance carriers. Base commissions are generally received monthly, whereas profit commissions are received only if the business underwritten is profitable. Cash provided from these sources is used primarily for commissions paid to sub-producers, distributions to its members (including AFG) and operating expenses.
Consolidated Cash Flow Statement Discussion
The following table summarizes the net cash flows for the periods presented. ($ in million) Year Ended December 31, 2021 2020 2019 Cash provided by (used in): Operating activities$ (131) $ (175) $ (311) Investing activities 776 432 1,000 Financing activities (657) (303) (691) Effect of foreign exchange on cash and cash equivalents - - - Net cash flow$ (12) $ (46) $ (2) Operating activities
The following represents the significant cash operating activities during the
years ended
•Debt service on the LSNI Ambac Note was
•Debt service on the Sitka AAC Note was
•Cash provided from financial guarantee premiums were
•Payments related to (i) operating expenses were$83 and$76 for the years endedDecember 31, 2021 and 2020, respectively, (ii) reinsurance premiums were$26 and$2 for the years endedDecember 31, 2021 and 2020, respectively, and (iii) interest rate derivatives were$(1) and$20 for the years endedDecember 31, 2021 and 2020, respectively.
•Interest, dividends and other distributed income from the investment portfolio
was
•Net loss and loss expenses paid, including commutation payments are detailed below: ($ in million) Year Ended December 31, 2021 2020 2019 Net losses paid$ 103 $ 159 $ 416 Net subrogation received (121) (118) (168) Net loss expenses paid 77 108 70 Net cash flow$ 59 $ 149 $ 318 Future operating cash flows will primarily be impacted by interest payments on outstanding debt, claim and expense payments, subrogation recoveries, investment income receipts and premium collections.
Investing Activities
Cash provided for investing activities in both 2021 and 2020 were to (i) provide liquidity for operating activities; (ii) diversify the investment portfolio from fixed maturity to other assets (total fair value of pooled investments of$683 atDecember 31, 2021 ) and (iii) support strategic initiatives, including AFG's purchase 80% of Xchange for$74 in 2020, net of cash acquired.
Financing Activities
Financing activities for the year endedDecember 31, 2021 , include paydowns of the LSNI Ambac Note of$1,641 , paydowns/maturities of VIE debt obligations of$170 , partially offset by the proceeds from the Sitka AAC Note issuance of 1,163.
Financing activities for the year ended
Collateral
AFS hedges a portion of the interest rate risk in the financial guarantee and investment portfolio, along with legacy customer interest rate swaps with standardized derivative contracts, including financial futures contracts, which contain collateral or margin requirements. Under these hedge agreements, AFS is required to post collateral or margin to its counterparties and futures commission merchants to cover unrealized losses. In addition, AFS is required to post collateral or margin in excess of the amounts needed to cover unrealized losses. All AFS derivative contracts containing ratings-based downgrade triggers that could result in collateral or margin posting or a termination have been triggered. If terminations were to occur, AFS would be required to make termination payments but would also receive a return of collateral or margin in the form of cash orU.S. Treasury obligations with market values equal to or in excess of market values of the swaps and futures contracts. AFS may look to re-establish hedge positions that are terminated early, resulting in additional collateral or margin obligations. The amount of additional collateral or margin posted on derivatives contracts will depend on several variables including the degree to which counterparties exercise their termination rights (or agreements terminate automatically) and the terms on which hedges can be replaced. All collateral and margin obligations are currently met. Collateral and margin posted by AFS totaled a net amount of$133 (cash and securities collateral of$13 and$120 respectively), including independent amounts, under these contracts atDecember 31, 2021 .
BALANCE SHEET ($ in millions)
Total assets decreased by approximately $917 from December 31, 2020 to $12,303
at December 31, 2021 , primarily due to the impacts of the Corolla Trust Exchange
and Secured Note Refinancing described in Note 1. Background and Business
Description in this Annual Report on Form 10-K located in Part II. Item 8,
payment of loss and loss expenses, interest and operating expenses, lower
subrogation recoverables, lower consolidated VIE assets from paydowns of
consolidated
| Ambac Financial Group, Inc. 48 2021 FORM 10-K |
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Table of Contents
VIE liabilities, lower derivative assets caused by rising interest rates and
lower premium receivables and intangible assets from the continued runoff of the
financial guarantee insurance portfolio.
Total liabilities decreased by approximately $886 from December 31, 2020 , to
$11,187 as of December 31, 2021 , primarily due to lower loss reserves, and the
payment of loss and loss expenses, lower VIE and non-VIE long-term debt (from
the surplus note exchange transactions and Secured Note Refinancing) and lower
derivative liabilities caused by rising interest rates.
As of December 31, 2021 , total stockholders' equity was $1,098 , compared with
total stockholders' equity of $1,140 at December 31, 2020 . This decrease was
primarily due to a Total Comprehensive Loss during 2021 and a $14 increase to
the carrying value of redeemable NCI which is offset directly against retained
earnings. The Comprehensive Loss was primarily driven by the net loss
attributable to common stockholders for the year ended December 31, 2021 , of
$17 , unrealized losses on investments of $12 and translation losses on the
consolidation of AFG's foreign subsidiaries.of $8 .
Investment Portfolio.
Ambac's investment portfolio is managed under established guidelines designed to meet the investment objectives of AAC, Everspan, AmbacUK and AFG. Refer to "Description of the Business - Investments and Investment Policy" in this Annual Report on Form 10-K located in Part I. Item 1, for further description ofAmbac's investment policies and applicable regulations.
Refer to Note 4. Investments to the Consolidated Financial Statements in this
Annual Report on Form 10-K located in Part II. Item 8 for information about
The following table summarizes the composition of
($ in millions) December 31, 2021 2020 Fixed maturity securities$ 1,730 $ 2,317 Short-term 414 492 Other investments 690 595
Securities pledged as collateral 120 140 Total investments (1)
$ 2,955 $ 3,544 (1) Includes investments denominated in non-US dollar currencies with a fair value of £341 ($462 ) and €38 ($43 ) as ofDecember 31, 2021 and £317 ($434 ) and €39 ($48 ) as ofDecember 31, 2020 .Ambac invests in various asset classes in its fixed maturity securities portfolio. Other investments include diversified equity interests in pooled funds. Refer to Note 4. Investments to the Consolidated Financial Statements in this Annual Report on Form 10-K located in Part II. Item 8 for information about fixed maturity securities and pooled funds by asset class.
The following charts provide the ratings(1) distribution of the fixed maturity
investment portfolio based on fair value at
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(1)Ratings are based on the lower of Moody's or S&P ratings. If ratings are unavailable from Moody's or S&P, Fitch ratings are used. If guaranteed, rating represents the higher of the underlying or guarantor's financial strength rating.
(2)Below investment grade and not rated bonds insured byAmbac represented 32% and 41% of the 2021 and 2020 combined fixed maturity investment portfolios, respectively. The decrease is primarily due to the impact of the Secured Note Refinancing described in Note 1. Background and Business Description to the Consolidated Financial Statements in this Annual Report Form 10-K located in Part II. Item 8. Premium Receivables.Ambac's premium receivables decreased to$323 atDecember 31, 2021 , from$370 atDecember 31, 2020 . As further discussed in Note 7. Insurance Contracts to the Consolidated Financial Statements, in this Annual Report Form 10-K located in Part II. Item 8, the decrease is due to premium |Ambac Financial Group, Inc. 49 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents receipts and adjustments for changes in expected and contractual cash flows on financial guarantee insurance contracts, partially offset by decreases to the allowance for credit losses, accretion of the financial guarantee premium receivable discount and premium receivables on the Specialty P&C business.
Premium receivables by payment currency were as follows:
Currency Premium Receivable Premium Receivable in (Amounts in millions) in Payment Currency U.S. dollars U.S. Dollars $ 199 $199 British Pounds £ 80108 Euros € 14 16 Total $ 323
Reinsurance Recoverable on Paid and Unpaid Losses.
Ambac has reinsurance in place pursuant to surplus share treaty and facultative agreements. To minimize its exposure to losses from reinsurers,Ambac (i) monitors the financial condition of its reinsurers; (ii) is entitled to receive collateral from its reinsurance counterparties under certain reinsurance contracts; and (iii) has certain cancellation rights that can be exercised in the event of rating agency downgrades of a reinsurer (among other events and circumstances). For those reinsurance counterparties that do not currently post collateral,Ambac's reinsurers are well capitalized, highly rated, authorized capacity providers.Ambac benefited from letters of credit and collateral amounting to approximately$111 from its reinsurers atDecember 31, 2021 . As ofDecember 31, 2021 and 2020, reinsurance recoverable on paid and unpaid losses were$55 and$33 , respectively. The increase was primarily a result of reinsurance recoverables of$30 added in connection with the PWIC transaction, offset by favorable development in financial guarantee insured exposures.
Intangible Assets.
Intangible assets includes (i) an insurance intangible asset that was established at AFG's emergence from bankruptcy, representing the difference between the fair value and aggregate carrying value of the financial guarantee insurance and reinsurance assets and liabilities, (ii) intangible assets established as part of the acquisition of Xchange onDecember 31, 2020 and (iii) an indefinite-lived intangible assets established as part of the acquisition of PWIC. Refer to Note 3. Business Combination to the Consolidated Financial Statements,
in this Annual Report Form 10-K located in Part II. Item 8 for further information relating to the Xchange acquisition.
As of
Derivative Assets and Liabilities.
The interest rate derivative portfolio is positioned to benefit from rising rates as a partial hedge against interest rate exposure in the financial guarantee and investment portfolios. Derivative assets and liabilities on the balance sheet primarily reflect the portion of the portfolio that is not subject to daily cash variation margin payments. Derivative assets decreased from$93 atDecember 31, 2020 , to$76 as ofDecember 31, 2021 . Derivative liabilities decreased from$114 atDecember 31, 2020 , to$95 as ofDecember 31, 2021 . The decreases resulted primarily from higher interest rates during the year endedDecember 31, 2021 , with the decline in assets partially offset by lower counterparty credit adjustments.
Loss and Loss Expense Reserves and Subrogation Recoverable.
Loss and loss expense reserves are based upon estimates of the ultimate aggregate losses inherent in the non-derivative portfolio for insurance policies issued to beneficiaries, including unconsolidated VIEs. The evaluation process for determining the level of reserves is subject to certain estimates and judgments. Refer to the "Critical Accounting Policies and Estimates" and "Results of Operations" sections of Management's Discussion and Analysis of Financial Condition and Results of Operations, in addition to Basis of Presentation and Significant Accounting Policies and Loss Reserves sections included in Note 2. Basis of Presentation and Significant Accounting Policies and Note 7. Insurance Contracts, respectively, to the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report on Form 10-K, for further information on loss and loss expenses. The loss and loss expense reserves net of subrogation recoverables and before reinsurance as ofDecember 31, 2021 and 2020 were$(522) and$(397) , respectively. Loss and loss expense reserves are included in the Consolidated Balance Sheets as follows: |Ambac Financial Group, Inc. 50 2021 FORM 10-K | --------------------------------------------------------------------------------
Table of Contents
Present Value of
Expected
Net Cash Flows Gross Loss
Claims and Unearned and Loss
($ in millions) Loss Premium Expense
Balance Sheet Line Item Expenses Revenue Reserves (2) Recoveries (1)
December 31, 2021 :
Loss and loss expense reserves $ 1,781 $ (155) $ (56) $ 1,570
Subrogation recoverable 88 (2,180) - (2,092)
Totals $ 1,869 $ (2,335) $ (56) $ (522)
December 31, 2020:
Loss and loss expense reserves $ 2,060 $ (229) $ (72) $ 1,759
Subrogation recoverable 100 (2,256) - (2,156)
Totals $ 2,160 $ (2,485) $ (72) $ (397) (1)Present value of future recoveries include R&W subrogation recoveries of
(2)Loss and loss expense reserves at
Financial Guarantee:
Ambac has exposure to various bond types issued in the debt capital markets. Our experience has shown that, for the majority of bond types, we have not experienced significant claims. The bond types that have experienced significant claims, including through commutations, are residential mortgage-backed securities ("RMBS"), student loan securities and public finance securities. These bond types represent 93% of our ever-to-date insurance claims recorded with RMBS comprising 74%. The table below indicates gross par outstanding and the components of gross loss and loss expense reserves related to policies inAmbac's gross loss and loss expense reserves atDecember 31, 2021 and 2020: Present Value of Expected Gross Loss Net Cash Flows and Loss Gross Par Claims and Unearned Expense Outstanding Loss Premium Reserves ($ in millions) (1)(2) Expenses Recoveries Revenue (1)(2)December 31, 2021 : Structured Finance$ 2,371 $
852
2,742 905 (312) (31) 562
Other 1,189 35 (5) (13) 17
Loss expenses - 45 - - 45
Totals $ 6,302 $ 1,837 $ (2,335) $ (56) $ (554)
December 31, 2020:
Structured Finance $ 2,945 $
940
3,016 1,112 (349) (39) 724
Other 1,612 40 - (17) 23
Loss expenses - 68 - - 68
Totals $ 7,573 $ 2,160 $ (2,485) $ (72) $ (397)
(1) Ceded par outstanding on policies with loss reserves and ceded loss and
loss expense reserves are $784 and $24 , respectively, at December 31, 2021 and
$739 and $33 , respectively at December 31, 2020 . Ceded loss and loss expense
reserves are included in Reinsurance recoverable on paid and unpaid losses.
(2) Loss reserves are included in the balance sheet as Loss and loss expense reserves or Subrogation recoverable dependent on if a policy is in a net liability or net recoverable position.
The table below reflects the timing of expected financial guarantee claim payments based on deal specific cash flows, excluding expected recoveries. These deal specific cash flows are based on the expected cash flows of the underlying transactions. The timing of expected claim payments for credits with reserves that were established using our statistical loss reserve method is determined based on the weighted average expected life of the exposure. Refer to the Loss Reserves section in Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further discussion of our statistical loss reserve method. The timing of these payments may vary significantly from the amounts shown above, especially for credits that are based on our statistical loss reserve method. |Ambac Financial Group, Inc. 51 2021 FORM 10-K | --------------------------------------------------------------------------------
Table of Contents
Payments Due by Period
Less Than More Than
($ in millions) Total 1 Year 1 - 3 Years 3 - 5 Years 5 Years
Claim payments $ 2,095 $ 422 $ 119 $ 109 $ 1,445 Variability of Expected Losses and Recoveries
Ambac's management believes loss reserves (present value of expected cash flows, net of recoveries) are adequate to cover future claim payments, but there can be no assurance that the ultimate liability will not be higher than such estimates. While our loss reserves consider our judgment regarding issuers' financial flexibility to adapt to adverse markets, they may not adequately capture sudden, unexpected or protracted uncertainty that adversely affects market conditions, such as COVID-19. Accordingly, it is possible that our estimated loss reserves, gross of reinsurance, for financial guarantee insurance policies could be understated. We have attempted to identify possible cash flows related to losses and recoveries using more stressful assumptions than the probability-weighted outcome recorded. The possible net cash flows consider the highest stress scenario that was utilized in the development of our probability-weighted expected loss atDecember 31, 2021 , and assumes an inability to execute any commutation transactions with issuers and/or investors. Such stress scenarios are developed based on management's view about all possible outcomes relating to losses and recoveries. In arriving at such view, management makes considerable judgments about the possibility of various future events. Although we do not believe it is possible to have stressed outcomes in all cases, it is possible that we could have stress case outcomes in some or even many cases. See "Risk Factors" in Part I, Item 1A of this Form 10-K as well as the descriptions of "Structured Finance Variability," "Public Finance Variability," and "Other Credits, including AmbacUK , Variability," below for further discussion of the risks relating to future losses and recoveries that could result in more highly stressed outcomes appearing below. The occurrence of these stressed outcomes individually or collectively would have a material adverse effect on our results of operations and financial condition and may result in materially adverse consequence forAmbac , including (without limitation) impairing the ability of AAC to honor its financial obligations, particularly its outstanding debt and preferred stock obligations; the initiation of rehabilitation proceedings against AAC; decreased likelihood of AAC delivering value to AFG, through dividends or otherwise; and a significant drop in the value of securities issued or insured by AFG or AAC. Structured Finance RMBS: Changes to assumptions that could make our reserves under-estimated include an increase in interest rates, deterioration in housing prices, poor servicing, government intervention into the functioning of the mortgage market and the effect of a weakened economy characterized by growing unemployment and wage pressures. We utilize a model to project losses in our RMBS exposures and changes to reserves, either upward or downward, are not unlikely if we used a different model or methodology to project losses. In the case of both first and second-lien exposures, the possible stress case assumes a lower housing
price appreciation projection, which in turn drives higher defaults and severities.
We established a representation and warranty subrogation recovery as further discussed in Note 7. Insurance Contracts to the Consolidated Financial Statements included in this Annual Report on Form 10-K. Our ability to realize RMBS representation and warranty recoveries is subject to significant uncertainty, including risks inherent in litigation, collectability of such amounts from counterparties (and/or their respective parents and affiliates), delays in realizing such recoveries, including delays in getting to trial due to court closures caused by COVID-19 or other events, intervention by the OCI, which could impede our ability to take actions required to realize such recoveries, and uncertainty inherent in the assumptions used in estimating such recoveries. Additionally, our R&W actual subrogation recoveries could be significantly lower than our estimate of$1,704 , net of reinsurance, as ofDecember 31, 2021 , if the sponsors of these transactions: (i) fail to honor their obligations to repurchase the mortgage loans, (ii) successfully dispute our breach findings or claims for damages, (iii) no longer have the financial means to fully satisfy their obligations under the transaction documents, or (iv) our pursuit of recoveries is otherwise unsuccessful due to any of the factors described in this Form 10-K in Part I, Item 1A Risk Factors - Risks Related to Capital, Liquidity and Markets. Failure to realize R&W subrogation recoveries for any reason or the realization of R&W subrogation recoveries materially below the amount recorded onAmbac's consolidated balance sheet would have a material adverse effect on our results of operations and financial condition.
Student Loans:
Changes to assumptions that could make our reserves under-estimated include, but are not limited to, increases in interest rates, default rates and loss severities on the collateral due to economic or other factors, including the COVID-19 related economic impact. Such factors may include lower recoveries on defaulted loans or additional losses on collateral or trust assets, including as a result of any enforcement actions by theConsumer Finance Protection Bureau .
Structured Finance Variability:
Using the approaches described above, the possible increase in loss reserves for structured finance credits for which we have an estimate of expected loss atDecember 31, 2021 , could be approximately$25 . Combined with the absence of any R&W subrogation recoveries, a possible increase in loss reserves for structured finance credits could be approximately$1,729 . A loss of this magnitude may render AAC insolvent. Additionally, loss payments are sensitive to changes in interest rates, increasing as interest rates rise. For example, an increase in interest rates of 0.50% could increase our estimate of expected losses by approximately$45 . There can be no assurance that losses may not exceed such amounts. Additionally, the |Ambac Financial Group, Inc. 52 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents structured finance portfolio is sensitive to the COVID-19 related forbearances and delinquencies caused by the general economic downturn. Due to the uncertainties related to the economic effects of the COVID-19 pandemic and other risks associated with structured finance credits, there can be no assurance that losses may not exceed our stress case estimates.
Public Finance
Ambac's U.S. public finance portfolio predominantly consists of municipal bonds such as general and revenue obligations and lease and tax-backed obligations of state and local government entities; however, the portfolio also includes a wide array of non-municipal types of bonds, including financings for not-for-profit entities and transactions with public and private elements, which generally finance infrastructure, housing and other public purpose facilities and interests. It is possible our loss reserves for public finance credits may be under-estimated if issuers are faced with prolonged exposure to adverse political, judicial, economic, fiscal or socioeconomic events or trends. Additionally, our loss reserves may be under-estimated because of the continuing effects of COVID-19 pandemic. The COVID-19 related economic downturn put a strain on municipal issuers, particularly those dependent upon narrow sources of revenues or dedicated taxes to support debt service, such as hotel occupancy taxes, parking revenues, tolls, etc. While the economy has been in recovery since mid-2020, the lingering impact of the pandemic continues to negatively impact certain of these municipal issuers that are dependent upon narrow sources of revenue. A further prolonged recovery from the COVID-19 pandemic could put additional stresses on these issuers and result in increased defaults and potential additional losses forAmbac . Our experience with the city ofDetroit's bankruptcy andCommonwealth of Puerto Rico's Title III proceedings as well as other municipal bankruptcies demonstrates the preferential treatment of certain creditor classes, especially the public pensions. The cost of pensions and the need to address frequently sizable unfunded or underfunded pensions is often a key driver of stress for many municipalities and their related authorities, including entities to whom we have significant exposure, such asChicago's school district, theState of New Jersey and many others. Less severe treatment of pension obligations in bankruptcy may lead to worse outcomes for traditional debt creditors. Variability of outcomes applies to even what are generally considered more secure municipal financings, such as dedicated sales tax revenue bonds that capture sales tax revenues for debt service ahead of any amounts being deposited into the general fund of an issuer. In the case of the Puerto Rico COFINA sales tax bonds that were part of theCommonwealth of Puerto Rico's Title III proceedings, AAC and other creditors agreed to settle at a recovery rate equal to about 93% of pre-petition amounts owed on theAmbac insured senior COFINA bonds. In the COFINA case, the senior bonds still received a reduction or "haircut" despite the existence of junior COFINA bonds, which received a recovery rate equal to about 56% of pre-petition amounts owed.
In addition, municipal entities may be more inclined to use bankruptcy to resolve their financial stresses if they believe preferred outcomes for various creditor groups can be achieved.
We expect municipal bankruptcies and defaults to continue to be challenging to project given the unique political, economic, fiscal, legal, governance and public policy differences among municipalities as well as the complexity, long duration and relative infrequency of the cases themselves in forums with a scarcity of legal precedent. Moreover, issuers in Chapter 9 or similar proceedings may obtain judicial rulings and orders that impair creditors' rights or their ability to collect on amounts owed. In certain cases, judicial decisions may be contrary to AAC's expectations or understanding of the law or its rights thereunder, which may lead to worse outcomes in Chapter 9 or similar proceedings than anticipated at the outset. Another potentially adverse development that could cause the loss reserves on our public finance credits to be underestimated is deterioration in the municipal bond market, resulting from reduced or limited access to alternative forms of credit (such as bank loans) or other exogenous factors, such as changes in tax law that could reduce certain municipal investors' appetite for tax-exempt municipal bonds or put pressure on issuers in states with high state and local taxes. These factors could deprive issuers access to funding at a level necessary to avoid defaulting on their obligations.Ambac's exposures to theCommonwealth of Puerto Rico across various instrumentalities and issuers are all now subject to plan support agreements and plans of adjustment or qualifying modifications. The Eighth Amended POA has been confirmed, and the PRIFA QM and the CCDA QM have been approved. All are expected to become effective on or beforeMarch 15, 2022 . However, uncertainty remains as to (i) whether the effective date will be stayed pending the appeal of the order confirming Eighth Amended POA; (ii) the result of the pending First Circuit appeal of the order confirming the Eighth Amended POA; (iii) the value or perceived value of the consideration provided by or on behalf of the debtors under the Eighth Amended POA, PRIFA QM, and CCDA QM; (iv) the extent to which exposure management strategies, such as commutation and acceleration, will be executed; (v) the tax treatment of the consideration provided by or on behalf of the debtors under the Eighth Amended POA, PRIFA QM, and CCDA QM; (vi) whether and when the PRHTA POA will be confirmed; and (vii) other factors, including market conditions such as interest rate movements, credit spread changes on the new GO and CVI instruments, and liquidity for the new GO and CVI instruments. Losses may exceed current reserves in a material manner due to favorable or unfavorable developments or results with respect to these factors. See Note 19. Commitments and Contingencies to the Consolidated Financial Statements in Part II, Item 8 and "Financial Guarantees in Force" section of Management's Discussion and Analysis of Financial Condition and Results of Operations included in Part II, Item 7 in this Annual Report on Form 10-K for further updates relating toPuerto Rico . Material additional losses on our public finance credits caused by the aforementioned factors, including the possibility of a protracted recovery related to the COVID-19 crisis would have a material adverse effect on our results of operations and financial condition. For the public finance credits, includingPuerto Rico , for which we have an estimate of expected loss atDecember 31, 2021 , the possible increase in loss reserves could be approximately$355 and there can be no assurance that losses may not exceed our stress case estimates. | Ambac Financial Group, Inc. 53 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents Other Credits, including AmbacUK , Variability It is possible our loss reserves on other types of credits, including those insured by AmbacUK , may be under-estimated because of various risks that vary widely, including the risk that we may not be able to recover or mitigate losses through our remediation processes. For all other credits, including AmbacUK , for which we have an estimate of expected loss, the sum of all the highest stress case loss scenarios is approximately$370 greater than the loss reserves atDecember 31, 2021 . Additionally, our loss reserves may be under-estimated as a result of the ultimate scope, duration and magnitude of the effects of COVID-19. There can be no assurance that losses may not exceed our stress case estimates. Long-term Debt. Long-term debt consists of surplus notes issued by AAC, the Sitka AAC Note (which refinanced the LSNI Ambac Note), the Tier 2 Notes issued in connection with the Rehabilitation Exit Transactions (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K), and AmbacUK debt issued in connection with the 2019 commutation of its exposure with respect toBallantyne Re plc . The carrying value of each of these as ofDecember 31, 2021 and 2020 is below: ($ in millions) December 31, 2021 2020 Surplus Notes (1)$ 729 $ 778 LSNI Ambac Note - 1,641 Sitka AAC Note 1,154 - Tier 2 Notes 333 306 Ambac UK Debt 15 14 Total Long-term Debt$ 2,230 $ 2,739
(1) Includes Junior Surplus Notes as of
The decrease in long-term debt fromDecember 31, 2020 resulted from the impact of the Secured Note Refinancing and 2021 Surplus Note Exchanges, described further in Note 1. Background and Business Description to the Consolidated Financial Statements, included in this Annual Report on Form 10-K, partially offset by issuances of surplus notes from AFG sales, accretion on the carrying value of surplus notes and AmbacUK debt and paid-in-kind interest on Tier 2 Notes. Subject to internal and regulatory guidelines, market conditions and other constraints,Ambac may opportunistically purchase or sell surplus notes and/or otherAmbac issued securities, and may consider opportunities to exchange securities issued by it from time to time (including newly issued securities) for other securities issued by it.
Redeemable Noncontrolling Interest. The increase during 2021 was the result of
the remeasurement of the redemption value of the put option provided to the
minority owners (noncontrolling interest holders) of Xchange as if it were
exercisable on
ACCOUNTING STANDARDS
The following accounting standards have been issued, but have not yet been
adopted. We do not expect these accounting standards to have a consequential
impact on
Equity-classified Written Call Options
InMay 2021 , the FASB issued ASU 2021-04, Issuer's Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options. The ASU clarifies and reduces diversity in practice for an issuer's accounting for modifications or exchanges of equity-classified written call options (e.g. warrants) that remain equity-classified after the modification or exchange. The ASU requires an issuer to account for the modification or exchange based on the economic substance of the transaction. For example, if the modification or exchange is related to the issuance of debt or equity, any change in the fair value of the written call option would be accounted for as part of the debt issuance cost in accordance with the debt guidance or equity issuance cost in accordance with the equity guidance, respectively. The ASU is effective for fiscal years beginning afterDecember 15, 2021 , with early adoption permitted.Ambac will adopt this ASU onJanuary 1, 2022 .
Convertible Instruments and Contracts in an Entity's Own Equity
InAugust 2020 , the FASB issued ASU 2020-06, Accounting for Convertible Instruments and Contracts in an Entity's Own Equity. The ASU i) simplifies the accounting for convertible debt and convertible preferred stock by reducing the number of accounting models, and amends certain disclosures, ii) amends and simplifies the derivative scope exception guidance for contracts in an entity's own equity, including share-based compensation, and iii) amends the diluted earnings per share calculations for convertible instruments and contracts in an entity's own equity. The ASU is effective for fiscal years ending afterDecember 15, 2021 , with early adoption permitted.Ambac will adopt this ASU onJanuary 1, 2022 . Please refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements, included in Part II, Item 8 in this Annual Report Form 10-K for the year endedDecember 31, 2021 , for a discussion of the impact of other recent accounting pronouncements onAmbac's financial condition and results of operations.U.S. STATUTORY BASIS FINANCIAL RESULTS ($ in millions) AFG'sU.S. insurance subsidiaries prepare financial statements under accounting practices prescribed or permitted by its domiciliary state regulator ("SAP") for determining and reporting the financial condition and results of operations of an insurance company. TheNational Association of Insurance Commissioners ("NAIC") Accounting Practices and Procedures manual ("NAIC SAP") is adopted as a component of prescribed practices by each domiciliary state. For further information, see Note 8. Insurance Regulatory Restrictions to the Consolidated |Ambac Financial Group, Inc. 54 2021 FORM 10-K | --------------------------------------------------------------------------------
Table of Contents Financial Statements included in Part II, Item 8 in this Annual Report Form 10-K.
AAC's statutory policyholder surplus and qualified statutory capital (defined as the sum of policyholders surplus and mandatory contingency reserves) were$757 and$1,322 atDecember 31, 2021 , respectively, as compared to$865 and$1,413 atDecember 31, 2020 , respectively. As ofDecember 31, 2021 , statutory policyholder surplus and qualified statutory capital included$853 principal balance of surplus notes outstanding and$138 liquidation preference of preferred stock outstanding. These surplus notes (including related accrued interest of$625 that is not recorded under statutory basis accounting principles); preferred stock; and all other liabilities, including insurance claims,$1,175 principal balance of Sitka AAC Notes (refinanced the LSNI Ambac Note as described in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K) and$333 principal balance of Tier 2 Notes are obligations that, individually and collectively, have claims on the resources of AAC that are senior to AFG's equity and therefore impede AFG's ability to realize residual value and/or receive dividends from AAC.
The significant drivers to the net decrease in policyholder surplus were
statutory net losses of
AAC's statutory surplus is sensitive to multiple factors, including: (i) loss reserve development, (ii) payments on surplus notes, if approved by OCI, (iii) on-going interest costs associated with the Sitka AAC Note and Tier 2 Notes, including changes to the interest rates as the Sitka AAC Note is a floating rate obligation, (iv) deterioration in the financial position of AAC subsidiaries that have their obligations guaranteed by AAC, (v) first time payment defaults of insured obligations, which increase statutory loss reserves, (vi) commutations of insurance policies or credit derivative contracts at amounts that differ from the amount of liabilities recorded, (vii) reinsurance contract terminations at amounts that differ from net assets recorded, (viii) changes to the fair value of pooled fund and other investments carried at fair value, (ix) settlements of representation and warranty breach claims at amounts that differ from amounts recorded, including failures to collect such amounts, (x) realized gains and losses, including losses arising from other than temporary impairments of investment securities, and (xi) future changes to prescribed SAP practices by the OCI.
The significant differences between GAAP and SAP are that under SAP:
•Loss reserves are only established for losses on guaranteed obligations that have experienced a payment default in an amount that is sufficient to cover the present value of the anticipated defaulted debt service payments over the expected period of default, less estimated recoveries under subrogation rights (5.1% as prescribed by OCI). Under GAAP, in addition to the establishment of loss reserves for defaulted obligations, loss reserves are established (net of GAAP basis unearned premium revenue) for obligations
that have experienced credit deterioration, but have not yet defaulted using a weighted-average risk-free discount rate, currently at 1.2%.
•Mandatory contingency reserves are required based upon the type of obligation insured, whereas GAAP does not require such a reserve. Releases of the contingency reserves are generally subject to OCI approval and relate to a determination that the held reserves are deemed excessive.
•Investment grade fixed maturity investments are stated at amortized cost and
certain below investment grade fixed maturity investments are reported at the
lower of amortized cost or fair value. Under GAAP, all fixed maturity
investments are reported at fair value.
•Wholly owned subsidiaries are not consolidated; rather, the equity basis of
accounting is utilized and the carrying values of these investments are subject
to admissibility tests.
•Variable interest entities ("VIE") are not required to be assessed for
consolidation. Under GAAP, a reporting entity that has both the following
characteristics is required to consolidate the VIE: a) the power to direct the
activities of the VIE that most significantly impact the VIE's economic
performance and b) the obligation to absorb losses of the VIE or the right to
receive benefits from the VIE that could potentially be significant to the VIE.
AAC generally has the obligation to absorb losses of VIEs that could potentially
be significant to the VIE as the result of its guarantee of insured obligations
issued by VIEs. For certain VIEs AAC has the power to direct the most
significant activities of the VIE and accordingly consolidates the related VIEs
under GAAP.
•All payments of principal and interest on the surplus notes are subject to the
approval of the OCI. Unpaid interest due on the surplus notes is expensed when
the approval for payment of interest has been granted by the OCI. Under GAAP,
interest on surplus notes is accrued regardless of OCI approval.
•Upfront premiums written are earned on a basis proportionate to the remaining
scheduled debt service to the original total principal and interest insured.
Installment premiums are reflected in income pro-rata over the period covered by
the premium payment. Under GAAP, premium revenues for both upfront and
installment premiums are earned over the life of the financial guarantee
contract in proportion to the insured principal amount outstanding at each
reporting date.
•Insurance intangibles that arose as a result of the implementation of Fresh
Start reporting are not a concept within SAP. This insurance intangible asset is
amortized as an expense on a level yield basis over the life of the related
insurance risks.
•Unearned premiums and loss reserves are presented net of ceded amounts, while under GAAP, they are reflected gross of ceded amounts.
|Ambac Financial Group, Inc. 55 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents The significant drivers to the increase in policyholder surplus for the year endedDecember 31, 2021 were capital contributions of$92 partially offset by operating expenses and changes in investment in subsidiaries, primarily due to a limitation on the amount of goodwill that may be admitted in accordance with SAP.
The significant differences between GAAP and SAP are that under SAP:
•Investment grade fixed maturity investments are stated at amortized cost and certain below investment grade fixed maturity investments are reported at the lower of amortized cost or fair value. Under GAAP, all fixed maturity investments are reported at fair value. •Wholly owned subsidiaries are not consolidated; rather, the equity basis of accounting is utilized and the carrying values of these investments are subject to admissibility tests. •The acquisition of PWIC was recorded as an equity method investment, which includes a goodwill component representing the acquisition cost in excess of PWIC's statutory surplus.Goodwill will be amortized over a period not to exceed ten years. Under GAAP, the acquisition of PWIC was recorded as an asset acquisition, which requires i) all net assets to initially be recorded at fair value and ii) the acquisition cost in excess of the fair value of net assets to be allocated to the bases of certain types of assets based on their relative fair values, if applicable. No goodwill is recorded for asset acquisitions. AMBACUK FINANCIAL RESULTS UNDERUK ACCOUNTING PRINCIPLES (£ in millions) AmbacUK is required to prepare financial statements under FRS 102 "The Financial Reporting Standard applicable in theUK andRepublic of Ireland ." AmbacUK's shareholder funds underUK GAAP were £444 atDecember 31, 2021 , as compared to £412 atDecember 31, 2020 . AtDecember 31, 2021 , the carrying value of cash and investments was £500, a increase from £481 atDecember 31, 2020 . The increase in shareholders' funds and cash and investments was primarily due to the continued receipt of premiums and investment income, partially offset by loss expenses, foreign exchange losses within AmbacUK's investment portfolio, operating expense and tax payments.
The significant differences between US GAAP and
•Loss reserves are only established for losses on guaranteed obligations when, in the judgment of management, a monetary default in the timely payment of debt service is likely to occur, which would result in AmbacUK incurring a loss. A loss provision is established in an amount that is sufficient to cover the present value of the anticipated defaulted debt service payments over the expected period of default, less estimated recoveries under subrogation rights. The discount rate is equal to the lower of the rate of return on invested assets for either the current year or the period covering the current year plus the four previous years, currently at 4.7%. UnderU.S. GAAP, loss reserves are established (net of US GAAP basis unearned premium
revenue) for obligations that have experienced credit deterioration, but have not yet defaulted using a weighted-average risk-free discount rate.
•Investments in fixed maturity securities are stated at amortized cost, subject to an other-than-temporary impairment evaluation. Under US GAAP, all bonds are reported at fair value. •VIEs are not required to be assessed for consolidation. Under US GAAP, as noted under AAC Statutory Basis Financial Results above, VIE's with certain characteristics are required to be consolidated. For several VIEs AmbacUK has the power to direct the most significant activities of the VIE and accordingly consolidates the related VIEs underU.S. GAAP. •Upfront premiums written are earned on a basis proportionate to the remaining scheduled debt service to the total principal and interest insured. Installment premiums are reflected in income pro-rata over the period covered by the premium payment. Under US GAAP, premium revenues for both upfront and installment premiums are earned over the life of the financial guarantee contract in proportion to the insured principal amount outstanding at each reporting date. •Insurance intangibles that arose as a result of the implementation of Fresh Start reporting is not a concept withinUK GAAP. Under US GAAP, this insurance intangible asset is amortized as an expense on a level yield basis over the life of the related insurance risks.
•Unearned premiums and loss reserves are presented net of ceded amounts, while under GAAP, they are reflected gross of ceded amounts.
AmbacUK is also required to prepare financial information in accordance with the Solvency II Directive. The basis of preparation of this information is significantly different from both US GAAP andUK GAAP. The calculation of capital resources, regulatory capital requirements and regulatory capital surplus / deficit under Solvency II atDecember 31, 2021 , will be published onAmbac's website duringMarch 2022 . Final annual Solvency II data and AmbacUK's annual Solvency and Financial Condition Report will be published onAmbac's website duringApril 2022 . Available capital resources under Solvency II were a surplus of £245 atSeptember 30, 2021 , the most recently published position, of which £237 are eligible to meet solvency capital requirements. This is an increase fromDecember 31, 2020 , when available capital resources were a surplus of £196 of which £184 were eligible to meet solvency capital requirements. Eligible capital resources atSeptember 30, 2021 andDecember 31, 2020 , are in comparison to regulatory capital requirements of £247 and £256, respectively. Therefore,Ambac UK was in a deficit position in terms of compliance with applicable regulatory capital requirements by £10 atSeptember 30, 2021 and was deficient in terms of compliance by £72 atDecember 31, 2020 . The deficit was reduced as atSeptember 30, 2021 , due to the combined impact of (i) the increase in long term interest rates, which resulted in a decrease in technical provision liabilities and hence an increase in eligible own funds and (ii) a decrease in capital requirements for non-life risk due to the maturity and de-risking of certain policies, together with |Ambac Financial Group, Inc. 56 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents natural run-off of the insured portfolio in the year. The regulators are fully aware of the deficiency in capital resources as compared to capital requirements as atSeptember 30, 2021 and dialogue between AmbacUK management and its regulators remains ongoing with respect to options for strengthening the capital position further. NON-GAAP FINANCIAL MEASURES ($ in millions) In addition to reporting the Company's financial results under GAAP, the Company currently reports two non-GAAP financial measures: adjusted earnings and adjusted book value. The most directly comparable GAAP measures are net income attributable to common stockholders for adjusted earnings andTotal Ambac Financial Group, Inc. stockholders' equity for adjusted book value. A non-GAAP financial measure is a numerical measure of financial performance or financial position that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP. We are presenting these non-GAAP financial measures because they provide greater transparency and enhanced visibility into the underlying drivers of our business. Adjusted earnings and adjusted book value are not substitutes for the Company's GAAP reporting, should not be viewed in isolation and may differ from similar reporting provided by other companies, which may define non-GAAP measures differently.Ambac has a significantU.S. tax net operating loss ("NOL") that is offset by a full valuation allowance in the GAAP consolidated financial statements. As a result of this and other considerations, we utilized a 0% effective tax rate for non-GAAP adjustments; which is subject to change. The following paragraphs define each non-GAAP financial measure and describe why it is useful. A reconciliation of the non-GAAP financial measure and the most directly comparable GAAP financial measure is also presented below.
Adjusted Earnings (Loss). Adjusted earnings (loss) is defined as net income (loss) attributable to common stockholders, as reported under GAAP, adjusted on an after-tax basis for the following:
•Non-credit impairment fair value (gain) loss on credit derivatives: Elimination of the non-credit impairment fair value gains (losses) on credit derivatives, which is the amount in excess of the present value of the expected estimated credit losses. Such fair value adjustments are affected by, and in part fluctuate with changes in market factors such as interest rates and credit spreads, including the market's perception ofAmbac's credit risk ("Ambac CVA"), and are not expected to result in an economic gain or loss. These adjustments allow for all financial guarantee contracts to be accounted for consistent with the Financial Services - Insurance Topic of ASC, whether or not they are subject to derivative accounting rules. This adjustment has become negligible and we will discontinue reporting it beginning in the first quarter of 2022. •Insurance intangible amortization: Elimination of the amortization of the financial guarantee insurance intangible asset that arose as a result ofAmbac's emergence from bankruptcy and the implementation of Fresh Start reporting. This adjustment ensures that all financial guarantee contracts are accounted for consistent with the provisions of the Financial Services - Insurance Topic of the ASC. •Foreign exchange (gains) losses: Elimination of the foreign exchange gains (losses) on the re-measurement of assets, liabilities and transactions in non-functional currencies. This adjustment eliminates the foreign exchange gains (losses) on all assets, liabilities and transactions in non-functional currencies, which enables users of our financial statements to better view the results without the impact of fluctuations in foreign currency exchange rates and facilitates period-to-period comparisons ofAmbac's operating performance. The following table reconciles net income attributable to common stockholders to the non-GAAP measure, Adjusted Earnings on a total dollar amount and per diluted share basis, for all periods presented: 2021 2020 2019 ($ in millions, except per share data) Per Diluted Per Diluted Per Diluted Year Ended December 31, $ Amount Share $ Amount Share $ Amount Share Net income (loss) attributable to common stockholders$ (17) $ (0.61) $ (437) $ (9.47) $ (216) $ (4.69) Adjustments: Non-credit impairment fair value (gain) loss on credit derivatives - - - - (1) (0.03) Insurance intangible amortization 52 1.12 57 1.23 295 6.43 Foreign exchange (gains) losses 7 0.15 3 0.06 (12) (0.26) Adjusted Earnings (Loss) (1)$ 43 $ 0.66 $ (378) $ (8.19) $ 66 $ 1.44
(1)Adjusted earnings per diluted share is calculated as adjusted earnings less the change in the redemption value of redeemable noncontrolling interest, divided by the GAAP weighted average number of diluted shares outstanding.
Adjusted Book Value. Adjusted book value is defined asTotal Ambac Financial Group, Inc. stockholders' equity as reported under GAAP, adjusted for after-tax impact of the following: •Non-credit impairment fair value losses on credit derivatives: Elimination of the non-credit impairment fair value loss on credit derivatives, which is the amount in excess of the present value of the expected estimated | Ambac Financial Group, Inc. 57 2021 FORM 10-K | -------------------------------------------------------------------------------- Table of Contents economic credit loss. GAAP fair values are affected by, and in part fluctuate with, changes in market factors such as interest rates, credit spreads, includingAmbac's CVA that are not expected to result in an economic gain or loss. These adjustments allow for all financial guarantee contracts to be accounted for within adjusted book value consistent with the provisions of the Financial Services-Insurance Topic of the ASC, whether or not they are subject to derivative accounting rules. This adjustment has become negligible and we will discontinue reporting it beginning in the first quarter of 2022. •Insurance intangible asset: Elimination of the financial guarantee insurance intangible asset that arose as a result ofAmbac's emergence from bankruptcy and the implementation of Fresh Start reporting. This adjustment ensures that all financial guarantee contracts are accounted for within adjusted book value consistent with the provisions of the Financial Services-Insurance Topic of the ASC. •Net unearned premiums and fees in excess of expected losses: Addition of the value of the unearned premium revenue ("UPR") on financial guarantee contracts, in excess of expected losses, net of reinsurance. This non-GAAP adjustment presents the economics of UPR and expected losses for financial guarantee contracts on a consistent basis. In accordance with GAAP, stockholders' equity reflects a reduction for expected losses only to the extent they exceed UPR. However, when expected losses are less than UPR for a financial guarantee contract, neither expected losses nor UPR have an impact on stockholders' equity. This non-GAAP adjustment adds UPR in excess of expected losses, net of reinsurance, to stockholders' equity for financial guarantee contracts where expected losses are less than UPR. This adjustment is only made for financial guarantee contracts since such premiums are non-refundable. •Net unrealized investment (gains) losses in Accumulated Other Comprehensive Income: Elimination of the unrealized gains and losses on the Company's investments that are recorded as a component of accumulated other comprehensive income ("AOCI"). The AOCI component of the fair value adjustment on the investment portfolio may differ from realized gains and losses ultimately recognized by the Company based on the Company's investment strategy. This adjustment only allows for such gains and losses in adjusted book value when realized. The following table reconcilesTotal Ambac Financial Group, Inc. stockholders' equity to the non-GAAP measure Adjusted Book Value on a dollar amount and per share basis, for all periods presented: 2021 2020 ($ in millions, except per share data) December 31, $ Amount Per Share $ Amount Per ShareTotal Ambac Financial Group, Inc. stockholders' equity$ 1,038 $ 22.42 $ 1,080 $ 23.57 Adjustments: Non-credit impairment fair value losses on credit derivatives - 0.01 - 0.01 Insurance intangible asset (320) (6.91) (373) (8.14) Net unearned premiums and fees in excess of expected losses 310 6.68 378 8.24 Net unrealized investment (gains) losses in Accumulated Other Comprehensive Income (Loss) (154) (3.32) (166) (3.63) Adjusted Book Value$ 874 $ 18.88 $ 919 $ 20.05 The decrease in Adjusted Book was primarily attributable to the$10 reduction to retained earnings from the increase to the carrying value of redeemable NCI, the impact on expected future premiums from reinsurance and de-risking transactions partially offset by Adjusted earnings for the year endedDecember 31, 2021 (excluding earned premium previously included in Adjusted Book Value). Factors that impact changes to Adjusted Book Value include many of the same factors that impact Adjusted Earnings, including the majority of revenues and expenses, but generally exclude components of premium earnings since they are embedded in prior period's Adjusted Book Value through the net unearned premiums and fees in excess of expected losses adjustment. Net unearned premiums and fees in excess of expected losses will affect Adjusted Book Value for (i) changes to future premium assumptions (e.g. expected term, interest rates, foreign currency rates, time passage) and (ii) changes to expected losses for policies which do not exceed their related unearned premiums and (iii) new reinsurance transactions.
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