AMBC-2014.12.31-10K
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 
EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2014
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 1-10777
Ambac Financial Group, Inc.
(Exact name of Registrant as specified in its charter)
Delaware
 
13-3621676
(State of incorporation)
 
(I.R.S. employer identification no.)
One State Street Plaza, New York, New York
 
10004
(Address of principal executive offices)
 
(Zip code)
212-658-7470
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III in this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes x No ¨
The aggregate market value of voting stock held by non-affiliates of the Registrant as of the close of business on June 30, 2014 was $1,229,020,323. As of February 25, 2015, there were 45,003,598 shares of Common Stock, par value $0.01 per share, were outstanding.
Documents Incorporated By Reference
Portions of the Registrant’s proxy statement for its 2015 annual meeting of stockholders are incorporated by reference in this Form 10-K in response to Part III Items 10, 11, 12, 13, and 14.



Table of Contents

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
 
 
PAGE
 
Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995
 
PART I
 
Item 1.
Business
 
 
 
Introduction
 
 
Financial Guaranty Segment
 
 
Financial Services Segment
 
 
Investments and Investment Policy
 
 
Employees
 
Item 1A.
Risk Factors
 
Item 1B.
Unresolved Staff Comments
 
Item 2.
Properties
 
Item 3.
Legal Proceedings
 
Item 4.
Mine Safety Disclosures
 
PART II
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Item 6.
Selected Financial Data
 
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
Company Overview
 
 
Critical Accounting Policies and Estimates
 
 
Results of Operations
 
 
Liquidity and Capital Resources
 
 
Balance Sheet
 
 
Special Purpose Entities Including Variable Interest Entities
 
 
Accounting Standards
 
 
Ambac Assurance Statutory Basis Financial Results
 
 
Ambac Assurance UK Limited Financial Results Under UK Accounting Principles
 
 
Non-GAAP Financial Measures
 
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
 
Item 8.
Financial Statements and Supplementary Data
 
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
 
Item 9A.
Controls and Procedures
 
Item 9B.
Other Information
 
PART III
 
Item 10.
Directors, Executive Officers and Corporate Governance
 
Item 11.
Executive Compensation
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
Item 13.
Certain Relationships and Related Transactions, and Director Independence
 
Item 14.
Principal Accountant Fees and Services
 
PART IV
 
Item 15.
Exhibits, Financial Statement Schedules
 
 
Schedule I—Summary of Investments Other Than Investments in Related Parties
 
 
Schedule II—Condensed Financial Information of Registrant (Parent Company Only)
 
 
Schedule IV—Reinsurance
 
SIGNATURES
 


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CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
In this Annual Report, we have included statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Words such as “estimate,” “project,” “plan,” “believe,” “anticipate,” “intend,” “planned,” “potential” and similar expressions, or future or conditional verbs such as “will,” “should,” “would,” “could,” and “may,” or the negative of those expressions or verbs, identify forward-looking statements. We caution readers that these statements are not guarantees of future performance. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, which, may by their nature be inherently uncertain and some of which may be outside our control. These statements may relate to plans and objectives with respect to the future, among other things which may change. We are alerting you to the possibility that our actual results may differ, possibly materially, from the expected objectives or anticipated results that may be suggested, expressed or implied by these forward-looking statements. Important factors that could cause our results to differ, possibly materially, from those indicated in the forward-looking statements include, among others, those discussed under “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K.
Any or all of management’s forward-looking statements here or in other publications may turn out to be incorrect and are based on management’s current belief or opinions. Ambac’s actual results may vary materially, and there are no guarantees about the performance of Ambac’s securities. Among events, risks, uncertainties or factors that could cause actual results to differ materially are: (1) volatility in the price of Ambac’s common stock; (2) uncertainty concerning our ability to achieve value for holders of Ambac securities, whether from Ambac Assurance Corporation (“Ambac Assurance”) or from new business opportunities; (3) dilution of current shareholder value or adverse effects on our share price resulting from the issuance of additional shares of common stock; (4) adverse effects on our share price resulting from future offerings of debt or equity securities that rank senior to our common stock; (5) potential of rehabilitation proceedings against Ambac Assurance; (6) decisions made by the rehabilitator of the Segregated Account of Ambac Assurance Corporation (the “Segregated Account”) for the benefit of policyholders that may result in material adverse consequences for Ambac’s security holders; (7) our inability to realize the expected recoveries included in our financial statements; (8) intercompany disputes or disputes with the rehabilitator of the Segregated Account; (9) our inability to monetize assets or restructure or exchange outstanding debt and insurance obligations, or the failure of any such monetization, restructuring or exchange to deliver anticipated results; (10) our results of operation may be adversely affected by events or circumstances that result in the accelerated amortization of our insurance intangible asset or impairments to goodwill; (11) increased fiscal stress experienced by issuers of public finance obligations or an increased incidence of Chapter 9 filings by municipal issuers; (12) adverse tax consequences or other costs resulting from the Segregated Account rehabilitation plan, from rules and procedures governing the payment of permitted policy claims, or from the characterization of our surplus notes as equity; (13) credit risk throughout our business, including but not limited to credit risk related to residential mortgage-backed securities, student loan and other asset securitizations, collateralized loan obligations, public finance obligations and exposures to reinsurers; (14) risks attendant to the change in composition of securities in our investment portfolio; (15) inadequacy of reserves established for losses and loss expenses; (16) the risk that our risk management policies and practices do not anticipate certain risks and/or the magnitude of potential for loss as a result of unforeseen risks; (17) changes in prevailing interest rates; (18) factors that may influence the amount of installment premiums paid to Ambac, including the Segregated Account rehabilitation proceedings; (19) default by one or more of Ambac Assurance’s portfolio investments, insured issuers or counterparties; (20) market risks impacting assets in our investment portfolio or the value of our assets posted as collateral in respect of investment agreements and interest rate swap transactions; (21) risks relating to determinations of amounts of impairments taken on investments; (22) the risk of litigation and regulatory inquiries or investigations, and the risk of adverse outcomes in connection therewith, which could have a material adverse effect on our business, operations, financial position, profitability or cash flows; (23) our inability to realize value from Ambac Assurance UK Limited; (24) system security risks; (25) market spreads and pricing on derivative products insured or issued by Ambac or its subsidiaries; (26) the risk of volatility in income and earnings, including volatility due to the application of fair value accounting; (27) changes in accounting principles or practices that may impact Ambac’s reported financial results; (28) legislative and regulatory developments; (29) operational risks, including with respect to internal processes, risk models, systems and employees, and failures in services or products provided by third parties; (30) Ambac’s financial position and the Segregated Account rehabilitation proceedings that may prompt departures of key employees and may impact our ability to attract qualified executives and employees; and (31) other risks and uncertainties that have not been identified at this time.

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PART I
Item 1.    Business
INTRODUCTION
Ambac Financial Group, Inc. (“Ambac” or the “Company”), headquartered in New York City, is a financial services holding company incorporated in the State of Delaware on April 29, 1991. On May 1, 2013 (the “Effective Date”), Ambac emerged from Chapter 11 bankruptcy protection when the Second Modified Fifth Amended Plan of Reorganization of Ambac Financial Group, Inc. (the “Reorganization Plan”) became effective. On December 26, 2013, the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) entered an order of final decree closing Ambac’s Chapter 11 case. Ambac filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the Bankruptcy Court on November 8, 2010 as a result of losses incurred since the beginning of the financial crisis in 2007. Refer to Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further discussion of Ambac’s bankruptcy.
Ambac’s primary goal is to maximize shareholder value through executing the following key strategies:
Increasing the value of its investment in Ambac Assurance Corporation ("Ambac Assurance") by actively managing its assets and liabilities with a focus on maximizing risk-adjusted investment portfolio returns and mitigating or remediating losses on poorly performing insured transactions through executing policy commutations, repurchasing liabilities at a discount, pursuing recoveries of losses through litigation and the exercise of contractual and legal rights, restructuring transactions, and other means; and
Selectively exploring opportunities to grow and diversify Ambac, which may include the development or acquisition of financial services businesses such as advisory, asset servicing, asset management, and/or insurance.
As part of its asset/liability management strategy, Ambac Assurance is considering the possibility of entering into transactions whereby it would monetize certain assets and/or restructure or exchange its outstanding debt and insurance obligations.
Opportunities for remediating losses on poorly performing insured transactions depend on market conditions, including the perception of Ambac Assurance’s creditworthiness, the structure of the underlying risk and associated policy, as well as other factors. Ambac Assurance's ability to commute policies or purchase liabilities may be limited by available liquidity or other factors, including regulatory restrictions.
Although we are exploring new business opportunities for Ambac, no assurance can be given that we will be able to identify or execute acquisitions or develop any new business. In addition, there can be no assurance that we will be able to generate or obtain the financial and other resources that may be required to finance the acquisition or development of any new business. Due to these factors, as well as uncertainties relating to the ability of Ambac Assurance to deliver value to Ambac, the value of our securities is speculative. For additional risks and uncertainties concerning Ambac, please refer to Part I, Item 1A in this Form 10-K.
Ambac has two reportable business segments: Financial Guarantee and Financial Services.
Ambac’s Financial Guarantee business segment is conducted through its primary operating subsidiary, Ambac Assurance and its wholly owned subsidiary Ambac Assurance UK Limited (“Ambac UK”), both of which have been in runoff since 2008. Insurance policies insured by Ambac Assurance and Ambac UK generally guarantee payment when due of the principal and interest on the obligation guaranteed. Ambac Assurance also has another wholly-owned financial guarantee subsidiary, Everspan Financial Guarantee Corp. (“Everspan”), which has been in runoff since its acquisition in 1997. The deterioration of Ambac Assurance’s financial condition resulting from losses in its insured portfolio since 2007 has prevented Ambac Assurance and Ambac UK from being able to write new business. An inability to write new business has and will continue to negatively impact Ambac’s future operations and financial results. Ambac Assurance’s ability to pay dividends and, as a result, Ambac’s liquidity, have been significantly restricted by the deterioration of Ambac Assurance’s financial condition, by the rehabilitation of the Segregated Account (defined below) and by the terms of the Settlement Agreement, dated as of June 7, 2010 (the "Settlement Agreement"), by and among Ambac Assurance, Ambac Credit Products LLC (“ACP”), Ambac and certain counterparties to credit default swaps with ACP that were guaranteed by Ambac Assurance. Ambac Assurance is also restricted in its ability to pay dividends pursuant to the terms of its Auction Market Preferred Shares. It is highly unlikely that Ambac Assurance will be able to make dividend payments to Ambac for the foreseeable future. Refer to "Dividend Restrictions, Including Contractual Restrictions" below and Note 9 . Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K, for more information on dividend payment restrictions.
In March 2010, Ambac Assurance established a segregated account pursuant to Wisconsin Stat. §611.24(2) (the “Segregated Account”) to segregate certain segments of Ambac Assurance’s liabilities. The Office of the Commissioner of Insurance for the State of Wisconsin (“OCI” (which term shall be understood to refer to such office as regulator of Ambac Assurance and to refer to the Commissioner of Insurance for the State of Wisconsin as rehabilitator of the Segregated Account (the “Rehabilitator”), as the context requires)) commenced rehabilitation proceedings in the Wisconsin Circuit Court for Dane County (the “Rehabilitation Court”) with respect to the Segregated Account (the “Segregated Account Rehabilitation Proceedings”) in order to permit the OCI to facilitate an orderly run-off and/or settlement of the liabilities allocated to the Segregated Account pursuant to the provisions of the Wisconsin Insurers Rehabilitation and Liquidation Act. Ambac Assurance is not, itself, in rehabilitation proceedings. The execution of Ambac’s strategy to increase the value of its investment in Ambac Assurance is subject to the authority of the Rehabilitator to control the management of the Segregated Account. In exercising such authority, the Rehabilitator will act for the benefit of policyholders, and will not take into account the interests of Ambac. Similarly, by operation of the contracts executed in connection

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with the establishment, and subsequent rehabilitation, of the Segregated Account, the Rehabilitator retains rights to oversee and approve certain actions taken by or in respect of Ambac Assurance. Refer to Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K, for more information on the Segregated Account.
Ambac’s Financial Services business segment is operated by subsidiaries of Ambac Assurance. This segment provides financial and investment products, including investment agreements, funding conduits and interest rate swaps, principally to the clients of its financial guarantee business. Ambac Assurance insured all of the obligations of its financial services subsidiaries. The financial services businesses are in active runoff, which is being effectuated by means including transaction terminations, settlements, assignments and scheduled amortization of contracts. The Financial Services business also maintains interest rate derivatives to mitigate exposure to floating rate insured obligations in the Financial Guarantee segment.
Our Internet address is www.ambac.com. We make available free of charge, through the investor relations section of our web site, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and any amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as well as proxy statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission. Our Investor Relations Department can be contacted at Ambac Financial Group, Inc., One State Street Plaza, New York, New York 10004, Attn: Investor Relations, telephone: 212-208-3222. The reference to our website address does not constitute inclusion or incorporation by reference of the information contained on our website in this Form 10-K or other filings with the SEC, and the information contained on our website is not part of this document.
Financial information concerning our business segments for each of 2014, 2013 and 2012 is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk,” and the Consolidated Financial Statements and the Notes thereto, included elsewhere in this Form 10-K.
FINANCIAL GUARANTEE SEGMENT
The Financial Guarantee segment includes insurance policies and credit derivative contracts. Generally, financial guarantees provide an unconditional and irrevocable guarantee which protects the holder of a debt obligation against non-payment when due. Pursuant to such guarantees, Ambac Assurance and its subsidiaries make payments if the obligor responsible for making payments fails to do so when scheduled. Credit derivatives permit certain counterparties to assert mark-to-market termination claims; however, the assertion of such mark-to-market claims has been enjoined by the Rehabilitation Court. See discussion of “Ambac Assurance Liquidity” in Part II, Item 7 included in this Form 10-K for further information.
Ambac’s financial guarantee insurance policies and credit derivative contracts expose the Company to the direct credit risk of the assets and/or obligor supporting the guaranteed obligation. In addition, insured transactions expose Ambac to indirect risks that may increase our overall risk, such as credit risk separate from, but correlated with, our direct credit risk, market, model , economic, natural disaster, and mortality or other non-credit type risks.
Ambac Assurance derives financial guarantee revenues from: (i) premiums earned from insurance contracts, net of reinsurance; (ii) net investment income; (iii) revenue from credit derivative transactions; (iv) net realized gains and losses from sales of investment securities; and (v) amendment and consent fees. Financial guarantee expenditures include (i) loss and commutation payments for credit exposures that have experienced significant credit deterioration and/or default, net of reinsurance; (ii) loss-related expenses, including those relating to the remediation of problem credits, and (iii) operating expenses. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Part II, Item 7 in this Form 10-K for further information. Premiums for financial guarantees were received either upfront (typical of public finance obligations) or on an installment basis from the cash flows generated by the underlying assets (typical of structured finance obligations). Despite not underwriting new business, Ambac continues to collect premiums on its existing portfolio of guarantees that pay premiums on an installment basis.
Risk Management
Ambac’s Asset Liability Management Committee (“ALCO”) is a multidisciplinary committee with the objective to implement and foster an enterprise wide culture and approach to liquidity management, asset valuation, hedging, and risk remediation. Members of ALCO include the Chief Executive Officer, Chief Financial Officer and senior managers from investment management, capital markets and risk management. ALCO has scheduled monthly meetings and will also meet on an ad hoc basis to consider, for example, the commutation of distressed financial guarantee exposures.
The Risk Management group is primarily responsible for the development, implementation and oversight of loss mitigation strategies, surveillance and remediation of the insured financial guarantee portfolio (including through the pursuit of recoveries in respect of paid claims and commutations of policies). These activities are integral to Ambac’s strategy of mitigating losses on poorly performing transactions. As a consequence of the Segregated Account Rehabilitation Proceedings, the Rehabilitator retains operational control and decision-making authority with respect to all matters related to the Segregated Account, including surveillance, remediation and loss mitigation. The Rehabilitator operates the Segregated Account through a management services contract executed between Ambac Assurance and the Segregated Account pursuant to which the Risk Management group and other personnel provide surveillance, remediation and loss mitigation services to the Segregated Account. Furthermore, by virtue of the contracts executed between Ambac Assurance and the Segregated Account, the Rehabilitator retains the discretion to oversee and approve certain actions taken by Ambac Assurance in respect of assets and liabilities that have not been allocated to the Segregated Account.

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Refer to Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K, for more information on the contracts between Ambac Assurance and the Segregated Account. As such, the following discussion of Ambac’s risk management practices is qualified by reference to the Rehabilitator’s exercise of its discretion to alter or eliminate any of these risk management practices.
Ambac’s Risk Management group has an organizational structure designed around the two major areas of focus: Portfolio Risk Management and Analysis and Credit Risk Management. As a result of the recent credit and economic environment, Ambac heightened its surveillance efforts on all exposures, focusing on the identification of credits and asset types across the portfolio that were likely to experience increased stress or potential for losses. The senior managers within the risk management groups report directly to Ambac Assurance's Chief Executive Officer and regularly inform and update the Audit Committees of the Board of Directors of Ambac and Ambac Assurance with respect to risk-related topics in the insured portfolio.
Portfolio Risk Management and Analysis ("PRM")
This group’s focus is on remediation, loss mitigation, risk reduction and surveillance. Proactive credit remediation can help to reduce exposure and/or reduce risk in the insured portfolio by securing rights and remedies, both of which help to mitigate losses in the event of default. The emphasis on reducing risk is centered on reducing enterprise-wide exposure on a prioritized basis.
PRM personnel perform periodic surveillance reviews of exposures according to a schedule based on the risk profile of the guaranteed obligations or as necessitated by specific credit events or other macro-economic variables. Risk-adjusted surveillance strategies have been developed for each bond type with review periods and scope of review based upon each bond type’s risk profile. The risk profile is assessed regularly in response to our own experience and judgments or external factors such as the economic environment and industry trends. Monitoring activities are designed to detect deterioration in credit quality or changes in the economic, regulatory or political environment which could adversely impact the portfolio. Active surveillance enables PRM to track single credit migration and industry credit trends. The focus of the surveillance review is to assess performance, identify credit trends and recommend appropriate credit classifications, ratings and changes to a transaction or bond type’s review period. If a problem is detected, the group focuses on loss mitigation by recommending appropriate action and working with the issuer, trustee, bond counsel, servicer and other interested parties in an attempt to remediate the problem and minimize Ambac Assurance’s exposure to potential loss. Those credits that are either in default or have developed problems that eventually may lead to a default or claim payment are tracked closely by the appropriate surveillance team, senior risk managers and discussed at regularly scheduled meetings with Credit Risk Management (see discussion following in “Credit Risk Management”). In some cases, PRM will engage workout experts or attorneys and other consultants with appropriate expertise in the targeted loss mitigation area to assist management in examining the underlying contracts or collateral, providing industry specific advice and/or executing strategies.
In structured transactions, including structured public finance transactions, Ambac Assurance often is the control party as a result of insuring the transaction’s senior class or tranche. The control party may direct specified parties, usually the trustee, to take or not take certain actions following contractual defaults or trigger events. Control rights and the scope of direction and remedies vary considerably among our insured transactions. Because Ambac Assurance is party to and/or has certain rights in documents supporting transactions in the insured portfolio, Ambac Assurance frequently receives requests for amendments, waivers and consents (“AWCs”). As discussed below under “Credit Risk Management,” Ambac Assurance’s risk management personnel review, analyze and process all requests for AWCs. As a part of the Segregated Account Rehabilitation Proceedings, the Rehabilitation Court enjoined certain actions by other parties to preserve Ambac Assurance’s control rights that could otherwise have lapsed or been compromised.
Surveillance for collateral dependent transactions, including, but not limited to, residential mortgage-backed securities (“RMBS”), asset-backed securities (“ABS”) and student loan transactions, focuses on review of the underlying asset cash flows and, if applicable, the performance of servicers or collateral managers. Ambac Assurance generally receives periodic reporting of transaction performance from issuers or trustees. Risk analysts review these reports to monitor performance and, if necessary, seek legal or accounting advice to assure that reporting and application of cash flows comply with transaction requirements.
Cross-functional teams have been established by senior risk managers in PRM to promote the active mitigation and/or targeted remediation of the insured portfolio. Examples of such teams include teams of professionals focused on (i) the review and enforcement of contractual representations and warranties in RMBS policies, (ii) RMBS servicing oversight and (iii) the analysis and prioritization of policies to target and execute risk reduction and commutation strategies. The establishment and purview of cross-functional teams is targeted to address our highest risk exposures. Members of such teams work with both internal and external experts in the pursuit of risk reduction on all fronts.
The RMBS servicing oversight team focuses on servicer oversight and remediation. Analysts monitor the performance of servicers through a combination of (i) regular reviews of servicer performance; (ii) compliance certificates received from servicer management; (iii) independent rating agency information; (iv) a review of servicer financial information; and (v) onsite servicing diligence. Servicer performance reviews typically include a review of collateral performance, including comparisons against benchmarks, as well as the processes of collection, default management, and loss mitigation. Ambac Assurance may require a back-up servicer or require “term-to-term” servicing which provides for limited, renewable servicing terms in order to provide greater flexibility regarding the servicing arrangements of a particular transaction.
In some transactions, Ambac Assurance has the right to direct a transfer of servicing to an alternative servicer, subject to certain conditions. The decision to exercise this right is made based on various factors, including an assessment of the performance of the existing servicer as outlined above, and an assessment of whether a transfer of servicing may improve the performance of the collateral and reduce risk to Ambac Assurance.

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Ambac Assurance assesses potential transferee servicers through on-site servicer reviews and reviews of servicer financial information. Accordingly, Ambac Assurance has developed relationships with preferred servicers in the residential mortgage backed sector. Preferred servicers are selected through a formalized servicer review process that determines, among other key factors, the servicer’s ability and willingness to actively manage intense and proven loss mitigation activities on RMBS. Ambac Assurance may decide to exercise its rights to direct the transfer of servicing to a preferred servicer where such rights are available. The transfer of servicing is done with the objectives of (i) minimizing losses and distress levels by deploying targeted and enhanced loss mitigation programs; (ii) increasing visibility to Ambac Assurance of all servicing activities that impact overall deal performance; (iii) better aligning the servicer’s financial interest to the performance of the underlying deal through the utilization of performance based incentives; and (iv) reducing the risk of servicer underperformance due to servicer financial difficulty.
. Ambac Assurance believes that the improved loss mitigation activities, alignment of interests and close monitoring of servicers constitute credible means of minimizing risks and losses related to insured RMBS.
A team of professionals has also been established to focus on recoveries from sponsors where Ambac Assurance believes that a material breach of representations and warranties has occurred with respect to certain RMBS policies. The team monitors monthly performance of the RMBS insured portfolio and uses criteria to determine which transactions to pursue with regard to such recoveries. The team engages experienced consultants to perform the re-underwriting of loan files and consult with internal and external legal counsel with regard to loan putbacks as well as settlement and litigation strategies (refer to Note 8. Financial Guarantee Insurance Contracts to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further discussion on this topic).
The risk restructuring group focuses on the analysis, implementation and execution of commutation and related claims reduction or defeasance strategies primarily for policies allocated to the Segregated Account. Analysts evaluate the estimated timing and severity of projected policy claims as well as the potential impact of other loss mitigation strategies in order to target and prioritize policies, or portions thereof, for commutation, refinancing or other claims reduction or defeasance strategies. For targeted policies, analysts will engage with bondholders, issuers and other economic stakeholders to negotiate, structure, and execute such strategies.
Credit Risk Management ("CRM")
CRM manages the decision process for all material matters that affect credit exposures within the insured portfolio. While PRM is responsible for the credit analysis and the recommendation and execution of credit remediation strategies, CRM provides a forum for independent assessments and sign-offs and drives consistency and timeliness. The scope of credit matters under the purview of CRM includes material amendments, waivers and consents, remediation plans, credit review scheduling, adverse credit classification and below investment grade rating designations, adversely classified credit reviews, sector reviews, and overall portfolio review. The decision process may involve a review of structural, legal, political and credit issues and also includes determining the proper level of approval, which varies based on the nature and materiality of the matter. Decisions that also have material asset, liability, and liquidity implications, such as commutations and buybacks also require ALCO approval of such asset, liability and liquidity implications. 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 Form 10-K for further discussion of the various credit classifications.
Adversely Classified Credit Review
Credits that are either in default or have developed problems that eventually may lead to a default are tracked closely by the appropriate PRM surveillance team and discussed at meetings with CRM. Adversely classified credit meetings include members of CRM, PRM and legal, as necessary. As part of the review, relevant information, along with the plan for corrective actions and a reassessment of the credit’s rating and credit classification is considered. Internal and/or external counsel generally review the documents underlying any problem credit and, if applicable, an analysis is prepared outlining Ambac Assurance’s rights and potential remedies, the duties of all parties involved and recommendations for corrective actions. Ambac Assurance also meets with relevant parties to the transaction as necessary. The review schedule for adversely classified credits is tailored to the remediation plan to track and prompt timely action and proper internal and external resourcing. A summary of developments regarding adversely classified credits and credit trends is also provided to Ambac’s and Ambac Assurance’s Board of Directors no less than on a quarterly basis.
The insured portfolio contains exposures that are correlated and/or concentrated. Ambac’s surveillance includes identifying these types of exposures and identifying the risks that would or could trigger credit deterioration across the related exposures. When such risks occur, adverse credit classification may be warranted across many of the correlated and/or concentrated exposures. This is the case with student loans and RMBS, for example. In the past, our not for profit healthcare and our leveraged lease exposures experienced periods of stress arising from their concentrated and/or correlated risks. In the future, Ambac’s portfolio may be subject to similar credit deterioration arising from concentrated and/or correlated risks. Examples of other such risks that could impact our portfolio, and that our surveillance is designed to monitor include the impact of potential municipal bankruptcy contagion or large scale domestic military cutbacks on our military housing portfolio or event risk such as natural disasters or other regional stresses. Most such risks cannot be predicted, and may materialize unexpectedly or develop rapidly. Although our surveillance allows us to connect the event and stress to the related exposures and assign an adverse credit classification and estimate losses across the affected credits, when necessary, we may not have adequate resources or contractual rights and remedies to mitigate loss arising from such risks.

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Amendment, Waiver and Consent Review / Approval
The decision to approve or reject AWCs is based upon certain credit factors, such as the issuer’s ability to repay the bonds and the bond’s security features and structure. Members of Ambac Assurance’s PRM group review, analyze and process all requests for AWCs. All AWCs are initially screened for materiality in the surveillance groups. Non-material AWCs require the approval of at least a PRM surveillance analyst and a portfolio risk manager. Material AWCs are within the purview of CRM, as noted above. For material AWCs, CRM has established minimum requirements that may be modified to require more or varied approvals depending upon the matter’s complexity, size or other characteristics.
Ambac Assurance assigns internal credit ratings to individual exposures as part of the AWC process and at surveillance reviews. These internal credit ratings, which represent Ambac Assurance’s independent judgments, are based upon underlying credit parameters consistent with the exposure type.
Financial Guarantees in Force
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 sector at December 31, 2014 and 2013. Net par exposures within the U.S. public finance market include capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy. Guaranteed net par outstanding includes the exposures of policies that insure variable interest entities (“VIEs”) consolidated in accordance with ASC Topic 810, Consolidation. Guaranteed net par outstanding excludes the exposures of policies that insure bonds which have been refunded or pre-refunded:
 
December 31,
($ in millions)
2014
 
2013
Public Finance
$
93,448

 
$
116,062

Structured Finance
26,334

 
31,412

International Finance
24,952

 
31,618

Total net par outstanding
$
144,734

 
$
179,092

Included in the above net par exposures at December 31, 2014 and 2013 are $1,530 and $2,776, respectively, of exposures that were executed in the form of credit derivatives, primarily collateralized loan exposures. See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, “Financial Statements and Supplementary Data” for further discussion of credit derivative exposures.
U.S. Public Finance Insured Portfolio
Ambac’s portfolio of U.S. public finance exposures is $93,448 million, representing 65% of Ambac’s net par outstanding as of December 31, 2014 and a 19% reduction from the amount outstanding at December 31, 2013. This reduction in exposure was mainly due to normal exposure runoff in addition to early terminations, primarily related to lease and tax-backed exposures. While Ambac’s U.S. public finance portfolio consists predominantly of municipal bonds such as general and revenue obligations and lease and tax-backed obligations of state and local government entities, the portfolio also comprises 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 interests. See Note 7. 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.
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 their debt service while undergoing severe stress. Municipal bankruptcy, while still uncommon, has increased, exposing Ambac to the risk of liquidity claims and ultimate losses if issuers cannot successfully adjust their liabilities without impairing debt creditors.
Not-for-profit transactions are generally supported by the not-for-profit entities’ net revenues and may also include specific pledges, liens and/or mortgages. The entity typically serves a well-defined market and promulgates a public purpose mission. These transactions may afford Ambac contractual protections such as financial covenants and control rights in the event of issuer breaches and defaults. Risk factors in these transactions derive from the creditworthiness of the issuer, including but not limited to its financial condition, leverage, management, business mix, competitive position, industry and socioeconomic trends, government programs, etc. Examples of these types of transactions include not-for-profit hospitals, universities, charities, associations and museums.
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, and privatized military and student housing. Protections within these financings provided to Ambac usually include the strength of the financed asset’s essentiality and public purpose, 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 is U.S. military housing. Ambac insures approximately $6.1 billion 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 domestic U.S. military bases. Debt service is not directly paid or guaranteed by the U.S. Government. Rather, the bonds are serviced from the cash flow generated by

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rental payments deposited by the military directly into lockbox accounts as part of each service personnel’s Basic Allowance for Housing (BAH). Collateral for these transactions includes the BAH payments as well as an interest in the ground lease. Risk factors affecting these transactions include the ongoing base essentiality, military deployments, the U.S. government’s commitment to fund the BAH, the marketability/attractiveness of the on-base housing units versus off base housing, construction completion, environmental remediation, utility and other operating costs, and housing management.
Certain issuers in our public finance portfolio have issued floating rate debt, which may introduce interest rate risk to Ambac Assurance. Refer to Auction Rate Securities and Variable Rate Demand Obligation Exposures below for further discussion.
The table below shows Ambac’s ten largest U.S. public finance exposures, by repayment source, as a percentage of total financial guarantee net par outstanding at December 31, 2014:
($ in millions)
Ambac
Ratings(1)
 
Net Par
Outstanding
 
% of Total
Net Par
Outstanding
California State - GO
A
 
$
2,090

 
1.4
%
New Jersey Transportation Trust Fund Authority-Transportation System
A-
 
1,868

 
1.3
%
Massachusetts School Building Authority, MA, Sales Tax Revenue
AA
 
1,224

 
0.8
%
Massachusetts Commonwealth-GO
AA
 
1,182

 
0.8
%
NYS Thruway Authority, Highway & Bridge Revenue
AA-
 
1,112

 
0.8
%
Puerto Rico Sales Tax Financing Corporation(2)
BIG
 
805

 
0.6
%
Washington State - GO
AA
 
764

 
0.5
%
Puerto Rico Highways & Transportation Authority, Transportation Revenue(2)
BIG
 
712

 
0.5
%
New York Convention Center Development Corporation, Hotel Fee Revenue
A-
 
650

 
0.4
%
Chicago, IL - GO
BBB+
 
642

 
0.4
%
Total
 
 
$
11,049

 
7.6
%
(1)
Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance. In cases where Ambac Assurance 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 Assurance credit ratings are subject to revision at any time and do not constitute investment advice. Ambac Assurance, or one of its affiliates, has guaranteed the obligations listed and may also provide other products or services to the issuers of these obligations for which Ambac Assurance may have received premiums or fees. “BIG” denotes credits deemed below investment grade.
(2)
Ambac Assurance has total net par outstanding to various Puerto Rico exposures with a total par of $2,437. Puerto Rico net par outstanding includes capital appreciation bonds which are reported at the par amount at the time of issuance of the related insurance policy.


U.S. Structured Finance Portfolio
Ambac’s portfolio of U.S. structured finance exposures is $26,334 million, representing 18% of Ambac’s net par outstanding as of December 31, 2014 and a 16% reduction from the amount outstanding at December 31, 2013. This reduction in exposure was the result of normal exposure runoff, primarily related to residential mortgage-backed policies, in addition to terminations of student loan and asset backed policies. Insured exposures include securitizations of mortgage loans, home equity loans, student loans, leases, operating assets, collateralized debt obligations ("CDO"), collateralized loan obligations (“CLO”), and other asset-backed financings, in each case where the majority of the underlying collateral risk is situated in the United States. Additionally, Ambac’s structured finance insured portfolio encompasses both secured and unsecured debt issued by investor-owned utilities. Included within the operating asset sector are securitizations of aircraft, shipping containers, rail car fleets and other assets. See Note 7. Financial Guarantees in-Force to the Consolidated Financial Statements, included in Part II, Item 8 included in this Form 10-K, for exposures by bond type as of December 31, 2014.
Structured finance exposures generally entail three forms of risks: (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. Ambac Assurance seeks to mitigate and manage these risks through its risk management practices.
Structured securities are usually designed to help protect the investors and, therefore, the guarantor from the bankruptcy or insolvency of the entity that originated the underlying assets as well as from the bankruptcy or insolvency of the servicer of those assets. The servicer of the assets is typically responsible for collecting cash payments on the underlying assets and forwarding such payments, net of servicing fees, to a trustee for the benefit of the issuer. One potential issue is whether the sale of the assets by the originator to the issuer would be upheld in the event of the bankruptcy or insolvency of the originator and whether the servicer of the assets may be permitted or stayed from remitting to investors cash collections held by it or received by it after the servicer or the originator becomes subject to bankruptcy or insolvency proceedings. Another potential issue is whether the originator sold ineligible assets to the securitization transaction that subsequently deteriorated, and, if so, whether the originator has the willingness or financial wherewithal to meet its contractual obligations to repurchase those assets out of the transaction. Structural protection in a transaction, such as control rights that are typically held by the senior note holders, or guarantor in insured transactions, will determine the extent to which underlying asset performance can be influenced upon non-performance to improve the revenues available to cover debt service.

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The following table presents the top five servicers by net par outstanding at December 31, 2014 for U.S. structured finance exposures:
Servicer
($ in millions)
Bond Type
 
Net Par
Outstanding
 
% of Total
Net Par
Outstanding
Bank of America N.A.
Mortgage-backed
 
$
3,205

 
2.2
%
Specialized Loan Servicing, LLC
Mortgage-backed
 
3,011

 
2.1
%
Pennsylvania Higher Education Assistance Agency
Student Loan
 
2,251

 
1.6
%
Ocwen Loan Servicing, LLC
Mortgage-backed
 
1,826

 
1.3
%
Wells Fargo Bank
Mortgage-backed
 
1,586

 
1.1
%
The table below shows Ambac’s ten largest structured finance transactions, as a percentage of total financial guarantee net par outstanding at December 31, 2014:
($ in millions)
Bond Type
 
Ambac
Rating(1)
 
Net Par
Outstanding
 
% of Total
Net Par
Outstanding
Ballantyne Re Plc(2)
Structured Insurance
 
BIG
 
$
900

 
0.6
%
Wachovia Asset Securitization Issuance II, LLC 2007-HE2(3)
Home Equity Loan
 
BIG
 
853

 
0.6
%
The National Collegiate Student Loan Trust 2007-4(3)
Student Loan
 
BIG
 
714

 
0.5
%
Timberlake Financial, LLC
Structured Insurance
 
BBB-
 
608

 
0.4
%
Wachovia Asset Securitization Issuance II, LLC 2007-HE1(3)
Home Equity Loan
 
BIG
 
602

 
0.4
%
Progress Energy Carolinas, Inc
Investor Owned Utility
 
A-
 
558

 
0.4
%
Local Insight Media Finance LLC
Asset Securitizations
 
BIG
 
489

 
0.3
%
Niagara Mohawk Power Corporation
Investor Owned Utility
 
A
 
414

 
0.3
%
Option One Mortgage Loan Trust 2007-FXD1(3)
Home Equity Loan
 
BIG
 
397

 
0.3
%
CenterPoint Energy, Inc.
Investor Owned Utility
 
BBB+
 
376

 
0.3
%
Total
 
 
 
 
$
5,911

 
4.1
%
(1)
Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance, and for Ambac UK related transactions, based on the view of Ambac UK. Ambac UK rates their transactions using the same rating definitions as Ambac Assurance. In cases where Ambac Assurance or Ambac UK 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 Assurance and Ambac UK credit ratings are subject to revision at any time and do not constitute investment advice. Ambac Assurance, or one of its affiliates, has guaranteed the obligations listed and may also provide other products or services to the issuers of these obligations for which Ambac may have received premiums or fees. “BIG” denotes credits deemed below investment grade.
(2)
Insurance policy issued by Ambac UK.
(3)
Ambac Assurance has allocated this transaction to the Segregated Account.
International Finance Insured Portfolio
Ambac’s portfolio of international finance insured exposures is $24,952 million, representing 17% of Ambac’s net par outstanding as of December 31, 2014 and a 21% reduction from the amount outstanding at December 31, 2013. This reduction in exposure was primarily the result of terminations of asset-backed and transportation policies, exposure runoff and the impact of the strengthening of the US dollar. Ambac’s international finance insured exposures include a wide array of obligations in the international markets, including infrastructure financings, asset-securitizations, CDOs, utility obligations, and whole business securitizations (e.g. securitizations of substantially all of the operating assets of a corporation). Ambac has minimal insured exposure remaining related to emerging markets. See Note 7. Financial Guarantees in-Force to the Consolidated Financial Statements, included in Part II, Item 8 included in this Form 10-K, for exposures by bond type as of December 31, 2014.
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 UK, which is regulated in the United Kingdom (“UK”), had been Ambac Assurance’s primary vehicle for directly issuing financial guarantee policies in the UK and the European Union with $21,015 million net par outstanding at December 31, 2014. Geographically, Ambac UK’s exposures are principally in the UK and continental Europe. The portfolio of insured exposures underwritten by Ambac UK is financially supported exclusively by the assets of Ambac UK and no capital support arrangements are in place with any other Ambac affiliate. See Additional Insured Portfolio Information - European Union for further details of non-UK exposures.

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The table below shows our ten largest international finance transactions as a percentage of total financial guarantee net par outstanding at December 31, 2014. Except where noted, all international finance transactions included in the table below are insured by Ambac UK:
($ in millions)
Country-Bond Type
 
Ambac
Rating(1)
 
Net Par
Outstanding
 
% of Total
Net Par
Outstanding
Mitchells & Butlers Finance plc-UK Pub Securitisation
UK-Asset  Securitizations
 
A+
 
$
1,868

 
1.3
%
National Grid Electricity Transmission
UK-Utility
 
A-
 
1,221

 
0.8
%
Aspire Defense Finance plc
UK-Infrastructure
 
BBB+
 
1,132

 
0.8
%
Capital Hospitals plc(2)
UK-Infrastructure
 
BBB
 
1,035

 
0.7
%
Telereal Securitisation plc
UK-Asset Securitizations
 
AA
 
1,026

 
0.7
%
Channel Link Enterprises
UK-Infrastructure
 
BBB-
 
929

 
0.6
%
Posillipo Finance II S.r.l.
Italy-Sub-Sovereign
 
BBB
 
899

 
0.6
%
Anglian Water
UK-Utility
 
A-
 
852

 
0.6
%
Ostregion Investmentgesellschaft NR 1 SA(2)
Austria-Infrastructure
 
BIG
 
841

 
0.6
%
National Grid Gas
UK-Utility
 
A-
 
787

 
0.5
%
Total
 
 
 
 
$
10,590

 
7.3
%
(1)
Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance, and for Ambac UK related transactions, based on the view of Ambac UK. Ambac UK rates their transactions using the same rating definitions as Ambac Assurance. In cases where Ambac Assurance or Ambac UK 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 Assurance and Ambac UK credit ratings are subject to revision at any time and do not constitute investment advice. Ambac Assurance, or one of its affiliates, has guaranteed the obligations listed and may also provide other products or services to the issuers of these obligations for which Ambac may have received premiums or fees. “BIG” denotes credits deemed below investment grade.
(2)
A portion of this transaction is insured by an insurance policy issued by Ambac Assurance.
Additional Insured Portfolio Information
CDO and CLO
CDO and CLO transactions involve the securitization of a portfolio of corporate bonds, corporate loan obligations and/or asset-backed securities. These transactions are included in either the US structured finance market or the international finance market dependent upon the geographic characteristics of the risk. The majority of these exposures are executed through credit derivatives. Ambac’s outstanding CDO and CLO exposures are comprised of the following types as of December 31, 2014 and 2013:
 
December 31,
Business Mix by Net Par
($ in billions)
2014
 
2013
Net Par
 
Percentage
 
Net Par
 
Percentage
High yield corporate
$
550

 
63
%
 
$
1,356

 
79
%
Market value CDOs
113

 
13
%
 
64

 
4
%
Other
207

 
24
%
 
299

 
17
%
Total
$
870

 
100
%
 
$
1,719

 
100
%
Average Life of Insured Portfolio
Ambac Assurance underwrote and priced financial guarantees based on the assumption that the guarantees would remain in force until the maturity of the underlying bonds. Ambac Assurance estimates that the average life of its guarantees on par in force at December 31, 2014 is approximately 11 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 voluntary and involuntary prepayments over the remaining life of the insured obligation.

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Issue Size
Ambac Assurance’s financial guarantee exposure in the U.S. public finance market reflects the historical participation across the whole range of deal sizes including those with an original par amount of less than $50 million. U.S. structured finance and international finance transactions generally involved larger transaction sizes. The following table sets forth the distribution of Ambac’s guaranteed portfolio as of December 31, 2014 with respect to the current size of each guaranteed issue:
 
 
 
 
 
Net Par Amount
as of December 31, 2014
Current Par Amount
($ in millions)
Number of
Issues
 
% of Total
Number of Issues
 
Amount
Outstanding
 
% of Total
Less than $10 million
4,488

 
67
%
 
$
12,716

 
9
%
$10—less than $50 million
1,572

 
23
%
 
34,788

 
24
%
$50—$250 million
548

 
8
%
 
52,914

 
36
%
Greater than $250 million
107

 
2
%
 
44,316

 
31
%
Total
6,715

 
100
%
 
$
144,734

 
100
%
Geographic Area
The following table sets forth the geographic distribution of Ambac Assurance’s insured exposure as of December 31, 2014:
Geographic Area
($ in millions)
Net Par
Amount
Outstanding
 
% of Total Net
Par Amount
Outstanding
Domestic:
 
 
 
California
$
20,744

 
14.3
%
New York
9,245

 
6.4
%
Florida
6,805

 
4.7
%
Texas
6,095

 
4.2
%
New Jersey
5,464

 
3.8
%
Illinois
4,326

 
3.0
%
Massachusetts
4,154

 
2.9
%
Colorado
3,574

 
2.5
%
Pennsylvania
3,082

 
2.1
%
Puerto Rico(1)
2,437

 
1.7
%
Mortgage and asset-backed(2)
15,021

 
10.4
%
Other domestic
38,835

 
26.8
%
Total Domestic
119,782

 
82.8
%
International:
 
 
 
United Kingdom
17,998

 
12.4
%
Australia
2,168

 
1.5
%
Italy
1,415

 
1.0
%
Austria
841

 
0.6
%
New Zealand
459

 
0.3
%
Internationally diversified(3)
1,225

 
0.8
%
Other international
846

 
0.6
%
Total International
24,952

 
17.2
%
Total
$
144,734

 
100.0
%
(1)
Puerto Rico net par outstanding includes capital appreciation bonds which are reported at the par amount at the time of issuance of the related insurance policy.
(2)
Mortgage and asset-backed obligations includes guarantees with multiple locations of risk within the United States and is primarily comprised of residential mortgage and commercial asset-backed securitizations.
(3)
Internationally diversified may include components of U.S. exposure.
Other European Union Exposures (“EU”)
Ambac's international exposures are principally in the United Kingdom; however, we also have exposures with credit risk based in various other EU member states, including Austria, France, Germany, Ireland, Italy and Spain.  The company also has limited indirect exposures to these countries through its CDO and CLO debt obligations. These obligations were structured to limit exposures to any given obligor and any given non-US country or region. Several of these countries have experienced significant economic, fiscal and/or political strains such that the likelihood

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of default on such obligations is higher than when the policies were underwritten. The Company’s exposures, net of reinsurance, to these countries are shown in the following table:
($ in Millions)
 
Austria
 
France
 
Germany
 
Ireland
 
Italy
 
Spain & Portugal
 
Total
Sub-sovereign
 
$

 
$
37

 
$

 
$

 
$
899

 
$

 
$
936

Infrastructure / operating ABS
 
841

 
50

 

 

 
516

 

 
1,407

Structured insurance
 

 

 

 
128

 

 

 
128

Investor-owned utility
 

 

 
64

 

 

 
51

 
115

Total
 
$
841

 
$
87

 
$
64

 
$
128

 
$
1,415

 
$
51

 
$
2,586

Total below investment grade
 
$
841

 
$

 
$
64

 
$

 
$

 
$
51

 
$
956

Ambac does not guarantee any sovereign bonds of the above EU countries. However, the exposures classified as sub sovereign may be impacted should there be continued adverse financial developments in the EU. Those exposures classified as infrastructure/operating asset backed are concession based where the underlying assets independently generate cash flow without operational reliance on the sovereign. Of the three below investment grade exposures, two are investor-owned utilities, one wind farm and one mini hydro-electric plant both of which are undergoing restructuring processes designed to address their performance issues. The other below investment grade exposure is a road transaction, where performance has been poorer than anticipated due to lower than forecast traffic volumes, however performance is improving. Below investment grade is defined as those exposures with a credit rating below BBB-.
Ambac UK also has exposure to Channel Link Enterprises, which is an infrastructure transaction connecting the United Kingdom with France; such exposure is classified within the United Kingdom in the Geographic Area section above.
Exposure Currency
The table below shows the distribution by currency of Ambac Assurance’s insured exposure as of December 31, 2014:
Currency
($ in millions)
Net Par Amount
Outstanding in
Base Currency
 
Net Par Amount
Outstanding in
U.S. Dollars
U.S. Dollars
$
122,022

 
$
122,022

British Pounds
£
11,350

 
17,687

Euros
2,149

 
2,600

Australian Dollars
A$
2,405

 
1,966

New Zealand Dollars
NZ$
589

 
459

Total
 
 
$
144,734

Ratings Distribution
The following tables provide a rating distribution of guaranteed total net par outstanding based upon internal Ambac Assurance credit ratings at December 31, 2014 and 2013 and a distribution by bond type of Ambac Assurance’s below investment grade net par exposures at December 31, 2014 and 2013. Below investment grade is defined as those exposures with an internal credit rating below BBB-:
 
December 31,
Ambac Rating(1)
2014
 
2013
AAA
<1%

 
<1%

AA
19

 
20

A
42

 
43

BBB
22

 
20

Below investment grade
17

 
17

Total
100
%
 
100
%
(1)
Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance, and for Ambac UK related transactions, based on the view of Ambac UK. In cases where Ambac Assurance or Ambac UK 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 Assurance and Ambac UK credit ratings are subject to revision at any time and do not constitute investment advice.

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Summary of Below Investment Grade Exposure:
Bond Type
Net Par Outstanding - December 31,
($ in millions)
2014
 
2013
Public Finance:
 
 
 
Tax-backed(1)
$
2,512

 
$
1,887

Housing(2)
841

 
732

General obligation(1)
564

 
363

Transportation
453

 
519

Health care
27

 
30

Other
1,293

 
1,291

Total Public Finance
5,690

 
4,822

Structured Finance:
 
 
 
Residential mortgage-backed and home equity—first lien
7,003

 
8,092

Residential mortgage-backed and home equity—second lien
5,466

 
6,440

Student loans
3,092

 
4,223

Structured Insurance
1,037

 
1,648

Mortgage-backed and home equity—other
299

 
346

Other
536

 
547

Total Structured Finance
17,433

 
21,296

International Finance:
 
 
 
Other
2,214

 
3,702

Total International Finance
2,214

 
3,702

Total
$
25,337

 
$
29,820

(1)
Tax-backed includes $2,187 and $1,430 of Puerto Rico net par at December 31, 2014 and 2013, respectively. General obligation includes $250 and $0 of Puerto Rico net par at December 31, 2014 and 2013, respectively. Puerto Rico net par outstanding includes capital appreciation bonds which are reported at the par amount at the time of issuance of the related insurance policy.
(2)
Includes $609 and $486 of military housing net par at December 31, 2014 and 2013, respectively.
The decrease in below investment grade exposures are primarily due to (i) reductions to residential mortgage-backed securities during the year as a result of both prepayments by issuers and claims presented to Ambac Assurance, (ii) improvements on a structured insurance transaction resulting in an upgrade to investment grade, (iii) issuer principal payments on student loans and (iv) a refinancing of an international asset securitization, partially offset by an increase due to deterioration in Puerto Rico and military housing exposures.
U.S. residential mortgage-backed securities exposure
Ambac has exposure to the U.S. mortgage market primarily through direct financial guarantees of RMBS, including transactions that contain risks to first and second liens. Ambac classifies its insured first-lien RMBS exposure principally into two broad credit risk classes: mid-prime (including Alt-A, interest only, and negative amortization) and sub-prime. Mid-prime loans were typically made to borrowers who had stronger credit profiles relative to sub-prime loans, but weaker than prime loans. Compared with mid-prime loans, sub-prime loans typically had higher loan-to-value ratios, reflecting the greater difficulty that sub-prime borrowers have in making down payments and the propensity of these borrowers to extract equity during refinancing. The mid-prime category includes:
Loans with specific payment features that afforded borrowers the option to have lower payments in the early years with potential resets after several years. For example, so-called interest only loans have monthly payments comprised of interest but no principal. So called negative amortization loans permit borrowers to defer interest and principal in the early years and then make higher payments in the period after the reset. Both types may also have lower interest rates in the early years. Increases in monthly payments, commonly called payment shock, raise the probability of delinquencies and defaults given the decline in house prices that has caused many borrowers’ loan balances to exceed their homes’ market value.
Loans backed by borrowers who typically did not meet standard agency guidelines for documentation requirement, property type or loan-to-value ratio. These are typically higher-balance loans made to individuals who might have past credit problems that were not severe enough to warrant “sub-prime” classification, or borrowers who chose not to obtain a prime mortgage due to documentation requirements.
Ambac's second lien insured RMBS transactions are collateralized predominantly by second-lien mortgage loans such as closed-end seconds and home equity lines of credit. A second-lien mortgage loan is a type of loan in which the borrower uses the equity in their home as collateral and the second-lien loan is subordinate to the first-lien loan outstanding on the home. The borrower is obligated to make monthly payments on both their first and second-lien loans. If the borrower defaults on the payments due under these loans and the property is subsequently liquidated, the liquidation proceeds are first utilized to pay off the first-lien loan (as well as costs due the servicer) and any remaining funds are applied to pay off the second-lien loan. As a result of this subordinate position to the first-lien loan, second-lien loans carry a significantly higher severity in the event of a loss, typically at or above 100% in the current housing market.

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The following tables provide, by vintage and type current net par outstanding of Ambac’s U.S. RMBS book of business:
 
Total Net Par Outstanding - December 31, 2014
Year of Issue
($ in millions)
Second Lien
 
First-lien
Sub-prime
 
First-lien
Mid-prime
 
Other(1)
1998-2001
$
23

 
$
450

 
$
2

 
$
293

2002
14

 
391

 
39

 
8

2003
13

 
565

 
227

 
127

2004
625

 
329

 
408

 
15

2005
724

 
767

 
1,394

 
49

2006
2,042

 
518

 
700

 
75

2007
2,070

 
398

 
1,252

 
168

Total
$
5,511

 
$
3,418

 
$
4,022

 
$
735

% of Total RMBS Portfolio
40.2
%
 
25.0
%
 
29.4
%
 
5.4
%
% of Related Par Outstanding rated below investment grade (2)
99.2
%
 
91.7
%
 
95.6
%
 
43.9
%
 
Total Net Par Outstanding - December 31, 2013
Year of Issue
($ in millions)
Second Lien
 
First-lien
Sub-prime
 
First-lien
Mid-prime
 
Other(1)
1998-2001
$
42

 
$
509

 
$
3

 
$
354

2002
23

 
445

 
45

 
12

2003
19

 
653

 
269

 
146

2004
833

 
365

 
488

 
23

2005
876

 
870

 
1,608

 
53

2006
2,305

 
588

 
827

 
87

2007
2,429

 
441

 
1,518

 
194

Total
$
6,527

 
$
3,871

 
$
4,758

 
$
869

% of Total RMBS Portfolio
40.7
%
 
24.2
%
 
29.7
%
 
5.4
%
% of Related Par Outstanding rated below investment grade (2)
98.7
%
 
91.9
%
 
94.8
%
 
43.0
%
(1)
Other primarily includes manufactured housing and lot loan exposures
(2)
Ambac’s below investment grade internal ratings reflect bonds which are of speculative grade credit quality with the adequacy of future margin levels for payment of interest and repayment of principal potentially adversely affected by major ongoing uncertainties or exposure to adverse conditions. Ambac Assurance’s below investment grade category includes transactions on which claims have been submitted.
Student Loans
Ambac Assurance’s student loan portfolio consists of credits collateralized by (i) federally guaranteed loans under the Federal Family Education Loan Program (“FFELP”) and (ii) private student loans. Whereas FFELP loans are guaranteed for a minimum of 97% of defaulted principal and interest, private loans have no government guarantee and, therefore, are subject to credit risk as with other types of unguaranteed credits. Default data has shown a significant deterioration in the performance of private student loans underlying some of our transactions. Additionally, due to the failure of the auction rate markets, the interest rates on some student loan securities have increased significantly to punitive levels pursuant to the transaction terms. Such increases have caused the collateralization ratio in these transactions to deteriorate on an accelerated basis due to negative excess spread and/or the use of principal receipts to pay current interest. The combined increase in defaults and the penalty rate on the auction rate securities continue to erode the collateralization levels in many of the trusts we insure. This impact has been offset modestly by the current low interest rate environment. Student loan net par outstanding on Ambac insured obligations are as follows:
 
December 31,
Issuer type
2014
 
2013
($ in millions)
Net Par
 
% of Net Par
 
Net Par
 
% of Net Par
For-Profit Issuers
$
2,624

 
77
%
 
$
2,660

 
61
%
Not-For-Profit Issuers
766

 
23
%
 
1,697

 
39
%
Total
$
3,390

 
100
%
 
$
4,357

 
100
%

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Collateral for the For-Profit Issuers consists of private loans which do not have any federal guarantee as to defaulted principal and interest. Collateral for the Not-For-Profit Issuers consists of both FFELP and private student loans. For the Not-For-Profit student loan portfolio, approximately 96% of the collateral backing student loan trusts consists of private loans while the remaining 4% consists of FFELP loans.
New private student loan capital market transactions require a significant amount of equity which makes the refinancing of Ambac insured transactions backed by private loans difficult for issuers. As such, we do not expect that our private loan exposure, particularly For-Profit Issuers, will be significantly reduced via refinancing in the near term. The following table represents the student loan net par outstanding by underlying debt-type on Ambac insured obligations:
 
December 31,
Debit Type
2014
 
2013
($ in millions)
Net Par
 
% of Net Par
 
Net Par
 
% of Net Par
Auction Rate
$
1,022

 
30
%
 
$
1,814

 
42
%
Fixed Rate
181

 
5
%
 
229

 
5
%
Floating Rate Notes
2,163

 
64
%
 
2,218

 
51
%
Debt Service Reserve
24

 
1
%
 
96

 
2
%
Total
$
3,390

 
100
%
 
$
4,357

 
100
%
All of the Auction Rate debt is paying interest at the maximum auction rate or the “penalty rate” pursuant to the transaction documents, reflecting both the failure of the auction rate market as well as the below investment grade credit ratings of the deals.
Auction Rate Securities (“ARS”) and Variable Rate Demand Obligations (“VRDO”):
Debt securities issued in the bond market include fixed and variable rate bonds. Included within the variable rate bond category are ARS and VRDO issued in the United States. The following table sets forth Ambac Assurance’s financial guarantee net par exposure outstanding, by bond type, relating to such variable rate securities at December 31, 2014 and 2013:
 
December 31,
($ in millions)
2014
 
2013
Investor-owned utilities
$
2,403

 
$
2,465

Student Loans
1,022

 
1,814

Healthcare
825

 
1,040

Lease and Tax-backed
570

 
708

Transportation
403

 
513

Utility
304

 
305

General Obligation
107

 
110

Other
403

 
537

Total
$
6,037

 
$
7,492

ARS are sold through a Dutch auction, which is a competitive bidding process used to determine rates on each auction date. VRDO are long-term bonds that bear a floating interest rate and that provide investors the option to tender or put securities back to the issuer or the liquidity provider at any time with appropriate notice. Additionally, there are certain mandatory events that require all bondholders to tender their VRDO to the issuer or liquidity provider. The interest rate resets daily or weekly, depending upon the security.
VRDO are typically supported by a liquidity facility in the form of a standby bond purchase agreement (“Standby Bond Purchase Agreement”), usually provided by a commercial bank (“Liquidity Provider”). If the remarketing agent is unable to remarket all tendered VRDO, the Liquidity Provider is required to purchase such VRDO at the purchase price, subject to limited conditions precedent, thus providing liquidity to investors. While held by the Liquidity Provider, VRDO bear interest at a rate determined under the Standby Bond Purchase Agreement, often based on the Prime Rate or LIBOR plus a spread (the “Bank Rate”). During such time, the remarketing agent remains obligated to continue to try to remarket the VRDO held by the Liquidity Provider. Many Standby Bond Purchase Agreements provide that, after the Liquidity Provider has held the VRDO for a specified time period, the issuer or other obligor is required to cause such VRDO to be redeemed prior to maturity, either: in periodic installments over a predetermined number of years, typically from three to five (the “Term-Out”); or with available funds as defined in the transaction documents; or in a single lump sum at the end of three to five years. Other Standby Bond Purchase Agreements do not contain a Term-Out. For VRDO insured by Ambac Assurance, Ambac Assurance typically endorsed its insurance policy to cover interest at the Bank Rate. For VRDO insured by Ambac Assurance that contain a Term-Out, Ambac often endorsed its insurance policy to cover the required redemptions in accordance with the Term-Out schedule (though not any acceleration of the VRDO maturity ahead of the Term-Out schedule).
Issuers have been working toward reducing their debt service costs for ARS and VRDO transactions. The most prevalent ways have been; (i) refunding or refinancing the obligations and issuing new bonds or other debt structures; (ii) entering into interest rate swaps to synthetically

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fix their interest rates; (iii) purchasing direct-pay letters of credit from other financial institutions; (iv) amending their liquidity facilities to address investor liquidity concerns; or (v) converting the bonds to fixed rate (to maturity or for a shorter period of time).
For Ambac Assurance insured ARS and VRDO transactions that have been unable to refinance, the higher debt service costs have resulted in decreased debt service coverage ratios and/or the erosion of first loss and/or other credit enhancements that are subordinate to Ambac Assurance’s risk position (such as excess spread). Ambac continues to actively review the credit implications of this additional issuer stress and its impact to our internal credit ratings and loss reserves as necessary.
Reinsurance
Ceded Reinsurance:

Ambac Assurance has reinsurance in place pursuant to surplus share treaty and facultative agreements. As a primary financial guarantor, Ambac Assurance is required to honor its obligations to its policyholders whether or not its reinsurers perform their obligations under these reinsurance agreements. For exposures reinsured, Ambac Assurance withholds a ceding commission to defray its underwriting and operating expenses. To minimize its exposure to losses from reinsurers, Ambac Assurance (i) monitors the financial condition of its reinsurers; (ii) is entitled to receive collateral from its reinsurance counterparties in certain reinsurance contracts; and (iii) has certain cancellation rights that can be exercised by Ambac Assurance in the event of rating agency downgrades of a reinsurer (among other events and circumstances). Ambac Assurance held letters of credit and collateral amounting to $141.3 million from its reinsurers at December 31, 2014. As of December 31, 2014, the aggregate amount of insured par ceded by Ambac Assurance to reinsurers under reinsurance agreements was $14,954 million, with the largest reinsurer accounting for $13,366 million or 8.4% of gross par outstanding at December 31, 2014. The following table represents the percentage ceded to reinsurers and reinsurance recoverable at December 31, 2014 and the reinsurers’ rating levels as of February 25, 2015:
Reinsurers
Moody’s
Rating
 
Moody’s
Outlook
 
Percentage
ceded Par
 
Net unsecured
reinsurance
recoverable (1)
($ in millions)
 
 
 
Assured Guaranty Re Ltd
Baa1
 
Negative
 
89.4%
 
$
37.6

Sompo Japan Nipponkoa Holdings, Inc.
A1
 
Stable
 
6.1%
 

Assured Guaranty Corporation
A3
 
Negative
 
4.5%
 
4.4

Total
 
 
 
 
100%
 
$
42.0

(1)
Represents reinsurance recoverables on paid and unpaid losses and deferred ceded premiums, net of ceded premium payables due to reinsurers, letters of credit, and collateral posted for the benefit of Ambac Assurance.

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The following table shows the distribution, by bond type, of Ambac Assurance’s ceded guaranteed portfolio at December 31, 2014:
Bond Type
($ in millions)
Ceded Par
Amount
Outstanding
 
% of Gross
Par Ceded
Public Finance:
 
 
 
Lease and tax-backed revenue
$
3,692

 
10
%
General obligation
2,888

 
11
%
Utility revenue
1,735

 
13
%
Transportation revenue
1,545

 
17
%
Housing revenue
1,023

 
13
%
Higher education
928

 
13
%
Health care revenue
366

 
11
%
Other
108

 
8
%
Total Public Finance
12,285

 
12
%
Structured Finance:
 
 
 
Student loan
809

 
19
%
Investor-owned utilities
607

 
10
%
Mortgage-backed and home equity
174

 
1
%
Asset-backed
76

 
5
%
Other
259

 
9
%
Total Structured Finance
1,925

 
7
%
Total Domestic
14,210

 
11
%
International Finance:
 
 
 
Investor-owned and public utilities
504

 
6
%
Asset-backed
117

 
3
%
Transportation
84

 
2
%
CDOs
39

 
14
%
Total International Finance
744

 
3
%
Total
$
14,954

 
9
%
Assumed Reinsurance:
At December 31, 2014, assumed par outstanding was $245.9 million. On March 24, 2010, all assumed reinsurance agreements with third parties were allocated to the Segregated Account, which will not allow for cancellations without the approval of the Rehabilitator.
Rating Agencies
Ambac Assurance’s financial strength ratings had been downgraded and subsequently withdrawn by Moody’s and S&P. Ambac Assurance requested such withdrawals upon a review of the value of such ratings relative to the cost.
Insurance Regulatory Matters
United States
Ambac Assurance and Everspan are domiciled in the State of Wisconsin and, as such, are subject to the insurance laws and regulations of the State of Wisconsin (the “Wisconsin Insurance Laws”) and are regulated by the OCI. In addition, Ambac Assurance and Everspan are subject to the insurance laws and regulations of the other jurisdictions in which they are licensed. Ambac Assurance is licensed in all other 49 states, the District of Columbia, the Commonwealth of Puerto Rico, and the U.S. Virgin Islands. Everspan is licensed in all the same jurisdictions as Ambac Assurance other than Virginia, the District of Columbia and the Commonwealth of Puerto Rico. Under Wisconsin insurance law, the Segregated Account is a separate insurer for purposes of the Segregated Account Rehabilitation Proceedings. The Segregated Account is separately licensed in the State of Wisconsin but not elsewhere, and is under the control of, and is overseen by, the Rehabilitator.
Insurance laws and regulations applicable to financial guarantee insurers vary by jurisdiction. The laws and regulations generally require financial guarantors to maintain minimum standards of business conduct and solvency; to meet certain financial tests; and to file policy forms, premium rate schedules and certain reports with regulatory authorities, including information concerning capital structure, ownership and financial condition. Regulated insurance companies are also required to file quarterly and annual statutory financial statements with the National Association of Insurance Commissioners (“NAIC”), and in each jurisdiction in which they are licensed. The level of supervisory authority that may be exercised by non-domiciliary insurance regulators varies by jurisdiction. Generally, however, non-domiciliary regulators are authorized to suspend or revoke insurance licenses and to impose license restrictions in the event that laws or regulations are breached by a regulated insurance company

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or in the event that continued or unrestricted licensure of the regulated insurance company constitutes a “hazardous condition” in the opinion of the regulator. As a result of losses from its insured portfolio, Ambac Assurance is no longer able to write new business. In addition, Ambac Assurance’s authority to write new business in Alabama, Connecticut, Louisiana, Mississippi, North Carolina, North Dakota, Ohio, Tennessee, Utah and Virginia has been restricted by regulatory action or by agreement with the relevant insurance department.
As the principal, or domiciliary, regulator of Ambac Assurance, the Segregated Account and Everspan, OCI has primary regulatory authority, including with respect to the initiation and administration of rehabilitation or liquidation proceedings. Additionally, the accounts and operations of Ambac Assurance and Everspan are subject to periodic comprehensive examinations by the OCI. Wisconsin Insurance Laws require regulated insurance companies to maintain minimum standards of business conduct, maintain minimum surplus to policyholders, meet certain financial tests, and file certain reports, including information concerning their capital structure, ownership and financial condition. Ambac Assurance, the Segregated Account, and Everspan are not subject to risk-based capital requirements, since they are financial guarantee insurers. Ambac Assurance, the Segregated Account and Everspan are in compliance with minimum surplus levels. Wisconsin Insurance Laws also require prior approval by OCI of certain transactions between Ambac Assurance or Everspan and their respective affiliates. 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, the Rehabilitator of the Segregated Account has imposed certain constraints upon Ambac Assurance through the covenants made for the benefit of the Segregated Account and has assumed the authority to control the management of the Segregated Account.
In addition, pursuant to the terms of the Settlement Agreement, Ambac Assurance must seek prior approval by OCI of certain corporate actions. The Settlement Agreement includes covenants which generally restrict the operations of Ambac Assurance and remain in force until the surplus notes that were issued to the counterparties by Ambac Assurance pursuant to the Settlement Agreement have been redeemed, repurchased or repaid in full. Certain of these restrictions may be waived with the approval of a majority of Unaffiliated Qualified Directors (described below) and/or the OCI. Pursuant to the Settlement Agreement, Ambac Assurance amended its articles of incorporation to require that at least one-third (and, in any event, not less than three members) of the board of directors of Ambac Assurance must be Unaffiliated Qualified Directors (as defined in the Settlement Agreement). If at any time Ambac Assurance does not have the requisite number of Unaffiliated Qualified Directors to authorize an action that is otherwise restricted by the Settlement Agreement, it will need to seek the approval of OCI to take such action.
New York’s comprehensive financial guarantee insurance law defines the scope of permitted financial guarantee insurance and governs the conduct of business of all financial guarantors licensed to do business in New York, including Ambac Assurance and Everspan. The New York financial guarantee insurance law also establishes single risk and aggregate limits with respect to insured obligations insured by financial guarantee insurers. Such single risk limits are specific to the type of insured obligation (for example, municipal or asset-backed). Under the aggregate limits, policyholders’ surplus and contingency reserves must at least equal a percentage of aggregate net liability that is equal to the sum of various percentages of aggregate net liability for various categories of specified obligations. Wisconsin laws and regulations applicable to financial guarantors, as well as the laws of several other states, are less comprehensive than New York law and relate primarily to single and aggregate risk limits. As a result of decreased statutory capital resulting from the significant losses experienced by Ambac Assurance, Ambac Assurance is not in compliance with applicable single and aggregate risk limits. Through run-off of the portfolio, Ambac Assurance will seek to reduce its exposure to no more than the permitted amounts, but may not be able to do so. Everspan is in compliance with all of such limits.
United Kingdom
The Prudential Regulatory Authority ("PRA") and Financial Conduct Authority ("FCA") (and their predecessor regulator the Financial Services Authority (“FSA”)) have exercised significant oversight of Ambac UK since 2008, after Ambac, Ambac Assurance and Ambac UK began experiencing financial stress. In 2009, Ambac UK’s license to write new business was curtailed by the FSA and the insurance license was limited to undertaking only run-off related activity. As such, Ambac UK is authorized to run-off its insurance portfolio in the United Kingdom, and to do the same through a branch in Milan, Italy, and a number of other EU countries. EU legislation has allowed Ambac UK to conduct business in EU states other than the United Kingdom through a “passporting” arrangement, which eliminates the necessity of additional licensing or authorization in those other EU jurisdictions.
Ambac UK remains subject to regulation by the PRA and FCA in the conduct of its business. The PRA and FCA are the dual statutory regulators responsible for regulating the financial services industry in the United Kingdom, with the purpose of maintaining confidence in the U.K. financial system, providing public understanding of the system, securing the proper degree of protection for consumers and helping to reduce financial crime. In addition, the regulatory regime in the United Kingdom must comply with certain EU legislation binding on all EU member states.
The PRA requires that non-life insurance companies such as Ambac UK maintain a margin of solvency at all times in respect of the liabilities of the insurance company, the calculation of which depends on the type and amount of insurance business a company writes. These solvency requirements will be amended in order to implement the European Union’s “Solvency II” directive on risk-based capital. The requirements of the Solvency II directive will become effective on January 1, 2016 and, during the course of 2015, Ambac UK will be required to make certain transitional Solvency II-compliant regulatory filings with the PRA.
Notwithstanding the foregoing, Ambac UK is deficient in terms of compliance with currently applicable regulatory capital requirements, and is expected to remain deficient in applicable regulatory requirements once the Solvency II directive becomes effective. The PRA and FCA are aware of the same, and dialogue between Ambac UK management and its regulators remains ongoing with respect to options for addressing the shortcoming, although such options remain few.

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Regulations over change in control
Under Wisconsin law applicable to insurance holding companies, any acquisition of control of Ambac, and any other direct or indirect control of Ambac Assurance and Everspan, requires the prior approval of the OCI. “Control” is defined as the direct or indirect power to direct or cause the direction of the management and policies of a person. Any purchaser of more than 10% of the outstanding voting stock of a corporation is presumed to have acquired control of that corporation and its subsidiaries unless the OCI, upon application, determines otherwise. For purposes of this test, Ambac believes that a holder of common stock having the right to cast more than 10% of the votes which may be cast by the holders of all shares of common stock of Ambac would be deemed to have control of Ambac Assurance and Everspan within the meaning of the Wisconsin Insurance Laws. The United Kingdom has similar requirements applicable in respect of Ambac, as the ultimate holding company of Ambac UK.
Dividend Restrictions, Including Contractual Restrictions
Due to losses experienced by Ambac Assurance, Ambac Assurance has been unable to pay common dividends to Ambac since 2008 and will be unable to pay common dividends in 2015 without the prior consent of the OCI, which is unlikely. See Note 9. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information on dividends.
Ambac Assurance’s ability to pay dividends is further restricted by the Settlement Agreement and by certain covenants made for the benefit of the Segregated Account. See Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information.
As a result of these restrictions, Ambac Assurance is not expected to pay dividends to Ambac for the foreseeable future.
Subject to the foregoing, pursuant to the Wisconsin Insurance Laws, Ambac Assurance and Everspan may declare dividends, subject to restrictions in their respective articles of incorporation, provided that, after giving effect to the distribution, such dividends would not violate certain statutory equity, solvency, income and asset tests. Board action authorizing a shareholder distribution by Ambac Assurance or Everspan (other than stock dividends) must be reported to the OCI at least 30 days prior to payment. Additionally, no quarterly dividend may exceed the dividend paid in the corresponding quarter of the preceding year by more than 15% without notifying the OCI 30 days in advance of payment. Extraordinary dividends must be reported prior to payment and are subject to disapproval by the OCI. An extraordinary dividend is defined as a dividend or distribution, the fair market value of which, together with all dividends from the preceding 12 months, exceeds the lesser of: (a) 10% of policyholders’ surplus as of the preceding December 31 or (b) the greater of: (i) statutory net income for the calendar year preceding the date of the dividend or distribution, minus realized capital gains for that calendar year; or (ii) the aggregate of statutory net income for the three calendar years preceding the date of the dividend or distribution, minus realized capital gains for those calendar years and minus dividends paid or credited and distributions made within the first two of the preceding three calendar years. Additionally, in connection with the termination of certain reinsurance contracts, OCI requires adjustments to the dividend calculations for any surplus or net income gains recognized.
Ambac UK is not expected to pay any dividends to Ambac Assurance for the foreseeable future. UK law prohibits Ambac UK from declaring a dividend to its shareholders unless it has “profits available for distribution.” The determination of whether a company has profits available for distribution is based on its accumulated realized profits less its accumulated realized losses. While the UK insurance regulatory laws impose no statutory restrictions on a general insurer’s ability to declare a dividend, the PRA’s and FCA’s capital requirements in practice act as a restriction on the payment of dividends. Further, the FSA amended Ambac UK’s license in 2010 such that the PRA must specifically approve (“non-objection”) any transfer of value and/or assets from Ambac UK to Ambac Assurance or any other Ambac group company, other than in respect of certain disclosed contracts between the two parties (such as in respect of a management services agreement between Ambac Assurance and Ambac UK).
Pursuant to the Settlement Agreement Ambac Assurance may not make any “Restricted Payment” (which includes dividends from Ambac Assurance to Ambac) in excess of $5 million in the aggregate per annum, other than Restricted Payments from Ambac Assurance to Ambac in an amount up to $7.5 million per annum solely to pay operating expenses of Ambac. Concurrent with making any such Restricted Payment, a pro rata amount of the surplus notes issued by Ambac Assurance under the Settlement Agreement would also need to be redeemed at par.
Under the terms of Ambac Assurance’s Auction Market Preferred Shares (“AMPS”), dividends may not be paid on the common stock of Ambac Assurance unless all accrued and unpaid dividends on the AMPS for the then current dividend period have been paid, provided, that dividends on the common stock may be made at all times for the purpose of, and only in such amounts as are necessary for, enabling Ambac (i) to service its indebtedness for borrowed money as such payments become due or (ii) to pay its operating expenses. If dividends are paid on the common stock as provided in the prior sentence, dividends on the AMPS become cumulative until the date that all accumulated and unpaid dividends have been paid on the AMPS.
FINANCIAL SERVICES SEGMENT
Ambac’s Financial Services business segment is conducted through subsidiaries of Ambac Assurance, which provide financial and investment products, including investment agreements, funding conduits and interest rate swaps, principally to the clients of its financial guarantee business. Ambac Assurance insures all of the obligations of its financial services subsidiaries. These businesses are in active runoff, which is being effectuated by transaction terminations, settlements, and scheduled amortization of contracts. The Financial Services business also maintains interest rate derivatives to mitigate exposure to floating rate insured obligations in the Financial Guarantee segment.

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The principal factors that may affect the Financial Services Segment results include: (1) availability of counterparties for hedging transactions; (2) investment returns; (3) the value of future contract terminations or settlements which may differ from carrying value of the those contracts; (4) collateral posting requirements; (5) the availability of liquidity from Ambac Assurance; (6) changes in the fair value of the derivatives portfolio resulting from interest rate fluctuations; (7) timing of investment agreement withdrawals; and (8) restrictions imposed upon Ambac Assurance by the contracts executed with the Segregated Account and the Settlement Agreement, and, to the extent that policies allocated to the Segregated Account are implicated, the authority of the Rehabilitator of the Segregated Account to control the management of the Segregated Account.
Investment Agreements
Ambac’s remaining investment agreements issued to structured finance and municipal issuers were issued through its wholly-owned subsidiary, Ambac Capital Funding. Investment agreements were customized for each investor to provide guaranteed interest and return of principal in accordance with their requirements. Each investment agreement was insured by Ambac Assurance through a financial guarantee insurance policy.
Liquidity risk exists in the business due to contract provisions which require collateral posting and allow for early termination of investment agreements. As of December 31, 2014, 91% of investment agreement principal and accrued interest outstanding of $148.9 million was collateralized. Funding for the collateral and previous early terminations was supported in part through loans between Ambac Capital Funding and Ambac Assurance. At December 31, 2014, Ambac Capital Funding was indebted to Ambac Assurance in the amount of $177.9 million.
See “Liquidity and Capital Resources” of the Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Part II, Item 7 and Note 15. Obligations Under Invstment Agreements to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information on investment agreements.
Derivative Products
The primary activities in the derivative products business are to manage the runoff of derivatives with financial guarantee clients and to facilitate the mitigation of interest rate exposure for the Financial Guarantee segment via swaps and exchange traded U.S. treasury futures. Derivative transactions are executed through Ambac Financial Services (“AFS”), a wholly-owned subsidiary of Ambac Assurance. The derivative products portfolio is positioned to benefit from rising rates as an economic hedge against interest rate exposure in the financial guarantee insurance portfolio. This hedge position may have a significant impact on the results of the Financial Services segment. Under the agreements governing the derivative positions, AFS generally must post collateral or margin in excess of the market value of the swaps and futures contracts. In addition, most of AFS’s counterparties currently possess the right to terminate their transactions with AFS and in the event of a full rehabilitation of Ambac Assurance, some of AFS’s swaps could automatically terminate. A sudden termination of AFS’s derivatives, whether voluntarily or automatically, could result in losses. AFS has borrowed cash and securities from Ambac Assurance, to help support its incremental collateral and margin posting requirements, previous termination payments and other cash needs. At December 31, 2014, AFS was indebted to Ambac Assurance in the amounts of $638.2 million in cash loans and $64.4 million in borrowed securities.
Credit risks relating to derivative positions primarily concern the default of a counterparty. Counterparty default exposure is mitigated through the use of industry standard collateral posting agreements. For counterparties subject to such collateral posting agreements, collateral is posted when a derivative counterparty’s credit exposure exceeds contractual limits. Derivative contracts entered into with financial guarantee customers are not subject to collateral posting agreements. Credit risk associated with such customer derivatives, including credit derivatives, is managed through the financial guarantee portfolio risk management processes described in the Financial Guarantee Segment noted above. In some cases, derivatives between Ambac and financial guarantee customers are placed through a third party financial intermediary and similarly do not require collateral posting.
AFS manages a variety of market risks inherent in its businesses, including credit, market, liquidity, operational and legal. These risks are identified, measured, and monitored through a variety of control mechanisms, which are in place at different levels throughout the organization. See “Quantitative and Qualitative Disclosures About Market Risk” included in Part II, Item 7A in this Form 10-K for further information.
Funding Conduits
A subsidiary of Ambac has previously transferred financial assets to two special purpose entities. The business purpose of these entities was to provide certain financial guarantee clients with funding for their debt obligations. The activities of the special purpose entities are contractually limited to purchasing assets from Ambac, issuing medium-term notes (“MTNs”) to fund such purchases, executing derivative hedges and obtaining financial guarantee policies with respect to indebtedness incurred. As of December 31, 2014, Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative contracts owned and outstanding by the entities. Ambac does not consolidate these entities under the relevant accounting guidance for consolidation of variable interest entities. See Note 2. Basis of Presentation and Significant Accounting Policies and Note 4. Special Purpose Entities, including Variable Interest Entities to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information.
INVESTMENTS AND INVESTMENT POLICY
As of December 31, 2014, the consolidated non-VIE investments of Ambac had an aggregate fair value of approximately $5.5 billion and an aggregate amortized cost of approximately $5.3 billion. Investments are managed internally by officers of Ambac, who are experienced investment managers, and by external investment managers. All investments are made in accordance with the general objectives and guidelines for investments

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reviewed or overseen by Ambac Assurance and Ambac UK’s respective Boards of Directors. These guidelines include liquidity, credit quality, diversification and duration objectives, and are periodically reviewed and revised as appropriate. Additionally, senior credit personnel monitor the portfolio on a continuous basis. Credit monitoring of the investment portfolio includes procedures on residential mortgage-backed securities consistent with those utilized to assess the risk of our insured RMBS exposures.
As of December 31, 2014, the Ambac Assurance and Everspan non-VIE investment portfolio had an aggregate fair value of approximately $4.6 billion and an aggregate amortized cost of approximately $4.4 billion. Ambac Assurance’s and Everspan’s investment objectives are to achieve the highest risk-adjusted after-tax return on a diversified portfolio consistent with Ambac Assurance’s and Everspan’s risk tolerance while employing active asset/liability management practices to satisfy all operating and strategic liquidity needs. Ambac Assurance’s investment portfolio is subject to internal investment guidelines and is subject to limits on types and quality of investments imposed by applicable insurance laws and regulations. Ambac Assurance purchases Ambac Assurance insured securities given their relative risk/reward characteristics. Ambac Assurance financial guarantee policies related to most of these securities have been allocated to the Segregated Account. 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, Ambac Assurance’s investment policies are subject to certain covenants made for the benefit of the Segregated Account and, therefore, such policies may be subject to restrictions outside the control of management. Such covenants could adversely impact the performance of the investment portfolio.
As of December 31, 2014, the non-VIE Ambac UK investment portfolio had an aggregate fair value of approximately $0.5 billion and an aggregate amortized cost of approximately $0.5 billion. Ambac UK’s investment policy is designed with the primary objective of ensuring that Ambac UK is able to meet its financial obligations as they fall due, in particular with respect to policy holders and meeting their claims. Ambac UK’s investment portfolio is subject to internal investment guidelines and may be subject to limits on types and quality of investments imposed by the PRA as regulator of Ambac UK. The Board of Directors of Ambac UK approves any changes or exceptions to Ambac UK’s investment policy.
As of December 31, 2014, the non-VIE Financial Services investment portfolio had an aggregate fair value of approximately $0.1 billion and an aggregate amortized cost of approximately $0.1 billion. The primary investment objective is to invest in a diversified portfolio of high-grade securities that produce sufficient cash flow to satisfy all investment agreement liabilities while meeting the related collateral requirements. The investment portfolio is subject to internal investment guidelines. Such guidelines set forth minimum credit rating requirements and credit risk concentration limits.
As of December 31, 2014, the non-VIE Corporate investment portfolio had an aggregate fair value of approximately $0.3 billion and an aggregate amortized cost of approximately $0.3 billion. The primary investment objective is to preserve capital for strategic uses while maximizing income. The investment portfolio is subject to internal investment guidelines. Such guidelines set forth minimum credit rating requirements and credit risk concentration limits.
The following tables provide certain information concerning the investments of Ambac:
 
Summary of Investments - December 31,
 
2014
 
2013
Investment Category
($ in thousands)
Carrying
Value (1)
 
Weighted
Average
Yield (2)
 
Carrying
Value
 (1)
 
Weighted
Average
Yield (2)
Long-term investments:
 
 
 
 
 
 
 
Taxable bonds
$
4,666,727

 
5.27
%
 
$
5,099,503

 
3.76
%
Tax-exempt bonds
123,226

 
4.15
%
 
912,036

 
3.95
%
Total long-term investments
4,789,953

 
5.24
%
 
6,011,539

 
3.79
%
Short-term investments
360,065

 
0.04
%
 
271,119

 
0.10
%
Other investments
357,016

 

 
241,069

 

Total
$
5,507,034

 
4.86
%
 
$
6,523,727

 
3.63
%
(1)
Includes investments guaranteed by Ambac Assurance and Ambac UK. Refer to Note 11. Investments of the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further discussion of Ambac insured securities held in the investment portfolio.
(2)
Yields are stated on a pre-tax basis, based on average amortized cost.


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Investments by Security Type - December 31,
 
2014
 
2013
Investment Category
($ in thousands)
Carrying
Value(1)
 
Weighted
Average
Yield(2)
 
Carrying
Value(1)
 
Weighted
Average
Yield(2)
Municipal obligations (3)
$
525,792

 
3.65
%
 
$
1,377,723

 
3.70
%
Corporate securities
1,385,594

 
2.54
%
 
1,489,369

 
2.28
%
Foreign obligations
127,757

 
1.86
%
 
124,877

 
1.29
%
U.S. government obligations
107,246

 
1.14
%
 
252,471

 
0.36
%
U.S. agency obligations
29,486

 
0.30
%
 
32,154

 
0.31
%
Residential mortgage-backed securities
1,710,955

 
9.70
%
 
1,558,625

 
7.04
%
Asset-backed securities
903,123

 
3.65
%
 
1,176,320

 
2.79
%
Total long-term investments
4,789,953

 
5.24
%
 
6,011,539

 
3.79
%
Short-term investments (3)
360,065

 
0.04
%
 
271,119

 
0.10
%
Other investments
357,016

 

 
241,069

 

Total
$
5,507,034

 
4.86
%
 
$
6,523,727

 
3.63
%
(1)
Includes investments guaranteed by Ambac Assurance and Ambac UK. Refer to Note 11. Investments of the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further discussion of Ambac insured securities held in the investment portfolio.
(2)
Yields are stated on a pre-tax basis, based on average amortized cost.
(3)
Includes taxable and tax-exempt investments.
Ambac has RMBS exposure in its investment portfolios. Please refer to the tables in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Balance Sheet” section below for a discussion of the fair value of mortgage and asset-backed securities by classification.
EMPLOYEES
As of December 31, 2014, Ambac had 175 employees in the United States and 13 employees in the UK. Ambac considers its employee relations to be satisfactory.
Item 1A.    Risk Factors
References in the risk factors to “Ambac” are to Ambac Financial Group, Inc. References to “we,” “our,” “us” and “Company” are to Ambac and its subsidiaries, as the context requires. Capitalized terms used but not defined in this section shall have the meanings ascribed thereto in Part I, Item 1 in this Form 10-K or in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K unless otherwise indicated.
The price per share of our common stock may be subject to a high degree of volatility, including significant price declines.
Our shares of common stock, which were issued pursuant to our Reorganization Plan, began trading on the NASDAQ Global Market on May 1, 2013. Although our common stock is listed on NASDAQ, there can be no assurance as to the liquidity of the trading market for our shares of common stock or the price at which such shares can be sold. The initial market price of our shares was determined by investors based upon the number of shares that were issued. The price of the shares may decline substantially in response to a number of events or circumstances, including but not limited to:
changes in investors’ or analysts’ valuation measures for our stock;
market trends unrelated to our stock;
market and industry perception of our success, or lack thereof, in pursuing our business strategy;
results and actions of other participants in our industry; and
adverse developments in our financial condition or results of operation.
 
In addition, the price of our shares will be affected by the additional risks described below, including risks associated with Ambac Assurance’s ability to deliver value to Ambac.
Ambac may not be able to realize value from Ambac Assurance.
Because Ambac is a holding company, the value of our stock is dependent upon the residual value of our main operating subsidiary, Ambac Assurance, the receipt of payments to be made by Ambac Assurance pursuant to the Amended TSA and the Cost Allocation Agreement, the receipt of payments on the Owner Trust Certificate issued to Ambac by Corolla Trust (the "Owner Trust Certificate"), and the receipt of dividends from Ambac Assurance. There can be no assurance that we will be able to realize residual value in Ambac Assurance, which is in run-off. In addition, the Segregated Account of Ambac Assurance Corporation is subject to rehabilitation proceedings and under the control of the Rehabilitator, as further described below. It is unclear whether Ambac Assurance and the Segregated Account will be able to satisfy all of their

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respective obligations to policyholders, holders of their respective surplus notes and holders of Ambac Assurance’s preferred stock, even if Ambac Assurance and the Segregated Account are successful in achieving recoveries and mitigating losses. Our ability to achieve recoveries and mitigate losses is subject to significant risks and uncertainties, including perceptions of the value of Ambac’s guarantees and securities.
Due to the above considerations, as well as applicable legal and contractual restrictions described elsewhere herein, it is highly unlikely that Ambac Assurance will be able to pay Ambac any dividends for the foreseeable future. Furthermore, the payments to be made to Ambac under the Amended TSA and the Cost Allocation Agreement are subject to contingencies that are difficult to predict, making the amount and timing, if any, of such payments uncertain. Payments to be made under the Amended TSA, in particular, depend on the generation of taxable income by Ambac Assurance above certain thresholds. Ambac Assurance’s ability to generate taxable income above such thresholds is uncertain. Due to these factors, there can be no assurance as to the amounts, if any, that Ambac will receive from Ambac Assurance under the Amended TSA.
It is also uncertain whether and to what extent Ambac will realize value from the Owner Trust Certificate. The Owner Trust Certificate is subordinated to $299.2 million of senior secured notes issued by Corolla Trust. Such notes and the Owner Trust Certificate are collateralized by and payable solely from a $350.0 million face amount Segregated Account junior surplus note plus accrued and unpaid interest thereon. No payment of interest on or principal of a Segregated Account junior surplus note may be made until all existing and future indebtedness of the Segregated Account, including Segregated Account surplus notes, policy claims and claims having statutory priority, and all existing and future senior ranking surplus notes, contribution notes or similar obligations of Ambac Assurance, have been paid in full. All payments of principal and interest on Segregated Account junior surplus notes are subject to the prior approval of the OCI. If the OCI does not approve the payment of interest on Segregated Account junior surplus notes, such interest will accrue and compound annually until paid. Payments on the senior secured notes issued by Corolla Trust will be only made when and to the extent that the Segregated Account makes payments on the junior surplus note held by Corolla Trust. The senior secured notes must be paid in full before any payments will be made on the Owner Trust Certificate. If Corolla Trust has failed to pay all interest and principal outstanding on the senior secured notes within three business days of August 28, 2039, the senior secured noteholders may also take possession of and sell the junior surplus note. If such a sale were to occur, it is uncertain whether and to what extent there would be any value for the Owner Trust Certificate after satisfaction of the senior secured notes.
The value of our common stock may also depend upon the ability of Ambac to generate earnings apart from Ambac Assurance. As noted below, we are exploring new business opportunities, but there are no assurances regarding our ability to enter new businesses or the prospects of any such new businesses.
We are exploring new business opportunities which may not be consummated, or if consummated, may not create value and may negatively impact our financial results.
We are exploring new business opportunities for the Company, which may involve the acquisition of assets or existing businesses or the development of businesses through new or existing subsidiaries. It is not possible at this time to predict the future prospects or other characteristics of any such new business. Our efforts to pursue new business opportunities may be unsuccessful or require significant financial or other resources, which could have a negative impact on our financial condition. No assurance can be given that we will be able to complete the acquisition or development of any business or, if acquired or developed, generate any earnings or be able to successfully integrate such business into our current operating structure.
Moreover, Ambac’s ability to enter new businesses, including new businesses apart from Ambac Assurance, is also subject to significant doubt, given the condition and circumstances of Ambac Assurance, the difficulty of leveraging or monetizing its other assets, and the uncertainty of its ability to raise capital. Due to these factors, as well as those relating to Ambac Assurance as described above, the value of our securities is highly speculative.
The issuance of new common stock may dilute current shareholder value or have adverse effects on the market price of our common stock.
If we raise capital through the issuance of additional shares of common stock, whether for a new business, general corporate purposes, or in exchange for other securities, the value of our current shareholders’ interests may be diluted as we are not required to offer any such shares to existing stockholders on a preemptive basis.
We cannot predict the effect, if any, of future sales of our common stock, or the availability of shares for future sales, on the market price of our common stock. Sales of substantial amounts of common stock or the perception that such sales could occur may adversely affect the prevailing market price for our common stock.
Future offerings of debt or equity securities that rank senior to our common stock may adversely affect the market price of our common stock.
If we decide to issue debt or additional equity securities in the future that rank senior to our common stock, it is likely that they will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Additionally, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock and may result in dilution to owners of our common stock. Because our decision to issue debt or equity securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Holders of our common stock bear the risk of our future offerings reducing the market price of our common stock and diluting the value of their stock holdings in us.

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The occurrence of certain events could result in the initiation of rehabilitation proceedings against Ambac Assurance, with resulting adverse consequences to holders of Ambac securities.
Increased loss development in the General Account of Ambac Assurance or significant losses resulting from litigation against Ambac Assurance may prompt OCI to determine that it is in the best interests of policyholders to initiate rehabilitation proceedings with respect to Ambac Assurance, either preemptively or in response to any such event.
If, as a result of the occurrence of any such event(s), OCI decides to initiate rehabilitation proceedings with respect to Ambac Assurance, adverse consequences may result, including, without limitation, the assertion of damages by counterparties (including mark-to-market claims with respect to insured transactions executed in ISDA format) and the acceleration of losses based on early termination triggers and the loss of control rights in insured transactions, thereby reducing the residual value of Ambac Assurance. Additionally, the Rehabilitator would assume control of all of Ambac Assurance’s assets and management of Ambac Assurance. In exercising control, the Rehabilitator will act for the benefit of policyholders, and will not take into account the interests of securityholders of Ambac. Such actions may result in material adverse consequences for Ambac’s securityholders.
Actions of the Rehabilitator could adversely affect Ambac, including impacting our ability to realize our remediation recoveries.
As a consequence of the Segregated Account Rehabilitation Proceedings, the Rehabilitator retains operational control and decision-making authority with respect to all matters related to the Segregated Account, including surveillance, remediation, loss mitigation and efforts to recover losses in the Segregated Account, including recovery efforts in respect of breaches of representations and warranties by sponsors of Ambac-insured RMBS. Similarly, by virtue of the contracts executed between Ambac Assurance and the Segregated Account in connection with the establishment, and subsequent rehabilitation, of the Segregated Account, the Rehabilitator retains the discretion to oversee and approve certain actions taken by Ambac Assurance in respect of assets and liabilities that remain in Ambac Assurance. Moreover, the Rehabilitator retains the sole discretion to adjust claim payments, to make payments on Deferred Amounts and, with regulatory approval, to make payments on or redeem Segregated Account surplus notes (which would require Ambac Assurance to make proportionate payments on or proportionately redeem its surplus notes). As a result, certain efforts to remediate losses, and certain other actions taken by Ambac Assurance, are subject to the approval of the Rehabilitator, as are decisions about the timing of payments of significant liabilities of the Segregated Account. In exercising such authority, the Rehabilitator will act for the benefit of policyholders, and will not take into account the interests of securityholders of Ambac. Decisions made by the Rehabilitator for the benefit of policyholders may result in material adverse consequences for Ambac’s securityholders. In addition, we are not able to predict the impact such decisions will have on the remediation of losses, and, in particular, on our efforts to recover losses attributable to breaches of representations and warranties by sponsors of Ambac-insured RMBS, our ability to commute outstanding policies and repurchase insured bonds or surplus notes, or how vigorously the Rehabilitator will pursue such remediations. We are similarly unable to predict the decisions of the Rehabilitator as to claims payments or payments on Deferred Amounts or, with regulatory approval, payments on or redemptions of Segregated Account surplus notes, the timing and impact of which may negatively affect our financial condition or results of operations. Furthermore, any negative consequences resulting from payments on or redemptions of Segregated Account surplus notes would be magnified due to the fact that the Rehabilitator’s decision to make such payments would require Ambac Assurance to make proportionate payments on its surplus notes.
Our inability to realize the expected recoveries included in our financial statements could adversely impact our liquidity and financial condition.
As of December 31, 2014, we have estimated representation and warranty subrogation recoveries of $2,496.5 million (net of reinsurance), which is included in our financial statements. These recoveries are based on contractual claims arising from RMBS transactions that we have insured, and represent a probability-weighted estimate of amounts we expect to recover under various possible scenarios, and do not reflect the best or the worst possible outcomes with respect to any particular transaction or group of transactions. Our ability to recover these amounts is subject to significant uncertainty, including risks inherent in litigation, collectability of such amounts from counterparties and/or their respective parents and affiliates, timing of receipt of any such recoveries, intervention by OCI or the Rehabilitator which could impede our ability to take the actions required to realize such recoveries, and uncertainties inherent in the assumptions used in estimating such recoveries. The amount of these subrogation recoveries is significant and if we were unable to recover any amounts our stockholders’ equity as of December 31, 2014 would decrease from $1,673.7 million to a deficit of $822.8 million.
We expect to recover material amounts of claims payments through remediation measures other than the litigation described above as well as through cash flows in the securitization structures of transactions that we insure. Realization of such expected recoveries is subject to various risks and uncertainties, including the rights and defenses of other parties with interests that conflict with our interests, the performance of the collateral and assets backing the obligations that we insure, the performance of servicers involved in securitizations in which we participate as insurer, and the effect on our rights of the Segregated Account Rehabilitation Plan and orders of the Rehabilitation Court. Additionally, the Segregated Account Rehabilitation Proceedings may result in the loss of future recoveries in insured transactions. Adverse developments with respect to such variables may cause our recoveries to fall below expectations.
Intercompany disputes or disputes with OCI may arise, which may have material adverse effects on the Company.
The Segregated Account, Ambac Assurance, Ambac and other affiliates have entered into agreements that govern certain activities of such entities. OCI has certain enforcement rights with respect to such agreements and, as regulator of Ambac Assurance and as Rehabilitator of the Segregated Account, has further authority over the activities of Ambac Assurance and the Segregated Account. Disputes may arise over the interpretation of such agreements, the exercise or purported exercise of rights thereunder, or the performance of or failure or purported failure to perform obligations thereunder. Disputes may also arise over certain actions taken or proposed to be taken by OCI in reliance on its contractual or legal rights or in reaction to actions taken or to be taken by the Company. In taking such actions or reacting to actions or decisions of the Company, the Rehabilitator will act for the benefit of policyholders, and will not take into account the interests of securityholders of Ambac.

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Any such dispute could have material adverse effects on the Company, whether through litigation, failure to execute transactions sought by management, interference with corporate strategies, objectives or prerogatives, inefficient decision-making or execution, forced realignment of resources, increased costs, distractions to management, strained working relationships or otherwise. Such effects would also increase the risk that OCI would seek to initiate rehabilitation proceedings against Ambac Assurance.
We may not be able to successfully monetize assets or restructure or exchange outstanding debt and insurance obligations.
Ambac Assurance is considering the possibility of entering into transactions whereby it would monetize certain assets and/or restructure or exchange its outstanding debt and insurance obligations. Transactions of this nature may not be feasible or economically viable. Moreover, Ambac Assurance may be unable to secure the approval of the Rehabilitator or OCI to consummate such a transaction. Even if such a transaction is consummated, it may ultimately prove to be unsuccessful in creating value.
The insurance intangible and goodwill assets, which resulted from the application of fresh start accounting, could adversely affect our results of operations.
Upon emergence from bankruptcy, we applied fresh start accounting pursuant to which an insurance intangible and goodwill asset were recorded. The insurance intangible asset represented the difference between the fair value and aggregate carrying value of the financial guarantee insurance and reinsurance assets and liabilities.  The insurance intangible asset is amortized using a level yield method based on actual and projected par exposure of the related financial guarantee insurance and reinsurance contracts.  Significant declines in actual or projected par exposure could accelerate the insurance intangible amortization and adversely affect our results of operations.
The excess reorganization value over the fair value of identified tangible and intangibles assets was reported as goodwill at the fresh start reporting date. The determination of reorganization value and fair value of assets and liabilities was dependent on various estimates and assumptions, including financial projections and the realization of certain events. All goodwill was assigned to the financial guarantee reporting unit, which primarily represents Ambac Assurance Corporation and its subsidiaries. We test goodwill for impairment annually or whenever events occur or circumstances change that would more likely than not reduce the fair value of the financial guarantee reporting unit below its carrying amount. Impairments could occur in the future if the expected future cash flows of the financial guarantee reporting unit decline for reasons addressed in other risk factors, adverse actions are taken by the Rehabilitator, or if carrying values change materially compared with changes in their respective fair values.
Some issuers of public finance obligations we insure are experiencing fiscal stress that could result in increased losses on those obligations or increased liquidity claims, including losses or claims resulting from payment defaults, Chapter 9 bankruptcy proceedings or loss of market access.
We have historically experienced low levels of defaults in our public finance insured portfolio, including during the financial crisis that began in mid-2007. However, some issuers of public finance obligations we insure have reported budget shortfalls and significantly underfunded pensions that will require them to significantly raise taxes and/or cut spending in order to satisfy their obligations. Government entities may also take other actions that may impact their own creditworthiness or the creditworthiness of related issuers. Some issuers of obligations we insure have either defaulted or filed for bankruptcy, raising concerns about their ultimate ability to service the debt we insure or recover claims paid in the future. If the issuers of the obligations in our public finance portfolio are unable to raise taxes, cut spending, or receive federal assistance, or if such issuers default or file for bankruptcy under Chapter 9, we may experience liquidity claims and/or ultimate losses on those obligations, which could adversely affect our business, financial condition and results of operations.
We insure obligations of several issuers that have filed for bankruptcy protection under Chapter 9. The consequences of such proceedings for creditors remain uncertain. For example, the treatment of General Obligation debt in relation to other obligations remains in flux, with Detroit's recent precedent unfavorable for debt creditors. If issuers succeed in materially adjusting their obligations to bondholders and financial guarantors, other issuers may be encouraged to default or file for Chapter 9 protection and seek similar adjustments to their debt. These events could materially increase losses in Ambac’s insured portfolio of municipal credits.
Loss of market access is a risk embedded in our municipal exposures. From time to time the municipal bond market evidences heightened investor concerns overall or for select sectors or issuers, as has recently been the case with Puerto Rico. Such adverse market conditions may trigger a loss of market liquidity for affected issuers, which in turn may significantly raise their cost of alternative financing or cause a liquidity crisis and potential for default on debt service payments we guarantee.
Certain surplus notes or other obligations issued by either Ambac Assurance or the Segregated Account may be characterized as equity of Ambac Assurance and as a result, Ambac Assurance may no longer be a member of the U.S. federal income tax consolidated group of which Ambac is the common parent.
It is possible that certain surplus notes or other obligations issued by either Ambac Assurance or the Segregated Account may be characterized as equity of Ambac Assurance for U.S. federal income tax purposes. If such surplus notes or other obligations are characterized as equity of Ambac Assurance and it is determined that such “equity” represented more than twenty percent of the total value of the stock of Ambac Assurance, Ambac Assurance may no longer be characterized as an includable corporation that is affiliated with Ambac. As a result, Ambac Assurance may no longer be characterized as a member of the U.S. federal income tax consolidated group of which Ambac is the common parent (the “Ambac Consolidated Group”) and Ambac Assurance would be required to file a separate consolidated tax return as the common parent of a new U.S. federal income tax consolidated group including Ambac Assurance as the new common parent and Ambac Assurance’s affiliated subsidiaries (the “Ambac Assurance Consolidated Tax Group”).

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To the extent Ambac Assurance is no longer a member of the Ambac Consolidated Group, Ambac Assurance’s NOLs (and certain other available tax attributes of Ambac Assurance and the other members of the Ambac Assurance Consolidated Tax Group) may no longer be available for use by the Ambac Assurance Consolidated Tax Group or any of the remaining members of the Ambac Assurance Consolidated Tax Group to reduce the U.S. federal income tax liabilities of the Ambac Assurance Consolidated Tax Group. Ambac, Ambac Assurance and their affiliates entered into a tax sharing agreement that would require Ambac to make certain tax elections that could mitigate the loss of NOLs and other tax attributes resulting from a deconsolidation of Ambac Assurance from the Ambac Consolidated Group. However, in the event of a deconsolidation, certain other benefits resulting from U.S. federal income tax consolidation may no longer be available to the Ambac Consolidated Group including certain favorable rules relating to transactions occurring between members of the Ambac Consolidated Group and members of the Ambac Assurance Consolidated Tax Group.
If surplus notes or other obligations are characterized as equity of Ambac Assurance, the Ambac Assurance NOLs (and certain other tax attributes or tax benefits of the Ambac Consolidated Group) may be subject to limitation under Section 382 of the Tax Code.
It is possible that certain surplus notes or other obligations may be characterized as equity of Ambac Assurance for U.S. federal income tax purposes. Such characterization could result in an “ownership change” of Ambac Assurance for purposes of Section 382 of the Tax Code. If such an ownership change were to occur, the value and amount of the Ambac Assurance NOLs would be substantially impaired, increasing the U.S. federal income tax liability of Ambac Assurance and materially reducing cash available to dividend to Ambac, as well as reducing the value of Ambac Assurance’s stock owned by Ambac.
Deductions with respect to interest accruing on certain surplus notes may be eliminated or deferred until payment.
To the extent certain surplus notes are characterized as equity for U.S. federal income tax purposes, accrued interest will not be deductible by Ambac Assurance. In addition, even if such surplus notes are characterized as debt for U.S. federal income tax purposes, the deduction of interest accruing on such surplus notes may be deferred until paid or eliminated in part depending upon (i) the terms of any deferral and payment provisions provided in such surplus notes, (ii) whether such surplus notes have “significant original issue discount,” and (iii) the yield to maturity of surplus notes. To the extent deductions with respect to interest are eliminated or deferred, the U.S. federal income tax of the members of the Ambac Consolidated Group or the members of the Ambac Assurance Consolidated Tax Group as the case maybe, could be increased reducing the amount of cash available to pay its obligations.
We are subject to credit risk and other risks related to RMBS and securities backed by student loans.
We have insured RMBS transactions, as well as securities backed by student loans, and are thus exposed to risk associated with those asset classes. Performance of these transactions, as well as others, can be adversely affected by general economic conditions, such as recession, rising unemployment rates, underemployment, home prices that decline or do not increase in the patterns assumed in our models, increasing foreclosure rates and unavailability of consumer credit, mortgage product attributes, such as interest rate adjustments and balloon payment obligations, borrower and/or originator fraud, mortgage and student loan servicer performance, including underperformance and financial difficulty.
While further deterioration in the performance of consumer assets, including mortgage-related assets and student loans, may occur, the timing, extent and duration of any future deterioration of the credit markets is unknown, as is the impact, if any, on potential claim payments and ultimate losses of the securities within Ambac Assurance’s portfolio. In addition, there can be no assurance that any governmental or private sector initiatives designed to address such credit deterioration in the markets will be successful or inure to the benefit of the transactions insured by Ambac. For example, borrower protection for student loan debt in bankruptcy may adversely affect our portfolio. Similarly, servicer settlements with governmental authorities regarding foreclosure irregularities are generally designed to protect homeowners and may increase losses on securities insured by Ambac.
In addition, there can be no assurance that we would be successful, or that we would not be delayed, in enforcing the subordination provisions, credit enhancements or other contractual provisions of the RMBS that Ambac Assurance insures in the event of litigation or the bankruptcy of other transaction parties.
The change in composition of the securities in our investment portfolio exposes us to greater risk.
Ambac Assurance maintains a portion of its investment portfolio in lower-rated securities in order to increase the risk-adjusted return on its portfolio. Investments in lower-rated securities and “alternative assets” could expose Ambac to increased losses and decreased liquidity in the investment portfolio.
Loss reserves may not be adequate to cover potential losses; changes in loss reserves may result in further volatility of net income and comprehensive earnings.
Loss reserves are established when management has observed credit deterioration, in most cases, when the underlying credit is considered below investment grade. Loss reserves established with respect to our non-derivative financial guarantee insurance policies are based upon estimates and judgments by management, including estimates and judgments with respect to the probability of default, the severity of loss upon default, management’s ability to execute policy commutations, and estimated remediation recoveries for, among other things, breaches by RMBS issuers of representations and warranties. Furthermore, the objective of establishing loss reserve estimates is not to reflect the worst possible outcome. As a result of the inherent uncertainties in the estimates and judgments made to determine loss reserves, there can be no assurance that either the actual losses in our financial guarantee insurance portfolio will not exceed such reserves or that our reserves will not increase or decrease materially over time as circumstances, our assumptions, or our models change.

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Additionally, inherent in our estimates of loss severities and remediation recoveries is the assumption that we will retain control rights in respect of our insured portfolio. However, according to the terms of relevant transaction documents, we are subject to the loss of control rights in many insured transactions in the event that we are the subject of delinquency proceedings and/or other regulatory actions which could result from our deteriorated financial position. In the event that we lose control rights, our ability to mitigate loss severities and realize remediation recoveries will be compromised, and actual ultimate losses in our insured portfolio could exceed our loss reserves. The Rehabilitation Court issued an injunction against certain actions by holders of policies in the Segregated Account and other counterparties, including actions resulting in, or based on, the loss of control rights. If this injunction does not successfully preclude such actions, Ambac Assurance could lose its control rights with respect to policies in the Segregated Account.
We also rely on internally and externally developed complex financial models, including licensed default models related to RMBS and waterfall modeling provided by a nationally recognized vendor for RMBS and student loan exposures, to project performance of our insured obligations. Differences in the models that we employ, and/or flaws in these financial models and/or faulty assumptions inherent in these financial models and those determined by management, could lead to material changes in projected outcomes, and could include increased losses and loss reserves. Uncertainty with respect to the ultimate performance of certain of our insured exposures may result in substantial changes in loss reserves and/or actual losses. Moreover, modeled estimates of transaction performance depend in part on our interpretations of contracts and other bases of our legal rights. Such interpretations may prove to be incorrect or different interpretations may be employed by bond trustees and other transaction participants, which could lead to increased losses and loss reserves.
Our credit risk management policies and practices may not adequately identify significant risks.
As described in Part I, Item 1, “Business-Risk Management” in this Form 10-K, we have established risk management policies and practices which seek to mitigate our exposure to credit risk in our insured portfolio. Ongoing surveillance of credit risks in our insured portfolio is an important component of our risk management. These policies and practices in the past have not insulated us from risks that were unforeseen and which had unanticipated loss severity, and such policies and practices may not do so in the future. There can be no assurance that these policies and practices will be adequate to avoid future losses. If we are not able to identify significant risks, we may not be able to and/or timely remediate such risks, thereby increasing the amount of losses to which we are exposed. An inability to identify significant risks could also result in the failure to establish loss reserves that are sufficient in relation to such risks.
Changes in prevailing interest rate levels and market conditions could adversely impact our business results and prospects.
Increases in prevailing interest rate levels can adversely affect the value of our investment portfolio and, therefore, our financial strength. In the event that investments must be sold in order to pay claims, to pay Deferred Amounts, to redeem surplus notes, or to meet Financial Services liquidity needs due to contract terminations or collateral posting requirements, such investments would likely be sold at discounted prices. Additionally, increasing interest rates would have an adverse impact on our insured portfolio. For example, increasing interest rates could result in higher claim payments in respect of defaulted obligations that bear interest at floating rates of interest. Higher interest rates can also lead to increased credit stress on consumer asset-backed transactions in our insured portfolio (as the securitized assets supporting a portion of these exposures are floating rate consumer obligations), slower prepayment speeds and resulting “extension risk” relative to such consumer asset-backed transactions in our insured portfolio and in our investment portfolio and decreased refinancing activity.
Decreasing interest rates could result in early terminations of financial guarantee insurance policies in respect of which we are paid on an installment basis and do not receive a termination premium, thus reducing premium earned in respect of these transactions. Decreases in prevailing interest rates may also limit growth of or reduce investment income and may adversely impact the result of our interest rate swap portfolio.
Our investment portfolio may also be adversely affected by credit rating downgrades, ABS and RMBS prepayment speeds, foreign exchange movements, spread volatility, and credit losses.
Revenues and cash flow would be adversely impacted due to a decline in realization of installment premiums.
Due to the installment nature of a significant percentage of its premium income, Ambac Assurance has an embedded future revenue stream. The amount of installment premiums actually realized by Ambac Assurance could be reduced in the future due to factors such as early termination of insurance contracts, accelerated prepayments of underlying obligations or insufficiency of cash flows (by the premium paying entity). Additionally, the Segregated Account Rehabilitation Proceedings may result in the loss of installment premium income from such insured transactions if orders of the Rehabilitation Court are not effective. Such reductions would result in lower revenues.
We are subject to credit risk throughout our businesses, including large single risks, risk concentrations, correlated risks and reinsurance counterparty credit risk.
We are exposed to the risk that issuers of debt which we have insured (or with respect to which we have written credit derivatives), issuers of debt which we hold in our investment portfolio, reinsurers and other contract counterparties (including derivative counterparties) may default in their financial obligations, whether as the result of insolvency, lack of liquidity, operational failure, fraud or other reasons. These credit risks could cause increased losses and loss reserves, estimates of credit impairments and mark-to-market losses with respect to credit derivatives in our financial guarantee business; and we could experience losses and decreases in the value of our investment portfolio and, therefore, our financial strength. Such credit risks may be in the form of large single risk exposures to particular issuers, reinsurers or counterparties; losses caused by catastrophic events (including terrorist acts and natural disasters); losses caused by increases in municipal defaults; or losses in respect of different, but correlated, credit exposures.

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Market risks could adversely impact our assets posted as collateral in respect of investment agreements and interest rate swap transactions.
We are required to post collateral with respect to certain investment agreements and interest rate swap transactions. See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Credit Ratings and Collateral” in this Form 10-K. We will be required to post additional collateral if the market value of the assets used to collateralize our obligations declines or if there are changes in the collateral posting obligations under these agreements and transactions.
These collateral-posting obligations could have a material adverse effect on our liquidity. At present, these collateral-posting requirements are being partially satisfied by loans from Ambac Assurance to the Financial Services businesses. As required by Wisconsin law, these transactions were approved by the OCI. To the extent that collateral-posting requirements increase as a result of changes in market conditions, as described above, it is likely that Ambac Assurance would need to provide increased lending capacity to the Financial Services businesses in order to satisfy these collateral-posting obligations. Any such increases to lending capacity would be subject to the prior consent of the OCI; there can be no assurance that we would obtain such consent. We believe that the OCI would consider several factors in determining whether to grant such consent, including its view of Ambac Assurance’s financial condition at the time of such loan or contribution.
If the Financial Services businesses fail to post collateral as required, counterparties may be entitled to terminate the transactions. Upon such terminations, we may be forced to liquidate securities with unrealized mark-to-market losses which could have a material adverse effect on our liquidity. See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Credit Ratings and Collateral” in this Form 10-K. The termination of such transactions, if unpaid by our Financial Services businesses, would trigger Ambac Assurance’s obligations to make payments under the financial guarantee insurance policies it previously issued. To the extent that the OCI determines that the payment by Ambac Assurance under such policies could place Ambac Assurance in a hazardous condition, the OCI could initiate rehabilitation proceedings with respect to Ambac Assurance.
The determination of the amount of other-than temporary impairments taken on our investments is highly subjective and could materially impact our results of operations or financial position.
The determination of the amount of impairments on our investments varies by investment type and is based upon our periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. Management updates its evaluations regularly and reflects changes in impairments as such evaluations are revised. There can be no assurance that our management has accurately assessed the level of impairments taken in our financial statements. Furthermore, additional impairments may need to be taken in the future. Historical trends may not be indicative of future impairments. We use externally developed financial models to project impairments with respect to RMBS held in our investment portfolio, including Ambac Assurance guaranteed RMBS. Differences in the models we employ and/or flaws in these models and/or faulty assumptions inherent in these models and those determined by management, could lead to increased impairments with respect to RMBS in our investment portfolio.
We are subject to the risk of litigation and regulatory inquiries or investigations, and the outcome of proceedings we are or may become involved in could have a material adverse effect on our business, operations, financial position, profitability or cash flows.
Ambac Assurance is defending various lawsuits relating to its financial guarantee business. In addition, the Company has received various regulatory inquiries and requests for information. Please see Note 18. Commitments and Contingencies to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for information on these various proceedings.
It is not possible to predict whether additional suits will be filed or whether additional inquiries or requests for information will be made, and it is also not possible to predict the outcome of litigation, inquiries or requests for information. It is possible that there could be unfavorable outcomes in these or other proceedings. Management is unable to make a meaningful estimate of the amount or range of loss that could result from unfavorable outcomes or of the expenses that will be incurred in defending these lawsuits. Under some circumstances, adverse results in any such proceedings and/or the incurrence of significant litigation expenses could be material to our business, operations, financial position, profitability or cash flows.
We may not be able to realize the value of our investment in Ambac Assurance UK Limited.
Our wholly-owned subsidiary, Ambac UK, has been subject to significant regulatory oversight due to its financial condition and material losses suffered in connection with the financial crisis that began in 2007. Ambac UK's license to write new business was curtailed by their insurance regulator. Additionally, Ambac UK's license was amended such that the PRA must specifically approve any transfer of value from Ambac UK to any other Ambac group company. Accordingly, we do not expect Ambac UK to pay dividends to Ambac Assurance for the foreseeable future. Due to these and other factors, we may not be able to realize value from our ownership interest in Ambac UK.
System security risks, data protection breaches and cyber-attacks could adversely affect our business and results of operations.
We rely on our information technology systems for many enterprise-critical functions and a prolonged failure or interruption of these systems for any reason could cause significant disruption to our operations and have a material adverse effect on our business, financial condition and operating results. Our information technology and application systems may be vulnerable to threats from computer viruses, natural disasters, unauthorized access, cyber attack and other similar disruptions. Computer hackers may be able to penetrate our network’s system security and misappropriate or compromise confidential information, create system disruptions or cause shutdowns. In addition to our own confidential information, we sometimes receive and are required to protect confidential information from third parties. To the extent any disruption or security breach results in a loss or damage to our data, or inappropriate disclosure of our confidential information or that of others, it could cause significant financial losses that are either not insured against or not fully covered by insurance, damage to our reputation, affect our relationships with third parties, lead to claims against us, result in regulatory action, or otherwise have a material adverse effect on our business or results of operations.

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In addition, we may be required to incur significant costs to mitigate the damage caused by any security breach, or to protect against future damage. Moreover, although we have disaster recovery and business continuity plans in place, we may not be able to adequately execute these plans in a timely fashion in the event of a disruption to our information technology and application systems.
We may incur losses resulting from operational risk due to inadequate or failed internal processes, breakdown of settlement or communication systems, inadequate execution of strategy or from external events leading to disruption of our business. Events subject to operational risk include:
Internal Fraud-misappropriation of assets, intentional mismarking of positions
External Fraud-theft of information, third-party theft and forgery
Clients, Products, & Business Practice-improper trade, fiduciary breaches
Damage to Physical Assets-vandalism
Business Disruption & System Failures-software failures, hardware failures; and
Execution, Delivery, & Process Management-data entry errors, accounting errors, failed mandatory reporting, settlement errors, and negligence.
We may be adversely affected by failures in services or products provided by third parties.
We have outsourced and may continue to outsource certain segments of our operations and business, and rely upon third-party vendors for other essential services and information, such as the provision of data used in setting loss reserves and the provision of risk management information and services. A material failure by an external service or information provider or a material defect in the products, services or information provided thereby could adversely affect our financial condition and results of operations.
Our inability to attract and retain qualified executives and employees or the loss of any of these personnel could negatively impact our business.
Our ability to execute on our business strategies depend on the retention and recruitment of qualified executives and other professionals. We rely substantially upon the services of our current executive team. In addition to these officers, we require key staff with risk mitigation, structured finance, insurance, credit, investment, accounting, finance, legal and technical skills. As a result of Ambac’s financial situation and the rehabilitation proceedings for the Segregated Account, there is a higher risk that executive officers and other key staff will leave the Company and replacements may not be incented to join the Company. The loss of the services of members of our senior management team or our inability to hire and retain other talented personnel could delay or prevent us from succeeding in executing our strategies, which could further negatively impact our business.
Item 1B.    Unresolved Staff Comments
None.
Item 2.    Properties
The executive office of Ambac is located at One State Street Plaza, New York, New York 10004, which consists of approximately 103,500 square feet of office space, under a lease agreement that expires in December 2015. The lease has a provision where Ambac Assurance can remain at One State Street Plaza through September 2019 (requires consent of both parties) with the potential for a reduced amount of space. In February 2015, both parties committed to extending the lease term with the rental cost still to be determined. This office houses operations for all reportable business segments. Ambac leases additional space outside of New York for its data center at a secure facility under a lease agreement that expires in May 2019.
Ambac UK maintains offices in London, England, which consist of approximately 3,500 square feet of office space, under a lease agreement that expires in October 2020, with an earlier termination option at Ambac UK’s discretion; and in Milan, Italy, under a lease agreement that expires in December 2015.
Additionally, Ambac maintains a disaster recovery site as part of its Disaster Recovery Plan, which is located approximately 100 miles from One State Street Plaza under a lease that expires in December 2015. This remote warm-back-up facility is complete with user work stations, phone system, data center, internet connectivity and a power generator, capable of serving the needs of the disaster recovery team to support all business segment operations. The plan, facility and systems are revised and upgraded where necessary, and user tested annually to confirm their readiness.
Item 3.    Legal Proceedings
Please refer to Notes to the Consolidated Financial Statements—Note 18. Commitments and Contingencies included included in Part II, Item 8 in this Form 10-K for a discussion on legal proceedings against Ambac and its subsidiaries.

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Item 4.    Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
On May 1, 2013 (the “Effective Date”), all of the outstanding common stock and all other equity securities, including stock options and restricted stock units of the Predecessor Company, were cancelled pursuant to the terms of the Reorganization Plan. Prior to the Effective Date, Ambac’s common stock traded on the OTCQB, the middle tier of the OTC marketplace reserved for fully reporting issuers, under the symbol “ABKFQ”. The common stock of the Successor Company began trading on NASDAQ under the symbol “AMBC” on the Effective Date. The Successor Company authorized capital stock consists of 130 million shares of common stock and 20 million shares of preferred stock. Under the Reorganization Plan, Ambac also distributed warrants to holders of allowed general unsecured claims and subordinated debt securities, which entitle such holders to acquire additional shares of new common stock of the Company at an exercise price of $16.67 per share at any time on or prior to April 30, 2023 (5,039,877 warrants remain outstanding at December 31, 2014).
The following table sets forth the high and low bid quotations of Ambac’s Common Stock as reported by Bloomberg Financial Services, Inc. for the periods presented.
 
High
 
Low
 
Dividends
2014:
 
 
 
 
 
Fourth quarter
$
26.74

 
$
18.60

 
$

Third quarter
$
27.54

 
$
21.86

 
$

Second quarter
$
32.20

 
$
26.37

 
$

First quarter
$
35.61

 
$
22.00

 
$

 
 
 
 
 
 
2013:
 
 
 
 
 
Fourth quarter
$
25.16

 
$
15.03

 
$

Third quarter
$
25.70

 
$
17.64

 
$

Second quarter (beginning May 1)
$
27.25

 
$
18.00

 
$

Holders
On February 25, 2015, there were 34 stockholders of record of Ambac’s common stock.
Dividends
Information concerning payments and restrictions on the payment of dividends is set forth in Item 1 above under the caption “Insurance Regulatory Matters" Note 9. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K.
Purchases of Equity Securities By the Issuer and Affiliated Purchasers
The following table summarizes Ambac’s activity of share purchases during the fourth quarter of 2014. When restricted stock unit awards issued by Ambac become taxable compensation to employees, shares may be withheld to cover the employee’s withholding taxes. In December 2014, Ambac purchased shares from employees that settled restricted stock units to meet the required tax withholdings.
 
Total Shares
Purchased
 
Average Price
Paid Per Share
 
Total Number of
Shares Purchased
as Part of Publicly
Announced Plan
 
Maximum
Number of Shares
That May Yet Be
Purchased Under
the Plan  
October 2014

 
$

 

 

November 2014

 

 

 

December 2014
1,522

 
24.04

 

 

Fourth Quarter 2014
1,522

 
$
24.04

 

 


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There were no other repurchases of equity securities made during the three months ended December 31, 2014. Ambac does not have a stock repurchase program.

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Stock Performance Graph
The following graph compares the performance of an investment in our common stock from the close of business on May 1, 2013, the date we emerged from bankruptcy through December 31, 2014, with the Russell 2000 Index and the S&P 500 Financials Index. The graph assumes $100 was invested on May 1, 2013 in our common Stock at the closing price of $20 per share and at the closing price for the Russell 2000 Index and the S&P 500 Financials Index. It also assumes that dividends (if any) were reinvested on the date of payment without payment of any commissions. The performance shown in the graph represents past performance and should not be considered an indication of future performance.

 
 
05/01/13
 
06/30/13
 
09/30/13
 
12/31/13
 
03/31/14
 
06/30/14
 
09/30/14
 
12/31/14
Ambac
 
$100.00
 
$119.15
 
$90.70
 
$122.80
 
$155.15
 
$136.55
 
$110.50
 
$122.50
Russell 2000 Index
 
$100.00
 
$106.06
 
$116.89
 
$127.08
 
$128.50
 
$131.13
 
$121.48
 
$133.30
S&P 500 Index
 
$100.00
 
$105.48
 
$108.51
 
$119.72
 
$122.85
 
$125.67
 
$128.60
 
$137.92
Source: S&P Capital IQ

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Item 6.
Selected Financial Data
The following financial information for the five years ended December 31, 2014, has been derived from Ambac’s Consolidated Financial Statements. Following the Company’s emergence from bankruptcy on May 1, 2013, the consolidated financial statements reflect the application of fresh start reporting (“Fresh Start”), incorporating, among other things, the discharge of debt obligations, issuance of new common stock and fair value adjustments. The effects of the reorganization and Fresh Start adjustments are recorded in Predecessor Ambac’s Consolidated Statement of Total Comprehensive Income for the period ended April 30, 2013. The financial results of the Company for the periods from May 1, 2013 are referred to as “Successor” and the financial results for the periods through April 30, 2013 are referred to as “Predecessor”. The 2013 Successor Period and the 2013 Predecessor Period are distinct reporting periods. As a result of the implementation of Fresh Start, results and balances are not comparable between Successor Ambac and Predecessor Ambac. This information should be read in conjunction with the Consolidated Financial Statements and related notes located in Part II, Item 8 in this Form 10-K.
 
Successor Ambac
 
 
Predecessor Ambac
 
 
 
Period from
 
 
Period from
 
 
 
 
 
 
 
Year Ended
 
May 1 through
 
 
Jan. 1 through
 
Year Ended December 31,
($ in millions, except per share data)
December 31,
2014
 
December 31,
2013
 
 
April 30,
2013
 
2012
 
2011
 
2010
Statement of Total Comprehensive Income Highlights:
 
 
 
 
 
 
 
 
 
 
 
 
Gross premiums written
$
(288.3
)
 
$
(80.3
)
 
 
$
(14.1
)
 
$
(277.5
)
 
(179.0
)
 
(476.1
)
Net premiums earned
246.4

 
213.5

 
 
130.0

 
414.6

 
406.0

 
546.0

Net investment income
300.9

 
146.4

 
 
116.7

 
382.9

 
354.8

 
358.6

Other than temporary impairment losses
(25.8
)
 
(46.8
)
 
 
(0.5
)
 
(6.0
)
 
(63.8
)
 
(59.8
)
Net realized investment gains
58.8

 
4.5

 
 
53.3

 
72.1

 
17.3

 
159.5

Net change in fair value of credit derivatives
23.9

 
192.9

 
 
(60.4
)
 
(9.2
)
 
48.0

 
60.2

Derivative products revenue
(181.1
)
 
114.8

 
 
(33.7
)
 
(125.0
)
 
(280.8
)
 
(106.6
)
Net realized (losses) gains on extinguishment of debt
(74.7
)
 

 
 

 
(177.6
)
 
3.1

 

Income (loss) on Variable Interest Entities ("VIEs")
(32.2
)
 
(48.6
)
 
 
426.6

 
27.8

 
(214.4
)
 
(616.7
)
Loss and loss expenses (benefit) (1)
(545.6
)
 
(185.1
)
 
 
(38.1
)
 
683.6

 
1,859.5

 
719.4

Interest and underwriting and operating expenses
229.0

 
153.7

 
 
75.6

 
251.3

 
269.4

 
435.8

Insurance intangible amortization
151.8

 
99.7

 
 

 

 

 

Reorganization items
0.2

 
0.5

 
 
(2,745.2
)
 
7.2

 
49.9

 
32.0

Pre-tax income (loss) from continuing operations
493.3

 
512.3

 
 
3,348.0

 
(256.5
)
 
(1,882.9
)
 
(753.0
)
Net income (loss) attributable to Common Shareholders
484.1

 
505.2

 
 
3,349.0

 
(256.7
)
 
(1,960.4
)
 
(753.2
)
Total comprehensive income attributable to Ambac Financial Group, Inc.
692.7

 
516.9

 
 
3,523.9

 
(94.6
)
 
(1,788.9
)
 
(439.6
)
Net income (loss) per share:
 
 
 
 
 
 
 
 
 
 
 
 
Basic
$
10.73

 
$
11.23

 
 
$
11.07

 
$
(0.85
)
 
$
(6.48
)
 
$
(2.56
)
Diluted
$
10.31

 
$
10.91

 
 
$
11.07

 
$
(0.85
)
 
$
(6.48
)
 
$
(2.56
)
(1)
Ambac records the impact of estimated recoveries related to securitized loans in RMBS transactions that breached certain representations and warranties within loss and loss expenses (benefit). The expense (benefit) associated with changes to our estimated recoveries for the year ended December 31, 2014, the eight months ended December 31, 2013, the four months ended April 30, 2013 and the years ended December 31, 2012, 2011 and 2010 were $(481.6) million, $199.4 million, $(61.6) million, $195.2 million, $(301.1) million and $(365.0) million, respectively.

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Successor Ambac
 
 
Predecessor Ambac
 
December 31,
 
 
December 31,
($ in millions)
2014
 
2013
 
 
2012
 
2011
 
2010
Balance Sheet Highlights:
 
 
 
 
 
 
 
 
 
 
Total non-variable interest entity investments
$
5,507.0

 
$
6,523.7

 
 
$
6,329.9

 
$
6,877.0

 
$
6,853.3

Cash
73.9

 
77.4

 
 
43.8

 
16.0

 
9.5

Premium receivable
1,000.6

 
1,453.0

 
 
1,620.6

 
2,028.5

 
2,422.6

Insurance intangible asset
1,410.9

 
1,598.0

 
 

 

 

Goodwill
514.5

 
514.5

 
 

 

 

Subrogation recoverable (1)
953.3

 
498.5

 
 
497.3

 
659.8

 
714.3

Deferred ceded premium
123.3

 
145.5

 
 
177.9

 
221.3

 
264.9

Total VIE assets
15,126.1

 
15,988.7

 
 
17,841.9

 
16,543.2

 
17,930.8

Total assets
25,159.9

 
27,092.5

 
 
27,085.3

 
27,113.7

 
29,047.1

Liabilities subject to compromise

 

 
 
1,704.9

 
1,707.4

 
1,695.2

Unearned premiums
1,673.8

 
2,255.7

 
 
2,778.4

 
3,457.2

 
4,007.9

Losses and loss expense reserve (1)
4,752.0

 
5,968.7

 
 
6,619.5

 
7,044.1

 
5,288.7

Obligations under investment and repurchase agreements
160.1

 
359.1

 
 
362.0

 
546.5

 
805.6

Long-term debt (2)
971.1

 
963.2

 
 
150.2

 
223.6

 
208.3

Derivative liabilities
406.9

 
253.9

 
 
531.3

 
414.5

 
348.8

Total VIE liabilities
15,085.7

 
15,872.8

 
 
17,661.7

 
16,379.4

 
17,696.4

Total liabilities
23,486.1

 
26,114.1

 
 
30,332.2

 
30,263.2

 
30,401.3

Total stockholders’ equity (deficit)
1,673.7

 
978.4

 
 
(3,247.0
)
 
(3,149.5
)
 
(1,354.2
)
Total liabilities and stockholders' equity
$
25,159.9

 
$
27,092.5

 
 
$
27,085.3

 
$
27,113.7

 
$
20,047.1

(1)
Ambac records as a component of its loss reserves and subrogation recoverable, estimated recoveries related to securitized loans in RMBS transactions that breached certain representations and warranties. Ambac has recorded estimated recoveries of $2,523.5 million, $2,206.6 million, $2,523.2 million, $2,720.3 million and $2,417.1 million at December 31, 2014, 2013, 2012, 2011 and 2010, respectively.
(2)
Long-term debt represents surplus notes issued to third parties by Ambac Assurance and the Segregated Account. In 2014, Ambac sold a $350.0 million junior surplus note issued to it by the Segregated Account to a newly formed Trust in exchange for cash of $224.3 million and a subordinated owner trust certificate issued by the Trust. Long-term debt for all years excludes the portion of long-term debt associated with variable interest entities. Long-term debt associated with Ambac is included under liabilities subject to compromise in Predecessor Ambac.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) contains certain financial measures, in particular the presentation of Operating Earnings (Losses) and Adjusted Book Value, which are not presented in accordance with accounting principles generally accepted in the United States (“GAAP”). We are presenting these non-GAAP financial measures because they provide greater transparency and enhanced visibility into the underlying drivers of our business. We do not intend for these non-GAAP financial measures to be a substitute for any GAAP financial measures and they may differ from similar reporting provided by other companies. Readers of this Form 10-K should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures. Operating Earnings (Losses) and Adjusted Book Value are non-GAAP financial measures that adjust for the impact of certain non-recurring or non-economic GAAP accounting requirements and include the addition of certain items that the Company has or expects to realize in the future, but that are not reported under GAAP. We also provide reconciliations to the most directly comparable GAAP measures; Operating Earnings (Losses) to Net income (loss) attributable to common stockholders and Adjusted Book Value to Total Ambac Financial Group, Inc. stockholders’ equity.
COMPANY OVERVIEW
Ambac Financial Group, Inc. (“Ambac” or the “Company”), headquartered in New York City, is a financial services holding company incorporated in the state of Delaware. On May 1, 2013, the Second Modified Fifth Amended Plan of Reorganization of Ambac Financial Group, Inc. (the “Reorganization Plan”) became effective and Ambac emerged from bankruptcy. On December 26, 2013, the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) entered an order of final decree closing Ambac’s Chapter 11 case. Ambac filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the Bankruptcy Court on November 8, 2010 as a result of losses incurred since the beginning of the financial crisis in 2007.  Ambac has two reportable business segments: Financial Guarantee and Financial Services.
Ambac’s primary goal is to maximize shareholder value through executing the following key strategies:
Increasing the value of its investment in Ambac Assurance Corporation ("Ambac Assurance") by actively managing its assets and liabilities with a focus on maximizing risk-adjusted investment portfolio returns and mitigating or remediating losses on poorly performing insured

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transactions through executing policy commutations, repurchasing liabilities at a discount, pursuing recoveries of losses through litigation and the exercise of contractual and legal rights, restructuring transactions, and other means; and
Selectively exploring opportunities to grow and diversify Ambac, which may include developing or acquiring financial services businesses such as advisory, asset servicing, asset management, and/or insurance.
As part of its asset/liability management strategy, Ambac Assurance is considering the possibility of entering into transactions whereby it would monetize certain assets and/or restructure or exchange its outstanding debt and insurance obligations.
The execution of Ambac’s strategy to increase the value of its investment in Ambac Assurance is subject to the authority of the Rehabilitator to control the management of the Segregated Account. In exercising such authority, the Rehabilitator will act for the benefit of policyholders, and will not take into account the interests of Ambac. Similarly, by operation of the contracts executed in connection with the establishment, and subsequent rehabilitation, of the Segregated Account, the Rehabilitator retains rights to oversee and approve certain actions taken by or in respect of Ambac Assurance. This oversight by the Rehabilitator could impair Ambac’s ability to execute certain of its strategies. Refer to Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K, for more information on the contracts between Ambac Assurance and the Segregated Account.
Although we are exploring new business opportunities for Ambac, no assurance can be given that we will be able to identify or execute the acquisition or development of any new business. In addition, there can be no assurance that we will be able to generate or obtain the financial and other resources that may be required to finance the acquisition or development of any new business. Due to these factors, as well as uncertainties relating to the ability of Ambac Assurance to deliver value to Ambac, the value of our securities is speculative. For additional risks and uncertainties concerning Ambac, please refer to Part I, Item 1A in this Form 10-K.
There are substantial restrictions on the ability to transfer Ambac’s common stock set forth in Article XII of Ambac’s Amended and Restated Certificate of Incorporation. In order to preserve certain tax benefits, subject to limited exceptions, any attempted transfer of common stock shall be prohibited and void to the extent that, as a result of such transfer (or any series of transfers of which such transfer is a part), either (i) any person or group of persons shall become a holder of 5% or more of the Company’s common stock or (ii) the percentage stock ownership interest in Ambac of any holder of 5% or more of the Company’s common stock shall be increased (a “Prohibited Transfer”). These restrictions shall not apply to an attempted transfer if the transferor or the transferee obtains the written approval of Ambac’s Board of Directors to such transfer. A purported transferee of a Prohibited Transfer shall not be recognized as a stockholder of Ambac for any purpose whatsoever in respect of the securities which are the subject of the Prohibited Transfer (the “Excess Securities”). Until the Excess Securities are acquired by another person in a transfer that is not a Prohibited Transfer, the purported transferee of a Prohibited Transfer shall not be entitled with respect to such Excess Securities to any rights of stockholders of Ambac, including, without limitation, the right to vote such Excess Securities and to receive dividends or distributions, whether liquidating or otherwise, in respect thereof, if any. Once the Excess Securities have been acquired in a transfer that is not a Prohibited Transfer, the securities shall cease to be Excess Securities. If the Board determines that a transfer of securities constitutes a Prohibited Transfer then, upon written demand by Ambac, the purported transferee shall transfer or cause to be transferred any certificate or other evidence of ownership of the Excess Securities within the purported transferee’s possession or control, together with any distributions paid by Ambac with respect to such Excess Securities, to an agent designated by Ambac. Such agent shall thereafter sell such Excess Securities and the proceeds of such sale shall be distributed as set forth in the Amended and Restated Certificate of Incorporation. If the purported transferee of a Prohibited Transfer has resold the Excess Securities before receiving such demand, such person shall be deemed to have sold the Excess Securities for Ambac’s agent and shall be required to transfer to such agent the proceeds of such sale, which shall be distributed as set forth in the Amended and Restated Certificate of Incorporation.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with GAAP. An appreciation of our critical accounting policies is necessary to understand our financial results. These policies require management to make difficult and subjective judgments regarding uncertainties, and as a result, such estimates may significantly impact our financial results. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. As a result, actual results may differ from these estimates. We applied our critical accounting policies and estimation methods consistently in all material respects, and for all periods presented. Management has identified (i) the accounting for loss and loss expenses of non-derivative financial guarantees, (ii) the valuation of financial instruments, including the determination of whether an investment impairment is other-than-temporary, (iii) valuation allowance on deferred tax assets, and (iv) goodwill as critical accounting policies. This discussion should be read in conjunction with the Consolidated Financial Statements and notes thereon included elsewhere in this report. We have discussed with the Audit Committee management’s assessment of such critical accounting policies, the reasons why they are considered critical, and how current and anticipated future events impact those determinations. The Company’s critical accounting policies and estimates are as follows:
Losses and Loss Expenses of Non-derivative Financial Guarantees:
The loss and loss expense reserves for financial guarantee insurance discussed herein relates only to Ambac’s non-derivative insurance business for insurance policies issued to beneficiaries, including VIEs, for which we do not consolidate the VIE. Losses and loss expenses are based upon estimates of the ultimate aggregate losses inherent in the non-derivative financial guarantee portfolio as of the reporting date. The evaluation process for determining the level of reserves is subject to certain estimates and judgments based on our assumptions regarding the probability

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of default by the issuer of the insured security, probability of settlement outcomes (which may include commutation settlements, refinancings and/or other settlement outcomes) and expected loss severity of credits for each insurance contract.
The Financial Services-Insurance Topic of the ASC provides accounting guidance for financial guarantee insurance contracts issued by insurance enterprises, including the recognition and measurement of claim liabilities (i.e. loss reserves). Loss reserve components of an insurance policy include unpaid claims plus the present value ("PV") of expected net cash flows, further described below:
Unpaid claims represent the sum of (i) claims presented and not yet paid for policies allocated to the Segregated Account, including Deferred Amounts and (ii) accrued interest on Deferred Amounts (generally at an effective rate of 5.1%) as required by the amended Segregated Account Rehabilitation Plan that became effective on June 12, 2014. Refer to Note 1. Background and Business Description to the Consolidated Financial Statements located in Part II Item 8 of this Form 10-K for further discussion of Deferred Amounts and the amended Segregated Account Rehabilitation Plan. In accordance ASC Topic 944, unpaid claims are measured based on the estimated cost of settling the claims, which is principal plus accrued interest.
The PV of expected net cash flows represents the PV of expected cash outflows less the PV of expected cash inflows. Expected cash outflows represent future claims to be paid under an insurance contract, including commutation payments and the impact of potential settlement outcomes upon future installment premiums. Expected cash inflows represent potential future recoveries. In accordance with the financial guarantee insurance accounting guidance of ASC Topic 944, the approaches used to estimate expected future claims and expected future recoveries considers the likelihood of all possible outcomes.
Net cash outflow policies represent contracts where the sum of unpaid claims plus the PV of expected cash outflows are greater than the PV of expected cash inflows. For such policies, a “Loss and loss expense reserves” liability is recorded for the sum of: a) unpaid claims plus b) the excess of the PV of expected net cash outflows over the unearned premium reserve. Net cash inflow policies represent contracts where losses have been paid, but not yet recovered, such that the PV of expected cash inflows are greater than the sum of unpaid claims plus the PV of expected cash outflows. For such policies, a “Subrogation recoverable” asset is recorded for the difference between a) the PV of expected net cash inflows and b) unpaid claims. Changes to the loss reserve estimate in subsequent periods are recorded as a loss and loss expense on the income statement.
Ambac’s loss reserves are based on management’s on-going review of the non-derivative financial guarantee insurance portfolio. Active surveillance of the insured portfolio enables Ambac’s Portfolio Risk Management (“PRM”) group to track credit migration of insured obligations from period to period and update internal credit ratings for each transaction. Non-adversely classified credits are assigned a Class I or Survey List (“SL”) risk classification, while adversely classified credits are assigned a risk classification of Class IA through Class V. The criteria for an exposure to be assigned an adversely classified credit rating includes the deterioration of an issuer’s financial condition, under-performance of the underlying collateral (for collateral dependent transactions such as mortgage-backed or student loan securitizations), poor performance by the servicer of the underlying collateral and other adverse economic events or trends. The servicer of the underlying collateral of an insured securitization transaction is a consideration in assessing credit quality because the servicer’s performance can directly impact the performance of the related issue. For example, a servicer of a mortgage-backed securitization that does not remain current in its collection and loss mitigation efforts could cause an increase in delinquencies and potential defaults of the underlying obligations. Similarly, loss severities increase when a servicer does not effectively handle loss mitigation activities such as (i) the advancing of delinquent principal and interest and default-related expenses which are deemed to be recoverable by the servicer, (ii) pursuit of loan charge-offs which maximize cash flows from the mortgage loan pool and (iii) foreclosure and real estate owned disposition strategies and timelines.
The population of credits evaluated in Ambac’s loss reserve process are (i) all adversely classified credits and (ii) non-adversely classified credits which have a lower internal Ambac credit rating than the rating at the time of the transaction’s inception. One of two approaches is then utilized to estimate expected losses to ultimately determine if a loss reserve should be established. The first approach is a statistical expected loss approach, which considers the likelihood of all possible outcomes. The “base case” statistical expected loss is the product of: (i) the par outstanding on the credit; (ii) internally developed historical default information (taking into consideration internal ratings and average life of an obligation); (iii) internally developed loss severities; and (iv) a discount factor. The loss severities and default information are based on rating agency information, are specific to each bond type and were established and approved by senior officers of the PRM group. For certain credit exposures, Ambac’s additional monitoring, loss remediation efforts and probabilities of potential settlement outcomes may provide information relevant to adjust this estimate of “base case” statistical expected losses. Analysts may accept the “base case” statistical expected loss as the best estimate of expected loss or assign multiple probability weighted scenarios to determine an adjusted statistical expected loss that better reflects management’s view of a given transaction’s expected losses, as well as the potential for additional remediation activities (i.e. commutations).
The second approach entails the use of more precise estimates of expected losses (future claim payments, net of potential recoveries, expected to be paid to the holder of the insured financial obligation). Ambac’s surveillance group will consider the likelihood of all possible outcomes and develop appropriate cash flow scenarios. This approach can include the utilization of internal or third party models to project future losses and resultant claim payment estimates. We utilize cash flow models for residential mortgage-backed, student loan and other exposures. In general, these models use historical performance of the collateral pools in order to then assume or derive future performance characteristics, such as default and voluntary prepayment rates, which in turn determine projected future claim payments. In this approach a probability-weighted expected loss estimate is developed based on assigning probabilities to multiple claim payment scenarios and applying an appropriate discount factor. Additionally, we assign a probability to the issuer’s ability to refinance an insured issue and/or Ambac’s ability to execute a potential settlement (i.e. commutation) of the insurance policy, including the impact on future installment premiums. The commutation scenarios and the related probabilities of occurrence vary by transaction, depending on our view of the likelihood of negotiating such a transaction with issuers and/or investors. The methodology used to estimate the most substantial amount of the potential recovery component of expected losses is further

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described in the “RMBS Representation and Warranty Subrogation Recovery” section below and 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.
The discount factor applied to the statistical expected loss approach is based on a risk-free discount rate corresponding to the remaining expected weighted-average life of the exposure and the exposure currency. For the cash flow scenario approach, discount factors are applied based on a risk-free discount rate term structure and correspond to the date of each respective cash flow payment or recovery and the exposure currency. Discount factors are updated for the current risk-free rate each reporting period.
Ambac establishes loss expense reserves based on our estimate of expected net cash outflows for loss expenses, such as legal and consulting costs.
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, economic, credit or other unforeseen events could have an adverse impact on default probabilities and loss severities. The loss reserves for many transactions (such as many public finance exposures) are derived from the issuer’s creditworthiness. The loss reserves for other transactions which have no direct issuer support, such as most structured finance exposures, including RMBS, are derived from the default activity and loss given default of collateral supporting the transactions. 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 as well as our ability to execute commutations. 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 stability. Reinsurance contracts mitigate our loss reserve. Since Ambac has little exposure ceded to reinsurers, it is unlikely to have a significant effect on loss reserve volatility.
The table below indicates the