| NEW YORK
NEW YORK Ambac Financial Group Inc's ABK.N
net worth is shrinking as it writes down bad assets linked to
subprime mortgages, but another potential problem elsewhere on
its balance sheet could also eat into the company's value.
The issue of Ambac's net worth is important, both because
it has already dipped below the minimum net worth required to
maintain a $400 million credit line and because too low a net
worth will make it harder to raise additional capital.
Ambac said last week its shareholder equity, an accounting
measure of net worth, shrank about 40 percent in the first
quarter. The company now has about $1.3 billion of shareholder
equity and writing down insurance on risky securities such as
subprime mortgage bonds could further reduce Ambac's net worth.
But the company could also see shareholders' equity hit by
a $3.57 billion deferred tax asset -- which can be seen as a
type of prepaid tax -- that currently sits on the company's
Ambac must generate enough taxable income in future years
to take advantage of its deferred tax asset, or else it could
be forced to essentially write that asset down.
Those write-downs -- which show up on the balance sheet as
valuation adjustments -- could conceivably be big enough to
leave Ambac with a negative net worth, at least on an
"The question with deferred tax assets in general is, if
the company will not be highly profitable in the future, how
will they generate the taxable income to take advantage of the
asset?" said Theodore Sougiannis, a professor of accounting at
University of Illinois at Urbana-Champaign who has worked on
deferred tax assets.
That proved to be a problem for General Motors Corp (GM.N)
in November, when it recorded a $39 billion loss driven largely
by a deferred tax asset valuation adjustment, leaving it with a
negative net worth.
Ambac's management says the bond insurer does not need to
raise new capital and its latest analysis of expected payouts
and receipt of insurance premiums indicates it will generate
enough taxable income to enjoy the benefit of the deferred tax
asset. The company also has mechanisms to boost taxable income.
PROFIT UNDER FIRE
But Ambac's profits will likely be under fire for at least
a few quarters, if not longer. Ambac Chief Executive Michael
Callen said during a recent conference call that the company
will not likely be able to generate much new business until
losses show evidence of reaching a plateau, which could take
until the beginning of next year.
Amid write-downs and weak new business generation, Ambac
posted a $1.66 billion first quarter loss last week. After
results, Ambac was below its net asset requirements for a $400
million credit facility it is not using. The company is talking
to its banks and says its liquidity position is strong.
Some investors speculate Ambac could have to raise capital
sooner rather than later after its abysmal results and, if it
does, its net worth could raise thorny questions for investors.
The company worked for weeks to raise capital earlier this
year and eventually sold $1.5 billion of shares and convertible
securities in March, in a deal that helped preserve its main
unit's top credit ratings.
Those ratings are crucial for winning new business. Any
downgrades could have forced investors that can only hold top
rated securities to dump billions of dollars of bonds into the
Ambac shares closed at $4.38 on Tuesday, down about 95
percent over the last 12 months.
WRITE-OFFS GENERATE FUTURE TAX BENEFITS
Deferred tax assets arise because U.S. companies are
allowed to keep two sets of books: one for shareholders and one
for the tax man.
Ambac's recent write-downs have cut into income reported to
shareholders. But many of those write-downs have not affected
income reported for tax purposes. That is because the company
only takes deductions on taxable income as it sets aside
reserves on specific insurance policies or makes payments on
So Ambac has higher income recorded for tax purposes
compared with the results it reported to investors. Over time,
as adjustments in the market value of assets end up translating
into actual payouts, Ambac will be able to deduct those
payments from taxable income.
In a telephone interview, Chief Financial Officer Sean
Leonard said Ambac has forecast its expected payouts, combined
with its expected incoming premium, and it expects to generate
enough taxable income to take advantage of the losses and
payouts in the future.
The company also has steps it can take to boost taxable
income, Leonard said. For example, Ambac could also switch its
tax-exempt investment portfolio to being taxable.
(Editing by Andre Grenon)