Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
 
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2017
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
 
OF THE SECURITIES EXCHANGE ACT OF 1934
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)
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 Web site, 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 whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act): (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨
Smaller reporting company
¨
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨    No  x
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 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  ¨
As of November 3, 2017, 45,251,166 shares of common stock, par value $0.01 per share, of the Registrant were outstanding.



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
 
 
PAGE
PART I.
FINANCIAL INFORMATION
 
 
Item 1.
Unaudited Consolidated Financial Statements of Ambac Financial Group, Inc. and Subsidiaries
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 3.
 
Item 4.
 
 
 
 
 
PART II.
OTHER INFORMATION
 
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 3.
 
 
Item 4.
 
Item 5.
 
Item 6.
 
 
 
 
 
 




PART I.    FINANCIAL INFORMATION
Item 1.     Unaudited Financial Statements of Ambac Financial Group, Inc. and Subsidiaries
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
 
September 30,
 
December 31,
(Dollars in thousands, except share data) (September 30, 2017 (Unaudited))
2017
 
2016
Assets:
 
 
 
Investments:
 
 
 
Fixed income securities, at fair value (amortized cost of $4,825,555 and $5,435,385)
$
4,978,118

 
$
5,554,215

Fixed income securities pledged as collateral, at fair value (amortized cost of $99,424 and $64,833)
99,424

 
64,905

Short-term investments, at fair value (amortized cost of $716,666 and $430,827)
716,516

 
430,788

Other investments (includes $406,310 and $420,304 at fair value)
439,987

 
450,307

Total investments
6,234,045

 
6,500,215

Cash and cash equivalents
107,018

 
91,025

Receivable for securities
68,686

 
2,090

Investment income due and accrued
20,137

 
26,023

Premium receivables
601,757

 
661,337

Reinsurance recoverable on paid and unpaid losses
45,976

 
30,418

Deferred ceded premium
54,773

 
69,624

Subrogation recoverable
703,930

 
684,731

Loans
10,390

 
4,160

Derivative assets
77,287

 
77,742

Insurance intangible asset
877,972

 
962,080

Other assets
48,228

 
158,423

Variable interest entity assets:
 
 
 
Fixed income securities, at fair value
2,785,608

 
2,622,566

Restricted cash
37,793

 
4,873

Loans, at fair value
11,557,788

 
10,658,963

Derivative assets
57,714

 
80,407

Other assets
3,481

 
1,025

Total assets
$
23,292,583

 
$
22,635,702

Liabilities and Stockholders’ Equity:
 
 
 
Liabilities:
 
 
 
Unearned premiums
$
817,538

 
$
967,258

Loss and loss expense reserves
4,704,285

 
4,380,769

Ceded premiums payable
38,593

 
42,529

Obligations under investment agreements

 
82,358

Deferred taxes
1,930

 
1,720

Current taxes
18,484

 
14,280

Long-term debt
988,148

 
1,114,405

Accrued interest payable
417,522

 
421,975

Derivative liabilities
90,899

 
319,286

Other liabilities
65,840

 
76,589

Payable for securities purchased
55,486

 
1,084

Variable interest entity liabilities:
 
 
 
Accrued interest payable
3,213

 
859

Long-term debt, at fair value
12,229,569

 
11,155,936

Derivative liabilities
2,088,922

 
2,078,601

Other liabilities
17

 
29

Total liabilities
21,520,446

 
20,657,678

Commitments and contingencies (See Note 11)
 
 
 
Stockholders’ equity:
 
 
 
Preferred stock, par value $0.01 per share; 20,000,000 shares authorized shares; issued and outstanding shares—none

 

Common stock, par value $0.01 per share; 130,000,000 shares authorized; issued and outstanding shares: 45,275,982 and 45,194,954
453

 
452

Additional paid-in capital
198,629

 
195,267

Accumulated other comprehensive income (loss)
62,680

 
(38,990
)
Retained earnings
1,246,736

 
1,557,681

Treasury stock, shares at cost: 24,816 and 22,458
(471
)
 
(496
)
Total Ambac Financial Group, Inc. stockholders’ equity
1,508,027

 
1,713,914

Noncontrolling interest
264,110

 
264,110

Total stockholders’ equity
1,772,137

 
1,978,024

Total liabilities and stockholders’ equity
$
23,292,583

 
$
22,635,702

See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 1 2017 Third Quarter FORM 10-Q |



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Total Comprehensive Income (Loss) (Unaudited)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in thousands, except share data)
 
2017
 
2016
 
2017
 
2016
Revenues:
 
 
 
 
 
 
 
 
Net premiums earned
 
$
52,989

 
$
53,218

 
$
143,754

 
147,420

Net investment income:
 
 
 
 
 
 
 
 
Securities available-for-sale and short-term
 
80,999

 
79,530

 
235,092

 
201,880

Other investments
 
6,178

 
11,387

 
18,804

 
20,616

Total net investment income
 
87,177

 
90,917

 
253,896

 
222,496

Other-than-temporary impairment losses:
 
 
 
 
 
 
 
 
Total other-than-temporary impairment losses
 
(25,664
)
 
(15,906
)
 
(48,581
)
 
(82,856
)
Portion of other-than-temporary impairment recognized in other comprehensive income
 
12,154

 
13,053

 
29,366

 
63,228

Net other-than-temporary impairment losses recognized in earnings
 
(13,510
)
 
(2,853
)
 
(19,215
)
 
(19,628
)
Net realized investment gains (losses)
 
6,150

 
11,749

 
5,434

 
27,748

Change in fair value of credit derivatives:
 
 
 
 
 
 
 
 
Realized gains and other settlements
 
134

 
226

 
1,467

 
711

Unrealized gains (losses)
 
45

 
1,507

 
6,388

 
17,843

Net change in fair value of credit derivatives
 
179

 
1,733

 
7,855

 
18,554

Net gains (losses) on interest rate derivatives
 
3,984

 
(14,510
)
 
36,538

 
(134,265
)
Net realized gains (losses) on extinguishment of debt
 

 
24

 
4,920

 
4,845

Other income (expense)
 
46

 
2,693

 
427

 
17,611

Income (loss) on variable interest entities
 
(4,049
)
 
2,057

 
(1,567
)
 
(16,119
)
Total revenues
 
132,966

 
145,028

 
432,042

 
268,662

Expenses:
 
 
 
 
 
 
 
 
Losses and loss expenses (benefit)
 
209,806

 
(69,204
)
 
410,917

 
(226,981
)
Insurance intangible amortization
 
45,690

 
44,553

 
116,686

 
134,456

Operating expenses
 
33,791

 
21,466

 
92,822

 
77,470

Interest expense
 
29,145

 
31,493

 
88,951

 
92,632

Total expenses
 
318,432

 
28,308

 
709,376

 
77,577

Pre-tax income (loss)
 
(185,466
)
 
116,720

 
(277,334
)
 
191,085

Provision for income taxes
 
5,439

 
15,282

 
31,902

 
21,877

Net income (loss)
 
(190,905
)
 
101,438

 
(309,236
)
 
169,208

Less: net gain (loss) attributable to noncontrolling interest
 

 
(36
)
 

 
(328
)
Net income (loss) attributable to common shareholders
 
$
(190,905
)
 
$
101,474

 
$
(309,236
)
 
$
169,536

Other comprehensive income (loss), after tax:
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(190,905
)
 
$
101,438

 
$
(309,236
)
 
$
169,208

Unrealized gains (losses) on securities, net of deferred income taxes of $0
 
(434
)
 
24,719

 
33,550

 
132,680

Gains (losses) on foreign currency translation, net of deferred income taxes of $0
 
24,624

 
(13,323
)
 
66,509

 
(86,256
)
Changes to postretirement benefit, net of tax of $0
 
(338
)
 
(254
)
 
1,611

 
278

Total other comprehensive income (loss), net of tax
 
23,852

 
11,142

 
101,670

 
46,702

Total comprehensive income (loss)
 
(167,053
)
 
112,580

 
(207,566
)
 
215,910

Less: comprehensive (gain) loss attributable to the noncontrolling interest:
 
 
 
 
 
 
 
 
Net gain (loss)
 

 
(36
)
 

 
(328
)
Total comprehensive income (loss) attributable to Ambac Financial Group, Inc.
 
$
(167,053
)
 
$
112,616

 
$
(207,566
)
 
$
216,238

Net income (loss) per share attributable to Ambac Financial Group, Inc. common stockholders
 
 
 
 
 
 
 
 
Basic
 
$
(4.20
)
 
$
2.24

 
$
(6.82
)
 
$
3.75

Diluted
 
$
(4.20
)
 
$
2.22

 
$
(6.82
)
 
$
3.74

See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 2 2017 Third Quarter FORM 10-Q |



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity (Unaudited)
 
 
 
Ambac Financial Group, Inc.
 
 
(Dollars in thousands)
Total
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Preferred
Stock
 
Common
Stock
 
Additional Paid-in
Capital
 
Common
Stock Held
in Treasury,
at Cost
 
Noncontrolling
Interest
Balance at January 1, 2017
$
1,978,024

 
$
1,557,681

 
$
(38,990
)
 
$

 
$
452

 
$
195,267

 
$
(496
)
 
$
264,110

Total comprehensive income
(207,566
)
 
(309,236
)
 
101,670

 

 

 

 

 

Adjustment to initially apply ASU 2016-09
(137
)
 
(137
)
 

 

 

 

 

 

Stock-based compensation
3,362

 

 

 

 

 
3,362

 

 

Cost of shares (acquired) issued under equity plan
(1,547
)
 
(1,572
)
 

 

 

 

 
25

 

Issuance of common stock
1

 

 

 

 
1

 

 

 

Balance at September 30, 2017
$
1,772,137

 
$
1,246,736

 
$
62,680

 
$

 
$
453

 
$
198,629

 
$
(471
)
 
$
264,110

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2016
$
1,958,346

 
$
1,478,439

 
$
15,215

 
$

 
$
450

 
$
190,813

 
$
(118
)
 
$
273,547

Total comprehensive income
215,910

 
169,536

 
46,702

 

 

 

 

 
(328
)
Adjustment to initially apply ASU 2014-13

 
6,442

 

 

 

 

 

 
(6,442
)
Stock-based compensation
4,228

 

 

 

 

 
4,228

 

 

Cost of shares (acquired) issued under equity plan
(9
)
 
(127
)
 

 

 

 

 
118

 

Cost of warrants acquired
(2,104
)
 
(1,444
)
 

 

 

 
(660
)
 

 

Issuance of common stock
1

 

 

 

 
1

 

 

 

Warrants exercised
2

 

 

 

 

 
2

 

 

Balance at September 30, 2016
$
2,176,374

 
$
1,652,846

 
$
61,917

 
$

 
$
451

 
$
194,383

 
$

 
$
266,777

See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 3 2017 Third Quarter FORM 10-Q |



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
 
 
Nine Months Ended September 30,
(Dollars in thousands)
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net income (loss) attributable to common shareholders
 
$
(309,236
)
 
$
169,536

Noncontrolling interest in subsidiaries’ earnings
 

 
(328
)
Net income (loss)
 
$
(309,236
)
 
$
169,208

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
Depreciation and amortization
 
766

 
920

Amortization of bond premium and discount
 
(133,901
)
 
(102,956
)
Share-based compensation
 
3,362

 
4,228

Deferred income taxes
 
210

 
(469
)
Current income taxes
 
4,441

 
11,848

Unearned premiums, net
 
(137,127
)
 
(210,722
)
Losses and loss expenses, net
 
282,317

 
666,196

Ceded premiums payable
 
(3,936
)
 
(9,983
)
Investment income due and accrued
 
5,874

 
(145
)
Premium receivables
 
62,205

 
126,047

Accrued interest payable
 
27,295

 
45,201

Amortization of insurance intangible assets
 
116,686

 
134,456

Net mark-to-market (gains) losses
 
(6,388
)
 
(17,843
)
Net realized investment gains
 
(5,434
)
 
(27,748
)
Other-than-temporary impairment charges
 
19,215

 
19,628

(Gain) loss on extinguishment of debt
 
(4,920
)
 
(4,845
)
Variable interest entity activities
 
1,567

 
16,119

Derivative assets and liabilities
 
(211,659
)
 
81,517

Other, net
 
9,932

 
(75,125
)
Net cash provided by (used in) operating activities
 
(278,731
)
 
825,532

Cash flows from investing activities:
 
 
 
 
Proceeds from sales of bonds
 
1,523,182

 
457,423

Proceeds from matured bonds
 
669,979

 
940,948

Purchases of bonds
 
(1,560,024
)
 
(2,085,939
)
Proceeds from sales of other invested assets
 
312,699

 
132,437

Purchases of other invested assets
 
(274,445
)
 
(250,727
)
Change in short-term investments
 
(285,775
)
 
94,651

Loans, net
 
(6,230
)
 
693

Change in cash collateral receivable
 
103,255

 
(51,986
)
Other, net
 
(8,524
)
 
(10,714
)
Net cash provided by (used in) investing activities
 
474,117

 
(773,214
)
Cash flows from financing activities:
 
 
 
 
Paydowns of a secured borrowing
 
(24,666
)
 
(25,306
)
Payments for investment agreement draws
 
(82,358
)
 
(17,964
)
Payments for extinguishment of long-term debt
 
(69,499
)
 
(19,550
)
Tax payments related to shares withheld for share-based compensation plans
 
(1,268
)
 

Proceeds from warrant exercises
 

 
2

Cost of warrants acquired
 

 
(2,104
)
Net cash used in financing activities
 
(177,791
)
 
(64,922
)
Effect of foreign exchange on cash and cash equivalents
 
(1,602
)
 
(1,922
)
Net cash flow
 
15,993

 
(14,526
)
Cash and cash equivalents at beginning of period
 
91,025

 
35,744

Cash and cash equivalents end of period
 
$
107,018

 
$
21,218

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid during the period for:
 
 
 
 
Income taxes
 
$
29,556

 
$
10,098

Interest on long-term debt and investment agreements
 
38,325

 
3,749

Non-cash financing activities:
 
 
 
 
Decrease in long-term debt as a result of an exchange for investment securities
 
$
55,426

 
$

See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 4 2017 Third Quarter FORM 10-Q |

Table of Contents
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)


1. BACKGROUND AND BUSINESS DESCRIPTION
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.
Ambac provides financial guarantee insurance policies through its principal operating subsidiary, Ambac Assurance Corporation (“Ambac Assurance" or "AAC") and its wholly owned subsidiary, Ambac Assurance UK Limited (“Ambac UK”). Insurance policies issued by Ambac Assurance and Ambac UK generally guarantee payment when due of the principal and interest on the obligations guaranteed. Ambac also has another wholly-owned 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. The 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 (as 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 regulatory restrictions, the terms of its Auction Market Preferred Shares and the terms of agreements entered into with the Segregated Account. It is highly unlikely that Ambac Assurance will be able to make dividend payments to Ambac for the foreseeable future.
Ambac also provides other financial products through subsidiaries of Ambac Assurance. These products consist of interest rate swaps, funding conduits, and investment agreements (until the first quarter of 2017) that were provided principally to clients that were also provided financial guarantee policies. These financial products have been in active run-off since 2007.
Prior to the second quarter of 2017, Ambac had two reportable business segments: i) the financial guarantee segment, which consisted of financial guarantee insurance policies and credit derivative contracts and ii) the financial services segment which consisted of the other financial products discussed above. With respect to the financial services segment, there were significant swap commutations in June 2017. The remaining interest rate swaps, along with other interest rate derivatives, are managed to economically hedge interest rate risk in the financial guarantee and investment portfolios. The last remaining investment agreement matured in March 2017 and the remaining conduit transactions are not material. The significant wind-down of these financial products, along with the appointment of a new Chief Executive Officer effective January 1, 2017, has resulted in a change in how the Company manages its business. Management now reviews financial information, allocates resources and measures financial performance on a consolidated basis. As a result, beginning with the second quarter of 2017, the Company has a single reportable segment. All prior period amounts and disclosures have been adjusted to reflect the reportable segment change.
During the third quarter of 2017, management and the Board of Directors of Ambac engaged in a comprehensive review of its key corporate strategies. Following that review, Ambac's key strategic objectives are as follows:
Active runoff of Ambac Assurance and its subsidiaries through transaction terminations, policy commutations, settlements and restructurings, with a focus on known and potential future adversely classified credits, that we believe will improve our risk profile, and maximizing the risk-adjusted return on invested assets;
Rationalization of Ambac's and its subsidiaries' capital and liability structures, enabling simplification of corporate governance and facilitating the successful rehabilitation of the Segregated Account of Ambac Assurance;
Loss recovery through active litigation management and exercise of contractual and legal rights;
Ongoing review of organizational effectiveness and efficiency of the operating platform; and
Evaluation of opportunities in certain business sectors that meet acceptable criteria that will generate long-term stockholder value with attractive risk-adjusted returns.
With respect to our new business strategy, we have identified certain business sectors adjacent to Ambac's core business, in which future opportunities will be evaluated. The evaluation will be conducted through a measured and disciplined approach to identify opportunities that are synergistic to Ambac, match Ambac's core competencies, are rapidly scalable or available through mergers and acquisitions and that may allow for the utilization of Ambac's net operating loss carry-forwards.  Although we are exploring new business opportunities for Ambac, no assurance can be given that we will be able to execute the acquisition or development of any new businesses or assets. In addition, there can be no assurance that we will be able to obtain the financial and other resources that may be required to finance the acquisition or development of new businesses or assets that may permit utilization of Ambac’s tax net operating loss carry-forwards. 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 remains speculative.


| Ambac Financial Group, Inc. 5 2017 Third Quarter FORM 10-Q |

Table of Contents
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

The execution of Ambac’s strategy to increase the value of its investment in Ambac Assurance remains 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. The Rehabilitator's authority includes, but is not limited to, sole discretion over the rate at which the Segregated Account pays claims and the accretion rate on Deferred Amounts. 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. As indicated below under "Stipulation and Order," OCI (defined below) is expected to exercise enhanced oversight over the activities of Ambac Assurance after the conclusion of the Segregated Account Rehabilitation Proceedings (as defined below). Opportunities for remediating losses on poorly performing insured transactions also 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 counterparty specific factors. Oversight by the Rehabilitator or OCI could impair Ambac’s ability to execute certain of its strategies. Ambac Assurance's ability to commute policies or purchase certain investments may also be limited by available liquidity.
As a result of uncertainties associated with the oversight by the Rehabilitator of the Segregated Account as noted herein, management has concluded that there is substantial doubt about Ambac's ability to continue as a going concern. Ambac’s financial statements as of and for the three and nine months ended September 30, 2017 and the year ended December 31, 2016, are prepared assuming Ambac continues as a going concern and do not include any adjustment that might result from its inability to continue as a going concern.
The Segregated Account
In March 2010, Ambac Assurance established a Segregated Account pursuant to Wisc. Stat. §611.24 (2) (the “Segregated Account”) to segregate certain segments of Ambac Assurance’s liabilities, and 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 Dane County, Wisconsin Circuit Court (the “Rehabilitation Court”) with respect to the Segregated Account (the “Segregated Account Rehabilitation Proceedings”) in order to permit 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. On October 8, 2010, OCI filed a plan of rehabilitation for the Segregated Account (the “Segregated Account Rehabilitation Plan”) in the Rehabilitation Court. The Rehabilitation Court confirmed the Segregated Account Rehabilitation Plan on January 24, 2011. On June 11, 2014, the Rehabilitation Court approved amendments to the Segregated Account Rehabilitation Plan and the Segregated Account Rehabilitation Plan, as amended, became effective on June 12, 2014. Net par exposure as of September 30, 2017 for policies allocated to the Segregated Account was $10,174,798. Policy obligations not allocated to the Segregated Account remain in the General Account of Ambac Assurance, and such policies in the General Account are not subject to and, therefore, are not directly impacted by the Segregated Account Rehabilitation Plan.
To pay claims and other liabilities, the Segregated Account has the ability to demand payment from time to time under an aggregate excess of loss reinsurance agreement provided by Ambac Assurance (the “Reinsurance Agreement”). In addition, certain operating and administrative costs and expenses of the Segregated Account are reimbursable by Ambac Assurance pursuant to the Cooperation Agreement, dated as of March 24, 2010, by and between the Segregated Account and Ambac Assurance, as amended (the “Cooperation Agreement”). Ambac Assurance is not obligated to make payments under the Reinsurance Agreement or Cooperation Agreement if its surplus as regards to policyholders is less than $100,000 (the “Minimum Surplus Amount”). As long as the surplus as regards to policyholders is not less than the Minimum Surplus Amount, payments by Ambac Assurance to the Segregated Account under the Reinsurance Agreement and Cooperation Agreement are not capped. At September 30, 2017, Ambac Assurance’s surplus as regards to policyholders exceeded the Minimum Surplus Amount. In the event that Ambac Assurance does not maintain surplus in excess of the Minimum Surplus Amount, the Segregated Account would experience a shortfall in funds available to pay its liabilities. Any such shortfall would be a consideration for the Rehabilitator in the determination of whether any changes to the Segregated Account Rehabilitation Plan and/or the amount of partial policy claim payments are necessary or appropriate or whether to institute general rehabilitation proceedings against Ambac Assurance.
Rehabilitation Exit Support Agreement
On July 19, 2017, Ambac Assurance and Ambac entered into an agreement (the “Rehabilitation Exit Support Agreement”) with holders or beneficial owners (the “Supporting Holders”) of surplus notes issued by Ambac Assurance and beneficial interests in Deferred Amounts (as defined in the Segregated Account Rehabilitation Plan) of the Segregated Account with respect to a transaction which, subject to the conditions precedent set forth in the Rehabilitation Exit Support Agreement, and if consummated, would generally involve (i) the exchange of certain surplus notes held by holders of surplus notes that elect to participate in a voluntary exchange transaction and (ii) the satisfaction and discharge of all Deferred Amounts, in each case for an effective consideration package comprised of cash and new Secured Notes (as defined below) and certain existing surplus notes and (iii) the exit from rehabilitation of the Segregated Account (the “Rehabilitation Exit Transactions”).
The settlement of the Deferred Amounts and the Segregated Account’s exit from rehabilitation are expected to be realized through the amendment (the “Rehabilitation Plan Amendment”) of the Segregated Account Rehabilitation Plan to be pursued by the Rehabilitator, and a series of transactions which would provide to holders of beneficial interests in Deferred Amounts (other than Ambac, but including Ambac Assurance) a total effective consideration package, in full satisfaction and discharge of each $1.00 of Deferred Amounts (including accretion), of (i) $0.40 in cash, (ii) $0.41 in principal amount of new Secured Notes (as defined below) and (iii) from certain holders of surplus notes, $0.125 currently outstanding surplus notes. Such consideration package would thereby provide a discount of $0.065 (set first against accretion of Deferred


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Amounts). Ambac would receive $0.91 in principal amount of Secured Notes for each $1.00 of Deferred Amounts (including accretion) that it holds, and would provide a $0.09 discount in full satisfaction and discharge of its Deferred Amount claims.
On September 25, 2017 the Rehabilitator filed a motion in the Rehabilitation Court by seeking entry of an order approving the Rehabilitation Plan Amendment. On September 26, 2017, the Rehabilitation Court entered a scheduling order in connection with this motion providing that objections to the motion shall be filed by November 24, 2017, the Rehabilitator’s response to any objections shall be filed by December 11, 2017, the Rehabilitator’s Pretrial Report shall be filed by December 11, 2017, the Pretrial Conference shall be held on December 14, 2017, and the evidentiary Confirmation Hearing shall be held on January 4 and 5, 2018.
The Rehabilitation Exit Support Agreement calls for a series of interrelated transactions involving the exchange of certain surplus notes (collectively, the “Exchange Offers”), pursuant to which, for each $1.00 of principal amount outstanding and accrued and unpaid interest thereon, holders effectively would (i) receive $0.40 in cash, (ii) receive $0.41 in principal amount of Secured Notes, (iii) retain $0.125 in principal amount and accrued and unpaid interest thereon of surplus notes and (iv) provide a discount of $0.065 in principal amount and accrued and unpaid interest thereon. Ambac will not participate in the Exchange Offers and will hold surplus notes issued by the Segregated Account and Ambac Assurance until the Rehabilitation Exit Transactions are consummated and a certain amount of such surplus notes for a time after such transactions are completed, as described below.
As part of the Rehabilitation Exit Transactions, Ambac and Ambac Assurance will seek consents from holders of surplus notes to a waiver and amendment (the “BSA Waiver and Amendment”) of certain provisions of the Settlement Agreement, such consents to be executed by holders of more than 50% in aggregate principal amount of the surplus notes. Holders who participate in the Exchange Offers will be required to deliver their consent to the BSA Waiver and Amendment.
As contemplated by the Rehabilitation Exit Support Agreement and as a portion of the consideration received by holders of beneficial interests in Deferred Amounts (including Ambac Assurance) in satisfaction and discharge of their claims pursuant to the Rehabilitation Plan Amendment and by holders of surplus notes pursuant to the Exchange Offers (as specified above), a newly formed special purpose entity will issue new secured notes (the “Secured Notes”), secured by all assets of the special purpose entity, which include a note issued by Ambac Assurance to the special purpose entity (the "Ambac Note"), which note is secured by a pledge of Ambac Assurance’s right, title and interest in up to the first $1,400,000 of proceeds (net of reinsurance) from certain litigations in which Ambac Assurance and the Segregated Account seek redress for breaches of representations and warranties and/or fraud related to residential mortgage-backed securitizations (the “RMBS Litigations”). In addition, the Ambac Note will be secured by RMBS securities having a market value of not less than $350,000 on the date that is not more than five business days prior to the closing date of the Rehabilitation Exit Transactions. Ambac Assurance will also pledge for the benefit of the holders of Secured Notes (other than Ambac Assurance) the proceeds of any Secured Notes held by AAC from time to time, and will issue a financial guaranty insurance policy to a trustee for the benefit of holders of Secured Notes irrevocably guarantying all principal and interest payments in respect of the Secured Notes as and when such payments become due and owing. Should Ambac Assurance settle any of the RMBS Litigations before the closing of the Rehabilitation Exit Transactions, any proceeds received by Ambac Assurance from any settlement which would have secured the Secured Notes will replace Secured Notes having a face amount equal to the amount of proceeds received that would otherwise be issued.
Following the consummation of the Rehabilitation Exit Transactions and until the earlier of (i) June 8, 2020 and (ii) the date on which at least 25% of the principal amount of Remaining Senior Surplus Notes (as defined the Rehabilitation Exit Support Agreement) are no longer outstanding, Ambac shall hold and not sell Remaining Senior Surplus Notes which, as of June 30, 2017, have an aggregate of $60,000 of principal amount and accrued and unpaid interest outstanding.
The Company may terminate the Rehabilitation Exit Support Agreement upon the occurrence of certain events, including if the Rehabilitation Exit Transactions have not been consummated within 365 days of the signing date of the Rehabilitation Exit Support Agreement.
Supporting Holders that, in the aggregate, beneficially own at least 66 2/3% of the principal amount outstanding under the surplus notes and 66 2/3% of the principal amount of the Deferred Amounts, held by the Supporting Holders as a whole may terminate the Rehabilitation Exit Support Agreement upon the occurrence of certain events, including if (i) within 75 days of signing date of the Rehabilitation Exit Support Agreement, the Rehabilitator has not filed a motion in the Rehabilitation Court seeking entry of the approval order; (ii) the confirmation hearing has not commenced within 180 days of the signing date of the Rehabilitation Exit Support Agreement; and (iii) the Rehabilitation Exit Transactions have not been consummated within 270 days of the Signing Date. The condition described in clause (i) of the preceding sentence has been satisfied. In addition if the Rehabilitation Exit Transactions have not been consummated within 365 days of the signing date of the Rehabilitation Exit Support Agreement, each Supporting Holder shall have the right to terminate the Agreement with respect to itself.
Ambac can provide no assurance that any of the termination events described above or in the Rehabilitation Exit Support Agreement will not arise.
On September 21, 2017, Ambac Assurance, Ambac and the Supporting Holders entered into the First Amendment to the Rehabilitation Exit Support Agreement (the “First Amendment”) to amend certain provisions of the Rehabilitation Exit Support Agreement, including the term sheets


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attached thereto, to reflect the terms of the definitive documents to which the parties had agreed during the course of their negotiation. The First Amendment, among other things:
(A) amends certain terms in the Rehabilitation Exit Term Sheet attached as Exhibit A to the Rehabilitation Exit Support Agreement (the “ Plan Amendment Term Sheet ”) to (i) specify that the record date with respect to the Rehabilitation Plan Amendment shall be September 30, 2017; (ii) provide that if the amount of accretion on a holder’s Deferred Amount is less than 7.4% on the record date, and if such Deferred Amount relates to an insured obligation that is undercollateralized, then the remaining amount of such Deferred Amount that is to be discharged may include the portion of the applicable Deferred Amount that is in excess of the amount of accretion; (iii) provide that the Rehabilitator may provide alternative consideration to holders of Deferred Amounts, in an amount equal to the currently contemplated consideration, to the extent that Ambac Assurance determines, in its sole discretion, that doing so is necessary or advisable to maintain compliance with any legal or regulatory requirements applicable to Ambac Assurance or the Segregated Account; (iv) provide that, subject to the occurrence of the effective date of the Rehabilitation Plan Amendment, no accretion shall arise or accrue with respect to policy claims arising on or after the record date through and including one business day immediately preceding the effective date and such policy claims shall be paid in cash; (v) provide that where underlying securities related to Deferred Amounts arising prior to the record date (“ Pre-Record Date Deferred Amounts ”) are held through the Depository Trust Company, the consideration for the Pre-Record Date Deferred Amounts shall be distributed to the ultimate beneficial holders of the securities and not to the applicable trustee; the consideration shall be deemed to be transferred to the trustee and the distribution will be deemed to have been received by beneficial holders on the next scheduled bond distribution date applicable to the relevant insured obligation or underlying indenture that gives rise to the related claim, notwithstanding the date when the consideration was actually received by such beneficial holders; and (vi) amend the condition to the effectiveness of the Rehabilitation Plan Amendment such that the confirmation order of the Rehabilitation Court approving the Rehabilitation Plan Amendment does not need to have become a final order; and
(B) amends certain terms in the Secured Notes Term Sheet attached as Exhibit C to the Rehabilitation Exit Support Agreement (the "Secured Notes Term Sheet") to (i) specify that the issuer (the “ Secured Notes Issuer ”) of the Secured Notes will liquidate on or after a date that is at least 12 months after the earlier of (a) the satisfaction of all of the Secured Notes Issuer’s obligations under the Secured Notes (other than contingent indemnification obligations) and (b) the maturity date of the Secured Notes (the “ Maturity Date ”); provided that (X) prior to the satisfaction of all of the Secured Notes Issuer’s obligations under the Secured Notes (other than contingent indemnification obligations), holders of the Secured Notes shall retain their rights to the collateral securing the Secured Notes and the financial guaranty insurance policy on the Secured Notes and any liquidation of the Secured Notes Issuer prior to such satisfaction shall result in the note collateral agent under the Secured Notes becoming the “Holder” of the Ambac Note (as defined in the Secured Notes Term Sheet) and retaining all rights and powers of the “Holder” thereunder (subject to the transfer restrictions for the Ambac Note) and (Y) such liquidation shall, in any event, be completed no later than the date that is 18 months after the earlier of (1) the satisfaction of all of the Secured Notes Issuer’s obligations under the Secured Notes (other than contingent indemnification obligations) and (2) the Maturity Date; and (ii) provide that none of the collateral agent, the trustee or the holders of Secured Notes may sell the Ambac Note or the right to receive the proceeds from the RMBS litigations without the prior consent of Ambac Assurance; provided that the foregoing shall not limit the assignment of the Ambac Note to the collateral agent in connection with a liquidation of the Secured Notes Issuer but shall limit the further assignment by the collateral agent without the prior consent of Ambac Assurance.
The Exchange Offers will be subject to a number of conditions precedent, including, among others, (i) approval by the OCI; (ii) the effectiveness of the Rehabilitation Plan Amendment concurrent with the closing of the Exchange Offers; (iii) participation by 85% of the outstanding principal amount owned by holders of surplus notes (including Ambac and Ambac Assurance) in the Exchange Offers; (iv) receipt of consents of at least a majority of the outstanding aggregate principal amount of the surplus notes (other than surplus notes beneficially owned by Ambac or Ambac Assurance or any of their affiliates) to the BSA Waiver and Amendment; and (v) subject to the approval of the OCI, a one-time current interest payment of approximately $12,500 on the surplus notes outstanding immediately following the effective date of the Rehabilitation Plan Amendment.
Effectiveness of the Rehabilitation Plan Amendment shall be determined and announced by the Rehabilitator provided that a number of conditions precedent have been satisfied or waived by the Rehabilitator, in his sole discretion, including, among others, (i) the Rehabilitation Plan Amendment will have been approved by the Rehabilitation Court; (ii) as of the effective date, Ambac Assurance will have sufficient capital and claims-paying resources to effect all of the Rehabilitation Exit Transactions and to exit rehabilitation, as determined by the Rehabilitator in his sole and absolute discretion; (iii) the conditions to consummation of the Exchange Offers will have been satisfied or waived in full in accordance with the terms thereof; and (iv) Ambac will have received from the Internal Revenue Service a ruling, in form and substance reasonably satisfactory to the Rehabilitator, Ambac Assurance, and Ambac.
Ambac can provide no assurances that these approvals or consents will be obtained or that the other conditions precedent will be satisfied or waived in a timely manner or at all. Even if the Rehabilitation Exit Transactions are consummated, OCI is expected to impose on Ambac and Ambac Assurance reporting requirements and restrictions on transactions or other activities, as described below under "Stipulation and Order," and may impose additional requirements or restrictions on Ambac or Ambac Assurance, which may create additional challenges or obstacles with respect to Ambac Assurance's ability to deliver value to Ambac and Ambac's ability to deliver value to its stockholders.
Tier 2 Commitment
On July 19, 2017, Ambac Assurance also entered into a commitment letter (the “Commitment Letter”) with certain investors (the “Investors”), with respect to the issuance of an aggregate principal amount of $240,000 of senior notes (the “Tier 2 Notes”) secured by Ambac Assurance’s


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Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

rights, title and interest in the cash and non-cash proceeds (net of reinsurance) above $1,600,000 received in connection with the RMBS Litigations. The Commitment Letter will terminate upon the earliest occurrence of: (i) 365 days from the execution of the Rehabilitation Exit Support Agreement, and (ii) the date on which the Tier 2 Notes are issued. In addition, Ambac Assurance and the Investors have the option to terminate the Commitment Letter following (i) the resolution of Ambac Assurance Corp. et al. v. Countrywide Home Loans, Inc. et al., Index No. 651612/2010 (N.Y. Sup. Ct. N.Y. Cnty.) (Bransten, J.) or (ii) the termination of the Rehabilitation Exit Support Agreement. The issuance of the Tier 2 Notes is subject to a number of conditions precedent including, among others, satisfaction or waiver of the conditions to effectiveness set forth in the Plan Amendment.
The terms, conditions, and timing of the conclusion of the Segregated Account Rehabilitation Proceedings are in the sole discretion of the OCI, and subject to the approval of the Rehabilitation Court. No assurance can be given that Rehabilitation Exit Transactions or issuance of the Tier 2 Notes will be consummated. OCI retains the authority, subject to the approval of the Rehabilitation Court, to address Segregated Account obligations without the agreement of Ambac Assurance or its board of directors. Moreover, even if the Segregated Account Rehabilitation Proceedings could be brought to a successful conclusion, there can be no assurance that any level of capital deemed sufficient by OCI to permit such conclusion will be sufficient to cover all future losses, whether currently anticipated or unanticipated.
Ambac Assurance will seek to further improve its financial condition by continuing to pursue asset monetizations; loss recoveries; restructurings, purchases, modifications or exchanges of certain outstanding obligations; extinguishment or modification of certain contractual restrictions; and/or commuting or reducing insured exposures Separately from or in connection with the actions described above, we may seek to further optimize our capital and corporate structure to unlock shareholder value.
Stipulation and Order
It is expected that a Stipulation and Order, the terms of which have been agreed between OCI, Ambac and Ambac Assurance, will become effective upon the effective date of the Rehabilitation Plan Amendment and provide as follows:
Ambac Assurance shall maintain a level of surplus and contingency reserves as regards policyholders which provides reasonable security against contingencies affecting its financial position that are not otherwise fully covered by reserves or reinsurance, such that the Commissioner may continue to determine that Ambac Assurance’s surplus and contingency reserves are reasonably in excess of a level that would constitute a financially hazardous condition.
Statutory surplus may not reflect the benefit of any reserve discounting, except to the extent approved by the Commissioner.
Ambac Assurance may not enter any transactions with affiliates, including the payment of a dividend or other distribution, without the approval of the Commissioner, subject to limited exceptions.
Ambac Assurance may not change its business plan or that of Everspan, including but not limited to the writing of new business, unless approved by the Commissioner.
Ambac Assurance must obtain OCI approval with respect to the exercise of certain control rights in connection with policies that had been allocated to the Segregated Account.
Ambac Assurance must obtain OCI approval with respect to any transaction Ambac Assurance proposes to enter into other than in ordinary course of business with non-affiliated counterparties where the aggregate consideration to be paid by Ambac Assurance is equal to or greater than$100,000.
Ambac Assurance must obtain OCI approval for any change to its Investment Policy or Derivative Use Plan.
Ambac Assurance must provide OCI with a monthly report of financial information, the scope of which is to be determined.
Ambac Assurance shall provide, and Ambac shall also provide, notice to the Commissioner within ten (10) days of receipt of any communication from any governmental authority, government-sponsored enterprise, or lender to Ambac Assurance, Ambac, or any affiliates which pertains to a circumstance, event or issue which would be reasonably likely to have a material adverse effect on the financial condition or operations of Ambac Assurance and its subsidiaries taken as whole.
Ambac Assurance shall provide notice as soon as practicable of any development in any litigation, including any delay in RMBS litigation, involving Ambac Assurance or any affiliate of Ambac Assurance which would or would be reasonably likely to have a material adverse effect on Ambac Assurance.
Ambac Assurance shall provide notice to the Commissioner of the occurrence, or failure to occur, of any event which would or would be reasonably likely to cause a material adverse effect to the business, assets, properties, operations, or condition, financial or otherwise, or, insofar as can reasonably be foreseen, prospects, financial or otherwise, of Ambac Assurance, an affiliate of Ambac Assurance, or Ambac Assurance and all affiliates taken as a whole. A material adverse effect shall be conclusively presumed if the effect results, or reasonably could result, in a reduction of more than 10% in Ambac Assurance’s surplus as regards policyholders.


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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

Ambac Assurance shall disclose, and Ambac shall disclose, to the Commissioner any instance of fraud or any significant change to the internal control environment incurred by Ambac Assurance, any of its subsidiaries, or Ambac.
If Ambac Assurance proposes to make any changes in the assumptions or vendors utilized in determining statutory loss reserves from the prior year’s statutory loss reserves which would cause the difference (whether positive or negative) between (a) Ambac Assurance’s statutory reserves determined with such proposed changes and (b) Ambac Assurance’s statutory reserves determined without such proposed changes to exceed the lesser of (i) $200,000 or (ii) 10% of Ambac Assurance’s statutory reserves without such proposed changes, Ambac Assurance shall notify the Commissioner.
Ambac shall use its best efforts to preserve use of net operating loss carry-forwards for the benefit of Ambac Assurance and its subsidiaries, including but not limited to, refraining from taking any action that would result in, and taking such affirmative steps as are appropriate to avoid, any deconsolidation event.
Ambac shall provide the Commissioner and Ambac Assurance its full cooperation in relation to any issues that Ambac Assurance or its subsidiaries may have relative to the United States Internal Revenue Service, including efforts to obtain a private letter ruling, pre-filing agreement, or other form of guidance or clarification.
The Commissioner reserves the right to modify or terminate the Stipulation and Order after it becomes effective in a manner consistent with the interests of policyholders, creditors and the public generally, and recognizes that Ambac Assurance may request the Commissioner to do so periodically as conditions warrant.
Augusta Funding Limited IV ("Augusta") Commutation
On June 27, 2017, Ambac entered into a termination agreement with various parties, including Augusta, in connection with the commutation of interest rate swaps between Augusta and Ambac's wholly-owned subsidiary, Ambac Financial Services. During the second quarter, Ambac paid $94,407 under the termination agreement and reported a gain on the Augusta swaps of $43,443. In July 2017, Augusta redeemed its outstanding Ambac-insured debt and accordingly Ambac recognized approximately $2,617 in accelerated earnings in the third quarter of 2017 relating to this redemption.
Ballantyne Litigation
On March 25, 2017, Ambac UK agreed in principle to a confidential settlement of litigation brought by Ambac UK in the name of Ballantyne Re plc ("Ballantyne") against J.P. Morgan Investment Management Inc. ("JPMIM") relating to the management of Ballantyne’s investment accounts, which were funded with the proceeds of notes issued in 2006 in connection with a structured reinsurance transaction and guaranteed in part by Ambac UK. On April 11, 2017, Ambac UK, Ballantyne and JPMIM signed a settlement agreement. Pursuant to the settlement, Ballantyne received a payment of $325,600 from JPMIM in return for releases of all claims by Ballantyne and Ambac UK. As a result of the settlement, Ambac recognized an incremental benefit through a reduction in losses and loss expenses of approximately $91,600 in the first quarter of 2017. Ambac had previously included an estimated benefit through a reduction of loss and loss expense reserves of approximately $53,000 related to our probability weighted estimate of the value of the litigation. The total $144,600 benefit recognized from the settlement of the litigation will reduce the ultimate Ballantyne claims Ambac UK is expecting to pay and not result in a direct cash payment to Ambac UK.
Puerto Rico
On March 13, 2017, the Financial Management and Oversight Board for Puerto Rico (the "Oversight Board") certified the 10-year Fiscal and Economic Growth Plan ("FEGP") for the Commonwealth of Puerto Rico (the “Commonwealth"). The certified FEGP, among other things, was intended to provide Commonwealth creditors a base from which to progress consensual negotiations under Title VI of the Puerto Rico Oversight, Management and Economic Stability Act ("PROMESA"). However, the certified FEGP implied a 77% discount to all debt service due to be paid by the Commonwealth and its instrumentalities covered by the FEGP over the ten-years of the plan (FY2017-2026). The FEGP did not provide details regarding its underlying assumptions and data, expense definitions, cause of expense growth or accounting adjustments and did not include any restructuring proposals. These deficiencies of the FEGP, when combined with the absence of sufficient projected cash flows for debt service, increased the uncertainty of whether successful consensual negotiations can be reached. As a result of the damage inflicted by Hurricane Maria, the anticipated influx of certain federal funds, and other structural changes following the hurricane, the Commonwealth is drafting a revised fiscal and economic growth plan (the “Revised FEGP”) that will cover 5 fiscal years, inclusive of the Commonwealth’s current fiscal year. A draft Revised FEGP is expected to be presented to the Oversight Board on or around December 22, 2017, after which time the Oversight Board is expected to either recommend revisions to or certify the Revised FEGP.
On April 28, 2017, the Fiscal Agency and Financial Advisory Authority of Puerto Rico (“FAFAA”) released a restructuring proposal covering General Obligation (“GO”), GO-guaranteed, Puerto Rico Sales Tax Financing Corporation ("COFINA"), Puerto Rico Highways and Transportation Authority ("PRHTA"), Puerto Rico Infrastructure Financing Authority ("PRIFA") and Puerto Rico Convention Center District Authority ("CCDA") bonds. Under the proposal, bondholders would receive a “senior bond” based on amounts expected to be available for debt service under the FEGP and a “cash flow bond” that would allow for additional payments if amounts available for debt service exceeded FEGP forecasts. FAFAA’s proposal further provides that GO and GO-guaranteed bondholders would be offered a maximum recovery of 77% (52% senior bond, 25% cash flow bond), COFINA bondholders would receive a maximum recovery of 58% (39% senior bond, 19% cash flow bond),


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(Dollar Amounts in Thousands, Except Share Amounts)

and PRHTA, CCDA, PRIFA, and Metropolitan Bus Authority bondholders would receive a maximum recovery of 30% (0% senior bond, 30% cash flow bond). Recoveries relating to the cash flow bond component could be lower depending upon future surpluses at the General Fund and future new money GO bond issuances. The proposal was premised only on the cash available for debt service included in the certified FEGP, despite challenges from creditors and repeated calls for a review and adjustment of the assumptions underlying such Plan. Among other infirmities, the proposal lacks textured narrative or economic or financial logic for treating Senior and Junior tranches within the COFINA structure as pari passu obligations and fails to explain how the allocation of cashflow between GO and GO-guaranteed bonds and COFINA bonds was derived. The proposal was not accepted by affected bondholders.
On April 29, 2017, the Commonwealth enacted the Fiscal Plan Compliance Act, also known as Act No. 26 (the “Fiscal Plan Compliance Act” or “Act 26-2017”). Articles 4.01 and 4.02 of Chapter 4 of the Fiscal Plan Compliance Act order all public corporations, agencies and instrumentalities of the Government of Puerto Rico to transfer their revenue surplus to the Commonwealth Treasury, after covering operational expenses and obligations, as per the expense budget recommended by the Office of Management and Budget of Puerto Rico for each fiscal year. Article 4.01 further states that such funds would be considered “available resources” for the Commonwealth and would be deposited in the Commonwealth’s General Fund to meet the liquidity requirements contemplated in the FEGP. Article 4.02 empowers a committee composed of the Executive Director of the Fiscal Agency and Financial Advisory Authority of Puerto Rico, the Secretary of the Puerto Rico Treasury Department and the Executive Director of the Office of Management and Budget of Puerto Rico to determine the amount each public corporation and instrumentality would contribute. Such committee is also empowered to revise the sources of revenue of the public corporations, agencies and instrumentalities and adjust, increase or reduce any of their charges, fees, tariffs and similar revenues, with the objective of complying with the metrics stated in the FEGP.
Article 4.03 of Chapter 4 of Act 26-2017, “Exclusions”, explicitly excludes certain entities from coverage of Articles 4.01 and 4.02, including the University of Puerto Rico, the Public Corporation for the Supervision and Insurance of Cooperatives (COSSEC), and funds from public corporations and entities received by private entities for community-related objectives.
While Article 4.03 does not explicitly exclude COFINA from coverage of such Articles 4.01 and 4.02, as it does with other entities, it does state that the Executive Branch shall be authorized to use the COFINA funds, occasionally, solely as a last alternative, and subject to the filing of a sworn certification before the Legislative Assembly. Such sworn certification, which, according to Article 4.03 shall not be interpreted to give the Executive Branch indefinite use of the COFINA funds, must establish the need, term and amount of funds that will be used to cover significant occasional cash flow deficits to comply with the FEGP. An Explicative Declaration of Act 26-2017 signed by the Governor of Puerto Rico on April 29, 2017 states that because COFINA does not generate surpluses, the dispositions of Chapter 4 are not applicable to COFINA. The Explicative Declaration further states that the Fiscal Plan Compliance Act does not refer to other revenues from public corporations except for those determined by fee adjustments of the corporations specifically included in the FEGP. The statements in the Explicative Declaration appear to contradict the statutory language of Articles 4.01, 4.02 and 4.03, resulting in uncertainty about how the Fiscal Plan Compliance Act will be implemented.
In its Chapter 6, the Fiscal Plan Compliance Act also requires that, commencing July 1, 2017, all special funds and other revenues of dependencies and public corporations must be deposited with the Puerto Rico Treasury. The Puerto Rico Secretary of Treasury is authorized to establish the order of priority for the disbursement of payments chargeable to the special funds and other revenues, in accordance with the approved budget and the Fiscal Plan.
On May 1, 2017, Ambac Assurance sent COFINA a notice of failures to comply with covenants and events of default under COFINA’s bond resolution and enabling legislation. Among other things, Ambac Assurance stated that the Commonwealth had violated its covenant not to limit or restrict the right granted by the Resolution or COFINA’s rights to meet its obligations to its bondholders by enacting the Fiscal Plan Compliance Act; that COFINA had violated its covenant to defend, preserve, and protect the pledge of the Dedicated Sales Tax to COFINA and the rights of COFINA’s bondholders under the Resolution against all claims and demands; and that both covenant violations were incurable and therefore constituted immediate Events of Default under the COFINA resolution. Also on May 1, 2017, the COFINA trustee, Bank of New York Mellon (“BNY”), sent a letter to COFINA and the Puerto Rico Fiscal Agency and FAFAA stating that the Fiscal Plan Compliance Act was inconsistent with COFINA’s and the Commonwealth’s covenants under COFINA’s resolution and enabling legislation, and seeking a response detailing any curative action either intended to take. On May 4, 2017, BNY sent COFINA a notice of default arising out of the Fiscal Plan Compliance Act, and stated that the defaults by COFINA and the Commonwealth would be deemed Events of Default under the COFINA resolution if left uncured within 30 days of Ambac’s May 1, 2017 letter noticing the defaults. Later on May 4, 2017, Ambac Assurance, together with holders of more than 25% of the senior COFINA bonds, sent a letter to BNY demanding immediate acceleration of all senior bonds issued by COFINA. On May 16, 2017, BNY filed an interpleader action in COFINA’s Title III case against COFINA and certain creditors of COFINA, including Ambac Assurance, that have made competing claims of entitlement to funds held by BNY. This action will resolve the parties’ respective entitlements to the funds, including a determination of whether an Event of Default have occurred under the COFINA resolution.
On May 2, 2017, the Oversight Board certified a ten-year fiscal plan (the “PRHTA Fiscal Plan”) for the PRHTA. The PRHTA Fiscal Plan reflects an expectation that the Puerto Rico Treasury and PRHTA will temporarily cease funding debt service payments in July of 2017. The PRHTA Fiscal Plan states that as a result of the “clawback” of certain revenues pledged to PRHTA, PRHTA has insufficient cash flow to service debt. It is currently unclear when the funding of PRHTA debt service payments with pledged revenues will resume. Similar to the revisions of the FEGP, however, PRHTA is drafting a revised fiscal plan (the “Revised PRHTA Fiscal Plan”) as a result of the changes occurring in the wake of Hurricane


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Table of Contents
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

Maria. Like the Revised FEGP, the Revised PRHTA Fiscal Plan will cover 5 fiscal years, inclusive of the Commonwealth’s current fiscal year. A draft Revised PRHTA Fiscal Plan is expected to be presented to the Oversight Board on or around February 9, 2018, after which time the Oversight Board is expected to either recommend revisions to or certify the Revised PRHTA Fiscal Plan.
The Governor signed into law Act No. 1 of 2017, on January 11, 2017, which amended the Commonwealth’s Public-Private Partnership Act (Act No. 29 of 2009) ("P3 Act") authorizing the Public-Private Partnerships Authority (“P3A”) to facilitate privatization agreements between Partnering Government Entities (as such term is defined in the P3 Act) and private entities. The 2017 amendments allow the P3A to receive and consider unsolicited or voluntary proposals from proponents that meet the minimum criteria set forth in the P3 Act, whereas prior to the 2017 amendments, proposals could only be received in response to a P3A request for proposals. Direct negotiations with proponents of unsolicited or voluntary proposals may be conducted without a request for qualifications or a request for proposals process if the P3A determines that certain criteria have been met. The 2017 amendments also permit the use of the initial and/or periodical payments received from any partnership for contributions to the retirement systems of the Government of Puerto Rico, in addition to other uses provided for by the P3 Act, including the payment of debts of Partnering Government Entities. It is unclear how Puerto Rico will make use of the law and to what extent it will impact the obligations that we insure.
In response to letter requests from Governor Rosselló, the Oversight Board commenced a Title III proceeding for the Commonwealth of Puerto Rico on May 3, 2017 and for COFINA on May 5, 2017, in the United States District Court for the District of Puerto Rico. Subsequently, the Oversight Board commenced a Title III proceeding for the Employees Retirement System ("ERS") and PRHTA on May 21, 2017, and for the Puerto Rico Electric Power Authority ("PREPA") on July 2, 2017. Ambac Assurance has not issued any financial guaranty policies with respect to obligations of ERS or PREPA. As part of the Title III filings for the Commonwealth, COFINA, and PRHTA, the Oversight Board noted that the Oversight Board and the Commonwealth intend to continue pursuing consensual negotiations under the protection of the Title III automatic stay.
On June 14, 2017, Judge Laura Taylor Swain entered an order appointing a team of mediators to facilitate confidential mediation discussions in order to facilitate consensual resolution of certain issues arising in the context of these Title III cases. The mediation team is led by Chief Judge Barbara Houser of the United States Bankruptcy Court for the Northern District of Texas, and consists of Circuit Judge Thomas Ambro of the United States Court of Appeals for the Third Circuit, Senior District Judge Nancy Atlas of the United States District Court for the Southern District of Texas, Bankruptcy Judge Christopher Klein of the United States Bankruptcy Court for the Eastern District of California, and Senior District Judge Victor Marrero of the United States District Court for the Southern District of New York. Confidential mediation proceedings are ongoing. No assurances can be given that consensual resolutions will be achieved with respect to the Commonwealth’s or COFINA’s obligations or those of any other Puerto Rico instrumentality. In addition, Ambac is uncertain how the Title III process will be implemented and to what extent the rights of Ambac Assurance will be respected as part of that process.
On June 30, 2017, the Oversight Board certified the Commonwealth’s fiscal year 2018 budget, which is largely compliant with the FEGP. The budget does not allocate funds for debt service, stating only that it will do so after a Title III plan of adjustment or Title VI agreement is approved by the Court.
Ambac Assurance is party to ten litigations related to its Puerto Rico exposures. These include three litigations challenging the constitutionality and legality of the FEGP and the Fiscal Plan Compliance Act, discussed below under Note 11. Commitments and Contingencies, one of which is an adversary proceeding actively pending in PRHTA’s Title III proceedings. Ambac Assurance filed several of those cases to protect and assert its rights under transaction documents and applicable law. Six of these litigations are stayed under Title III of PROMESA, and one has been stayed by order of the United States District Court for the District of Puerto Rico pending resolution of an interpleader action related to COFINA funds (to which interpleader action Ambac is also a party). The three active litigations are proceeding as adversary proceedings under the Title III process before the United States District Court for the District of Puerto Rico. Accordingly, Ambac is unable to predict when and how the issues raised in those cases will be resolved. If Ambac Assurance is unsuccessful with any of these challenges, Ambac’s financial condition, including liquidity, loss reserves and capital resources may suffer a material negative impact. On September 6, 2017, Hurricane Irma, a Category 5 storm, passed north of Puerto Rico, leaving more than one million people without electricity on the island. On September 20, 2017, Hurricane Maria, a Category 4 storm at the time, made landfall in Puerto Rico, causing severe damage to the island and its infrastructure, including the destruction to a significant portion of the electrical transmission and distribution system. It will take time to fully evaluate and remedy damage to public infrastructure and private property as well as assess future capital needs. In addition, the amount, timing, and structure of anticipated federal aid is uncertain beyond an initial $4.9 billion liquidity loan for Puerto Rico and the U.S. Virgin Islands as part of a $36.5 billion disaster aid bill signed into law on October 26, 2017. Consequently, for at least the near-term, the Commonwealth faces uncertain financial and economic prospects due to the scale and scope of the damage caused by Hurricane Maria. As a result of the damage, the anticipated influx of certain federal funds, and other structural changes following the hurricane, a "Revised FEGP" and a "Revised PRHTA Fiscal Plan" are being drafted, both of which will cover 5 fiscal years, inclusive of the Commonwealth’s current fiscal year. The revised fiscal plans are expected to be presented to the Oversight Board (on or around December 22, 2017 for the "Revised FEGP" and on or around February 9, 2018 for the “Revised PRHTA Fiscal Plan”) after which time the Oversight Board is expected to either recommend revisions to or certify. While certain litigation and mediation deadlines have been postponed, the ultimate impact of Hurricane Maria on Puerto Rico, its instrumentalities, the FEGP, the PRHTA Fiscal Plan, the Title III proceedings and related restructuring activity remains unclear.


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Table of Contents
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

Ambac has considered these developments and other factors in evaluating its Puerto Rico loss reserves. During the nine months ended September 30, 2017, Ambac had incurred losses associated with its Domestic Public Finance insured portfolio of $434,100, which was significantly impacted by the continued uncertainty and volatility of the situation in Puerto Rico. While management believes its reserves are adequate to cover losses in its Public Finance insured portfolio, there can be no assurance that Ambac may not incur additional losses in the future, particularly given the developing economic, political, and legal circumstances in Puerto Rico. Such additional losses may have a material adverse effect on Ambac’s results of operations and financial condition. For public finance credits, including Puerto Rico, as well as other issuers, for which Ambac has an estimate of expected loss at September 30, 2017, the possible increase in loss reserves under stress or other adverse conditions and circumstances was estimated to be approximately $1,500,000. However, there can be no assurance that losses may not exceed such amount.
Impact of Hurricane Maria and Other Natural Disasters
In August and September 2017, there were three major hurricanes, Harvey, Irma and Maria, which made landfall in regions where a number of issuers of Ambac-insured bonds, including municipalities, state or commonwealth instrumentalities, military housing related issuers, residential mortgage backed securities issuers, and utilities, are located.
Areas affected where Ambac has exposure include Houston, Texas, Harris County, Texas, a number of counties in southern and western Florida, the U.S. Virgin Islands and the Commonwealth of Puerto Rico. Early assessments of the near-term credit impact on insured exposure to the hurricanes in Texas and Florida is modest with no expectations of missed debt service payments. However, we continue to monitor the recovery process in both areas for any change in expectations. The credit impact on insured exposures related to Hurricanes Irma and Maria on the U.S. Virgin Islands, where Ambac Assurance has relatively little exposure ($42,615 net par outstanding), and Puerto Rico, where Ambac Assurance has a large exposure ($1.968 billion of net par outstanding), is negative at least in the near-term due to the uncertainty related to the recovery from the hurricanes and to the size and timing of Federal aid and support in the recovery. As previously noted, Ambac has considered these developments and other factors in evaluating its Puerto Rico reserves as well as those related to the U.S. Virgin Islands.
In October 2017, large wildfires in Northern California caused significant damage in a number of municipalities where Ambac Assurance provides financial guaranty insurance. Early assessments of near-term credit impact on insured exposures in the affected areas is modest at this time, but subject to further evaluation as the full scope of the damage becomes available.
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The Company has disclosed its significant accounting policies in Note 2. Basis of Presentation and Significant Accounting Policies in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. The following significant accounting policies provide an update to those included in the Company’s Annual Report on Form 10-K.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial reporting and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by GAAP for annual periods. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2016. The accompanying consolidated financial statements have not been audited by an independent registered public accounting firm in accordance with the standards of the Public Company Accounting Oversight Board (U.S.), but in the opinion of management such financial statements include all adjustments necessary for the fair presentation of the Company’s consolidated financial position and results of operations. All intercompany balances and transactions have been eliminated. The results of operations for the three and nine months ended September 30, 2017 may not be indicative of the results that may be expected for the year ending December 31, 2017. The December 31, 2016 consolidated balance sheet was derived from audited financial statements.
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. As additional information becomes available or actual amounts become determinable, the recorded estimates are revised and reflected in operating results.
Foreign Currency:
Financial statement accounts expressed in foreign currencies are translated into U.S. dollars in accordance with the Foreign Currency Matters Topic of the ASC. The functional currencies of Ambac's subsidiaries are the local currencies of the country where the respective subsidiaries are based, which are also the primary operating environments in which the subsidiaries operate.
Foreign currency translation: Functional currency assets and liabilities of Ambac’s foreign subsidiaries are translated into U.S. dollars using exchange rates in effect at the balance sheet dates and the related translation adjustments, net of deferred taxes, are included as a component of Accumulated Other Comprehensive Income in Stockholders' Equity. Consolidated Statements of Total Comprehensive Income (Loss) accounts expressed in functional currencies are translated using average exchange rates.


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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

Foreign currency transactions: The impact of non-functional currency transactions and the remeasurement of non-functional currency assets and liabilities into the respective subsidiaries' functional currency (collectively "foreign currency transactions gains/(losses)") are $19,142 and $(26,741) for the nine months ended September 30, 2017 and 2016. Foreign currency transactions gains/(losses) are primarily the result of remeasuring Ambac UK's assets and liabilities denominated in currencies other than its functional currency, primarily the U.S. dollar and the Euro. The significant components of foreign currency transaction gains/(losses), including the respective classifications in the Consolidated Statement of Total Comprehensive Income, are as follows:
Remeasurement of loss reserves, classified in Loss and loss expenses, in the amount of $26,556 and $(56,910) for the nine months ended September 30, 2017 and 2016, respectively;
Realized gain (losses) from the sale of investment securities and the unrealized gains (losses) of trading and short-term investment securities, classified in Net realized investment gains, in the amount of $(3,780) and $22,030 for the nine months ended September 30, 2017 and 2016, respectively;
Remeasurement of premium receivables, classified in Other income, in the amount of $(1,960) and $8,264 for the nine months ended September 30, 2017 and 2016, respectively; and
Remeasurement of credit derivative liabilities, classified in Net change in fair value of credit derivative, in the amount of $(1,141) and $(929) for the nine months ended September 30, 2017 and 2016, respectively.
Reclassifications:
Reclassifications may have been made to prior years' amounts to conform to the current year's presentation.
Recently Adopted Accounting Standards:
Effective January 1, 2017, Ambac adopted the following accounting standards:
Consolidation of Variable Interest Entities - Decision Makers
In October 2016, the FASB issued ASU 2016-17, Consolidation (Topic 810) - Interests Held through Related Parties That Are under Common Control. The new guidance changes how a reporting entity that is a single decision maker for a VIE will consider its indirect interests in that VIE when determining whether the reporting entity is the primary beneficiary and should consolidate the VIE. Under previous GAAP, a single decision maker in a VIE is required to consider an indirect interest held by a related party under common control in its entirety. Under the new ASU, the single decision maker will consider the indirect interest on a proportionate basis. Adoption of this ASU did not have an impact on Ambac's financial statements.
Improvements to Employee Share-Based Payment Accounting
In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting. The objective of this ASU is to improve and simplify the accounting for employee share-based payment accounting. The amendments are as follows: (i) recognizing excess tax benefits and tax deficiencies as income tax expense, (ii) recognizing excess tax benefits regardless of whether it reduces taxes payable in the current period, (iii) classifying excess tax benefits related to share-based payments along with other income tax cash flows as an operating activity on the statement of cash flows, (iv) for purposes of accruing compensation costs, allowing companies to make an accounting policy election to either: a) estimate forfeitures or b) account for forfeitures as they occur, which Ambac elected to do upon adoption, (v) to qualify for equity classification treatment, permitting tax withholding by employees up to the maximum statutory tax rate and (vi) classifying cash paid by an employer to a taxing authority when directly withholding shares as a financing activity on the statement of cash flows. Adoption of this ASU did not have a material impact on Ambac's financial statements.
Equity Method of Accounting
In March 2016, the FASB issued ASU 2016-07, Investments-Equity Method and Joint Ventures (Topic 323) - Simplifying the Transition to the Equity Method of Accounting. This ASU eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively as if the equity method had been in effect during all previous periods that the investment had been owned. The ASU will now require that at the date an available-for-sale equity security becomes qualified for the equity method of accounting, the reporting entity will recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income. Adoption of this ASU did not have an impact on Ambac's financial statements.
Contingent Put and Call Options in Debt Instruments
In March 2016, the FASB issued ASU 2016-06, Derivatives and Hedging (Topic 815) - Contingent Put and Call Options in Debt Instruments. Previous accounting rules required that embedded derivatives be separated from the host contract in a financial instrument and accounted for separately as derivatives if certain criteria are met. One of these criteria is that the economic characteristics and risks of the embedded derivatives are not "clearly and closely related" to the host contract. The objective of the ASU is to resolve diversity in practice in assessing embedded


| Ambac Financial Group, Inc. 14 2017 Third Quarter FORM 10-Q |

Table of Contents
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

contingent put and call options. The ASU clarifies what steps are required when assessing whether the economic characteristics and risk of put and call options are clearly and closely related to their debt host contracts. Adoption of this ASU did not have an impact on Ambac's financial statements.
Future Application of Accounting Standards:
Equity-linked instruments with down round features
In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260) and Derivatives and Hedging (Topic 815) - Accounting for Certain Financial Instruments with Down Round Features. Equity-linked instruments, such as warrants and convertible instruments may contain down round features that result in the strike price being reduced on the basis of the pricing of future equity offerings. Under the ASU, a down round feature will no longer require a freestanding equity-linked instrument (or embedded conversion option) to be classified as a liability that is remeasured at fair value through the income statement (i.e. marked-to-market). However, other features of the equity-linked instrument (or embedded conversion option) must still be evaluated to determine whether liability or equity classification is appropriate. Equity classified instruments are not marked-to-market. For earnings per share ("EPS") reporting, the ASU requires companies to recognize the effect of the down round feature only when it is triggered by treating it as a dividend and as a reduction of income available to common shareholders in basic EPS. The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in any interim period. We have not determined whether Ambac will early adopt this ASU. The adoption of this ASU is not expected to have a material impact on Ambac's financial statements.
Stock Compensation--Scope of Modification Accounting
In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718) - Scope of Modification Accounting. The ASU provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. Entities will apply the modification accounting guidance if the value, vesting conditions or classification of the award changes. The current disclosure requirements in Topic 718 apply regardless of whether an entity is required to apply modification accounting under the amendments in this ASU. The amendments in this ASU are effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period for which financial statements have not yet been issued. Ambac will adopt this ASU on January 1, 2018. The adoption of this ASU is not expected to have a consequential impact on Ambac's financial statements.
Premium Amortization on Callable Debt Securities
In March 2017, the FASB issued ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20) - Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for the premium on callable debt securities to the earliest call date. Under current GAAP, a reporting entity generally amortizes the premium as yield adjustment over the contractual life (i.e. maturity) of the debt security and if that debt security is called, the entity would record a loss equal to the unamortized premium. The ASU does not change the accounting for callable debt securities held at a discount, which will continue to be amortized to maturity. ASU 2017-08 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The ASU must be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. We have not determined whether Ambac will early adopt this ASU and are evaluating the impact on Ambac's financial statements.
Net Periodic Pension and Postretirement Costs
In March 2017, the FASB issued ASU 2017-07, Compensation-Retirement Benefits (Topic 715) - Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The objective of the ASU is to increase transparency in the reporting of net pension cost and net postretirement cost (collectively "net benefit cost"). The ASU requires that the service cost component of net benefit cost be reported on the same line item as other compensation costs arising from services rendered by employees. It further requires that the other components of net benefit costs (i.e. interest costs, amortization of prior service cost, etc.) be presented separately from the service cost component and outside the subtotal of income from operations, if one is presented. ASU 2017-09 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, with early adoption permitted. Ambac will adopt this ASU on January 1, 2018. The adoption of this ASU is not expected to have a consequential impact on Ambac's financial statements.
Revenue recognition
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) that amends the accounting guidance for recognizing revenue for contracts with customers to transfer goods and contracts for the transfer of non-financial assets unless those contracts are within the scope of other accounting standards. ASU 2015-14 deferred the effective date of ASU 2014-09 to annual periods beginning after December 15, 2017, including interim periods within that reporting period. Ambac will adopt this ASU on January 1, 2018. While we have made significant progress evaluating the ASU, we note that this ASU does not apply to insurance contracts and most financial instruments and therefore is not expected to have a consequential impact on Ambac's financial statements.


| Ambac Financial Group, Inc. 15 2017 Third Quarter FORM 10-Q |

Table of Contents
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

3. SPECIAL PURPOSE ENTITIES, INCLUDING VARIABLE INTEREST ENTITIES
Ambac, with its subsidiaries, has engaged in transactions with special purpose entities, including VIEs, in various capacities.
Ambac most commonly provides financial guarantees, including credit derivative contracts, for various debt obligations issued by special purpose entities, including VIEs ("FG VIEs").
Ambac sponsors special purpose entities that issued notes to fund the purchase of certain financial assets.
Ambac monetized its ownership of the junior surplus note issued to it by the Segregated Account by depositing the junior surplus note into a newly formed VIE trust in exchange for cash and an owner trust certificate, which represents Ambac's right to residual cash flows from the junior surplus note.
Ambac is an investor in collateralized debt obligations, mortgage-backed and other asset-backed securities issued by VIEs and its ownership interest is generally insignificant to the VIE and/or Ambac does not have rights that direct the activities that are most significant to such VIE.
FG VIEs:
Ambac’s subsidiaries provide financial guarantees in respect of assets held or debt obligations of special purpose entities, including VIEs. Ambac’s primary variable interest exists through this financial guarantee insurance or credit derivative contract. The transaction structures provide certain financial protection to Ambac. This financial protection can take several forms; however, the most common are over-collateralization, first loss and excess spread. In the case of over-collateralization (i.e., the principal amount of the securitized assets exceeds the principal amount of the debt obligations guaranteed), the structure allows the transaction to experience defaults among the securitized assets before a default is experienced on the debt obligations that have been guaranteed by Ambac’s subsidiaries. In the case of first loss, the financial guarantee insurance policy or credit derivative contract only covers a senior layer of losses on assets held or debt issued by special purpose entities, including VIEs. The first loss with respect to the assets is either retained by the asset seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the securitized assets contributed to special purpose entities, including VIEs, generate interest cash flows that are in excess of the interest payments on the related debt; such excess cash flow is applied to redeem debt, thus creating over-collateralization. Generally, upon deterioration in the performance of a transaction or upon an event of default as specified in the transaction legal documents, Ambac will obtain certain loss remediation rights. These rights may enable Ambac to direct the activities of the entity that most significantly impact the entity’s economic performance.
We determined that Ambac’s subsidiaries generally have the obligation to absorb a FG VIE's expected losses given that they have issued financial guarantees supporting the liabilities (and in certain cases assets). As further described below, we consolidated certain FG VIEs because: (i) we determined, for certain transactions that experienced the aforementioned performance deterioration, that Ambac’s subsidiaries had the power, through voting rights or similar rights, to direct the activities that most significantly impact the VIE’s economic performance because certain triggers had been breached in these transactions resulting in Ambac's subsidiaries' ability to exercise certain loss remediation activities, or (ii) due to the passive nature of the VIEs’ activities, Ambac’s subsidiaries’ contingent loss remediation rights upon a breach of certain triggers in the future is considered to be the power to direct the activities that most significantly impact the VIEs’ economic performance. With respect to existing VIEs involving Ambac financial guarantees, Ambac is generally required to consolidate a VIE in the period that applicable triggers result in Ambac having control over the VIE’s most significant economic activities. In connection with the potential exit from Rehabilitation of the Segregated Account, as further described in Note 1. Background and Business Description, Ambac will need to evaluate consolidation of certain VIEs in the event certain rights are obtained by Ambac Assurance. As further discussed in Note 1. Background and Business Description, the OCI is expected to require Ambac Assurance to obtain their approval with respect to the exercise of certain control rights in connection with policies that had been allocated to the Segregated Account. Accordingly management expects the number of additional VIEs that may be consolidated as a result of the Segregated Account's potential exit from Rehabilitation will be reduced and possibly eliminated. A VIE is deconsolidated in the period that Ambac no longer has such control, which could occur in connection with the execution of remediation activities on the transaction or amortization of insured exposure, any of which may reduce the degree of Ambac’s control over a VIE. Assets and liabilities of FG VIEs that are consolidated are reported within Variable interest entity assets or Variable interest entity liabilities on the Consolidated Balance Sheets. The net results from such FG VIEs are reported within Income (loss) on variable interest entities in the Consolidated Statements of Total Comprehensive Income (Loss).
Upon initial consolidation of a FG VIE, we recognize a gain or loss in earnings for the difference between: (i) the fair value of the consideration paid, the fair value of any non-controlling interests and the reported amount of any previously held interests and (ii) the net amount, as measured on a fair value basis, of the assets and liabilities consolidated. Upon deconsolidation of a FG VIE, we recognize a gain or loss for the difference between: (i) the fair value of any consideration received, the fair value of any retained non-controlling investment in the VIE and the carrying amount of any non-controlling interest in the VIE and (ii) the carrying amount of the VIE’s assets and liabilities. Gains or losses from consolidation and deconsolidation that are reported in earnings are reported within Income (loss) on variable interest entities on the Consolidated Statements of Total Comprehensive Income (Loss).


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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

The impact of consolidating such FG VIEs on Ambac’s balance sheet is the elimination of transactions between the consolidated FG VIEs and Ambac’s operating subsidiaries and the inclusion of the FG VIE’s third party assets and liabilities. For a financial guarantee insurance policy issued to a consolidated VIE, Ambac does not reflect the financial guarantee insurance policy in accordance with the related insurance accounting rules under the Financial Services – Insurance Topic of the ASC. Consequently, upon consolidation, Ambac eliminates the insurance assets and liabilities associated with the policy from the Consolidated Balance Sheets. Such insurance assets and liabilities may include premium receivables, reinsurance recoverable, deferred ceded premium, subrogation recoverable, unearned premiums, loss and loss expense reserves, ceded premiums payable and insurance intangible assets. For investment securities owned by Ambac that are debt instruments issued by the VIE, the investment securities balance is eliminated upon consolidation.
As of September 30, 2017 consolidated FG VIE assets and liabilities relating to 12 consolidated entities were $14,442,384 and $14,321,721, respectively. As of December 31, 2016, consolidated FG VIE assets and liabilities relating to 12 consolidated entities were $13,367,834 and $13,235,425, respectively. As of both September 30, 2017 and December 31, 2016, eight and four consolidated FG VIEs related to transactions insured by Ambac UK and Ambac Assurance, respectively. As of September 30, 2017, FG VIE assets and liabilities of $14,056,435 and $13,941,513 and as of December 31, 2016, FG VIE assets and liabilities of $12,950,009 and $12,833,466 related to transactions guaranteed by Ambac UK. The remaining balance of consolidated FG VIE assets and liabilities are related to transactions guaranteed by Ambac Assurance. Ambac is not primarily liable for, and generally does not guarantee all of the debt obligations issued by the VIEs. Ambac would only be required to make payments on the VIE debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest due and such obligation is guaranteed by Ambac. Additionally, Ambac’s general creditors, other than those specific policy holders which own the VIE debt obligations, do not have rights with regard to the assets of the VIEs. Ambac evaluates the net income effects and earnings per share effects to determine attributions between Ambac and non-controlling interests as a result of consolidating a VIE. Ambac has determined that the net income and earnings per share effect of most consolidated FG VIEs are attributable to Ambac’s interests through financial guarantee premium and loss payments with the VIE.
Below is a schedule detailing the change in fair value of the various financial instruments within the consolidated FG VIEs, along with gains (losses) from consolidating and deconsolidating FG VIEs that together comprise Income (loss) on variable interest entities for the affected periods:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Income (loss) on changes related to:
 
 
 
 
 
 
 
 
Net fair value of VIE assets and liabilities
 
$
(4,049
)
 
$
2,057

 
$
(1,567
)
 
$
(16,119
)
Consolidation / Deconsolidation
 

 

 

 

Income (loss) on Variable Interest Entities
 
$
(4,049
)
 
$
2,057

 
$
(1,567
)
 
$
(16,119
)
Ambac consolidated zero and deconsolidated zero VIEs for the three and nine months ended September 30, 2017 and 2016.
The table below provides the fair value of fixed income securities, by asset-type, held by consolidated VIEs as of September 30, 2017 and December 31, 2016:
 
September 30,
2017
 
December 31,
2016
Investments:
 
 
 
Corporate obligations
$
2,785,608

 
$
2,622,566

Total variable interest entity assets: fixed income securities
$
2,785,608

 
$
2,622,566

The following table provides supplemental information about the loans held as assets and long-term debt associated with the VIEs for which the fair value option has been elected as of September 30, 2017 and December 31, 2016:
 
Estimated fair value
 
Unpaid principal balance
September 30, 2017:
 
 
 
Loans
$
11,557,788

 
$
8,133,313

Long-term debt
12,229,569

 
9,373,933

December 31, 2016:
 
 
 
Loans
$
10,658,963

 
$
7,641,756

Long-term debt
11,155,936

 
8,854,530

Ambac Sponsored VIEs:


| Ambac Financial Group, Inc. 17 2017 Third Quarter FORM 10-Q |

Table of Contents
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

A subsidiary of Ambac transferred financial assets to a special purpose entity. The business purpose of this entity was to provide certain financial guarantee clients with funding for their debt obligations. This special purpose entity was established as a separate legal entity, demonstrably distinct from Ambac and that Ambac, its affiliates or its agents could not unilaterally dissolve. The permitted activities of this entity 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. Ambac does not consolidate this entity because Ambac Assurance’s policies issued to this entity were allocated to the Segregated Account, thereby limiting Ambac’s control over the entity's most significant economic activities. Ambac elected to account for its equity interest in this entity at fair value under the fair value option in accordance with the Financial Instruments Topic of the ASC. We believe that the fair value of the investments in this entity provides for greater transparency for recording profit or loss as compared to the equity method under the Investments – Equity Method and Joint Ventures Topic of the ASC. Refer to Note 7. Fair Value Measurements for further information on the valuation technique and inputs used to measure the fair value of Ambac’s equity interest in this entity. At September 30, 2017 and December 31, 2016 the fair value of this entity was $6,337 and $7,382, respectively, and is reported within Other assets on the Consolidated Balance Sheets.
Total principal amount of debt outstanding was $421,560 and $388,950 at September 30, 2017 and December 31, 2016, respectively. In each case, Ambac sold assets to this entity. The assets are composed of utility obligations with a weighted average rating of BBB+ at September 30, 2017 and weighted average life of 3.3 years. The purchase by this entity of financial assets was financed through the issuance of MTNs, which are cross-collateralized by the purchased assets. The MTNs have the same expected weighted average life as the purchased assets. Derivative contracts (interest rate swaps) are used within the entity for economic hedging purposes only. Derivative positions were established at the time MTNs were issued to purchase financial assets. As of September 30, 2017 Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative contracts owned and outstanding by the entity.
Insurance premiums paid to Ambac Assurance by this entity are earned in a manner consistent with other insurance policies, over the risk period. Additionally, any losses incurred on such insurance policies are included in Ambac’s Consolidated Statements of Total Comprehensive Income (Loss). Under the terms of an Administrative Agency Agreement, Ambac provides certain administrative duties, primarily collecting amounts due on the obligations and making interest payments on the MTNs.
In July 2015, Ambac Assurance entered into a secured borrowing transaction whereby it sold 17 Ambac insured residential mortgage-backed securities (the "Securities") and all rights associated therewith as of May 31, 2015, to a Delaware statutory trust (the "Trust") in exchange for an equity certificate in the Trust, all financial guarantee claim payments associated with the Securities and cash of $146,000 (prior to expenses associated with the transaction). Although the Securities were legally sold to the Trust, the Securities will remain in Invested assets on the Consolidated Balance Sheets. The Securities had par and fair value of $301,130 and $351,339 as of September 30, 2017, respectively. Refer to Note 8. Investments for further discussion of the restrictions on the invested assets. At the same time, a second Delaware statutory trust (the "Issuer"), issued $146,000 of debt securities and used the proceeds, together with an equity certificate of the Issuer, to purchase from the Trust a certificate secured by and entitling the Issuer to all principal and interest payments (other than financial guarantee claim payments) on the Securities. Interest on the debt securities is payable monthly at an annual rate of one month LIBOR + 2.8%. Both the Trust and the Issuer are consolidated VIEs because Ambac Assurance was involved in their design and holds a significant amount of the beneficial interests issued by the VIEs or guaranteed the assets held by the VIEs. VIE debt outstanding to third parties under this secured borrowing transaction had a carrying value of $78,319 and $102,403 as of September 30, 2017 and December 31, 2016, respectively, and is reported in Long-Term Debt on the Consolidated Balance Sheets.
Interests in Non-Consolidated VIEs
On August 28, 2014, Ambac monetized its ownership of the junior surplus note issued to it by the Segregated Account by depositing the junior surplus note into a newly formed VIE trust in exchange for cash and an owner trust certificate, which represents Ambac's right to residual cash flows from the junior surplus note. Ambac does not consolidate the VIE. Ambac reports this interest in the VIE as an equity investment within Other investments on the Consolidated Balance Sheets with associated results from operations included within Net investment income: Other investments on the Consolidated Statements of Total Comprehensive Income (Loss). The equity investment had a carrying value of $33,677 and $30,003 as of September 30, 2017 and December 31, 2016, respectively. Additionally, at September 30, 2017 Ambac held $45,000 of the debt issued by this VIE.


| Ambac Financial Group, Inc. 18 2017 Third Quarter FORM 10-Q |

Table of Contents
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

The following table displays the carrying amount of the assets, liabilities and maximum exposure to loss of Ambac’s variable interests in non-consolidated VIEs resulting from financial guarantee and derivative contracts by major underlying asset classes, as of September 30, 2017 and December 31, 2016:
 
Carrying Value of Assets and Liabilities
 
Maximum
Exposure
To Loss
(1)
 
Insurance
Assets
(2)
 
Insurance
Liabilities
(3)
 
Net Derivative
Assets (Liabilities) 
(4)
September 30, 2017:
 
 
 
 
 
 
 
Global structured finance:
 
 
 
 
 
 
 
Collateralized debt obligations
$
38,405

 
$
182

 
$

 
$
(23
)
Mortgage-backed—residential
13,589,640

 
694,449

 
3,184,474

 

Other consumer asset-backed
2,263,774

 
24,458

 
328,216

 

Other commercial asset-backed
1,031,168

 
32,355

 
35,321

 

Other
2,616,461

 
60,812

 
311,968

 
10,770

Total global structured finance
19,539,448

 
812,256

 
3,859,979

 
10,747

Global public finance
25,814,183

 
338,562

 
374,312

 
(8,938
)
Total
$
45,353,631

 
$
1,150,818

 
$
4,234,291

 
$
1,809

 
 
 
 
 
 
 
 
December 31, 2016:
 
 
 
 
 
 
 
Global structured finance:
 
 
 
 
 
 
 
Collateralized debt obligations
$
761,451

 
$
218

 
$
3,319

 
$
(145,402
)
Mortgage-backed—residential
14,859,909

 
725,106

 
3,118,892

 

Other consumer asset-backed
2,391,604

 
26,758

 
302,335

 

Other commercial asset-backed
1,686,256

 
66,277

 
64,961

 

Other
2,963,521

 
66,091

 
412,929

 
13,347

Total global structured finance
22,662,741

 
884,450

 
3,902,436

 
(132,055
)
Global public finance
25,608,471

 
338,587

 
359,142

 
(8,827
)
Total
$
48,271,212

 
$
1,223,037

 
$
4,261,578

 
$
(140,882
)
(1)
Maximum exposure to loss represents the maximum future payments of principal and interest on insured obligations and derivative contracts plus Deferred Amounts and accrued and unpaid interest thereon. Ambac’s maximum exposure to loss does not include the benefit of any financial instruments (such as reinsurance or hedge contracts) that Ambac may utilize to mitigate the risks associated with these variable interests.
(2)
Insurance assets represent the amount recorded in “Premium receivables” and “Subrogation recoverable” for financial guarantee contracts on Ambac’s Consolidated Balance Sheets.
(3)
Insurance liabilities represent the amount recorded in “Loss and loss expense reserves” and “Unearned premiums” for financial guarantee contracts on Ambac’s Consolidated Balance Sheets.
(4)
Net derivative assets (liabilities) represent the fair value recognized on credit derivative contracts and interest rate swaps on Ambac’s Consolidated Balance Sheets.


| Ambac Financial Group, Inc. 19 2017 Third Quarter FORM 10-Q |

Table of Contents
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

4. COMPREHENSIVE INCOME
The following tables detail the changes in the balances of each component of accumulated other comprehensive income for the affected periods:
 
Unrealized Gains
(Losses) on
Available for
Sale Securities
(1)
 
Amortization of
Postretirement
Benefit
(1)
 
Gain (Loss) on
Foreign Currency
Translation
(1)
 
Total
Three Months Ended September 30, 2017:
 
 
 
 
 
 
 
Beginning Balance
$
152,847

 
$
11,316

 
$
(125,335
)
 
$
38,828

Other comprehensive income (loss) before reclassifications
(7,801
)
 

 
24,624

 
16,823

Amounts reclassified from accumulated other comprehensive income (loss)
7,367

 
(338
)
 

 
7,029

Net current period other comprehensive income (loss)
(434
)
 
(338
)
 
24,624

 
23,852

Balance at September 30, 2017
$
152,413

 
$
10,978

 
$
(100,711
)
 
$
62,680

 
 
 
 
 
 
 
 
Three Months Ended September 30, 2016:
 
 
 
 
 
 
 
Beginning Balance
$
158,924

 
$
9,876

 
$
(118,025
)
 
$
50,775

Other comprehensive income (loss) before reclassifications
33,625

 

 
(13,323
)
 
20,302

Amounts reclassified from accumulated other comprehensive income (loss)
(8,906
)
 
(254
)
 

 
(9,160
)
Net current period other comprehensive income (loss)
24,719

 
(254
)
 
(13,323
)
 
11,142

Balance at September 30, 2016
$
183,643

 
$
9,622

 
$
(131,348
)
 
$
61,917

 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2017:
 
 
 
 
 
 
 
Beginning Balance
$
118,863

 
$
9,367

 
$
(167,220
)
 
$
(38,990
)
Other comprehensive income (loss) before reclassifications
19,769

 

 
66,509

 
86,278

Amounts reclassified from accumulated other comprehensive income (loss)
13,781

 
1,611

 

 
15,392

Net current period other comprehensive income (loss)
33,550

 
1,611

 
66,509

 
101,670

Balance at September 30, 2017
$
152,413

 
$
10,978

 
$
(100,711
)
 
$
62,680

 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2016:
 
 
 
 
 
 
 
Beginning Balance
$
50,963

 
$
9,344

 
$
(45,092
)
 
$
15,215

Other comprehensive income (loss) before reclassifications
140,810

 

 
(86,256
)
 
54,554

Amounts reclassified from accumulated other comprehensive income (loss)
(8,130
)
 
278

 

 
(7,852
)
Net current period other comprehensive income (loss)
132,680

 
278

 
(86,256
)
 
46,702

Balance at September 30, 2016
$
183,643

 
$
9,622

 
$
(131,348
)
 
$
61,917

(1)
All amounts are net of tax and noncontrolling interest. Amounts in parentheses indicate debits.


| Ambac Financial Group, Inc. 20 2017 Third Quarter FORM 10-Q |

Table of Contents
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

The following table details the significant amounts reclassified from each component of accumulated other comprehensive income, shown in the above rollforward tables, for the affected periods:
Details about Accumulated Other
Comprehensive Income Components
 
Amount Reclassified from Accumulated
Other Comprehensive Income
(1)
 
Affected Line Item in the
Consolidated Statement of
Total Comprehensive Income (Loss)
 
Three Months Ended September 30,
 
 
2017
 
2016
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
 
 
 
 
 
 
 
$
7,367

 
$
(8,906
)
 
Net realized investment (losses) gains and other-than-temporary impairment losses
 
 

 

 
Tax (expense) benefit
 
 
$
7,367

 
$
(8,906
)
 
Net of tax and noncontrolling interest 
Amortization of Postretirement Benefit
 
 
 
 
 
 
Prior service cost
 
$
(241
)
 
$
(167
)
 
Operating expenses (2)
Actuarial (losses)
 
(97
)
 
(87
)
 
Operating expenses (2)
 
 
(338
)
 
(254
)
 
Total before tax
 
 

 

 
Tax (expense) benefit
 
 
(338
)
 
(254
)
 
Net of tax and noncontrolling interest 
Total reclassifications for the period
 
$
7,029

 
$
(9,160
)
 
Net of tax and noncontrolling interest 
 
 
 
 
 
 
 
Details about Accumulated Other
Comprehensive Income Components
 
Amount Reclassified from Accumulated
Other Comprehensive Income
(1)
 
Affected Line Item in the
Consolidated Statement of
Total Comprehensive Income (Loss)
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
 
 
 
 
 
 
 
$
13,781

 
$
(8,130
)
 
Net realized investment (losses) gains and other-than-temporary impairment losses
 
 

 

 
Tax (expense) benefit
 
 
$
13,781

 
$
(8,130
)
 
Net of tax and noncontrolling interest 
Amortization of Postretirement Benefit
 
 
 
 
 
 
Prior service cost
 
$
(723
)
 
$
(500
)
 
Operating expenses (2)
Actuarial gains
 
2,334

 
778

 
Operating expenses (2)
 
 
1,611

 
278

 
Total before tax
 
 

 

 
Tax (expense) benefit
 
 
$
1,611

 
$
278

 
Net of tax and noncontrolling interest 
Total reclassifications for the period
 
$
15,392

 
$
(7,852
)
 
Net of tax and noncontrolling interest 
(1)
Amounts in parentheses indicate debits to the Consolidated Statement of Total Comprehensive Income (Loss).
(2)
These accumulated other comprehensive income components are included in the computation of net periodic benefit cost.
5. NET INCOME PER SHARE
On May 1, 2013, pursuant to the Second Modified Fifth Amended Plan of Reorganization of Ambac (the "Reorganization Plan"), 45,000,000 shares of new common stock at par value of $0.01 per share and 5,047,138 of warrants were issued. Warrants entitled such holders to acquire up to 5,047,138 shares of new common stock at an exercise price of $16.67 per share at any time on or prior to April 30, 2023. For the nine months ended September 30, 2017 and 2016, 0 and 136 warrants were exercised, respectively, resulting in an issuance of 0 and 136 shares of common stock, respectively.
On June 30, 2015, the Board of Directors of Ambac authorized the establishment of a warrant repurchase program that permits the repurchase of up to $10,000 of warrants. On November 3, 2016, the Board of Directors of Ambac authorized a $10,000 increase to the warrant repurchase program. For the nine months ended September 30, 2017, Ambac repurchased 0 warrants at a cost of $0. As of September 30, 2017, Ambac has repurchased 985,331 warrants totaling $8,092, (average cost of $8.21 per warrant) leaving 4,053,670 warrants outstanding. The remaining aggregate authorization at September 30, 2017 is $11,939.


| Ambac Financial Group, Inc. 21 2017 Third Quarter FORM 10-Q |

Table of Contents
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

Basic net income per share is computed by dividing net income attributable to common stockholders by the weighted-average number of common shares outstanding and vested restricted stock units. Diluted net income per share is computed by dividing net income attributable to common stockholders by the weighted-average number of common shares used for basic earnings per share plus all potential dilutive common shares outstanding during the period. All potential dilutive common shares outstanding consider common stock deliverable pursuant to warrants issued under the Reorganization Plan, vested and unvested options, unvested restricted stock units and performance stock units granted under employee and director compensation plans.
The following table provides a reconciliation of the common shares used for basic net income per share to the diluted shares used for diluted net income per share:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Basic weighted average shares outstanding
 
45,404,315

 
45,229,570

 
45,355,671

 
45,206,429

Effect of potential dilutive shares (1):
 
 
 
 
 
 
 
 
Warrants
 

 
293,311

 

 

Restricted stock units
 

 
156,023

 

 
105,794

Performance stock units
 

 
113,179

 

 
60,481

Diluted weighted average shares outstanding
 
45,404,315

 
45,792,083

 
45,355,671

 
45,372,704

Anti-dilutive shares excluded from the above reconciliation:
 
 
 
 
 
 
 
 
Stock options
 
126,667

 
143,334

 
126,667

 
143,334

Warrants
 
4,053,670

 

 
4,053,670

 

Restricted stock units
 
68,654

 
23,334

 
68,654

 
23,334

Performance stock units (2)
 
327,109

 

 
327,109

 

(1)
For the three and nine months ended September 30, 2017, Ambac had a net loss and accordingly excluded all potentially dilutive securities from the determination of diluted loss per share as their impact was anti-dilutive.
(2)
Performance stock units are reflected herein at their target issuance amounts. Vesting of these units is contingent upon meeting certain performance metrics. Although a portion of these performance metrics have been achieved as of the respective period end, it is possible that awards may no longer meet the metric at the end of the performance period.
6. FINANCIAL GUARANTEE INSURANCE CONTRACTS
Amounts presented in this Note relate only to Ambac’s non-derivative insurance business for insurance policies issued to beneficiaries, including VIEs, for which we do not consolidate the VIE.
Net Premiums Earned:
Gross premiums are received either upfront or in installments. For premiums received upfront, an unearned premium revenue (“UPR”) liability is established, which is initially recorded as the cash amount received. For installment premium transactions, a premium receivable asset and offsetting UPR liability is initially established in an amount equal to: (i) the present value of future contractual premiums due (the “contractual” method) or (ii) if the assets underlying the insured obligation are homogenous pools which are contractually prepayable, the present value of premiums to be collected over the expected life of the transaction (the “expected” method). An appropriate risk-free rate corresponding to the weighted average life of each policy and currency is used to discount the future premiums contractually due or expected to be collected. For example, U.S. dollar exposures are discounted using U.S. Treasury rates while exposures denominated in a foreign currency are discounted using the appropriate risk-free rate for the respective currency. The weighted average risk-free rate at September 30, 2017 and December 31, 2016, was 2.6% and 2.6%, respectively, and the weighted average period of future premiums used to estimate the premium receivable at September 30, 2017 and December 31, 2016, was 8.9 years and 9.0 years, respectively.
Insured obligations consisting of homogeneous pools for which Ambac uses expected future premiums to estimate the premium receivable and UPR include residential mortgage-backed securities. As prepayment assumptions change for homogenous pool transactions, or if there is an actual prepayment for a “contractual” method installment transaction, the related premium receivable and UPR are adjusted in equal and offsetting amounts with no immediate effect on earnings using new premium cash flows and the then current risk-free rate.
In structured finance transactions, the priority for the payment of financial guarantee premiums to Ambac, as required by bond indentures of insured structured finance obligations, is generally senior in the waterfall. Additionally, in connection with the allocation of certain liabilities to the Segregated Account, trustees and other parties are required under the Segregated Account Rehabilitation Plan and related court orders to continue to pay installment premiums, notwithstanding the Segregated Account Rehabilitation Proceedings. In evaluating the credit quality of the premium receivables, management evaluates the transaction waterfall structures and the internal ratings of the transactions underlying the premium receivables. Uncollectable premiums are determined on a policy basis and utilize a combination of historical premium collection data in addition to cash flow analysis to determine if an impairment in the related policy's premium receivables exist. At September 30, 2017 and


| Ambac Financial Group, Inc. 22 2017 Third Quarter FORM 10-Q |

Table of Contents
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

December 31, 2016, $9,289 and $9,186 respectively, of premium receivables were deemed uncollectable. As of September 30, 2017 and December 31, 2016, approximately 23% and 25% of the premium receivables, net of uncollectable receivables, related to transactions with non-investment grade internal ratings, comprised mainly of non-investment grade RMBS, structured insurance, lease securitizations and student loan transactions, which comprised 7%, 6%, 2% and 3%, of the total premium receivables at September 30, 2017 and 8%, 5%, 4% and 3% of the total premium receivables at December 31, 2016, respectively. Past due premiums on policies insuring non-investment grade obligations amounted to less than $500 at September 30, 2017.
Below is the gross premium receivable roll-forward for the affected periods:
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
Beginning premium receivable
 
$
661,337

 
$
831,575

Premium receipts
 
(66,141
)
 
(60,609
)
Adjustments for changes in expected and contractual cash flows
 
(24,407
)
 
(57,932
)
Accretion of premium receivable discount
 
12,326

 
14,304

Changes to uncollectable premiums
 
(103
)
 
4,264

Other adjustments (including foreign exchange)
 
18,745

 
(25,374
)
Ending premium receivable (1)
 
$
601,757

 
$
706,228

(1)
Gross premium receivable includes premiums to be received in foreign denominated currencies most notably in British Pounds and Euros. At September 30, 2017 and 2016, premium receivables include British Pounds of $153,964 (£114,847) and $195,187 (£150,575), respectively, and Euros of $36,815 (€31,154) and $38,284 (€34,067), respectively.
Similar to gross premiums, premiums ceded to reinsurers are paid either upfront or in installments. Premiums ceded to reinsurers reduce the amount of premiums earned by Ambac from its financial guarantee insurance policies.
When a bond issue insured by Ambac Assurance has been retired early, typically due to an issuer call, any remaining UPR is recognized at that time to the extent the financial guarantee contract is legally extinguished, causing accelerated premium revenue. For installment premium paying transactions, we offset the recognition of any remaining UPR by the reduction of the related premium receivable to zero (as it will not be collected as a result of the retirement), which may cause negative accelerated premium revenue. Ambac’s accelerated premium revenue for retired obligations for the three and nine months ended September 30, 2017 was $26,178 and $55,648, respectively, and for the three and nine months ended September 30, 2016 was $18,174 and $38,231, respectively. Certain obligations insured by Ambac have been legally defeased whereby government securities are purchased by the issuer with the proceeds of a new bond issuance, or less frequently with other funds of the issuer, and held in escrow. The principal and interest received from the escrowed securities are then used to retire the Ambac-insured obligations at a future date either to their maturity date (a refunding) or a specified call date (a pre-refunding). Ambac has evaluated the provisions in policies issued on these obligations and determined those insurance policies have not been legally extinguished. For policies with refunding securities, premium revenue recognition is not impacted as the escrowed maturity date is the same as the previous legal maturity date. For policies with pre-refunding securities, the maturity date of the pre-refunded security has been shortened from its previous legal maturity. Although premium revenue recognition has not been accelerated in the period of the pre-refunding, it results in an increase in the rate at which the policy's remaining UPR is to be recognized.
The effect of reinsurance on premiums written and earned for the respective periods was as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
Written
 
Earned
 
Written
 
Earned
 
Written
 
Earned
 
Written
 
Earned
Direct
$
(24,696
)
 
$
57,282

 
$
(10,543
)
 
$
59,096

 
$
(12,184
)
 
$
156,582

 
$
(39,364
)
 
$
161,058

Assumed

 
20

 

 
21

 

 
61

 

 
64

Ceded
(385
)
 
4,313

 
(1,526
)
 
5,899

 
(1,962
)
 
12,889

 
(8,425
)
 
13,702

Net premiums
$
(24,311
)
 
$
52,989

 
$
(9,017
)
 
$
53,218

 
$
(10,222
)
 
$
143,754

 
$
(30,939
)
 
$
147,420



| Ambac Financial Group, Inc. 23 2017 Third Quarter FORM 10-Q |

Table of Contents
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

The following table summarizes net premiums earned by location of risk for the respective periods:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
United States
 
$
31,929

 
$
45,257

 
$
108,556

 
$
126,003

United Kingdom
 
17,273

 
6,018

 
28,094

 
19,111

Other international
 
3,787

 
1,943

 
7,104

 
2,306

Total
 
$
52,989

 
$
53,218

 
$
143,754

 
$
147,420

The table below summarizes the future gross undiscounted premiums to be collected and future premiums earned, net of reinsurance at September 30, 2017:
 
Future premiums
to be collected
(1)
 
Future
premiums to
be earned net of
reinsurance
(1)
Three months ended:
 
 
 
December 31, 2017
$
14,211

 
$
19,425

Twelve months ended:
 
 
 
December 31, 2018
58,939