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 June 30, 2018
¨
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 August 6, 2018, 45,332,214 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 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
 
June 30,
 
December 31,
(Dollars in thousands, except share data) (June 30, 2018 (Unaudited))
2018
 
2017
Assets:
 
 
 
Investments:
 
 
 
Fixed income securities, at fair value (amortized cost of $3,355,223 and $4,614,623)
$
3,514,927

 
$
4,652,172

Fixed income securities pledged as collateral, at fair value (amortized cost of $84,641 and $99,719)
84,641

 
99,719

Short-term investments, at fair value (amortized cost of $393,516 and $557,476)
393,447

 
557,270

Other investments (includes $356,899 and $396,689 at fair value)
394,396

 
431,630

Total investments
4,387,411

 
5,740,791

Cash and cash equivalents
44,398

 
623,703

Receivable for securities
82,513

 
11,177

Investment income due and accrued
12,157

 
16,532

Premium receivables
553,958

 
586,312

Reinsurance recoverable on paid and unpaid losses
39,071

 
40,997

Deferred ceded premium
47,886

 
52,195

Subrogation recoverable
1,876,188

 
631,213

Loans
10,007

 
10,358

Derivative assets
56,510

 
73,199

Current taxes
34,619

 
11,803

Insurance intangible asset
786,208

 
846,973

Other assets
33,631

 
46,614

Variable interest entity assets:
 
 
 
Fixed income securities, at fair value
2,756,924

 
2,914,145

Restricted cash
1,052

 
978

Loans, at fair value
10,751,199

 
11,529,384

Derivative assets
60,403

 
54,877

Other assets
1,088

 
1,123

Total assets
$
21,535,223

 
$
23,192,374

Liabilities and Stockholders’ Equity:
 
 
 
Liabilities:
 
 
 
Unearned premiums
$
721,689

 
$
783,155

Loss and loss expense reserves
2,057,334

 
4,745,015

Ceded premiums payable
35,594

 
37,876

Deferred taxes
32,781

 
33,659

Long-term debt
2,796,389

 
991,696

Accrued interest payable
237,558

 
436,984

Derivative liabilities
67,648

 
82,782

Other liabilities
58,191

 
67,583

Payable for securities purchased
16,556

 
1,932

Variable interest entity liabilities:
 
 
 
Accrued interest payable
550

 
589

Long-term debt, at fair value
11,454,746

 
12,160,544

Derivative liabilities
1,992,227

 
2,205,264

Other liabilities
39

 
37

Total liabilities
19,471,302

 
21,547,116

Commitments and contingencies (See Note 12)
 
 
 
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: 45,365,170 and 45,275,982
454

 
453

Additional paid-in capital
208,328

 
199,560

Accumulated other comprehensive income (loss)
45,854

 
(52,239
)
Retained earnings
1,545,702

 
1,233,845

Treasury stock, shares at cost: 32,956 and 24,816
(527
)
 
(471
)
Total Ambac Financial Group, Inc. stockholders’ equity
1,799,811

 
1,381,148

Noncontrolling interest
264,110

 
264,110

Total stockholders’ equity
2,063,921

 
1,645,258

Total liabilities and stockholders’ equity
$
21,535,223

 
$
23,192,374

See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 1 2018 Second Quarter FORM 10-Q |



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Total Comprehensive Income (Loss) (Unaudited)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(Dollars in thousands, except share data)
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
 
Net premiums earned
 
$
25,836

 
$
43,152

 
$
56,719

 
90,765

Net investment income:
 
 
 
 
 
 
 
 
Securities available-for-sale and short-term
 
61,742

 
80,943

 
172,293

 
154,093

Other investments
 
4,920

 
4,217

 
4,609

 
12,626

Total net investment income
 
66,662

 
85,160

 
176,902

 
166,719

Other-than-temporary impairment losses:
 
 
 
 
 
 
 
 
Total other-than-temporary impairment losses
 
(1,010
)
 
(1,763
)
 
(1,351
)
 
(22,917
)
Portion of other-than-temporary impairment recognized in other comprehensive income
 
(4
)
 

 
38

 
17,212

Net other-than-temporary impairment losses recognized in earnings
 
(1,014
)
 
(1,763
)
 
(1,313
)
 
(5,705
)
Net realized investment gains (losses)
 
47,148

 
4,180

 
52,010

 
(716
)
Change in fair value of credit derivatives:
 
 
 
 
 
 
 
 
Realized gains and other settlements
 
91

 
1,134

 
197

 
1,333

Unrealized gains (losses)
 
(308
)
 
5,490

 
(760
)
 
6,343

Net change in fair value of credit derivatives
 
(217
)
 
6,624

 
(563
)
 
7,676

Net gains (losses) on interest rate derivatives
 
9,149

 
34,068

 
34,686

 
32,554

Net realized gains (losses) on extinguishment of debt
 
6

 
2,179

 
3,121

 
4,920

Other income (expense)
 
2,491

 
720

 
1,982

 
778

Income (loss) on variable interest entities
 
577

 
(1,219
)
 
1,151

 
2,482

Total revenues
 
150,638

 
173,101

 
324,695

 
299,473

Expenses:
 
 
 
 
 
 
 
 
Losses and loss expenses (benefit)
 
32,579

 
66,100

 
(214,816
)
 
201,111

Insurance intangible amortization
 
23,242

 
33,471

 
51,878

 
70,996

Operating expenses
 
26,063

 
31,304

 
62,497

 
59,428

Interest expense
 
62,446

 
28,234

 
110,519

 
59,806

Total expenses
 
144,330

 
159,109

 
10,078

 
391,341

Pre-tax income (loss)
 
6,308

 
13,992

 
314,617

 
(91,868
)
Provision for income taxes
 
1,995

 
6,882

 
4,600

 
26,463

Net income (loss) attributable to common stockholders
 
$
4,313

 
$
7,110

 
$
310,017

 
$
(118,331
)
Other comprehensive income (loss), after tax:
 
 
 
 
 
 
 
 
Net income (loss) attributable to common stockholders
 
$
4,313

 
$
7,110

 
$
310,017

 
$
(118,331
)
Unrealized gains (losses) on securities, net of income tax provision (benefit) of $1,122, $0, $(586) and $0
 
575

 
12,649

 
122,879

 
33,984

Gains (losses) on foreign currency translation, net of income tax provision (benefit) of $0, $0, $0 and $0
 
(52,989
)
 
29,292

 
(20,933
)
 
41,885

Credit risk changes of fair value option liabilities, net of income tax provision (benefit) of $(188), $0, $42 and $0
 
(906
)
 

 
208

 

Changes to postretirement benefit, net of income tax provision (benefit) of $0, $0, $0 and $0
 
(302
)
 
(338
)
 
(1,161
)
 
1,949

Total other comprehensive income (loss), net of income tax
 
(53,622
)
 
41,603

 
100,993

 
77,818

Total comprehensive income (loss) attributable to common stockholders
 
$
(49,309
)
 
$
48,713

 
$
411,010

 
$
(40,513
)
Net income (loss) per share attributable to common stockholders:
 
 
 
 
 
 
 
 
Basic
 
$
0.09

 
$
0.16

 
$
6.80

 
$
(2.61
)
Diluted
 
$
0.09

 
$
0.16

 
$
6.73

 
$
(2.61
)
See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 2 2018 Second 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, 2018
$
1,645,258

 
$
1,233,845

 
$
(52,239
)
 
$

 
$
453

 
$
199,560

 
$
(471
)
 
$
264,110

Total comprehensive income
411,010

 
310,017

 
100,993

 

 

 

 

 

Adjustment to initially apply ASU 2016-01

 
2,900

 
(2,900
)
 

 

 

 

 

Stock-based compensation
8,765

 

 

 

 

 
8,765

 

 

Cost of shares (acquired) issued under equity plan
(1,116
)
 
(1,060
)
 

 

 

 

 
(56
)
 

Issuance of common stock
1

 

 

 

 
1

 

 

 

Warrants exercised
3

 

 

 

 

 
3

 

 

Balance at June 30, 2018
$
2,063,921

 
$
1,545,702

 
$
45,854

 
$

 
$
454

 
$
208,328

 
$
(527
)
 
$
264,110

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2017
$
1,978,024

 
$
1,557,681

 
$
(38,990
)
 
$

 
$
452

 
$
195,267

 
$
(496
)
 
$
264,110

Total comprehensive income
(40,513
)
 
(118,331
)
 
77,818

 

 

 

 

 

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

 

 

 

 

 

Stock-based compensation
2,385

 

 

 

 

 
2,385

 

 

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

 

 

 

 
25

 

Issuance of common stock
1

 

 

 

 
1

 

 

 

Balance at June 30, 2017
$
1,938,213

 
$
1,437,641

 
$
38,828

 
$

 
$
453

 
$
197,652

 
$
(471
)
 
$
264,110

See accompanying Notes to Unaudited Consolidated Financial Statements
    


| Ambac Financial Group, Inc. 3 2018 Second Quarter FORM 10-Q |



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
 
 
Six Months Ended June 30,
(Dollars in thousands)
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net income (loss) attributable to common stockholders
 
$
310,017

 
$
(118,331
)
Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
Depreciation and amortization
 
363

 
533

Amortization of bond premium and discount
 
(102,602
)
 
(83,180
)
Share-based compensation
 
8,765

 
2,385

Deferred income taxes
 
(880
)
 
146

Current income taxes
 
(23,564
)
 
12,283

Unearned premiums, net
 
(57,310
)
 
(63,820
)
Losses and loss expenses, net
 
(1,435,042
)
 
206,693

Ceded premiums payable
 
(2,282
)
 
(2,865
)
Investment income due and accrued
 
4,433

 
1,755

Premium receivables
 
32,432

 
8,378

Accrued interest payable
 
(89,633
)
 
6,576

Amortization of insurance intangible assets
 
51,878

 
70,996

Net mark-to-market (gains) losses
 
760

 
(6,343
)
Net realized investment gains
 
(52,010
)
 
716

Other-than-temporary impairment charges
 
1,313

 
5,705

(Gain) loss on extinguishment of debt
 
(3,121
)
 
(4,920
)
Variable interest entity activities
 
(1,151
)
 
(2,482
)
Derivative assets and liabilities
 
(120
)
 
(211,149
)
Other, net
 
46,166

 
11,455

Net cash used in operating activities
 
(1,311,588
)
 
(165,469
)
Cash flows from investing activities:
 
 
 
 
Proceeds from sales of bonds
 
623,495

 
885,507

Proceeds from matured bonds
 
214,066

 
390,309

Purchases of bonds
 
(163,917
)
 
(986,364
)
Proceeds from sales of other invested assets
 
51,402

 
177,805

Purchases of other invested assets
 
(18,862
)
 
(161,375
)
Change in short-term investments
 
164,860

 
(73,092
)
Loans, net
 

 
(5,965
)
Change in cash collateral receivable
 
781

 
73,174

Proceeds from paydowns of consolidated VIE assets
 
137,983

 
120,142

Other, net
 
5,543

 
(4,534
)
Net cash provided by investing activities
 
1,015,351

 
415,607

Cash flows from financing activities:
 
 
 
 
Net proceeds from issuance of Tier 2 notes
 
240,000

 

Proceeds from sales of Senior Surplus Notes
 
4,571

 

Paydowns of Ambac Note
 
(113,457
)
 

Paydowns of a secured borrowing
 
(73,993
)
 
(16,929
)
Payments for investment agreement draws
 

 
(82,358
)
Payments for extinguishment of long-term debt
 
(191,258
)
 
(69,499
)
Payments for debt issuance costs
 
(9,221
)
 

Tax payments related to shares withheld for share-based compensation plans
 
(1,116
)
 
(1,268
)
Proceeds from warrant exercises
 
3

 

Payments of consolidated VIE liabilities
 
(137,984
)
 
(115,534
)
Net cash used in financing activities
 
(282,455
)
 
(285,588
)
Effect of foreign exchange on cash, cash equivalents and restricted cash
 
(539
)
 
(1,195
)
Net cash flow
 
(579,231
)
 
(36,645
)
Cash, cash equivalents, and restricted cash at beginning of period
 
624,681

 
95,898

Cash, cash equivalents, and restricted cash at end of period
 
$
45,450

 
$
59,253

See accompanying Notes to Unaudited Consolidated Financial Statements    


| Ambac Financial Group, Inc. 4 2018 Second 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 and by the terms of the Settlement Agreement, dated as of June 7, 2010, as amended (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 Stipulation and Order (as described in Note 1. Background and Business Description in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017) and the terms of its Auction Market Preferred Shares ("AMPS"). 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 include 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.
Management reviews financial information, allocates resources and measures financial performance on a consolidated basis. As a result, the Company has a single reportable segment.
In February 2018, Ambac achieved one of its key strategic priorities, the exit from rehabilitation of the Segregated Account.  Having accomplished this milestone, Ambac continues to pursue and prioritize its remaining key strategic priorities, namely:
Active runoff of Ambac Assurance and its subsidiaries through transaction terminations, policy commutations, settlements and restructurings, with a focus on our watch list credits and known and potential future adversely classified credits, that we believe will improve our risk profile, and maximizing the risk-adjusted return on invested assets;
Ongoing rationalization of Ambac's and its subsidiaries' capital and liability structures;
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, no assurance can be given that we will be able to execute or obtain the financial and other resources that may be required to finance the acquisition or development of any new businesses or assets. The execution of Ambac’s objective to increase the value of its investment in Ambac Assurance is subject to the rights of OCI (as defined below) under the Stipulation and Order, which requires OCI to approve certain actions taken by or in respect of Ambac Assurance, as well as the restrictions in the Settlement Agreement. Opportunities for remediating losses on poorly performing insured transactions also depend on market conditions, including the perception of Ambac Assurance’s and its subsidiaries' creditworthiness, the structure of the underlying risk and associated policy as well as other counterparty specific factors. Decisions by 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. 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.
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


| Ambac Financial Group, Inc. 5 2018 Second 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)

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, which was confirmed by the Rehabilitation Court 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. Policy obligations not allocated to the Segregated Account remained in the General Account of Ambac Assurance, and such policies in the General Account were not subject to and, therefore, were not directly impacted by the Segregated Account Rehabilitation Plan.
On February 12, 2018, Ambac successfully concluded the rehabilitation of the Segregated Account pursuant to an amendment of the Segregated Account Rehabilitation Plan (the "Second Amended Plan of Rehabilitation"). The conclusion of the rehabilitation followed the successful completion of Ambac's surplus note exchange offers and consent solicitation, which, together with the satisfaction of all conditions precedent to the effectiveness of the Second Amended Plan of Rehabilitation, including the discharge of all unpaid policy claims of the Segregated Account, including accretion amounts thereon ("Deferred Amounts"), completed the restructuring transactions (the "Rehabilitation Exit Transactions") announced on July 19, 2017, as more fully described in Note 1. Background and Business Description in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.
In exchange for an effective consideration package of 40% cash, 41% Secured Notes (as defined below) and 12.5% General Account Surplus Notes (as defined below), paid in respect of outstanding Deferred Amounts and General Account Surplus Notes. Ambac Assurance received the following benefits as a result of the completion of the Rehabilitation Exit Transactions:
Satisfaction and discharge of all outstanding Deferred Amounts (including accretion) of the Segregated Account, totaling $3,856,992;
Cancellation of $552,320 in principal amount outstanding, plus accrued and unpaid interest of $257,200 thereon, of AAC's 5.1% surplus notes due 2020 (the "General Account Surplus Notes"); and
An effective discount of 6.5% on Deferred Amounts (applied first against accretion) and the outstanding amount of principal and accrued and unpaid interest on tendered General Account Surplus Notes.
Ambac received $0.91 in principal amount of Secured Notes for each $1.00 of Deferred Amounts that it held, and provided a $0.09 discount in full satisfaction and discharge of its Deferred Amount claims. Ambac did not participate in the voluntary surplus note exchange offers.
A newly formed special purpose entity Ambac LSNI, LLC ("Ambac LSNI") issued $2,154,332 of 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 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 seeks redress for breaches of representations and warranties and/or fraud related to residential mortgage-backed securitizations (the “RMBS Litigations”). In addition, the Ambac Note is secured by cash and securities having a market value of $255,628 as of June 30, 2018. Ambac Assurance also pledged for the benefit of the holders of Secured Notes (other than Ambac Assurance) the proceeds of the Secured Notes held by Ambac Assurance from time to time, and issued 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.
Prior to the Rehabilitation Exit Transactions, Ambac and Ambac Assurance owned securities that were insured by Ambac Assurance and allocated to the Segregated Account. As a result of the Rehabilitation Exit Transactions, Ambac and Ambac Assurance received $124,881 and $643,583, respectively, of par amount of Secured Notes issued by Ambac LSNI. Such secured notes are reported in Investments in the Consolidated Balance Sheets at their fair value.
Ambac Assurance also received $240,000 in cash proceeds from the issuance of notes secured by recoveries from RMBS Litigations in excess of $1,600,000 ("Tier 2 Notes").
Receipt of Requisite Consents for Bank Settlement Agreement Waiver and Amendment
Ambac received sufficient consents from holders of General Account Surplus Notes for a waiver and amendment (the "BSA Waiver and Amendment") of the Settlement Agreement. Among other provisions, the BSA Waiver and Amendment includes amendments to the Settlement Agreement that (i) eliminate the requirement for Ambac Assurance to have "unaffiliated qualified directors" on its Board of Directors; (ii) eliminate the prohibition on new business activities; (iii) modify the restrictions on the incurrence of indebtedness and other material obligations; (iv) modify the restrictions on liens securing permitted indebtedness; (v) modify restrictions applicable to junior surplus notes; and (vi) modify restrictions on mergers or similar transactions.


| Ambac Financial Group, Inc. 6 2018 Second 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)

Regulatory Approval of the Rehabilitation Exit Transactions, including a partial interest payment on Surplus Notes
OCI provided all approvals necessary to consummate the Rehabilitation Exit Transactions, to give effect to the BSA Waiver and Amendment, and to make a $13,501 pro-rata interest payment, representing approximately six months of interest, on the outstanding principal and accrued and unpaid interest of General Account Surplus Notes that remained outstanding (of which $2,618 was received by Ambac for surplus notes that it owns that are considered extinguished for accounting purposes) after the closing of the Rehabilitation Exit Transactions on February 12, 2018. 
For more information about the Segregated Account rehabilitation and the Rehabilitation Exit Transactions and related matters, please refer to Note 1. Background and Business Description in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.
Final Decree and Order
On June 22, 2018, the Rehabilitation Court entered the Final Decree and Order discharging the Rehabilitator and the Special Deputy Commissioner for the Segregated Account and formally closing the case that was commenced by OCI in the Rehabilitation Court in 2010.
August 2018 AMPS Exchange
At June 30, 2018, Ambac Assurance had 26,411 shares of issued and outstanding AMPS with a liquidation preference of $660,275 (reported as noncontrolling interest of $264,110 on Ambac's balance sheet).
On July 3, 2018, Ambac and Ambac Assurance commenced an offer to exchange (the “AMPS Exchange”) all of Ambac Assurance’s outstanding AMPS for General Account Surplus Notes and, from Ambac, cash and warrants to purchase Ambac's common stock. Concurrently with the AMPS Exchange, Ambac Assurance solicited proxies (each a “Proxy” and together the “Proxies”) from the holders of the AMPS to vote in favor of a resolution to be passed at a special meeting (“Special Meeting”) of Ambac Assurance’s shareholders (the “Proxy Solicitation”). The General Account Surplus Notes offered in the AMPS Exchange have the same terms as other outstanding surplus notes of Ambac Assurance (other than junior surplus notes). The offering period for the AMPS Exchange expired on August 1, 2018 and the transaction closed on August 3, 2018 (the "Settlement Date").
In exchange for each $25 of liquidation preference (i.e., per share), AMPS, holders received from Ambac Assurance, General Account Surplus Notes with a total outstanding amount (including accrued and unpaid interest thereon through on June 22, 2018 (the "Signing Date")) equal to $13.875 (the “Repurchase”). AMPS holders who tendered on or before July 17, 2018, representing 22,096 of the AMPS, also received from Ambac $0.500 in cash and 37.3076 warrants (rounded down to the nearest whole warrant) to purchase an equivalent number of shares of common stock of Ambac at an exercise price of $16.67 per share (the “AFG Purchase” and, together with the Repurchase, the “Purchases”).
As a result of the completion of the Purchases, Ambac:
1.
Repurchased 84.4% or 22,296 AMPS with an aggregate liquidation preference of $557,400, including $34,650 in aggregate liquidation preference in the AFG Purchase;
2.
Captured a nominal discount of approximately $227,000 (a discount of approximately $252,000 on a fair market value basis) on $557,400 of the total outstanding liquidation preference of AMPS; and
3.
Issued, in aggregate, $212,740 in current principal amount of surplus notes with accrued interest thereon of $96,617, issued 824,307 warrants and paid $11,048 in cash.
Prior to the Purchases, the AMPS were reported on the balance sheet within non-controlling interests and were carried at their fair value at the date Ambac emerged from bankruptcy, which is lower than the fair value of the total consideration provided to the AMPS holders in the Purchases. The difference between the fair value of consideration provided to AMPS holders and the carrying amount of the AMPS will be reflected as a reduction to Net income attributable to common stockholders in the third quarter of 2018 for approximately $83,000. The noncontrolling interest balance that will be reported on the balance sheet after the AMPS Exchange will be $41,150.
Concurrently with the offering of the AMPS Exchange, Ambac Assurance launched the Proxy Solicitation to approve (i) for the holders of AMPS only, the Purchases and (ii) an amendment to Ambac Assurance’s Restated Articles of Incorporation to delete Section 7(c) of the Fifth Article, which provided for the purported right of holders of AMPS to elect Ambac Assurance directors in certain circumstances (the “Charter Amendment” and together with the Purchases, the “Transactions”). The affirmative vote of the holders of at least two-thirds in aggregate liquidation preference of AMPS was required for the Purchases and the Charter Amendment to be operative. Additionally, the affirmative vote of at least two-thirds of the outstanding shares of Ambac Assurance common stock entitled to vote at the Special Meeting was required for the Charter Amendment to be operative. The Special Meeting was held on July 18, 2018, at which the Transactions were duly approved. The Charter Amendment became effective on the Settlement Date.
Certain holders of AMPS agreed to support the Transactions and signed and became parties to a Preferred Stock Repurchase and Support Agreement, dated as of June 22, 2018 (the “Preferred Stock Repurchase and Support Agreement”), by and among certain holders of AMPS party thereto (each, a “Supporting Holder” and together, the “Supporting Holders”), Ambac and Ambac Assurance. The Supporting Holders, who


| Ambac Financial Group, Inc. 7 2018 Second 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)

represented approximately 89% in liquidation preference of outstanding AMPS as of the Signing Date, agreed under the Preferred Stock Repurchase and Support Agreement to vote in favor of the Transactions and also committed to tender at least 80% of the aggregate liquidation preference of outstanding AMPS.
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, 2017. 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 consolidated 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, 2017. 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 six months ended June 30, 2018 may not be indicative of the results that may be expected for the year ending December 31, 2018. The December 31, 2017 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. Functional currency operating results of foreign subsidiaries are translated using average exchange rates.
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 $(3,591) and $14,786 for the six months ended June 30, 2018 and 2017, of which $(6,359) and $17,622 relate to the remeasurement of loss reserves, classified in Loss and loss expenses, respectively. 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.


| Ambac Financial Group, Inc. 8 2018 Second 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)

Supplemental Disclosure of Cash Flow Information
 
 
Six Months Ended June 30,
 
 
2018
 
2017
Cash paid during the period for:
 
 
 
 
Income taxes
 
$
26,910

 
$
16,012

Interest on long-term debt and investment agreements
 
157,896

 
37,471

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

 
$
55,426

Rehabilitation exit transaction discharge of all Deferred Amounts and cancellation of certain General Account Surplus Notes
 
1,918,561

 

Reconciliation of cash, cash equivalents, and restricted cash reported within the Consolidated Balance Sheets to the Consolidated Statements of Cash Flows:
 
 
 
 
Cash and cash equivalents
 
$
44,398

 
$
54,238

Restricted cash
 
1,052

 
5,015

Total cash, cash equivalents, and restricted cash shown on the Consolidated Statements of Cash Flows
 
$
45,450

 
$
59,253

In addition to the non-cash financing activities disclosed in the above table, the Rehabilitation Exit Transactions involved the exchange of cash and non-cash consideration for the discharge of all Deferred Amounts and cancellation of certain General Account Surplus Notes. Refer to Note 1. Background and Business Description of this Form 10-Q and Note 1. Background and Business Description in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 for further details of the Rehabilitation Exit Transactions.
Reclassifications:
Reclassifications have been made to prior years' amounts to conform to the current year's presentation. Such reclassifications are primarily the result of certain new standards discussed in the Recently Adopted Accounting Standards section below.
Recently Adopted Accounting Standards:
Effective January 1, 2018, Ambac adopted the following accounting standards:
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 adoption of this ASU did not have an 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. Prior to adoption of this ASU, Ambac reported all postretirement costs in Operating expenses on the Consolidated Statements of Total Comprehensive Income (Loss). Adoption of this ASU resulted in a reclassification of other non-service related costs from Operating expenses to Other income (expense) of $253 and $397 for the three and six months ended June 30, 2017.
Restricted Cash
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) - Restricted Cash. Prior to the effective date of this ASU, GAAP did not include specific guidance on the cash flow classification and presentation of changes in restricted cash and restricted cash flow equivalents other than limited guidance for non-for-profit entities. This ASU is intended to resolve diversity in practice in the classification of changes in restricted cash and restricted cash flow equivalents on the statement of cash flows. The ASU requires that restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning and ending period amounts on the statement of cash flows, along with certain disclosures. Adoption of this ASU resulted in the inclusion of restricted cash activity related to consolidated VIEs on the Consolidated Statements of Cash Flows for all periods presented. Also refer to the Supplemental Disclosure of Cash Flow Information


| Ambac Financial Group, Inc. 9 2018 Second 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)

section above for the reconciliation of cash, cash equivalents, and restricted cash reported on the Consolidated Statement of Position that sum to the total of the same such amounts on the Consolidated Statements of Cash Flows.
Income Taxes
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740) - Intra-Entity Transfers of Assets Other Than Inventory. Prior to the effective date of this ASU, GAAP prohibited the recognition of current and deferred income taxes for intercompany transfers of assets until the asset had been sold to an outside party. The ASU requires companies to recognize the income tax effects of intercompany sales and transfers of assets other than inventory, as income tax expense (or benefit) in the period in which the transfer occurs. The adoption of this ASU did not have an impact on Ambac's financial statements.
Classification of Certain Cash Receipts and Cash Payments
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments. The ASU resolves diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. Transactions addressed in the ASU that are potentially relevant to Ambac include the following:
Debt prepayment or debt extinguishment costs - such payments will be classified as a financing cash outflow.
Settlement of zero-coupon debt or other debt with coupon rates that are insignificant in relation to the effective interest rate of the borrowing - the portion of the cash payment attributable to accreted interest will be classified as an operating cash outflow and the portion attributable to the principal will be classified as a financing cash outflow.
Distributions from equity-method investees - an entity will elect one of the two following approaches. Under the "cumulative earnings approach": i) distributions received up to the amount of cumulative earnings recognized will be treated as returns on investments and classified as cash inflows from operating activities and ii) distributions received in excess of earnings recognized will be treated as returns of investments and classified as cash inflows from investing activities. Under the "nature of the distribution" approach, distributions received will be classified based on the nature of the activity that generated the distribution (i.e. classified as a return on investment or return of investment), when such information is available to the investor.
Beneficial interests in securitization transactions - any beneficial interests obtained in financial assets transferred to an unconsolidated securitization entity will be disclosed as a non-cash investing activity. Subsequent cash receipts from the beneficial interests in previously transferred trade receivables will be classified as cash inflows from investing activities.
After further evaluating the potentially relevant items, we determined the adoption of this ASU did not have an impact on Ambac's financial statements.
Recognition and Measurement of Financial Assets and Liabilities
In January 2016, the FASB issued ASC 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities. The ASU makes the following targeted changes for financial assets and liabilities: i) requires equity investments with readily determinable fair values to be measured at fair value with changes recognized in net income; ii) simplifies the impairment assessment of equity securities without readily determinable fair values using a qualitative approach; iii) eliminates disclosure of the method and significant assumptions used to fair value instruments measured at amortized cost on the balance sheet; iv) requires the use of the exit price notion when measuring the fair value of instruments for disclosure purposes; v) for financial liabilities where the fair value option has been elected, requires the portion of the fair value change related to instrument-specific credit risk, to be separately reported in other comprehensive income; vi) requires the separate presentation of financial assets and liabilities by measurement category and form of financial asset (liability) on the balance sheet or accompanying notes; and vii) clarifies that the evaluation of a valuation allowance on a deferred tax asset related to available-for-sale securities should be performed in combination with the entity's other deferred tax assets.
With respect to item (v) above, Ambac has elected the fair value option for all VIE financial liabilities. For these VIE liabilities this ASU has resulted in a cumulative-effect reclassification of $2,900, net of deferred tax of $590, between Retained earnings and Accumulated other comprehensive income, with no net change to Total stockholders' equity as of January 1, 2018. For the six months ended June 30, 2018 and going forward, the instrument-specific credit risk of fair value changes in VIE liabilities has been and will be reported in Accumulated other comprehensive income in accordance with this ASU, with all other fair value changes continuing to be reported through net income. There was no material impact on Ambac's financial statements for the other provisions of this ASU.
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. As this ASU does not apply to insurance contracts and most financial instruments, management determined there was no impact on Ambac's financial statements.


| Ambac Financial Group, Inc. 10 2018 Second 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)

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 stockholders 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. Ambac will adopt this ASU on January 1, 2019. 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 a 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. Ambac will adopt this ASU on January 1, 2019 and we are evaluating its impact on Ambac's financial statements.
Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments. This ASU significantly affects how reporting entities will measure credit losses for financial assets that are not accounted for at fair value through net income, which include loans, debt securities, trade receivables, net investments in leases, and certain off-balance sheet credit exposures. For financial assets measured at amortized cost, the ASU replaces the "incurred loss" model, which generally delayed recognition of the full amount of credit losses until the loss was probable of occurring, with an "expected loss" model, which reflects an entity's current estimate of all expected credit losses. Expected credit losses for amortized cost assets will be recorded as a valuation allowance, with subsequent increases or decreases in the allowance reflected in the income statement each period. For available-for-sale debt securities, credit losses under the ASU will be measured similarly to current GAAP. However, under the ASU, credit losses for available-for-sale securities will be recorded as a valuation allowance (similar to the amortized cost assets approach described above), rather than as a direct write-down of the security as is required under current GAAP. As a result, improvements to estimated credit losses for available-for-sale debt securities will be recognized immediately in the income statement rather than as interest income over time. The ASU is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted as of the fiscal year beginning after December 15, 2018. Ambac has not determined whether it will early adopt this ASU and we are currently evaluating its impact on Ambac's financial statements. The significant implementation matters to be addressed include identifying the inventory of financial assets that will be affected by this standard, identifying new data requirements and data sources for implementing the expected loss model for those instruments not already using this model and identifying and documenting accounting process changes, including related controls.
Leases
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The main difference between current U.S. GAAP and this ASU is the recognition of lease assets and lease liabilities for those leases classified as operating leases. For operating leases, a lessee is required to: 1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the balance sheet, 2) recognize a single lease cost, calculated so that the cost is allocated over the lease term generally on a straight-line basis and 3) classify all cash payment within operating activities in the statement of cash flows. The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The transition guidance requires lessees to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach which include a number of optional practical expedients. We will adopt ASU 2015-02 on January 1, 2019. We are evaluating the impact of this ASU, including the transitional practical expedients, on Ambac's financial statements. We believe Ambac's office leases will be the most significantly impacted by this ASU. We have identified the preliminary inventory of leases that will be affected by this standard. Other significant implementation matters to be addressed are identifying and documenting accounting process changes, including related controls.


| Ambac Financial Group, Inc. 11 2018 Second 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. VARIABLE INTEREST ENTITIES
Ambac, with its subsidiaries, has engaged in transactions with variable interest entities ("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 investors for various purposes;
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; and
Ambac is an investor in collateralized loan 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 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. 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 certain liabilities (and in some cases certain 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. FG VIEs which are consolidated include recourse liabilities and, in some cases, may include non-recourse liabilities. FG VIEs' liabilities that are insured by the Company are with recourse, because the Company guarantees the payment of principal and interest to the extent there is a shortfall in the FG VIEs' assets. FG VIEs' liabilities that are not insured by the Company are without recourse, because the payment of principal and interest of these liabilities is wholly dependent on the performance of the FG VIEs' assets. The Company’s exposure to consolidated FG VIEs is limited to the financial guarantees issued for recourse liabilities and any additional variable interests held by Ambac.
In connection with the exit from rehabilitation of the Segregated Account, as further described in Note 1. Background and Business Description and in Note 1. Background and Business Description in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, Ambac evaluated the consolidation of certain VIEs. Under the Stipulation and Order, the OCI retained the authority requiring Ambac Assurance to obtain their approval with respect to the exercise of certain control rights in connection with policies that had previously been allocated to the Segregated Account. Accordingly, Ambac did not consolidate any additional VIEs as a result of the Segregated Account's exit from rehabilitation. 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, either 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. Ambac has elected the fair value option for all FG VIE financial assets and financial liabilities which are consolidated. The total fair value changes in the financial assets of such FG VIEs are reported within Income (loss) on variable interest entities in the Consolidated Statements of Total Comprehensive Income (Loss). Prior to January 1, 2018, the total fair value changes in the financial liabilities of such FG VIEs were also reported within Income (loss) on variable interest entities. As further described in Note 2. Basis of Presentation and Significant Accounting Policies, effective January 1, 2018, Ambac adopted ASU 2016-01. Under this ASU, for financial liabilities where fair value option has been elected, the portion of the total change in fair value caused by changes in the instrument-specific credit risk is presented separately in OCI.
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).


| Ambac Financial Group, Inc. 12 2018 Second 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 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 June 30, 2018 consolidated FG VIE assets and liabilities relating to 11 consolidated entities were $13,570,666 and $13,447,562, respectively. As of December 31, 2017, consolidated FG VIE assets and liabilities relating to 11 consolidated entities were $14,500,507 and $14,366,434, respectively. As of both June 30, 2018 and December 31, 2017, eight and three consolidated FG VIEs related to transactions insured by Ambac UK and Ambac Assurance, respectively. As of June 30, 2018, FG VIE assets and liabilities of $13,274,042 and $13,151,223 and as of December 31, 2017, FG VIE assets and liabilities of $14,160,152 and $14,026,704 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 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 June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Income (loss) on changes related to:
 
 
 
 
 
 
 
 
Net change in fair value of VIE assets and liabilities
 
$
(450
)
 
$
(1,219
)
 
$
1,468

 
$
2,482

Less: Credit risk changes of fair value liabilities
 
1,027

 

 
(317
)
 

Consolidation / Deconsolidation
 

 

 

 

Income (loss) on Variable Interest Entities
 
$
577

 
$
(1,219
)
 
$
1,151

 
$
2,482

Ambac consolidated zero and deconsolidated zero VIEs for the three and six months ended June 30, 2018 and 2017.
The table below provides the fair value of fixed income securities, by asset-type, held by consolidated VIEs as of June 30, 2018 and December 31, 2017:
 
June 30,
2018
 
December 31,
2017
Investments:
 
 
 
Corporate obligations
$
2,756,924

 
$
2,914,145

Total variable interest entity assets: fixed income securities
$
2,756,924

 
$
2,914,145

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 June 30, 2018 and December 31, 2017:
 
Estimated Fair Value
 
Unpaid Principal Balance
June 30, 2018:
 
 
 
Loans
$
10,751,199

 
$
7,905,992

Long-term debt
11,454,746

 
9,095,639

December 31, 2017:
 
 
 
Loans
$
11,529,384

 
$
8,168,651

Long-term debt
12,160,544

 
9,387,884



| Ambac Financial Group, Inc. 13 2018 Second 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)

Ambac Sponsored VIEs:
A subsidiary of Ambac transferred financial assets to a VIE. The business purpose of this entity was to provide certain financial guarantee clients with funding for their debt obligations. This VIE 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 previously allocated to the Segregated Account and, as discussed above, the exercise of related control rights in such policies remain subject to OCI approval under the Stipulation and Order. 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 investment 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 June 30, 2018 and December 31, 2017 the fair value of this entity was $5,255 and $5,979, respectively, and is reported within Other assets on the Consolidated Balance Sheets.
Total principal amount of debt outstanding was $410,760 and $420,600 at June 30, 2018 and December 31, 2017, 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 June 30, 2018 and weighted average life of 2.6 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 June 30, 2018 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 (the "Secured Borrowing") 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 remain in Invested assets on the Consolidated Balance Sheets. 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 were consolidated VIEs because Ambac Assurance was involved in their design and holds a significant amount of the beneficial interests issued by the VIEs and guaranteed the assets held by the VIEs. On June 22, 2018, Ambac Assurance exercised its right to terminate this structure though its right to sell a sufficient quantity of Securities to redeem the remaining outstanding Notes of the Issuer at par plus accrued interest.  Accordingly, proceeds from the sale of Securities were used to redeem the outstanding Notes. VIE debt outstanding to third parties under this secured borrowing transaction had a carrying value of $0 and $73,993 as of June 30, 2018 and December 31, 2017, respectively, and is reported in Long-Term Debt on the Consolidated Balance Sheets.
Variable 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 $37,497 and $34,941 as of June 30, 2018 and December 31, 2017, respectively.
On February 12, 2018, Ambac formed a VIE, Ambac LSNI, to issue Secured Notes in connection with the Rehabilitation Exit Transactions. Prior to the Rehabilitation Exit Transactions, Ambac and Ambac Assurance owned securities that were insured by Ambac Assurance and allocated to the Segregated Account. As a result of the Rehabilitation Exit Transactions, Ambac Assurance and Ambac received $643,583 and $124,881, respectively, of par amount of Secured Notes issued by Ambac LSNI. Ambac does not consolidate the VIE and reports its holdings of Secured Notes as Fixed Income Securities in the Consolidated Balance Sheets. The carrying values of Secured Notes held by Ambac Assurance and Ambac as of June 30, 2018 were $621,849 and $120,233, respectively. In addition, unsettled amounts from the June 30, 2018 interest payment and partial principal redemption of the Secured Notes owned by Ambac Assurance and Ambac were $50,878 and$9,837, respectively, and are included in Receivable for securities on the Consolidated Balance Sheet as of June 30, 2018.


| Ambac Financial Group, Inc. 14 2018 Second 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 June 30, 2018 and December 31, 2017:
 
Carrying Value of Assets and Liabilities
 
Maximum
Exposure
To Loss
(1)
 
Insurance
Assets
(2)
 
Insurance
Liabilities
(3)
 
Net Derivative
Assets (Liabilities) 
(4)
June 30, 2018:
 
 
 
 
 
 
 
Global structured finance:
 
 
 
 
 
 
 
Collateralized debt obligations
$
26,882

 
$
108

 
$
1

 
$
(8
)
Mortgage-backed—residential (5)
7,355,039

 
1,862,269

 
598,722

 

Other consumer asset-backed
2,144,354

 
21,150

 
326,476

 

Other commercial asset-backed
893,643

 
25,768

 
23,508

 

Other
2,191,571

 
57,438

 
304,820

 
7,498

Total global structured finance
12,611,489

 
1,966,733

 
1,253,527

 
7,490

Global public finance
24,895,558

 
332,151

 
363,598

 
(1,318
)
Total
$
37,507,047

 
$
2,298,884

 
$
1,617,125

 
$
6,172

 
 
 
 
 
 
 
 
December 31, 2017:
 
 
 
 
 
 
 
Global structured finance:
 
 
 
 
 
 
 
Collateralized debt obligations
$
35,555

 
$
169

 
$
1

 
$
(15
)
Mortgage-backed—residential
12,766,685

 
619,848

 
3,218,356

 

Other consumer asset-backed
2,266,610

 
23,405

 
328,732

 

Other commercial asset-backed
987,797

 
30,413

 
35,976

 

Other
2,513,304

 
60,086

 
306,457

 
10,311

Total global structured finance
18,569,951

 
733,921

 
3,889,522

 
10,296

Global public finance
25,629,816

 
335,347

 
371,056

 
(551
)
Total
$
44,199,767

 
$
1,069,268

 
$
4,260,578

 
$
9,745

(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. On February 12, 2018, all Deferred Amounts and interest accrued on Deferred Amounts were settled in connection with the Rehabilitation Exit Transactions. 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.
(5)
On February 12, 2018, Deferred Amounts and Interest Accrued on Deferred Amounts in the amount of $3,000,158 and $856,834, respectively were settled. This settlement impacted both insurance assets and insurance liabilities in the table above.


| Ambac Financial Group, Inc. 15 2018 Second 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)
 
Credit Risk Changes of Fair Value Option Liabilities (1) (2)
 
Total
Three Months Ended June 30, 2018:
 
 
 
 
 
 
 
 
 
 
Beginning Balance
 
$
153,059

 
$
9,781

 
$
(61,578
)
 
$
(1,786
)
 
$
99,476

Other comprehensive income (loss) before reclassifications
 
46,709

 

 
(52,989
)
 

 
(6,280
)
Amounts reclassified from accumulated other comprehensive income (loss)
 
(46,134
)
 
(302
)
 

 
(906
)
 
(47,342
)
Net current period other comprehensive income (loss)
 
575

 
(302
)
 
(52,989
)
 
(906
)
 
(53,622
)
Balance at June 30, 2018
 
$
153,634

 
$
9,479

 
$
(114,567
)
 
$
(2,692
)
 
$
45,854

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30, 2017:
 
 
 
 
 
 
 
 
 
 
Beginning Balance
 
$
140,198

 
$
11,654

 
$
(154,627
)
 
$

 
$
(2,775
)
Other comprehensive income (loss) before reclassifications
 
15,070

 

 
29,292

 

 
44,362

Amounts reclassified from accumulated other comprehensive income (loss)
 
(2,421
)
 
(338
)
 

 

 
(2,759
)
Net current period other comprehensive income (loss)
 
12,649

 
(338
)
 
29,292

 

 
41,603

Balance at June 30, 2017
 
$
152,847

 
$
11,316

 
$
(125,335
)
 
$

 
$
38,828

 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2018:
 
 
 
 
 
 
 
 
 
 
Beginning Balance
 
$
30,755

 
$
10,640

 
$
(93,634
)
 
$

 
$
(52,239
)
Adjustment to opening balance, net of taxes (3)
 

 

 

 
(2,900
)
 
(2,900
)
Adjusted balance, beginning of period
 
30,755

 
10,640

 
(93,634
)
 
(2,900
)
 
(55,139
)
Other comprehensive income (loss) before reclassifications
 
173,576

 
(556
)
 
(20,933
)
 

 
152,087

Amounts reclassified from accumulated other comprehensive income (loss)
 
(50,697
)
 
(605
)
 

 
208

 
(51,094
)
Net current period other comprehensive income (loss)
 
122,879

 
(1,161
)
 
(20,933
)
 
208

 
100,993

Balance at June 30, 2018
 
$
153,634

 
$
9,479

 
$
(114,567
)
 
$
(2,692
)
 
$
45,854

 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2017:
 
 
 
 
 
 
 
 
 
 
Beginning Balance
 
$
118,863

 
$
9,367

 
$
(167,220
)
 
$

 
$
(38,990
)
Other comprehensive income (loss) before reclassifications
 
27,570

 
2,625

 
41,885

 

 
72,080

Amounts reclassified from accumulated other comprehensive income (loss)
 
6,414

 
(676
)
 

 

 
5,738

Net current period other comprehensive income (loss)
 
33,984

 
1,949

 
41,885

 

 
77,818

Balance at June 30, 2017
 
$
152,847

 
$
11,316

 
$
(125,335
)
 
$

 
$
38,828

(1)
All amounts are net of tax and noncontrolling interest. Amounts in parentheses indicate reductions to Accumulated Other Comprehensive Income.
(2)
Represents the changes in fair value attributable to instrument-specific credit risk of liabilities for which the fair value option is elected.
(3)
Beginning in 2018, Credit risk changes of fair value option liabilities are reflected as a component of Accumulated Other Comprehensive Income pursuant to the adoption of ASU 2016-01. See Note 2 to the Consolidated Financial Statements included in this Form 10-Q for further information regarding this change.


| Ambac Financial Group, Inc. 16 2018 Second 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 June 30,
 
 
2018
 
2017
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
 
 
 
 
 
 
 
$
(47,256
)
 
$
(2,421
)
 
Net realized investment gains (losses) and other-than-temporary impairment losses
 
 
1,122

 

 
Provision for income taxes
 
 
$
(46,134
)
 
$
(2,421
)
 
Net of tax and noncontrolling interest 
Amortization of Postretirement Benefit
 
 
 
 
 
 
Prior service cost
 
$
(241
)
 
$
(241
)
 
Other income (2)
Actuarial (losses)
 
(61
)
 
(97
)
 
Other income (2)
 
 
(302
)
 
(338
)
 
Total before tax
 
 

 

 
Provision for income taxes
 
 
(302
)
 
(338
)
 
Net of tax and noncontrolling interest
Credit risk changes of fair value option liabilities
 
 
 
 
 
 
 
 
$
(1,094
)
 
$

 
Credit Risk Changes of Fair Value Option Liabilities
 
 
188

 

 
Provision for income taxes
 
 
$
(906
)
 
$

 
Net of tax and noncontrolling interest
Total reclassifications for the period
 
$
(47,342
)
 
$
(2,759
)
 
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)
 
Six Months Ended June 30,
 
 
2018
 
2017
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
 
 
 
 
 
 
 
$
(50,111
)
 
$
6,414

 
Net realized investment (losses) gains and other-than-temporary impairment losses
 
 
(586
)
 

 
Tax (expense) benefit
 
 
$
(50,697
)
 
$
6,414

 
Net of tax and noncontrolling interest 
Amortization of Postretirement Benefit
 
 
 
 
 
 
Prior service cost
 
$
(482
)
 
$
(482
)
 
Other income (2)
Actuarial gains
 
(123
)
 
(194
)
 
Other income (2)
 
 
(605
)
 
(676
)
 
Total before tax
 
 

 

 
Tax (expense) benefit
 
 
$
(605
)
 
$
(676
)
 
Net of tax and noncontrolling interest 
Credit risk changes of fair value option liabilities
 
 
 
 
 
 
 
 
$
250

 
$

 
Credit Risk Changes of Fair Value Option Liabilities
 
 
(42
)
 

 
Provision for income taxes
 
 
$
208

 
$

 
Net of tax and noncontrolling interest
Total reclassifications for the period
 
$
(51,094
)
 
$
5,738

 
Net of tax and noncontrolling interest 
(1)
Amounts in parentheses indicate reductions to Accumulated Other Comprehensive Income with corresponding increases to the affected line items in the Consolidated Statement of Total Comprehensive Income.
(2)
These accumulated other comprehensive income components are included in the computation of net periodic benefit cost.


| Ambac Financial Group, Inc. 17 2018 Second 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)

5. NET INCOME PER SHARE
As of June 30, 2018, 45,332,214 shares of Ambac's common stock (par value $0.01) and warrants entitling holders to acquire up to 4,053,476 shares of new common stock at an exercise price of $16.67 per share were issued and outstanding. For the six months ended June 30, 2018 and 2017, 194 and 0 warrants were exercised, respectively, resulting in an issuance of 194 and 0 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 six months ended June 30, 2018, Ambac did not repurchase any warrants. As of June 30, 2018, Ambac had repurchased 985,331 warrants at a total cost of $8,092, (average cost of $8.21 per warrant). The remaining aggregate authorization at June 30, 2018 was $11,939. In connection with the AMPS Exchange, Ambac issued 824,307 of the repurchased warrants on August 3, 2018. Refer to Note 1. Background and Business Description for further discussion of the AMPS Exchange.
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 Ambac's Chapter 11 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 June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Basic weighted average shares outstanding
 
45,683,058

 
45,369,213

 
45,577,656

 
45,330,946

Effect of potential dilutive shares (1):
 
 
 
 
 
 
 
 
Warrants
 
392,772

 
250,289

 
196,386

 

Restricted stock units
 
70,498

 
27,609

 
54,720

 

Performance stock units (2)
 
326,047

 
126,398

 
268,885

 

Diluted weighted average shares outstanding
 
46,472,375

 
45,773,509

 
46,097,647

 
45,330,946

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

 
126,667

 
126,667

 
126,667

Warrants
 

 

 

 
4,053,670

Restricted stock units
 

 

 
5,362

 
68,654

Performance stock units (2)
 

 
151,527

 

 
342,092

(1)
For the six months ended June 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 that are dilutive are reflected based on the performance metrics through the balance sheet date. Performance stock units that are anti-dilutive are reflected 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 June 30, 2018 and December 31, 2017, was 2.7% and 2.5%, respectively, and the weighted average period of future premiums used to estimate the premium receivable at June 30, 2018 and December 31, 2017, was 8.9 years and 9.8 years, respectively.


| Ambac Financial Group, Inc. 18 2018 Second 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)

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 evaluating the credit quality of the premium receivables, management evaluates the obligor's ability to pay. For structured finance transactions, this evaluation will include a review of the priority for the payment of financial guarantee premiums to Ambac, as required by bond indentures, in the transaction's waterfall structure. The financial guarantee premium is generally senior in the waterfall. 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 June 30, 2018 and December 31, 2017, $9,329 and $9,331 respectively, of premium receivables were deemed uncollectable. As of June 30, 2018 and December 31, 2017, approximately 21% and 22% of the premium receivables, net of uncollectable receivables, related to transactions with non-investment grade internal ratings, mainly of structured finance transactions, which comprised 14% and 16% of the total premium receivables at June 30, 2018 and December 31, 2017, respectively. Past due premiums on policies insuring non-investment grade obligations amounted to less than $500 at June 30, 2018.
Below is the gross premium receivable roll-forward for the affected periods:
 
 
Six Months Ended June 30,
 
 
2018
 
2017
Beginning premium receivable
 
$
586,312

 
$
661,337

Premium receipts
 
(29,822
)
 
(33,953
)
Adjustments for changes in expected and contractual cash flows
 
(5,066
)
 
4,285

Accretion of premium receivable discount
 
7,627

 
8,379

Changes to uncollectable premiums
 
(11
)
 
(151
)
Other adjustments (including foreign exchange)
 
(5,082
)
 
13,279

Ending premium receivable (1)
 
$
553,958

 
$
653,176

(1)
Gross premium receivable includes premiums to be received in foreign denominated currencies most notably in British Pounds and Euros. At June 30, 2018 and 2017, premium receivables include British Pounds of $151,316 (£114,729) and $192,983 (£148,277), respectively, and Euros of $33,114 (€28,380) and $35,814 (€31,361), 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 six months ended June 30, 2018 was $6,103 and $15,495, respectively, and for the three and six months ended June 30, 2017 was $13,190 and $29,470, 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 June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
Written
 
Earned
 
Written
 
Earned
 
Written
 
Earned
 
Written
 
Earned
Direct
$
(611
)
 
$
27,339

 
$
6,928

 
$
47,235

 
$
3,650

 
$
59,947

 
$
12,512

 
$
99,300

Assumed

 
19

 

 
20

 

 
39

 

 
41

Ceded
(224
)
 
1,522

 
238

 
4,103

 
(1,043
)
 
3,267

 
(1,577
)
 
8,576

Net premiums
$
(387
)
 
$
25,836

 
$
6,690

 
$
43,152

 
$
4,693

 
$
56,719

 
$
14,089

 
$
90,765



| Ambac Financial Group, Inc. 19 2018 Second 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 June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
United States
 
$
19,752

 
$
36,006

 
$
44,469

 
$
76,627

United Kingdom
 
4,958

 
5,558

 
9,815

 
10,821

Other international
 
1,126

 
1,588

 
2,435

 
3,317

Total
 
$
25,836

 
$
43,152

 
$
56,719

 
$
90,765

The table below summarizes the future gross undiscounted premiums to be collected and future premiums earned, net of reinsurance at June 30, 2018:
 
Future Premiums
to be Collected
(1)
 
Future
Premiums to
be Earned Net of
Reinsurance
(1)
Three months ended: