November 19, 2009
Research Associate: Binod Kr. Das, M.Com.
Editor: Tanuka De, M.Com.,MBA.
Sr. Ed.: Ian Madsen, CFA: ; 1-800-767-3771 x9417
www.zackspro.com 111 N. Canal Street, Suite 1101 Chicago, IL 60606
Ambac Financial Group, Inc. / (NYSE - ABK) / $1.00Note: FLASH REPORT; more details to come; changes are highlighted. Except where noted, and highlighted, no other sections of this report have been updated.
Reason for Report: FLASH UPDATE: Ambac says capital exceeds statutory minimum
Previous Edition: 3Q09 Earnings Update, November 4, 2009.
Flash Update
On November 18, 2009, Ambac Financial Group, Inc. announced that the statutory capital of its main unit Ambac Assurance Corp was $856 million at the end of third quarter – well above a regualtory minimum requirement. Ambac also said it has negotiated to settle four derivatives contracts valued at $5.03 billion for cash payment of about $520 million.
On November 4, 2009, Ambac Financial Group, Inc. announced its 3Q09 earnings results. Highlights are as follows:
· Net premium earned was $238.4 million, compared with $282.3 million in 3Q08.
· Net investment income was $135 million, compared with $126.8 million in 3Q08.
· Total revenue was $2,689.5 million, compared with ($2,320.4) million in 3Q08.
· The Company reported a net income of $2,188.3 million, compared with a net loss of $2,431.2 million in 3Q08.
· The Company reported a net income of $7.58 per share, compared with a net loss of $8.45 per share in 3Q08.
MORE DETAILS WILL COME IN THE IMMINENT EDITIONS OF ZACKS RD REPORTS ON ABK.
Overview [Note: Only highlighted material has been changed.]
The analysts identified the following investment considerations for the prospective investors:
Key Positive Arguments / Key Negative Arguments· ABK has an experienced management team.
· ABK funds various programs through internal capital generation.
· International markets provide opportunities for growth.
· ABK focuses on niche areas, such as student loans or commercial asset backed securities.
· The Company is expected to step up its share repurchase activity, unless new businesses pick up significantly. / · Pricing pressures could arise in the municipal sector.
· ABK targets more complex business to earn high returns on its capital, and thus, a higher ROE may come at a higher risk.
· ABK is the largest writer of financial guarantees for mortgage backed securitization (MBS) and home equity securitizations. Its earnings are sensitive to the residential real estate market.
· ABK has a large portfolio of high-risk healthcare bonds.
· ABK does not provide earnings guidance, given the volatility and unpredictability of its markets.
· Ambac, like its peers, turned away a significant portion of business that was uninsured in the marketplace as credit was mispriced.
· Analysts believe tight credit spread and a competitive pricing environment will continue to pressure the topline.
New York-based Ambac Financial Group, Inc. (ABK or the Company), through its subsidiaries, provides financial guarantee products, and other financial services to clients of both public and private sectors. The Company and its subsidiaries have two reportable segments - Financial Guarantee and Financial Services. In the Financial Guarantee segment, the Company provides financial guarantees for public finance, and structured finance obligations through its principal operating subsidiary, Ambac Assurance Corporation. The Company provides unconditional guarantees for the timely payment of principal and interest on municipal bonds, and asset securitization transactions. Through its Financial Services subsidiaries the Company provides financial and investment products including investment agreements, interest rates, and total return swaps principally to its clients, which include municipalities and their authorities, school districts, healthcare organizations, and asset-backed issuers. Ambac works closely with governments and government agencies throughout the United States and around the world to improve access to capital necessary for infrastructure projects and local financing needs. Ambac's principal operating subsidiary, Ambac Assurance Corporation, a guarantor of public finance and structured finance obligations, has a Caa2 rating (developing outlook) from Moody's Investors Service, Inc. and a CC rating (outlook developing) from Standard & Poor's Ratings Services.
More information about the Company is available at its website: www.ambac.com.
Note: ABK’s fiscal year coincides with the calendar year.
October 22, 2009
Recent Events [Note: Only highlighted material has been changed.]
On September 25, 2009, it was announced that ABK was among new entities claiming assets against Lehman Brothers after banks and investors worldwide took losses to the largest bankruptcy in the U.S. history. Ambac Assurance, the bond insurance arm of Ambac Financial, has filed around $1.3 billion in claims relating to mortgage securitizations.
On August 7, 2009, ABK announced its 2Q09 financial results. Highlights are as follows:
· Net premiums earned were $177.7 million, down 45% from $325.5 million in 2Q08.
· Net investment income was $122.9 million, compared with $130.7 million in 2Q08.
· Total revenue was $(502.2) million, compared with $1,331.8 million in 2Q08.
· The Company reported a net loss of $2,396.6 million versus net income of $823.1 million in 2Q08.
· The Company reported a net loss of $8.33 per share, compared with a net income of $2.80 per share in 2Q08.
Revenue [Note: Only highlighted material has been changed.]
Total revenue, as compiled by Zacks Digest, is shown in the table below:
Revenue ($ in M) / 2Q08A / 1Q09A / 2Q09A / 3Q09E / 4Q09E / 2008A / 2009EDigest High / $514.9 / $305.4 / $1,518.5
Digest Low / $514.9 / $305.4 / $1,518.5
Digest Average / $514.9 / $305.4 / $1,518.5
Y/Y Growth / 24.8% / -13.2% / -17.7%
Sequential Growth / 46.3% / -9.7%
Zacks Consensus / $281.0 / $268.0↑ / $1,975.0↑
Note: Blank cells indicate that brokers did not provide estimates.
Revenue as per the Company was ($502.2) million in 2Q09 versus $1,331.8 million in 2Q08.
Revenue components as compiled by Zacks Digest are shown in the table below:
$ in M / 2Q08A / 1Q09A / 2Q09A / 3Q09E / 4Q09E / 2008A / 2009ENet Premium Earned / $325.5 / $196.8 / $1,022.8
Net Investment Income / $129.0 / $100.3 / $490.7
Financial Guarantee / $15.6 / $6.6
Financial Services / $41.6
Other Income / $6.4 / $1.7 / $8.5
Total Revenue / $514.9 / $305.4 / $1,518.5
Note: Blank cells indicate that brokers did not provide estimates.
Net Premiums Earned
As per the Company, net premiums earned for 2Q09 were $177.7 million, down 45% from $325.5 million in 2Q08. Normal earned premiums amounted to $143.9 million and $166.2 million in 2Q09 and 2Q08, respectively. As a result of the implementation of FAS 163 on January 1, 2009, normal earned premium amounts reported in 2009, are not comparable with amounts that were reported in 2008.
Net premiums earned include accelerated premiums, which result from refundings, calls and other accelerations recognized during the quarter. Accelerated premiums were $33.8 million in 2Q09 down significantly from $159.2 million in 2Q08. During 2Q08, a lack of liquidity in the auction rate and variable rate bond markets had resulted in significant refinancing activity in the municipal sector.
Net Investment Income
Net investment income excluding variable interest entities for 2Q09 was $120.4 million, representing a decrease of 5% from $127.3 million in 2Q08. The decrease was primarily due to lower invested assets driven by reductions in the portfolio to pay commutations on CDO of ABS transactions and RMBS claim payments, partially offset by $800 million proceeds from the issuance of AAC preferred stock in December 2008, and January 2009, and cash flow from the collection of financial guarantee premiums, tax refunds and fees and coupon receipts on invested assets.
Financial Services
The financial services segment comprises the investment agreement business and the derivative products business. Gross interest income less gross interest expense from investment and payment agreements plus the results from the derivative products business, excluding net realized investment gains and losses and unrealized gains and losses on total return swaps and non-trading derivative contracts, was ($33.5) million in 2Q09 down from ($16.7) million in 2Q08. Derivative products results declined by $28.7 million, primarily due to losses realized on transactions professional derivative counterparties terminated as a result of the downgrades of AAC as guarantor of the swaps. The majority of ABK’s professional derivative counterparties retain the right to terminate contracts and, accordingly, the Company may have similar losses in the future. The negative effect of swap termination costs was partially offset by the reduction of high rate resets associated with cost of funds swaps. Net investment income from the investment agreement business improved by $11.5 million primarily as a result of favorable variable interest rate reset adjustments versus 2Q08 and the effects of intercompany loans from AAC.
Other-than-temporary losses in the investment agreement investment portfolio amounted to ($186.7) million in 2Q09. Similar to the insurance company strategy discussed above, during 2Q09 management determined its intent to sell certain investment securities (primarily Alt-A RMBS securities rated below investment grade by Moody’s or S&P) held in the investment agreement investment portfolio.
The interest rate swap and investment agreement businesses are in run-off. The investment and payment agreement portfolio has been reduced by approximately $1.1 billion 1H09 to approximately $1.5 billion as on June 30, 2009, through negotiated terminations, terminations contractually triggered by rating downgrades of AAC, and scheduled amortization.
A graphical representation of revenue components is given below:
Please refer to the Zacks Research Digest ABK spreadsheet for more details on revenue estimates.
Margins [Note: Only highlighted material has been changed.]
Margins, as compiled by Zacks Digest, are shown in the table below.
Margins / 2Q08A / 1Q09A / 2Q09A / 3Q09E / 4Q09E / 2008A / 2009EPre-tax Margin / -71.9% / -371.9%
Net Operating Margin / -86.2% / -370.8%
Note: Blank cells indicate that brokers did not provide estimates.
Total operating expenses, as per the Company, (which include Loss and LAE, Underwriting and Operating expenses, Financial Services Expense, and Interest from investment and payment agreements) were $3,541 million in 2Q09 versus $3,297 million in 2Q08.
Please refer to the Zacks Research Digest ABK spreadsheet for more details on margin estimates.
Earnings per Share [Note: Only highlighted material has been changed.]
Pro forma EPS, as compiled by Zacks Digest average was ($1.00) in 2Q09 versus ($1.53) in 2Q08 and ($3.22) in 1Q09.
ABK reported a 2Q09 net loss of $2,396.6 million, or a net loss of $8.33 per share versus 2Q08 net income of $823.1 million, or income of $2.80 per share. 2Q09 results reflect higher loss and loss expenses primarily related to the residential mortgage-backed securities (RMBS) insured portfolio and other-than-temporary impairment losses in its investment portfolios related to RMBS and tax-exempt municipal securities that it is prepared to sell. Furthermore, during the quarter Ambac increased its deferred tax asset valuation allowance. ABK’s 2Q08 results reflected a positive change in fair value of credit derivatives amounting to $961.6 million, primarily related to its own credit spreads widening and a reduction of loss reserves amounting to $339.3 million, primarily related to the insured second lien residential mortgage-backed securities portfolio.
EPS as compiled by Zacks Digest is shown in the table below:
EPS / 2Q08A / 1Q09A / 2Q09A / 3Q09E / 4Q09E / 2008A / 2009E / 2010EDigest High / ($1.53) / ($3.22) / ($1.00) / ($1.01) ↓ / ($1.01) ↓ / ($23.06) / ($3.95)↑ / ($1.75)
Digest Low / ($1.54) / ($3.22) / ($1.00) / ($1.01) / ($1.01) / ($23.07) / ($3.95)↑ / ($1.75)
Digest Avg. / ($1.53) / ($3.22) / ($1.00) / ($1.01)↓ / ($1.01)↓ / ($23.07) / ($3.95)↑ / ($1.75)
Digest Y/Y Growth / -176.3% / 53.5% / 34.8% / 87.5%↓ / 85.1%↓ / -8506.3% / 82.9%↑ / 55.7%
Digest Sequential Growth / 77.9% / 52.6% / 68.9% / -1.0%↓ / 0.0%↓
Zacks Consensus / ($1.75) ↓ / ($8.61) ↓ / ($1.75)
Highlights from the above chart are as follows:
· 2009 forecast given by one firm (Deutsche Bank) is ($3.95).
· 2010 forecast given by one firm (Deutsche Bank) is ($1.75).
Please refer to the Zacks Research Digest ABK spreadsheet for more details on EPS estimates.
Target Price/Valuation [Note: Only highlighted material has been changed.]
Average target price for ABK given by one firm is $1.00 (30.6% downside from the current market price). The firm (Deutsche Bank) with the target price of $1.00 did not provide any valuation metric and rated the stock old.
Rating DistributionPositive / 0.0%
Neutral / 100.0%
Negative / 0.0%
Average Price Target / $1.00↑
Digest High / $1.00
Digest Low / $1.00↑
Number of analysts with target price/Total / 1/1
Metrics detailing current management effectiveness are as follows:
Metric (TTM) / ABK / Industry / S&P 500Return on Assets (ROA) / -35.1%↓↓ / 0.2%↑ / 3.3%↓
Return on Investments (ROI) / NM / -0.0% / 4.5%↓
Return on Equity (ROE) / NM / 0.6%↑ / 8.1%↓
ROA is lower than the overall market averages (measured by S&P 500).
Capital Structure/Solvency/Cash Flow/Governance/Other [Note: Only highlighted material has been changed.]
Balance Sheet and Liquidity
As on June 30, 2009, AAC reported statutory capital and surplus of $305.6 million and contingency reserves of $173.6 million, down from $372.8 million and $1,946.6 million, respectively, on March 31, 2009. AAC statutory capital and surplus was negatively impacted by the net loss recorded during the quarter. The primary drivers of the statutory net loss were: (i) statutory impairment losses on credit derivatives amounting to $1,568.7 million; and (ii) statutory loss and loss expenses incurred of $751.0 million during the second quarter. The statutory impairment losses, which relate to AAC’s insured portfolio of CDOs of ABS, was driven by rising forward LIBOR rates, which increase estimated future cash outflows, and further deterioration of the underlying collateral within the CDO of ABS transactions. The statutory loss and loss expenses relate primarily to deterioration in AAC’s second-lien and Alt-A mortgage-backed securities financial guarantee portfolios, as discussed above under “Financial Guarantee Loss Reserves.”